10 Essential Things you need to know about Corporate Law

Corporate law (also known as company law) first started when business owners wanted to organise their businesses as separate legal entities to keep their personal assets separate from their business assets. A corporate entity protects its members from being liable for all debts of the business (unlike a partnership). It also keeps the life of the business indefinitely as a going concern, and the shares can be passed on to the next generation of owners. 

Here are ten essential things you will need to know about Corporate Law:

1. What are the Features of a Corporate Entity?

The four main features of a corporate entity/company are:

·      Separate legal entity – the company is regarded as a separate legal from its members.

·      Limited liability – liability of members is limited to their shares in the company.

·      Ownership – ownership in form of shares that can be traded and transferred. 

·      Management – managed by a board of directors, which is separated from ownership. 

Corporate law derives both from legislation and from the common law. There is a lot of relevant case law relating to certain areas, such as directors' duties and rights of minority shareholders, which are derived more from precedents rather than legislations.

2. What are the Different Types of Corporate Entities?

The principal types of corporate entities are companies that are formed and registered under company law. Companies are registered at a central, not local, registry. Companies have separate legal personalities. It is the company, not its shareholders/ members, which will be liable to any third party.

The principal forms of corporate entities are:

Limited Companies (limited by shares or guarantee) 

The liability of the shareholders to the company will be limited to the amount (if any) unpaid on his shares. In the case of a guarantee, the member only has to contribute the amount guaranteed (which is usually small) if the company is wound up. Companies limited by shares may be public or private. Companies limited by guarantee may only be private and do not have a share capital (although in the past they could do so), and are most commonly used for charities, clubs, and other non-profit-making bodies.

Unlimited Companies 

The liability of the member to the company will be unlimited. Unlimited companies are subject to less regulation than limited companies but are not a very popular form of business organisation. Unlimited companies cannot be public companies and must have a share capital.

Limited Liability Companies (“LLC”)

In the U.S., LLC is another form of corporate structure which is different from that of a limited corporation. The owners of the company are called members and not shareholders. The liability of members is limited. LLCs are easy to organise and do not require a board, directors, or directors’ meetings. The company is managed by the members directly without having an extra layer of directors.

3. What are other forms of business organisations?

There are various other forms of business organisation. These include:

Partnerships

Partnerships arise where two or more people carry on business together with a view to making a profit, on the basis that they will make business decisions together, share ownership of the assets of the business, share the profits of the business and share responsibility for the debts and obligations of the business without any limit (this liability is joint and several, i.e. if one partner does not pay, the others must pay his share). Partnerships have no separate legal personality. They are relatively easy to form and unwind. Similarly, there are fewer continuing obligations imposed on partnerships than on companies. 

Limited Partnerships

Limited partnerships consist of at least one general partner (who will have unlimited liability and sole responsibility for the management of the partnership) and one or more limited partners (with liability limited to the extent of their capital contribution but no right to participate in the management of the partnership). 

Limited Liability Partnerships (LLPs)

The essential feature of an LLP that distinguishes it from other entities is that it combines the organisational flexibility and (for many purposes) tax status of a partnership with corporate personality and limited liability for its members.

Public Companies

A public company must state in its memorandum of association that it is a public company. A public company can offer shares to the public provided other requirements are met. A public company may or may not have securities listed on a stock exchange. It must have at least two members. There are special rules on payment for shares in public companies, and certain provisions are stricter for public companies to protect the public. 

Private companies

Private companies cannot offer their shares or debentures to the public. A private company may need only have one member (depending on the jurisdiction). Private companies can elect to dispense with various requirements which would otherwise apply to them, for example, the requirement to lay accounts before a general meeting.

4. What are the Constitution Documents of a Corporate Entity?

Every company must have a memorandum of association and articles of association.

