Meaning of Dissolution of Firm
The Dissolution of a Firm refers to the complete closure of the partnership business, resulting in the end of the relationship among all partners. Unlike dissolution of partnership (where only the relationship with one partner changes), dissolution of a firm brings the entire business to an end. All assets are sold, liabilities are paid, loan obligations are settled and the remaining balance is distributed among partners according to their capital accounts.
Dissolution results in the final settlement of accounts through the preparation of a Realisation Account, Partner’s Capital Accounts and Cash/Bank Account.
Circumstances Under Which a Firm is Dissolved
The Partnership Act, 1932 lays down several circumstances in which a firm may be dissolved. These circumstances may be voluntary, compulsory, automatic or court-ordered.
1. Dissolution by Agreement
The firm may be dissolved whenever all partners mutually agree to close the business. Since partnership arises from a contract, it can be ended by contract.
2. Compulsory Dissolution
The firm is compulsorily dissolved in the following circumstances:
- Insolvency of all partners or all except one.
- Business becomes unlawful due to changes in legislation (e.g., ban on trading in a particular product).
3. Dissolution on the Happening of Certain Events
A firm is automatically dissolved when:
- The term of partnership expires (in a partnership for a fixed period).
- The venture for which the firm was formed completes (in case of a particular partnership).
- The death of a partner, unless otherwise agreed by the partners.
- The insolvency of a partner, making further continuation impossible.
4. Dissolution by Notice (in Partnership at Will)
If the partnership is "at will", any partner can dissolve the firm by giving a written notice expressing intention to dissolve.
5. Dissolution by Court
The court may order dissolution when:
- A partner becomes of unsound mind.
- A partner becomes permanently incapable of performing duties.
- A partner is found guilty of misconduct affecting the business.
- A partner wilfully commits breach of the partnership agreement.
- Business cannot be carried on except at a loss.
- Circumstances arise which make it just and equitable to dissolve the firm.
6. Dissolution Due to Continuous Losses
When the business suffers continuous losses and there is no hope of recovery, partners may mutually decide to dissolve the firm to avoid further financial damage.
Conclusion
Dissolution of a firm marks the complete closure of the partnership and requires the settlement of all assets and liabilities. It may occur due to agreement, operation of law, partner-related events, or intervention of the court. Understanding these circumstances is essential for proper legal and accounting treatment during dissolution.