UNIT 1 - Business Mediums Flashcards
A client wishes to set up a new business with a friend. She does not know whether she would like to trade as a partnership, limited liability partnership or company. The business is a clothing manufacturing business and eventually the client and her friend would like
to attract business from multinational retailers. They want to make their business seem as professional as possible to attract business from other parts of the world. They will need to take out substantial loans in the future to expand. They do not envisage anyone joining them in running the business, but they will be taking on employees.
Which of the following best describes the type of business that the client should set up?
A) The client’s best option would be to start a partnership because the process is informal, there is no obvious reason why the client and her friend would need their liability for the business’s debts to be limited, and there would be no need for them to grant a floating charge.
B) The client’s best option would be to start a company because the shareholders’ liability for debts would be limited, they would be able to attract finance because companies can grant floating charges, and the company is a widely recognised business medium worldwide.
C) The client’s best option would be to start an LLP because the partners’ liability for debts would be limited, they would be able to attract finance because LLPs can grant floating charges, and the LLP is a widely recognised business medium worldwide.
D) The client’s best option would be to start either an LLP or a partnership because there will only be two partners and there is no need to start a company and have the burden of the legal and administrative requirements it brings.
E) The client’s best option would be to start a company or an LLP because this will enable them to run the business in a more organised way, whereas partnerships tend to be run more informally because no partnership agreement is necessary.
CORRECT ANSWER B - In a trading business, having limited liability for the debt of the business is an advantage because of the risk of paying for materials and then not being paid for
the manufactured goods and being in debt. In a partnership, the liability of the partners is unlimited. Accordingly, option A does not represent the best advice in the circumstances. Further, the client wants to attract finance so a company or LLP would be better than a partnership, because they can grant floating charges. The company has a higher status than an LLP and is more widely recognised worldwide, which would benefit the client because she has said they want to attract international business. Accordingly, the option of starting an LLP set out in options C to E does not represent the best advice to the client.
A client wishes to set up a private company limited by shares (ordinary £1 shares only) and, following advice, wishes to adopt the Model Articles in their entirety. The company is being formed for the lawful purpose of selling clothes. The client has already supplied the necessary information regarding the company’s shareholders.
Which of the following best describes the additional information that should be requested from the client before completing form IN01?
A) The identity, date of birth and service and residential addresses of the proposed company’s directors and any company secretary, the address of the registered office, a registered email address and the name of the company.
B) The identity, date of birth and service and residential addresses of the proposed company’s directors and any company secretary, the address of the registered office, a registered email address, the name of the company and the contents of its articles of association.
C) The identity, date of birth and service and residential addresses of the proposed company’s directors and any company secretary, the address of the registered office, a registered email address, the name of the company and whether the client wishes to appoint additional directors once the company is incorporated.
D) The identity, date of birth and service and residential addresses of the proposed company’s first shareholders, directors and any company secretary, the address of the registered office, a registered email address, the name of the company and the contents of its articles of association.
E) The identity, date of birth and service and residential addresses of the proposed company’s first shareholders, directors and any company secretary, the address of the registered office, a registered email address, the name of the company, any trading name of the company, the number, type and nominal value of the shares and the contents of its articles of association.
CORRECT ANSWER A - All of this information is needed in order to complete form IN01 and
the client has not yet provided it. The client wishes to adopt the Model Articles so they do
not need to be asked about the contents of the proposed company’s articles. Similarly, we already know the company will have ordinary £1 shares, so we only need to know how
many shares the client wishes the company to have on incorporation. The IN01 does not need the company’s trading name: this is a business decision which can be made following incorporation, as can the decision to appoint more directors. Lastly, we are told that the client has already provided any necessary details of the company’s shareholders, so information about them is not needed.
What is the concept of separate legal personality?
A) All businesses have a separate legal personality from the people that run and/or own them
B) All businesses have a legal separation between the owners and managers
C) Only companies can have separate legal personality
D) Companies and some partnerships have separate legal personality
E) Multiple individuals cannot be treated as a single legal person unless trading together as a partnership.
CORRECT ANSWER D - Companies and Limited Liability Partnerships benefit from a separate legal personality. Allowing them to (amongst other things) own property, enter into contracts and sue in their own name.
What is the concept of limited liability?
A) Limited liability means that there is a cap (£1,000,000) on the amount that the business will have to pay to settle any individual debt.
B) Limited liability allows the owners of a business to limit their liability for the debts of the business to the amount they have agreed to contribute.
C) Limited liability is impossible under the laws of England and Wales.
D) Limited liability prevents the managers of a business from having to contribute to the assets of the business in an insolvency situation.
E) Limited liability means that the owners of a business will only lose the amount they have already invested.
CORRECT ANSWER B - Shareholders buy shares in their company. If they fully pay for their shares (which is almost always the case) then even if the company becomes insolvent, they can only lose the money they have already paid. In the rare circumstances where the shares are not fully paid, the shareholders can be asked to pay the remaining money owed on the shares.
