Business Law: An Introduction

F84P 34
LO3
The Legal Characteristics of the Different Types of Business
Organisations.
 Business Law: An Introduction. LO3

LO3 Business Law: An Introduction

Incorporated Bodies
The third type of business organisation is the incorporated body- in other words companies.

Like a partnership a company is well-suited towards joining together of a number of persons

for the purposes of carrying on a business. In a company, a number of individuals, namely
the members, voluntarily agree to combine for a common purpose and thus form a company
as a means of carrying on a business. Each of those individuals will contribute capital
investment, skills, know-how, expertise and contacts and pool those resources as a means
of selling products or services.

A company is formed by applying to the Registrar of Companies, providing a constitution

(essentially a set of rules that the company has to follow), the names of the first director and
members plus a small fee. The formation process is called incorporation. The registered
company has become the dominant legal business form in the UK.

There are a number of reasons why a business person may decide to set up a company. For
example:-

 Prestige and business credibility – many small businesses consider that one of the
major advantages of forming a company was that it conferred prestige, legitimacy
and credibility on the venture.
 Additional ways to raise finance
 Possibility of Limited Liability.

Companies are regulated by the Companies Act 2006.

Categories of Companies

There are 4 types of Company that can be incorporated in the United Kingdom.

1. Private Companies limited by Shares – This is the most common type of Company
and is what most people have in mind when considering whether to set up a
company. Each shareholder’s liability is limited to the amount unpaid on the
shareholding owned by them. The company’s shares, however, are not permitted to
be offered for sale to the public.
2. Private Companies limited by Capital – no shares capital is issued. Instead the
members agree the extent of their liability when they first join the company – so they
agree what they will contribute to the company’s assets in the event of the company
going into insolvency. Companies which operate with these kinds of arrangements
are often incorporated to pursue a range of social objectives e.g. university student
unions.
3. Private Unlimited Companies - this type of corporate body is very rare. The members
of the Company have complete unlimited liability – which means that on the

F84P 34 Fife College 2015 Page 2

 Business Law: An Introduction. LO3

insolvency the members will have unlimited liability for any of the debts of the
company. One of the main advantages of a corporate body it the limited liability of its
members. However the benefits are more privacy in their financial affairs as they do
not need to submit annual accounts.
4. Public Limited Companies- like private limited companies, these types of corporate
bodies enjoy limited liability. Unlike private limited companies they can offer its
shares for sale to the public and its shares can be publicly traded on the stock
exchange.

In practice, it is much more common to encounter private companies limited by shares

and public limited companies so we shall concentrate on these.

Private Limited Companies

Usually, theses are small businesses, often family businesses. You only need a single
member as under the 2006 Act you can now have single persons private companies.

Investment comes either usually from the founding members in the form of personal
savings or from a bank loan. They cannot offer shares for sale to the general public i.e.
via the stock exchange. Therefore shares are generally sold to family and friends. There
are further restrictions on whom members can sell their shares to in that you cannot re-
sell your shares without the consent of the directors.

Shareholders have control of the company i.e. they have power to appoint directors.
Directors are employees of the company and manage the day to day running of the
company. However, in the majority of private limited companies the directors tend also to
be the shareholders.

Public Limited Companies

These are large organisations. There must be a minimum of two members and must
have a minimum allotted share capital of £50,000. Private Companies in contrast have
no requirement to have this. It must have the words “public limited company” at the end
of its name, usually abbreviated to PLC.

Public Companies can sell its shares to the general public – via the stock exchange.

The share-holders are free to sell their shares at any time; this does not require the
permission of the board of the directors.

Formation of a company

Persons forming a company must submit several documents to the Registrar of

Companies (George Street, Edinburgh) together with the appropriate fee.
The following documents must be sent:-
 Forms 10 and 12
 The articles of association

F84P 34 Fife College 2015 Page 3

 Business Law: An Introduction. LO3

 The memorandum of association.

Form 10 – provides details of the first directors, company secretary (if any) and the
registered office.

Form 12 – a statutory declaration of compliance stating that the company will comply
with all the legal requirements.

The memorandum of association – this is simply a statement that the applicants wish to
form a Company and that they agree to become members of the company.

The Articles of Association – this is the most important document in the incorporation
process as they regulate the internal management of the company. They will govern inter
alia
 Appointment and removal of directors
 Rules for running shareholder’s meetings
 Voting powers of the shareholders
 Powers of the company to raise additional capital.

Limited Liability

One of the main advantages of an incorporated body is that it can have limited liability.

The term limited relates to the fact that the members of the company enjoy limited
liability status. This means that each member’s liability for the company’s debts in the
event of insolvency, is limited to the amount, unpaid, if any, on their shareholding in the
business. If for example a member has agreed to purchases £30,000 worth of shares in
a company, should the company fail, the creditors can only pursue the individual
member for any money that he still owes for his shares. So, if the member still owed
£15,000 for his shares he would have to pay this sum over to the company’s creditors..
Once this sum has been paid, however, the member cannot be held liable for any more
of the company’s debts. If, on the other hand, the member has paid for all of his shares
his liability is at an end and he cannot be forced to pay out any more.. Therefore the
huge advantage of limited liability is that it allows members of a company to at least
reduce their losses to an agreed sum if the company fails.

The next case is the most important of all company law cases as it settles once and for
all that shareholders of a limited liability company enjoy limited liability of the debts of the
company. In addition it also establishes that a company has a separate legal personality
distinct from it s members.

