Sale Of Goodwill After Dissolution Of A Partnership Firm - Author - Vanshaja Shukla

Vanshaja Shukla - IIIrd year student at National Law Instituteuniversity,Bhopal


I

Section 55 of The Indian Partnership Act, 1932 :
Sale of Goodwill after dissolution.- (1) In settling the accounts of a firm after dissolution , the goodwill shall, subject to contract between the partners, be included in the assets , and it may be sold either separately or along with other property of the firm.

Rights of buyer and seller of goodwill.- (2) Where the goodwill of a firm is sold after dissolution , a partner may carry on business competing with that of the buyer and he may advertise such business, but, subject to agreement between him and the buyer., he may not,-
(a) use the firm name,
(b) present himself as carrying on the business of the firm, or
(c) solicit the custom of persons who were dealing with the firm before its dissolution.

Agreements in restraint of trade-(3) Any partner may, upon the sale of the goodwill of a firm , make an agreement with the buyer that such partner will not carry on any business similar to that of the firm within a specified local limits and notwithstanding anything contained in Section 27 of the Indian Contract Act , 1872 ,such agreement shall be valid if the restrictions imposed are reasonable.

Introduction
Dissolution of a firm implies dissolution of the partnership between all partners of a firm. It may be by agreement, compulsory, due to contingency, by will and by the court. The settlement of accounts at this point of time is mentioned in Section 48 and basically provides for payment of debts and payments to partners. Now, the special provision for Goodwill is Section 55 which deals with the mode of dealing with goodwill at the time of dissolution. A close connection of this section exists with Section 53 and Section 54 both of which speak of restraint of trade. In this article, I have attempted to study Section 55 and have discussed its essentials and select relevant case law.

What is Goodwill?
The first issue towards approaching this section is the definition of goodwill.
'The goodwill which has been the subject of sale is nothing more than the probability that the old customer will resort to the old place.' The definition cited above is of course the very simplistic and rather lay men meaning of what goodwill results in.
It has been more elaborately defined in Trego v. Hunt by Lord Macnaughten as:
' often it happens that goodwill is the very sap and life of the business , without which the business would yield little or no profits . It is the whole advantage whatever it may be , of the reputation and connection of the firm , which may have been built up by years of honest work or gained by lavish expenditure of money.'

Goodwill is essentially an intangible asset of a firm accruing to it by the good conduct and business performance. Therefore it can effectively be defined as the benefits arising from connection and reputation of the business and is primarily an asset. It is intangible and rather difficult to identify per se. Its is also difficult to specify when the goodwill takes existence and no business which commences possesses goodwill from the start. It is generated as the business is carried on and may be augmented with the passage of time.

It has been held in the case of CIT v. B.C. Srinivasa Setty that the goodwill is affected by everything relating to the business , the personality of the owners, the nature and character of the business , its name and reputation , its location , its impact on the contemporary market and on the prevailing socio-economic ecology.

Lord Eldon's observation in the case of Churton v. Douglas is a very important aspect of the meaning of goodwill, 'goodwill must mean every advantage -every positive advantage , If I may so express it as contrasted with negative advantage of the later partner not carrying on the business himself - that has been acquired by the old firm in carrying on its business , whether connected with the premises in which the business was previously carried on, or with the late firm , or with any other matter carrying with it the benefit of business.'

It is the public approbation which has been won by the business , and that is considered as a marketable thing ; it is the probability of the customers or clientele of the firm resorting to the person or persons who succeed to the business as a going concern. 'Approbation ' was one of the original meaning of goodwill before it was used as commercial slang.

Now, at the time of dissolution, the goodwill may be sold separately or along with the other assets. If there is dissolution of a partnership with a condition that the assets fall to a particular partner and no mention of goodwill is made, it is assumed that the goodwill also falls to the partner getting the other assets. It is therefore quite clear that goodwill is an integral part of the assets. At this time goodwill might infact be the most important and valuable asset. Also if there is no express or implied agreement to the effect then the goodwill may be sold as an asset on insistence of a partner. It must be noted that earlier neither the Contract Act nor the Partnership Act had any specific provision on goodwill and it has been only a recent development to include the section on goodwill as part of partnership act. The question whether the firm has goodwill or not is a question of fact.

