INVESTING IN A COMPANY

I.                   Incorporation: To register as a company, a person must officially claim for an application with ASIC (Australian securities and investment commission), the registration form must comply with s 117 which contains the contents of the application.

·         When? A company comes into existence as a “body corporate” at the beginning of the day on which it is registered. The company’s name specified in the certificate of registration. s 119

·         Who must incorporate? Corporation with 20 or more members that has the object of gaining for itself or for any of its members must form the company.S115

·         A body corporate is an artificial legal person as opposed to individuals, who are known as natural person.

II.                Effects of incorporation/ Characteristics of a company:

1)      A company has legal capacity and powers of an individual and a body corporates124

2)      Separate legal entity: once registered, a company becomes a “legal person” recognized by law. It is a legal entity that is separate and distinct from those who have incorporated it.  It is able to own property, enters contract, sue and be sued, and has responsibilities for its own debts all in its own name. Any contracts entered by the company will create rights and liabilities that vest in the company and not in its members. Salomon’s case [1897] AC 22

·         Salomon’s case [1897] AC 22: Salomon was a boots manufacturer.  He formed a proprietary company, in which the shareholders were himself, his wife and his sons.  In effect, the company was a “one man company”. Salomon held 20,001 of the total 20,007 shares. Business began to struggle; Salomon lent his personal money to the company.  The company issued debentures to Salomon, which is a document acknowledging the debt. The debt was secured by a charge over the property of the company. Company eventually failed, went into liquidation. Liquidators argued that Salomon’s entitlements should be postponed to the unsecured creditors. Salomon gets priority over unsecured creditors. Even if the company is controlled by one person, it is still a separate legal entity.  So Salomon and the company are two different persons.  Members of the company may obtain limited liability; and also at the same time obtain priority as a secured creditor.

·         Lee v Lee’s Air Farming: Lee and Lee’s company are separate legal entity, Lee is employee of Lee’s company, therefore, his wife can claim for compensation for his death under insurance contract.

·         McCaura v Northern Assurance [1925] AC 619:McCaura and his company are separate legal entity, and he has no insurable/proprietary interest as he already sold the wood to the co., the owner of property is now McCaura’s company, therefore, the Northern Assurance does not have to pay for destruction of wood by fire.

·         Lifting/ piercing the “corporate veil”: this is an exception of principle “separate legal entity”, which makes a person other than company liable for company’s contractual obligations, or allows a person other than the company entitled to exercise some of the company’s right. 

I: The legal issue here is whether the court can lift the “corporate veil” to make Plasto 2 Pty ltd.liable for damage caused by Plasto Pty Ltd to customers.

R: According to Salomon’s case [1897] AC 22, the rule applicable here is that Plasto and Plasto 2 are two separate legal entities, which means Plasto is able to own property, enters contract, sue and be sued, and has responsibilities for its own debts all in its own name, therefore, Plasto 2 Pty ltd has no legal obligation to damages caused by Plasto.

a)      LIFTING CORPORATE VEIL BY COMMON LAW:

R: However, there are certain exceptions where unfair consequences could occur when a company is created as a sham to avoid legal obligations. The court can “lift” the “corporate veil” making a person other than the company liable for the company’s contractual obligations. Basing on decisions made in the case

·         Gilford Motor v Horne [1933] CH 935:Horne used his company as a sham to avoid his contractual obligation under employment contract which is not to solicit business from customers of Gilford Motor

·         Creasy v Breachwood Motors Ltd (1992): the “phoenix company” – Breachwood take all assets of the old company – Welwyn, but not the liabilities, is used as a sham to avoid Welwyn’s debts toward Creasy =>Breachwood must honour the legal obligations of the original company.

·         Green v Bestobel 1982: Green breached fiduciary duty as a director to help Bestobel win the tender by taking away business opportunity from Bestobel, his own corporation knowingly and participated on Green’s breach of duty must pay Bestobel profit it derived.

A: In this case, Plasto’s low-quality products cause considerable damages to no. of customers, and is binding to pay for all damages caused by the products. Fearing that Plasto would lose in court against the customers, Plasto 2 is created and all assets are transferred to the new company leaving the old company no money and assets to pay for the customer’s claim. Plasto 2 is just a “phoenix company” and in fact is operated by 2 directors John and Peter the same way as Plasto; thus, the two are pretty much the same.

