Legal Environment

Business Types
2
Learning Objectives
Business ownership
Individuals
Partnerships
Companies (corporations)
Comparison of Ownership Types
3
Introduction
In England, there are three general ways of
owning and operating a business
as an individual
as a partnership
as a limited company
4
Individuals
The situation with an individual is fairly
straightforward as only one person is
involved
That 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
5
Partnership
The basic framework of law for
partnerships is in the Partnership Act 1890
It defines a partnership as the relation
which subsists between two or more
persons carrying on a business in common
with a view to profit
6
Definition of Partnership
There must be at least 2 people on a
partnership 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 a
partnership
The relationship between partners is based
in contract
ie the terms of their partnership agreement
7
Definition of Partnership (cont.)
To qualify as a partnership, the people must
be carrying on a business
Business means any trade, profession or
occupation
However, simply sharing in the profits of a
business does not make you a partner in that
business
8
Definition of Partnership (cont.)
The business must be carried out in
common
A partnership does not have a separate legal
personality from the people who run the
business
A partnership is simply a group of people
who carry on a business together
9
Definition of Partnership (cont.)
Partnerships are not only for carrying on
business over a period of time, it is possible
to create a partnership for a single event or
business venture
The business must be run with the aim of
making a profit
However, simply sharing in the gross profits
of a business does not make you a partner
10
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 not
have a separate legal identity from the
partners (ie the owners)
As you will see, a limited company does
have a separate legal identity from its
owners
11
Legal Status (cont)
However, the Partnership Act does allow the
partnership to be known as a firm
The firm can have its own name
Court 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)
12
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 the
partnership
Therefore, the rules from the law of agency
which we looked at recently apply to
contracts made by partners
13
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
14
Formation of a Partnership (cont)
However, it is common to have a written
partnership 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
15
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 the
partners individually
Where the third party receives payment
from one partner, then the other partners
must contribute equally to the amount paid
by him (indemnify that partner)
16
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 business
or with the approval of the other partners
17
What is a Company?
A company is a body corporate or
corporation
There are 4 types of corporation. Those
created
1. by Royal Charter
This was the earliest way of creating
corporations.
18
What is a Company? (cont.)
However, nowadays, it is not used to create
trading bodies. It is used for charitable and
educational bodies
The BBC (British Broadcasting
Corporation) and the Bank of England were
both created by Royal Charter
19
What is a Company? (cont.)
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
20
What is a Company? (cont.)
3. by registration under the Companies Act
1985
The current law relating to companies is
mainly contained in this Act
It is the most common way of creating a
corporation
4. by registration under the Limited Liability
Partnership Act 2000
21
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
22
Separate Legal Personality (cont.)
The most famous case in this area is
Salomon v Salomon & Co
In this case, the House of Lords decided that
a company which is properly formed under
the 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)
23
Consequences
This concept of separate legal personality
has several consequences
Limited liability
Perpetual succession
Business property
Court actions
Liability in tort and crime
The rule in Foss v Harbottle
24
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
25
Perpetual Succession
Changes in the membership of a company
have no effect on the continuation of that
company
Unlike a partnership, the death or
bankruptcy of a member does not end the
company
In public limited companies, members are
free to sell their shares on the stock
exchange
26
Business Property
Business property is owned by the company
and not its shareholders
That means a creditor cannot take action
against company assets in respect of a debt
due by a member of that company
27
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 is
limited
28
Liability in Tort and Crime
Companies are vicariously liable for the torts of
their employees
Companies can be guilty of crimes which do not
require a mental element (eg intention or
recklessness)
However, it has been more difficult to prosecute
companies where the crime has such an element as
it has to be shown that one of the directors of the
company had the required mental element
This can be very difficult in a large company
where the directors are not involved in the day to
day operation of the business
29
Foss v Harbottle
This case gives us the idea of majority
rule in a company
If a company suffers injury then the
majority of members must agree to raise a
court action
A single member cannot take action against
the wrongdoer
30
Lifting the Veil of Incorporation
Although the general rule is that a company
has a separate legal identity from its
members, there are exceptions to this rule
when a court will not treat a company as a
separate entity
This is often referred to as lifting the veil
of incorporation
Often, this is to prevent abuse of the
principle of separate identity
31
Lifting the Veil of Incorporation
(cont.)
