Analysis of Formation of a Partnership by Two Limited Companies

Introduction

In a business organization, there are four types of business. They are Sole Proprietorship, Partnership, Company and Limited Liability Partnership. For doing business, it is a notion to have limited liability and corporate existence. It can be seen in India the environment of business is not that friendly as in other countries. But with time, there are many amendments been done, and there are various improvements that we are learning from other countries to improve the working environment of business. As per the Ease of Doing Business Report, 2020[i] by World Bank, wherein India was placed in 63rd position out of 190 countries. India improved its position by 14 places as per the last report of 2019[ii]. One of the parameters on which India worked upon was Starting a Business. Though it is an improvement to be counted as yet, it has to be noted that we still lie at 63rd position in the ease of doing business. Therefore, we need to improve upon all forms of business organizations, whether it’s a Sole Proprietorship or Partnership or Limited Liability Company or a Corporation.

History

What is a Partnership?

Before the Partnership Act, 1932 was enacted, it was needed to get to boost up the business culture in the county and to make the trade and commerce efficient. There was a need to make a separate Act; therefore, The Partnership Act, 1932, was enforced. When two or more persons agree to do business to share profits by all or any of them acting for all is called a Partnership under the Act. All the partners share the legal binding relationship, and the agreement between them is contractual in form. A partnership agreement is known as a partnership deed. The nature of the business has to be legal. All the partners are equally and jointly liable for the payment of the debts of the firm. The partnership firm has unlimited liability. A partnership firm is not a legal person in the eyes of the law. Therefore the firm cannot register as a member of a company.

What is a Company?

A Company is a business organization which holds an artificial legal person entity formed by a legal person or a group of legal person persons with the purpose to carry on a business with limited liability. According to different countries, the definition and features of a company are a bit different. In the UK, the definition of a company is:

“A company is a body corporate or an incorporated business organization registered under the Companies Act. It can be a limited or an unlimited company, private or a public company, company limited by guarantee or a company having a share capital, or a community interest company.”[iii]

As per the law in the USA, it comes with a different definition which says:

A company can be a “corporation, partnership, association, joint-stock company, trust, fund, or organized group of persons, whether incorporated or not, and (in an official capacity) any receiver, trustee in bankruptcy, or similar official, or liquidating agent, for any of the foregoing.”[iv]

In India, the Companies Act, 2013 states that a company is an association of person whether natural or legal or both having separate legal entity from its member with perpetual succession. It is an artificial person in the eyes of the law having the same rights as a natural person to sue or be sued or borrow or pay taxes. It also has a common seal for its signature and has assets and carries limited liability.

Limited Liability Company

A limited liability company is a company in which the liability of the members extends to the amount of investment made by them or the guarantee given by them. A limited company is either limited by shares or by the guarantee provided by them. There can be three forms of limited companies which includes both private or public company or a one-person company.

Partnership Firm as a Member of a Company

A partnership firm consists of partners wherein the firm is not different from its partners. It does not hold a legal entity in the eyes of the law. It is not a distinct entity as that of a company. In the case of a company, a member must be a natural or legal person. It has to be noted that the Companies Act, 1956, defines a member. It states that-

“1) The subscribers of the memorandum of a company shall be deemed to have agreed to become members of the company, and on its registration, shall be entered as members in its register of members.

 (2) Every other person who agrees in writing to become a member of a company and whose name is entered in its register of members shall be a member of the company.

 (3) Every person holding equity share capital of the company and whose name is entered as a beneficial owner in the records of the depository shall be deemed to be a member of the concerned company.”[v]

Also by the Circular No. 4/72 dated, March 9, 1972, the Company Law Department has clarified the position regarding registration of firm as a member of a company that a firm not being a person cannot be registered as a member of a company except where the company is licensed under Section 25 of Companies Act, 1956.[vi] Therefore a partnership cannot be a member of a company. To support my views, there are some significant cases of the courts.

Relevant cases

  1. Third Income Tax Officer, Circle-I, Salem and Ors. vs Arunagiri Chettiar[vii]It was observed that the partnership firm is not a distinct legal entity apart from partners constituting it.[viii]
  2. Malabar Fisheries Co. vs Commissioner of Income Tax, Kerala[ix]It was held that a partnership firm under the Indian Partnership Act, 1932 is not a distinct legal entity apart from the partners constituting it and equally, in law, the firm as such has no separate rights of the owner in the partnership assets.”[x]

Company to become a Partner in Partnership Firm

As stated above of the characteristics of a company, it is known that a company is an artificial person in the eyes of the law. It has all the rights and liabilities as of that of a member or a person. It is also liable for the debts and can hold shares and assets. To authorize it with a signature, there is a common seal. Therefore, it becomes a wholesome legal person. Whereas in the case for the requirements of a partner in the partnership, the partner is a person who holds the liability of the firm. Hence, a company being a legal person can be a partner in the firm.

