Limited Liability Registered Company - Essay Example

The Advantages of a Limited Liability Registered Company vs A Partnership Introduction When a registered company limits liability according to shareholding it has a number of advantages over a partnership. Essentially, owners of the company are able to separated their personal assets and liabilities from that of the company’s in a way that partnerships may not. Although partners may limit liability if they are formed under the Limited Liability Partnerships Act 2000, personal liability may still arise in the event of the winding up of the partnership.1 This study sets out the most important features of the registered company limiting liability in accordance with shareholding and explains how those features provide an advantage over partnerships. This will be accomplished by setting out the main features of the limited liability company and the partnership. Once these features are set out, comparisons relative to the advantages of a registered limited liability company over a partnership can be explained and evaluated. I. Features of the Registered Company with Limited Liability The main legal benefits of a registered limited liability company is the existence of perpetual life, its separate legal personality from its incorporators and the limited liability of shareholders and other classes of owners and investors.2 Under UK company law, a company has limited liability status when the shareholders’ liability is limited to the amount that is “payable for the shares”.3 A registered company simply refers to the fact that the company is registered with the companies’ registrar and is a typical function of UK company law formalities.4 A. Limited Liability The concept of limited liability was first introduced in UK law under the Limited Liability Act 1855 conferring upon shareholders what was characterized as “conditional limited liability”.5 Liability was conditional upon providing “a minimal capital” which necessitated adding the word limited to the company’s name signaling the fact of liability.6 In 1856 the UK introduced the Joint Stock Companies Act which officially made limited liability unconditional. The Companies Act 1862 reflected the concept of limited liability and the era of limited liability was deeply entrenched in the UK’s corporate culture.7 Essentially, what limited liability means is that the shareholders of the company many not be held liable for the company’s debts “beyond the amount that he has chosen to invest”.8 In other words, if the company is unable to discharge its debts the shareholders cannot be personally liable for the shortfall. B. Separate Legal Personality A limited liability company also enjoys the status of legal personality which separates it from its founders and owners. In this separate and distinct existence, the limited liability company may sue and be sued without any reference to its owners and/or founders.9 Professor Sealy maintains that the “principle of corporate personality” is firmly established by case law and “forms the corner-stone of company law”.10 Even so, the courts will in exceptional circumstances lift the corporate veil or “look beyond the corporate personality and have regard to the realities of the situation”.11 The prohibition against going behind the corporate veil was established early on in the case of Salomon v Salomon and Co. Ltd [1897] AC 22 by the House of Lords.12 However, over time economic realities permitted the piercing of the corporate seal in exceptional circumstances where protection was not justified. Standards were set by both statute and case law for going beyond the corporate veil and typically include fraud or circumstance suggesting that the corporation was established as sham to avoid personal liability.13 In other words, if a limited liability company is established for authentic purposes, it will enjoy the protection of separate legal entity thereby separating liability of shareholders and investors from the liability of the company as an artificial legal personality. C. Perpetual Life The limited liability company also enjoys perpetual life because of its distinct legal personality. It continues to exist irrespective of changes in ownership and changes among the ranks of control. Moreover, the incorporating documents permits the founders to set the company’s term of being.14 The ability to have perpetual life is significant for security purposes. This means that despite changes in ownership and control, the corporation continues to have legal status. This means that a corporation can continue to own property unlike a natural person who is dispossessed of property upon death. Since corporations cannot die, although they may be dissolved, will continue to own property and can exceed the perpetuities’ rule.15 D. Tax Benefits Another advantageous feature of the limited liability company is taxation. While individuals pay income taxes, companies pay corporate taxes which are assessable against its taxable profits. Not only are corporate taxes typically lower than individual income taxes, corporations can be more flexible in tax deductibles than the individual can.16 For instance, taxes against profits can be exempt or reduced for transaction costs.17 II. Partnerships: A Comparison Between Partnerships and Limited Liability Companies By definition, a partnership is “an organization