Company Law: Introduction to Companies And Company Law

Company Law: Introduction to Companies And Company Law

The exact scope of company law is difficult to define, on account that the laws of Kenya do not define the term in testament to the words of Buckley J in Re: Stanley (1906)

“The word company has no strict legal meaning…”

However, section 3 (1) of the Companies Act, No. 17 of 2015 (The Companies Act) it is provided that a company refers to:

“A company formed and registered under this Act [the 2015 Companies Act of Kenya] or an existing company [one incorporated under a pre-existing or other statute e.g. CAP 486]”

This definition fails to identify the attributes of the company as it only describes a registered company i.e. a company incorporated by registration.

A company may also be defined as an association of many persons who contribute money or money’s worth to a common stock and who employ it to a common purpose. Regrettably, this explanation fails to distinguish a company from a partnership.

In common law, a company is a ‘legal person’ or ‘legal entity’ separate from, and capable of surviving beyond the lives of its members. Like any juristic person a company is legally an entity apart from its members, capable of rights and duties of its own, and endowed with the potential of perpetual succession.

However, ‘a company’ is not merely a legal institution; it is also a legal device for the attainment of any social or economic end, and to a large extent has public and social responsibility.

 

The Historical Evolution of Companies

This is traceable to early forms of business associations created by the Romans in the early 13^th Century.

However the company as a form of business organization emerged during the mercantile era due to 2 reasons:

1. The need for large scale investments and large scale production to satisfy the market demand, as a result of which, traders were in dire need of a commercial device that could facilitate the raising of capital on a large scale basis.

 

1855. The need to limit the liability of investors for debts and other liabilities from the association. This was realized by the Limited Liability Act of 1855.

Members contribute money or money’s worth to a common stock. The money is put together by the members and is employed to a common purpose.

Under the Kenyan law, companies are only one of the various forms of recognized business associations.

 

TYPES OF COMPANIES

Although company law is concerned with registered companies our Kenyan law recognizes other corporations which shares attributes similar to those of the registered company.

1. Corporations Sole.

This is a legally established office distinct from the holder and can only be occupied by one person after which he is succeeded by another. It is a legal person in its own right with limited liability, perpetual succession, capacity to contract, own property and sue or be sued. E.g. include the Office of the Public Trustee and the Office of the Principal Secretary to the National Treasury.

2. Corporations Aggregate                                                                                                            This is a legal entity formed by two or more persons for a lawful purpose and whose membership consists of at least two persons. It has an independent legal existence with limited liability, capacity to contract, own property, sue or be sued and perpetual succession. E.g. public and private companies.

 

3. Registered Corporations

These are corporations created in accordance with the provisions of Companies Act. Certain documents must be delivered to the Registrar of companies to facilitate registration of the company.  E.g. memorandum of association, Articles of association, statement of nominal capital.  Examples of registered corporations are; public and private companies

4. Statutory Corporations

These are corporations created by Acts of Parliament or an order of the President in accordance with the provisions of Section 3 (1) of the State Corporations Act (Cap 446).

A state corporation is a legal person with perpetual succession. In case of a corporation created by an Act of Parliament, the Act gives it a name, management structure and prescribes the objects. E.g. Kenya Wildlife Services, Agricultural Finance Corporation, Public Universities, Central Bank etc.

Statutory corporations have the following characteristics:

1. No shareholders
2. Initial capital provided by the National Treasury
3. It is expected to operate according to commercial principles and make profit
4. If it makes profits and becomes unable to pay debts, its property can be attached by its creditors but it cannot be wound up on the application of any creditor. The Central Government come to its aid.
5. It can only be wound up on the repeal or revocation of the enabling Act which created it.

 

5. Chartered Corporations

These are corporations created by a charter granted by the relevant authority. The charter constitutes the association a corporation by the name of the charter. E.g. Private Universities are chartered corporations under the Universities Act, Chapter 210 Laws of Kenya. To establish a private university, an application must be made to the Commission for Higher Education which forwards the same to the Cabinet Secretary for Education who in turn forwards the same to the President for the grant of a charter. The Charter must set out the name, membership, powers and functions of the University. Under Section 14 of the Universities Act, a private University becomes a legal person when the charter is published in the Kenya Gazette by the Cabinet Secretary in charge.

 

COMPANY LAW

This is the study of the rules and principles that governs and regulates the affairs of that which the law recognizes as a company.

Sources of Company law:

1. Companies Act 2015

It is an Act of Kenyan legislature and it came into operation in September 2015. The New Act has drawn heavily on the Companies Act, 2006 of the United Kingdom. At 1,026 sections running to over 1,600 pages (without schedules) the New Act is by far the most extensive piece of legislation on the statute books in Kenya. By comparison, the old Companies Act (Cap 486) had 406 sections covering 270 pages (which included a regime for corporate insolvency).

2. Common Law and Doctrines of Equity

Common law is a term that may refer to the English system of law as a whole when being contrasted with alternative systems of law.  It can also be used to refer to the rules of law which evolved over the years within the English jurisdiction through decisions by judges in court cases (judicial precedent)

Doctrines of equity are principles of justice and fairness which also evolved over the years within the English jurisdiction. They apply to company law in the same way as they apply to any other legal matter in the country.

