Company Law The Business Structure

Question: Describe about the Company Law for The Business Structure. Answer: 1. In a partnership type of business structure, two or more people, carry on a business, with a common goal of earning profit. A mutual participation forms the participations is enough to form a partnership, as was held in the case of Green v Beesley[1]. The necessary elements of a partnership include the carrying on of a business, a commonality, as well as, a view to earning profits. A business should be a going concern, instead of a sole isolated transaction, to establish a partnership. There has to be mutuality in the interests, obligations and rights of the individuals, to formulate a partnership. Most importantly, the business should be run by the individuals to earn a profit. The prima facie evidence for the existence of a partnership is the sharing of the profits. The percentage of sharing the profit is mostly equal, unless a different percentage if prescribed in the partnership agreement. In the given case, Aysha and Dilara were operating a partnership form of business structure. Aysha and Dilara, are two people, operating a common business of winery, as a going concern, to earn profits. Further, they share the profits equally. These fulfill the criteria for a partnership. So, from the above analysis, it can be clearly concluded that type of business organization operated by Aysha and Dilara was a partnership. In a partnership type of business, there is a restriction for transfer of the interest of a partner[2]. Unless and until, all the partners agree to the transfer of interest, such an interest cannot be transferred in a partnership. Further, to add a new partner in the partnership firm, the consent of each of the partners is required. And so, there is a difficulty in transfer of ownership in this business form. So, there is a restriction on both entry, as well as, exit of a partner from the partnership firm. In order to sell a part of the business, in a partnership, all the partners have to agree to it. The major disadvantage of this business type is that there is a high risk of dispute arising from friction, as well as, disagreements amongst the partners. So, when there is a dispute amongst the partners, the business of the firm can come at a standstill. In the present case, Dilara and Aysha had been approached by Polat to buy a part of their Winery. Being a partnership firm, Dilara and Aysha are eligible to do so, as long as both of them are willing to go forward with the sale. But, upon the sale of the part of winery, Polat would become a partner in their partnership firm. So, in the future, the profits would be shared by Dilara, Aysha and Polat. And the business would be run by these three. But being a partnership firm, the control of business would be shared amongst these three. But, when a dispute arises in future, a deadlock can occur in the business. In a company form of business, generally there is no restriction regarding the entry or exit of a member, unless specifically provided. To become a member of the company, a person can buy shares in the company, and attain membership. A member can transfer his shares to another person and such transfer is considered as valid, as long as such transfer is registered as provided in Section 1072F[3] of the Corporations Act, 2001[4]. As long as the transfer of shares is done as per the will of the person, Section 1071B(5)[5] of this act, allows the transfer of shares in a company. In case of a dispute on any matter in a company, the company does not reach a standstill, because of the majority rule. In a company, to pass any matter, generally the majority rule is applicable. So, in case of a dispute, the item pertaining to the dispute can still be passed by a majority of the members, and so the business continues to run. So, the disadvantage which is faced in the company regarding the deadlock of communication can be resolved by adapting corporations act, as majority rules is applicable there. So, in the present case, Aysha and Dilara should opt for a company as a business structure, so that, in case of future disputes, the matters can be resolved. Further, in case of a company, there is no restriction regarding the transfer of share/interest. So, even if one of them disagrees, the other can go through with this sale to Polat. 2. A shareholder of a company has the right to share the earnings or profits of the company, and payment of dividend is the way in which the shareholders share the earnings and profits, and is a reward for such shareholders. Section 254T[6] of the Corporations Act, 2001 provides that a company should not pay the dividends unless and until the assets of the company exceed its liabilities before declaration of the dividend and such excess is enough to pay the dividend; as a whole, the payment of such dividend is reasonable, as well as, fair to the shareholders of the company; and such payment does not significantly prejudice the ability of the company to pay off its creditors. Section 588G[7] of this act contains the duty of a director to prevent insolvent trading of the company, and prohibits the incurring of such debts which result in the insolvency of the company. So, as long as both these sections are complied with, the right of the shareholder regarding the attainment of dividend continues. The director of the company has to discharge his duties, and exercise his powers for a proper purpose and in good faith[8], which is in the best interest of the company, as provided by section 181 of this act. Section 180 provides that a director has to discharge his duties, and exercise his powers with diligence and a degree of care, which a prudent person in similar circumstances would exercise[9]. This section further provides that a director has to make the business judgment in good faith and for a proper purse and should not have a material personal interest in the matter of