A partnership is one of the most primitive types of organization. It is created by law, mostly governed by the Indian Partnership Act, 1932. In a partnership, there are 2 or more individuals that agree to share the profits (and losses!) and agree on responsibilities in that Partnership. Partnerships can be made verbally; however, I suggest a written partnership deed to avoid confusion or legal issues.
This article looks at the clauses that must be included in a partnership deed, as well as cite some relevant case laws to illustrate the clauses discussed.
What is a Partnership Deed?
A partnership deed (or “partnership agreement”) is a written document that describes the terms and conditions used to govern the partnership. Although verbal contracts are still enforceable without a deed, verbal contracts are naturally more ambiguous. A deed eliminates confusion and risk, and provides written clarity on the parameters of the partnership. A written deed will explain how to deal with disagreements and problems, profit-sharing, who can spend money, if and how money will be contributed to the partnership, and break-up procedures. A good deed will govern the business from start to the end.
First-hand Experience: One of the clients, a small textile manufacturer, was in a substantial mess because of their oral agreement when they started their partnership. When the business progressed and the partners had disagreements over their assigned proportion of capital contribution, and the ensuing profit-share, they ended up with a lengthy and costly legal action. The absence of a clear partnership deed delayed resolution and cost them much more than they would have paid for a professionally drafted agreement.
Why a Partnership Deed is Your Best Defense Against Disputes
A partnership deed is not a filing or flunkey affair; it merely ensures smooth operations in the long run. The crucial clauses that ought to be clearly stated for an efficient functioning of the partnership are as follows:
- Defines partner duties and obligations
- Prevents future conflicts by setting expectations
- Offers legal backing for resolving conflicts
- Helps ensure compliance with tax regulations
- Registers the firm under Section 58 of the Partnership Act, giving your firm a legal identity
Essential Clauses That Protect Your Business
A partnership deed isn’t just a formality, it’s essential for smooth operations and long-term business success. These are the key clauses you must include to ensure your partnership runs efficiently.
1. Firm Name and Partners’ Details: Establishing Your Identity
The first thing you’ll want to do is clearly define the name of the firm and list all the partners. This clause should specify:
- The legal name of the firm
- Registered office address
- Names and residential addresses of partners
Case Law: In Cox v. Hickman (1860) 8 HLC 268, partnership is a legal relationship and the courts emphasised that the legal name of the partnership is significant in determining the legal entity of a partnership.
2. What is Your Business About? Defining the Nature of Business
Defining the nature of business clarifies the parameters of your business and prevents ambiguities at a later stage.
Example clause: “The firm shall engage in the manufacture and allied trade of textile.”
3. Duration: Is your Partnership Forever or for a set Term?
Clarifying whether your partnership is for a term of months, an evolving business or a business for a particular purpose is vital in identifying the nature of your agreement.
4. Capital Contribution: Keeping It Transparent
Clearly identifying the capital that will be provided by partners (whether it is money or assets) will prevent conflict from arising in the future. Be clear about what capital is to be contributed by partners:
- The amount each partner contributes
- Whether contributions are in cash or kind
- Interest on capital, if applicable
First-hand Experience: In another case, the clients struggled to secure a loan because there was no clear capital contributions defined in the deed. The lack of clarity creates delays in attempts to exhibit a stake for ownership as security for loan applications.
Case Law: In K.D. Kamath & Co. v. CIT (1971) 82 ITR 680 (SC), the Court set out that failing to set out the terms of a capital contribution increases uncertainty, in order to support legitimate claims to receive interest.
5. Profit and Loss Sharing: Clarity to Avoid Disputes
You must explicitly define the ratio in which profits and losses are shared among partners. The law assumes equal sharing in the absence of an agreement, but it’s best to define this clearly in the deed.
Case Law: In Munshi Ram v. Firm Radha Kishan AIR 1970 SC 1292, the Court held that the law, by default, assumes equality unless the Deed provides otherwise.
6. Remuneration to Partners: Salary, Bonus, and Tax Implications
If your partners are entitled to a salary, commission, or bonus, it should be clearly mentioned in the deed. This is essential for tax deductions under the Income Tax Act.
