Nature and Constitution of Company Derives

Company has “no strictly technical meaning”; the nature and constitution of company derives from formation and practice and is governed by Companies Act 2006, and is also crystallised in other bodies of legislation, entrenched case law and equitable principles. The use of the word company is evidenced in economic principle and is a main reason for establishing a company and expanding the corporation as a private limited company is a vehicle for the driving of Emma’s commercial enterprise.

The principle in Salomon v Salomon is that corporations in the eyes of the law are a distinct person with own personality separate from its shareholders, with rights and duties distinct and separate; this creates an illusory veil around the company and applies to all companies. The Salomon decision is a motive for companies becoming incorporated, because once incorporated this limits liability. In advising Emma to the advantages of forming a private company, one must consider the different forms of companies. S.4(2) CA defines a public company and this is appropriate for a larger company as it allows the public to subscribe for shares which is an unrestricted right, but in a private company this is prohibited. In public companies there is a minimum capital which is not needed in private companies. Therefore private company is appropriate for Emma’s business as it is suitable for a small number of persons involved where no minimum capital is required. There is also partnership and the law places few requirements on this. Ordinary partnerships are governed by Partnership Act 1890 but unlike a company has no distinct legal personality of its own making shareholders directly liable for their debts.

There is Limited Partnership Act 1907 which means partners are liable only to the extent of their debts, these are known as limited partners and means the general partners are fully liable. There is also limited liability partnership which is governed by the Limited Liability Partnership Act 2000 and is similar to a company limited by shares but the main difference is that LLP’s have less legal certainty and this is not practical or desirable in company law. Thus Emma is advised to form a private company; the private company must have at least one director, a single resolution will allow two or more directors to be appointed, the private company must have ‘Ltd’ at the end of the company name on registration, such as ‘Emmas Salon Ltd’ which refers to liability of the company, not companies actions. The private company has an established legal framework but before the business becomes a corporate body it must first be incorporated and registered with the Registrar of Companies. Section 7 CA details the method of forming a company and application for registration and can be found in s.9 which gives guidance on what Emma must do to register her private company limited by shares. S.15 of the Act certifies that a company has been registered and s.16 then gives the effect of registration which allows the business to exercise all functions of an incorporated company.

When Emma registers the company she must state that the business is to be incorporated as a ‘private company limited by shares’, thus members will have limited liability in relation to the company debts, thus it is the liability of the members and not the company at issue. The members of a company agree on the nominal value to pay in the event of liability, thus contributing to the capital of company. The members may alternatively agree to a premium of shares which is more than the nominal value and must be pay agreed sum. Effect of limited liability by shares means that once a member has paid the company for the agreed shares, the member is released from an obligation, debt or liability and is not held liable to the company for deficiencies of other shareholders. The advantages of incorporation as a private company limited by shares outweigh the disadvantages and Emma, Chris and David as shareholders will be safeguarded by the Salomon principle of limited liability and further by incorporation of a company limited by shares. The doctrine of corporate personality is the foundation for the fortification of limited liability, and “every system of law…seems compelled by the…complexity of human affairs to create persons who are not men” therefore the separate legal doctrine exists as an advocate to certainty within company law. The doctrine benefits shareholders and they will not be sued as they hold property separately to the company, thus in legal proceedings a company can sue and be sued and will not affect the shareholders, because once company incorporated it is ‘…treated like any other independent person with rights and liabilities appropriate to itself…” Thus shareholders who have paid their agreed shares will not be made to pay more, for example shareholders will have no liability to creditors for debts as ‘…property and action in law are not the property or actions of their incorporators or shareholders.”, therefore incorporation with no risk of liability is an enticing concept of company law.

A company can own property which illustrates that no member can own“…property legal or equitable in the property.” The benefits of a separate legal entity are that a company can employ people, act as a director or secretary of another company and enter into contracts. Further advantages are persons receive shares in return for providing capital and is usually in proportion with the capital sum, thus they become members and able to attend the general meeting. A further aspect to this is that a shareholder is entitled to dividends, which is a profit from the company distinct from the company, reinforcing corporate personality. Also perpetual succession allows the company to continue in existence when members die or retire. Incorporating can be seen to increase methods of finance, and there are also tax advantages and having ‘Ltd’ shows that it is safer to invest than unincorporated companies. The advantages of limited liability correlate with the principle of corporate personality, but incorporation must take effect if the shareholders are to benefit limited liability. It is advisable that Emma incorporates as there are few disadvantages, which are merely technical and administrative.

The main advantage of corporate personality is the concept of limited liability which has caused academic debate and is argued that limited liability benefits “…invite the probability of exploitation.” In accord with this, Salomon effectively opened incorporation for all and is universally recognised to create a creature of corporate personality which is inter-twined with the concept of limited liability, allowing a veil to be cast on the shareholders to be protected from liability. The Salomon decision is an incentive behind companies’ incorporation because of limited liability which safeguards shareholders at law, “without it, company law would virtually collapse…” as small companies would not take risks no such surety that liability could be evaded. Kahn Freund argued the Salomon decision was “calamitous” as the doctrine is susceptible to abuse, however in advising Emma it is made clear the courts use protective mechanisms to enshrine the Salomon decision and to safeguard the corporate personality. It is recognised that limited liability should not be an incentive for engaging in commercial enterprises involving high risk, but must universally benefit society and “therefore justified the spreading of the commercial risk.” This reinforces that limited liability is the logical consequence of corporate personality with public policy at play and “limited liability corporation is the greatest single discovery of modern times” as it allows investors to pay money into a company without risks of liability and members do not have to pay debts of a company if not agreed, thus justice and policy with the need to avoid “a grinding to a halt of the corporate capitalist machine”.

Further advantage of limited liability is risks are taken by companies “so that new avenues of increasing commerce are explored’ and this a vital lifeline of company to be able to trade and make money. The courts and statute will lift the corporate veil to expose the members behind the company, therefore stripping the privilege of limited liability and in effect revealing the commercial reality behind corporate personality – so although incorporation creates a separate entity it must act within the framework of the law. Salomon principle is rarely challenged and there are reticent in “…disregarding the autonomous legal personality of a registered company.” Abuse of the corporate form will result in the veil being lifted, however there is no exhaustive list: where the company is incorporated as a sham, façade or a mask to evade liability, there is also s.214 Insolvency Act and s.24 Companies Act 1985, however intention of parliament must be certain before the veil is lifted, and must “be expressed in clear and unequivocal language.” The veil is pierced in state of emergency, or if an agency relationship is found between shareholders and company, if a subsidiary company is acting as agent for holding company. Although justice is fundamental in law, after much academic debate and from Adams v Cape that Salomon prevails as the court cannot “disregard the principle of Salomon merely because it considers it just to do so.” Therefore it is the discretion of the court that will decide whether the corporate veil is to be lifted and Emma must not abuse the corporate form or members will face direct liability.

Provided the correct formalities of registration have been met, the Hair Salon is incorporated as a corporate entity and is able to enjoy the advantages of a limited company limited by shares, further under the 2006 Act it is seen as a company de jure. The importance of articles of association within a company constitution is in s.17 CA and on registration the articles of the company are made public to ensure constructive notice and also any ‘resolutions and agreements…’ form part of company constitution in accordance with s.29 making them sui generis. The articles are the company’s most important constitutional document representing internal rules of a company and the organisational structure of a company which are analogous to an instruction book. They provide a framework for the directors and members, in matters such as directors duties, decision making and shares. Whilst articles provide flexibility they also constrain any abuse or violation to protect the company and its members and minority shareholders. Ben has helped draft the articles of association based on the Model Articles thus is able to enhance the company’s own articles to reflect the desires of the members.

Agreement must have been made between the members and as Ben has adopted company’s own articles guidance is found in Table A. Company as a separate legal entity is reliant on having directors for the running of the business as the company ‘…can only act through its directors.” Table A regulation 70 allows directors to become the driving mechanism of the company and make decisions, use power and obey the articles, this is universally recognised and breach of director duties can result in derivative actions. The effect of the articles on a company as a separate entity are seen in s.33(1) which create a ‘statutory contract’ and the articles bind the company to its members, and also bind member to member, thus ‘…constitute a contract not merely between the shareholders and the company but between each individual shareholder and each other.’ The characteristics create a ‘special contract’ which is distinct from a typical contract and are described as sacrosanct thus courts are reticent to intervene, even where articles conflict with intentions of parties. Drury argues that the s.33 not ‘sacrosanct or immutable’, simply that the contract adjusts to meet the requirements of rights and interests of members. However it is argued that s.33 is sacrosanct as it is exclusively for members to ensure the company is protected.

Salomon encouraged growth of ‘qausi-partnerships’ and persons envisage expectations, such as the right to be a director, thus persons tried to secure position by cementing terms in the articles. It must be identified who can enforce and rely on provisions within articleswhich promulgated in Hickman and is seen as a filter mechanism with a two limb test that decides if a person can rely on the s.33 contract. It established that the company can enforce articles only against the members, “not to bind him in his capacity as an individual” and Astbury J crystallised that the contract binds a person only in a capacity as a member, which means that ‘solicitor, promoter or director’ cannot enforce rights against the company.

As Emma is a director she is classed as an ‘outsider’ and thus unable to rely on the provisions and Eley is proposition that articles are only able to confer rights on members, which highlights privity of contract, that only the parties to the contract can sue. Brown v La Trinidad is authority that Emma will be unable to enforce her right as a director as it is a matter ‘not connected with the holding of shares’. Beattie v Beattie proves unenforceability of outsider rights even though Emma is also a member and enshrines that an outsider cannot enforce s.33 regardless of how directly connected with the company Emma appears as s.33 only applies, ‘to the relationship of the members in their capacity as members.’

The second limb identifies the type of right an individual is enforcing and must be an insider right. Salmon v Quin held that a person in the capacity as an outsider was able to enforce his right by bringing the action as a member to prevent the company abuse. Wedderburn supports this judgement that company should act in accordance with articles, thus giving every person a statutory right under the contract. However if one is to take this view the aim of s.33 is contravened. There are four main types of insider rights which are the rights to attend general meeting, vote at general meeting, have vote recorded and receive a dividend. Emma is an outsider in her capacity as a director thus no locus standi to sue under the articles. However in her capacity as a shareholder she is an insider and she is trying to enforce her right to vote which is an insider right, thus does have locus standi to sue and right to rely on the articles. Ben is an outsider as he is not a shareholder and is not enforcing an insider right, thus no locus standi to sue, which is part and parcel of the rule in Foss v Harbottle to prevent company becoming flooded with litigation.

Chris and David must rely on powerful mandatory sanction of s.168 to remove Emma as a director and entitles a company ‘by ordinary resolution at a meeting to remove a director before the expiration of his period of office’. Articles cannot exclude or restrict effect of s.168, and company articles must be followed and special notice must be given to the company of their intention to remove Emma not less than 28 days before the general meeting and must have 50%+1 of the votes. Chris and David have 60 votes each and Emma only has 40 it would appear that removal by ordinary resolution would be work and Chris and David must only remove a director bona fide and, act in “the best interests of the company.’ Special voting rights can be attached to shares thus s.168 can be circumvented, authority is Bushall v Faith giving Emma minority protection in the form of a weighted voting clause as the article states ‘the shares held by her shall carry four votes per share’ Lord Morris dissenting stated that, “Its unconcealed effect is to make a director irremovable.”Emma cannot be removed by ordinary resolution on a calculation of the vote as Chris and David hold 60% of the votes and Emma now has 160%. To alter articles which a special resolution at general meeting must gain 75% of the vote and the Article is amended, shareholders must however exercise their voting power “bona fide for the benefit of the company as a whole”. Chris and David have not got 75% of members to change the articles and in any case this is a class right and needs a procedure which is over and above s.21.

Cumbrian case set in stone class rights, as Emma has rights attached to shares by virtue of weighted voting. This allows the mandatory nature of s.168 to be avoided and aim to protect minority shareholders from majority oppression. They must be aware this is a ‘class right’ and removal of the weighted voting clause in the articles of association, to remove Emma from board of directors, can only way be altered by following s.630. The rule is that rights attaching to class of Emma’s shares cannot be altered by other class share holders without Emma’s consent; need 75% consent of that class in question. To remove the director s.630(2)(b) would require Emma’s consent either in writing or by special resolution to be removed. White v Bristol Aeroplane held there is a ‘…distinction, between an affecting of the rights and effecting of the enjoyment of the rights…’ Variation amounts to an ‘attempt to amend a provision contained in the articles for the variation of the rights attached to a class of shares’. This requires 75% consent from Emma to remove the weighted voted clause in articles and is unlikely. Chris and David could issue more within her class to another person to consent to the variation and create a shareholders agreement to ensure they vote in their favour to remove the Bushall clause. As Emma is a member of that class she may be able to object to the variation under s.633 and must hold not less than 15% of the class share, the variation has no effect until confirmed by the court.

The variation must be bona fide in the interest of that class, which is the duty of the directors under s.171. This is an objective test and it can be argued that increasing shares to her dilute her 15%, Emma would be unable to object to the variation and find herself outvoted on the s.630 resolution to remove the Bushall clause, thus variation of class right not permissible and breach of director duties occurred. A non-variation option not affecting the class right would be to issue more share capital outside that class, therefore issue of more capital does not require the consent from Emma. Chris and David can only offer shares to existing members first and only companies and professional investors, they cannot offer to the public. To meet the requirements of their business it is advised that they issue ordinary shares, as voting powers attached and ordinary shareholders retain certain degree of control in general meeting. It is submitted issuing more shares does not vary or abrogate Emma’s class right thus protecting her minority position. Thus s.168 ordinary resolution would be able to remove Emma as a director on a calculation of the votes. Need not alter articles under s.21 after removal, as no rights to enforce and article will lie dormant.

Remedy s.994 allows a shareholder with any capacity of shares to request the court allow a claim. This is brought by the company against persons who conduct business in a way which is prejudicial to interests of members. It must be established objectively there is unfair prejudice to a member and it may be claimed shares have only been issued to remove Emma as a director, thus affecting her interest as a member in the company. The conduct of those in control of the company’s affairs are entrusted with a fiduciary duty to ensure that powers are exercised for the benefit of the company as a whole and if conduct is viewed as violating the articles which is ‘more than trivial’ then a claim under s.994 is made.

Emma has her right in the articles that she is to be a director, thus must prove that the conduct was unfairly prejudice as it is “…in a manner which equity would regard as contrary to good faith.” The fact it is a small business is contrary to mutual trust and confidence to issue more shares for improper purpose and thus to exclude Emma from management participation may be deemed by the court as unfair prejudice. It is argued David and Chris have followed the correct procedure to remove of a director, not affecting her class right, thus it is the discretion of the court that will decide if the conduct is unfairly prejudice. However it may eb argued they were acting capricously in the issue of more shares. Courts powers under s.996 redress Emma and an appropriate remedy is shares be bought by Chris and David, as to keep her as a member would cause detriment to the company. As Emma is an accountant, she is an officer, owing a contractual duty to the company to exercise care and skill properly and owes a duty of care to the others in the company, a departure from this standard will result in a breach. It is argued that as Emma did not insure in her position as an accountant she will incur a debt instead of the company, which is distinguished from the company holding an asset as an independent entity; not the shareholder.

This reinforces the need to remove Emma and may support Chris and David when the court is deciding if unfair prejudice. It is submitted that the rule in Foss v Harbottle allows shareholders with majority to act and prevents minority bringing a claim, it must be remembered that company is the proper claimant and thus Chris and David removing Emma can be seen to be in the best interest of the company, as to remain as a director and an incompetent accountant will cause detriment to the company, thus no statutory derivative action is permissible as there is no evident breach of director duty thus no ‘fraud on the minority’. There are also contractual restraints as Emma and Ben have a service contract and removal of a director may amount to a breach by the company. Shareholders agreements ‘…create personal obligations…against themselves only,’ supplement the articles, allowing agreements that are not membership rights. It must be evidenced an agreement was signed by the parties and terms can be changed by 100% agreement by all the parties. If a conflict between the articles and agreement arise, court apply the Duomatic principle and informal and unanimous agreements are enforceable as a separate contract. Ben may argue that a shareholders agreement was in existence to be the company solicitor, thus contract law principles apply. If a shareholders agreement is found Ben may claim an injunction to prevent removal or claim damages and raise s.994 and remedy for breach of service contract

It is submitted that Emma may be removed on a calculation of the votes on a s.168 removal if correct formalities are followed and class right not abrogated without correct consent. It is the courts discretion to hold as being unfair prejudice. The test is objective as to directors breach of duty and if found that issue of more share capital is for improper purposes will breach s.171 if success of company is not the motive behind issue of share capital to remove Emma.

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