Law of organisations
SBAQ – master sheet
Unit one
Question 1
Which of the following statements best explains the concept of limited
liability?
A. A validly incorporated company has its own separate legal
personality.
B. A validly incorporated company is not liable for its own debts.
C. The shareholders of a validly incorporated company will be liable for
the debts of the business but only to the extent of their investment
in the company.
D. The directors of a validly incorporated company will not be liable for
the debts of the company.
E. A creditor of a validly incorporated company can choose to sue any
or all of the shareholders of the company.
Feedback
Option C is correct. An incorporated business has its own separate legal
personality. As a separate legal person, an incorporated business is
responsible for its own debts. If the company fails, and is wound up, the
members lose the money which they have invested in the company, but
no more. They will only ever be liable to contribute to the company’s
assets up to the amount unpaid on their shares, and only in the event of a
winding up. They have no direct liability to the company's creditors. This is
known as limited liability.
Option A is wrong. Legal personality is not the same as limited liability –
limited liability is a consequence of separate legal personality.
Option B is wrong. The company itself has unlimited liability for these
debts.
Option D is wrong. Unlike shareholders, directors do not have the benefit
of limited liability in their role as directors. They are (generally) protected
from liability for the acts of the company, e.g. breach of contract,
including non-payment of debts. This is because the company itself, not
the directors, is liable. This is not the same as limited liability – it is a
consequence of the company’s separate legal personality.
Option E is wrong. Shareholders are not jointly or severally liable for the
debts of the company. Option E wrongly attributes the liability of partners
in a general partnership to the company structure.
,Question 2
An entrepreneur set up a private limited company three years ago. The
entrepreneur was issued with 10,000 shares, which were paid for in full.
The entrepreneur is the sole shareholder and director of the company.
Recently, the company has struggled financially. It has an overdraft of
£20,000. When the company agreed the overdraft facility with the bank
two years ago, the bank asked for a personal guarantee from the
entrepreneur for the amount of the overdraft. The entrepreneur signed a
written guarantee agreement with the bank, agreeing to be personally
liable for all amounts owed to the bank in the event that the company fails
to pay. The company is insolvent and has no assets with which to pay its
creditors.
Is the entrepreneur liable for the £20,000 owed to the bank?
A. Yes, because the entrepreneur is the sole shareholder.
B. No, because the entrepreneur has the protection of limited liability.
C. Yes, because the entrepreneur is the sole director.
D. No, because the contract for the overdraft facility is a contract
between the bank and the company.
E. Yes, because the guarantee is a separate contract between the
entrepreneur and the bank.
Feedback
Option E is correct. Generally, it is the company, as a separate legal entity
which is responsible for its own debts and the shareholders have the
protection of limited liability. In this case, the company itself is liable on
the overdraft itself, but here the entrepreneur is liable under the separate
contract made between themselves and the bank under which they
agreed to guarantee payment of the overdraft.
Option A is wrong. The shareholders are protected by the concept of
limited liability. It makes no difference that the company has only one
shareholder (and that the management of the company is in their hands.
The entrepreneur is liable under the guarantee, not because he is a
shareholder.
Option B is correct as far as it goes. Although the entrepreneur is
protected by the concept of limited liability for the debts of the company,
this will not protect them from liability under the guarantee.
Option C is wrong. A director, although they act as the agent of the
company in entering into contracts, e.g. as here, an overdraft facility
agreement, is not personally responsible for those debts.
Option D is wrong. As above, the entrepreneur is not liable under the
overdraft facility agreement but under the guarantee.
,Question 1
Which one of the following law firms is an unincorporated business entity?
A. The City firm, Slaughter and May.
B. The City firm, Linklaters LLP
C. The Leeds based firm, Clarion Solicitors Limited
D. The national group of solicitors’ firms, Gateley plc
E. The Cambridgeshire based firm, Copleys Solictitors LLP
Feedback
Option A is the correct answer. Slaughter and May is not a separate legal
entity. It is a partnership, an unincorporated business entity. You will note
that size is not relevant. Slaughter and May is an international firm
with over 100 partners and has never been incorporated as either a
limited liability partnership or a company.
The other options are wrong. These all refer to separate legal entities, or
‘legal persons’, which you can tell from their names: Linklaters LLP is a
limited liability partnership, Clarion Solicitors Limited is a private limited
company, and Gateley plc is a public limited company. The comparatively
small Cambridgeshire firm, Copleys Solicitors LLP, with only four
members, has been incorporated as a limited liability partnership.
[Note that here we have referred generically to ‘law firms’ and ‘firm’. s.4
of the Partnership Act 1890 provides that the persons who have entered
into business in partnership are collectively called a ‘firm’ (The word ‘firm’
describes in the singular what is, in fact, the partners in the plural.). The
partners of Slaughter and May can therefore be described as a ‘firm’. The
others are not technically ‘firms’ in the strict legal sense but will often be
described as such.]
