Advice On Business Structures And Director’s Responsibilities

Research on Relevant Law

The two business structures that need to be discussed in this case which are partnership and company structure.

Partnership may be defined as a business structure where there are more than one owners having stake in the business and are known as partners. The underlying rights and obligations of partners is outlined in the partnership agreement which is usually written and forms the basis of the partnership. The partnership agreement may or may not be registered. Also, partnership must be for profit purpose only and has common ownership. Some of the key attributes of partnership are highlighted as follows.

• The partnership is not a separate legal entity and hence is known by the partners.
• There is unlimited personal liability on the partners in regards to the contractual relations that the business or partners may enter into for business. However, it is noteworthy that personal liability on the partners can be limited through the use of alternative partnerships such as limited partnership and LLP (Limited Liability Partnership).
• If there is change in the partners or their respective shares, then the existence partnership firm ought to be dissolved and a partnership firm needs to be put in place.
• In a partnership firm, every partner acts as both principal and agent. Every partner acts as agent when he/she is representing the firm or the absent partners. Additionally, each partner also acts as principal since the decision of the other partners acting as the agent with outside parties would be binding on the firm and the remaining partners.

Company is a business structure which has shareholders instead of partners and also the number of shareholders can be significantly large. The name of each company is unique and each company has to be registered with ASIC. The various attributes to company are as follows.

• The company has a separate legal entity which has been captured in s. 124(1), Corporations Act 2001. Thus, unlike partnership, the company can enter into contracts with internal and external parties giving rise to contractual rights and obligations for which the company would be liable.
• A key feature of company business structure is succession on perpetual basis. This becomes possible since company has existence that is not dependent on the shareholders. Besides, the company’s shares are transferrable and thereby the current investors in the company can transfer their shares to others with or without consideration.
• The liability of the shareholders of the company is limited to the amount of equity investment that has been invested in company. Thus, unlike partnership, there does not exist any personal liability for the shareholders for the unpaid debts and unsettled creditors of the company as highlighted in Salomon v A Salomon and Co Ltd
• Also, for the execution of various contracts, the company or common seal is used as company’s signature besides the signature of the designated agents in accordance with s. 123 of the Corporations Act 2001.

The key objective of this section is to highlight the relative advantages and disadvantages of the two business structures which have been introduced above.

• Unlike the other business structures (i.e. sole trader and partnership), the company offers limited liability and hence in case of any business liability, the personal wealth of the owners are shielded from liquidation. This is because there is difference in company assets and personal assets as apparent from the verdict in the Salomon v A Salomon and Co Ltd.
• Additional benefit of running business in the form of company is that the ownership may be altered for raising additional financial resources. For the other business structures, the transfer in equity cannot be done since the others are not separate legal entities. Hence, additional finance can be arranged without dissolving the company in accordance with s. 1.5.6 Corporations Act 2001.

• A particular disadvantage of the company structure is on account of the underlying legal formalities which are required for company formation and registration. Such legal formalities are minimal for other business structures.

• Further, companies are governed by a higher regulation burden in comparison to other business structures. As a result, on periodic basis, the company needs to lodge various documents such as financial reports etc.

• The main advantage of partnership structure is the ease with which this can be established as only a partnership agreement is required which may or may not be registered. Thus, a partnership firm may be formed at short notice.
• The regulatory burden is quite limited since there are no reporting requirements for a partnership firm on a periodic basis.
• Another advantage is that in a partnership structure, there are multiple partners and hence more resources are available for running the business. This aspect makes partnership superior to the sole trader business structure.

• One of main disadvantages of partnership structure is that the liability of partners is potentially unlimited. This is because the partnership is not a separate legal entity and hence the liabilities of the business extend to the partners and hence their personal assets can be liquidated for discharging the business liabilities.
• Another disadvantage of partnership structure is that raising incremental finance may be difficult considering that new partners cannot be inducted into the partnership. If the partners change, then the partnership firm has to be dissolved.

For the given clients, considering the nature of business, a partnership firm would be more suitable. This is because the real estate sale business does not involve any significant capital for running the business or expansion of the same. As a result, the business would not need to raise capital. Also, the partnership can be formed easily without any hassle which is not the case with company. This is quite important as this would provide the clients access to the clients and market before the entry of new players and further intensification of competition, thereby making the most of the opportunity at hand. Further, at this start up stage, the owners would like to minimise the overhead expenses which again makes partnership firm a preferable option with no reporting obligations. Also, there are minimal liabilities owing to given business being regulated which make partnership structure a suitable choice to begin which at a later stage may be converted into company.

One of the landmark cases in regards to duties of directors and the consequences of the breach of theses is ASIC v Adler case. This case took place in the aftermath of the noticeable bankruptcy of HIH Insurance which was one of the leading Australian insurance firms at the time.  The various takeaways of this case for directors are highlighted below.

• As per section 180(1) Corporations Act 2001, there is duty on the directors to exhibit their power and discharge their duty with adequate care and due diligence. Negligence in this regards can result is liability for the directors as was apparent in the given case where $ 10 million was extended by select officials without consulting with the entire board or the investment committee.
• Further, most executives with relation to contravention under s.180(1) tend to deploy s.180(2) as the defence. This is known as business judgement rule and would be applicable only when there is no conflict of interest and requisite measures that a reasonable person would undertake have been assumed to reach a decision. In this case, the directors could not defend under this section.
• Besides, s. 181(1) imposes the duty on directors to use their powers not only in good faith but also for appropriate reason so that the interest of the shareholders and the company is safeguarded. However, the directors of the company violated this duty in the underlying case by entering into transactions that were aimed at personal interest and not interest of company.
• The directors also have the duty under s.182(1) so that the power provided to them is not used to bring benefit to themselves or any associate. In this case, the company directors were in violation of this duty because first a $ 10 million loan was provided to a entity (PEE) which then invested this money into purchasing share of HIH Insurance. This transaction was enacted only to support the share price of the company and thus represents abuse of position and contravention of aforesaid duty.
• Further, a director owing to the privileged position has access to confidential information and thus section 183 imposes the duty on directors not to use this information for benefit of self or associates. Further, this duty is also applicable on the retired and former executives. In the given case, insider information was given to an outsider based on which share trading in HIH Insurance was performed which contravenes this section.
• Besides, it is noteworthy that s.260A forbids extension of financial assistance to any entity or individual for the purpose of buying shares of the company. This is permissible only when such an activity does not have material impact on the shareholder’s interest. Clearly, this is not true in the given case as the company extended money to PEE for share purchase so that prices of HIH share be supported thereby allowing Alder Corporation to sell the shares.
• Also, the directors of other companies must notice that penalties of breach of the various duties are not limited to only civil liability in the form of fines but may also attract capital punishment. This is especially the case when the concerned director has been dishonest and deceitful in conduct and discharge of duty.

References

Austlii, Corporations Act 2001- Sec 182 https://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s5(182).html%3E

Austlii, Corporations Act 2001- Sec 183 https://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s5(183).html%3E

Latimer, Paul, Australian business law, (CCH Australia Ltd, 24^th ed., 2005)

Julie, Cassidy, Corporations Law Text and Essential Cases, (Federation Press, 4^th ed., 2013)