NATURE AND FORMATION OF COMPANIES

Question 1

TYPES OF REGISTERED COMPANIES
Under English law, all companies are required to be regis-
tered with the Registrar of Companies. There are however
several diferent categories of registered company

Answer 1

1. Unlimited Companies
2. Limited Companies
   （1）Limited by Guarantee
   （2）Limited by Shares
   a. Private Company
   b.Public Company

Question 3

Unlimited Companies

Answer 3

1. Unlimited companies are rare. The members of an unlimited
   company are personally liable for all the debts of the compa-
   ny, in the same way as the partners in a general partnership
   or a sole trader.
2. One of the benefts of being an unlimited company is
   that it is not obliged to publish its accounts and so enjoys a
   higher degree of confdentiality than a limited company.

Question 4

Limited by Guarantee

Answer 4

A company limited by guarantee requires its members to pay a fxed, guaranteed amount (usually £1) in the event of the
company being wound up. This type of business model is
usually used for not-for-proft organisations, such as charities where there is no need for members to make large capital
contributions for the business to be capable of running. In a
company limited by guarantee there are no shareholders (for obvious reasons), but the company must have at least one
member (or guarantor).

Question 5

Limited by Shares

Answer 5

1. In a company limited by shares the members (also called
   shareholders) do not have any personal liability for obliga-
   tions of the company beyond the amount they agreed to
   pay for their shares.
2. If a shareholder has fully paid for their shares (the usual case) and the company becomes insolvent, the shareholder has no personal liability to pay any more.
3. Companies limited by shares are classifed either as private
   limited companies or public limited companie

Question 6

Private Limited Companies

Answer 6

1. Private limited companies are the most commonly registered business medium at Companies House
2. The main
   diference between a private limited company and a public
   limited company is that a private limited company is not per-
   mitted to issue its shares to the public, they are allowed to be sold only by private agreement.

Question 7

Public Limited Companies

Answer 7

1. Public limited companies (‘PLCs’), in contrast to limited com-
   panies, are permitted to issue their shares to the public, and
   if the PLC is listed, to trade their shares on a stock market.
2. To be able to publicly trade, the PLC is subject to additional
   registration and fling requirements, most notably the need to have a minimum nominal share capital of £50,000 and a
   trading certifcate.

Question 8

FORMATION
Promoters

Answer 8

Since a company is a legal entity that does not exist until it
registers at Companies House, someone has to go about
arranging for investors and registration to bring the compa-ny into existence. We call such people the company’s ‘pro-moters’.

Question 9

Memorandum of Association

Answer 9

One of the things a promoter will do is create a Memoran-
dum of Association. This is a statement authenticated/signed by persons wishing to become members of the company.
It indicates that the subscribers (signers) wish to form the
company and agree to become members of the company.

Question 10

Promoter Owe Fiduciary Duties

Answer 10

Like directors and partners in a partnership, promoters owe
a fduciary duty to the company—a duty of good faith. For
example, a promoter must disclose any personal interests in
any transactions entered into with/on behalf of the company and account for any proft made as a result.

Question 11

Pre-Incorporation Contracts

Answer 11

1. In addition to gathering interested investors, often, before a company comes into existence, promoters will make contrac-
   tual arrangements to enable the company to operate once
   it is registered and a certifcate of incorporation is issued.
   We call such contracts ‘pre-incorporation contracts.’
2. Because the company is not yet in existence, it
   cannot be a party to such contracts. Therefore, both common law and the Companies Act 2006 provide that a promoter
   will be personally liable on pre-incorporation contracts, that
   is, contracts purported to be entered into by a company
   before it has been registered at Companies House and
   the certifcate of incorporation received.
3. And note that this
   liability does not disappear once the company is formed—the promoter remains personally liable even after the company is formed unless diferent arrangements are made

Question 12

Ways Promoters Can Protect Themselves
There are a number of ways a promoter can protect them-selves against personal liability:

