ABE Principles of Business Law 2008-1

The Law Relating to Associations 75

A. THE CONCEPT OF CORPORATIONS

Definition

A corporation may be defined as:

an artificial unity or entity, normally consisting of a group of individuals, which the law treats as having a common will and, therefore, capable of holding rights and duties.

In other words, a corporation is a purely artificial entity, treated by the law as a legal person.

One of the root principles of the corporation is immortality, for it exists independently of its members, unless it is brought to an end in certain specific ways. This at once distinguishes it from the individual person, whose span of life is restricted and uncertain.

Types of Corporation

We can distinguish two main classes of corporation – the corporation sole and the corporation aggregate.

Corporation Sole

A corporation sole consists of a single individual – having, however, a legal personality completely different from the personality of the human being who, at any one particular time, makes up the corporation. For example, the Bishop of Oxford is both a human being – let us say, Dr Jones – as well as a corporation sole, since the legal personality of the Bishop of Oxford has an existence which dates back to the original foundation and looks forward continuously to the future until, for any reason, it is dissolved. The office of Bishop of Oxford may become vacant upon the death of Dr Jones, but the corporation is only in abeyance until a new bishop is appointed, and its legal personality is continuous.

In the case of the Crown, however, owing to the maxim "The Sovereign never dies", there is no gap between the death of one monarch and the coming into office of the successor.

Corporation Aggregate

Here, the corporation is made up of a number of corporators or members, e.g. a trading company which is made up of its shareholders, a borough which consists of the mayor, and councillors, and a university college which is made up of its master and fellows.

The Crown as Corporation Sole

We should here consider the special position of the Crown as a corporation sole, apart from the constitutional position. We must, as in the case of the example of corporation sole mentioned above, distinguish between the Queen in her personal capacity, and the Crown in its corporate sense.

The Queen is able to hold property in her private capacity, but this must be distinguished from property known as "Crown lands", which are held in right of the Crown and the profits of which form a part of the revenue of the Crown.

It is in regard to the law of tort that we must give special attention to the unique position of the Crown. The maxim of the common law was "The King can do no wrong" – and, therefore, the King cannot be sued in his own court. Until the passing of the Crown Proceedings Act 1947, there was only a very restricted right of action against the Crown. It was possible, by means of a special procedure – called "the petition of right" – to bring actions involving breach of contract or actions for the recovery of property against the Crown, but no action in tort was possible, and a person who had a right of action in tort

©ABE and RRC

76 The Law Relating to Associations

against a servant of the Crown was only able to bring an action against the servant personally. There was no action either against the Crown or against any officer of the Crown for the tortious acts of servants or subordinates.

The Crown Proceedings Act 1947 has provided, however, that an action may be brought against the Crown in its corporate capacity, but not against the Sovereign in his or her personal capacity, for breach of contract or debt or in cases of torts committed by Crown servants. The more important modifications made by the Act are as follows:

The antiquated procedure by petition of right is abolished.

An ordinary action may now be brought against the Crown, but the Claim Form in the action should be served on the appropriate government department concerned or upon the Attorney-General. Only in special cases can a government department be sued. (Although the Claim Form may be served on the government department concerned, the action is against the Crown.)

Action will lie for breach of contract and for the recovery of property.

In regard to torts, the Crown is made liable for the torts of its servants to the same extent as is an ordinary master, i.e. for torts committed within the scope of the servant's authority.

The Act, however, imposes the following limits:

(i)The Crown shall not be liable for the tort of a judicial officer, e.g. a judge or magistrate.

(ii)Liability extends only to those servants who are paid directly by the Treasury out of public funds, e.g. borough and county police are not paid direct by the Treasury, so the Crown is not liable for their wrongs.

(iii)Where a member of the forces, while on duty, tortiously injures another member of the forces also on duty at the time, the latter shall have no right of action against the Crown in respect of the tort of the former, unless the Secretary of State for Social Services certifies that he/she would not be entitled to compensation under the royal warrant.

The Act imposes no personal liability upon the Queen herself. She cannot be sued in her personal capacity but only in her corporate capacity as the Crown.

Note, however, that the head of a government department is not the master of the subordinates of her department. She is not liable for their torts, unless the tort was substantially her act, for both she and they are equally servants of the Crown, although she may appoint her own subordinates.