Common law and doctrines of equity apply to Kenya by virtue of the section 3 of the Judicature Act Cap 8 Laws of Kenya

3. Precedents

These are judicial decisions made by the superior courts in Kenya and are binding on subordinate courts and the High court as well as the Court of Appeal when they originate from the Supreme Court.

To the extent that the decisions of superior courts relate to interpretation of company law, they guide the subordinate courts.

 

THE FOUNDATION OF COMPANY LAW

It is based on two fundamental principles:

1. Legal or corporate personality.
2. Theory of limited liability.

 

1. Legal or Corporate personality

This principle is set to the effect that when a company is registered it becomes a legal person separate and distinct from its members and managers. It acquires an independent existence with certain capacities and subject to incapacities. This principle was first formulated in the House of Lords in the matter of Salomon v. Salomon [1897] A C 22., where Lord Macnaghten was emphatic that the company is at law a different person altogether from the subscribers to the memorandum. In this case, Salomon was a prosperous leather merchant.  He sold his business to Salomon and Co. Limited which he formed for that purpose at the price of £39,000 satisfied by £1,000 in cash, £10,000 in debentures conferring a floating charge on the company’s assets and £20,000 in fully paid up £1 shares.  Salomon was both a creditor because he held a debenture and also a shareholder because he held shares in the company.  Seven shares were then subscribed for in cash by Salomon, his wife and daughter and each of his 4 sons.  Salomon therefore had 20,001 of the 20,007 shares in the company and each member of the family had 1 share as Salomon‘s nominees. Within one year of incorporation the company ran into financial problems and consequently it was wound up.  Its assets were not enough to satisfy the debenture holder (Salomon) and having done so there was nothing left for the unsecured creditors.  The court of first instance and the Court of Appeal held that the company was a mere sham an alias, agents or nominees of Salomon and that Mr. Salomon should therefore indemnify the company against its trade loss.

The House of Lords unanimously reversed this decision.

In the words of Lord Halsbury:

“Either the limited company was a legal entity or it was not.  If it was, the business belonged to 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.”

In the words of Lord Macnaghten:

“the company is at a law a different person altogether from the subscribers and though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them nor are the subscribers as members liable in any shape or form except to the extent and manner prescribed by the Act. … In order to form a company limited by shares the Act requires that a Memorandum of Association should be signed by at least two persons who are each to take one share at least. If those conditions are satisfied, what can it matter, whether the signatories are relations or strangers. There is nothing in the Act requiring that the subscribers to the Memorandum should be independent or unconnected or that they or anyone of them should take a substantial interest in the undertaking or that they should have a mind and will of their own. When the Memorandum is duly signed and registered the subscribers are a body corporate capable forthwith of exercising all the functions of an incorporated company…

… The company attains maturity on its birth. There is no period of minority and no interval of incapacity. A body corporate thus made capable by statutes cannot lose its individuality by issuing the bulk of its capital to one person whether he be a subscriber to the Memorandum or not.”

This principle is now contained in Section 19 of the 2015 Companies Act which provides inter alia:

“From the date of incorporation of a company the subscribers to the memorandum, together with such other persons as may from time to time become members of the company, become a body corporate by the name stated in the certificate of incorporation…”

The significance of the Salomon decision is threefold.

1. The decision established the legality of the so called one man company;
2. It showed that incorporation was as readily available to the small private partnership and sole traders as to the large private company; and
3. 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 (in addition to shareholding, it is possible for member of a company to subscribe for its debentures and thus become a creditor.

Since the decision in Salomon’s case the complete separation of the company and its members has never been doubted.

The above legal principle as formulated in Salomon’s case was applied in several cases subsequently such as:

a)      Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619

The Appellant owner of a timber estate assigned the whole of the timber to a company known as Irish Canadian Sawmills Company Limited for a consideration of £42,000.  Payment was effected by the allotment to the Appellant of 42,000 shares fully paid up in £1 shares in the company. No other shares were ever issued.  The company proceeded with the cutting of the timber.  In the course of these operations, the Appellant lent the company some £19,000.  Apart from this the company’s debts were minimal.  The Appellant then insured the timber against fire by policies effected in his own name.  Then the timber was destroyed by fire.  The insurance company refused to pay any indemnity to the appellant on the ground that he had no insurable interest in the timber at the time of effecting the policy.

The courts held that it was clear that the Appellant had no insurable interest in the timber and though he owned almost all the shares in the company and the company owed him a good deal of money, nevertheless, neither as creditor or shareholder could he insure the company’s assets.  So he lost the Company.

b)      Lee v Lee’s Air Farming Ltd. (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 involved in 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 relations and the widow was therefore entitled to compensation.”

c)       Katate v Nyakatukura (1956) 7 U.L.R 47A

The Respondent sued the Petitioner for the recovery of certain sums of money allegedly due to the Ankore African Commercial Society Ltd in which the petitioner was a Director and also the deputy chairman.  The Respondent conceded that in filing the action he was acting entirely on behalf of the society which was therefore the proper Plaintiff.  The action was filed in the Central Native Court.  Under the Relevant Native Court Ordinance the Central Native Court had jurisdiction in civil cases in which all parties were natives.  The issue was whether the Ankore African Commercial Society Ltd of whom all the shareholders were natives was also a native.

