Month: November 2020

Relationship of partners to one another

TheLawStudent

The Partnership Agreement or Deed

Most partnerships will have some form of express agreement. As a minimum, this will normally include provision for sharing the profits and, on dissolution, the capital. It will usually also provide for the joining of new partners, the retirement of existing partners and termination of the partnership.

The PA 1890 contains a default code, which applies to relations between the partners themselves in the absence of any contrary agreement.

The partners’ mutual rights and obligations (under an agreement or under PA 1890) can be varied at any time by their unanimous consent (s.19 PA 1890) and this can be express or inferred from a course of dealing. Clearly it is preferable for any such agreement to be expressly and properly documented for certainty.

‘Fall back’ provisions on internal affairs

PA 1890 contains provisions dealing with the internal regulation of the partnership. These are subject to any agreement, express or implied, between the partners. The fall back provisions include the following:

  • S.24(1) Profits: Partners are entitled to share equally in the profits of the business. This is the case even where the parties have contributed to the capital unequally. There should therefore be an express provision in the agreement setting out a profit sharing ratio (PSR), otherwise profits and losses are shared equally, which may not be desirable if one partner has invested more (or less) in the partnership than the others.
  • S.24(6) Remuneration: Without an agreement a partner is not entitled to a salary.
  • S.24(8) Decision Making: Decisions arising during the ordinary course of the business are decided by a majority, except for any change to the nature of the partnership business which requires unanimity.
  • S.25 Expulsion: A partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority can do this. The partners should therefore agree expulsion provisions in advance, otherwise it will be impossible to remove a partner without dissolving the partnership.

Partnership property

As a partnership does not have a separate legal personality, each partner is deemed to own a share in the property belonging to the partnership. An individual partner does not have a right to any particular partnership asset.

Section 20 PA 1890 provides that all property brought into the partnership whether by purchase or otherwise, on account of the firm or for the purposes and in the course of the partnership business, is partnership property. Whether or not a particular asset is partnership property is a question of fact, depending on the intentions of the partners at the time they acquire it. This subjective element can be difficult to prove and so it is sensible for partners to agree which assets are partnership property to minimise the potential for dispute later.

Section 21 PA 1890 provides that all property bought with money belonging to the firm/partnership is deemed to have been bought on account of the firm/partnership, unless the contrary intention is shown.

Fiduciary relationship

There is an overriding duty of good faith in a partnership. The duty owed by the partners to one another is similar to that owed by a trustee to a beneficiary. These equitable principles are reflected in the following sections of the PA 1890:

  • Honest and full disclosure (s.28 PA 1890)
  • Unauthorised personal profit (s.29(1) PA 1890)
  • Conflict of duty and interest (s.30 PA 1890).

General partnerships

TheLawStudent

In practice, you will sometimes find that clients ask for your help to avoid creating a partnership, rather than asking you to create one for them. One reason for this is that the legislation governing partnerships is over 100 years old and the default provisions, which will be implied by that legislation, are often unsuited to the modern business environment. Additionally, clients may have concerns about being subject to unlimited liability.

Nevertheless, there are some advantages. For example, it costs nothing to create a partnership, because no formality is required to create one. In fact, there are almost as many partnerships in the UK as there are companies and many of them are professional partnerships such as lawyers, accountants, surveyors and architects. Many businesses start as partnerships before they convert to a limited company.

The Partnership Act 1890 (PA 1890)

The PA 1890 provides the framework for regulating traditional partnerships. However, there is case law to supplement the PA 1890, and I will cover a small number of cases in later posts.

Whilst the PA 1890 and case law provide a framework for governing traditional partnerships, they are really ‘fall-back’ provisions in the absence of a partnership agreement or where the agreement is silent on any matter. Most traditional partnerships will have a formal written partnership agreement.

Existence of partnerships

As mentioned previously, a partnership is a relationship between persons carrying on a business in common with a view of profit (s.1(1) PA 1890).

Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. The purpose of s.2 is to provide more detailed guidance in determining if the criteria in s.1(1) have been met. For example, evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence (s.2(3) PA 1890). Case law provides that if there is an agreement to share losses as well as profits this makes the existence of a partnership more likely (Northern Sales (1963) Limited v Ministry of National Revenue (1973)). A loan of money by one party to another does not create a partnership.

Case law has also held that if the person is not being “held out” as a partner this makes the existence of a partnership less likely. In Walker v Hirsch (1884) a clerk lent money to the partnership, was paid a fixed salary and took 1/8th of the profits and of the losses but was never held out as a partner. No partnership was found to exist.

