ATP 108: COMMERCIAL TRANSACTIONS (DETAILED) NOTES – UPDATED -PART 1

CHAPTER1: INTRODUCTION TO COMPANY LAW IN KENYA

1.       BUSINESS STRUCTURES

·       The four principal business structures under the Companies Act 2015 are: the sole proprietorship; the partnership; the limited liability partnership; and the company

·       Sole proprietorships are the most common business structure and involve little formality, but the liability of a sole proprietor is personaland unlimited

·       Where two or more persons wish to conduct business together, they may form apartnership. Such partnerships are subject to greater regulation than sole proprietorships, but less regulation than limited liability partnerships and companies. The liability of the partners is personaland unlimited

·       Limited liability partnerships (LLP’s)were created largelyto be a suitable businessvehicle for largeprofessional firms, and in many respects, they closely resemble companies

·       Public companies are so called because they can offer to sell their shares to the public at large, while private companies cannotoffer to sell their shares to the public at large. Thereare also other notable differences between public and private companies

·       Both LLP’s and companies are created via a process called incorporation, and are thus known as incorporated business structures or ‘bodies corporate’ – the other two business structures (sole proprietorships and ordinary partnerships) are not created via incorporation and so areknown as unincorporated business structures

·       A person wishing to engage in some form of business activity will need to do so via one of the business structures identified above, with each providing different advantages and disadvantages

2.       SOLE PROPRIETORSHIP

·       The simplest and most popular business structure is the sole proprietorship, and a sole proprietor is simply a single natural person carryingon some form of businessactivity on his own account

·       Whilst a sole proprietorwill be carried on by an individualfor that individual’s benefit, sole proprietorships can take on

employees (althoughthe vast majoritydo not)

·       The key points are: the sole proprietorship is not incorporated, and the sole proprietor does not carry on businessin partnership with anyone else

·       Sole proprietorships will come in two forms:

(i)            Sole practitioners – this is where the sole proprietor is a professional, e.g. an accountant, an advocate, etc.

(ii)            Sole trader – this is where the sole proprietor is not a professional

·       There is no separation between a sole proprietor and his business, and the sole proprietorships do not have corporate personality. Accordingly, the sole proprietor owns all of the assets of the business and is entitled to all the profit that the business generates

2.1        FORMATION AND REGULATION

·       Commencing a business as a sole proprietor is extremely straightforward and involved much less formalitythan creating an LLP or a company

·       All that an individual needs to do in order to commence business as a sole proprietor is to registerhimself with the Registrar

·       Requirements for registering as a Sole Proprietor in Kenya are:

(i)            Unique business name – your business has to be unique and not an imitation of another business name;

(ii)            Nature and businessor company must be stated clearly (and specifically)

(iii)            Having a specificphysical and postaladdress, and contactinformation of the sole proprietor

(iv)            Names of the business owner and all other partners involved in the business, as well as other details such as: nationality, age, gender, location of residence, copy of identification documents, additional business occupation passport photos, copies of KRA PIN Certificates and signed B2N Forms

2.2        FINANCE

·       In terms of raisingfinance, sole proprietorships are at a disadvantage when compared to other businessstructures

·       E.g. partnerships can raise finance by admitting new partners and companies can raise financeby selling shares,however, neither of these optionsis available to a sole proprietor (who wishes to remain as such)

·       To raise finance, sole proprietors must either invest their own money into the business (and risk losing it should the business fail) or obtain a loan

·       However, given that many sole proprietorships are small affairs, banks are ordinarily cautious when lending money and obtaining large amounts of debtcapital or usually impossible

2.3        LIABILITY

·       The principledisadvantage of carrying on business as a sole proprietor is that the liability of the sole proprietorship is

personal and unlimited

·       Whereas partnerships and companies can be limited, it is impossible to create a limited sole proprietorship. Accordingly, the sole proprietor’s assets (including personal assets such as his house, car and bank accounts) can be seized and sold in order to satisfy the debts and liabilities of the sole proprietorship

·       If the sole proprietorship’s debts and liabilities exceed the assets,then the sole proprietor will likely be declared bankrupt

3.       COMPANY

·       Section 3(1) Companies Act 2015 (‘CA 2015’) defines a company as ‘a company formed and registered under this Act or an existing company’

·       Aregistered company is a legal, juristicperson, capable of owning land and other property, and entitled to enter into contracts, sue and be sued, have a bank account in its own name, owe money and be a creditor to others

·       Aregistered company is liable for torts and crimes committedby its servants and agents of the company, and is distinct and separate from its foundersand members

·       In legal theory, a company denotes an association of persons for some common object or objects, who contribute money

or money’sworth into a common stock and who employ it for some common purpose

·       There are three fundamental legal concepts pertinent to companies:

o   The concept of legal personality (i.e. corporate personality);

o   The capacity to create legal binding relations; and

o   The concept of limited liability

3.1    FUNDAMENTAL CONCEPTS

3.1.1       LEGAL PERSONALITY (CORPORATE PERSONALITY)

·       Legal personality means that the law recognises certainpersons as having certain legal rights and duties which can be enforced through the courts. Apart from human beings,the law also affords this legal personality to corporations

·       A corporation is an artificial person created by law, and once it comes into being it is treated by law as a person in its own right, and is independent from the individual memberswho compose it

·       Corporate personality thus encompasses the capacity of a corporation to have a name of its own, to sue and be sued, to have the right to purchase/sell/lease/mortgage its property in its own name, etc.

