Company Law Workbook PDF

Company Law Workbook Published by A note about copyright BPP Professional Education What does the little © mean and why does it matter? BPP House, Aldine Place Your market-leading...

Company Law Workbook Published by A note about copyright BPP Professional Education What does the little © mean and why does it matter? BPP House, Aldine Place Your market-leading BPP books, course materials and e-learning materials do not write and update 142-144 Uxbridge Road themselves. People write them on their own behalf or London, W12 8AA as employees of an organisation that invests in this activity. Copyright law protects their livelihoods. It www.bpp.com does so by creating rights over the use of the content. All rights reserved. No part of this publication may be Breach of copyright is a form of theft – as well as being reproduced, stored in a retrieval system or transmitted, a criminal offence in some jurisdictions, it is potentially in any form or by any means, electronic, mechanical, a serious breach of professional ethics. With current photocopying, recording or otherwise, without the technology, things might seem a bit hazy but, prior written permission of BPP Professional Education basically, without the express permission of BPP Ltd. Professional Education: The contents of this course material are intended as a Conversion of our digital materials into different file guide and not professional advice. Although every formats, uploading them to social media or e- effort has been made to ensure that the contents of mailing or otherwise forwarding them to a third this course material are correct at the time of going to party is a breach of copyright. press, BPP Professional Education Group makes no Printing our digital materials in order to share them warranty that the information in this course material is with or forward them to a third party or use them in accurate or complete and accept no liability for any any way other than in connection with your BPP loss or damage suffered by any person acting or studies is a breach of copyright. refraining from acting as a result of the material in this course material. © BPP Professional Education Ltd 2022 Contents Introduction Introduction to Company Law iv 1 Different business models and introduction to companies 1 2 Corporate personality 33 3 Ultra vires 43 4 Managing companies - Directors and the Board 55 5 Managing companies - Shares and shareholders 85 6 Minority shareholder remedies 99 7 Equity finance and further considerations relating to shares 119 8 Debt finance 131 9 Corporate Insolvency I 141 10 Corporate Insolvency II 157 Introduction to Company Law Companies are one of the most important business structures. There are approximately four million companies in England and Wales, ranging from small private companies with only one or two directors and shareholders to public listed companies with a valuation of millions of pounds. All of these companies are governed by the provisions of the Companies Act 2006. A good understanding of company law is invaluable to practice in corporate or commercial law and any area of law where you may act for or against companies. iv Company Law  1 Different business models and introduction to companies 1 Different legal forms of business This section covers the main legal characteristics of the following forms of business: Sole trader Partnership Limited partnership Limited liability partnership You will look at the main characteristics of public and private companies in the next section. 1.1 Introduction Businesses are generally set up to make a profit. A business generates income by selling products and/or services. In order to sell the products and/or services the business will incur certain expenses. Provided the income generated exceeds the expenses of the business, it will make a profit. Once a business has made a profit, a proportion of that profit is likely to be given to the owners of the business, and the rest will be retained in the business in order to help it grow. 1.2 Raising finance 1.2.1 Why businesses raise finance A business is likely to need to raise finance for a number of reasons including the following: To purchase premises from which to operate, plant and machinery, stock or raw materials, computer hardware and software in order to be able to manufacture and sell goods, or provide a service; To employ staff to make the goods and/or provide the services to customers; To obtain the advice of professional advisers from time to time, particularly accountants; and To expand and grow, which it may do by acquiring other businesses, carrying out marketing activities eg advertising and investing in new premises and equipment. 1.2.2 How businesses raise finance There are four basic ways in which a business can raise money:  The owners of the business may invest in it by making contributions of capital to the business; Outside investors may be prepared to make a capital contribution to the business in order to share in its future profits; The business may borrow money, for instance, from a bank; and As already mentioned, a proportion of the profit that the business has generated is likely to be retained within the business to help it grow, rather than being distributed to the owners and investors in the business. 1.3 Business models In practice, lawyers may have to advise clients on the most appropriate business model for their business. In order to do this, you need to be aware of the different possible business models and the key considerations when forming a business and choosing a business model. In order for you to understand the significance of companies, it is helpful to first consider the features of alternative business structures. This will enable you to put into context the advantages and disadvantages that the company structure offers for businesses. In this section you will explore the legal features of the following business models: Sole trader Partnership Limited partnership Limited liability partnership (LLP) In the next section you will consider the key characteristics of public and private companies. 1.4 Key considerations when forming a business Costs How much does this business model cost to set up? Risk Will the participants in the business have personal liability for debts of the business? Structure Does the business model provide a clear organisational structure? Is this flexible? Formalities Are there legal formalities that must be followed in running the business? How flexible is this business model regarding formalities? Privacy To what extent is information about the business required to be publicly disclosed? Finance How can the business raise capital? 1.5 Sole traders – Key characteristics No set up costs – there are no formalities, the sole trader can start trading straight away. A sole trader is not a separate legal entity – contracts are formed between the individual themselves and third parties. Unlimited personal liability – the sole trader’s personal assets such as their home and cars are potentially liable to be sold to meet the debts of the business. No formal structure - the individual can choose how they wish to run their business. No Companies House filing or procedural requirements for running the business. Complete privacy – no need for publicly filed accounts etc. Example: Happy Rags You enjoy making clothes and decide to set up your own ethical organic cotton clothes business, making personalised t shirts and sweatshirts for adults and children. You call the business ‘Happy Rags’ and start selling items at craft markets and by word of mouth to friends and family. 2 Company Law  You are a sole trader. Although you refer to your business as Happy Rags, this is not a separate legal entity, merely the name which you use to refer to the business. Your customers and suppliers enter into contracts with you in your personal capacity. There are no legal set up costs or formalities to start the business and no specific legislation that governs how you run your business (although all businesses are subject to relevant commercial and tax legislation, accounting rules and the common law). There is no requirement for you to disclose any information about the business. You have unlimited personal liability, so if the business incurs debts, you are personally liable to meet these debts. 1.6 Partnerships – Key characteristics No set up costs – there are no formalities, the partnership can start trading straight away. Partnerships can be formed without any formal agreement or even intention. See the next page for more detail on formation of partnerships. A partnership is not a separate legal entity. Contracts are formed between third parties and the partners in the partnership as individuals. Unlimited personal liability - partners have unlimited joint (in contract) or joint and several (in tort) liability for the debts and obligations of the partnership incurred while they are partners. This means that their personal assets such as their houses may need to be sold to meet the debts of the business. There are no Companies House filing or procedural requirements for running the business. Complete privacy – there is no requirement for publicly filed accounts etc. Partnerships are governed by the provisions of the Partnership Act 1890 (PA 1890). 1.7 Partnership - Formation Partnerships can be created without any formalities. This is because s1(1) PA 1890 defines a partnership as: ‘...the relation which subsists between persons carrying on a business in common with a view to profit’. There does not need to be any intention to form a partnership – two or more people working together with a view to profit automatically form a partnership. Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. Factors to consider include whether profits and/or losses are shared, whether a loan is made from one partner to another, whether property is held jointly. Evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence. A loan of money by one party to another does not of itself create a partnership. 1.7.1 Does a partnership exist? No one factor alone will suffice to create a partnership – it is necessary in all cases to consider all the facts. Some examples from the case law are below: Note. If there is an agreement to share losses as well as profits, this makes the existence of a partnership more likely (Northern Sales (1963) Limited v Ministry of National Revenue (1973)). Case law has also held that if the person is not being ‘held out’ as a partner this makes the existence of a partnership less likely. In Walker v Hirsch a clerk lent money to the partnership, was paid a fixed salary and took 1/8th of the profits and of the losses, but was never held out as a partner. No partnership was found to exist. 