2 Company law: company formation and management

 

 

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2

Company law: company
formation and management

1

Reading A: Introduction to company law

This text provides an introduction to the key terms used when talking about companies as
legal entities, how they are formed and how they are managed. It also covers the legal duties
of company directors and the courts’ role in policing them.

Read the text below quickly, then match these phrases (a–f) with the paragraphs (1–6).

a directors’ duties
b management roles

c company definition
d company health

e partnership definition
f company formation

1 A company1 is a business association which has the character of a legal person,
distinct from its officers and shareholders. This is significant, as it allows the
company to own property in its own name, continue perpetually despite changes in
ownership, and insulate the owners against personal liability. However, in some
instances, for example when the company is used to perpetrate fraud or acts ultra
vires, the court may ‘lift2 the corporate veil’ and subject the shareholders to
personal liability.

2 By contrast, a partnership is a business association which, strictly speaking, is

not considered to be a legal entity but, rather, merely an association of owners.
However, in order to avoid impractical results, such as the partnership being
precluded from owning property in its own name, certain rules of partnership law
treat a partnership as if it were a legal entity. Nonetheless, partners are not
insulated against personal liability, and the partnership may cease to exist if a
change in ownership occurs, for example when one of the partners dies.

3 A company is formed when a certificate of incorporation3 is issued by the

appropriate governmental authority. A certificate of incorporation is issued when
the constitutional documents of the company, together with statutory forms, have
been filed and a filing fee has been paid. The ‘constitution’ of a company consists
of two documents. One, the memorandum of association4, states the objects of
the company and the details of its authorised capital, otherwise known as the
nominal capital. The second document, the articles of association5, contains
provisions for the internal management of the company, for example shareholders’
annual general meetings6, or AGMs, and extraordinary general meetings7, the
board of directors, corporate contracts and loans.

4 The management of a company is carried out by its officers, who include a

director, manager and/or company secretary. A director is appointed to carry
out and control the day-to-day affairs of the company. The structure, procedures
and work of the board of directors, which as a body govern the company, are
determined by the company’s articles of association. A manager is delegated

1 (US) corporation
2 (US) pierce
3 (US) Generally no official certificate is issued;
companies are formed when the articles/certificate
of incorporation are filed (see footnote 4).

4 (US) articles of incorporation or certificate of incorporation
5 (US) bylaws
6 (US) annual meetings of the shareholders
7 (US) special meetings of the shareholders

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supervisory control of the affairs of the company. A manager’s duties to the company
are generally more burdensome than those of the employees, who basically owe a duty
of confidentiality to the company. A company’s auditors are appointed at general
meetings. The auditors do not owe a duty to the company as a legal entity, but, rather,
to the shareholders, to whom the auditor’s report is addressed.

5 The duties owed by directors to a company can be classified into two groups.

The first is a duty of care and the second is a fiduciary duty. The duty of care
requires that the directors must exercise the care of an ordinarily prudent and
diligent person under the relevant circumstances. The fiduciary duty stems from
the position of trust and responsibility entrusted to directors. This duty has many
aspects, but, broadly speaking, a director must act in the best interests of the
company and not for any collateral purpose. However, the courts are generally
reluctant to interfere, provided the relevant act or omission involves no fraud,
illegality or conflict of interest.

6 Finally, a company’s state of health is reflected in its accounts1, including its
balance sheet and profit-and-loss account2. Healthy profits might lead to a
bonus or capitalisation issue3 to the shareholders. On the other hand, continuous
losses may result in insolvency and the company going into liquidation.

1 (US) financial statements
2 (US) profit-and-loss statement or income statement
3 (US) stock dividend

2

Key terms: Roles in company management

2.1 Some of the important roles in company management are discussed in Reading A

above. Which roles are mentioned?

2.2 Here is a more comprehensive list of roles in company management. Match the roles

(1–10) with their definitions (a–j).

