Major Differences between Partnerships - Essay Example

"The fundamental difference between a partnership, a LLP and a private limited company is that in the former, a partner is exposed to a potential liability for all the debts and obligations of the firm" The scope of this paper is to examine how a partnership differs from other forms of organisations like limited liability partnership and private limited company in terms of liability fastened to the shares held by individuals or entities. Unqualified form of partnership places the entire burden of business liability on the partners of the firm. On the other Limited Liability Partnership (LLP) and a Private Limited Company do not impose as much liability as the Partnership does. An LLP is almost similar to standard form of partnership without unlimited liabilities on the partners. Partners' liabilities are differently prescribed in that liability caused by any error of one partner need not affect the other partners. State registration is required but some of the states stipulate that partners should take liability insurance or has adequate assets to meet likely claims. This is very much applicable to firms of professionals like accountants, lawyers, architects. Not all the states recognize them. A partner's interest in an LLP can be assigned to third parties in which the assignee gets only the financial benefit and he can not take part in the management nor can he become a partner. There can be more than two partners. An LLP will stand dissolved on the death of a partner and on filing dissolution deed with the Sate authority. A clear advantage of an LLP is that it need not conduct annual meetings and maintain minutes of meetings though it has the features of a limited company. Profit is not taxable at the hands of the firm but that of the individual partners. One disadvantage is that a partner of an LLP can bind his share without the other partners. And all contributions made by a partners in the forms of money or property become the property of the firm unless otherwise stated in the partnership agreements.1 Section 13(4) of Limited Liability Partnership Act 2000 stipulates that all partners must contribute to national insurance which shall be chargeable on their shares of profit. The name of LLP displayed on all the documents must end with llp or LLP as per schedule Part I. An LLP name with the above letters can not be registered unless it ends with them. It is an offence to use an LLP's name if the Secretary of State so considers and if the name already exists for an LLP or a registered company. The summary of the act states that main feature of the act is that it offers organisational flexibility and limited liability of the partners.2 The overview of the Act says that an LLP has an unlimited capacity and can act as a separate legal entity as any natural person would. It can contract and own properties and can continue to exist if there is any change in the membership. It implies that any third party can transact with the LLP as an entity unlike in case of traditional partnership where in third party is presumed to deal with the partners jointly and severally. If a partner of LLP is negligent only the firm can be proceeded with and not the individual partner by virtue of limited liability. But in a recent case law 3states that liability by an individual negligent partner causing economic loss to the clients depends the fact of any specific assumption personal responsibility of the partner concerned and whether the client also relied on the responsibility of the individual partner. Section 4 (1) Companies Act 2006 defines a private limited company as any company which is not a public limited company. Hence in order to understand that, what a public limited company means must be seen. As per section 4(2) of the act, a public limited company whose liability is limited to the extent of its share capital or to the extent of any guarantee where there is no share capital and its certificate of incorporation must state that it is public limited.4 As per section 9 of Partnership Act 1890, partners' liability is jointly borne. In Scotland partners are liable severally also for all liabilities including obligations of the firm occurred during the concerned partner's term of partnership and his estate is liable for debts and obligations after his death severally in due course of the administration of his debts. As per section 12 of the Act, partners are jointly and severally liable for all wrongs committed under sections 10 and 11 reproduced below. 