7. Interest on Capital and Loans: Keep It Legal
Partners may contribute additional funds or capital. Clearly outline the rate of interest applicable to these contributions to avoid misunderstandings.
First-hand Experience: In one of the cases, the partners had to revise their agreement after disputes arose regarding the interest on capital. Some partners argued that the interest rate was not fair, which led to legal intervention.
8. Duties and Powers: Who Does What in Your Business?
It shall be specified who is authorized to carry on the day-to-day operations of the business and who is authorized to make key business decisions, including:
- Who can sign contracts or cheques?
- Restrictions on borrowing or investing
Case Law: In Ramdeo v. Rameshwar AIR 2006 MP 68, the court emphasized the need for clarity in duties to avoid actions beyond the scope of powers.
9. Dispute Resolution: Avoid Disputes and Courts with Clear Procedures
Including a dispute resolution clause will save you time and money. It stated, be it mediation, arbitration, or the court’s jurisdiction will be determined beforehand so that disputes can be quickly and clearly resolved.
Case Law: In Sukanya Holdings v. Jayesh Pandya AIR 2003 SC 2252, the Court holds arbitration clauses in partnership agreements as legally enforceable.
10. What Happens When Partners Retire, Die, or Become Insolvent?
A properly-drafted Deed should specify:
- Process of retirement, the death, or the insolvency of a partner
- Continuation or dissolution of a firm
Case Law: In CIT v. A.W. Figgies & Co. (1953) 24 ITR 405 (SC), the Court observed that a specific clause in the deed stating that the firm will continue unconditionally after any partner’s death would clear ambiguity.
11. Non-Compete Clause: Protecting Your Business
Non- compete clauses prohibit partners from engaging with any competing business while in partnership, or after the partnership has ended.
Case law: In Gujarat Bottling Co. Ltd. v. Coca Cola AIR 1995 SC 2372 and the validity of non-compete clauses in partnership deeds was upheld by the Court.
Should You Register Your Partnership Deed?
Noting that registration is not compulsory, it is recommended. An unregistered partnership cannot coerce contracts in court, sue third parties or claim certain rights.
What if you don’t have a proper deed of partnership?
Without a properly drawn deed:
- you may have legal disputes about profit-sharing,
- you may have disputes about roles, or capital,
- you may have taxation issues, with the Income Tax Department.
Real Life Experience: A client had to start costly legal proceeding simply because the partnership agreement was not spelled out right. Partners could not produce the proper clauses to show what was each of their contributions and what share of the profits was entitled to.
Conclusion
The partnership deed becomes the linchpin of your business. It ought to make things clearer, prevent conflicts, and in certain ways, offer legal protection. As businesses grow, development, so too, should the partnership agreement. Get professional advice to save the partnership from future disputes.
Key Takeaways
- Even while verbal agreements can have legal force behind them, partnership deeds must always be documented in writing.
- Role definition must be clear; contributions must be stated; profit-sharing must be delineated.
- Periodically have your deed checked by a lawyer to ensure that it adheres to tax and regulatory requirements.
- Review and amend the deed as the business grows.
One can talk to lawyer from Lead India for any kind of legal support. In India, free legal advice online can be obtained at Lead India. Along with receiving free legal advice online, one can also ask questions to the experts online free through Lead India.
FAQs
1. Can a Partnership Deed be oral or is it to be in writing?
While an oral agreement does carry legal binding, it would best always be recommended to have the partnership agreement in writing because that would serve as a clear source of the agreed terms to avoid conflicts and circumvention.
2. What are the essential elements of a Partnership Deed?
At the very least, a deed contains clauses relating to the firm’s name, business nature, contributions of capital, profit sharing ratio, dispute resolution method, addition or expulsion of partners, and winding up.
3. Can a partner withdraw Capital from the Partnership?
The partnership deed should be clear on whether capital can be withdrawn and whether it is fixed or fluctuating. If not clear, disputes can arise if some partners withdraw capital.
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