A very similar concept applies to LLPs.
Option D is wrong because the concept of limited liability does not apply to managers of the business only the owners. The managers of the business did not have any liability for the debts of the company at all so it would not need to be limited (except in very unusual circumstances where their conduct has been in breach of the relevant legislation).
Two people go into business together. They have set up a general partnership, they are both partners. The partnership dissolves and after the assets have been sold it still owes creditors £4,000.
How much will the two people have to pay between them?
A) Nothing. The principle of limited liability prevents any further contribution from the partners.
B) £4,000.
C) £2,000.
D) £8,000.
E) An unlimited amount.
CORRECT ANSWER B - between them they must cover the whole of the partnership’s debt. This may mean that person A covers the whole debt or person B does (or any combination in between). The most likely outcome is they will split the debt between them and pay £2,000 each.
Two people go into business together. They have set up a private company limited by shares, they are both equal shareholders. Their shares are fully paid. The company becomes insolvent and, after the assets have been sold it still owes creditors £4,000.
How much will the two people have to pay between them?
How much will the two people have to pay between them?
A) Nothing. The principle of limited liability prevents any further contribution from the partners.
B) £4,000.
C) £2,000.
D) £8,000.
E) An unlimited amount.
CORRECT ANSWER A - There has been no indication of wrongdoing, and person A and person B have both already paid for their shares in the company. The principle of limited liability prevents any further money being due to the creditors from the shareholders.
Two people go into business together. They have set up a limited liability partnership, they both made equal capital contributions and they are both designated members. The LLP becomes insolvent and after the assets have been sold, it still owes creditors £4,000.
How much will the two people have to pay between them?
A) Nothing. The principle of limited liability prevents any further contribution from the partners.
B) £4,000.
C) £2,000.
D) £8,000.
E) An unlimited amount.
CORRECT ANSWER A - There has been no indication of wrongdoing, and person A and person B have both already paid their capital contribution. The principle of limited liability prevents any further money being due to the creditors from the partners in an LLP.
A man owns all the shares in a private company limited by shares. He is also the only director. The company has Model Articles.
The company is a fraudulent telemarketing company that sells advertising space to other companies on a directory that does not exist. In order to protect his money, in case his crimes are discovered, he creates a holding company (owned by himself) and transfers all the company’s assets to its holding company.
Once evidence of the crimes comes to light, which of the following options best describes the options available to creditors?
A) Separate legal personality and limited liability mean that only the assets in the company are available to creditors.
B) The company and its holding company are a single economic unit and therefore the funds in both companies will be available to creditors.
C) As the man is the sole director and sole shareholder of the company (sometimes referred to as a “single member company”), he will be liable for their debts in any event.
D) Companies cannot commit crimes if other companies are the victims. A natural person must be either the perpetrator or the victim in order for there to be a crime.
E) The holding company will be liable for the debts of the company as the owner is deliberately evading an existing legal obligation by interposing a company under their control.
CORRECT ANSWER E - This a clear case of a fraud or sham as set out in Salomon v Salomon. But it is the later test of Prest v Petrodel Resources Limited which is the more recent case and the most relevant. When the owner is deliberately evading an existing legal obligation by interposing a company under their control the veil can be pierced. If the holding company’s assets were insufficient to satisfy the debts, the man’s resources would also be available.
A woman owns 45% of the shares in the company. The company has four directors (the woman is not a director). The company has five shareholders which are the woman and the four directors.
How would you describe the woman’s role within the company?
A) The woman is able to vote at shareholder meetings and is also able to take part in the day to day management of the company.
B) The woman is not able to vote at shareholders meetings but is able to take part in the day to day management of the company.
C) The woman is able to vote at shareholder meetings but is prohibited from being a director.
D) The woman is able to vote at shareholder meetings but is not able to take part in the day to day management of the company.
E) The woman is not able to vote at shareholder meetings and is not able to take part in the day to day management of the company.
CORRECT ANSWER D - The shares owned by the woman allow her to vote at shareholder meetings but only directors take part in the day to day management of the company. It is true that model article 4 allows the shareholders to instruct the directors to perform a specified action - however this is not the same as continual day to day management decisions and the woman does not control enough shares to give such an instruction on her own.
A woman is the managing director of a private company limited by shares. She is the chairperson of the board of directors and oversees the running of the company.
What decisions is the woman able to take on her own?
A) As a majority shareholder, the woman can appoint new shareholders in order to pass any decision that she chooses to.
B) The woman can choose to remove the other directors if they do not comply with their instructions.
C) The default position is that all management decisions are taken by the board of directors as a whole (majority vote).
D) The woman is able to make all day to day management decisions on her own if she holds the position of managing director and chairman of the board.
E) The woman is not able to take part in any decisions regarding the day to day management of the company.