judgment. When a director breaches his duty, which is owed towards the shareholders or the company, the shareholder has the right to bring legal action against such director. Further, in case of oppressive, unfair discriminatory or prejudicial conduct is established, a shareholder can seek relief[10] as per Section 233 of this act. Through this section, the court has the power to restrain a director from doing a specific act, or from engaging in specified conduct. In the present case, Leo had the right to receive dividend. The company had increased revenues of 300%. The two executive directors of the company paid themselves a huge bonus, along with a pay raise. They also leased two expensive cars for their personal use. The directors have a duty of care towards the company and have to act in a diligent manner. But here, the directors failed to discharge their duties in the manner stated in the Corporations Act. They personally benefitted themselves from the profits of the company, instead of sharing this profit with the shareholders of the company. Even though it is in the discretion of the directors to declare the dividend, but in case, the provisions of the Corporations act are fulfilled, it is their duty to pay such dividend to the shareholders. So, in this case, Leo has the right to approach the court against this breach of duty by Amanda and Ruby. Further, he can also request the court to restrain Amanda and Ruby from removing Leo from the Board. 3. Section 180 of the Corporations Act, 2001[11] provides that the director of a company has to discharge his duties, as well as exercise his powers in a diligent manner and with a degree of care, which a prudent person in similar circumstances would exercise. Further, a director has to make the business judgments for a proper purpose, in good faith and should not have any kind of material personal interest in the matter of judgment. Also, the directors are required to inform themselves about the matter of judgments, which are believed to be reasonably appropriate and finally make such a decision which is in the best inertest of the company. Section 181[12] of this act provides that a director of a company has to discharge his duties, as well as exercise his powers for a proper purpose and in good faith, which is in best interest of the company. Section 182[13] of this act contains the provisions which prohibit a director from using their position in an improper manner so as to gain an advantage for someone else or themselves, or in a way which is detrimental to the corporation. Section 183[14] of the Corporations Act, 2001 provides that an individual, who attains information by being the director of the company, should not use this information in an improper manner so as to gain an advantage for someone else or themselves, or in a way which is detrimental to the corporation. Section 588G[15] of this act contains the provisions regarding the duty of a director to prevent insolvent trading by a company. The applicability of this section is dependent on the person being a director at the time of incurring the debt. Further, the company becomes insolvent due to incurring such a debt and there are reasonable grounds to suspect that the result of such transaction would be make the company insolvent, or is already insolvent. Being a director, a director has to be constantly aware about the financial position of the company to prevent insolvent trading. Section 189[16] of this act contains the provisions regarding the reliance made by the directors for the information provided by the others. In case a director of the company, relies on the information, expert or professional advice, which has been provided by: Companys employee who is believed, on reasonable grounds, to be competent, as well as reliable regarding the relevant matter, as per the director. An expert or a professional adviser who is believed, on reasonable grounds, to have the expertise or professional competence, as per the director. Some other director or an officer of the company regarding the relevant matter, which are within the authority of such director or the officer. A committee of directors, where the director did not serve regarding the matters which were within the authority of the committee. The director has to show that such reliance was made in good faith, as well as, after making a proper assessment of the advice or the information, as per the knowledge of the director regarding the operations and structure of the company. And the reasonableness of such reliance has to be shown and this determines whether or not the director has performed his duties as per provisions of this part. Section 286[17] provides that the company has to keep the adequate financial records which correctly record, as well as, explain the transaction, along with the financial position and performance of the company. The section further states that such financial records should enable the true and fair preparation, as well as, audit of the financial statements of the company. A failure on part of the director to ensure the fulfillment of this section, results in contravention of the Corporations Act. And in case of an insolvent trading action is brought against a director of the company, it is generally assumed that throughput the entire period of the insolvency, the company failed to keep the necessary financial records. Section 347A[18] of this act provides that the directors of the company have to pass a solvency resolution, within two months after each of the review date for the company. There are numerous consequences, as well as, penalties applicable on a director due to insolvent trading, and this includes civil penalties, criminal charges, as well as, compensation proceedings. The civil penalties are provided in the Corporations Act for contravention of the insolvent trading provisions, which includes pecuniary penalty for an amount up to $200,000. The criminal charges are