Partnership: Formation and tests for its existence

Repoter : News Room
Published: 30 September, 2021 10:47 am

Soeb Aktar

Soeb Aktar:

Introduction: A partnership is a lot like a friendship. Both parties to a friendship have to want to be in the relationship for a friendship to exist. Mutual intent is just as important in a partnership. It’s impossible to form a partnership if one of the parties doesn’t intend that result. However, a person’s intent to form a partnership can be proven through his actions, regardless of what he claims was his intention at the start of an endeavour. In this writing I will try to analyse how the existence of partnership can be examined and which one is the true test for the identification of existence of partnership.

Formation of partnership: Partnership is a form of business in which two or more persons come together with their resources to invest in a common business with the purpose of sharing the profits of the business. According to section four of Partnership Act 1932, four essential elements of a partnership are found:^[1]

It is the result of an agreement
It is organised to carry on a business
The person concerned agree to share the profits of the business
The business is to be carried on by all or any of them acting for all.

Agreement: Under section 5 of Partnership Act 1932, the relation of partnership arises from contract and not by status or operation of law. The relation between the partners is created by an agreement, for example, Partnership Deed between two or more persons. An agreement may be expressed (oral or written) or implied (by conduct).^[2]

Association of two or more persons: Partnership Act, 1932 has put no limitations on maximum numbers of partners in a firm. But however, Companies Act 1994 puts a limit on number of partners in a firm as follow:^[3]

For banking purpose, partners must not be more than 10
For any other business, partners must not be more than 20

There must be at least two persons to form a partnership. All the partners must be competent to contract. Therefore, if in a firm, the number of partners is reduced to one, the firm is said to be dissolved.

Profit sharing: The main objective of a firm is to earn profit. These profits are shared among partners in a pre-decided ratio. However, if no such ratio is decided, it will be considered that the partners have equal ratio in profit sharing.^[4]

Mutual agency: Mutual Agency relation means that the business of the firm must be carried out by all or any of the partners.^[5] A Partner is the agent of the other partner and therefore can bind other partners by his acts.^[6] In the same way, a partner is a principal who can be made liable for the acts of other partners of the firm. That means partnership generally has these four elements. But a problem sometimes arises, when and how can it be determined whether partnership exists there or not?

Test to identify partnership:

Many tests can be used to justify the existence of partnership. But most of the time three big tests have been used by the court. One should consider the following essentials as parameters to test the reliability of partnership:^[7]

An agreement as a test: An agreement is a physical documentation of all the rules, obligations and activities which all the partners used to follow properly. It is a tangible proof during the case of solving disputes if any occurs. As the agreement consists of all issues involving the business, it plays a significant role in the test of partnership. Agreement is the easiest way to test whether partnership exists or not if the agreement is in written form. But the problem comes where the agreement is not in written but by conduct. An agreement to create partnership may arise from the conduct of the parties concerned and the court in the case Abdul vs Century Wood Industries^[8] held this principle.

Sharing profits as a test: The word partnership derived from the word ‘to part’ which means ‘to divide’. The division of profits is an essential condition of the existence of partnership.^[9] Once sharing of profit was considered to be the final determination of the existence of partnership. But this was the state of law up to the year 1860 when a new principle was established in the case of Cox Vs Hickman^[10] which talks about sharing of profits as a right to consider the existence of partnership.

Mutual agency: By this test, though it is seen whether the parties are in an agent-principal relationship or not, the problem arises when the party works as employee agent but not as partner agent. In a case, a person was held to be working as an employee agent but not as partner agent though the relationship was agent and principle with profit sharing.^[11]

In these three big tests, some problems are always found where the court always tries another test when these three tests fail and that is the real intention of the parties concerned.

Real intention: Section 6 of Partnership Act 1932 is the root and gives hints of real intention test. In this section it is said that whether a person is or is not a partner, regard shall be had to the real relation between the parties as shown by all relevant facts taken together. Profit sharing, mutual agency and agreement can create a presumption only that there exists partnership. But the final decision of whether the relation exists or not depends on two things:^[12]

Real Intention of Parties
Conduct of Parties

In the case of Badley vs Consolidated Bank^[13] the court held that it is no longer right to infer either partnership or agency from the mere fact that one person shares the profit of another. In this case a lender advanced money to a contractor on the condition that the lender was to receive 10% profit from the business and some other conditions. It was held that these terms did not show any intention of constituting a partnership rather the intention was to secure the repayment of the loan. In this field the intention of the parties is supreme. The existence of partnership depends upon their intention as shown by their agreement or conduct or both put together. In another case, S and A were two joint owners of land and jointly raised crops and borrowed money for cultivation and jointly controlled the business. The court held that though there was no tangible agreement between them, their intention was to form partnership and to share profit from the land.^[14] In this case the court based its decision on the ground of intention of the parties.

In a landmark case the court directly used real intention and the conduct of the parties as the ultimate way to test partnership:^[15]

“It appears to be now that although a right to participate in the profits of trade is a strong test of partnership and that there may be cases where from such participation alone it may as a presumption, not of law but of fact, be inferred; yet whether the relation does or does not exist depends on the real intention and conduct of the parties.”

In this case 20% profits from the business were agreed to share with the lender who advanced money for the business. Subsequently the property of the firm was mortgaged to the lender and he released his right to commission. The court held that there was no intention to take him in as a partner. The agreement and profit sharing were to give maximum security for the repayment of the loan. There are also many case laws where this real intention test has been approved and established as a true test for the existence of partnership.

Conclusion: In this write up, I have tried to show some tests how the existence of partnership can be determined. But among these tests, except real intention tests, all the tests have some limitations where these tests do not work appropriately as these tests create presumption only. But coming to the real intention test, it starts working from that point where other tests fail. Real intention is the ultimate and final test of how one can determine the existence of partnership between the parties.

Writer: student of Department of Law, University of Dhaka.

Email: soeb-45-2017817365@law.du.ac.bd

^[1] Dy. CST vs K. Kelukutty, [1985] 4 SCC 41

^[2] Abdul vs Century Wood Industries, [1954] AIR Mys 33

^[3] The Companies Act 1994, s 4

^[4] The Partnership Act 1932, s 13(b)

^[5] The Partnership Act 1932, s 4

^[6] The Partnership Act 1932, s 18

^[7] Helper Girdharbhai vs Saiyed Mohd Mirasaheb Kadri, [1987] 3 SCC 538

^[8] [1954] AIR Mys 33

^[9] Avtar Singh, ‘Introduction to Law of Partnership’, 6th edition 2001, page 10

^[10] 8 HLC 268