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M100 LLB Law : Fictionalization and Company Law

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Task 1: 
Section 1 of the Partnership Act 1890 states that: Partnership is the relation which subsists between persons carrying on a business in common with a view of profit." 


With reference to relevant case law, critically discuss each of the four elements of this definition. 

Task 2: 
With reference to relevant legislation and case law, critically discuss the following duties of a director of a company: 


• Duty to avoid conflicts of interest (section 175 Companies Act 2006)

• Duty not to accept benefits from third parties (section 176 Companies Act 2006)

• Duty to declare interest in proposed transactions or arrangements (section 177 Companies Act 2006) 

Answer:

Task 1

In the United Kingdom, as per section 1 of the Partnerships Act 1890, partnership is defined as a relationship that exists between persons who carries on business in common with a view of profit. In other words, any person who carries on common business activities with the intention to earn profit is said to have carrying on a partnership form of business. The definition comprises four essential elements, which are as follows:


  • Relationship existing between persons;
  • Carrying on a business;
  • Business in common;
  • A view to earn profit;

Relationship existing between persons 

The partnership law states that partnership is formed when more than two persons determines to perform the same business activities with the intention to earn profits. The relationship between the partners is usually determined by the substance of the interaction and not according to the wishes of the parties involved in carrying on such business. The persons may include individuals or companies or any of the two combination with the maximum limit of 20. However, majority of business professionals has exempted such limitation. The partners are entitled to take active part in management and are severally and jointly liable without any limitation for the obligations and the debts of such partnership.

However, Dorrill et al. (2017) states that there has arisen a need for reforming the partnership law significantly due to the persistent problems due to changes in ownership and while raising finance. As per the law commission, there is a continued lack of model agreement and issues associated with separate legal personality, which requires significant reforms. The vocabulary used to define the essential element pertaining to the definition of partnership stipulated under section 1 of the Partnership Act 1890 is undoubtedly clear. In fact, the lucid language used in the statute permits the non-professionals to comprehend the dentition of partnership but question arises relating to the implication of such plain language in the legal context.

Although the definition has served the purpose of defining partnership, the Law Commission requires changes to be made to the meaning only to make it more comprehensible. For instance the language used in the definition defining partnership as the ‘relation that subsists between persons’ should be modified into ‘relations that exists between persons’. According to Cox and Hazen (2016), the simple vocabulary does not provide a strong evidence of certain level of certainty regarding the type of conduct that is necessary to create a partnership. Further, there is a strong ground that contends that a lack in formality often results in formation of partnership only to avoid the confusing and time-consuming procedures that is otherwise observed in company law. The simplicity of the statute has overshadowed the notion of certainty. This leads to the interpretation of the other essential element of the definition ‘carrying on the businesses.

Carrying on a business 

This phrase has drawn much attention of the courts to determine the exact appropriate behavior that would establish ‘carrying on a business’. the mere existence of a partnership agreement without the intention to implement the same shall not give rise to any partnership, hence, it is imperative that the persons engaged into the partnership business intends to carry on a business activities to form a partnership form of business. In the case of Miah v Khan [2000] 1 W.L.R. 2123, the House of Lords asserted that partnership arises on the commencement of actual trading. The persons who are engaged become partners only when they actually commences upon the activity that they are engaged to carry out. The ruling of the House of Lords in this case that the preparatory acts are adequate to establish existence of partnership business even when the intended business is not implemented or carried out, it amounts lack of clarity. According to Deegan and Shelly (2014), the acts done during the preparatory stage does not establish ‘carrying of business’ because the parties may pretend to be partners at such stage, hence, it is necessary to establish that some business has been carried out by the partners.

In the words of Keay (2014), this ruling disregard the importance of any act that takes place before the commencement of the intended business, hence, it is unrealistic in the context of contemporary business. Cox and Hazen (2016) stated regarding the capacity of parties in case partnership does not exist before commencement of business, dissenting judgment given in Miah’s case suggested that in the absence of trust between the parties, the law of agency shall exist between the parties resulting in separate legal action for each disputed transaction arising between the parties. Hence, it can be argued that certainty is required to clarify the fact that a partnership exists only when a business is carried on or it is intended to be carried on but until the existence of partnership, the partners involved cannot carry on business. Hence, the solution is to maintain a status quo, which implies that the partners must carry on a business to bring partnership into existence.

