Business Organisations Notes

Business Organisations

Learning Outcomes

• Define and distinguish between different types of organizations.
• Understand the importance of limited liability in companies.
• Identify the main differences between private and public companies.
• Understand the concept of separate legal personality, including holding and subsidiaries.
• Understand the role of the Companies Act 2006 in business organizations.

Methods of Trading

• An individual who wishes to create his own business can form one of the following business structures:
  • Sole Trader
  • Business Partnerships
  • Companies
    • Public
    • Private

Key Components of Business Structure

• When comparing these three structures, we will consider the four key components of any business structure:
  • Capital
  • Liability
  • Organizational Structure
  • Accountability

Sole Trader

• Simplest form of trading with no formalities.
• It is a one-person organization.

Capital

• Responsible for funding the business, usually from personal savings or loans.

Liability

• Contracts in his own name.
• Earns all the money from the business and entitled to all the profits.
• Personally liable for all losses/debts sustained by the business.
• Sole trader, therefore, has unlimited liability for losses and debts, as the sole trader and the business are considered one and the same entity.
• If the business falls into financial difficulty, creditors can call in his personal wealth in order to settle debts, leading to a high possibility of bankruptcy if the business fails.

Ownership and Control

• The sole trader has sole ownership and control over the business and its assets.
• The property of the business is considered his property, and he has complete control over what is done with the property and any other business assets.

External Accountability and Regulation

• Sole trader is considered independent and self-accountable.
• No requirements to disclose accounts publicly or reveal his state of affairs to anyone.
• Not regulated by Companies House; do not have to file annual returns or accounts.
• There is minimal legal regulation of sole traders; only obligation is to file a tax return annually.
• May need to register their premises for business use with the Local Council and, if they trade under a certain name, comply with the Business Names (NI) Order 1986 as amended.

Business Partnership

• Bound by mutual trust and confidence.
• A common form of business structure when two or more persons wish to engage in business together.
• Partnership is defined as: ‘The relationship which subsists between persons carrying on a business in common with a view to profit’…. Partnership Act 1890 s1.

Capital

• Capital usually comes from partners (equally or in agreed percentages).
• May fund this from their own pocket – personal savings/loan in the name of the partnership.

Liability

• No distinction is made between the assets belonging to the partners and the assets belonging to the partnership.
• Partners are entitled to an equal share of the profit; each partner is also equally liable for any debt/loss of the business.
• Each partner has unlimited liability.
• This type of business carries great risk; personal wealth can be used to pay business debts, a risk shared with the other partners equally.

Ownership and Control

• Ownership and control can be apportioned equally over the business and the assets or according to initial capital investment/participation, etc.

External Accountability and Regulation

• Partners are accountable to each other and bear the consequences of each other's decisions.
• Not accountable to an external body and do not have to reveal the state of affairs to anyone.
• Not considered a Company; not regulated by Companies House.
• Do not have to file annual returns or accounts.
• There is minimal legal regulation – only obligation – file tax return annually.
• May need to register their premises for business use with the Local Council and if they trade under a certain name – comply with the Business Names (NI) Order 1986 as amended.

Companies and Limited Liability

What is a Company?

• Most common form of business structure.
• Must be registered with Companies House.
• Upon registration, the company will receive a ‘Certificate of Incorporation’ as evidence that their company is now registered or ‘incorporated’ under the Companies Act.
• All Companies must comply with Companies Act 2006, Companies (NI) Order 1986, Insolvency (NI) Orders 1990.
• A company will consist of members and directors; in small companies, these may be the same people.
• Can be public (registered; ‘PLC’; limited by shares or guarantee; shares or securities offered to the public) or private (‘Ltd’ or ‘Limited’; shares or securities not offered to the public).
• A company can have either limited or unlimited liability.

Limited Liability Explained

• A fundamental difference between a Company and a partnership or sole trader is the ability of the Company to trade with limited liability.
• This only becomes an issue if the business fails or has to be wound up.
• A partner/sole trader is personally liable for all business debts because of the unlimited liability.
• In a limited company, members have limited liability for the debts/losses of the company.
• They are not personally responsible for the debts or losses of the company; their personal wealth remains intact.
• The company is a separate legal entity, ensuring it is separate from those who own/run it.
• This separate legal entity is referred to as Corporate Personality.
• Corporate Personality ensures that members of a company have limited liability for the debts of the company.
• From a liability perspective, a company is the least risky form of business choice.
• The majority of companies are limited by shares or guarantee.
• Liability is limited to the amount that is unpaid (owed) on their company shares (if any) or the amount stated on the guarantee.