10 Liability of the firm for wrongs Where, by any wrongful act or omission of any partner acting in the ordinary course of the business of the firm, or with the authority of his co-partners, loss or injury is caused to any person not being a partner in the firm, or any penalty is incurred, the firm is liable therefore to the same extent as the partner so acting or omitting to act. 11 Misapplication of money or property received for or in custody of the firm In the following cases; namely- (a)Where one partner acting within the scope of his apparent authority receives the money or property of a third person and misapplies it; and (b)Where a firm in the course of its business receives money or property of a third person, and the money or property so received is misapplied by one or more of the partners while it is in the custody of the firm; the firm is liable to make good the loss.5 The proposition in this paper is that partnership f form business entails unlimited liability on the partners jointly and in some case severally also. In case of limited company, it operates like a partnership and is rightly called archetypal company. It can be formed with the least formalities. It is like partnership firm because the owners are invariably directors and also employees. At the same time company directors will enjoy protection from unlimited liability of the company. The private limited company can not be offered to public and therefore not freely transferable. The private limited company is allowed to have even one member thus indistinguishable from a sole trading proprietorship concern. The Memorandum of association may say that the private limited company has an authorized capital of 100,000 comprised of 1 or 50 p per share but will have only one or two shares allocated and fully paid. There can be cases in which just 80000 shares 1 each allocated and the remaining 20,000 remaining unallocated and even the allocated shares need not have been fully paid. Such allocated shares will continue to be partly paid up in the balance sheet. However in the event of dissolution or dispute, the unpaid portion of shares will have to be recovered to meet company's liabilities. Similarly a private limited company limited by guarantee will have no paid up shares as such but will have to be met by the shareholders to the extent of their guarantee in the event of a claim. This type of company is generally formed for the purpose of non-profit activities.6 The leading case to explain the corporate personality distinct from its share holders is Solomon v Solomon & Company Ltd7 Although Solon lost originally on the ground that his act of forming a limited company was only to avoid liability more than his share capital, House of Lords sympathetically considered his position as he had endeavored to improve the lot of his company with own money and also initial creditors had already been paid by him and even though he valued his company more, he could not sell it more than what statute allowed thus defaulting in his commitments. . However, injustice might well result from permitting shareholders and directors to hide behind the 'veil of incorporation' of company legal personality and there are a number of examples where the 'veil of incorporation' is lifted or pierced. Some of these instances are statutory, others judicial. Whilst judicial attempts to lift the corporate veil have been assembled by commentators and textbook writers into rough categories, these are not sacrosanct, and an analysis of the cases reveals an element of unpredictability. A controversial area relates to groups of companies. As registered companies are persons in the eyes of the law, and can exercise all the functions of a human being, subject only to their physical limitations as artificial persons and to their registered constitutions (the memorandum and articles), it follows that a company may be empowered to buy shares in other companies, or to set up companies in which it is the major shareholder. Where one company controls another they are in the relationship of holding company and subsidiary. The current definition of this situation is to be found in s736 Companies Act 1985, as amended by Companies Act 1989, s.144.8... It is evident therefore from the case of Solomon v Solomon Ltd that corporate veil can not be always pierced or lifted to expose the real owner or debtor responsible for the benefit of creditor if the form of business is chosen is company limited by shares or guarantee. Thus in MACAURA v NORTHERN ASSURANCE CO LTD [1923] AC 619 a controlling shareholder failed to obtain compensation because of the refusal of the Privy Council to lift the veil. Macaura had taken out insurance on certain timber but failed to assign the fire insurance policy to the company to which the timber was transferred and in which he was a major shareholder. Macaura could surely have demonstrated an insurable interest in the assets of the company, but the court refused to consider this, perhaps because of a suspicion of arson on his part. The timber no longer belonged to him and hence he could not claim when it was destroyed. In LEE v LEE'S AIR FARMING LTD [1961] AC 12 [1960] 3 All ER 420 Lee's widow sought compensation from the state under the Workmen's Compensation Act when he was killed in a flying accident. Lee was the beneficial owner of all the shares and the governing director of a company he had formed to carry out the business of aerial crop-spraying. He was legally required to take out the insurance for the company's employees, of which he was chief pilot, and had kept up payments. His widow succeeded in the Privy Council, although the identity of company and employee was as close as it could be. Presumably few people are likely