Chapter 1: Introduction to Business Law & Practice Flashcards
1
Q
1 Different legal forms of business
1.1 Introduction to business models
A
In practice, lawyers may have to advise clients on the most appropriate business model for their
business. In order to do this, you need to be aware of the different possible business models and
the key considerations when forming a business and choosing a business model.
2
Q
The business models that you
will need to understand for the SQE are:
A
- Sole trader
- Partnership
- Limited partnership
- Limited liability partnership (LLP)
- Private and unlisted public companies
3
Q
The business models that you
will need to understand for the SQE are:
A
We will consider the following features of each of these business models: costs, risk, structure,
formalities, privacy and finance.
You will learn about the taxation of the different business models in the next section which might
be a consideration for your client when deciding which model is best.
4
Q
1.1.1 Why businesses are set up
A
It might be useful background to consider why businesses are set up before we explore the different ways in which they may be set up.
Businesses are generally set up to make a profit. A business generates income by selling products and/or services. In order to sell the products and/or services the business will incur certain expenses. Provided the income generated exceeds the expenses of the business, it will make a profit. Once a business has made a profit, a proportion of that profit is likely to be given to the
owners of the business, and the rest will be retained in the business in order to help it grow.
5
Q
1.1.2 Why do businesses need to raise finance?
A
It might also be helpful to consider why businesses need to raise finance and how they can raise finance to understand the considerations to be taken into account about which business model might be the best one to choose.
6
Q
A business is likely to need to raise finance for a number of reasons including the following:
A
- To purchase premises from which to operate, plant and machinery, stock or raw materials, computer hardware and software in order to be able to manufacture and sell goods, or provide a service;
- To employ staff to make the goods and/or provide the services to customers;
- To obtain the advice of professional advisers from time to time, particularly accountants and
lawyers; and - To expand and grow, which it may do by acquiring other businesses, carrying out marketing activities eg advertising and investing in new premises and equipment.
7
Q
1.1.3 How do businesses raise finance?
A
There are four basic ways in which a business can raise money:
* The owners of the business may invest in it by making contributions of capital to the business;
* Outside investors may be prepared to make a capital contribution to the business in order to
share in its future profits;
* The business may borrow money, for instance, from a bank; and
* As already mentioned, a proportion of the profit that the business has generated is likely to be
retained within the business to help it grow, rather than being distributed to the owners and
investors in the business.
8
Q
1.2 Business model overview
A
There are several basic ways in which businesses can be structured. The business model can be
unincorporated and incorporated.
Unincorporated businesses are those run in the main by individuals rather than through a separate legal entity who have full personal liability for the liabilities of the business such as sole traders and partnerships.
9
Q
1.2 Business model overview
A
Incorporated businesses exist as legal entities separate from their owners who enjoy limited liability in respect of the debts that are owed by the incorporated business. Perhaps the most widely used are limited companies. We will look at the key considerations for a client when choosing an appropriate business model and apply these to the most common of business models looking at their key features
10
Q
1.2.1 Factors influencing the choice of business model
A
As there are several structures within which it is possible to operate a business. It is therefore
important to be able to recognise some of the factors which may affect your client’s choice and these are set out here in overview and will be explored in further detail in later sections and chapters.
11
Q
Set-up costs and formalities
A
There may not be any upfront cost in setting up in business as a sole trader or partnership, since
there are no formal incorporation requirements. There may be costs of incurring legal advice and in the case of a partnership seeking advice on the terms of a partnership agreement. There are, however, costs involved in incorporating a company or LLP, and these will be increased by the associated legal fees.
12
Q
The Economic Crime and Corporate Transparency Bill (ECCTB),
A
The Economic Crime and Corporate Transparency Bill (ECCTB), which is aimed at preventing abuse of UK corporate structures and addressing economic crime, will impact upon set up (and ongoing costs) for incorporated businesses.
13
Q
Some of the relevant provisions are set out below:
A
- It will introduce identity verification requirements for new and existing registered company directors, people with significant control and those delivering documents to the Registrar of Companies (Registrar) such as company secretaries and authorised corporate service
providers such as accountants and legal advisers.
14
Q
More active gatekeeper
A
It proposes to give the Registrar wider powers to allow it to become a more active gatekeeper over company creation and a custodian of more reliable data. This includes powers to verify and decline information submitted or already on the register.
15
Q
Improve financial information
A
It will also improve financial information in respect of accounts and reports on the register, so it
is more reliable and accurate enabling better business decisions to be made.
16
Q
Greater protection
A
It will give greater protection to some personal information provided to Companies House to
limit fraud.
17
Q
Amendments to current provisions
A
There will be amendments to the current provisions on company names, the registered office
and members to improve transparency and a requirement to maintain a registered email
address.
18
Q
Tighten provisions
A
It will tighten the provisions surrounding limited partnerships.
19
Q
Ongoing costs
A
Due to the principle of limited liability (see below), companies (and, to a lesser extent, LLPs) are
subject to greater regulation and disclosure requirements than either sole traders or partnerships.
This increased level of regulation adds to the administrative cost of running a company and an
LLP.
20
Q
Liability on insolvency
A
Partners’ and sole traders’ personal assets are at risk if the business loses money or becomes insolvent. Shareholders of limited companies or members of LLPs, however, will only be liable to contribute the amount unpaid, if any, on their share capital or capital contribution respectively. Lenders often try to circumvent this principle of limited liability by seeking personal guarantees from shareholders, directors of a company or members of an LLP.
21
Q
Tradition
A
Many types of professional businesses, eg architects, accountants and law firms, are traditionally operated as partnerships. This may too influence the client’s choice of business medium.
22
Q
Raising finance
A
If loans are being used to raise finance many lenders (often banks) may prefer to lend to companies and LLPs rather than to a sole trader or partnership. This is because a company (and to a lesser extent an LLP) is subject to a higher degree of regulation and disclosure, and therefore the lender may feel comfortable that it has full information against which to measure the risk it is undertaking in lending to a company
23
Q
Raising finance
A
You will see that directors of companies also owe duties to
the company and creditors which you will look at in later chapters. In addition, companies and
LLPs are usually able to offer more forms of security for borrowing than individuals or partnerships.
Companies also have more flexibility in raising finance as they usually have the ability to sell shares to investors in addition to through obtaining loans from lenders.
You will consider how companies can obtain finance in more detail in later chapters.
24
Q
Risk
A
When establishing a business, it is necessary, from the outset, to appreciate the concept of commercial risk. ‘Risk’ refers to the likelihood of things going wrong.
The role of a lawyer includes advising your client on how to operate its business within the law: ie. to inform it of what is and what is not permitted. An equally important aspect of your role is to help your client address and minimise commercial risk with legal solutions. To do this, it is necessary to understand the risks that clients face in given situations.
25
Risk
In business, clients constantly face choices as to whether or not to take a given commercial risk. It is necessary for a lawyer to understand the risks, to help a client spot them and to identify the possible liabilities that could confront the client if it fails to address the risks adequately. A client will almost always want to know:
* What the main elements of risk in the current proposed course of action are;
* What the consequences if things do go wrong (ie the potential liabilities) are; and
* What strategies can be employed to reduce or minimise these risks and potential liabilities.
