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Advice to Jack and Jill based on Company Law

COMPANY LAW


Background information:

Jack and Jill have been best of friends since high school. Jack is currently employed as physical education teacher and Jill is a nutritionist. After working many years as employees they have decided to join forces and set up a Fitness Centre. They come to your office and seek your advice in setting up their new business venture.

Jack would like to know and understand what his obligations and liabilities are as co-owner and director should he and Jill elect to set up a company. 


Task

You have been asked by your managing partner to prepare a draft letter of advice for Jack and Jill which addresses their concerns. In particular the letter of advice should address the following:

  1. What are the various business structures that are available to Jack and Jill with respect to the type of business that they would like to establish.
  2. Assume that a company structure is the most appropriate business entity to operate the Fitness Centre and provide advice on:
  3. the type of company to be formulated;
  4. the various types of obligations and liabilities that each director is subjected to; and
  5. can Jack and Jill be employees of the company.



Answer

Partnership in business 

Date:

Mr. Jack

Address 

RE: LEGAL OPTIONS

Dear Mr. Jack as per your query regarding the obligations and liabilities that are associated with ownership and directorial position of a business in partnership if you and Ms. Jill decide to join forces in order to start up a Fitness Centre. In this letter I am informing you the legal consequences of starting a business with another shareholder regarding the several business structures that are available according to your criteria. Along with that I am going to focus my concern on the most appropriate business entity that is suitable for your pursuit. In revealing the most appropriate business entity that you might be willing to opt for, I shall explain you the type of company that can be formulated and the obligations and liabilities that are to be associated with your position as one of the directors of the company and also inform you whether or not you and Miss Jill can be employees of the company.


Available business structures

There are several business structures that can be used in order to start a new business entity. Different types of business structures include the following:

  • Sole trader
  • Partnership
  • Company
  • Trust 
  • Joint venture

Among the mentioned business structures the structures that are appropriate for you and Ms. Jill to set up a business entity are:

  • Partnership
  • Company
  • Joint venture

In order to understand the best structure for your business it is important to understand the pros and cons that are associated with each of the structure. Every business structure has its own advantages and disadvantages [1] . The directors of different type of business structure are subjected to different limitations and liabilities. Along with the general fiduciary duties of the directors few duties and responsibilities and power are specific to the director of each business entity.


  1. Partnership

Partnership is one of the most obvious choices that you can opt for as elaborated by present scenario. Partnership is considered to be a form of collective ownership and section 1 of partnership Act 1892 defines partnership as the relation that exists between the persons who are carrying on a business and have a common view of profit. 


Advantages of partnership

The foremost advantage of partnership is it is primarily informal and inexpensive. Partnership is conducted primarily in form of oral, written or implied agreement or ‘partnership by estoppels [2]

This type of business structure has greater management resources and capital than sole trader. 

Section 115 of Corporations Act limits the size of partnership to maximum of twenty partners and it also comes with financial privacy because this category of business unit does not have any registration of documents with ASIC [3] .span> 


Disadvantages of partnership

Along with the advantages partnership has much more disadvantages that you need to consider before choosing this structure. For instance partnership suggests unlimited liability for the subsequent debts and obligations of a business unit. Although another important factor that needs consideration is limited partnership [4]

Limited partnership needs to registered and the rules for registered limited partnership are:

  • It consists of limited partner and one of the partner is considered as the general partner who is subjected to unlimited liability.
  • This type of business unit just like companies is a taxed one. 

The partners can have agency relationship that often causes issues regarding the legal duties as they have joint liability for the contracts. The joint liability is applicable for torts as well as the breaches of duties of the partners as mentioned in the Partnership Act of 1892 [5] . The partnership does not indicate any perpetual existence that stands for limited life.


Necessary legal information

In partnership all of the partners of a business unit are liable for partnership contracts as defined in section 9 of the Partnership Act. Joint liability indicates at collective liability and partners can be sued together in only one legal action and the subsequent judgement in the name of the firm will include all the partners.


  1. Company

Company is another business structure that is suitable for your purpose. It is important to understand the definition of a company. A company is considered to be a legal entity which is governed by Corporations Act, 2001 [6] . As company is a legal entity, it is separated from its owners and the shareholders of the company. 

As per the regulations of Corporations Act, 2001 a company is consisted of the below mentioned characteristics and they are:

  • A company is generally incorporated with limited liability and has a few exceptions to limited liability as well. 
  • It has a perpetual existence 
  • A company is an entity that possesses the right to sue and also has the chance to be sued.
  • It has the right to hold property.

Forming a company is the best option as it is treated as separate legal entity that makes it different from the other business units. Being a separate legal entity indicates that the company has a legal existence and the rights and obligations that the company hold are completely separate from the people who are participating in the company. 


As per the instructions of the case law Solomon v Solomon & Co Ltd [1897], court held the decision that the debts of a company that are not personal debts of the person who is obliged to control the company and its activities. It indicates that the debts of the company is not regarded to be the debt of the directors of the company. This is one of the major advantages of a company that provides the opportunity of limited liability to the controller of the company even in the case of the company being a one person business having no other shareholders or directors.


