Chapter 11 The Nature of Limited Companies

Corporate Law: is the international term for what is called in the UK company law. It is essentially the law governing the establishment, structure and operation of corporate bodies used to run businesses for profit. Core company law contains company Act 2006, Insolvency law, securities regulation and corporate governance. The key sources of company law are case law, statutes, statutory instruments or government regulations and self regulatory rules such as the UK Stewardship Code. The principles statues are: (i) Companies Act 2006 (ii) Insolvency Act 1986 (iii) Companies Directors Disqualification Act 1986 (iv) Financial Services and Market Act 2000 (v) Criminal Justice Act 1993 (Insider dealing) (vi) Companies Act 1985 (company investigation) (vii) Companies 9 audit, Investigations and Community Enterprise) Act 2004. Definition of a "Company" A company is a "corporation" - an artificial person created by law. A human being is a "natural" person. A company is a "legal" person. A company thus has legal rights and obligations in the same way that a natural person does. 1. identify the different types of company

Categories company

Registered companies

Company limited by Shares

Company limited by Guarantee (private)

Unlimited Company (private)

CIC Company

Private (Ltd)

Public (PLC)

limited by Share

limited by Guarantee

Quoted

Unquoted

Private (CIC)

Public (CII PLC)

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S1 Companies Act 1985 allows a company to be registered with or without limited liability. SI CA85 allows a limited company to be public or private. An unlimited company must be private. Limited liability Companies Although the phrase limited liability company is used, it is the liability of the members which is limited. There are two ways of limiting liability by shares and by guarantee. Companies limited by shares In the case of a company limited by shares the liability of a member to contribute to the companys assets is limited to the amount, if any, unpaid on the nominal value of his shares. Once the shares are fully paid there is, in general, no further liability; i.e. if the company becomes insolvent the members are not required in this case to make any further contribution to discharge its debts. Companies of this type are the normal model used for business operations where there is a real risk of commercial loss. Limited liability is particularly useful where the shareholders leave the management of the company in the hands of its directors and have no immediate control over its financial situation and day to day transactions. Since most shares are issued, fully paid holders of such shares can have no further liability. Companies limited by guarantee In the case of a company limited by guarantee, the liability of members is limited to such amount as they undertake to contribute to the assets in the event of its being wound up. That amount is specified in the memorandum of association which is part of a companys constitution. If a company is wound up, each person who is a member at that time or has been a member within the preceding year may be required to contribute up to the amount of his guarantee towards payment of debts incurred while he was a member. Pas members are liable only if present members default. Many such companies are formed for non-profit making purposes and where the ability to raise capital is not important. Examples are most of the supervisory and regulatory bodies in the investment industry, e.g. SIB. Such associations reckon to recover the cost of their services by charge or levies on those who use them. However, as companies limited by guarantee, they have the general advantages of corporate status and the members' guarantees are a form of reserve fund to be called on in case of crisis. Unlimited Companies In the case of an unlimited company, there is no limit on the liability of members to contribute to assets on a winding up. Past members who ceased to be members within the previous year may be liable in respect of debts incurred before they ceased to be members. However, there is no such liability of members until the company is wound up. Special features of unlimited companies are: 1. they are not required to file their accounts at the Companies Registry for the information of the public 2. they are free to purchase their own shares 3. they must have special articles of association however, rule 1 does not apply to an unlimited company which is controlled by one or more limited companies or which has a limited company as a subsidiary

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Public companies and private companies The CA85 defines a public company as a company limited by shares or limited by guarantee and having a share capital and: the companys memorandum states that the company is to be a public company the provisions of the Companies Act as to registration re-registration of a company as a public company have been complied with in particular the requirements relating to a minimum share capital.

A private company is a company which is not a public company. The major differences between private (limited) companies and public companies are: Public Companies Private (limited) companies Minimum number of members At least two members Minimum capital requirements 50,000 Public subscription A public company may raise capital by advertising its securities (shares and debentures) as available for public subscription. Companies Act Can have a single member No minimum or maximum requirements It is illegal for a private company to advertise its securities to the public Some provisions of the Companies Act do not apply whilst many others are relaxed.