C: as a consequence, the corporate veil between Plasto and Plasto 2 could be lifted in this case and the court would require Plasto 2 to be liable for debts of the original company – Plasto.

b)     LIFTING CORPORATE VEIL BY STATUTE:

R: However, according to s 588G of the Corporation Act, directors can be personally liable for company’s debts if they fail to prevent the company from incurring those debts at the time knowing or having reasonable ground to suspect that the company is insolvent.

A: In this case, John and Peter as directors allow the company to engage in “insolvent trading” by transferring all assets of Plasto to their new company, this would lead to the company being so insolvent if the customers took legal actions against it. Both of them were aware that Plasto could be liable for customers’ claim and incurred debts but they did not do anything to avoid it, and even left the company with no money and assets to pay its debt.

C: Therefore, the corporate veil is lifted and John & Peter are personally liable for Plasto’s debt because they breached duty contained in s588G

·         Requirements for contents of financial report SS295(2) (b) &AASB 127: financial reports must

ü  Comply with accounting standards set by Australian Accounting Standards Board.

ü  Exception of separate legal entity: group/ holding (parent) company & subsidiaries, these companies are separate legal entities but they relate to each other.

ð  Financial reports are prepared by parent company, which is an exception because each company is supposed to responsible for their own finance and submitting financial reports to the government.

·         SS 153 – 155:A.C.N must be displayed on its common seal and on all its public documents and negotiable instruments, A.C.N – Australian company number, which is a nine-digit number allocated by ASIC upon the company’s registration.

3)      Limited liability: shareholders are not personally liable for their company’s debts.

·         The liability of shareholders of a company limited by shares is limited to the amount, if any, unpaid on the issue price of their shares. Shareholders who own fully paid shares have no further liability to pay further amounts to the company.

·         Holders of partly-paid shares are contractually obligated to pay “calls” on those shares until the price is fully paid s254M.

4)      Other characteristics:

·         Sue and be sued in its own name

·         May be sued by its own members Foss v Harbottle [1843]

·         Perpetual succession: death or incapacity of members does not affect the co.

·         Common seal: optional, no need to use seal to bound a contract

·         Ownership of assets:

ü  Separate from members

ü  Members only own shares & have no proprietary interest in the property of the company.

ü  Change in membership has no effect on co’s assets.

III.             Types of companies: Companies limited by shares

·         All Australian companies need to have at least 1 shareholder s114

	1)      Private (Proprietary) companies: ·         Have no more than 50 non-employee shareholders s113(1) ·         Not engage in activity which requires disclosure under Ch 6D – e.g. invite the public to subscribe for shares s113(3) ·         In the company name: Pty Ltd. S148(2) ü  Pty: proprietary (small business) – the proprietary company does not have to disclose lots of financial information with ASIC& has no obligation to tell other people about profit & loss, no need for auditors to come and check financial statements.	2)      Public companies: ·         Require public funding, more disclosure requirements from Corporation Act and ASX listing rules to protect investors. ·         No restriction for no. of shareholders. ·         In the company name: Ltd S148(2) ü  Ltd: limited liability – to inform anybody doing business with the company, that they can only sue the company not the shareholders/ directors unless there is any way to lift corporation veil.
Directors & Secretary	·         Minimum of 1 director resident in Australia s201A(1) ·         No requirement for secretary s204A	·         Minimum of 3 directors, 2 must reside in Australia s201A(2) ·         Restriction: min. age is 18 to be appointed as a director s201B(1) ·         Director must be appointed and removed by resolutions of members s203Dnot by other directors s203E ·         Minimum of one secretary, at least one residing in AU.
Meetings	·         AGM is not required by law unless written in Constitution. ·         Can pass resolution without a general meeting as long as all shareholders sign and agree.	·         Hold annual general meeting within 18 months after its registration s250N(1) ·         Hold AGM once a year s250N(2) ·         A public comp. with only 1 member is not required to hold an AGM s250N(4)
Auditors	·         Large prop. must appoint independent auditor ·         Small prop. must only prepare audited financial reports if: ü  Requested by ASIC ü  5% of shareholders ü  Auditor need not be independent s324CH	Appoint independent auditor
Large and small prop company	Public company would try to avoid disclosing their financial information, by setting up subsidiaries which are proprietary co. (loophole). In order to close the loophole, proprietary co is divided into large and small. ·         Small proprietary company: s45Aif two of three criteria are met: ü  consolidated gross operating revenue for the financial year is less  than 25 million ü  value of gross assets less than 12.5 million ü  Fewer than 50 employees. ·         Large proprietary company: same disclosure requirements as public company.

