Letter to John Smith on Business Structures
1.You have the task of advising clients as an accountant. John Smith has come to your office and has told you that he is considering the establishment of a small business in the fashion industry, particularly in men’s clothing. He seeks you advice in relation to the formation of the most appropriate business structure to operate his new venture.
Draft a short letter to John advising him of the key issues that you consider important. Your answer should be set out in the form of a letter. You should try and present you letter in the most informative manner that is suitable for a client.
2.Outline the various directors’ duties that exist and discuss their importance in relation to the governance of companies.
1.To
Mr John Smith
Re: Advice on the business structures which can be used by you for your fashion business
Respected Mr John
We have come to known about your business requirements. Let me brief it for you in order to avoid any misunderstandings. You want to establish a small business in the fashion industry and specifically you want to enter into the Men’s Clothing segment. You want to know which would be the most appropriate business structures for your venture. Our advice to you will incorporate information relating to all forms of business structures present legally so that you have a clear understanding about which structure would best suit your business.
Out of the various business structures available we are informing you about a few specific structures as they may be relate to your business idea
- Sole Proprietorship
- Partnership
- Joint Venture
- Company
As the name suggests a sole proprietorship is carried out by a single person. You also want to carry out you business also thus this may be a suitable business structure for you. If you choose this business structure you would be provided with total control over the way in which you want your business to function. When you select this business structure to carry out you business you would also have an advantage of low cost. This is because forming a sole trading business is one of the cheapest alternatives to any other form of businesses. You would not require any cost of registration with respect to either the business or the business name. The business can run smoothly with the use of your personal name itself. The legal regulations which would be imposed on you if you opt to choose this business structure will also be very less as compared to other business structures. However there are a few things which may be of concern to you if you opt to select sole trading as a business structure. Firstly there is no difference between you and your business. Your personal identity and the identity of the business is the same. Subsequently there is no provisions form a limited liability. This means that business liability and your personal liability same. All losses which is faced by the business are your personal losses. Secondly as the income of the business and your personal income is same you may fall within the upper tier of taxation which is 47% and will have to pay more tax. Thirdly, your personal assets will also be at risk in case of loss if you select this business structure. Thus in the light of the features of sole trading we would not advice you of choosing this business structure as it may be too risk in terms of your personal liability.
Different Types of Business Structures
We would now have a look at another business structure which is known as a “partnership”. As suggested by the name this business is carried out by two or more people together who are known as the partners. The business may or may not be registered and its presence is identified by applying the rules of common law or the Partnership Act 1963(Cth). To make it simple, you will deem to carry out a partnership form of business if you jointly conduct its operation with another person(s) with the view of making profit on an ongoing basis. The cost of forming the business may also be low because it may or may not be registered and the registration and formation process is also simple. It may however require you to have a partnership deed based in which the rights and duties of the people involved are identified. If you choose to select partnership as your business structure you will be having additional resources in terms of capital and skill which the other partner will bring into the business. However there are certain significant cons of selecting partnership as a business structure because of which we are not advising you to select it for your business. In the same way as the above structure of a sole trading, partnership also lack provides related to limited liability. Thus here also you can be liable personally forms the business debt. In addition the feature of “jointly and severally liable” in a partnership makes a partner liable to all actions of other partners in the course of business. The partner is the agent and the principal of this business. This means that any action committed by your partner will have the potential to bind you and your personal assets to its liabilities. As this is your own business idea having a partner may cause unnecessary interventions in the business management and decision making as they will be jointly involved in making the business decisions in the capacity as partners of the business (Cohen, 2017).
A company is a most common form of business structures is used in Australia and any other country to carry out a business. This structure has certain distinct features which no other business structure has. These are separate legal entity, perpetual existence, limited liability and transfer of ownership.
The features of separate legal entity suggest that the identity of the owner and the identity of the business are different. When a company is formed it becomes a separate legal entity at law and is treated as a totally different citizen in the society. It has its own rights and liability. The company has the right to get into contracts like a natural person. It can be held liable for breach of contract and can also sue another person who has not complied with the contractual terms. The company is managed by persons called directors as defined under section 9 of the Corporation Act. The company can execute any document in its own name by the use of its common seal or by the any person who acts on its behalf. Thereby the company is able hold assets in its personal name. The name of the company likewise is also different from the owners. All owners of a company may not be required to participate in its management. There are a few specific types of company in Australia but the most relevant to you would be a public or a proprietary company. A public company has an addition feature via which you may be able to raise funds from the general public. A proprietary company on the other hand does not have such features. The compliance requirement of a public company is more as compared to a proprietary company. We would like you to know that the proprietary company would be more suited to you as compared to a public company as you are going to operate a small business. The features of limited liability which a company has would limit your liability to the investment which has been made by you in the business and your personal assets would be totally safe and untouched unless you are found to have contravened the duties of a director. In addition using a company will also ensure that you can be the sole director of the company which signifies that the power to manage the company will totally be in your hands and would be free from outside interference. You may also seek private investment be issuing to some shares in the business. These shares can also be transferred easily from one person to another. In the light of these features there are certain disadvantages also which this from you business may pose to you.