Single member private limited companies As a general rule every company must have a minimum of two members S24 CA85. The Companies (Single Member Private Limited Companies) Regulations or CSMPLCR as made allowing a private limited company (whether newly incorporated as such or pre-existing) to have one member only. Thus if the membership of a private limited company falls to one, that member does not incur personal liability for the companys debts. The CSMPLCR 1992 makes the following consequential amendments to existing law in relation to such single member companies: 1. only one subscriber to the memorandum is needed 2. where the membership of a company falls to one the fact, date and persons name and address must be entered on the Register of Members. A corresponding statement must be made where the membership of a single member company increases. 3. The quorum at meetings is one member present personally or by proxy 4. Where the sole member takes a decision instead of holding a general meeting with himself he must (unless he uses the written resolution procedure) provide the company with a written record of that decision. Failure results in a fine but does not affect the validity of the decision. 5. S122 (e) Insolvency Act 1986, which allows a company to be compulsorily wound up where the number of members is reduced below two does not apply 6. Where the sole member is also the sole director and he makes a contract with the company, the company must, unless the contract is in writing, ensure the terms are set out in a written memorandum or are recorded in the minutes of the first board meeting held after the making of the contract. Failure results in a fine but does not affect the validity of the contract. However, it may be a breach of a provision requiring directors to disclose an interest in a contract and if so may result in the contract being voidable for breach of directors duty. Overseas companies

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A company incorporated outside Great Britain which establishes a place of business in Great Britain is called an overseas company. S744 CA85 provides that place of business in this context includes a share transfer or share registration office; but it has been held that a company which only employs agents within Great Britain and has no office, has not established a place of business. Such companies are, at least to some degree, regulated by UK company law. They must, for example, file accounts with the Registrar of Companies and must maintain an address within the jurisdiction where official communications can be sent. Community Interest Companies (CIC) Community Interest Companies (CIC) is a relatively new corporate vehicle, introduced in October 2004 as a unique legal structure to assist social enterprise, that is, organizations that combine social purpose with commercial activities. A CIC has three main additional characteristics: (a) It must be carried on for the benefit of the community. (b) It is subject to an asset lock, a general term to describe various restrictions on profits and assets designed to ensure that it is run for the benefit of the community. (c) It must file community interest annual reports which are available to the public. 2. explain the doctrine of incorporation as established by Salomon v Salomon The doctrine of incorporation states that a company is a legal person i.e. it is an entity in its own right this is the doctrine of incorporation. Recognition that a company has legal personality independent of its members was established last century by the House of Lords in Salomon v Salomon. Salomon v Salomon & Co Ltd Mr. Salomon had, for thirty years, carried on a successful business as a sole trader in the manufacture of boots and shoes. In 1892 he formed a company. In those days, the minimum number of shareholders was seven, and he had one share issued to himself, his wife and five of his children; his wife and children had their shares as his nominees. He then transferred his business to the company at a value of over 39,000. This price was very much in excess of the true value but as Salomon owned the company no one was thereby defrauded. He took the price partly in 20,000 1 shares, partly in cash withdrawn from the business in the course of transfer, and partly in a 10,000 debenture issued by the company and secured by a floating charge on its assets. The effect was that whoever held the debenture had a claim to the assets (to the extent of 10,000) in priority to the claims of any other creditor of the company. So Salomon became a secured creditor of his own one-man company. The business of the company did not prosper. Salomon pledged his debenture to one Broderip who lent him 5,000 in cash, which Salomon in turn paid over to the company. Eventually the company became insolvent: if the debenture were repaid in full there would be nothing left for the other creditors. In the confused lawsuit which followed, the main body of unsecured creditors advanced two principal arguments: a) the sale transaction was a sham and so Salomon was still the owner of the business and liable for its debts b) the company was irregularly formed because six of the seven shareholders where mere nominees of Salomon Argument a) prevailed in the High Court but was rejected by the Court of Appeal which upheld argument b). the House of Lords turned down argument b) also and held that Salomon and his company were two separate persons. Held: Page 4 of 12

