Chapter 1


Chapter Contents

1.1      A company or a partnership

1.2      Types of companies

1.3      Legislation

1.4      European law

1.5      The Department for Business, Innovation and Skills


Self-test questions

Further reading

1.1  A company or a partnership

When a group of people get together and decide to start a business, one decision that they will need to make early on is whether to operate as a company or as a partnership (or ‘firm’). There are certain advantages, and indeed certain disadvantages, that attach to incorporation, which is the process of creating a company. A partnership is unincorporated and is defined in the Partnership Act 1890 as the carrying on of a trade or profession with a view of profit (s 1). The following are, therefore, matters which those setting up a business will need to consider. The essence of the company is that it is a separate person in law, see Salomon v A Salomon & Co Ltd [1897] AC 22 (see section 2.1). The partnership does not have legal personality. The partners are agents of the partnership (s 5 of the Partnership Act 1890). From this very basic difference between the company and the partnership flow many of the advantages and disadvantages of incorporation.

Unlike the company where there is, at least in theory, a clear division between shareholders who invest in the business and the directors who manage the business, in partnership law there is no such division. In partnership law a person who invests in the firm’s business will inevitably find that he is a partner in the firm and fully liable for the firm’s debts (unless he is a limited partner within the Limited Partnerships Act 1907 or the Limited Liability Partnerships Act 2000).

It is possible for the partnership to employ people but the partners themselves are not employed by the firm. The two relationships are mutually exclusive. The position of a director, even a sole director, is quite different. He may be employed by the company, see Lee v Lee’s Air Farming [1961] AC 12.

Sometimes the position of the salaried partner causes particular difficulty. The position is used most prevalently in professional firms as a ‘first step on the ladder’. If a person is represented to the outside world as a partner, then, of course, he may bind the firm by his actions, see United Bank of Kuwait Ltd v Hammond [1988] 1 WLR 1051. However, within the partnership itself, the position will be affected by the question of whether a salaried partner is, in reality, an employee or a partner, see Stekel v Ellice [1973] 1 WLR 191.

The most obvious advantage in incorporation is the access to limited liability. Not all companies are limited companies. Unlimited companies do not need to file accounts so sometimes this is an attraction for those setting up a business. However, the possibility of limiting the liability of the participators to the amount of the issued shares is an attractive one. Sometimes this advantage is, of course, more apparent than real. If a small private company goes to a bank and asks to borrow a large sum of money, the bank is unlikely to be satisfied with the possibility of recourse against the company’s assets. In practice, the bank manager will require some collateral security from the company’s directors. In a partnership, however, all the partners will have unlimited liability for the business’s debts and liabilities. This is the case except in a limited partnership governed by the Limited Partnerships Act 1907. In a limited partnership under this Act, however, only sleeping partners may have limited liability and it is not possible to form a partnership made up entirely of limited partners. There must always be somebody who is ‘picking up the tab’ with no limitation of liability.

Under the Limited Liability Partnerships Act 2000, it is possible to opt for a new form of business association, namely a limited liability partnership (LLP). The relationship between the members is like that of a general partnership but the institution has to be registered with the Registrar of Companies. Members of a limited liability partnership are not responsible for its debts. Limited liability partnerships are regarded as legal persons with their own rights and obligations. Accounts have to be prepared and audited although there is no requirement to prepare the equivalent of a directors’ report.

A further advantage of the company is the possibility of separating ownership from control. In a partnership, all of the partners are agents for the firm. In a company, and this is particularly the case in public companies, the ownership and the control are separated. Those people owning the share capital will not generally be the people who are running the business (however, in private companies, the owners and the managers may well be the same).

An attraction of incorporation is what is sometimes termed perpetual succession. This means that the company need never die. Companies do go into liquidation but they need not do so. There is no theoretical reason why a company cannot go on for ever. The Hudson’s Bay Company has been running for well over 300 years, for example. In the case of partnerships, however, wherever there is a change of partners, there has to be a drawing up of partnership accounts and a re-formation of the partnership.

Incorporation is an attractive business medium where the participators wish to be able to transfer their shares at some later stage. In a company, shares are freely transferable, subject to the terms of the company’s constitution (section 7.4). In a partnership, by contrast, a partner’s share is not so transferable unless the agreement so provides. The advantage of transferability is seen at its clearest where a company is quoted on the Stock Exchange or the Alternative Investment Market (AIM). At this stage, there will be a market mechanism for disposing of and purchasing shares.

It is said to be easier to raise finance where a company is formed as opposed to a partnership. Clearly, if a company is quoted, it has access to the Stock Exchange to raise finance by issuing its shares and debentures (collectively called securities) to the public (Chapter 20). In the case of debentures, these may be secured by a floating charge over all of the company’s assets and undertaking (section 20.6). Although this does not in general provide advantages for companies on or after 15 September 2003 (section 20.6). The device of the floating charge is open to the company and a general partnership cannot take advantage of this means of raising finance, although it is open to limited liability partnerships to create floating charges.