The court held that a limited liability company is a corporation and as such it has existence which is distinct from that of the shareholders who own it.  Being a distinct legal entity and abstract in nature, it was not capable of having racial attributes.

2. The Theory of Limited Liability

Liability refers to the extent to which a person may be called upon to contribute to the assets of a company and in the event of its being wound up.

The liability of a company may be limited or unlimited.  Under Section 5, a Company is deemed a Limited Company if it is a company limited by shares or by guarantee.

 

Companies Limited by Shares

Under Section 6of the Act, these are companies having the liability of the members limited by the Company’s Articles to the amount, if any, unpaid on the shares held, beyond which the member is not liable. In Salomon’s case, Salomon was not liable to contribute the assets of the company as his shares were fully paid.

 

Companies Limited by Guarantee

Section 7 provides that a company is a company limited by guarantee if:

1. it does not have a share capital;
2. the liability of its members is limited by the Company’s Articles to the amount that the members undertake, by those Articles, to contribute to the assets of the company in the event of its liquidation; and
3. its Certificate of Incorporate states that it is a company limited by guarantee.

 

Unlimited Companies

Section 8 provides that a company is an unlimited company if:

1. there is no limit on the liability of its members; and
2. its Certificate of Incorporation states that the liability of its members is unlimited.

 

CLASSIFICATION OF COMPANIES

	Companies Act	Classification	Details
1.	Section 5	Limited	A company limited by shares or by guarantee
2.	Section 6	Limited by shares	The liability of its members is limited by the company’s articles to any amount unpaid on the shares held by the members.
3.	Section 7	Limited by guarantee	a)      It does not have a share capital;   b)      The liability of its members is limited by the company’s articles to the amount that the members undertake, by those articles, to contribute to the assets of the company in the event of its liquidation; and   c)       Its certificate of incorporate states that it is a company limited by guarantee.
4.	Section 8	Unlimited Company	a)      There is no limit on the liability of its members; and   b)      Its certificate of incorporation states that the liability of its members is unlimited.
5.	Section 9	Private Company	a)      Its Articles: (i)      restrict a member’s right to transfer shares; (ii)    limit the number of members to fifty; and (iii)   prohibit invitations to the public to subscribe for shares or debentures of the company;   b)      it is not a company limited by guarantee; and   c)       its certificate of incorporation states that it is a private company.
6.	Section 10	Public Company	a)      its articles allow its members the right to transfer their shares in the company;   b)      its articles do not prohibit invitations to the public to subscribe for shares or debentures of the company ; and   c)       its Certificate of Incorporation states that it is a public company.

 

THE FORMAL PROCEDURE OF COMPANY FORMATION

In Kenya the process involves the registration of a company under the Companies Act.

If a company is not registered it does not exist as legal person. It has no rights and cannot bear any obligations; for example, it cannot bring an action to court and it cannot enter into contract

Courts have illustrated the disabilities of unregistered companies in the following cases:

1. Fort Hall Bakery Supply Co vs Wangoe

In this case a plaint was drawn by Fort Hall Bakery Supply Company purporting to be the plaintiff in a claim for recovery of a debt. The defendant argued at the trial that the plaintiff ‘company’ was not registered as a company under the Companies Act and therefore lacked the legal standing to institute a case in its own name. The court agreed with this argument and held that the plaintiff could not be recognized as having any legal existence and was incapable of maintaining an action i.e. it lacked locus standi. In terminating the proceedings, the court did not make any order as to costs because a plaintiff that does not exist can neither pay nor receive costs.

1. Kelner v. Baxter

In this case, promoters of a hotel company contracted for the purchase of wine before the company was incorporated. Upon incorporation, the company purported to ratify the contract. Before payment, the company went into liquidation. The promoters were held personally liable since the company did not exist and so could not contract. This supplanted the rule in Salomon’s case that a company comes into existence only after registration as evidenced by the Certificate of Incorporation.

 

REGISTRATION OF A COMPANY UNDER THE COMPANIES ACT

Method of Company Formation

Under Section 11, one or more persons who wish to form a company must:

1. Subscribe their names to a memorandum of association
2. Comply with the requirements of the Companies Act (sections 13 to 16) with respect to registration; and
3. Ensure their company is not formed for an unlawful purpose otherwise it will not me registered

S.12 also provides that a company may not be registered unless its memorandum of association is:

1. in the form prescribed by the regulations; and
2. Authenticated by each subscriber.

 

THE REGISTRATION PROCESS

The process of registering a company follows the following steps:

1. Preliminaries – Type of Company, Company Name (Choice, Reservation etc.)
2. Preparation of constitutive documents – MEMARTS
3. Presentation of documents for scrutiny and stamping
4. Payment of stamp duty
5. Issuance of Certificate of Incorporation

The Company Name

All companies must have a name. This is because, as a juristic person, the Company needs a name for identification.

Registered names are however different from trading names.

1. Name Search

The Promoters of the conduct a ‘Search’ at the Registrar of Companies to ensure that the name they want to incorporate into a company has not been utilized by another company.

This involves giving three choices of names, which are approved or disapproved by the Officers in the Registry.

Section 57 provides that The Registrar shall not register a company under the Act by a name that is the same as another name appearing in the Index of Company Names.

