LAW TERM PAPER

ABSTRACT In order to explain the statement this essay will explore the background to treating companies as distinct legal entities; review certain cases trying to pierce limited liability; discuss the application of these rules to registering companies; and then consider whether there is a need for the registration of company. Contents Pages Introduction.............................................................................................................1 Steps in registering a company....................................................................................2 The legal and economic consequences of registered company..............................2 The company as a separate legal entity...................................................................6 Conclusion...............................................................................................................12 References...............................................................................................................13 “Companies are favourably being used by people as a tool for running businesses.” Critically discuss the legal and economic consequences of conducting business through the medium of a registered company. Introduction Section 112 of the Corporations Act lists the types of companies that can be registered under that Act. Those companies are as follows: proprietary companies - limited by shares or unlimited with share capital; public companies - limited by shares; limited by guarantee; unlimited with share capital; or no liability companies. With respect to no liability companies, note section 112(2), (3) and (4) and the need for the relevant constitution requiring that the sole object of the company be for “mining purposes” (defined in section 9). With respect to proprietary companies, note section 113 of the Corporations Act. One of the most important prohibitions contained in the Corporations Act in this regard is set out in section 115. That section precludes a person from participating in the formation of a partnership or association that has an object gain for itself or for any of its members; and has more than 20 members unless the partnership or association is incorporated under an Australian law. Note the prohibition in section 116 of the Corporations Act. Steps in registering a company You should note Part 2A.2 of the Corporations Act beginning at section 117. Once an application is lodged under section 117 ASIC may give the company an ACN and register the company and issue a certificate setting out the matters contained in section 118(1)(c). ASIC must keep a record of the registration. In relation to names note Part 2B.6 of the Corporations Act beginning at section 147. However, note the need for a company to exhibit its name: section 144. In particular, note the need to have “Limited”, “No liability” or “Proprietary” as part of the name: (section 156) unless sections 150 or 151 apply. In relation to change its name to see section 157 and 157A. A company comes into existence on registration: section 119. With respective jurisdiction of registration note section 119A. A company must have at least one member: section 114. A person becomes a member, director or company secretary on registration if the person is specified in the application with their consent: section 120. Note also sections 121 and 122 dealing with registered office and expenses in promoting and setting up the company. Finally, a company may have a common seal (section 123) and this aspect is important when dealing with the application of sections 127 and 129 which is covered in Topic 8 in this course. The legal and economic consequences of registered company. Separate legal personality Upon incorporation the company becomes a new and independent legal entity. It is completely separate from the subscribers who formed it and from those who manage it. A creditor can generally only sue the company, not its members, to recover damages. However exceptions exist to this latter point and these are outlined later in this Topic. Limited liability If the company is one limited by shares (defined in section 1070A), then section 516 of the Corporations Act provides that a member's liability is limited to the amount unpaid, if any, on these shares. This can be contrasted with a partnership where there is, except for limited liability partnerships, unlimited liability and therefore all the assets of a partner are vulnerable in the event of default by another partner It should be noted that limited liability applies only to members. A company does not enjoy limited liability in its dealings with outsiders. Flexibility When drafting up the company's constitutional documents "Constitution" is defined in sec 9., it is possible to give directors and shareholders various combinations of rights. For example, it is possible to have differing voting rights and varied entitlements to dividends and the division of powers between members and shareholders can be established. It should be noted that a private company, known as a proprietary company, has some restraints imposed on its flexible structure. Some of these restraints are set out in sections 113(1) and (3) of the Company Act. Perpetual succession A company will continue as a legal entity regardless of the death or changing circumstances of its members. It does