Answer 12

*Prepare the contract in draft and do not execute it until the company has been incorporated;
*Enter into a novation agreement after the company is in-
corporated (a novation agreement is a contract between
the three parties—the promoter, the company, and the
outside contracting party—under which the parties agree
to substitute the company for the promoter, thus releas-
ing the promoter from personal liability on the underlying
pre-incorporation contract);
*After the company is incorporated, enter into a contract
with it assigning the beneft of the pre-incorporation
contract to the company in exchange for the company’s
agreement to indemnify the promoter for any liability to
the other contracting party (that is, obtain an agreement
from the company that it will reimburse the promoter if
the promoter is held personally liable on the contract); or
*Set up the company faster by using a shelf company and
then entering into the contract

Question 13

Shelf Companies

Answer 13

If a promoter is in a hurry to incorporate a company, then a
shelf company may be a good option. These are companies
that are pre-incorporated, but have never traded, often set
up by solicitors, that the promoter can simply purchase and
take over by changing basic details like the members. The
shelf company will be in a standard form, so it may not be
suitable if a company with bespoke articles of association is
required

Question 14

Application for Registration
For a company to become incorporated and come into exis-
tence, the promoters of the company must fle the Memoran-dum of Association (discussed above) with the Registrar of
Companies at Companies House along with an application
for registration. The application for registration must include the following:

Answer 14

*The proposed name of the company;
*The location of the registered ofce (that is, the place
where all communications or notices are to be addressed;
it must be in the jurisdiction in which the business is locat-
ed, and it usually is the place where the company does
business or its solicitor’s or accountant’s ofce);
*Details of the company’s business activity and SIC (Stan-
dard Industrial Classifcation) code;
*Whether the company will be limited by shares or guar-
antee;
*Whether the company is private or public;
*Details of subscribers;
*A statement of capital and initial shareholdings
*A statement of the proposed ofcers (the people who
run the company; its directors who may, but need not
be members of the company), including their residential
address, and the company secretary (required for public
companies but not for private companies)
*Details of persons with signifcant control
*A statement of compliance with the terms of the Compa-
nies Act 2006
*Payment of the relevant fee.

Question 15

Statement of Capital and Initial
Shareholdings
If the company is limited by shares, the Application for Regis-
tration must include:

Answer 15

*A statement of the total number of shares of the compa-
ny to be taken by the subscribers of the Memorandum of
Association;
*The aggregate nominal value of those shares (that is, a
statement of the aggregate amount of the least amount
for which each share is to be sold, which often is stated
as £1 per share in private companies and has nothing to
do with what the shares are actually sold for, although it
certainly can be more realistic; if the directors approve a
sale for less than the stated value, they can be liable for
breach of duty);
*If the shares are to be divided into classes with varying
rights, a description of those classes and rights; and
*The amount that will be paid up by shareholders and any
amount left unpaid for the shares.

Question 16

Certifcate of Incorporation

Answer 16

Once the Registrar has inspected the registration documents, and assuming they are all in order, they will issue a certifcate of incorporation containing the company’s unique registra-
tion number. This document is essentially the birth certifcate of the company, and it is from the date stated on this certif-
cate that the company becomes a legal entity and can legally commence trading with the protection of limited liability.

Question 17

CONSTITUTION

Answer 17

1. A company’s constitution is simply its articles of association plus any resolutions or agreements adopted by the members to amend its articles of association
2. The Secretary of State has prescribed model sets of articles
   for the various types of companies. The model articles apply automatically if a company has not drafted and submitted
   amended or bespoke articles to Companies House
   Exam Tip
   Because the Registrar may supply a set of model ar-
   ticles, Articles of Association are not one of the doc-
   uments required to be fled at Companies House to
   register a company.

Question 18

Content of Articles of Association

Answer 18

*Directors’ meetings and decision making;
*Appointment and removal of directors;
*Share capital (including issuing, allotting, and transferring
shares);
*Rights attached to shares, including voting and divi-
dends; and
*Shareholder meetings (including, for example, notice and
quorum requirements).

Question 19

Objects of the Company
The articles can restrict the objectives of the company (for
example, “The object of this Company is to operate restau-
rants”).