Registrar’s Restrictions on the Company Name

Under Section 49, the Registrar may not register a company by a particular name if:

1. the use of the name would constitute an offence;
2. the name consists of abbreviations or initials not authorized by or under the Act;
3. the Registrar is, after taking into account the relevant criteria, of the opinion that the name is offensive or undesirable;
4. the name is restricted by Statute e.g. Banking Act and Co-operative Societies Act

NB: Section 50 provides that the approval of the Registrar will be required for a name that would connote a connection with a State organ; a County Government; or any public authority.

2. Reservation of Company Name – S.58

The Registrar may, on written application, reserve a name pending registration of a company or a change of name by a company for a period of 30 – 60 days.

During this reserve period, no other company is entitled to be registered by that name.

3. Indications of type of company

Under S.53, a company that is both a public limited companymay only be registered with a name that ends with the words “public limited company” or the abbreviation “plc“.

Under S.54, a company that is both a private limited company may be registered only with a name that ends with the word “limited” or the abbreviation “ltd.”

The Cabinet Secretary may, by notice given to the company, exempt a private company from using the word “limited” or “ltd” as required by section 54.

Lodging Application Documents with the Registrar

Section 13 thereafter provides that a person who wishes to register a company shall lodge with the Registrar:

1. An application for registration of the company,
2. A Memorandum of association of the company; and
3. A copy of the proposed Articles of association unless exempted by S.21

Additionally:

1. The Statement of Capital and Initial Shareholdings
2. Statement of Guarantee
3. The Statement of Proposed Officers

 

1. The Application for Registration – S.13(2)

An application for registration must state:

1. The proposed name of the company;
2. The proposed location of the registered office of the company;
3. Whether the liability of the members of the company is to be limited, and if so whether it is to be limited by shares or by guarantee; and
4. Whether the company is to be a private or a public company.

Further, the application must contain, or be accompanied by:

1. a statement of capital and initial shareholding (S.14) – in the case of a company that is to have a share capital;
2. a statement of guarantee (S.15) – in the case of a company that is to be limited by guarantee;and
3. a statement of the company’s proposed officers (S.16).

If this application is made by an agent, his name and address must be included in the application.

2. The Memorandum of Association – S.12

This is a memorandum stating that the subscribers:

1. wish to form a company under this Act;
2. agree to become members of the company; and
3. agree to take at least one share each, if the company is to have share capital

The memorandum of association MUST be:

1. in the form prescribed by the regulations; and
2. authenticated by each subscriber.

 

3. The Articles of Association – S.13

These are the rules of internal management of a company and for they to be registered, they must:

1. be contained in a single document;
2. be printed
3. be divided into paragraphs numbered consecutively;
4. be dated;
5. be signed by each subscriber to the articles; and
6. contain an attestation of each subscriber’s signature.

 

4. The Statement of Capital and Initial Shareholdings – S.14

The statement of capital and initial shareholding must state:

1. the total number of shares of the company to be taken on formation by the subscribers to the memorandum;
2. the aggregate nominal value of those shares;
3. for each class of shares-

• the particulars of the rights attached to the shares;
• the total number of shares of that class; and
• the aggregate nominal value of shares of that class; and

1. the amount to be paid up and the amount (if any) to be unpaid on each share, whether on account of the nominal value of the share or in the form of a premium.

The statement of capital and initial shareholding must:

1. contain information for identifying the subscribers; and
2. state the nominal value of each share held by a subscriber.

 

5. Statement of Guarantee – S.15

This must accompany an application to register a company to be limited by guarantee.

The statement is to the effect that each member undertakes, if the company is liquidated while the person is a member or within 12 months after the person ceasesto be a member, to contribute to the assets of the companysuch amount as may be required for:

1. paying the debts and liabilities of the company contracted before the person ceases to be a member;
2. paying the costs, charges and expenses of liquidation; and
3. adjusting the rights of the contributories among themselves.

It must contain the prescribed informationto enable the identification of subscribers to the memorandum.

6. The Statement of Proposed Officers – S.16

This statement must contain required particulars of the following officers:

1. the person(s) who is (are) to be the first director(s)of the company;
2. the company secretary of the company – if the company is to be a public company; and
3. any person appointed to be an authorized signatory of the company.

The required particulars are the particulars that will be required to be stated:

1. in the company’s register of directors and register of directors’ residential addresses ;
2. in the company’s register of secretaries; and
3. in the company’s register of authorized signatories.

The statement of the company’s proposed officers must contain a consent by each of the named persons to act in the respective capacities.

Registration of Company by Registrar – S.17

After all these documents have been prepared the promoters of the company are required to take them to the Registrar of Companies. The documents are then scrutinized by the officers of the Registrar of companies who ensure that they have been prepared in accordance with the provisions of the Companies Act.

Section 17 of the Companies Act provides that if satisfied that an application for registration complies with the requirements of the Act relating to registration, the Registrar shall register the company and allocate to it a unique identifying number

Section 18 thereafter provides that on the registration of a company in accordance with section 17, the Registrar shall issue to the company a Certificate of Incorporation.

 

THE CERTIFICATE OF INCORPORATION – S.18

Issued as evidence of registration of a company.

It is signed by the Registrar, who authenticates it with the Registrar’s official seal.

The certificate is conclusiveevidence that the requirements of the Act relating to registration have been complied with and that the company is duly registered under the Companies Act.