26
Tax
When choosing the appropriate business structure or model, another key consideration will be how much tax will be payable on the profits of the business. The way in which the profits of a business are taxed depends to a large extent on its business medium, and many clients will want to obtain advice on the potential tax consequences of
operating via different business models when deciding on a business structure
27
Complex, specialist area
This is a complex, specialist area and as a commercial lawyer you will need an awareness of how tax will impact your client’s choice of business structure, but you will almost certainly seek specialist advice from tax lawyers and accountants. An overview of tax in respect of different business models is dealt with in the next section and more detail about calculating tax for
individuals and companies is set out in later chapters.
28
Summary
The key considerations when forming a business are:
* Costs: How much does this business model cost to set up?
* Risk: Will the participants in the business have personal liability for debts of the business?
* Structure: Does the business model provide a clear organisational structure? Is this flexible?
* Formalities: Are there legal formalities that must be followed in running the business? How
flexible is this business model regarding formalities?
29
Summary
Privacy: To what extent is information about the business required to be publicly disclosed?
* Finance: How can the business raise capital?
* Tax: How is this business model taxed? This will be considered in more detail in the next section.
Having set out the considerations to be taken into account when setting up a new business we will now give an introductory overview of the different types of business model that a business can be operated through setting out and summarising their key characteristics. You will look at some of these business models (partnerships, LLPs and companies) in more detail in later chapters.
30
1.2.2 Sole traders: Key characteristics
* Costs: There are no set up costs –the sole trader can start trading straight away as there are
no formalities to comply with.
* Risk: The sole trader has unlimited personal liability meaning the sole trader’s personal assets
such as their home and cars are potentially liable to be sold to meet the debts of the business.
* Structure: There is no formal structure required - the individual can choose how they wish to
run their business. A sole trader is not a separate legal entity.
31
1.2.2 Sole traders: Key characteristics
* Formalities: There are no Companies House filing or procedural requirements for running the business.
* Privacy: There is complete privacy with no need for publicly filed accounts, etc.
* Finance: There is a personal capital injection of cash by the sole trader. Contracts are formed between the individual themselves and third parties, so an individual can take out a personal loan.
32
1.2.3 Partnership: Formation
Partnerships can be created without any formalities. This is because s1(1) Partnership Act 1890 (PA
1890) defines a partnership as ‘[…] the relation which subsists between persons carrying on a business in common with a view to profit’. There does not need to be any intention to form a partnership – two or more people working together with a view to profit automatically form a partnership.
33
1.2.3 Partnership: Formation
Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. Factors to
consider include whether profits and/or losses are shared, whether a loan is made from one partner to another, whether property is held jointly. Evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence. A loan of money by one party to another does not of itself create a partnership.
34
Does a partnership exist?
No one factor alone will suffice to create a partnership – it is necessary in all cases to consider all the facts. Some examples from the case law follow. If there is an agreement to share losses as well as profits, this makes the existence of a partnership more likely (Northern Sales (1963) Limited v Ministry of National Revenue (1973)).
35
Does a partnership exist?
Case law has also held that if the person is not being ‘held out’ as a partner this makes the existence of a partnership less likely. In Walker v Hirsch (1884) a clerk lent money to the partnership, was paid a fixed salary and took 1/8th of the profits and of the losses, but was never
held out as a partner. No partnership was found to exist.
36
The terms of the partnership – PA 1890
Can be formed without formalities
Although a partnership can be formed without any required formalities, it is advisable to have a
partnership agreement drawn up by a solicitor as otherwise the partnership will be governed by
the default provisions of the PA 1890. These include the following:
37
Section 24(1) Profits and losses
Partners are entitled to share equally in the profits of the business, and must share equally in the losses of the business, even where the parties have contributed to the capital unequally. There should therefore be an express provision in the
agreement setting out a profit sharing ratio, otherwise both profits and losses are shared equally.
38
Section 24(6) Remuneration
Partners are not entitled to a salary.
39
Section 24(8) Decision Making
Decisions arising during the ordinary course of the business
are decided by a majority, except for any change to the nature of the partnership business
which requires unanimity.
40
Section 25 Expulsion:
A partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority of the partners can do this.
41
Partnership agreements
Varied by unanimous consent
The partners’ mutual rights and obligations can be varied at any time by their unanimous consent
(s 19 PA 1890). This means that partners can themselves draw up a partnership agreement setting
out how they wish their partnership to run. It is important in a modern partnership that partners
seek legal advice and enter into a binding partnership agreement governing the terms of their
relationship
42
Partnership agreements
Partners will wish to vary the default provisions of PA 1890 as these are not suitable for a modern business. Typically, a partnership agreement will deal with the following key
principles as well as other more practical details:
* Profit sharing ratio
* Salaries
* Decision making – eg are certain partners able to make decisions on particular issues alone or in small committees?
* What happens when a partner leaves the partnership
* How new partners may be appointed and how partners may be removed
43
Partnerships: Key characteristics
Cost
* Costs: There are no set up costs as there are no formalities. The partnership can start trading
straight away. Partnerships can be formed without any formal agreement or even intention
although it might be advisable for certainty to have a partnership agreement drafted which
may incur costs and take time to agree.
44
Risk
Risk: Generally partners have unlimited joint (in contract) or joint and several (in tort) liability
for the debts and obligations of the partnership incurred while they are partners. This means that their personal assets such as their houses may need to be sold to meet the debts of the business. For tax purposes each partner is liable to pay tax on their share of the income or gains of the LLP
45
Structure, Formalities & Privacy
Structure: A partnership is not a separate legal entity.
* Formalities: There are no Companies House filing or procedural requirements for running the business.
* Privacy : There is complete privacy. There is no requirement for publicly filed accounts etc.
46
Finance
Finance: Contracts are formed between third parties and the partners in the partnership as
individuals. Individual partners can take out personal loans or inject their own cash into the
partnership
47
Limited Partnerships
Limited partnerships (LP) are quite rare but included here for completeness. An LP has two different types of partners:
48
Limited partners
Who have limited liability. These limited partners must not be involved in the management of the business (they are often called ‘sleeping partners’ eg passive investors). If they do become involved in management, they lose their limited status and become general partners with unlimited personal liability
49
General partners
who run the business and have unlimited liability (as in a traditional
partnership). There must be at least one limited partner and one general partner.
50
The Limited Partnership Act
LPs are governed by the Limited Partnership Act 1907 (as amended). LPs must be registered at Companies House but there is no requirement to file accounts at the moment.
51
Investment Vehicles
LPs are not commonly used for general business but often used for investment vehicles. They are
popular joint venture business structures where an investor (the limited partner) puts money into a
business run by the general partner.
52
Investment Vehicles
Note that on 6 April 2017 a new sub-category of limited partnership called a private fund limited partnership was created. These are now commonly used for investment vehicles and will be subject to greater scrutiny as a result of the ECCTB provisions which are aimed at tackling the misuse of limited partnerships through strengthening
transparency and disclosure requirements and enabling them to be deregistered.’ after ‘investment vehicles’
53
1.2.5 Limited liability partnership (LLP)
* LLPs were introduced by the Limited Liability Partnership Act 2000 (LLPA 2000).
