Legal forms of business

Question 1

What are the 6 key considerations when forming a business?

Answer 1

• Costs – How much does this business model cost to set up?
• Risk – Will the participants in the business have personal liability for debts of the business?
• Structure – Does the business model provide a clear organisational structure? Is this flexible?
• Formalities – What are the legal formalities that must be followed in running the business?
• Privacy – to what extent is information about the business required to be publicly disclosed?
• Finance – How can the business raise capital?

Question 2

Name the key characteristics of sole traders.

Answer 2

• No set up costs / formalities
• Not a separate legal entity – contracts are formed between the individual and third parties.
• Unlimited personal liability – trader’s personal assets are potentially liable to be sold to meet debts of the business
• No formal structure
• No Companies House filing or procedural requirements
• Complete privacy – no publicly filed accounts etc.

Question 3

What are the key characteristics of traditional partnerships?

Answer 3

• No set up costs / formalities – partnerships can be formed without any formal agreement or even intention. Partnerships are defined simply as a ‘relation which subsists between persons carrying on a business in common with a view to profit’ (s1(1) PA 1890)
• Not a separate legal entity
• Unlimited personal liability – joint (in contract) or joint and several (in tort) liability
• No Companies House filing or procedural requirements
• Complete privacy
• Partnerships are governed by the provisions of the Partnership Act 1890 (PA 1890).

Question 4

How do you determine the existence of a traditional partnership?

Answer 4

• Section 2 PA 1890 contains a list of rules for determining the existence of a partnership, including whether profits/losses are shared, whether a loan of money is made from one partner to another, joint-holding of property
• No one factor will suffice to create a partnership
• Northern Sales (1963) Limited v Ministry of National Revenue (1973) provides that if there is an agreement to share losses as well as profits this makes the existence of a partnership more likely.
• Case law also held that if the person is not being ‘held out’ as a partner this makes the existence less likely (Walker v Hirsch 1884).

Question 5

Terms of a partnership.

Answer 5

• Most partnerships will have some variation of express agreement (minimum provision for sharing profits and on dissolution; decision-making; appointment and removal of partners)
• If there is no express agreement, the PA 1890 contains default provisions which apply in absence of any contrary agreement. These include:
• S 24(1) Profits and losses – partners are entitled to share equally in the profits of the business, and must share equally in the losses of the business.
• S 24(6) Remuneration – partners are not entitled to a salary.
• S 25(8) Decision making – decisions arising during the ordinary course of business are decided by a majority, except for any change to the nature of the partnership business which requires unanimity.
• S 19 – Partners mutual rights and obligations can be varied at any time by their unanimous consent.
  – s 25 Expulsion – A partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority can do this.

Question 6

Limited Partnerships (LP) – key characteristics.

Answer 6

• An LP has two different types of partners:
• Limited Partners who have limited liability; must not be involved in the management of the business (‘sleeping partners’)
  – General partners who run the business and have unlimited liabiliy
• There must be at least one limited partner and general partner.
• LPs are governed by the Limited Partnership Act 1907 (as amended).
• LPs must be registered at Companies House but have no requirement to file accounts.
• LPs are not commonly used for general business but often for investment vehicles, in which an investor can put money into a business as a limited partner and allow it the business to be run by a general partnership.
• April 2017 a new sub-category of LPs was created called a private fund LP, commonly used for investment vehicles.

Question 7

Limited Liability Partnership (LLP) – Key Characteristics.

Answer 7

• Introduced by the Limited Liability Partnership Act 2000 (LLPA 2000)
• The key difference between LLPs and the above business models is that an LLP has a separate legal personality – it can enter contracts and own property
• For tax purposes, it is treated as a partnership and the members are taxed as partners, each being liable to pay tax on their shares of the income or gains of the LLP (known as ‘tax transparency’)
• Section 2(1)(a) LLPA 2000: two or more persons for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual.
• All partners have limited liability, which is limited to the amount they have agreed to pay under the terms of their partnership agreement.
• LLPs are registered at Companies House and are required to file annual accounts and other information.
• In effect an LLP is a hybrid between a traditional partnership and a company.

Question 8

Organisational structure of a Limited Liability Partnership (LLP).

Answer 8

• A flexible structure which should be decided between the partners in a formal written Members’ Agreement
• In absence of any such agreement, regulations 7 and 8 of Limited Liability Partnership Regulations 2001 contains default provisions:
  – Members must share equally in capital and profits.
  – An LLP must indemnify its members for payments made and personal liabilities incurred by them in the ordinary and proper conduct of the business of the LLP
  – Every member may take part in management but no member is entitled to remuneration for managing the LLP
  – No person can become a member or assign their membership without the consent of all existing members
  – Ordinary decision may be made by the majority of members but proposed changes to nature of business requires consent of all the members
  – there is no implied power of expulsion of a member by the majority unless the members have expressly provided for such a power in a Members’ Agreement.