Business Types (2)

8/3/2019 Business Types (2)

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Legal Environment

Business Types


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Learning Objectives

Business ownership

Individuals

Partnerships Companies (corporations)

Comparison of Ownership Types


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Introduction

In England, there are three general ways of

owning and operating a business

as an individual

as a partnership

as a limited company


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Individuals

The situation with an individual is fairly

straightforward as only one person is

involvedThat person is the business

That person is often called a sole trader

S/he enters contracts in his/her own name in

order to do business

The general rules on contract and tort apply


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Partnership

The basic framework of law for

partnerships is in the Partnership Act 1890

It defines a partnership as the relationwhich subsists between two or more

persons carrying on a business in common

with a view to profit


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Definition of Partnership

There must be at least 2 people on apartnership and not more than 20 (except in

law, medicine and accountancy)A limited company cannot be a partnership,although it can be one partner in apartnership

The relationship between partners is basedin contract

ie the terms of theirpartnership agreement


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Definition of Partnership (cont.)

To qualify as a partnership, the people must

be carrying on a business

Business means any trade, profession oroccupation

However, simply sharing in the profits of a

business does not make you a partner in thatbusiness


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The business must be carried out in

common

A partnership does not have a separate legalpersonality from the people who run the

business

A partnership is simply a group of peoplewho carry on a business together


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Partnerships are not only for carrying on

business over a period of time, it is possible

to create a partnership for a single event orbusiness venture

The business must be run with the aim of

making a profitHowever, simply sharing in the gross profits

of a business does not make you a partner


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Legal Status of a Partnership

As we saw, the Partnership Act says that a

partnership is a relationship between people

That means that the partnership does nothave a separate legal identity from the

partners (ie the owners)

As you will see, a limited company doeshave a separate legal identity from its

owners


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Legal Status (cont)

However, the Partnership Act does allow the

partnership to be known as a firm

The firm can have its own nameCourt actions can be raised by and against the

partnership in the firms name

Because there is no separate legal identity,

partners are self-employed and not employees

However, the firm may have employees (eg

secretaries, clerks, etc)


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Legal Status (cont)

The Partnership Act states that each partner

acts as an agent for the firm and for the

other partners for the business of thepartnership

Therefore, the rules from the law of agency

which we looked at recently apply tocontracts made by partners


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Formation of a Partnership

There are no special legal rules for forming

a partnership

It is an agreement between individuals

It may be made orally, in writing, or implied

from the behaviour of the individuals


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Formation of a Partnership (cont)

However, it is common to have a writtenpartnership agreement which sets out

the name of the firm the nature of its business

the method for sharing profits

the amount of capital to be contributed by each

partner the reasons and method for ending the

partnership

This helps to avoid arguments later


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Liability of Partners

Each partner is liable for the full amount of

the firms debts and other liabilities

A third party can sue the firm or thepartners individually

Where the third party receives payment

from one partner, then the other partnersmust contribute equally to the amount paid

by him (indemnify that partner)


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Liability of Partners (cont.)

In order for a firm to be liable in tort, the

wrongful act must have been done by a

partner in the course of the firms businessor with the approval of the other partners


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What is a Company?

A company is a body corporate or

corporation

There are 4 types of corporation. Thosecreated

1. by Royal Charter

This was the earliest way of creatingcorporations.


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What is a Company? (cont.)

However, nowadays, it is not used to create

trading bodies. It is used for charitable and

educational bodiesThe BBC (British Broadcasting

Corporation) and the Bank of England were

both created by Royal Charter


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2. by special Act of Parliament

Again, this is an old way of creating

corporations which is no longer used

Bank of Scotland was created in 1695 by

and Act of the old Scots Parliament


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3. by registration under the Companies Act

1985

The current law relating to companies ismainly contained in this Act

It is the most common way of creating a

corporation4. by registration under the Limited Liability

Partnership Act 2000


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Separate Legal Personality

As companies are a kind of corporation,

they have their own separate identity

In law, they are regarded as a person

Although a company is not a natural person

(like you or me) the law treats it in the same

way in many areas


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Separate Legal Personality (cont.)

The most famous case in this area isSalomon v Salomon & Co

In this case, the House of Lords decided thata company which is properly formed underthe Companies Act is a separate person,and, as a result, the debts of a company

were its own and not those of its members(ie shareholders)


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Consequences

This concept of separate legal personalityhas several consequences

Limited liabilityPerpetual succession

Business property

Court actionsLiability in tort and crime

The rule in Foss v Harbottle


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Limited Liability

The liability of the members of a company

for its debts is limited

Under the Companies Act 1985 a member of a company limited by shares is

only liable to pay the full amount of his shares,

and a member of a company limited by guarantee is

only liable to pay the amount which he

guarantees to pay if the company is wound up


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Perpetual Succession

Changes in the membership of a companyhave no effect on the continuation of that

companyUnlike a partnership, the death orbankruptcy of a member does not end thecompany

In public limited companies, members arefree to sell their shares on the stockexchange


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Business Property

Business property is owned by the company

and not its shareholders

That means a creditor cannot take actionagainst company assets in respect of a debt

due by a member of that company


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Court Actions

A company can sue and be sued in its own

name

It can also enter contracts in its own name

The companys liability for contractual

debts is unlimited

It is only the members liability which islimited


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Liability in Tort and Crime

Companies are vicariously liable for the torts oftheir employees

Companies can be guilty of crimes which do not

require a mental element (eg intention orrecklessness)

However, it has been more difficult to prosecutecompanies where the crime has such an element as

it has to be shown that one of the directors of thecompany had the required mental element

This can be very difficult in a large companywhere the directors are not involved in the day to

day operation of the business


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Foss v Harbottle

This case gives us the idea of majority

rule in a company

If a company suffers injury then themajority of members must agree to raise a

court action

A single member cannot take action againstthe wrongdoer


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Lifting the Veil of Incorporation

Although the general rule is that a companyhas a separate legal identity from itsmembers, there are exceptions to this rulewhen a court will not treat a company as aseparate entity

This is often referred to as lifting the veil

of incorporationOften, this is to prevent abuse of theprinciple of separate identity

Lif i h V il f I i


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(cont.)

