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Appropriate form of business organisation

Introduction

As of present, David, Peter and Danielle are sole proprietors or self-employed in their individual business enterprises. If they wish to combine their businesses in order to increase the financial resources available to grow the business, they would have to choose a form of business organisation that allows them to combine these resources. At the same time, they all expect to take an active part in the management of the new merged business.

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Considering the above, this essay seeks to discuss the different forms of business organisations and their merits and demerits, with the purpose of identifying and justifying the form of organisation, which will be the most appropriate for David, Peter and Danielle.

At the outset, it is appropriate to note that primarily there are five forms of business organisations: sole traders; partnerships; private limited companies; public limited companies; and co-operatives. Each form has certain advantages and disadvantages and the choice of which form of organisation would be adopted depends on a number of factors.

Forms of Business Organisations

There are many forms of business organisations, which allow two or more persons to come together and conduct a business for common purposes and gains. These forms may include: Partnership, Private Limited Company (Ltd), and Public Limited Company (Plc). The decision to opt for any one of these forms of organisation for the business ownership depends on a number of factors. Some of the important factors include considerations of number of employees, market value, profit, etc.

At the present time, David, Peter and Danielle have each employed sole tradership to define their ownership of their individual businesses. This has allowed each of them to own their business completely, and keep all the profit of their individual businesses for themselves. On the other hand, they were also subject to unlimited liability with respect to their individual businesses. The principle of unlimited liability provides that the risks of the business and all its losses are to be faced by the owner of the business. Even the personal assets of the owner can be used to pay off the debts of the business. Therefore, the form of business organisation that they now will choose for the merging of their businesses into one, would also be done keeping in mind the advantages and disadvantages of the various forms of businesses for their purposes.

Sole Trader to Partnership: Advantages and Disadvantages for David, Peter and Danielle

In M Young Legal Associates Ltd v Zahid, partnership was defined as two or more people coming together and acting in common to form or with a view to form a business with a view to earning profit.

A sole trader organisation can be easily converted into a partnership with the least amount of formalities to be followed. There are no specific formalities or registration requirements which are to be followed for the conversion of the business from a sole trader to partnership. The only requirements are that the partnership must not use Ltd or Plc in the name because these are applicable only to Limited liability companies, or Public Limited companies.

The three parties can choose to form a partnership for the combined running of their business. This would allow them to get the benefits of partnership, which were deprived to them individually as sole traders. These benefits are discussed here along with the disadvantages.

The first such benefit is that this would allow them to spread their risk across more people. Up until now, each of them had unlimited liability for their individual sole trader businesses.

The second benefit of this move would be that each of the partner would bring in money and resources into business, therefore, there will be more resources for the development and running of the business. This may translate into better office premises, more investments for the business, hiring of new talent, etc. The Partnership Act 1890, ss. 20 and 21, identify any property that is purchased with the help of partnership money to be property of the partnership. When the business is dissolved, the partners can take back whatever property or assets they brought into the business. This is a safeguard for each of the three, that is, David, Peter and Danielle, that in the event of the partnership not working out, each of them will be able to take back the property that they brought into the business, because partnership property is only that which is purchased with partnership money. This property would belong to all of them.

The third benefit of the move to a partnership would be that each partner may bring some specific skills and ideas to business. This would increase the knowledge capital of the business greatly and combined knowledge capital would benefit each of the partners.

The fourth advantage of converting the individual businesses into a partnership would be the increased credibility with potential customers and suppliers, as they would see doing business with an LLP as a less risky option than dealing with sole traders. It is also to be noted here that partners are the agents of the partnership and each partner would have to power to bind the partnership to actions taken by him for the partnership and also that the partners can contract on their own in the name of the partnership and bind the partnership.

There may also be certain drawbacks of a partnership, when compared with the sole tradership form that David, Peter and Danielle were involved in earlier. The first disadvantage is that now they will have to share the profits of the business, whereas earlier, as sole traders, each of them had complete control over the profit of the business.

The second disadvantage is that now each of the three partners would have less control over the business as they would have to take all decisions with regard to the business together. This could also translate into disputes over of direction of business and disputes regarding the workload.

The most important disadvantage of the partnership form of business organisation is that the liability of the partners remains unlimited. This means that the risks that are there in the business or the debts of the business will be the liability of David, Peter and Danielle and for this even their personal liability will arise. Also, partners are jointly and severally liable for their actions. This means that if one partner commits a tort or a crime, in the course of the business, the other partners would be liable for the same if these actions were within the actual or apparent authority of such partners. Also important is the fact that the liability for the actions continues long after the partner leaves the business, if the action was conducted when he was in the business.

These risks can be avoided if instead of a partnership, the three parties choose to form a Limited Liability Company (LLP). This is discussed as follows.

Limited Liability Partnership: Advantages and Disadvantages for David, Peter and Danielle

If David, Peter and Danielle decide convert their individual sole traderships into a combined Limited Liability Partnership (LLP), there are certain benefits of such a move that they will be able to avail. Therefore, they would have the benefits of partnership (discussed above), without the option of the unlimited liability that partners have in a simple partnership.

