There are 4 specific instances which may necessitate this restructuring. They are:
When there is any alteration in the profit-sharing ratio between partners.
When there is imminent admission of a new partner into a firm.
When a partner resigns or retires, and
On occasions when a partner dies or is rendered insolvent.
We will look at each instance closely.
Before that, here’s a task for you. Log on to the Internet and find out the story behind Apple and its co-founders: the ‘Two Steves.’ They were Steve Jobs and Steve Wozniak. Jobs was a terrific sales-person and an excellent brand ambassador. Wozniak was the ‘geek’ and the trouble-shooter.
How did They Get On?
Forms of Reconstitution of a Partnership Firm
The four types are explained below.
Changes in Profit-Sharing Ratios Between Partners
One of the guiding principles of partnership firms is profit-sharing. If two persons form a partnership firm, they are entitled to split the gains made. They must also manage the losses incurred, if any.
If there are pressing issues regarding profit-sharing between partners, a reconstitution of partnership firm is needed.
The old ratio in which all profits made were divided will stand null and void. A new legally valid partnership deed will be drawn up. All the new details of profit sharing will be mentioned therein.
Only these new terms will be applicable in future.
There can be several reasons why profit-sharing ratios may need a relook. One partner may not be happy with the status quo. Someone else may not be pleased with how his or her partners are being compensated. At times, a partner may decide to take on reduced responsibilities. In that case, his share of a firm’s profits is likely to take a hit.
Admission of a New Partner
Whenever a new partner joins a firm, the legalities must be reconstituted. Admittance of a new partner should be unanimous. However, the Partnership Act of 1932, which governs the reconstitution of partnership firms in India, has certain provisions which will take effect if there is no unanimity between extant partners.
The new partner may bring in fresh ideas, new sources of capital, a renewed drive to the business or enhanced managerial ability.
Note that it is not mandated under the law that every time a new partner joins a firm, an older one has to leave.
This new partner will take a part in the profits generated. He will also have a say in day-to-day activities of the partnership firm. All assets and liabilities, and even intangible articles like goodwill, will be re-tailored to suit the new partner/s.
DIY tasks for advanced students: Find out details on India’s Partnership Act of 1932. It is obviously an old set of laws. Why has it not seen amendments? Or are there amendments waiting in the wings?
You will also find later additions including the Limited Liability Partnership Act of 2008, which laid out the foundations for LLPs and LLCs in India.
Retirement of a Partner
Often, a partner may choose to retire on account of age or ill-health. Retirement is voluntary and no law dictates when a partner in a firm can, or cannot, retire or exit a partnership. Reconstitution of partnership firms is needed in such instances as profit-sharing, capital inputs and shouldering of liabilities are bound to change.
Upon retirement, that partner will be paid his share of profits valued till the period he or she has served.
Note that there is a provision for prolonged payments to a retired partner if he continues to shoulder certain responsibilities even after a new deed is constituted and agreed upon.
Before you move on to the last part, you must know that reconstitution of partnership deed is a serious legal process. A majority of active partners need to witness it, and it must be admissible in a court of law.
An example of a fresh partnership deed post reconstitution follows.
Death/Insolvency of a Partner
Reconstitution of partnership firms is necessitated when a partner passes away or becomes insolvent. In case of insolvency, the laws state that he or she cannot continue being a partner in a firm. All dues are to be repaid to the bankrupt partner. The partnership agreement which existed before ceases to exist.
In case of death, all outstanding dues will be paid to any legal heir of that partner. Note that the heir has to stake a claim.
Find out more on partnership laws, firms and related topics in Vedantu’s study materials. You can also install the app for easy access to the same.
1. What is Modes of Reconstitution of a Partnership Firm?
Ans. In any business entity, if there is a change in profit-sharing between partners, if a new member is joining, or if one of the partners retires or passes away, the modes of reconstitution, or rebuilding that firm from scratch, starts.
Modes of Reconstitution of a Partnership Firm - Admission of a Partner
Ans. A new partnership deed has to be drafted and agreed upon when admitting a partner. All procedures must follow India’s Partnership Act of 1932.
Modes of Reconstitution of a Partnership Firm - A Death of a Partner
Ans. If a partner in any firm dies, his or her legal heir is entitled to all outstanding dues that the deceased person was to receive till his term of service.