Company Law

Answer

The provisions of Companies Act 2006 (hereinafter referred to as the ‘CA’) govern companies. The aim of this legislation is to ensure order in the operations of Corporations.[1] This paper uses the case study of a new company incorporated by Andrea to discuss the corporate personality and the concept of lifting the corporate veil. Additionally, the benefits and disadvantages of incorporation will be prese nted as well as the registration of companies and the commencement of trading. Various ways of raising capital and requirements for the articles and memorandum of association will be provided. Before the end of the paper, the powers of the directors and the control of the powers by the shareholders will be discussed. Additionally, the rights on liquidation will be presented.

Task 1

Part A: Company Formation

The type of company that Andrea can set up which will ensure that the shareholders are not personally liable and that capital can be raised from the public is a public limited company (PLC).

• The Concept of Corporate Personality

The concept of  legal personality states that corporations are separate legal entities which have a legal persona different from those of its shareholders. The separate legal personality concept is also known as the ‘Salomon principle’ as it was established in the case of Salomon v A Salomon and Co Ltd.[2] In the case, the House of Lords held, inter alia, that any company formed in accordance with the provisions of the Company Act is a separate person and not a trustee or agent of its shareholders. Additionally, in Lee v Lee’s Air Farming Ltd the London Privy Council stated that the company was separate from Mr. Lee and had distinct legal entities, which made it capable of entering into legal relations.[3] Various features of the concept of corporate personality include the company outliving its members (perpetual succession), contracting on its own name, owning property, suing and being sued in its own name, among others.

Despite the company being a separate legal entity from its members, there are circumstances in which the shareholders can be made accountable for the acts of the company in what is referred to as ‘lifting the veil of incorporation.’ Notably, the veil can be lifted if it is being used as a cloak or sham. Additionally, the corporate veil can be lifted based on the provisions of the statute (statutory veil lifting) or judicial decisions (judicial veil lifting). In the statutory veil lifting, the provisions of the Companies Act 2006 s.399 and s.993 (1) are inferred. [4]  Notably, these sections are related to wrongful trading and fraudulent trading. More specifically, s.993 (1) stipulates that any business which is carried out with the sole intention of defrauding the creditors or for a fraudulent purpose can result in the veil being lifted. Additionally, s.214 of the Insolvency Act (IA) states that where negligence of corporate liability can lead to the lifting of the corporate veil. [5]  Judicial lifting was underscored in Gilford Motor Co Ltd v Horne, where the court held that the veil could be lifted where the company is a sham.[6] Similarly, in Jones v Lipmann, the veil was lifted when the corporation was being used as a façade.[7]

• The Key Advantages and Disadvantages of the Corporate Form Recommended To Andrea

The public corporation with separate personality suggested to Andrea will provide various benefits and disadvantages. One of the benefits is that Andrea will not be personally liable for the debts of the company and his personal property cannot, therefore, be used in settlement of debts of the enterprise. The reason behind this is that the corporation is a separate legal person and liable for carrying out its mandates in accordance with the contractual terms. Secondly, the company enjoys perpetual succession and Andrea can change the membership and directorship without necessarily affecting the legal existence of the corporation.  Thirdly, the company can own its own property, and as it was the case in Macaura v Northern Assurance Co, shares will not constitute a fractional value of the assets of the Company. [8] Finally, Andrea does not have to worry about being sued as the Company has a separate persona, which means that it can not only sue, but also be sued in its own name.

Despite the massive advantages of a public company which makes it desirable than other forms of business organizations, it has various disadvantages. One of the advantages is increased publicity. Specifically, a public company is required to make most of its information accessible to the public. The range of information which should be publicized includes the number of shares and the shareholding ratios, accounts of the company, annual returns, as well as the directorship. Secondly, the regulations for a public company are more compared to those which govern private companies. For instance, under s.475 of the CA, public companies are mandated to deploy auditors with the sole mandate of carrying out audits hence make the cost of compliance very high compared to private enterprises.

