Sale of Goodwill After Dissolution of Firm
Section 55 of the Indian Partnership Act, 1932 deals with the sale and treatment of goodwill after the dissolution of a partnership firm. Goodwill is considered an important asset of the firm and, unless partners agree otherwise, it must be included while settling accounts after dissolution. The provision also explains the rights of buyers and sellers of goodwill and allows reasonable agreements restricting competing businesses.
What Is Goodwill Of A Partnership Firm?
Goodwill refers to the reputation, customer connection, business identity, and commercial value that a firm develops over time due to its successful operations. It represents the advantage a business enjoys because of its established name, customer loyalty, location, quality of services, and market reputation.
Add LawBhoomi as your preferred source on Google.
In a partnership firm, goodwill is treated as an intangible asset because it does not have a physical existence but contributes significant economic value to the business. When a partnership firm is dissolved, the goodwill becomes an important part of the assets that must be considered while settling accounts between partners.
The value of goodwill may arise from various factors, including:
- Reputation and goodwill built among customers.
- Long-standing business relationships.
- Trade name and brand recognition.
- Location advantage of the business.
- Customer loyalty and future earning potential.
Section 55 of the Indian Partnership Act, 1932 specifically provides rules regarding the sale and distribution of goodwill after dissolution of a firm.
Meaning Of Section 55 Of Indian Partnership Act, 1932
Section 55 deals with the sale of goodwill after dissolution of a partnership firm. It provides that while settling the accounts of a firm after dissolution, goodwill shall be included among the assets of the firm unless there is an agreement between the partners stating otherwise.
Access subject-wise law notes for free on LawBhoomi.
The section allows the goodwill of the firm to be sold in two ways:
- Separately from other assets of the firm.
- Along with other assets of the firm.
The provision recognises that goodwill has monetary value and must be dealt with like other partnership assets during the winding-up process.
The general rule is that goodwill belongs to the firm collectively and not to any individual partner. Therefore, after dissolution, it must normally be valued and distributed among partners according to their rights in the partnership.
In Laxmidas Dayabhai Kabrawala v. Nanabhai Chunilal Kabrawala (1964), the Supreme Court observed that goodwill forms part of the assets of a partnership firm and, unless there is a contrary agreement, it should be taken into consideration while settling accounts after dissolution.
Why Is Goodwill Included In Partnership Assets After Dissolution?
A partnership firm is created through the combined efforts of all partners. The goodwill of the firm generally develops because of the contribution of every partner through their skills, capital, management, and business relationships.
Therefore, when the firm is dissolved, the benefit arising from such goodwill cannot normally be ignored. Since goodwill has commercial value, excluding it from the assets would result in an unfair distribution of partnership property.
The inclusion of goodwill ensures that:
- Partners receive their rightful share in the value created by the firm.
- The business reputation developed jointly by partners is properly accounted for.
- Settlement of partnership accounts takes place in a fair manner.
However, partners have the freedom to enter into an agreement regarding the treatment of goodwill. If the partnership agreement provides a different arrangement, such agreement will generally govern the rights of partners.
Explore practical law courses to build career-ready legal skills.
Rights Of Partners Regarding Goodwill After Dissolution
On dissolution of a partnership firm, every partner generally has a right to have the goodwill sold for the common benefit of all partners, unless there is an agreement stating otherwise.
This means that one partner cannot normally appropriate the goodwill of the firm for personal benefit without accounting for the interests of other partners.
The sale of goodwill ensures that all partners receive their proportionate share from the value generated through the reputation and customer base of the firm.
In Khushi Lal Khemgar Shah v. Khorshed Banu Dadiba Boatwala (1970), the Supreme Court recognised that goodwill is an asset of the partnership and partners have rights over it. The Court also clarified that the entitlement to goodwill is not restricted only to situations involving complete dissolution of the firm.
The legal representatives of a deceased partner may also have a right to claim a share in the goodwill of the partnership if the circumstances require such entitlement.
Does Goodwill Automatically Pass To Surviving Partners After Death Of A Partner?
Goodwill does not automatically belong exclusively to surviving partners after the death of a partner.
Earlier, it was believed that when a partner died, the surviving partners automatically obtained the entire benefit of the goodwill of the firm. However, this position is no longer accepted as a general rule.
The surviving partners may continue to use the goodwill of the firm, but such continuation does not automatically remove the rights of the deceased partner’s legal representatives.
The intention of partners regarding goodwill becomes important. The rights of surviving partners depend on factors such as:
Find the latest legal internship opportunities, updated daily.
- Terms of the partnership agreement.
- Conduct of partners after the death of a partner.
- Use of the firm name and business identity.