The name of a firm which is included in the goodwill may be excluded from the sale where use of that name is likely , to expose continuing partners , who carry on business , to liability. Goodwill of the business sold -- seller of goodwill may set up rival business but if he tries to attract customs of old firms he can be restrained by an injunction from doing so, where a person is taken on the condition that the goodwill shall bring to other partner on termination of the partnership above principles applies. Also if there exists a deed of modification to separate business , it cannot be considered a deed of dissolution and thus will not attract Section 55 of the Indian Partnership Act.

In Laxmidas v. Nanabhai , the question was regarding maintainability of a suit and counter claims.
The essential reading regarding Section 55 was laid down as ' Goodwill is a part of the assets of a firm. The prima facie rule is that the goodwill of the firm being a part of that assets has to be sold just like other assets before the account between the partners can be settled and partnership wound up.' But no particular reference to goodwill which is only one of the several assets of a firm in a plaint for taking accounts of a dissolved partnership is required. Similarly the existence of goodwill is an asset of the firm , which has to be sold and the proceeds divided between the partners in the account taking is no bar to the conversion of a counter claim into a plaint in a cross suit is not easy to comprehend.

What is therefore seen is that goodwill like any other asset can be sold at the time of dissolution.
The most relevant judgement on this section has been the case of Khushal Khemgar Shah & others v. m/s Khorshed Banu Dadibar.

The facts of the case read as follows, Dadiba Boatwalla was one of the eight partners of m/s Meghji Thoban & co. Boatwalla died and by virtue of clause 8 of the deed of partnership , the business of the firm was continued by surviving partners.
Now , his widow and son obtained the letter of administration and commenced an action in the High Court.

This was resisted by the surviving partners and the High Court held that the plaintiff (widow and son) were not entitled to an account of profits and losses after the death of Boatwalla. However the court held that the plaintiff was entitled to 6% interest per annum on Boatwalla's share including the goodwill.

In return the defendants appealed again, contending that the plaintiffs as a legal representatives were not entitled to a share in the goodwill. The reason being that the goodwill may be taken into account only when there is dissolution of the firm and in any event because Boatwalla had already agreed the interest on goodwill would cease on his death and the business would be continued by the surviving partners. The Supreme Court through Justice Shah, opined that"

'Section 55 does not allow the interpretation, that, goodwill may be taken into account only when there is a general dissolution of the firm, and not when the representatives of the partner claim their share in the firm , which by express stipulate is to continue notwithstanding death of a partner. The provision deals with the concept and consequences of dissolution of the firm. The Act does not operate to extinguish the right in the assets of the firm of a partner who dies , when the partnership agreement provides that on his death, the partnership continues.'

The court also laid down the guidelines of interpretation of the deed of partnership.

'The court must insist upon some indication that the right to a share in the assets is by virtue of an agreement; that the surviving partners are entitled to carry on business on the death of the partner to be extinguished. In the absence of a provision expressly made or clearly implied , the normal rule that the share of a partner in the assets devolves upon his legal representatives will apply to the goodwill as to other assets.'

In Dulaldas Mullick & others v. Ganesh Das Damani and others , the plaintiff was carrying on business as a paint and varnish dealer in a shop room, paying rent under the name of D Mullick & Co. He was indebted to one Gopal Lal Daga , who instituted a suit and got a decree in his favour. Execution proceedings started and the stock in trade, goodwill and furniture was sold to one Damani who took possession of the room . The basic point was whether goodwill includes right of a plaintiff as a tenant.' there can be no hard and fast rule ; no simple formula and no inflexible and rigid definitions of the term goodwill, but in each case it is necessary to see the entire nexus of facts connected with the business whose goodwill is to be determined. The bench cited Commr. Of Inland Revenue v. Muller & Co. Margarine Ltd. with respect to the meaning of the word goodwill. Lord Lindley said ' I understand the word to include whatever adds value to a business by reason of situation , name and reputation, connection .goodwill is inseparable from the business to which it adds value and in my opinion exists where the business is carried on'.

Finally the bench reached the conclusion that tenancy rights were included in goodwill. Therefore the position which emerges is goodwill is essentially a form of an asset and is treated in the same way as an ordinary asset.