* The key difference between LLPs and sole traders, partnerships or LPs is that an LLP has a separate legal personality – it can own property and enter into contracts on its own behalf. However, for tax purposes it is treated as a partnership and the members are taxed as partners, each being liable to pay tax on their shares of the income or gains of the LLP. This is referred to as ‘tax transparency’.
54
Two or more associated persons
Section 2(1)(a) LLPA 2000 states that two or more persons associated for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual
55
All members have limited liability
All members (partners) in an LLP have limited liability. Their liability to third parties is limited to the amount that they have agreed to pay under the terms of their partnership or membership agreement.
56
Registration at Companies House
LLPs are registered at Companies House in the same way as companies and are required to
file annual accounts and other information. LLPs are in effect a hybrid between a traditional
partnership (with procedural flexibility) and a company (with limited liability). Many law and
accountancy firms are LLPs
57
Organisational structure
The organisational structure of an LLP is very flexible and should be decided between the
members in a formal written partnership or members’ agreement. In the absence of any such
agreement Regulations 7 and 8 of the Limited Liability Partnerships Regulations 2001 (SI
2001/1090) contain default provisions as follows:
58
Contain default provisions
* Members share equally in capital and profits.
* An LLP must indemnify its members for payments made and personal liabilities incurred by
them in the ordinary and proper conduct of the business of the LLP.
* Every member may take part in management but no member is entitled to remuneration for
managing the LLP
59
Contain default provisions
* No person can become a member or assign their membership without the consent of all existing members.
* Ordinary decision making may be by the majority of the members. Any proposed change to
the nature of the business requires the consent of all the members.
* There is no implied power of expulsion of a member by the majority unless the members have
expressly provided for such a power in a members’ agreement.
60
LLPs: Key characteristics:
* Costs: Costs are involved in setting up an LLP including legal fees.
* Risk: All members in an LLP have limited liability. Their liability to third parties is limited to the amount that they have agreed to pay under the terms of their partnership agreement. Many law and accountancy firms are LLPs. For tax purposes it is treated as a partnership or membership so each member is liable to pay tax on their share of the income or gains of the
LLP.
61
LLPs: Key characteristics:
Structure: An LLP has a separate legal personality and can own property and enter into contracts on its own behalf. In effect it is a hybrid of a traditional partnership and a company. The organisational structure of an LLP is flexible and should be decided between the members in a formal written members’ agreement. In the absence of such an agreement
Regulations 7 and 8 of the Limited Liability Partnerships Regulations 2001 will apply.
61
Formalities, Privacy, Finance
Formalities: There is a requirement to be registered at Companies House.
* Privacy : LLPs are required to file annual accounts and other information.
* Finance: As it is a separate legal entity, an LLP can borrow in its own name. It can also create floating charges, which are a particular type of security favoured by banks on lending.
62
Formalities, Privacy, Finance
* Formalities: There is a requirement to be registered at Companies House.
* Privacy : LLPs are required to file annual accounts and other information.
* Finance: As it is a separate legal entity, an LLP can borrow in its own name. It can also create
floating charges, which are a particular type of security favoured by banks on lending.
63
1.2.6 Companies
Companies are the most popular business model in England and Wales. There were over 4.5
million private limited companies registered with Companies House in 2023. We will consider what
makes companies such a popular business model in later sections and chapters but in the meantime, here is an introductory overview of the basics in respect of companies.
64
Companies Act 2006 (CA 2006)
The CA 2006 is the key legislation governing companies in England and Wales. This statute replaced the Companies Act 1985 (CA 1985) and brought about many changes in company law. The primary aim of CA 2006 was to simplify the law for private companies. Key changes made include:
65
Companies Act 2006 (CA 2006)
* The removal of the requirement for private companies to hold Annual General Meetings
* Codification of directors’ duties so that directors of small private companies can more easily
understand their obligations
* Allowing private companies to pass shareholder resolutions in writing, dispensing with the
requirement for meetings of shareholders (known as General Meetings)
You will learn more about the requirements of CA 2006 as you progress through these materials.
66
Constitutional documents
CA 2006 came into force on 1 October 2009. Prior to this, companies were governed by the
principles of the CA 1985. In practice you will deal with many companies incorporated prior to CA
2006 therefore it is important to understand some of the provisions of CA 1985 which still affect
those companies.
67
Constitutional documents
CA 1985 required companies to have two constitutional documents: the Articles of Association
(Articles) and the Memorandum.
Under s 17 CA 2006 the memorandum no longer forms part of the company’s constitution - it is
only required as part of the procedure to register a company at Companies House. The
memorandum of a company incorporated under CA 2006 simply amounts to a declaration on the
part of the company’s subscribers ie that the first members of the company wish to form a
company and agree to become members of that company (s 8 CA 2006)
68
Formation of a company
A client wishing to start a business through the medium of a company can either incorporate a new company from scratch or purchase and then convert an existing shelf company to conduct its business.
69
1.2.7 An overview of who’s who in a company
Shareholders (also known as members)
* Owners of the company
* Invest money in return for shares and possibility of dividends
* Not involved in day-to-day management but usually have voting rights and control key decisions
70
Subscribers
The name given to the first shareholders in a company who invest in the company when it is
initially set up (ie incorporated)
71
Directors
* Officers/managers of the company
* Involved in day-to-day running of the company
* Collectively known as the Board
* In small private companies, directors are often also shareholders
72
Persons with significant control
Details of PSCs must be provided to Companies House. In general, PSCs are shareholders with over 25% of shares.
73
Other stakeholders
Other stakeholders include anyone interested in the company, such as employees, creditors, etc.
74
1.2.8 Shareholders
The owners of a company are its shareholders, otherwise known as its members. Shareholders
invest money (share capital) in the company in return for a share in the ownership of the
company, evidenced by a share certificate. Shareholders’ rights such as voting rights and rights
to a dividend are set out in the Articles (and sometimes also in a shareholders’ agreement. You will
learn more about shareholder agreements later in theses materials).
75
Beginning of membership
Membership begins when the member’s name is entered in the company’s register of members (s
112(2) CA 2006). The first shareholders of the company are its subscribers under s 8 – so called as
they subscribe to the company’s memorandum of association
76
Shareholder does not have to be human
A shareholder need not be a human being. A company has a separate legal identity and can,
amongst other things, own property in its own name. A company can therefore own shares in
another company. Where company A owns all the shares in company B, company B will be a
wholly owned subsidiary of company A. If company A owns some, but not all, of the shares in
company B, company B may still be a subsidiary of company A but not a wholly owned
subsidiary. Section 1159 CA 2006 gives the definition of a subsidiary.
