Sole Trader Partnership and Limited Company

A business can be conducted through the following ways:

a. by an individual as a sole proprietor;

b. by two or more individuals in partnership; or

c. by the medium of a body corporate.

Sole Trader

The sole trader is his or her own boss and no other parties will be involved. There is no requirement to register accounts. The set up is by applying for a business licence from the Business Registration Office of the Inland Revenue Department. However, the disadvantages are that:

a. the sole trader is personally liable for all the debts incurred in the business; and

b. it is difficult to raise capital, i.e. to obtain finance from the bank.

1. 1. the death or illness of the sole trader ends the business

The main advantages are the flexibility and lack of legal formality in establishing a business as a sole trader, and having total control and full decision-making powers over policy, profits, and capital investment.

Partnership

Partnership refers to the relationship between persons carrying on a business together with a view to making a profit. Their relations are often regulated by a partnership agreement in writing entered into between the partners, though the contract may also be created verbally or inferred from the conduct of the parties. Partnership business is also regulated by partnership law in Hong Kong, i.e. the Partnership Ordinance (Cap. 38) (PO) and the Limited Partnership Ordinance (Cap.37) (LPO).

The main characteristics of a partnership can be summarised as follows:

• It must be involved in an activity intended to be for profit by persons carrying on a business in common.
• A partnership is not a separate legal person.
• The partners are the agents for the firm.
• All the partners in the firm are entitled to share in the profits equally unless they agree otherwise.

The Firm Name

There should be a firm name to represent the business conducted by the partners but the name should not contain the word ‘Limited’ or its Chinese version.

Registration Of The Business

Partners must register their business under the Business Registration Ordinance (Cap. 310) with the Business Registration Office of the Inland Revenue Department.

Types Of Partners

The LPO classifies partners into general partners and limited partners.

Limited partner –

One whose liability for the firm’s debts is limited to the amount of his capital contribution. He takes no part in the management of the partnership business. A limited partnership must consist of one or more general partners and must be registered with the Registrar of Companies.

General partner –

Every partner is liable jointly with the other partners for all debts and obligations of the firm incurred while he is a partner. A general partner may take part in the management of the partnership business.

Salaried partner –

The persons are held out as partners to the outside world, but within the partnership they may be mere employees.

Dormant or sleeping partners –

They take no actual part in the management of the company but are full partners in every respect as far as liabilities and duties are concerned.

Partners And Third Parties

Section 7 of the PO provides :

Every partner is an agent of the firm and his other partners for the purpose of the business of the partnership; and the acts of every partner who does any act for carrying on the business of the firm bind the firm and the partners, unless he has no authority to do so and the person with whom he is dealing either knows that he has no authority or does not know or believe him to be a partner.

Liability Of Partners

Section 11 of the PO provides that the partners are jointly liable in respect of the firm’s debts and obligations.

Relations Among The Partners

The following rules apply in respect of the rights and duties of the partners unless otherwise governed by an express agreement :

1. 1. all the partners are entitled to share equally in the capital and profits and must contribute equally towards the losses.

2. 2. the firm must indemnify every partner in respect of their payments and personal liabilities incurred in the ordinary and proper conduct of the business.

3. 3. a partner is entitled to interest at the rate of a certain per cent. for the money lent by him to the firm.

4. 4. a partner is not entitled to interest on the capital subscribed.

5. 5. every partner may take part in the management of the partnership business.

6. 6. no partner is entitled to remuneration for acting in the partnership but he may take a salary as manager in the business.

7. 7. no person may be introduced as a partner without the consent of all the existing partners.

8. 8. decision made in the business is by a majority of the partners unless in relation to the change of the nature of partnership business or terms in the partnership agreement, then the consent of all the existing partners is required.

9. 9. the majority of partners in making their decision must do so in good faith and after giving consideration to the views of the minority. It is not proper for a majority to act without consulting the minority.

10. 10. books are to be kept at the place of business of the partnership (or its principal place if more than one).

11. 11. every partner shall have access to and inspect and copy any of these books.

More importantly, partnership is a relationship which is based on mutual trust and partners owe each other a wide variety of fiduciary duties: they must render true accounts and information, and not to compete with the firm or earn secret profits.

Dissolution Of A Partnership

A partnership can be dissolved by either non-judicial means or judicial means

Non-judicial Dissolution

Subject to any agreement between the partners, a partnership is dissolved as follows:

1. 1. if the partnership was for a fixed term and such term has expired.

2. 2. if the partnership was for a particular adventure and such adventure has completed or accomplished.

3. 3. by a notice of intention to dissolve the partnership given by one partner to the others.

4. 4. by the death or bankruptcy of any partner

5. 5. by a partner charging his share of the partnership for his debt (a cause for dissolution at the option of the other partners).

6. 6. by any event which makes the business unlawful.

Judicial Dissolution

A partner may apply to the court for a dissolution order in any of the following cases :

1. 1. a partner is found to be insane or becomes incapable of performing his part of the partnership agreement.

2. 2. a partner has been guilty of conduct which affects prejudicially the partnership business.

3. 3. a partner wilfully or persistently commits breaches of the partnership agreement.

4. the business of the partnership can only be carried on at a loss.
5. when the court opines that it is just and equitable to dissolve the partnership business in view of the circumstances e.g. want of mutual confidence among the partners, a deadlock in the management, etc.

Formation Of A Company

A company can be incorporated by:

1. by registration as a company limited by guarantee under the Companies Ordinance (Cap.32) e.g. the Law Society
2. by an ordinance passed e.g Vocational Training Council
3. by the most popular way – registration as a company under the Companies Ordinance.

