Company (law)

2007 Schools Wikipedia Selection. Related subjects: Business

In law, a company refers to a legal entity formed which has a separate legal identity from its members, and is ordinarily incorporated to undertake commercial business. Although some jurisdictions refer to unincorporated entities as companies, in most jurisdictions the term refers only to incorporated entities. It has been judicially remarked that "the word company has no strictly legal meaning", but is taken to mean a specific form of entity created under the laws of the relevant jurisdiction. Because of the limited liability of the members of the company for the company's debts and the separate personality and tax treatment of the company, it has become the most popular form of business vehicle in most countries in the world.

Lacking a concise definition of their own, companies are often defined by reference to what they are not. Companies are separate and distinct from:

• sole proprietorships
• partnerships
• trusts, although conceptually trustees managing a trust fund for the benefit of beneficiaries is in many ways similar to the directors managing the company's assets for the benefit of the shareholders.
• guilds
• unincorporated associations of persons, such as clubs, cooperatives and collectives.

Modern companies are generally formed for one of three purposes:

• "non-profit companies", formed for social, charitable or quasi-charitable purposes to provide the sponsors with the benefit of limited liability and to form an administratively convenient mechanisms for the administration of the organization.
• small business companies, usually formed by either sole traders or partners to take advantage of limited liability and (sometimes) as a means of tax avoidance, whilst still retaining overall control in the hands of the founders.
• public investment companies, formed to enable members of the public to invest in a business or enterprise without actually becoming involved in the running of it (which is left to the board of directors).

However, companies have a number of other uses. They are not normally subject to rules against mortmain or perpetuity, and may have perpetual existence. Companies are often used in tax structuring. Companies, being commercial entities, are often easier to utilise in financing arrangements than partnerships and individuals. Companies have an inherent flexibility which can let them grow; there is no legal reason why a company initially formed by a sole proprietor cannot eventually grow to be a publicly listed company, but a partnership will generally always be limited as to the maximum number of partners.

History

Although some forms of companies are thought to have existed during Ancient Rome and Ancient Greece, the closest recognizable ancestors of the modern company did not appear until the second millennium. The first recognizable commercial associations were medieval guilds, where guild members agreed to abide by guild rules, but did not participate in ventures for common profit. The earliest forms of joint commercial enterprise under the lex mercatoria were in fact partnerships.

But with the expansion of international trade, Royal charters were increasingly granted in Europe (notably in England and Holland) to merchant adventurers. The Royal charters usually conferred special privileges on the trading company (including, usually, some form of monopoly). Originally, traders in these entities traded stock on their own account, but later the members came to operate on joint account and with joint stock, and the new Joint stock company was born.

Early companies were purely economic ventures; it was only belatedly realized that an incidental benefit of holding joint stock was that the company's stock could not be seized for the debts of any individual member.

The development of company law in Europe was hampered by two notorious "bubbles" (the South Sea Bubble in England and the Tulip Bulb Bubble in Holland) in the 17th century, which set the development of companies in the two leading jurisdictions back by over a century in popular estimation.

But companies, almost inevitably, returned to the forefront of commerce, although in England to circumvent the Bubble Act 1720 investors had reverted to trading the stock of unincorporated associations, until it was repealed in 1825. However, the cumbersome process of obtaining Royal charters was simply insufficient to keep up with demand. In England there was a lively trade in the charters of defunct companies. However, prevarication amongst the legislation meant that in England it was not until the Joint Stock Companies Act 1844 that the first equivalent of modern companies, formed by registration, appeared. That legislation shortly preceded the railway boom, and from there the numbers of companies formed soared.

The last significant development in the history of companies was the decision of the House of Lords in Salomon v. Salomon & Co. where the House of Lords confirmed the separate legal personality of the company, and that the liabilities of the company were separate and distinct from those of its owners.

Types

There are various types of company that can be formed in different jurisdictions, but the most common forms of company are:

• a company limited by shares. The most common form of company used for business ventures.
• a company limited by guarantee. Commonly used where companies are formed for non-commercial purposes, such as clubs or charities. The members guarantee the payment of certain (usually nominal) amounts if the company goes into insolvent liquidation, but otherwise they have no economic rights in relation to the company .
• a company limited by guarantee with a share capital. A hybrid entity, usually used where the company is formed for non-commercial purposes, but the activities of the company are partly funded by investors who expect a return.
• an unlimited liability company. A company where the liability of members for the debts of the company are unlimited. Today these are only seen in rare and unusual circumstances.

