Who assumes responsibility if the proprietor of a Sole Proprietorship passes away without resolving their debts?

A.?? Introduction

A sole proprietor is a person who owns a business single-handedly or by itself. Being the sole owner can, on the one hand, make it easier to operate as the owner is the sole decision maker of the business and on the other hand, it is the only risk bearer and thereby any liability arising out of it will be construed as his liability.??

Generally, in a sole proprietorship, a proprietor can sue and can be sued in the name of the business, along with it they have the right to own property. Moreover, the issue arises when the position of the sole proprietorship is concerned after the death of the sole proprietor. The issues regarding the setting of the liabilities of the deceased owner by his legal representatives.

B.??? Legal status of sole proprietorship post owner's demise

?Under Indian law, a sole proprietorship does not have a perpetual succession, meaning that the business will immediately come to an end, the moment the sole proprietor dies or become insolvent. In S.A. Enterprise. v. General Manager, Eastern Railways and Ors[1], the Calcutta High Court has held that a “sole proprietor does not have perpetual succession and thereby, in that case, it was considered that the petitioner could not claim to be the sole proprietor of the firm upon the death of the mother”.

?Moreover, as per S.306 of the Indian Succession Act of 1925, after the death of the sole proprietor, his/her legal heirs do not automatically start to inherit the old business, but they only get to inherit the assets. There are two cases in this:?

1.???? Deceased proprietor has made a will: In this case, the will has to be followed by the executor/administrator and accordingly deal with assets and debts.

2.???? Deceased proprietor has not made a will: In this case, the assets could be sold to a family member as per the beneficiary's or administrator's decision. If a beneficiary purchases the business, they have the option to either continue operating it under their ownership, sell it to another family member, appoint someone else to manage it, or even bring in a partner to run the business.

In the case of any debts in the business, the executor/administrator will have to liquidate all assets of the business and settle the outstanding debt. As far as the effect of the death of the sole proprietor is concerned, then the business cannot be continued further, either it has to be wound up completely or transferred to another person or should be dissolved as per the written will of the deceased.

In Commissioner of C. Ex., Chandigarh v. Shree Ambica Steel Industries,[2] after Bimla Rani, the proprietor of M/s. Shree Ambica Steel Industries passed away, and her legal heir requested the cancellation of the firm's Excise registration, which was granted by the Department in October 2006. The court ruled that since a sole proprietorship does not have a separate legal identity from its owner, the firm ceased to exist after her death. Therefore, any notice issued against the firm was deemed invalid as it pertained to a non-existent entity. This led to the dismissal of the appeal filed by the Department.

Henceforth, under Indian law, the legal heirs of the deceased have the option to wind up the business after filing GST and Tax u/s 29(1) and S.93(1)(b) of CGST Act, 2017.

C.?? The obligations of legal heirs following the passing of a sole proprietor

It is a general practice that for recovery of loans and debts of the deceased person, his/her legal heirs are approached first. It becomes necessary to understand to what extent the legal heirs will be obligated to settle such debts. Moreover, it becomes a complex matter which is governed by S.50 CPC 1908. While, the CPC allows decree holders to execute judgments against the assets of the deceased, but also safeguarding the legal representatives by restricting their liability to the extent of the deceased's estate.

This position has recently been clarified by the Supreme Court in its ruling on Vinayak Dube v. Jayashree Padamkar Bhat & Or.[3] Here, Nagarathna J. has clarified that, legal heirs are obligated to fulfil monetary responsibilities stemming from the deceased's estate, but they are not personally liable for obligations that are related to the unique skills or expertise of the deceased.

Moreover, the court has emphasized S.306 of ISA 1925 which dealt with the transfer of rights and obligations following an individual death. The court has acknowledged the maxim of “actio personalis moritur cum persona”, which extinguishes personal rights of action upon an individual’s death. This brings the court to the conclusion of whether the deceased’s obligations could be transferred to the legal representatives.

Further court has also examined the legal representative’s liability from the tapestry of S.37 & 40 of the Indian Contract Act 1872. These provisions specifically emphasise that the legal representatives are only bound to the contracts of their predecessors to the extent of the inherited estate, but are not personally liable for the deceased’s contractual obligations, particularly those arising from their specific skills or expertise and for this court has relied on Raghu Lakshminarayanan v. Fine Tubes[4] and Ajmera Housing Corporation v. Amrit M. Patel,[5] which states that the liability w.r.t. individual skills or expertise terminate upon the demise of the sole proprietor and cannot be imposed upon their legal heirs.

Exponentially, the court underscored the importance of S.2(11) of the CPC 1908, which defines “legal representative”. This clarifies that legal representatives are liable only to the extent of the inherited estate and must fulfil their obligations accordingly.

Hence, the court determined that legal representatives cannot be compelled to fulfil the personal contractual obligations of the deceased, particularly those that demand a specific skill set.

D.?? Conclusion

It would be inaccurate to claim that the legal heirs of a sole proprietor are absolved of the responsibility to settle the proprietor's debts entirely. However, there are limitations to this liability. While sole proprietorship offers numerous benefits, it also entails significant risks for the owner and places an indirect burden on the legal heirs in terms of liability.

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[1] W.P. No. 26493(w) 2017.

[2] Final order No. A/1168/2012-EX(BR) (PB), in Appeal No. E/1501/2012.

[3] Civil Appeal Nos. 7768-7769/2023.

[4] (2007) 5 SCC 103.

[5] (1998) 6 SCC 500.