Legal Aspects of Business: Duties of Directors and Business Structures

This essay examines the legal aspects of business in the UK, focusing on two key areas: the comparison between unlimited partnerships and private limited companies, and the duties of company directors. The first part of the essay delves into the characteristics, advantages, and disadvantages of unlimited partnerships and private limited companies, analyzing relevant case laws such as Stekel v Ellice, Smith v Anderson, and Salomon v Salomon & Co Ltd to illustrate key legal principles. The essay highlights the distinctions between these business structures, emphasizing liability, legal formalities, and the concept of separate legal entities. The second part of the essay evaluates the duties of directors under the Companies Act 2006, specifically sections 171, 172, and 173. It explores the scope of directors' powers, their duty to promote the success of the company, and the importance of acting in good faith, referencing cases like Hogg v Cramphorn Ltd and GHLM Trading Ltd v Maroo to demonstrate how directors' actions are scrutinized and the consequences of breaching their fiduciary duties. Overall, the essay provides a comprehensive overview of the legal framework governing business operations and corporate governance in the UK.

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Legal Aspects of Business

LEGAL ASPECTS 1
TASK 1
The business environment in the United Kingdom is considerably friendly for organisations
which are operated in the country. Primarily, there are three types of business structures in
the UK: sole trader, partnership and limited company (Simple Formations, 2018). These
business structures have both merits and limitation which are required to analyse by parties
before selecting them. In the UK, partnership and private limited company are two most
popular business structures which parties choose for operating their business. The aim of this
essay is to evaluate advantage and disadvantages of an unlimited partnership and private
limited company by analysing relevant case laws and legislation. The Partnership Act 1890 is
the key document which provides provisions regarding partnerships operating in the UK
(Legislation.gov.uk, 2018a). The definition of partnership is given under section 1 of the Act
which provides it as a relation that exists between two or more parties with a purpose of
carrying on a business in common with a view of profit. In the UK, partnerships are
categorised into three types: limited partnership, unlimited partnership and limited liability
partnership. There are both advantages and disadvantages of an unlimited partnership. The
advantages include easier formation by either written, oral or implied by conduct, fewer legal
formalities, and private of documents.
The disadvantages include dissolution in case any disagreement arises between partners, no
limited liability, and no separate legal entity. There are four key elements of a partnership
which includes the relationship between parties, carry out a business, in common and view of
profit. In Stekel v Ellice (1973) 1 WLR 191 case the plaintiff was a salaried employee, and he
also agreed with the defendant to enter into a partnership (Prassl, 2014). However, the
agreement wasn’t constructed, and the plaintiff leaves with his clients. The question arises
whether arrangements between parties constitute a partnership. Megarry J held that the
plaintiff and the defendant have entered into a partnership even when the plaintiff receives a
salary from the defendant rather than the portion in profits and his name did not appear as the
partner. It is important to analyse the substance of the relationship between parties in order to
determine a partnership which assists in classifying between a mere employee and a partner.
Next essential element is ‘to carry out a business’ which means partners must together carry
out a business. In Smith v Anderson (1880) 15 Ch D 247 case, the court held that a party
doing any isolated act is not considered as “carrying on” a business that is an association

LEGAL ASPECTS 2
formed for performing an act which will not be repeated in the future is not considered as a
partnership (Salim, 2009).
In Checker Taxicab v Stone (1930) NZLR 169 case, a driver hid a cab from its owner which
was not considered as a partnership because it was not a business that is being carried out by
parties in common (Hawes, 2011). Another element of partnership is “in common” which
means that partnership business must be operated in a common way by all the partners in a
firm. A good example was given in Keith Spicer Ltd v Mansell (1970) 1 All ER 462 case. In
this case, X and Y decided to form a company and X purchased furniture from the third party
and delivered it to Y. The party sued Y for the unpaid amount; the court held that a
partnership hadn’t been constructed because they are not carrying on a business in common
(Deards, 2013). The final element of the partnership is “with a view of profit” which means
partners must earn and share profit of the business they run in common. In Britton v The
Commissioners of Customs & Excise (1986) VATIR 204 case, the court held that agreement
between a married couple for sharing of profits could not be constituted as a partnership
because only sharing of profits is not enough and other elements are required to fulfil as well
(Morse, 2010).
The provisions regarding a private limited company are given in the Companies Act 2006.
The definition of a private limited company or ‘Ltd’ is given under section 4 which provides
that it is the company which is not a public limited company or PLC (Legislation.gov.uk,
2018b). The differences between PLC and Ltd assist in understanding the definition of a
private limited company. A PLC can issue its shares and list them on a stock exchange for
free trade which can be bought by anyone. In case of private limited, the shares are not freely
traded, and they are issued to friend and family of the members. The section 9-11 of the CA
2006 provided significant provisions which are required to comply by a corporation.
According to section 9, a company is required to maintain its registration documents which
include the memorandum of association and the article of association. The article of
association is a significant document which provides bylaws basic structure and
administrative structure of a corporation which governs the actions of its members. Under
section 10 the provisions regarding the statement of capital and initial shareholdings are
given which are delivered by a Ltd in case it has share capital.
As per section 11, 12 and 13, different statements are required to be made by a corporation
which includes a statement of guarantee, proposed officers and compliance respectively.