77
Wholly owned subsidiary
A Ltd owns all the shares in B Ltd. A Ltd is therefore described (for certain company law purposes)
as B Ltd’s ‘parent’ or ‘holding’ company. In turn, B Ltd is A Ltd’s (wholly owned) ‘subsidiary’
78
Forming a group of companies
A Ltd and B Ltd together form a ‘group’ of companies. There is no limit on the number of
companies that can form a group, which means, therefore, that subsidiary companies may have
their own subsidiaries too. This means that B Ltd could have its own subsidiary (eg C Ltd). In
addition, there is no limit on the number of subsidiaries that a company may have, so it would be
possible for either A Ltd or B Ltd to have more than one subsidiary. Group structures are
frequently used to isolate risk and/or mitigate tax liabilities.
79
1.2.9 Shares
A share is often described as a ‘bundle of rights’. By investing in the share capital of any company, the investor (shareholder or member) becomes a part owner of the company and will often have voting rights in shareholder meetings.
80
Several different classes of shares
There are several different classes of share that a company may issue to its shareholders. Different classes of shares may carry different rights and entitlements. All rights and entitlements in relation to shares of all classes are set out in the company’s Articles
81
Most common type = ordinary share
The most common type of
share is known as an ordinary share. An ordinary share will usually entitle its holder to vote at shareholder meetings and to receive a share of the profits and surplus assets of a company after it is wound up (if there are any).
82
Nominal or par value
Shares in a limited company having a share capital must have a fixed nominal value. Common
nominal values for ordinary shares are 1p, 5p or £1. The nominal (or ‘par’) value of a share is
the minimum subscription price for that share. It represents a unit of ownership rather than the
actual value of the share.
83
Premium share
A share may not be allotted/issued by a company at a discount to its nominal value. A share
may however be allotted/issued for more than its nominal value, and the excess over nominal
value is known as the ‘premium’. The market value of a share (ie the amount at which a share
may be traded between shareholders) will often be much higher than the nominal value of the
share.
84
Issued, paid-up and called-up shares
The total amount in value (nominal and premium) of all shares in issue at any time is known as
the ‘issued share capital’. This is the amount of share capital that will be shown in the company’s accounts.
85
Paid up shared capital
It is not always necessary for shareholders to pay the full amount due on their shares immediately. The amount paid is known as the ‘paid-up share capital’. The amount outstanding can be demanded by the company at any time. Once demanded, the payment has been ‘called a paid up shared capital
86
* Share capital
A company’s issued share capital is made up of:
- Shares purchased by the first members of the company, known as the ‘subscriber shares’; and
- Further shares issued after the company has been incorporated, to new or existing shareholders. New shares can be issued at any time provided that the correct procedures
are followed.
87
Allotment
‘Allotment’ is defined in s 558 CA 2006. Shares are said to be allotted when a person acquires the unconditional right to be included in the company’s register of members in respect of those shares.
88
Allotment
The term ‘allotment’ is often used interchangeably with ‘issue’ of shares but the two have different meanings. There is no statutory definition of ‘issue’ but it has been held that shares are only issued, and only form part of a company’s issued share capital, once the shareholder
has actually been registered as such in the company’s register of members, and their title has
become complete.
89
Different classes of share
A company may create different classes of share. For example, there may be two classes of ordinary share, each carrying different voting rights, or perhaps one carrying no voting rights at all. There may also be preference shares, which entitle the holder to a preferential right,
such as the first claim to a dividend or the return of capital (ie the return of money the shareholders had invested in their shares) on a winding up
90
Terms of the issue
The rights will depend on the terms of the issue and are usually (and in some cases, must be) set out in the company’s Articles. You will find out more about different class rights in a later chapter
91
Relevance of class rights
Class rights may be relevant when determining which shareholders can vote at general meetings and whether some shareholders have enhanced voting rights. It is also important to examine class rights where it is proposed to vary the terms of the rights attaching to a
particular class of share.
92
Different classes of shares
When looking at the rights of shareholders it is important to check the company’s Articles and
also to ascertain whether there is a shareholders’ agreement in place. You will learn about Shareholders’ Agreements later in a later chapter
93
Limited liability
The total nominal value of the shares held by a shareholder is equal to the total amount of that shareholder’s liability to contribute to the assets of the company if it becomes insolvent. This means that, if all the shareholder’s shares are fully paid, they will not have to contribute any
further amount to the company on insolvency. This is the way in which a shareholder’s liability is said to be ‘limited’
94
Example: Limited liability
If you subscribe for 10 shares of £1 each in a company, and that company later becomes
insolvent and is wound up, providing you paid £10 in total when you acquired the shares, you would have no further liability to the liquidator of the company. If, however, when you acquired the shares, you only paid up £6 of their total £10 nominal value then, if the company later
becomes insolvent and is wound up, you would be liable to pay a further £4 to the liquidator. Therefore, the shareholder’s total liability is limited to the amount, if any, unpaid on their shares.
95
1.2.10 Persons with significant control (PSC)
Every UK company is required to identify its ‘people with significant control’ (PSC). Broadly, this term refers to any person who:
* Owns more than 25% of the shares or voting rights in the company;
* Has the power to appoint or remove a majority of its board of directors; or
* Otherwise exercises ‘significant influence or control’ over the company.
96
1.2.10 Persons with significant control (PSC)
Every company must maintain a register of its PSCs, and this register must be open to public
inspection (see ss 790A - 790ZG CA 2006). The intended purpose of the PSC register is to increase transparency so as to help combat tax evasion, money laundering and terrorist financing and to allow those dealing with companies to see who has influence over the company.
97
PSC Register
The PSC register must be filed at Companies House along with a company’s confirmation
statement (an annual statement confirming the company’s constitution and details).
98
1.2.11 Directors
A company is an artificial person and therefore needs human agents to take decisions and act on its behalf to run the company. All companies will therefore have one or more directors who will be officers of the company. The directors are responsible for the day-to-day management of the company.
99
1.2.11 Directors
Directors are agents of the company and their conduct is governed by statute and the common law principles of agency. They also owe fiduciary duties to the company. These duties have been codified by the CA 2006. Together the directors of a company constitute the ‘board of directors’, often simply referred to as ‘the Board’. References in CA 2006 to ‘the directors of a company’
(plural) are references to that company’s Board
100
Fundamental Decisions
Some fundamental decisions cannot be taken by the directors but are reserved for the shareholders, for instance the making of changes to the company’s Articles under s 21 CA 2006. You will consider directors in more detail in a later chapter.
101
Number and nature of directors
Under s 154 CA 2006:
* A private company must have at least one director; and
* A public company must have at least two directors.
At least one director must be a natural person (s 155 CA 2006). This is intended to ensure that for
all companies, there will always be one individual in place to aid accountability
102
Government has enacted legislation
The Government has enacted legislation providing that all corporate directors (that is, directors
which are, themselves, companies) will be prohibited subject to certain exceptions so that, as a
general rule, all directors will have to be individuals. However, the implementation date to
incorporate these restrictions into CA 2006 has not yet been confirmed although it may coincide
with the implementation of the ECCTB. There is a minimum age limit of 16 years for directors (s 157
CA 2006)
103
Role of director is separate
The role of a director is always separate from that of a shareholder though in small private
companies they are often the same people. In this situation it is important to consider the two
roles as separate – that individual wears different ‘hats’ when acting as a director and as a shareholder.
