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The following scenario is relevant to the assignment question.

James wants to go into business for himself although he does not have a clear idea of what to do. He sees an accountant who recommends that, firstly he transfer his business to a company for which James will be the sole director and majority shareholder and that, secondly, James consider buying a franchise.

The accountant warns James a company is a separate legal entity and that after forming his company he must make clear in business transactions that other parties realise they are dealing with James's company and not James himself. This includes James signing documents as director of the company rather than signing himself personally.

The accountant recommends franchises as a good way to get into business.

James is not sure he fully understands what he has been told and would appreciate more advice about the nature of companies and franchises. He wonders if there is any risks that buyers of a franchise should watch out for when negotiating a franchise contract with a franchisee.

Required

Briefly discuss the nature of a company especially the principles of separate legal entity and limited liability. Also discuss the nature of franchises including any risks of which a buyer should be aware. Refer to the scenario to illustrate your answer.

Nature of a Company

The essay is concern to analyze as to what is the best option that is available to James for his business. The question is whether James should opt for a company or to avail a franchise.  Normally, If James wishes to conduct business, then, there are various options that are available to him, that is, sole trade ship, a company, a partnership, a trust or buying a franchisee. All the kinds of business have their own procedural framework and different pros and cons that are attached with them.

James intends to establish a business for himself but has no idea as what exactly is required by him to do in order to formulate a business. In order to resolve his query he visits an accountant. There are two options that are given by the accountant, that is, either to form a company or to buy a franchisee. Before advising James as what is the better option it is important to understand the nature of both, keeping in minds the specific requirements of James.

A company is one of the business forms which can be availed by James. A company is a kind of business structure which only comes into existence upon its registration. No person is permitted to carry out business activities in the form of a company unless and until the same is registered.

Now, as per the facts given, the accountant recommends James that he must first transfer his business to a company wherein he will be the sole director and majority shareholder. Thus, it is important that James must be aware of the nature and features of the company before registering the same. Some of the basic features or the nature of the company can be analyzed as under:

Separate Legal Entity of a company – Essential feature

A company is a separate legal entity which signifies that the acts that are carried out by the officers and the directors are carried out in the company’s name. That the officers are not liable for such acts personally. In New Zealand, it was held in Ede v JA Russell Ltd, that the closely held companies have a separate existence and can take actions in their own name.

Once a company is registered then it is considered as an artificial legal person in the eyes of law. In the leading case of Salomon v Salomon the court held that whenever a company is established then it has a separate legal entity. The Separate Legal entity principle signifies that the directors and shareholders are distinct from the company. The acts that are carried out by the officers are carried in the name of the company. In the leading case of Lee v Lees’ Air Farming Ltd the court held that when a company is made by a single person, then, it is a one man company. Such one man company is also has a distinct personality in law. The shareholder can also become the employee of the company in his individual capacity and the acts that are carried out by the company with such employee are independent in nature.

Advantages of a Company

At this point it is submitted that it is warned by the accountant that if a company is incorporated by James then it is a separate legal entity. Thus, it is very necessary that James must be very clear in the business transactions that are carried out by him with the other parties. This is because the outsider will be dealing with the company and not with James. When a company is formulated then any contract that is made will be in the name of the company. All the documents will be signed by James on behalf of the company and not by James in his individual capacity. It is one of the most significant feature that can be attained by James as the acts that are carried out by him will not make him liable in any manner whatsoever. Thus the outsider who is dealing with the company can only hold the company liable.

Limited Liability – Essential feature  

The liability of the shareholders is limited in nature. The shareholders or the members are responsible to the debts of the company only to the extent of their shareholdings. Thus, the liability of the company is limited in nature.

Thus, it is suggested that since James will be the only director and the majority shareholder, so, the liability of James is limited to the extent of his shareholding. He cannot be held personally liable for any debt which the company is not able to pay.But, it is also suggested to James that apart from few advantages that can be attributed to a company, there are few drawback that can also be associated with a company. It is thus advisable that James must also take the same into account.

Piercing of veil of the company 

One of the major drawbacks is that the separate legal existence can be shed away by piercing the veil of the company. when the veil is pierced then the acts of the directors are considered as their own and not that of the company. In Prest v Petrodel Resources Limited, the court held that the veil can be pierced when there is presence of impropriety wherein the acts are such to avoid liability. Thus, any act of façade on the part of officers results in piercing the veil of the company.

Other risks

It is necessary that James has to file annual returns to both the Inland Revenue Department and the Companies office. It is obligatory on the James that he has to provide all the information relating to the shareholders and directors to the companies office. He has to comply with more regulations when compared with any other business form. He also has to look for resources as a company needs investment to grow.

Disadvantages of a Company

Pooling of assets

Further, as per section 271 of the Companies Act 1993, the company has an obligation to comply with any claims that are raised in the liquidation. If any application is submitted by the liquidator, shareholder or creditor, then, section 271 can be initiated. As per section 272, the orders under section 271 should be made only when it is just and equitable. Thus, when there is liquidation then the related company can be held liable for the liabilities of the insolvent company.