• Legal Implications if Andrea is Involved in Incorporating this Subsidiary Company

A person who undertakes the role of forming a company and sets it going is referred to as a promoter. As a result, if Andrea is involved in the incorporation of the subsidiary company, he becomes the promoter of the enterprise. However, there are various duties and liabilities which have legal implications to promoters. One of these is that promoters are only fiduciaries and are, therefore, mandated to act in good faith and loyalty only in the best interests of the company as illustrated by the Erlanger v New Sombrero Phosphate Co case.[9]. As such, Andrea, as the promoter, cannot act in a manner that contradicts with the best interest of the subsidiary company. Secondly, promoters are required to make full disclosures on the nature and amounts of profits that they may have done once the company has been incorporated to the independent Board of Directors.

            Any contract between the promoter and the company can be voided at the option of the company, as was the case in Gluckstein v Barnes.[10] However, the company will lose its right to rescind contracts entered into between it and the promoter on various grounds. From the judgment in Re Cape Breton Co, one of those is when the company affirms the contract. [11] Additionally, a delay in the company exercising its right of rescission will lead to loss of the option, as was the case in Long v Lloyd.[12] When a third party acquires rights in the subject matter of the contract before rescission, then the right is lost as indicated by the  Hanley Theatres of Varieties Ltd case[13]. Finally, the impossibility of substantially restoring the parties to their original position leads to loss of the option of rescission by the company.

There is no possibility that the subsidiary company will enter into a contract before it is incorporated because the company does not exist before it is incorporated. As such, Andrea as the promoter will need to enter into a contract with third parties to facilitate fulfillment of the requirements for incorporation. Although Andrea may enter into a contract before the incorporation of the company, the Company cannot be held liable due to the doctrine of the ‘privity of contracts’ (Kelner v Baxter). [14]Andrea cannot also be the agent of the company before incorporation as it is not legally in existence. However, s.51 (1) of CA 2006 stipulates that third parties can hold Andrea to be acting on behalf of the company subject to any contrary agreement.[15]  Lord Denning in Phonogram Ltd v Lane explained the agreement to the contrary as the contract having express provisions for the exclusion of the promoter.[16]

• The Requirements for Incorporating a Company

Incorporating the subsidiary company will require Andrea to fulfill various legal requirements. One of the requirements is the memorandum of association as stipulated in s.7 (1), which specifies the names of the subscribers and their shareholding ratios. According to s.9 of CA 2006, Andrea should deliver various documents to the Registrar of Companies to facilitate incorporation. Apart from the memorandum of association, he should present the proposed name and address of the registered office of the Company, the capital as well as the initial shareholdings, and the proposed officers of the company including the directors and the secretary. He should also deliver the proposed articles of association and a statement of compliance. The Registrar of Companies is mandated under s.14 to register the documents presented only if he/she is satisfied with them and subsequently issue a certification of incorporation.

Andrea will need to have the articles of association, which are also the company’s constitution. Notably, the purpose of the articles is to regulate the operations of the corporation. In the current case, the article will state the name of the company and that the liabilities of the members are limited. Additionally, the share capital will be indicated and the shareholding of Andrea and other members. The founder members of the subsidiary company should be included and their number of shares. Other information which should be contained in the articles of association includes the powers and responsibilities of the directors as well as their decision-making process.[17] The manner in which they will be appointed and retired should be also included, as well as the alternate managing directors. The decision should include the general meetings and the voting procedures. It is critical that Andrea states the shares and distributions and how the shares can be transferred and transmitted. Such articles should be contained in the constitution to ensure smooth operations upon incorporation.

