Partnership – Key Features and Legal Perspectives
PART 1
The key objective of this section is to provide an overview of partnership and company as two feasible business structures along with noteworthy attributes.
The basis of partnership relationship is found in agency relationship which highlights the relation between principal and agent. In partnership, there are multiple owners who are called the partners. These partners tend to act in the capacity of agent when representing the other partners to other parties whereby act as principal when are being represented by other partners. Hence, owing to this inter-relationship within the partners, it is expected that the partners would act faithfully thereby safeguarding the interest of all the partners. This is because any contract which an authorised partner executes with any party, such a contract would be binding on the remaining partners as indicated in the Lang v James Morrison & Co Ltd case
From a legal perspective, the partnership firms need to comply with three conditions which have been specified in s.1 Partnership Act 1892 (NSW). One of these requires that partnerships conduct business on an ongoing basis rather than limiting to isolated transactions which usually is not regarded as partnership. The business ownership and operations need to be assumed as common whereby all the partners are collectively responsible. Also, in line with the judgement announced in the Bond Corporation Holdings Ltd & Anor v Grace Bros Holdings Ltd & Ors case, the partnership needs to be run with the motive of earning profit which is why clubs are not considered as partnerships
A key feature of a partnership firm is that it is recognised by the constituent partners and lacks a legal identify that is separate from that of partners. As a result, the contracts that the partnership firm enters for business are essentially entered by the partners. The consequence of this understanding is that the contractual rights and obligations arising from these contracts are also attributed to the partners. Hence, it is not surprising that partners would be held personally liable for any unsettled business liability of the partnership firm. It is noteworthy that this personal liability of the partners can potentially be limited if instead of general partnership, there is a limited partnership or Limited Liability Partnership (LLP) in place. Also, the partnership firm is dissolved if there is any change in the partners since it lacks an independent legal status. The formation of the partnership firm is based on the partnership agreement between the partners which governs all the major aspects of the partnership particularly profit sharing.
Company – Key Features and Benefits
The various aspects of the company are defined by the Corporations Act 2001. A key characteristic of company is the separate legal; identity it enjoys that is independent of the owners. This implies that the assets and liabilities of the company and shareholders are separate. Further, the contractual relationships required to conduct the business are entered in company’s name and is enacted through the authorised agents in accordance with Corporations Act 2001. For these contracts, the rights and obligations are directed to the company and the owners are insulated. This understanding has been developed more than a century ago with the verdict in the Salomon v A Salomon and Co Ltd . However, over the years there has been a abuse of this separate identity where owners have tried to commit fraud and other wrongful activities. Thus, in such cases, the courts have resorted to piercing the veil thereby doing away with the limited immunity of the shareholders to understand the true relationship between the company and owner.
Considering that company existence is independent of the owners or shareholders, hence till the time of de-registration, a company theoretically continues to exist. This is facilitated by the share transfer which allows existing investors to exit and new investors to enter. Another aspect to be noticed about the company is that the incorporation of company is a tedious affair with mandatory ASIC registration coupled with unique name and clarity on internal management and directors. Also, for running the company, there are a host of regulations which need to be complied depending on the type of company incorporated.
PART 2
Advantages
- Ease and simplicity:The process of establishment of partnership is very straight forward and same can be said about the working which is determined by the partnership agreement in place.
- Legal aspect: Partnership firm can be formed without involving in much legal formalities. A simple partnership agreement would be enough to enact partnership among the partners.
- Reporting:It is not necessary for the partnership firm to present the financial statements to any regulator which is then lowers the total regulatory costs.
- Registration: It is not imperative provision to register the partnership firm and therefore, it is free from registration hassles.
- Available resources: Higher number of partners would provide more financial resource to form the partnership firm. Also, each partner would have some experience, skill and expertise which can be beneficial to run the business.
- Distribution of profit: The profit derived by the firm would be divided among the business partners directly which is considered a favourable aspect. Additionally, the rights, fiduciary duties and liabilities are also divided among them based on the factors of the agreement.
- Common interest: The partners of the firm work for same motive which is making profit.
Disadvantages
- Liability: Partners are responsible for the unresolved liability of the firm because the partnership does not possess a separate legal status.
- Burden due to agency relations: The partners are bounded with the agency relations. It means the contract formation conducted by one partner with third party would be binding on the rest of the partners despite the fact that the partner who has entered into the contract does not exhibit the requisite authority.
- Ambiguity: It is a critical drawback of partnership as the death of one of the partners would terminate the existing partnership agreement and in order to conduct the business, a new partnership agreement needs to be prepared.