The foregoing types of company are generally formed by registration under applicable companies legislation. Less commonly seen types of companies are:

• charter corporations. Prior to the passing of modern companies legislation, these were the only types of companies. Now they are relatively rare, except for very old companies that still survive (of which there are still many, particularly many British banks), or modern societies that fulfil a quasi regulatory function (for example, the Bank of England is a corporation formed by a modern charter).
• statutory companies. Relatively rare today, certain companies have been formed by a private statute passed in the relevant jurisdiction.
• companies formed by letters patent. Most corporations by letters patent are corporations sole and not companies as the term is commonly understood today.

In legal parlance, the owners of a company are normally referred to as the "members". In a company limited by shares, this will be the shareholders. In a company limited by guarantee, this will be the guarantors.

Some offshore jurisdictions have created special forms of offshore company in a bid to attract business for their jurisdictions. Examples include " segregated portfolio companies" and restricted purpose companies.

There are however, many, many sub-categories of types of company which can be formed in various jurisdictions in the world.

Companies are also sometimes distinguished for legal and regulatory purposes between public companies and private companies. Public companies are companies whose shares can be publicly traded, often (although not always) on a regulated stock exchange. Private companies do not have publicly traded shares, and often contain restrictions on transfers of shares. In some jurisdictions, private companies have maximum numbers of shareholders.

Corporate constitution

In almost every jurisdiction in the world, a company must have a corporate constitution, which defines the existence of the company and regulates the structure and control of the company.

By convention, most common law jurisdictions divide the corporate constitution into two separate documents:

• the Memorandum of Association (in some countries referred to as the Articles of Incorporation) is the primary document, and will generally regulate the company's activities with the outside world, such as the company's objects and powers and specify the authorised share capital of the company.
• the Articles of Association (in some countries referred to as the by-laws) is the secondary document, and will generally regulate the company's internal affairs and management, such as procedures for board meetings, dividend entitlements etc.

In many countries, only the primary document is filed, and the secondary document remains private. In other countries, both documents are filed. Some countries provide statutory forms of basic corporate constitution which a company may adopt (for example, Table A in the United Kingdom).

In civil law jurisdictions, the company's constitution is normally consolidated into a single document, often called the charter.

It is quite common for members of a company to supplement the corporate constitution with additional arrangements, such as shareholders' agreements, whereby they agree to exercise their membership rights in a certain way. Conceptually a shareholders' agreement fulfills many of the same functions as the corporate constitution, but because it is a contract, it will not normally bind new members of the company unless they accede to it somehow. One benefit of shareholders' agreement is that they will usually be confidential, as most jurisdictions do not require shareholders' agreements to be publicly filed.

Another common method of supplementing the corporate constitution is by means of voting trusts, although these are relatively uncommon outside of the United States and certain offshore jurisdictions.

Some jurisdictions consider the company seal to be a party of the "constitution" (in the loose sense of the word) of the company, but the requirement for a seal has been abrogated by legislation in most countries.

Shares and share capital

Companies generally raise capital for their business ventures either by debt or equity. Capital raised by way of equity is usually raised by issued shares (sometimes called "stock" (not to be confused with stock-in-trade)) or warrants.

A share is an item of property, and can be sold or transferred. Holding a share makes the holder a member of the company, and entitles them to enforce the provisions of the company's constitution against the company and against other members. Shares also normally have a nominal or par value, which is the limit of the shareholder's liability to contribute to the debts of the company on an insolvent liquidation.

Shares usually confer a number of rights on the holder. These will normally include:

• voting rights
• rights to dividends declared by the company
• rights to any return of capital either upon redemption of the share, or upon the liquidation of the company
• in some countries, shareholders have preemption rights, whereby they have a preferential right to participate in future share issues by the company

Many companies have different classes of shares, offering different rights to the shareholders. For example, a company might issue both ordinary shares and preference shares, with the two types having different voting and/or economic rights. For example, a company might provide that preference shareholders shall each receive a cumulative preferred dividend of a certain amount per annum, but the ordinary shareholders shall receive everything else.