1.8 The terms of the partnership – PA 1890 Although a partnership can be formed without any required formalities, it is advisable to have a partnership agreement drawn up by a solicitor as otherwise the partnership will be governed by the default provisions of the PA 1890. These include the following: Section 24(1) Profits and losses: Partners are entitled to share equally in the profits of the business, and must share equally in the losses of the business, even where the parties have contributed to the capital unequally. There should therefore be an express provision in the 1: Different business models and introduction to companies 3  agreement setting out a profit sharing ratio, otherwise both profits and losses are shared equally. Section 24(6) Remuneration: Partners are not entitled to a salary. Section 24(8) Decision Making: Decisions arising during the ordinary course of the business are decided by a majority, except for any change to the nature of the partnership business which requires unanimity. Section 25 Expulsion: A partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority can do this. 1.9 Partnership Agreements The partners’ mutual rights and obligations can be varied at any time by their unanimous consent (s 19 PA 1890). This means that partners can themselves draw up a partnership agreement setting out how they wish their partnership to run. It is important in a modern partnership that partners seek legal advice and enter into a binding partnership agreement governing the terms of their relationship. Partners will wish to vary the default provisions of PA 1890 as these are not suitable for a modern business. Typically, a partnership agreement will deal with the following key principles as well as other more practical details: Profit sharing ratio Salaries Decision making – eg are certain partners able to make decisions on particular issues alone or in small committees? What happens when a partner leaves the partnership How new partners may be appointed and how partners may be removed Example: Happy Rags expands! Your Happy Rags business is doing well and demand for your clothing has grown to the point where you are no longer able to run the business alone. Your friend Catherine suggests that she would like to get involved and go into business with you. She is going to set up a website and deal with the orders, whilst you concentrate on making the clothing. You and Catherine have formed a partnership. Although you refer to your business as Happy Rags, this is not a separate legal entity. Your customers and suppliers enter into contracts with you both personally. There are no legal set up costs or formalities required to set up the partnership, but it is advisable for you to agree between you how you would like the partnership to operate, for example how you will share profits and how you will make decisions, and to seek advice from a solicitor who will draft a formal Partnership Agreement. There is no requirement for you to disclose any information about the business. You both have unlimited personal liability, so if the business incurs debts, you are jointly personally liable to meet these debts. 1.10 Limited Partnerships (LP) – Key characteristics A LP has two different types of partners: - Limited partners who have limited liability. These limited partners must not be involved in the management of the business (they are often called ‘sleeping partners’ eg passive investors). If they do become involved in management, they lose their limited status and become general partners with unlimited personal liability. - General partners who run the business and have unlimited liability (as in a traditional partnership). - There must be at least one limited partner and one general partner. LPs are governed by the Limited Partnership Act 1907 (as amended). LPs must be registered at Companies House but have no requirement to file accounts. LPs are not commonly used for general business but often used for investment vehicles. They are popular joint venture business structures where an investor (limited partner) puts money into a business run by the general partner. Note that on 6 April 2017 a new sub-category of 4 Company Law  limited partnership called a private fund limited partnership was created. These are now commonly used for investment vehicles. 1.11 Limited Liability Partnership (LLP) – Key characteristics LLPs were introduced by the Limited Liability Partnership Act 2000 (LLPA 2000). The key difference between LLPs and sole traders, partnerships or LPs is that an LLP has a separate legal personality – it can own property and enter into contracts on its own behalf. However, for tax purposes it is treated as a partnership and the members are taxed as partners, each being liable to pay tax on their shares of the income or gains of the LLP. This is referred to as ‘tax transparency’. Section 2(1)(a) LLPA 2000 states that two or more persons associated for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual. All partners in an LLP have limited liability. Their liability to third parties is limited to the amount that they have agreed to pay under the terms of their partnership agreement. LLPs are registered at Companies House in the same way as companies and are required to file annual accounts and other information. LLPs are in effect a hybrid between a traditional partnership (with procedural flexibility) and a company (with limited liability). Many law and accountancy firms are LLPs. The organisational structure of an LLP is very flexible and should be decided between the partners in a formal written Members’ Agreement. In the absence of any such agreement Regulations 7 and 8 of the Limited Liability Partnerships Regulations 2001 (SI 2001/1090) contain default provisions as follows: Members share equally in capital and profits. An LLP must indemnify its members for payments made and personal liabilities incurred by them in the ordinary and proper conduct of the business of the LLP. Every member may take part in management but no member is entitled to remuneration for managing the LLP. No person can become a member or assign their membership without the consent of all existing members. Ordinary decision making may be by the majority of the members. Any proposed change to the nature of the business requires the consent of all the members. There is no implied power of expulsion of a member by the majority unless the members have expressly provided for such a power in a Members’ Agreement. Example: Price Prior LLP Price Prior LLP is a limited liability partnership, similarly to many law and accountancy firms. The LLP structure allows the partners in the business to have limited liability for the debts or liabilities of the partnership, rather than being personally liable for the partnership’s debts and liabilities as is the case with a traditional partnership. This is the reason that many professional partnerships have changed their structure from a traditional partnership to an LLP. The LLP structure allows the partners to have the tax transparency and procedural flexibility of a traditional partnership without the personal liability. They are able to prescribe their own management structure and to set out how they wish profits to be shared, decide on the salaries of all their partners and staff etc. However, incorporating as an LLP means that the partners will need to ensure that annual accounts and other prescribed information are filed at Companies House in accordance with the provisions of LLPA 2000. 1.12 Summary Key considerations in choosing a business model include costs, risk, structure, formalities, privacy and finance. Possible business models include the sole trader, partnership, limited partnership, limited liability partnership, private limited company and public limited company. In this element you 1: Different business models and introduction to companies 5  have considered the main characteristics of sole traders, partnerships, limited partnerships and limited liability partnerships. Careful consideration should be given to the advantages and disadvantages of different models based on the features and requirements of the particular business. Clients will also need to carefully consider financial issues of choosing a particular business model such as the tax implications. 2 Introduction to companies This section covers the main legal characteristics of public and private companies. 2.1 Companies – Key characteristics Companies are the most popular business model in England and Wales. There were over 3 million private limited companies registered with Companies House in 2018. What makes companies such a popular business model? The key point is that a company is a separate legal entity – companies are distinct from their owners (known as shareholders or members). This means that the company owns property, enters into contracts and can sue and be sued in its own name. Profits and losses belong to the company and not the shareholders and it is the company that is therefore liable for its own debts, not the shareholders. Limited liability – the liability of shareholders is limited to the amount unpaid on their shares (if any). This protects shareholders and facilitates investment. Companies are governed by the Companies Act 2006 (which superseded the Companies Act 1985) which contains detailed requirements regulating how companies are run and the filings and disclosures that must be made by all companies at Companies House. However, these formal procedural requirements can be onerous, especially for small private companies where the shareholders and directors are often the same individuals. 2.2 Companies – Who’s who Shareholders/ Owners of the company Members Invest money in return for shares and possibility of dividends Not involved in day-to-day management but usually have voting rights and control key decisions Subscribers The name given to the first shareholders in a company who invest in the company when it is initially set up (incorporated) Directors Officers / managers of the company Involved in day to day running of the company Collectively known as the Board In small private companies, directors are often also shareholders Persons with Details of PSCs must be provided to Companies House. In general, PSCs significant are shareholders with over 25% of shares. control Other Other stakeholders include anyone interested in the company, such as stakeholders employees, creditors etc 2.3 Companies Act 2006 (CA 2006) CA 2006 is the key legislation governing companies in England and Wales. This statute replaced the Companies Act 1985 and brought about many changes in company law. The primary aim of CA 2006 was to simplify the law for private companies. Key changes made include: 6 Company Law  The removal of the requirement for private companies to hold Annual General Meetings or submit Annual Returns (this has been replaced with a simpler annual Confirmation Statement) Codification of directors’ duties so that directors of small private companies can more easily understand their obligations Allowing private companies to pass shareholder resolutions in writing, dispensing with the requirement for meetings of shareholders (known as General Meetings) You will learn more about the requirements of CA 2006 as you progress through this module. 