It is probably the case that there is more prestige attached to the company than to the partnership. There is no reason that this should be the case but probably the trading and investing public sees a company in a more favourable light than a partnership.

A further consideration, although it might not be an advantage for companies, is taxation. Companies will pay corporation tax on their profits. In the case of partnerships, the profits of the partnership business are attributable to the partners of the firm, who will pay schedular income tax on those profits. It is not possible to say in isolation from factors concerning the circumstances of the participators and their other sources of income whether this is an advantage or not. It will depend on the circumstances.

The disadvantages that attach to incorporation are not numerous. There are clearly formalities to be complied with. A partnership agreement need not even be written (provided it is not a limited or a limited liability partnership). Clearly, it is desirable to have a written agreement for evidential purposes but there is no legal reason why the agreement should be in writing. Companies are subject to a comprehensive code of rules contained in the Companies Act 2006 and elsewhere; the general partnership is not subject to a detailed statutory regime although the Partnership Act 1890 does set out some rules.

The Limited Liability Partnership Regulations 2001 (S1 2001/1090) do apply detailed rules to limited liability partnerships which are similar to the regime that applies to companies.

In the case of a company, there are various formalities to be complied with. A constitution has to be drafted. Articles of association (the constitution) have to be delivered to the Registrar at Companies House in Cardiff in the case of English and Welsh companies, together with a statement of capital and a statement of compliance. A certificate of incorporation will then be issued to the company. There are various ongoing formalities for a company, including the filing of an annual return, the filing of annual accounts (unless the company is unlimited) and the filing of various forms connected with changes of directors, issue of shares, issue of debentures, change of company secretary, etc. Companies also have to comply with formalities regarding the holding of meetings, which is not the case in a partnership. Private companies are not required to hold AGMs but may do so if they wish.

Together with these formalities, there is the disadvantage of publicity in the case of the company. This is generally seen as a disadvantage as a company has no option but to make certain of its affairs public. These would include the names of the company’s directors and company secretary, the accounts of the company (unless unlimited), the annual return of the company, the company’s constitution and various registers that have to be kept at the company’s registered office.

Together with formalities and publicity, one may add expense as a disadvantage. However, the expense of setting up a company is not great. There is a charge for the issue of a certificate of incorporation and an annual fee for filing the company’s annual return, but few other charges are made by the company’s registry. The cost of the annual audit may well be a deterrent, however, in the case of a limited company, although small companies are exempted from the statutory audit.

Two other disadvantages of incorporation may be mentioned here. These are the rules on the maintenance of capital that apply to companies – and which are much stricter than in relation to partnerships – and the remaining vestigial rules on ultra vires that limit a company’s freedom of manoeuvre. Partnerships by contrast are free to do what is legal within the law of the land.

Sometimes an individual may elect to run a business as a sole trader. This is, in essence, the firm without partners. There will be no limit on liability but no formalities either. It is almost invariably a small business.

Comparison of partnerships and limited companies

Partnership Limited company
No separate legal personality Separate legal personality
Governed by Partnership Act 1890 Governed by Companies Act 2006 and Insolvency Act 1986
No comprehensive statutory rules Complex rules which need interpreting by a lawyer
Partnership profits allocated to partners and taxed under normal income tax rules Company profits liable for corporation tax
Partners have generally unlimited liability Shareholders’ liability limited to paying for the number of shares they have taken up
Partnership may be ended on death or bankruptcy of partner, or by notice Company perpetual – can go on for ever
Difficult to realise investment Investment readily available through trading shares in the Stock Exchange (if quoted)
Debts secured against assets of individual partners Debts secured against company assets
All partners are agents of the firm Possible to separate ownership and control (members own; directors control)
Difficult to raise money Easier to raise money by debentures and shares
No requirement to make any information public in general Required to make information public, and file information with Registrar of Companies including filing of annual accounts

1.2  Types of companies

There are various classifications of companies that may be made.

1.2.1  Chartered company

A company may be chartered, that is, set up by a charter from the Crown, and may then derive its powers from the charter. The very first companies were of this variety, for example, the East India Company, the Massachusetts Bay Company and the Hudson’s Bay Company. Today, chartered companies are not of economic significance but they still exist. Generally, they are not trading concerns. They may be professional organisations – the Institute of Chartered Accountants of England and Wales is an example. They may be local government corporations, for example, the Corporation of Chesterfield. Perhaps the most famous chartered company of them all is the British Broadcasting Corporation.

1.2.2  Statutory company

A further type of company is the statutory company. In Victorian England, there was a great plethora of incorporations. Each company had to be set up by a separate Act of Parliament. During this period of industrial revolution, the great mass of companies involved public utilities such as gas and water, or transportation such as canal companies and railway companies. Today, there are few statutory companies. The process is too cumbersome for periods of massive economic activity, as each company is incorporated by a separate Act of Parliament.

1.2.3  Registered company