Memorandum of association

The memorandum of association sets out the company's name, its objects, where the registered office is situated, that it has limited liability, and details of its share capital (if it has a share capital). The form of the memorandum is usually laid down by statute. Although the objects clause sets out what the company can do (and the company is described as acting "ultra vires" if it goes beyond this), third parties are generally protected when dealing with companies if the company does not have sufficient capacity. Shareholders may still have rights against the company. Some jurisdictions have abolished the memorandum of association, and therefore the objects clause and ultra vires no longer apply.

Articles of association

Articles of association prescribe regulations for the company on matters such as shareholders' meetings, directors' meetings, appointment, and removal of directors. There is usually a statutory standard form published by the local Companies House / Registry, which will apply unless the company modifies or excludes it.

Both articles of association and the objects clause can be amended by special resolution. 

We have standard form memoranda and articles of association and notes for private, public and public listed companies - see below:

https://docpro.com/cat31/setup-of-business-entity/articles-of-association-company-incorporation 

5. How is a Company/Corporation being managed?

There is a separation of ownership and management for a corporate entity. Owners/shareholders/members are not necessarily the managers of the company. The ultimate management responsibility of a company lies in its board of directors.

Directors

A private company must have at least one director. A public company must have at least two directors. In both cases, the articles may prescribe a higher minimum number and may impose a maximum number. A director is an "officer" of the company. A body corporate can be a director. Companies have a single, unitary board of directors, and there is no requirement for employees to be represented on the board. 

Directors can be appointed either by the shareholders or in accordance with the articles. There is no statutory qualification or nationality requirement (although undischarged bankrupts cannot, without leave, be directors). Shareholders can always remove a director by ordinary resolution provided certain procedural requirements are met. Usually, the articles have provisions for the appointment and removal of directors. In some articles, directors are required to resign "by rotation" after a fixed number of years (usually three). Details of directors must be registered. A director may or may not also be an employee of the company. Non-employee directors are normally called "non-executive directors" ("NEDs").

Secretary

Every company must have a secretary, which can be a body corporate, and there are statutory qualification requirements for secretaries of public companies. A sole director cannot also be the secretary. Details of secretaries must also be registered. The secretary is also an "officer" of the company.

Auditors

Every company must appoint an auditor or auditors unless it is exempt from this obligation. Public companies and private companies who have not dispensed with the laying of accounts must appoint the auditors at the annual general meeting. There are statutory provisions on auditors' rights to information, to receive notice of and attend company meetings, their removal, remuneration (including for non-audit work) and resignation. There is also a provision restricting the extent to which a company can exempt auditors from liability.

6. How board/general meetings are conducted? 

Directors' meetings

Rules relating to directors' meetings are normally set out in the company's articles, which will include provisions on how meetings are called, proceedings at meetings, and whether resolutions can be passed in writing or meetings can be held by telephone. A director may appoint an "alternate" for a particular meeting or generally act in his or her place at board meetings if the company's articles allow. Where a private company has a sole director, he or she will normally act by written resolution.

Shareholders' meetings and resolutions

A company must hold an annual general meeting (AGM) each year, although private companies can elect to dispense with the AGM. Any other meeting is called an extraordinary general meeting (EGM). There are statutory provisions relating to notices of meetings, shareholders' ability to require directors to convene an EGM (known as a "requisition") and general provisions on meetings and votes. Shareholders can also require companies to circulate proposed resolutions and accompanying statements.

Resolutions passed at meetings are either ordinary resolutions (passed by a majority of those voting), special resolutions (passed by at least 75% of those who actually vote) or, unusually, extraordinary resolutions (passed by at least 75% of those who actually vote). Normally voting is by a show of hands where each shareholder has one vote however many shares he holds, and proxies cannot vote. However, shareholders, proxies and the chairman can require a poll to be held (i.e. a vote where the number of votes a shareholder has is determined by the number of shares he has). There are special notice requirements for special and extraordinary resolutions. 

There is a statutory procedure for private companies to pass written resolutions signed by all shareholders. In addition, there is a principle - known as the unanimous consent principle - that shareholders can, by unanimous consent, bind the company to any act within its capacity. 