Rights and Duties of Partners: at the time of sale of goodwill
At the time of dissolution all partners have the right to sell the goodwill of the firm for the common benefit of the partners. This does not restrict the right merely to general dissolution. The legal representatives of the deceased partner are also entitled to a share in the goodwill of the partnership which is continued after the death of the partner.

Goodwill is essentially an estimation by the customers and protecting goodwill means protecting the custom of the firm. The seller may continue to trade in the same field, can offer competition in every lawful manner, advertise to the general public and follow other commercial tactics. He may offer better and cheaper services , if he can so afford , and divert the flow of customers to his new place , but not, by a personalized approach or solicitation. This is necessary to ensure freedom of trade to every individual.

However if the seller of the goodwill represents to the customer that he is the same person carrying on the old business, it would destroy the buyer's purchase of goodwill. Therefore certain restrictions are required to be imposed on the seller and buyer of goodwill. This section essentially speaks of such restrictions and the boundary within which both parties have to function. Though restrictions are to be imposed, it must also be noted that common law normally does not provide for restrictions on trade . Therefore a level of balance has to be maintained.

Sub section 2 of Section 55 provides that though the seller may continue the business as he pleases, he may however not ,
# Use the firm name,
#Cannot represent to the people that he is carrying on the old business.
# He cannot solicit the custom of persons who were dealing with the firm before its dissolution.
# He cannot approach customers with the intention of diverting them to his business, but 'is at liberty to deal with them if they come to him of their own accord'.
Even the representatives of a deceased partner cannot do such solicitation.

An appropriate example at this stage can be the case of Churton v. Doughlas where a partnership business was being carried on by three persons. One of them J.D retired and the other partners continued the business under the name of 'Late J.D. & Co.' ,instead of the previous name 'J.D. & Co.'. They also resumed business in premises adjoining the old premise and distributed a circular to the customers to this effect. Towards such action, the court decided that. 'though the remaining partners had a right to establish a rival business, but they had no right to use the same name or to solicit the customers of the old firm.'

The case also held that the restriction laid down in this 'section applies not only to the use of the firm name but also use of any other name, so similar to the firm name as to lead the public to believe that they are dealing with the old firm.'

The person may be allowed to use the firm name if that happens to be his own name , though he may be restricted from using his name dishonestly. He can be restrained if it is established that the similarity of the to be assigned trade name is such as its use would be, under the particular circumstances a derogation from the grant.

Subsection 3 deals with agreement in restraint of trade and lays down that any partner may, upon sale of goodwill of a firm, make an agreement with the buyer that such partner will not carry on any business similar to that of the firm within a specified period or within a specified local limit, and not withstanding anything contained in Section 27 of the Indian Contract Act 1872., such agreement shall be valid if the restrictions imposed are reasonable.

Therefore the essential components of the section are as follows:
The seller may make an agreement with the buyer of not carrying on business :
# Similar to the firms
# Within a specified period
# Within the specified local limits, if the restrictions imposed are reasonable.
The parties provide for restrictions in the agreement. In order to maintain the value of the goodwill it is usual for the buyer to require the seller to enter into an agreement restricting his right of competition. Sub-section 3 legitimizes this. The object of the agreement is to enable the buyer of goodwill to have time to establish himself and attach to himself the custom he has bought and make it his very own. Accordingly the restriction cannot be absolute and thus the section provides that the
# It should specify the period of local limits of the restraint.
#The restriction must be reasonable.

The reasonableness of the restriction depends on the nature of the business. Where a partner of the firm manufacturing and selling bakelite goods, sold the business to the other partner and agreed not to carry on a similar business for three years within the city of Bombay , the restriction was held reasonable in the case of Krishnarao v. Shankar . Also where the agreement for dissolving a firm of insurance agents, in which an outgoing partner was restrained from carrying on insurance business anywhere except Karachi , the restriction was regarded as unreasonable because though 'it was unlimited and worldwide, permission was within very narrow limits.'