CORRECT ANSWER C - Although in practice the woman may have been given delegated powers to make certain decisions on their own, the default position is that all management decisions are taken by the board of directors as a whole (majority vote). The woman may not be able to make decisions on her own, but she does take part in the decisions as she is a director.
A man is already trading in a business along with a friend. They own and run a market stall together, splitting the profits between them. They have not filed any forms or performed any sort of formalities, they just started trading.
Which type of business medium are they most likely to be?
A) Two separate sole traders.
B) A general partnership.
C) A limited liability partnership.
D) A private company limited by shares.
E) A public company limited by shares.
CORRECT ANSWER B - Only general partnerships and sole traders can begin without any sort of forms/formalities. As the two of them meet the definition of a partnership - more than one person, with a business in common and a view to a profit - they are in a general partnership.
How is the concept of separate legal personality best expressed?
A) The creation of another person who takes on the business’s liabilities. The owners are shielded from any liability over and above the amount they agreed to invest.
B) A separate legal person is a private company limited by shares or a limited liability partnership.
C) Separate legal personality is the same legal concept as limited liability.
D) Within a general partnership, the partners may trade under a single name (a trading or business name) but the individual partners retain their own legal personalities with regard to creditors of the company.
E) The creation in law of another “person” which represents a business. That “person” is capable of many things, such as owning property and signing contracts in their own name. In this way they can do some of the things a human being can do.
CORRECT ANSWER E - Option A describes limited liability more than it describes separate legal personality. Option B leaves out the obvious example of a public company limited by shares but there are other examples which we have not studied as well. Option C conflates separate legal personality with limited liability, and this is not the case - they rely on each other, but they are not the same thing. Option D is not a real concept. Option E is the correct answer.
Three partners set up a partnership together. One partner was negligent and did not check one of the deliveries sent to a customer. As such, the customer successfully sued under the contract with the partnership. The partnership does not have enough money to pay any of the debt.
With regard to this liability to the customer, which of the following best describes the situation:
A) The negligent partner is personally liable for the whole amount.
B) The negligent partner must pay the customer the full amount owed.
C) The partners are each personally liable for one third of the total amount.
D) Any one of the partners (or any combination of them) could be asked to pay the entire amount personally.
E) There is no personal liability for any of the partners after they have paid their initial capital contributions to the partnership.
CORRECT ANSWER D - Even though the Partnership Act only refers to joint
liability, a later act called the Civil Liability (Contribution) Act 1978 made partners
jointly and severally liable. This means that any one, any combination, or all of the
partners can be sued for the entire amount. So, in our scenario, the negligent partner
could be sued for the whole amount - or one of the other partners could - or both of
the other partners could be sued together - there are plenty of possible
combinations. If the customer choses to sue one or 2 of the partners, then the ones who end up paying can seek a contribution from the partners who have not paid. In an ideal
world, unless they have an agreement to the contrary, they will all end up paying one
third each. However, it is possible that one of them cannot pay their full share and
the other partners are left footing the b
A private company limited by shares is created by a business person. The company is 100% owned by the business person, and the only director is the business person. The business person lends the company £10,000 in order to buy new machinery. The company has not repaid any of the loan yet. The company did not grant any security to the business person.
Who is the legal owner of the machinery?
A) The business person - because the business person made the loan to the company for the sole purpose of purchasing the machinery and the loan has not yet been paid off.
B) The business person - because the business person controls and owns the company through the positions of 100% shareholder and sole director.
C) The company - because they did not grant any security to the business person.
D) The company - because they own the shares.
E) The company - because they are a separate legal person.
CORRECT ANSWER E -. This question refers to Salomon v Salomon and the
arguments put forward about separate legal personality. The fact that the company
owes money to the business person is irrelevant, it does not affect the ownership of
the machinery. Similarly, the “single member company” argument was rejected by
the courts, so having a 100% shareholder and sole director makes no difference.
Option D cannot be correct as a company cannot own shares in itself.
Option C has some merit, because it is possible through some types of security -
notably a legal mortgage - to transfer legal ownership. However, option E is the
single best answer as the overriding principle here is separate legal personality
When can the corporate veil be pierced?
A) When the owner is deliberately evading an existing legal obligation by interposing a company under their control.
B) When the owner is deliberately evading an existing legal obligation by interposing a company under their control or if maintaining the corporate veil would result in “manifest injustice”.
C) When a group of companies forms a single economic unit or if maintaining the corporate veil would result in “manifest injustice”.
D) When a group of companies forms a single economic unit or when the company is enabling a fraud or a sham.
E) When the needs of equity require that justice be served.
CORRECT ANSWER A - You must combine the examples given in two of the
cases studied in the prep task - Salomon and Prest v Petrodel. Salomon discussed
piercing the veil when there was dishonesty - i.e. a fraud or a sham and Prest v
Petrodel made the point that the veil could be pierced if the owner was deliberately
evading an existing legal obligation. The single economic unit argument was
dismissed in Cape v Adams and the concept of “manifest injustice” or that “justice be
served” do not apply to this contex
