Law on Companies

Companies

The trading company provides two important factors which have underpinned the success of capitalism:

1. The company provides a structure which allows for the efficient separation of ownership of resources and management of those resources; it is specially designed as a capital raising vehicle.

2. The company provides a mechanism by which the owner of capital can limit his or her liability to third parties.

CHARACTERISTICS OF COMPANIES

Artificial legal person with rights, powers and liabilities of its own.

Separate legal entity – independent of people that control or run the entity

Can sue and be sued in its own name Perpetual succession - lifespan of the

company is not affected by the death of it members or officers

Can hold and dispose of the property.

Powers of the company The company has the legal capacity and powers

of an individual as well as the powers of a Owners Corporation, including the power to

Issue and cancel the shares of the company; Issue debentures of the company; Grant options over unissued shares in the company; Distribute any of the company's property among the

members; Give security by charging uncalled capital; Grant a floating charge over the company's property; Arrange for the company to be registered or recognized as a

Owners Corporation in other jurisdictions (subsidiaries, representative offices, branch offices);

Do anything that it is authorized to do by any other law.

Consequences of the Separate legal entity doctrine

1. Corporate capacity – the company can do most things that a natural person can do:

The companies obligations and liabilities are its own and not those of its participantsA company can sue and be sued in its own name

2. Perpetual succession – continues until it is wound down and deregistered irrespective of changes in its participants;

3. A company’s property is not the property of its participants;

4. A company can contract with its own controlling participants.

How a company acts A company does not have a physical existence. It must act

through other people. Individual directors, the company administration, company

employees or agents may be authorized to enter into contracts that bind the company

The management of the company is in the hands of the directors, who are elected according to the rules of the company or nominated in the constitution

Number of directors will sway according to the type and size of the company

Public companies will have a board of directors consisting of at least 3 directors – executive & non executive

Processes involved in setting up a company

Step 1: Decide on your business structure Step 2: Choose a company name Step 3: Obtain consents - member(s), director(s)

and administration Step 4: Complete and lodge the application

forms

Effect of the Rules or Constitution A company’s constitution, if any, and any

replaceable rules, have effect as a contract between: The company and each member The company and each director and company

secretary A member and each other member

Ultra vires doctrine

Broad classification of Companies Private vs. Public Private legal entity vs. Public legal entity Private company vs. Public company

Broad classification of Companies Private vs. Public Private CompanyUsually the company is owned by the company's founders, management or a group of private investors.

Commonly used for small or family owned businesses May be formed by 1 person (Director & Shareholder) Membership is limited to ~ 50 persons (excluding

employees who hold shares in the company) Must have share capital Cannot list their shares on the stock exchange

Broad classification of Companies Private vs. Public

Public CompanyThe company that has sold a portion of itself to the public via an initial public offering of some of its stock, meaning shareholders have claim to part of the company's assets and profits

May have unlimited number of members May invite the public to subscribe for any shares in, or debentures of,

the company and it may be required to prepare disclosure documents when it issues shares

It is usually limited liability company. If it is a limited company, it includes the word limited or an abbreviation thereof (For instance: Ltd., Plc.)

May be listed on the Stock exchange and comply with listing rules Must prepare financial accountability statements, that must be audited,

and presented publicly.

Public companies have wider powers to raise capital from members of the public than proprietary companies but are subject to more regulation.

Large Private Companies vs. Small Private Companies

Classification is based on criteria in respect of revenue, assets and number of employees

1. Large Private companies have increased reporting obligations to members and Public

• They must prepare financial statements• Those statements must be audited• The audited statements must be submitted publicly

2. Small Private companies are not required to prepare financial statements or appoint an auditor

Specific classification of Companies

A public company can be any one of the following whereas private company can only be one of two types

1. Companies limited by shares Most common type Either public or private in nature Extent of members liability is restricted to the amount

unpaid on the issue price of shares held by the member

Specific classification of Companies

2. Unlimited liability companies Private or Public No limitation on a member’s liability Liability may extend to members personal assets Suitable more to professional firms such as

solicitors which are not permitted to limit liability

Limited Liability

If the company is a limited liability company, the shareholders' liability, should the company fail, is limited to the amount, if any, remaining unpaid on the shares held by them.

A company is a separate legal entity and, therefore, is separate and distinct from those who run it. Only the company can be sued for its obligations and can sue to enforce its rights.