Contents of the Certificate of Incorporation – S.18(2)

1. The name of the company and its unique identifying number;
2. The date of the company’s incorporation;
3. Whether the company’s liability is limited or unlimited, and if it is limited, whether it is limited by shares or by guarantee; and
4. Whether the company a private or a public one

 

Effects of Registration – S.19

From the date of incorporation of the Company:

1. The subscribers to the memorandum (founding members), together with such other persons as may from time to time become members of the company (other members), become a body corporate by the name stated in the certificate of incorporation;
2. The company can do all of the things that anincorporated company can do;
3. The registered office of the company is as statedin the application for registration;
4. The status of the company is as stated in itscertificate of incorporation;
5. In the case of a company having a share capital,the subscribers to the memorandum ofassociation become holders of the sharesspecified in the statement of capital and initialshareholdings; and
6. The persons named in the statement of proposed officers (directors, CS and authorized signatories) become holders of those offices.

It is conclusive evidence as to the date of incorporation as it was held in the case of Jubilee Cotton Millls (N0. 2) Vs Lewis (1920) where Lewis was a promoter of a company formed to purchase a cotton mill and carry on the business of cotton spinning. The Memorandum and Articles were delivered to the Registrar on 1st January 1920, and the company was registered on 8th January 1920, however the Certificate of Incorporation bore the date of 6th January 1920. On 6th January a large number of the company’s shares were allotted to the persons who had sold the mill to the company and were subsequently transferred to Lewis. The legal question was whether the allotment was valid.

The House of Lords held that it was as if was effected on the date the company was incorporated. The Court was of the view that the words “from the date of incorporation” in section 16 (2) of the Companies Act (Repealed) meant the whole of that day.

 

EFFECTS/CONSEQUENCES OF INCORPORATION

Under section 19 of the Act, from the date of incorporation of the company as stated in the Certificate of Incorporation, the subscribers to the Memorandum shall be a body corporate by the name contained in the Certificate of Incorporation. This is the rule in Salomon’s case i.e. the company becomes a legal person separate and distinct from its members and managers.

The most fundamental attribute of incorporation from which all other consequences flow is that the company acquires an independent legal existence. In the words of Lord Macnaghten:

“The company is at law a different person altogether from the subscribers to the memorandum”

The judge meant that the juristic person created on incorporation is very different from its members and its managers. This difference is exemplified by the characteristics of the company as explained below.

1. Limited liability

Under section 5, the liability of a registered company is limited by shares or guarantee. A member can only be called upon to contribute to the assets of a company either:

• The amount, if any, outstanding on the shares held.
• The amount he undertook to contribute if the company was wound up during his membership or within 1 year of cessation of membership

The members are not generally liable for the debts and other obligations of the company.

2. Perpetual succession

Company Law is emphatic that an incorporated company has perpetual succession. Being a creation of the law, its life lies in the intendment of law.

It has the capacity to exist to perpetuity as it is not susceptible to natural shock. The death of its members and/or directors has no effect on its existence.

However its existence can be brought to an end only through the legal process of winding up.

3. Owning of property

As a legal person a registered company has the right to own property. Company Law provides that it has power to own land meaning that the property of a registered company is vested in it as opposed to its members and the company alone has an insurable interest in such property.

This was so held in Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619. The plaintiff owned a forest. He then formed a company to which he transferred the forest in return for 42,000 fully paid shares. He was the principal shareholder of the company. He lent the company £19,000 (unsecured loan). The company subsequently converted the tress to timber. The plaintiff insured the timber held by the defendant but in his own name. It was destroyed by fire 2 weeks later and his claim for compensation was rejected. He sued.

It was held that he was not entitled to indemnity as he had no insurable interest in the timber as it belonged to the company. As such a company could own property.

4. Capacity to contract

A registered company has capacity to enter into contractual relationships such as borrowing in furtherance of its objectives.

It has the capacity to hire and fire as held in the case of Lee v Lee’s Air Farming Ltd. (1961) A.C. 12 Mr. Lee formed a company to carry on the business or aerial top dressing with a capital of £3,000 divided into 3,000 shares of £1 each. He had 2999 of the shares; the other share (1) was held by a solicitor on his behalf. He was the governing director of the company as well as its chief pilot. He died in an air crash while working for the company. Mrs. Lee sued for compensation under the Workmen’s Compensation Act (1922). The legal question was whether Mr. Lee was an employee of the company.

It was held that since Lee’s air farming Co Ltd was properly incorporated. It was a legal person distinct from Mr. Lee and the two were capable of establishing a contractual relationship, thus Mr. Lee was a worker and Mrs. Lee was entitled to compensation.

5. Capacity to sue and be sued

As a legal person a registered company has rights and is subject to obligations. It has the capacity to enforce the rights by action and may be sued on its obligations. At common law, when a wrong is done to a company, the company is prima facie the proper plaintiff for redress.

It was so held in Foss V. Harbottle (1843) 2 Hare 461where the directors had defrauded their company but its members in a general meeting resolved not to sue them. Two minority shareholders Foss and Turton sued the directors to compel them to make good the loss of the company. Their action was dismissed on the ground that they had no locus standi as the wrong in question had been committed to the company (therefore the company was prima facie the proper plaintiff)

6. Common seal

In law, an incorporated company has a common seal to authenticate its transactions. This is the company’s signature.