In Hukmi Chand v. Jaipur Ice & Oil Mills Co. most elaborate observations have been made on this aspect of the issue. There was a partnership composed of six partners. Two partners left the firm and the remaining continued the business upto March 31, 1958, the date on which it dissolved. Firm had a factory and a residential house. On the day of dissolution one partner Kalicharan retired and was paid his of assets and Rs. 11001 as goodwill share. At the time of dissolution , it was agreed between Kalicharan and the others like Kishanlal, Mahadeo Prasad, Satya Narayan that the land premise and the house could be the exclusive property of Kalicharan with full rights of sale and mortgage and that Kalicharan could get a boundary wall constituted or have a wire fencing and open a separate door towards the road side , but there could be no entry or exit towards the factory compound. It was also decided that Kalicharan could not carry the same kind of business on the Land.

Now, Kalicharan sold his share to his father for a consideration, by a registered sale deed. Later, Kalicharan's father, wife and son (Hukum Chand-major son, Rajgopal- minor son) entered into a partnership to carry on the business on the land. The company filed a suit through Mahadeo Prasad and asked for a permanent injunction.

The Trial Court adjudged in favour of the Company. The High Court made a reference to Section 27 , of the Indian Contract Act and Section 32, 54 and 55 of the Indian Partnership Act.

Some important observations from this landmark case are discussed below:
'The onus to prove that the condition imposed on an agreement in restraint of trade is reasonable is on the party which pleads that they are reasonable'.

It was said that there was nothing indefinite about the covenant because it appears to be reasonable to safeguard the interest of the buyer of the goodwill. Also it cannot be said that there is no time limit. The moment the purchaser ceases to carry on such business the inherent time limit ends.

The case of Shaikh Kalu v. Ram Saran Bhagat was cited stating
' whether the limits prescribed in the contract are reasonable or not depends upon the kind of business to protect which the contract is made and the reasonableness of the restraint imposed must be ascertained by reference to nature of business and situation of parties.'
A restraint can only be reasonable when:
# Its in the interest of the restraining parties
# Its in the interest of public.

In the same case Lord Macnaughten said that:
'it is not right to profess and to purport to sell that which you do not mean the purchaser to have , it is not an honest thing to pocket the price and then to recapture the subject of sale , to decoy it away or call it back before the purchaser had had time to attract it to himself and make it his very own.'

The bench also relied on the Restatement of the Law of Contract of the American Law Institute (1932 Edn. Vol II), while mentioning the situations under which trade may be considered unreasonable:
The observation was that a restraint on trade is unreasonable if it :
# Is greater than required for the protection of person for whose benefit the restraint is imposed.
# Imposes undue hardships.
# Tends to create a monopoly or controls prices artificially or unreasonably results in the alienation or use of anything.
# Is based on a promise to refrain or is not ancillary to any issue.

The case dealt at length with the issue of restraint on trade and the contractual principles attached. They applied the rule from Tulk v. Moxhay in reaching the conclusion that the,
'benefit of a negative restricted covenant with regard to the contracts concerning land may be assigned and so third parties may acquire such rights under a contract to which they are not privy. If a person acquires interest in the land from another , either by purchase , lease etc, or at the time of dissolution upon a term which binds him to observe certain covenants, the assignee will take the rights and obligations and will be bound by it.'

Where restraint affecting the commercial use of and is accepted by one who enjoyed his interest in the land before making of the arrangement under which the restraint was imposed it is clearly established that the doctrine of restraint of trade applies to the same extent as it otherwise would.

The bench finally concluded that while signing the agreement Kalicharan was aware of the restraint and therefore was expected to act according to it. Moreover, since the parties involved in the present case happen to be Kalicharan's closes family members they were also expected to know such details.

Conclusion
Despite availability of very scarce case law on the issue it can still be concluded, that the position on Section 55 is well settled and that goodwill is a saleable asset at the time of dissolution and renders certain obligations on part of both the buyer and the seller. The restraint under this section is similar to the one under Section 27 of the Indian Contract Act. The situation tackled by this section, is essentially one that falls within the exceptions of section 27. The said provision reads: 'One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein; provided that such limits appear to the court reasonable, regard being had to the nature of the business.' A litigation under this section would essentially involve, determination of goodwill and thereafter the duties connected and to ensue that they are in 'consonance with the common understanding of mankind and the rudiments of commercial morality.' The underlying principle of this section is benefit of the buyer of goodwill which here is assured by a relative restraint on trade by the seller.

Source:http://www.legalserviceindia.com/articles/saleog.htm