·       In addition, property cannot be taken away from a corporation withoutthe due process of the law

3.1.2       LEGAL BINDINGRELATIONS

·       The validity of a business transaction rests almost entirely on the status of the parties and on their legal capacity to crea tea relationship attended to by legal consequences

·       Accordingly, to attract legal intervention in any case, recognition as a body corporate is vital – i.e. to engage in any legal

process as a party to a transaction depends on one’s status and recognition as a legalperson

·       Therefore, legal personality is a fundamental ingredient of capacity,without which a person cannot enter into a binding contract

·       Institutions that enjoy corporate personality, separate from the memberswho formed it, are:

o   Companies registered under the Companies Act (i.e. incorporated entities/corporations)

o   Statutory corporations established by Acts of Parliament

o   Chartered companies

·       Onthe other hand, there are institutions that do not have legal personality and do not attract recognition as legal entitiesdue to the fact that they advanceinterests of a social rather than commercial nature, e.g. societies, guilds,NGOs, etc.

·       Due to the fact that these institutions lack the status of a body corporate, they cannot be liable for contractual debts and obligations incurredby officers on their behalf, whetheror not they purport to act for and on behalf of the members

·       Liability vests in actual officers who act on behalf of members or who have been given express authority by members to carry out certainacts, e.g. in the case of societies: they are an unincorporated association (though registered and regulated by statute), and so do not enjoy recognition as legal entities and are not conferred with corporate personality. Thus, they may transact business in their own name, but the members are jointly and severally liable to account for the society’s debts and obligations without any limitation

3.1.3       LIMITED LIABILITY

·       Liability is the extent to which a person can be made to account by law – i.e. he can be made accountable either for the full amountof his debts or else pay towards that debt only to a certainlimit and not beyond it

·       In the context of company law, liability may be limitedeither by shares or by guarantee:

o   Section 6(2) CA 2015: in a company limited by shares, the liability of the members of the company is taken to be limited to anyamount unpaid on the shares held by that member

o   Section 7(1)(b)CA 2015: in a companylimited by guarantee, the liability of the membersis limited to the amountthat they undertake, within the articlesof association, to contribute to the companyin the event of its liquidation

·       Note: nearly all statutory rules embodied in CA 2015 are for the protection of the company’screditors and investors(who

are ordinarily the members)

3.2                     INCORPORATION OF A COMPANY

·       Sole proprietorships and ordinarypartnerships can be brought into existence very easily and with minimalstate involvement

·       Conversely, companies (and LLPs) are brought into existence at the discretion of the state via a formal process known as ‘incorporation’ à the word ‘incorporation’ is used because successful incorporation brings into existence a ‘corporation’ (Section 18, 19CA 2015)

·       There are three principal methods by whicha company can be incorporated:

o   Incorporation by an Act of Parliament;

o   Incorporation by an Executive Order;or

o   Incorporation by registration

·       The provisions of the CA 2015 generally applyonly to companiesincorporated by registration (known as registered companies), although they canbe extended to cover unregistered companies (i.e. state corporations)

·       The vast majority of companies in Kenya, however,are registered

3.2.1     INCORPORATION BY ACT OF PARLIAMENT

·       Parliament can create a company by passing an Act of Parliament

·       E.g. the Kenya RailwayCorporation Act (Cap. 397) gave rise to the Kenya Railway Corporation

3.2.2  INCORPORATION BY EXECUTIVE ORDER

·       A companycan be created by an Executive Order (Section 3 of the State Corporations Act)

·       E.g. in March 2013, the LAPSSETCorridor Development Authority (LCDA) was established through the Presidential Order Kenya GazetteSupplement No. 52, Legal Notice N. 58, The LAPPSETCorridor Development Authority Order 2013

·       This was established to coordinate, plan and manage the implementation of the Lamu Port – South Sudan – EthiopiaTransport Corridor

3.2.3  INCORPORATION BY REGISTRATION

·       There are three generally recognised corporate personalities: companies, chartered corporations and statutory companies

·       Although they all have corporate personalities, the procedure in forming them varies

·       The procedurein incorporation of a companyis generally as follows:

(i)       Determine whether you are incorporating a public or a privatecompany

(ii)     Determine whether you will be incorporating a limited or unlimited company

(iii)    If your companyis limited, determine whether your companywill be limitedby shares or by guarantee

(iv)    Choose a name for your company

§  The chosenname must be reserved at the company’s registry

§  This involves writing to the Registrar of Companies asking that a search be run on the name to confirm that a company with the same name does not already exist, and if so, asking that the name be reserved for use as a company name

§  The Registrar checks if the name sought is desirable, and once this is confirmed, the reservation remainsin force for a period of 30 days

§  This period can be extended for a further 30 days, during which time no other company may be registered in that name

(v)     Develop the Memorandum and Articles of Association

§  The MEMARTSare the foundingdocument and providethe basis for the whole corporate structure

§  This is the documentin which the promoters expressinter alia their desire to be formed into a company with a specific name and objects

§  The MEMARTS are the primary document which set up the company constitution and its objects– as the founding document, it determines the natureand scope of the company

§  The Articles play a subordinate role to the Memorandum – they contain the rules and regulations b which the company’s internal affairs are governed, e.g. how shares and share capital are to be allotted, how companymeetings are to be conducted, how directors are appointed, etc.

3.2.3.1    PREPARATION OF THE MEMARTS

·       Before preparingthe MEMARTS, the draftsman will need to obtain the following information from the promoters:

(i)       The nature of the business

(ii)     The amount of the nominalcapital and the denomination of the sharesinto which it is to be divided

§  These detailswill need to be statedin the MEMARTS

§  For the articles, the drafter will also requireto know if the shares are all to be of one class, and if not, what special rights are to be attached to each class

(iii)    Any other special requirements which deviate from the normal,as exemplified by the appropriate table

·       The MEMARTSshould be printedin the English language and should providefor the following:

o   The name of the company with ‘limited’ as the last word of the name

o   The registered officeof the company (to be situated in Kenya)

o   The objects of the company

o   The liability of the membersof the company (i.e. unlimited)

o   The share capitalof the company and how the same is divided up)

·       Moreover, the memorandum should be dated and signed by each subscriber. Opposite the signatures of the subscribers, the memorandum should state the subscribers’ full name, his occupation, full address and for furtherclarity it is important to indicate their national identity numbersand PIN numbers

