Fundamentals of Ethics, Corporate Governance and Business Law

Module: 07

Legal Personalities and Companies

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1. Types of Business Organisations

Have you ever wondered who runs an organisation? How do they make

decisions? Who are they accountable to?

Simply put, an organisation is a group of people that is organised and

managed in a way that aims to follow a corporate goal or need. All types of

businesses follow a structure that is controlled by management, who determine

how the business performs particular activities and the key roles and

responsibilities of its members.

Sole traders

Sole tradership is where the trader owns and runs the business. A sole trader

has authority to make decisions about how the business is run and the authority to

make legally binding decisions. They also have full personal liability for the debts

of the business. There is no distinction between the individual and the business.

Advantages of sole trading include:

No formal procedures required setting up in business.

Independence and self-accountability. A sole trader is self-employed and

relatively unregulated as they are fully liable.

All profits go to the sole trader as they are the sole owner of the

business.

Disadvantages of being a sole trader include:

No limit on their personal responsibility for the debts of the

business. This means private property might be lost to pay for a debt

owed by the business.

Expansion of the business may require using business profits as capital and

so expansion may be slow.

High dependence on the individual can result in long working hours.

Financial risk of sole trading

Legally a sole proprietor cannot segregate his or her private means from

those of his or her business. Hence in the event of a business-related crisis,

debts relating to the sole proprietor’s business must be met from his or her

private finance and could leave both them and their family in debt.

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General partnerships

A general partnership is a business arrangement where two or more people (who

are not husband and wife) are owners of a business. It has the advantage of

being a flexible arrangement, but the partners have no protection if the business

fails.

Unless the partners have a partnership agreement, each partner will have equal

authority. In a general partnership, the partners have full personal liability for

the debts of the partnership, like with the sole trader. For this reason general

partnerships require much less regulation than limited liability partnerships.

Partnership requirements:

• Partners must be associated as joint proprietors. The partners declare

their intention by following certain steps which include signing a written

partnership agreement and adopting a firm name.

• Partners are taxed on their share of the profits, as technically they are

self employed.

• Partnerships do not have to publish or audit their accounts, however

large they get, allowing financial results to remain confidential.

Limited companies

A limited company has special status in the eyes of the law. The company is

incorporated, which means it has its own legal identity and can sue or own

assets in its own right.

The ownership of a limited company is divided up into equal parts or shares.

Shareholders own one or more shares in the business and because limited

companies have their own legal identity, their owners are not personally liable for the firm's debts. The shareholders have limited liability, which is the major

advantage of this type of business legal structure. If the business incurs

debts and can't pay them back the shareholders have no personal responsibility

(unlike for sole traders or partnerships).

Limited companies that can sell shares on a stock exchange are known as

public limited companies (PLCs). We'll learn more about them later on.

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COMPANY GENERAL PARTNERSHIP

A company must be registered

(incorporated) with the companies

registrar in their country (e.g. in the

UK this is Companies House). Must

have at least one director.

Each partner registers with the tax

authorities as self-employed.

Management decisions are made by a

director or board of directors.

Partners themselves usually

manage the business, though they

can delegate responsibilities to

employees.

Shareholders are responsible for

financing the business and receive

dividends out of profits.

Finance comes from shareholders,

borrowing and retained profits.

Larger limited companies (called

Public Limited Companies or PLCs)

can raise money by selling shares on

the stock market, but private limited

companies cannot.

Money for the business is raised

out of partners' own assets, and/or

with loans.

Companies must file regular (usually

annual) financial accounts with their

company registrar (e.g. Companies

House in the UK).

The partnership itself, plus each

individual member must make annual

self-assessment returns to the tax

authorities. Partners must keep

records showing business income

and expenses.

Shareholders are not personally

responsible for the company's debts.

The partners are personally liable

for the debts of the firm. Their homes

or other assets may be at risk if the

business fails.

Profits are usually distributed to

shareholders in the form of dividends.

Each partner takes a share of the

profits.