2.4 Different types of company 2.4.1 Private companies Private limited company: Section 4(1) CA 2006 states that ‘a private company is any KEY TERM company that is not a public company’. Private companies’ names end with the word ‘Limited’ or ‘Ltd’ (s 59(1)). The vast majority of companies in England and Wales are private companies, and it is this type of company that this module focuses on. Private companies Private companies Unlimited companies limited by shares (Ltd) limited by guarantee Most common type of No share capital The liability of the members is company Liability of members is limited unlimited No minimum share capital to the amount that they These companies are rare requirements agreed to contribute in the Prohibited from offering event of a winding up shares to the public Membership is not Can be formed by one person transferable These companies are relatively rare 2.4.2 Public companies Public limited company (plc): Section 4(2) CA 2006 states that a ‘public company is a KEY TERM company […] whose certificate of incorporation states that it is a public company’. A public company’s name ends with the words ‘Public Limited Company’ or ‘plc’ (s 58(1)). For practical purposes, the main difference between a public and a private company is that generally only public companies can offer their shares to the public, eg through public listing on a recognised stock exchange such as the London Stock Exchange, therefore permitting trading to take place in its shares. Public companies are also subject to more onerous regulatory requirements (eg public companies are not able to pass shareholder resolutions by written resolution – you will explore this later in the module). Public companies limited by shares Listed companies (plc) Can offer their shares to the public Only public companies can be listed. Need a minimum of two directors Not all public companies are listed. Minimum share capital requirement of ‘Listed’ means admitted on a regulated £50,000 (s 763 CA 2006) investment exchange such as the London Requires a trading certificate before it can Stock Exchange trade (s 761 CA 2006) 1: Different business models and introduction to companies 7  2.5 Reasons to list a company To enable a company to raise greater funds by offering shares to the public at large, a private company’s shareholders may decide to convert the company into a public limited company (plc). After converting to plc status, a company may seek a listing of its shares on a stock exchange. Companies whose shares are listed on the London Stock Exchange are known as ‘listed companies’ (but note that it is not the company that is listed, but its shares). Most commercial investors want to be able to deal freely in their investments, and a stock exchange listing allows them that freedom, making the company more attractive as an investment. A company must be a public company before it applies to have its shares listed on a stock exchange. However, not all public companies apply to have their shares listed. You should not therefore assume that a company whose name ends in ‘plc’ is a listed company. 2.6 Principal differences between a private and a public company 2.6.1 Name As already mentioned, the name of a private company will end in ‘Limited’ or ‘Ltd’ and the name of a public company will end in ‘Public Limited Company’ or ‘plc’. 2.6.2 Share capital There is no requirement for a private company to have any specified minimum amount of share capital. A private company could be incorporated with just one share of 1p. In practice many companies are incorporated with a share capital of £1, that is with one share that has a nominal value of £1. A public company must have a share capital with a nominal value of at least £50,000 (or the euro equivalent), of which at least one quarter must be paid up (this means paid at the time of purchase) (s 586 and s 763 CA 2006). 2.6.3 Number of directors A private company need only have one director, and a public company must have a minimum of two directors (s 154 CA 2006). 2.6.4 Company secretary A private company may choose to have a company secretary but it is not obliged to have one (s 270(1) CA 2006). If a private company does not have a company secretary, the directors (or any person the directors authorise) may do anything that the secretary is required or authorised to do (s 270(3)(b) CA 2006). A public company must have a company secretary (s 271 CA 2006), and the person appointed to that post must have the requisite knowledge and experience and hold one of the qualifications specified in s 273(2) CA 2006. 2.6.5 Annual general meetings A public company is required to have one annual general meeting (AGM) each year (s 336 CA 2006). Private companies are no longer required to hold an AGM, although they may do so if they wish. An AGM provides members who are not directors with an opportunity to question directors, particularly on the issue of a company’s finances. 2.6.6 Regulation Public companies are potentially able to offer their shares to the public. For this reason they are subject to a higher level of regulation than private companies. As well as the requirements of the CA 2006, further legislation governs public companies. 8 Company Law 2.7 How popular are the different forms of business? Figure 1.1: Approximate numbers of different types of company, LLPs and LPs in England and Wales Source: Companies register activities for 2018 to 2019, Companies House Note. Remaining corporate bodies not shown include charitable organisations and overseas companies. Example: Happy Rags – should the business incorporate? Often when a business grows, at a certain point the owners of the business may decide to set up a company to run the business. Setting up as a company is called ‘incorporation’. Exercise: Engage Using the Happy Rags example that we have referred to earlier, what are the advantages and disadvantages of incorporation for this business? Create a table of advantages and disadvantages before clicking on to the next page. Suggested solution Advantages Allows investment with limited liability Minimises risk Gives a formal structure for the business to run Easier to raise finance through issue of shares / bank loans Potential for return on investment through dividends Disadvantages For small private companies where the directors and shareholders are the same individuals, the effective separation of ownership from control is not achieved High levels of formality may not be appropriate or desirable Public disclosures necessary eg annual accounts, personal details 2.8 Summary In this element you have looked at the features of private limited companies, public limited companies and listed companies. Private limited companies are the most popular business model. A key advantage of this business model is limited liability. You will learn more about this as you progress through the module. 1: Different business models and introduction to companies 9  The majority of companies in England and Wales are private limited companies. Public limited companies are able to offer shares to the public and can also seek a listing of their shares on a recognised stock exchange. They have more stringent regulatory requirements than private companies. Listed companies are a small subset of public limited companies, being those that have their shares listed on a recognised stock exchange. 3 The company’s constitution This section covers the constitutional documents of a company – the Memorandum and Articles of Association. 3.1 Constitutional documents CA 2006 came into force on 1 October 2009. Prior to this, companies were governed by the principles of the Companies Act 1985 (CA 1985). In practice you will deal with many companies incorporated prior to CA 2006 therefore it is important to understand some of the provisions of CA 1985 which still affect those companies. CA 1985 required companies to have two constitutional documents: the Articles of Association and the Memorandum. Under s 17 CA 2006 the memorandum no longer forms part of the company’s constitution - it is only required as part of the procedure to register a company at Companies House. The memorandum of a company incorporated under CA 2006 simply amounts to a declaration on the part of the company’s subscribers ie that the first members of the company wish to form a company and agree to become members of that company (s 8 CA 2006). 3.2 Memorandum Under the Companies Act 1985 (CA 1985) the memorandum was a more complex document and formed part of the company’s constitution. Companies could set out constitutional restrictions in their memorandum and were required to include an objects clause setting out the purposes for which the company has been formed. Acting outside of this purpose was described as acting ultra vires or outside the company’s capacity. Companies formed under CA 2006 have unrestricted objects (s 31 CA 2006) unless the objects are specifically restricted in the company’s Articles. So the ultra vires rule is not applicable to a 2006 Act company unless it has chosen to insert an objects clause into its Articles. You will learn more about this in the next Topic. For older companies that were incorporated under the CA 1985, s 28 CA 2006 provides that any provisions in a memorandum must be treated as provisions of the company’s Articles. This includes the objects clauses included in the memoranda of all CA 1985-incorporated companies. Under CA 2006, therefore, the objects clause of an older company continues in force, operating as a limitation on that company’s capacity unless and until the Articles of that company are amended to remove its objects clause. 10 Company Law  Figure 1.2: Example memorandum under CA 2006 in prescribed form 3.3 Articles of association All companies must have articles of association (Articles) (s 18 CA 2006). Under CA 2006, the Articles form the main constitutional document of a company. The purpose of the Articles is to regulate the relationship between the shareholders, the directors and the company. Examples of the types of provisions which are included in the Articles of a company are: The number of directors required to transact business (both to form a quorum at board meetings and to take decisions at board meetings); The method of appointment of directors; The powers of directors; How board meetings are to be conducted; Any special rights attaching to shares; How shareholder meetings are to be conducted; and How and to whom shareholders may transfer their shares. 