not exist for a specific period of time. Transferability and transmissibility of shares Shareholders in companies often have flexibility in being able to transfer or assign their shares to other parties. In such cases a transfer will occur when the ownership of the share passes from one shareholder to another resulting in the transferee becoming a member of the company after registration of the transfer. However, companies can impose restrictions on the ability to transfer shares and this is common with respect to proprietary companies. In this regard section 1072G provides for a replaceable rule that directors may refuse to register a transfer of shares in the company for any reason. Similarly transmission of shares is possible where a shareholder dies, becomes incapable through incapacity or becomes bankrupt. In such cases the shares vest in the deceased shareholder's personal representative or the Official Trustee in bankruptcy. Imputation of taxation Companies are able to impute the tax they have paid back to shareholders. This ability means that the same revenue is not taxed twice and that an individual can receive dividends which may not attract any further tax. Power to acquire, hold and dispose of property A company being a separate legal entity can own property. This property is not owned by the members as they only own shares in the company. In Macaura v Northern Assurance Co Ltd [1925] AC 619, Macaura owned a timber yard. He had an effective insurance policy to cover the destruction of any timber by fire. He subsequently formed a limited company in which he was a substantial shareholder and assigned the timber to the company, the purchase money for the timber remaining owing to him. He did not assign the insurance policy to the company, nor did the company take out its own policy. A fire destroyed the timber. The insurance company's refusal to pay the claim made by Macaura was upheld by the court. The limited company, considered by law to be a legal entity separate to its shareholders, had an insurable interest in the timber but had no policy. Macaura had a policy, but he had no insurable interest in the timber: all he had was a debt owing to him by the company Now sections 16 and 17 of the Insurance Contracts Act 1984 (Cth) require only that the claimant suffer a "pecuniary or financial loss" through the destruction of, or damage to, the insured property.. Also changes in membership of the company have no effect on the ownership of the company's assets. Capability of suing and being sued As a company is a separate legal entity it may sue to enforce rights and it may be sued by others. Importantly, members in some instances may sue on behalf of the company. This latter aspect will be dealt with in Topic 7 under the headings, “Members Remedies” and “Derivative Actions”. Privilege against self-incrimination Historically courts have preceded on the basis that a corporation could claim privilege against self-incrimination. This was clearly an advantage. However since the recent decision in Environment Protection Authority v Caltex Refining Co Pty Ltd (1994) 68 ALJR 127 this position is no longer clear. In this case Caltex was the holder of a licence under the State Pollution Control Commission Act 1970 (NSW) to discharge waste into the ocean. The Environmental Protection Authority prosecuted Caltex for discharging oil and grease into the ocean in breach of its licence. The Authority subsequently served Caltex with a notice under the Clean Waters Act 1970 (NSW), sec 29(2)(a) requiring it to produce certain documents relating to its discharge of waste. Caltex objected to the validity of the notice and the Authority then issued a notice to produce under the Land and Environment Court Rules 1980 (NSW). Caltex sought to have the notices set aside on the basis that a production could incriminate them. The trial judge held that the privilege against self incrimination did not apply to corporations but the New South Wales Court of appeal allowed the appeal. The High Court held however, by majority, that the privilege was not available to corporations. THE COMPANY AS A SEPARATE LEGAL ENTITY A company is an artificial legal entity which enjoys rights and is subject to duties and obligations. It comprises a number of members, both natural and non natural persons. The company is also a separate legal entity and can have limited liability. Separate legal personality was firmly established in Salomon v A. Salomon & Co Ltd [1897] AC 22. Salomon had traded on his own as a leather merchant and shoe manufacturer for over thirty years. While his business was solvent he formed a company called "Aron Salomon and Company Limited" and sold his business to this company. The Companies Act 1862 (UK) required seven subscribers and Salomon, his wife and five children each subscribed one share to satisfy the statute. Salomon valued his business at 39,000 pounds which appeared to be an inflated figure. However instead of taking cash for the sale of the business, Salomon took 20,000 fully paid one pound shares in addition to debentures to the value of 10,000 pounds. These debentures were secured by a floating charge. The balance of the purchase price remained as an unsecured debt.. Payments to Broderip fell into arrears and Broderip enforced his security. The company's liquidation followed. After Broderip was