Companies pay corporation tax and

must make an annual return to the

tax authorities.

Partners are taxed on their share of

the profits using personal tax rules.

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Limited Liability Partnership (LLP)

LLPs offer limited liability whilst maintaining a traditional partnership.

As the members have limited liability, the protection of those dealing with an LLP

requires that the LLP maintains accounting records, prepares and delivers

audited annual accounts to the registrar of companies, and submits an

annual return in a similar manner to companies.

Public sector organisations

So far, we have mostly considered private sector organisations. However, some

organisations are owned by the public sector e.g. a government department or a

state owned industry such as the BBC in the UK, Amtrak in the USA or SNCF in

France.

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2. Incorporation and corporate identity

Formation

That’s it! You’ve had it with the rat race, the nine to five and your overbearing

boss. It’s time you went into business by yourself, for yourself! I’m sure many of us

have had these thoughts before but never gone through with them.

If you were to do it though, and do so as a limited company, you would need to

create a company. However, it’s not quite as simple as that! You cannot just come

up with a name and say, “that’s my company!” You first need to register your

company and send some documents to your respective country’s company

house. Most counties have a slightly different but mostly similar process. For the

purposes of this section we will use the UK companies house process:

1. Choose an effective company name – Your name can’t be the same as

another registered company’s name. If your name is too similar to another

company’s name you may have to change it if someone makes a complaint.

2. Register a company address – You must have a physical address where you

operate from and can have company correspondence sent to.

3. Appoint a company secretary and register your directors – Directors are

responsible for running the business. You must have at least one. The company

secretary is responsible for being the company’s representative to companies’

house. They are not mandatory for private companies but are for public ones.

4. Resister shares and shareholders – Who owns the company and what is the

proportion of their ownership? If one person owns the company then they own

100%; if four do, then do they own it in equal shares? Or does one person have a

controlling stake – one person owns 60%, two own 15% and one owns 10% etc.

5. Submit your memorandum and articles of association (this will be

discussed in more detail later) - When you register your company you need a

‘memorandum of association’, which is a legal statement signed by all initial

shareholders agreeing to form the company. You also need to register your

‘articles of association’ - written rules about running the company agreed by the

shareholders, directors and the company secretary.

6. Register your company and for corporation tax – Finally, once you have all

these together you need to submit them to the registrar (companies house in the

UK). Once accepted, your company will be created and can begin submitting

accounts and paying corporation tax.

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Off the shelf companies

If this all seems like too much effort you can always purchase a ready-made

company with a standard set of articles of association. These often have

non-descriptive names so can be purchased for any purpose. For example,

purchasing a company with the name ‘plumbernation’ would be no good if you

planned on opening a vegan sandwich outlet. However, they can be changed if

necessary.

Corporate identity

Many companies are seen as being synonymous with their CEOs or founders.

Think of Mark Zuckerberg and Facebook or Richard Branson and Virgin. But

legally speaking most companies have their own corporate identity and

trade as a legal person separate from its members.

This is known as incorporation. As a corporate body, a company has a

discrete legal personality distinct from its members.

What this means?

The landmark case of Salomon v Salomon means that regardless of an owner

holding (you could be the sole shareholder of a private company holding 100% of

the shares) the company is separate. Its money is its money… NOT yours. Its

assets are its assets...NOT yours. If your company owned a fleet of vehicles or a

private jet, use of those vehicles or that jet by you for personal use (again, even if

you owned 100% of the shares) would be a misappropriate use of company

assets.

Legal personality

A legal personality of a company means that:

The liability of members is limited - e.g. by shares.

The company can be sued or can sue in its own name.

The company itself can own property - e.g. factories or equipment.

A company has perpetual succession, which is independent of

individual shareholders. The company carries on existing indefinitely.

So if a shareholder dies, for example, the company doesn't cease to exist.

The company has to be formally wound-up. Because companies are

perpetual they must be officially ended or closed in order to cease its

existence.

