Default Loss Guarantee Guidelines in Digital Lending – A step in the right direction

By Bhargav Mitra, on June 27, 2023

POSTED IN Fintech/Corporate and Commercial,

Section 25 of the Indian Partnership Act, 1932 (the “Act”) lays down the liability of partners for acts of their partnership firm. The aforesaid section expressly states that every partner is liable, jointly, and severally, with all the other partners, for all acts of the firm done while they are partners. Notably, Section 25 does not distinguish between a continuing partner and an erstwhile partner. The principle, also upheld in jurisprudence, is clear and specific – every partner is liable for all the acts of the firm done while he is a partner, jointly along with other partners, and also severally.i

In case of retirement of partners, Section 32 of the Act lays down that until public notice is issued for their retirement in terms of subsection (3), they shall continue to be liable as partners for the acts of the firm, unless there is an agreement to the contrary as laid down in subsection (2).

Illustrating the aforesaid principle, Lindley & Bank on Partnership (Sixteenth Edition) (at page 358), state as follows (quoted with approval in Syndicate Bank Versus R.S.R. Engineering Works & Orsii):-

“It is perhaps self evident that a creditor’s rights will not normally be prejudiced by an agreement transferring an accrued liability from one partner to another unless the creditor is made a party to the agreement or assents to its operation. Otherwise the agreement will, as regards him, be strictly res inter alios acta. Lord Lindley illustrated this proposition for the following example:

–let it be supposed that a firm of three members, A, B, and C, is indebted to D; that A retires, and B and C either alone, or together with a new partner, E, take upon themselves the liabilities of the old firm. D’s right to obtain payment form A, B, and C is not affected by the by arrangement, and A does not cease to be liable to him for the debt in question. But if, after A’s retirement, D accepts as his sole debtors B and

C, or B, C, and E (if E enters the firm), then A’s liability will have ceased, and D must look for payment to B and C, or to B, C and E, as the case may be.”

In cases of dissolution of a partnership, Section 45 of the Act follows the same principle laid down in case of retirement. Consequently, partners are liable for the actions of the firm until a public notice is given in terms of Section 45(1) of the Act. In a case for prosecution under the Bombay Sales Tax Act, 1959, the Supreme Court observed that Section 19(3) of the Bombay Sales Tax Act, 1959 envisages the assessment of a dissolved firm by providing that the erstwhile partners of a dissolved firm shall be liable jointly and severally to pay the tax and penalty due from the firm whether the tax, including any penalty, has been assessed before or after the dissolution. The assessment which the sub-section speaks of is assessment of the firm because if the assessment were to be made on the partners themselves, it would have been unnecessary to provide that they shall be liable jointly and severally to pay the tax levied on them. The joint and several liability of the partners in respect of taxes which the firm is liable to pay is provided under Section 18 of the Bombay Sales Tax Act, 1959. The purpose of Section 19(3) is to foist joint and several liability on the partners even if the firm is assessed to pay sales tax after its dissolution. Section 19(3) would otherwise be otiose1.iii Similarly, Section 15 of The Karnataka Sales Tax Act, 1957 dealing with tax liability on transfer of business,

1 Section 19(3) of the Bombay Sales Tax Act, 1959 :- Where a dealer, liable to pay tax under this Act, is a firm, and the firm is dissolved, then every person who was a partner shall be jointly and severally liable to pay to the extent to which he is liable under section 18, the tax 8[(including any penalty and interest)] due from the firm under this Act or under earlier law up to the time of dissolution, whether such tax 8[(including any penalty and interest)] has been assessed before such dissolution but has remained unpaid, or is assessed” after dissolution.

postulates in sub-section (2)2, that when a firm is liable to pay any tax or penalty or any other amount under the aforesaid legislation, the firm and each of the partners of the firm shall be jointly and severally liable for such payment.

Section 188A of the Income Tax Act, 19613, also declares a partner and his legal representatives as jointly and severally liable to pay any tax, penalty or sum payable for the year in which he was a partner. Section 188 A explicitly provides what was implicit hitherto.iv

In conclusion, it is clear that mere retirement of a partner or dissolution of the firm does not absolve partners of their liability and due process is to be followed to that effect.

i (1996)9SCC 33 (Income Tax Officer (III), Circle – I, Salem & Anr Versus Arunagiri Chettiar)
ii (2003)6SC C 265 (Syndicate Bank Versus R.S.R. Engineering Works & Ors)
iii (1975)2SCC736 (Murailal Mahabir Prasad & Ors Versus Shri B.R. Vad & Ors)
iv AIR 1966 SC 2160 (Third Income Tax Officer Versus Arunagiri Chettiar)

2 Section 15(2) of the Karnataka Sales Tax Act, 1957 :- When a firm liable to pay the tax, or penalty is dissolved, the assessment of the tax and imposition of penalty shall be made as if no dissolution of the firm had taken place, and every person who was at the time of dissolution a partner of the firm and the legal representative of any such person who is deceased, shall be jointly and severally liable to pay the tax or penalty assessed or imposed. (2A) Where any firm is liable to pay any tax or penalty or any other amount under this Act, the firm and each of the partners of the firm shall be jointly and severally liable for such payment. (2B) Where a partner of a firm liable to pay any tax or penalty or any other amount under this Act retires, he shall, notwithstanding any contract to the contrary, be liable to pay any tax or penalty or any other amount remaining unpaid at the time of his retirement and any tax or penalty or any other amount due upto the date of retirement, though unassessed.

3 Section 188A of The Income Tax Act, 1961:- Joint and several liability of partners for tax payable by firm.—Every person who was, during the previous year, a partner of a firm, and the legal representative of any such person who is deceased, shall be jointly and severally liable along with the firm for the amount of tax, penalty or other sum payable by the firm for the assessment year to which such previous year is relevant, and all the provisions of this Act, so far as may be, shall apply to the assessment of such tax or imposition or levy of such penalty or other sum.