Business Types

Legal Environment Business Types

Learning Objectives Business ownership   

Individuals Partnerships Companies

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 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 4

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”

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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 6

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 7

Definition of Partnership (cont.) The business must be carried out in common A partnership does not have a separate legal personality from the people run the business A partnership is simply a group of people who carry on a business together

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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 of 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

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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 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 10

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 firm’s 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) 11

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 12

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 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

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Liability of Partners Each partner is liable for the full amount of the firm’s 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 15

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 firm’s business or 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. Those created 3. by Royal Charter This was the earliest way of creating corporations. 17

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

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What is a Company? (cont.) 1.

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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What is a Company? (cont.) 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 1.

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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 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) 22

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 23

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 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 25

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

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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 company’s liability for contractual debts is unlimited 

It is only the members’ liability which is limited

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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 28 day operation of the business

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 29

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 30

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 company’s full name 31

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 employee’s contract prevented him from approaching former customers after he left Gilford Motor Co 32

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

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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 company without 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 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

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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 up Usually, the amounts are small, so the risk is low 37

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 38

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

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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 your own. Simplicity – one person does not need a complex organisational structure.

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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 42 debts of the business.

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. 43

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.

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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 45

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. 46

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. 47

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 48

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 in common 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 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 51

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 52

Reading Chapter 12 Pages 307-314  Pages 335-339 chapter summary 

Chapter 13 

Pages 341-350

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