Company Law notes

Company Law

• Meaning of a company
• Types of companies
• Procedure of forming and incorporating a company
• Functions of companies
• Types of shareholders in a company
• Procedure of winding up a company

There is no precise legal definition of a company‟ .The word „company‟ is a by- product of mercantile rather than legal ingenuity and was in use in England long before what is now called „company law‟ came into existence

Although the word was initially used by English merchants to denote associations which they had formed for trading overseas, such as the British East India Company and the Hudson Bay Company, it was gradually extended with surprising latitude to diverse association until it ceased to have a specific meaning. One major consequences of this extension is that the English Company Law which has been adopted in Kenya defines or classifies „companies‟ according to the mode of their formation rather than according to their intrinsic attributes.

CLASSIFICATION OF COMPANIES

Section 389 of the Companies Act provides that „‟no Company, association or partnership consisting of more than twenty persons shall; be formed ….. Unless it is registered as a company under this Act, or is formed in pursuance of some other Act, Act of the United Kingdom or of letters patent‟‟.

Three types of companies are provided for under this section. They are:

1. Chartered companies
2. Statutory companies
3. Registered companies

 

1. CHARTERED COMPANIES

A chartered company is formed when the queen or King of England issue a charter, or „letters patent‟, to a group of people who intend to carry on a business as a chartered company. No such company can be formed in Kenya after political independence and the words „letters patent‟ in s. 389 only serve as a reminder of the England origin of our Companies Act which is the replica of the English Companies Act, 1948, with a few minor modifications.

 

2. STATUTORY COMPANIES

Statutory companies are set up by specific Act of Parliament or under authority of an Act of parliament by the state. The Act confers upon the statutory company corporate personality to enable it to exist separate from the government.

In the past, the government established such companies under specific Act of parliament e.g. Kenya Railways (set up under the Kenya Railways Corporations Act), the former Kenya Post and Telecommunications (set up under the Kenya posts and telecommunications Act which has since been repealed) and the Kenya ports Authority (set up under the Kenya ports Authority Act). However, since the passing of the state Corporation Act (Cap 446) law of Kenya, the government has moved towards formation of state corporations under the Act.

Section3 (1) of the Act provides that, the president may, by order, establish a state corporation as a body corporate to perform the functions specified in the order. In this regard many state corporations have been established through the authority of this Act as fewer are being formed through specific Acts. Such state corporations are endowed with perpetual succession; the ability to institute suits and being sued in their corporate name; and capacity to hold and alienate movable and immovable property in accordance with the Act.

The object of statutory corporations is set out in the Act which creates them or the creating instrument which is usually an order from the president under the State Corporations Act issued as a subsidiary legislation to the Act. Therefore a statutory corporation can only carry out those functions for which it was created. Moreover the capital of a statutory corporation is raised through borrowing, guaranteed by the Treasury, or by Treasury. Its profits and gains are injected back into the corporation or paid to the Treasury as dividend. When it makes loss and is unable to pay its debt it can be sued and its property attached to settle a judgment of the court but it cannot be wound up on the grounds that it is unable to pay its debts as happens in registered companies. Such statutory corporations are wound up on the repeal or revocation of the parent statute.

3. REGISTERED COMPANIES

A registered company is formed by registration under the companies Act. It is this type of company that people usually have in mind when they talk of „a company‟. The notes that follow are concerned exclusively with „registered companies‟. It should be noted that s.2 of the Companies Act defines a company as „„a company formed and registered under this Act’’.

 

 

CLASSIFICATION OF REGISTERED COMPANIES/TYPES OF COMPANIES

Registered companies are classified by s.4 (1) of the companies Act into:

1. A company formed by „‟any seven or more persons‟‟. Such a company is known as a public
2. A company formed by „‟any two or more person‟‟. Such a company is referred to in the Act as „‟a privatecompany‟‟.

 

A PRIVATE COMPANY OR A PUBLIC COMPANY MAY BE:

1. Limited by shares if the liability of its members is limited by its memorandum to the amount, if any, unpaid on the shares, respectively held by them.
2. Limited by guarantee if the liability of its members is limited by its memorandumto an amount which the members have undertaken to contribute to the assets of the company in the event of its being would up.
3. Unlimited if it does not have any limit on the liability of its members.