to want to suffer a serious industrial accident or death in order to collect compensation. There was, of course, no suggestion that Lee was ordering himself to be killed, although putatively qua director he might have given himself an order qua pilot of the tasks he had to perform that day. The situation might be different where a director decides to make himself, in his capacity as an employee, redundant. In the Employment Appeal Tribunal case of BUCHAN v SECRETARY OF STATE FOR EMPLOYMENT [1997] BCC 145 the claimant was a controlling shareholder. Disbursements were claimed from a fund (now under the Employment Rights Act 1996) set up in accordance with EU law to pay the wages/salaries of employees owed money by insolvent employers. The Tribunal held that two controlling shareholders who were also directors were not employees for this purpose, on the somewhat strange ground that their control of the company somehow conferred upon them some sort of control over the financial fortunes of the company. Buchan spent some 5% of his full-time occupation in the company on work as a director, the remainder as a sales manager and scanner operator, receiving the not entirely princely salary of 35,000 per annum.9 The partnership form of businesses is resorted to only by small firms and individuals of limited capacity. Yet there is no protection from liability unlimited unlike in the case of large organisations in the form of LLPs and Limited companies. Freedman10 says that an alternative form incorporation for small businesses as a protection from unlimited liability has yet be announced or devised. It is the case that the UK still has not had a thorough review of the relationship between limited liability and unlimited liability legal forms for small firms and that the LLP's role for small firms has not been properly addressed. Nevertheless, the need for a special limited liability company regime for owner-managed firms has been reviewed and rejected for clear and convincing reasons. The temptation to create a new legal form because other jurisdictions have something of this type has been resisted, rightly. The focus on competitiveness in the CLR might have tempted the CLRSG to follow the US, which evidence suggests is a more entrepreneurial society than our own, by creating a number of different legal vehicles for small firms. This would have been a move in the wrong direction. There is increasing criticism in the US of the proliferation of legal forms, often with tax driven origins, often resulting in confused creations, and there is now a move towards "one-entity fits all" statutes.11 Booth A 12 proposes that instead of expanding the forms of organisations as corporations, partnerships, limited partnerships, LLCs, LLPs, LLLPs, a unified system could be arrived at. But the reaction has been not encouraging. It seems once an organization is formed, it is difficult to change it or rather no interim relief available to change the form. Though every form of organization is to suit convenience of the individual concerned, least concern is shown to people who deal with them like creditors and employees. John Whittaker 13 says that LLPs also have the potential for unlimited liability in that depending on the contract between the partner and the client, liability can be fastened to the partner of the firm irrespective of limited liability. He will be responsible even for the acts of his employee. . . Individual members and employees In relation to individual members and employees, the position is generally perceived as one of considerable uncertainty as a result of the Court of Appeal decision in Merrett v. Babb in February 2001, 1 coming after Williams v. Natural Life Health Foods Ltd in the House of Lords in 1998.2 In Williams, the managing director and controlling shareholder of the negligent company (engaged in the business of franchising retail health food shops, and giving advice to franchisees) was held not personally liable for the negligent advice which had been given to the claimant franchisees, as he was found not to have assumed a personal responsibility to the claimants in respect of that advice. There were no personal dealings between him and the claimants. In Merrett v. Babb, on the other hand, a salaried employee of a professional firm of surveyors which had been instructed to carry out a valuation was held personally liable in negligence to third parties who had had no contact with him and did not know who he was: indeed they were not themselves the clients of the firm. The present uncertainty arises essentially from a feeling that it is difficult to reconcile the decision in Merrett v. Babb with (a) the House of Lords appearing to indicate in Williams that the assumption of personal responsibility test is the test for determining liability for economic loss resulting from the negligent performance of services (and indicating also that there is no need to embark on any further inquiry whether it is ''fair, just and equitable'' to impose liability) and (b) this test being seen as focusing largely on direct contact between the client and the relevant professional. The reconciliation