Company Law: Memorandum - Case Study Example

Memorandum This Memorandum deals with some of the issues that would arise in the case of the Company proposed to be formed by American Chuck Bass and Blair Waldorf. Major aspects covered in this memorandum are (a) formation of the Company (b) legal personality of the proposed Company, GG International and (c) Draft Articles of Association with proposed amendments and revisions that need to be made. Formation of the Company: At the outset, the Company that is to be formed would be a private limited Company. It would be a private Company because shares are being issued1 but the Company would still be largely owned by Chuck and Blair because between them, they hold a majority of the total shares in the organization. The Company would qualify as a “limited” company, because the personal liability of the members of the corporation is restricted, with both Chuck and Blair being anxious to limit the extent of their personal liability in the event the business is not successful. The procedure that Chuck and Blair will need to follow is to first of all subscribe their names to a memorandum of Association and then registering the Company, as laid out under Part 2, Section 7 (1) (a) and (b) of the Companies Act of 20072. The memorandum must state that Chuck and Blair wish to form a Company titled GG International and they need to become members of the Company. Both these members must take at least one share each,3 hence in this case the Memorandum of Association must state that Chuck is being issued 90,000 ordinary shares and 10,000 preference shares with Blair being issued 10,000 ordinary shares. The Memorandum needs to be executed on the prescribed forms available for this purpose and authenticated by both members. Next, GG International needs to be registered as a Company and an application needs to be submitted for this purpose. The application must also contain information on the proposed name of the Company, i.e., GG International and the registered office, i.e., in Birmingham, with the associated address. The registration application must also contain a statement of capital and initial shareholdings, listing the (a) total share capital of the Company which is £150,000 (b) the total number and breakdown of those shares, i.e., 140,000 ordinary shares with a value of £1 each and 10,000 Preference shares, also at £1 each (c) the particulars of each class of shares, with its total number and aggregate nominal value, i.e., 90,000 ordinary shares and 10,000 preference shares with an aggregate value of £100,000 for Chuck and 10,000 ordinary shares with a value of £10,000. The statement of capital and initial shareholdings must also specify for each subscriber, in this case Chuck and Blair, the procedure to be followed if the Company is to be wound up for any reason4. Since Chuck would like to be able to sell the Company as soon as possible if it is not successful and Blair would like to have the right of first refusal to purchase Chuck’s shares in this instance, this would have to be specified, both in the Articles of Association which are discussed below, as well as the statement of capital and initial shareholdings. Since the Company is to be limited by shares, it may not be necessary to also provide a certificate of guarantee in order to enable registration of the Company. In order to complete the registration process, the new Company would need to file the Memorandum of Association, the registration application as well as the Articles of Association. This would contain information about the statement of proposed officers of the Company, i.e., information about directors. Chuck and Blair would need to include details about the number of directors, i.e., three, with Blair as one of the directors and each director being paid a fee of £25,000. It would provide details about the directors, their addresses as well as other information, such as the proposed business of the Company, i.e, fashion business, the distribution of shares and their value. Lastly, Chuck and Blair would also need to file a statement of compliance5, which would state that the requirements of registration have been complied with. Once the registration application is received by the Registrar of Companies and found to be in order, the new Company is issued with a certificate of Incorporation. This certificate sets out the name and registration number and date of the corporation, its registered office and whether Legal personality of GG International: In so far as the legal personality of GG International Ltd is concerned, its corporate identity and liability would be separate and distinct from the personal liability of either Chuck or Blair. The decision of the House of Lords in the case of Salomon v Salomon & Co Ltd6 established the corporation as a distinct and separate legal entity in common law, with an existence and personality separate from its shareholders. This case firmly established that when a corporation is incorporated, a new and separate artificial legal entity is brought into existence, and this is the essence of the Doctrine of Corporate Personality. This separate identity that is accorded to corporations is a fictional one, since a company does not have a physical or spiritual existence on par with the individual status it has been accorded. This also allows a corporation to retain a permanent status, while its shareholders and directors may come and go; it allows the Company to sue and be sued, to hold property and be liable for its own debts. Hence, since GG International has been set up