• The Extent of Ultra Vires

The articles of association will contain the objects of the company. As such, the company is expected to operate within the confines of the objects clause and any action ultra vires the objects clause are not only void but also unenforceable. Notably, the activities of the company should be restricted to the provisions of its constitution. S.39 (1) of CA 2006 which states that the validity of any action taken by a corporation might be questioned based on the lack of capacity on grounds of the Company’s constitution. [18]  For instance, the fact that the staff and agents of the Company are delegated the duty to facilitate the operations of the company requires them to act within their actual or apparent authority. As a result, agents of the corporation who act ultra vires their agency principles will be held personally liable. However, outsiders who include the suppliers and customers are entitled to assume that the internal procedures of the company have been complied with (indoor management rule) as was the holding in Royal British Bank v Turquand.[19] As a result, outsiders dealing with the company through the directors or their authorized agents are protected by the general agency principles. Future suppliers and customers should, therefore, be comfortable when dealing with the directors or their authorized agents, as they are sure that they are protected.

Part B: Capital

• The Various types of Capital that Andrea can Consider for this new Company

Andrea will require the necessary capital for the operation of the company. The new business will need to raise capital from the public through the issuance of equity or borrow through loans and debentures. Shares depict a contract between the shareholders of the company. S.541 of CA states that shares can only be personal property and not real estate. [20] The shares issued to the public should each have a nominal value which is fixed. As such, the public cannot buy the shares below the minim price (nominal value) subject to a few exceptions. The new company has the power to issue shares of different classes. Some of the categories of shares which can be issued by the company include preference shares, ordinary shares, and redeemable shares. Preference shares have special rights attached to them as the shareholders of preference shares are given priority over other rights holders in the company. Ordinary shares, on the other hand, are second to the preference shares as the common shareholders can only be entitled to any dividends after preference shareholders have received theirs. Finally, the redeemable shares are those which can be redeemed either at the option of the company or that of the shareholder. The raising of capital through borrowing can be in form of debentures and charges.

• The Specific Features of Ordinary Shares and Preference Shares

Common shares and preference shares have distinct features which make them different from each other. Ordinary shares are also referred to as common shares and are representations of the fundamental voting rights of a company. In this regard, the holders of such shares are only entitled to one vote per share. Additionally, shareholders of ordinary shares do not have any predetermined amounts of dividends. Ordinary shares present the equity ownership in a corporation and are proportional with the other ordinary shareholders concerning their percentage of ownership. Businesses ought to have ordinary shares as part of their stock and there should be at least one ordinary share issued to a shareholder. Common shareholders have the right to the residual benefits of the company. Additionally, should the corporation unwind, they are entitled to the residual economic value despite the fact that they are the last to receive the business proceeds. Shareholders of ordinary shares face a greater financial risk than the preferred shareholders and creditors. They can, however, have more profits if the company makes higher profits.

Preference shares, on the other hand, take precedence over ordinary shares and paid out to the shareholders before the issuance of the common stock dividends. In the case that a company is unwound, preference shareholders are entitled to payment from the accompany assets before ordinary shareholders. As such, preference shareholders do not face greater risk compared to common shareholders. However, the disadvantage of such shares is that preference shareholders have a fixed dividend and they do not hold any voting rights. As a result, preference shares are the best alternative for risk-averse equity investors as they are less volatile than the ordinary shares, and have a steady flow of dividends. Moreover, preference shares can be redeemed at any time, offering shareholders an opportunity to redeem them as they deem fit , unlike ordinary shares.

Whether the Company can issue Shares at a Discount to their Nominal Value

The general rule is that shares cannot be released at an amount that is less than their nominal value. As such, issuing shares at a discounted price is akin to issuing them at a value less than the nominal one. The rule of issuance of shares at nominal value was set out in Ooregum Gold Mining Co of India v Roper whereby the company had issued shares with a nominal value less than the nominal value.[21] The House of Lords was categorical that this was unlawful. The position of the House of Lords was embedded in s.580 of the CA 2006 which states that a company’s shares out not be allotted at a discounted price. [22]However, in the case that the shares are granted at a discounted price, the allottee is mandated to pay an amount, which is equal to the discount and an additional interest at the most appropriate rate. It should be noted, however, that the nominal value is not meant to protect creditors, as it is not an accurate indication of their real value of the shares being issued.

