The Incorporation and Set-up of Companies

Several factors emerge in this scenario which will involve consideration of the law relating to companies and businesses. The main statute that has the job of regulating the operation of companies is the Companies Act 1985. In this scenario, there are three companies whose position with regard to their transactions and relationships with the other parties will need to be considered. These are Crownco Ltd, Lowcopse Ltd, and a supplier company, Clucknosh. The most significant issues that will arise in the course of the scenario include a consideration of the legal nature of a company, questions about incorporation, and the so-called ‘lifting the veil of incorporation’, the registration of companies’ constitutional documents (that is, their memoranda and articles of association) with particular reference to companies’ objects clauses, the issue of share capital and transfer of shares, and duties of directors.

The first transactions to consider relate to the company Lowcopse Ltd which, we are told, has recently been incorporated. This means that it has been registered as a company, and therefore as a legal entity, at Companies House, pursuant to section 1 of the Companies Act 1985. As the company has already been registered, it can begin trading as soon as it receives it Certificate of Incorporation from Companies House. At this time, ‘the subscribers of the memorandum, together with such other persons as may from time to time become members of the company, shall be a body corporate by the name contained in the memorandum’ (CA 1985, s13(3)(a)). As the first directors are the first shareholders, Harry (who owns 25%) and Diana (who is the majority shareholder owning 75%), these two should have no problem purchasing the organic farm, Wheatacre. That is to say if there is a resolution needed to permit the large purchase, it should not be a problem as the only shareholders are the two who make the purchase. An important factor that should be checked, however, is whether the company’s articles of association permit the directors to act in this way (that is, make purchases in the name of the company). Further, the memorandum of association of Lowcopse Ltd should be checked to see whether the purchase of an organic farm would be considered within the objects of the company.

Crownco Ltd is the company to be set up by Charles, William and Harry. Although they have the idea to form the company in November, however, the company is not incorporated until 1 March. Again, this means that the company does not exist as a body corporate (and therefore a legal entity) until this date. The first problematic issue is the contract of 1 February which Charles signs on behalf of the company with the third company, Clucknosh. It was signed prior to the incorporation of Crownco Ltd, which means that as the body corporate did not exist, its agents (of which Charles is one) could not act on its behalf. Pre-incorporation contracts are governed by section 36 of the CA 1985. According to this, the person making the contract prior to incorporation (Charles, in this instance), will be personally liable for the burden of the contract. The various options for directors prior to incorporation in this respect are as follows. Charles could have waited to sign the contract on behalf of the company until after incorporation, or he could simply ‘novate’ the contract to the company after incorporation. Finally he could sign the contract prior to incorporation, and then subsequently assign it to the company. The difference between novation and assignment is that under a novated contract, the benefit and the burden pass to the company, while under an assignment, only the benefit passes.

The second problematic issue which relates to the setting up and registration of Crownco Ltd relates to the directors. Charles, William and Harry are to be the directors of the company as well as shareholders (each holding 25%). Directors’ duties are regulated by various sections of the CA 1985. The three will have become directors upon incorporation by signing Form 10 (pursuant to section 10 of the CA 1985). The fact that Harry is a 25% shareholder in another company, Lowcopse Ltd, is not necessarily a problem or incompatible with his position as a director of Crownco Ltd. The important factor is that this interest must be disclosed in the register of directors’ interests which Crownco Ltd are obliged to keep pursuant to section 288 of the CA 1985.

This interest is again significant in the next transaction, which involves the sale to Crownco Ltd of Wheatacre Farm by Lowcopse. According to section 317 of the CA 1985, a director who is directly or indirectly interested in a contract or proposed contract with his company must declare the nature of this interest at a board meeting. Again, as long as the statutory formalities are complied with, this will probably not be a problem.

William and Harry, at a board meeting on 18 March, refuse to pay the consideration on the contract with Clucknosh which Charles signed earlier. They may be able to refuse this based on the fact that Charles was acting beyond his directorship powers when he signed the contract. It seems they will not escape payment, however, as the Companies Act 1985 makes provision to attempt to counter this type of behaviour. Section 35 of the CA 1985 all but abolishes the doctrine of ultra vires with regard to a company dealing with a third party. This is for the protection of the third party who acts in good faith in contracting with persons whom he assumes have the authority to transact. According to this section, the third party is entitled to assume that the representative of the company (in this case, Charles), is entitled to contract, and as such, the contract will be enforceable. Charles will be liable to his own company, Crownco Ltd, for any damage caused by this, but Crownco itself will have to perform their contractual obligation to pay Clucknosh.

The doctrine of ultra vires is again an issue when William seeks to purchase non-organic carrots from Phillip. This relates to the objects clause of Crownco Ltd. The company was set up to produce and market organic products. One would need to see the objects clause of their memorandum of association, but it is possible that by purchasing the non-organic products, this would be an act ultra vires the company. It is possible that the company’s memorandum has adopted a general commercial activities objects clause, in which case this would not be ultra vires. If it is more limited, however, (for example, stating that the object of the company was simply to produce and market organic products), then it almost certainly would be ultra vires. Again, the contract with Philip will be enforceable because of the effect of section 35 of the CA 1985, but the significance is that it would be William who would be personally liable to Crownco Ltd.

On 1 May, Diana offers to sell Crownco Ltd much needed machinery at 80% of the market value. Later that month, the three directors pass a special resolution (that is, with 75% of the shareholder vote which together, the three make up). This transaction should not, on the face of it, be a problem. The directors’ knowledge that Diana wishes to use the proceeds of the sale to buy shares in the company, however, could make the sale illegal. Section 151 of the CA 1985 makes it illegal for a company to give financial assistance, directly or indirectly, to assist in the purchase of shares in the company. A sale at an undervalue would be an example of such assistance. The company would merely have to pay the full market price for the machinery in order to avoid liability under section 151. It is, however, possible, that the exception to this prohibition set out in section 153 would apply. This concerns directors giving assistance in good faith, in the interests of the company. The directors would have to meet the burden of proof that it was in the interests of the company to prevent Camilla abandoning the ethical, organic ethos of the company if she acquired a larger shareholding.

With regard to the fact that Wheatacre turns out to be valueless, there is little that Crownco Ltd can do when they discover this. It is possible that they would have a cause of action for misrepresentation against Diana who dealt with them over their purchase of Wheatacre, if it were found that she had represented that the farm would be suitable for organic use.

There are, then, a number of significant legal issues arising out of the series of transactions and dealings relating to these three companies.

BIBLIOGRAPHY

Statute

Companies Act 1985

Business Names Act 1985

Secondary sources

Kennan, D., Smith and Keenan’s Company Law (London, 2004)

Morse, G., et al, Company Law (London, 2004)

Scott Slorach, J., and Ellis, J., Business Law (Oxford, 2005)

Walmsey, K., Butterworths’ Company Law Handbook (2005)