If we want to understand more about how to model the entity legal form appropriately, we need to understand the stakeholders and various other aspects surrounding the legal form. There are several types of stakeholders involved in the administration of the legal form of an entity, and concerns for each may be different. These will be described here.
The company or legal entity itself
The first stakeholder for the legal form of a given legal entity, is the company/legal entity itself. The legal entity wants to have a very clear view of what its own legal form was at any given time. It also wants to communicate its current legal form to other stakeholders so they can estimate the risks attached to doing business and then proceed from there. Nobody wants to do business with a legal entity when you cannot tell if you have any recourse if you never get paid or if paid items are never delivered.
However, nobody will take the company’s word for their legal form, so you need an independent party, preferably embedded in a legal framework, to vouch for your current legal form. That party is called the registrar.
The registrar of legal entities and legal forms for a given region is concerned with making sure that there is an official administration where you can examine the legal form of any given legal entity without having to rely on their word or examine the legal papers of their incorporation. Basically, the registrar wants businesses to be clear on each others legal form so they can do business with each other.
Registrars can be local, national or even international, such as the Global Legal Entity Identifier Foundation (GLEIF). The closer the registrar is located to the company, the more reliable will the registration be, in general. Often, the legal framework mandates a single registrar to be responsible for the registration of the company’s legal entity and legal form.
We enable smarter, less costly and more reliable decisions about who to do business with.
– Global Legal Entity Identifier Fondation
Banks and financial institutions
Banks and financial institutions are particularly interested in the legal form of any company that they are involved with, especially if they are providing a loan in any form to the legal entity. In the European Union, they have to report to the regulatory authorities on the loan, as well as on the counterparties, due to the fact that the bank now has a counterparty risk. Weighing those risks on a national and even systemwide level is the task of the central banks. The legal form is necessary if you want to estimate how much money you can recover in case of failure: can you recover from only the entity involved, or can you also recover money from the shareholders or owners?
Apart from financial services, a company may also contract other vendors for products or services. Most of the business of any company is done with these parties.
Vendors typically want to know the same thing as a bank, but are not usually required to report to regulatory authorities. They are mostly interested in the current legal form, because once the goods are delivered, the service is rendered or payments received, the interest in the legal form of the counterparty ends as well. Vendors are always other legal entities with their own legal form, and this means the company has an interest in their legal form as well.
Clients can be natural persons or legal entities. Natural persons are usually not overly concerned with the legal form of the company, as they are normally protected by consumer laws and the monetary amounts involved make it hard to recoup losses in court. However, clients can also be other large companies and they will certainly want to recoup any losses, for instance in case of malpractice or fraud. This means that they are very similar to a vendor in their interest in the current legal form of the company.
Many legal forms have tax implications. When moving from one legal form to another, there can be tax implications as well. You can, for instance, have a “quiet” transfer from one form to another, or a “noisy” transition, where you pay everything off and basically start fresh. But even in setting up a company with a given legal form, there are often tax rules you have to follow. For instance, in the Netherlands the director of a limited liability company must have a certain minimum wage which must be approved by the tax authorities.
Other government agencies
While in many countries the legal forms are quite generic, there are also countries where certain professions or specific types of company have their own legal form. An example would be “trader” or “farm operator” in France (read more interesting details on French legal forms here). One can imagine that certain legal forms (like “chemical factory”) would come with a certain amount of paperwork and various stakeholders that would like to know more.
Local versus national versus international stakeholders
In a local environment (usually on the level of the ISO 3166-2 country subdivision such as a province or state), the legal form is known to both sides, as well as the approximate risks and rights that come with it. This usually (but perhaps not always) translates to the national legal framework in a way that makes a legal form in one area legally consistent with a similar legal form in another area, even if they have different names.
This does not always work however. The USA is well known for the way in which different states have set up legal forms with some very specific rights and obligations, such as in Delaware, which is known as a tax haven.
In any case, this translation breaks down whenever you cross national boundaries into other legal frameworks. To combat this inside the European Union, the EU has created a number of legal forms that are implemented exactly the same in any national legal framework, such as for instance the Societas Europaea (SE), the Societas Europaea Cooperativa (SCE) and the European Grouping of Territorial Cooperation (EGTC). They are defined in European law. But this mechanism does not extend to other legal frameworks, such as the one in the USA or China.
Note that it is possible to have a legal entity in one country with a given legal form, whih has a local company branch with a local legal form, that can be subtly different from the main one. The complexities of offices, branches and holdings are beyond the scope of this article however.
The next part
I hope you liked this part as well. In the next part, we are finally going to start modelling!