·       The signatures must be witnessed by at least one witness who should state his occupation and postal address à witnessing is best done by an advocate

3.2.3.2    EFFECT OF THE MEMARTS

·       The MEMARTSform a contract which is binding on members of the company

·       Action to enforce this contract must be broughtin the name of the company, exceptwhere a personalright is infringed

·       The MEMARTS bind the company and each of the members as if they had been signed and sealed by each member and containedcovenants for the part of each member to observe all theirprovisions

·       Hickman v Kent [1950]: the MEMARTS provided that any suit between any member and the company should be referred to arbitration. A dispute arose between Hickman and the company, and instead of referring the same to arbitration, he filed an action against the company. The court held that the company was entitled to have the action stayed since the articles amount to a contract between the company and the Plaintiff, one of the terms of which was to refer such matters to arbitration. JusticeAshbury had the following to say à The law is clear and could be reduced to 3 propositions:

(i)       No Article can constitute a contract betweenthe company and a thirdparty;

(ii)     No right merely purporting to be conferred by an article to any person, whether a member or not, in a capacity other than that of a member (for example, a solicitor, promoteror director) can be enforcedagainst the company

(iii)    Articles regulating the right and obligation of the membersgenerally as such do not create rights and obligations between members and the company

CASE

HOLDING

Eley v Positive Government Security Life Assurance Company [1876]

The claimant solicitor drafted the defendant company’s articles, which were duly registered. The articles provided that the claimant would act as the company’s solicitor and could not be removed unless he engaged in some form of misconduct. Soon thereafter, the company ceased to employ the claimant and engaged another firm of solicitors. The claimant held that the company had breached the terms of the articles.

The claimant’s action failed. The company might very well have breached the

articles, but as the claimant was not party to the statutory contract, he could not sue for such a breach

3.3    ADVANTAGES OF INCORPORATION

3.3.1       CORPORATE PERSONALITY

·       The primary advantage, from which many other advantages flow, is that the companyacquires corporate (or separate, or legal) personality à This means that the company is regarded by the law as a person

·       Whereas humans are classified as natural persons, the company is a legal person and can therefore do many things that humans can

3.3.2       LIMITED LIABILITY

·       Since a corporation is a separate person from its members, the members are not liable for its debts – in the absence of provisions to the contrary, the members are completely free from any personal liability

·       In a company limited by shares, the members’ liability is limited to the amount unpaid on shares, whereas in a company limited by shares, the members’ liability is limited to theamount they guaranteed to pay

·       Thus, a corporation is a legal entity, distinct from its members,capable of enjoyingrights and being subject to duties which are not the same asthose enjoyed or borne by the members

·       Limited liability is a powerful incentive to incorporate, but may not provide substantial benefit to smaller companies in practice, e.g. banks will often require that the directors/members of small companies sign personal guarantees, thereby ensuring that they become personally liable should the companydefault on the loan

·       Further, limited liability companies pay for limitedliability in the form of increased regulation, e.g. disclosure requirements

·       Salomon v Salomon [1987] AC 22: The House of Lords held that there is a complete separation of a company and its members, i.e. ‘either the limited company was a limited entity or it was not. If it was, the business belongedto it and not to Salomon. If it was not, there was no person and nothing at all and it is impossible to say at the same time that there is the company and there is not’. The significance of the case is threefold:

(i)            The decision established the legality of the so-calledone-man company;

(ii)            The decision showed that incorporation was as readily available to small private partnerships and sole traders as to the large private company; and

(iii)            It also revealed that it is possible for a trader not merely to limit his liability to the money invested in his enterprise but even to avoid any serious risk to that capital by subscribing for debentures rather than shares

·       It is noteworthy that while limited liability minimises the risk faced by members and so encourages investment in companies, it weakens the position of the company’s creditors who cannot access the personal assets of the members to offsetany debts of the company.It is therefore argued that limited liability does not so much minimisethe members’ risk, but instead shifts it from them to the company’s creditors

3.3.3       CONTRACTUAL CAPACITY

·       As the company is a person, it can enter into contracts with both personsinside and outsidethe company

·       Lee v Lee’s Air Farming Limited [1961] A.C. 12: Lee’s company was formed with capital of £3000 divided into 3000 £1 shares. Of these shares, Mr. Lee held 2,999 and the remaining one share was held by a third party as his nominee. In his capacity as controlling shareholder, Lee voted himself as company director and Chief Pilot. In the course of his duty as a pilot he was involvedin a crash in which he died. His widow brought an action for compensation under the Workman’s

Compensation Act and in this Act, workman was defined as “A person employed under a contract of service” so the issue was whether Mr. Lee was a workman under the Act? The House of Lords held “that it was the logical consequence of the decision in Salomon’s case that Lee and the company were two separate entities capable of entering into contractual relationsand the widow wastherefore entitled to compensation”

3.3.4       HOLDING PROPERTY/OWNERSHIP OF ASSETS

·       Corporate personality enables the propertyof the association to be distinguishable from that of the members

·       The property of the incorporated entity must be dealt with according to the rules (i.e. memorandum and articles of association) and no individualmember can claim any particular asset within that pool of property

3.3.5       SUING AND BEING SUED

·       As a legal person, a company can take action in its own name to enforce its legal rights. Conversely, it may be sued for breach of its legal duties (the only restriction being that it must be represented by a lawyer in allthese actions)

·       East Africa Roofing Company v Pandit [1954] 27 KLR 96: the court held that a corporation such as a limited liabilitycompany cannotappear in person as a legal entity without any visible personand having no pshysical existenceit cannot at common law appear by its agent but only by its lawyer (the CA 2015 has not changed this common law rule so as to enable a limited company to appear in court by anyof its officers)

3.3.6       PERPETUAL SUCCESSION

·       A company can only cease to exist by the same process of law which brought it into existence; otherwise, it is not subject to the death of a natural body

·       Even though the company’s membersmay change over the years,the company continues in existence