A seal is an embossed symbol used as attestation or evidence of authenticity.

Affixing the seal signifies that the document is the act and deed of the company. If the document is only signed by the director, it is deemed to be the work of the company’s agent and therefore agency law applies.

 

ADVANTAGES OF INCORPORATION

The registered company is the most advanced form of business association and it dominates the commercial sector. This may be explained by the advantages that accrue from incorporation which tilts the balance in favour of the company.

Carrying on a business by way of a company has certain legal advantages:

1. Limited liability

Members of a company are not liable for debts and other liabilities of the company. Their liability is limited by shares or guarantee and there is no risk of loss of private assets in the event of the company’s insolvency.

2. Perpetual succession

The fact that a registered company has capacity to exist in perpetuity is an advantage where the company’s is business is prosperous as it encourages business investment on a long term basis.

3. Capacity to contract

A registered company has the legal ability to enter into various contractual relationships in furtherance of its objects, thereby enabling it to enhance profitability. The wider the objects clause the wider the company’s contractual capacity.

4. Owning of property

The fact that a registered company has ability to own various towns of property such as land, marketable securities, plant and machinery means that is has capacity to invest for the benefit of its members.

5. Sue or be sued

Members of a registered company are not obliged to sue on behalf of the company and cannot be generally sued for its wrong doings.

6. Wide capital base

Compared to other forms of business associations the registered company has the widest capital base by reason of its wide spectrum of membership

7. Transferability of shares

Under the Act, the shares or other interests of any member of a company shall be moveable property, transferable in the manner provided by the Articles of the company.

Shares in a public or private company are transferable, however transfer in private companies is restricted (Section 9).

Transferability of the shares means that the company’s member’s outlook keeps changing from time to time and the company could take advantage of the entrepreneurial skills of new members by appointing them as directors.

8. Qualified / Specialized management

Under section 128 of the Act, whereas a company public must have at least 2 directors, a private company must have at least 1.

Companies are run by directors appointed in an AGM. Shareholders can appoint qualified persons as directors.

9. Borrowing by floating charge

Registered companies are free to utilize the facility of floating charge to borrow.

This is an equitable charge. It is a charge securing a debenture on the assets of a going concern, but which remain dormant until crystallization.

It is a charge secured on the assets that keep on changing from time to time (non-current assets) in the ordinary course of business.

This charge has several advantages:

• It enables companies with no fixed assets to borrow.
• It enhances the borrowing capacity of companies with fixed assets.
• It enables to use the future assets as collateral.
• It does not interfere with the ordinary business of a company.
• On crystallization the charge fastens on the assets within its reach, it then becomes fixed on the asset.

 

DISADVANTAGES OF INCORPORATION

1. Formalities

The registered company is characterized by legal formalities from incorporation to winding up e.g. an application must be made to the Registrar to reserve the proposed name.

Company formation is subject to the provision of the Companies Act.

During its life a company must hold general meetings register resolution and documents, file the annual returns and elect directors.

The winding up of a company is also an elaborate legal process.

2. Publicity

Companies are subject to undue publicity e.g. under the Act, the public documents of a company (Constitutive documents, Registers, Minutes etc.) are open to public scrutiny on payment of the prescribed fee.

A registered company must have a physical and postal address. Its name must be displayed on the outside of the place of business.

The company’s AGMs are held in public and the winding up of a company is also conducted in the public eye.

3. Corporation tax

It is argued that the tax payable by a registered company is comparatively higher than other business forms thereby reducing the amount of profit available to shareholders as dividends.

5. Non-participation in management

Shareholders other than directors are not involved in the day to day affairs of the company and rarely influence its policy.

6. Expenses

The registered company is the most expensive form of business association to form, maintain and wind up. Formation expenses include fee, registration fee, stamp duty and legal fee. During its life, a company must hold general meetings, contract directors and auditors register documents and file the annual returns. The winding up of a company is also an expensive undertaking. In the words of L.C .B Gower in his book ‘Principles of Modern Company Law’ 4th Ed. pg 471: “At the worst liquidation is like the extraction of an aching tooth, it puts an end to the victim’s agony and may even enable him to bite back, but it cannot guarantee him a square mean and it may be painful at the time particularly if the operation is delayed too long.”

 

THE VEIL OF INCORPORATION

The veil of incorporation is commonly referred to as the corporate shell. It vests on a company after incorporation, legally separating membership and management from the company itself. It is brought about by the separate and distinct legal personality acquired by the company upon incorporation.

In Salomon’s case, it was established that a company is a legal person separate and distinct from its members and managers. It has an independent legal existence (what is referred to as the veil of incorporation)

As a general rule, company law does not go behind the veil of incorporation to the individual members as illustrated in Macaura Vs Northern Assurance Co Ltd.

However in certain situations the rule in Salomon’s case is modified by lifting of the veil whereby, the law disregards the legal personality of a company in favor of the individual members or disregards the distinct legal personality of a company and its subsidiaries in favor of the economic realities constituted by the group. Such instances will result in personal liability of the company officers or agents.

These circumstances where the rule in Salomon’s case is ignored modified or qualified are collectively referred to as lifting the veil of incorporation (piercing the corporate shell). They are exceptions to the rule in Salomon’s case as recognized by statue and case law.