3.3.1 Relationship between CA 2006 and the Articles A company’s Articles must be interpreted in the light of relevant legislation. There is considerable scope for overlap between the procedures set out in CA 2006 and those that may also be contained in the company’s Articles. The Articles must comply with the minimum provisions of CA 2006 (this is known as the Legality Test). A company may in certain circumstances provide a procedure in its Articles which is more onerous than that contained in CA 2006. Example Section 154(1) CA 2006 provides that a private company must have a minimum of one director. Company X Ltd could provide in its Articles that it requires three directors. Company X Ltd would need to comply with the three-director requirement in its Articles, rather than the requirement set out in CA 2006. There are some CA 2006 provisions which override anything in a company’s Articles. 1: Different business models and introduction to companies 11  Example Section 321 CA 2006 (the right to demand a poll vote at a general meeting). This cannot be removed in the Articles. There are also powers available to companies by default under the provisions of CA 2006 unless the Articles provide otherwise, for instance, the power of a private company to issue redeemable shares. It is important to always check the procedures set out both in the relevant legislation and in your client’s Articles. A company effectively has three choices as to the form of its Articles: (a) Model Articles (MA)/Table A The Secretary of State has prescribed MA for different types of company (under s 19 CA 2006). If a new company does not register Articles at Companies House, s 20(1) CA 2006 provides that the relevant MA will constitute the company’s Articles in default. There was a similar provision under the CA 1985. For companies incorporated under the CA 1985 the default Articles were known as Table A. In practice, you may encounter older companies with Table A Articles. (b) Amended MA Not all of the provisions contained in the MA are suitable for all companies. Many companies therefore choose to adopt the MA as their Articles, but elect to exclude, or modify the effect of, some of its provisions. (c) Tailor made Articles The third option available to a client is to instruct a solicitor to draft Articles which are tailor- made for the particular company concerned. Law firms often have a precedent form of Articles that can be adapted for this purpose. However, generally this is a very time- consuming process and therefore costly for the client, although the end product can often be more useful to them in the long run. Most small companies will prefer to adopt MA, subject to certain amendments. 3.4 Amending the Articles Once a company has adopted Articles, it is able to alter them at any future date by special resolution (s 21(1) CA 2006). A special resolution is a decision of the shareholders. You will consider the different types of shareholder resolutions later in this module. Section 22 CA 2006 permits the entrenchment of specific provisions within a company’s Articles, though this occurs relatively rarely in practice. An entrenched provision of a company’s Articles is one which can only be amended or repealed if specific conditions are met, or if procedures more restrictive than a special resolution are complied with. Entrenched Articles can nevertheless always be amended by the agreement of all of the members, or by a court order (s 22(3) CA 2006). There is a great deal of case law relating to the alteration of a company’s Articles. The basic rule is that, to be valid, any alteration must be made bona fide in the interests of the company as a whole (Allen v Gold Reefs 1 Ch 656). In Shuttleworth v Cox 2 KB 9 the court held that an amendment to the Articles is not valid if no reasonable man could consider it to be for the benefit of the company. Key case: Sidebottom v Kershaw, Leese & Co Ltd 1 Ch 154 (Court of Appeal) The defendant company had altered its articles by introducing a provision which gave the directors power to buy out, at a fair price, the shareholding of any member who competed with the company’s business. The plaintiffs, who were minority shareholders and who carried on a competing business, unsuccessfully challenged the validity of the alteration. The Court of Appeal found that the alteration was initiated in good faith and bona fide in the interests of the company and therefore allowed this to stand to protect the company. 12 Company Law  Key case: Re Charterhouse Capital Ltd EWCA Civ 536 (Court of Appeal) The amendment of a company’s articles to permit the shares of a minority shareholder to be compulsorily acquired under a takeover offer was held to be valid as it was consistent with the terms of a shareholders’ agreement. It was not open to challenge on other grounds such as unfair prejudice. The Court of Appeal held that the amendment was no more than a ‘tidying up exercise’ which had been consistent with the initial bargain of the founding members, which included the appellant himself. In the absence of any finding of bad faith, improper motive or irrationality, there was no basis for the challenge to the validity of the amendment. 3.5 Legal effect of the Articles The nature of the contract established by the Articles of a company is set out in s 33(1) CA 2006, which provides that the provisions in the company’s Articles bind the company and its members to the same extent as if there were covenants on the part of the company and each member to observe those provisions. Whatever form the company’s Articles take, therefore, they will be binding on both the company and its members and enforceable. The predecessor to s 33(1) CA 2006 (namely s 14 CA 1985) has been the subject of a large amount of case law. The generally established rule is that the Articles evidence a contract between the company and its members in their capacity as members and with respect to their rights and obligations as members (Hickman v Kent or Romney Marsh Sheep-Breeders’ Association 1 Ch 881 (Ch)). 3.5.1 Articles as a contract between the company and its members Courts have been willing to prevent a company from infringing its members’ rights in breach of the Articles by granting an injunction. Each member, acting in his capacity as a member, is similarly obliged to the company to comply with the Articles. However, a member may not enforce any rights contained in the Articles against the company that are not relevant to his capacity as a member. Rights contained in the Articles that would probably be enforceable by members under s 33 CA 2006 would be the right to vote or the right to receive a final dividend once it has been declared (ie approved by a resolution of the shareholders). Key case: Eley v Positive Government Security Life Assurance Company (1876) 1 Ex D 88 (CA) In Eley v Positive Government Security Life Assurance Company (1876) 1 Ex D 88 (CA), a member of the company who had inserted a right into the company’s Articles for him to be employed as the company’s solicitor for life could not enforce this provision (under a forerunner of s 33 CA 2006) as this was not a right which he held in his capacity as a member, but rather in his capacity as the company’s solicitor. 3.5.2 Articles as a contract between the members themselves Although the courts have acknowledged that the forerunners to s 33 CA 2006 provide that the Articles constitute a contract between the members themselves, as well as between the company and its members, there is conflicting authority as to whether one member may enforce the Articles against another member directly (Rayfield v Hands Ch 1 (Ch)) or only through the 1: Different business models and introduction to companies 13  company itself, ie by requiring the company to enforce the provisions against the member (Welton v Saffery AC 299). The particular facts of Rayfield v Hands would suggest that, if a member accepts a personal obligation to another member through the Articles (eg to transfer shares), that member can enforce the right against the other member directly. Otherwise the courts appear to be of the opinion that members will only be able to enforce provisions contained in Articles through the company itself. If a member is likely to wish to enforce rights against other members, he/she should be advised to enter into a shareholders’ agreement. A shareholders’ agreement is a private agreement between the shareholders which is enforceable as a contract between the members. You will consider shareholders’ agreements later on this module. 3.6 Summary Although previously of constitutional significance, in companies incorporated since CA 2006 came into force the company’s memorandum is now merely a formality. The main constitutional document for a company is its Articles. The provisions in the company’s Articles bind the company and its members to the same extent as if there were covenants on the part of the company and each member to observe those provisions. Companies may have the standard Model Articles under CA 2006 or these may be amended. The Articles must always be interpreted alongside CA 2006. 4 Incorporation This section covers how companies are incorporated. 4.1 Formation of a company A client wishing to start a business through the medium of a company can either incorporate a new company from scratch or purchase and then convert an existing shelf company to conduct its business. 4.2 Incorporation from scratch In order to incorporate a new company from scratch, an application must be made to the Registrar of Companies to have the new company registered at Companies House. This method was traditionally slightly slower than purchasing a shelf company. However, it is now possible to incorporate a company online and many law firms are now increasingly making use of this facility rather than using the shelf company procedure. 