Question 2
A client, an entrepreneur, is proposing to set up in business working with
two friends. The client wants to do so quickly, with the minimum of
formality and to minimise any legal costs. The client wants to be
responsible for the day to day management decisions of the business
himself. The client will invest £100,000 in the business, which will have
minimal borrowings. Neither of the two friends are in a position to make
an investment in the business, but they have skills and expertise which
will be useful in the running of the business.
Which one of the following would be the best option for the client?
A. A general partnership
B. A limited liability partnership
, C. A limited partnership
D. A sole tradership with employees
E. A private limited company
Feedback
Option D is correct. There are no formalities for setting up as a sole trader,
apart from notifying the tax authorities. The client can simply open the
doors and start trading. Sole traders are, however, personally liable for all
the debts of the business, so the risk is greater, but the facts indicate that
there would be minimal borrowing, so the risk is not substantial and the
client is an ‘entrepreneur’ so may be more prepared to assume a higher
degree of risk.
Option A is not the best answer. A general partnership would be less
suitable as, in the absence of a formal partnership agreement (for which it
would be advisable to take legal advice), the partners share responsibility
for the day-to-day management of the business. Partners have joint and
several liability for the debts of the business.
Options B, C and E are not the best options for the client. Setting up either
a private limited company, a limited partnership or a limited liability
partnership requires a formal registration process.
[Commercial awareness: The facts state that the client is an entrepreneur,
and so may be more prepared to assume a higher degree of risk, but
should be warned that the enterprise may become riskier in the future, if,
e.g. borrowing is required to expand the business.]
Question 3
A client runs a catering business with his friend. The business has not
been incorporated but both the client and the friend invested equal
amounts in the business and the two share profits equally. The client
signed a long-term supply contract with a limited company which supplies
seafood, for the regular purchase of seafood for the business. The terms
of the contract were negotiated with the Purchasing Director of the
seafood company by the client’s friend.
Which one of the following options most accurately describes who are the
parties to the contract?
A. The client and the seafood company.
B. The client and the Purchasing Director of the seafood company.
C. The client, his friend and the seafood company.
D. The client, his friend and the Purchasing Director.
E. The client’s friend and the seafood company.
Feedback
Option C is correct. The catering business appears to be run as a
partnership, as it meets the definition in s.1 Partnership Act 1890. The two
SBAQ – master sheet
Unit one
Question 1
Which of the following statements best explains the concept of limited
liability?
A. A validly incorporated company has its own separate legal
personality.
B. A validly incorporated company is not liable for its own debts.
C. The shareholders of a validly incorporated company will be liable for
the debts of the business but only to the extent of their investment
in the company.
D. The directors of a validly incorporated company will not be liable for
the debts of the company.
E. A creditor of a validly incorporated company can choose to sue any
or all of the shareholders of the company.
Feedback
Option C is correct. An incorporated business has its own separate legal
personality. As a separate legal person, an incorporated business is
responsible for its own debts. If the company fails, and is wound up, the
members lose the money which they have invested in the company, but
no more. They will only ever be liable to contribute to the company’s
assets up to the amount unpaid on their shares, and only in the event of a
winding up. They have no direct liability to the company's creditors. This is
known as limited liability.
Option A is wrong. Legal personality is not the same as limited liability –
limited liability is a consequence of separate legal personality.
Option B is wrong. The company itself has unlimited liability for these
debts.
Option D is wrong. Unlike shareholders, directors do not have the benefit
of limited liability in their role as directors. They are (generally) protected
from liability for the acts of the company, e.g. breach of contract,
including non-payment of debts. This is because the company itself, not
the directors, is liable. This is not the same as limited liability – it is a
consequence of the company’s separate legal personality.
Option E is wrong. Shareholders are not jointly or severally liable for the
debts of the company. Option E wrongly attributes the liability of partners
in a general partnership to the company structure.
,Question 2
An entrepreneur set up a private limited company three years ago. The
entrepreneur was issued with 10,000 shares, which were paid for in full.
The entrepreneur is the sole shareholder and director of the company.
Recently, the company has struggled financially. It has an overdraft of
£20,000. When the company agreed the overdraft facility with the bank
two years ago, the bank asked for a personal guarantee from the
entrepreneur for the amount of the overdraft. The entrepreneur signed a
written guarantee agreement with the bank, agreeing to be personally
liable for all amounts owed to the bank in the event that the company fails
to pay. The company is insolvent and has no assets with which to pay its
creditors.
Is the entrepreneur liable for the £20,000 owed to the bank?
A. Yes, because the entrepreneur is the sole shareholder.
B. No, because the entrepreneur has the protection of limited liability.
C. Yes, because the entrepreneur is the sole director.
D. No, because the contract for the overdraft facility is a contract
between the bank and the company.