Lifting or piercing the veil is company law’s most widely used doctrine to decide when a shareholder or shareholders will be held liable for obligations of the corporation. Lifting the veil doctrine exists as a check on the principle that, in general, shareholders should not be held liable for the debts of their corporation beyond the value of their investment. The corporate veil is said to be lifted when the court ignores the company and concerns itself directly with the members or the managers.

It can be said “that adherence to the Solomon principle will not be doggedly followed where this would cause an unjust result”.

One of the grounds for lifting of the corporate veil is fraud. The courts have pierced the corporate veil when they feel that fraud is or could be perpetrated behind the veil. The courts will not allow the Salomon principal to be used as an engine of fraud. The two classic cases of the fraud exception are Gilford Motor Company Ltd v. Horne in which Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this he incorporated a limited company in his wife’s name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that:

“… the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne. In this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud…”

Thus the court of appeal regarded it as a mere sham to cloak his wrongdoings.

The veil of incorporation can be lifted either by Statute or by Common law.

 

LIFTING THE VEIL BY STATUTE

This refers to the Parliamentary/Statutory exceptions to the rule in Salomon’s case. These are exceptions recognized by the Companies Act. In the words of Devin J in Bank VoorHendel V Stalford:

“The Legislature can forge a sledge hammer capable of cracking open the corporate shell’”

1. Non-publication of a Company’s Name – S.67

Section 67 of the Companies Act requires a company, through its principal officers, to disclose its name on its seal, letters, business documents and negotiable instruments.  This is done for the benefit of 3rd parties who might contract with a company without realizing the extent of its liability (limited, unlimited etc.).

Any officer or agent of the company who does not comply with S.67 shall be personally liable to a fine not exceeding KES 500,000.

This imposition of personal liability on the company’s agent is what is regarded as “lifting the veil of incorporation”.

In Duram Fancy Goods Ltd V Michael Jackson (Fancy Goods) where M was used to abbreviate Michael in a bill of exchange, it was held that this amounted to a mis-description of the company’s name as M is not an accepted abbreviation of Michael.

1. Investigation the Company’s affairs – S.788

Section 788 gives an Inspector appointed by the Court (High Court) to investigate company’s affairs the power to investigate the affairs of a company’s Subsidiary or Holding company, if the inspector thinks it necessary to do so for the purpose of his investigation.

In such cases, the veil is lifted because the order to investigate a company under S.787 allows the Inspector to investigate the company’s members and link them to their related entities as if they were one corporate entity.

NB: It would be near impossible to establish the connection between entities without reviewing their membership i.e. lifting the veil of incorporation.

1. Investigation of Company’s membership – S.801

Section 800 empowers the Attorney General to appoint an inspector to investigate and report on the membership of a company for the purpose of determining the persons who are or have been:

• financially interested in the success or failure of the company; or
• are able to control or materially influence the company’s policy.

For this to happen, the distinction between the company, its members and managers is done away with i.e. the veil of incorporation is lifted.

Further, S.801 the Inspector appointed by dint of S.800 has the power to investigate the affairs of the Company’s holding or subsidiary entities.

1. Group Accounts – S.642

If a Group financial statement is required to be prepared, the directors of the parent company shall prepare the statement in accordance with the Act.

Under section 643 the Group accounts laid before the General Meeting must comprise:

1. A consolidated balance sheet dealing with the state of affairs of the parent company and its subsidiary undertakings
2. A consolidated profit and loss account dealing with the profit or loss of the parent company and its subsidiary undertakings

S.642 (2) however places personal liability on the directors of the parent company which does not comply. The directors are deemed to have committedan offence and on conviction is liable to a fine not exceeding KES 500,000.

Personal liability means the veil of incorporation is lifted, in this case by Statute.

1. Fraudulent Trading – S.1002

If a business of a company is carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, each person who knowingly participates in carrying on the business in that manner commits the offence of fraudulent trading – and is personally liable.

‘Each person’ here includes directors and principal officers of the company.

S.1002 is clear that the offence crystallizes whether or not the company has been liquidated or is in liquidation.

A person found guilty of an offence under this section is liable on conviction to imprisonment for a term not exceeding 10 years or a fine not exceeding KES 10 Million, or to both. This effectively means that the corporate shield is dispensed with.

In Re William C. Leitch Ltd (1932) 2 Ch. 71 the company was incorporated to acquire William’s business as a furniture manufacturer.  The directors of the company were William and his wife and they appointed William as the Managing Director at a Salary of £1000 per annum.  Within the period of one month, the company was debited with an amount which was £500 more than what was actually due to William.  By that time the company had made a loss of £2500.  Within 2 years of formation, and while the company was still in financial problems, the directors paid to themselves the dividends of £250.  By the end of the 3rd year since incorporation the company was in such serious difficulties such that it could not pay debts as they fell due.  In spite of this William ordered goods worth £6000 which became subject to a charge contained in a debenture held by them.  At the same time he continued to repay himself a loan of £600 which he had lent to the company at the beginning of the 4th year the company with the knowledge of William owed £6500 for goods supplied.  In the winding up of the company the official receiver applied for a declaration that in no circumstances William had carried on the company’s business with intent to defraud and therefore should be held responsible for the repayment of the company’s debts.  It was held that since that company continued to carry on business at a time when William knew that the company could not comfortably pay its debts, then this was fraudulent trading within the meaning of Section 323 and William should be responsible for repaying the debts.  These are the words of Justice Maugham J:

“if a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospects of the creditors ever receiving payments of those debts, it is in general a proper inference that the company is carrying on business with intent to defraud.”

