Chapter 7 - Companies: the consequences of incorporation

Question 1

What is a company?

Answer 1

A UK company is formed by incorporation under the Companies Acts 2006. A company is a legal person. It has a separate legal entity from its owners (shareholders) and its managers (directors).

Question 2

What are the different types of companies? (4)

Answer 2

• Unlimited companies (very rare)
• Private Limited Company limited by shares
• Private Limited Company limited by guarantee
• Public Limited Company

Question 3

Define a private company.

Answer 3

A private company is any registered company (limited or unlimited) that is not stated to be a public limited company.

Question 4

Define a public company.

Answer 4

A public company is a limited company expressly registered as a public company under the Act.

Question 5

Define liability limited by shares (public or private).

Answer 5

Liability is limited to the amount of the nominal value, if any, unpaid on members’ shares held by them (including any premium payable by the current owner in respect of them).

Question 6

Define liability by guarantee (private only).

Answer 6

Liability is limited to such amount as the members undertake to contribute to the company’s assets in the event of it being wound up.

A company limited by guarantee cannot be registered with a share capital.

A company limited by guarantee is often a charity or trade association.

Question 7

Are the liabilities of a limited company unlimited?

Answer 7

The liability of the company itself is always unlimited.

However, the liability of the members of a company for the debts of the company may be limited.

Question 8

Define unlimited liability (private only).

Answer 8

There is no limit on the members’ liability. They can be compelled to contribute as much as may be necessary to pay the company’s debts in full.

An unlimited company does not need to file annual accounts, subject to certain conditions.

Question 9

What are listed companies?

Answer 9

Quoted companies are also known as listed companies. This is because their shares are listed (or quoted) on public stock exchanges.

Question 10

What is meant by a company being a seperate legal entity to its owners and managers?

Answer 10

A company is a separate legal entity to its shareholders and its directors. This means:
* It is an artificial person
* Its members have limited liability
* It can sue and be sued in its own right
* It has the ability to hold property
* It continues in existence (despite changes in membership) known as continual succession

Question 11

What is the seperate legal entity given to incorporated companies referred to as?

Answer 11

The veil of incorporation

Question 12

What is the veil of incorporation?

Answer 12

The veil of incorporation is a legal concept that separates a company from its shareholders, directors, and managers, and protects the personal assets of these individuals from the company’s actions

Question 13

Outline the case of Salomon v Salomon & Co Ltd 1897 and what we can conclude from it

Answer 13

The facts: The claimant, Salomon, had carried on business as a leather merchant and boot manufacturer for 30 years. He decided to form a limited company to purchase the business. He and six members of his family each subscribed for one share. The company then purchased the business from Salomon for £38,782, the purchase price being by way of the issue of 20,000 £1 shares, the issue of debentures for £10,000 (effectively making Salomon a secured creditor) and the balance in cash. The company did not prosper and was wound up a year later, at which point its liabilities exceeded its assets. The liquidator, representing unsecured trade creditors of the company, claimed that the company’s business was in effect still the claimant’s (since he owned all but six of the issued shares), that he should bear liability for its debts and that payment of the debenture debt to him should be postponed until the company’s trade creditors had been paid.

Decision: The Court of Appeal held that since the other shareholders were ‘mere puppets’ and that the company had been irregularly incorporated, Salomon should indemnify the company against its liabilities. The House of Lords however held that the business was owned by, and its debts were liabilities of, the company. The claimant was under no liability to the company or its creditors, his debentures were validly issued and the security created by them over the company’s assets was effective. This was because once the company had been found to have been formed in compliance with the formal procedures set out in the Companies Act, the company was regarded as a legal entity in its own right, notwithstanding the dominant position of Salomon within the company.

The first case that clearly demonstrated the separate legal personality of companies - the veil of incorporation

Question 14

Upon a company limited by shares being wound up, what amount would be owed by members for: i) fully paid shares, ii) partly paid shares, iii) unpaid share premiums

Answer 14

Question 15

Upon a company limited by guarantee being wound up, what amount would be owed by members

Answer 15

The amount they guaranteed to pay in the event of a winding up.

Question 16

Can the ‘veil of incorporation’ be lifted?

Answer 16

The ‘veil of incorporation’ said to be drawn between the company and its members may be lifted in certain circumstances.

This may be done by the courts in order to defeat fraud, sharp practices or illegality.