Incorporation is said to cast a veil over the company (an entity separate from its owners and officers) through which the courts cannot see

Lifting/piercing the corporate veil In exceptional cases the law will look to participants in the

company in respect of breaches of law Statutary exceptions usually include:

1. Duty on directors to prevent insolvent trading; By law, a director must prevent their company from incurring a debt when it is insolvent or about to become so. Or else risk exposing themselves to criminal prosecution, substantial fines or to action by a liquidator, creditors of the company to recover amounts lost by creditors due to your actions. Personal assets - not just their company's - may be at risk

2. Promoters remain personally liable on contract: – Anyone who enters a contract on behalf of the company before the company is formed may be personally liable under that contract

3. Winding up on just and equitable grounds; 4. Directors pay a dividend to shareholders when there are not

sufficient company profits - Director may be personally liable to creditors it is unable to pay its debts

Lifting/piercing the corporate veil In exceptional cases the law will look to

participants in the company in respect of breaches of law

– General Law exceptions include the following:1. Agency. Where a subsidiary is found to be acting as

agent for a holding company. The courts look beyond the separate entity principle and treat the group of companies as one

2. Fraud. Where the company forms a cloak for fraud i.e. the company was formed for fraudulent or improper purpose

3. Avoid an existing obligation. Where the company has been used solely or dominantly to do something that one of its participants is prevented from doing.

Powers of directors

Directors power of management is usually included in the articles of asociation or prescribed in the replaceable rules

A Director is: Responsible for managing the company’s business A person who makes or participates in making

decisions that affect the whole or a substantial part of the organisation

Who has the capacity to signifincally affect the company’s financial standing

A receiver or manager of property of the company

What are the legal obligations of a company officer?Directors of all companies have various duties imposed

upon them under both the law, articles of asociation and General Meeting decisions.

Common Law duties can be divided into two groups:1. Fiduciary duties

1. To act in good faith in the companies best interests2. To exercise powers for a proper purpose3. To maintain freedom to exercise their discretions4. To avoid actual and potential conflicts of interest

2. Duties of reasonable care, diligence and skill1. Directors must act using reasonable competence and keep

themselves informed about the company’s activities and maintain supervision over its financial position

General Meeting of the Company The shareholder shall have the following property rights:

1) to receive a part of the company's profit (dividend); 2) to receive the company’s funds; 3) to receive shares without payment if the authorised capital is

increased; 4) to have the pre-emption right in acquiring shares or

convertible debentures; 5) to lend to the company in the manner prescribed by law; 6) to receive a part of assets of the company in liquidation; 7) other property rights established by this and other laws.

General Meeting of the Company Shareholders shall have the following non-property rights:

1) to attend the General Meetings; 2) to vote at General Meetings according to voting rights

carried by their shares; 3) to receive information on the company; 4) to file a claim with the court for reparation of damage

resulting from nonfeasance or malfeasance by the company manager and Board members.

Raising and Maintaining CapitalCompanies finance their operations through the

following sources

1. Equity Capital

2. Retained earnings

3. Debt Financing

Equity Funds

Most Companies are incorporated with an authorised share capital in the memorandum of association.

Equity Capital represents the funds contributed by members in return for a share in the company

The amount of authorised capital represents the maximum number of shares that can be offered to individuals and firms to raise funds for the company.

Equity FundsThere are three main types of shares

Ordinary shares; Preference shares; Deferred shares.

Each class of share will have rights in respect of: Control : This includes the right to receive information

and voting rights Distribution: This includes the priority right to dividends

and distributions in the event of winding up

Equity Capital -Ordinary Shares Ownership.

Ordinary shareholders are part owners of the company. Have equal right to share the dividends with other ordinary

shareholders, if declared They usually have the right to vote at shareholder meetings and

elect the board of directors who manage the operations of the business on their behalf.

Have a right to be repaid capital contributed in a winding up after all other claimants are repaid

Have a right to share in surplus assets pro rate in a winding up The ordinary shareholders measure their return on their investment

from the dividends received from the company and any changes in the market price.

Limited Liability. A company may issue shares which are paid to less than their

nominal value. (E.g. A share with a nominal value of $1 may be issued as a partially paid share for, say, 60 cents) In this case there is a legal obligation on the shareholder to pay the remaining 40 cents if the company makes a call on the unpaid capital.

Equity Capital -Preference shares Preference shares are shares that give holders some right or preference

e.g. a guaranteed minimum dividend. The rights attached to a preference share must be approved by special

resolution of members, or alternatively are set out in the company’s constitution. This protects the interests of existing members by ensuring that they agree to the terms of the preference shares.

Preference shareholders have limited rights in respect of: Variation of their class rights Payment of fixed dividends arrears

Can be cumulative – entitled to an annual dividend regardles of whether it is declared in

that year or non cumulative Redeemable - preference shares that, according to their terms of issue, may be

redeemed at: the company’s option, or the members' option, or a fixed time or on a specified date.

Equity Capital -Deferred Shares

The deferred aspect of the shares relates to the low priority position of shareholders in regard to payment of dividends and/or return of capital.

Are seen as the most risky and are often taken up by directors to indicate their confidence in the company.

