Formation of a company - Lecture notes 3 PDF

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Company Law notes on the topic Formation of a company thought by professor John Quin....

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Company Law – Topic 3 Formation of Companies

1. Promoters The person who undertake the formation of a company are termed its promoters. Although often a promoter may be a professional advisor. In Twycross v Grant (1877) it has been said that a promoter is: “One who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose.” 1.1.

Promoters’ duties

Promoters own fiduciary duties to both the company and the company’s shareholder. These duties are based on general principles of equity. Turning from the general to the specific; like a company director, a promoter is considered to be a trustee, so where he acquires assets “on behalf of the company”, he does so in trust. The promoter of public companies can often be professional investment houses who specialise in establishing companies and attracting investment from the public. The promoters of a small private company will be the individuals who takes the steps to incorporate his business into a limited liability company. In Re Great Wheel Poolgooth Ltd. (1883) Solicitors or accounts who are employed by the promoter to prepare the necessary documentation for registration will not be classified as promoters as they are merely acting in their professional capacity. There are great opportunities for a disobedient promoter to make a profit for himself at the expense of the company. Promoters have therefore been subject to strict regulation and are deemed to owe fiduciary duties to the company they are forming, i.e. they are not permitted to make secret profits from transactions and must make full disclosure of any potential profits to the company as a whole. So a promoter must declare any conflicts of interest, must account for any profits and must compensate the company for any breach. In Salomon v Salomon [1897] it was established that the disclosed rule is satisfied once a promoter discloses an interest or a profit to “all shareholders who ever were, or were likely to be, members of the company”.

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1.2.

Consequences of breach of duty

In Erlanger v New Sombrero Phosphate Co [1878], Emile Erlanger was a Parisian banker. He bought the lease of the Anguilla island of Sombrero for phosphate mining for £55,000. He then set up the New Sombrero Phosphate Co. Eight days after the incorporation, he sold the island to the company for £110,000 through a nominee. One of the director was the Lord Mayor of London, who himself was independent of the syndicate that formed the company. Two other directors were abroad, and the other were mere puppet directors of Erlanger. The board, which was effectively Erlanger, ratified the sale of the lease. Erlanger, through promotion and advertising, got many members of the public to invest in the company. After 8 months, the public investors found out the fact that Erlanger (and his syndicates) have bought the island at half the price the company (now with their money) had paid for it. The New Sombrero Phosphate Co sued for rescission based on non-disclosure, if they gave back the mine and an account of profits, or for the difference. The House of Lords unanimously held that promoters of a company stand in a fiduciary relationship to the investors, meaning they have a duty of disclosure. He had to give back the profits that he made. “I do not say that the owner of property may not promote and form a company and then sell his property to it, but I do say that if he does he is bound to take care that he sells it to the company through the medium of a board of directors who can and do exercise an independent and intelligent judgment on the transaction” So if a company enters a transaction, in which a promoter had an interest, that transaction can be voidable at the behest of the company, unless they approve it after the promoter has made full disclosure of the interest which he may have. And if the promoter did make profit, it can be recovered by the company. In Gluckstein v Barnes [1900], the promoter of a public company formed a syndicate and bought property in London for £140,000 and then sold the property to the new company which they were promoting for £180,000. They disclosed the £40,000 profit to the public who were subscribing for shares, but did not disclose a further £20,000 profit which had been acquired by them due to the fact that they had bought debentures in the company which had sold them the property at a below rate and the liquidator of the company was paying off the debentures at par rate. It was held that there was inadequate disclosure to the company in this regard which left open the option of rescinding the contract or claiming damages. In Hopkins v Shannon Transport Ltd, it was established that promoters must make full disclosure and if not full disclosure contract is voidable by the company. 2|Page

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Constitutional Documentation LTD – private company limited by shares -> section 19. DAC – designated activity company -> section 967 PLC – public limited company – section 1006 CLG – private company limited by guarantee -> section 1176 UC – unlimited company -> section 1233

The memorandum of association states the details about the company, the shareholders, the limited liability. The article of association provides the rules. Section 19 of the Company Act 2014 no longer separates articles and memorandum for private companies limited by shares. 2.1.

Memorandum of Association

Section 16 of the Company acts refers to the memorandum for all companies, while section 1006(2) of the CA 2014 refers to the requirement for public companies. The following requires has to be meet in a memorandum: -

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The name clause: must obviously state the company’s name and, if the company is limited by shares or guarantee, the last word must be “limited” or “teoranta” if the name is Irish. The name cannot be the same as any other companies. It can be altered by special resolution. It is referred in section 26(5) of the CA 2014. The objects clause: sets out the objects of the company, i.e. that which it is set up to do, and these will be decided by the promotors. Sets out parameters of permitted corporate activity. Anything that is done by a company which is outside of the objects clause is ultra vires. This is no longer a requirement for private companies, but it is still a requirement for DACs (section 972), CLG (section 1182) and PLC (section 1012). The function of the objects clause is to grant the company capacity to act in furtherance of its stated objects and it limits the capacity to anything that is not in furtherance of its objects. Liability Clause: this sets out what liability attach to the members. Section 19(1)(c) on the CA 2014, refers to the private companies, and Section 32(4) CA can’t alter constitution to increase the liability of a member. Capital Clause: refers to the authorised v issued share capital. Section 19(1)(d) states that is no longer a need to declare authorised shares capital. Association Clause

The new Company Act 2014, no longer separate the articles and memorandum for private companies limited by shares, Section 19 CA 2014 - single documentation for private companies called the company constitution. Section 32 CA 2014 – can be altered by special resolution. 3|Page

2.2.