For example, under the Companies Act
1985, if a company trades with fewer than
two members then the sole member has
unlimited liability for company debts
Also under the Companies Act, officers of
the company will become personally liable
if they issue bills of exchange or enter into
contracts on behalf of the company but do
not use the companys full name
32
Lifting the Veil of Incorporation
(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 avoid
a legal duty
For example, in Gilford Motor Co v Horne,
a term in an employees contract prevented
him from approaching former customers
after he left Gilford Motor Co
33
Lifting the Veil of Incorporation
(cont.)
Therefore, when he left he formed his own
company, and the company approached his
former customers
The court held the company was a sham
being used to avoid the term in his contract
34
Types of Company
Companies can be classified in several ways
Limited and Unlimited
Limited by Shares or by Guarantee
Public and Private
35
Limited and Unlimited Companies
Companies are usually formed because of
the limited liability for their members
However, it is possible to create a company
without limited liability
Such companies do not have disclose their
accounts as limited companies do
36
Limited by Shares or Guarantee
The most common kind of limited company
is one limited by shares
Once the shareholder has paid the full value
on his shares then he has no further liability
This is true even if the company does not
have enough money to pay its debts
37
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 up
Usually, the amounts are small, so the risk
is low
38
Public and Private Companies
The main difference between public and
private companies is that the shares in a
public company may be bought and sold on
a stock exchange
Public companies must have at least two
directors, whereas a private company can
have one
Public companies must have a minimum
issued share capital of 50,000
39
Public and Private Companies
(cont.)
Private companies may purchase their own
shares out of capital, whereas public
companies cannot
Private companies may elect not to appoint
auditors or hold an AGM (Annual General
Meeting), whereas a public company cannot
40
Comparison of Ownership
It is useful to compare the advantages and
disadvantages of the three forms of business
Sole trader
Partnership
Company
41
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 your
own.
Simplicity one person does not need a
complex organisational structure.
42
Sole Trader - Disadvantages
The disadvantages are that it is not a particularly
useful business form for raising capital (money).
For most sole traders the capital will be provided
by personal savings or a bank loan.
Unlimited liability the most important point to
note in terms of comparing this form to the
company in that there is no difference between the
sole trading business and the sole trader himself.
The profits of the business belong to the sole
trader but so do the losses.
As a result he has personal liability for all the
debts of the business.
43
Partnership - Advantages
No formal legal filing requirement involved
in becoming a partnership beyond the
minimum requirement that there be two
members of the partnership.
Easier to obtain capital as there can be up to
20 members of the partnership, all of whom
could pool their investment within the
partnership.
44
Partnership Advantages (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 for
legal advice.
45
Partnership - Disadvantages
A partnership will end on the death of a
partner.
If you are unaware of this when the
partnership is formed, the Act may not
reflect 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 sued
for the total debts of the partnership
46
Company - Advantages
Companies are designed as to make it easy to raise
capital.
Companies have the ability to subdivide their
capital 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.
47
Company Advantages (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 you
have large numbers of participants.
48
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 of
Directors and the shareholders are
often the same people
49
Summary
In England, there are three general ways of
owning and operating a business
as an individual
as a partnership
as a limited company
50
Summary (cont.)
The Partnership Act 1890 defines a
partnership as the relationship between two
or more persons carrying on a business in
common with a view to profit
51
Summary (cont)
A partnership does not have a separate legal
identity from its partners
The partners are jointly and severally liable for the
debts of the partnership.
This means that each partner can be sued for the
total debts of the partnership
Partners are agents for their firm and the other
partners, so the rules from the law of agency apply
especially implied authority
52
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