UK case example: Salomon v Salomon (1897)

The judgement in this case led to the fundamental concept that a company

has an identity or a legal personality or separate from its members. A

company is thus a legal ‘person’.

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The company is subject to the company law of it's country.

Management of the company is distinct from ownership. The board of

directors won't be shareholders.

If a company suffers injury the company itself must remedy the

situation.

Having its own legal identity frees members of the company from legal liability.

UK case example: Foss V Harbottle (1843)

A very important rule was established from the case of Foss v. Harbottle. This rule states that individual shareholders (minorities) may not take

legal action for any wrong doings done by the corporation. Any action

concerning losses must be brought either by the company itself via the

management or it must be brought either by the corporation itself (through

management) or by way of a derivative (class) action.

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3. Private vs Public companies

Private company limited by shares

Private Limited companies are companies that limit the liability of their

shareholders to the amount unpaid on their share capital. i.e. they have to pay to

purchase the shares but after that they won't have any more liability even if the

company fails with significant debts.

If you owned 50% of the shares in a company, but you still had to pay for

£1,000 worth of those shares when the company failed, you would only have to

pay the £1,000 and not any more - even if the company had a debt of

£1,000,000.

Characteristics:

• They are generally small enterprises in which some if not all shareholders

are also directors and vice versa.

• They may have a suffix after their name denoting the company type. In the

UK this is ‘Ltd’, in Germany 'GmbH'.

• A private company cannot offer its shares for sale to the general public.

Public Limited Company

A small proportion of limited companies are public companies. This type of company is appropriate for larger businesses where shares are intended to be

available to the general public. Most public companies are converted from

private ones. Not all PLCs are listed on the stock market but many are and they

often have the suffix PLC after their name.

A public company:

Is registered as such under the Companies Registrar.

Can offer its shares on the stock market.

Must hold a minimum capital e.g. in the UK this is £50,000.

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Private vs. public limited companies

There are important differences between private (e.g. Ltd) and public limited

companies (e.g. PLC). The rules governing public limited companies are

more elaborate.

Public Companies Private Companies

Name

In the UK the words 'public

limited company' or 'plc'

denotes a public company.

This can vary around the

world.

In the UK the word 'limited' or

'Ltd' in the name denotes a

private company. This can

vary around the world.

Function

A public company is intended

as a vehicle not only for a

business but also public

investment in that business.

A private company is a private

concern of the persons

engaged in it.

Staff

Rules over management

staffing are greater.

e.g. in the UK: must have at

least two directors and one

company secretary (looking

after the statutory

requirements of the business).

Rules over management

staffing are less.

e.g. in the UK: must have one

director, and a company

secretary is optional.

Shares

Shares can be listed or dealt

with on a recognised Stock

Exchange, enabling the company to raise capital by

offering shares.

To have this advantage, and

to protect public investors,

public companies are subject

to stringent controls

compared to private

companies.

Can only sell shares

privately. Can't sell shares on

a stock exchange.

Capital

Often a minimum e.g. in the

UK it is £50,000.

No minimum.

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Registration

Must register with the

company registrar. In the UK

they also need a trading

certificate to be issued by the

registrar.

Must register with the

company registrar.

A private company can usually

begin business as soon as it’s

incorporated.

Accounts

Must publish full accounts

and reports on the company

website.

Has nine months, or

depending on size, a partial

exemption from certain

accounting provisions.

Annual

General

Meetings

(AGMs)

Usually have to hold an

Annual General Meeting of

shareholders (compulsory in

the UK within six months of

the ending of their financial

year.

Usually do not have to hold

annual general meetings

(AGMs).

Disclosure requirements

It’s common to read about the performance of businesses in the newspaper and

often it is the bad news that gets the most publicity.

Why would a big company like Tesco or Volkswagen want to publicise whether

they made a loss recently?

Well, as a public company, a plc has special disclosure and publicity

requirements. For example, a plc may be required to disclose the bonuses paid to

its management or the profit/loss it made in the last year.

