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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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Definition of Partnership (cont.)
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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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 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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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
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What is a Company? (cont.)
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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Lifting the Veil of Incorporation
(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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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 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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Lifting the Veil of Incorporation
(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