7. What are the Directors' duties?

With the separation of ownership and management of the company/corporation, directors act as fiduciaries to the company (and not just to the owners). 

In most jurisdictions, there is no specific legislation that sets out a director's duties. Instead, these are set out in case law, and different textbooks formulate them in different ways. Directors' duties are owed to the company (not to individual shareholders). One of the principal requirements is for directors to act bona fide in what they consider (not what the court may consider) is in the interests of the company and for a proper purpose. There is a statutory provision that allows directors to have regard for the interests of the company's employees in general as well as the interests of members.

All directors are expected to exercise a degree of skill and care. Broadly, the required level of skill is what can reasonably be expected from a person of the director's knowledge and experience. This test concentrates on the individual rather than the nature of their office. The degree of care expected is more likely to depend on the nature of the directorship. Executive directors are expected to devote more time and attention to the company's affairs than non-executive, although a director must play a proper part in the company's affairs. The case law shows that the courts look not only at an individual's general knowledge, skill and expertise but also what can reasonably be expected of a person carrying out the director's functions.

The directors' relationship with the company is that of a fiduciary. The duties and disabilities imposed on directors, as a result, fall into three main areas: 

1. A director must not put himself or herself into a position where the interests of the company conflict with his or her personal interest or duty to a third party. This is sometimes described as a disability rather than a duty. 
2. A director must not make a profit out of his or her position as a director unless the company allows this. 
3. A director must act in good faith in the interests of the company. 

Fiduciary duties can be used to invalidate an action a director has taken on behalf of the company or to recover a loss or prevent the unjust enrichment of a director. In some circumstances, the breach of a director's duties can be "ratified" by the shareholders. 

8. How are Share Capital Issued and Transferred?

A company can have a share capital made up of one or more classes of shares, e.g. ordinary shares and preference shares. If there is more than one class of shares, the articles of association usually set out the rights attached to the shares. There are few limits on what these rights can be - so they can be voting or non-voting, have preferred or deferred rights, and can be redeemable.

Shares in a limited company must have a par (or nominal) value - e.g. one ordinary share of a certain amount – e.g. $1 / £1. If more than the par or nominal value is paid (whether in cash or something else) this is a "premium". The "premium" must be credited to a separate "share premium account". There are special rules on what the share premium can be used for. 

Transfer of Share Certificates

Traditionally, shares have been represented by share certificates and are transferred by executing a stock transfer form. Shares can also be held and transferred in uncertificated (or dematerialized) form (normally, for publicly listed companies, they can be held in a computer-based system, and the title to the shares can be transferred using that system). Stamp duty (depending on the jurisdiction, usually at around 0.5%) is payable on the consideration paid when shares are transferred. A person becomes the legal owner of a share when his name is entered in the register of members, although he may have a beneficial interest in the shares before then. A person who is the legal owner of a share but not the beneficial owner is often called a "nominee".

For documents relating to the transfer of shares, please go to:

https://docpro.com/cat160/debt-equity-investment-and-capital-raising/sale-and-transfer-of-shares-initial-public-offering 

Authorized and Issued Share Capital

A company has an authorised and issued share capital. The authorised share capital (i.e. the maximum share capital of the company) is set by the shareholders. It can be increased by ordinary resolution as many times as the shareholders choose. The issued share capital is the number or amount of shares that have been issued to shareholders. A share is allotted when a person acquires the unconditional right to be included in the register of members. A share is issued when the name of the shareholder is entered on the register of members. 

Articles may give additional or different pre-emption rights to existing shareholders on the allotment of new shares. As well as increasing its authorised share capital, a company can consolidate or divide shares and cancel shares that no one has yet agreed to take.

