Source: Supreme Court  

Why in News? 

The Supreme Court in M/s Crystal Transport Private Limited & Anr. v. a Fathima Fareed Unisa & Ors. has ruled that an outgoing partner of a dissolved firm has the right to seek accounts, and a share of the profits earned from the firm's assets, even if the assets are taken over by another entity without the partner's consent.  

• The bench, led by Chief Justice DY Chandrachud, emphasized that profits derived from the firm’s assets should be proportionally distributed to the outgoing partner.  
• This ruling came in a dispute over the dissolution and settlement of accounts of the Crystal Transport Service partnership. 

What was the Background of M/s Crystal Transport Private Limited & Anr. v. a Fathima Fareed Unisa & Ors. case? 

• A partnership firm named Crystal Transport Service was established in the early 1970s with four partners, each holding a one-fourth share in the business. 
• In 1978, three partners allegedly diverted funds from the partnership firm to a private limited company (the fourth defendant) without obtaining consent from the fourth partner (plaintiff). 
• When the plaintiff demanded accounts from the other three partners regarding this diversion of funds, they refused to provide the same. 
• Subsequently, the plaintiff filed Original Suit No.286 of 1978 seeking dissolution of the partnership, settlement of accounts, distribution of shares, and appointment of a receiver to manage the firm's assets until winding up. 
• The three defendant partners contested the suit claiming that the joint stock company was formed with the approval of all partners, including the plaintiff, and that all assets and liabilities of the firm were transferred to the fourth defendant company through an agreement dated 25th June1978. 
• Multiple receivers were appointed over time to manage the assets and take accounts, but faced challenges in executing their duties effectively, leading to several interim applications and legal proceedings. 
• The matter involved complex proceedings including preliminary decrees, appeals, revisions, and cross-objections, primarily centered around the proper accounting of firm assets and determination of the plaintiff's rightful share. 
• The core dispute revolved around whether the plaintiff was entitled to profits generated from the firm's assets after the date of dissolution, particularly those earned by the fourth defendant company.  

What were the Court’s Observations? 

• The Supreme Court upheld the High Court's finding that parties were not afforded proper opportunity to prove or challenge the reports which formed the basis of the final decree, thereby necessitating a remand of the matter. 
• The Court observed that as per the preliminary decree, which attained finality, there existed a clear direction that the Commissioner shall take accounts with due regard to Sections 37 and 48 of the Indian Partnership Act, 1932. 
• The Court noted the significant finding on record that the fourth defendant (appellant company) had taken over the assets of the firm, bringing the matter squarely within the ambit of Section 37 of the Partnership Act. 
• The Court interpreted Section 37 to hold that where an entity carries on business with the assets of the firm without final settlement of accounts, the outgoing partner is entitled to such share of profits made since cessation of partnership as may be attributable to the use of their share of property. 
• The Bench clarified that the quantum of business derived from the firm's assets by the appellant company remains a matter of evidence, which parties must establish during proceedings for preparation of the final decree pursuant to remand. 
• The Court, while disposing of the appeals, explicitly refrained from expressing any binding opinion on the merits of either party's claims, making them subject to evidence led during final decree proceedings. 
• The Court emphasized that the outgoing partner's entitlement to profits extends until final settlement is achieved, regardless of the dissolution date, provided the business continues to operate using the firm's assets. 

Section 37 of the Partnership Act 1932 

• Section 37 primarily deals with the rights of outgoing partners or their estates in scenarios where the business continues to operate using firm property without a final settlement of accounts. 
• The section applies in two specific circumstances:  
  • When a partner has died, or  
  • When a partner has otherwise ceased to be a partner 
• Three essential conditions must be satisfied for invoking Section 37:  
  • The surviving/continuing partners must carry on the firm's business. 
  • They must use the property of the firm. 
  • There must be no final settlement of accounts with the outgoing partner/estate. 
• In the absence of any contrary agreement, the outgoing partner or their estate has two options:  
  • Claim a share in profits attributable to their share in the firm's property, OR 
  • Claim interest at 6% per annum on their share in the firm's property 
• The right to claim subsequent profits continues until there is a final settlement of accounts between the parties, regardless of the date of cessation of partnership. 
• The section includes a proviso that creates an exception where there exists a contract giving surviving/continuing partners an option to purchase the interest of the outgoing/deceased partner. 
• If such an option is properly exercised in accordance with the contract, the outgoing partner/estate loses the right to claim any further share in profits. 
• However, if the continuing partners fail to comply with all material terms of the purchase option, they become liable to account under the main provisions of Section 37. 
• The section essentially acts as a safeguard against misuse of firm property by continuing partners and ensures fair compensation to outgoing partners until final settlement. 

Section 48 of the Partnership Act 1932 

• Section 48 prescribes the statutory rules for settlement of accounts between partners after dissolution of a firm, which are subject to any contrary agreement between partners. 
• The section establishes a hierarchical order for payment of losses:  
  • First from profits 
  • Then from capital 
  • Finally, if necessary, from partners individually in their profit-sharing ratio 
• For application of firm's assets, the section creates a mandatory waterfall mechanism in the following order:  
  • Priority 1: Payment of third-party debts 
  • Priority 2: Payment of advances made by partners 
  • Priority 3: Payment of capital contribution to partners 
  • Priority 4: Distribution of residue among partners in profit-sharing ratio 
• Partners' advances are distinguished from capital contributions and are given priority over return of capital, reflecting the principle that advances are essentially loans made by partners to the firm. 
• The section ensures equitable distribution by mandating that payments to partners for advances and capital must be made 'rateably', meaning proportionately according to their respective entitlements. 
• While the section provides a default framework, partners retain the freedom to contractually modify these rules through partnership agreement, emphasizing the primacy of partner autonomy in determining settlement terms.