14 Company Law Incorporating a new company from scratch has the advantage of ensuring that the company is tailor-made to meet your client’s requirements from the outset. Under s 9 CA 2006, the following must be delivered to the Registrar of Companies at Companies House for a company to be registered: A copy of the company’s memorandum; Articles prescribing regulations for the company (if the company does not intend to use the Model Articles (MA)); The fee – the required fee for incorporation can be found on the Companies House website. Applications may take the Registrar of Companies up to five days to process, but to ensure that the company is registered on the same day as the incorporation documents are submitted, the applicant may pay a higher fee for a premium (same-day) incorporation service; and An application for registration (Form IN01) stating the company’s proposed name, whether the company’s registered office is to be situated in England and Wales, Scotland or Northern Ireland, whether the liability is limited and whether the company is to be private or public. (The registered office is the address at which the company can be contacted and legal proceedings can be served). The application must contain: - A statement of capital and initial shareholdings (s 10 CA 2006) (where the company is to have a share capital and is not a company limited by guarantee). - A statement of the company’s proposed officers (directors, company secretary) (s 12 CA 2006). - If the company is to be limited by guarantee, details must be given of the guarantee (s 11 CA 2006). - It must also contain a statement of compliance stating that the requirements of CA 2006 have been complied with (s 13 CA 2006). Once the Registrar of Companies has approved the application for incorporation of the company, the company is sent a certificate of incorporation authenticated by the Registrar’s official seal. The certificate sets out: The name of the company (although this may be changed at a later date); The company’s registered number. The company’s registered number will never change and must therefore be used when drafting any legal agreements to which the company is a party to ensure that the company can be correctly identified following future changes to its name; and The date of incorporation. The company becomes a legal entity (s 16(3)) from the date of incorporation set out in the certificate of incorporation (s 15 CA 2006). 1: Different business models and introduction to companies 15 Figure 1.3: Example of a Certificate of Incorporation 16 Company Law 4.3 Summary of process for incorporating a company from scratch 4.4 Purchasing a shelf company It has been more common traditionally for a solicitor to purchase a shelf company on behalf of the client than to incorporate a new company from scratch. This position however is changing as a result of online incorporation services. A shelf company is one that has been set up in advance by a company registration agent or law stationer. Many firms of solicitors also operate an in-house service that sets up shelf companies for sale to clients. Traditionally, the greatest advantage of using the shelf company method to set up a company has been that it can be done quickly, as it avoids the need to draft and submit incorporation documentation. With the advent of online incorporation services, the difference in speed between converting a shelf company and incorporation from scratch is negligible. However conversion of a shelf company retains the advantage of being an available option all the time on every day of the year, whereas online incorporation can only take place during Companies House opening hours. It is likely that the client will have to make some, or all, of the following changes (amongst others) to the shelf company to meet their requirements. Name - most shelf companies will have a name that has no connection with your client or its business (eg ABC 123 Ltd). It will therefore need to be changed to a name selected by your client. Under s 77(1) CA 2006 a company’s name can be changed by a special resolution of the shareholders or by any other means provided by the company’s Articles (eg a decision of the directors, ‘board resolution’). Articles - it is common for a shelf company to have been incorporated with MA (though some firms and registration agents incorporate their shelf companies with a different form of Articles drafted in-house). You will need to consider whether the company’s existing Articles need to be amended, in accordance with s 21(1) CA 2006, to meet the specific requirements of your client. A company may as a general rule alter its Articles by special resolution. Registered office - you may need to substitute your client’s chosen address for the first registered office in accordance with s 87(1) CA 2006. Members, directors and the company secretary - representatives of the company registration agent or law firm will have become the first member(s) (subscriber(s)), director(s) and company secretary (if the company has one) of the company. It is therefore essential that: - The share(s) held by the subscriber(s) (the first members) is/are transferred to your client; - Your client’s representatives are appointed as director(s) and the company secretary (if there is to be one); and - The first director(s) and company secretary (if there was one) resign from their positions. Purchasing a shelf company has traditionally been regarded as the cheaper way to form a company for your client although, because your client is likely to instruct you to put changes into 1: Different business models and introduction to companies 17  effect as described below, it may be that, once legal fees are factored in, the costs of the two methods are not materially different. Figure 1.4: Summary of the process for setting up a new company using a shelf company 4.5 Summary A company may be incorporated from scratch directly with Companies House or converted from a shelf company. Where a company is incorporation from scratch, the following documents must be sent to Companies House: - Fee - Form IN01 - Memorandum - Articles (unless incorporating using Model Articles) Where a company is converted from a shelf company, meetings of the directors and shareholders must be held in order to make the necessary changes. 5 Stakeholders in a company This section covers the roles and features of some of the key different stakeholders in a company: Shareholders Directors Persons with significant control 18 Company Law 5.1 Who are the key stakeholders in a company? Figure 1.5: Key stakeholders in a company 5.2 Shareholders The owners of a company are its shareholders, otherwise known as its members. Shareholders invest money (share capital) in the company in return for a share in the ownership of the company, evidenced by a share certificate. Shareholders’ rights such as voting rights and rights to a dividend are set out in the Articles (and sometimes also in a shareholders’ agreement. You will learn more about shareholder agreements later in this module). Membership begins when the member’s name is entered in the company’s register of members (s 112(2) CA 2006). The first shareholders of the company are its subscribers under s 8 – so called as they subscribe to the company’s memorandum of association. A shareholder need not be a human being. A company has a separate legal identity and can, amongst other things, own property in its own name. A company can therefore own shares in another company. Where company A owns all the shares in company B, company B will be a wholly owned subsidiary of company A. If company A owns some, but not all, of the shares in company B, company B may still be a subsidiary of company A but not a wholly owned subsidiary. Section 1159 CA 2006 gives the definition of a subsidiary. Example A Ltd owns all the shares in B Ltd. A Ltd is therefore described (for certain company law purposes) as B Ltd’s ‘parent’ or ‘holding’ company. In turn, B Ltd is A Ltd’s (wholly owned) ‘subsidiary’. A Ltd and B Ltd together form a ‘group’ of companies. There is no limit on the number of companies that can form a group, which means, therefore, that subsidiary companies may have their own subsidiaries too. This means that B Ltd could have its own subsidiary (eg C Ltd). In addition, there is no limit on the number of subsidiaries that a company may have, so it would be possible for either A Ltd or B Ltd to have more than one subsidiary. Group structures are frequently used to isolate risk and/or mitigate tax liabilities. 1: Different business models and introduction to companies 19  5.3 Shares A share is often described as a ‘bundle of rights’. By investing in the share capital of any company, the investor (shareholder) becomes a part owner of the company and will often have voting rights in shareholder meetings. There are several different classes of share that a company may issue to its shareholders. Different classes of shares may carry different rights and entitlements. All rights and entitlements in relation to shares of all classes are set out in the company’s Articles. The most common type of share is known as an ordinary share. An ordinary share will usually entitle its holder to vote at shareholder meetings and to receive a share of the profits and surplus assets of a company after it is wound up (if there are any). 5.3.1 Nominal or par value Shares in a limited company having a share capital must have a fixed nominal value. Common nominal values for ordinary shares are 1p, 5p or £1. The nominal (or ‘par’) value of a share is the minimum subscription price for that share. It represents a unit of ownership rather than the actual value of the share. A share may not be allotted/issued by a company at a discount to its nominal value. A share may however be allotted/issued for more than its nominal value, and the excess over nominal value is known as the ‘premium’. The market value of a share (ie the amount at which a share may be traded between shareholders) will often be much higher than the nominal value of the share. 5.3.2 Issued, paid-up and called-up shares The total amount in value (nominal and premium) of all shares in issue at any time is known as the ‘issued share capital’. This is the amount of share capital that will be shown in the company’s accounts. It is not always necessary for shareholders to pay the full amount due on their shares immediately. The amount paid is known as the ‘paid-up share capital’. The amount outstanding can be demanded by the company at any time. Once demanded, the payment has been ‘called’. Example Sadiq subscribes for 100 £1 shares in Happy Rags Ltd. The nominal value of the shares is £1. Sadiq may purchase the shares at the nominal value – if so he will pay £100 in total. However, the 20 Company Law  company may issue the shares at a premium, for example £1.25 per share. This would mean that Sadiq will pay £125 in total for the 100 £1 shares. If Happy Rags Ltd has 500 £1 shares in issue, all of which were issued at a premium of £1.25 per share, then the total issued share capital of Happy Rags Ltd will be £625 (500 × £1.25). Not all of these shares may necessarily be fully paid-up. The amount that has been paid by the shareholders for the shares is called the paid-up share capital. 5.3.3 Share capital A company’s issued share capital is made up of: Shares purchased by the first members of the company, known as the ‘subscriber shares’; and Further shares issued after the company has been incorporated, to new or existing shareholders. New shares can be issued at any time provided that the correct procedures are followed. 