Inna frolova. English law for Students of English

Chapter 11. Business Law

1 Business Law

Text 1: Forms of Business Organisation

1. Pre-reading tasks

1. Before you read the text, answer these questions: a) what forms of running a business do you know? b) What do you know about each form?

2. Look at the following statements and mark what you think the answers are. Then scan the first two sections of the text and check your initial hypotheses.

1. In the event of bankruptcy, a sole trader may lose not only True / False his investment but his personal property too.

2. In the event of bankruptcy, partners may lose their True/False investment but their personal property is not at risk.

3. In the event of bankruptcy, company shareholders may True/False lose their investment and personal property too.

3. Read the text and say: a) what is specific about each type of business; b) what is the main difference between a memorandum of association and articles of association; c) what are the two main ways of raising capital?

Sole Trading and Partnership

If one wants to set up a business under English law, one of the first questions to consider is its organisational form: one will have to decide whether to operate as a sole trader or form a partnership or a company.

A sole trader (‘sole proprietor’) is the only owner of a business. Although he may employ other people full-time or part-time, he is the only person who has money in the business and is responsible for its management. One of the problems of running a business in this way is that the owner has what is called unlimited liability. This means that if a venture fails, creditors may sue the owner to recover the money, and he may find that he can lose not only his initial investment but his own personal property, such as his house or car, which the court can order to be sold to pay his debts.

Another way to run a business is for two or more persons to form a general partnership, in which they share management, profits and liability to debts. The legal position of partners is not very different from that of sole traders: if they are sued by creditors, they may find their personal property at risk. A partnership agreement usually defines: (1) the involvement of the partners in the business: which of them are going to be general partners and which may be sleeping partners, i.e. not taking any part in the running of the business but fully liable for the obligations of the partnership; (2) how the profit is to be shared (the share is not necessarily an equal one, but depends upon the amount of capital each partner has invested in the business); (3) the obligations of each partner not to start any competing business; (4) the obligation to give the other partners full information about any dealings in respect of the common business. In firms of solicitors or accountants one can find a category of salaried partner. This is usually an employee whose name will appear on the firm’s letterhead but his terms and conditions of employment may remain the same. However, if the business suffers losses, the salaried partner will have to contribute with the general partners.

In limited partnerships some partners have limited liability, being liable only for the amount they have invested. They cannot take part in the running of the partnership (if they do, they lose their limits of liability), and there must be at least one general partner.

Partnerships can be formed very easily and they are not as strictly controlled by the state as companies. However one big disadvantage of running a business in this way is the partners’ unlimited liability, especially since a partner is liable not only for his own acts but also for those of his colleagues. Some professional firms (solicitors, accountants, architects practices) now have several hundred partners; they may never meet, yet each is liable for the others’ debts and obligations. The irresponsible conduct of one solicitor may bring personal ruin to all the other partners. Therefore in 2000 a new institution came into existence, a limited liability partnership (LLP). It is a legal entity, a kind of artificial legal person that has corporate personality, i.e. personality distinct from those of its members. This fictional ‘legal person' can own property and incur debts; it can sue and be sued in its own name as if it were a natural person. Its liability is unlimited (as long as the business has money or assets, creditors may sue), but the liability of its members is limited to the amount of their investment. If the business becomes unable to pay its debts, it will go into liquidation but the owners’ personal property is insulated from the threat. This form of business is a cross between the traditional partnership and the limited company and, like a company, it needs to be registered with the Companies Registry.

Company

Companies are perhaps the most common tool for running a commercial enterprise. They are owned by their members, i.e. shareholders, and are managed by a board of directors. While a sole trader’s business or a partnership may cease to exist upon the death or retirement of its members, companies are capable of perpetual succession regardless of changes in membership. A limited liability company (LLC), or corporation, may consist of a single person or several persons but in each case it has a legal identity separate from its members, it has corporate personality. In the event of bankruptcy, owners may lose their investment, but they are otherwise not liable for the company’s financial problems. Creditors cannot sue the members as individuals beyond their stated limits. In a company limited by shares, shareholders may be liable for up to the value of shares they hold but have not yet paid for; in other words, their liability is limited to the nominal value of their shares. In a company limited by guarantee, members must pay the amount they have guaranteed to contribute to company assets in the event of liquidation (such companies often lack a working capital and are more appropriate for charitable or social purposes than for trading).

Certain very large companies are registered as public limited companies (plc). They are privately owned companies which raise capital by selling shares to the general public, and these shares are listed on the Stock Exchange. If you see in newspapers names of companies advertising their shares, you will know that these companies are public. By contrast, a limited liability company may not offer or advertise shares to the public, its shares are only available privately. In everyday usage, these two types of company are called ‘public’ and ‘private’ respectively.

In the UK there are a number of legal bodies which have a legal status of a company but are owned by the state. They are called public corporations. It is important to understand the difference between a ‘public company’ and a ‘public corporation'. A public company is owned privately and it is called ‘public’ because its shares are available to the public. A public corporation is owned by the state (the public) and it is called ‘public’ because it is established to perform a certain public function - commercial, social, advisory, or of any other character. Thus, bodies established to manage nationalised industries are public corporations. Normally a public corporation is established by an Act of Parliament or a Royal Charter. Examples of statutory corporations include the Post Office, the Independent Broadcasting Authority, local authorities. Examples of chartered corporations are the BBC, charities, some universities.