Advice

Thus, it is suggested that a company has a distinct nature of separate legal entity along with limited liability. But, there are several disadvantages that can also be attributed to a company. Thus, as per the advice of the accountant, the other option that can be availed by James is that he can buy a franchise.   

A Franchisee

In New Zealand there is no precise definition that is attributed to a franchisee. But, every franchisor must comply with the Code of Practice and Code of Ethics after being the member of the Franchise Association of New Zealand (FANZ). FANZ has define a franchise as a business structure that can be operated by a person for the selling, distribution and offering of goods and services. But there are few additional features that must be comply with in order to consider any business as a franchise.

Right to use the mark of the franchisor

Whenever the franchisor gave the franchise to the franchisee, then, the franchisee has the right to use the mark of the franchisor. But, it is the obligation of the franchisee that the mark must be used in such manner so that the general public can identify that the mark to be associated or controlled by the franchisor.

Franchisee to be govern as per the agreement 

Whenever a franchise is given by the franchisor, then, it is obligatory on the franchisee that he must comply with his business as per the agreement that is established amid the franchisor and the franchisee. One of the prime obligations that must be catered by every buyer is that the agreement for the purchase of the franchise must be in writing. The general principle of laws must be catered, thus, when the franchise agreement is drafted there should be presence of consideration. Also, that the subject matter must be clear and the document must be executed by the relevant parties. When any agreement is formulated amid the parties then there is no need for any kind of registration or notarization.

Nature of Franchise

At this stage it is advised that since there are no requirements of any kind of registration for the establishment of the franchise, thus, James in order to avoid any kind of hurdles, cost, time has an option to select the franchise in order to carry on his business activity. By mere entering into a franchise agreement, James can establish a binding contractual relationship with the seller.

Benefits of a Franchisee

But, if James decides that he must carry on his business by way of a franchisee, then, there are few provisions that are found to be favor of James:

Whenever a franchise is purchased, then, the franchisee is given a seven day cooling off period which permits the franchisee to terminate the agreement within seven days of making of the agreement. The franchisee can seek full refund of the amount except the reasonable costs that is suffered by franchisor. If there is dispute amid the parties, then, mediation proceeding can be sought amid the parties to resolve the conflict.

Risks associated with Franchisee

The formation of franchisee is quite easy in comparison with a company. But it is submitted that whenever the buyer take the franchise from the franchisor, then, there are generally no rules that are laid down that govern the sale and purchase of the franchise. But, there are various laws that impacts a franchise in New Zealand and every purchaser must be aware of the same.

For instance, in Valda Video Ltd v United Video Franchising Ltd HC Auckland the court analyzed that the Contractual Remedies Act 1979 and the Fair Trading Act 1986 must be comply with. In the given case the franchisor before giving his franchise to the buyer has not represented the genuine profits and turnover of the business. Thus there is misrepresentation that is caused. The court emphasis that the acts of misrepresentation should be avoided. It is necessary that the parties must comply the codes and rules.

Generally the duty of good faith is not imposed on the franchisor and is held in Dymocks Franchise Systems (NSW) Pty Ltd v Todd. But, generally the courts are of the view that the duty of good faith should be made part of the agreement in order to sought fairness.

Considering these scenario, the advice of the accountant that franchise is a good way to get into business is a correct advice. There is no need for the registration and the rules ad obligations are also simple. Also, a closely held company has a separate legal entity in the eyes of law. In such scenario, a franchise is a better choice of running a business.

Reference List

Books/Articles/Journals

Davies, Paul and Davies, Paul, Introduction to Company Law, OUP Oxford, 23-Sep-2010, p 25.

Farrington, Matthew "A Closely-Held Companies Act For New Zealand" [2007] VUWLawRw 31, chapter 2, question 4, <https://nzlii.org/nz/journals/VUWLawRw/2007/31.html#fnB239>.

Germann, Stewart , Franchising in New Zealand: overview,  2018, <https://uk.practicallaw.thomsonreuters.com/5-631-4412?transitionType=Default&contextData=(sc.Default)&firstPage=true&comp=pluk&bhcp=1;

Gunasekara, Gehan and Sims, Alexandra , Franchising: A case for regulation,  Business Review, Volume 9 No. 1, p 52,<https://www.uabr.auckland.ac.nz/files/articles/Volume13/v13i1-franchising.pdf>.

Walker, Pekmezovic et al, Commercial Applications of Company Law in New Zealand (5th edition, CCH, Auckland 2015) (Wolters Kluwer)

Case Laws

Dymocks Franchise Systems (NSW) Pty Ltd v Todd  [2004] 1 NZLR 289

Ede v JA Russell Ltd (2001) 9 NZCLC 262,539 .

Lee v Lees’ Air Farming Ltd [1960]3 WLR 758.

Prest v Petrodel Resources Limited [2013] UKSC 34

Salomon v Salomon [1897] AC 22 (HL).

Valda Video Ltd v United Video Franchising Ltd HC Auckland CP123/00, 21 August 200

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[Accessed 23 July 2024].

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