of Merrett v. Babb with Williams, it is suggested, is to be found in an appreciation of three factors. First, that there is small print in the Williams test itself; secondly, that the principal concern of the court in any particular case coming before it is to arrive at what it sees as the generally acceptable and just result as between this claimant and this defendant, whatever any test or formula says; and, thirdly, that Merrett v. Babb was a rather special case.14 In a case decided by House of Lords in Miah and others v Khan (A.P) and one another Action 15, it was decided that it was not necessary to start the business operation to constitute partnership. One of the parties tried to escape liability contending that his liability would arise only when business started since the partnership agreement was to carry on business and hence any liability before the business was to start could not bind him. The question in the present case is not whether the parties "had so far advanced towards the establishment of a restaurant as properly to be described as having entered upon the trade of running a restaurant," for it does not matter how the enterprise should properly be described. The question is whether they had actually embarked upon the venture on which they had agreed. The mutual rights and obligations of the parties do not depend on whether their relationship broke up the day before or the day after they opened the restaurant, but on whether it broke up before or after they actually transacted any business of the joint venture. The question is not whether the restaurant had commenced trading, but whether the parties had done enough to be found to have commenced the joint enterprise in which they had agreed to engage. Once the judge found that the assets had been acquired, the liabilities incurred and the expenditure laid out in the course of the joint venture and with the authority of all parties, the conclusion inevitably followed.16 Conclusion It would be clear from the foregoing that partnership form of business has been singled out to bear the brunt of liabilities in full by its partners. All other forms of business in one way or other have the methods of avoiding personal liabilities to be borne by the individuals ultimately owning the organisations. It was seen in Solomon v Solomon ltd that the ultimate person Solomon indeed tried to pay his debts in full in spite of the limited liability protection, But for the restraints in assets valuation, he would have settled the liabilities in full. Similarly in LLPs also there are in- built provisions to bind the partners for acts of omissions and commissions by the firm, employees and fellow partners. It is a reality that in spite of limited liability provisions, the large lenders do take personal guarantees from the directors so that in the event of default, they can not avoid liability under limited liability provisions. It is history what happened personally to the directors of failed corporation such as Enron. They were not spared. In fact creditors prefer partnership types of organisations so that they will not be facing limited liability provisions of protections by the defaulting firms' partners. Hence forms of business do not really matter in the event of liabilities provided shrewd creditors take care to ensure personal guarantees are obtained from the ultimate owners. The different forms of organisations are available only for the sake of convenience of operations according to the individual needs and according to the necessity of raising funds from a limited circle or large circle of prospective shareholders. The businesses are carried out according to the exigencies. The only sufferers are hapless share holders like any other ultimate owners of any enterprise. They are supposed to venture out taking risks and company form is so designed that in the event of loss, the share holders do not lose a fortune. Partnership with unlimited liability will be a necessary evil lest wheels of business would stop moving. There are several thousands of small businesses having partnership structure without which the individuals cannot start businesses. Not all can start big companies. And even if there are large limited companies, these partnership businesses have to coexist for representing and supplementing the businesses of these large limited companies in retail sector that is the tail end of the business structures i.e. the meeting point of consumers which have to be necessarily in personalized forms. . Bibliography Companies Act 2006 Limited Liability Partnership Act 2000 accessed 14 January 2008 < http://www.opsi.gov.uk/acts/acts2000/en/ukpgaen_20000012_en_1.htm#end> Coollawyer "Limited Liability Partnership Business Info" accessed 14 January 2008 http://www.coollawyer.com/webfront/bizfilings/LLP.php Partnership Act 1890 Rochez Piggot Semple Company Law Chapter 2 accessed 14 January 2008 www.spr-law.com Salomon v Salomon & Co Ltd [1897] AC 22 HL, Williams & anor v (1) Natural Life Health Foods Ltd (2) Richard Mistlin (1998) 1 WLR 830 accessed 14 January 2008 < http://www.opsi.gov.uk/acts/acts2000/en/ukpgaen_20000012_en_1> Read More