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.
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