Reasons for Corporate Existence

The primary reason for the creation and recognition of corporations is commercial and economic. Under the protection of the corporation, large-scale enterprises flourish for centuries, having perpetual succession undisturbed by the death of individual members. The continuity of the corporation is not affected, whether old members die, existing members retire or new members are added. The main point to grasp is that the collective personality of the corporation is entirely distinct from that of its members operating the corporation.

There are two distinct lives – the juristic life of the corporation and the life of the individual members. Obviously, although a corporation is a "person" in the eyes of the law, it cannot marry or be imprisoned, as an individual can – so it is frequently referred to as a "fictitious person". Because of the artificiality of its personality, the legal capacity of a corporation differs in some respects from that of ordinary individuals.

©ABE and RRC

The Law Relating to Associations 77

The distinction between the personality of a corporation and the personality of the individuals making up the corporation was clearly laid down in the case of Salomon v. Salomon & Company Ltd (1897). Salomon incorporated his business as a limited company, which consisted of seven members of his family and himself. He held all the shares except seven, and also debentures to the value of £10,000, representing a loan which the company borrowed from him. The debentures entitled him to a first charge on the assets of the company. Thus, when the company went into liquidation, Salomon claimed that, as a debenture holder, he was a "secured" creditor. The other creditors claimed that Salomon and the company were the same person, and that a man could not owe money to himself. The House of Lords, however, held that a company, once incorporated, had a legal existence of its own, which was quite independent of the existence of any individual member.

B. CORPORATIONS IN LAW

Creation of a Corporation

Since corporate personality is acquired only by state recognition, it can be conferred only by an authoritative document, having the state's approval. The law, therefore, prescribes that a corporation can be created by one of the following:

A Royal Charter whereby the Crown by its prerogative creates one particular corporation, e.g. a borough such as Oxford was incorporated by Royal Charter, and so was the BBC.

A special statute whereby a special Act of Parliament creates corporations to fulfil public functions, e.g. the Post Office Corporation.

A general Act of Parliament which grants the privilege of incorporation to all groups complying with certain requirements e.g. the Companies Acts which govern the formation of companies, and the Building Societies Act which governs building societies.

Immemorial custom, whereby a few corporations which never had charters are presumed to have acquired incorporation by immemorial custom in accordance with the fiction that the original charter was lost, e.g. certain very ancient boroughs.

The Acts of a Corporation

Exercise of Powers

Since a corporation has no material existence, but has the right to express its will, it has to act through its agents. As it is obviously impossible to allow all the members of a numerous body to act as its representative and to bind it by words or writing, some smaller group within the corporation is selected to administer its affairs. A typical example is that of the Board of Directors of a limited liability company who manage and act for the company as a whole.

There is, however, an important difference in the scope of the actions of corporations created by charter or "lost charter" theory and those created by statute. Corporations formed by charters, also known as common law corporations, have all the powers of ordinary persons except those which are specifically withdrawn by the charter which created them. They may, for example, do many things which are not clearly inconsistent with the purposes for which they were created.

On the other hand, statutory corporations may do only those things permitted expressly or impliedly in the statute incorporating them or in the documents of incorporation granted under the statute. Every act done in excess of these powers is ultra vires, and is legally void. An act which is ultra vires does not bind the corporation in any way. It is treated merely as the act of the agent or official which authorises or performs it.

©ABE and RRC

78 The Law Relating to Associations

Since 1989 it has been necessary to distinguish companies which are formed or registered under the Companies Act 1985 from other forms of corporation as the ultra vires rule has been virtually abolished in the case of the former category.

Formal Contracts

A company is represented in any matter concerning the law of contract by its agent or agents. Their contracts must, of course, be intra vires, i.e. within the company's powers.

The common law required that, when a corporation entered into a contract it used its common seal – the outward sign of authority of the whole body. However, the Companies Act 1948 made companies incorporated under the Companies Act exempt from the formality of contracting only by means of the common seal, and such corporations are now on the same footing as individuals as regards the form of their contracts.

The same rule now applies to contracts made on behalf of any corporation (Corporate Bodies' Contracts Act 1960).

Torts

A corporate body is, in the law of tort, liable for the wrongful act of its servants, provided that the act was done within the scope of the servant's employment and within the powers of the corporation, and it was an act which would have been actionable if done by an individual.

Owing to its nature, a corporate body is not able to sue or to be sued in respect of certain torts. For example, a corporation cannot sue for assault or battery.

