Comparison Of Partnership And Company As Business Structures

Partnership

The primary aim is to highlight an overview of namely two business structures i.e. partnership and company.

A partnership needs to be viewed as a type of agency relationship where business is conducted in common by partners who tend to act as agents for each other.  This aspect is apparent in Lang v James Morrison & Co Ltd case. There ought to be three main requirements for partnership as have been indicated under s. 1 of Partnership Act 1892 (NSW). The business must be carried on which typically implies that isolated transactions usually do not constitute as valid partnerships even though there have been exceptions. The second requirement relates to business being run and owned in common by the partners. The phrase “in common” implies that there is common ownership, rights and obligations related to the partnership firm which tends to be dictated by the underlying partnership agreement. The last requirement relates to profit motive being present behind the business as has been indicted in Bond Corporation Holdings Ltd & Anor v Grace Bros Holdings Ltd & Ors case. All the above three conditions ought to be present for terming a business structure as partnership.

The partnership firm lacks an independent identity and is known by the presence of the partners. The net result is that whenever there is any change in the ownership share or underlying partners, the previous partnership firm ought to be dissolved and replaced by a new firm. Also, the various contractual relations that are executed on behalf of partnership essentially are enacted on partners’ name. This implies that liability arising from business would be borne by partners even though personal assets may be liquidated. The liability of the partners tends to vary in the different partnership forms. In a general partnership, unlimited liability exists for partners. This is in contract with limited partnership where there are general partners (with unlimited liability) and limited partners (with limited liability). Also, there is another type known as LLP or Limited Liability Partnership which is allowed in certain professions and has limited personal liability for all the partners.

The tax treatment of partnership is quite interesting since the partnership income is taxed at the end of partners after the same is divided amongst the partners. Besides, the partners share a principal agent relationship with each other and hence owe a fiduciary relationship in instances when they are acting as agents. It is expected that when a given partner is executing contract with any outsider, there should not be abuse of authority since the contract would be binding on all partners.

Company

The most prominent aspect of a company is the distinction between the company and the legal owners. This has far reaching consequences. A critical one is that the company is able to negotiate contracts with outside parties and executes the same with the help of authorised agents. The end result is that contractual rights and obligations are on the company and not the owners thus allowing them immunity from personal asset liquidation for settling business liability. A landmark case testifying the same is Salomon v A Salomon and Co Ltd. However, this immunity is likely to be misused and therefore the separation between company and owners can be waived under the corporate veil piercing. This is decided by the court in cases where it is felt that the owner is deliberately using company structure to engage in illegal conduct or fraud.

The company cannot be dissolved owing to changes in ownership structure and can cease to exist only if it is deregistered. Hence, it can be concluded that it has a perpetual succession. As a given shareholder dies, the ownership passes on to the legal heirs and thus the company continues to exist. This transferring in shares is permissible by s. 1-5(6). Further, it is imperative to note that formation of company involves an elaborate process and mandatory registration with ASIC. Also, after the formation also, there is significant regulatory burden associated with company structure. Besides, the taxation of the company is based on corporate tax which is 30% flat in Australia.

Analysis

For recommending the suitable business structure to client, it is essential to carry out a critical analysis of the choices that are presented here.

To incorporate a partnership, the procedure is quite simple and easy to implement with minimal time and finance requirements. This is because only a partnership agreement is to be executed amongst the partners. There is no mandatory requirement in regards to registration of the partnership agreement. Besides, the regulatory burden on partnership firm is quite low leading to negligible compliance costs which is quite beneficial for small businesses.  Considering that partnership involves multiple partners, hence larger manpower is available to perform business functions and also correspondingly financial resources available would also swell.

Partnership (Disadvantages)

The main issue with partnership is the personal liability burden on partners which even though can be managed by choosing suitable partnership form cannot be completely avoided. Further, the partnership firm can face potential issue when it comes to raise finances. This may be attributed to the non-transferability of equity stake to other partners without first dissolving the existing partnership firm. Thus, for every time, an ownership pattern changes, new partnership agreement needs to be inked. Also, for firms where the taxable income generated is high, the high rate of personal taxes could imply that the outflow of tax is higher when compared to the company structure where corporate tax at a flat rate of 30% is levied. However, the same may not be true when the income levels are lower since marginal tax rate may not exceed 30%.