Salomon v Salomon & Co Ltd [1897] A.C. 22

Mr Salomon was a merchant running a wholesale leather boot manufacturing business.

He decided to convert his business from a sole trader to a limited liability company. Mr
Salomon took 20,001 shares of £1 each in the share capital His wife and five children
took one share each. Therefore Mr Salomon held 2001 out of 2007 shares issued. Mr

F84P 34 Fife College 2015 Page 4

 Business Law: An Introduction. LO3

Salomon’s business was transferred to the new company in exchange for those shares.
Mr Salomon also received £1,000 and £10,000 worth of debentures (a debt instrument
issued by the company). In essence Mr Salomon controlled the company and it was a
“one-man band” despite that it had 7 shareholders.

Eventually the company fell on hard times and the company went into liquidation. The
assets at the time of liquidation were insufficient to meet the debts owed. Therefore not
all the creditors could be paid in full. The liquidator argued that he could look to Mr
Salomon to pay the outstanding debt as the company effectively was his.

The Court held that the company had a separate personality and under this concept
shareholder’s liability was limited to their unpaid share capital. Mr Salomon was not liable
for the outstanding Company’s debts.

The principle of separate legal personality was confirmed in the following case

Macaura v Northern Assurance Co Ltd

Macaura owned a timber state He formed a limited company and sold the timber estate
to it. The purchase price was paid to him in the form of 42,000 fully-paid shares of £1
each. No other shares were issued. He also financed the company and was an
unsecured creditor for £19,000. Macaura effected an insurance policy in his own name
on the timber. And not in the name of the company.

The timber was destroyed by fire. Macaura tried to claim under the insurance policy but
was held he did not have an insurable interest. It did not matter that again the company
was really a “one man band”. As a company has a separate legal personality separate
from his members then the policy should have been in the name of the company itself
and not Mr. Macaura.

Effects of separate legal personality

 Company can enter into contracts in their own name.

 Company can sue or be sued
 Company can purchase assets
 Company can incur debts
 Company can employ staff.

Advantages of a Limited Liability Companies

1. Members have limited liability to the company’s debts – see Salomon v

Salomon above.

F84P 34 Fife College 2015 Page 5

 Business Law: An Introduction. LO3

2. Companies can issues transferable shares as investments to

shareholders/investors. The company can raise finance from investors in
return for allotting shares to that investor. Obviously partnerships and sole
traders do not have this facility. Remember however, that there are
restrictions on transferring of shares for a private limited company.

3. There is a distinction between ownership of the company and its control. If an

individual owns shares in the company this does not give them a right to be
involved in the management of the company. A shareholder does not have to
participate in the day to day running of the business. As a company has the
right itself to employ, it can employ people to manage its affairs. These
employees are called directors. Therefore the company can appoint
somebody who doesn’t own any shares in the company. It is the board of the
directors who are responsible for the management of the company. Since
shareholders do not require to be directors the company the company can
therefore introduce specialised management to run the business.

Although the shareholders are not involved in the management of the

business they still do have control over the business. For example the
shareholders can remove a director if they pass an ordinary resolution. They
also have the right to attend and vote at the Annual General Meeting of the
Company. The business of an AGM includes considering the accounts,
approving director’s and auditor’s reports, level of dividends to be paid,
appointing directors and auditors.

4. A company has perpetual succession. They will continue even though the
shareholders and directors may change. This is not the case with
partnerships and sole traders. The only way a company can be terminated is
by going through the formal process of liquidation.

5. A company have alternate ways of raising finance. In addition to issuing

shares, company can also grant floating charges. A floating charge is a
security that can be granted over the company’s entire assets. Sole traders
and partnerships cannot grant floating charges and there is potential that
borrowing costs will be higher.

Disadvantages of Companies

1. Companies have to comply with burdensome regulatory regulations. One of

the dominant features of the Companies Act 2006 is the requirement for a
company to comply with a number of initial and continuing administrative filing
obligations. As we have seen above there are a number of documents that
have to be filed with Companies House before a company is incorporated.

F84P 34 Fife College 2015 Page 6

 Business Law: An Introduction. LO3

Once incorporated there are various continuing obligations which are

imposed on companies. For example they must prepare individual accounts
and file these with the Registrar of Companies every year.

2. Companies lose their privacy. As seen above lots of information on the

Company have to registered with Companies House e.g. the names of the
directors, annual accounts. Therefore any member of the public can consult
and review details of a company at Companies house. Anybody can go on
the Registrar of Companies’ web-site to ascertain these details. It is therefore
impossible to keep certain matters secret and, for obvious reasons, this may
sometimes be undesirable from a commercial perspective.

3. Due to the extra regulatory requirements imposed on companies this means it

can be expensive. In a larger company a company secretary will be appointed
to ensure compliance with all regulations. In addition accountancy fees will be
incurred to have accounts prepared.

Directors’ responsibilities

A company is regarded in law as a separate legal entity, but it can only function and
make decisions through its board of directors and its shareholders in general
meetings. It is the board of directors, acting collectively and not individually, that is
responsible for the management of the company on behalf of the shareholders. The
role of a director should not be taken on lightly. They must comply with a whole raft of
legislation including the Companies Act 2006. There are a number of duties imposed
on a director. If theses duties are breached it may result in civil or criminal liability for
a director with penalties imposed by way of a fine or imprisonment or both.

F84P 34 Fife College 2015 Page 7