Topic 1 – Legal Structures for Collective Activity
Sole Trader, Partnership and Incorporated Company
1. Sole Trader
- One person business – No others have a proprietary interest.
- !!Proprietor has unlimited liability – No distinction exists between business and private assets and debts. Proprietor may become bankrupt if the business fails.
- Common Law imposes no Restrictions – There are no general registration requirements.
The Position of the Sole Trader
- Subject to minimum legal regulation and formality
- Proprietor has complete managerial control
- It is easy to sell or transfer the business.
- Unlimited liability
- Capital for investment can come from proprietor alone or from borrowing
- Business may become too large for one proprietor to control.
- Tax – less generous than the corporate tax rate
Arises from an express (i.e. partnership deed) or implied contract (i.e. by operation of law) between the parties.
- Partnership Act 1980 – s. 1 “the relation which subsists between two or more persons carrying on business in common with a view to profit.”
- Minimum of 2 members and maximum of 20
Advantages of Partnership:
- Easy to form;
- Low cost;
- Minimal Disclosure
- Simple Tax Structures;
- Only need to tax profits
- Less Regulation;
- Equality in Management;
- No regulations of meetings.
- Capital Freely alterable
- Tax – cannot avail of lower rates of Corporation Tax
- Limited Size – (20)*
- Unlimited Liability
- Uncertain Termination
- Not a Legal Entity; Problems of Management, Capital Accumulation, Continuity (No perpetual succession). Death dissolves partnership – unless otherwise specified. + No floating charges. Each loan that a partner raises from a bank is the partner’s own loan.
- Restrictions on Transfer of Interests.
3. Incorporated Company
i. The effects of incorporation
- Separate legal personality – can own property, sue and be sued in its own name – over and above this, a company never dies.
- The impact of this is such that there is a division between members of the company and the company itself (limited liability).
- ****Salomon v Salomon & Co. Ltd  AC 22.
- Landmark case where the HofL definitively said that once a company is properly incorporated, it has its own legal personality, recognized as such and separate from the members/directors of the company.
- Facts: Salomon was a sole trader in the manufacture of boots and shoes. He carried on business for 30 years. It was profitable. He had a number of sons working in the business. They wanted a formal share in the business. In 1892, Salomon decided to form a registered company and transfer his business to the company (This is incorporation so as to give sons shares). The new company was called Salomon and Co Ltd. Salomon valued his business at £39,000. The company had to pay a price for the business. Salomon was to be allotted 20,000 shares of £1 each and also Salomon took a loan from the company to the value of £19,000 in the form a debenture (evidences a loan from a company) so he essentially became a secured creditor of the/his company for £19,000. A debenture is a security (secured loan). After a number of years, the company began to suffer losses – economic downturn. The company failed, owing money to trade creditors. Because of the debenture, Salomon argues that as a secured creditor, he must get paid first before all the other creditors. The liquidator named this claim outrageous. Liquidator did not distinguish between Salomon and the company. House of Lords disagreed. They said yes, on the ground nothing had changed post sole trader-ship, except the sign outside the door. Customers contracted with the company, not with Salomon – therefore his liability for the debts of the company had changed from unlimited to limited liability. Not only was he not liable, he was also a creditor. HofL held that the company was a different (juristic) person. Salomon was entitled to be paid first.
- The courts have on occasion been asked to set aside limited liability – in cases of fraud or a sham device, or trying to use a company to get out of existing legal obligations. These are limited circumstances – they are making it narrower all the time.
- Therefore a company can commit a crime, be sued and can sue, own property, commit a tort etc.
- Limited Liability – Once incorporated, a company’s members enjoy limited liability provided that their shared are fully paid up and it is a limited liability company. This means that if the company goes into liquidation with outstanding debts, the debt is the debt of the company and not that of the shareholders and members. Their liability is limited to any money that they owe for their shares. If they have fully paid for their shares, they owe nothing.
- Perpetual Succession – A company, once formed will continue until such time that it is wound up. The fact that a member dies has no effect on the legal existence of the company.
These may be said to be the 3 main advantages of incorporation.
Other advantages of incorporation:
- Tax advantages
- Number of members
- Any number from 1-99 (Private) – 99+ (Public listed company) – Partnerships are limited to 20.
- Ease of transfer of shares
- Considered to be personal property. Can be transferred the same as other personal property (sold, bequeathed etc.) Partnerships have restrictions on the transfer of shares.
- Flexibility in raising capital – concept of the floating charge.
- Hugely significant. Either shared capital or loan capital – there is a form of lending only available to the company format. A company can grant a floating charge over its assets so as to raise capital from its lenders. It is a type of security. It means the company can create this charge over its assets – it can use those as a security for a loan. Cannot be granted to a sole trader or partnership.
Disadvantages to Incorporation:
- Costs – registration costs, possibly legal advice (generally setting up costs).
- Complex regulation
- Accounts, tax etc.
- Certain information must be in the public domain. Put in the companies registration office.
- Capital Maintenance – How capital is used.
- Set of rules surrounding companies – keeping share capital intact – to protect investors and shareholders – e.g. rules on dividends etc.
- In a Partnership there are no restrictions – you can do what you want with the capital.