Answer 19

1. restricted object
2. unrestricted object

Question 20

Restricted Objects

Answer 20

If the articles restrict the objects, the directors have a duty to adhere to the restriction. If they do not adhere to the re-
striction, they breach their duty and may be subject to (1) an
injunction preventing the restricted action if it has not already carried out or (2) an equitable action by the company for any damage caused. **However, the company action that was be-
yond the scope of what was authorised is nevertheless valid. **

Question 21

Unrestricted Objects

Answer 21

If the articles do not restrict the objects of the company, the
company is free to carry on commercial activity of any kind.
The model articles do not include any restriction and, thus,
most newly formed companies are unrestricted.

Question 22

Legal Effect ofArticles ofAssociation

Answer 22

1. **The articles form a contract between the company and each of the shareholders, and the shareholders with each other.
2. It is important to note that the right of shareholders to enforce
   provisions of the articles relates to their** membership rights **
   only (for example, to enforce dividend or voting rights against the company).
3. A shareholder is unable to enforce the articles acting in any other capacity, for example, if they also act as a director of the company.

Question 23

Compare—Shareholders’ Agreements

Answer 23

In addition to whatever the articles provide, the sharehold-
ers may wish to enter into an additional contract to regulate
their afairs, known as a shareholders’ agreement. Unlike the articles, which are a public document and bind all members
whether or not they sign them, a shareholder agreement is a private contractual agreement which binds only those mem-
bers who sign it.

Question 24

Alteration of the Articles ofAssociation

Answer 24

A company can alter its articles by special resolution (which
is discussed at 7.1.4, below). However, an alteration cannot re-quire a shareholder to increase their liability to the company,
that is, force a shareholder to subscribe for more shares.

Question 25

Entrenchment

Answer 25

1. under the provisions of the Companies Act 2006, ordinary shareholder resolutions require approval by a simple majority of the shareholders
   (that is, more than 50%), but special resolutions must be
   approved by at least 75% of the members.
2. The Companies Act also allows for certain provisions of the articles to be
   ‘entrenched’, that is, to require a more onerous process for alteration than those required for a special resolution (for
   example, approval by all members).
3. Restriction Can Be in Articles at Formation or Included by an Alteration to the Articles
4. Registrar Must Be Given Notice Of Restriction
5. The company must give notice to the Registrar that its
   articles include such a restriction.
   uRestriction Cannot Completely Prevent Amendment
   A provision purporting to prevent amendment of a com-
   pany’s articles will be inefective because, regardless
   of the provision, the articles may be revised if a special
   resolution of the members is passed.

Question 26

Constitution
Alteration in the Best Interests of the Company

Answer 26

Generally, it is for the shareholders to decide whether an
alteration of the articles is for the beneft of the company.
However, if the shareholders make an alteration that no
reasonable person would consider to be for the beneft of
the company, a shareholder who did not vote in favour of the alteration can challenge it by making an application to court.
If the court decides that no reasonable person would deem
the alteration to be a beneft to the company, it can set the
alteration aside

Question 27

Constitution
Alterations Adversely Affecting MinorityInterests

Answer 27

That an amendment adversely afects minority sharehold-ers is not sufcient grounds for objection if the alteration is made in good faith in the interests of the company.
However, the alteration cannot be in the interests of
the company as a whole if it discriminates against some members rather than others, so the courts will consider
whether the beneft derived from the alteration is one
that any individual hypothetical member could enjoy.

Question 28

Lifting the Veil of Incorporation

Answer 28

This is most likely
to happen if the company is formed to carry out a fraud or to avoid an existing obligation.

Question 29

Fraudulent and Wrongful Trading

Answer 29

If a director causes the company to trade while knowing
the company is insolvent, the director may be charged
with the civil ofence of wrongful trading or the criminal
ofence of fraudulent trading and incur personal fnes
and other penalties

Question 30

PLCs Require a Trading Certifcate

Answer 30

If a PLC trades without a trading certifcate, the directors
of the PLC can be held personally liable for any losses
arising as a result.

Question 31

Group Accounts

Answer 31

If companies are members of a group, it may be nec-
essary to prepare group consolidated accounts which
recognise the common link between them.
But note: Even where group accounts are required the subsidiary companies are not liable for the debts of the other subsidiaries or parent company, nor is the parent company liable for the debts of the subsidiaries.