as a Company, it is unlikely that either Chuck or Blair would bear any liability for losses suffered and GG International would be liable for any losses arising out of the failure of the Company. The Doctrine of Corporate Personality has provided the facility for small agencies and businesses to assume a corporate form, functioning as a front that shields the agency/individuals from creditors rather than being purely directed towards raising capital for risky business purposes7. The corporation itself is a perpetual entity, existing until it is wound up and while individuals may deal with a corporation8, they cannot claim any interest in the assets or property of the corporation.9 The corporate body as an entity is impersonal and individuals may function in different capacities within an organization10, with their financial activities being shielded from the public eye, by virtue of the corporate veil. The net result of such a legal identity for a corporation is that it has created circumstances where personal greed may override ethical considerations. It also allows individuals within business firms to avoid liability to members of the public, so that even if Chuck and Blair for instance, engage in illegal financial activities which result in losses for the Company, they will not be held personally liable nor will they be expected to compensate shareholders for any losses sustained. From the perspective of social jurisprudence, the Doctrine of Corporate Personality can also assist a corporation in avoiding liability, especially by channelling its risky activities into subsidiary companies and thereby absolving the parent company from liability. Thus, if GG International should be very successful and make huge profits, it would also allow Chuck and Blair the option to plough their profits into subsidiary operations to avoid payment of large amounts on taxes. In the case of Macaura v Northern Assurance Co11 the plaintiff Macaura was the owner of timber that was sold to a corporation, however despite insuring the timber in his own name, Macaura was unable to recover on an insurance claim when the timber was burnt. In this case, the Court demonstrated that while limited liability and corporate personality may produce huge advantages for shareholders, it also indicates that a Company is a separate legal entity with its own property and obligations.12 Hence, if GG International was to choose to engage in risky activities by using a subsidiary Company, the head office in Birmingham could avoid any liability for such losses. On the other hand, without this corporate legal personality, Chuck and Blair would not be eligible to recover any claims from insurance or other compensation from the Government. The Doctrine of Corporate Personality, which also imposes a limited liability on the officers of the corporation, has been strongly supported because it facilitates entrepreneurial activity.13 It is held to favour economic expansion in the market through encouraging investment. Since individuals are separate and distinct from the corporation, their liability is limited and this makes investors more ready to risk their monies. This would make it more favourable for outsiders to also invest in GG International and thereby help Chuck and Blair to collect funds for business activities more easily through the issue of shares in the market. However this notion of corporate Personality has also been opposed due to the scope for its misuse. For instance, one example that could be cited is that one company can become a shareholder in another Company by virtue of its separate legal identity. The establishment of corporate identity has brought into being a well settled principle in English Company Law that where a company suffers a loss due to a breach in the duty that is owed to it, then it is only the corporation itself that may sue for recovery of those losses. This was the case in Barings plc (in liquidation) v Coopers and Lybrand 14 where the parent company suffered a loss due to a loss at its subsidiary Company, however this loss was not actionable because the subsidiary itself was the proper plaintiff. As a result, Corporate Personality allows Companies to deliberately structure themselves through subsidiary activities in such a manner that all risky activities are shunted off to the subsidiary Companies operating in other countries in order to escape liability.15 Draft Articles of Association: The passage of the Companies Act of 2006 has brought about certain key changes, which may be summarized as follows: (a) refining of the scope of director duties (b) promoting shareholder engagement in the functioning of the Company (c) simplifying capital maintenance provisions and (d) facilitating e-communications.16 The draft articles of Association need to be set out under the following headings – Interpretation and limitation of liability, Directors, Shares and distributions, decision making by shareholders and administrative arrangements. 