It has, however, been held that a corporation may sue for defamation, i.e. libel and slander, if it can prove actual damage to its trade or business interest. This does not apply, however, to a municipal corporation, the income of which depends upon the rates it chooses to raise and not upon any trade. A municipal corporation, therefore, cannot sue for defamation, since its reputation is immaterial (Mayor of Manchester v. Williams (1891)).

In Cornford v. Carlton Bank (1900), it was held that a corporate body can be considered to have a malicious mind and, therefore, to be liable for the tort of malicious prosecution.

Cessation of a Corporation

A corporation continues to exist until it is dissolved in one of the following ways:

By voluntary surrender of its charter to the Sovereign.

By forfeiture of the charter through some default.

By Act of Parliament.

By the method provided for dissolution in the incorporating statute, e.g. under the Companies Act 1985 companies are dissolved by means of a "winding-up".

Note that a corporation does not cease to exist merely because all its members are dead. In such a case it is merely in abeyance and it can be revived at any time.

©ABE and RRC

The Law Relating to Associations 79

C. COMPANIES

Definition

The major statute governing companies is the Companies Act 1985 which consolidated all previous statutes relevant to company law.

The 1985 Act has itself been superseded by a 2006 Companies Act, due to come into full implementation by 2009.

One definition of a company is that it is:

an association of members whose shares in the property of the company are transferable.

Another way of defining it is:

an association of individuals for purposes of profit, possessing a common capital contributed by the members composing it, such capital being commonly divided into shares of which each member possesses at least one, and which are transferable by the owner.

A limited company is one in which the liability of its members is limited by the Memorandum of Association (see later) to the amount, if any, unpaid on the shares respectively held by them.

Limited companies are often referred to in the press, on radio and TV and in everyday speech as "firms". You should remember, however, that in the language of the law, a firm is a partnership or a one-man business, not a limited company.

Classes of Company

As a result of the Companies Act 1985, the following five classes of company now exist:

Public limited companies (plcs)

Private companies limited by shares

Private companies limited by guarantee without a share capital

Private companies limited by guarantee with a share capital

Unlimited companies

In practice, these companies fall into three basic legal categories:

(a)Unlimited Companies

These are rare, and do not call for a great deal of discussion. Note that the word "limited" is not used as the last word in the name of the company, and that the liability of the members is unlimited. An unlimited company may be reregistered as a limited company.

(b)Companies Limited by Guarantee

A company limited by guarantee is a private company which has the liability of its members limited by the Memorandum of Association to such amount as the members may respectively thereby guarantee to contribute to the assets of the company in the event of its being wound up. Leading examples are trade associations and organisations formed to promote charity, education, science, etc. They do not normally have a share capital, as they are not formed for profit, but they acquire the benefits of incorporation by registration.

©ABE and RRC

80 The Law Relating to Associations

(c)Companies Limited by Shares

This category is by far the most common, and it represents the ordinary limited company of modern commerce and industry. In a company limited by shares, the shareholders can only be called on at any time to pay the company the amount unpaid on their shares. This liability is stated in the Memorandum and, once the shares are fully paid up, it ceases.

Under the Act, companies limited by shares are classified as either public or private. A public limited company (plc) is defined by the Act as a limited company (whether by shares or by guarantee with a share capital) whose Memorandum states that it is a public company and which has registered as a public company. Such a company must have a minimum nominal allotted share capital of £50,000, and must identify itself on business stationery, etc. as "Public Limited Company". A private company is then defined in the Act as any company that is not a public company. The minimum number of persons who may form a public company is two. For private companies there is now no restriction on the number of members or shareholders, or on their right to transfer shares.

Note that companies limited by shares are often known generally as joint stock companies.

Advantages and Disadvantages of Creating a Company

The choice between using a limited company as a trading vehicle and remaining unincorporated as a sole trader or a partnership is one which has significant implications for businesses.

Once incorporated, the members of a limited company enjoy limited liability. So long as they have paid for their shares in full they cannot be required to contribute to the debts of the company. However, you will find examples later where the "veil of incorporation" can be lifted to remove the benefits of limited liability.

The company can sue and be sued in its own name. This is an advantage to shareholders in that they do not become immediately responsible for the debts of the company. In the event of a liquidation, however, ordinary shareholders rank last in the list of creditors of a company and rarely recover the full value of their investment. This reinforces the basis on which a company owns property, which is that its assets belong to the company itself, not to its members.