Analysis

Company (Advantages)

Perhaps the most highlighted benefit of company is without doubt the limited liability that the shareholders enjoy. This directly links from the separate legal entity of company as confirmed from s.124(1).  This limits the amount at risk for the investors in the company when compared to alternate business structures. The tax applicable on profits earned by company may be lesser than that applicable in case of partnership primarily because corporate profits are subject to flat 30% corporate tax unlike partnership profit whereby personal income tax is levied on the partners which could have higher marginal tax rate.  Also, there is immense flexibility in company with regards to share transfer and ownership which implies that entry or exit of investors is quite convenient. Further, this allows ease in raising incremental financial resources if and when required.  

Company(Disadvantages)

One of the key issues with the running of business as company is the underlying complexity of company incorporation which typically requires time along with incurring legal expenses since the company is to be registered with ASIC without any exception for any type of company. Besides, another issue is the high compliance cost owing to the high regulatory burden that is associated with company. As a result, the company structure may not be suitable for small businesses or those with limited profits.

Recommendation (Client)

Based on the critical analysis of the above two business structures along with nature of business, the recommended business structure is partnership. The real estate sales business which the clients intend to enter is essentially an asset light business since the clients would act as agent for individuals who are interested in buying and selling of real estate and earn a commission in the process. Considering the above business model, capital requirement on an ongoing basis is minimal. Thus, dilution of equity or resorting to lending for funds may not be required.

Also, partnership can be easily setup with minimal costs. Also, there would be minimal compliance costs which augers well for a new business which aims to minimise the overhead costs. Further, it is quite likely that for the beginning years, the profits for each partner would not be too high considering that the business would have atleast four partners which would lead to profit distribution.  Additionally, the associated risk of business liability is low in the given business as there are clear regulations which need to be adhered. Once the business expands, it may be feasible to move to a company structure primarily on tax considerations.

One of the most pivotal agents for the company are the directors which have extensive powers and are entrusted with vital decision making regarding the company. Their importance is also reflected from the fact that both in common law along with statutes, there are certain duties that directors are expected to comply during exercise of their powers. The most comprehensive legal coverage of directors’ duties is presented by Corporations Act 2001. This act also outlines the implications of breach in different duties of the directors.

One of the most famous cases involving breach of the above duties is ASIC v Adler (2002).  Post the Corporations Act 2001 enactment, this became the first big case where the provisions of this act were contravened.  Also, the given case was linked to HIH Insurance bankruptcy which was one of the biggest in Australia at the time especially in the insurance sector and therefore it was imperative to fix accountability for the losses suffered by plethora of stakeholders. The various aspects in relation to this case which company directors ought to take note of are discussed below.

• There is a duty on the directors to act with care and conduct due diligence before taking any particular decision. This is indicated in s. 180(1) in line with the common law duty of discharging duty to care towards company and respective owners. The conduct of defendants in the ASIC v Adlercase was found to be in violation as appropriate safeguards (investment committee or board) were ignored by defendants on purpose for extension of $ 10 million loan to an outside entity.
• Usually for breach of s. 180(1), the directors assume defence under s. 180(2) which provides immunity from personal liability to directors for any losses suffered by the company provided if the conduct of the directors was reasonable considering the circumstances. The presence of conflict of interest tends to negate this line of defence which was visible in the given case since the defendants did not receive any relief under s. 180(2).
• Yet another duty of director is to ensure that their actions are taken in good faith with the underlying intent to safeguard the company interests. This has been highlighted in s. 181(1). In the ASIC v Adlercase, the actions of the management are driven by serving their own material interests at the cost of that of shareholders and thereby the conduct is dishonest.
• The directors have a powerful position in the company and s.182(1) forbids them from abusing this power for drawing any favours. This could be for self or any outside party. The abuse of power is established by defendants in the ASIC v Adlercase since the loan amount of $ 10 million was extended without taking due permissions.
• The directors have a powerful position in the company owing to which they are aware of a host of classified material information and s.183(1) forbids them from abusing this information for drawing any favours. This could be for self or any outside party. The defendants in case of HIH Insurance passed on key private information to outside parties with wrong intentions and thereby indulged in insider trading which amounts to breach of this duty. This is because the involvement of directors in share price manipulation of the company eventually triggered the share price plummeting causing huge losses to owners.
• Typically, a company cannot extend financial loans to an outside entity with the objective of making purchases in the shares of the company.  This in as per s. 260 A which also provides an exception to the above understanding only under the circumstance when such a practice is not detrimental for shareholders’ interest. Clearly, the conduct of the defendants has been in violation since extension of loan had a material adverse impact on the wealth of shareholders as it was aimed at providing exit to directors at a high share price.
• In relation of the statutory breach of duties, the directors need to make notice that the personal liability is not limited to only fines but also extends to capital punishment. This is in sharp contrast to the situation which existed before the enactment of Corporations act 2001 since the duties of directors were only common law duties and therefore attracted civil penalties only