Partnerships, Limited Partnerships & Limited Liability Partnerships

TheLawStudent

Introduction to partnerships

I briefly touched on the different types of businesses entites in my posts about business taxation, where we looked at sole traders, partnerships and limited companies. Over the next series of posts, we will look in depth at the different types of partnerships that exist.

We will consider three different types of partnerships:

  • The traditional partnership, which is governed by the Partnership Act 1890, which contains the basic structure of partnership law. this type of partnership is often known as a ‘general partnership’. The partners in a partnership of this type have unlimited liability for the debts and obligations of the partnership.
  • The Limited Partnership (LP), which was introduced by the Limited Partnership Act 1907. Provided one partner is the general partner and therefore accepts unlimited liability, all of the other partners (known as the limited partners) can benefit from limited liability. The limited partners must not be involved in the day-to-day running of the partnership business (otherwise they lose their limited liability status). For this reason, LPs are often used in fund structures. The limited partners are passive investors with no active role in managing the partnership business.
  • The Limited Liability Partnership (LLP), which was introduced by the Limited Liability Partnerships Act 2000. LLPs are often described as hybrids as they combine elements of both a partnership and a company. They have the flexibility of conventional partnerships in relation to their internal arrangements but they are treated as single legal entities with limited liability of their own. LLPs are subject to many provisions of the Companies Acts (and most particularly the Companies Act 2006).

Business Strategy

TheLawStudent

Over the past couple of posts, I have looked at different types of business analysis. Of course, analysis is only part of the picture of business management, there is also a strategic process. Strategy goes on at all levels of an organisation all the time. As the diagram below shows, strategies can exist at corporate, business or functional levels.

Most large businesses have a clearly verbalised mission which rarely changes and any strategic work that they do on a day-to-day basis will be focused on achieving this mission. Therefore, modern businesses are very aware of strategic alignment. This simply means that any strategic activity which takes place which is not at the level of changing the overall strategy or mission of the business needs to align with the bigger picture which already exists.

Businesses often suffer the basic structural dilemma of how much autonomy to allow lower order units in implementing the overall strategy. For example, the question of how much independence the main board gives subsidiary boards in implementing their strategies.

Organisations can either deal with this dilemma by centralising the decision making processes or decentralising it so that the managers at each business unit make the decisions. This will be a significant consideration for you when dealing with clients that are business units or larger organisations as to identifying who the actual decision makers are.

The more clear employees and customers are on what a business stands for and how things are ‘done around here’, the quicker the business can react to changes because there is a better instinctive understanding of what to do. This is really important in large businesses, because it is not possible to seek consensus on every decision from every level of the organisation. As long as senior management has made it clear what the business’ overall strategy is and how this works in practice, employees can be fairly comfortable, when making decisions that affect the organisation that they are acting in a way which reflects, rather than conflicts with, this overall strategy.

Legal professionals involvement in businesses

Much of the advice that businesses seek from legal firms will be as result of strategic change or activity. Often, managers will require legal advice in connection with the implementation of their plans. Some examples of such situations may be:

  • managers may need advice about new contracts with suppliers, staff or customers;
  • businesses may want help with acquiring property, other businesses or entering into a joint venture;
  • a referral to the Competition and Markets Authority;
  • a recession may have led to the need to make staff redundant;
  • setting up a new business vehicle to enter into a new marketplace; and
  • understanding the legislation to set up a new division of the business overseas.

For all of these reasons, and many more, lawyers are an essential part of the business process, particularly where strategic activity is involved. As such, having a good understanding of this area will ensure that you are able to provide appropriate, considered, timely and cost efficient advice.

Environmental scanning

TheLawStudent

Whilst a SWOT analysis is a good initial tool for understanding what lies just outside the business in terms of opportunities and threats, it is very important for a business to have a very good understanding of the external environment as it is filled with opportunities and risks. This is often referred to as ‘Environmental Scanning’.

Therefore, in conjunction with a SWOT analysis, businesses will also undertake a detailed environmental scan to identify what would be considered as ‘threats’ in the SWOT analysis. To do this, they will often use a further framework. Increasingly, the frameworks which are used are sophisticated, complicated and involve weighting a number of factors which have been identified as critical to future business success.

However, there is a simple model which can help to undertake environmental scanning regardless of business or sector, which is PESTLE. This is another acronym, which stands for ‘Political, Economic, Socio-cultural, Technological, Legal and Environmental’, representing six types of environmental factors which need to be taken into account. Here Apple Inc. will be used as an example.