5.3.4 Allotment ‘Allotment’ is defined in s 558 CA 2006. Shares are said to be allotted when a person acquires the unconditional right to be included in the company’s register of members in respect of those shares. The term ‘allotment’ is often used interchangeably with ‘issue’ of shares but the two have different meanings. There is no statutory definition of ‘issue’ but it has been held that shares are only issued, and only form part of a company’s issued share capital, once the shareholder has actually been registered as such in the company’s register of members, and his or her title has become complete. 5.3.5 Different classes of share A company may create different classes of share. For example, there may be two classes of ordinary share, each carrying different voting rights, or perhaps one carrying no voting rights at all. There may also be preference shares, which entitle the holder to a preferential right, such as the first claim to a dividend or the return of capital (ie the return of money the shareholders had invested in their shares) on a winding up. The rights will depend on the terms of the issue and are usually (and in some cases, must be) set out in the company’s Articles. You will find out more about different class rights during this module. Class rights may be relevant when determining which shareholders can vote at general meetings and whether some shareholders have enhanced voting rights. It is also important to examine class rights where it is proposed to vary the terms of the rights attaching to a particular class of share. When looking at the rights of shareholders it is important to check the company’s Articles and also to ascertain whether there is a Shareholders’ Agreement in place. You will learn about Shareholders’ Agreements later in this module. 5.3.6 Limited liability The total nominal value of the shares held by a shareholder is equal to the total amount of that shareholder’s liability to contribute to the assets of the company if it becomes insolvent. This means that, if all the shareholder’s shares are fully paid, he will not have to contribute any further amount to the company on insolvency. This is the way in which a shareholder’s liability is said to be ‘limited’. Example If you subscribe for 10 shares of £1 each in a company, and that company later becomes insolvent and is wound up, providing you paid £10 in total when you acquired the shares, you would have no further liability to the liquidator of the company. If, however, when you acquired the shares, you only paid up £6 of their total £10 nominal value then, if the company later becomes insolvent and is wound up, you would be liable to pay a further £4 to the liquidator. 1: Different business models and introduction to companies 21  Therefore the shareholder’s total liability is limited to the amount, if any, unpaid on his/her shares. 5.4 Persons with significant control (PSC) Every UK company is required to identify its ‘people with significant control’ (PSC). Broadly, this term refers to any individual (ie human being) who: Owns more than 25% of the shares or voting rights in the company; Has the power to appoint or remove a majority of its board of directors; or Otherwise exercises ‘significant influence or control’ over the company. Every company must maintain a register of its PSCs, and this register must be open to public inspection (see ss 790A-790ZG CA 2006). The intended purpose of the PSC register is to increase transparency so as to help combat tax evasion, money laundering and terrorist financing. The PSC register must be filed at Companies House along with a company’s confirmation statement (annual statement confirming the company’s constitution and details). 5.5 Directors A company is an artificial person and therefore needs human agents to take decisions and act on its behalf to run the company. All companies will therefore have one or more directors who will be officers of the company. The directors are responsible for the day-to-day management of the company. Directors are agents of the company and their conduct is governed by statute and the common law principles of agency. They also owe fiduciary duties to the company. These duties have been codified by the CA 2006. Together the directors of a company constitute the ‘board of directors’, often simply referred to as ‘the board’. References in CA 2006 to ‘the directors of a company’ (plural) are references to that company’s board. Some fundamental decisions cannot be taken by the directors but are reserved for the shareholders, for instance the making of changes to the company’s Articles under s 21 CA 2006. 5.5.1 Number and nature of directors Under s 154 CA 2006: A private company must have at least one director; and A public company must have at least two directors. At least one director must be a natural person (s 155 CA 2006). This is intended to ensure that for all companies, there will always be one individual in place to aid accountability. The Government has enacted legislation providing that all corporate directors (that is, directors which are, themselves, companies) will be prohibited subject to certain exceptions so that, as a general rule, all directors will have to be individuals. However the implementation date to incorporate these restrictions into CA 2006 has not yet been confirmed. There is a minimum age limit of 16 for directors (s 157 CA 2006). The role of a director is always separate from that of a shareholder though in small private companies they are often the same people. In this situation it is important to consider the two roles as separate – that individual wears different ‘hats’ when acting as a director and as a shareholder. 5.6 Types of director There are various different types of director: executive directors, non-executive directors, shadow directors, de facto directors and alternate directors. You will consider these in more detail later in the module. A brief overview is set out below. A key point to understand is that all of these directors owe the same duties to the company and are subject to the same responsibilities under CA 2006 and also under the insolvency legislation (Insolvency Act 1986). 22 Company Law 5.6.1 Executive directors An executive director is a director who has been appointed to executive office eg finance director, managing director. Such a director will generally spend the majority, if not all, of their working time on the business of the company and will be both an officer and an employee of their company (pursuant to a service contract). 5.6.2 Non-executive directors A non-executive director is also an officer of the company, but will not be an employee of the company. Non-executive directors do not take part in the day-to-day running of the company. Their role is generally to provide independent guidance and advice to the board and to protect the interests of shareholders. 5.6.3 Shadow directors Shadow directors: Under s 251 CA 2006 a ‘shadow director’ is defined as a person ‘in KEY TERM accordance with whose directions or instructions the directors of the company are accustomed to act’. However, a person is not deemed to be a shadow director by reason only that the directors act on advice given by them in a professional capacity (s 251(2) CA 2006). This legislation is designed to prevent for example a disqualified director from getting around the prohibitions placed on them and still being involved in the running of a company, by running it and acting behind the scenes. 5.6.4 Alternate directors Companies may provide in their Articles for the appointment of alternate directors. An alternate director attends board meetings and acts in the director’s place, if the actual director is incapacitated, otherwise engaged or out of the country. An alternate director is usually either a fellow director of the company or someone who has been approved by a resolution of the board of directors. 5.6.5 De facto directors A de facto director is someone who assumes to act as a director but has in fact not been validly appointed and therefore is not a de jure (legal) director. 5.7 Appointment of directors under CA 2006 and MA The CA 2006 does not stipulate a procedure for the appointment of directors, so this is something that will be governed by the Articles of the company. The MA deal with the matter simply, as follows: ‘Art 17(1): ‘Any person who is willing to act as a director, and is permitted by law to do so, may be appointed to be a director: (a) by ordinary resolution [of the shareholders], or (b) by a decision of the directors.’ The second of these two procedures is easier to put into effect than the first and therefore, unless there is a particular reason for using the ordinary resolution procedure, it is usual for the board of directors to appoint new directors. Of course, companies may not have followed the approach set out in the MA. They may instead have customised articles on this point which you must always check before advising on the appointment, retirement or removal of directors. 5.8 Directors’ service contracts An executive director will be an employee of the company and should be given a written contract of employment (‘service contract’), setting out the terms and conditions of employment including duties, remuneration package, notice provisions etc. 1: Different business models and introduction to companies 23  The effect of Art 19 MA is that the terms of an individual director’s service contract, including remuneration, are for the board to determine. As a general rule, a director’s service agreement will only require the approval of a resolution of the board of directors. However, shareholder approval may be required to enter into long-term service contracts. 5.9 Long-term service contracts Section 188 CA 2006 applies where a service contract provides for a director’s employment to have a ‘guaranteed term’ which is, or may be, longer than two years. Where s 188 CA 2006 applies, the relevant provision of the service contract requires shareholder approval. This would apply, for instance, if a director had a service contract for one year and had an option to renew the contract for a further two-year term at their sole discretion. If shareholder approval is not given, then the term incorporated into the service contract in contravention of s 188 CA 2006 is void under s 189(a) CA 2006. In addition, under s 189(b) CA 2006, the service contract will be deemed to contain a term entitling the company to terminate the contract at any time, by the giving of reasonable notice. 5.10 Summary Shareholders are the owners of the company. A company can itself be a shareholder in another company. A company may have different classes of shares. The rights attaching to each class of shares will be set out in the company’s Articles. All companies must maintain a register which is filed at Companies House of Persons with Significant Control. This generally means shareholders with over 25% of the voting rights in the company. Directors are responsible for the day-to-day management of the company and are agents of the company. There are different types of director, but all are governed by the CA 2006. 