• The Content Requirements of the Prospectus Required for Raising Funds from the Public

When the new Company starts to offer its shares to the public, it would have to do so through the inviting public document referred to as the ‘prospectus.’ The purpose of this document would be to provide the public with information which enable them make informed decisions. The prospectus used by Andrea’s Company should have different essential contents. S.87A of the FSMA 2000 states that the prospectus should contain the necessary information which will enable the investors to make informed decisions. Such required information includes the assets and liabilities as well as the financial position, profit and losses. Additionally, the rights, which attach to the transferable securities, constitute the necessary information. It is also required that the prospectus should have the summary of critical information to the securities which form the subject of the prospectus. Critical information including the characteristics and risks of the issue and guarantee is mandatory. Additionally, the features and risks of the investment must be provided as part of the essential information. Moreover, the general terms of the offer and detailed information about the admission of trading, reasons for the proposal, and the proposed use of the proceeds of the offer are critical information, which forms an integral part of a prospectus.

Task 2

• Directors’ Powers and Measures to Control Such Powers by the Shareholders

The model articles which Andrea has incorporated in the public Company vest the management of the company in the board of directors. The powers of the directors who are involved in the day-to-day administration of the Company are broad. One of the powers is that of fiduciary responsibilities as was the position taken in Towers v Premier Waste Management Ltd whereby the court stated that the director should promote the success of the company and corporation’s interests.[23] Under common law, directors are expected to exercise reasonable care, skills, as well as diligence. Additionally, the directors have the general duties under sections 170 to 181 of CA 2006. Specifically, one of the tasks is for the directors to act within their powers in accordance with the articles of association. In Re Smith Fawcett Lord Greene MR. was categorical that directorscannot act for any collateral purpose but rather for their proper use. [24] Directors have the power under s.172 of the CA to promote the success of the company. The duty to exercise independent judgment is essential and has been provided for in Fulham Football Club Ltd v Cabra Estates plc.[25] Moreover, directors have an obligation to avoid any conflict of interest and not to accept benefits from third parties.

The control of the powers of the directors by the shareholders of the Company of Andrea is pegged on common law as well as the Company Act 2006. One of the ways of control of such powers is through a special resolution. Under s.168 (1) of the CA 2006 the directors can be removed by an ordinary resolution.[26] Additionally, the director’s powers can be controlled by the alteration of the articles thus refusing to re-elect the directors whose actions the shareholders disapprove. As such, the directors in the present case (Andrea Francis, Billy, Tom, and John) can use either of the options to ensure that they control the powers of the directors of the public company.

The Rules of Decision-Making at Directors’ Meetings

Article 7 of the model articles state that public enterprises are expected to act and make decisions on a collective basis. However, article 5 of the model articles provides an exception to this general rule whereby the articles of the company may delegate such powers of decision making to the board or smaller committees. During the directors’ meeting, article 13 states that each of the directors participating in such a meeting has one vote. However, in the present case whereby Andrea owns majority of shares, the number of shares will determine the number of votes. The other rule on decision-making is that in the case where one of the directors has an interest in any actual or proposed transaction, the director or his alternate may not vote in accordance with article 13(3). When there is equality in the number of votes between those supporting and opposing, the chairperson of the meeting will provide the breaking vote. In the case the directors pass a written resolution, article 18(1) of the CA stipulates that there be a unanimous approval by the directors entitled to vote. [27] These rules ought to be followed in the new public company as it has adopted the model articles in their totality.

• The main Legal Remedies available to John

The directors have a duty to promote the interests of the company and John is entitled to various remedies if the other directors (Andrea, Francis, Billy, and Tom) use the company’s financial resources to help another company they own, as this would have an adverse effect on the liquidity of the company. Specifically, John has the power to bring a derivative claim in which he will seek relief on behalf of the company. The basis of the derivative action will be s.260(3) of the Act where John will claim that the decisions of the directors of using the company’s cash for another company they own are contrary to the duty to promote the interests of the company as well as a breach of trust.