Corporate veil that ensures that the company is a separate legal entity from the directors and the shareholders also imposes several liabilities on the director of the company in case of a breach of legal duties of a director.

From the aspect of liability company can be classified as following:


Company:

  1. Limited by shares       
  2. limited by guarantee   
  3. unlimited             
  4. no liability 

The companies that are limited by shares can be classified as public companies and proprietary companies.

Limited liability indicates that liability of the members limited to the amount of unpaid on the shares and their personal assets are not at risk. 


Necessary legal information

Setting up a business unit as a company needs to have necessary legal information regarding the director’s duties and responsibilities and their due responsibility to the creditors and the suppliers of the company. Prudent creditor can take necessary steps in order to avoid the circumstances of limited liability [7]


Disadvantages of a setting a proprietary company

The formation of a proprietary company is a complex task and it generally takes up to six weeks to fulfil all the legal requirements. 

It is important for the founders to adhere to the regulations under the Corporations Act and the monitoring of the ASIC [8] . A proprietary company needs to be registered and have a registered office.


  1. Joint venture

This is a common business structure that is used in high risk capitals or high risk business activities. This type of structure has the ability to bring together different skills into the business. Manufacturing and publishing are some of the potent instances where joint venture is commonly used as the structure [9] .

It is important to identify the underlying difficulty in drawing the line between partnership and joint ventures as joint venture does not have a settled law meaning.


Advantages of JVs

Formalities can be minimal or optimal based on the commercial activity. JVs are not functioned by any particular law, it is majorly governed by contract law and other laws which regulates a particular project.

It is managed and controlled by joint committee.

The liability in this case is not joint but individual 


Disadvantages of JVs

Activities of a JV are of specific duration or limited.

Joint venture is a separate venture for each party.


Necessary legal information

As per the instructions of ASIC v Citigroup Global Markets Australia [2007] FCA 963 [10] , each of the parties are free to contract out of the fiduciary duties. On the property, each parties has his or her own share and each party is liable for own tax and there is no joint tax return.


Company structure 

  • Type of company

From the discussion, as per my expertise I suggest you to set up a small proprietary company for this business that is limited by shares. As two of the shareholders are willing to forma company, I suggest you to opt for. There are several reasons for this suggestions and that includes the advantages of forming a small proprietary company. Before that it is important to have a look at the criteria that are required for forming a proprietary company. As per the guidelines of ASIC it is important to register the name of your company with ASIC and also it is significant to obtain a company number. Along with that it is important to comply with the legal obligation of the regulation of Corporations Act, 2001 and to have a registered office. Along with that the requirement of the application process needs to be fulfilled and to have written consent from the to be directors of the company [11] .


Characteristics of a proprietary company

1. As per the definitions of sections 112 and 113 under Corporations Act of 2001 the company is based on share capital which indicates both you and Miss Jill have to be the shareholders.

2. You can have maximum of 50 non-employee shareholders.

3. The company should not under any circumstance can be engaged in any activity that requires disclosure to investors under the guidelines of chapter 6D of Corporations Act [12] .

4. As per the guidelines of Section 45A small Pty company needs to satisfy any 2 out of the mentioned 3 criteria:

$ 25m as consolidated operating revenue [13]

$12.5 m consolidated gross assets [14]

It is important to have minimum 50 employees [15] .


Advantages of small Pty companies

Small Pty co. Needs not to prepare a profit and loss account balance sheet as per the section 292(1) or appoint an auditor and also they are not obliged to lodge any financial statements with ASIC [16]

  • Obligations and liabilities of each director

As the directors of the company you and Miss Jill need to know the individual duties and obligations that you are subjected to. As per the guidelines of ASIC the directors of the company need to abide by several fiduciary and statutory duties. The function of the duties imposed upon the directors is to protect shareholders from risk of harm to the company or to its property. This also indicates that the directors are accountable for harm to the company or any kind of mismanagement and to maintain the loyalty and trust. The section 9 also includes the definition of de facto and shadow directors [17]


The general law indicates that directors are subjected to the fiduciary duties that are:

1. To act in good faith and in the interest of the company

2. proper use of power

3. Avoidance of any conflict of interest

4. The directors are obliged to retain discretion

As per the instructions of Common Law under sections 180-183 of Corporations Act the directors need to exercise the duties of care, skill and diligence.


Sections 180 indicates duty to exercise care and diligence, section 181 to act honestly, section 181 indicates proper use of power and section 183 indicates prohibition of improper use of information.

Breaching any of the mentioned duties are subjected to civil penalty under section 1317E and the breaches can also be considered as result of criminal offence under section 184 and criminal offence does not concern breach of duty of care and diligence. 


The directors also owe duties to the creditors in case of insolvency of the company or possible insolvency of the company and the directors needs to preserve control as mentioned in Ngurli Ltd v McCann [18] that the directors are prohibited from:

1. Acting for personal interest and benefit

2. Manipulation of the voting power


  • Employability of the directors

In this case and you and miss Jill plan to be the sole shareholders of the company, you can not be the employees of the company. As a small proprietary company is the best option you can choose, in that case it is important to have at least one secretary and it is possible to hold both the position of a secretary and the director of the company. Therefore, one of you and Miss Jill can be the secretary of the company along with being the director of the company.  



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