Business in common

According to the definition stipulated under section 1 of the Partnership Act 1890, the partners of a partnership firm must carry on a common business activity to establish partnership. In the words of Keay (2014), the definition suggests that in order to develop partnership, joint participation is required but not exclusively the co-operation between the partners while carrying on such business activity. The joint participation of the partners involved may give rise to a partnership that is formed without any formal agreement entered into by both the partners. Here, the law can be said to lack clarity and is bit confusing. This is because the partnership law itself stipulates that an agreement that is drafted and signed with the intention to be bound by such agreement does not give rise to partnership. On the other hand, mere participation by both the partners without entering into any formal partnership agreement shall bring partnership into existence.

This implies that the statutory provisions are self-contradictory. This is further evident from the fact that the level of participation is not relevant while allocating profits but it becomes relevant at the time of considering the existence of the partnership with respect to carrying on the common business activities.

A view to earn profit

If the partners of a business fails to carry on a business without the intention to earn profit the business cannot be considered a partnership form of business. This is evident from the fact that the definition of partnership under section 1 of the Partnership Act 1890 which stipulates that the persons carrying out a common business activity must do so with a view to earn profit.

According to Sealy and Worthington (2013), as long as partnership is capable of achieving profit, even though the partnership may not realize the profit in practice, but the intention of the parties and the ability of the partners is considered to be relevant in this context. The law is unclear about the fact whether the intention of the partners to make profits should be considered as dominant or the secondary. Therefore, the reforms proposed by the Law Commission with respect to the objective to earn profit is that the partners are required to have an objective to earn profits rater than actually realizing the profit. The underlying intention behind the proposed reform is to simplify the statutory position of businesses that are undergoing the processes of being established.

From the above discussion, it can be inferred that the ambiguity in the statute grants flexibility, which attributes to the persisting existence of the statute even today. However, it can be argued that reforms to a minimal extent would be equally beneficial for the persons engaged in partnership business. In the era of contemporary business, it has become highly imperative to strike a balance between certainty and flexibility of the Act. Although majority of the issues arising from the Act can be resolved with the drafting of a Partnership agreement as it enables each partnership to develop its own provisions, partnerships arising verbally faces inconvenience to implement the statute. Therefore, the reforms in the statute might result in more reliance on partnerships, thus, reducing the adverse effect, the absence of a partnership agreement might have on the partnership business.

Task 2

The directors of an organization are conferred with certain fiduciary duties towards the company and acts as the agents of an organization. The fundamental duty of the directors is to ensure welfare of the employees and to act in the best interest of the company. The following are some of the essential duties of the directors towards an organization.

Duty to avoid conflicts of interests

The duty of a director to avoid conflict of interest is stipulated under section 175 of the Corporations Act 2006. The provision requires the directors to avert any situation in which any direct or indirect interest of the directors may be in conflict with the interests of the company.  As was observed in Keech v Sandford [1726] 2 it was held that the fiduciary duty is to avert situations where conflicts of interest may arise and it not the duty to simply refrain from taking advantage of such conflict of interest.

According to De Lacy (2013), the precise conflict of interest that arises is the conflict between the interest of the company and the personal interest of the directors. In Aberdeen Rly Ltd v Blaikie Brothers, it was held that the directors are prohibited from entering into any agreement that results in conflict between the personal interest of the directors and the interests of the company. It is imperative to understand that the duty of the directors to avoid conflicts of interest of the company does not imply the personal interests of any specific shareholder or some of the shareholders. This signifies that the duty is broader than the duty to avert taking profits from conflicts of interest or causing loss to the shareholders of the company or to the company directly.

The scope of the duty of the directors is stipulated under section 175(2) of the Act, which is applicable to exploitation of any property, opportunity or information irrespective of the fact whether such company could actually take advantage of such opportunity, property or information. Hannigan (2015) states that the term ‘exploitation’ could be interpreted either as an abuse of property or simply as the use of property where the director intends to earn personal profit from such use or exploitation of the property. In the context of section 175(1) of the Act, the interpretation of the term ‘exploitation’ is used to signify exploitation of property with the view to earn profit.

The exploitation of the property of the company would imply that the director for obtaining personal gains has misappropriated the property. In regards to the commercial activities of the company, it will be equally important to include opportunity or an information as information that has commercial value or is confidential in the form of intellectual property which if exploited by the company would be beneficial for the company. The misappropriation of the company’s information or opportunity shall include exploitation of the information of the company. However, the provision under section 175 (3) stipulates the exception applicable to the fiduciary duty of the director according to which the duty is exempted when a conflict of interest arises with respect to the arrangement or transaction with the company.