- Agreement regarding continuation of business.
Therefore, goodwill must be considered separately while determining the financial rights of partners or their legal representatives.
Case Law On Goodwill And Surviving Partners
Menendoz v. Holt (1888)
In Menendoz v. Holt (1888), the court recognised that where a partner retires or leaves a firm and allows the remaining partners to continue business using the old place of business and firm name, the goodwill may remain with the continuing partners.
The case established that goodwill may follow the continued operation of the business where there is clear intention or conduct showing that the remaining partners are entitled to retain the benefit of the goodwill.
However, such circumstances depend on the facts of each case and do not create an automatic right in favour of surviving partners in every situation.
Khushi Lal Khemgar Shah v. Khorshed Banu Dadiba Boatwala (1970)
In this case, the Supreme Court observed that an agreement allowing surviving partners to continue using the firm name, reputation, and place of business does not necessarily mean that the heirs of a deceased partner lose their right to claim a share in the goodwill.
The case highlighted that goodwill rights depend upon the agreement and intention of the partners. Mere continuation of business does not always exclude other lawful claims over goodwill.
Sale Of Goodwill After Dissolution: Rights Of Buyer And Seller
When goodwill of a firm is sold after dissolution, Section 55 provides certain rights and restrictions for both the buyer and the seller.
A partner who sells the goodwill has certain freedom to start a competing business. However, certain limitations apply to protect the interest of the buyer who has purchased the goodwill.
Rights Of Seller Of Goodwill
After selling the goodwill, a former partner has the right to:
- Carry on a business similar to the business of the dissolved firm.
- Advertise the new business.
- Use personal skills and experience gained during partnership.
The sale of goodwill does not completely prevent a former partner from engaging in a similar trade or profession.
However, unless there is an agreement allowing such actions, the former partner cannot:
- Use the old firm name.
- Represent that the old firm’s business is being continued by him.
- Approach or solicit customers who were dealing with the dissolved firm before dissolution.
These restrictions protect the buyer because the buyer has paid for acquiring the commercial advantage associated with the goodwill.
Rights Of Buyer Of Goodwill
The buyer of goodwill acquires the benefit associated with the reputation and customer base of the firm.
The buyer has the right to prevent the seller from misleading customers by creating an impression that the old firm is still being operated by the former partner.
The buyer can object when the seller:
- Uses the old business name.
- Claims to represent the original firm.
- Attempts to attract existing customers of the dissolved firm by exploiting the goodwill purchased by the buyer.
These protections ensure that the value of purchased goodwill is not reduced by the actions of former partners.
Agreement In Restraint Of Trade Under Section 55(2)
Section 55(2) allows partners to enter into an agreement with the buyer of goodwill that they will not carry on a similar business after the sale of goodwill.
Normally, agreements restricting a person from carrying on a lawful profession, trade, or business are considered void under Section 27 of the Indian Contract Act, 1872.
However, Section 55 creates an exception for agreements made during the sale of goodwill.
Such agreements are valid if:
- The restriction is reasonable.
- The restriction relates to a specified period.
- The restriction applies within specified local limits.
Therefore, a partner selling goodwill can legally agree not to compete with the buyer for a reasonable period or within a reasonable geographical area.
Conditions For Valid Restraint Agreement Under Section 55
For an agreement restricting competition after sale of goodwill to be valid, the following conditions must be satisfied:
Sale Of Goodwill Must Take Place
The agreement must arise in connection with the sale of goodwill of the firm. A general agreement preventing competition without any sale of goodwill will not receive protection under this section.
Restriction Must Be Reasonable
The restriction cannot be unlimited or excessive. Courts examine whether the restriction is fair considering the nature of business and circumstances of the parties.
Period And Area Must Be Specified
The agreement should clearly mention:
- The duration for which the restriction will operate.
- The geographical area where the restriction applies.
An unreasonable restriction affecting a person’s livelihood may not be enforced.
Conclusion
Section 55 of the Indian Partnership Act, 1932 provides a complete framework for dealing with goodwill after dissolution of a partnership firm. It recognises goodwill as an important asset, provides rules for its sale, and defines the rights of buyers and sellers. While former partners retain the right to conduct business, reasonable restrictions protect the purchaser of goodwill. The provision ensures fairness in the settlement of partnership accounts and balances commercial freedom with protection of business reputation.
Attention all law students and lawyers!
Are you tired of missing out on internship, job opportunities and law notes?
Well, fear no more! With 2+ lakhs students already on board, you don't want to be left behind. Be a part of the biggest legal community around!
Join our WhatsApp Groups (Click Here) and Telegram Channel (Click Here) and get instant notifications.
