The Difference between Partnerships and Private Companies in Relation to Debt Liability - Essay Example

Discuss the difference between partnerships and private companies in relation to debt liability. Partnerships Partnerships can be formally wound upeither by the partners or under the Partnership Act 1890 (Macintyre, 2005, 464). One of the key differences is the way in which a partnership can be wound up. Firstly the partnership must come to an end (dissolution). Since a partnership is based upon a contract (usually a formal partnership agreement), any repudiatory breach of contract could lead to dissolution as it is based on common law contractual rules. Further misrepresentation is also grounds for seeking dissolution (Macintyre, 2005, 464). In a partnership consisting of two members, expelling one partner would force a winding up. In larger partnerships, expelling a member would led to a dissolution, but not necessarily a winding up. In certain circumstances partnerships must be dissolved under the Partnership Act 1890: once a partnership contract is performed - eg it was for a fixed term or for a specific purpose; the death or bankruptcy of a partner; a partner assigns his share to a creditor to satisfy a private debt; any event which makes it unlawful for the firm to continue its business or to have the status of a partnership (s34) (Macintyre, 2005, 464). Under s35 a partner may seek for dissolution on the basis of one of the following five grounds: permanent disability to perform the partnership contract; conduct prejudicial to the carrying on of the firm; wilful or persistent breach of the agreement which makes it untenable for the other partners to continue the agreement; the firm is making a loss and there is no chance of its finances being turned around; and/or that the Court considers it to be 'just and equitable' to dissolve the firm. Under the Mental Health Act 1983 the mental incapacity of a partner can also lead to the dissolution of a partnership. (s34) (Macintyre, 2005, 465). The partners retain the ability to bind the firm following a dissolution to the extent of completing unfinished transactions and all matters incidental to the winding up of the firm (s38 Partnership Act 1890). An example of this was Re Bourne [1906] 2 Ch 427 where it was held that the surviving partner had the authority to mortgage partnership land following the death of the other partner since the sole reason for doing so was to ensure the efficient winding up of the firm. A bankrupt partner cannot bind a firm following dissolution. However, if a receiver is appointed by the Court at the request of one or more partners, then all partners lose their authority to bind the firm (Macintyre, 2005, 466). An organisation's assets consist of both property and goodwill. Goodwill can be defined as "the excess of the market value of a business over the value of its individual assets" (Macintyre, 2005, 466). Once the firm's goodwill is sold it is unlawful for any partner to use the firm's name or solicit its customers. "[H]e must not, I think, avail himself of his special knowledge of the old customers to regain, without consideration, that which he has parted with for value. He must not make his approaches from the vantage ground of his former position. He may not sell the custom and steal away the customers" per Lord MacNachten Trego v Hunt [1896] AC 7 (Macintyre, 2005, 466). If a firm is solvent and has made a profit after settling its debts, then these proceeds will be split between the partners according to the proportion agreed upon in their current contracts. However, if the firm is solvent but has made a loss then either the partnership agreement will determine how the loss should be resolved or s44 Partnership Act 1890 is used to determine how the loss should be resolved (Macintyre, 2005, 467). Losses are to be paid out of profit, or capital or by the individual partners in the proportion they would have shared the profits (s44(a)). Following its winding up the firm must pay its creditors in the order of; external creditors are to be paid in full; partners' loans are to be repaid; partners' capital is to be repaid; finally the remnants are divided amongst the partners in the same proportions as any profit would have been shared (s44(b)). Any shortfall is treated as a loss, and s44 (a) applies unless the partnership agreement states otherwise. Note however that if the loss is due to one or more partners having been declared insolvent - and there is no contrary agreement between the partners - then the rule in Garner v Murray [1904] 1 Ch 57 is applied. Essentially the insolvent partner(s) are ignored for the purpose of the calculations. Where the firm does not have enough money to pay its debts it is technically insolvent. Any solvent partners will be jointly liable to repay any outstanding debtors in the proportion in which they would have shared the profits - unless there is a contrary agreement (s44 (a)). Under the Limited Partnerships Act 1907 it is possible for one or more partners to limit their exposure to partnership debts. However, at least one partner must retain general liability. Macintyre states that the legislation is relatively unsuccessful. This may be because