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CONTENTS

Introduction
A company's constitution
Forming a new company
Shares and share capital
Borrowing and providing security
Control
The duties of directors
Company records
Identifying the company
The Registrar of Companies
Accounting requirements
Insolvency

A work of this kind can do no more than provide a brief outline of the law. Each case depends on its own facts and action should not be taken in reliance on this summary. As always it is desirable to take appropriate advice.

Introduction

This sets out to be a simple guide to clients in the formation and administration of a limited company.

It is intended for use by:-

Those considering the start up of a new business

Those forming a new company

People becoming officers of a company, possibly for the first time

Existing company officers who wish to broaden their knowledge

It is more important today than ever that directors and others involved in running a limited company appreciate their legal obligations and the liabilities which come with the holding of office in a company.

The key feature of a company is that it is a separate legal entity from its members - that is the owners of its shares. Even if one person owns all the shares in a company, that person and the company are, in law, different people. Something which belongs to the company must not be regarded as the property of the members. Generally, the debts of the company are not the debts of the members.

Most companies are limited companies. This means that the members of the company are not liable for its debts beyond the amount which they have paid (or should have paid) for their shares in the company.

The protection which limited liability offers to those carrying on business through a company is of great practical importance.

This publication deals only with limited companies.

Limited companies can be either private or public. A private company has the word "Limited" as the last word of its name. Public companies use "Public Limited Company", usually abbreviated to "plc".

A booklet of this type cannot cater for every possible situation and appropriate professional advice should always be taken.

A company's   constitution

Company law lays down the framework within which companies exist. The main Act is the Companies Act 1985.

Every company must have a memorandum and articles of association. These are the company's individual rule book.

Strictly the memorandum and the articles are separate documents but they are invariably bound together in a single book form document.

Companies have members and officers. The members are the people who own the shares in the company. The officers are the directors and the secretary. The directors and secretary can of course also be members. A company must have at least one director. The secretary may be a director but cannot be the sole director.

The officers are chosen by the members, although the directors can normally appoint other directors.

The directors have the power to manage the business of the company, but this power is subject to constraints contained in the memorandum and articles and to any directions given to them by the members by what is called a "special resolution". The members have ultimate control of the company.

One of the directors is usually appointed managing director. Although in law the managing director has little extra status not enjoyed by the other directors, in practice the directors will delegate substantial powers and authority to him (often simply informally).

Meetings of the members are called "general meetings". A general meeting is either the annual general meeting or an extraordinary general meeting. In theory the members can only exercise control of the company through general meetings.

Sometimes, one person will be the guiding force behind a company but will not wish to be a director. This may be because of a desire to avoid his name appearing on the public register of directors or for any number of other reasons. such a person may be what is called a "shadow" director. Where the directors of a company are accustomed to act in accordance with the directions or instructions of a person who is not a director of the company, that person is a shadow director. A shadow director's name and particulars must be given to the Registrar of Companies and for many practical purposes he is treated as if he were a director duly appointed.

Company officers should be aware that failure to comply with company law is often a criminal offence and can also involve them in personally liability.

Forming a new company

Forming a company can be carried out in about ten days, less if required.

The quickest method is for us to buy a ready made company from formation agents. Experience over the years has led us to select Jordans Limited as our preferred supplier. We find that their product is of high quality, delivered accurately and quickly and at reasonable cost.

In order to form a company we need to know some basic things about how the company is to be set up. We will discuss these requirements with you. The information required includes:-

The type of business to be carried on by the company.

The names of and certain basic information about the first directors and the secretary.

The proposed registered office.

The auditors.

The maximum share capital and the way it is to be divided up into shares.

The number of shares to be issued and to whom.

The date to which the company will make up its annual accounts (called its "accounting reference date").

The proposed name of the company.

We shall need to buy and pay for the company immediately. We shall therefore ask you to pay is sufficient on account to enable us to pay for the company.

The registered office of the company is an address at which legal documents may be served on the company. It does not have to be the company's own premises. Very often the address is that of the company's auditors or our own address.

There will be a number of forms to sign. Having obtained the company, we normally arrange to hold the first board meeting with you to get the company structured in accordance with your instructions.

