Foundations of Company and Commercial Law - Case Study Example

FOUNDATIONS OF COMPANY AND COMMERCIAL LAW Name of the School Professor Name of the Class City and State Where it is Located Date FOUNDATIONS OF COMPANY AND COMMERCIAL LAW QUESTION 1 Dilara and Aysha are currently operating a sole proprietorship that previously belonged to their grandfather who owned and operated the business alone. They run it as a going concern and share their profits equally. It is not a legal entity and the owner is liable for its debts and can be termed as unincorporated. Sometimes raising money may be difficult since banks and other sources of finance may be reluctant to give loans and instead one has to find another means of acquiring capital. For such kind of businesses the tax aspects are more appealing since they are included in one’s personal income tax return. The business earnings are taxed only once a year unlike other business structures. Their business structure is not the best for selling part of the winery since it was only managed by one person. It would mean that they would still be liable for any debts the company would accrue and as such it is wiser to turn the business into a corporation. This can be done by way of registering the business again but this time as a corporation so they can take advantage of the liability protection that they would receive. Even though corporate structures are complex and also expensive than other structures of business, they are an independent legal entity that is separate from its owners. The advantage of incorporating is the liability protection that is received since the corporations debts are not considered as the owners meaning the owners assets are not under any risk (Hamilton 2010). Corporations can also retain some of their profits without having to pay tax on them. Another advantage is that corporations have the ability to raise funds by way of selling stock, either common or preferred. They continue infinitely even after the death of one of the shareholders or the in the case they sell their stock or become disabled to continue. Corporations are formed under different laws in each state where they have their own set of regulations. They also have more complex rules than those of a partnership or sole partnership and need more accounting and tax preparation services. Owners of corporations are subject to double tax on the earnings (Ridstein 2008, 661). It is because they pay taxes at both the federal and state levels. Any earnings that are given to shareholders in the form of dividends are taxed on their personal income tax returns. Ways of easing the double taxation include paying some of the money as salaries to corporate shareholders who work for the company as directors or otherwise. Since they are not required to pay tax on earning paid as compensation to its employees, they can deduct the payments as business expenses but it is done under limits of what the IRS considers reasonable compensation. Incorporating mans that they could have Mr. Polat as one of the directors to play the role of supplying his expertise when it comes to wine making. They would also be able to raise more funds for the business by way of selling shares. It would mean that they would have to come up with a proper management structure to allow for good running of the business while also making sure they follow all the rules and regulations pertained to corporations (Graham 2011, 59). The cost and ease of registering their business under a new structure and also the restoration should also be considered to make sure they have raised enough money to enable them to make these changes. QUESTION 2 As a shareholder Leo has the right to vote when there are meetings held by the board since he is one of the owners of the company. Voting is done on a number of issues which include voting in or out of directors who run the company. There can also be voting on a number of other issues which are concerned with the running of the business. He has the right to acquire all financial records of the company and look into them. It is usually done weeks before the board meeting is held (Fahlenbach 2009, 81). He is allowed to call board meetings like the EGM’s where matters of urgency arise that cannot wait for the next AGM to be discussed. He is allowed to receive dividends from profits gained by the company and also to have a say on the remuneration of boards members who run the organization. In Leo case he was not allowed to access the financial records of the organization meaning there was something the directors were trying to hide. He was not included when they were deciding on the salaries of the two board members, who continued to assign themselves large amounts of remuneration which meant they were acting in their own interests instead of upholding the interests of the shareholders. They also took on expensive leases to obtain cars for their executive use without the approval of the shareholders and this was done at the cost of the company. The large bonuses they awarded themselves were at the expense of Leo who got nothing. Leo was entitled to dividends which are paid annually to the shareholders. Being a non-executive director meant that he could get no remuneration but was allowed to receive dividends which he had not received for two years. Leo can present a case under the grounds of oppression under s232 (a) Corporations Act. He could argue that the running of the company was being conducted