paid, there remained a balance of indebtedness secured by the debentures. Salomon claimed his reversionary entitlement. However if this claim was satisfied there would be no funds left to pay out the other unsecured creditors. The liquidator attempted to resist the claim by arguing that the debentures were invalid on the ground of fraud. At first instance, Vaughan Williams J [1895] 2 Ch 323., held that the company was merely acting as Salomon's nominee and agent and therefore Salomon as principal had to indemnify the company's creditors personally. On appeal, the Court of Appeal in rejecting Salomon's appeal, held that Salomon was a trustee for the company which was his mere shadow. Salomon appealed to the House of Lords which rejected the lower courts' rulings. According to Lord MacNaghten [1897] AC 22 at 51.: "The company is at law a different person altogether from the subscribers to the Memorandum and, although it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act. That is, I think, the declared intention of the enactment". Lord Watson emphasised [1897] AC 22 at 40. that the creditors of the company could have searched the Companies Register to ascertain the names of the shareholders and the number of shares which they held. However the failure to do this should not impute a charge of fraud against Salomon. Lord Herschell [1897] AC 22 at 45. looked at the intention of the statute in that it sought to protect shareholders by limiting their liability. Lord Halsbury LC had a similar view. According to his Lordship there was no right to add to the requirements of the statute, nor to take from the requirements which had been enacted. "The sole guide must be the statute itself." Once a person was a shareholder they were shareholders for all purposes and the statute was silent as to the extent or degree of interest which had to be held by the individual corporators. The Court held that the company was a separate legal entity. According to Lord Morris: "A contractual relationship could only exist on the basis that there was consensus between two contracting parties. It was never suggested (nor in their Lordships' view could it reasonably have been suggested) that the company was a sham or a mere simulacrum. It is well established that the mere fact someone is a director of a company is no impediment to his entering into a contract to serve the company. If, then, it be accepted that the respondent company was a legal entity their Lordships see no reason to challenge the validity of any contractual obligations which were created between the company and the deceased." In order to overcome the problem and to assist in determining whether or not a company was insolvent at the time a debt is incurred or becomes insolvent by incurring that debt or by incurring at that time debts including that debt, section 588E(3) and 588E(4) of the Corporations Act contain two rebuttable presumptions of insolvency in civil recovery proceedings and, if applicable, reverse the onus of proof. Thus section 95A will only be relied on where the statutory presumptions of insolvency are unable to be relied upon or are able to be rebutted. Conclusion Section 588G(1)(c) provides that a director of an insolvent company is exposed to liability for insolvent trading if, at the time the debts are incurred: The test described by section 588G(1)(c) is an objective one (Powell v Fryer (2001) 37 ACSR 589, at [76]-[77]) per Olsson J (with whom Duggan and Williams JJ agreed): “the state of knowledge of a particular director and any assessment which he may have made as to the ability of the company to pay its debts is irrelevant. The court must make its own judgment on the basis of facts as they existed at the relevant time and without the benefit of hindsight. [234], where his Honour held that a suspicion of insolvency falls somewhere between a belief that insolvency exists, on the one hand, and a mere wondering whether it exists, on the other. Suspicion is a positive feeling of apprehension, an admittedly tentative belief, without sufficient evidence to form a concluded and supportable opinion. Aligned with demonstrating whether there are reasonable grounds for suspecting that the company is insolvent or would so become insolvent, section 588G(2) provides for two distinct ways in which a director can be found to have had the requisite suspicion: Actual awareness, that is if the person is aware at that time that there are such grounds for so suspecting; (section 588G(2)(a)) or Where a reasonable person in that position would have been so aware (section 588G (2)(b)). The test set out in section 588G (2)(a) is a subjective test. The test set out in section 588G(2)(b) is an objective test A number of cases have reiterated this view in relation to predecessor legislation. See Shapowloff v Dunn (1981) ACLC 33,127 at 33,133 - 33,134; Pioneer Concrete Pty Ltd v Ellston (1985) . References Statutes Companies Act, Cap 212 R.E 2002 The Companies Act 1862 (UK) Cases Macaura v Northern Assurance Co Ltd [1925] AC 619 Environment Protection Authority v Caltex Refining Co Pty Ltd (1994) 68 ALJR 127 Salomon v A. Salomon & Co Ltd [1897] AC 22. Shapowloff v Dunn (1981) ACLC 33,127 at 33,133 - 33,134 Pioneer Concrete Pty Ltd v Ellston (1985) Book Saleemi, N. A. and Opiyo, A. G., (1998), Company Law Simplified, (1st Edn.),SaleemiPublishers Ltd, Nairobi 3