Background
Most of business scratch from a sole trader or
The principal benefit of trading in a limited company has always been the limited liability bestowed upon the company's directors and shareholders. As a sole trader or other non-limited business, personal assets can be at risk in the event of a failure of the business, but this is not the case for a limited company. The debts and contracts of the registered company are those of the company and not those of the members, whereas in the case of a partnership every partner is jointly and severally liable with the other partners for all the firm's debts and obligations incurred while he is a partner.
Meanwhile, operating as a limited company often provids suppliers and customers a sense of confidence in a business. Larger organisations in particular will prefer to deal with limited businesses which is usually regarded as more credible and reliable firm.
Based on above consideration, Lorraine and Brenda, who have traded in the antique in partnership for many years, have decided to incorporate their business as a private company limitied by shares recently. As most business people who start incorporating, Lorraine and Brenda are perplexed by a plenty of matters on how to make best use of incorporation to protect their benefit and to avoid breaching the company law.
This article tends to provide reasonable resolutions and advices towards Lorraine and Brenda's matters.
What are the benefits of becoming a limited company?Becoming a limited company bestows many advantages:
- Risk avoidance
– limited financial liability - Reduced tax bills
- Prestige and credibility
- Defined ownership
– issuing shares to represent percentage of ownership makes clear who is entitled to what percentage of profits - Protection of your business name
- Avoidance of common problems associated with unlimited partnerships
- Minimize the risk of the assets transferred
--- Doctrine of incorporation
In this scenario, Lorraine and Brenda have decided to incororprate their businesses as private limited liability companies. Although operating such a company generates an administrative burden of reports to Companies House, they may consider this outweighed by the benefits of "limited" liability. This basically means that although the directors and shareholders are wholly responsible for the business if the enterprise ultimately fails; this failure only requires them to contribute up to the maximum amount payable under their shares. This is so even if the company goes insolvent leaving any number of creditors out of pocket. In theory the directors/shareholders' personal "liability" is "limited".However, under the various circumstances this limitation of liability is not effective.
As Lorraine and Brenda have decided to incorporate their business as a private company limited by shares, they intent to transfer original assets to the new company. As all other companies, the new company under the risk that it maybe fail in the business. If that happened, Lorraine and Brenda will lose all the amount they have inversted in the company. To avoid those happen to them, they shoud not only be shareholder of the company, meanwhile they could be the creditors of company as well.
In order to meet the target, Lorraine and Breda can transfer the assets e.g. land, equipment, stocks to the company, and require the company to give him fully paid shares and a debenture secured by a floating charge on the company's assets in return ( Salomon v Salomon & Co.Ltd.(1897)).
According to the
When Lorraine and Breda transfer their assets to the new company, the assets belongs to the company, not to Lorraine and Breda any more. On the conctract, they own the company by the shares, which is fully paied means the shareholder will not personally liability to any debt of the company; on the other hand, as a creditor, they can get repaid before unsecured debts, for their having a secured debenture which is a document evidencing a loan.
- Realise the shareholding in the company
--- Pre-emption clause
In the articles, there is a clause inserted as pre-emption clause, which provides power to remain the company under control of the existing members in the private company. It means if either of Lorraine or Brenda wish to leave the business, the pre-emption clause in the articles of association ensure that they can realise their shareholding in the company. In other words, this clause chould be treated as a restricting of the right of members to transfer their shares in the company to outsiders.
“Pre-emption clause is a requirement imposed that a menber who wishes to realise his shares to offer them first to the existing members or to the company at a fair price determined in accordance with the articles ( e.g. by valuation of the directors or auditors ) before they can be offered to outsiders.”
“Section 162 allows a company, if authorised by its articles, to purchase its own shares (whether redeemable or not) at a fixed date or at the option of either the company or the shareholder, and the terms of the purchase need not be set out in the articles. In addition, the company must obtain permission from its memebers before it can make the purchase. This permission is given by passing a special resolution in general meeting. Before the resolution is passed, a copy of the proposed purchase contract must be made available for inspection by the members at the company's registered office for at least 15 days immediately preceding the meeting and at the meeting itself; and the identity of the vendor must be disclosed. However, voting rights attached to the shares to be purchased cannot be exercised to secure the passing of resolution.”
“A member who transfers his share in breach of a pre-emption clause is not entitled to have the transfer registered in the register of members, and the company can make an application to the courts to have the transfer set aside. In Lyle &Scott v Scott's Trustees (1959), the court set aside a contract by the defendants, who in breach of a pre-emption clause, had transferred their shares to an outsider with the intention that he should delay applying for registration and giving him their proxies, so that he could obtain control of the company.”
An purchase by a company of their own shares or by a existing shareholder may be effected to buy out a dissident member, to retain family control when a member wishs to leave the company.