The ‘veil of incorporation’ might be lifted in the following situations:

1. To produce tax liability
2. To prevent tax evasion
3. To give entitlement to compensation
4. To reveal true national identity and expose illegality
5. Quasi-partnership
6. Where a company is a sham (i.e. to prevent an evasion of obligations, to reveal national identity)
7. Where director is disqualified
8. Fraudulent and wrongful trading
9. Trading without a trading certificate

(read the notes for specific case examples)

Question 17

Can a company change its status (i.e. limited to unlimited) and if so how many times and how?

Answer 17

A company may alter its status once, as follows:

1. Limited to unlimited: with the consent of all members of the company.
2. Unlimited to limited: by passing a special resolution to that effect and specifying whether the company is to be limited by shares or guarantee

A company limited by shares may not re-register as a company limited by guarantee, and vice versa.

Question 18

Compare these key features for public and private companies: i) Liability, ii) Share capital, iii) Ability to commence trade, iv) Public offers, v) Name, vi) Loans, vii) Directors, viii) Company secretary, ix) Written resolutions, x) AGMs, xi) Accounts and report, xii) Audit exemptions, xiii) Appointment of auditors, xix) Pre-emption rights, xx) Payment for shares, xxi) Reduction of capital, xxii) Power to redeem or purchase shares out of capital

Answer 18

Question 19

What are “off the shelf” companies

Answer 19

Where you can buy a company that has already been incorporated.

Question 20

What are the advantages and disadvantages of ‘off-the-shelf’ companies?

Answer 20

Advantages:
* It is obviously a quicker way of achieving the result of having a company ‘ready to go’.
* It avoids any potential liability arising from pre-incorporation contracts (see section 3.3) as the company already exists.

Disadvantages:
* The following changes may need to be made which will take time or cost money: Change of name, Transfer of subscribers’ shares, Change of directors and possibly company secretary, Alteration of articles

Question 21

Which documents must be sent to the Registrar of Companies in order to form a company?

Answer 21

1. Memorandum of association
2. Application
3. Statement of capital and initial shareholdings (applicable to a company with a share capital)
4. Statement of guarantee (applicable to a company limited by guarantee)
5. Statement of proposed officers
6. Statement of compliance

Articles of association may also be submitted, but if none is supplied, the default articles will apply.

Question 22

ONce the neccesary documentation has been filed with the registrar, what will the registrar provide the company with?

Answer 22

The Company Registrar will register the company and will issue a certificate of incorporation, naming and describing the company and giving its date of incorporation and registered number.

Question 23

What further documentation must public companies acquire before they can commence trading?

Answer 23

Note that a public company also needs to obtain a trading certificate before it can commence trading. It must submit:
* An application stating (amongst other things) that the nominal value of the company’s allotted share capital is not less than the ‘authorised minimum’
* A statement of compliance

Question 24

What is a promoter?

Answer 24

A promoter is a person who takes the procedural steps to get a company incorporated; the term ‘promoter’ includes anyone who makes business preparations for the company.

However a person who acts merely in a professional capacity in company formation, such as a solicitor or an accountant, is not on that account a promoter.

Question 25

What duties does a promoter owe to a company?

Answer 25

1. A general duty to exercise reasonable care and skill
2. A fiduciary duty to disclose any personal interest in a transaction and, sometimes, to account for monies received. Generally speaking, any profits which they make from promoting the company and fails to disclose must be surrendered to the company. However, if they disclose them and the company gives consent, they may retain any legitimate profits.

Question 26

What are pre-incorporation contracts?

Answer 26

A contract which the promoter enters into purportedly in the name of the company before the company has come into existence (i.e. received the certificate of incorporation).

Question 27

What are the consequences of a promoter entering into a pre-incorporation contract?

Answer 27

1. The company cannot ratify the contract since it did not exist when the contract was made.
2. The company is not bound by it even after incorporation and even if it has derived some benefit from it.
3. The company cannot enforce the contract against the third party unless the promoter and third party have given rights of action to the company.
4. The contract takes effect (subject to any agreement to the contrary) in the same way as one made with the promoter and they are personally liable on it.

Question 28

In what ways can a promoter avoid potential liability?

Answer 28

By:

1. not making contracts until the company has been incorporated;
2. using an off-the-shelf company; or
3. agreeing a draft only with the third party on the basis that the company, once formed, will enter into the agreed form with the third party.