Essentially, these requirements exist because the shares in the company are

owned by the general public and therefore it would be wrong to hide the

financial performance and misguide potential investors.

Parent or Holding Company

A parent or holding company is an organisation that owns and controls,

wholly or partially, separate businesses called subsidiaries. The managers

and board of directors of the parent company generally maintain control of the

subsidiaries. A wholly owned subsidiary is 100% owned by a parent company.

A parent company is virtually the same as a holding company. In legal terms, a holding company is inactive except for the fact that it owns the subsidiary

company. In contrast, a parent company is more active in the running of the

subsidiary company.

Parent companies can be either private or public companies.

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Multinational companies

A multinational company is a company that produces and markets its

products in more than one country. They are complex organisations, as they

have to be aware of and follow all the regulations and laws of the countries they

operate within.

Coca-Cola is a massive and well-known multinational company. They are present

in most countries in the world and have to devote huge resources to following the

rules of each one.

Multinational companies can be either private or public companies.

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4. Articles of Association (AoA)

Most states have a constitution. For example, the U.S. is famous for its

constitution and the importance placed on it by the American people. The

constitution ensures the country is governed according to certain rules and

regulations, protecting the citizens from unlawful or tyrannical rule. The Articles

of Association are essentially the same thing for

companies: they determine the governing rules that companies must follow,

protecting those involved. They also regulate the relationship between the

company, its shareholders and directors.

To become incorporated, a company must set out its rules for operation which

are to be followed by its officers. Rather than writing out its own set of rules and

regulations of a company, it can often be easier to copy the generic rules pre-

written. In the UK for example the Companies Act 2006 sets out a set of rules for

UK companies known as ‘model’ Articles of Association which are also used as

the default rules if a company sets itself up without any articles.

Typical contents

Typical contents of the articles of association include:

Appointment and dismissal of directors. What procedures must be

followed in either instance - e.g. do you need an appointment committee for

appointing new directors?

The directors powers and responsibilities. These are usually

unrestricted unless specified in the articles. For instance, directors may be

restricted from making decisions on borrowing money.

Organisation of directors’ meetings. For example, what's the minimum

number of directors needed to vote on a decision.

Issuing and transference of shares. Some companies will have rule

stating any shares must be offered to existing shareholders before being

offered to non-shareholders.

Different voting rights attached to classes of shares.

Dividends. What should be done with profits or excess cash - i.e. profits

that are not needed by the company. For example, they can be used to re-

purchase stock in the company or paid out as dividends to shareholders.

Winding up. The conditions and notice need to be given to members if the

company is wound up (ended).

They also regulate the relationship between the company, its shareholders

and directors.

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Certificate of incorporation

In most countries, once the registrar is satisfied that the documents are all in order

the company is given a registered number. After this, a certificate of incorporation

is issued stating the date on which the company was incorporated.

Binding power of Articles of Association

Members (shareholders) of a company are bound by the articles of

association (AoA). A company is able to compel its members to obey the AoA.

The company is also bound by them. Members can compel the company to

obey the AoA.

UK case example: Pender v Lushington (1877)

is a leading case in UK company law, which confirms that a company

member's right to vote may not be interfered with, because it is a right of

property. One member with more than 1,000 shares transferred the surplus to

a nominee and directed him how to vote. The chairman refused to accept

the nominee’s votes. Held: The right to vote was enforceable against the

company and as a breach of the articles this should have been recognised by

the company

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5. Lifting the veil

The term lifting the veil may make you think about stage performances and

magicians. The veil is hiding how the magician is doing their trick and to lift the veil

reveals the secret to you.

Well, lifting the veil in a legal sense actually refers to ignoring the separate legal

identity of a company. Although, the principal is similar. We lift the veils of

companies to reveal what they have done and who has done it to identify

any illegal activity. This allows courts to attribute blame or responsibility to

the guilty parties.

Let's restart with a more formal definition of lifting the veil.