- Keep financial information safe
--- depen on the size of private company
Financial figure or affairs is too essential for a company; as the business secret, they directly reflect the strategy of the company which survive or succeed in this highly competitive environment.
All UK companies are required to prepare and file accounts in statutory form according to the Registrar of Companies and the Inland Revenue whether trading or not. These accounts should include:
(a) a profit and loss account (or income and expenditure account if the company is not trading for profit);
(b) a balance sheet signed by a director;
(c) an auditors' report signed by the auditor (if appropriate);
(d) a directors' report signed by a director or the secretary of the company;
notes to the company accounts; and
(e) group company accounts (if appropriate).
(b) a balance sheet signed by a director;
(c) an auditors' report signed by the auditor (if appropriate);
(d) a directors' report signed by a director or the secretary of the company;
notes to the company accounts; and
(e) group company accounts (if appropriate).
Nevertheless, a private company should only file a modified version of these accounts. To these private companies, it is their qualified size to determine the extent that the company can keep its financial affairs secret from the public. In other words,
To qualify as a medium company, at least two of the following conditions must be met:
annual turnover must be £22.8 million or less;
the balance sheet total must be £11.4 million or less;
the average number of employees must be 250 or fewer.
“A medium-sized company need not disclose its turnover figure, and certain items ( e.g. cost of sales, gross profit or less, and other operating income) in its profit and loss account may be combined to give one heading
To qualify as a small company, at least two of the following conditions must be met:
annual turnover must be not over £5.6 million;
the balance sheet total must be not over £2.8 million;
the average number of employees must be not over 50.
“As a small-sized company, it need not file a copy of its profit and loss account or a directors's report; and may file only an abbreviated balance sheet. It can also send its shareholders a shorter form of directors' report and accounts.”
Companies whose annual turnover does not exceed £5,600,000 may qualify for an Audit Exemption and are not required to file independently audited accounts and in such cases the directors must self-certify the accounts.
To qualify for total audit exemption, a company must
qualify as small (see above)
have a turnover of not more than £5.6 million; and
have a balance sheet total of not more than £2.8 million
- Statutory books and registers keeping and the rights to inspect them
English law requires all companies to have a registered office at all times. The registered office is the official address at which legal documents, notices and other communications are formally presented.
In this scenario, the company's registered office will be situated in Chancery Lane, London, so the company will be an English company and English law will govern the company. Under the company law, Lorraine and Brenda should disclose the registered office address on their company's stationery (eg letterhead, order forms, inovices etc), website and e-mails, as well as the company's registration number and country of registration. The company should display its name outside every place in which it carries on business. Therefore they should display the company's name where you run your business and at the company's registered office. Whilst the name may be placed inside, it needs to be visible from the outside (ie inside a window).
Meanwhile, the company trade in Essex other than the register office. Lorraine and Brenda have to decide which statutory books and registers must be kept in London, and which may be kept in Essex, according to English Law.
“The following statutory books and registers must be kept at the registered office
- the minutes book of the members meeting (s.383);
- a record of written resolutions used to exercise the company's powers which are exercisable in general meeting and the signature of the members who signed them (s.382A);
- the register of changes (s.411); and
- the register of directors and secretary (s.288).
If the company has given notice to Companies House on a Form 353, the following statutory books and registers may be kept at the trading premises in Essex:
- accounting records (i.e. the day-to-day entries of monies received and
expended, record of assets and liabilities and statements of stocktaking);
- the register of members (s.353);
- the register of debenture holders (s.190);
- the register of directors' interest in shares and debentures and their service contracts (s.325);
- the register of substantial shareholding (s.211); and
- the minutes book of the directors' meeting (s.382).
All the above books are available for inspection by members, free of charge during business hours for at least two hours a day, except the minutes book of the directors' meeting and the accounting records. Creditors may inspect the register of charges also without a fee. The general public is entitled to view all the above-mentioned books, subject to some exceptions (e.g. the minutes books and accounting records), on payment of a prescribed fee.”
However, in reality, requests of visiting a registered office to inspect the statutory books and registers are rarely made. All the information that would be typically kept relating to any given company is available electronically and by post from Companies House for a small fee. It is often far more practicable for the persons seeking information (and the company itself) to have enquiries satisfied at Companies House rather than at the registered office.
- Personal liability for the company's debts
--- as a shareholder and a director
As the enterprise grows and dealings become more complicated, there are various situations Lorraine and Brenda need to be aware of where the benefit of limited liability is potentially lost leaving them at personal liability for the company's debts.
