When a partner is unable to contribute towards the deficiency of his capital account he is said to be insolvent and the loss arising out of his insolvency is called ‘capital loss.’ In the absence of any contract to the contrary, such a capital loss is to be borne by other solvent partners in accordance with the principle laid down in Garner vs. Murray? In that case it was held that the solvent partners have to bear the loss arising from insolvency of a partner in their capital ratio.
Capital ratio explained. Partners are free to have fixed or fluctuating capital in the firm. If they are maintaining capitals at fixed amounts then all adjustments regarding their share of profits, interest on capitals, drawings, interest on drawings, salary, etc., are done through Current Account, which may have debit or credit balance and insolvency loss is distributed in the ratio of fixed capitals.
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ADVERTISEMENTS:
But if capitals are not fixed and all transactions relating to drawings, profits, interest, etc., are passed through Capital Accounts then Balance Sheet of the business shall not exhibit Current Accounts of the partners and capital ratio will be determined after adjusting all the reserves and accumulated profits to the date of dissolution, all drawings to the date of dissolution, all interest on capital and drawing to the date of dissolution but before adjusting profit or loss on Realisation Account.
If some partner is having a debit balance on his Capital Account and is not insolvent then he cannot be called upon to bear loss on account of the insolvency of other partner.