limited partner status means that the partner cannot be involved in the management of the firm, nor can they act as agents of the firm i.e. they cannot bind the firm. Under the Insolvency Act 1986 an insolvent firm can be compulsorily or voluntarily wound up - either by a partner or a creditor. In this case the firm would be treated like an unregistered company and those laws would apply to the discharging of its obligations. Limited Liability Partnerships (LLPs) are treated similarly to companies in insolvency actions. Part III Limited Liability Partnerships Regulations 2001 (SI 2001/1090) applies the insolvency provisions of both the 2006 Companies Act and the company Directors Disqualification Act 1986 to LLPs. Part IV applies the provisions of the Insolvency Act 1986 to LLPs in terms of voluntary arrangements, administration and winding-up. Company procedures are followed. (Keenan and Riches, 2007, 143)In general members of a LLP do not have any liability to repay the debts of the LLP. This is because the LLP is a corporate body created by registration through Companies House. However, if the members agree to sharing liability for the LLP's debts, then they are free to do so (s74 Insolvency Act 1986). Further if a member withdraws LLP property within 2 years of the LLP being declared insolvent, that member may be liable to make a contribution to the debt of the LLP. Liability arises if the member had reasonable grounds to suspect that the LLP would not be able to meet its liabilities. One interesting point is that although a member of an LLP can leave with reasonable notice, the partnership is not immediately dissolved. In effect this means that a member has no automatic right to share in the assets of the LLP. It is essential that such an eventuality is covered in the LLP agreement (Macintyre, 2007, 325). Each member can bind the LLP since members act as agents. Like companies LLPs can issue fixed and floating charges on the organisation's assets; they can also be liable for wrongful or fraudulent trading like company directors. Also members of an LLP can be barred from being either a member of an LLP or a director of a company. Any member may petition the Court for a compulsory winding up order under the 'just and equitable' ground (s122 Insolvency Act 1986). S459 Companies Act 1985 applies to LLP unless there is a contract agreement. Companies can be voluntarily wound-up by its members (members' voluntarily liquidation) or its creditors (creditors' voluntarily liquidation). A members' voluntary liquidation requires a special resolution by the company, whilst a creditors' voluntary liquidation requires an extraordinary resolution. A members' voluntary liquidation application must be accompanied with a declaration of solvency (s89 Insolvency Act 1986) and a liquidator must be appointed by the members. In the case of a creditors' voluntary liquidation, there is no need for the solvency declaration, but the creditors will appoint the liquidator. Other parties may apply for a winding up of a Company, such as the Official Receiver. S124 (1) Insolvency Act 1986 There are seven grounds upon which a Court can order the winding up of a company. (s122(1) Insolvency Act 1986).The two most important ones are that the Company cannot pay its debts (s123(1) ) or the 'just and equitable' ground. A company will be held to be unable to pay its debts if it cannot satisfy a court judgement in favour of a creditor or where a creditor demands repayment of more than 750 served at the company's registered address and does not receive payment within 3 weeks. Examples of the 'just and equitable ground are a management deadlock, a justified lack of confidence in the management or that the company was inaugurated for the purposes of fraud. (Macintyre, 2007, 300). Under s122(1)(g) the court can wind up a company on the petition of a minority on the grounds it is just and equitable to do so. Since the unfair prejudice provisions were enacted and following the decision in Re a Company [1983] 2 All ER 854 the courts are not as flexible regarding the interpretation of this section. If the majority shareholders offer to buy out the minority, the court will favour this, since the ex-director's capital has been made available to him. Should such an offer not be made, then petitioning under the unfair prejudice provision, since the court can order the purchase of the ex-director's shares at a market or 'fair' price. It should be noted that the 'just and equitable ground' remains in force: Jsner v Jarrad, The Times, 26 October 1992 Keenan, 2003, 606. From the moment the resolution to seek a winding up order is passed, all trading must cease, shares should not be traded and the employees are effectively dismissed. The directors' powers are then limited, and cease altogether once a liquidator is appointed. As soon as the winding up order is granted, it becomes unlawful to dispose of any of the Company's property without a further court order; all transactions cease or crystallise; and the employees are dismissed. The liquidator has all authority to determine the disposal of the Company's assets and goodwill. S230 (3) Insolvency Act requires that the liquidator is a qualified insolvency