Q.All partners wish to dissolve the firm. Yastin, a partner wants that her loan of Rs. 2,00,000 must be paid off before the payment of capitals to the partners. But, Amart, another partner wants that the capitals must be paid before the payment of Yastin's loan. You are required to settle the conflict giving reasons.
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Start your 14-day free trial to unlock the full solution →Yastin’s loan must be paid before partners’ capitals because, under the Partnership Act, a partner’s loan ranks as an outside liability (higher priority), while capital is a partner’s own claim (subordinate to all external debts and loans from partners).
The Concept: Priority of Claims on Dissolution
When a partnership firm is dissolved, the order in which claims are paid is not a matter of personal preference — it is strictly governed by Section 48 of the Indian Partnership Act, 1932. This section lays down a clear waterfall of payments:
- External debts (to third parties, including banks, trade creditors, etc.)
- Loans from partners (money lent by a partner to the firm, separate from capital)
- Capitals of partners (the amounts each partner contributed as capital)
- Any surplus is divided among partners in their profit-sharing ratio.
The logic is simple: a partner who has lent money to the firm is treated as a creditor of the firm for that loan. The partner’s own capital is a residual claim — it comes only after all outside debts and all partner loans are fully satisfied. This distinction exists because capital is the partner’s ownership stake, while a loan is a debt owed by the firm to the partner.
Why Yastin Is Correct
Yastin’s loan of ₹2,00,000 is a loan from a partner. Under Section 48, it ranks immediately after external debts but before the repayment of partners’ capitals. Amart’s demand — that capitals be paid first — would violate the statutory priority. If capitals were paid before Yastin’s loan, and the firm had insufficient assets, Yastin would be left unpaid despite being a creditor. That would be legally incorrect.
A common mistake is to treat all money a partner has in the firm as “capital.” A partner’s loan is a separate liability — it is not part of the capital account. On dissolution, the loan account is settled before any capital account is touched.
The Correct Order of Payment
Assuming the firm has enough assets to pay all external debts first, the sequence is:
- Pay all external liabilities (trade creditors, bank loans, etc.)
- Pay Yastin’s loan of ₹2,00,000
- Pay partners’ capitals (including Amart’s capital)
- Distribute any remaining surplus in the profit-sharing ratio …
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