17 At the outset, the draft articles must provide a list of definitions of the terms which are used, such as “Chairman”, “bankruptcy”, “document”, “subsidiary”, “shareholder”, etc and also a statement spelling out the limitations on the liability of members of the Company. The next section needs to elucidate all aspects related to director function. This would include stating director duties, their general authority and their powers of delegation, appointment of directors, decision making and remuneration paid to them. The Companies Act of 2006 retains many of the provisions of earlier Acts, mandating that directors are expected to act in the best interests of the Company.18 While their decisions may be conditioned by their own judgment of what they consider to be best at the time the decision is made,19 however, all such decisions and judgments are expected to be made on the basis of what they believe is best for the Company. In the case of GG International however, Blair’s function as Director could pose a problem because of her ownership of 10,000 shares which is roughly about a 10% share in the Company. According to Hoffman J, “….if a director chooses to participate in the management of a Company and exercise powers on its behalf, he owes a duty to act bona fide in the interests of the Company.”20 This was also stated by Latham CJ in Mills v Mills, that a director must act “bonafide for the benefit of the company.”21 Due to Blair’s substantial ownership of shares, decision making could veer in favor of promoting Blair’s personal interests, so this issue needs to be addressed. The new Act specifically states that Directors must promote the success of the company, but Blair wants to ensure first rights of refusal in case Chuck wants to sell the business of its being unsuccessful, thereby pushing for her own rights rather than purely those of the Company. This could pose a problem later in interpreting the “success of the Company”, especially in the event of take overs or mergers. For example, one aspect that may be considered here is what would happen in the event of a hostile take over, if Blair as Director recommends that the lower of two bids that would benefit the Company on a long term basis but would not however serve the short term interests of the Board. Refusal to accept the lower bid could hasten the failure of GG International and serve Blair’s future interests while acceptance of the lower bid would improve chances of success of the Company and still promote Blair’s interests. Hence, there is a conflict of interest that must be identified here. A Director of a Company is expected to look out for the interests of the Company before their own interests.22 Under the fiduciary duties that a Director owes to his Company, he may not profit from his position as Director of the Company - should he do so, he must reveal such profits because there cannot be a conflict of interest between a Director’s duty to his Company and his personal interests.23 In the recent case of Bhullar v Bhullar, the Court strictly enforced the existing principle of the fiduciary duties of directors to their Company, in the case of conflicts that arise when there is a clash of fiduciary duties and personal interests, so that allowing such personal interests to predominate would make a Director legally liable.24 The new law under the Companies Act of 2006 also requires that Directors disclose an conflict of interest and any profits arising out of such a conflict of interest. This also includes those transactions where the Director could have a conflict of interest but which the company has not yet entered into. Only three directors are proposed for GG International, hence a majority vote of 2 would be required to execute decision making; but if both the other directors are against a decision which Blair supports, then Blair’s intimacy with the primary shareholder Chuck, could influence decision making in her favor and provide here with a level of operational control which could be unacceptable. Hence, this could raise a serious issue of conflict of interest uunder the Companies Act of 2006. Higher standards that are being expected of Directors in their fiduciary duty to the Corporation and one aspect in which the New Companies Act had added some provisions is in the expansion of the category of people who are close to the Director and whose interests will also be assessed when taking into account whether the Director is using his position to illegally transfer benefits to those who are close to him. Bibliography Baughn, S, 1995. “Multinationals and the export of hazard”, 58 MLR 54 “Companies Act 2006 and private companies”, retrieved February 17, 2009 from: http://www.bytestart.co.uk/content/19/19_1/companies-act-guide.shtml Companies Act of 2006. Retrieved February 16, 2009 from: http://www.opsi.gov.uk/acts/acts2006/pdf/ukpga_20060046_en.pdf Davies, Paul L and Gower, LCB, 1997. Gower’s Principles of Modern Company Law 6th edition, Paul Davies. Sweet & Maxwell pp 303-305 Farrar, J.H, Hannigan, B.M, 1998. Farrars Company Law, London Edinburgh and Dublin: Butterworths, pp 378 Ferran, E, 1999. “Company Law and Corporate Finance”, Oxford University Press at 16-25 “Model Articles for private Companies limited by shares”, Retrieved February 17, 2009 from: http://www.companieshouse.gov.uk/about/modelArticles/modelArticles.shtml Villalta G, “A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine” (2000) 7(3) Murdoch University Electronic Journal of Law, at p 5, [online] available at: http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a_text.html Watson, S, 2002. “Who hides behind the corporate veil? Finding a way out of “the legal quagmire” 20 Company and Law Securities Journal 198 at p 202 Cases cited: Barings plc (in liquidation) v Coopers and Lybrand (No 4) (2002) 2 BCLC 2004 Bhullar v Bhullar (2003) EWCA Civ 424; (2003) WL 1202661 Bishopsgate Investment Management Ltd v Maxwell (No 2) [1993] BCLC 1282 at P1286 Giles v Rhind CH 618 Lee v Lee’s Air Farming Ltd (1961) AC 12 MaCaura v Northern Assurance Co Ltd (1925) AC 619 Mills v Mills (1938) 60 CLR 150 at 158 Salomon v Salomon and Co Ltd (1897) AC 22 Read More