6 Resolutions This section covers the different ways in which shareholders and directors can vote to effect decisions on behalf of the company. 6.1 Board and shareholder resolutions Since a company is an artificial person, it is unable to make decisions or carry out company business itself. Instead, decisions are made on behalf of the company by its directors and its shareholders. Decisions of the directors are taken by passing Board Resolutions in Board Meetings (BM). Decisions of the shareholders are taken by passing Shareholder Resolutions, either in a meeting of the shareholders (referred to as a General Meeting (GM)) or in writing. There are two different types of shareholder resolution: Ordinary Resolutions and Special Resolutions. 6.2 Directors: Board resolutions The standard day to day decisions of the company are taken by its board of directors in board meetings. Unless the power to take a particular decision has been delegated by the board to a particular director or committee of directors, a decision of the board of directors of a company must be taken in accordance with the procedure set out in the company’s Articles. 6.2.1 Procedure for passing a board resolution at a BM Art 7(1) MA provides that any decision of the directors can be made by majority decision at a meeting of the directors. This is the usual procedure for directors’ decision-making. Decisions at BMs are taken by majority vote on a show of hands. For example, if there are four directors 24 Company Law  participating in the BM, at least three must vote in favour of a resolution for the board resolution to be validly passed. On the other hand if two of the directors vote for the resolution and the other two directors vote against it there will be deadlock. Art 13 MA provides that in the event of a deadlock the chairman of the BM (if appointed under Art 12 MA) will have a casting vote. 6.2.2 Chairman of the Board The chairman is chosen by the directors from amongst themselves (Art 12 MA). Therefore, using the same example, if a resolution fails because there are equal votes, ie two for and two against, the chairman has considerable power. They can tip the balance. Furthermore, in a company with only two directors, a chairman with a casting vote is effectively able to take decisions alone. For this reason the company’s members may decide to amend the Articles by removing the chairman’s right to a casting vote in some circumstances. 6.2.3 The quorum necessary for a valid BM The number of people required to attend a meeting in order for the meeting to be valid is known as the quorum. If a sufficient number of people attend the meeting then the meeting is said to be quorate. Art 11 MA confirms that no proposal may be voted on at a BM unless a quorum is participating in the meeting. Art 11(2) states that the quorum for a directors’ meeting may be fixed from time to time by a decision of the directors but it must never be less than two and, unless otherwise fixed, it is two. 6.2.4 Alternative procedure: unanimous decision of the directors Art 8 MA makes provision for directors to make decisions, by unanimous agreement, without having to hold a BM. Such a decision requires all the directors to indicate to each other that they share a common view on the matter and they can indicate this ‘by any means’ so this can include, for example, a written resolution or a telephone conversation (but note that a written record of the decision must be kept – Art 15). However since it is easy to hold a BM under the MA, in practice the preferred procedure for decision-making by directors is by resolution in a BM. 6.2.5 Companies with one director The requirements in the MA as to decision-making by directors do not apply to companies with only one director. In such companies the sole director can take decisions on his own (Art 7(2) MA). 6.3 Shareholder resolutions Some fundamental decisions cannot be taken by the directors until they receive authorisation from the shareholders to do so, for instance: The making of changes to the company’s constitution; The approval of certain transactions between the directors and the company; and The formal declaration of dividends. There are two types of shareholder resolution under the CA 2006 requiring different voting thresholds. These are: Ordinary resolutions; and Special resolutions. Where the CA 2006 does not specify the type of resolution to be used then an ordinary resolution is sufficient unless the company’s Articles require a higher majority (s 281(3) CA 2006). 6.4 Types of shareholder resolutions Ordinary resolution: An ordinary resolution of the members of a company means a resolution KEY TERM that is passed by a simple majority (more than 50% of votes are cast in favour of the resolution) (s 282(1) CA 2006). 1: Different business models and introduction to companies 25  Special resolution: Under s 283(1) CA 2006 a special resolution requires a majority of not less than 75%. 6.4.1 Voting on a show of hands and voting on a poll Shareholders may vote at a GM on a show of hands or on a poll. When the shareholders vote on a show of hands each shareholder who is present at the meeting will be entitled to one vote, regardless of the number of shares held by that shareholder (provided the share has voting rights under the Articles). When the shareholders are voting on a poll, every shareholder has one vote in respect of each share held by him (s 284 CA 2006). The votes are counted out of the shareholders who are present and voting at the meeting. 6.4.2 The right to appoint a proxy A member of a company is entitled to appoint another person as his proxy to exercise all or any of his rights to attend and to speak and vote at any GM, in his place (s 324 CA 2006). Exercise: Engage PGDL Publications Ltd Shareholder’s name No. of shares held Archie 55 Grace 20 Clare 10 Saad 15 Total no. of shares issued 100 PGDL Publications Ltd has the shareholders above. Assuming all the shareholders are present and voting at the General Meeting, how many shareholders and who would need to vote to pass: (a) An ordinary resolution on a show of hands? (b) An ordinary resolution on a poll vote? (c) A special resolution on a show of hands? (d) A special resolution on a poll vote? PGDL Publications Ltd Solution Show of hands Poll Voting on an If the shareholders were to vote on If the shareholders were ordinary resolution a show of hands at a GM of PGDL voting on a poll then Archie Publications Ltd then at least three could pass the ordinary of the shareholders would need to resolution on his own, even if vote in favour of an ordinary the other three shareholders resolution in order for the resolution were to vote against the to be validly passed as the resolution, because he holds resolution must have the support of more than 50% of the total more than 50% of the shareholders number of shares in PGDL who are present and voting at the Publications Ltd. On the other meeting. hand, if Archie were to vote against the ordinary resolution the other three shareholders would not be able to pass it even if they all voted in favour of it, because, together, they hold only 45% 26 Company Law  Show of hands Poll of the shares. Voting on a special If a special resolution were If the shareholders were resolution proposed at a GM of PGDL voting on a poll Archie could Publications Ltd and the not pass the special shareholders were to vote on a resolution on his own, but show of hands, the resolution would Archie and Grace together be validly passed if three of the four could pass the special shareholders (ie 75%) voted in resolution even if Clare and favour of it. Saad both voted against it. As before, if Archie voted against the special resolution the other three shareholders would not be able to pass it since they hold only 45% of the shares between them. 6.4.3 Quorum for a GM According to s 318(2) CA 2006 the quorum required for a GM is two qualifying persons, and qualifying persons include proxies and representatives of corporate shareholders. As you know, a company can hold shares in another company. In fact very many companies have corporate shareholders because they are subsidiaries within a group of companies. Section 323 CA 2006 provides that if a corporation is a member of a company, it may by resolution of its directors authorise a person or persons to act as its representative at any meeting of the company. 6.4.4 Single member companies Under s 318(1) CA 2006 where a company has only one member, one qualifying person present is sufficient to constitute a quorum for a GM. 6.5 Written resolutions Under s 281 CA 2006, private companies may also pass a shareholders’ resolution without holding a General Meeting by using the written resolution procedure (subject to s 288 CA 2006). When votes are cast in writing, the relevant majority is counted out of all the shareholders entitled to vote on the resolution (rather than those present and voting at the meeting as for votes cast at a general meeting). Note that a written resolution is a method of voting, not a type of vote. Shareholders must always vote by ordinary or special resolution, but they may do this either at a meeting or (for private companies), in writing as a written resolution. There are two resolutions that may not be passed as written resolutions (s 288(2)), which are: Removal of a director under s 168; and Removal of an auditor under s 510. For both of these resolutions, the person concerned has the right to address the shareholders in general meeting. 6.6 Summary Decisions are made on behalf of the company by directors and shareholders. Directors make decisions by passing board resolutions in board meetings. Shareholders make decisions by passing shareholder resolutions (ordinary and special resolutions) in general meetings or by written resolution. Shareholders can vote either on a show of hands (where each shareholder has one vote) or by poll vote (where each shareholder has one vote per share held). 1: Different business models and introduction to companies 27  An ordinary resolution is passed by a simple majority (more than 50%) of shareholders voting in favour. A special resolution is passed by 75% or more shareholders voting in favour. 7 Introduction to company procedure This section introduces you to the formal procedures and processes involved in running a company. 7.1 Company Procedure As you have already seen, much of the day-to-day business of a company is carried out by the directors and, where the company has a managing director (as almost all do), the managing director will have authority to enter into all routine commercial contracts on behalf of the company. From time to time however, it will be necessary for specific authority to be given to a director (perhaps in connection with the execution of documentation on behalf of the company in respect of an especially important transaction). Alternatively, a matter may need to be approved by the company’s shareholders. 