Once this has been done, we will draw the minutes, issue the shares, give the appropriate notices to the Registrar of Companies, make up the company registers and then hand everything over to you in due course.

Shares and share capital

When the company is formed, the memorandum of the company will lay down the maximum authorised capital. This is divided into shares of a given value, usually a pound.

For example a typical company may have an authorised share capital of £1,000 divided into 1,000 ordinary shares of £1 each.

The company does not have to issue the whole of the authorised share capital. The "off the shelf" companies which we obtain are formed with only two £1 shares actually issued. Sometimes, no more need be issued for the time being. Usually however, additional shares will be issued.

To trade the company must have money. The main ways of obtaining funds at start-up are:-

The issue of shares to those who are to be members and who then pay the company for their shares;

By borrowing, either from the members or from an outside source such as a bank.

Later on, cash may be generated from profits.

The funding method chosen will depend on the objectives of the members. Those forming a company must decide how the company is to be funded. Usually this will be by a combination of both methods.

The money which comes into the company as payment for the issue of shares is its "issued share capital". It is illegal for the company to reduce its capital unless certain conditions apply and the prescribed procedures are followed.

A company exists to benefit its members. Therefore if the company makes profits, it is logical (subject to financial prudence) to distribute the profit among the members. This is done by paying a dividend. A dividend is usually expressed as a given sum per share. That way, the more shares a member holds, the greater the proportion of the profits he will receive.

The issued shares may be divided into two or more classes. Each class of shares will have different rights. The way in which rights can be allocated to different classes of shares in infinitely variable. For example, some shares may be non-voting or may enjoy a priority right to share in the profits of the company.

Borrowing and providing security

Nearly every business needs working capital. Whatever the type of business, the product which it proposes to sell (which may be goods or services) will almost certainly have to be produced before the company is paid for it. Most businesses will have start up costs (e.g. setting up the factory, buying the machinery) and production costs (buying material, labour, general overheads).

Therefore a business needs money to pay for all the things it needs to buy in order to make its products and to cover the time before it will be paid by its customers.

A company will typically borrow money from its bank. This may be on overdraft or under a longer term finance arrangement.

An overdraft is technically repayable on demand. Since most businesses will not have the resources to repay at any given time, prudence dictates that money which will require to be borrowed long term should not be borrowed on overdraft. That said, overdraft remains the most common source of finance for small businesses.

If a bank is to lend, it will normally require security. In the context of a small company the security options are:-

A charge over some or (usually) all of the assets of the company;

A guarantee by the directors, who may at the same time grant the bank a charge over their privately owned property.

When it comes to providing security, a company has one advantage over an individual. Both companies and individuals can charge land which they own. However, an individual cannot in practical terms grant a charge over moveable property such as plant and machinery, or over goodwill. If an individual wants to grant a charge he can mortgage the business premises, but not the business itself. A company however can grant what is called a "floating charge" over all its assets. The effect is that the bank can get more security from a company than an individual and this may persuade the bank to lend more, or to lend where otherwise it would not have done so.

A floating charge is a charge which "floats" over the assets of the company. Goods can be bought and sold in the ordinary course of business without difficulty. However, if the company gets into difficulties the charge is said to "crystallise" and then bites on all the company's assets over which it has been granted.

The document granting a floating charge is usually called a debenture. Most standard form bank debentures contain:-

A fixed charge over all land (freehold or leasehold) acquired by the company, including land bought after the date of the debenture; and

A floating charge over all other assets of the company including its goodwill.

Control

Although the directors have day to day control of the company, it is the members who have the final say. This is because:-

The members appoint the directors and can vote to remove them;

The members can give directions to the directors by special resolution.

In a small company, the directors or some of them usually own all or most of the shares. The distinction between directors and members may in some cases be less important, especially where the directors own all the shares in equal proportions.

If one member owns half the shares plus one, he can in practical terms, control the company because (provided he acts properly) he can summon a general meeting, remove the directors and appoint new ones. There are some things he cannot do on his own (e.g. amend the memorandum and articles which needs a 75% majority) but his position becomes very strong.

Where there are more than two members, it may be that no member has more than half the shares and thus no single person will have control. Management of the company will depend on the votes of two or more members.