Where a promoter is already liable on a pre-incorporation contract, they may be able to arrange for the company to novate the contract (ie, enter into a new contract on identical terms), in which case they should also secure the third party’s consent to the promoter thereupon being released from personal liability.

Question 29

What are the rules regarding company names?

Answer 29

1. The company will not be registered if the Registrar considers the name to be offensive, or if its use could constitute a criminal offence.
2. The approval of the Secretary of State is required if the name is sensitive in some way or likely to suggest some connection with central or local government, or any public authority. Words such as ‘British’ or ‘International’, for example, are only likely to be sanctioned if the size of the company matches its pretensions.
3. Words which indicate that the company is of another type or legal form are not permitted (i.e. XYZ Limited Plc).
4. A company cannot be registered if its name is the same as or virtually the same as the name of an existing company.

Question 30

Can a company change its name? How?

Answer 30

Yes.

A company may choose to alter its name at any time by passing a special resolution to that effect or otherwise as provided for in its articles.

Question 31

Can the Secretary of State order a company to change its name?

Answer 31

Yes.

The Secretary of State may order a company to change its name for a number of reasons, including where it is considered to be the same as or virtually the same as an existing company name or that it might otherwise mislead the public.

Question 32

What are the rules around disclosure of company names? What are the repurcussions for breach of this?

Answer 32

• The name of the company must be displayed in certain locations and on certain documents in accordance with regulations made by the Secretary of State
• The name must also be engraved legibly on the company seal

Breach of either provision may result in a fine.

Question 33

What are business names and what are the rules around them?

Answer 33

A company may adopt a ‘business name’ - trading name it uses to operate (can be the same or seperate to their registered name)

Business names are subject to similar rules as to words or names that are misleading or otherwise prohibited or that require the approval of the Secretary of State in the case of company names.

Most companies carry on business under their registered names.

Question 34

What are articles of association and are they necessary to be filed with the registrar?

Answer 34

Articles of association are articles (documents) that prescribe regulations governing the management of the company’s affairs, the rights of the shareholders and the powers and duties of the directors - company’s internal rules that define how the company is run.

Articles of Association are also required to filed with the registrar if the company does not want to use the default articles (which will apply if no other articles are submitted).

Question 35

What is a companies constitution and what is its contractutal effect?

Answer 35

A company’s constitution is a set of rules that govern how a company is run and the relationship between the company and its shareholders, made up of the the articles of association and relevant resolutions

A company’s constitution has the following contractual effect:
* Binds the company to its members
* Binds members to members
* Does not bind the company to third parties.
* Only to members in their capacity as members (not as third parties)

Question 36

How can articles be altered? What is required of the company once the alteration is agreed?

Answer 36

A company may normally alter its articles by passing a special resolution to that effect

However, where the articles contain ‘provision for entrenchment’ such provisions can only be altered with the agreement of all company members or by court order.

A copy of any amended article must be sent to the Registrar within 15 days.

Question 37

Define company records?

Answer 37

The term ‘company records’ refers to any register, agreement, minutes, accounting records or other documents required to be kept by the Act.

Question 38

What records are a company required to keep?

Answer 38

1. A register of members
2. A register of directors and (if applicable) company secretaries
3. A register of people with significant control
4. A register of directors’ residential addresses
5. Copies of directors’ service contracts and indemnity provisions restricting directors’ liabilities
6. Records of resolutions and minutes of members’ and directors’ meetings (for a period of 10 years)
7. Directors’ statement and auditor’s report
8. A register of charges and copies of charges

Question 39

What does the register of each company contain?

Answer 39

1. the certificate of incorporation
2. the trading certificate (if it is a public company)
3. certificates of registration of charges
4. the information contained in documents delivered to the Registrar in accordance with any statutory provision

Question 40

Who has the right to inspect a company’s register?

Answer 40

Any person has the right to inspect the register and, with payment of a fee, to require a copy of any material on the register. The exception of information one can inspect is with this right include:
* Protected information on directors’ residential addresses
* The contents of any charges

Question 41

What is a confirmation statement? When must it be filed?

Answer 41

A confirmation statement is a form that confirms a company’s information is up to date with the registrar

Every company must send a confirmation statement to the Registrar. The statement can be sent at any time, but no more than 12 months may elapse between statement submissions.

Question 42

Give examples of examples of information requiring confirmation?