7.2 Board meetings (meetings of directors) Board resolutions can be passed by directors, without great formality, at a board meeting (BM). Example Olivia is a director of Ready Rentals Ltd (RRL). She wishes RRL to contract to purchase a new fleet of rental cars. RRL’s board of directors has the power to enter into such a contract without reference to RRL’s shareholders. Olivia therefore calls a BM of RRL, at which RRL’s directors review the terms of the proposed contract, resolve that RRL should enter into the contract, and authorise Olivia to sign the contract on behalf of RRL. No shareholder meeting is necessary. Art 9 MA gives the directors flexibility in regulating their meetings, providing that any director may call a BM or require the company secretary (if the company has one) to do so at any time. 7.2.1 Notice In the case of Browne v La Trinidad (1887) 37 ChD 1, the court held that reasonable notice of the BM was necessary, and that this would be whatever notice is usual for the directors to give. Therefore, if all of the directors are in the same building, the meeting could be called almost immediately, if such notice is customary for the directors. If the directors are in various buildings or in other parts of the country, then a couple of days’ or even a couple of weeks’ notice may be required. 7.2.2 Quorum Directors may not validly make a decision on company business unless a minimum number of directors entitled to vote are present at the time the meeting takes place. Article 11(2) MA requires a minimum of two directors to be present for the meeting to be quorate (unless the articles provide otherwise). 7.2.3 Voting Board resolutions are passed by majority vote on a show of hands. Each director has one vote. As we saw, the chairman may have a casting vote to prevent deadlock, depending on whether this is provided in the company’s Articles. 7.3 Matters to be referred to the shareholders There will need to be a referral to the shareholders of the company in the following situations: (a) Where a matter is outside the powers of the directors and must be approved by a resolution of the shareholders 28 Company Law  Example The making of amendments to a company’s articles of association. Section 21 CA 2006 provides that amendments to articles of association are to be made by a special resolution of the company’s shareholders. (b) Where a matter is within the powers of the directors but requires the prior approval of the shareholders before the directors can be authorised to act. Example The making of a loan to a director of the company. Under s 197 CA 2006 a company may make a loan to a director, but not without the prior approval by a resolution of the shareholders. Once the shareholders have given their approval the matter will be referred back to the Board and the board will actually make the loan to the director, on behalf of the company. 7.4 General meetings (mMeetings of shareholders) If a shareholder resolution is required then there must be a shareholders’ meeting (also referred to as a ‘general meeting’ or GM). It is the board’s responsibility to convene (ie call) general meetings. The board must decide when the GM is to take place. Section 307 CA 2006 prescribes minimum notice periods for GMs. For private companies, 14 clear days’ notice is required for the calling of a GM (s 307(1) CA 2006). In this paragraph, the word ‘notice’ refers to a period of time (between the board’s act of convening a GM and its actually taking place). In order to actually convene the GM, the board must inform the shareholders of when (and where) it is taking place, by giving notice to the shareholders. In this paragraph, the word ‘notice’ refers to a document inviting shareholders to attend the GM, drafted in accordance with relevant provisions of CA 2006. The directors must approve the form of the notice of the GM (to confirm that it complies with the relevant statutory requirements) and then they must authorise its circulation to the shareholders. The quorum for a GM is generally two shareholders (s 318(2) CA 2006) (although this is one for single member companies (s 318(1)). Notice: You should note that the word ‘notice’ is used above to bear two distinct meanings and KEY TERM that the expression ‘notice of a GM’ can, therefore, depending on its context, refer either to: A document sent by the directors to the shareholders, announcing that a GM will take place; or A period of time, which elapses between the directors’ act of calling a GM (by circulating the notice document to the shareholders) and the GM itself taking place. After the GM has taken place, a second BM will be necessary, to enable the directors to implement the matter on which the shareholders have voted. The net effect is that, if a company wishes to put into effect any change or business decision of a type for which shareholder approval is needed, there will be a sequence of three meetings (BM, GM, BM). This sequence is necessary to (i) allow the directors at the first BM to propose the changes or business decision and convene a GM, (ii) obtain shareholder approval in the GM, and (iii) allow the board of directors, at the second BM, to implement the shareholders’ decision(s). Example RRL’s directors consider that RRL should change its articles. The directors have no power to do this by themselves – it can only be done by shareholders (s 21(1) CA 2006). A GM is therefore necessary, for a shareholder vote. Before the GM can take place, RRL’s directors must call the GM. RRL’s directors will take this step at a BM. Therefore a BM will take place, followed by a GM. 1: Different business models and introduction to companies 29  After the GM, another BM will be necessary as it is the board’s responsibility to ensure that the shareholders’ decision is implemented and that all necessary follow-up action is taken. In this example, the CA 2006 requires the company to register its new articles at Companies House. 7.4.1 Sequence of meetings - summary In the normal course of events, the process of holding a GM called by the board will involve four distinct stages. Step 1 BM – a BM is held to decide on the issues to be considered at the GM, to resolve to convene the GM, to approve the form of notice for the GM and to authorise its circulation. The notice of the GM will set out the wording of the resolutions to be put before the shareholders. The notice of the GM is then circulated to the shareholders by the company secretary (if the company has one) or by the directors. Step 2 GM - on the day appointed, the GM will take place and the shareholders will vote on the resolutions set out in the notice. Step 3 BM – a further BM will be held and the directors will be informed as to how the shareholders voted at the GM and whether the resolutions were passed. The directors will then authorise the company secretary (if there is one), or one of the directors (if there is not), to deal with the post-meeting matters. Step 4 Post meeting matters (PMM) - the post-meeting matters will then be carried out by the company secretary (if the company has one) or a director (if not). This means that copies of the relevant documents will be filed at Companies House, and the company’s internal records (minute books and registers) will be brought up-to-date. 30 Company Law  7.5 Sequence of meetings - summary 7.5.1 Short notice GMs GMs may be called on less than the usual amount of short notice if sufficient members agree. Section 307(5) CA 2006 provides that, for a private company, a GM may be called on short notice if this is agreed to by a majority in number of the members who together hold shares with a nominal value of not less than 90% of the total nominal value of the shares which give the right to attend and vote at the GM. This percentage may be increased to up to 95% by a provision in the company’s articles of association but there is no such provision in the MA. Therefore, where companies have few shareholders, it is often possible for meetings to be held at short notice. If all the shareholders are available at the time the directors decide to convene a GM, the following sequence of events may be possible. All of this can be done in well under an hour. 7.5.2 Written resolution procedure for private companies Board resolutions Art 8(2) MA allows directors to take decisions in the form of a directors’ written resolution provided the prescribed procedure is followed. This is uncommon in practice. Ordinary and special resolutions Under s 281 CA 2006 only private companies may pass a shareholders’ resolution by way of a written resolution. Section 282 CA 2006 states that a written ordinary resolution can be passed by a simple majority of the total voting rights of eligible members. Sections 283 CA 2006 state that a written special resolution can be passed by a majority of members representing not less than 75% of the total voting rights of eligible members. Section 284 CA 2006 states that, where a company has a share capital, every member has one vote in respect of each share held by him when voting on a written resolution. 1: Different business models and introduction to companies 31  Section 288 CA 2006 provides that resolutions to remove a director or auditor from office may not be passed by way of written resolutions. 7.6 Post-meeting - dealing with documentation Copies of all resolutions affecting the company’s constitution must be sent to the Registrar of Companies within 15 days of their being passed. All special resolutions must be filed as they form part of a company’s constitution (ss 17(b) and 29(1)(a) CA 2006), as do a few particular ordinary resolutions specified by the relevant provisions of the CA 2006. Copies of any amended articles must also be filed (s 26(1) CA 2006), together with various company forms. The CA 2006 refers in numerous places (eg s 87(1) CA 2006) to requirements for notice of certain events and/or decisions to be given to the Registrar of Companies. The directors will also be responsible for updating the statutory books, eg the registers of members and directors, and the BM and GM minute books. If the company has a company secretary they will update the statutory books. 7.7 Why is it important to follow the correct procedures? If the correct procedures are not followed, then resolutions purportedly passed at meetings may be invalid. For example, if written notice for GMs is not given in the proper form to all those entitled to it, then any resolutions are invalid, unless the error is accidental. Similarly, if a meeting is not quorate, then resolutions will not be validly passed, nor will they be valid