applicable in case it is established that the insolvent trading resulted from dishonesty. So, along with penalty of $200,000 or imprisonment of up to 5 years, the criminal charges would apply on the director. An action initiated by the liquidator, creditor or the ASIC, for the amount lost by creditors results in a compensation order against such director, along with the civil penalties. Further, the breach of directors duty also attracts the civil penalties as stated in Section 1317E[19] of this act. In the matter of Australian Securities and Investments Commission v Edwards[20], the judge held that such a debt involves any act or omission, or such other circumstances, which can cause the company to owe a debt. In the landmark case of Southern Cross Interiors Pty Ltd (in liq) v Deputy Commissioner of Taxation[21], the judge held that the solvency of the company, for the purpose of Corporations Act, is ascertained by considering the financial position of the company, as a whole. The judge in the case of Elliott v Australian Securities and Investments Commission[22] held that a director would have contravened the provisions of this act by not preventing, or by failing to prevent the company from incurring the debt when reasonable ground was present regarding the insolvency of the company. The judge further held that it was not required to prove that each director failed his duty. The facts of this case are very similar to the facts of the case Commonwealth Bank of Australia v Friedrich[23]. In this case the court held the director liable for the debts which were incurred by the company as the director failed to prevent the insolvency of the company due to incurring such debts. The judge held that as a director of the company, it was his duty to know about the financial position of the company and had to read the reports provided to him, on which reliance was made regarding the soundness of the financial position of the company. And this added to the culpability of the director. Further, in the case of Metal Manufacturers Limited v Lewis[24], it was held by the court that the directors of the company are not allowed to merely surrender their duties, which are owed to the company, as well as, the corporation, by leaving a single director or general manager to discharge their responsibilities for them. On the basis of above, the three directors of the company have breached their duties as a director of the company, as well as their duties to prevent the insolvent trading. A director has to check for the soundness of the financial statements of the company and cannot use failure of reading such statements as a defense. Further, as provided in the above cases, a director cannot discharge their responsibilities by dumping all the responsibilities on one person. To conclude, the directors of TACH Ltd have breached their duties and are liable for civil penalties as stated above. 4. The accounts of a company are audited by the auditors and these audited accounts are used by the audit clients. The auditor of such a client owed the duty of care as per the terms of the contract, as well as, in tort, to its audit clients[25]. But, it is often seen that people other than the audit clients rely on such audited accounts. The creditors, along with the potential investors, are the most frequent users of these audited accounts of the company, so as to assess the value of the company, or the creditworthiness of the company. In the case of Caparo Industries plc v Dickman[26], the House of Lords restricted the extension of the auditor liability to the third parties, apart from their audit clients. According to the approach of privity test, the auditor owes a duty of care in case of a tort, only when there is a privity of the contract between the parties. And so, no liability is owed to the third parties in cases of tort. This approach was established in the case of Ultramares Corporation v Touche[27]. The judge in this case held that by holding the auditor liable to the third parties for a tort, other than the client of such auditor, the auditor would be exposed to indeterminate amount of liabilities for an indeterminate time to the indeterminate class of people. Though, in some case, going beyond the privity test, the liability of the auditor is set for the third parties and the test of existence of duty of care is applied. The available test regarding the existence of duty of care was provided in the case of Haig v Bamford[28]. The foreseeability regarding the use of the financial statement, as well as, the auditors report has to be established, along with the reliance. There should be an actual knowledge regarding the use and reliance of such statement by the limited class of people. And, there must be an actual knowledge regarding the plaintiff who would use, as well as, rely on the auditors statement. So, a third party has to prove one of these three points to establish the liability of the auditor for a tort. Due to the rising trend of litigation, the auditing profession has to huge costs on such ligations[29]. The possible risks as well as costs of a huge business could act has a prohibition for the audit firms to take up the audit of such businesses, due to the risk of litigations. And so, the auditors are only responsible to the audit clients. There is a growing consensus that the auditors should be held liable to the third parties in all the cases and the decisions of Caparo Industries plc v Dickman should not be followed anymore. The reason behind this consensus is that the auditors should be accountable for the statements they prepare, irrespective of the party for which they prepare such statements. The above stated tests, available for the third party, would restrict the duty of care which is owed by the auditors to the third parties. And so, this concept is wrong and should not be adopted, to bring fairness, as well as, reasonableness regarding the accountability of the auditors.