LAWS20059 Corporations And Business Structures

You are working at an accounting firm. Your overall task is to advise clients on how to structure their business – either as a partnership or company. The clients’ circumstances are extremely important considerations.

You should not consider the topic of trusts, as they are used primarily to minimise tax, and tax law is not part of this course. (Assume that the clients instruct you that they’ve had bad past experience with trusts because of the extra administration and accountancy fees that trusts create, and they don’t want to do that again). You should also avoid any advice on tax. The tax implications of business structures are more complicated than websites suggest, and since tax is not part of this course, you should avoid it. (Assume that the clients specifically instruct you not to advise on tax).

In order to provide this advice you need to perform several sub-tasks:-

1. Research the law relevant to your advice.
2. Provide a written report to your supervising partner on your research.


Provide a written report to your supervising partner weighing up the alternatives for your clients and making a recommendation for a particular business structure.
Provide a separate written report to the supervising partner on the selected case showing the responsibilities imposed on a company director by legislation.
Provide an oral advice (in plain language) to the client in the form of a YouTube video, advising on the law, weighing up the alternatives and providing a recommendation.

Answer:

The objective is to present an overview about the two major business structures i.e. company structure and partnership structure.

Partnership

Agency relation is taken into account in case of partnership structure because the partners comprising the partnership firm would work as an agent on each-others behalf. The verdict given in Lang v James Morrison & Co Ltd case is the testimony of the presence of agency relation in the partnership structure. In accordance of s. 1 of Partnership Act 1892 (NSW), there are three central essential requirements that are necessary in the formation of any partnership.

• The primary requirement is that the business must be carried on which implies any single transaction would not establish a valid partnership
• The secondary requirement is that the conduct of the partners must be in common which implies that partners must hold common rights, ownership and liabilities based on the provisions of the partnership agreement as per Tindal CJ in Green v Beesley The third and imperative requirement is that profit motive of the partners behind the formation of partnership firm as evident in Corporation Holdings Ltd & Anor v Grace Bros Holdings Ltd & Ors case.  It is noteworthy that absence of any of the above requirement would not lead to a valid partnership structure.

The partnership firm is based on the identity of its partners because partnership does not represent a separate business entity and hence, is directly linked with the identity of its concerned partners. The result can be drawn based on above understanding that in order to make any significant change in the firm, change in the share of the ownership or to raise the fund through equity dilution, the existing partnership needs to be terminated and a new partnership firm ought to be made through new partnership agreement. Additionally, the contract enacted on the part of the partnership firm would be signed and executed on the name of the partners only. It also indicates that the liabilities of the firm are actually the liabilities of the partners and therefore, if required the individual partners personal assets may also get sold.

It is apparent that partners work on the agent-principal relationship. Therefore, they must owe fiduciary duty in order to safeguard the interest of each other while acting as an agent. Further, it is essential that agent must not use the authority for dishonest or self-interest work while enacting contract with external parties because the contractual liabilities would be imposed on all the concerned partners. The level of liabilities on the partners depends on the several aspects of the different type of partnership firms. For example, in case of general partnership, the liability of the partner is unlimited. In case of limited partnership, there is combination of general partners who hold unlimited liability and limited partners who hold limited liability. In case of Limited Liability Partnership (LLP), all the respective partners of the partnership firm hold limited liability and the use of LLP is restricted to some defined professions only.

Company

The imperative factor in relation to the company is the distinction between company and its legal stakeholders. It is because the company is itself a legal entity and can execute contracts with the external parties through authorized agents and also is held to be liable for the contractual duties (s. 124(1) Corporations Act, 2001). Therefore, the owners of the company are independent of the liquidation of their own assets because of the outstanding liability on the company.  The relevant case law is Salomon v A Salomon and Co Ltd. Corporate veil piercing is enforceable in order to prevent the misuse of the immunity extended to the owners or shareholder. This is generally used by the honourable court, when there is possibility that the owners of the company are intentionally involved in fraudulent action or illegal activity by using the business of the company.

It is not required to dissolve the company in order to change the ownership because the ownership can easily be dissolved or shifted as it has perpetual succession. Also, the company continues to run even though the owner of the company is dead as the ownership is then passed on to the concerned legal heirs.  In accordance with s. 1-5(6), the shares of the company can easily be transferred to others. Incorporation and running of any company needs adherence to a detailed process, requisite registration procedures for ASIC and also substantial regulatory aspects that are complex in nature.  

Part 2

An in-depth analysis needs to be done for the business structure in regards to advice the appropriate business structure to the clients.

Partnership (Benefits)

Any partnership firm can be established with the help of nominal finance and it requires less time to incorporate.  The overall procedure of the incorporation is simple and easy which needs a partnership agreement only and thus, it is free from the complex legal hassles. Further, no registration is compulsory for the partnership agreement which also reduces the overall incorporation costs. It is apparent that more than one individual is required to form partnership and hence, the presence of multiple partners is a beneficial aspect as it increases the total manpower to conduct the operational activities and also enhance the financial resources of the partnership firm.

