Business Law Assignment Examining Most Suitable Business Structure for the Case
Question
Task:
You and your friends Adam and Betty are thinking about opening three cafés in Adelaide based around a theme.
You have all identified the locations you want to have the cafes.
You have offered to write a report on the most suitable business structure.
Adam and Betty would like to manage one of the cafes each and if you want to manage the third café you can but if you do not want to manage the third cafe their friend Charles will be happy to manage the third cafe. Charles has no money, so he is unable to invest in the business.
You all believe you need a total investment of $300,000. Adam and Betty can contribute $50,000 each and you can contribute the remaining amount of $200,000.
Consider the situation above, prepare a report on business law assignment for your next meeting with Adam and Betty, making sure you address the following questions:
a. Consider the scenario above and choose the two most suitable business structures and compare and contrast the suitability of each.
b. Identify the advantages and disadvantages of starting/investing in the business based on the two business structures you have chosen.
c. Considering the inclusion of Charles as a manager of the third café discuss the advantages and disadvantages of including a restraint of trade clause in any contract you may offer Charles. Write an example of a restraint of trade clause for Charles that would be valid?
Answer
Introduction
Selection of legal structure for a business as illustrated in the sections of business law assignment, is a crucial work for the owner/s when starting a new business. The selected legal structure of business controls several aspects of the business such as legal liability, tax payment, tax benefits, the share of profitability, and control over business operations (Entrepreneurship In A Box, 2021). Hence, while selecting the business structure, the advantages and disadvantages of each business structure need to be analyzed thoroughly and their impact on the current business types also needs to be analyzed. The most common legal structures in Australia are partnership, trust, cooperative, sole trader, and company. In the present case of business, there are three main investors in the café business, and the initial investment required for the business is $300,000.
A total of three cafes will be established in Adelaide and two will be merged. Two partners can manage $100,000 for the investment by providing $50,000 each. Charles is another person who will work as a manager of the third café and cannot able to provide any investment. Following the scenario, the two best legal structures for the business are presented and the advantages and disadvantages related to each structure are also illustrated. In the third part of this report, the restraint of trade and the advantages and disadvantages of it are also discussed.
Suitable business structures
Following the present scenario of the business, it can be said that three main investors in the business will carry out the work as partners. The income and losses of the business need to be distributed equally. There are two best options to structure the business to gain maximum benefits, and they are limited liability partnership and Pty Ltd Company (James, 2019). The two structures are selected for the present business by following the contribution of partners in the business and the type of business. The basic information for the two structures is shown below to reflect their suitability.
Limited liability partnership: Partnership structure requires less cost to operate and set up. In the partnership structure, the losses, income, and control over the business are shared among the partners and carried out as per the written agreement of the partnership (James, 2019). In the partnership firm, the partnership does not have to pay any income tax on the profit amount warned in a specific period. The partners pay tax based on the partnership profit at a rate of the individual tax rate. A firm that formed under partnership needs to register for GST if its annual GST turnover exceeds $75,000 (Qld.gov.au, 2020). There are severe types of partnership structures such as general partnership and LLP or limited liability partnership (Qld.gov.au, 2020). In the present case, LLP is selected for the business as it is suitable for the business. LLP restricts the liability of the partners by reducing the liability for limited partners. In the case of LLP, there must be one limited partner and one general partner (Qld.gov.au, 2020).
The role of the general partner is to run the regular business of the partnership and the liability of the general partner is not limited. On the other hand, the limited partner enters into the contract of partnership on the behalf of the firm but does not take part in regular activities (James, 2019). While a business decides to form under LLP, then it has to follow LLPA 2000. According to sec- 1(5), the partnership laws are not applicable for LLPs, so the legal basis for an LLP is LLPA 2000 (Qld.gov.au, 2020).