In times of success, these shares offer high returns because deferred shareholders will have access to the remaining distributable profits after ordinary dividends are paid.

Deferred shares are not a common source of equity.

Equity Capital -Bonus shares

Bonus shares are shares issued where no fee is payable to the company and the issue does not require any increase to the company’s share capital.

Equity Capital – Share Options

A share option represents the right to purchase shares in a company, at a predetermined price within a specified period.

The maximum period of an option is five years. Potential buyers generally pay a small premium to allow them to

participate The advantage to option holders it that they can buy shares at

the option price regardless of the market price. Disadvantageous if market price is lower than the share option

price. Options are often issued to employees of companies of

encouraging profit consciousness and as a reward for periods of service.

Another use of options is to attract investors to equity issues by offering the option to take up more shares in the future

Internal Finance- Retained earnings

Internally generated funds from trading can also be used as a source of equity finance.

Major source of finance for most firms. The extent of these funds will be affected by the

dividend policy of the company. Known as undistributed profits or retained

earnings

Debt Funds - Debentures

Debentures Can be distinguished form other forms of debt financing in that funds are sought

from the public at large. In contrast to other forms of debt finance that require the company to approach individual lending institutions.

Requires the preparation of a prospectus. Lenders will be advised as to the terms and conditions, maturity date and interest

rates. Amount regularly paid as interest is known as the coupon rate which will be close

to the market or effective rate of interest at the time of issue. That is the debenture holder is a secured creditor The security arranged for

debenture holders can be in two forms:1. Fixed charge over specified asset; or2. Floating charge over unpledged (other creditors) assets.

There are three ways a company can make a debenture issue:1. Public issue2. Family Issue3. Private Placement

Debt Funds -Bank Term Loans Term loans are provided for a number of

purposes such as the purchase of buildings and real estate and financing capital expenditure in industrial rural and commercial fields.

The term of the loan will normally range from 3 to 10 years.

Normally interest will be charged at a variable rate.

In addition to interest, banks will also charge fees for the loan establishments and mortgage arrangements

What is the difference between debt funding (debentures) & equity Funding (shares)?

Equity funds represent funds raised via the issue of shares in return for ownership interest in the company Shareholders only have a residual claim on asets Higher rate of return Payment in the form of dividends which is not fixed Dividends are not tax deductible No maturity date Shareholders have voting power

Debt funds represent borrowings from the public or financial institutions Lenders have prior claim on liquidation Lower rate of return than shareholders Interest payments fixed or variable Interest payments are tax deductible Maturity date No voting rights for the debt holders

Maintenance of Capital

Common Law -Companies are required under common law to maintain their share capital. This means they cannot return the capital paid by their shareholders to the shareholders

The basic principle provides for the protection of creditors of the company Statute –

1. Prohibited self acquisition: Reasons for the prohibition:

Prevent officers enhancing their control through a block of voting shares Prevent maipulation of share prices Prevent manipulation of share prices Prevent a false appearance of substance where a company’s assets consist of shares in itself Avoid potential unfair treatment between shareholders

They have the right under the Corporations Act 2001 to buy back their shares from shareholders if:

The buyback is fair and reasonable overall The company’s capacity to repay its creditors is not significantly prejudiced All shareholders are advised of the propsal; and A majority of shareholders vote for the buyback

2. Dividends Under s 254T, companies must pay dividends only out of profits

DIVIDENDS

Payment made out of company profits; Dividends may be declared/paid from a profit

arising from the sale of fixed assets Dividends cannot be paid out of capital; Dividends may be declared/paid from unrealised

increases in genuine revaluations of fixed asset; Dividends may be declare by a holding company

from the profits of its subsidiaries. Directors can be personally liable if allow

dividends to be paid out when there are reasonable grounds for suspecting company insolvent.

Declaration of Dividends

Generally dividends must be declared before payable

What types of disclosure documents are to be provided to potential investors when raising capital?

As a general rule, if you are a public company offering securities for sale (for example shares or debentures) then you must provide a disclosure document of some sort to potential investors.

A disclosure document is the broad term used to describe all regulated fundraising documents for the issue of securities (for example shares or debentures).

There are three types of disclosure document: a prospectus an offer information statement, and a profile statement.

These documents must be lodged with Sec. Comision before it can be used to raise funds

Disclosure documents

A prospectus is the standard disclosure document and has the broadest information requirements

An offer information sheet (OIS)has lower disclosure. A copy of an audited financial report with a balance date within the last six months must be attached to the OIS

A profile statement is a document setting out limited key information about the company and the offer.

Shareholder participation and Information Notices and practices at meetings to be

improved for efficiency Bundled resolutions More information on company websites on

the component bundled resolutions Categories of resolutions that should not be

bundled, e.g executive remuneration.