Oppression

Suppose there are four shareholders, each with a 25% share holding. Any three can out vote the fourth. If they do so in such a way as to oppress the fourth unfairly, the court can be asked to intervene. The court has a range of weapons at its disposal to protect the minority member. In some cases, particularly where the relationship between the members has broken down, the court can wind up the company. Another solution may be to order the sale of a member's shares.

Minority protection

Needless to say it is often unwise to structure a company in such a way that an oppressed member's only remedy is the expensive and clumsy one of applying for an injunction or some other remedy. Sometimes it is appropriate to enter into agreements restricting the power of the majority of the members in certain ways, or to have special provisions in the articles to protect minority members.

The deadlock company

Where two individuals intend to set up business the may want equal control. In practice, this will mean that nothing can be done without agreement because no resolution can be passed unless both support it. This can be a very simple and cheap way of arranging the company. The two would only be going into business if there was a relationship of trust between them. In such a case it is essential to ensure that no member has a chairman's casting vote because this would upset the balance. If the two fall out, they must rely on the oppression rules already mentioned if they cannot solve their problems by agreement.

Care necessary

Decisions on control and the amount of protection to be afforded to minority shareholders can be among the most difficult problems to resolve once it has been decided to form a new company. Expert advice is always desirable.

The duties of directors

Directors owe what in law are called "fiduciary" duties to the company. These duties may be divided into two categories:-

A duty to act in good faith in what the director considers to be in the interests of the company and not for any collateral purpose;

A duty not to allow his own interests to conflict with his duties to the company.

A director acting in breach of these duties will be liable to compensate the company for any loss suffered. In certain circumstances a director will be liable to account to the company for any profit he makes.

If a third party deals with the company knowing that the director is acting in breach of his fiduciary duty, the transaction is voidable at the option of the company.

If a director makes a profit from his office, he must pay it to the company unless the profit has previously been disclosed to the company and the company has authorised the making of the profit.

As a general rule directors owe their duties only to the company and not to individual members.

There are numerous provisions which directors must follow and which are designed to enforce fair dealing by directors:-

The payment of remuneration to a director on a net of tax basis is unlawful;

Any payment to a director for compensation for loss of office must be approved by a general meeting;

A director must declare at a meeting of the directors of the company any interest he has in any contract or proposed contract. Note that if a director is the only director, he must declare the interest to himself (and he must not forget to prepare minutes of the declaration as well).

Director's service contracts must be kept available for inspection by the members. Service contracts for more than five years must be approved by a general meeting.

Where a director is to buy from or sell to the company an asset of substantial value, the transaction is voidable at the option of the company unless it has been properly approved by a general meeting. "Substantial" is defined in the legislation.

A director must notify the company of any interest he has in shares in the company.

There are complex provisions in the legislation relating to interests of relatives of the director and other persons connected with him, designed to stop a director from side-stepping these provisions.

Personal liability

In certain circumstances directors may be liable for the debts of the company or to contribute to its assets.

These include the following situations but the list is by no means conclusive.

Fraudulent trading

When a company goes into liquidation, if it appears that the business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose, the liquidator can apply to the court for an order that anyone party to the fraud make such contribution to the company's assets as the court thinks proper. Note that it is not only directors who can be made liable under this provision.

Wrongful trading

When a company goes into insolvent liquidation and at some time before the liquidation a director knew that there was no reasonable prospect of avoiding liquidation, then the court can order that director to make a contribution to the assets of the company. This rule will not apply if the director can show that he took every step with a view to minimising loss to creditors which he ought to have taken. The most common type of wrongful trading arises where the company carries on trading when it is insolvent and has no reasonable prospect of paying its debts.

Phoenix-like from the ashes

When a company goes into insolvent liquidation, the directors of the company cannot set up another company in the same or a similar name for five years. If a director is involved in the management of such a company, he becomes personally responsible for the new company's debts. This is to stop the directors of a company in difficulty simply closing down the old company and setting up a new one with the same name, often in the same line of business trading from the same premises.

Company name not appearing on cheques or orders for goods

An officer or other person signing a cheque or order for goods on behalf of the company is personally liable to meet the cheque or pay for the goods if the name of the company does not appear on the cheque or order.

Company records

Company law requires a company to keep certain important records about itself. Usually these records must be kept at the company's registered office.