Duty not to accept benefits from third parties

This duty is stipulated under section 176 of the CA 2006, which prohibits the directors of a company from accepting benefits from the third parties. The director is prohibited from accepting such benefits from third parties while he holds the position of a director or he is conducting or not conducting any duties as a director. The term ‘third party’ refers to a person except the company or any associated corporate body or person that is acting on behalf of such company. The essence of the liability of the director is based on the duty to avoid conflict of interests as is stipulated under section 176(2) of the Act. According to section 176 (4) of the Act stipulates that the duty of the director is not violated if the benefit accepted is not likely to give rise to any conflicts of interests.

According to Keay (2014), the principle stipulated under section 176 is predicted on the case law that had been interpreted before the enforcement of the section. In Attorney-General for Hong Kong v Reid [1994] 1 AC 324, a modern principle was established that held that a bribe received by the directors must be considered as constructive trust from the time such bribe is received and if the director receives any property along with the bribe, it shall be considered as constructive trust as well. This principle is established based on the fact that a bribe is a gift that i given to a fiduciary to induce him to deceive his trust. Although a fiduciary cannot be held responsible for any secret benefit but the fiduciary is definitely responsible for any secret benefit that amounts to a bribe as was held in Daraydan Holdings Ltd v Solland International Ltd [2004] EWHC 622.

Duty to declare interest in proposed transactions or arrangements

This duty of director is stipulated under section 177 where the director is required to declare the extent and nature of the interest of the directors in any proposed arrangement or transaction with the company. According to Gerner-Beuerle et al. (2013), the interest of the director in any transaction may arise under various circumstances. A situation where the director acted as a sole trader and was acting as other party to a contract with the company shall be included under this section. According to section 177 (2) of the Act, the declaration must be made at the meeting held by the directors or by notice given to the directors either in writing or through general notice.

The exception to this section is stipulated under section 177 (5) of the Act according to which a declaration of interest is not required to be declared if the director is not aware of such interest or where the director is not aware of the concerned arrangement or transaction. Gerner-Beuerle et al. (2013) states that the impact of section 177 is to safeguard the impact of such transaction on the ground that the director has acted in compliance with section 177 of the Act. The necessity to disclose any interest was extended to be included in contracts that were directly made towards the directors such as the service contract of the director but to those contracts where the director had an interest. Nevertheless, this provision does not extend to the personal contracts or the spouse of any director. In the event the provision is applicable to the spouse or the other contract, the onus to establish good faith shall remain upon the directors.

Reference:

Aberdeen Rly Ltd v Blaikie Brothers [1854] UKHL 1

Attorney-General for Hong Kong v Reid [1994] 1 AC 324

Collison, D., Cross, S., Ferguson, J., Power, D. and Stevenson, L., 2014. Financialization and company law: A study of the UK Company Law Review. Critical Perspectives on Accounting, 25(1), pp.5-16.

Company Act 2006

Cox, J. and Hazen, T., 2016. Business organizations law. West Academic.

Daraydan Holdings Ltd v Solland International Ltd [2004] EWHC 622

De Lacy, J. ed., 2013. Reform of UK Company Law. Routledge.

Deegan, C. and Shelly, M., 2014. Corporate social responsibilities: Alternative perspectives about the need to legislate. Journal of Business Ethics, 121(4), pp.499-526.

Dorrill, J., Schindel, M., Christensen, T., Ingle, A. and Lewey, J., 2017. Partnership Law. SMU Annual Texas Survey, 3(1), p.321.

French, D., Mayson, S. and Ryan, C.L., 2014. Mayson, French & Ryan on company law. Oxford University Press, USA.

Gerner-Beuerle, C., Paech, P. and Schuster, E.P., 2013. Study on directors’ duties and liability.

Hannigan, B., 2015. Company law. Oxford University Press, USA.

Keay, A.R., 2014. Directors' Duties. Jordans.

Keech v Sandford [1726] 2

McMeeking, K.P., Baskerville, R. and Sim, D., 2017. Partnership law and its spawn: Did LLP deliver on its promises?.

Miah v Khan [2000] 1 W.L.R. 2123

Partnerships Act 1890

Sealy, L. and Worthington, S., 2013. Sealy & Worthington's Cases and Materials in Company Law. Oxford University Press.

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