Pty Ltd Company: If the business is formed under Pty Ltd Company then the identity of the business will be different from its owners. As per Corporations Act 2001, the identity of a company is separate legally from the owners, which has perpetual succession, can sell, acquire or hold property, able to perform the functions of body corporate and can sue or be used. Pty Ltd is the most common type of company structure (Guides.slv.vic.gov.au, 2020). If the business wants to form under the company then there are certain options such as Pty Ltd, Limited or Pvt Ltd. in the present case Pty Ltd is selected as the best option for the business (Guides.slv.vic.gov.au, 2020). If the business will be registered as Pty Ltd then the number of non-employee shareholders cannot exceed 50 (Bloomfield, 2020). A proprietary company can be considered as small or large proprietary. Initially, the current business will be considered as small proprietary if it registers as Pty Ltd. The company will be considered as large proprietary if the annual turnover of the company is $10 million, more than 50 employees, and $5 million assets exist in the business (Bloomfield, 2020).
Analyzing the basic criteria of both the business structures and aligning it with the current business scenario, it can be said that Pty Ltd is most suitable for the business. However, the limited liability partnership is also a suitable option for the business, but it requires 1 general partner, who will carry unlimited liability, and 1 limited partner who will carry limited liability but will not have any control over the business. The partners who are investing in the business always aim to have some control over the business. In this case, Charles is not investing in the business but will involve in company operations, by managing the third café, so he will act as a general partner. If I, Betty, or Adam, any of us will act as a limited partner then we will not have control over business operations, which may not meet the expectancy of the partners. The case of Flanagan v Liontrust Investment Partners LLP & Ors (2015) reflects how the structure of LLP may create problems in the future in terms of following the partnership rules (Flockhart, Simons and Hadwin, 2016). In this case, the claimant argued that an invalid retirement notice was provided to the claimant, which is a breach of contract of LLP agreement. After analyzing the sides of both parties, the court decision was against the claimant, and the judgment created new law. Hence, in certain areas of LLP, partnership rules are not applicable (Flockhart, Simons, and Hadwin, 2016).
On the other hand, the liability in Pty Ltd is not similar to LLP, and the owners of the company are considered distinct from the company, and the personal assets of the owners are not at risk.
Advantages and disadvantages of identified business structures
Limited liability partnership:
Advantages
1. LLP protects the personal assets of the members from the liability of the business.
2. The business operations in LLP and the profit distribution is considered as per the written agreement. LLP allows more flexibility for the management of business (Simpleformations.com, 2021).
3. In LLP, there are different levels of membership, which may include the members in the business as non-designated or designate members.
4. In LLP, any individual or a company can be appointed as a member of the LLP (Simpleformations.com, 2021).
5. The businesses that are registered under LLP can lease, rent, buy, employ staff, or enter into new contracts (Scott, 2019).
6. While registering the business as LLP any other business, partnership, or company cannot register itself with the same name.
Disadvantages
1. In LLP, the business must have a minimum of two members, and if any of the members choose to terminate the partnership contract then the LLP may dissolve.
2. While a business is registered as LLP, then the income of the members are also disclosed in public disclosures. There will be no privacy about the income of the members (Simpleformations.com, 2021).
3. The income gained by each member is considered as personal income (Scott, 2019).
4. In LLP, the tax filing requirements are complex, and the tax authorities in certain states consider the business as non-partnership in the case of tax purposes, so it may not bring major tax benefits (Simpleformations.com, 2021).
5. In LLP, if the decisions are not taken by consulting with each member involved in the business, the others may follow the decisions taken by one member (Scott, 2019).
Pty Ltd Company:
Advantages
1. If the business is registered as a Pty Ltd, which is the most common form of the company then the members will gain huge relief from liability of the business. The legal identity of a company is distinct from its owners.
2. The company structure attracts the investors, and suppliers the most because it provides security from liability, flexible in terms of selling shares, and maintains transparency under ASIC regulations (Leacock, 2020).
3. The tax rate of a company structure business is 27.5% regardless of its profit, which is less compared to a sole proprietorship (Leacock, 2020).
4. The company structure is helpful o avoid conflict, as the members and shareholders have to follow the rules that are defined in the memorandum of the company.
Disadvantages
1. While developing the business as under company structure, there must be 1 director appointed, and the director has to carry out key duties, and if the director breaches any of the duty, then the individual has to pay fine or the individual will be considered as criminally liable (Leacock, 2020).
2. In a company, the tax will be counted from the first earning of the business at a rate of 27.5%, and if the profits are distributed to the shareholders, then also, the tax will be counted from the amount of dividend as shareholder's tax rates.
3. The expenses of setting up a company and its operations are costly, which includes $495 for registration, additional fees for hiring a lawyer, and $267 as ASIC reporting fees.