practitioner. As he acts in the company's name, the liquidator cannot be held personally liable on contracts made by him for the company nor does he personally have to repay any professional costs to solicitors who he instructs on the company's behalf (Lowry and Dignam, 2007, 449-50). The liquidator may opt to re-employ the employees and carry on the company business in order to ensure the most beneficial winding up. The liquidtor is to ensure that each class of creditor is paid in full before the lower ranking classes qualify for settlement of their debts. Where there are insufficient funds to pay a class in full, each member of the class is paid the same percentage of what he is owed. A fixed charge holder has the right to sell the asset, but must return any excess to the company's asset pool. If the sale does not settle the debt then the fixed charge holder can claim the balance as an unsecured creditor. The costs of realising the assets subject to a floating charge come next (Macintyre, 2005, 581). Thereafter preferential creditors must be satisfied. Preferential creditors include occupational pension schemes, holiday pay accrued, loans taken to pay wages/holiday pay - Enterprise Act 2002.Where appropriate a top sliced fund of a minimum of 50% of the company's property - after settling debts of the preferential creditors and the costs of realising the company's assets - goes to unsecured creditors, followed by holders of floating charges. Penultimately the general costs of liquidation are paid. Thereafter any surplus is distributed to the company's members. One of the key roles of the liquidator is to ensure that the directors have not sought to make an unlawful profit or otherwise acted unlawfully. Directors and shadow directors can be liable for wrongful trading where s/he knew there was a strong possibility of an insolvency action and s/he failed to "take all reasonable steps to minimise the potential loss to the company's creditors'". The liquidator can also apply for a court order which allows the company to avoid transactions which appear suspicious, for example they appear to be at an undervalue or give preference to one or more creditors of the company. Floating charges which appear not to have given the company full value in return for their creation, or which was made in favour of a connected person within 1-2 years of the company being wound up are likely to be made invalid. Other criteria apply such as whether or not the company was solvent at the time, but the Liquidator is clearly looking for any indication of fraud on the company. In the event that the company goes into administration for an agreed time period rather than liquidation then the priorities change. The Administrator's primary concern is to ensure the company continues as a profit making entity. It is only if this is not possible that considerations of ensuring creditors receive an adequate or full return for their investment/credit or selling the company to the benefit of secured and preferential creditors will come into play. Where there is a strong chance the company can be made viable any petition for a winding up will be dismissed or suspended until the period of administration expires. (Macintyre, 2005, 604-5). Although Paragraph 2 of Article 11 of the First Company Law Directive (68/151/EEC) requires that the dissolution or 'nullity' of limited companies may be ordered by a court only on the given six grounds (eg no constitution, unlawful objects, failure to state the company's name etc), no UK legislation has been passed to implement this (Mayson et al, 2004, 772). "With their new entity the DTI seem to have met a commercial need that was actually there; the LLP is being used. It takes the advantage of limited liability from company law and combines it with what some will regard as advantageous aspects of partnerships, namely partnership taxation." (Pettet, ,2005, 22). (Need latest info: Statistical information on country court administration orders can be found at www.lcd.gov.uk in the Judges and QC's section and all other information at the Insolvency Service - www.insolvency.gov.uk Corporate insolvency procedures 99 00 01 Compulsory liquidations 5,209 4,925 4,675 Creditors' voluntary liquidations 9,071 9,392 10,297 Receiverships 1,618 1,595 1,914 Company administrations 440 438 698 Company voluntary arrangements 475 557 597 Total corporate insolvency procedures 16,813 16,907 18,181 (Tolmie, 2003, 14) MacIntyre, E. (2005). 2nd Edition. Business Law. Harlow: Pearson Education Ltd. Adams, A. (2003). Law for business students. 3rd Edition. Harlow: Pearson Education Ltd. MacIntyre, E. (2007). Essentials of Business Law. Harlow: Pearson Education Ltd. Lowry, J and Dignam, A. (2006). 3rd Edition. Company Law. Oxford: OUP. Keenan, D. (2003).12th Edition. Smith & Keenan's Law for Business. Harlow: Pearson Education Ltd. Keenan, D. and Riches, S. (2007). 8th Edition. Business Law. Harlow: Pearson Education Ltd. Mayson, S., French, D. and Ryan, C. (2005) 21st Edition. Company Law 2004-2005. Oxford: OUP. Pettet, B. (2005). 2nd Edition. Company Law. Harlow: Pearson Education Ltd. Tolmie, F. 2nd Edition. 2003. Corporate & Personal Insolvency Law. London: Cavendish Publishing Limited. Read More