Legal Environment

Company Law
The Nature of Companies
Learning Objectives
Introduction
What is a company?
Separate Legal Personality
Consequences of Separate Legal Personality
Types of Company
Comparison of Sole Trader, Partnership and
Company

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Introduction
The three main forms of business are
 Sole trader
 Partnership

 Company

A major disadvantage for sole traders and

partners is that they have unlimited liability
for the debts of their business

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Introduction
The owners of companies, on the other
hand, have limited liability
Companies are also fairly flexible - ranging
from small, one person companies to large
multinationals

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 What is a Company?
A company is a body corporate or
corporation
There are 4 types of corporation. Those
created
1. by Royal Charter
This was the earliest way of creating
corporations.

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What is a Company? (cont.)
However, nowadays, it is not used to create
trading bodies. It is used for charitable and
educational bodies
The BBC (British Broadcasting
Corporation) and the Bank of England were
both created by Royal Charter

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 What is a Company? (cont.)
2. by special Act of Parliament
Again, this is an old way of creating
corporations which is no longer used
Bank of Scotland was created in 1695 by
and Act of the old Scots Parliament
 The Governor and Company of the Bank of
Scotland

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 What is a Company? (cont.)
3. by registration under the Companies Act
1985
The current law relating to companies is
mainly contained in this Act
It is the most common way of creating a
corporation
4. by registration under the Limited Liability
Partnership Act 2000
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Separate Legal Personality
As companies are a kind of corporation,
they have their own separate identity
In law, they are regarded as a person
Although a company is not a natural person
(like you or me) the law treats it in the same
way in many areas

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Separate Legal Personality (cont.)
The most famous case in this area is
Salomon v Salomon & Co
Mr Salomon was in business as a leather
merchant
In 1892, he formed Salomon & Co Ltd
He held most of the shares with his wife and
5 of his children each holding one share as
company law at that time required at least 7
shareholders in a company
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Separate Legal Personality (cont.)
Unfortunately, the company did not do well
and it went into liquidation
A liquidator was appointed to sell the assets
of the company and pay its debts

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Separate Legal Personality (cont.)
The liquidator claimed that the company
was a fake because Mr Salomon owned
20 001 shares and his family owned only 6
altogether
Mr Salomon was really just running the
same business
Therefore, the liquidator argued that Mr
Salomon was liable for all the debts of the
company

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 Separate Legal Personality (cont.)
However, the House of Lords disagreed
The court held that
1. The fact that some shareholders only held
1 share as a technicality was not relevant
The registration procedure could be used
to create a one-man company

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 Separate Legal Personality (cont.)
2. A company which is properly formed
under the Companies Act is a separate
person
As a result the debts of a company were
its own and not those of its members

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Separate Legal Personality (cont.)
Two more cases also help to demonstrate
the idea of separate legal personality.
In Macaura v Northern Assurance Co,
Macaura sold all the timber on his estate to
a company in return for all the shares in that
company
The timber was stored on Macaura’s estate
Macaura insured the timber in his own
name
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Separate Legal Personality (cont.)
Two weeks later, the timber was destroyed
in a fire
The insurance company refused to pay out
because it said Macaura did not have an
insurable interest in the timber because he
did not own it. The company owned it.
The House of Lords agreed

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 Separate Legal Personality (cont.)
The court held
1. The timber belonged to the company not
Macaura
2. Macaura had not insurable interest in the
timber even though he owned all the shared
in the company
3. Just as the separate legal identity of a
company gives the members limited liability,
it also means that the assets of a company
belong to it and not to its shareholders
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Consequences
This concept of separate legal personality
has several consequences
Limited liability
Perpetual succession
Business property
Court actions
Liability in tort and crime
The rule in Foss v Harbottle
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Limited Liability
The liability of the members of a company
for its debts is limited
Under the Companies Act 1985
 a member of a company limited by shares is
only liable to pay the full amount of his shares,
and
 a member of a company limited by guarantee is
only liable to pay the amount which he
guarantees to pay if the company is wound up
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Perpetual Succession
Changes in the membership of a company
have no effect on the continuation of that
company
Unlike a partnership, the death or
bankruptcy of a member does not end the
company
In public limited companies, members are
free to sell their shares on the stock
exchange
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Business Property
Business property is owned by the company
and not its shareholders
That means a creditor cannot take action
against company assets in respect of a debt
due by a member of that company

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Court Actions
A company can sue and be sued in its own
name
It can also enter contracts in its own name
The company’s liability for contractual
debts is unlimited
 It is only the members’ liability which is limited

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Liability in Tort and Crime
Companies are vicariously liable for the torts of
their employees
Companies can be guilty of crimes which do not
require a mental element (eg intention or
recklessness)
However, it has been more difficult to prosecute
companies where the crime has such an element as
it has to be shown that one of the directors of the
company had the required mental element
This can be very difficult in a large company
where the directors are not involved in the day to
day operation of the business 23
Foss v Harbottle
This case gives us the idea of ‘majority rule’
in a company
If a company suffers injury then the
majority of members must agree to raise a
court action
A single member cannot take action against
the wrongdoer

