LAWS10083 Company law notes week 1 and 2-Types and functions of companies, Study notes of Law

Download LAWS10083 Company law notes week 1 and 2-Types and functions of companies and more Study notes Law in PDF only on Docsity! Company Law Week 1 Types and functions of companies The term company implies an association of a number of people for some common object. The purposes of association are multifarious. However, in common parlance the word company is normally reserved for those associated for economic purposes i.e. to carry on a business for gain. It should be noted that companies are not the only legal vehicles which people may use for gainful business and there are companies incorporated under the Companies Act that are non profit motivated. Business vehicles: companies and partnerships (limited and unlimited) Partnership law is codified in the Partnership Act 1890 is largely based on the law of agency, each partner becoming an agent of the other. Companies are different: it constitutes a distinct legal person, subject to legal duties and entitled to legal right separate from those of its members and is formed upon registration in accordance with the Companies Act 2006. The above distinction might imply that partnerships are created for small operations and companies for big operations. This is certainly true for the early times, where it can be seen that s716 of the Companies Act 1985 provided that in principle as association of 20 or more persons formed for the purposes of carrying out a profit making business must be formed as a company. S7(1) of the Companies Act 2006 extends the decision of Salomon to public companies, in that you can have a one man public company. For partnerships, the limit of 20 partners has been removed for a number of professions, including solicitors. Normally a company is built on a distinction between the owners i.e. shareholders and management i.e. directors, this is not normally the case for partnerships, however, there it can be arranged in the partnership deed. There is an introduction by way of the Limited Liability Partnerships Act 2000 a hybrid vehicle of business, which is comprised of elements of a company and a partnership. Like companies, LLPs have separate legal personality and the partners like shareholders in companies, have limited liability. However, they are taxed in accordance to partnership taxation rules i.e. the partners are subject to income tax and not corporation tax. The management is run as if it were a partnership. LLPS are to be distinguished from the Limited Partnerships Act 1907, in which there are some partners who have limited liability, but are prohibited from taking part in management and do not have the power to bind the partnership as against outsiders. Non- business vehicles: charities, community interest and limited by guarantee companies A company may be not- for- profit, in that the MemArts prohibit the distribution of profits by way of dividend or in a winding up case to its members. They may pursue activities that are charitable or in public interest but are not confined to these. The government has created a special vehicle for charities known as Community Interest Company. The Companies Act does not permit the creation of a company in which all members are free from any sort of liability, but as an alternative to limiting their contribution to the amount payable on their shares, it enables them to agree that in the event of liquidation they will, if required, subscribe an agreed amount- companies limited by guarantee. The members are only liable to the extent of their guarantee, and this is not when the company is an ongoing concern, but when it is going to be wound up. It can be noted though that companies can be registered with nominal share capital and as such the liability a member exposes himself to is minimal, and as such many non-profits are set up as general companies instead of companies limited by guarantee. Membership admission and resignation are easier than that in a company. In a company one member resigning means that his shares must be reallocated whereas, in a company limited by guarantee it would be as simple as an agreement between the company and the member and the termination of said agreement. Advantages of the new corporate form Company law, by insisting upon the central role of directors in the running of the company, permits a large and fluctuating body of shareholders to delegate oversight of the company’s business to directors. This delegation of authority is well supervised and regulated on by the Companies Act 2006. Company form will create separate legal personality, limited liability, transferable shares, and company law makes it possible to isolate business risks within the business vehicle (insulating shareholders) and facilities of raising risk capital from the public for financing corporate ventures or by raising funds by shares. Advantages and Disadvantages of incorporation Legal entity distinct from its members A company is a legal entity distinct from its members, hence it is capable of enjoying rights and being subjected to duties that are not the same as those enjoyed by its members. It has LEGAL PERSONALITY. Salomon v Salomon- the HL held that the company has been validly formed since the Act only required seven members holding at least one share each. It did not go to tell us what interest a shareholder must hold, it said nothing about the members being independent of one another, or that they should have a mind and will of their own of that there should a balance of power in the company constitution. Hence