The “LTD” Constitution

This is for private companies only. Section 19(1) of the CA 2014, states that a memorandum should include the following: -

Name clauses Members have limited liability Diversion of shares capital Any supplemental regulations

3. Articles of Association The articles of association set out the rules and regulations for the management of the company. These are some of the publicly registered rules of a company which governs it internal regulation: the articles will provide for the holding of meetings, the transfer of shares which are to be exercised by the directors, appointment and removal of directors, powers to be exercised by directors. Section 13(2) of the Company Act 1963 states that if no article, registered company will adopt model regulation table A part 2. The new Company Act 2014 states that no longer a Table A model registered – all rules are now encompassed by the Act. 4. Section 25 of the old act and section 31 of the new - contract Company constitution comprises a statutory contract. Section 25 CA 1963 and Section 31(1) CA 2014. “Subject to the provision of this Act, the constitution shall, when registered, bind the company and the members of it to the same extent as if it had been signed and sealed by each member, and contained covenants by the company and each member to observe all the provisions of the constitution and any provision of this Act as to the governance of the company. In Clarke v. Workman [1920], it was established that section 25 of the CA 1963, “constitutes a contract between every shareholder and all the others, and between the company itself and all the shareholders. It is a contract of the most sacred character, and it is on the faith of it that each shareholder advances his money” Section 31 of the 2014 Act, has three elements: it binds he members and the company; it binds the members to the other members; and is enforceable by and against members acting in their capacity as members.

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5. Alteration of the constitution and articles Section 32 of the Company Act states (1) subject to this provisions of the Act, a company may be special resolution amend its constitution. (2) Any amendments so made of the constitution shall, subject to the provisions of this Act, be as valid as if originally contained therein, and be subject in like manner to amendment by a special resolution. (3) Where any amendment is made to a company’s constitution notice of which section 33 requires to be published as therein mentioned, the company shall deliver to the Registrar, in addition to the amendment, a copy of the text of the constitution as so amended. Restrictions to ability to alter articles: 1. Contrary to the regulations of company - Hennessy v National agriculture and Industrial Development Association. 2. Increasing the liability of a member. Section 32(4) CA 2014. 3. Must be bona fide in the interests of the company. Thomas Courtney stated in his book The Land of Companies: “The greatest and most nebulous prohibition on the alteration of the articles of a company is that an alteration will be declared to be null and void where the power to alter the articles is not exercised bona fide and in the interest of the company as a whole”. But what is the meaning of the company as a whole? In Allen v Gold Reefs of West Africa Ltd [1900], the company had altered its articles so as to five itself a lien on paid up shares in respect of the failure of the shareholder to pay calls on other shares which had not been fully paid. The articles of the company said that the company had to lean on the shares that are not fully paid off. The company tried to change the articles, and remove this, and lean on all the company shares. One of the shareholders died and owned them 6 thousand, and the company wanted to take the shares back and sell them to someone else, and that is why they want to change it. But this resulted in a clash of interest. The amendment to the articles was within the power of the company under section 50 of the 1862 Act, and it was held that the alternation of the articles was valid. So here a company as a whole was seen as -> a company as a separate legal entity. In Greenhalgh v Ardene Cinemas LTD [1950], was held that company as a whole is -> a company as a collective of shareholders. Objective test 1 – in Court’s view did the alternation actually benefit the company? Dafen v Llanely Steel (1907) Objective test 2 – Would a reasonable person believe the alteration was in the interest of the company? 5|Page

Subjective test – Did the shareholders honestly believe they altered the articles in the best interest of the company ? – Shuttleworth v Cox [1927] Cox Bros and Co (Maidenhead) had appointed a board of directors for life, and had fixed this under its articles of association. Then it proposed to amend its articles so that a director would lose his position if the other directors requested in writing for him to resign. Mr. Shuttleworth, who was targeted by the changes, brought a claim alleging that the alteration of the articles was not bona fide for the benefit of the company as a whole. 6. Shareholder Agreements This is very common in practice. The shareholders’ agreement cannot be enforced against the company unless the company has been included as a party to the agreement. A shareholder agreement is often entered where minority shareholders wish to protect their position in excess of any protections contained in the articles of association or in statute. It Usually deals with management of the company and voting rights. 7. Companies Act 2014  Distinction between Memorandum and Articles abolished for private companies; not it is combined into a single Document called the “constitution”.  It is no longer a requirement for an objects clause;  Provisions contained in the Model Regs/Table A are brought within the Act itself.

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