104
1.2.12 Overview of different types of companies
There are different types of companies as follows:
* Private companies
Section 4(1) CA 2006 states that ‘a private company is any company that is not a public
company’. Private companies may be:
- Limited by shares – this is the most common type of company where at least one share is
issued in the company, there are no minimum share capital requirements and can be
formed by one person. Shares are generally prohibited from being offered to the public
105
1.2.12 Overview of different types of companies
- Limited by guarantee - instead of holding shares, the members of a company limited by guarantee will guarantee that if the company is ever in financial difficulties and is wound up, they will each contribute a certain amount (commonly £1) to the funds to be distributed
to creditors. The members’ liability to third parties is limited to the amount guaranteed.
- Unlimited - this type of business model is rare. The fundamental feature of an unlimited company is that the liability of its members is unlimited.
106
1.2.12 Overview of different types of companies
* Public companies
Section 4(2) CA 2006 states that a ‘public company is a company […] whose certificate of incorporation states that it is a public company’. A public company’s name ends with the words ‘Public Limited Company’ or ‘Plc’ (s 58(1)).
107
For practical purposes
For practical purposes, the main difference between a public and a private company is that
generally only public companies can offer their shares to the public, eg through public listing on a
recognised stock exchange such as the London Stock Exchange (although not all public
companies are listed), therefore permitting trading to take place in its shares and to have access
to a wider pool of investors. Public companies are also subject to more onerous regulatory and
disclosure requirements
108
Companies: Key characteristics
Costs: There are costs involved in incorporating a company including legal fees.
* Risk: The liability of the owners of the company (known as shareholders or members) is limited
to the amount unpaid on their shares (if any). This protects the shareholders and facilitates
investment.
* Structure: A company is a separate legal entity – companies are distinct from their owners.
This means the company owns property and enters into contracts, sues and can be sued in its
own name. Profits and losses belong to the company and not the shareholders and it is the
company that is liable for its debts not the shareholders.
109
Formalities, privacy, finance
* Formalities: Companies are governed by the CA 2006 (which superseded the CA 1985) which
contains detailed requirements regulating how companies are run. For example, there is a
requirement to be registered at Companies House.
* Privacy: There are various filings and disclosures that must be made by all companies at Companies House. These formal procedural requirements can be onerous, especially for small private companies.
* Finance : Many lenders will prefer to lend to companies rather than to a sole trader or partnership because a company is subject to a higher degree of regulation and disclosure. In addition, companies can give more forms of security for borrowing than individuals or partnerships. Significantly, companies can issue shares to raise funds
110
1.3 Summary
* Key considerations in choosing a business model include costs, risk, structure, formalities,
privacy, finance and tax.
* Possible business models include the sole trader, partnership, limited liability partnership and
private limited company. In this section you have considered the main characteristics of sole
traders, partnerships, limited liability partnerships and private and unlisted public companies
111
1.3 Summary
* A key advantage of sole trader and partnership models is that no public disclosure is required. However, a key disadvantage of both of these models is unlimited liability.
* A key advantage of an LLP or company is limited liability. However, both of these models have
public filing requirements
112
1.3 Summary
* Careful consideration should be given to the advantages and disadvantages of different
models based on the features and requirements of the particular business and often tax is the
main driver which is explored in the next section.
113
2 Tax treatment of different business models
This section covers the taxation of the following business models:
* Sole trader
* Partnership
* Limited liability partnership
* Private and unlisted public companies
114
2.1 Additional consideration when forming a business: Tax
When choosing the appropriate business structure, another key consideration will be how much
tax will be payable on the profits of the business. The way in which the profits of a business are taxed depends to a large extent on its business medium, and many clients will want to obtain advice on the potential tax consequences of
operating via different business models when deciding on a business structure
115
2.1 Additional consideration when forming a business: Tax
This is a complex, specialist area and as a commercial lawyer you will need an awareness of how tax will impact your client’s choice of business structure, but you will almost certainly seek specialist advice from tax lawyers and accountants.
116
2.2 Sole traders: Tax
* The first thing to remember is that if your client is a sole trader, the business is not a separate entity.
* Therefore, any profits that the sole trader makes are taxed as the individual’s income for income tax purposes and any gains made on one-off transactions will be charged to the individual as capital gains tax.
* You will learn more about how an individual is taxed in a later chapter.
117
2.3 Partnerships: Tax
* Again, if your client is operating as a partnership, the business is not a separate entity.
* Partnerships are said to be tax transparent which means that HMRC looks through the partnership to the profits and gains of the partners. Partners are taxed on their individual shares of the profits and chargeable gains as either income tax or capital gains tax.
118
2.4 LLPs: Tax
* LLPs are a hybrid entity: they have features in common with both private companies and partnerships.
* Whilst they are treated like a company for liability and company law purposes, they are
treated like a partnership for tax purposes, so:
- Partners are taxed as individuals; and
- They are taxed on their share of the LLP’s profits and gains.
119
2.5 Companies: Tax
* A company is a separate legal entity from its owners (the shareholders/members).
* Companies pay corporation tax on their taxable total profits (TTP) which are made up of the company’s income profits and its capital gains.
* The TTP is taxed at a flat rate for the current tax year and it is the company itself that is liable to pay.
120
2.5 Companies: Tax
* One consideration when deciding whether to incorporate a company will be the issue of double taxation of profits. A company will pay corporation tax on its profits. It may then pay dividends to a shareholder. The individual in receipt of these will then be taxed to income tax.
* You will learn more about corporation tax in a later chapter.
121
2.6 Summary
* Tax considerations will be important when deciding which business model to use.
* Sole traders and partners (including LLP partners) all pay income tax on their share of the profits and capital gains tax on their share of any capital gains.
* Companies pay corporation tax on their TTP (ie their income profits and chargeable gains added together).
122
2.6 Summary
* Shareholders pay income tax on dividends received from companies.
* Careful consideration should be given to the advantages and disadvantages of different
business models based on the features and requirements of each particular business.
123
3 Private and public companies
This section sets out the differences between private and public limited companies. Most companies in England and Wales are private limited companies. The diagram below is not to scale but illustrates this point.
124
3 Private and public companies
A smaller number are public limited companies. Only a small sub-set of public companies (represented by the smallest dark square) are listed on the Official List and traded on the Main Market of the London Stock Exchange
125
Listed companies
It is important that you are aware of the concept of public companies and, in particular, listed companies because they are run very differently to private companies.
126
3.1 Private companies
Section 4(1) CA 2006 states that ‘a private company is any company that is not a public company’. There are different types of private companies:
* Private companies limited by shares – these are the most common type of company
* Private companies limited by guarantee – these companies have no share capital. Instead, the liability of members is limited to the amount that they agreed to contribute in the event of a winding up. These companies are relatively rare.
* Unlimited companies - liability of the members is unlimited. These companies are rare. In these materials we will focus on private companies limited by shares.
127
3.2 Public companies
Section 4(2) CA 2006 states that a ‘public company is a company […] whose certificate of incorporation states that it is a public company’.