the business belonged to the company and Salomon was simply an agent of the company. “(at 51) the company is at law a different person altogether from the subscribers… and though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive profits, the company is Macaura v Nothern Assurance Co- company law takes very seriously the principles of separate legal personality and limited liability- a company owns its own property. At common law Adams v Cape Industries- this case concerned liability within a group of companies and the purpose of the claim was to circumvent the separate legal personality of the subsidiary in order to make the aren’t company liable for the obligations of the subsidiary towards involuntary tort victims. The court ultimately had to determine whether judgements obtained in the US against Cape an English Company whose business was mining asbestos in SA would be recognised and enforced in English Courts. This depended on whether it could be said Cape was present in the US through its wholly owned subsidiaries or through a company (CPC) with which it had business links. The court rejected all arguments through which it was sought to make Cape liable:  Single economic unit argument- there is no general principle that all companies in a group of companies are to be treated as one, the fundamental principle is that each company in a group is a separate legal entity which possess separate rights and obligations. It was argued in court that where the group operated as a single economic unit then then the distinction between the subsidiary and a parent should be abandoned. It was also accepted that the wording of a particular statute or document may justify the court in interpreting it so that a parent and subsidiary be treated as one unit at any rate for the same purpose.  Façade or sham- the court accepted that there is one rule recognised exception to the rule prohibiting the piercing of the corporate veil. The company’s separate personality is disregarded when the corporate structure is a mere façade concealing the true facts or a sham. In general the court felt that it was left with rather sparse guidance as to the principles which should guide the court in determining whether or not the arrangements of a corporate group involve a façade but unfortunately it failed to attempt a comprehensive definition of those principles. The court held that as a matter of law the court is entitled to lift the corporate veil as against a defendant company which is the member of a group, merely because the corporate structure has been used so as to ensure that the legal liability in respect of particular future activities of the group will fall on another member of the group rather than the defendant company.  Agency argument- a company having power to act as an agent may do so as agent for its parent company or indeed for all or any of its individual members if it or they authorise it to do so. If so a parent company or the members will be liable or bound by the acts of the agent so long as said acts are within the scope of the authority. There must be express agreement between the members and company for such an agency relation to exist. In cape the attempt to do so failed.  Impropriety- corporate veil can be set aside on the grounds that the company has been used to carry on an unlawful activity or in order to avoid the impact of an order of court. Usually here when the veil is lifted it does not affect the principle of limited liability. The company is the one who is made liable for some action of its members. Gilford Motor Co v Horne, where the director of a company sought to avoid a post- employment restraint by setting up a rival business through a company which he controlled, rather than conducting it personally, but the court extended the injunction to the company. Separate Legal Personality The Private Origins of the Private Company: Britain 1862- 1907 Introduction and Early History:  The most famous single-person company, ‘Aron Salomon and Company, Limited’, one of the earliest private companies, was not formed until 1892, almost 300 years later  Until the introduction of the general incorporation Act in 1844, no one in Britain envisioned small, closely held corporations. A corporation could be formed only by royal charter, special Act of Parliament, or a combination of the two. The King or the Parliament had to be convinced that the incorporation could promote the public good.  Single proprietor enterprises never sought incorporation. Small enterprises of two or more proprietors were, by default, common law partnerships.  The Registration, Incorporation and Regulation Act 1844 shuffled the cards. Now incorporated joint-stock companies could be created by mere registration with the Companies Registry Office, the forerunner of Companies House, established by the Act. Registration required filing a few documents and forms that provided the public with basic information about the company. The Act also made a clear distinction between companies and partnerships. The unincorporated company, a popular form used by some of the smaller firms to avoid the costs of incorporation, lost ground. Unincorporated companies could easily register and enjoy all the legal features of a corporation.  On the other hand, they were obliged to register. The Act required partnerships with transferable shares and partnerships with more than 25 members to register in a manner similar to that required by joint-stock companies.  