Political

A business will scan the political environment, looking for opportunities and threats brought about by government intervention or wider political influences. For example, Apple would be concerned about the Competition and Markets Authority intervening in its business due to its growing dominance in the handheld computer market. The political stability of a nation such as China, which is heavily involved in the production (and, increasingly, consumption) of computing goods, would also be of interest to Apple. Alternatively, a change in the political landscape may bring opportunities to Microsoft, too, such as a more liberal market approach from a government which is less concerned with monopolistic markets.

Economic

A business will also be interested in the economic environment, for example the cost of borrowing, the availability of borrowing, exchange rate movements, inflation and whether a country is in a period of growth or recession. Apple would see a threat in any weakening of the dollar relative to the Euro. Apple is based in the US and so a weakening of the dollar would increase the cost of production abroad and reduce the profits made in sales abroad.

Socio-cultural

Social factors commonly encompass demographic issues and lifestyle changes. For example, Apple may see the growth of the affluent middle classes in India as a real opportunity to increase sales in this market.

Similarly, lifestyle changes will have an impact. Factors such as a greater concern for the natural environment, an increase in Higher Education and the rise of social networking have all created new opportunities and threats for businesses in various ways. For Apple, the growth in social networking has created real opportunities but the interest in the natural environment has meant that it has received some considerable negative publicity over the mining and use of rare metals in its electronic devices.

Legal

This encompasses statutory provisions and the common law in relation to relevant areas of law including company, employment, commercial, environmental protection, intellectual property and data protection. This will also include regulatory provisions governing such matters as competition, corporate governance, advertising and trading standards. You can see here how there is some considerable overlap with Political and Economic factors. An example of a legal factor impacting Apple is the complex international litigation with Samsung for various intellectual property patent infringements.

Environmental impact

There has been a rapid growth in pressure on businesses to be environmentally friendly. This has impacted on what businesses do and how they operate with many being called to account for negative impacts on the environment. As Apple works in a sector which has a heavy impact on natural resources, it needs to recognise the potential threats of depletion of these resources as well as negative publicity for such depletion. However, opportunities exist for Apple to establish itself as a green manufacturer if this is an avenue it chooses to exploit.

Criticisms of PESTLE

PESTLE analysis is often criticised for being too simplistic, for not weighing different factors to take into account the relative opportunities and threats which they present and for not being sensitive to the differences in sectors. However, it is useful just because it is a simple tool and it can be applied across businesses. You may find, however, that you are encouraged to use more complex or different tools in later strategic work.

Types of market

TheLawStudent

When you are trying to understand the status quo of a business, a key factor is the nature of the market in which it operates, in particular, you will be interested in the number of competitors and therefore the level of competition it can expect.

Some common classifications are set out below.

Monopoly

A market form in which there is only one business undertaking, meaning that there are no competitors. Within the UK, the Competition and Markets Authority tries to guard against abuses of monopolies.

Oligopoly

A market in which there are only a few (perhaps three of four) major competitors, which control the vast majority of the market. The small number of sellers makes it easier for any particular business to be more aware of what the other players in the market are doing. Price fixing is often seen in this type of market. This is where key players collude to set prices. They can set prices high, because there is nowhere else where consumers can then go to get a lower price. Alternatively, perhaps two providers will collude together to set prices low in order to push out other players and then raise their prices to recoup their losses. This is known as predatory pricing.

Monopolistic Competition

In this scenario, there are many competing businesses and consumers in the market and, because products are differentiated between businesses, there is more than just a price consideration between products. In the short run, firms may have a monopoly on their products but in the longer run, because there are usually low barriers to entry, other providers may step in to their market.

Oligopsony

This is quite a specific type of market form but one which you are likely to come across if you work within the farming sector, where there are many suppliers, such as cocoa, tobacco or cattle farmers but they have only a few possible buyers to which that they can sell. In the case of cocoa, there are only three major buyers which sell the cocoa beans on to chocolate makers.

When you are trying to understand a business, it is very useful to understand the market form that it operates within as it will provide you with an idea of how competitive its sector is and therefore what conditions it operates within.

SWOT analysis

TheLawStudent

Another way of examining a business’ ‘status quo’ is to look at its internal and external risks and opportunities as they currently stand. A classic yet simple way of doing this is through a SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis, which provides a systematic way of doing so.

As an example of the SWOT analysis approach, we will consider Walmart, the multinational supermarket chain.

Strengths

A business’ strengths are those factors which make it somehow ‘better’ or potentially better than the competition. These may also be labelled ‘competitive advantages‘. Walmart’s strengths include:

  • exceptional buying power, due to its size relative to the competition;
  • considered to be a very good employer, helping with recruitment and retention of top quality staff; and
  • strong reputation based on a wide range of products at affordable prices.