Sole Proprietorship
The Australian Securities and Investment Commission keep a constant check in relation to the functioning of this business structure under the provisions of the CA. The business has to be registered and there is a complex procedure which needs to be followed for such registration as provided under section 112 of the CA. Form 201 provided by the ASIC has to be filled. You also need to have a distinct name for your business which must not be the same for any other form of business. The name has to be registered also. Thus it can be stated that the disadvantages which this form of business possesses are related to high cost of formation and maintenance along with additional legal compliance. However in the light of the advantages and protection this business structure provides the businessmen it is the best suited business structure. Thus we are advising you to select a company form of business structure specifically a proprietary company for carrying out you business in the fashion industry. The structure would protect you from any personal liabilities and also reduce you tax obligations as the tax would depend upon the turnover and would be either 27.5% or 30% of the profits of the business. You may also offset any losses which the business faces in subsequent years to claim tax deduction under the Income Tax Assessment Act 1997. Please let us know if you have any more questions as we are always willing to help you.
Yours sincerely
2.One of the implications of selecting a company form of business is being subjected to directors’ duties if a person is the director of the business. Directors’ duties are available at both common law and also the corporate statue Corporation Act 2001 (Cth) (Cohen, 2017). These duties are as follows
- Duty of diligence and care (Section 180(1))
- Good faith, proper purpose and best interest of the company (section 181)
- Not misusing position in the company (Section 182)
- Not misusing information of the company (section 183)
- Disclosing material personal interest in the subject matter of a transaction (section 191)
- Not indulging in Insolvent trading (section 588G)
- No indulging in misleading and deceptive conduct (section 1041H)
Duty of diligence and care
The duty is present under section 180(1) and asks an officer or directors to perform their functions in compliance of standards which a reasonable person/ officer / director would apply if they were in the same position and had the same circumstances to tackle. The standards required to meet this duty are not compared to an expert but a merely reasonable person. If the reasonable person would think that he decision is not good form the company then the officer / director would be held liable for contravention of the section. The business judgement rule which had been applied in the landmark case of ASIC v Rich [2005] NSWSC 256 as provided under section 180(2) is also analyzed to determine the compliance with the diligence and care duty. The factors which the court takes into consideration in relation to the duty includes any personal interest of the directors in the decision , informed decision making by the directors and whether the decision is such that no reasonable person will take. The defence is only related to “business” decision and not any other forms of decisions. Corporate governance is a term which is associated with the ethical and legal functioning of a corporation. This means that the corporation has to be managed in compliance with ethical guidelines and legal principles. In the case of ASIC v Cassimatis (No. 8) [2016] FCA 1023 the court stated that the directors will liable for the breach of section 180(1) where they had breached the law by providing defective financial advice to those who had no scope of recovering from losses. Thus the duty helps in ensuring that the directors operate in a legal manner.
Partnership
Duty of honesty, best interest good faith and proper purpose
This is the duty which ask the directors to be honest and depict good faith when dealing with the companies affairs are provided under the provisions of section 181 of the CA. The duty also requires a director or officer to act in the best interest of the company which ensures a proper purpose. In the case of Whitehouse v Carlton Hotel Pty Ltd [1987] HCA 11 the court stated that the duty of good faith and proper purpose has to be determined subjectively. In addition the best interest of the company will be the interest of the members collectively when the company is solvent and when the company is insolvent interest of the creditors is company’s best interest. The duty addresses corporate governance by addressing the protection of stakeholders of the company and prohibiting dishonest conduct by the officers and directors. These requirements for corporate governance are provided under the “Corporate Governance principles 3rd edition” given by the Australian Securities Exchange.
Duty of not misusing position in the company
The duty is given under section 182 of the CA, it prohibits a director or officer from misusing the position in a company for attaining a personal advantage or an advantage for a third party and which may be at the cost of losses to the company. This ensures in relation to corporate governance that the interest of the creditors and shareholders of the company is taken care of by providing them protection.
Duty of not misusing information of the company
The duty is given under section 183 of the CA, it prohibits a director or officer from misusing the information in a company for attaining a personal advantage or an advantage for a third party and which may be at the cost of losses to the company. This also ensures in relation to corporate governance that the interest of the creditors and shareholders of the company is taken care of by providing them protection (Watts, 2015).
Duty of disclosing material personal interest
Under section 191 of the Act the directors have been imposed with an obligation to notify the board of directors all relevant facts about a personal interest they may be having in a subject matter of a decision or resolution of a company. The duty ensures that the directors are not hiding any facts which will make them gain personally.
Insolvent trading
Insolvent trading is not allowed by the CA through section 588G. The CA states that a person should not indulge in trading when the company is insolvent, they believe that the company is insolvent or they believe that the company will turn to be insolvent if such trading is done. Insolvent under section 92A means the inability to repay the debt as and when they arise. The person may be excluded from liability under this section if they have relied in a reasonable way on the advice provided by a person who is responsible for the financial affairs of the company. Thus this section protects the interest of the creditors of the company and upholds principles of corporate governance (Keay, 2014).
Thus from the analysis of the duties imposed on the directors can be derived that the duties act to protect the interest of the shareholders and creditors of the company. The duties also ensure that the company is operated in an ethical and legal manner by the officers and directors ensuring a health corporate culture and corporate governance
References
ASIC v Cassimatis (No. 8) [2016] FCA 1023
ASIC v Rich [2005] NSWSC 256
Cohen, G.M., 2017. Law and Economics of Agency and Partnership. The Oxford Handbook of Law and Economics: Volume 2: Private and Commercial Law, p.399.
Corporation Act 2001 (Cth)
Keay, A.R., 2014. Directors’ Duties. Jordans.
Watts, P.G., 2015. Directors’ powers and duties. LexisNexis NZ Limited.
Whitehouse v Carlton Hotel Pty Ltd [1987] HCA
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