The Unlimited Liability Partnerships Act 2000, provided for the establishment of partnership organisations, with certain features of an incorporated company. These are two features: first, an LLP is a separate legal entity, where its personality is separate from the personality of the company; second, the partners in the LLP do not have unlimited liability, and they can choose to keep their liability limited.

The formation of an LLP needs to be done by following the requirements of registration provided under the Unlimited Liability Partnerships Act 2000. These requirements include registration of the LLP with the Registrar of Companies. Once registered, the LLP is incorporated as a legal person. One important fact here is that the LLP does not have unlimited liability and its own liabilities for the partnership debts and losses is unlimited. This means that the investment that is brought into the partnership by David, Peter and Danielle, will become partnership property, which is subject to unlimited liability. The unlimited liability principle is applicable only to David, Peter and Danielle.

Another advantage of the LLP is that the contracts and obligations of the partnership will be created with the LLP and not the individual partners. Again, the LLP will not come to an end when one or more partners die as LLP has its own personality, it does not come to an end in such an event.

As such, there are decided advantages that are given by a LLP to David, Peter and Danielle that are not given by a simple partnership. However, one disadvantage of an LLP is that shares in the business cannot be bought or sold by them. Therefore, if they later want to expand their business by bringing in more people on ownership basis, they will be restricted in doing that. For that reason, they may want to consider a limited company, which would allow them to sell the shares.

Sole Tradership to Private Limited Company: Advantages and Disadvantages for David, Peter and Danielle

In a private limited company, a business is owned by shareholders and not by partners. Such a company has to be registered with the Companies House, whereupon it is issued with a Certificate of Incorporation.

The shareholders of the company may be the directors. The directors of the company are usually the majority shareholders of the company.

The company itself is a separate legal entity and its contracts and property is held in its own name, and the accounts of the company are kept separately from those of these shareholders. The shareholders have limited liability, therefore, that benefit can be availed by David, Peter and Danielle in the business. Their liability will be limited to their original investment at the time when the limited company was formed.

The shares of the company can be sold to other people as well, so that if David, Peter and Danielle wish to include more people at a later time into the business, they can do so by selling shares in the company. However, in order to maintain their control over their business, David, Peter and Danielle can ensure that they do not sell too many shares to outsiders. In other words, they have to make sure that the controlling shareholding remains with them, even if they want to expand their business. Another advantage is that the shares of the company can only be sold to someone after getting the approval of the other members.

The disadvantages of the limited company are also to be considered. First, forming a company is a far more complicated matter than forming a LLP, which is simpler. The interested parties would have to make the Memorandum of Association, Articles of Association and send these to the Registrar of Companies. The Registrar of Companies will see the documents and verify the information and after all the formalities are completed, the company will be registered.

As David, Peter and Daniella are old college friends and seek to combine their businesses because of their friendship, which makes them feel secure that they will have good relations with each other in future as well, it does not seem appropriate that they would form a company with the intention of involving more people in the future. Therefore, the most appropriate form of business organisation for them would be a Limited Liability Partnership (LLP).

Conclusion

At this point, the most appropriate form of business organisation that David, Peter and Daniella should form is a Limited Liability Partnership (LLP). This will enable them to pool their combined businesses and resources and get the advantages of a partnership, and also avoid the unlimited liability feature of a simple partnership. An LLP will allow them to take their business forward with more resources, sharing of risks and profits and avoidance of unlimited liability.

Remedies of Shareholders

The scenario involves remedies of company in a private limited company. David, Peter and Danielle have incorporated DP&D Designs Ltd (“DP&D”), a private company limited by shares. They each hold 100 ordinary shares in the company and all of them are directors in the company. David had noticed in a project portfolio regarding a supply of services contract signed between DP&D and a company unknown to him with the latter providing printing services to DP&D. The contract was signed ‘For and on behalf of DP&D Designs Ltd, as agents, Peter and Danielle’. This is the first important issue in the essay, that is, can two of the directors, sign a contract with a third party, as agents on behalf of the company, without the knowledge and consent of the third director, each of the three being a shareholder in the company as well.

David also learned that Danielle made a profit shortly after the incorporation of the company, through the sale of business assets to the new company but has not revealed this to the other directors.

Peter is not interested in taking any action to recover the profit, therefore, David becomes a minority party wanting to take such an action. The issue here is, what remedy is available to David to take such action against Danielle and can he take such action if the other two shareholders do not authorise it.

This essay considers the two issues that are mentioned above. First, the essay discusses the the contract made without the knowledge and consent of David and what the implications of such contract are with respect to David in the company, vis a vis the other members and the second issue involved here. In other words, can it be said that David is a minority shareholder and that can have repercussions with regard to action for recovery of profits by Danielle, as Danielle and Peter seem to be keeping David out of the important decisions in the company? Could this also translate into fraud being faced by David at the hands of Peter and Danielle?