Weaknesses

A business’ weaknesses are those factors which somehow place the business at a disadvantage relative to other companies operating in the same market. Walmart’s weaknesses include:

  • it may be a global company but its business is focused in particular countries, such as the UK and US, meaning that it does not have market domination in many of the rapidly growing countries such as China and India;
  • it has a very bad reputation for corporate social responsibility, despite considerable efforts in this field. Documentaries such as ‘Walmart: The High Cost of Low Price’ mean that it is seen as an unethical trader, reducing its brand value; and
  • it is so big that it may be difficult to react quickly to rapid changes in the market, leaving it exposed.

Opportunities

Opportunities exist external to the business and are chances to increase sales or profits within the wider environment. Walmart’s opportunities include:

  • mergers or acquisitions with companies in areas such as China or India to increase market share quickly; and
  • the trend for smaller, local branches of supermarkets in the US and UK is something which Walmart has not yet exploited but where there is a potential for money to be made.

Threats

Threats also exist external to the business and are things which could cause problems. These may also be labelled as ‘competitive disadvantages’. For Walmart, these include:

  • continuing bad reputation for corporate social responsibility means that Walmart needs to be very careful not to expose itself to bad publicity with regard to this;
  • intense price competition between Walmart and other supermarkets or suppliers could reduce Walmart’s profit margins significantly; and
  • the growing costs of food which are being experienced across the world may also reduce Walmart’s profit margins.

Once a business has undertaken a SWOT analysis, those involved will have a much better idea of its current status. This analysis will feed into the process of creating strategic options, allowing the business to capitalise on opportunities and competitive advantages and mitigate where possible the weaknesses and threats.

The Business Life Cycle

TheLawStudent

Every business is likely to go through a whole life cycle, from set-up to shutdown. Understanding what stage a business is at in this life cycle will help you to know what their opportunities and challenges may be.

Stages in the business life cycle

Incorporation

All new business ventures start with an idea. An entrepreneur might have an idea about starting a brand new business in order to launch a new product or service. Examples of this would be James Dyson’s idea of a new type of vacuum cleaner or the launch of Facebook by Harvard students. Alternatively, an idea may come from a pre-existing business that wants to head in a new direction, bringing something fresh to the market. Whenever a business begins its life the people with the ideas for that business must decide which business medium to use i.e. sole trader, partnership, limited liability partnership or company. If it is decided that the new business should be operated through a company then the first stage will be to incorporate that company.

Raising Money

If a business chooses to incorporate, it can begin to trade as a company once it has been incorporated. Early in the growth cycle the business will need to raise money to begin its life because it will need to buy the resources needed in order to start to sell its products or services. For some businesses, set-up costs will be low, for example setting up a recruitment consultancy requires very little to get started. For others, for example beginning a brand new chain of restaurants, there will be very high set-up costs associated with recruiting staff, fitting out restaurants and marketing the restaurants to ensure that people come to eat there.

There are two main ways in which a company can raise money, firstly through the issue of shares known as equity finance. This is where the company issues shares in exchange for cash. The shareholders will therefore own a stake in the company and will expect to receive dividends (income) on their shares and a capital return (i.e. a gain over and above what they originally paid for the shares) if and when they sell their shares. Shares could be offered publicly, to friends or colleagues, or even sold to venture capitalists such as 3i. Venture capitalists tend to invest in high-risk start-ups which they believe will offer a high return on investment if they are successful.

The second way a company can raise capital is through debt finance. This is where a company borrows money and in return promises to repay that loan plus interest. A lender, such as a bank, will usually insist on taking some form of security over assets from the company which, through security enforcement processes, will help it to receive back as much of its money as possible if the company defaults on the loan payment or if the company breaches the loan agreement.

Expansion

Successful businesses often want to grow. A business can do this organically, by increasing sales and profit through natural growth of its own business. Expanding the range of products or services or widening the target market can both be effective strategies for natural or organic growth.

A business can also grow acquisitively. If the company buys a competitor, perhaps to gain its customer list and therefore its market share, this is known as horizontal integration. In the 2000s, there were a significant number of horizontal integrations in the pharmaceutical sector, for example between Glaxo Wellcome Plc. and Smithkline Beecham Plc., which subsequently became GlaxoSmithKline Plc. Alternatively the successful business might acquire a business which is part of its supply chain; either a supplier or a distributor. This process can be referred to as vertical integration, an example of which is the takeover by the wholesaler Booker of Budgens and Londis grocery chains.