Limited liability companies may be classified into either private or public limited company:

 

PRIVATE LIMITED COMPANIES.

A private limited company may be identified by the following characteristics:

• Can be formed by two to fifty members.
• Does not invite subscription for shares and debentures from the public.
• Restricts the transfer of shares and debentures.
• Can be managed by at least one director.
• Can start business immediately after receiving a certificate of incorporation.

 

PUBLIC LIMITED COMPANIES

A public limited company may be identified by the following characteristics:

• Formed by a minimum of seven members and no maximum.
• Cannot start business before it receives a certificate of trading.
• Accounts are required to be published.
• Shares and debentures are freely transferable.
• Invite the public to subscribe for shares and debentures.

 

ADVANTAGES OF LIMITED COMPANY

1. Shareholders have limited liability (can only lose what they have put in the business)
2. Additional capital can be raised through issuing of more shares, bills and bonds.
3. More access to additional capital from external lenders.
4. Company name is protected by law
5. Perpetual existence
6. Democratic management
7. Easy transfer of ownership through sale of stocks to interested buyers.
8. It’s an artificial legal person ie shareholders are independent from company assets and liabilities.

 

DISADVANTAGES OF A LIMITED COMPANY

1. Employee may feel distant from  owners
2. Company records are open to the public e.g. annual records-financial disclosure
3. Expensive to form a company
4. Decision making is complex due to the number of people involved
5. Affair are strongly controlled according to companies Acts .
6. Double taxation, after a company pays its corporate tax its owner will have to pay personal taxes on any distributions of its profits they receive from the corporation in the form of stock dividend.
7. Agency problem- when managers do not act as responsible agents for the shareholders who own the business. Since managers run the business on behalf of the owners, they may not always act in the best interest of the owners. For examples managers may take an expensive trip which necessarily may not benefit the business, this bring about the problem of agency. Company such as Enron in USA went down due to agency problem
8. May suffer from diseconomies of large scale.

Businesses today are experiencing changes in the global market. This has seen most firms come together to join forces in order to be able to cope with the dynamics. There are several ways that firms are coming together and these includes; merger-where two or more firms combine to form one company, acquisition-where one firm purchase the property and assumes the obligations of another or where one firm buys a division or subsidiary from another firm. Joint venture- is a partnership between companies formed for a specific undertaking.

PRINCIPLE OF LEGAL/CORPORATE PERSONALITY AND VEIL OF INCORPORATION

PRINCIPLE OF LEGAL/CORPORATE PERSONALITY

A company is a legal person distinct and separate from the subscribers to the memorandum. A company thus has rights and duties similar to those of human beings. This principle holds that when a company is incorporated it becomes a legal person distinct and separate from its members and managers. It becomes a body corporate with an independent legal existence with limited liability, perpetual succession, capacity to contract, own property and sue or be sued. The principle of legal personality was first formulated by the House of Lords in its famous case of Salomon v Salomon and Company limited where Lord Macnaghten was emphatic (express something clearly) that the company is at law a different person from the subscribers to the memorandum.

This principle is now contained in section 16(1) of the Companies Act which provides inter alia that from the date of incorporation, the subscribers to the memorandum together with such other persons that may become members of the company are a body corporate by the name contained in the memorandum capable of exercising the functions of an incorporated company with power to hold and having perpetual succession and a common seal. The decision in Salomon’s case lay to rest certain principles:

1. That even the so called one man companies were legal persons distinct and separate from the members and managers
2. That incorporation was available not only to large companies but to partnerships and sole proprietorships as well
3. That in addition to membership, it was possible for a member to subscribe to the company’s debentures

PRINCIPLE OFVEIL OF INCORPORATION

A company is a legal person and is distinct from its members. This principle is regarded as a curtain, a veil or shield between the company and its members. This principle of separate legal entity was established in the famous case of Salomon Vs Salomon & Co Ltd. This precedent has been followed in a number of cases and it has come to be regarded as a fundamental principle of company laws. This shows that once the company is registered under the Act, there is a veil between the company and its members. Following this principle, the courts in most cases have refused to go behind the curtain and see who are the real persons composing the company.

