Company Law: Incorporation of Companies - Essay Example

This paper is an analysis on the notion that incorporation of companies has made it possible for individuals to have the ability of controlling companies, without them being liable for the liabilities of the company. In defending this statement, the researcher will analyze various statutes and case laws in regard to incorporation of companies, after which, the researcher will come up with a relevant conclusion. Incorporation refers to the process of legally creating a corporate entity, as separate from that of the owners of the organization1. This concept of incorporation comes with numerous advantages to the owners of the business under consideration. Scholars denote that because a business organization is incorporated, then the assets of these people are protected from seizures by creditors of the company. That is, the owners of the business under consideration are not liable for the liabilities of the company2. It is also easy for the owners of the company to raise capital through the stock market; it is simple to transfer the ownership of this company to another individual, the tax charged on a company is lower as compared to a personal income, and finally, a company that is incorporated is able to achieve a lenient tax restriction, on losses that are carried forward. The Company’s Act of 2006 provides for the issuance of an article of incorporation once a company is incorporated. This article of incorporation is responsible for identifying the main purpose of the company, the location of the company, the number of shares issued by the company, etc. This article of incorporation will also contain the specific date of the company’s registration, and the fees paid for the incorporation. It is important to understand that majority of companies are created for the main purpose of doing business. This is an aspect that the British parliament wants to encourage, and this is because the existence of many companies in Britain will lead to an improvement in the economy of the country, and creation of jobs. However, it is important to understand that doing business is a risky affair, and a business organization might fail, or it may acquire some profits3. This acquisition of profits is the major incentive that makes people to engage in a business initiative. It is important to understand that the common law principle denotes that an individual who provides capital for a business operation, and is responsible for sharing the profits that the business makes, is also liable for any debts that the business under consideration incurs. For example, in cases whereby a business organization is a partnership, then the partners of the organization under consideration are liable for the debts of the business4. Under the partnership Act of 1890, partners of a business organization are held responsible for the debts and liabilities of a company. However, the Partnership Act of 1907 provides a relief to sleeping partners, who are not liable to the debts that the business organization incurs5. In 2000, parliament passed an amended the partnership act, and it made the partners to be liable for the general trading debts of the company. However, this law allows partners to have no liability on cases involving the negligence of the company, and where large sum of money is involved. The aim of passing this law by parliament was to protect the partners of a business organization from going bankrupt6. However, to be fully protected from the liabilities of a business organization, parliament encourages owners of business organization to incorporate their establishment. This will help them not to acquire any liability of the company, whether it occurs through negligence, or if it is as a result of the general trading practices. The companies Act (CA) of 2006 allows for the incorporation of various companies that have a limited liability status. Under this law, an investor in a limited company is not liable for the debts of the company, in case the company fails in business. This concept of protecting investors from the liabilities of the company did not begin with the 2006 companies act, but it is reflected in the 1897 case of Salomon vs. Salomon. This was a case based on the company’s act of 1862, whereby the law provided that a share holder is not liable for the debts and liabilities of a company. In this case, Mr. Salomon was a manufacturer of leather boots, and he turned the company into a limited company when his sons wished to join the company. Soon after incorporation, the company went bankrupt and one of his creditors, Mr. Broderip sued him for the recovery of his debts. The House of Lords gave a ruling that the business of Salomon was rightfully registered as a limited company, and on this basis, it is the company that is liable to its creditors, and not Salomon7. Based on this ruling by the House of Lord, it is correct to denote that the main purpose of incorporation is to protect individual business men, from the liabilities of limited companies that they own. Another case is the 1843 case involving Foss vs. Harbottle. In this case, the court ruled that a limited company is a person, and it can be sued, and also sue. On this basis, a limited company is responsible for its actions. This aspect of incorporation therefore began over a long period of time, and laws such as the CA 2006 are only meant to strengthen this aspect of incorporation, and introduce new terms, based on the needs of the modern society8. To fully understand the importance of incorporation as outlined by the company’s act of 2006, it is important to understand the legal meaning of a limited company. CA 2006 (3) defines a limited company. In the definition contained in this section, a limited company is a company whose liability is limited by the owners of the company9. CA 2006 (3.1) denotes that the liability under consideration can be through the shares that the owners hold, or it can be limited through guarantee. CA 2006 (3.2) denotes that a company is limited by shares, in case the liability of the company will be paid, based on the percentage of shares an individual holds. This section further goes on that a company is limited by guarantee when owners of the company agree to share the liabilities of the company through a mutual agreement. However, if a limited company is incorporated, then the owners of the company are not responsible for the various debts of the company. The provision contained in the CA 2006 protects them against any liability10. However, the question