Remedies Available to David

A minority shareholder can be defined as a person who finds himself in a position where he cannot command sufficient votes in order to secure himself of the passage of the resolution which the minority shareholder favours and there is another group of shareholders who are acting together and it appears that they are in a position to achieve the passage of the resolutions that are particularly favoured by them. The test for understanding the minority or majority status of a shareholder with the above definition in mind is on the basis of the default rule of the passage of shareholders resolutions, which is that resolutions are passed when the ordinary or simple majority is achieved, which is, 50 percent plus 1 of the votes cast.

Considering the discussion above, the actions of Peter and Danielle show that they enjoy each other’s confidence and for some reason, David does not share the same level of confidence with the other two shareholders. This is clear from two facts. First fact is that both Peter and Danielle have entered into an agreement with a third party as agents acting for their company and have not taken David’s consent or advice or even kept him in the know for the purpose of the decision making. This shows a level of trust and confidence between Peter and Danielle and an exclusion of David from the same. The second fact is the unwillingness of Peter to want to take action against Danielle for the recovery of profits, although such an action is in the interest of the company. Both these facts show some kind of exclusion for David as far as Peter and Danielle are concerned.

Thus, it can be concluded that David is a minority shareholder in the company and he can expect that in case relations between the members break down and he wants to take action against Danielle for recovery of profits, Peter in all likelihood would vote against such a resolution. Therefore, David would have to explore the possibility of minority shareholder remedies in such an event.

As far as action for recovery of profit from Danielle is concerned, first it is pertinent to consider the nature of Danielle’s actions. A person can sell their business to the company in the pre-incorporation stage and in return shares are issued to the person at par (face value). Assets and liabilities are taken over by the company when this happens and a formal transfer agreement is executed for transferring the existing assets and liabilities to the new company when it is incorporated. The details of the transaction has to be disclosed to the other shareholders and in the first general meeting, these details are to be minuted. Not only that, the sale agreement has to be lodged with the Registrar within one month of the transaction. As Danielle has not followed these requirements, it is obvious that she is in the wrong and that she has made a profit out of the transaction, other than the issuing of shares that has been done in her favour at the time of incorporation. Action can therefore lie against her, but the question is if the action can be taken by David alone of Peter is not willing to support such action?

In a situation where a wrong has been done to the company, the only proper plaintiff to take action against the wrongdoer, is the company itself. This is called as the proper plaintiff rule of the Foss rule. Again in Gray v Lewis, it has been held that where the company is capable of taking action to recover property from its directors or from any other person, then the company alone is the proper plaintiff. In the present scenario, such an action by the company would be initiated only if the shareholders authorise such an action in a general meeting. However, as the facts of the case show, Peter is unlikely to vote in favour of a resolution authorising such action against Danielle, therefore, David is a minority shareholder for the purpose of passage of such a resolution.

Here, David can take the ground of ‘fraud against minority’ laid down in Edwards v Halliwell,as per which action can be taken by a minority shareholder on behalf of the company when the company itself is prevented in taking such an action by its majority shareholders who are doing a fraud against minority. In Daniels v Daniels, fraud against minority is seen where the directors used their powers fraudulently or negligently, in a manner which benefitted themselves at the expense of the company.

This is also provided in Companies Act 2006, in part 11, which provides for statutory derivative actions. Thus, as per s. 260 (1), derivative claims can be taken in respect of a cause of action vested in the company, where the minority shareholder is seeking relief on behalf of the company.

David can use this route to take action against the other shareholders if no other resolution can be found to the problem. Therefore, the remedies of minority shareholders in derivative action can be used by David. Derivative actions allow the minority shareholders to exercise control on the management if they fulfil the statutory and common law requirements for filing such an action. Such actions are meant to be not for the personal benefit of the members but for the benefit of the company. Therefore, the ultimate objective is the benefit of the company to which profits made by Danielle must be returned.

Conclusion

David is a minority shareholder as Peter and Danielle seem to enjoy each other’s confidence and David is excluded from the same. The remedies of a minority shareholder, particularly, derivative action can be used by David to get a resolution of the problem as Peter is unwilling to support David in taking such action against Danielle.

Bibliography

  • Borrington K, Stimpson P, Cambridge IGCSE Business Studies 4th edition (Cambridge: Cambridge University Press 2015)
  • Clayton P, Forming a Limited Company:
  • Davies PL, Introduction to Company Law (2nd Edition, Oxford: Oxford University Press 2010)
  • Dine J, Koutsias M, The Nature of Corporate Governance (Cheltenham: Edward Elgar Publishing 2013)
  • Hannigan B, Company Law (4th Edition, Oxford University Press 2015)
  • Marson J, Business Law (3rd Edition, Oxford: Oxford University Press 2013)
  • Worthington S, Sealy and Worthington's Text, Cases, and Materials in Company Law (11th Edition, Oxford: Oxford University Press 2016)

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