3.3.7       TRANSFERABILITY OF SHARES

·       Section 326 CA 2015: ‘the shares or any other interests of a memberin a company shall be moveable propertytransferable in the manner providedby the Articles of Association’

·       Therefore, shares in a company are transferable and upon a transfer being effected, the assignee steps into the shoes of the assignoras a member of the company with the full attendant rights thereto

·       Note: this transferability does not relate to private companies, which companies often have their own rules regarding transfer and sale of shares (containedin the memorandum and articles of association – ‘MEMARTS’)

3.3.8       BORROWING FACILITIES

·       In practice, companies can raise capital by borrowing much more easilythan the sole trader or partnership

·       This borrowing is enabled by the device of the ‘floating charge’ – it is a charge that ‘floats’ over the assets of a company, from time to time with a certaindescription, but withoutpreventing the companyfrom using those assets or disposing off those assets in the ordinary course of its business, until an event which causesthe charge to become crystallised or fixed

·       This is facilitated by the Chattels Transfers Act which exempts companies from compiling an inventory on the particulars of such charges

3.4    DISADVANTAGES OF INCORPORATION

3.4.1       INCREASEDFORMALITY, REGULATION AND PUBLICITY

·       Companies are subject to significantly more formality and regulation than unincorporated businesses

·       Setting up a companyis a more complextask than settingup a sole proprietorship or an ordinarypartnership

·       The increasedformality and regulation extend beyond formation, and complex rulescan apply throughout the company’s

existence (e.g. the rules relatingto the calling and runningof general meetings)

·       Directors are also subjectto a raft of statutory duties that sole proprietors and partners are not subjectto

·       Incorporation also results in a loss of privacyas most companies are required to make certain information (e.g. financial accounts)publicly available throughout their existence

3.4.2       CIVIL LIABILITY

·       If a company has been wronged, it can commence legal proceedings to redressthat wrong. Similarly, if a companycommits a civil wring, it can be sued and made liable to pay compensation

·       In many cases, imposing liability upon the company for civil wrongs of its directors/employees poses no problem, as the company can be made liable via the doctrine of vicarious liability (in the case of tortious liability) or via the law of agen cy (in relation to contractual liability)

·       However, the issue is often more complex as certain civil wrongs require defendants to have a certain level of knowledge that the company, as an entity, will lack for obvious reasons

·       The law’s answer is to use the ‘identification theory’ which states that knowledge of certain persons will be attributed to a company.However, the courts will only attribute to the company the knowledge of persons who constitute the ‘directing willand mind’ of the company (Lennard’s Carrying Companylimited v AsiaticPetroleum Company Limited[1915])

·       In many cases, this will be limited to the directors and senior officers of the company, and to persons in management to whom the directors have delegated managerial functions (Tesco Supermarkets Limitedv Nattrass [1972])

3.4.3       CRIMINAL LIABILITY

·       Just as a company can be found liable for committing a civil wrong, so too can it be found guilty of committing a crime

·       However, in the case of R v ICR Haulage Limited[1944] it was held that a companycannot be imprisoned, i.e. it cannotbe found guilty of any crime for which the only punishment is imprisonment (e.g. murder)

·       Where the crime is one that requires mens rea, the courts will utilise the identification theory and attributemens rea to those who are the directing will and mind of the company

·       Corporate manslaughter is a relaxation of this rule – i.e. courts would only impose liability on the company if the death was the result of the actions and gross negligence of an identifiable member of the directing mind and will of the company

3.5    PUBLIC AND PRIVATE COMPANIES

·       The CA 2015 provides for a number of different forms of company,classifiable by reference to certain characteristics:

o   Is the company public or private?

o   Is the liability of the company’smembers to be limited or unlimited? – If liabilityis to be unlimited, then the companymust be private.The law does not allow for creation of unlimited public companies (CA 2015, S. 5 & 8)

o   Does the company have share capital or not? – Public companies must have a share capital,but private companies

need not. A limited company that does not have a share capital will be a company ‘limitedby guarantee’ (CA 2015,

S. 6 & 7)

·       When creating a company,the promoters are required to state whetherthe company is to be registered as a private company or asa public company

o   Section 10 CA 2015: A publiccompany is a company limitedby shares, or limited by guarantee and having a share capital,whose certificate of incorporation states that it is a public company

o   Section 9 CA 2015: A private company is a company whose MEMARTS restrict a member’srights to transfershares, limit the number of members to 50, and prohibit invitations to the public to subscribe for shares; it is not a company limitedby guarantee; and, its certificate of incorporation states that is it a private company

PUBLIC COMPANY

PRIVATE COMPANY

May offer to sell its shares to the public at large, and to facilitate this end, may list its shares on a stock market. Such companies are known as ‘listed companies’ or

‘quoted companies’

Are not permitted to sell their shares to the public at large, nor can they list their shares on a stock exchange (CA 2015, S. 11)

Required to have an allotted share capital of at least Kshs.

6, 750, 000 (‘minimum authorised capital requirement’

under CA 2015, S. 518)

Can be created with a trivial amount of capital

Can be created with only one member, but must have at

least two directors (CA 2015, S. 128)

Can be created with only one member, and can be formed

with only one director

Required to appoint a Company Secretary

Only required to appoint a Company Secretary if the paid-

up capital is more than Kshs. 5, 000, 000 (but may also do so if they otherwise wish) (CA 2015, S. 243 – 244)

Must add the suffix ‘Plc’ to their name (CA 2015, S. 53)

Must add the suffix ‘Ltd’ to their name (CA 2015, S. 54)

3.6    LIMITED AND UNLIMITED COMPANIES

·       The terms‘limited’ and ‘unlimited’ do not refer to the company itself,but to the liability of its members

·       It is not clear whether the liability of a public company must be limited (as is the case in the United Kingdom), however, when the promoters decide to form a private company, they will need to decide whether the liability of the company’s members will be limited or unlimited