The records required to be kept include:-

Register of members. In practice the company will keep registers of members, of allotments of shares and of transfers. These will show how the share capital is held among the members and how it was held at all previous times in the history of the company.

Register of directors.

Register of director's interests in shares in the company.

Register of company secretaries.

Register of charges (i.e. mortgages or other securities granted by the company over any of its assets).

Minutes of company meetings.

It is good practice to keep records of all notices lodged with the Registrar of Companies.

With small companies, these records are normally kept in a convenient purpose designed ring binder system supplied at formation stage.

A member of the company is entitled to inspect the minutes of general meetings of the company.

Identifying the company

There are a number of regulatory requirements relating to the name of the company and the information which must appear on letters etc. It is generally an offence if these requirements are ignored. Sometimes, failure to comply can have the effect that directors or others inadvertently become liable on contracts which they intended to have been made between suppliers or customers of the company on the one hand and the company on the other.

Display of name at business premises

A company must display its name on the outside of every place at which it carries on business.

Company notepaper etc.

The name of the company must also appear on all business letters of the company, all its notices and official publications, on its cheques, its order forms and on its receipts. (There are other categories of documents on which the name must appear, but these are beyond the scope of this publication).

The requirement for the name of the company to appear on company cheques and orders is of utmost practical importance. Unless the name is correctly shown, the person signing the cheque or order is personally liable on it.

Additional information which must appear on all business letters and order forms is:-

Where the company is registered (for English companies, this would be England);

The company number;

The address of the registered office;

If the company is an investment company, the fact that it is.

The share capital need not be shown on letters or order forms, but if it is the reference must be to paid up share capital.

The name of a director of the company must not appears on the company's business letters (other than in the text of the letter or as a signatory) unless the names of all the directors appear.

Company seal

A company need not have a seal, but if it does the seal must show the company's name. In practical terms, a seal is useful and we will normally obtain one as part of our normal company formation procedures.

The registrar of companies

The policy of the legislation is that limited liability is a privilege and that companies must be properly regulated so as to protect both creditors and investors. The Registrar of Companies maintains central records of all companies and is the agency which incorporates new companies.

Each company has a file at the Companies Registration Office, otherwise known as "Companies House". The file is open to public inspection and it is very common for those dealing with, investing in or extending credit to a company to inspect the file. If you carry on business in a competitive filed, you can be sure that at least some of your competitors will regularly make searches against you in order to monitor your business.

To enable these records to be kept up to date, each company must notify the registrar of a number of events occurring in relation to it. These include:-

The appointment of any person as a director or the secretary of the company, or the departure of a person from such office.

A change in the company's registered office.

The allotment of any shares in the company (called a "return of allotments").

The passing of a special resolution and of certain other types of resolution.

Any increase or decrease in the share capital of the company.

A change in the company's accounting reference date.

Any change in the company's memorandum or articles of association.

The grant of any security over any of the company's assets.

As well as giving notice of these events, a company must:-

File its annual accounts with the registrar.

File an annual return (this is a form which gives the registrar up to date information about the company).

Penalties apply if these notices are not given and criminal proceedings can also be taken for failure to comply.

Accounting requirements

Every company is under a legal duty to keep accounting records sufficient to show the company's transactions and disclose the financial position of the company. The accounts must identify all income and expenditure and provide a record of the assets and liabilities of the company.

A company must have an accounting reference date, effectively its year end date, to which its annual accounts are made up. In fact the company can vary its year end date by up to seven days either way each year so that the year can end on a convenient date.

A company can choose its own accounting reference date within nine months from the date it was formed. If no choice is made the date is the same date as the last day of the month in which the company was incorporated.

Once set, a company can change its accounting reference date. After making a change, a company can only make a further change during the next five years if special permission is obtained.

A company must appoint an auditor who must be a person with a recognised professional qualification. A dormant company can obtain exemption from the duty to appoint an auditor.

The annual accounts must be audited and the auditors must attach a report to the accounts. The accounts must be laid before a general meeting and a copy sent to every member of the company.

A copy of the annual accounts must be sent to the Registrar of Companies and are then open to public inspection. If accounts are not filed in time, the directors responsible are guilty of an offence and the company is liable to a civil penalty.

