Indian Partnership Act
Settlement of Accounts after Dissolution: Section 48
When a firm ends, the money is paid out in a fixed order, and the losses are made good in the reverse of the order in which they went in. Section 48 sets that order: losses come first out of profits, then capital, then the partners' pockets; and the assets go first to outside creditors, then to partners' advances, then to capital, and lastly the surplus in the profit-sharing ratio. Two things complicate it: Section 49 keeps firm and separate estates apart, and the rule in Garner v Murray decides who bears an insolvent partner's deficiency. This note works through it all.
The order of paying for losses and applying the assets, the two-estates rule, and Garner v Murray
1. The Two Rules of Section 48
§ Section 48, subject to agreement by the partners Rule (a): losses, including deficiencies of capital, are paid first out of profits, next out of capital, and lastly, if necessary, by the partners individually in their profit-sharing proportions. Rule (b): assets, including any sums contributed to make up deficiencies of capital, are applied in this order: first, in paying the debts of the firm to third parties; secondly, rateably to each partner what is due for advances as distinguished from capital; thirdly, rateably to each partner what is due on account of capital; lastly, the residue is divided in the profit-sharing proportions. |
2. Treatment of Losses and Deficiency of Capital
§ Working through rule (a) • Profits first. Undivided profits are applied against the loss before anything else is touched. • Capital next. If profits are insufficient, the partners' capital bears the loss. • Partners personally last. If capital too is exhausted, the partners contribute personally, in the ratio in which they shared profits. • Deficiency of capital is a loss. Where the assets are not enough to return the capital, the shortfall is a loss to be borne in the same way. • The order is the reverse of contribution. Money went in as capital and was meant to earn profits; on winding up, profits absorb loss first, then capital, then the partners. |
3. Applying the Assets: Outside Creditors before Partners
Priority | Payment | Note |
|---|---|---|
First | Debts of the firm to third parties | Outside creditors are paid in full before any partner receives anything |
Second | Partners' advances, rateably | Loans a partner made beyond his agreed capital rank ahead of capital |
Third | Partners' capital, rateably | Return of the capital each partner contributed |
Last | The residue | Divided among the partners in the profit-sharing ratio |
- Advances and capital are different. An advance is a debt of the firm to the partner and is repaid before capital; this is why Section 13(d) also treats an advance as carrying interest whether or not there are profits.
4. Firm Debts and Separate Debts: Section 49
§ The two-estates rule Firm property is applied first to the debts of the firm; any surplus is divided among the partners, and each partner's share then goes to his separate creditors. A partner's separate property is applied first to his separate debts; any surplus goes towards the firm's debts. The result. Firm creditors have priority over firm assets; separate creditors have priority over separate assets. Neither class can leap over the other. |
5. The Rule in Garner v Murray
📖 Garner v Murray, [1904] 1 Ch 57 On dissolution, one of three partners was insolvent and could not make good the debit balance on his capital account. The English court held that, in the absence of agreement, the loss arising from that deficiency is borne by the solvent partners in the ratio of their capitals (their last agreed capitals), and not in their profit-sharing ratio. The reasoning is that the deficiency is a loss of capital, to be shared in proportion to capital. |
§ The Indian position • Applied, subject to contract. Indian courts have applied Garner v Murray, but it yields to a contrary agreement in the deed. • Two steps in practice. First, the solvent partners bring in cash equal to their own share of the general loss. Then the insolvent partner's capital deficiency is borne by the solvent partners in the ratio of their capitals. • Criticism. The rule is technical and can produce results the partners did not intend; a well-drafted deed usually provides that all deficiencies are shared in the profit-sharing ratio, displacing the rule. |
6. Related Points
Point | The position |
|---|---|
Settlement and Section 37 | Section 48 governs a full settlement on dissolution; Section 37 gives the outgoing partner an option (profits or six per cent) where the business continues WITHOUT a final settlement |
Insolvency during dissolution | The insolvent partner's estate is dealt with under the insolvency law; his capital deficiency is apportioned under Garner v Murray |
A two-partner firm | When the firm of two dissolves, the accounts are settled under Section 48; there is no continuing firm, so the assets are realised and divided |
Personal liability for deficiency | A partner remains personally liable to contribute to a deficiency in his profit-sharing ratio, subject to contract |
7. Frequently Asked Questions
In what order are losses borne under Section 48?
First out of profits, then out of capital, and lastly by the partners personally in their profit-sharing ratio.
Who is paid first out of the assets of a dissolved firm?
The firm's debts to third parties, then partners' advances, then capital, and lastly the residue is divided in the profit-sharing ratio.
What is the rule in Garner v Murray?
That an insolvent partner's capital deficiency is borne by the solvent partners in the ratio of their capitals, not their profit-sharing ratio, subject to a contrary agreement.
How does Section 48 differ from Section 37?
Section 48 settles accounts on a full winding up; Section 37 gives an outgoing partner an option where the business is continued without a final settlement.