For other documents relating to Share capital, please go to:

https://docpro.com/cat63/corporate/authorised-capital-issue-of-shares-allotment-letter  

Payment for shares

There are special rules on payment for shares. In general, shares can be paid for in cash or in "money's worth", which includes goodwill or know-how. A company's shares cannot be allotted at a discount (i.e. for less than their nominal or par value). Shares in private companies can be issued "nil paid" (i.e. nothing has yet been paid), and the company can call up the amount to be paid on the shares, depending on the terms of issue. 

Public companies' shares must be allotted paid up as to at least one-quarter of the nominal value and all of any premium, but a private company's shares may be allotted nil paid or partly paid to a lesser amount. There are special rules on public companies accepting long-term undertakings and undertakings to do work or perform services as consideration for the allotment of shares. If a public company allots shares other than for cash (e.g. in exchange for shares), the consideration has to be independently valued unless one of the exceptions applies.

Offers of securities

Unless you are a public company, in general, a company cannot offer its shares or debentures to the public (rule of thumb – offer to more than 50 people, including offering your securities online). Where securities are being offered to the public, special rules apply in particular if you are listing your securities on an exchange. Generally, one will need to prepare a prospectus when offering shares to the public. Companies around the world are circumventing this restriction by offering security tokens instead of securities to the public.

9. What are the Company’s obligations to keep accounts?

Every company must keep accounting records. A company must prepare annual accounts for each financial year, comprising a balance sheet and profit and loss account. The balance sheet must give "a true and fair view" of the company's state of affairs at the end of the financial year, and the profit and loss account must give a true and fair view of the profit or loss for the financial year. The directors of the company must prepare a directors' report. The annual accounts and directors' report must be approved and signed on behalf of the board. The company's auditors must report on the annual accounts to the company's members.

The company's financial year is not necessarily a year. Companies are allocated an accounting reference date unless they choose a date for themselves, within limits. A company can change its accounting reference date, within limits. There are requirements on the contents and format of accounts, and the accounts must state whether the financial statements have been prepared by accounting standards. 

Distribution of profits and assets

There are statutory restrictions on the "distributions" a company can make. Distribution includes dividends and distributions of non-cash assets (e.g. shares in another company). Broadly, a company must have "available profits" to make the distribution. There are special capital rules for financial institutions and public companies. 

10. How to protect minority shareholders?

Much of the law relating to a shareholder's right to assert rights against the company, its directors, or members comes from case law and has been described as complex, obscure, unclear, and inaccessible except to specialist lawyers. There are four types of cases where the law recognises an individual shareholder's right to intervene by litigation:

• where the shareholder should be recognised as having a "personal right" which he can enforce as an individual because of his special interest in the subject matter (e.g. the right to vote or receive dividends lawfully declared in his favour);
• where the conduct of the majority is so "unfairly prejudicial" that it is appropriate, subject to the court's discretion, to grant the shareholder a remedy;
• where, although the right remains the company's, it is appropriate to allow an individual shareholder to assert that right on behalf of the company; and
• where the special circumstances are such that the individual shareholder may challenge the validity of a majority decision as beyond its powers.

There are also statutory rights to allow minorities to challenge majority decisions in particular cases (e.g. changes to the objects clause or changes to class rights). For more on minority shareholders’ protection, please refer to our blog:

How to protect Minority Shareholder’s Rights?

It is dangerous to rely on limited case laws and legislation to protect the rights of minority shareholders. Instead, the shareholders should enter into a shareholders’ agreement to agree and stipulate the rights of minority shareholders. For examples of shareholders’ agreements, please go to:

https://docpro.com/cat129/setup-of-business-entity/shareholders-agreement 

This guide gives an overview of corporate law but does not cover all the relevant areas in any detail. Nor does it deal with any requirements relating to listed companies. In addition, some legislations impose additional requirements on certain types of companies, such as financial institutions and companies which provide specific services. These are not dealt with here.

Please note that this is a guide on the general position of Corporate Law under common law. This does not constitute legal advice. As each jurisdiction may be different, you may want to speak to your local lawyer.