1 auditor
2 company secretary
3 director
4 liquidator
5 managing director
6 official receiver
7 promoter
8 proxy
9 receiver
10 shareholder

a person appointed by a shareholder to attend and vote at a meeting in

his/her place when the shareholder is unable to attend

b director responsible for the day-to-day operation of the company
c person elected by the shareholders to manage the company and decide

its general policy

d person engaged in developing or taking the initiative to form a company
(arranging capital, obtaining personnel, making arrangements for filing
corporate documentation)

e person appointed by the company to examine the company’s accounts

and to report to the shareholders annually on the accounts

f company’s chief administrative officer, whose responsibilities include

accounting and finance duties, personnel administration and
compliance with employment legislation, security of documentation,
insurance and intellectual property rights

g member of the company by virtue of an acquisition of shares
h officer of the court who commonly acts as a liquidator of a company

being wound up by the court

i person appointed by creditors to oversee the repayment of debts
j person appointed by a court, the company or its creditors to wind up the

company’s affairs

Unit 2 Company law: company formation and management

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3

Listening A: Company formation

Lawyers play important roles in the formation of a company, advising clients which entities
are most suited to their needs and ensuring that the proper documents are duly filed.

You are going to hear a conversation between an American lawyer, Ms Norris, and her client,
Mr Herzog. The lawyer describes how a specific type of corporation is formed in the state of
Delaware.

3.1 (cid:59)(cid:210)Listen to the conversation and tick the documents required for formation that the

lawyer mentions.

1 DBA filing
2 articles of incorporation
3 stock ledger
4 general partnership agreement
5 stock certificates
6 IRS and State S Corporation election
7 bylaws
8 organisational board resolutions

3.2 (cid:59)(cid:210)Listen again and answer these questions.

1 According to the lawyer, what is the advantage of incorporating an entity in the

state of Delaware?

2 What information is included in the articles of incorporation?
3 What happens at the first organisational meeting of a corporation?

3.3 Company types (USA) Look at this table, which provides information on the

documents required to form and operate the different company types in the United
States. Based on what you heard in Exercise 3.1, which type of business association
was the lawyer discussing with her client?

US entities

sole proprietorship

general partnership

limited partnership

C corporation

S corporation

Documents required for formation and operation

DBA fi ling

General Partnership Agreement, local fi lings if partnership holds real estate

Limited Partnership Certifi cate, Limited Partnership Agreement

Articles of Incorporation, Bylaws, Organisational Board Resolutions,
Stock Certifi cates, Stock Ledger

Articles of Incorporation, Bylaws, Organisational Board Resolutions,
Stock Certifi cates, Stock Ledger, IRS and State S corporation election

3.4 Company types (UK) The table on the next page contains information about five
types of common UK business associations, covering the aspects of liability of
owners, capital contributions and management. (In many jurisdictions in the world,
there are entities which share some or all of these characteristics.) Look at the table
and decide which entity (a–e) is being described in each row (1–5).

a private limited company (Ltd)
b general partnership
c public limited company (PLC)
d limited partnership
e sole proprietorship

22

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Entity

Liability of owners

Capital contributions

Management

1) ……

2) ……

3) ……

4) ……

5) ……

Unlimited personal liability for
the obligations of the business.

Capital needed is contributed by
sole proprietor.

Business is managed by the sole
proprietor.

Generally no personal liability of
the members for obligations of
the business.

No minimum share capital
requirement. However, capital
can be raised through the
issuance of shares to members
or through a guarantee.

Company is managed through
its managing director or the
board of directors acting as a
whole.

No personal liability; liability is
generally limited to shareholder
contributions (i.e. consideration
for shares).

The minimum share capital
of £50,000 is raised through
issuance of shares to the public
and/or existing members.

Company is managed by the
board of directors; shareholders
have no power to participate in
management.

Unlimited personal liability of
the general partners for the
obligations of the business.

Partners contribute money or
services to the partnership; they
share profi ts and losses.

The partners have equal
management rights, unless they
agree otherwise.

Unlimited personal liability of
the general partners for the
obligations of the business;
limited partners generally have
no personal liability.

General and limited partners
contribute money or services
to the limited partnership; they
share profi ts and losses.

The general partner manages
the business, subject to any
limitations of the Limited
Partnership Agreement.