a) the business was owned by and its debts were liabilities of the company, not of Salomon personally b) although Salomon owned beneficially all the issued shares of the company he (and Broderip as his successor) could also be a secured creditor with enforceable rights against the company in that capacity. Lee v Lees Air Farming Ltd This case concerned an aerial crop-spraying business, in which Mr. Lee, who owned the majority of the shares (all but one) and was the sole working director of the company, was killed while piloting the aircraft. Held: although he was the majority shareholder and sole working director of the company, he and the company were separate legal persons and therefore he could also be an employee of it for the purposes of the relevant statute with rights against it when killed in an accident in the course of his employment. The veil of incorporation The legal consequence of the doctrine of incorporation, namely that a company is a separate legal entity from its members, is expressed by saying that there is a veil of incorporation drawn down between the company and its members. A number of consequences flow from the fact that corporations are treated as having legal personality in their own right. (i) Limited liability No one is responsible for anyone elses debts unless they agree to accept such responsibility. Similarly, at common law, members of a corporation are not responsible for its debts without agreement. However, registered companies, i.e. those formed under the Companies Acts, are not permitted unless the shareholders agree to accept liability for their companys debts. In return for this agreement the extent of their liability is set at a fixed amount. In the case of a company limited by shares the level of liability is the amount remaining unpaid on the nominal value of the shares held. In the case of a company limited by guarantee it is the amount that shareholders have agreed to pay in the event of the company being wound up. (ii) Perpetual existence As the corporation exists in its own right changes in its membership have no effect on its status or existence. Members may die, be declared bankrupt or insane, or transfer their shares without any effect on the company. As an abstract legal person the company cannot die, although its existence can be brought to an end through the winding up procedure. (iii) Business property is owned by the company Any business assets are owned by the company itself and not the shareholders. This is normally a major advantage in that the companys assets are not subject to claims based on the ownership rights of its members. It can, however, cause unforeseen problems as may be seen in Macaura v Northern Assurance (1925). The plaintiff had owned a timber estate and later formed a one-man company and transferred the estate to it. He continued to insure the estate in his own name. When the timber was lost in a fire it was held that Macaura could not claim on the insurance as he had no personal interest in the timber, which belonged to the company. (iv) Legal capacity The company has contractual capacity in its own right and can sue and be sued in its own name. The extent of the companys liability, as opposed to the members, is unlimited and all its assets Page 5 of 12

may be used to pay off debts. The company may also be liable in tort for any injuries sustained as a consequence of the negligence of its agents or employees. (iv) The rule in Foss v Harbottle This states that where a company suffers an injury, it is for the company, acting through the majority of the members, to take the appropriate remedial action. Perhaps of more importance is the corollary of the rule which is that an individual cannot raise an action in response to a wrong suffered by the company.

Rule in Foss v. Harbottle is actually rule of majority supremacy. It means that once a resolution is passed by majority, it is binding on all the members. Also the courts will in such cases not interfere to protect the minority interest. This is based on the rational that on becoming a member, each person impliedly consents to submit to the will of majority. Said in another way it is a corollary to the rule that only the company can sue, which again translates to the wish of the majority.

RATIONAL BEHIND THE RULE: (i) that the rule refers to two distinct but linked propositions of law. First, the court will not intervene in case of internal irregularity. Second, in case of an alleged wrong, the company is the plaintiff. (ii)the real reason behind the rule is given. It was said that where an illegal thing is done which can be rectified by the majority, there is no use of litigating, as the ultimate end will be that a meeting will be held, and the majority wishes will be granted. (iii)that where the majority is in favour of what is done then, cadet quaestio (i.e. it cannot be questioned) EXCEPTIONS MAJORITY SUPREMACY AND MINORITY PROTECTION The protection of minority rights as mentioned in the previous part is realized by making out some exceptions to the Foss v. Harbottle rule. These exceptions are: (A) ULTRA VIRES OR ILLEGAL ACT : EXCEPTION ONE : -Where the act complained of is against the memorandum the Foss v. Harbottle rule is inapplicable. (B) WRONGDOER IN CONTROL : EXCEPTION TWO :If the person against whom the relief is sought is himself in control, the rule of majority supremacy cannot be applied. FRAUD ON MINORITY : EXCEPTION THREE :Where the act is not for the benefit of the company and discriminates between majority and minority shareholders, action can be brought by the minority. (D) INADEQUATE NOTICE : EXCEPTION FOUR :-