- Need of finance: Finance resourcing is another major issue as the ownership of firm cannot be given to others. It indicates that partners have to make new agreement to involve more owners for the firm.
- Limited liability:The shareholders are not responsible for the unresolved liabilities of the company because shareholders and company represent two different legal identities. Thereby, the private wealth, asset and holdings of the shareholders would not be liquidated for settling the liability of company.
- Ownership dilution: In accordance with Corporations Act 2001, the company can easily dilute its ownership to others.
- Need of finance: The finance can be obtained easily through equity dilution and issue of shares to investors.
- Certainty: The dissolution of the company is not simple as several shareholders are associated with the company and various legal formalities needs to be done before closing the company. Hence, the company is stable option for running a business in long term with minimal risk of dissolution.
- Legal aspect: Starting a company requires various legal formalities.
- Registration: It is vital to register the company with ASIC that needs a suitable name and directors along with model of operations which is time consuming.
- Costs involved: Company formation is associated with numerous compliance related costs
- Reporting:It is necessary for the company to represent the financial statements to the regulators along with comply with other applicable regulations which is then increase the total regulatory costs.
The optimal business structure for the clients would be partnership. The primarily reason for the same is that the partnership firm would allow the clients to establish a business at the earliest and thereby allow immediate entry into a competitive market. Also, the business is primarily service dominated with limited finance requirement which make partnership a suitable structure. Also, considering that clients are setting a new business, partnership firm would enable avoidance of compliance costs that are associated with company. Also, the nature of the business is regulated which would clearly demonstrate the applicable standards of customer conduct and hence help in avoiding claims and resolving the issue of personal liability for the partners.
PART 3
At the turn of the 21st century, there were some high profile bankruptcies in Australia involving established listed firms such as OneTel, ABC Learning and HIH Insurance. On close scrutiny in all these cases, the role of the directors stood out. As a result, when the Corporations Law 2001 was enacted, the duties of directors were included so as to provide it a statutory status and also prescribe punishments for breach of various duties. A prominent case involving potential breach of duties of directors after the statute had come into effect was the ASIC v Adler (2002) case.
Advantages and Disadvantages of Partnership vs Company
In this case, the defendants were some directors of HIH Insurance including the managing director. This case was brought about by ASIC with the claim that the directors of the company had not been complaint with the directors duties outlined under statute law and also common law. As a result, it was felt that directors must be personally held responsible for the consequences and losses to the investors. This was imperative as in the past the directors typically were given only civil penalties. The critical aspects related to this case which are noteworthy for directors in general have been briefly discussed below.
One of the most important duties bestowed on directors is that they should take decisions after having conducted adequate diligence so that there is no negligent action on their part which may breach duty to care which directors owe to the owners. This is as per s.180(1) Corporations Act 2001. There was a clear breach of this duty in the Adler case as the conduct of the directors was driven not by company’s interests but by their own motives and to fulfil the same, the erring directors provided $10 million financial assistance without due discussion with the appropriate committee and board of directors. It was apparent that this failure on the part of the directors was not driven by circumstances or any rational prudence but on account of conflict of interest. In such a scenario, the defence of business judgement rule provided under s. 180(2) could not be granted to the erring directors.
The directors yield a high quantum of power with regards to decision making in company on crucial aspects and s. 182 expects that this power must not be abused in extending benefit to other parties at the company’s cost. The conduct of the directors clearly was in violation of the expectation as there was abuse of the power resulting in financial assistance extension for the sake of ensuring that the directors could liquidate their share holdings at a high price. Further, the directors may have access to private price sensitive information which as per s. 183 directors are not supposed to reap person benefits. In Adler case, crucial price sensitive information was passed on thereby allowing for share price manipulation which amounted to breach of this duty.
Another duty which Corporations Act 2001 bestows on the company’s directors is as per s. 181 which highlights that faithful conduct ought to be present. This is imperative as dishonest conduct is detrimental to the interest of shareholders and the company alike. The directors in HIH Insurance did not acted in good faith and took actions which were not driven by the shareholders’ interest but instead aimed for serving their own interest. It is apparent that in the Adler case, there were violations in accordance to s. 180, s. 181, s.182 and s.183. Owing to the above breaches, the court banned the erring directors from acting as director for period of 10 years and 20 years. Additionally, hefty fines were also imposed on the two erring directors. However, it is to be noted that in relation to duties of directors being breached, there are provisions with regards to capital punishment especially when fraud is involved.
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