Ownership and management are fundamentally separate in a company. Although in many small companies the reality is that the directors are also the company's shareholders, this does not change the fundamental point under English company law; and it is unusual for large public companies which have a Stock Exchange listing to have a similar situation. While directors of a public limited company will usually have a shareholding, it is rare for them to have a controlling interest.

Once incorporated a company is subject to all the rules of company law as laid down in the Companies Acts. These are often complex rules but companies and their directors are deemed to be aware of them and to understand that non-compliance may often lead to personal criminal liability.

In comparison with other trading entities, such as sole traders or partnerships, the company enjoys greater flexibility in the raising of capital. For example, it may raise capital by means of a floating charge over the whole company or a specific part of the company's assets. Until the charge crystallises the directors are free to deal with or sell those assets subject to the charge. Companies can also raise capital, subject to compliance with Stock Exchange regulations, from the various securities markets such as the Alternative Investment Market and the Unlisted Securities Market. In due course this can lead to a full Stock Exchange listing where the company's shares are fully traded, with its activities being subject to full public scrutiny.

©ABE and RRC

The Law Relating to Associations 81

While many business operators elect to trade as a limited company to reduce their personal risks, banks and other lending institutions will not necessarily provide finance to the company itself. In the absence of a good trading record and substantial fixed assets which can be charged in the event of default, banks will frequently only lend to companies where the directors provide their own personal guarantees.

In order to incorporate a company the subscribers must register a range of documents with the Registrar of Companies together with a fee. There are usually fees payable to professional advisers who form the company, although it is increasingly the case for new companies to be purchased "off the shelf" from a company formation agent in order to minimise costs. During the life of the company there are annual compliance requirements such as submission of annual accounts to the Registrar of Companies, completion of an annual return and notification of all other relevant statutory issues such as appointment or resignation of directors and the company secretary, registration of mortgages and charges and any changes in the location of the registered office. Although the preparation and submission of annual accounts will involve a cost to the company, the audit requirements have been considerably relaxed for companies with annual turnovers under the thresholds of £90,000 and £350,000.

In recent years there has been an increasing number of companies formed as trading vehicles by individuals offering personal services, particularly in the information technology field. This has enabled the owners of the company, usually a single shareholder, to maximise their personal earnings by taking dividends from the company instead of salaries as employees. This practice, however, has come under the scrutiny of the Inland Revenue and its advantages may be restricted where the personal service company contracts with a single client company.

Distinction between Directors and Shareholders

A company is an artificial legal person recognised in law as having an existence distinct from that of its members. Once incorporated the members (shareholders) of a limited company enjoy limited liability. As long as they have paid for their shares in full they cannot be required to contribute to the debts of the company.

It is important to recognise that ownership and management of a company can be separate even though the individuals concerned are physically the same. Shareholders as owners of the equity or share capital of the company have the right to freely transfer their shares unless there is some restriction in the company's constitution. Shareholders, however, have no authority to "manage" the business of the company. Directors exercise day-to-day management of the company subject to the Companies Act, the Memorandum and Articles of the company (see later) and the directions given by the members of the company by special resolution at a general meeting.

Shareholders have the following rights by virtue of owning shares in a company:

To receive dividends

To receive a return of capital in a winding-up

To participate in surplus assets on a winding-up

To attend and vote at general meetings

Shareholders have no right to see the minutes of directors' meetings, only of shareholder meetings. Their decisions at general meetings may in some instances require a 75% majority.

Directors are appointed by the company in accordance with its Articles of Association. Their activities are controlled by the Articles, which deal with appointment, qualification, rotation

©ABE and RRC

The Law Relating to Associations 83

Certificate to commence trading – before a public company can commence trading it must obtain a certificate permitting it to do so under Section 117 of the Companies Act. If the directors trade or borrow money without having obtained this certificate, then the directors become jointly and severally liable with the company to indemnify the other party to the transaction for any loss suffered.

Company name not appearing in full on a cheque – if an officer (director or secretary) of a company signs on behalf of the company any cheque or order for money or goods in which the company's name is not mentioned in full, then the Companies Act provides for this to be a criminal offence and the officer becomes personally liable for the amount of the cheque unless it is duly paid by the company.

Fraudulent trading – the Insolvency Act states that if when a company is being wound up it appears that its business has been carried on with intent to defraud the company's creditors, then the liquidator of the company can apply for a declaration that individuals who were party to such a fraud should be liable to contribute to the assets of the company.

