Dissolution of a Firm

What is the Dissolution of a Firm?

Dissolution of a firm refers to the dissolution of an existing partnership which owns and controls a firm or an organisation. While numerous reasons can lead to the partnership’s dissolution in a firm, usually a concerned organisation is also dissolved under these circumstances. However, this may not always be the case.

Vitally, students must learn under what circumstances the partnership firm is dissolved. These are listed below:

  • Change or shift in its existing profit-sharing ratio

  • A new partner’s entry or admission

  • Retirement of one or more existing partners of a firm

  • Demise of one of the partners

  • A partner’s insolvency due to incompetence to contract

  • Completion of a specific partnership venture

  • Expiry of partnership period of agreement

While understanding dissolution meaning, students must note that according to Partnership Act, 1932, “The dissolution of a partnership between all the partners of a firm is called the dissolution of the firm”. By definition, this distinguishes between the dissolution of a firm and that of a partnership.

Only in the event of an existing agreement among a firm’s partners can it be reconstituted without any dissolution despite the partnership being dissolved. Consequently, a firm’s dissolution always involves the dissolution of a partnership, while its inverse may or may not be accurate and depends on existing agreements.


Types of Dissolutions

While learning how is a firm dissolved, students must note these ways mentioned below:

  1. Dissolution by Agreement: A firm can be dissolved with an agreement among its existing partners, though it should meet the following criteria:

  • Every partner of a firm must consent to its dissolution.

  • There must be legally binding contracts among existing partners.

  1. Mandatory Dissolution: Circumstances under which a firm is dissolved compulsorily are as follows:

  • When one or more partners of a firm become insolvent, making them incompetent to enter any contract or agreement.

  • If it becomes unlawful for a specific partnership firm to continue its business and revenue generation. Notably, this is not the same as that of dissolution by court order. An example in this regard would be when a partnership firm has a foreign partner and war is declared by this firm’s country of origin on that of its foreign partner. Under such circumstances, this firm must be dissolved.

  1. Emergency Dissolution Due to Contingencies: A firm can be dissolved based on an existing contract among its partners only under these circumstances that are listed below:

  • If a firm was established for a fixed tenure and that term has expired

  • If a firm was established for a specific venture and that venture has been completed

  • A partner’s demise

  • If a partner of a firm becomes insolvent

  1. Dissolution by Notice: If the partnership of a firm is at will, one of its partners can issue a notice for its dissolution. It must be issued in writing to all the existing partners and clearly state his/her intention towards dissolving a firm.

  2. Dissolution by the Court: When one of the partners of a firm files a legal suit, a court of law can direct the dissolution of a firm. That can be done on any of these following grounds described below.

  • If a partner loses mental stability

  • If one partners becomes incapable of fulfilling his/her duties

  • When a partner is found guilty of any misconduct that goes on to affect this firm’s business adversely

  • If one or more partners turn their whole interest in the partnership to a third party

  • When a lawful court deems its dissolution just


Settlement of Accounts

Accounts settlement after the dissolution of a firm, are directed by provisions included in the Indian Partnership Act, 1932. These provisions mention these following guidelines.

  1. A firm will pay for its losses and liabilities, including capital deficiency from its profits. If this profit is inadequate to clear its losses, a firm must pay for it from its partners’ capital. If it still does not clear all a firm’s losses, partners will have to clear it in the same ratio as that of their profit sharing.

  2. When the firm is dissolved, its assets are applied to make for existing deficiencies and losses. The firm should begin by clearing third party debts, followed by loans and advances made by any partner. Once these debts are cleared, the capital of every partner must be cleared. If a firm still has surplus funds, it should be divided among partners in the same ratio as that of profit-sharing.

Along with learning what is meant by the dissolution of partnership firms and its settlement of accounts, students of standard 10 + 2 commerce stream must address numerous other topics too. Vedantu offers well-explained study materials on all these relevant topics, along with questionnaires that help a student assess his/her level of preparation. Furthermore, students can also attend live classes offered by Vedantu that are especially helpful in clearing doubts.

FAQ (Frequently Asked Questions)

1. What is the Dissolution of a Partnership Firm?

A. Dissolution of a partnership firm occurs when the controlling partnership of a concerned organisation is dissolved due to a court order or otherwise. Notably, dissolution of a firm necessarily dissolves its partnership, though its reciprocal might not be true if there is an existing agreement relevant to such circumstances.

2. What is the Dissolution of a Firm?

A. Dissolution definition, as per Partnership Act, 1932 states that dissolution of partnership among all existing partners of a firm is known as the dissolution of this firm. However, students should note that partners can have agreement deeds, which allow a firm to be reconstituted even after the partnership’s dissolution. Resultantly, a firm’s dissolution always leads to the dissolution of a partnership, though its reciprocal might not be true in specific circumstances.

3. What are the Types of Dissolution?

A. A firm’s dissolution can occur under these circumstances – by agreement, mandatory dissolution, due to contingency, court order, and by notice.