4

Reading B: A memorandum of association

An important document in company formation is the memorandum of association (UK) or
articles/certificate of incorporation (USA). This document sets forth the objects of the
company and its capital structure; as such, it represents a legally binding declaration of
intent to which the members of the company must adhere.

4.1 Below is an extract from the articles of incorporation of a US company. Read through

the extract quickly and tick the issues it addresses.

1 appointing members of the board of directors
2 changing corporation bylaws
3 procedures for holding a vote of the shareholders
4 stipulations for keeping corporation records

5

10

The power to alter, amend or repeal the bylaws or to adopt new bylaws shall be vested in the Board
of Directors; provided, however, that any bylaw or amendment thereto as adopted by the Board of
Directors may be altered, amended or repealed by a vote of the shareholders entitled to vote for the
election of directors, or a new bylaw in lieu thereof may be adopted by vote of such shareholders.
No bylaw which has been altered, amended or adopted by such a vote of the shareholders may be
altered, amended or repealed by vote of the directors until two years shall have expired since such
action by vote of such shareholders. […]

The Corporation shall keep as permanent records minutes of all meetings of its shareholders and
directors, a record of all action taken by the shareholders or the directors without a meeting, and a
record of all actions taken by a committee of the directors in place of the Board of Directors on
behalf of the Corporation. The Corporation shall also maintain appropriate accounting records.
The Corporation, or its agent, shall maintain a record of its shareholders in a form that permits
preparation of a list of the names and addresses of all shareholders, in alphabetical order, by class
of shares, showing the number and class of shares held by each.

Unit 2 Company law: company formation and management

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4.2 Read the extract again and decide whether these statements are true or false.

1 The board of directors only has the power to change the bylaws if the shareholders

in turn have the power to amend any changes made by the board of directors.
2 The board of directors is proscribed at all times from changing any bylaw which

has been altered by a vote of the shareholders.

3 Records must only be kept of decisions reached by shareholders and

directors in the course of a meeting.

4 Records of the shareholders must list the number

of shares they own.

proscribe
= prohibit, ban
prescribe
= stipulate

4.3 For each of these words or phrases, find the italicised word(s) in the extract that

most closely matches its meaning.

1 passed
2 who have the right to

3 instead
4 on condition

5 cancelled
6 revised

7 given to
8 these

5

Language use: Shall and may

Read through the extract on page 23 again, noting how shall and may are used, and
answer these questions.

1 Which of these words most closely matches the meaning of shall in each case?
a) will
2 What do you notice about the use of shall in line 6?
3 Which of these words most closely matches the meaning of may in the text?
a) can

b) could

b) must

In legal documents, the verb shall is mainly used to indicate obligation, to express
a promise or to make a declaration to which the parties involved are legally
bound. This use differs from that in everyday speech, where it is most often used
to make offers (Shall I open the window?) or to refer to the future (I shall miss
you), although this latter use is less frequent in modern English.

In legal texts, shall usually expresses the meaning of ‘must’ (obligation):
Every notice of the meeting of the shareholders shall state the place, date and hour.
or ‘will’ (in the sense of a promise):
The board of directors shall have the power to enact bylaws.
Shall can also be used in legal texts to refer to a future action or state:
… until two years shall have expired since such action by vote of such
shareholders.

In everyday speech, this future meaning is commonly expressed using only the
present perfect (… until two years have expired …).

Another verb commonly found in legal documents is may, which generally expresses
permission, in the sense of ‘can’ (this use is less common in everyday English):

… any bylaw or amendment thereto as adopted by the Board of Directors may be
altered, amended or repealed by a vote of the shareholders.

In everyday English, may is sometimes used as a substitute for might, indicating
probability (He may want to see the document).

