A Comparison Of Partnership And Company As Business Structures

Partnership as a Business Structure

The objective is to present partnership and company as two potential business structures along with their underlying attributes.

A partnership is defined as an agency relationship whereby the partners tend to represent each other as agents and thereby conduct business in common as indicated in the Smith v Anderson case.  In accordance with s.1 Partnership Acts 1892 (NSW), any partnership needs to have three conditions satisfied. One of these relates to carrying on of business which implies that business usually is not restricted to only one transaction even though recently partnerships have been declared where only a single transaction is present.  The next requirement is that the business of partnership firm must be run with profit making intent as highlighted in the Bond Corporation Holdings Ltd & Anor v Grace Bros Holdings Ltd & Ors case. The third requirement is that the partnership business must be conducted in common by the partners as highlighted in Re Ruddock (1879) 5 VLR (IP & M) 51. This implies that partners have common ownership of the business and the associated rights and liabilities as per the partnership agreement. Violation of any conditions outlined above would imply absence of partnership. 

A key aspect of partnership structure is that it does not a separate legal entity and thereby is defined by the underlying partners. As a result, the various business of the partnership firm is conducted in the name of the partners who are personally held liable for business liabilities. Based on the underlying liability of partners, there are three types of partnership firms that are possible as highlighted below.

• General Partnership – In this type of partnership, the partners would have unlimited liability.
• Limited Partnership – In this type of partnership, there is atleast one general partner having unlimited liability along with limited partners who would assume limited personal liability only.
• Limited Liability Partnership – This is typically permissible in certain professions where the liability of all the partners is limited and personal assets are safeguarded to a large extent.

An important aspect related to partnership as per s. 5 is the agency rule which highlights that the partners share a fiduciary relationship since every partner acts as agent for the other. This is because any contractual relation enacted by any partner with outside party is binding on the other parties irrespective whether the underlying partner had the requisite authority or not. In order to discharge their fiduciary duty, the partners are expected to act in accordance with the partnership agreement and other relevant rules.

The company unlike partnership possesses a legal entity as highlighted in s. 124(1) Corporations act 2001. This has significant implications and leads to key attributes. One of these is in the form of limited liability for the shareholders whose maximum loss is capped to the equity investment in the company as per the decision in the Salomon v A Salomon and Co Ltd case. This is observed since the various contractual relations are executed by agents on behalf of the company, thus making company liable for any potential liabilities. The limited liability of owners implies that company structure is susceptible to abuse and hence the concept of piercing the corporate veil exists. As per this, in certain circumstances where the courts consider is necessary, they can do away with the separate legal entity of owners and company.

Partnership Requirements

Another key attribute of the company structure is perpetual succession. This is because the company exists independent of the owners and therefore the existence of company is not impacted by the death of given owner or change in ownership. In fact, s.1-5(6) Corporations Act 2001 allows for transfer of shares in the company. The company is typically governed using replaceable rules, company constitution or both.  All companies have a unique name and are registered with ASIC. Besides, there are regulatory reporting requirements for companies which vary based on their type.

• One person company – Single owner serving as director, small in size and unlisted
• Proprietary company – Small in size with limited share capital or shares, limited reporting
• Private company – Medium to large is size (unlisted), high reporting requirement
• Public company – Large in size (usually listed), Maximum reporting requirement

In this section, the business structures outlined in the previous section would be critically analysed based on which recommendation would be provided.

Advantages (Partnership)

• One of the key advantages of forming partnership is that it is free from legal hassles and can be easily incorporated with the help of a partnership agreement and there is no mandatory provision of registration.
• The partnership does not need to report financial performance and comply with other such regulations which results in lower regulatory costs.
• In partnership, there is more than one person who have ownership and hence the underlying resources available for taking business decisions, running business and providing capital increases when compared to sole trader.

Disadvantages (Partnership)

• The key disadvantage is in the form of personal liability of partners. Even though in some forms of partnership, it can be limited to some extent but it cannot be done away with due to which there is high risk for the partners and their wealth.
• Yet another disadvantage arises if additional finance ought to be raised. This is because there cannot be any transfer of stake without dissolving the firm since the partnership firm is defined by the underlying partners. Further, exit options for existing partners are also limited.
• The taxation also can be an issue for the partnership firm. This is especially the case when a high amount of profits are earned. This arises on account of partnership acting as a pass-through mechanism for tax purposes thus implying profits being taxed at the end of partners as income tax on personal income. The marginal tax rate applicable on the partnership income can thus exceed 30% and hence disadvantageous to the partner.