The total number of issued shares in a company is said to represent its capital. Many jurisdictions regulate the minimum amount of capital which a company may have, although some countries only prescribe minimum amounts of capital for companies engaging in certain types of business (e.g. banking, insurance etc.).

Similarly, most jurisdictions regulate the maintenance of capital, and prevent companies returning funds to shareholders by way of distribution when this might leave the company financially exposed. In some jurisdictions this extends to prohibiting a company from providing financial assistance for the purchase of its own shares.

Corporate personality

One of the key legal features of companies are their separate legal personality. However, the separate legal personality was not confirmed under English law until 1895 by the House of Lords in Salomon v. Salomon & Co. [1897] AC 22. However, it is now largely accepted throughout the world that companies are legally separate and distinct entities.

Separate legal personality often has unintended consequences, particularly in relation to smaller, family companies.

• In B v B [1978] Fam 181 it was held that a discovery order obtained by a wife against her husband was not effective against the husband's company as it was not named in the order and was separate and distinct from him.
• In Macaura v Northern Assurance Co Ltd [1925] AC 619 a claim under an insurance policy failed where the insured had transferred timber from his name into the name of a company wholly owned by him, and it was subsequently destroyed in a fire; as the property now belonged to the company and not to him, he no longer had an "insurable interest" in it and his claim failed.

However, separate legal personality does allow corporate groups a great deal of flexibility in relation to tax planning, and also enables multinational companies to manage the liability of their overseas operations (see Adams v Cape Industries plc [1990] Ch 433).

There are certain specific situations where courts are generally prepared to " pierce the corporate veil": to look directly at, and impose liability directly on the individuals behind the company. The most commonly cited examples are:

• where the company is a mere façade
• where the company is effectively just the agent of its members or controllers
• Where a representative of the company has taken some personal responsibility for a statement or action.
• where the company is engaged in fraud or other criminal wrongdoing
• where the natural interpretation of a contract or statute is as a reference to the corporate group and not the individual company
• where permitted by statute (for example, many jurisdictions provide for shareholder liability where a company breaches environmental protection laws)
• in many jurisdictions, where a company continues to trade despite inevitable bankruptcy, the directors can be forced to account for trading losses personally

Capacity and powers

Historically, because companies are artificial persons created by operation of law, the law prescribed what the company could and could not do. Usually this was an expression of the commercial purpose which the company was formed for, and came to referred to as the company's objects, and the extent of the objects are referred to as the company's capacity. If an activity fell outside of the company's capacity it was said to be ultra vires and void.

By way of distinction, the organs of the company were expressed to have various corporate powers. If the objects were the things that the company was able to do, then the powers were the means by which it could them. Usually expressions of powers were limited to methods of raising capital, although from earlier times distinctions between objects and powers have caused lawyers difficulty.

Most jurisdictions have now modified the position by statute, and companies generally have capacity to do all the things that a natural person could do, and power to do it in any way that a natural person could do it.

However, references to corporate capacity and powers have not quite been consigned to the dustbin of legal history. In many jurisdictions, directors can still be liable to their shareholders if they cause the company to engage in businesses outside of its objects, even if the transactions are still valid as between the company and the third party. And many jurisdictions also still permit transactions to be challenged for lack of " corporate benefit", where the relevant transaction has no prospect of being for the commercial benefit of the company or its shareholders.

Officers and agents

As artificial persons, companies can only act through human agents. As was once memorably remarked, "It has no soul to damn and no body to kick."

The main agent who deals with the company's management and business is the board of directors, but in many jurisdictions other officers can be appointed too. The board of directors is normally elected by the members, and the other officers are normally appointed by the board. These agents enter into contracts on behalf of the company with third parties.

Although the company's agents owe duties to the company (and, indirectly, to the shareholders) to exercise those powers for a proper purpose, generally speaking third parties' rights are not impugned if it transpires that the officers were acting improperly. Third parties are entitled to rely on the ostensible authority of agents held out by the company to act on its behalf. A line of common law cases reaching back to Royal British Bank v Turquand established in common law that third parties were entitled to assume that the internal management of the company was being conducted properly, and the rule has now been codified into statute in most countries.