under unfair and oppressive conditions. The conditions would include the refusal for him to access financial records, assignment of large remuneration packages coupled with bonuses at the expense of the company. Refusal to issue him with dividends and also the choice to remove him as a director of the company are also included (Baber 2009). The court could remedy this by ruling that Leo be allowed to access the financial records of the company. If Leo did not wish to remain as a member of the company he could sell his shares and have the other members buy him out. It is also wise to note that a claim to oppression does not include failure to pay dividends but when put together with other factors it holds weight. He can also bring personal action against Amanda and Ruby to enforce the statutory right of access to the businesses financial records as well as other books of importance (Harris 1988, 203). There is also the option of derivative action which would claim that Amanda and Ruby were paying themselves large salaries and bonuses and as such not acting in the best interest of the company. It can also be termed as misuse of position under the corporations act. The court could consequently rule that Leo be allowed to look at all the records he had requested. QUESTION 3 The directors of TACH ltd were in breach of section 180 of the Corporations Act since they did not act with care, skill and diligence and are liable to civil penalty provisions. They were in breach of section 588G. This is because the company was insolvent and there was enough reason to suspect insolvency but they did not check the company records due to lack of time on their part and also the failure to attend these meetings. They were expected to exercise care and act in the best interest of the company but did so with negligence. It is evident after Mr. Erol prepared financial records that indicated there were profits when in fact there were none. Vanessa the managing director due to lack of time did not go through the records and believed that MR. Erol would discuss with her any issues that required attention but he did not do so. It can be seen as negligence. They should have checked the records further but instead went on to conduct business using money that was not available to make further investments leading the company to insolvency (DuPlessis 2010). The directors can be held liable since they did not exercise proper oversight. Even though these directors were not aware that the company was facing insolvency they could be held liable since they participated negligently. It means that they could be held liable to pay compensation due to their negligence. Reference can be made to the case of the Australian securities and investments commission vs Jodhee Rich. In this case the ASIC accused Jodee Rich and Mark Silbermann who were directors of One. Tel telecommunications for failing to meet their duty of care, skill and diligence in the months that led to the company’s collapse in May 2001. They did not inform the board of directors about the true financial status of One. Tel. ASIC sought claims amounting to ninety two million dollars and a lifetime ban for all former directors of One.Tel. ASIC claimed that the withdrawal of support for an underwritten rights issue from Packer and Murdochs PBL and News Corporation led to the company’s downfall. It was claimed that One. Tel needed three hundred million for them to survive but it was later found out they did not need as much. The rights issue and the support of the shareholders would have been enough to last them until November 2001 being calculated as the time the company would have been generating enough money to sustain themselves. The directors were seen as to have behaved underhandedly in conspiring to bring the company to a close. Following these claims the directors were held liable and criminal warrants were granted to raid Jodee Rich’s home while also obtaining a freezing order on all his assets. After nine years of court sessions the court ruled that ASIC had not given enough evidence to prove that Jodee Rich had failed to uphold his duty of care and diligence as a director at One. Tel. Looking at TACH Ltd the directors would be held liable for failure to exercise care if it were proven that the financial records prepared by MR. Erol were in fact not correct, and that they continued to conduct business having not discussed the statements which would have given them the chance to come across the mistakes. In this case the consequences could include getting banned from practicing as directors in other firms while also being forced to pay for the company’s debt. Mr. Erol could be brought under criminal charges under s588G for preparing records that had errors (Knepper 2015, vol 1). Vanessa the managing director would be liable since she did not show reasonable and diligent interest in the financial records prepared by Erol. Kurt would also be held liable since he did not attend the meetings which were intended to uphold the interest of the organization. They may be saved by the business judgment rule found in section 180 (2) which states that if genuine business decisions are made in good faith with no material personal interest then it is thought that it was in the best interest of the company. Vanessa and Kurt could also find relief since they were working on advice that was supplied by Eron regarding the company’s financial status. QUESTION 4 In April 2008 provisions