Three Friends Choosing a Legal Form for Their Coaching and Stationery Shop

Test each form against the friends' four constraints: ₹8 lakh of capital, low cost, a three-month deadline, and the fear of unlimited liability.

• Sole proprietorship - ruled out by definition: three persons cannot own one proprietorship, and liability would be unlimited.
• Partnership firm - cheapest and fastest; a deed can be drafted in days and registration is optional (though desirable). Its weakness is that every partner is jointly and severally liable for the firm's debts, and internal shares do not bind outsiders such as the landlord.
• Cooperative society - needs at least ten members and registration under the Cooperative Societies Act; decision-making is slower and the fit is poor for a three-person shop.
• Joint stock company - limited liability and a separate legal entity, but incorporation, statutory audit, annual returns and professional fees, and those compliance costs repeat every year.

Recommendation: a partnership firm with a written deed. The decisive reasoning is that Sarita's father's risk is already capped by the nature of his money: a lender can lose only the ₹1,00,000 lent, whether the firm is a partnership or a company. A company would protect Rehan, but a recurring audit and filing burden on an ₹8 lakh business with thin margins is not worth it in year one. Record in the deed that conversion to a private company will be reviewed once turnover crosses about ₹40,00,000.

Clauses the deed must contain:

1. Name and nature of the business and the place of business.
2. Capital contributed by each partner - Ankit ₹4,00,000, Sarita ₹2,50,000, Rehan ₹50,000.
3. Profit-sharing ratio; suggest 4 : 2.5 : 0.5 on capital, with an extra share or a fixed monthly salary for Rehan, who works full time.
4. Interest on capital and on loans advanced by partners.
5. Limit on drawings and on the amount each partner may spend without the others' consent.
6. Who may sign cheques and contracts, and up to what value.
7. Admission, retirement and death of a partner, and valuation of goodwill.
8. Dispute settlement and the method of dissolution.

Documenting the ₹1,00,000: treat it as a loan, not capital. Use a written loan agreement stating the amount, a fixed rate of interest (say 10 per cent), the repayment schedule and security, and issue a receipt. Crucially, Sarita's father must not be given a share of profits or any management right. Under the Indian Partnership Act, receipt of a share of profits is prima facie evidence of partnership, so a fixed interest payment plus a written loan agreement is what keeps him a creditor. He should also not sign cheques or appear before suppliers as an owner.

Liability: as a partner, Rehan is jointly and severally liable for debts incurred by the firm. The landlord is an outsider and is not bound by any internal ratio in the deed; he can sue Rehan alone for the entire rent due and recover it from him. Rehan could then claim the co-partners' shares under the deed, but that right is worth only as much as their solvency. Signing the lease in his own name makes the position worse, because he also becomes personally liable as a direct contracting party, independently of partnership law. His fear is therefore legally correct, not imaginary.

Two ways to reduce exposure:

1. Take the premises in the firm's name, with the deed expressly authorising him to sign for and on behalf of the firm, and have all three partners sign as partners and not merely as witnesses.
2. Reduce the size of the commitment - negotiate an eleven-month lease or a short lock-in with a notice period instead of a multi-year term, and keep one or two months' rent as a security deposit already paid, so that any dispute is limited to a few months' rent.

An internal indemnity clause in the deed is useful between the partners but does not protect Rehan against the landlord.