LEGAL ASPECTS 3
After its registration, a company is incorporated in the eyes of the law, and it gains its rights
and liabilities as a corporate entity. A private limited company is required to add the word
‘Limited’ or ‘Ltd’ at the end of its name as per section 59 (Omar, 2009). Its attributes include
a limited liability of members and a separate corporate entity in the eyes of the law. It
provides that a company can hold property under its name and it can sue or be sued by third
parties. It members cannot be held personally liable by the court for repaying debts of the
corporation in case it failed to do so. It has perpetual succession which means it does not
dissolve in case all of its members die and it ceases to exist after its liquidation. In Lee v
Lee’s Air Farming (1961) AC 12 case, the court held that a company has the ability to create
a contractual relationship with its members (Sharma, 2013).
Salomon v Salomon & Co Ltd (1897) AC 22 case is a leading case in which the court
established provisions of limited liability and separate personality. In this case, Salomon
terminated his shoe manufacturing sole trading business and started a new company by
transferring his assets. He holds shares and debentures of the company. After some time, the
corporation failed, and the unsecured creditors demand their money back. Salomon and other
debenture holders receive their money, but unsecured creditors such as suppliers did not
receive their share. They filed a suit against Salomon in the court by arguing that the
corporation was his agent as he holds the majority of shares and the debentures are a scam.
The House of Lords rejected the argument of unsecured creditors and provided that
debentures were not a scam because information about them is present in the company’s
documents (Kershaw, 2012). It was held that the company is not an agent of Salomon just
because he was the majority shareholder. The corporation has its own identity, and it is liable
for business debts and liabilities rather than its members. Therefore, Salomon did not have to
pay the debts of the company. The judgement of this case established the provision of limited
liability and separate legal entity. Hence, it can be concluded that unlimited liability and
private limited company have different characteristics based on which they have various
advantages and disadvantages.

LEGAL ASPECTS 4
TASK 2
A director is a person who is responsible for leading or supervising a particular area or
division in a company. Directors of a corporation take business decisions in order to run its
operations effectively. While taking business actions, directors have to comply with a number
of duties as provided by the Companies Act 2006. The aim of this essay is to evaluate the
duties of directors as given under section 171,172 and 173 of the Companies Act 2006.
Directors have a number of powers based on which they take business decisions, and duties
ensure that such decisions are focused towards the benefit of the company rather than the
self-interest of the director. Section 171 provides the duty of a director to act within the scope
of his powers. The decisions or actions taken by directors must comply with the guidelines
provided in the constitution of the corporation (Section 171 (a)) (Sealy and Worthington,
2013). Additional, while using their powers, directors should ensure that they use them for
the purpose for which they were conferred (Section 171 (b)). The provisions regarding the
constitution of a corporation are given under section 257 which are required to comply by
directors.
There are a number of examples in case laws in which the court held directors liable for
breaching their duties as given under the Companies Act 2006. One of such examples was
given in Hogg v Cramphorn Ltd (1967) Ch 254 case. In this case, it was given that issuing of
a corporation’s shares is a fiduciary duty of directors and it is their right use such duties as
they deemed fit. However, this duty can be set aside in case the directors take action based on
ulterior motives for gaining personal gains even if that action would ultimately benefit the
company. The court held that in case directors have more than one motive for taking action,
the court provides their judgement based on their primary motive (Valsan, 2016). The
judgement, in this case, shows that their duties bind directors in order to take business
decisions which are beneficial for the corporation. In Exposure Travel Insurances Ltd v
Scattergood case, directors transferred the capital of the company to its subsidiary in order to
fulfil its debts. The court held that using their power to misuse the company’s assets to pay
off others debts is an improper exercise of power by directors.
Another significant duty of directors is to promote the growth and success of the enterprise
which was given under section 172. This section provides that directors have to keep in mind
the interest of the company while taking business decisions for promoting its success and