Learners of legal English should be aware that the use of shall in legal texts has been
criticised in recent years, particularly with regard to what some consider its inconsistent

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and excessive use. Language reformers point out that in many instances, shall does
not express obligation, but rather is used solely to give a text a ‘legal feel’. This
tendency, which can in part be attributed to the conservative nature of legal writing,
can lead to undesirable consequences, ranging from legal disputes arising from the
ambiguous use of shall in contracts to difficulties in translating English-language
legislation into other languages. Furthermore, the fact that shall is often used in legal
texts in ways which differ from general English usage serves to make these texts harder
to understand and less transparent to the average person. For this reason, supporters
of the Plain English Movement even recommend replacing shall with must to express
obligation (see Unit 3). At the very least, learners of legal English should know about
the issues surrounding the use of shall and exercise care when writing.

6

Listening B: Forming a business in the UK

You are going to hear a phone conversation in which a lawyer, Mr Larsen, discusses some of
the characteristics of two business entities with Mr García, a client who is interested in
forming a company in the UK.

6.1 (cid:59)(cid:210)Listen to the phone conversation and decide whether these statements are true

or false.

1 The client has not yet decided what type of company he wants to form.
2 The client has never founded a company before.
3 The lawyer points out that the two types of company differ with regard to the

matter of personal liability.

4 The shares of a US C corporation can be freely traded on a stock exchange.
5 Both company types mentioned by the lawyer can be formed by a person who is a

citizen of another country.

6 The UK company type discussed places a restriction on the number of people

permitted to buy shares in the company.

7 The fastest way to form a company is to submit the documents directly to

Companies House.

6.2 In the conversation, the lawyer compares and contrasts two company types.
Complete the sentences below (1–4) using the phrases in the box (a–d).

a are like each other

b are similar to

c differs

d in both

1 C corporations ………… private limited companies in the UK in many ways,

particularly in respect of liability.

2 Shareholders are not personally liable for the debts of the corporation ………… a

C corporation and a private limited company.

3 In this respect, a private limited company …………. . Its shares are not available to

the general public.

4 The two types of company ………… in that both can be founded by persons of any

nationality, who need not be a resident of the country.

6.3 Compare and contrast two types of company from the table on page 23 using these

phrases.

X differs from Y in that …
X resembles Y in that …

EXAMPLE: A sole proprietorship differs from a private limited company in that it is managed by the sole

proprietor rather than by a managing director or a board of directors.

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7

Speaking: An informal presentation: a type of company

When speaking briefly about a topic of professional interest, experienced speakers
will organise their thoughts in advance. A simple but effective structure divides
information into three parts:

1 introductory remarks

2 main points

3 concluding statement

The main points are also best limited to three, as this is easy to remember.
Notes for a response to the exercise below might look like this:

Introductory remarks
A publikt aktiebolag is the closest Swedish equivalent to a public limited company –
most common form for major international businesses in Sweden.

Main points
1 liability: no personal liability
2 management: board of directors (Swedish equivalent, styrelsen) has power to

make decisions; shareholders don’t participate in management

3 needed for formation: memorandum of association (stiftelseurkund) and articles

of association (bolagsordning)

Concluding statement
An aktiebolag is similar to a public limited company, with the most significant
difference being that its shares do not need to be listed on an exchange or
authorised marketplace.

Which types of companies are there in your jurisdiction? Choose one and describe it as
you would for a client from another country. In your description, refer to some of the
features given in the UK company table on page 23. Tell your client which documents
must be filed to complete the formation process. Wherever relevant, compare and
contrast your company type with a UK business entity.

8

Reading C: Russian entity formation

Law firms often publish informative articles on their websites which they believe will be of
interest to their clients. Typically, these articles deal with areas of the law in which the firm
has particular expertise. The text on the next page, which appeared on the website of a US
law firm, deals with entity formation in Russia, and contrasts a Wholly Foreign-Owned Entity
(WFOE) with a representative office.

8.1 Read the first paragraph. Which three types of business enterprise are mentioned?
8.2 Read through the entire article and decide whether these statements are true or false.

1 The option of forming a WFOE to do business in Russia has existed for many years.
2 Establishing a representative office is not recommended for merchants unless

they are primarily interested in engaging in marketing activities.

3 Since an OOO has the status of a legal person, it is fully liable for its own

obligations, and the foreign entity is free from all liability.