But sometimes the necessity of the situation may compel the authorities to disregard the corporate legal entity and look to individual members who are in fact the real beneficial owners of all corporate property, and this in fact is what is known as, “Lifting or Piercing the Corporate Veil.” Thus the doctrine of lifting the corporate veil may be understood as the identification of a company with its members and when the corporate veil is lifted the individual members may be held liable for its acts or entitled to its property.

The courts will lift the corporate veil where it is essential to secure justice, where it is in the public interest to do so or where it is for the benefit of revenue. But it must be kept in mind that a separate legal entity is still the general rule. The corporate entity will be disregarded only in exceptional cases. These cases are exceptions to the principle in Salomon and Co Ltd. The various cases in which corporate veil have been lifted can be divided into two:-

1. Lifting by the courts
2. Lifting by the Statute

These are explained as under:-

1. Lifting By the Courts
2. Determination of the Character of the company

A company may assume an enemy character when persons in de facto control of its affairs are residents in an enemy country. In such a case, the court may examine the character of persons in real control of the company and declare the company to be an enemy company.

Daimler Co. Ltd vs. Continental Tyre & Rubber Co. Ltd (1916) A. C. 307.

A company was incorporated in England for the purpose of selling in England tyres made in Germany by a German company which held the bulk of shares in the English company. The holders of the remaining shares except one and all the directors were German residents in Germany.

During the First World War, the English company commenced an action for recovery of a trade debt. It was held that the company was an alien company and the payment of debt to it would amount to trading with the enemy and, therefore, the company was not allowed to proceed with the action.

2. Prevention of Fraud or Improper Conduct

The court will refuse to uphold the separate existence of the company where it is formed for a fraudulent purpose or to avoid legal obligations.

Professor Gower observed in this regard that the veil of a corporate body will be lifted where the corporate personality is being blatantly used as a cloak for fraud or improper conduct. Thus in the following case where a company was incorporated as a device to conceal the identity of the perpetrators of the fraud the court disregarded the corporate personality.

Jones vs Limpman (1962)

L agreed to sell a certain land to J. He subsequently changed his mind and to avoid the specific performance of the contract he sold it to a company which was formed specifically for the purpose. The company had L and the clerk of his solicitors as the only members. J brought an action for the specific performance against L and the company. The court looked to the reality of the situation ignored the transfer and ordered that the company should convey the land to J.

3. Where the Company is a Sham

The court will lift the veil where the company is a mere cloak or sham i.e. where the device of incorporation is used for some illegal or improper purpose. The following case illustrates this point.

Guilford Motors Co. Ltd Vs Horne (1933):-

Horne was appointed as a managing director of the plaintiff company on the condition that he shall not at any time solicit or entice away the customers of the company. He, however, formed a new company to carry on the same business. The new company solicited the plaintiff’s customers. An injunction was granted against both Horne and the Company. The court held the company was a mere cloak for the purpose of enabling the defendant to commit a breach of his agreement against solicitation”

4. Where the company is acting as the agent of the shareholders

When a company is acting as an agent of its shareholders or of another company, it will be liable for its acts. However, it is a question of fact in each case whether the company is acting as agent for its shareholders. There may be express agreement to this effect or an agreement may be implied from the circumstances of each particular case. Note the following case.

F.G. Film Ltd In Re (1953) I ALL E. R 615.

An American company financed the production of a film in India in the name of a British company. The president of the American company held 90 per cent of the capital of the British company. The Board of Trade of Great Britain refused to register the film as a British film. It was held that the decision was valid in view of the fact that British company acted merely as the agent or nominee of the American company.