·       Limited liability:

o   The vast majorityof companies are limited liability companies as comparedto unlimited companies

o   Where the liability of a company is limited, the form and extent of the limitation will depend upon whether their liability is limited by guarantee or limited by shares

o   Where a company is limited by guarantee, the liability of the members is limited to the amount stated in the statement of guarantee (Insolvency Act 2015, Section 385(3))

o   Where a company is limited by shares, the liability of the company’s members will usually be limited to the amount that is unpaid on their shares (Insolvency Act 2015, Section 385(2)(d)) à members who have fully paid for their shares are generally not liable to contribute any more to the company

·       Unlimited liability:

o   In the UnitedKingdom, for example,only 0.1% of all companies are unlimited

o   The reason why there are so few unlimited companies is because upon winding up, the liability of the members is personal and unlimited, and so their personal assets (e.g. house, car, bank accounts, etc.) can be seized and sold to satisfy the company’s debts

o   The primary reason a company would choose unlimited liability is that such companies are subject to less regulation than limited companies, and so theiraffairs can be conducted with less formality and more privacy

o   It is unlikely that the promoters will wish to form an unlimited company if the company is intended to trade, howeverif the company is merely for holding land or other investments, the absence of limited liability would not matter

3.7    PROMOTION OF A COMPANY

·       Persons who wish to create a company may need to undertake various activities in order for the company to be able to commence business (e.g. preparing incorporation documents, hiring or buying business premises, obtaining supplies or operating capital, etc.)

·       Such persons,who usually go on to become the company’s first directors, are known as ‘promoters’ of the company and

their activities are closely regulated by the law

·       Notably, these promoters owe fiduciary and statutory duties to the unformed company notably, e.g. a promoter cannot make a secret profit out of the company’spromotion. In addition, a promoter will usually be personally liable on a contract enteredinto on behalf of a company if that companyhas not been incorporated at the time the contractwas entered into

3.7.1      WHEN WILL A PERSON BE A PROMOTER?

·       The law has not sought to define preciselywhat a promoter is, as if it did, personswould try take themselves out of the definition in order to avoid regulation

·       However, lack of a definition is problematic, as determining whethera person is a promoteris crucial for several reasons:

o   Promoters owe fiduciary duties to the unformed company;

o   Promoters can be held liablefor acts in engaged in on behalf of the unformed company; and

o   While the word ‘promoter’ only appears once in the CA 2015, the common law imposesa number of obligations

on company promoters (especially those of public companies)

·       Accordingly, the court in Whaley Bridge Calico Printing Co. v Green [1880] described a promoter: ‘the term promoter is a term not of law, but of business, usefully summing up in a single word a number of business operations familiar to the commercial world,by which a company is generally broughtinto existence’

·       Accordingly, the word promoter refers to those persons involved in the formation of the company, but based upon the particular facts of each case

·       However, not all persons involved in the formation of a company will be categorised as promoters, e.g. those involved by virtue of their professional duties (such as advocates or accountants) will not be regarded as promoters (Re Great Wheal PolgoothCo. Limited [1883])

3.7.2      DUTIES OF A PROMOTER

·       A promoter occupies a dominant position in relation to the unformed company and, to prevent that position being abused, the promoter will owe the unformed companya number of duties

·       Two board categories of duties can be identified: fiduciary duties and duties imposedby statute

(i)             Fiduciary duties

·       A promoteroccupies a fiduciaryposition in relationto the unformed company

·       Accordingly, the promoter is not permitted to make a profit out of the company’s promotion, unless the nature of the promoter’s interest and the profit made by the promoter is disclosed

o   Should the promoter fail to disclose the profit, the transaction in question will be voidable and can be rescinded by the companyà Erlanger v new Sombrero Phosphate Co. [1978]: in this case,the promoters of a companysold a lease to the company at twice the price paid for it without disclosing this fact to the company. It was held that the promoters had breachedtheir duties and that they should have disclosed this fact to the company’sboard of directors. Since a promoter owes his duty to a company, in the event of any non-disclosure, the primary remedy is for the company to bring proceedings for rescission of any contract with the promoter, or, recovery of any profitsfrom the promoter

o   If rescission fails to recover the value of the profit,or if the right to rescind is lost, then the promotercan be made to accountto the company for the value of the profit(Emma Silver Mining Co. v Grant [1897])

·       For example: if, upon incorporation, a promoter sells to the newly formed company an asset that he acquired during the company’s promotion, he will not be permittedto keep the proceeds of sale, unlesshe discloses the nature of the interestand the extent of the profit made. However, disclosure will only be valid if the persons to whom it is made are independent (Erlanger v new Sombrero Phosphate Co. [1978])

(ii)            Duties imposed by statute

·        In addition to the commonlaw fiduciary duty, promoters are also subjectto statutory duties

·       E.g. CA 2015, Section373 states that a non-cashasset cannot be sold to a publiccompany by a person who is a subscriber to the company’s memorandum, unless the non-cash asset has been independently valued and the members have approvedthe same (2-year initial period)

3.7.3      PRE-INCORPORATIONCONTRACTS

·       Prior to incorporation being completed, the promoters of the unformedcompany will likelyneed to enter into contractual

agreements with third parties in order to cater for the company’s future needs

·       E.g. the promoters may need to contract with creditors to obtain capital, or they may need to contract for supplies or office premises, or take on employees

·       A companydoes not have the capacityto enter into such contracts until it is fully incorporated

·       The validity of these contracts has been (through case law) based on determining the intent of the parties as revealed in the contract– a process which provednotoriously difficult and which resultedin a significant confusion in the law (as well as a perception that cases in this area could turn based on complex and technicaldistinctions) – see: Phonogram Ltd v Lane

·       This confusion is shown by contrasting the two followingcases:

o   Kelner v Baxter [1866]: the promoter signed the contract ‘on behalf of’ the unformed company, and it was held that a binding contractexisted between the promoter and thethird party

o   Newborne v Sensolid (Great Britain) ltd [1954]: the promoter signed the contract using the company’s name and added his own signature underneath. It was held that the contractwas between the promoter and the unformedcompany, and, as the company had no legal capacity, no contract existed