E. Yes, because the guarantee is a separate contract between the
entrepreneur and the bank.
Feedback
Option E is correct. Generally, it is the company, as a separate legal entity
which is responsible for its own debts and the shareholders have the
protection of limited liability. In this case, the company itself is liable on
the overdraft itself, but here the entrepreneur is liable under the separate
contract made between themselves and the bank under which they
agreed to guarantee payment of the overdraft.
Option A is wrong. The shareholders are protected by the concept of
limited liability. It makes no difference that the company has only one
shareholder (and that the management of the company is in their hands.
The entrepreneur is liable under the guarantee, not because he is a
shareholder.
Option B is correct as far as it goes. Although the entrepreneur is
protected by the concept of limited liability for the debts of the company,
this will not protect them from liability under the guarantee.
Option C is wrong. A director, although they act as the agent of the
company in entering into contracts, e.g. as here, an overdraft facility
agreement, is not personally responsible for those debts.
Option D is wrong. As above, the entrepreneur is not liable under the
overdraft facility agreement but under the guarantee.
,Question 1
Which one of the following law firms is an unincorporated business entity?
A. The City firm, Slaughter and May.
B. The City firm, Linklaters LLP
C. The Leeds based firm, Clarion Solicitors Limited
D. The national group of solicitors’ firms, Gateley plc
E. The Cambridgeshire based firm, Copleys Solictitors LLP
Feedback
Option A is the correct answer. Slaughter and May is not a separate legal
entity. It is a partnership, an unincorporated business entity. You will note
that size is not relevant. Slaughter and May is an international firm
with over 100 partners and has never been incorporated as either a
limited liability partnership or a company.
The other options are wrong. These all refer to separate legal entities, or
‘legal persons’, which you can tell from their names: Linklaters LLP is a
limited liability partnership, Clarion Solicitors Limited is a private limited
company, and Gateley plc is a public limited company. The comparatively
small Cambridgeshire firm, Copleys Solicitors LLP, with only four
members, has been incorporated as a limited liability partnership.
[Note that here we have referred generically to ‘law firms’ and ‘firm’. s.4
of the Partnership Act 1890 provides that the persons who have entered
into business in partnership are collectively called a ‘firm’ (The word ‘firm’
describes in the singular what is, in fact, the partners in the plural.). The
partners of Slaughter and May can therefore be described as a ‘firm’. The
others are not technically ‘firms’ in the strict legal sense but will often be
described as such.]
Question 2
A client, an entrepreneur, is proposing to set up in business working with
two friends. The client wants to do so quickly, with the minimum of
formality and to minimise any legal costs. The client wants to be
responsible for the day to day management decisions of the business
himself. The client will invest £100,000 in the business, which will have
minimal borrowings. Neither of the two friends are in a position to make
an investment in the business, but they have skills and expertise which
will be useful in the running of the business.
Which one of the following would be the best option for the client?
A. A general partnership
B. A limited liability partnership
, C. A limited partnership
D. A sole tradership with employees
E. A private limited company
Feedback
Option D is correct. There are no formalities for setting up as a sole trader,
apart from notifying the tax authorities. The client can simply open the
doors and start trading. Sole traders are, however, personally liable for all
the debts of the business, so the risk is greater, but the facts indicate that
there would be minimal borrowing, so the risk is not substantial and the
client is an ‘entrepreneur’ so may be more prepared to assume a higher
degree of risk.
Option A is not the best answer. A general partnership would be less
suitable as, in the absence of a formal partnership agreement (for which it
would be advisable to take legal advice), the partners share responsibility
for the day-to-day management of the business. Partners have joint and
several liability for the debts of the business.
Options B, C and E are not the best options for the client. Setting up either
a private limited company, a limited partnership or a limited liability
partnership requires a formal registration process.
[Commercial awareness: The facts state that the client is an entrepreneur,
and so may be more prepared to assume a higher degree of risk, but
should be warned that the enterprise may become riskier in the future, if,
e.g. borrowing is required to expand the business.]
Question 3
A client runs a catering business with his friend. The business has not
been incorporated but both the client and the friend invested equal
amounts in the business and the two share profits equally. The client
signed a long-term supply contract with a limited company which supplies
seafood, for the regular purchase of seafood for the business. The terms
of the contract were negotiated with the Purchasing Director of the
seafood company by the client’s friend.
Which one of the following options most accurately describes who are the
parties to the contract?
A. The client and the seafood company.
B. The client and the Purchasing Director of the seafood company.
C. The client, his friend and the seafood company.
D. The client, his friend and the Purchasing Director.
E. The client’s friend and the seafood company.
Feedback
Option C is correct. The catering business appears to be run as a
partnership, as it meets the definition in s.1 Partnership Act 1890. The two