For example, under the Companies Act1985, if a company trades with fewer thantwo members then the sole member hasunlimited liability for company debts

Also under the Companies Act, officers ofthe company will become personally liable

if they issue bills of exchange or enter intocontracts on behalf of the company but donot use the companys full name

Lif i h V il f I i


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(cont.)

At common law, the general principle is

that the courts will not allow a company to

be used for a fraudulent purpose or to avoida legal duty

For example, in Gilford Motor Co v Horne,

a term in an employees contract preventedhim from approaching former customers

after he left Gilford Motor Co

Lifti th V il f I ti


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(cont.)

Therefore, when he left he formed his own

company, and the company approached his

former customersThe court held the company was a sham

being used to avoid the term in his contract


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Types of Company

Companies can be classified in several ways

Limited and Unlimited

Limited by Shares or by Guarantee

Public and Private


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Limited and Unlimited Companies

Companies are usually formed because of

the limited liability for their members

However, it is possible to create a companywithout limited liability

Such companies do not have disclose their

accounts as limited companies do


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Limited by Shares or Guarantee

The most common kind of limited company

is one limited by shares

Once the shareholder has paid the full valueon his shares then he has no further liability

This is true even if the company does not

have enough money to pay its debts

Li it d b Sh G t


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Limited by Shares or Guarantee

(cont)

A company limited by guarantee is usually

created for charitable, educational or

professional purposes ie it is not a trading company

The liability of members is to pay an agreed

amount if the company is wound upUsually, the amounts are small, so the risk

is low


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Public and Private Companies

The main difference between public andprivate companies is that the shares in apublic company may be bought and sold ona stock exchange

Public companies must have at least twodirectors, whereas a private company can

have onePublic companies must have a minimumissued share capital of 50,000

P bli d P i t C i


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Public and Private Companies

(cont.)

Private companies may purchase their own

shares out of capital, whereas public

companies cannotPrivate companies may elect not to appoint

auditors or hold an AGM (Annual General

Meeting), whereas a public company cannot


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Comparison of Ownership

It is useful to compare the advantages and

disadvantages of the three forms of business

Sole trader Partnership

Company


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Sole Trader - Advantages

No legal filing requirements or fees and no

professional advice is needed to set it up.

You just literally go into business on yourown.

Simplicityone person does not need a

complex organisational structure.


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Sole Trader - Disadvantages

The disadvantages are that it is not a particularlyuseful business form for raising capital (money).

For most sole traders the capital will be provided

by personal savings or a bank loan.Unlimited liabilitythe most important point tonote in terms of comparing this form to thecompany in that there is no difference between the

sole trading business and the sole trader himself.The profits of the business belong to the soletrader but so do the losses.

As a result he has personal liability for all thedebts of the business.


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Partnership - Advantages

No formal legal filing requirement involved

in becoming a partnership beyond the

minimum requirement that there be twomembers of the partnership.

Easier to obtain capital as there can be up to

20 members of the partnership, all of whomcould pool their investment within the

partnership.


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PartnershipAdvantages (cont.)

If you are aware of the problems the Partnership

Act can cause (see disadvantages) then you can

draft a partnership agreement to vary these terms

of the Act

The partnership agreement can therefore be used

to provide a very flexible organisational structure

although this usually involves having to pay forlegal advice.


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Partnership - Disadvantages

A partnership will end on the death of apartner.

If you are unaware of this when thepartnership is formed, the Act may notreflect the intention of the partners.

The partners are jointly and severally liable

for the debts of the partnership.

This means that each partner can be suedfor the total debts of the partnership


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Company - Advantages

Companies are designed as to make it easy to raise

capital.

Companies have the ability to subdivide theircapital into small amounts, allowing them to draw

in huge numbers of investors who also benefit

from the sub-division by being able to sell on

small parts of their investment.Limited liability also minimises the risk for

investors and is said to encourage investment.


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CompanyAdvantages (cont.)

It is also said to allow managers to take

greater risk in the knowledge that the

shareholders will not lose everything.The constitution of the company provides a

clear organisational structure which is

essential in a business venture where youhave large numbers of participants.


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Company - Disadvantages

Forming a company and complying with

company law is expensive and time

consuming.It also appears to be an very complex

organisational form for small

businesses, where the Board ofDirectors and the shareholders are

often the same people


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Summary

In England, there are three general ways of

owning and operating a business

as an individual as a partnership

as a limited company


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Summary (cont.)

The Partnership Act 1890 defines a

partnership as the relationship between two

or more persons carrying on a business incommon with a view to profit


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Summary (cont)

A partnership does not have a separate legal

identity from its partners

The partners are jointly and severally liable for thedebts of the partnership.

This means that each partner can be sued for thetotal debts of the partnership

Partners are agents for their firm and the otherpartners, so the rules from the law of agency apply

especially implied authority


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Summary (cont.)

Most companies nowadays are formed under the

Companies Act 1985

The law regards a company as a legal person

It has a separate identity from its owners (ie its

shareholders)

A company is liable for its own debts

Its shareholders are not liable for its debts. They

are only liable to pay for their shares

Business Types (2)

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