Limitation of the individual liability as a director/shareholder is achieved by the artificial
concept of the company being a different legal "person" to the real people running or
owning it, as been mention above. A "veil" of incorporation is drawn between the two. It is possible, however, for the Courts to "pierce the corporate veil" and to make the shareholders responsible for more of the company's debts when the business fails than would otherwise be expected.The circumstances in which a Court will make such an order are many and varied,depending often on what would be fair in each individual case.
concept of the company being a different legal "person" to the real people running or
owning it, as been mention above. A "veil" of incorporation is drawn between the two. It is possible, however, for the Courts to "pierce the corporate veil" and to make the shareholders responsible for more of the company's debts when the business fails than would otherwise be expected.The circumstances in which a Court will make such an order are many and varied,depending often on what would be fair in each individual case.
Shares partly paid up
The general rule is that no-one is liable for the debts of a company except the company itself. The shareholders of the company are not liable for its debts, except where their shares are partly paid, and then only to the extent of the unpaid amount.
Personal guarantees
As the enterprise grows bigger the directors/shareholders may decide that they want to
inject more finance into the company. They might seek finance from a bank. It is common practice for the bank to insist on personal guarantees from the directors/shareholders .“To a large extent the benefit of limited liability is then lost. If the directors are unable to pay under these guarantees there is every possibility that the bank would take enforcement action against the personal assets of the individual directors with the real likelihood of their losing their homes and nearly all they own, or even being made personally bankrupt.”
inject more finance into the company. They might seek finance from a bank. It is common practice for the bank to insist on personal guarantees from the directors/shareholders .“To a large extent the benefit of limited liability is then lost. If the directors are unable to pay under these guarantees there is every possibility that the bank would take enforcement action against the personal assets of the individual directors with the real likelihood of their losing their homes and nearly all they own, or even being made personally bankrupt.”
Fraudulent trading
Fraudulent trading arises when, in the course of winding up a company, it is shown that the business has been carried on with intent to defraud creditors or for any fraudulent purpose. Any person including a member of the company participating in the fraud commit a criminal offence and can be made personally liable by the courts for all or any of the company's debts and liabilities( s.213 IA).
Wrongful trading
Wrongful trading occurs if a company is in insolvent liquidation and at some time before the commencement of the winding up a director (including a former director) or shadow director knew (or ought to have known) that there was no
The level of personal contribution will be determined by the court; it will reflect the extent to which the company's assets have been depleted by the director's conduct. A court may make a contribution order if a liquidator can show that before winding-up began the person knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation. The only defence open to a director in these circumstances will be that they took every step they could to minimise the potential loss to a company's creditors. The onus will be on the director to prove this defence.
To avoid incuring personal liability for the company's debts and liabilities, Lorraine and Brenda need
- Always remain as company directors
--- prevent removal as a director
When Lorraine and Brenda running the business together, it cannot be avoided that they may disagree with each other, or with the new shareholders or directors introduced to the company. In that case, how can Lorraine and Brenda should always have a right to participate in the management?
Removal of a director must be conducted in accordance with the Companies Act 1985 s.303. By the Companies Act 1985 s.303, a company may remove a director by ordinary resolution (a simple majority of the shareholders) before the expiration of this period of office, notwithstanding any provision to the contrary in the Articles of the company and notwithstanding any term of his contract.
To prevent the removal of directors.
“Section 303 overrides any clause in the articles aimed at entrenching the position of directors; but a number of factions restrict its use.”
Shareholder agreement
“If the directors hold shares in the company, as Lorraine and Brenda, they may enter into an agreement with all (or a majority) of the shareholders as to how each party to the agreement will vote at general meeting (Russell v Northern Bank Development Corpn.Ltd.(1992)) or how a quorum for a general meeting shall be determined (Harman and Another v BML Group Ltd). Such a shareholders agreement will be upheld by the courts.”
Extra votes by the articles
“An article can be added to give directors who are also shareholders extra votes (i.e., more than one vote for each share they possess)on any ordinary resolution of the shareholders to remove them from office, and this may make it diffficult for the other shareholders to get enough votes to pass the ordinary resolution. In Bushell v Faith (1962), a company had three members, all of whom were directors holding 100 shares each. The article provided that in the event of a resolution being proposed at a general meeeting of the company for the removal from office of any director, each of that director's shares will carry the right to three votes per share. A motion to remove one of the directors was proposed; two directors vote in favour, and the director in question against. The votes in favour were thus 200, and the against 300. the court held that it was permissible to have weighted voting rights, and directors could be removed only if the resolution was carried. In this instance, the ordinary resolution was defeated. In additional, if the other two members try to dilute the shares held by the director concerned by issuing new shares. The pre-emption right will give the director right to defend himself.”
Bibliography
chapter 22 p345 & 26 p399
Jerry DeFreitas
Janet dine & marios koutsias
John Lowry & Alan Dignam
Stephen Judge (2006)
“Fraudulent and Wrongful Trading”
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