How unlimited is the liability of a Partner? – Lessons for creditors

In today's interconnected business landscape, partnership firms, that is, firms registered under the Indian Partnership Act, 1932 (Partnership Act) continue to remain a critical vehicle for doing business. Partnerships, established with the intent to drive profit, often engage in a multitude of transactions and financial exchanges. Amidst these dealings, it is possible for dues to accumulate. When a partner passes away, any unresolved debts can become a complex issue, impacting both the surviving partners and the creditors.

In this article, we explore the automatic dissolution of partnerships upon a partner's death, the unlimited liability of the surviving partner/s, and the limited liability of legal heirs. Further, we examine landmark legal cases and relevant provisions of the Indian Contract Act, 1872, and the Civil Procedure Code, 1908 (CPC) which elucidate the rights and obligations of creditors and heirs. Additionally, we also highlight the importance of timely legal action by creditors to maximize debt recovery and the nuanced legal protections that balance the interests of creditors and heirs in the aftermath of a partnership's dissolution.

The Partnership Act defines ‘Partnership’ as 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. Naturally, for a partnership to exist and subsist, a minimum of two surviving partners is mandatory. As per Section 42 of the Partnership Act, in a situation where one of the two partners dies or there remains only one surviving partner the partnership firm automatically dissolves.

The fundamental principle of a partnership as encapsulated under Section 25 of the Partnership Act is that every partner is liable jointly and severally for all acts of the firm while he was/ is a partner. As a consequence, a sole surviving partner even after the dissolution of the firm upon the death of a partner, assumes unlimited liability to discharge any debt owed by the firm. This provision ensures that creditors can seek repayment from any partner for the full amount of the firm's debts, regardless of which partner was responsible for incurring the debt.

However, creditors face significant challenges in enforcing their debt in a situation where none of the partners survive. In such cases, the legal heirs of the partners are not liable for the debts of the firm, as they were never parties to the partnership agreement and thus cannot be held responsible for the obligations incurred by the firm. The principle of limited liability for heirs ensures that they are not required to pay the firm's debts from their personal assets.

In the same vein in the landmark case of SP Mishra & Ors. v. Mohd. Laiquddin Khan & Anr., the Hon’ble Supreme Court held that even a favourable decree obtained by a creditor against a partner cannot bind his/ her legal heirs, as such, the decree is not executable against them. The legal heirs of a deceased partner are not parties to the contract and such contract cannot confer rights or impose obligations arising under it on any third party, except parties to it.

In fact, the Hon’ble Supreme Court went a step further to hold that even if the partnership deed envisages that after the death of a partner his legal heirs would automatically enter the partnership, such a clause would be void ab initio as it would run contrary to the provisions of the Partnership Act and would be opposed to public policy.

Personal rights, distinct from proprietary rights, arise from contractual obligations or pertain to an individual's status. These personal rights are neither transferable nor inheritable. Correspondingly, even Section 306 of the Indian Succession Act, 1925, embodies the maxim "actio personalis moritur cum persona" (a personal right of action dies with the person), which applies to a specific class of cases where the right in question is not inheritable.

Therefore, creditors may find themselves without recourse to recover the amounts owed, as the deceased partners' estates may not have sufficient assets to cover the debts, and the heirs are protected from any personal financial liability.

However, it is pertinent to note that a creditors' claim is not entirely extinguished and depends on the specific circumstances of each case. If none of the partners survives, and any part of the deceased partner's estate has been transferred to an heir, creditors may pursue claims against those transferred assets. While the heirs are not personally liable for the firm's debts, the inherited assets can still be subject to creditor claims.

Section 37 of the Indian Contract Act, 1872, stipulates that a promise made by a promisor is binding on his representatives in the event of his/ her death unless the contract explicitly indicates otherwise.

Where the creditor has a decree to enforce its debt against the firm, the creditor may take recourse against the legal heirs under Section 50 of the CPC:

50(1). Where a judgment-debtor dies before the decree has been fully satisfied, the holder of the decree may apply to the Court which passed it to execute the same against the legal representative of the deceased.

50(2). Where the decree is executed against such legal representative, he shall be liable only to the extent of the property of the deceased which has come to his hands and has not been duly disposed of; and, for the purpose ascertaining such liability, the Court executing the decree may, of its own motion or on the application of the decree-holder, compel such legal representative to produce such accounts as it thinks fit.”

Therefore, creditors can seek repayment from the value of the estate's assets that have been transferred/ inherited, ensuring their claims are addressed to the extent of the inherited estate. In the case of Ambili Devi v. Kerala State Road Transport Corporation, Ambili Devi was given compassionate employment upon the death of her husband, and the respondent was attempting to attach her salary from such an appointment to secure the debt due from her deceased husband. The Kerala High Court interpreted Section 50 of CPC and held that a legal heir was only liable to the extent of the property secured by him/ her from the estate of the deceased. The Court thus did not allow attachment of her salary towards the debts due from her deceased husband.

Interestingly, as per Section 50(2) of the CPC, once the assets of the deceased partner have been transferred and subsequently sold or otherwise disposed of, the connection to the original estate is severed, and the creditors cannot pursue those assets to satisfy the firm's debts. Consequently, the heirs are further protected from creditor claims related to the disposed property.

In conclusion, it is evident that the legal framework strives to balance creditor rights and legal heir protections, ensuring debts are settled fairly without imposing undue burden on the legal heirs. The liability of legal heirs following the dissolution of a partnership is distinctly circumscribed by the extent of their inheritance.

The dissolution of a partnership due to the death of partners presents intricate challenges for creditors seeking to recover outstanding debts. While the surviving partners bear joint and several liability, creditors face significant obstacles when none of the partners are alive. The legal heirs, shielded by the principle of limited liability, are only accountable to the extent of the inherited estate and not beyond that to their personal assets. To maximize recovery, it is crucial for creditors to act swiftly. The sooner a claim is made, the better the chances of accessing the deceased partner's estate before it is transferred or disposed of. By initiating prompt claims, creditors can improve their likelihood of recouping debts owed by the dissolved partnership.

About the authors: Naman Golechha and Manichandan G Reddy are Associates at Chandhiok & Mahajan.

They authored the article under the guidance of Avinash Amarnath (Partner).

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