The accounts must be filed within 10 months after the end of the accounting period (seven months for a public company). Special rules may apply in respect of the first accounting period.

The legislation lays down detailed requirements for the preparation of the accounts and in addition standards laid down by the accountancy profession will apply.

There are simplified accounting requirements for small companies.

The accounts filed with the Registrar of Companies are open to public inspection. It will be appreciated that companies therefore do not have the privacy in relation to their finances which is enjoyed by individuals and partnership.

Insolvency

There is no single definition of company insolvency. In general terms, a company is insolvent if it cannot pay its debts as and when they become due. A company can also be regarded as insolvent if a court finds that the value of its assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

If the directors become aware that the company is insolvent, they must consider a cessation of the company's business. Directors who continue to trade knowing that the company is insolvent run a serious risk of personal liability for wrongful trading.

There are four basic remedies if the company becomes insolvent and there is no reasonable prospect of recovery.

Receivership

The company's bank might decide that enough is enough and "pull the rug" by appointing a receiver. Alternatively the directors may approach the bank and invite them to appoint a receiver.

A receiver has a wide range of powers in relation to the company's assets and business. He can trade the business with a view to sale or recovery or he can close it down and sell the assets. Many companies trade for long periods while in receivership, especially if the receiver thinks that there is a good prospect of selling the business in the end.

If the assets are eventually sold the money will be distributed to the creditors and the company will (save in unusual circumstances) be wound up.

Winding up

If the directors decide that the company is insolvent, they will probably decide to put the company into voluntary liquidation. A creditors' meeting will be called and a liquidator appointed. The liquidator has all the powers of the directors and, like a receiver can trade the company's business with a view to sale.

Winding up can also be ordered by the court. The grounds for this are laid down in the Insolvency Act 1986 and are not all insolvency related. If the court makes an order, the official receiver will carry out an investigation and either he or some other suitable person will eventually be appointed liquidator.

The objective of the liquidator is to raise as much as he can for the creditors. The funds raised will be paid to the creditors, any surplus going to the members of the company.

When all assets have been sold and monies distributed, the liquidator will make his final reports and in due course the Registrar of Companies will dissolve the company.

Company voluntary arrangement

The company voluntary arrangement ("CVA") is an alternative to liquidation. Under this procedure, the directors (with the approval of the court) make a proposal to the creditors for an arrangement by which the company will be run by a nominee and an agreement is entered into between the company and the creditors which if fulfilled will write off their debts.

An agreement might for example provide that the company will continue to trade and that creditors will receive 50p per £1 of debt over a period of time. All creditors who are notified of the meeting can vote on the proposal, their respective voting power being in proportion to their debts. If the creditors accept the proposal, then all creditors who were notified of the proposal are bound by it.

A CVA might be proposed where it is likely that the creditors will receive more than they would from a winding up of the company. The theoretical objective of the procedure is to enable the company to be preserved.

Administration

The fourth way of dealing with an insolvent company is an application to the court for an administration order. Application can be made by the company, the directors or a creditor. The court must be satisfied that the company is (or is likely to become) unable to pay its debts.

It must also be satisfied that the order would achieve one or more of certain objectives, which include:-

The survival of the company and the whole or part of its undertaking as a going concern;

A more advantageous realisation of the company's assets than would be achieved by a winding up.

Once made the order has a number of effects, all designed to protect the company against creditors. An administrator is appointed with wide ranging powers to run the company. The administrator can be discharged when the purposes for which the order was made have been fulfilled.

Statutory demand procedure

If a creditor cannot obtain payment of a debt of the company exceeding £750, he can serve what is called a "statutory demand" on the company for payment. If the debt is not then paid within three weeks, the company is by statute deemed to be unable to pay its debts. The creditor can then petition the court to wind up the company. It is open to the company to argue that the debt has not been paid because it is disputed but the court will look to see that the dispute is genuine and not a hopeless one.

Because the effect of a winding up petition is to freeze the company's bank account and can cause serious damage to the company by precipitating a loss of confidence, the service of a statutory demand is a serious matter. If the company has a genuine defence and the creditor will not withdraw the notice, the company has little option but to seek an injunction restraining the creditor from issuing a petition.