Wrongful trading – the Insolvency Act states that if a company has gone into insolvent liquidation and a director knew before the winding up started that there was no reasonable prospect that the company would avoid going into insolvent liquidation, then the liquidator can apply for a declaration that the director should be liable to contribute to the assets of the company.

As well as the above provisions of the Companies Act and the Insolvency Act, courts have decided cases where the veil of incorporation has been lifted. This has been done where circumstances indicated that the company was a sham concealing the true facts. This has been particularly important where courts have believed that the corporate structure has been established in an attempt to avoid the limitations imposed by the Companies Act.

In Jones v. Lipman (1962) the court decided to enforce specific performance of a contract against Lipman since he had formed a company as a sham to avoid fulfilling his contract with Jones.

In Gilford Motor Company v. Horne (1933) the veil was lifted to see whether a company was being used as a means of conducting activities which it was unlawful for the defendant to conduct – in this case the avoidance by Horne of a restrictive covenant made with his former employer.

In Aveling Barford Ltd v. Perion Ltd (1989) the sale of assets at a substantial undervalue by a company to another company which was controlled by the same shareholder was found by the court to be an attempt to disguise an unauthorised return of capital to the shareholder.

In Creasey v. Breachwood Motors Ltd (1993), where a company transferred its assets to another company to avoid liabilities arising from a wrongful dismissal claim brought against the first company, the court allowed the claimant to pursue the assets of the first company into the second company. See also Gencor v. Dalby (2000).

Cases which Affect Directors and Shareholders

Williams v. Natural Life Health Foods (1998)

Here the House of Lords stated that a director of a limited company was only personally liable for loss suffered as a result of negligent advice given by him on behalf of the company if he had assumed personal responsibility for that advice. In this case such an assumption of responsibility had to be determined objectively and the absence of personal dealings would indicate very strongly that the director would have no responsibility.

©ABE and RRC

84 The Law Relating to Associations

Re Continental Assurance Co. of London plc (1996)

Here the court decided that a non-executive director of a company had failed to appreciate what the responsibilities of a director were in relation to the understanding of a company's financial affairs. The director was required to exercise the competence required by the Companies Act in relation to the affairs of the company. His conduct as a director of the company made him unfit to be concerned in the management of a company and he was disqualified for three years from holding office as a director.

Hood Sailmakers Ltd v. Axford (1997)

Here the company's Articles stated that a quorum for a meeting was two directors. As the company only had two directors and one of them was abroad, it was not possible to hold a valid meeting. The director remaining in the UK attempted to use the written solution procedure to enable decisions to be made effectively by himself, who remained in the UK. The court decided that this written resolution procedure was invalid as one director was attempting to override the quorum requirements to his advantage.

Ross v. Telford (1997)

Here the court examined a case of corporate deadlock where equal shareholdings held by two parties in a company were preventing decisions being made by the company. In this case and in others where deadlock arises either from non-attendance rendering meetings inquorate or from equality of voting power, companies find it impossible to function. However the decision in this case makes it clear that courts will not attempt to solve a dilemma for parties which they have caused by the way in which they have divided the share capital or organised the quorum requirements. The solution is most likely to rest with the parties themselves, who can resolve the deadlock by agreeing to wind up the company.

Re Park House Properties Ltd (1997)

Here the court held that where directors had never played any active role in a company and had never been paid as directors, they still had obligations to fulfil. In this case three directors were disqualified from holding office since the law imposes statutory and financial duties on all directors. Their complete lack of involvement in the running of the company, its financial problems and the preparation and filing of accounts led the court to conclude that they were unfit to hold office as directors.

D. COMPANIES IN LAW

Formation

Incorporation

A company is formed by the requisite number of persons lodging with the Registrar of Companies a signed Memorandum of Association and Articles of Association. Once these documents are approved by the Registrar, he/she issues a Certificate of Incorporation which brings into being a new legal entity.

A private company may begin business on the issue of the Certificate of Incorporation but, in the case of a public company, certain other formalities must be observed before the Registrar issues a certificate to commence business.

Memorandum of Association

The Memorandum of Association states that its signatories wish to be incorporated as a company; the proposed company's name, objects (no longer required under the 2006 Act, S.31(1), powers, and capital and the situation of its registered office are stated. It must also contain a clause stating that the liability of members is limited. It is expected that, as this document expresses the powers of the company, all persons having dealings with the

©ABE and RRC