Advantages (Company)

• The most significant advantage of company is the separate legal identity which gives rise to limited liability for the owners. As a result, for any liability arising from business activity, the personal assets of the owners would not be liquidated. This is significant when compared to other business structures such as partnership.
• The profits earned from company are taxed in accordance with corporate tax which is 30% in case of Australia. In comparison the marginal rate of income tax on individuals goes significantly higher than 30%. Therefore, for businesses making large sums of money as profit, there is a clear savings in taxation by choosing company.
• The shares in case of company can be transferred from one owner to the other and hence equity dilution can be used to garner necessary financial resources without impacting the underlying business structure. This is not possible for partnership where the firm would be dissolved and new firm ought to be created.

Disadvantages (Company)

• The inception of company requires certain steps which requires time and expenses. These include choosing an apt name, having requisite rules, identifying directors and registration with ASIC.
• Also, the regulatory burden on the company structure is highest and hence compliance costs would be incurred in periodic reporting and compliance with relevant provisions of Corporations Act 2001.

In the given scenario, taking into consideration the business type, the preferred business structure would be partnership. One of the key reasons for the advice is the limited capital requirement for business operations and expansion. Thus, the need for incremental capital does not arise.  Besides, the formation of partnership would be quite easy and save costs.  Besides, in partnership, the compliance costs would be quite limited which is quite preferable at the start of the business. The tax computations would also favour partnership considering that the business is in nascent stage and at a minimum has four partners which implies profit distribution and lower marginal personal tax than 30%. Besides, the nature of the business is such that there are not much liabilities associated and also limited partnership option can be explored to further minimise liability.

The directors play a vital role in the organisation success and thereby create wealth for the shareholders. Owing to this fact, various duties have been bestowed on the directors both in common law as well as statutory law. In relation to statutory law, the most prominent in the context of duties of directors is Corporations Act 2001 which not only mentions these but also fixes the accountability by highlighting the personal liabilities for directors on violation of these duties.

A significant case in the context of breach of directors’ duties is ASIC v Adler. This was the first major case dealing with potential breach of directors’ duty after incorporation of the Corporations Act 2001. This case pertained to the ill-fated failure of HIH Insurance which caused loss to a host of stakeholders besides shareholders. The directors had a key role to play in this failure as was also confirmed by the verdict of the honourable case. This case can render numerous noticeable aspects for the other company directors which are enumerated as follows.

• In accordance with s. 180(1), the directors owe duty to care to the company and various stakeholders and hence must exhibit actions and decision with appropriate diligence. Failure on the part of the directors to extend care can lead to civil penalties. In Adler case, a sum of $ 10 million was given by directors of the company without taking any permission from the investment committee or the board of directors.
• In order to provide protection to directors from unnecessary hassle under s. 180(1), business judgement rule is present in s. 180(2). As a result, if directors exhibit their sound judgement while taking the decision, then no personal liability would arise for the directors. However, there are limitations to this section and the same cannot act as defence when there is conflict of interest. The directors in Adler case could not seek defence for their conduct using business judgement rule.
• Additionally, directors are supposed to act in good faith as highlighted in s. 181(1) which would ensure that no action is taken which harms the company and shareholders wealth. The conduct of the directors breached the above duty since extension of loan to another entity was mainly to keep the share price inflated thereby allowing the Alder Corporation to liquidate the holdings
• Section 182(1) places the duty on directors not to use the powers vested in their position to extend favour for own self or any related party. Clearly, there has been abuse of this provision in Adler case as some directors used their power to derive benefit for self by extension of loan worth $ 10 million without appropriate authorization.
• Section 183(1) places the duty on directors not to use the information obtained due to their position to extend favour for own self or any related party. This is imperative since directors have access to crucial private information which can be critical especially in case of public listed companies. In the Adler case, crucial insider information for the purpose of insider trading was extended to outsider which is in breach of the duty imposed under the given section.
• An additional relevant section with regards to the given case is s.260A which forbids the company the providing financial help to any company or individual for facilitating purchase of shares of own company. An exception to this rule in when this activity does not violate and does not harm the interests of the shareholders. It is evident that in the given scenario, there has been an adverse impact on the shareholders’ wealth as the share price of the company has plummeted and the investors have lost money.

• Further, another pivotal aspect that should be kept in mind by directors is that the breach of the statutory duties does not lead to only civil penalty but can potentially lead to capital penalty which is apparent in this case. The criminal penalty is highly probable where fraud or dishonest conduct is witnessed on part of the directors.