To enable a company to raise greater funds by offering shares to the public at large, a private company’s shareholders may decide to convert the company into a public limited company (Plc). Public companies limited by shares can offer their shares to the public.
128
3.3 Listed companies
After converting to Plc status, a company may seek a listing of its shares on a recognised stock
exchange such as the London Stock Exchange, therefore permitting trading to take place in its
shares.
129
3.3 Listed companies
Companies whose shares are listed on the London Stock Exchange are known as ‘listed companies’ (but note that it is not the company that is listed, but its shares). Most commercial investors want to be able to deal freely in their investments, and a stock exchange listing allows them that freedom, making the company more attractive as an investment
130
Public requirement
A company must be a public company before it applies to have its shares listed on a stock exchange. However, not all public companies apply to have their shares listed
131
3.3.1 Route to listing
Often listed companies operate their various businesses through subsidiaries which are private
companies. Although such private companies are not listed themselves, they will be affected by the rules which govern their listed holding companies. Seeking a listing is the third stage of development for many companies, after converting to public
company status.
132
3.4 Different levels of regulation
Significant degree of similarity
There is a significant degree of similarity between the way in which the CA 2006 applies to the
smallest private company and the largest public listed company. Essentially the same legislation
governs both types of companies, though with refinements.
133
Important differences
There are important differences between private companies and public listed companies. Listed
companies are run very differently to private companies, since they may have thousands of shareholders, only a few of whom will have any managerial role at all. In a listed company, an individual shareholder will not normally have any access to the Board of directors, and additional regulation is therefore needed to ensure the accountability of the directors
134
Listed companies require more regulation
Listed companies therefore require far more regulation than private companies and even publi unlisted companies. Private companies enjoy lighter regulation under CA 2006 than public companies. One of the aims of the CA 2006 reforms was to make it easier to set up and run a
private company
135
Offering shares to public and written resolutions
Two important differences between private and public companies concern offering shares to the
public and written resolutions. We will look at these two differences in more detail below
136
3.4.1 Offering shares to the public
Private companies
Private companies are generally prohibited from offering their shares to the public at large (s 755
CA 2006). An ‘offer to the public’ for these purposes is defined in s 756 CA 2006. The prohibition applies to shares or debt securities (eg bonds).
137
Public companies
As the business of a private company gets larger and more successful, its shareholders may decide that the company requires further equity and debt finance. If the company re-registers as a public company it will then be able to apply for a listing (eg via a flotation on the London Stock
Exchange), in order to access a much wider investor base. A listed public company also has greater access to the international debt capital markets for the issuing of debt securities.
138
Registered as a PLC
However, the fact that a company is registered as a public limited company, and has ‘Plc’ after its
name, does not indicate that the company is listed. Most public companies are not listed.
139
3.4.2 Written resolutions
The written resolution procedure can be a very convenient, and sometimes time saving, method of passing shareholder resolutions, avoiding the need for a general meeting of the shareholders.
140
Written Resolution Proceedure
CA 2006 made the written resolution procedure easier to use for private companies. Under CA 1985, any shareholder resolution passed as a written resolution had to be agreed to by unanimous consent. This is no longer the case. Instead, written resolutions are passed by the usual thresholds depending on whether an ordinary or special resolution of the shareholders is required.
141
3.4.2 Written resolutions
You will look at these types of shareholder resolution and voting thresholds in a later chapter. This change has resulted in considerable cost, time and administration savings for many private companies, although such companies can still call general meetings of the shareholders if they prefer
142
3.4.2 Written resolutions
Passing shareholder resolutions
Private companies can pass any shareholder resolutions as written resolutions (s 288 CA 2006).
However, note there are two exceptions where written resolutions cannot be used: these are for
resolutions to remove a director or to remove an auditor.
143
Public Companies
Public companies cannot pass shareholder resolutions using the written resolution procedure.
144
3.6 Summary
* In this section you have looked at the principal differences between private limited companies, public limited companies and listed companies.
* The majority of companies in England and Wales are private limited companies.
* Public limited companies are able to offer shares to the public and can also seek a listing of their shares on a recognised stock exchange. They have more stringent regulatory
requirements than private companies.
145
3.6 Summary
* Listed companies are a small subset of public limited companies, being those that have their shares listed on a recognised stock exchange.
* One major difference between a private company and a public company is that the private
company is strictly prohibited from issuing shares to the public at large; whereas this is a significant positive for a public company.
* The Companies Act 2006 applies to all companies, whether private or public, in England and Wales but with refinements to cater for the differences between private and public companies.
146
4 Legal personality and limited liability
This section covers the separate legal personality of the company and the practical consequences
of this.
147
4.1 Introduction: Two basic principles of company law
You have seen that when choosing which business medium to adopt, there are a number of commercial, legal and financial considerations to consider. This section will consider two of the legal considerations in more detail. Remember: there are two key principles of company law which make a company an attractive
business medium for many investors. These are
148
4.2 Separate personality of a company
A company is an entity that is distinct from its owners (ie its shareholders) as well as from its directors, creditors and employees. It has a separate legal personality. This fundamental principle comes from the landmark case of Salomon v Salomon [1897] AC 22, in which the claimant argued that the principal shareholder and director of the company, who had previously run his business as a sole trader, should be held personally liable for the company’s debts. The House of Lords rejected this argument, stating that a legally incorporated company is a separate person and responsible for its own debts and liabilities
149
4.2 Separate personality of a company
A company continues to exist even if its shareholders and/or directors change. This is a fundamental concept of company law, since there is always an extra entity to take into account: the company. Directors, in general, owe their duties to the company, not to the shareholders. Shareholders usually have rights against the company, rather than against the directors, and third parties with whom the company does business contract with the company, even though they negotiate with the directors.
150
4.3 The consequences of separate legal personality
There are a number of consequences that follow from the fact that a company is an independent legal person:
* The company owns its own property;
* The company enters into its own contracts and thus it follows that the benefits and liabilities under the contract belong to the company, not to the shareholders or directors;
* The company sues and is sued on its own liabilities, and
* The company can separate out different elements of a business.
151
Example: Group companies
A group might incorporate separate companies (all with separate legal personalities):
* For different products or groups of products; and/or
* For separate geographical regions; and/or
* By specialty (eg a company to deal with property; another to deal with manufacturing; and another to deal with sales).
152
4.4 Limited liability
Limited liability refers to the liability of the shareholders for the company’s debts. As set out
earlier in this chapter, their liability is limited to the amount they paid (or agreed to pay) for their shares. The personal assets of shareholders are entirely separate from the assets of the company.
153
4.4 Limited liability
The creditors to whom the company owes money (usually through a contract) can claim against the company but if the company has insufficient funds to meet its liabilities the company’s creditors cannot then pursue their claims against the shareholders
154
4.4 Limited liability
If a company becomes insolvent the shareholders will be liable to lose the money that they have invested (or agreed to invest) in the company by subscribing for its shares, but that is the extent of their liability.
155
4.4 Limited liability
Section 74 Insolvency Act 1986 enshrines the concept of limited liability, confirming that the
shareholders of a limited company are, generally speaking, not liable to a liquidator in the event of such a company’s insolvency.
