TRADING WITH MAINLAND AUSTRALIA: WHAT ARE THE BENEFITS OF COMPANY FORMATION & WHAT TYPE OF COMPANY SHOULD

BE FORMED?

Vinay Kataria 07-02283

April 15, 2011

1.0. INTRODUCTION
1.1. PURPOSE
The purpose of this report is to explain the benefits of company formation, the procedure for registration and the type of company which would best suit Penguin Islands situation.

1.2. SCOPE
This report considers the various advantages of company formation, the general steps involved in incorporation, and examines the most suitable form the company on Penguin Island should take. The report also addresses the number and type of directors, as well as the capital structure, that this company should have. Included is the citation of legal rules in relation to companies, particularly the sections of the Corporations Act 2001 (Cth).

1.3. BACKGROUND
Different stakeholders on Penguin Island, including retirees, farmers and a boat building family, are keen on exporting the islands produce and livestock to mainland Australia for the overall economic development of Penguin Island. However, the lack of a large enough ship on Penguin Island to transport these goods means that this trade is not economically viable. In order to address and overcome this stumbling block, some financial advisors explained that forming a company may be appropriate. To this end, this report looks at the benefits, applicability, and the type of company that would be suitable for enabling trade to begin with the rest of Australia.

2.0. DISCUSSION
2.1. BENEFITS OF INCORPORATION
The formation of a company is also known as registration or incorporation. Incorporation provides important advantages, which may not be available with other types of business organizations, such as sole proprietorships, partnerships or trading trusts. Following are the benefits of incorporation:

Separate legal identity

Upon registration under the Corporations Act 2001 (Cth), a company becomes a separate legal entity that is distinct from its shareholders (or members) and directors. This basic principle is contained in s 119 of the Corporations Act. At common law, this principle was first established in the case Salomon v Salomon & Co Ltd [1897] AC 22 (Lipton, Herzberg & Welsh, 2010). In this case, Mr. Salomon was a shoe manufacturer who held most of the shares in Salomon & Co Ltd, and was the sole person managing it. When the company faced financial difficulties and was subsequently wound up, it was discovered that the companys realizable assets were insufficient to pay its unsecured creditors. The liquidator brought an action against Mr. Salomon, arguing that he was liable to indemnify the liquidator for the unsecured debts of the company. The House of Lords ruled that the company was a separate legal entity, even though a single person owned virtually all the shares and controlled the company. Thus, Mr. Salomon was not liable for the companys debts (Cassidy, 2006).

Under s 124, a company has the legal capacity and powers of an individual and a body corporate. The powers of an individual that apply to companies include the power to acquire and dispose of property, contract, and the right to sue in its own name.

Section 124(1) lists the powers of a company as a body corporate. These include the power to:

a) issue and cancel shares in the company;

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b) issue debentures; c) grant options over unissued shares;

d) distribute any of the companys property among its members, in kind or

otherwise;
e) give security by charging uncalled capital; f) grant a floating charge over the companys property;

g) do anything it is lawfully authorized to do.

Parts (a), (b), (d), (e), (f), and (h) are important benefits for a small company just starting up, such as Penguin Islands company.

Limited liability
One of the principal advantages of the company form over other forms of business organization is limited liability (Lipton et al., 2010). Limited liability means that shareholders are not personally liable for their companys debts (ibid). By contrast, sole proprietorships and partnerships generally have unlimited liability (Cassidy, 2006). Since the company is a separate legal entity, it is primarily liable for its debts (Lipton et al., 2010). In case of a company limited by shares (the most common type of company), the liability of shareholders is limited to the amount, if any, unpaid on the issue price of their shares: s 516. Thus, shareholders who own fully paid shares have no further liability to pay further amounts to the company. In effect, limited liability transfers the risk of business failure from the companys shareholders to its creditors (Lipton et al., 2010).

The leading case on limited liability is Salomon v Salomon & Co Ltd [1897] AC 22 (where it was held that Mr. Salomon was not personally liable for the companys debts) (Cassidy, 2006).

Perpetual succession
A company remains in existence until it is deregistered by the Australian Securities and Investments Commission (ASIC): s 601AD(1). If a shareholder leaves the company or dies, this will not affect the continuing legal personality of the company. This allows for
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greater continuity of commercial relations, and prevents dissatisfied members from being able to threaten the dissolution of the enterprise (Cassidy, 2006).

Finance
The company characteristic of perpetual succession gives financial institutions, such as banks, the confidence to enter into long-term financing agreements with companies (Cassidy, 2006). Thus, as compared with other business organizations, companies may find it easier to obtain finance from outside institutions (ibid). In addition, a company may raise funds by the issue of shares and debentures.

Entity shielding
Hansmann and Kraakman argue that companies became popular owing to what is known as affirmative asset partitioning or entity shielding (2000). Creditors are more willing to lend large amounts of money to companies as the company is a separate legal entity distinct from its shareholders. This implies that shareholders do not own the assets of the company. Thus, the personal creditors of company shareholders do not have access to the assets of the company to satisfy their debts.

2.2. General steps involved in incorporation

Registration Procedure Application for registration
In order to register a company, a person must lodge an application with ASIC using the prescribed form (Form 201): s 117(1). The application must state specified information: s 117(2). This includes: the type of company: s 112
o

As per s 113, two types of proprietary companies can be incorporated: limited by shares or unlimited with share capital. Under s 9, four types of public companies can be registered: limited by shares/limited by guarantee/unlimited with share capital/no liability company.

the companys proposed name: s 148 names and addresses of persons consenting to be members; names, addresses and date and place of birth of persons consenting in writing to be directors and company secretary; address of registered office and hours of opening; address of principal place of business; details of issued shares including whether fully paid and beneficially owned by the member of registration; whether the company will have an ultimate holding company and if so, details of that ultimate holding company; and prescribed information regarding issues of shares for non-cash consideration by public companies.

The applicant must obtain the consents of proposed members, directors and company secretary when the application is lodged: s 117(5). After registration, these consents and agreements must be retained by the company.

Registered office As per s 142(1), a company must have a registered office in Australia to which communications and notices to the company may be addressed.

Replaceable rules and constitution Replaceable rules are sections in the Corporations Act that regulate the internal administration and management of companies. Under s 134, new companies may choose to be governed by the replaceable rules, their constitution or by a combination of both.

Shareholders and officers

As per s 120(1), the persons named with their consent in the application for registration become the members, directors and company secretary from the time of the companys registration.

Fees Together with lodgment of the application for registration, prescribed fees are payable for registration ($400) and reservation of name where this is sought ($40). These fees are applicable as at 1 September 2009.

Certificate of registration After the application for registration is lodged, ASIC may:
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allot the company an ACN (Australian Company Number); register the company; and issue a certificate stating the company's name, ACN and type of company. The certificate states the date of registration and that the company is registered under the Corporations Act: s 118 (1).

References
Baxt, R., Finnane, E. & Harris, J. 2010. Corporations Legislation, 2010 edition, Sydney: Lawbook Co.

Cassidy, J. 2006. Concise corporations law, 5th edition, Sydney: The Federation Press.

Lipton, P., Herzberg A., & Welsh, M. 2010. Understanding Company Law, 15th edition, Sydney: Lawbook Co.