LEGAL ASPECTS 5
ensure that they take a decision in good faith. The success of a corporation depends on
effective relationship with customers and suppliers, maintaining its reputation, fulfilling
interest of employees, development of local communities, fulfilment of shareholders interest,
and protection of the environment (Section 172 (1)) (Fisher, 2009). A director should
consider these factors before taking business actions since it assists in ensuring the success of
the enterprise. As per section 172 (2), the promoting of success include fulfilment of the
purpose for which the company is incorporated and fulfilling the interest of its shareholders.
Additionally, creditors are an important part of a corporation and directors have to ensure that
their interest is protected in the organisation (Section 172 (3)). Another crucial factor is that
courts did not have the right to interfere with the business judgment of directors, and they
should avoid reviewing situations based on the benefit of hindsight.
A good example was given in GHLM Trading Ltd v Maroo (2012) EWHC 61 (Ch) case. In
this case, before giving their judgement, the court considered a number of aspects regarding
duties of directors towards the corporation whose shareholders had been purchased by paying
cash by the decision of directors. The court provided in its judgement that the directors did
not act in good faith hence breaching their fiduciary duty towards in the corporation because
they acted in promoting their personal interest (Bowstead, Watts and Reynolds, 2012). They
used the company’s money to repay their personal debts while risking the interest of creditors
in the situation when the corporation is financial difficulties and the court held that it is
unacceptable and breach of section 172. The court uses a subjective test to identify whether
directors use good faith while taking business decisions however the tests have many
limitations. In Hutton v West Cork Railway Co (1883) 23 Ch D 654 case, the court held that a
bona fide test cannot be used as a sole test to identify the good faith of directors because an
action can be bona fide yet still irrational. Bowen LJ held that due to the limits of the
subjective test it is irrelevant to use it solely for evaluating the good faith of directors and it
could be unreasonable and detrimental for an organisation (Mordi et al., 2012). Therefore, it
is necessary that while taking business decisions directors ensure that such decisions are
focused towards achieving the common interest of the corporation rather than fulfilling their
personal interest.
Section 173 is a significant section which provides that a director must exercise independent
judgement while taking business decisions. The director should take business decisions
without any external influence or force, and their decisions should focus towards achieving
common organisational objectives. The duty to apply the independent judgement of directors

LEGAL ASPECTS 6
is not infringed in case he/she takes business decisions in as per the agreement which is
entered with the company for restricting the future discretion of the director (section 173 (2))
(Legislation.gov.uk, 2018b). This section also provides that the duty of applying independent
judgement in not infringed if the actions of the directors are within the constitution of the
corporation. The decisions of the directors should be what they believe is for the benefit of
the company rather than what court believes. Fulham Football Club Ltd v Cabra Estates PLC
(1994) 1 BCLC 363 is a good example in which the court evaluated the discretion power of
directors. In this case, a corporation signed a deal with another entity for developing a
football ground. The corporation gave its guarantee to the party that this project will not be
objected by Fulham Football Club Ltd in the future (Gibbs, 2016).
Moreover, they would not support any purchasing or investment decision of compulsory
purchase order against the project. The Court of Appeal provided that the directors have
misused their duty regarding their discretion. It is permissible for directors to restrict their
future discretion however it is prohibited to bind their discretion. In this case, the directors
bind their discretion which is wrong, and it was held that they breached their duties towards
the company (Keay, 2016). Therefore, directors should carefully analyse the provisions given
in the constitution of the company in order to ensure that their decisions are based on
independent judgement and free from outside influences. In conclusion, the Companies Act
2006 provides a number of duties for directors which they are required to fulfil in order to
ensure that they did not misuse their powers while taking business decisions. These duties
ensure that the actions of the directors are focused towards promoting the success of the
corporation and fulfilling the interest of its shareholders. Directors can avoid legal
consequences of their decisions if they comply with the duties given under the Companies
Act 2006.

LEGAL ASPECTS 7
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LEGAL ASPECTS 8
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