Answer 42

1. The address of the registered office of the company
2. The address (if different) at which the register of members or debenture holders is kept
3. The type of company and its principal business activities
4. The total number of issued shares, their aggregate nominal value and the amounts paid and unpaid on each share
5. For each class of share, the rights of those shares, the total number of shares in that class and their total nominal value
6. Particulars of members of the company
7. Particulars of those who have ceased to be members since the last return
8. The number of shares of each class held by members at the return date, and transferred by members since incorporation or the last return date
9. The particulars of directors, and secretary (if applicable)

Question 43

What records and reports are companies required to produce with regards to accounts?

Answer 43

• Accounting records
• Annual accounts
• Director’s report
• Director’s remuneration report (quoted companies only)
• Audit report (where applicable)
• Strategic report (large and medium companies only)

Question 44

What are the regulations for companies with regards to accounting records?

Answer 44

A company must keep ‘adequate accounting records’ that are sufficient to show the company’s financial position at any time with reasonable accuracy, including:
* Daily entries of income and expenditure
* Record of assets and liabilities
* Statements of stock and stock takings (if applicable)

Question 45

What are the regulations for companies with regards to annual accounts?

Answer 45

A company must prepare annual accounts (i.e. a statement of financial position and statement of profit or loss).
The accounts must be:
* Approved by and signed on behalf of the board of directors
* Filed at the Registry within 9 months (private company) or 6 months (public company) after the end of the accounting period
* Give a ‘true and fair view’ of the company’s financial position in respect of its financial year

Consolidated group accounts are normally required where the company is a parent company.

Question 46

What are the regulations for companies with regards to a director’s report?

Answer 46

A director’s report, approved by and signed on behalf of the board of directors, must be prepared in respect of the financial year, including the following details:
* Names of directors
* Principal activities of the company
* Statement that the auditor is not unaware of any relevant audit information (if applicable)

A consolidated report should be produced where group accounts are prepared

Question 47

What are the regulations for companies with regards to a director’s remuneration report?

Answer 47

Quoted companies must disclose directors’ remuneration.

Question 48

What are the regulations for companies with regards to an auditor’s report?

Answer 48

Where accounts are audited the report must:
* Identify the accounts audited and the financial reporting framework applied in their preparation
* Describe the scope of the audit
* State that, in the auditor’s opinion, the accounts give a true and fair view of the company’s financial affairs
* State that the directors’ report is consistent with the accounts

Question 49

What are the regulations for companies with regards to a strategic report?

Answer 49

Large and medium sized companies must prepare a strategic report as part of their financial statements. T

his includes a fair review of the company’s business as well as a description of the principal risks and uncertainties facing the business. Its purpose is to allow members to assess how well the directors have performed their duty to promote the success of the company.

Must also report on environmental matters, to the extent that this environmental information is necessary for an understanding of the development, performance or position of the companies business

Question 50

ADDITIONAL COMPANY REGULATIONS

Question 51

What companies are exempt from audit?

Answer 51

All companies are required to carry out an annual audit unless they fall within the following exceptions:
* Micro and small companies (unless insurance or banking)
* Dormant companies (unless insurance or banking)
* Non-profit making companies subject to a public sector audit
* Subsidiaries whose parent company guarantees their liabilities at the balance sheet date

Question 52

Can shareholders request a company to be audited?

Answer 52

10% of the shareholders can request an audit even where an exemption applies.

Question 53

Outline the rules that determine if a company is micro, small or medium sized

Answer 53

Must comply with 2 or more of the tests in the table

Question 54

Who appoints auditors? How can auditors be removed?

Answer 54

Auditors are appointed for each financial year by the shareholders or directors, and in a private company are deemed to be reappointed unless the company decides otherwise. An auditor can be removed by ordinary resolution on special notice.

Question 55

What is a company secretary?

Answer 55

A company secretary is a key governance role that ensures a company complies with legal and financial requirements. They also act as a liaison between the board of directors and shareholders.

A company secretary:
* is an employee of the company
* is an ‘officer’ of the company and therefore faces potential civil and criminal liability alongside the directors
* will convene the meetings of the board of directors, issue the agenda and draft the minutes
* will be responsible for the various statutory registers and for filing documents with the Registrar
* has the power to contract on behalf of the company in respect of its administrative operations, including the employment of office staff and management of the office generally. Thus he may bind the company by his actions on the basis of implied actual authority as well as any express or ostensible authority. However, a company secretary’s implied authority is limited and does not extend to buying land, for example, nor to borrowing money, nor to doing other acts usually undertaken by the directors.