Although the Act has no specific provisions for the remedies available after John brings a derivative action, s.996 states that if the courts find that the claim is well founded, it may make orders which are appropriate for providing relief in respect of the matter which has been brought before it. As such, John will either get remedies in the nature of the following options. The courts may order the company’s directors to refrain from using the company’s cash for the benefit of another company owned by the directors. Additionally, John may be authorized to commence legal proceedings which will be brought in the manner of and on behalf of the Company. John may also under s.122 (1) of the Insolvency Act 1986 petition the court for the wounding up of the Company. [28]However, John will have to convince the court that it is not only just but also equitable for the company to be wound up.

• The Priority of Payment on Liquidation if John Succeeds in Petitioning

In the case that John can convince the court that winding-up is the best remedy, the winding-up process would start with the liquidator being allowed to take control of the Company. The aim of appointing a liquidator will be to realize the assets of the company and thereby distribute them among the various claimants including the creditors and the shareholders in the order of priority. Notably, any of the Company’s property which is subject to a fixed charge will be the first to be used to redeem the secured loan. Additionally, if any of the suppliers of goods have not passed title, ownership would then not have passed to the company.

The priority of payment will be subject to the provisions of compulsory winding up of the Insolvency Act s.175 as well as sections 143 and 156. Specifically, the first payment will be to the costs incurred in the winding-up process as well s the remunerations of the liquidator. The second payment will be on the preferential debts including wages of the employees of the Company. Any ordinary shares will then follow as well as the deferred and subordinated debts. The balance that remains after all those expenses have been paid will then be distributed to the shareholders. However, the distribution will be based on the entitlement they have in accordance with the constitution of the corporation. For instance, if the model articles state that the contributions will be shared based on the number of shares, then Andrea will receive the largest share of the balance followed by the other directors.

In conclusion, the aim of these articles was to use the case of Andrea’s company to discuss the various aspects related to company law. Notably, these include the concept of corporate veil and the circumstances which can lead to the lifting of the corporate veil. Additionally, the advantages and disadvantages of incorporation of the public limited company have been discussed. The incorporation of the company as well as how the capital was raised is provided in the discussion. The powers of the directors and how it is controlled by the shareholders is presented. This discussion has offered various insights on the operations of companies and the practical applications of the legislations governing public limited companies.

[1] Sarah Worthington, Geoffrey, and Morse. Palmer's company law. Sweet & Maxwell, 2010.

[2][1897] AC 22, 66 LJCh 35.

[3][1961] AC 12.

[4]Companies Act 2006. [online] Available at: http://www.legislation.gov.uk/ukpga/2006/46/section/993 [Accessed 15 July 2017].

[5] Insolvency Act 1986. Available at: http://www.legislation.gov.uk/ukpga/1986/45/contents [Accessed 15 July 2017]

[6][1933] All ER 109.

[7][1962] 1 WLR 832.

[8][1925] AC 619.

[9] [1878] 3 App Cas 1218

[10][1900] AC 240.

[11] [1885] 29 Ch D 795.

[12] [1958] 1 WLR 753.

[13][1902] 2 Ch. 809.

[14][1866] L.R.2 CP 174.

[15]Companies Act 2006, op. cit., n.3

[16] [1982] Q.B. 938.

[17] David, Kershaw. Company law in context: Text and materials. Oxford University Press, 2012.

[18]Companies Act 2006, op. cit., n.3

[19] [1856] 6 E&B 327.

[20]Companies Act 2006, op. cit., n.3

[21][1892] AC 125.

[22]Companies Act 2006, op. cit., n.3

[23][2011] EWCA Civ 923.

[24][1942] Ch 304.

[25] [1994] 1 BCLC 363.

[26]Companies Act 2006, op. cit., n.3

[27]Companies Act 2006, op. cit., n.3

[28] Insolvency Act 1986. Available at: http://www.legislation.gov.uk/ukpga/1986/45/contents [Accessed 15 July 2017]