were established in the Companies Act 2006 allowing accountants or auditors to reduce their liability in regards to statutory audit work done for an organization by going into a specific agreement with their patron. Sections 534 to 538 of the 2006 Act allow for the legitimacy of liability agreements that imply to reduce the level of liability owed to an organization by its auditors in regards to any breach of duty or trust, negligence and default that might take place in the time the audit of accounts was being done. This means that auditors can reduce their liability by negotiating terms with the client in regards to a particular job being done (Rossouw 2010). For these liability limitations to work well there is the requirement to actualize the terms that are allowed by shareholders of the company. The liability limitation agreement does not cover more than a single financial year at a time and should strictly indicate which financial year it is. While writing up these agreements, references are to be made in the first letter of agreement indicating any restrictions or exclusions of liability. It is done to avoid the introduction of such provisions in already existing arrangements where instructions have already been accepted. The Unfair Contract Terms Act of 1977 establishes substantial limitations on the implementation of exclusions of liability for breach of contract. There are very few case laws that can be referred to when looking for guidelines as to which exclusions or limitations of liability for negligence are thought of as reasonable. Liability to third parties indicate that an accountant may be held responsible for negligence not only in contract but also in tort if the person to whom they owed a duty of care has undergone loss due to the accountants negligence. In almost all cases an accountant always owes a duty of care to their client and the duty can also be a co-extension of the contractual duty. Courts including the House of Lords have added the levels of cases in which an accountant would be responsible for negligence to someone else who is not their client in this case the third party. Liability to third parties occurs when an auditor performs a task for his or her client in a setting where he/she has been made aware that the work might be depended upon by a third party. Liability can also occur in cases where the third party may undergo financial loss if the particular task being handled is done negligently. When these conditions are established then the third party by law is regarded as a person who ought to have been on the mind of the auditor when they were applying their skills to the particular task. Even in cases where the auditor was not informed that his work would be depended on by a third party, it is wise that they consider the possibility of such an occurrence (Chung 2010, 66). Examples where liability to third parties may occur are found where there is production of financial accounts or projections to be presented in a bank supporting the application of a loan. I agree with this concept of liability to third parties in tort since it protects the rights of the extra person who might otherwise suffer losses if they are not considered when auditing is being done by the professional. Liability to such people also ensures that the duty of care is exercised to the highest of standards seeing as failure to do so may lead to the auditor being held liable in a court of law due to negligence. Avoiding liability to third parties is in most cases thought to be difficult since there are no defined actions on how an accountant can restrict the distribution of his or her work or what it may be used for. Audit reports of large public companies are some of the hardest to keep restricted since they are demanded by many people. References. Hamilton, R. and Freer, R., 2010. Hamilton and Freer's The Law of Corporations in a Nutshell, 6th. West Academic. Ribstein, L.E. and O'Hara, E.A., 2008. Corporations and the Market for Law.U. Ill. L. Rev., p.661. Graham, J.R., 2011. Taxes and corporate finance. Handbook of Empirical Corporate Finance: Empirical Corporate Finance, 2, p.59. Fahlenbrach, R., 2009. Shareholder rights, boards, and CEO compensation.Review of Finance, 13(1), pp.81-113. Baber, W., Kang, S., Liang, L. and Zhu, Z., 2009. Shareholder rights, corporate governance and accounting restatement. In Working paper, Georgetown University. Harris, M. and Raviv, A., 1988. Corporate governance: Voting rights and majority rules. Journal of Financial Economics, 20, pp.203-235. Du Plessis, J.J., Hargovan, A. and Bagaric, M., 2010. Principles of contemporary corporate governance. Cambridge University Press. Knepper, W.E., Bailey, D.A., Bowman, K.B., Eblin, R.L. and Lane, R.S., 2015.Duty of Loyalty (Vol. 1). Liability of Corporate Officers and Directors. https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwji_PGzku7PAhWHr48KHQcPBVUQFggjMAE&url=http%3A%2F%2Fwww.accaglobal.com%2Fcontent%2Fdam%2Facca%2Fglobal%2FPDF-members%2F2012%2F2012p%2FProf_liability.pdf&usg=AFQjCNEC-DDLtoESibbJcxTzz7aZf2A4Pw&sig2=oYuvdNwfFWBLDe9t_TYTUA Rossouw, D., Prozesky, M., du Plessis, C. and Prinsloo, F., 2010. Ethics for Accountants & Auditors. OUP Catalogue. Chung, J., Farrar, J., Puri, P. and Thorne, L., 2010. Auditor liability to third parties after Sarbanes-Oxley: An international comparison of regulatory and legal reforms. Journal of International Accounting, Auditing and Taxation,19(1), pp.66-78. Read More