Limited by Shares

• A Company limited by shares is the most common type of limited company.
• Each member of the company owns at least one share in the company.
• When they purchase the share, they do not have to pay the full amount.
• The member is liable to pay the outstanding amount owed on their share if the company gets into financial difficulty.
• Therefore, liability of a member in a company limited by shares is limited to the amount they owe on their shares.

Limited by Guarantee

• A select number of private companies and many charities are limited by guarantee.
• Applies to education and charitable companies.
• Public companies can only be limited by shares and not by guarantee.
• Members guarantee to contribute a certain specified amount if the company gets into financial difficulty.
• The members liability is limited to the amount they have guaranteed to pay when the company was set up – in the Constitution of the Company.

Advantages and Disadvantages of Limited Liability

• Limited Liability is a great incentive for entrepreneurs; it encourages them to set up, invest, and take risks, knowing that their personal wealth is not at risk.
• Protects a company’s assets from being called in the event of a company member declaring personal bankruptcy.
• Disadvantage: Creditors bear all the financial risk if the company becomes insolvent.

Public and Private Companies

Ownership and Control

• The company is owned by members who will own at least one share (shareholders).
• Members vote on important issues, but directors have day-to-day control and management of the company and are accountable to the shareholders for any decisions made.
• Division of ownership and control is unique to a company structure.

Accountability and Regulation

• Companies are subject to considerable external regulation and accountability, in particular, public companies, because of their dealings with the general public.
• Companies must comply with the Companies Act 2006.
• From the point of registration, the Registrar at Companies House will supervise the incorporation and dissolution if necessary.
• The company is under an obligation to file Annual reports in Companies House (Cardiff).
• Public companies must disclose more information than private companies, e.g., they must disclose information to external regulatory bodies - stock exchange.

Public and Private Companies – Characteristics in Common

• Registration
  • All companies must apply and be registered with the Companies Registry and have a Certificate of Incorporation.
• Regulation
  • All governed by the Companies Act 2006 and other legislation. Public Companies are subject to more regulation and control.
• Separate Legal Entity
  • Have a separate legal entity distinct from members.
• Liability
  • Members have limited liability.
• Publicity
  • Must make available certain information each year to the public.
• Management
  • Owned by members and controlled by directors.

Public and Private Companies – Characteristics in Contrast

Separate Legal Entity – Corporate Personality

• Fundamental basis of company law in the UK.
• The company is known as a separate legal person, albeit an ‘artificial person’ in the eyes of the law.
• The company as a separate entity can enter contracts with natural persons or other companies, sue or be sued, borrow money in the company’s own name, own property, commit crimes, etc.
• As the Company is an artificial person, it can continue to exist even after the death of its owners, known as perpetual succession.
• The company is liable for debts in the event of a winding up, not the natural person. Assets of the company and those of the natural person are separate; the natural person has limited liability for company debts.

Salomon v Salomon [1897]

• The concept of the separate ‘corporate personality’ was first recognized in the case of Salomon v Salomon [1897].
• Held that on formation, a company becomes a legal entity, separate and distinct from its members.
• Mr. S made and sold boots/shoes as a sole trader; he incorporated his business into a limited company; he owned the majority of shares, and his family owned 6. On incorporation, the company created a debenture to the value of £10,000 in favor of Mr. S, meaning that in the event of a liquidation, the company would have to pay secured debts first, so Mr. S’s debt would be a priority.
• The company went into liquidation; liquidators tried to prevent the debt from being paid to Mr. S, saying he and the company were one and the same; the debt belonged to Mr. S and the company.
• HOL’s – as the company was properly incorporated –company was separate to Mr. S – debenture was valid – he was entitled to repayment of the debt by the company.

Characteristics of a Separate Legal Entity (SLE)

• Limited Liability
• Transferable shares
• Perpetual succession
• Asset rights and liabilities are those of the company and not its members as per Macaura v Northern Assurance (1925).