that usually emanate is who should be responsible for paying the debts that the company incurs. The normal standard established for identifying the person who should pay the debts of a business organization is to identify an individual who had the capability of easily and cheaply preventing the debts of the business organization from occurring. On this basis, the right people to be responsible for the debts of the organization are the shareholders of the company. This is because they are the people who have the capability of influencing the decisions of the directors, and the policies that these directors make. Scholars argue that it is therefore not prudent for the creditors of the organization to be responsible for its debts and liabilities, and this is because they have little influence on the costs of investments incurred by the company11. However, scholars denote that the principles of externalization of costs are what are guiding the formation and operations of a limited company12. Under this principle, an individual responsible for generating costs of the organization is not under the obligation of paying the debts that arise from these costs13. On this basis, if the debt of the company exceeds the total value of assets, then the debts under consideration will be incurred by the creditors of the company. The creditors under target are the ones whose debts have not been satisfied through the sale of the company’s assets. Scholars denote that this transfer is justified, based on the requirements established by CA 2006 that the accurate financial statements of a limited company must always be made public14. For instance, CA 2006 (82.1b and c) denotes that it is the responsibilit6y of a limited company to disclose information pertaining to their business operations. It is important to understand that this includes information that touches on the financial position and capability of the limited company15. CA 2006 (82.1c) further denotes that a limited liability company must provide any information that its stakeholders request it to provide. Stakeholders of a company include shareholders, and creditors of a company. Based on these provisions of the law, scholars denote that parliament is justified to pass over the debts of a company to creditors who are unable to recover their debts through the sale of a company’s assets16. This is because, before these creditors are able to make any financial dealings with the company, they are supposed to check the financial records of the organization, and judge whether the organization under consideration has the capability of paying their debts, and meeting its financial obligations. Because of treating a company as a legal entity, the concept of lifting the corporate veil has emerged. It is important to understand that the principles established in the 1897 case of Salomon vs. Salomon have never been challenged, however, under some circumstances, the courts may fail to honor the principles established in this case, and hence make the shareholders and owners of a limited company to be liable for the debts accrued by the company. This is a concept referred to as lifting the corporate veil. However, it is important to understand that cases where the courts allowed this principle to be established are always difficult to predict, and they do not establish a clear set of principles that can be used by parties that are seeking the lifting of a corporate veil, against particular shareholders of a company. Most creditors of an organization argue that it is unjustifiable for parliament to enact laws that would shield shareholders from the liabilities of the company. This is because shareholders would benefit from the operations of the business if it becomes successful, that is in terms of sharing the profits of the organization. On this basis, shareholders must also be willing to partake the risks that the organization might face, and this includes paying the debts of the company17. The 1990 Adams vs. Cape Industries is a common law principle that establishes circumstances when the courts can lift the corporate veil. In this case, Adams wanted to ignore the concept of a separate legal person of a parent company, referred to as Cape plc and that of its subsidiary company. On this basis, Adams wanted to make the parent company, to be liable to the activities and debts of its subsidiary company. However, the courts ruled that it does not have the ability to disregard the principles established under Salomon vs. Salomon, but the corporate veil can be lifted under the following three justifications, agency, façade, and a single economic unit18. In this case, the courts established that for a corporate veil to be lifted, the claimant must provide a proof that there was an express agency. This concept of agency was also established by the House of Lords in their ruling, in the case of Salomon vs. Salomon19. An establishment as a single economic unit also emerged in this case. The court ruled that Adams had to prove that the subsidiary company of Cape plc had a single economic interest with plc, i.e. the companies were the same. Failure to prove this, the court ruled that they were unable to lift the corporate veil, and on this basis, the principles established in Salomon vs. Salomon stands20. Finally, the corporate veil can be lifted, when the limited company gives out false information, or fails to declare its financial obligations. On this basis, the courts ruled that a claimant can seek for the lifting of the corporate veil, and hence go for the individual personalities who control the affairs of the company. In conclusion, this concept of incorporation is a noble idea that parliament developed for purposes of protecting entrepreneurs from the liabilities of their companies. Under this concept of incorporation, a company acquires a separate legal entity, as opposed to that of the owners of the company under consideration. On this basis, creditors cannot claim the assets of the owners of the company, but they will claim the assets of the company, in case of insolvency, or bankruptcy. It is important to denote that several case laws, such as that of Salomon vs. Salomon provide a justification for the use of this principle of incorporation. A law that is widely used to create an incorporated company is the company’s act of 2006. This act gives a detailed analysis of this aspect of incorporation, and the various roles of the directors of a company. Bibliography: B Nicholas, Bourne on company law (6th ed. 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