The Companies Acts 1855–56 provided all companies that decided to opt into it with limited liability. The consolidated 1862 Act was the basis of statutory law for the rest of the 19th century. It adopted the same framework, which assumed companies to be large and public. The 1862 Act, like those of 1844, 1855 and 1856, did not distinguish between companies based on the number of incorporators and shareholders, on capital, or on transferability of shares. The Emergence of the Private Company:  With the introduction of the Companies Act 1962 emerged two new trends: one being the shift to larger firms and the resulting incorporation of growing firms incorporated as what we today call public companies; and two the incorporation of smaller firms, as what we would today call private companies.  Number of companies listed in the market rose from 520 to 1100 by 1913 and much of the increase was in industrial and commercial companies, mining and banking.  Separation of ownership and control in the UK took place early in only a few sectors, notably banking and railway companies. But in other sectors, including industrial companies, insurance companies, shipping companies and electric utilities, the separation of ownership and control began only in the interwar period and was completed only after the Second World War1 1 BR Cheffins, Corporate Ownership and Control: British Business Transformed (OUP 2008) 221–51, 292–300, 350–70.  Annual registration of companies: o The first pattern to be noted is the sharp increase in the total number of companies. Only 124 companies existed in 1824. In 1843, on the eve of general incorporation, about 720 companies were ‘known on the London market’. These were concentrated mostly in the banking, insurance, canal, railway, mining and shipping sectors. o Within 14 months of the passage of the General Incorporation Act 1844, 1,639 joint- stock companies were provisionally registered. o The passage of the Limited Liability Acts caused the re-registration of many companies as limited companies and a continued rise in the number of new registrations. The average number of registrations for the period 1856–69 was 445. In most years after 1872, the number was over 1,000. In each year after 1889, the number was more than 2,500. The annual average for the 1890s was 3,661. In 1907, the year in which the private company was formally introduced, the number of registrations reached 5,147. o Despite the fact that the private company was formally introduced only in 1907, in fact it evolved informally from below after 1862 and was privately ordered by shrewd lawyers.  Average Nominal Capital: o Another indication of the incorporation of the new, smaller type of companies can be found in the average registered nominal capital per company. This average is taken from summaries in the annual reports. The average nominal capital per company declined from £170,188 in the years 1863–69 (average of annual averages in the range), to £82,093 in the 1870s, to £54,479 in the 1890s, to £33,519 in 1900– 1907.  Number of Shareholders: o Another perspective regarding the size of companies is the number of shareholders. As seven was the minimum required by law, even one-person companies had seven nominal shareholders. But larger companies as well incorporated with only seven shareholders: the required signees of the memorandum. This became the standard practice of company lawyers. As a result, the number of shareholders at incorporation provides no valid information on the size of the company.  Who were the private companies? o Until the Companies Act 1907, no formal legal distinction between public and private companies existed2 o One end of the range is the one man company. The Companies Act required a minimum of seven members in a company. The simple solution was to use six dummy members, the legality of which will be discussed below. One step up was a family company in which one of the family members, typically the patriarch, controlled and managed the company by himself. Other members could be employed by the company or receive some of the profits at the discretion of the manager. But governance was not an issue and was not regulated by law. 2 The 1907 Act defined the private company as one whose articles of association prohibited inviting the public to subscribe to its share and debenture capital, restricted the transferability of its shares and limited the number of its shareholders to 50. Companies Act 1907 (7 Edw 7 c 50) s 37(1). made available to the public. This enhanced disclosure requirement created, for the first time, a distinction between private and public companies.  Salomon v Salomon and the legality of private companies: o The 1862 Act, the major consolidated Act in force until 1907, required that any association or partnership with more than 20 partners (10 in banking) be incorporated. It also required a minimum of seven members for the incorporation of a company. o The Act did not include a minimum capital requirement for incorporation. Thus, it allowed for the formation of small, family firm-like and partnership-like companies, as long as they had seven shareholders. o Could a company of less than seven shareholders be formed? What could incorporators and their attorneys do when they wanted to form companies of one to six shareholders in the period between 1862 and 1907? They used nominal shareholders. Was this legal? Were they even recognised as companies? Salomon v Salomon, arguably the most famous case in the 400-year history of English company law, deals, among other issues, with this very question. o Aron Salomon was a well to do boot and shoe manufacturer in July 1892. He traded as sole proprietor under the firm of ‘A Salomon & Co’. Beginning with little or no capital, over 30 years, he gradually built up a thriving business. o In July 1892, ‘Aron Salomon and Company, Limited’, was incorporated with liability limited by shares, and with nominal capital of £40,000 divided into 40,000 shares of £1 each. The memorandum of the company was signed by Aron Salomon, his wife, four sons and one of his daughters. They were each initially allocated one share. Then Salomon sold his sole proprietorship business to the company for 20,000 fully paid shares of £1 and a debenture of £10,000. o In the following year, the company had difficulties due to external factors, such as strikes and changes in the government contracting policy with suppliers, became insolvent, and went into receivership and liquidation. As holder of the debenture, Salomon claimed a dividend as senior creditor, even though some of the unsecured creditors had not been paid. o Salomon utilized, to the utmost, the shielding not only of his private assets but also of the business assets he had transferred from the sole proprietorship by combining fully paid shares, a debenture and floating charges, a common practice at the time. He was protected not only by limited liability as shareholder but also by a senior claim that he personally had as a creditor of the company. The liquidator tried to invalidate Salomon’s claim and to obtain a judgment against Salomon personally in order to pay the unsecured creditors. o The High Court found the arrangement to be a sham and stated- this business was Mr. Salomon’s business and no one else’s; that he chose to employ as agent a limited company; that he is bound to indemnify that agent, the company; and that his agent, the company, has a lien on the assets which overrides his claims. The creditors of the company could, in my opinion have sued Mr. Salomon. The just solution was to allow the liquidator of the company and its creditors access to the private assets of Salomon, the person who remained solvent despite the liquidation of the company. This could be done either through principal’s liability in agency or through personal liability of the principal. o The court of appeal reached a similar conclusion, but framed it differently- There can be no doubt that in this case an attempt has been made to use the machinery of the Companies Act, 1862, for a purpose for which it never was intended. The legislature contemplated the encouragement of trade by enabling a comparatively small number of persons - namely, not less than seven - to carry on business with a limited joint stock or capital, and without the risk of liability beyond the loss of such joint stock or capital. But the legislature never contemplated an extension of limited liability to sole traders or to a fewer number than seven. In truth, the legislature clearly intended to prevent anything of the kind, for s. 48 takes away the privileges conferred by the Act from those members of limited companies who allow such companies to carry on business with less than seven members; and by s. 79 the reduction of the number of members below seven is a ground for winding up the company. Although in the present case there were, and are, seven members, yet it is manifest that six of them are members simply in order to enable the seventh himself to carry on business with limited liability. The object of the whole arrangement is to do the very thing which the legislature intended not to be done; and, ingenious as the scheme is, it cannot have the effect desired so long as the law remains unaltered. o HL reversed the decision of the lower courts- I must pause here to point out that the statute enacts nothing as to the extent or degree of interest which may be held by each of the seven, or as to the proportion of interest or influence possessed by one or the majority of the share-holders over the others. One share is enough. Still less is it possible to contend that the motive of becoming shareholders or of making them shareholders is a field of inquiry which the statute itself recognises as legitimate. If they are shareholders, they are shareholders for all purposes; and even if the statute was silent as to the recognition of trusts, I should be prepared to hold that if six of them were the cestui que trust of the seventh, whatever might be their rights inter se, the statute would have made them shareholders to all intents and purposes with their respective rights and liabilities, and, dealing with them in their relation to the company, the only relations which I believe the law would sanction would be that they were corporators of the corporate body. All the other Law Lords held, similarly, that the question is one of statutory interpretation and that the statute is very clear. Any seven members, whatever their interest in the company, even a single nominal share, and whatever the relationship between them, patriarchal subordination or entrustment, can constitute a company. Lord MacNaghten said, Four of the sons were working with their father. The eldest, who was about thirty years of age, was practically the manager. But the sons were not partners: they were only servants. Not unnaturally, perhaps, they were dissatisfied with their position. They kept pressing their father to give them a share in the concern. ‘They troubled me,’ says Mr. Salomon, ‘all the while.’ So at length Mr. Salomon did what hundreds of others have done under similar circumstances. He turned his business into a limited company. He wanted, he says, to extend the business and make provision for his family. Lord MacNaghten’s description is remarkable. Incorporation was the first step in changing the governance structure of the firm, in preparation for transferring this family firm to the second generation. The firm was in the process of transforming from a single-person or patriarchal family firm into a second-generation family firm that is more like a partnership among the siblings. The Lords in Salomon v Salomon intended to facilitate a productive and advantageous social phenomenon—the conversion of under- legalized family firms into joint-stock companies with well-defined legal status. o The 1907 Act settled the issues of nominal shareholders and a single-person company by introducing the private company. This was defined, as mentioned above, as a company that, in its Articles of Association, commits not to raise capital from the public, to have restrictions on share transferability and to have no more than 50 shareholders. One of the features that distinguished this new type of company from the public company was that it could be formed with only two shareholders, unlike the public company that still required the magical number of seven. Piercing the Corporate Veil in the UKSC Following a decades-long wait for the House of Lords to clarify Lord Keith’s dictum in Woolfson v Strathclyde Regional Council 1978 S.C. (H.L.) 90 that the corporate veil can only be “pierced” at common law “where special circumstances exist indicating that [a company] is a mere fac¸ade concealing the true facts”, the Supreme Court has now considered this jurisdiction twice in quick succession (its first decision being VTB Capital plc v Nutritek International Corporation [2013] UKSC 5; noted [2013] C.L.J. 280). Prest v Petrodel Resources Ltd. [2013] UKSC 34 concerned an application by Mrs Prest against her husband for ancillary relief under the Matrimonial Causes Act 1973 (“MCA”), ss. 23–24 following their divorce. Mrs Prest joined seven companies, ultimately owned and controlled by her ex- husband, as co-respondents to her application, alleging that they held certain London properties (including the matrimonial home) on behalf of Mr Prest. Moylan J. ordered Mr Prest to pay his ex- wife £17.5m ([2011] EWHC 2956 (Fam)) and to procure the transfer of seven London properties held by Petrodel Resources Ltd (“PRL”) and Vermont Petroleum Ltd (“Vermont”) in satisfaction of that liability. His Lordship considered that, as Mr Prest “effectively” owned those properties, the MCA’s “purpose and intention” justified his ordering their transfer. A majority of the Court of Appeal disagreed ([2012] EWCA Civ 1395), finding no basis at common law or under the MCA for Moylan J.’s property transfer order. Before a seven-member Supreme Court, Mrs Prest argued that Moylan J.’s property transfer order was justifiable if the court was prepared to pierce the companies’ veil (either at common law or pursuant to the MCA) or to accept that the companies held the London properties on trust for Mr Prest, so that he was “entitled, either in possession or reversion” to them under MCA, s. 24(1)(a). The Supreme Court unanimously accepted the latter suggestion. Lord Sumption considered that the meagre evidence pointed to Mr Prest having directly or indirectly provided the purchase price for the London properties. Accordingly, it was presumed that “PRL was not intended to acquire a beneficial interest in [those properties]” and held them on resulting trust for Mr Prest. Moreover, Mr Lord Sumption held that the properties owned by the companies were indeed owned beneficially by Prest by means of a resulting trust, rather than by piercing the corporate veil. A resulting trust is a specific term of English law. “Resulting” in this context is from the Latin resultare, to spring back, meaning that under certain circumstances a transfer may not be seen as final and, despite the transferee’s apparent ownership of the asset, the ownership “springs back” to the transferor. A common example is when an asset is transferred to another person or company for a particular purpose but that purpose is not the one for which that the asset is used or the purpose is impossible to fulfil. The transferee only holds the asset as a resulting trustee for the transferor who is the beneficial owner of the asset and in these circumstances the asset “springs back” to the transferor.9 Megarry VC stated in Re Sick and Funeral Society of St John’s Sunday School, Golcar,10 that “a resulting trust is essentially a property concept; any property that a man does not effectually dispose of remains his own”. The important word is “effectually”. Although Prest had transferred the properties to the various companies, sometimes only for £1, given the smallness of the consideration, the reluctance of the companies to comply with any of the previous courtordersand,inparticular,therefusaltogivedetailsofthecompletionstatements or loan agreements for the purchases of the various properties, it was acceptable to draw the adverse inference that the companies were acting as resulting trustees for Prest and that Prest retained the beneficial ownership of the properties. In that case the properties constituted assets that “sprang back” to him personally. As the properties were his, even if the titles to the properties were in the companies’ hands, the companies could be required to transfer the properties to his wife. The essential point was not who controlled the companies but for whose benefit the companies owned the properties. In the process of arriving at this solution to Mrs Prest’s difficulties, the Supreme Court thoroughly examined the concept of piercing of the corporate