It is also possible to form an unlimited company, a type of registered company whose members have an unlimited liability. The risk that members of unlimited companies assume is balanced by less rigid control of the company’s activities (e.g. they do not have to deliver their accounts to the Registrar of Companies) and more freedom to deal with its capital than a limited company.

Registration and Internal Management of a Company

An obvious advantage of forming a company is that it offers its members some protection in the case of bankruptcy. The disadvantage, however, is that there are many regulations to observe in setting it up and running it. In order for a company to be formed, whether public or private, certain statutory requirements have to be met. These requirements are laid down by the Companies Acts 1985 and 2006. To form a company, it is necessary for the promoters to deposit with the Registrar of Companies two documents that form the ‘constitution’ of the company: the memorandum of association and the articles of association.

The memorandum of association must contain certain compulsory clauses: the company’s name and registered address; the amount of its authorised share capital, i.e. the total value of the shares that it is authorised to issue; the purpose(s) for which the company has been formed (an ‘objects clause’); and whether it is a limited company or a public company. There are some restrictions on the choice of name: a name will never be allowed if it conflicts with another company name on the Registrar’s list, or if it claims an international, national or royal connection, e.g. ‘Royal Tires pic’ or ‘European Union pic’. The name of a limited company must end with the words Ltd (‘Limited’) or pic (‘public limited company’) respectively, as a warning to creditors of the limit upon members’ liability.

The objects clause of the memorandum is very important because a company may not engage in activity beyond its registered objects, or ultra vires. Any agreement entered into by a company which is outside its capacity is void and cannot be enforced against the other party. Nowadays companies usually draft very wide objects clauses to include any activities they are likely to be engaged in, now or in the future. The purpose of the whole doctrine is to stop company assets from being used for unauthorised activities but in the past this rule virtually allowed a dishonest trader to avoid payment for ordered goods saying that the transaction was ultra vires. The rule now is that a company acting ultra vires cannot use this as a reason for not meeting its contractual obligations.

Just as the memorandum of association regulates the external affairs of a company, the articles of association are concerned with its internal running. They detail rules about such matters as the issuing of shares; shareholders' voting rights; annual general meetings (AGM); the appointment, powers and removal of directors. The articles must be signed by at least two company members, the same people who signed the memorandum. One of the directors and the company secretary must also sign what is called a ‘statutory declaration’, which is merely a form stating that all the requirements of the Companies Act have been complied with.

Once the Registrar is satisfied, he will enter the company’s name in the companies’ register and will issue the applicant company with a ‘certificate of incorporation’ allowing it to begin trading right away (in the case of a public limited company, it must first obtain a ‘trading certificate’). Incorporation, quite simply, means the formation of an association that has corporate personality. The law requires a limited company to keep accounting records at its registered office, including entries of receipts and payments and a record of assets and liabilities. These documents must be open to inspection, and a copy must be sent to the Registrar each year. A profit and loss account, together with a financial report by the directors and a report from an independent auditor must be put before a general meeting of the company’s members every year. Breaking these regulations may result in criminal prosecution.

Raising Capital

There are essentially two ways in which a company can raise capital. One way is by selling shares. A share is ownership of a proportion of the company, and thus the right to a proportion of any profit it makes, a dividend. The maximum amount of share capital that a company can issue is called the authorised share capital. It must be stated in the memorandum of association together with the names of the subscribers. For a public company, the minimum capital requirement is £50,000. The factual amount of shares issued is called issued share capital; it is the amount actually held by shareholders. A company’s share capital may be split between

ordinary shares and preference shares. Ordinary shareholders cannot insist on the payment of a dividend every year, since this is up to the directors to decide. But they have voting rights (the more shares a member holds, the more voting rights he will have in general meetings) and if they are dissatisfied with the management of the company, they have the right to remove the directors. By contrast, preference shareholders normally have no voting rights but they receive a fixed dividend before all the other shareholders, irrespective of the company’s performance, and their shares are repaid first if the company is in liquidation.

The alternative way for a business to fund its activities is to raise a loan. This is done by issuing debentures, or bonds, in return for loans. Finance raised by the issue of debentures is known as loan capital (in contrast to share capital, the holders of which are company members). Debenture holders are entitled to an annual payment of interest, and this is not linked to the company’s profits and losses. In general, they have the right to sell their debentures back to the company (that is, ‘call in their loan’), or sell them on to someone else. The lender will make sure his loan is secured by a charge over a company asset, so that he will have the right to take company property should there be no money to repay him. A charge is a form of security over property and it can be fixed or floating. A fixed charge is a charge over particular assets; a floating charge is a charge over the entire assets of a company. The owner cannot dispose of property subject to a fixed charge without the consent of the chargee, i.e. the person who holds the charge, whereas such consent is not required in the case of a floating charge.