4. Directors are mostly responsible for all the obligations.
Restraint of trade clause
The restraint of trade is a common law doctrine that is declared under the Restraints of Trade Act 1976. The clause is mainly applied by employers to protect their business interests (Kavanagh, Pearce, and McRae, 2017). Under this act, the restrictions are imposed on the freedom of an individual to take employment as unenforceable and illegal (Kavanagh, Pearce and McRae, 2017). The restriction is not considered valid until it is proven reasonable. Restraint of trade clause needs to be added in the contract with Charles as he will be responsible for managing the third café.
Advantages
1. The restraint of trade will help the employer to make restrictions on the future activities of the employee, and the decision to leave the business (ROCHOW, 2021).
2. Restraints give legitimate and reasonable protection to the employers, which helps them to avoid the exploitation of the proprietary interest of the company. The restraints of trade mainly safeguard the trade connections, confidential information, and goodwill of the company (ROCHOW, 2021).
3. It acts as a security measure for the business by protecting the interest of the business and crucial information.
Disadvantages
1. If the specific restraint is not proved as reasonable then it will not be considered valid in the contract (Herbison, 2016).
2. If the restraints are drafted poorly without the help of legal advice then it may not provide adequate protection to the business (Kavanagh, Pearce, and McRae, 2017).
In the present case, Charles will not invest in the business, so he will be not be considered as a key member of the business, but he will be appointed as a manager for the third café, so he needs to keep all the business secrets and information confidential. As Charles is responsible to take care of the business operations of the third café, so his continuous engagement with the business is required (Mupangavanhu, 2017). If in the future, he wants to leave the position of manager and wants to leave his role then he has to give at least a notice for 6 months before leaving his role. Along with that, he has to maintain confidentiality about business information. EzyDVD Pty Ltd v Lahrs Investments Qld Pty Ltd & Ors (2009) is a case example of restraint of trade, in which a franchise agreement was terminated after the one-year operation of the business by a franchisee (Haarsma.com.au, 2021). The franchisor enforced certain restraints of trade clause to safeguard the interest of the business.
Conclusion
The business structure plays a crucial role in a business not for the time of its registration, but also in the continuous operation of the business. There are main factors such as liability, tax, and control over the business that are very much influence due to the selection of a specific business structure. LLP and Pty Ltd are selected as the best two options to register the business. Both have advantages and disadvantages, but Pty Ltd is safer following business conditions.
References
Bloomfield, T., 2020. A Proprietary Limited Company In Australia. [online] Boardroom Pty Limited. Available at:
Entrepreneurship In A Box, 2021. 7 Factors To Consider When Choosing A Legal Structure For Your Business. [online] Entrepreneurship In A Box. Available at:
Flockhart, F., Simons, C. and Hadwin, S., 2016. Partnership And LLP Disputes. [online] Nortonrosefulbright.com. Available at:
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Haarsma.com.au, 2021. What Is A Restraint Of Trade Clause? | Haarsma Lawyers. [online] Haarsma.com.au. Available at:
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James, N, 2019. Business Law, Wiley, Milton, QLD, Australia. (5th Edition)
Kavanagh, M., Pearce, B. and McRae, E., 2017. Restraint Of Trade Clauses: Lessons For Employers - Employment And HR - Australia. [online] Mondaq.com. Available at:
Leacock, A., 2020. Pros And Cons Of Running A Proprietary Limited Company | Legalvision. [online] LegalVision. Available at:
Mupangavanhu, Y., 2017. The relationship between restraints of trade and garden leave. Potchefstroom Electronic Law Journal/Potchefstroomse Elektroniese Regsblad, 20(1).
Qld.gov.au, 2020. Limited Liability Partnership. [online] Qld.gov.au. Available at:
ROCHOW, N., 2021. TOWARD A MODERN REASONED APPROACH TO THE DOCTRINE OF RESTRAINT OF TRADE. [online] Murdoch.edu.au. Available at:
Scott, S., 2019. Limited Liability Partnership Advantages & Disadvantages. [online] Small Business - Chron.com. Available at:
Simpleformations.com, 2021. LLP Benefits And Disadvantages. [online] Simpleformations.com. Available at:
