Legal Environment

Company Law The Nature of Companies

Learning Objectives
Introduction What is a company? Separate Legal Personality Consequences of Separate Legal Personality Types of Company Comparison of Sole Trader, Partnership and Company
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Introduction
The three main forms of business are
Sole trader Partnership Company

A major disadvantage for sole traders and partners is that they have unlimited liability for the debts of their business
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Introduction
The owners of companies, on the other hand, have limited liability Companies are also fairly flexible - ranging from small, one person companies to large multinationals

What is a Company?
A company is a body corporate or corporation There are 4 types of corporation. Those created 1. by Royal Charter This was the earliest way of creating corporations.
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What is a Company? (cont.)

However, nowadays, it is not used to create trading bodies. It is used for charitable and educational bodies The BBC (British Broadcasting Corporation) and the Bank of England were both created by Royal Charter

What is a Company? (cont.)

2.

by special Act of Parliament Again, this is an old way of creating corporations which is no longer used Bank of Scotland was created in 1695 by and Act of the old Scots Parliament

The Governor and Company of the Bank of Scotland

What is a Company? (cont.)

by registration under the Companies Act 1985 The current law relating to companies is mainly contained in this Act It is the most common way of creating a corporation 4. by registration under the Limited Liability Partnership Act 2000
3.
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Separate Legal Personality

As companies are a kind of corporation, they have their own separate identity In law, they are regarded as a person Although a company is not a natural person (like you or me) the law treats it in the same way in many areas

Separate Legal Personality (cont.)

The most famous case in this area is Salomon v Salomon & Co Mr Salomon was in business as a leather merchant In 1892, he formed Salomon & Co Ltd He held most of the shares with his wife and 5 of his children each holding one share as company law at that time required at least 7 shareholders in a company
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Separate Legal Personality (cont.)

Unfortunately, the company did not do well and it went into liquidation A liquidator was appointed to sell the assets of the company and pay its debts

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Separate Legal Personality (cont.)

The liquidator claimed that the company was a fake because Mr Salomon owned 20 001 shares and his family owned only 6 altogether Mr Salomon was really just running the same business Therefore, the liquidator argued that Mr Salomon was liable for all the debts of the company
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Separate Legal Personality (cont.)

However, the House of Lords disagreed The court held that 1. The fact that some shareholders only held 1 share as a technicality was not relevant The registration procedure could be used to create a one-man company

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Separate Legal Personality (cont.)

2.

A company which is properly formed under the Companies Act is a separate person As a result the debts of a company were its own and not those of its members

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Separate Legal Personality (cont.)

Two more cases also help to demonstrate the idea of separate legal personality. In Macaura v Northern Assurance Co, Macaura sold all the timber on his estate to a company in return for all the shares in that company The timber was stored on Macauras estate Macaura insured the timber in his own name
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Separate Legal Personality (cont.)

Two weeks later, the timber was destroyed in a fire The insurance company refused to pay out because it said Macaura did not have an insurable interest in the timber because he did not own it. The company owned it. The House of Lords agreed
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Separate Legal Personality (cont.)

The court held 1. The timber belonged to the company not Macaura 2. Macaura had not insurable interest in the timber even though he owned all the shared in the company 3. Just as the separate legal identity of a company gives the members limited liability, it also means that the assets of a company belong to it and not to its shareholders
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Consequences
This concept of separate legal personality has several consequences Limited liability Perpetual succession Business property Court actions Liability in tort and crime The rule in Foss v Harbottle
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Limited Liability
The liability of the members of a company for its debts is limited Under the Companies Act 1985
a member of a company limited by shares is only liable to pay the full amount of his shares, and a member of a company limited by guarantee is only liable to pay the amount which he guarantees to pay if the company is wound up

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Perpetual Succession
Changes in the membership of a company have no effect on the continuation of that company Unlike a partnership, the death or bankruptcy of a member does not end the company In public limited companies, members are free to sell their shares on the stock exchange
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Business Property
Business property is owned by the company and not its shareholders That means a creditor cannot take action against company assets in respect of a debt due by a member of that company

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Court Actions
A company can sue and be sued in its own name It can also enter contracts in its own name The companys liability for contractual debts is unlimited

It is only the members liability which is limited

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Liability in Tort and Crime

Companies are vicariously liable for the torts of their employees Companies can be guilty of crimes which do not require a mental element (eg intention or recklessness) However, it has been more difficult to prosecute companies where the crime has such an element as it has to be shown that one of the directors of the company had the required mental element This can be very difficult in a large company where the directors are not involved in the day to 23 day operation of the business

Foss v Harbottle
This case gives us the idea of majority rule in a company If a company suffers injury then the majority of members must agree to raise a court action A single member cannot take action against the wrongdoer
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Lifting the Veil of Incorporation

Although the general rule is that a company has a separate legal identity from its members, there are exceptions to this rule when a court will not treat a company as a separate entity This is often referred to as lifting the veil of incorporation Often, this is to prevent abuse of the principle of separate identity
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Lifting the Veil of Incorporation (cont.)

