Grounds On Which A Partnership Firm Is Presumed To Be Illegal

A partnership firm is presumed to be legal unless its object, purpose or formation involves an unlawful activity. A partnership becomes illegal when its agreement violates law, involves an unlawful object or consideration, is opposed to public policy, or is formed in breach of statutory restrictions. However, mere illegality of association between partners does not automatically affect third parties who are not involved in the illegal act.

When Is A Partnership Firm Considered Illegal?

A partnership firm is considered illegal when the purpose for which it is created or the manner in which it is formed violates the law.

Add LawBhoomi as your preferred source on Google.

Add Now →

The legality of a partnership depends mainly on the following grounds:

• The object of the partnership is unlawful.
• The consideration for forming the partnership is unlawful.
• The partnership agreement is opposed to public policy.
• The formation of the firm violates a statutory prohibition.
• The business carried on by the firm requires illegal activities.

A partnership is not presumed to be illegal merely because some irregularity exists between the partners. The illegality must be established by showing that the partnership itself has an unlawful foundation or necessarily involves an illegal activity.

Partnership Formed For An Unlawful Object

The most important ground for treating a partnership firm as illegal is that its object is unlawful.

The object of a partnership refers to the purpose for which the partners join together and carry on business. If that purpose requires the partners to violate law, the partnership cannot be recognised.

Examples of unlawful objects may include:

• Partnership created for carrying on prohibited activities.
• Partnership agreement designed to commit fraud.
• Partnership formed to defeat the provisions of any statute.
• Partnership established for activities against public policy.

The courts examine whether the illegal activity is the foundation of the partnership or merely an independent act committed by one partner.

If the business itself is lawful but one partner independently commits an illegal act, the partnership may not automatically become illegal.

Partnership Agreement Opposed To Public Policy

A partnership agreement can also become illegal if its object is against public policy.

Public policy refers to principles that protect public interest, morality, justice and the welfare of society. Agreements that harm public interest cannot be enforced by courts.

For instance, an agreement between persons to create a partnership for influencing public officials through illegal means would be considered against public policy.

However, courts apply the principle of public policy carefully because an excessively broad interpretation may restrict legitimate business activities.

Partnership Formed In Violation Of Statutory Restrictions

A partnership firm may be considered illegal if its formation violates a specific legal prohibition.

One such restriction relates to the maximum number of persons who can form a partnership for carrying on business.

Under company law, certain restrictions have existed regarding the number of persons who may associate together for business purposes without registration as a company. A partnership exceeding the permitted limit may be treated as illegal.

In Badri Prasad v. Nagarmal, AIR 1959 SC 559, the Supreme Court considered the validity of a partnership formed in violation of the statutory limit regarding the number of partners. The Court recognised that a partnership exceeding the prescribed limit could not claim legal validity.

The principle established is that where the law prohibits a particular form of association, persons cannot avoid the statutory requirement by merely describing their relationship as a partnership.

Effect Of Section 23 Of The Indian Contract Act, 1872 On Partnership Agreements

Section 23 of the Indian Contract Act, 1872 plays an important role in determining whether a partnership agreement is valid or illegal.

According to Section 23, the consideration or object of an agreement is unlawful when it:

• Is forbidden by law.
• Defeats the provisions of any law.
• Is fraudulent.
• Involves injury to the person or property of another.
• Is considered immoral by the court.
• Is opposed to public policy.

Since a partnership agreement is a contract, a partnership formed with an unlawful object becomes void.

For example, if persons enter into a partnership agreement for conducting an illegal business, the agreement itself has no legal validity. The courts will not enforce rights arising from such an illegal arrangement.

Therefore, the legality of the partnership firm depends upon the legality of its purpose and activities.

Presumption Of Legality Of A Partnership Firm

A partnership firm is presumed to be legal unless sufficient evidence proves otherwise.

The burden of proving illegality lies on the person who alleges that the partnership is unlawful. Courts do not presume that a partnership agreement is illegal without examining the object, purpose and circumstances surrounding its formation.

A partnership will generally be treated as valid unless:

• The partnership agreement contains an unlawful object.
• The business activity itself is prohibited by law.
• The agreement violates mandatory legal provisions.
• The partnership necessarily involves illegal conduct.

This presumption protects genuine commercial relationships and prevents parties from avoiding contractual obligations by making unsupported allegations of illegality.

Difference Between Illegal Partnership And Illegal Act By A Partner

An important distinction exists between an illegal partnership and an illegal act committed by an individual partner.

An illegal partnership means that the very foundation of the partnership is unlawful. In such cases, the partnership agreement itself cannot be enforced.

However, where the partnership business is lawful but a partner commits an illegal act without the knowledge or authority of other partners, the entire partnership may not automatically become illegal.

For example:

• A partnership formed to operate a lawful trading business is valid.
• If one partner independently commits fraud, the fraudulent act may create personal liability for that partner.
• The partnership itself may continue to exist if its purpose remains lawful.

Therefore, the legality of a partnership depends on its object and essential nature rather than every individual action of its partners.

Rights Of Third Parties Dealing With An Illegal Partnership

The illegality of a partnership does not always prevent third parties from claiming their legitimate rights.

The principle applied by courts is that a person who participates in an illegal transaction cannot seek legal remedies arising from that transaction. This principle is known as ex turpi causa non oritur actio, meaning that no action arises from an immoral or illegal cause.

However, this principle applies only when the person claiming a remedy is himself involved in the illegal act.

A third party dealing with a partnership firm may still enforce rights if:

• The third party was not aware of the illegality.
• The third party did not participate in the unlawful purpose.
• The transaction itself was independent of the illegal activity.

Therefore, an innocent outsider is not automatically deprived of legal protection merely because the persons operating the firm were illegally associated.

Meaning Of Particeps Criminis In Partnership Law

The expression particeps criminis means a person who participates in an illegal act or shares responsibility for the unlawful purpose.

In partnership law, a person dealing with an illegal partnership cannot claim legal protection if that person was aware of and involved in the illegal purpose.

For example:

• A person knowingly enters into a transaction designed to support an illegal business.
• Such person becomes a participant in the illegality.
• The courts may refuse assistance because the claimant is equally responsible for the unlawful act.

However, where a person has no connection with the illegal purpose and merely enters into an ordinary commercial transaction, such person cannot be treated as a participant in the illegality.

Consequences Of An Illegal Partnership Firm

An illegal partnership firm faces several legal consequences:

• The partnership agreement becomes unenforceable.
• Partners cannot claim contractual rights arising from the illegal agreement.
• Courts generally refuse to assist partners seeking benefits from illegal transactions.
• Profits or benefits arising from unlawful activities may not receive legal protection.
• Third-party rights depend upon their involvement in the illegality.

Thus, illegality affects not only the existence of the partnership but also the ability of persons connected with it to seek judicial remedies.

Conclusion

A partnership firm is presumed to be legal unless its object, formation or activities are proved to be unlawful. The primary grounds for illegality include violation of Section 23 of the Indian Contract Act, 1872, formation against public policy, breach of statutory restrictions and involvement in illegal activities. 

However, illegality of the partnership does not automatically affect innocent third parties who are not participants in the unlawful conduct. The law distinguishes between persons involved in illegality and those who act in good faith while dealing with such firms.