Important: Note that limited liability does not mean that the company’s liability is limited. It refers to the liability of the shareholders of the company being limited
156
4.5 Commercial significance of limited liability
The limited liability of companies is the quality that has made them such useful commercial tools. The concept of limited liability is fundamental to understanding:
* Passive Investment through the shareholders investing in a company following an assessment of the risks of losing that investment, knowing that the rest of their personal assets are safe and without having to take an active role in management;
157
4.5 Commercial significance of limited liability
* Why many entrepreneurs seek to conduct business through the medium of a limited liability company; and
* Why groups of companies have developed with riskier business divisions being conducted through separate companies within the group without the less risky companies becoming vulnerable to the creditors of the riskier companies
158
4.6 Commercial awareness and limited liability
Limited liability encourages investment and encourages businesses to take risks, which
generates money and therefore benefits the wider community
159
4.6 Commercial awareness and limited liability
Note that it is possible to incorporate unlimited companies and also that there are limits on the doctrine of limited liability, both commercially and legally. In certain, much debated, situations the court can ‘pierce the corporate veil’ in the interests of justice; for example, if the company is considered a façade
160
4.6 Commercial awareness and limited liability
A commercially strong counterparty can negate much of the advantage that limited liability confers. This is usually by contractual means. For example, a bank could require a guarantee from the shareholder(s) of a company, as part of an agreement to lend money to the company, which will then circumvent the limited liability of the shareholder(s). The use of these strategies depends upon the bargaining power of the parties and often, the ingenuity of their advisers.
161
Assess the financial viability of a company
Creditors should assess the financial viability of a company by checking the publicly filed documents at Companies House (although small private companies’ accounts provide more limited financial information).
162
4.7 Summary
* A company is a separate legal person from the date of its incorporation.
* This means that a company:
- Owns its own property;
- Enters into its own contracts; and
- Sues and is sued on its own liabilities.
163
4.7 Summary
* Shareholders have limited liability. Their liability is limited to the amount paid on their shares
even when a shareholder in reality is the controlling mind of the company (eg the sole
shareholder and the sole director).
* The liability of the company itself is not limited.
164
4.7 Summary
It is the dual concepts of separate legal personality and limited liability that make companies such attractive and ubiquitous business models.
165
Principles of contract law
This section sets out some of the principles of contract law as they relate to Business Law and
Practice.
166
5.1 Introduction: Contract law in Business Law and Practice
* Contract law underpins many areas of business law. This section, therefore, sets out a summary of the principles of contract law which are relevant to Business Law and Practice.
* Every type of trading entity (sole trader, partnership, LLP and company) enters into contracts
in the course of its business to buy and sell goods and/or services.
167
5.1 Introduction: Contract law in Business Law and Practice
These materials introduce certain types of occasional transactions which most businesses undertake from time to time, such as borrowing money from a bank or purchasing a
subsidiary.
168
5.1 Introduction: Contract law in Business Law and Practice
In addition, businesses may appoint agents to sell or distribute their goods or services. Within a company or a partnership, particular directors or partners may be given authority to act as agents of the business and cause it to enter into contracts. To understand the extent of such
authority and its effect on both the business and the specific individual, some knowledge of the basic elements of agency, which is a branch of contract law, is required.
169
5.2 Key elements for formation of a contract
There are three fundamental elements in any simple contract. They are:
(a) Agreement – the parties must have reached, or be deemed to have reached, agreement. An agreement may be made in any manner whatsoever, provided that the parties are in communication with each other. Whether or not an agreement has been reached, and if it has, the terms of that agreement, are established by looking at the intention of the parties on an objective test. In order to discover whether agreement was reached between the parties, it is usual to analyse the negotiations in terms of offer and acceptance.
170
5.2 Key elements for formation of a contract
(b) Intention and capacity – the parties must have intended, or be deemed to have intended, to
create legal relations, and they must also be capable of making a contract.
(c) Consideration – according to the terms of the agreement, some advantage must move from
each party to the other.
In any transaction where one of these elements is missing, there is no contract.
171
5.3 Terms of a contract: Express and implied
Express terms
Express terms are express statements made by the parties and by which they intended to be
bound. There is a general presumption that the parties have expressed, orally or in writing, every material term which they intend should govern their contract. But there are circumstances where terms which have not been expressed by the parties are implied into the contract by the law or on the
facts. An implied term is binding to the same extent as an express term.
172
5.3 Terms of a contract: Express and implied
A term is implied in fact to give effect to the presumed but unexpressed intentions of the parties. The courts may take notice of trade customs, the conduct of the parties, a course of dealing between the parties and the need to give ‘business efficacy’ to a contract ie without the implied
term, the arrangement would be so un-businesslike that sensible people could not be supposed to have entered into it
173
5.3 Terms of a contract: Express and implied
A term implied in law, either by the courts or by statute, is in principle effective regardless of the intention of the parties. Parties may seek to ‘contract out’ of a term implied in law, by including an express term to that effect (depending on the facts).
174
5.4 How a contract comes to an end
Every contractual obligation gives rise to a corresponding contractual right. Thus, where the obligation of one party is discharged, the corresponding right of the other party is extinguished. Where all obligations arising under a contract are discharged and all rights thus extinguished, the contract is discharged. A contract might be discharged in one of five ways: performance, agreement, breach, frustration or discharge by expiry. It should be noted, however, that the
doctrine of frustration should be applied within very narrow limits. Therefore, the doctrine of frustration rarely affects businesses in practice.
175
5.4.1 Performance
A contractual obligation is discharged by the complete performance of the undertaking. Where the promisor is unable or unwilling to give more than partial performance, the general rule is that
there is no discharge.
176
5.4.1 Performance
The practical effect of this rule is that where a contract provides for payment by one party after
performance by the other, no action to recover payment may be maintained until the performance is complete.
177
5.4.1 Performance
However, this rule, like every good rule, is subject to a number of exceptions. For example, where
one party has rendered only partial performance of the contractual obligations, it is possible that
the other party, rather than reject the work done, might accept that part of the performance.
178
5.4.2 Agreement
A contractual obligation may be discharged by agreement, either by a subsequent binding contract between the parties or by operation of a term of the original contract.
179
5.4.3 Breach
The usual remedy for breach of contract is an award of compensatory damages (so most
breaches do not terminate the contract). However, sometimes, the injured party may treat the contract as having been repudiated by the breach. In such cases, the injured party is discharged from further liability under the contract and may sue for damages
180
5.4.4 Discharge by expiry
A contract will expire when it is completed in accordance with its own terms. This could be by date
or on the occurrence of a specified event.
181
5.4.5 Frustration
This may be raised as a defence to an action for breach of contract where something happens
after the contract is formed that makes performance of the contract impossible. Frustration may
occur where:
182
5.4.5 Frustration
* The contract becomes impossible to perform due to the total or partial destruction of some object necessary to the performance of the contract;
* A change in the law or state intervention renders any attempted performance illegal; or
* An event fundamental to the contract does not occur, the contract may be frustrated despite the fact that it is still physically possible to carry out the contract.