4 Regarding employee permits, the same requirements apply for both business types.
5 The tax and reporting requirements connected with a WFOE are disadvantages

that should be weighed against the advantage it offers with regard to the freedom
to carry out business in Russia.

8.3 Is there a comparable WFOE in your jurisdiction? Describe its features with regard to

the points listed in the table in the article.

26

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One of the most common requests our law firm gets regarding Russia comes from a non-Russian company
seeking assistance in setting up a Russian joint venture or a representative office. When we tell them in response
to their queries that only rarely does it make sense to go into Russia with a joint venture or a representative
office, they commonly respond either with surprise that there are other alternatives or by telling us that this is
how their very well-run competitor entered the Russian market. When we explain that Russia now allows
Wholly Foreign-Owned Entities (WFOE), they quickly realise the benefits of not getting enmeshed with a Russian
joint-venture partner. However, the benefits of a WFOE over a representative office are more difficult to explain.
The purpose of this article and the accompanying table is to briefly compare the advantages and disadvantages
of a representative office and of a limited liability company (known as an Obschtschestvo s Ogranitschennoj
Otvetstvennostju, or OOO) wholly owned by a foreign entity in terms of those characteristics that are relevant for
companies interested in establishing and running a business in Russia. At the outset, however, it must be made
clear that if your intention is to buy or sell goods in Russia, you cannot legally go in as a representative office.
A representative office is limited to representing or marketing for a foreign-owned entity. In the past, many foreign
companies would go into Russia by way of a representative office and then conduct business within Russia, but
only because they had no other real choice. Companies have that choice now.

Comparison

Representative office

Limited liability company (OOO)

Legal status

Not an independent legal entity.
All property would be owned by
the foreign (non-Russian) entity.
Not allowed to conduct commercial
activity, so it doesn’t technically
generate profits. Limited to
negotiating contracts, marketing or
conducting other supporting
activities for the foreign entity.

Can act only through a manager authorised to
act for and on behalf of the foreign entity
pursuant to power of attorney. All the rights of a
Russian company. Managing director elected by
the foreign company can act on behalf of OOO
without a power of attorney within the framework
provided by Russian legislation, OOO corporate
documents and agreements concluded between
OOO and the director.

Liability

Foreign entity would be liable for
acts of its representative office
done pursuant to the power of
attorney.

OOO is liable for its own obligations. The
foreign entity’s liability generally limited to its
contribution to charter capital.

Charter capital

None

Approximately $330 minimum charter
capital required

Fees and costs

$10,000–$18,000

$3,500–$6,500

Foreign employee
issue

Foreign employees must obtain
personal work permit.

Taxation

Subject to payroll, retirement, road
and social security taxes.

In order to employ foreign employees, a
company must obtain an employment permit.
Afterwards, every foreign employee must
obtain a personal work permit.

Subject to same taxes at same rates as
representative office, but also subject to
income tax, VAT (e.g. equipment shipped for
sale to Russia is subject to VAT), property
taxes and transportation taxes (if OOO owns
vehicles). The foreign entity dividends
received from OOO may be subject to either
US or Russian taxation according to the
Treaty signed between USA and Russia
regarding double taxation.

In the course of deciding whether to establish a representative office or a WFOE, the investor must balance the
convenience of a representative office with the ability to conduct business in Russia through a WFOE. A representative
office in Russia can be opened and closed with relatively little formality. Since the office is not a Russian legal person,
it is not subject to many of the burdensome regulations that apply to legally established Russian companies, such as
tax and reporting requirements. However, the business activities of a representative office are severely restricted, to
the point that it usually can do little more than act as a company’s marketing arm in Russia. On the other hand, a
WFOE entity in Russia is considered to be a legal person, and as such, it enjoys both the rights and obligations of
any other Russian company. Thus the scope of business operations for a WFOE in Russia is nearly always equivalent
to that of any other Russian company. But a WFOE in Russia is also subject to the same taxation, reporting and
company regulation requirements of any Russian company. The burden of these obligations for a WFOE must be
balanced against the freedom to conduct real business in Russia.

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