Key Man Insurance for Partners & Directors
Partners and directors are often key persons. This lesson covers what the law says happens to a firm or a board when one of them dies, what keyman cover on such a person does, what it does not do, and how tax affects the amount the business keeps.
A partner's death and the firm
A partnership is built on the partners themselves. Section 42 of the Indian Partnership Act, 1932 provides that, subject to contract between the partners, a firm is dissolved by the death of a partner.
The words 'subject to contract' are the important part. A clause in the partnership deed can provide for the firm to continue with the surviving partners. That is why the deed matters when a firm plans for the loss of a partner: without such a clause the default rule is dissolution.
A director's death and the company
A company is a separate legal person and does not end when a director dies, but the board is left with an empty seat. Under section 161(4) of the Companies Act, 2013, a casual vacancy in the office of a director appointed by the company in general meeting, such as one caused by death, may be filled by the Board.
The person appointed holds office only for the remainder of the predecessor's term, not until the next annual general meeting. The law fills the seat; it does not replace the knowledge, relationships or revenue the director brought.
What keyman cover does here
Keyman cover on a partner or director compensates the firm or company for the financial loss of losing that person. The business proposes the policy, and the proceeds are paid to the business.
Funding the purchase of a deceased partner's or shareholder's stake from the heirs is a different arrangement. It needs its own structure and professional advice. A keyman policy by itself does not provide it, since its money belongs to the business and is meant for the business's loss.
The effect of tax on the amount
Keyman proceeds are taxable as business income. A business that wants a certain sum left after tax therefore has to start from a larger gross figure. The relation is: gross amount = net amount wanted ÷ (1 − tax rate). The rate depends on the taxpayer and the year.
Rules at a glance
Illustration: two deeds
Two imaginary firms of architects each have three partners. The first firm's deed says nothing about death. When a partner dies, the default rule in section 42 applies and the firm is dissolved. The second firm's deed says the firm will continue with the surviving partners. When a partner dies there, the firm carries on.
Keyman cover would work the same way in both: the proceeds would come to the firm for its own financial loss. Paying the deceased partner's heirs for his share is a separate question in both, to be handled by its own arrangement.
Grossing up for tax (assumed figures)
- Assume a firm wants ₹1,20,00,000 left after tax from a keyman claim, and that the proceeds are taxed as business income at 31.2%. The rate is an assumption for arithmetic only.
- Share kept after tax: 1 − 0.312 = 0.688.
- Gross amount needed: ₹1,20,00,000 ÷ 0.688 = ₹1,74,41,860 (rounded to the nearest rupee), about ₹1.74 crore.
- Check: tax = ₹1,74,41,860 × 31.2% = ₹54,41,860; ₹1,74,41,860 − ₹54,41,860 = ₹1,20,00,000.
Result. A gross sum of about ₹1.74 crore leaves ₹1.2 crore after tax at the assumed rate.
Key points
- Under section 42 of the Indian Partnership Act, 1932 a firm is dissolved by a partner's death unless the partners have agreed otherwise.
- A clause in the partnership deed can provide for the firm to continue.
- Under section 161(4) of the Companies Act, 2013 the Board may fill a casual vacancy of a director caused by death.
- The director so appointed serves only for the rest of the predecessor's term.
- Keyman cover on a partner or director compensates the business, and the proceeds are paid to the business.
- Buying out a deceased partner's or shareholder's stake is a separate arrangement needing its own structure.
Common misunderstandings
- A firm is not always dissolved by a partner's death: section 42 is subject to contract, and the deed can provide for continuation.
- A director filling a casual vacancy does not serve only until the next annual general meeting: the term is the remainder of the predecessor's.
- Keyman insurance is not a buy-out arrangement: its proceeds go to the business for its loss, and purchasing the stake of the deceased needs a separate structure.
- The gross-up is not net amount plus the tax percentage: it is net amount divided by one minus the rate.
Questions people ask
Who receives the money when a partner covered by keyman insurance dies?
The firm, as owner of the policy.
Why not simply add 31.2% to ₹1.2 crore?
Because tax is charged on the gross amount. ₹1.2 crore plus 31.2% is ₹1,57,44,000, and after 31.2% tax on that only ₹1,08,31,872 would remain.
Does a company dissolve when a director dies?
No. The vacancy on the board may be filled under section 161(4).
What this lesson relies on
- Indian Partnership Act, 1932 — section 42
- Companies Act, 2013 — section 161(4)
- Income-tax Act, 2025 — Schedule II (keyman policies excluded from the exemption)
This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.