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Where a shareholder because of inadequate notice, could not present himself in the meeting where a resolution against him is passed, the rule does not apply. (E) QUALIFIED MAJORITY : EXCEPTION FIVE :Where a resolution requiring special majority is actually passed by simple majority, an exception to the rule is found. 9F) PERSONAL RIGHTS : EXCEPTION SIX :Personal rights are not covered by Foss v. Harbottle rule.

Lifting the veil of incorporation Sometimes the law is prepared to examine the reality which lies behind the company faade - this is described as "lifting" or "piercing" the corporate veil (a) Statute Some statutory provisions have the effect of piercing the corporate veil to make directors personally liable. Presumption is in favour of separate personality and courts will not normally infer that legislation is intended to pierce the corporate veil. Case: Dimbleby & Sons Ltd v NUJ (Case 20) The NUJ was involved in a trade dispute with T Bailey Forman Ltd. NUJ members had also been picketing a company called TBF (Printers) Ltd and the question arose as to whether this amounted to unlawful secondary picketing. The NUJ argued that it did not, as both companies were wholly owned subsidiaries of the same holding company, and were therefore both employers who were party to the dispute, within the meaning of s.17(3) of the Employment Act 1980. Held: Both companies were separate entities and the picketing was therefore unlawful. Lord Diplock said: "The corporate veil in the case of companies incorporated under the Companies Acts is drawn by statute and it can be pierced by some other statute if such other statute so provides; but, in view of its raison d'etre and its consistent recognition by the courts since Salomon v A Salomon & Co Ltd, one would expect that any Parliamentary intention to pierce the corporate veil would be expressed in clear and unequivocal language."

Situations where "veil is lifted" by Statute (i) Companies Act 1985 s.24 - where membership of a company falls below two for more than six months. Member who knows he is the sole member but continues to trade will be jointly and severally liable with the company for company debts contracted after the six month period has elapsed. (s.24 no longer applies to private limited companies) (ii) Companies Act 1985, s.117(8) - where public company trades without obtaining a trading certificate. If the company fails to comply with any obligations under a transaction within 21 days of being called on to do so, the directors of the company are jointly and severally liable to indemnify the third party against any loss.

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(iii) Companies Act 1985, s.349 - if person acting on behalf of a company signs or authorises the signing of a bill of exchange, cheque, order for goods or similar document in which the companys name is not correctly stated, the person signing will be personally liable if the company fails to pay.

Case:

Durham Fancy Goods v Michael Jackson (Fancy Goods) Ltd (Case 21)

Durham Fancy Goods drew a bill of exchange on the defendants which was accepted on behalf of the company by M Jackson, who was a director and a company secretary. The bill and the form of acceptance, both of which were drawn up by the plaintiffs, referred to "M Jackson (Fancy Goods) Ltd", whereas the proper name of the company was "Michael Jackson (Fancy Goods) Ltd". The bill was dishonoured and the plaintiffs brought an action against M Jackson personally, arguing that by signing a document which did not correctly state the company's name, he had made himself personally liable on the bill. Held: There was sufficient misdescription to impose personal liability under what is now s.349 CA 1985. (Mr Jackson in fact escaped liability because it was the plaintiffs who had prepared the bill with the incorrectly stated name - they were therefore personally barred from going back on their implied representation that it was acceptable to them.) (iv) Insolvency Act 1986, ss.213 & 214 s.213 applies where company is being wound up and it appears that business has been carried on with intent to defraud creditors. s.214 applies where company is in insolvent liquidation and the director(s) should have known this, but did not take sufficient steps to minimise losses to creditors. In either case, the court can order that those involved make a contribution to the companies assets for the benefit of creditors. (v) Insolvency Act 1986, s.216 & 217 The director of a company which has gone into insolvent liquidation cannot become a director of another company with the same name within a five year period. If he does he can be made personally liable for all the debts of the new company. (vi) Company Directors Disqualification Act 1986, s.15 A person will be jointly and severally liable with the company for all the companys debts if he takes part in the management of the company while he is under a disqualification order. NB: For the purposes of these provisions, "person" includes legal as well as natural persons. (b) Common Law - The courts are willing to pierce the veil of incorporation in some circumstances: (i) Fraud, Faade or Sham Courts will examine the reality behind the company where the company was set up purely to evade a legal obligation, or to allow someone to do something he would not be allowed to do as an individual: Case: Gilford Motor Co v Horne (Case 22) Page 8 of 12