·       Under statute, the generalposition is that if, beforea company has acquired legalpersonality, action has been carriedout in its name, and the company does not assume the obligations arising from such an action, the persons who acted shall – without limited– be jointly and severally liabletherefore (unless otherwiseagreed)

·       CA 2015, Section 44: ‘a contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as a contract made with the person purporting to act for the company or as an agent for it, and the person is personally liable on the contract accordingly’

o   The basic effectof this sectionis to render a promoterpersonally liable for the pe-incorporation contract

o   This clearly benefits third parties who contract with the promoter, as they will be able to sue the promoter should the termsof the pre-incorporation contract be breached

o   However, the section does notindicate whether or not the third party can be liable to the promoterin the event of the third party failing to honour the contract

o   Braymist Ltd v Wise finance Co Ltd [2002]: it was held that a promoter could sue a third party, but the fact that judicial clarification was required demonstrates a flaw in drafting of the section

·       The courts have clearly stated that a company, once incorporated, cannot ratify or adopt a pre-incorporation contract made on its behalf (Re Northumberland Avenue Hotel Co [1886]) à The only way that a company can take advantage of apre-incorporation contract is for the promoter and third party to discharge the pre-incorporation contract and the company then to enter into a new contract with the third party in respect of the same subject matter (Howard v Patent Ivory Manufacturing Co (1888)).This process of substituting one contract with another is known as ‘novation’

3.7.4      ‘SUBJECT TO ANY AGREEMENT TO THE CONTRARY’

·       The imposition of liability under Section 44 is ‘subject to any agreement to the contrary’, which means that a promoter can avoid liabilityif he can show that he and the other party to the contractagreed that, upon incorporation, the promoter would be released from liability and the company would enter into a second contract with the other party on the same terms as the first contract(i.e. an agreement to novate the contract was present)

·       The agreement can be express or implied, but the courts will require clear evidence that such an agreement exists ( Bagot PneumaticTyre Co v Clipper Pneumatic Tyre Co [1902])

·       In the absence of an express agreement, this will likely be difficult for a promoter to prove. Simply acting as a promoter or agent of an unformed company will not be enough to infer the existence of a contrary agreement (Phonogram Ltd v Lane [1982])

CHAPTER2: LIFTING THE CORPORATE VEIL

·       Upon incorporation, the company becomesa person in its own right and can do many thingsthat a natural person can do

·       Corporate personality was available to unregistered companies, but with the passing of the Joint Stock Companies Act 1844 and the abilityto incorporate a company by registration, corporatepersonality took on a new found importance

·       However, it was not until Salomon v Salomon [1897] that courts appreciated the true significance of corporate personality

o   It recognised that a companycould legitimately be set up to shield its membersand directors from liability;

o   It implicitly recognised the validity of the ‘one-man company’(i.e. a company run by one person,with a number

of dormant nomineemembers) nearly a century beforesingle-person companies could be formallycreated; and

o   The fact that a person holds shares (even all the shares) is not enoughto create a relationship of agency or trusteeship

·       There is no doubt that Salomon is the cornerstone upon which company law is based. However,the ability to set up a company to shield oneself from liability is clearly open to abuse

·       Therefore, both Parliament and the courts have the ability to ignore a court’s corporatepersonality and impose liability upon those behind the company’s corporate personality

·       This is known as ‘piercing’ or ‘lifting’ the ‘corporate veil’ – referring to the ‘corporate veil’ that hides the company’s

members and directors from liability

1.       STATUTE

·       Ascompanies are grantedcorporate personality by statute, it follows that statute can set aside corporate personality and impose liability on those behind the veil

SECTION 519, CA 2015

No trading certificate: if a public company carries on business, or exercises any borrowing

powers, prior to being issued with a trading certificate, then the directors can be made personally liable

SECTION     505,                   632,

INSOLVENCY ACT 2015

Fraudulent trading: where, in the course of winding up, it appears that the company has been run with an intent to defraud the creditors (known as fraudulent trading), the court may lift the

veil and impose personal liability on any persons who were knowing parties to such conduct

SECTION                               506,

INSOLVENCY ACT 2015

Wrongful trading: where a company has gone into insolvent liquidation, the directors may be

personally liable if they continued trading when they knew, or ought to have known, that there was no reasonable prospect of the company avoiding liquidation

2.       COMMON LAW

·       Ascorporate personality is bestowed by statute, it follows that the courtsare reluctant to pierce the veil, as case of Adams v Cape Industries Plc [1990] demonstrates:

o   FACTS:The defendant parent company (Cape) was based in England. A subsidiary of Cape was based in South Africa, where it mined asbestos. The asbestos was sold by other subsidiaries, one of which was based in Illinois, USA. The asbestos was sold to a factory in Texas and a number of the factory’s employees developed asbestos- relates medical conditions. A US court ordered that $15 million be paid in damages, but this could only be enforced against Cape in the UK if the claimants could show that Cape was present in the USA. Accordingly, the claimants argued that Cape was present in the USA through its Illinois subsidiary. For this argument to succeed, the separatepersonalities of the variouscompanies would need to be ignored

o   HELD: The court refused to lift the veil and held that the US subsidiary was separateand distinct from its UK parent company. Accordingly, Cape was not present in the USA and the judgement of the US court could not be enforced against it. Salomon allowed a parent to use its subsidiaries to avoid liability in this way, and the Court was of the opinion that, on the facts, there were no ground to avoid following Salomon

·       However, as we shall see below, the courts have developed a string of jurisprudence touching on situations where the corporate veil will be lifted

2.1    FRAUD, SHAM OR CLOAK

·       The most straightforward and least problematic situation in which courts could pierce the corporate veil was where the company was being used to perpetuate fraud, or the company was a façade or sham

·       Acommon theme amongstsuch cases is that the company was used to evade some form of existing contractual provision or obligation (i.e. avoiding an existingliability, not a future liability)

CASE

HOLDING

Gilford Motor Company Limited v Horne [1933] Ch 935

The defendant was the managing director of the claimant company. His employment contract provided that, should he leave the company, he would not attempt to solicit any of its customers. His employment was terminated, and his wife set up a rival company which competed directly with the claimant. It was clear that this new company was set up at the defendant’s behest and was under the defendant’s control.