established by individuals to pursue some business activity”.18Kelly, Holmes and Hayward explain however, that: Although the law is permissive in relation to the establishment of such enterprises, there are particular ways in which the law impinges on and controls not just the operation of partnerships, but their very formation and existence.19 Although the same may be said of the limited liability company, those controls and limitations relative to the limited company are offset by the advantages set out in the preceding part of this research study. Many of the limitations and controls of company formation and existence are set out to preserve the continuation of the company and for protecting shareholders and the advantageous features of the company. The controls over the formation and existence of the partnership are quite different. To begin with, a partnership is defined as a “relationship between persons”.20 What this means is that a partnership unlike a company has no separate legal existence outside of its members. Under English partnership law, a partnership is nothing more than a “group of individuals collectively involved in a business activity”.21 Although, by virtue of Section 4 of the Partnership Act 1890, a partnership may carry on business under a designated name22 , the Civil Procedure Rules 1998, permits legal proceedings against the individual partners and in the event of any award against the partnership, the award may be executed against a partner.23 In other words, regardless of the partnership formation, any liabilities incurred in the course of the partnership’s business dealings may extend that liability to the individual members of the partnership. Therefore if the partnership does not have the ability to discharge its debts, debtors may seek recovery from the personal assets of the individual partners. As previously noted, no such liability is automatically extended to the founders and/or owners of the limited liability company. The introduction of the Limited Liability Partnerships Act 2000 permits the formation of a separate legal entity however. However there is significant set back that distinguishes the limited liability partnership from the limited liability company. Members of the limited liability partnership are required to pay income taxes in the same way as they would under a conventional partnership. Moreover, partners under the Limited Liability Partnerships Act 2000 are required to make National Insurance contributions in the same manner as the self-employed individual. Likewise, capital gains taxes are applicable to limited liability partnerships in the same manner as they are applicable to the conventional partnership.24 One of the most significant differences between the partnership and the limited liability company is the manner in which third party rights are interpreted and applied. Partnerships are typically formed by the implementation of the articles of partnership which is similar to that of the articles and memorandum of association of the limited liability company. The articles of partnership sets out the name of the partnership, the distribution and contribution of capital on the part of partners, business account systems and the distribution of profits and the manner in which the partnership will be dissolved and how conflicts will be resolved between the partners.25 However, as Kelly, Holmes and Hayward explain: The partnership agreement is an internal document and, although it has effect between the partners, it does not necessarily affect the rights of third parties. Thus, where the agreement seeks to place limitations on the usual authority of a partner, it is effective with regard to the internal relations of the partners but does not have any effect as regards an outsider who deals with the partner without knowledge of the limitation.26 What this means is that if a partner is not authorized by virtue of the partnership agreement to make a decision binding the other partners and he/she makes a decision impacting a third party, the third party is at liberty to sue any of the other partners for any damages provided he/she is not award of the existing agreement between the partners. For example in Mercantile Credit Co. Ltid. v Garrod [1962] 3 All ER 1103, a partner in a car repair partnership sold a car although it was outside of the partnership’s business agreement. The car was sold without the knowledge of the other partner. The court concluded that the offending partner was carrying on a transaction that an outsider might reasonably expect the partnership to carry out, therefore the other partner was also liable27. Within the realm of limited liability companies, the conduct of an offending officer will permit the company to take action against the director under the Companies Act 2006. Under the Companies Act 2006, directors are required to act within their powers.28 Although the director may bind the company, the company has redress against the offending director, unlike the partners in a partnership. The very nature of the partnership binds the partners to one another, although they may have redress under the law of contract. The fact is, the protective laws are not rigid in relation to partnership agreements as they are in limited liability companies. In any event, the company itself will be bound by the offending director’s malfeasance, but the