Insolvency

Finally, if things do not go to plan, the last stage in a company’s life cycle may be insolvency. This is where an insolvency process is commenced in circumstances where the company is not able to pay its debts. Over the past few years there have been a number of high profile insolvencies in the travel and retail sectors, such as Thomas Cook in September 2019, Debenhams, which went into administration in April 2020 and Arcadia Group (owners of brands such as Topshop, Dorothy Perkins, Burton and Miss Selfridge) in November 2020.

Why does this matter to a lawyer?

If you can understand where in the business life cycle the business you are working with is positioned, you will have a better understanding of the types of opportunities and threats they are facing. For example, a company that is teetering on the brink of insolvency will have a very different range of concerns to one which has just been offered a £10 million equity investment by a venture capitalist to develop a new business idea.

Business Law and Practice

TheLawStudent

Introduction to business law and practice

Over the next few posts, I am going to focus on the LPC module on Business Law and Practice (BLP). The BLP module covers a number of areas of legislation, the primary of which is the CA 2006. The CA 2006 represented the biggest overhaul of UK company law since the Companies Act 1985.

The Government’s aim was to simplify, and to introduce more flexibility into, the law. The CA 2006 is intended to make it easier to set up and run a private company. In addition, the Government intended that the CA 2006 should “promote shareholder engagement and a long-term investment culture”.

The key areas of reform in the CA 2006 include:

  • statutory statement of directors’ duties;
  • statutory control of directors;
  • widening of shareholder remedies;
  • simplification of shareholder meetings and resolutions;
  • greater use of electronic communications; and
  • simplification of the rules concerning share capital and its maintenance.

Another key area of reform was company constitution, by which I mean the company’s rule book. CA 2006 sets out the minimum rules and the constitution of a company can then apply more rigid or detailed systems of management. An integral part of a company’s constitution is its Articles of Association (‘Articles’). The Articles form a contract between the company and the shareholders (and, to an extent, between the shareholders themselves). The Articles govern the rules of their relationship and determine the company’s internal management. Essentially, the Articles set out how the company must be run. The CA 2006 provides a precedent set of Articles called the Model Articles (the CA 1985 equivalent was called Table A). A company can choose its Articles but a company incorporated under the CA 2006 will automatically have the Model Articles unless it chooses otherwise.

Company Procedure

Decisions are made on behalf of a company by its directors (board resolutions taken at board meetings) and shareholders (ordinary or special resolutions taken by shareholders at general meetings or passed by written resolution). Company procedure is a fundamental part of the BLP module and an area that we will focus on the law relating to.

Consolidated accounts

TheLawStudent

Companies with one or more subsidiaries are required to publish accounts for the group of companies as a whole as well as their own annual accounts (s.399 CA 2006). This is because (subject to certain exemptions) shareholders of the parent company should have access to some information regarding the subsidiary company. In principle, every subsidiary in the group also has a duty to prepare its own individual accounts, but exemptions are widely available so it is likely to be rare in practice for subsidiaries to do so (ss.394A and 479A CA 2006).

In this post, I discuss the concept of consolidated accounts at a high level, without considering the rules in any detail.

The consolidated Profit and Loss Account

In consolidated accounts, the Profit and Loss Account of the parent company and its subsidiaries are brought together (see the third column in the example below).

The Profit and Loss Account of the parent company (column 1 above) will include dividends paid to it by the subsidiary but not the subsidiary’s profits. Such dividends and any intra group trading that has taken place between the subsidiary and the parent company are excluded from the consolidated Profit and Loss Account (column 3 above).

There is one further factor to consider if the subsidiary is not wholly owned (i.e. if there is a third-party minority interest in the subsidiary). In this scenario, the entire profit for the parent company and its subsidiaries will be shown in the group accounts – then the minority interest’s share is deducted.

The consolidated Balance Sheet

The Balance Sheets of each company in the group will be amalgamated and the only issued share capital represented on the consolidated Balance Sheet (column 3) will be that of the parent company.

The Balance Sheet of the parent company will include the share capital of the subsidiary as a long-term investment, at cost. The subsidiary in this example has no subsidiary of its own and so shows no long term investment in its Balance Sheet (Column 2).

The assets of the subsidiary must however be added to the assets of the parent and represented in the consolidated Balance Sheet accordingly. After a subsidiary has been acquired, its profits are included in the consolidated Profit and Loss Account.

What if the subsidiary is not wholly owned? The total assets and liabilities of the companies in the group are shown, along with the minority interest’s share in those assets and liabilities as a deduction.