IV.             Rules governing internal management: A company’s internal management may be governed by replaceable rules or by constitution or by both.

Constitution and Replaceable rules (RR): each company needs a set of rules for how company is going to be managed inside the company. These rules deal with such matters as:

ü  What power are directors going to have (CDO: all the power)

ü  What can shareholders vote for

ü  Types of shares

ü  Rights of shareholders to dividends.

·         All companies must have one: constitution or RR (table in s141) or combination of boths134.

·         A company may be formed with a constitution that replaces or modifies any one or all of replaceable rules s135 (2)

·         Some replaceable rules apply only to proprietary companies. S135

·         Some rules are replaceable rules for Pty Ltd co. but mandatory for Ltd. co.

·         RR:  s.1072G prop co directors have the power to refuse to register a transfer of shares for any reason.

·         Single director/shareholder need not have formal constitution or RR s135, s198E, s201F, s202C

V.                Separation of management and ownership:

·         There is usually a separation of management from ownership, especially in larger companies.  Institutional investors (Life Insurance Company, banks, and investment companies) hold more than 80% of the shares in listed companies; they have a stronger influence than individual investors.

·         Corporate governance(the rules, processes, or laws by which businesses are operated, regulated, and controlled) and the role of the board of directors

ü  Rules, practices, checks and incentives to ensure management act in the interest of shareholders

ü  Also addresses roles, functions and structures of the board and its relationship to management

ü  Accountability

ü  How objectives and policies are set and achieved, how risk is monitored, and assessed, how performance is optimised.

VI.             Shares: every company has legal capacity to issue shares s124. The Corporation Act 2001 also gives companies power to allot shares with different kind of rights s254B

1)      Sources of capital

·         Share capital also called “equity capital” – major source of funds for companies

·         Loan capital - borrowing

2)      Nature of Shares

·         A Share is an item of intangible property.  Ownership of a share gives the shareholder proprietary rights as defined by the Constitution and the law.

·         Just like tangible property (such as real estate), shares can be bought and sold, left by will and given as security

3)      Issue of shares

·         Contract law Rules

·         Applicant makes the offer by sending in the application form (attached to disclosure documents) AND payment;

·         Usually the application form says that applicant agrees to take applied number OR lesser number.

·         Co accepts the offer, by allotting shares to the applicant;

·         Postal Rule: acceptance is at the time of post;

·         Offer will lapse if not accepted within a reasonable time.

·         Consideration can be either cash OR other than cash (Re Wragg Ltd 1897), e.g.  Assets sold by a partnership to a newly formed Pty co, to convert partners into shareholders; but NOT past services (Rationale:  consideration is important because Corps Act wishes to ensure that issued capital is a meaningful indicator of funds available to creditors).

4)      Classes of Shares

a)      Co can issue different classes of shares for reasons such as

ü   fixed dividend – like a loan

ü  retain control (limit voting rights)

ü  tax advantage

b)     Most common classes : ordinary and preference

	Preference shares	Ordinary shares
Rights of shareholders	·         s. 254A (2) &s.254G (2) – co must set out in its constitution or special resolution – the rights of preference shareholders. ·         more similar to external creditors ·         Preferential right to receive dividend, usually at fixed percentage of issue price ·         Preferential right to be repaid capital if co is wound up ·         Restricted voting rights (e.g. only vote on a proposal to wind up; reduce capital).	·         Rank after the holders of preference shares.  ·         Dividends can only be paid out of profits (s 254T) so ordinary shareholders won’t get dividends if no profit is made.
Types of preference shares	ü  Participating PS: investor that has an entitlement to receive additional dividends over and above the preferential entitlement. ü  Cumulative PS: if any dividends have been omitted in the past, they must be paid out to preferred shareholders first ü  Converting PS: Preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares. The term of issue will require conversion at the expiration of a certain period. ü  Redeemable PS: can be redeemed at a certain of time at option of company or shareholder or both s254A(3).Investor can recover the capital that was invested in the company, but they can only receive a return on investment if company is profitable s254K