individual shareholders and directors will not be personally liable. The Partnership Act 1890 does offer some semblance to the governing documents of the limited liability company. Like the limited liability company, alteration of the initial agreement cannot be done unless all of the partners agree.29 In this regard, governance of a partnership is such that it is not so different from a limited liability company where alteration of the governing documents must comply with a similar protocol. However, alteration of the articles of association of a limited liability company does not typically require a unanimous decision. In other words, managing the limited liability company provides more flexibility than managing a partnership. A unique feature of the partnership that distinguishes it from the limited liability company is the extension of liability to the retired partners in respect of debts incurred prior to his retirement.30 When a shareholder disposes of shares, all assets and liabilities vested in those shares pass from the vendor to the purchaser unless there are exceptional circumstances. Under partnership law, the reverse appears to be the case. When an individual conducts business with a partnership once membership has changed, the individual may continue to rely on “the apparent members of the old firm as still being members” until such time as they have been notified in the change of membership.31 These kinds of complications will not arise under a limited liability company because of the segregation of ownership and control as well as the separate legal personality of the company. Individuals dealing with a limited liability company are not dealing with individual company members. They are at all times dealing with a company which has its own separate legal personality. The lack of perpetual life can also be problematic for partnerships. Partnerships may come to an end for any number of reasons. A company on the other hand, may be dissolved if it become insolvent, but in usual circumstances the company may continue indefinitely if its members deem it necessary or desirable. The partnership for example may come to an end if it was set up for a specific purpose and that purpose “has been achieved”.32 Unlike a limited liability company, the partnership does not have perpetual life and is often regarded as temporary or even transient. Partnerships are dissolved automatically when a partner dies or becomes insolvent or is declared incompetent or withdraws or is expelled.33 Limited liability companies will not be dissolved if any of its shareholders or founders die, become insolvent, is declared incompetent, is expelled or withdraws. In other words, a company may go on in a variety of circumstances where a partnership may not. Conclusion While partnerships have become popular methods for two or more persons to engage in business activities together, there are still a number of reasons to forego the temptation to engage in a partnership when a limited liability company provides a better alternative. The limited liability company provides a better alternative to the partnership for a number of reasons. The main reasons that the limited liability company are a better alternative to the partnership agreement are detailed above. Even so the main reason for preferring the limited liability company over the partnership is the manner in which personal assets are protected. Although similar protections may be accorded under the quasi-partnership as provided for under the Limited Liability Partnerships Act 2000, there are tax liabilities such as personal income tax and national insurance contributions that undermine any benefit limited liability may confer upon a limited liability partnership. Moreover, the legal nature of the partnership generally and the fact that all partners are agents for each other, provides a major set back and disadvantage to partnership agreements that do not apply to the relationship between company owners. Ultimately ownership and control are segregated in a limited liability company and it is this segregation that provides it with its greatest advantage over the partnership arrangement. Bibliography Aoki, M. (2010) Corporations in Evolving Diversity: Cognition, Governance, and Institutions. Oxford University Press. Cassidy, J. (2006) Concise Corporations Law. The Federation Press. Civil Procedure Code 1998. Companies Act 2006. Gordon, R. and Slemrod, J. (2000) “Are ‘Real’ Responses to Taxes Simply Income Shifting Between Corporate and Personal Tax Bases?” Cited in Slemrod, J. (ed) Does Atlas Shift? The Economic Consequence of Taxing the Rich. Russell Sage Foundation and Harvard University Press. Hassen, R. (1998) In Defense of the Corporation. Hoover Press. Kelly, D.; Holmes, A. and Hayward, R. (2005) Business Law. Psychology Press. Limited Liability Partnerships Act 2000. Lutter, M. (2006) Legal Capital in Europe. Walter de Gruyter. McQueen, R. (2010) A Social History of Company Law: Great Britain and the Australian Colonies. Ashgate Publishing. Mercantile Credit Co. Ltid. v Garrod [1962] 3 All ER 1103. Partnership Act 1890. Rossini, C. (1998) English as a Legal Language. Martinus Nijhoff Publishers. Salomon v Salomon and Co. Ltd [1897] AC 22. Schon, W. (2008) Tax and Corporate Governance. Springer. Sealy, L. (1971) Cases and Materials in Company Law. Cambridge University Press. Read More