5. Protection of Revenue

The court may also lift the corporate veil in the interests of revenue. The court will not hesitate to look behind the corporate veil where it is found that the company has been formed for evasion of taxes. In such cases, the individual shareholders may be held liable to pay income tax. The following case illustrates this point:-

Sir Dinshaw Maneckjee Petit, Re A. I. R. (1927) Bom. 371. D,

An assessee-a person by whom any tax is payable, who was receiving huge dividend and interest income, transferred his investments to four private companies formed for the purpose of reducing his tax liability. These companies transferred the income to D as a pretended loan. Held; the companies were formed by D purely and simply as a means of avoiding tax obligation and the companies were nothing more than the assessee himself. They did no business but were created simply as legal entities to ostensibly receive the dividends and interest and to hand them over to D as pretended loans.

6. Protecting Public Policy

The Courts invariably lift the corporate veil to protect the public policy and prevent transactions contrary to public policy. Thus where there is a conflict with the public policy, the courts ignore the form and take into account the substance

Lifting by statute

1. Number of Members Below Statutory Minimum:

As per section 33 of the Act, when the company carries on business for more than six months after its number of members is reduced below seven in the case of a public company and below two in the case of a private company, person who is cognizant of the fact and is a member during the time the company so carries on business after these six months, is severally liable for all the debts of the company contracted during that time. However, the members or members will enjoy the privilege of limited liability for the six months. This section enables creditors to look beyond the company to its members for satisfaction of their amounts.

2. Misdescription of the Company

Section 109 of the Act states that the name of the company must be fully and properly mentioned on all documents issued by it. Where an officer of a company signs, on behalf of the company, a bill of exchange, promissory note, cheque or order for money or goods in which the company’s name is not mentioned, the officer is personally liable to the holder of the bill of exchange, etc for the amount thereof unless it is paid by the company. The liability under this section is illustrated by Hendon vs. Alderman 91973) 117 S. J. 631. The directors of L & R Agencies Ltd signed a cheque in the name of the company stating the company’s name as L. R Agencies Ltd (omitting the word & from the name).It was held that they were personally liable.

3. Holding and Subsidiary Companies

In the eye of the law, the holding company and its subsidiary are separated legal entities. Even a 100% subsidiary is a separate legal entity and its creator and controller (ie the holding company) is not liable for its breaches of contracts and torts. Nor can the holding company sue to enforce rights which belong to the subsidiary

But in the following two cases, a subsidiary company may loose its separate identity to a certain extent:

1. Where at the end of its financial year a company has subsidiaries, it must lay before its members in general meeting not only its own account but also a set of group accounts shoeing the profit or loss earned or suffered by the holding company and its subsidiaries collectively and their collective state of affairs at the end of the year
2. Section 167 empowers the inspector appointed by the court to regard the subsidiary and the holding company as one entity for the purpose of investigation.
3. Investigation of Company Membership

Section 173 (5) empowers the registrar to appoint one or more competent inspectors to investigate and report on the membership of any company for the purpose of determining the persons who are or have been financially interested in the success or failure of the company or able to control or to influence the policy of the company. This will be done by lifting the corporate veil so as to ascertain the real persons controlling it.

5. Take – Over Bids

Section 210 provides that where a scheme or contract inviting the transfer of shares or class of shares or class of shares in the company to another company has been approved by the holders of not less than nine tenths in the value of shares whose transfer is involved, the transferee company may, at any time within two months after the making of the offer by the transferor company, give notice in the prescribed manner to any dissenting share holder that it deserves to acquire his shares.

This is well illustrated in the case of Re. Bufle Press Ltd in which an offer made by the company was regarded as having been made, in substance, by the company members. The court thereby lifted the veil of incorporation by treating the company and its members as one entity for the purpose of acceptances of the offer.

6. Fraudulent Conduct of Business

Section 323 of the Act states that if in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors, the court may declare that any person who were knowingly, parties to the carrying on of such business are to be personally liable for the debts and other liabilities of the company.

7. Prosecution of Delinquent Officers and Members of Company

Section 325 of the Act states that if in the course of a winding up of company it appears that any past or present officer or any member of the company has been guilty of any offence in relation to the company then the court may declare such a person liable for his offence. In this case also, the corporate veil will be lifted.