Provision under the Companies Act, 2013 for being a partner

The Companies Act,2013 under Schedule VI of the Act, it stated ‘Advances and Loans to partnership firms in which the company or any of its subsidiaries is a partner’[xi] should be disclosed separately in the Balance Sheet. Now, this indicates the possibility of a company being a partner in a partnership firm. It is also necessary that under the object clause of memorandum of association of the company there must include a statement and disclosure of allowing or sanctioning a company to enter into a partnership with any legal person or a company. But it becomes confusing to which act to be explicitly followed.

There are a few relevant cases to this matter:

  1. Nand Lal Sohan Lal vs The Commissioner of Income Tax, Patiala[xii]

    “There is no definition of the word “person” in the Partnership Act. The General Clauses Act, 1897, however, by Section 3(42) provides that” “a person shall include any company or association or body of individuals whether incorporated or not”.” The firm is not a company but is undoubtedly an association or body of individuals. The definitions are given in Section 3 of the General Clauses Act, 1897, however, apply when there is nothing repugnant in the subject context. It is difficult to say that there is anything repugnant in the context of Section 4 itself, which will exclude the application of that definition to the word “persons” occurring in Section 4.”[xiii]
  2. Steel Brothers & Co. Ltd. vs Commissioner of Income-tax[xiv]

    It was observed in this case that forming of a partnership firm is possible in the case of Income Tax.
  3. Ganga Metal Refining Co. Pte. Ltd.  vs Commissioner of Income Tax[xv] 

“Section 4 of the Partnership Act says that ‘Partnership’ is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered into a partnership with one another are called individually ‘partners’ and collectively ‘a firm’ and the name under which their business is carried on is called the ‘firm name’. Notionally and juristically if two incorporated companies under the Indian Companies Act enter into a partnership, then each company becomes an agent for the other and agrees to share the profits. This will create many problems for the two incorporated companies. The two companies will have to be, therefore, agents for each other in a manner which may not be permissible at all by their charters, articles and memorandum. It would be difficult to apply the very specific rights and obligations as between partners in the case of companies as partners such as in Chapter III (Sections 9 to 17), Chapter IV (Sections 18 to 30), and Chapter VI (Sections 39 to 55) of the Partnership Act. Then there is need also for the registration of firms, and the companies as such partners in a partnership will have to, therefore, obey two masters, the Registrar of Firms and Registrar of Companies. The access of each partner to the other partner’s books of accounts will mean that one incorporated company would be entitled to get into the fields of the accounts of the other incorporated company which is its partner. This will make nonsense of the Companies Act. Strangers then will have access to the books, accounts and papers of the companies, whereas, under the Companies Act, they are only limited to their members and shareholders.”[xvi]

Therefore, the concept of partnership between the two companies which are registered under the Companies Act, 2013 can form a partnership for business would be confusing and not practical. No doubt, there could be such partnership in the loose sense of the term between two incorporated companies for the Income Tax Act.[xvii] It can be done so that the companies enter into the partnership if they mention in their memorandum and articles of association with an article for authorizing the company to enter into a partnership.

Conclusion

The concept of two limited companies forming a partnership is not against the law. Still, it is something which causes confusion and requires that under the object clause of memorandum of association of the company, it must include a statement and disclosure of allowing or sanctioning a company to enter into a partnership. As it is known that in the case of a limited company, the liability is limited only with the amount of guarantee given or by the shares. In contrast, the liability of the partners is unlimited. Therefore, these contradicting provisions are confusing. Yet the two limited companies can form a partnership. This concept would improve the tie-ups between two limited companies which will end up improving the business and would beneficiate the business environment. Two limited companies would be able to share each other’s work structure and market, which will ultimately cause profitable to both.

Frequently Asked Questions

  1. What is a partnership?
  2. What is a company?
  3. Can a partnership firm become a member of a registered company?
  4. Can a company be a member of a partnership firm?
  5. What is the provision under Company Act, 2013, for a company to be a partner?

[i]https://openknowledge.worldbank.org/bitstream/handle/10986/32436/9781464814402.pdf

[ii] https://www.doingbusiness.org/en/reports/global-reports/doing-business-2020

[iii] https://www.feedough.com/what-is-a-company-meaning-types-features-of-a-company/

[iv] Ibid

[v] COMPANIES ACT, 1956

[vi]http://www.manupatra.com/roundup/370/Articles/Can%20two%20limited%20Companies.pdf

[vii] MANU/SC/0543/1996

[viii] Ibid

[ix] MANU/SC/0326/1979

[x] Ibid

[xi] https://www.mca.gov.in/XBRL/pdf/Guidance_Note_Rev_ScheduleVI.pdf

[xii] MANU/PH/0052/1977

[xiii] Ibid

[xiv] MANU/SC/0062/1957

[xv] MANU/WB/0002/1966

[xvi] Ibid

[xvii] Ganga Metal Refining Co. Pte. Ltd.  vs. Commissioner of Income Tax, MANU/WB/0002/1966

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