veil. Lord Sumption and Lord Neuberger set out for the future the law on corporate veilpiercing and have restricted it only to those occasions when a company is being used to evadea legal obligation or to frustrate the operation of law. Other recent corporate veil cases such as VTB Capital plc v Nutritek International Corp11 and Chandler v Cape plc,12 show a similar reluctance to pierce the veil.13 Lord Neuberger’s judgement in Prest also looked at piercing the veil in the Commonwealth and in the USA.14 Given the absence of consensus, he decided that it was almost impossible to specify exactly when the corporate veil should be pierced and that perhaps the whole concept should be abandoned.15 However, given the weight of previous cases, he was persuaded that Lord Sumption’s limited formula of piercing the veil only where there was evasion of a legal obligation or frustration of the operation of the law was acceptable16 except where Parliament specifically allowed for it in statute. So what is meant by evasion of a legal obligation or frustration of the operation of law? A good example in Lord Sumption’s eyes was Gilford Motor Co Ltd v Horne where Horne unsuccessfully tried to avoid a restrictive covenant, preventing him soliciting former clients, by using a company owned by his wife and an employee to solicit them instead. Notes from the seminar Companies do have separate legal personality, but this is a fiction of the true picture as to get a real picture of the company, one must look at the members of the company and their relation with the company and third party outsiders. Consequences of separate legal personality: asset partitioning, the assets of the company and the assets of the members are separate- Benefits creditors as there is no competition between the creditors of the member and the creditors of the company. Limited liability for its members. Transferability of shares- the actual wealth of a shareholder is irrelevant for the assets of the company and the creditors, other members do not have to worry about the credit worthiness of other members as they are only liable up to the nominal value of their interest. Facilitation of transferability of shares has allowed for the facilitation of capital markets and allowed for hostile take overs to take place. Perpetual succession- their existence does not depend on the fluctuation of members. If the MemArts have a company expiration date and upon naturalisation of this day it must be decided by the members that the company should be dissolved, failing to which the company will carry on being a living entity. Management under a board- thus splitting management from ownership- the law requires to have two different bodies i.e. the owners and directors and this leads to the imposition of rights duties and obligations on directors over shareholders. Due to separate personality, companies have a reputation thus can be defamed and can sue for defamation. Rationale apathy- unless there is a primary investor who holds a majority of the shares, small members don’t have the power to influence change. Lifting the corporate veil VTB case- questions the doctrine of piercing the corporate veil- is there such a thing? They raised the issue in the case. Simply because someone is a controller of company this should not be a reason to pierce the veil and hold him liable for faults of the company. Prest- court said a lot about piercing the veil- veil will be pierced if the company structure is used to evade a legal obligation or frustrate the operation of law. Concealing the true identity is a legitimate reason to incorporate and it is not difficult to find out who is in control of the company due to for example the register of controlling shareholders- do not need to use piercing the corporate veil where it is a façade? Sham- only case of abuse of separate personality e.g. defrauding pre-existing creditors. Lifting the veil should be available as a last resort remedy! Adam- piercing the veil should be available when justice is required and thus the court must have discretion to decide when to pierce the veil when justice is abused- this argument was shot down in the court i.e. it was not accepted. Abuse of limited liability: 1. Fraudulent trading- in the course of winding up of the company, if it is realised that the actions of the company were carried out with an intent to defraud creditors of the company or any other fraudulent purpose, anyone involved can be held to be personally liable. (s. 213 IA 1985 – civil liability and s. 993 CA 2006 – criminal offence; s. 246ZA IA 1985 - fraudulent trading: administration) there needs to be actual proof of intention to defraud creditors this may be very difficult to prove. 2. Wrongful trading- (s. 214 IA 1986; s. 246ZB IA 1986 - wrongful trading: administration)- a director or a shadow director at some time before the commencement of the winding up of the company, knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation, but continued to trade (not taking account of the creditors as a result). Requires recklessness or negligence- directors have a fiduciary duty to take into account the interest of creditors- decide on the level of risk they want to undertake- cease trading no obligation in its own due to the rescue culture as obliging them to cease trading in the event the presume the company is going under then it may not be beneficial for creditors in some instances for the company to stop trading. The problem with this claim is that until recently only the liquidator could introduce-now liquidators can sell the claim to specialised third parties.