Perpetual Succession

• Perpetual succession refers to the continuous existence of a company or corporation, regardless of changes in its membership, ownership, or management. This concept is closely tied to the idea of a separate legal entity, which means that a company is legally distinct from its owners (shareholders) and managers.
• In terms of a separate legal entity, perpetual succession ensures that a company continues to exist even when individuals associated with it, such as shareholders or directors, die, resign, or transfer their shares. The company’s operations, rights, and obligations remain unaffected by these personal changes because the company itself has its own independent legal identity.
• For example:
  • If a shareholder of a company passes away, the company continues to function as usual without being dissolved.
  • The company's contracts, debts, and assets are retained under its name, not under the names of its individual members or shareholders.
• This concept is a fundamental feature of corporations, protecting the entity from being dissolved due to personal changes in ownership or management, thereby ensuring stability and continuity.

Macaura v Northern Assurance Co Ltd (1925)

• Reinforces the principle that a company, as a separate legal entity, owns its assets, holds its rights, and bears its liabilities independently of its members (shareholders or owners).
• Key Facts of the Case:
  • Mr. Macaura was the sole shareholder of a timber company. He owned a large quantity of timber, which he sold to the company, becoming its largest creditor. However, he insured the timber in his own name rather than in the company’s name. Later, the timber was destroyed in a fire, and Macaura sought to claim the insurance.
  • The insurance company refused to pay, arguing that Macaura had no insurable interest in the timber because it was owned by the company, not him personally. As a shareholder, he did not have ownership of the company’s assets, only shares in the company itself.
• Legal Principle:
  • The House of Lords ruled in favor of the insurance company, stating that:
    • Ownership of Assets: The timber was owned by the company, not by Mr. Macaura, despite him being the sole shareholder. A company, as a separate legal entity, owns its own assets. Shareholders, even if they own all or most of the company’s shares, do not have a direct claim over the company's assets.
    • Insurable Interest: Since Macaura was not the legal owner of the timber, he had no "insurable interest" in it and thus could not claim compensation for its destruction. The company, as the owner of the timber, should have taken out the insurance in its own name.
• Implications of the Case:
  • Separate Legal Entity: This case reinforces the concept that a company’s assets, rights, and liabilities are distinct from those of its shareholders or members. Shareholders do not directly own the company’s property—they own shares, which give them certain financial rights but no direct interest in the company’s assets.
  • Asset Ownership and Liabilities: The assets and liabilities belong to the company itself, meaning that creditors can only claim against the company’s property, not the personal property of its shareholders. Likewise, the company's liabilities do not automatically become the liabilities of its members.
  • Corporate Veil: This case underscores the principle of the corporate veil, which separates the identity of the company from its shareholders. Shareholders cannot claim rights over company property or be held personally liable for company debts.
• In summary, Macaura v Northern Assurance (1925) established that a company's assets and liabilities are its own, and shareholders cannot claim ownership or rights over those assets, even if they are the sole or major shareholders. The decision highlights the legal distinction between the company and its members.

Holding Company v Subsidiary Company

• A holding company is a parent company, either trading or otherwise, that holds a majority of shares in another company known as a subsidiary company.
• The parent company, therefore, controls the subsidiary because of the ownership of shares, and this provides the parent company with the necessary votes to determine the composition of the board of the subsidiary.
• The term ‘holding company’ is normally used in respect of a company set up for the sole purpose of holding shares in other companies and tends to have no business of their own.

Companies Act 2006

• S.1159 CA 2006 defines a subsidiary:
  • A company is a subsidiary of another company – it is holding company – if that other company:
    • Holds a majority of voting rights in it – or
    • Is a member of it and has the right to appoint or remove a majority of its board of directors – or
    • Is a member of it and controls alone, pursuant to an agreement with other members, a majority of the voting rights in it.
• The parent company is not necessarily more powerful than its subsidiary; it may be smaller.
• They are separate legal entities; one may be involved in bankruptcy or corporate offense proceedings, and the other may not.
• They may be competitors in the same market – Hewlett Packard (Parent) and Compaq (subsidiary) – compete in the sale of desktop computers.

After Class Learning

• Complete PQ 24, 25, and 26 from Chapter 8.