UNIT 1 - Business Structures Flashcards
Which of the following statements best explains the concept of limited liability?
A) A validly incorporated company has its own separate legal personality.
B) A validly incorporated company is not liable for its own debts.
C) The shareholders of a validly incorporated company will be liable for the debts of the business but only to the extent of their investment in the company.
D) The directors of a validly incorporated company will not be liable for the debts of the company.
E) A creditor of a validly incorporated company can choose to sue any or all of the shareholders of the company.
CORRECT ANSWER C
An entrepreneur set up a private limited company three years ago. The entrepreneur was issued with 10,000 shares, which were paid for in full. The entrepreneur is the sole shareholder and director of the company.
Recently, the company has struggled financially. It has an overdraft of £20,000. When the company agreed the overdraft facility with the bank two years ago, the bank asked for a personal guarantee from the entrepreneur for the amount of the overdraft. The entrepreneur signed a written guarantee agreement with the bank, agreeing to be personally liable for all amounts owed to the bank in the event that the company fails to pay. The company is insolvent and has no assets with which to pay its creditors .
Is the entrepreneur liable for the £20,000 owed to the bank?
A) Yes, because the entrepreneur is the sole shareholder.
B) No, because the entrepreneur has the protection of limited liability.
C) Yes, because the entrepreneur is the sole director.
D) No, because the contract for the overdraft facility is a contract between the bank and the company.
E) Yes, because the guarantee is a separate contract between the entrepreneur and the bank.
CORRECT ANSWER E
Which one of the following law firms is an unincorporated business entity?
A) The City firm, Slaughter and May.
B) The City firm, Linklaters LLP
C) The Leeds based firm, Clarion Solicitors Limited
D) The national group of solicitors’ firms, Gateley plc
E) The Cambridgeshire based firm, Copleys Solictitors LLP
CORRECT ANSWER A - Slaughter and May is not a separate legal entity. It is a partnership, an unincorporated business entity. You will note that size is not relevant. Slaughter and May is an international firm with over 100 partners and has never been incorporated as either a limited liability partnership or a company.
The other options are wrong. These all refer to separate legal entities, or ‘legal persons’, which you can tell from their names: Linklaters LLP is a limited liability partnership, Clarion Solicitors Limited is a private limited company, and Gateley plc is a public limited company. The comparatively small Cambridgeshire firm, Copleys Solicitors LLP, with only four members, has been incorporated as a limited liability partnership.
[Note that here we have referred generically to ‘law firms’ and ‘firm’. s.4 of the Partnership Act 1890 provides that the persons who have entered into business in partnership are collectively called a ‘firm’ (The word ‘firm’ describes in the singular what is, in fact, the partners in the plural.). The partners of Slaughter and May can therefore be described as a ‘firm’. The others are not technically ‘firms’ in the strict legal sense but will often be described as such.]
A client, an entrepreneur, is proposing to set up in business working with two friends. The client wants to do so quickly, with the minimum of formality and to minimise any legal costs. The client wants to be responsible for the day to day management decisions of the business himself. The client will invest £100,000 in the business, which will have minimal borrowings. Neither of the two friends are in a position to make an investment in the business, but they have skills and expertise which will be useful in the running of the business.
Which one of the following would be the best option for the client?
A) A general partnership
B) A limited liability partnership
C) A limited partnership
D) A sole tradership with employees
E) A private limited company
CORRECT ANSWER D - There are no formalities for setting up as a sole trader, apart from notifying the tax authorities. The client can simply open the doors and start trading. Sole traders are, however, personally liable for all the debts of the business, so the risk is greater, but the facts indicate that there would be minimal borrowing, so the risk is not substantial and the client is an ‘entrepreneur’ so may be more prepared to assume a higher degree of risk.
Option A is not the best answer. A general partnership would be less suitable as, in the absence of a formal partnership agreement (for which it would be advisable to take legal advice), the partners share responsibility for the day-to-day management of the business. Partners have joint and several liability for the debts of the business.
Options B, C and E are not the best options for the client. Setting up either a private limited company, a limited partnership or a limited liability partnership requires a formal registration process.
[Commercial awareness: The facts state that the client is an entrepreneur, and so may be more prepared to assume a higher degree of risk, but should be warned that the enterprise may become riskier in the future, if, e.g. borrowing is required to expand the business.]
A client runs a catering business with his friend. The business has not been incorporated but both the client and the friend invested equal amounts in the business and the two share profits equally. The client signed a long-term supply contract with a limited company which supplies seafood, for the regular purchase of seafood for the business. The terms of the contract were negotiated with the Purchasing Director of the seafood company by the client’s friend.