DISTINCTION BETWEEN COMPANIES AND OTHER FORMS OF BUSINESS ORGANISATIONS

The main distinction between a company and other forms of business organizations is found in the two fundamental principles of company law as discussed earlier.

• Legal/Corporate personality
• Theory of limited liability

1. UNINCORPORATED BUSINESSES e.g. sole proprietorship and partnership

These are businesses that do not have separate entity or existence from that of their owners. According to law such organizations are one and the same with their owners and they do not have separate rights and obligations from those of their owners. The enterprises have no existence apart from its owner. The owner has rights to all profits and bears all the liability for the debts. The owner has unlimited liability meaning, if business cannot meet its financial obligations, the owner can be forced to sell his property that will satisfy creditors or clear the business debts.

2. INCORPORATED BUSINESS.

These are legally separate and distinct organizations from their owners. They are advanced forms of business where a group of people pull their savings together and contribute as capital to set up a business enterprise.eg

• Cooperative societies
• Corporation

We then pay attention to the main differences between a company and a partnership. The basic differences between registered companies and partnerships are as follows:

1. Formation

Registration is the legal pre-requisite for the formation of a registered company:

FortHall Bakery Supply Co v Wangoe (1).–The Partnership Act does not prescribe registration as a condition precedent to partnership formation. A partnership may therefore be formed informally or, if the partners deem it prudent, in writing under a Partnership Deed or Articles.

2. Legal Status

A registered company enjoys the legal status of a body corporate, which is conferred on it by the Companies Act. A partnership is not a body corporate and is non-existent in the contemplation of the law. Such business as appears to be carried on by it is, in fact, carried on by the individual partners.

3. Number of Members

A registered private company must have at least two members under section 4 ofthe Companies Act and a maximum of 50 members (excluding current and formeremployees of the company who are also its members), under section 30 of the Act. Apublic registered company must have at least seven members under section 4 of theCompanies Act but without a prescribed upper limit. A partnership cannot consist ofmore than 20 partners.

4. Transfer of Shares

Shares in a registered company are freely transferable unless the company’s articles incorporate restrictive provisions. A partnership has no shares as such but a partner cannot transfer his interest in the firm to a third party unless all the partners have agreed to the proposed transfer.

5. Management

A company’s members have no right to participate in the company’s day-to-day management. Such management is vested in the board of directors. Partners have the right to participate in the firm’s day-to-day management since section3 of the Partnership Act requires the business to be carried on “in common”. The rightof participation in the firm’s management is, however not given to a partner who has limited his liability for the firm’s debts.

6. Agency

A member is not, per se, an agent of the company (Salomon v Salomon & Co Ltd(3). A partner is an agent of the firm because the business is carried on “in common” by the partners themselves. The Partnership Act, section 7 also expressly provides that every partner is an agent of the firm and his other partners for the purpose of the partnership.

7. Liability of members

A company’s member is not personally liable for the company’s debts because, legally, they are not his debts. A partner is personally liable for the firm’s debts. This rule has been codified by section11 of the Partnership Act, which provides that “every partner in a firm is liable jointly with the other partners for all debts and obligations of the firm incurred while he is a partner”, unless the partner is a limited partner.

8. Powers

The ultra vires doctrine limits a company’s powers to the attainment of the company’s objects under its memorandum of association. Partnerships are not affected by the ultravires doctrine and partners enjoy relative freedom to diversify the firm’s operations.

9. Termination

A member’s death, bankruptcy or insanity does not terminate the company’s legal existence whereas a partner’s death, bankruptcy or insanity may terminate the partnership unless the partnership agreement provides otherwise.

10. Borrowing money

A company can borrow on the security of a “floating charge”. A partnership cannot borrow on a “floating charge”. Concept of invitation of memebers of public to subscribe for shares.

11. Ownership of property

A company’s property does not belong to the shareholders, either individually or collectively. Consequently, a member cannot insure the property since he has no insurable interest therein: Macaura v Northern Assurance Co (4). A firm’s property is the property of the partners who can, therefore, insure it and, in the case of cash, make drawings from it.