'Lifting of the veil' refers to a legal decision to treat the rights and duties of a

corporation as those of their members, rather than treating the company as

a legally separate entity.

As we have seen, a corporation is usually treated as a separate legal person from

its individual members. This can lead to a veil of incorporation whereby

corporations such as members of companies can evade their legal obligations or

to commit frauds. In some cases, it is necessary to look to legally ascertain who the owners of a company really are in a process referred to as 'lifting the veil’.

After ‘lifting the veil’ a court can look behind the ‘fiction’ in a suspicious case and

members or directors of a company can be held personally liable for the debts of

the company.

When the veil has been lifted, anyone can be liable if they are guilty

of/responsible for an offense.

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When might the veil be lifted?

Cases when the veil might be lifted include:

Failure to disclose the company’s full name on company documents,

perhaps in a misleading way.

Wrongful trading. This is when a company continues to trade when they

know they cannot avoid insolvent liquidation (irreversible ending of a

company) and haven’t taken measures to limit the company's debts.

Liability for trading without trading certificate.

Evasion of taxation.

Fraudulent trading. A court may decide that the persons (usually the

directors) who were knowingly party to a fraudulent trading shall be

personally responsible for debts and other liabilities of the company.

Accounts are not prepared properly by a group of closely related

companies. Usually they should be combined to recognise the common

link between them.

If a disqualified director participates in the management of a company.

Public interest or times of emergency

A company is forbidden from trading with enemy aliens in times of

war.

To reveal the company as a quasi-partnership. In this case, the courts

can recognise that a company is really acting as a partnership and not a

limited company and lift he veil and treat the company as if the members

were partners.

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Example UK cases

You do not need to learn these (after all this is UK law and it's an international

exam that is independent of any law). However, they do give so me good example

of lifting the veil in the real world.

Fraud

Wartime

should be made both against the defendant and the company which he had

formed as a sham.

UK case example: Gilford Motor Co v Horne (1933)

Horne was formerly a managing director of the Gilford Motor Co Ltd. His

employment contract had forbidden him to solicit its customers after leaving

its service.

After he was fired he formed a company with his wife and an employee as

sole directors and shareholders. Horne ignored the employment contract

clause forbidding him from soliciting customers of Gilford Motor Co saying

that it was the company that was acting and not himself.

The court decided that an injunction requiring observance of the covenant

UK case example: Daimler Co Ltd v Continental Tyre and Rubber Co

(Great Britain) Ltd (1916)

This case concerns the concept of ‘control’ and enemy character of a

company. It was decided during the time when England was at war with

Germany.

Continental Tyre and Rubber co. (UK) sued Daimler for money for goods

supplied. Daimler claimed that the Company was actually owned by

German Nationals and paying them was illegal under the Trading with the

Enemy Act.

The Court lifted the corporate veil to discover if this was so, and found

that it was the Germans who were operating the business. Daimler was

therefore successful in its defence.

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Corporate manslaughter

Company groups

UK case example: R v OLL Ltd (1994)

This was the first UK case in the development of a corporate offence for

manslaughter.

The company Active Learning and Leisure Limited, operating as a leisure

centre in Lyme Regis, was charged with corporate manslaughter. Peter Kite,

managing director became the first director to be imprisoned for

manslaughter after four teenagers tragically drowned off Lyme Regis while

on a canoe trip. The accident was due to a dreadful catalogue of errors on

the part of the company.

UK case example: DHN Food Distributors v London Borough of Tower

Hamlets (1976)

DHN was the holding company in a group of three companies. DHN had two

subsidiaries: one owned the land used by DHN, the other that owned

vehicles used by them. When the land was subject to compulsory purchase

by the government, DHN sought compensation. The problem was that it

was the subsidiary that was the owner now DHN.

The judge, Lord Denning, said that the subsidiaries “are bound hand and

foot to the parent company and must do just what the parent company

says... They should not be treated separately”. It was therefore held that

DHN was entitled to claim, and the doctrine of separate corporate

personality was overridden.