The court granted an injunction preventing the defendant (and the new company) from soliciting the claimant’s customers. Lord Hanworth MR stated that the new company was ‘formed as a device, a stratagem, in order to mask the effective

carrying on of a business of [the defendant]’ and to avoid the restrictive covenant.

Jones v Lipman [1962]

Lipman entered into a contract to sell property to Jones. Shortly thereafter, Lipman changed his mind. To avoid selling the property to Jones, Lipman transferred the property to a company he owned and controlled and had set up to hold the property. When Jones decided to sue Lipman, Lipman said he did not own the land anymore as it was owned by the company.

The court found that Lipman created the company only to avoid existing legal obligations and so it lifted the corporate veil – ‘the defendant company is the creature of the first defendant, a device and sham, a mask which he holds before his

face in an attempt to avoid recognition by the eye of equity’.

Antonio Gramsci Shipping Corn v Stepanovs [2011]

The holding developed a number of principles to apply in cases involving companies set up fraudulently:

·       The defendant need not be in sole control of the company in question – where there were a number of wrongdoers, with a common purpose, in control of the company, then liability could be imposed on all, or one, of them

·       The veil would not be pierced simply because the company behaved fraudulently

– what must be established is that there was a fraudulent misuse of the company structure

·       The veil will only be pierced when the fraud or wrongdoing in question is within the ordinary business of the company in question

·       A contract entered into by a ‘puppet company’ could be enforced against both

the puppet company and the puppeteer, although the puppeteer would not be permitted to enforce the contract on policy grounds

VTB     Capital     Plc     v     Nutritek International Corp [2013]

VTB Capital plc (VTB) lent US$225 million to Russagroprom LLC (RAP), which RAP intended to use to purchase a number of Russian companies from Nutritek. RAP defaulted on the loan. VTB alleged that it was induced into entering into the loan agreement with RAP based on fraudulent misrepresentations made by Nutritek. VTB alleged that representations were made indicating that RAP and Nutritek were not under common control, whereas both companies were, in reality, controlled by Mr Malofeev, a Russian entrepreneur. VTB commenced proceedings against Nutritek, Malofeev and several other companies that were involved, alleging that they were liable for RAP’s breach of contract. In order for this claim to succeed, the corporate personality of RAP would need to be pierced and VTB argued that the veil should be pierced on the ground that Malofeev and his associated companies were using RAP as a puppet company to orchestrate a fraud against VTB. VTB claimed that once the veil was pierced, the defendants would become party to the original loan agreement between VTB and RAP, and so would be liable on it.

The Supreme Court refused to pierce the corporate veil. Lord Neuberger stated that,

to find the defendants liable on the loan agreement, would involve an extension of

the circumstances in which the veil could be pierced. It would, in effect, result in Malofeev becoming a co-contracting party with RAP under the loan agreement. He refused to do this on the ground that where B and C are the contracting parties and A is not, there is simply no justification for holding A responsible for B’s contractual liabilities to C simply because A controls B and has made misrepresentations about B to induce C to enter into the contract. This could not be said to result in unfairness to C: the law provides redress for C against A, in the form of a cause of action in

negligent or fraudulent misrepresentation

Creasy     v   Breachwood  Motors Limited [1993]

Creasy claimed wrongful dismissal from Breachwood Motors. Breachwood Motors, in response, ceased trading and transferred its assets to BW, leaving nothing with which to compensate Creasy. Creasy sought to lift the corporate veil and bring action against BW, as the directors of BW and Breachwood Motors were the same. The

court lifted the corporate veil to allow for this.

Adams v Cape Industries [1990]

[TO SHOW that avoiding future liability is permissible]:

‘We do not accept that the corporate veil should be lifted simply because the corporate structure has been used so as to ensure that legal liability (if any) in respect of particular future activities of the group (and correspondingly the risk of enforcement of that liability) will fall on another member of the group rather than the defendant company. Whether or not this is desirable, the right to use a

corporate structure in this manner is inherent in our corporate law’

2.2    GROUPS OF COMPANIES [SINGLE ECONOMIC UNIT]

·       It is common for larger companies to carry out their functions via a numberof smaller subsidiary companies

·       Initially, each subsidiary in a group of companies was regarded as its own ‘single economic unit’ à The Albazero [1977]: the court stated that it was ‘long established and now unchallengeable by judicial decision… that each company in a group of companies … is a separate entity possessed of separate legalrights and liabilities’

·       However, this position was changed by DHN Food Distributors v Tower Hamlets

CASE

HOLDING

DHN Food Distributors v Tower hamlets LBC [1976]

DHN was a holding company that included two other wholly owned subsidiaries. One of these subsidiaries owned the land upon which DHN conducted business, with DHN occupying the land as a bare licensee. The land was compulsorily purchased by the defendant, who paid £360,000 compensation to the subsidiary. DHN could not find suitable replacement premises, and went into liquidation. DHN argued that it was entitled to compensation for loss of business, but the law provided that only those with a legal or equitable interest in the land were entitled to such compensation, with a bare license not conferring such an interest.

DHN was awarded compensation for loss of business. Lord Denning MR stated that the subsidiaries were ‘bound hand and foot’ to DHN and that ‘the group is virtually the same as a partnership where all three companies are partners’. Accordingly, the

three companies were treated as one, with DHN regarded as that one.

Adams v Cape Industries [1990]

[HOWEVER, this decision took a different approach:]

Slade LJ held: ‘save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon … merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which normally attach to

separate legal entities’.