Which one of the following options most accurately describes who are the parties to the contract?
A) The client and the seafood company.
B) The client and the Purchasing Director of the seafood company.
C) The client, his friend and the seafood company.
D) The client, his friend and the Purchasing Director.
E) The client’s friend and the seafood company.
CORRECT ANSWER C - The catering business appears to be run as a partnership, as it meets the definition in s.1 Partnership Act 1890. The two friends are carrying on a business in common with a view to profit. As every partner is an agent of the firm and the other partners for the purpose of the business of the partnership, the client’s purchase of the seafood binds both the client and his friend. Both are therefore liable under the contract. Accordingly, options A and E are wrong.
Options B and D are wrong. The seafood company, as an incorporated body, can enter into contracts on its own behalf, so it is the company itself that is liable under the contract. The Purchasing Director is an agent of the company so is not personally liable.
A client and her brother are accountants practicing in general partnership. Both the client and her brother invested £10,000 when the firm was set up. There are no other partners. The client’s brother gave a businessman tax advice which turned out to be wrong. The firm has admitted negligence and has agreed to settle the dispute and pay the businessman £30,000 to compensate for the loss. The firm does not have sufficient assets to pay the debt.
Will the client be personally liable for the debt?
A) Yes, because the client is a general partner with one other, the client will be liable for his half of the debt, £15,000.
B) Yes, because the client is a partner in a general partnership, the client will be liable for the full £30,000.
C) Yes, because the client invested £10,000 in the firm, the client will be liable for £10,000.
D) No, because it was the client’s brother who gave the advice.
E) No, because the client will have the benefit of limited liability.
CORRECT ANSWER B - Partners have unlimited liability for the debts of the partnership and are jointly liable for the full amount of the debt.
Options A and C are wrong. Joint liability does not mean that partners are only liable for half of the debt and, unlike shareholders, their liability is not capped at the amount of their investment in the company.
Option D is wrong as partners are jointly and severally liable, regardless of who concluded the contract.
Option E is wrong. The liability of a partner for the debts of the partnership is unlimited, not limited.
Two friends have set up a private limited company, which is a client of the firm. The friends are both shareholders in the company and have paid in full for their shares in the company. One of the shareholders is also the Managing Director. There is one other director, the Finance Director, who is not a shareholder.
The Managing Director has transferred an item of equipment to the company in exchange for shares.
The Finance Director has entered into a contract with the Sales Manager of a computer company to purchase two laptops, with delivery due in three days and payment in cash within 28 days of delivery.
Which of the following statements best describes the position in relation to these transactions?
A) The client company will own the laptops but not the item of equipment.
B) The parties to the contract for the purchase of the computers will be the Finance Director and the Sales Manager of the computer company.
C) The parties to the contract will be the two shareholders of the client company and the shareholders of the computer company.
D) If the computer company fails to deliver the computers, the client company can bring an action for breach of contract in its own name.
E) If the client company cannot pay for the computers at the end of the 28 day credit period, the shareholders will be personally liable to pay the full purchase price.
CORRECT ANSWER D - A company is a legal person in its own right and can therefore do most of the things which a human person can do, including entering into contracts, owning property and, as here, bringing an action for breach of contract in its own name.
Option A is wrong. The item of equipment has been transferred to the company and paid for by the company issuing shares to the Managing Director, so it will own that item and also the computers (which will be paid for in cash).
Options B and C are wrong. As companies can enter into contracts in their own name, the client company and the computer company themselves – not the directors, shareholders or employees – will be the parties to the contract.
Option E is wrong as the company is liable for its own debts. The shareholders have limited liability for the debts of the company, and are not personally liable.
A company makes yoghurts and other dairy products. It has four shareholders who are also the four directors of the company. It has a company secretary. The company is profitable. It has outgrown its existing premises and needs to move to a larger factory. Two of the directors negotiate the purchase of a new large factory on an industrial estate on the edge of the town. The same two directors sign the contract and transfer document on behalf of the company.
Which of the following best reflects whose name(s) will appear on the registered title of the property?
A) The names of the two directors who signed the contract and transfer document.
B) The names of all the directors.
C) The names of one of the directors and the company secretary.
D) The names of all the shareholders.
E) The name of the company.
CORRECT ANSWER E - The company is a separate legal person capable of owning all property, including land in its own right.
Options A, B and C are wrong. The directors who signed the documentation are acting as agents of the company in the transaction, and have done so on behalf of the company.
Option D is wrong. The shareholders own shares in the company, which give them certain rights, including a right to a share of the assets of the company when it is wound up, but they do not own its assets (including land) themselves.