183
5.5 Remedies available to contracting parties
5.5.1 Conditions and warranties
The traditional view is that each term of a contract, express or implied, is either a condition or a warranty, depending upon its importance with regard to the purpose of the contract. The question of whether a term is a condition, or a warranty becomes significant in cases of breach of contract
184
5.5.2 Remedies
The law has developed a range of remedial responses where a breach of contract occurs. The successful claimant will be granted only one remedy. For example:
Unliquidated damages are assessed on the compensatory principle ie to make good the claimant’s losses and nothing else. The purpose of damages as a remedy is to put the claimant into the position he would have been in had the contract not been breached. Entitlement to
unliquidated damages is subject to the rule in Hadley v Baxendale (regarding remoteness) and the
duty to mitigate any loss suffered
185
5.5.2 Remedies
Liquidated damages are where contracting parties stipulate in the contract a fixed or predetermined sum to be payable as damages in the event of a breach by one of the parties. Where the sum inserted in the clause is intended as a punishment of the contract-breaker and cannot be justified commercially (in accordance with the principles applicable to unliquidated damages),
that sum is seen as a penalty. A penalty clause is unenforceable
Equitable remedies include specific performance and injunctions.
186
5.6 Principal/agent relationship
The principles of agency are concerned with the circumstances in which one person (the agent)
can form contracts on behalf of another person (the principal) to create contractual obligations
enforceable against the principal by a third party. A principal is bound by acts which it has authorised the agent to do on its behalf.
187
These principles apply to all forms of agency as follows:
* If the agent acts within their actual authority (express or implied), the principal is bound;
* If the agent acts outside their actual authority but within their apparent (or ostensible)
authority, the principal is bound; and
* If the agent acts outside of their actual and apparent authority, the principal is not bound but they can ‘ratify’ the agent’s acts.
188
5.7 Commercial contracts: Specific issues
5.7.1 Heads of terms
Heads of terms (also known as ‘memoranda of understanding’) are used in many corporate and
commercial transactions in order to outline the agreed intentions of the parties prior to the negotiation of a formal contract and to set out the framework for future negotiations. They are commonly intended to be non-binding (except for one or two clauses) and there will be express
provision to this effect, but they often carry a substantial amount of moral force and are often
negotiated before lawyers become involved.
189
5.7.2 Letters of comfort
One of the most common areas in which letters of comfort are given are loan finance transactions
where, for example, a parent company may be seeking to provide ‘comfort’ to a bank that its subsidiary will be able to make loan repayments. In such a letter, the parent may make representations as to the subsidiary’s past or future performance, or it may state that its policy is to make sure that all subsidiary companies are able to service their bank debt
190
5.7.2 Letters of comfort
There has been a lot of debate through case law as to whether such letters enable a bank to sue the parent company as a result of the subsidiary’s default. This remains a grey area, and whether a legal obligation has arisen will always depend on the facts of the case in question.
191
5.7.3 Battle of the forms
One common situation in which counter-offers arise is in the ‘battle of the forms’. This is where the
parties each attempt to contract on their own standard terms. In this example, there has been no acceptance of the buyer’s offer by the supplier. Instead, the supplier has made a counter-offer on its own terms and conditions.
192
5.7.3 Battle of the forms
This often means that whoever sends their terms last, prevails. However, this approach is by no
means a safe way of ensuring that a party’s terms prevail and it is far safer for the parties to agree unequivocally what terms will apply.
193
5.7.4 Conditions precedent
Usually found at the start of an agreement, conditions precedent are stipulated criteria or conditions that must be met before the agreement, or certain parts of the agreement, can come into force.
194
5.7.5 Assignment and novation
The issue of assignment and novation often arises when a party to a contract is seeking to transfer its rights and obligations under that agreement to a third party. With assignment, only the benefit (rights) of an agreement can be assigned and not the burden (obligations/liabilities).
195
5.7.5 Assignment and novation
An assignment is a bipartite agreement between the assignor and the assignee and can be
effected without the consent (or even knowledge of) the other party to the contract. Contracts often expressly state whether or not assignment is permitted.
196
5.7.5 Assignment and novation
On the other hand, novations allow both the benefit and the burden to be transferred, with the effect that the third party ‘steps into the shoes’ of the party that they are replacing. Novations are tripartite agreements between the original parties to the contract and the third party and require the consent of all.
197
5.7.6 Contracts (Rights of Third Parties) Act 1999 (the Act)
The doctrine of privity provides that only the parties to a contract have rights or obligations under that contract. The Act confers rights on parties who were not parties to the original contract and therefore amends the principles of the doctrine of privity of contract.
In order to avoid inadvertently providing rights to third parties, it is possible for a contract to
specifically state that, save for express provisions, third party rights are excluded.
198
5.8 Execution of agreements
There are generally two types of contract:
* A simple contract/agreement under hand (ie an agreement which is not intended to take
effect as a deed); and
* A deed.
199
Generally, a contract will take the form of an agreement under hand unless it has to take the form
of a deed for one (or more) of the following reasons:
* It is a document which is required to be executed as a deed eg certain transactions relating to
land
* It is desirable to have a limitation period for an action arising from the contract of twelve years (a deed) rather than six years (an agreement under hand)
* It is questionable whether a party to the document is providing valuable consideration. If a document takes the form of a deed, the document will be binding even if valuable consideration is not given.
200
5.8.1 Simple contract/Agreement under hand
A duly authorised person can execute a simple contract/agreement under hand on behalf of each party
201
Company
In the case of a company, this would usually be by a director authorised by a Board resolution. However, a company’s Articles should always be checked in order to ensure that there are no
further requirements relating to the execution of documents.
202
Individual
If the party is an individual, the individual can simply sign the agreement without the signature being witnessed
203
Partnership
In the case of a partnership, the agreement can be entered into by one or more of the partners.
204
5.8.2 Deeds
A deed must make it clear on its face that it is a deed and it must be delivered. In addition, a deed must be executed properly as follows.
205
Company
* Signed by two authorised signatories (who must be directors or, if the company has one, the company secretary);
* If its common seal is used, or
* Signed by a single director in the presence of a witness.
206
Individual
The individual needs to sign the deed and have his or her signature witnessed.
207
Partnership
An individual partner does not have authority to execute a deed on behalf of a partnership unless the authority has expressly been conferred by deed. Deeds should therefore be executed by all partners unless one or more partners is given a power of attorney to execute deeds on behalf of the partnership. The signature of the partner(s) should also be witnessed.
208
5.9 Summary
* In order to ensure there is a validly formed contract, there needs to exist:
- Offer;
- Acceptance;
- Intention; and
- Consideration.
209
Contractual terms
may be conditions or warranties (or innominate terms) and they may be
express or implied. These factors will have a bearing on the remedies available to a non-defaulting party if one party breaches the contract.
210
5.9 Summary
* It is important to ensure that a contract or deed is properly executed to ensure that the contract is likely to be enforceable.There are many issues that arise in the drafting of commercial contracts, such as conditions precedent and the Contracts (Rights of Third Parties) Act 1999
* It is important to ensure that a contract or deed is properly executed to ensure that the contract is likely to be enforceable.
211