Horne had been employed by Gilford Motor Company under a contract in which he undertook not to compete with the company. He tried to evade the covenant by getting his wife to set up a company. All the shares in the company were held by Horne's wife and an employee. The new company then carried on business in competition with Horne's employer. Held: The court was prepared to look behind the corporate identity and issued an injunction to prevent the company trading in competition with Gilford Motor Co. Lord Hanworth said: "I am quite satisfied that this company was formed as a device, a stratagem, in order to mask the effective carrying on of a business by Mr E B Horne. Case: Jones v Lipman (Case 23) Lipman sold land to Jones by a written contract but refused to complete the sale, offering damages for breach of contract. To put the house out of reach of Jones, he bought a company "off the shelf" and conveyed the house to it. Jones brought an action against Lipman and the company for specific performance. The court granted the decree. "The defendant company is the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity." Case: Re Bugle Press Ltd (Case 24)

A company had three members, two of whom wanted to buy out the third, but he refused to sell. Under statutory provisions (now s.429 CA 1985), a takeover bidder which has acquired 90% of the target company's shares can compulsorily purchase the remaining shares. The two owned 90% of the shares so they formed a new company to make a takeover bid for the original one. They sold their 90% shareholding to the new company, which then attempted to compulsorily purchase the remaining 10%. The attempt failed. Held: The court lifted the veil of incorporation to reveal that the new company was merely a tool to lever the third shareholder from the original company (ii) Agency Court may lift the veil on the basis that one company is merely carrying on business as the agent of another - so that transactions entered into by the subsidiary can be regarded as transactions of the holding company: Case: Smith, Stone & Knight v Birmingham Corporation (Case 25)

Premises owned by the plaintiffs were compulsorily acquired by the corporation. Questions arose as to whether the business for which the premises were used was being carried on by Smith, Stone & Knight or by its subsidiary - the distinction was important because an owner-occupier could get compensation, but a tenant-occupier could not. It was held that the plaintiffs were entitled to compensation. Held: The business carried on at the premises by the subsidiary was being carried on by them purely as agents for the plaintiffs Case: Firestone Tyre & Rubber Co v Lewellin (Case 26) A US company formed a wholly-owned subsidiary in England to manufacture and sell tyres in Europe. The subsidiary received the money for the tyres sold and, after deducting its manufacturing expenses plus 5%, if forwarded the money to the US company. Held: The American company was carrying on business in the UK through its English subsidiary acting as its agent. The US company was therefore liable to UK tax. Page 9 of 12

Case: Adams v Cape Industries Ltd (Case 27) Cape was an English company which mined asbestos in South Africa. Products were marketed in the USA through a complex range of subsidiaries. Factory workers in Texas who had contracted illnesses through exposure to asbestos dust obtained judgment in Texas against the holding company, Cape. They sought to have the judgment enforced against Cape in England, arguing that Cape had been present, through its subsidiaries, in the USA. Three arguments were put forward: (1) The agency argument - that the subsidiaries were mere agents making contracts for their principal, Cape. (2) The single economic unit argument - that Cape and its subsidiaries were really one economic unit, and (3) The "facade" argument - that the separate identities of the subsidiaries was merely a facade concealing the true facts. Held: All of the arguments failed. The court stated that: "Save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v A Salomon & Co merely because it considers that justice so requires. (iii) Single Economic Unit In the past, courts have been willing to lift the veil on the basis that a group of companies was not a group of separate persons, but a single economic unit: Case: DHN Food Distributors v Tower Hamlets (Case 28) DHN was a holding company which ran its business through two wholly owned subsidiaries: Bronze Investments Ltd and DHN Food Transport Ltd. Bronze owned the premises from which the business was conducted and Transport ran the business. The Council compulsorily purchased the land. Compensation could be paid under two heads: (a) the value of the land, and (b) disturbance of business. The Council was prepared to pay for the value of the land but refused to pay for disturbance of business because neither DHN or DHN Food Transport had any rights of ownership in the land. Held: Lord Denning pierced the veil of incorporation to treat DHN as the owners of the land, which entitled them to payment of compensation. He felt that the group of companies was a single economic entity. Later cases have doubted this principle: Case: Woolfson v Strathclyde Regional Council (Case 29)