Partnership (Limitations)

The central drawback of selecting the partnership firm is the personal liability on the individual partners. However, the level of liability can be minimized by adopting the appropriate partnership type but one cannot completely avoid the personal liability in partnership.  When the firm requires finance, then it becomes one of the major issues. This is because the ownership of the firm cannot be transferred or diluted and therefore, it is essential to first dissolve the current partnership firm and then incorporate the new firm which essentially requires time and new partnership agreement.

Company (Benefits)

The most significant feature of the company is presence of limited liability of the owners (shareholders) of the company. It is because the company is recognised as separate entity from its shareholders as outlined in s. 124(1).  As a result, the liability of individual shareholders is limited and the associated risk to their personal wealth is avoided completely. It means, if there is outstanding liability on the company, then this amount of liability would not be extended to the shareholders even if company becomes insolvent. Thereby, the possible loss to the shareholder is only the amount that they have invested in the company. In order to generate the funds for the company, the shares can easily be transferred which means there is no exit or entry barrier to the shareholders of the company that makes the company business structure more flexible in businesses where capital requirement is high.

Company (Limitations)

The formation of any company requires time and specified procedures that include mandatory registration with ASIC, legal expenditure and apt name and so forth.  Further, it is apparent that carrying a business as company results in significantly high compliance costs which comes from excessive regulatory environment which direct linked to the company’s operations. Therefore, the company business structure is not appropriate for small businesses where the expected profit is limited or less.

Advice to the client

The recommendation has been made based on the above analysis and as per the given information it would be suitable for the clients to adopt partnership structure for running their business. In real estate sales industry, each of the four partners would work as an agent on other partner behalf in regards to advising their customers. Also, due to the limited capital requirement of the business, the alteration of the ownership for raising the funds for the firm may not be required l and therefore, partnership structure would be the suitable option for the client. Additionally, partnership firm can easily be established with lesser compliance costs, time period and with nominal overhead costs which is essential aspect when one need to incorporate a new business line in the competitive market. The risk involved due to the liability is also not very high owing to business having clear regulations. Further, the liability arising from such claims would also not be very high. Thereby, the initial setup is preferable as partnership which in subsequent years might be converted into company if the situation desires so.

PART 3

The role of the directors is considered as quite pivotal which is apparent from the duties imposed on directors in common law and also statue law (i.e. Corporations Law). It is imperative that the directors must adhere to these duties while exercising their authority as the agent for the company and the shareholders. The common law duties primarily arise from the fiduciary duties an agent owes to the principal particularly with regards to taking care and safeguarding the interest. The duties under statute can be derived from Corporations Law 2001 which was enacted in the aftermath of some major corporate bankruptcies in Australia involving active role of the directors.

A prominent case where directors duties were breached is ASIC v Adler (2002).  This case involved the tainted directors of HIH Insurance which was one of the biggest bankruptcies in Australian corporate history. A host of stakeholders including shareholders suffered on account of this bankruptcy and it was imperative to put the erring directors to task. The key aspects related to the case with relevance to directors in general are indicated as follows.

• Both common law and statute law (s. 180(1) Corporations Act 2001) expect the directors to discharge their duty while exhibiting adequate care and requisite due diligence so that their conduct is not negligent and harm is not suffered by the company. There was breach of this duty by some the HIH Insurance directors since a $ 10 million loan was sanctioned to an entity without following due procedure i.e obtaining consent from the board as a whole or the investment committee.
• Section 180(2) highlights the business judgement rule which is frequently used as a valid defence on the part of directors to protect themselves from personal penalties for breach in s.180(1). This clause was inserted so that the directors could take decision to the best of their rational judgement considering the scenario. The accused directors of HIH Insurance also tried to claim protection but were unsuccessful owing o presence of conflict of interest thus impairing their objectivity and integrity.
• Both common law and statute law (s. 181(1) Corporations Act 2001) expect the directors to conduct their activities in good faith and not to engage in any activity or decision which can harm the company and shareholders’ interest. There was breach in this regards as the accused directors of HIH acted in an dishonest manner to further their material personal interests ahead of the company.
• Section 182 imposes that there is no abuse of power from directors either to gain any material benefit for any party (self or other). However, the conduct of the accused directors at HIH clearly indicates that their use of power was to derive material gains for self along with their associates (such as auditors) which left the company and shareholders at a material loss.
• Section 182 imposes that there is no abuse of confidential or private information on part of directors either to gain any material benefit for any party (self or other). However, the conduct of the accused directors at HIH clearly indicates that this duty was breached since private price sensitive information was leaked to outside parties leading to share price manipulation.
• There are certain other duties on directors particularly related to disclosing conflict of interest (s. 191) along with ensuring that the company does not assume incremental debt or liabilities leading to insolvent trading (588G).
• Additionally, there is restriction on the company in accordance with s. 260A which forbids extension of financial assistance to outsider with the intention of purchasing own company shares. Such a practice could lead to share price manipulation and thereby harm the interest of investors and hence allowed only when investors would not be materially impacted.  There has been breach in this regards since an external entity was given financial assistance with the specific objective of buying company shares so as to support the price while providing exit to the directors’ holding and thereafter dump the shares to the peril of the investors.
• Another noteworthy observation is that while common law limits punishment for directors to only civil penalties, it is not the case under Corporations Law since strict and absolute personal liability is permissible and thus directors may also get capital punishment especially if their conduct is fraudulent as observed in the ASIC v Adlercase.