The Separate Legal Entity

A company is a legal entity distinct from its members. It has its legal personality and be described as an ‘artificial person’, a ‘body corporate’ or a persona at law. It can sue and be sued, enter into a contract, own property and commit crimes and torts.

Salomon V Salomon And Co. Ltd. (1897)

A boot manufacturer converted its business into a company with its shares being held by his wife, 5 children and himself. He sold its business to the company for 39,000 pounds to which 9,000 from cash, 20,000 from the share capital of 20,000 shares of 1 pound each and the remaining 10,000 from loan lent by himself to the company. Salomon on the one hand got 39,000pounds by selling his boot manufacturing business to the company, on the other hand the consideration of 39,000 pounds paid by the company being collected as above. Salomon got a security from the company for his 10,000 pounds loan by creating debentures given in his favour by the company which were secured by a charge on the company assets.

After a depression, the company went into liquidation. The company assets were sufficient to satisfy the secured debentures but not the unsecured creditors. The court held that Salomon was entitled to be paid before the unsecured creditors.

The essence of this case is that the company has its own personality. It is a corporate person as distinct from its shareholders. In case Salmon had not converted its business into a limited company, he would be personally liable for all the debts owed from its business, not to mention that he could, as a secured creditor in the above case, got payment from the company before the other unsecured creditors.

Limited Liability Of A Company

Section 4(2) provides that a company may be either

1. limited by shares, or
2. limited by guarantee with or without a share capital, or
3. without limited liability.

Company Limited By Shares

This is the most common one which is often used as a device for trading and doing business.

A company limited by shares shall in its memorandum state the maximum number of shares which it may issue and each share will have a nominal value.

e.g. The share capital of the company is $10,000 divided into 10,000 shares of HK$1 each.

The nominal value of a share of the company is referring to that stated in the memorandum, i.e. in the above example HK$1. However the actual value or the issued price of the share is determined by the market value of the share. Suppose the company having a share capital of $10,000 divided into 10,000 shares of HK$1 each but its assets value at HK$1 million, then the market value of a share of the company is HK$100.

The shares of a company are usually paid in full when they are issued, in which case, even if the company is wound up and is unable to pay its debts, the members are not liable to pay those debts; their liability is limited to the nominal value of the shares and this has already been contributed.

In case the shares are only partly paid, then the members would then be liable to the unpaid portion of the shares.

Memorandum And Articles

The Memorandum and Articles of Association of a company contains the regulations of the company:

1. The memorandum sets out its basic constitution and presents the company to the outside world.
2. The articles deal with matters of internal administration.

The Memorandum may contain the following clauses:

Clause 1 – the name of the company with ‘Limited’ as the last word S5(1)(a)).

Clause 2 – the registered office of the company will be situated in Hong Kong.

Clause 3 – The objects of the company (S5(1)(b)).

The Doctrine Of Ultra Vires

If a company acts outside the objects stated in the memorandum, the transaction will be ultra vires (beyond its capacity) and void. A void contract cannot be enforced by either party. In practice, the ultra vires rule has caused many hardships and has become a trap for innocent victims. As a result, it has now been changed by law that an object clause is optional. If a company’s memorandum does not state its objects, it has the powers of a natural person.

Clause 4 – The liability of its members is limited (S5(2)).

Clause 5 – the amount and division of shares of the company e.g. $10,000

divided into 10,000 shares of $1 each.

The Articles Of Association

The articles prescribe regulations for the internal management of a company. A company may adopt all or part of the regulations contained in Table A of Schedule 1 of the Companies Ordinance as the articles of a company.

The regulations contained in Table A cover all aspects of the management of a company but they may broadly be divided into :

• Capital -share capital, class rights, liens, calls, transfer, forfeiture and conversion of shares, alteration of capital and allotment of shares
• Members – meetings, notices, proceedings of meetings, votes and representatives
• Officers – directors’ borrowing powers, general powers and duties, disqualification and rotation, and proceedings of directors, managing director and secretary
• Distributions – dividends, reserves, accounts, capitalization of profits and audit

Effect Of The Memorandum And Articles

Section 28 provides that the subscribers to the memorandum will be deemed to have agreed to become members of the company, and on its registration they will be entered as members in the register of members.

Once the memorandum and articles are registered, they have the effect of binding the company and its members to the same extent as if they had been signed and sealed by each member and contained covenants on the part of each member to observe all their terms (S23(1)).

Section 23 has the effect of creating two contracts :

1. a contract between a company and each member, and
2. a contract between each member and each other member, a contract among the members inter se (between themselves).

Companies And Partnerships Compared

Liability –

The liability of the members for the company is limited to the amount of their respective shareholdings. Partners are usually jointly and severally liable for the debts of the partnership.

Perpetual Succession –

Any change of membership will not affect the existence of the company, whereas a partnership will be dissolved for any change of partners.

Finance –

A company may obtain finance and create a floating charge by way of security. Partnership cannot create such a charge.

Ownership –

Ownership of property is vested in the company, and the company enters contracts in its own name and is not affected by a change in shareholders. A partnership can enter contracts in the name of the firm, but the partnership are personally liable on its contracts.

Disclosure –

A registered company is required to disclose certain information to the public by filing some returns with the Companies Registry. A partnership business only requires a business registration certificate.

Expenses –

Administrative fees for operating a limited company will be higher when compared with that for a partnership business. Audited accounts are required for a limited company.

Regulations –

A company is regulated by the Companies Ordinance and its Memorandum and Articles of Association. A partnership business is created by a partnership agreement and is guided by the Partnership Ordinance.

Corporate-

A company is a legal entity but not a partnership business.

Management –

Members of a company only makes investment and the company is managed by the directors of the company, though normally members are also the officers of the company. For a partnership, all partners will usually be fully involved in the management process.