2.3    AGENCY

·       A relationship of agency usually arises where one person (known as the principal) appoints another person (known as the agent) to acton his behalf

·       Where two parties are involved in an agency relationship, the principal is normally legally responsible for the acts of his agent – in the corporate context, a relationship of agency can arise in two situations:

(i)            The company could be regarded as an agent of a member à i.e. the member, as principal, is responsible forthe acts of the company (i.e. the company’s corporate personality is ignored and the member made liable). However, Salomon emphatically stated that the mere fact of incorporation does not cause a relationship of agency to be created between a company and its members, although an agency relationship can arise betweena member and the companybased on the particular facts of a case (Gramophone & Typewriter Ltd v Stanley)

(ii)            Where two companies are in an agency relationship, the principal (normally the parent or holding company) can be liable for the acts of its agent (normally, a subsidiary company). In effect, the corporate personality of the subsidiary is ignored and the parentcompany is made liablefor the subsidiary’s acts

CASE

HOLDING

Smith,     Stone     and     Knight     v Birmingham Corporation

The claimant company purchased a business, and set up a new subsidiary company to run this business. However, the claimant never transferred ownership of the business to the newly created subsidiary. The land upon which the subsidiary conducted business was compulsorily purchased by the defendant, who planned to pay compensation to the subsidiary for loss of business. The claimant contended that it was entitled to the compensation.

The court held that the subsidiary was the agent of the claimant and therefore, the corporate personality of the subsidiary was ignored and the claimant obtained the compensation. The crucial factor was that the newly acquired business and the land

on which it operated still belonged to the claimant.

2.4    JUSTICE OR CONVENIENCE [TORT]

·       The final ground for lifting of the corporate veil is where justice of the case demands so – however, the courts have consistently held that justice is not a ground to lift the corporate veil

·       This is unfortunate for victims of tort (‘involuntary creditors’), therefore, courts have developed a way to hold companies

accountable for tortiousharm to individuals

CASE

HOLDING

Chandler v Cape Plc [2012]

Chandler worked for Cape products, a subsidiary of Cape Industries. He was exposed to asbestos and later he developed asbestosis, however, by the time he was diagnosed the subsidiary had closed down and so there was no one to sue. Chandler therefore elected to sue the parent company, but the parent company said that they were not to blame for any illness faced by the employee due to the actions of the company’s subsidiary (even the insurance did not cover employees of the subsidiaries).

The court agreed later that cape industries was liable, but it only agreed that it was liable on the ground that cape industries had a duty of care to the employees of its subsidiaries à (this is not a veil lifting case, it is a case where the parent company is held accountable on the basis of the duty of care, i.e. the court found an inventive

way to hold the parent company liable)

3.       THE NEED/DESIRABILITY FOR CORPORATE STRUCTURES

(i)            To take advantage of integrated finance: assets and liabilities are passed from one company to another in the group, and this obscuresthe true financial position of each company

(ii)            Enhances anonymity of beneficial owners: people who have a lot of money do not like people to know wheretheir money is/where their money comes from, and so they create corporate vehicles which are interconnected in order to obscure the trail of theirmoney

(iii)            For management, avoidance or evasion of tax obligations: “tax heavens” are jurisdictions which have very low regimes of tax, or in some cases no taxes at all

o   Many Multi National Corporations have their holding companies or entities registered in those jurisdictions (it is very difficult to trace money in these jurisdictions)

o   This makes it is possible to manage tax liabilities or reduce tax liabilities by organising your corporate group in such a way which reduces the profitsyou are earningin any particular jurisdiction

(iv)            Regulatory arbitrage: different jurisdictions have different regulations, and sometimes companies will try to avoid jurisdictions which have higher regulations by setting up an officein a country with lower regulatory hurdles/standards

(v)            Avoiding creditors by concealing or shielding assets: for instance – if someoneis suing you in jurisdiction X and you realise that you are in trouble then it may be a good idea to move your assets to jurisdiction Y, and this is done by forming a corporateentity in jurisdiction Y

(vi)            Limiting exposure to/avoiding tortious liability: principle that one cannot be liable for the actions of another à if you are going to carry out riskyactivities then you want to do so in a manner that will shieldyou from the damages that may occur in the process. Since each company in a corporate entityis only liable for itself, it may be possible to escape liability

(vii)            Compliance with domestic laws: sometimes corporate groups are enforced upon companies by domestic laws, e.g. in Zimbabweany company that invests in the countrycannot have 100% ownership in the company;the most they can have is 49%, and 51% is to be owned by locals. Thus, you have to formulate mechanisms which would enable you to retain ownership and control in the company (e.g. you may create phantom organisation in Zimbabwe that is owned 51% by locals, but that 51% is controlled by external forces)

(viii)            Facilitating illicit activities such as bribery,corruption or moneylaundering

CHAPTER3: THE CONSTITUTION OF A COMPANY

·       Acompany’s constitution consistsprimarily of the articles of association, agreements, and resolutions affecting the company

·       The CA 2015 has significantly reduced the importance of the Memorandum of Association, and the Articles of Association now form the company’s principal constitutional document

·       The constitution forms a statutory contractbetween the companyand its members, and betweenthe members themselves. However, only those provisions relatingto membership rightswill constitute terms of the statutory contract

·       While ordinarily an act outside the scope of a company’sobjects clause would be ultra vires,companies incorporated under the CA 2015 have unrestricted objects by default(CA 2015, Section 28)

·       A company can alter its articles by passing a specialresolution, however, statute and common law restricta company’s

ability to alter its articles

·       The CA 2015 does not seek to exhaustively regulate the internal affairs of the company, much is left to the companies themselves – accordingly, a company’s constitution aims to set out the powers, rights and obligations of the company’s members and directors, and also to lay down certain processes regardinghow the company is to be run

1.       EVOLUTION OF THE CORPORATE CONSTITUTION

·       The CA 2015 has altered significantly the form and content of the corporateconstitution: