Business Entities Y2S1 Week 5: L9 Incorporating your Company & L10 Separate Legal Personality

Key terms and cases (Issue / Facts / Held) from my OneNote notes. 'Added' notes are from outside the notes (Grier / Macgregor).

Altering the articles: what is the procedure, and what limit applies?

• PROCEDURE: a SPECIAL RESOLUTION (75% of votes) under CA 2006 s.21. • LIMIT: the alteration must be made BONA FIDE FOR THE BENEFIT OF THE COMPANY AS A WHOLE (Allen v Gold Reefs of West Africa 1900). Shareholders must vote in good faith for what they think benefits the company. • Even an alteration that takes away a member's rights can be valid if passed bona fide (Sidebottom v Kershaw, Leese 1920; Citco Banking v Pussers 2007 (PC)).

Company registers: what must a company keep, and what changed under ECCTA 2023?

Victorian background: searching a central register was hard, so companies kept their OWN registers, and for most matters these were DETERMINATIVE. The exceptions were existence, NAME and REGISTERED OFFICE, which change only when Companies House records the change. Registers required: • SECRETARIES (s.275); • PERSONS WITH SIGNIFICANT CONTROL (s.790M); • MEMBERS (s.113); • DIRECTORS (s.162). Private companies could elect to keep this information on the central register. ECCTA 2023 s.51 ABOLISHES the requirement to keep own registers, so the information is held publicly at Companies House. ECCTA also requires directors' IDENTITY to be VERIFIED.

The s.33 statutory contract: what does it say, and who is bound?

CA 2006 s.33: 'The provisions of a company's constitution BIND the company and its members to the same extent as if there were COVENANTS on the part of the company and of each member to observe those provisions.' The articles are therefore a STATUTORY CONTRACT binding: (a) the company towards its shareholders; (b) the shareholders towards the company; and (c) the shareholders towards EACH OTHER (Wood v Odessa Waterworks). LIMIT: only rights held IN THE CAPACITY OF A MEMBER are enforceable. Outsider rights (e.g. as solicitor or director) are NOT enforceable under s.33 (Eley; Beattie; Hickman).

Shareholders' agreements vs the articles

A SHAREHOLDERS' AGREEMENT is a PRIVATE contract between shareholders regulating their conduct (e.g. voting, transfers). • It is enforceable BETWEEN the parties as an ordinary contract. • A company cannot validly contract to FETTER its STATUTORY POWERS (e.g. to increase its share capital). Such a promise by the company is unenforceable against it, but the shareholders' personal agreement among themselves remains valid (Russell v Northern Bank Development Corp 1992). • Unlike the articles, it is PRIVATE (not filed), and it cannot be altered without unanimous agreement.

The Duomatic principle

The INFORMAL UNANIMOUS AGREEMENT of all the shareholders entitled to vote binds the company, as if a formal resolution had been passed at a general meeting, even though no meeting or formal resolution took place (Re Duomatic Ltd 1969). Added: it does not override statutory procedures that protect third parties (e.g. creditors), or matters outside the shareholders' powers.

Company capacity (s.39) and the directors' power to bind (s.40)

• s.39(1) CAPACITY: 'The validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company's constitution.' Nothing in the constitution stops the company being bound to third parties. • s.40(1) AUTHORITY: 'In favour of a person dealing with a company in GOOD FAITH, the power of the DIRECTORS to bind the company, or authorise others to do so, is deemed to be free of any limitation under the company's constitution.' • This means acts of the BOARD acting collectively, not a lone director (Smith v Henniker-Major 2002). SHAREHOLDERS receiving bonus shares are not 'persons dealing with' the company (EIC Services v Phipps 2004). • EXCEPTION, s.41: transactions with DIRECTORS or their ASSOCIATES, who are expected to know the constitution. • A breach of constitutional limits has NO EXTERNAL effect, but it has INTERNAL effect: directors who exceed the limits breach their duties and can be sued.

Old law: objects clauses and ultra vires. What replaced them?

OLD LAW: a company's MEMORANDUM set out its OBJECTS. Acts outside them were ULTRA VIRES and void, so objects clauses were drafted extremely widely (Rolled Steel Products v British Steel Corp 1986). NOW: • s.31: a company's objects are UNRESTRICTED unless the articles restrict them; • s.39: lack of capacity under the constitution cannot invalidate an act; • s.28: for pre-2006 companies, the provisions of the old memorandum (including any objects clause) are treated as part of the ARTICLES, so they can be changed like the articles.

The indoor management rule (the rule in Turquand's case)

An outsider dealing with a company in good faith, who does not know otherwise, can ASSUME that all INTERNAL procedures required by the constitution have been complied with (e.g. a necessary resolution has been passed): Royal British Bank v Turquand (1856). Today it overlaps substantially with s.40. It does not protect insiders, or anyone who knows (or should have suspected) the irregularity.

Company names, number and registered office

NAME: • change by SPECIAL RESOLUTION, or by any procedure in the articles (ss.77–81); • regulated on formation and on change (ss.53–85, ss.1192–1199A; Company, LLP and Business Names (Sensitive Words and Expressions) Regulations 2014): no names the SAME as existing ones, none suggesting a GOVERNMENT connection (s.1193), none MISLEADING as to activities (s.1198), and sensitive words need approval; • ECCTA 2023 ss.8–22 adds bans on names for CRIMINAL purposes, suggesting a connection with FOREIGN governments, or including computer code; • the name must end with the correct SUFFIX ('Ltd', 'plc') (s.58); the COMPANY NAMES TRIBUNAL resolves disputes; names must be DISCLOSED (s.82), or civil and criminal consequences follow. NUMBER: can NEVER be changed (s.1066). REGISTERED OFFICE: it must be in the company's JURISDICTION (s.86) and 'APPROPRIATE' (ECCTA s.28). It is changed by the board, but the change takes effect only when the REGISTRAR processes it (s.87).

Separate legal personality: what can a company do, and what can it not do?

A company is a JURISTIC (legal) person, separate from its members and directors. It can: • OWN PROPERTY; • CONTRACT; • OWE and BE OWED money; • SUE and BE SUED; • commit a DELICT (and some crimes). It CANNOT marry, adopt children, be an MP, and so on. Its personality allows what we expect profit-making businesses to do. Scottish PARTNERSHIPS also have separate personality, but a weaker kind that does not survive changes of partner (Partnership Act 1890 s.4(2)).

Holding a company liable for crime: why was it difficult, and what is the current law?

• IDENTIFICATION doctrine: the crime had to be the act and intention of the company's 'DIRECTING MIND AND WILL' (Lennard's Carrying Co v Asiatic Petroleum 1915). The knowledge of different employees could not be aggregated, so mere corporate negligence was hard to prosecute (Transco plc v HMA 2004: the culpable homicide charge failed). • The response was the CORPORATE MANSLAUGHTER AND CORPORATE HOMICIDE ACT 2007: an offence where the way the organisation's activities are MANAGED or ORGANISED causes death through a GROSS BREACH of a duty of care. • The courts 'anthropomorphise' the company: it is compared to a human PRINCIPAL that must act through human AGENTS (VTB Capital v Nutritek 2013).

The five characteristic features of a company

1. SEPARATE LEGAL PERSONALITY (Prest v Petrodel: a 'fiction', but real in law).
2. LIMITED LIABILITY of members, which lowers their risk.
3. DELEGATED MANAGEMENT to a BOARD: DIRECTORS manage, and SHAREHOLDERS own shares.
4. SHAREHOLDERS have CONTROL and governance rights over how the company is run.
5. Shares are FREELY TRANSFERABLE (and the company can be PERPETUAL, outliving its shareholders). Together these give the company its commercial importance (Standard Chartered Bank v Pakistan National Shipping Corp 2003, paras 36–37). Lord Sumption in Prest: 'limited companies have been the principal unit of commercial life for more than a century'.

Types of company (CA 2006 ss.3–5)

• UNLIMITED company (s.3(4)): members are liable for its debts WITHOUT LIMIT. It has all the downsides of a company and none of the main upside. • Company LIMITED BY SHARES (s.3(2)): liability is limited to any amount UNPAID on members' shares. – PRIVATE ('Ltd', s.4(1)): CANNOT offer shares to the public. – PUBLIC ('plc', s.4(2)): CAN offer shares to the public (it need not be listed). There are few (about 500–600 listed) but they are the biggest, and further requirements apply. • Company LIMITED BY GUARANTEE (s.3(3), s.5): members promise to contribute a set amount on winding up. It is mostly used for CHARITIES and non-profits. The default focus of the course is the PRIVATE company LIMITED BY SHARES.

Limited liability (Insolvency Act 1986 s.74): what does a shareholder actually have to pay?

A shareholder is liable to pay into the company ONLY the amount UNPAID on their shares (or the amount of their guarantee), however much the company owes. • NOMINAL (par) VALUE: the 'face value' of a share (e.g. £1). Every share must have one (CA 2006 s.542). • MARKET VALUE: what the share is worth, which is unrelated (e.g. Tesco: market price about 445p, nominal value about 6⅓p). • SHARE PREMIUM: the amount a subscriber agrees to pay ABOVE nominal value (e.g. in a rights issue). Liability is limited to the unpaid NOMINAL VALUE + PREMIUM agreed. • On a SALE of existing shares, the price goes to the SELLING SHAREHOLDER, not the company. Consequence: companies can be 'THINLY CAPITALISED' (e.g. £1 of share capital), and the capital paid in says nothing about the company's real value.

Attribution: how are acts and knowledge attributed to a company? (Meridian)

OLD LAW: the 'directing mind and will' (Lennard's Carrying Co 1915). It still occasionally reappears (Bilta v Nazir). CURRENT LAW, Meridian Global Funds Management v Securities Commission (PC 1995), sets out THREE levels of attribution:

1. PRIMARY rules: the company's CONSTITUTION (and company law, e.g. decisions of the board or the general meeting);
2. GENERAL rules: AGENCY and VICARIOUS LIABILITY, the usual way the company's rights and obligations are attributed (Bilta);
3. SPECIAL rules: where a particular rule of law requires it, the court decides whose act or knowledge counts AS the company's, by interpreting that rule's purpose.

Company groups: holding companies and subsidiaries (CA 2006 s.1159)

Company A is the HOLDING company of company B (its SUBSIDIARY) if A: • holds a MAJORITY of B's VOTING RIGHTS; or • is a member of B and can APPOINT or REMOVE a MAJORITY of its BOARD; or • is a member and CONTROLS a majority of voting rights (alone or under an agreement with others). The test 'looks through' chains (a subsidiary of a subsidiary is also a subsidiary). A 'WHOLLY OWNED' subsidiary is one where all the shares are held by the group. • A subsidiary CANNOT hold shares in its parent (s.136), which avoids circularity. • A holding company is NOT liable for its subsidiaries' debts (Adams v Cape Industries 1990). • Groups must prepare CONSOLIDATED accounts (ss.394, 399, 404).

Problem question: is the company bound by a contract made by its directors in breach of the articles?

Added (exam technique, combining Weeks 1 and 5):

1. CAPACITY: is anything in the constitution relevant? It does not matter (s.39).
2. AUTHORITY: • Was it the BOARD (collectively)? The good faith outsider is protected by s.40 (Smith v Henniker-Major on a lone director). • Is the outsider a DIRECTOR or associate? Then s.41 applies, and the transaction is voidable. • Was an individual officer acting? Then apply AGENCY rules (actual or apparent authority: Freeman & Lockyer, Week 1) and the TURQUAND indoor management rule.
3. INTERNAL consequences: the directors are in breach of duty to the company, even if the third party is protected.
4. Pre-incorporation contract? Then the person acting is personally liable under s.51 (Week 1).

CASE: Sidebottom v Kershaw, Leese & Co Ltd [1920] 1 Ch 154 (CA)

Issue: Can the articles be altered to take away the rights of a shareholder who COMPETES with the company? Facts: A minority shareholder ran a COMPETING business. Shareholders owe no fiduciary duty not to compete, but the majority feared he would use his shareholder rights against the company. They altered the articles. Your notes say the alteration stopped a competing shareholder voting. Added: the usual account is that the articles were altered to require a competing member to TRANSFER his shares at fair value. Check this against Grier. Held: The alteration was VALID. It was passed BONA FIDE for the benefit of the company as a whole, even though it took away the minority's rights.

CASE: Citco Banking Corporation NV v Pusser's Ltd [2007] UKPC 13

Issue: Was an alteration of the articles that benefited the controlling shareholder valid? Facts: Added: the articles were altered to create a new class of shares carrying enhanced voting rights, which were issued to the chairman, who controlled the company. A minority shareholder challenged it. Check the detail. Held (PC): The alteration was UPHELD. Applying Allen v Gold Reefs, the test is whether the shareholders voted BONA FIDE for the benefit of the company as a whole. The court will not interfere unless no reasonable shareholder could have regarded the change as beneficial.

CASE: Wood v Odessa Waterworks Co (1889) 42 Ch D 636

Issue: Do the articles create a CONTRACT between the company and its shareholders, and between the shareholders themselves? Facts: Added: the articles provided for the payment of DIVIDENDS. The directors proposed to pay a 'dividend' in the form of debenture bonds rather than cash. A shareholder sought to restrain this. Held (Stirling J): the articles constitute a contract not merely between the shareholders and the company, but between EACH individual shareholder and EVERY other. The shareholder could enforce the articles, and a 'dividend' meant payment in cash. Non-shareholders are not party to this statutory contract.

CASE: Eley v Positive Government Security Life Assurance Co (1876) 1 Ex D 88 (CA)

Issue: Can an OUTSIDER (a solicitor) enforce a right given to him in the articles? Facts: The life assurance company's articles provided that Mr ELEY would be the company's SOLICITOR for life, removable only for misconduct. The company stopped using him (not for misconduct), and he sued for breach of the articles. Held: He could NOT enforce the provision. The articles are a contract only between the company and its MEMBERS in their capacity as members, and Eley was claiming in his capacity as SOLICITOR, an outsider. (Even though he later became a member, the right was not given to him as a member.)

CASE: Beattie v E & F Beattie Ltd [1938] Ch 708 (CA)

Issue: Can a DIRECTOR enforce a provision of the articles in his capacity as director? Facts: The articles contained provisions concerning a person's position as director (your notes: director for life), and an arbitration clause for disputes between the company and its members. A director who was also a member tried to rely on the articles in a dispute about his conduct as DIRECTOR. Held: He was NOT a party to the statutory contract IN THAT CAPACITY, so he could not rely on the articles. Rights held as a director, not as a member, are outsider rights.

CASE: Hickman v Kent or Romney Marsh Sheep-Breeders' Association [1915] 1 Ch 881

Issue: Which provisions of the articles are enforceable under the statutory contract? Facts: Added: a member in dispute with the association (about expulsion) sued in court, but the articles required disputes between the association and its members to go to ARBITRATION. The association sought to enforce the arbitration clause. Held (Astbury J): the arbitration clause was ENFORCEABLE against the member. He set out three propositions: (1) no article can constitute a contract between the company and a THIRD PERSON; (2) no right given in a capacity OTHER than that of member (e.g. solicitor, promoter, director) can be enforced against the company; and (3) articles regulating members' rights and obligations GENERALLY, AS MEMBERS, create rights and obligations between them and the company.

CASE: Russell v Northern Bank Development Corporation Ltd [1992] 1 WLR 588 (HL)

Issue: Is a SHAREHOLDERS' AGREEMENT not to increase the company's share capital without unanimous consent enforceable? Facts: Added: the shareholders AND the company signed an agreement that no further share capital would be created without the written consent of all parties. A shareholder sought to prevent a capital increase. Held: The COMPANY'S undertaking was UNENFORCEABLE: a company cannot FETTER its statutory power to alter its capital. But the agreement was ENFORCEABLE as a PERSONAL contract BETWEEN THE SHAREHOLDERS, binding how they would vote.

CASE: Re Duomatic Ltd [1969] 2 Ch 365

Issue: Can shareholders bind the company without a formal resolution at a meeting? Facts: Added: payments were made to directors without the formal shareholder approval required, but ALL the shareholders with voting rights had in fact approved them informally. Held: The INFORMAL UNANIMOUS ASSENT of all the shareholders entitled to vote is as binding as a resolution passed at a general meeting. This is the Duomatic principle.

CASE: Smith v Henniker-Major & Co [2002] EWCA Civ 762, [2003] Ch 182

Issue: Can a DIRECTOR who acts ALONE, in breach of the quorum requirement, rely on the s.40 protection (formerly CA 1985 s.35A)? Facts: Added: a director (who was also the chairman) purported to pass a board resolution on his own, at an inquorate meeting, to assign a claim to himself. Held: He could NOT rely on the statutory protection. 'The directors' means the BOARD acting COLLECTIVELY, not a single director. A director is also expected to know the company's constitution (compare s.41).

CASE: EIC Services Ltd v Phipps [2004] EWCA Civ 1069

Issue: Is a SHAREHOLDER who receives BONUS SHARES a 'person dealing with the company' within s.40 (formerly s.35A)? Facts: Added: the directors made a bonus issue of shares without proper authority, and the shareholders who received the shares relied on the statutory protection. Held: NO. A shareholder receiving a bonus issue is not 'dealing with' the company in the relevant sense (there is no bilateral transaction), so they do not get the protection.

CASE: Royal British Bank v Turquand (1856) 6 E & B 327

Issue: Can an outsider assume that a company's internal procedures have been complied with? Facts: Added: the company's deed of settlement allowed the directors to borrow on bond only if authorised by a resolution of the company. The directors borrowed from the bank without such a resolution, and the company argued it was not bound. Held: The company WAS BOUND. The bank was entitled to ASSUME that the necessary internal resolution had been passed. This is the INDOOR MANAGEMENT rule.

CASE: Salomon v A Salomon & Co Ltd [1897] AC 22 (HL)

Issue: Is a company that is effectively a 'one-man company' a SEPARATE PERSON from its controller, so that he is not liable for its debts? Facts: Aron SALOMON, a successful leather boot manufacturer and sole trader, INCORPORATED his business and sold it to the company. The Act then required 7 members: Salomon took 20,001 of the 20,007 shares and six family members held one each. Added: part of the price was paid in DEBENTURES, making Salomon a SECURED CREDITOR. In the 1890s recession the company became insolvent. The liquidator and unsecured creditors argued the company was merely Salomon's agent or alias, so he should indemnify its debts. He LOST in the lower courts. Held (HL): The company was a SEPARATE LEGAL PERSON, validly formed. Its debts were its own, not Salomon's, and he was not liable. (As a secured creditor, he was even paid ahead of the unsecured creditors.) This is the foundation of separate legal personality and limited liability.

CASE: Macaura v Northern Assurance Co Ltd [1925] AC 619 (HL)

Issue: Can a sole shareholder claim under his PERSONAL insurance policy for loss of the COMPANY'S property? Facts: Macaura sold his TIMBER to a company in which he held almost all the shares, but kept the timber INSURED in his OWN name. The timber, stored on his land, was destroyed by FIRE. He claimed on his policies. Held: NO claim. Macaura had no INSURABLE INTEREST in the timber, because it belonged to the COMPANY, a separate legal person. A shareholder has no legal or equitable interest in the company's assets. The company needed its own policy. This is the separation cutting AGAINST the controller.

CASE: Lee v Lee's Air Farming Ltd [1961] AC 12 (PC, New Zealand)

Issue: Can a controlling shareholder and director also be an EMPLOYEE of his own company? Facts: Lee formed a company for AERIAL TOP-DRESSING (crop spraying from a plane) in NEW ZEALAND (your notes say the US; it was NZ). He held almost all the shares, was governing director, and was also its chief PILOT. He was killed when his plane CRASHED. His WIDOW claimed workers' compensation, which required him to have been a 'worker' (employee). The company argued he could not employ himself. Held (PC): He WAS an EMPLOYEE. A person can act in MULTIPLE CAPACITIES: he could, as director, contract on the company's behalf with himself as pilot. This is a logical extension of Salomon.

CASE: Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 (PC)

Issue: Whose KNOWLEDGE counts as the company's for the purposes of a statutory disclosure obligation? Facts: Added: Meridian's chief investment officer and a senior manager, acting within their authority but without the board's knowledge, used company funds to buy shares in another company. The New Zealand securities legislation required a substantial security holder to give notice 'as soon as it knows'. The board did not know. Held (Lord Hoffmann): the company KNEW. The question is a matter of INTERPRETING the statute: whose knowledge was INTENDED to count as the company's. Given the purpose of the legislation, it was the knowledge of the person who acquired the shares. This set out the three levels of attribution: PRIMARY, GENERAL and SPECIAL rules.

CASE: VTB Capital plc v Nutritek International Corp [2013] UKSC 5

Issue: Can the corporate veil be pierced to make a company's CONTROLLER liable as a party to the company's CONTRACT? Facts: Added: VTB lent money to a company. It alleged that it was induced by misrepresentations and that the company was controlled by Mr Malofeev, and it sought to make him jointly liable on the loan agreement as if he were a party. Held: NO. Even if veil-piercing were possible, it could not make the controller a party to a contract he never entered. Lord Neuberger (paras 124–128) cast DOUBT on Woolfson and the 'façade' approach. The court also preferred the terminology 'PIERCING THE VEIL' (see Week 6, Pres