Test of Partnership under the Indian Partnership Act, 1932

Introduction

Imagine a business venture where two or more individuals pool their resources, skills, and efforts with a shared profit goal. This is the essence of a partnership. In India, such relationships are governed by the Indian Partnership Act, 1932. While the law provides a framework for these collaborations, it also recognizes the potential for disagreements and disputes. When such conflicts arise, the “test of partnership” becomes a crucial factor in determining the rights and liabilities of the partners.

Partners and the Partnership firm are defined under Section 4 of the Indian Partnership Act. While profit sharing is an essential element of a partnership, the question arises as to whether profit sharing is the sole test of determining a partnership or whether it is subjected to certain other conditions.

What is Partnership?

• The provisions of the Partnership Act were earlier entailed in the Indian Contract Act, 1872. However, since those provisions were not exhaustive, the legislature found it necessary to enact a separate statute pertaining to the partnership.
• Partners and the Partnership firm have been defined under Section 4 of the Indian Partnership Act, 1932. As per Section 4, if A, B, C, and D have agreed to share profits of business where the business activity is carried by all or any of them acting for all, individually, all of them will be labeled to be partners of each other.
• The name under which all the partners carry on the business is deemed as a partnership firm. The partnership firm does not have a separate legal entity; rather, it is merely a collaboration of partners working with each other. 
• In the case of Munshi Ram v. Municipal Committee[1], the court observed that the partnership firm is not a separate entity, distinct from its partners; rather, it is a compendious description of individuals who compose the firm.

Types of Partners

• The concept of choosing partners is based on the maxim Delectus Personae, which means the partners have the right to select their co-partners. A partner can be inducted only upon the consent of all the other partners as per the provisions of Section 31 of the Indian Partnership Act.
• The Indian Partnership Act recognizes two primary types of partners: Active and Sleeping partners. Active partners take an active part in the business and have the authority to bind the firm by their acts. They are generally involved in the partnership’s day-to-day operations and share in its profits and losses.
• On the other hand, sleeping partners, also known as dormant or silent partners, contribute capital to the firm but do not participate in its management. They are generally uninvolved in the business’s operations and have limited liability, typically limited to their capital contribution. In a partnership firm, every partner is considered an agent of the firm under Section 18 of the Act.
• It is essential to note that the rights and liabilities of both active and sleeping partners can vary depending on the terms of the partnership agreement. However, if an active partner does an act, even the sleeping partner will be liable for it.

Is profit sharing the sole test of partnership?

• From the language of Section 4, it can be inferred that profit sharing is the test to determine whether a partnership exists or not. However, such an inference is incorrect because profit sharing is not the sole test of partnership.
• In Pratibha Rani v. Suraj Kumar[2], the court laid down three elements of partnership:
  • There must be an agreement entered into by all the persons concerned; it implies that persons must enter into a voluntary contract.
  • The agreement between the partners must be to share the profit accruing from the business. Profit sharing provides a motive for constituting a firm.
  • All or any of them acting for all must carry on the business. Therefore, the act of one partner makes all the other partners accountable for his actions.

Real test of partnership

• The real test of partnership is the creation of mutual agency. Mutual agency is a concept that states that every partner is an agent of the firm, as per Section 18. Furthermore, every partner has a dual capacity of principal and agent.
• The test of mutual agency was laid down in the landmark case of Cox v. Hickman[3]. As per the landmark case, each member acts as an agent for the entire business in a partnership. This means they can decide and enter into agreements binding the partnership. Essentially, every partner has the authority to represent the business and commit it to contracts with third parties.
• The landmark case concluded that while profit sharing is important, it’s not the only key factor in determining if a partnership exists. The real test is whether one partner can represent and legally bind the others. If this is the case, and if the partners are interconnected in their business activities, then a partnership can be established.
• In the case of K.D. Kamath v. C.I.T.[4], the court ruled that whether there is a partnership or not may not only be a question of fact but also of law. The court observed that whether a person is a partner or not shall be determined by the real relation between the parties. The court reiterated the points laid down in Cox v. Hickman and stated that profit sharing is essential but not the sole test of partnership. The real test is mutual agency, which can be determined by an express agreement or by the parties’ conduct.

Conclusion

While profit-sharing is often considered a hallmark of partnership under the Indian Partnership Act, 1932, it is not the sole determinant. The real test of partnership lies in the existence of a mutual agency, where each partner acts as both principal and agent for the firm. This concept ensures that one partner’s actions can legally bind the others, reflecting the essence of a partnership’s collaborative nature. Landmark judgments, such as Cox v. Hickman[5] and K.D. Kamath v. C.I.T[6]. has reinforced this principle, emphasizing that the true measure of a partnership is not merely sharing profits but the mutual responsibility and authority inherent in the partners’ relationship. Thus, the partnership under Indian law combines shared profits and mutual agency, making it a complex yet balanced business structure.

[1] AIR 1979 SC 1160.

[2] AIR 1985 SC 628.

[3] (1860) 8 HLC 268.

[4] (1971) 2 SCC 873.

[5] 1860) 8 HLC 268.

[6] (1971) 2 SCC 873.