W ran a shop in Glasgow, which in 1966 was compulsorily purchased by the Council. Part of the shop premises was owned by W himself, the rest being owned by a company called Solfred Holdings Ltd, whose shares were owned by W and his wife. W and Solfred received compensation for the value of the land, but the Council refused to pay compensation for disturbance of the business, because the business was operated by M & L Campbell Ltd, another company owned by W and his wife. Campbell Ltd occupied the premises, but had no interest in the land. W tried to persuade the court that he and his two companies were, in reality, a single entity which both owned and occupied the land. Held: The court did not accept this. It was held that W's case was distinguishable from the DHN case. Whereas, in that case, DHN had owned and totally controlled both its subsidiaries, W himself held only two-thirds of the shares in Solfred, and Solfred owned no shares in Campbell Ltd. The three were distinct entities. (iv) State of Hostility - In times of war, courts may regard a British company as an enemy alien if the company is controlled by nationals of an enemy country: Page 10 of 12

Case:

Daimler Co Ltd v Continental Tyre and Rubber Co (GB) Ltd (Case 30)

After war broke out with Germany, the tyre company, which was registered in England and had its registered office there, sued Daimler for the cost of goods supplied before war broke out. Daimler claimed that, as the members and officers of the company were German, paying the debt would amount to trading with the enemy, therefore the matter should not be permitted to go to trial. Held: The action should not go to trial. Though the domicile and nationality of a company is normally determined by its place of registration and the situation of its registered office, the court was prepared to lift the corporate veil to determine who was in control of the company. If the company was controlled by enemy aliens, the company could also be regarded as an enemy alien. (v) Justice and Equity - Courts have sometimes been prepared to pierce the corporate veil where they feel this is in the interests of justice:

1. identify the main differences between a company and a partnership

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Company Documents A company must have written constitution, i.e. memorandum and articles of association Separation A company is a separate legal person so may: own ownership contract in its own name sue/be sued in its own name Transferability Shares in a company are in principle transferable though the right of transfer may be restricted Numbers There is no maximum number of members; but for a public company there is a minimum of 2 Owners and managers The owner (members) of a company as such are neither its managers (directors) nor its agents Withdrawal of capital Capital subscribed by members for their shares cannot ordinarily be returned to them but (in a limited company) they are not liable for its debts once they hold fully paid shares Borrowing Companies can borrow in the same way as individuals but only for purposes covered by their objects. They can use current assets as security by creating floating charges. Supplying Information Both in their formation and in their subsequent trading and other activities companies are subject to a number of statutory rules of procedure and supply of information available to the public. Dissolution The dissolution of a company usually entails a formal liquidation

Partnership There need not be a written partnership agreement though it is usual A partnership is not a separate person the partners personally: own property are liable on contracts are liable if sued A partner cannot transfer his status as partner to someone else without the consent of all the other partners. The max is 20. Most professional partnerships however are no longer subject to a maximum The owners (partners) are entitled to share in its mgt and are agents of the firm for carrying on its business in the usual way Partners may withdraw capital but are still liable without limit for the firms debts to its creditors

Partners have unrestricted powers of burrowing in terms of amount and purpose. They cannot create floating charges but can mortgage fixed assets. Partnerships may be created informally and need not disclose any information about their affairs (except to the Inland Revenue over taxable profits) Partnerships can be dissolved by mere agreement of the partners but the creditors have first claim on the assets and some general legal principles apply.

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