Accordingly, companies will normally be liable for all the act and omissions of their officers and agents. This will include almost all torts, but the law relating to crimes committed by companies is complex, and varies significantly between countries.

Members' rights and majority rule

Members of a company generally have rights against each other and against the company, as framed under the company's constitution. In relation to the exercise of their rights, minority shareholders usually have to accept that, because of the limits of their voting rights, they cannot direct the overall control of the company and must accept the will of the majority (often expressed as majority rule). However, majority rule can be iniquitous, particularly where there is one controlling shareholder.

Accordingly, a number of exceptions have developed in law in relation to the general principle of majority rule.

• Where the majority shareholder(s) are exercising their votes to perpetrate a fraud on the minority, the courts may permit the minority to sue
• members always retain their personal right to sue if the company's affairs are not conducted in accordance with the company's constitution
• in many jurisdictions it is possible for minority shareholders to take a representative or derivative action in the name of the company, where the company is controlled by the alleged wrongdoers

Director's duties

In most jurisdictions, directors owe strict duties of good faith, as well as duties of care and skill, to safeguard the interests of the company and the members.

The standard of skill and care that a director owes is usually described as acquiring and maintaining sufficient knowledge and understanding of the company's business to enable him to properly discharge his duties.

Directors are also strictly charged to exercise their powers only for a proper purpose. For instance, were a director to issue a large number of new shares, not for the purposes of raising capital but in order to defeat a potential takeover bid, that would be an improper purpose.

Directors also owe strict duties not to permit any conflict of interest or conflict with their duty to act in the best interests of the company. This rule is so strictly enforced that, even where the conflict of interest or conflict of duty is purely hypothetical, the directors can be forced to disgorge all personal gains arising from it. In Aberdeen Ry v Blaikie (1854) 1 Macq HL 461 Lord Cranworth stated in his judgment that:

"A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect... So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of the contract entered into..." (emphasis added)

However, in many jurisdictions the members of the company are permitted to ratify transactions which would otherwise fall foul of this principle. It is also largely accepted in most jurisdictions that this principle should be capable of being abrogated in the company's constitution.

Liquidations

Liquidation is the normal means by which a company's existence is brought to an end. It is also referred to (either alternatively or concurrently) in some jurisdictions as winding up and/or dissolution.

Liquidations generally come in two forms, either compulsory liquidations (sometimes called creditors' liquidations) and voluntary liquidations (sometimes called members' liquidations, although a voluntary liquidation where the company is insolvent will also be controlled by the creditors, and is properly referred to as a creditors' voluntary liquidation).

As its names imply, applications for compulsory liquidation are normally made by creditors of the company when the company is unable to pay its debts. However, in some jurisdictions, regulators have the power to apply for the liquidation of the company on the grounds of public good, i.e. where the company is believed to have engaged in unlawful conduct, or conduct which is otherwise harmful to the public at large.

Voluntary liquidations occur when the company's members decide voluntarily to wind up the affairs of the company. This may be because they believe that the company will soon become insolvent, or it may be on economic grounds if they believe that the purpose for which the company was formed is now at an end, or that the company is not providing an adequate return on assets and should be broken up and sold off.

Some jurisdictions also permit companies to be wound up on "just and equitable" grounds. Generally, applications for just and equitable winding-up are brought by a member of the company who alleges that the affairs of the company are being conducted in a prejudicial manner, and asking the court to bring an end to the company's existence. For obvious reasons, in most countries, the courts have been reluctant to wind up a company solely on the basis of the disappointment of one member, regardless of how well-founded that member's complaints are. Accordingly, most jurisdictions which permit just and equitable winding up also permit the court to impose other remedies, such as requiring the majority shareholder(s) to buy out the disappointed minority shareholder at a fair value.

Where a company goes into liquidation, normally a liquidator is appointed to gather in all the company's assets and settle all claims against the company. If there is any surplus after paying off all the creditors of the company, this surplus is then distributed to the members.