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Lifting the Veil of Incorporation
Although the general rule is that a company
has a separate legal identity from its
members, there are exceptions to this rule
when a court will not treat a company as a
separate entity
This is often referred to as “lifting the veil
of incorporation”
Often, this is to prevent abuse of the
principle of separate identity
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Lifting the Veil of Incorporation
(cont.)
For example, under the Companies Act
1985, if a company trades with fewer than
two members then the sole member has
unlimited liability for company debts
Also under the Companies Act, officers of
the company will become personally liable
if they issue bills of exchange or enter into
contracts on behalf of the company but do
not use the company’s full name
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Lifting the Veil of Incorporation
(cont.)
At common law, the general principle is that
the courts will not allow a company to be
used for a fraudulent purpose or to avoid a
legal duty
For example, in Gilford Motor Co v Horne,
a term in an employee’s contract prevented
him from approaching former customers
after he left Gilford Motor Co
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Lifting the Veil of Incorporation
(cont.)
Therefore, when he left he formed his own
company, and the company approached his
former customers
The court held the company was a sham
being used to avoid the term in his contract

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 Types of Company
Companies can be classified in several ways
Limited and Unlimited
Limited by Shares or by Guarantee
Public and Private

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Limited and Unlimited Companies

Companies are usually formed because of

the limited liability for their members
However, it is possible to create a company
without limited liability
Such companies do not have disclose their
accounts as limited companies do

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Limited by Shares or Guarantee
The most common kind of limited company
is one limited by shares
Once the shareholder has paid the full value
on his shares then he has no further liability
This is true even if the company does not
have enough money to pay its debts

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Limited by Shares or Guarantee
(cont)
A company limited by guarantee is usually
created for charitable, educational or
professional purposes
 ie it is not a trading company
The liability of members is to pay an agreed
amount if the company is wound up
Usually, the amounts are small, so the risk
is low
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Public and Private Companies
The main difference between public and
private companies is that the shares in a
public company may be bought and sold on
a stock exchange
Public companies must have at least two
directors, whereas a private company can
have one
Public companies must have a minimum
issued share capital of £50,000
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Public and Private Companies
(cont.)
Private companies may purchase their own
shares out of capital, whereas public
companies cannot
Private companies may elect not to appoint
auditors or hold an AGM (Annual General
Meeting), whereas a public company cannot

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Comparison of Ownership
It is useful to compare the advantages and
disadvantages of the three forms of business
 Sole trader
 Partnership

 Company

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Sole Trader - Advantages
No legal filing requirements or fees and no
professional advice is needed to set it up.
You just literally go into business on your
own.
Simplicity – one person does not need a
complex organisational structure.

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Sole Trader - Disadvantages
The disadvantages are that it is not a particularly
useful business form for raising capital (money).
For most sole traders the capital will be provided
by personal savings or a bank loan.
Unlimited liability – the most important point to
note in terms of comparing this form to the
company in that there is no difference between the
sole trading business and the sole trader himself.
The profits of the business belong to the sole
trader but so do the losses.
As a result he has personal liability for all the
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debts of the business.
Partnership - Advantages
No formal legal filing requirement involved
in becoming a partnership beyond the
minimum requirement that there be two
members of the partnership.
Easier to obtain capital as there can be up to
20 members of the partnership, all of whom
could pool their investment within the
partnership.
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Partnership – Advantages (cont.)
If you are aware of the problems the Partnership
Act can cause (see disadvantages) then you can
draft a partnership agreement to vary these terms
of the Act
The partnership agreement can therefore be used
to provide a very flexible organisational structure
although this usually involves having to pay for
legal advice.

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Partnership - Disadvantages
A partnership will end on the death of a
partner.
If you are unaware of this when the
partnership is formed, the Act may not
reflect the intention of the partners.
The partners are jointly and severally liable
for the debts of the partnership.
This means that each partner can be sued
for the total debts of the partnership
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Company - Advantages
Companies are designed as to make it easy to raise
capital.
Companies have the ability to subdivide their
capital into small amounts, allowing them to draw
in huge numbers of investors who also benefit
from the sub-division by being able to sell on
small parts of their investment.
Limited liability also minimises the risk for
investors and is said to encourage investment.

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Company – Advantages (cont.)
It is also said to allow managers to take
greater risk in the knowledge that the
shareholders will not lose everything.
The constitution of the company provides a
clear organisational structure which is
essential in a business venture where you
have large numbers of participants.

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Company - Disadvantages
Forming a company and complying with
company law is expensive and time
consuming.
It also appears to be an very complex
organisational form for small
businesses, where the Board of
Directors and the shareholders are
often the same people
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Summary
What is a company?
 Types of corporation
Separate Legal Personality
Consequences of Separate Legal Personality
Types of Company
Comparison of Sole Trader, Partnership and
Company

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Reading
Chapter 13
 Pages 341-350

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