For example, under the Companies Act 1985, if a company trades with fewer than two members then the sole member has unlimited liability for company debts Also under the Companies Act, officers of the company will become personally liable if they issue bills of exchange or enter into contracts on behalf of the company but do not use the companys full name
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Lifting the Veil of Incorporation (cont.)

At common law, the general principle is that the courts will not allow a company to be used for a fraudulent purpose or to avoid a legal duty For example, in Gilford Motor Co v Horne, a term in an employees contract prevented him from approaching former customers after he left Gilford Motor Co
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Lifting the Veil of Incorporation (cont.)

Therefore, when he left he formed his own company, and the company approached his former customers The court held the company was a sham being used to avoid the term in his contract

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Types of Company
Companies can be classified in several ways Limited and Unlimited Limited by Shares or by Guarantee Public and Private

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Limited and Unlimited Companies

Companies are usually formed because of the limited liability for their members However, it is possible to create a company without limited liability Such companies do not have disclose their accounts as limited companies do

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Limited by Shares or Guarantee

The most common kind of limited company is one limited by shares Once the shareholder has paid the full value on his shares then he has no further liability This is true even if the company does not have enough money to pay its debts

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Limited by Shares or Guarantee (cont)

A company limited by guarantee is usually created for charitable, educational or professional purposes

ie it is not a trading company

The liability of members is to pay an agreed amount if the company is wound up Usually, the amounts are small, so the risk is low
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Public and Private Companies

The main difference between public and private companies is that the shares in a public company may be bought and sold on a stock exchange Public companies must have at least two directors, whereas a private company can have one Public companies must have a minimum issued share capital of 50,000
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Public and Private Companies (cont.)

Private companies may purchase their own shares out of capital, whereas public companies cannot Private companies may elect not to appoint auditors or hold an AGM (Annual General Meeting), whereas a public company cannot

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Comparison of Ownership
It is useful to compare the advantages and disadvantages of the three forms of business
Sole trader Partnership Company

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Sole Trader - Advantages

No legal filing requirements or fees and no professional advice is needed to set it up. You just literally go into business on your own. Simplicity one person does not need a complex organisational structure.

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Sole Trader - Disadvantages

The disadvantages are that it is not a particularly useful business form for raising capital (money). For most sole traders the capital will be provided by personal savings or a bank loan. Unlimited liability the most important point to note in terms of comparing this form to the company in that there is no difference between the sole trading business and the sole trader himself. The profits of the business belong to the sole trader but so do the losses. As a result he has personal liability for all the 37 debts of the business.

Partnership - Advantages
No formal legal filing requirement involved in becoming a partnership beyond the minimum requirement that there be two members of the partnership. Easier to obtain capital as there can be up to 20 members of the partnership, all of whom could pool their investment within the partnership.
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Partnership Advantages (cont.)

If you are aware of the problems the Partnership Act can cause (see disadvantages) then you can draft a partnership agreement to vary these terms of the Act The partnership agreement can therefore be used to provide a very flexible organisational structure although this usually involves having to pay for legal advice.

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Partnership - Disadvantages
A partnership will end on the death of a partner. If you are unaware of this when the partnership is formed, the Act may not reflect the intention of the partners. The partners are jointly and severally liable for the debts of the partnership. This means that each partner can be sued for the total debts of the partnership
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Company - Advantages
Companies are designed as to make it easy to raise capital. Companies have the ability to subdivide their capital into small amounts, allowing them to draw in huge numbers of investors who also benefit from the sub-division by being able to sell on small parts of their investment. Limited liability also minimises the risk for investors and is said to encourage investment.
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Company Advantages (cont.)

It is also said to allow managers to take greater risk in the knowledge that the shareholders will not lose everything. The constitution of the company provides a clear organisational structure which is essential in a business venture where you have large numbers of participants.

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Company - Disadvantages
Forming a company and complying with company law is expensive and time consuming. It also appears to be an very complex organisational form for small businesses, where the Board of Directors and the shareholders are often the same people
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Summary
What is a company?

Types of corporation

Separate Legal Personality Consequences of Separate Legal Personality Types of Company Comparison of Sole Trader, Partnership and Company
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Reading
Chapter 13

Pages 341-350

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