Sharing of capital deficiency by the partners

[This article distinguishes on General rule and Garner v Murray rule, in sharing of deficiency of capital on account of insolvency of the partner(s)]

Capital deficiency means that one or more partner has a debit balance in his/their capital account at the point of final cash distribution.  The capital deficiency may arise from liquidation losses, excessive withdrawals before liquidation or recurring losses in prior periods. A partner with a capital deficiency must cover the deficit by paying cash into partnership. When a partner is not in a position to pay deficiency of capital due to insolvency, the remaining partners with credit balances shall absorb such partner’s debt according to their income and loss sharing ratio. This is called the capital loss of the individual partners due to the default of other partners.

However, there is no uniform opinion on whether to apply the losses on account of capital deficiency of a partner who is insolvent, as an ordinary trading loss to the firm, or it should be treated as a loss to the remaining partners individually and not to the firm. Prior to the decision in the  famous Garner v/s Murray case,  it was the general rule practiced by the partnership firms that any whenever capital deficiency arise due to default of  one of the partners, such loss is treated as ordinary business loss and the remaining partners used to bear the loss in the proportions in which they shared profits and losses of a firm.

But in the case Garner v Murray (1904), it was held by the court that the loss on account of capital deficiency of an insolvent partner is a CAPITAL loss to the solvent partners and it is not a business loss to the firm. Hence, the solvent partners were asked to bear the loss at the ratio of their capitals standing (not at the rate of income and loss sharing) in the balance sheet on the date of dissolution of the firm. The above ruling of the court is popularly known as Garner v Murray rule across the globe.

In India, many people think that the ruling of Garner v/s Murray case may not be applicable in India. But in the absence of any concrete court ruling in India clarifying the position  in above situation or anything in Indian Partnership Act that goes against the rule laid down in the above case, many partnership agreements include a  clause that Garner v/s Murray rule is not applicable to their partnership business and all the solvent partners are agreeable to make the necessary contribution to the partnership  in case of the deficit balance on their capital accounts at the end of the dissolution of a partnership which will be according to their income and loss sharing ratio.

Related articles

  1. Legal rights of minor as a partner
  2. Active, Sleeping partner & partners of different types
  3. Different Partnership models in business
  4. Legal aspects of partnership business

 

Surendra Naik

Share
Published by
Surendra Naik

Recent Posts

Reporting of Foreign Exchange Transactions to Trade Repository

The Reserve Bank of India is expanding reporting requirements for foreign exchange transactions. Starting February…

15 hours ago

Bank Holidays 2025: State of Kerala

“Under the explanation to Section 25 of the Negotiable Instruments Act, 1881 (Central Act 26…

18 hours ago

Meaning of a Trial Balance, Features and Purpose of a Trial Balance

A trial balance is a bookkeeping tool that lists all the balances in a business's…

20 hours ago

Causes for Passbook and Cashbook being different

The balance of a cash book and a passbook can differ for several reasons, including:…

2 days ago

Understanding Reconciliation

Reconciliation is an accounting procedure that compares two sets of records to check that the…

2 days ago

How to Adjust the Cash Book balance, and reconciliation Advantages

The adjusted cash balance is calculated by taking the ending cash balance from the bank…

2 days ago