The test is both subjective and objective.

In the Case of Re Patrick Lyon Ltd (1933) Ch. 786 on facts which were similar to the Williams case, the same Judge Maugham J. said as follows:

“the words fraud and fraudulent purpose where they appear in the Section in question are words which connote actual dishonesty involving according to the current notions of fair trading among commercial men real moral blame. No judge has ever been willing to define fraud and I am attempting no definition.”

The statutes are not clear as to the meaning of fraud the question arises that once the money has been recovered from the fraudulent director, is it to be laid as part of the company’s general assets available to all creditors or should it go back to those creditors who are actually defrauded.

In the case of Re William C. Leitch Ltd (1932) 2 Ch. 71Justice Eve J. stated that such money should form part of the company’s general assets and should not be refunded to the defrauded creditors.

In the case of Re Cyona Distributors Ltd (1967) Ch. 889 the Court of Appeal ruled that if the application under Section 323 is made by the debtor then the money recovered should form part of the company’s general assets but where the application is made by a creditor himself, then that creditor is entitled to retain the money in the discharge of the debts due to him.

Although Section 1002 uses the word creditors, the Court will impose personal liability where only one creditor has been defrauded. This was so held in Re Gerald Cooper Chemicals Ltd.

 

LIFTING THE VEIL BY COMMON LAW

The courts have time and time again identified circumstances in which the veil of incorporation can be lifted.  These circumstances are as follows:

1. Agency

If one company is to be fixed with liability as a principal for the acts of another company the relationship of agency should be substantively established.

In Smith, Stone & Knight Ltd v. Birmingham Corporation where a relationship of this kind was revealed, Lord Atkinson laid down a test as to whether such a relationship would exist.

In this case a company acquired a partnership concern, registered it as a company, and then continued to carry it on as a subsidiary company. The parent company held all the shares except a few; treated the subsidiary profits as its own, appointed managers and exercised effectual and constant control. When the business of the subsidiary was acquired by the defendant corporation the court allowed the parent company, brushing aside the legal distinction between the two companies, to claim compensation in respect of removal and disturbance.

In that judgment, Lord Atkinson laid down the necessary questions one need to ask to know if the company will constitute the shareholders’ as agents for purpose of carrying on the business:

1. Were the profits treated as the profits of the parent company?
2. Were the persons conducting the business appointed by the parent company?
3. Was the parent company the head and the brain of the trading company?
4. Did the parent company govern the adventure; decide what should be done and what capital should be embarked on the venture?
5. Did the trading company make the profit by its skill and direction?
6. Was the parent company in constant and effectual control?

 

1. Ratification of Corporate Acts

In the past a company would be bound in a matter which would otherwise be ultra vires after a unanimous agreement of its members in ratification. It is now clear that there is no need for unanimity.  All the members of a company need not agree on a certain matter for it to be ratified. All is required now is agreement of all members entitled to vote on the matter.

Once such a decision has been reached in this manner the members are said to have ratified an action despite the fact that the action was beyond the power of the company’s official who took it. When a court of law looks at the circumstances of a case and concludes that during a meeting of members, members ratified an act done on behalf of the company; in regarding the decision of the members as the decision of the company itself, then the court would have to lift the veil of incorporation.

This was the case in Bamford V Bamford where directors of a company exercised their power to issue shares for an improper purpose but the members in the general meeting voted in favour of the ultra-vires action of the directors and therefore ratified it.  It was held that the ratification validated the issue of the shares.

1. Fraud/Improper Conduct

The common law has constantly and consistently declared that the veil of incorporated will be lifted in order to prevent a fraudulent or improper design by members of a company.  This is normally in order to prevent individuals from using the advantage of the incorporation of a company to willfully and knowingly perpetuate fraud, illegal acts or improper conduct.

In Re Bugle Press LtdHorman L. J, to indicate that he would lift the veil of incorporation for the purpose of disallowing the takeover bid since Jackson & Shaw (Holdings Co. Ltd) had been formed to enable the majority shareholders acquire the shares of the minority, stated that,

‘this is a bare faced attempt to evade that fundamental rule of company law which forbids the majority of shareholders, unless the articles so provide to expropriate a minority.  The transferee company was nothing but a small hut built round two company shareholders and the so called sham was made by themselves as directors of that company.  The whole thing is seen to be a hollow sham.’

In Jones & Another v. Lipman & Another James bought a house from Lipman for £5,250.  Before the transaction was concluded, Lipman changed his mind and opted out of the contract.  He formed a company to which he transferred the house.  James sued Lipman and his company for specific performance of the contract. The court lifted the veil of incorporation with regard to the second defendant and decreed specific performance since the defendant had formed the company to enable him evade an existing legal obligation. Lawrence L.J stated:

‘The defendant company is the creature of the 1st defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity.  The proper order to make is an order on both the defendants specifically to perform the agreement between the plaintiff and the 1st defendant.’

1. Determination of Residence

In order to ascertain a company’s residence it is necessary to lift the veil of incorporation.  This is because a company resides in the country in which its affairs are controlled and managed from.  This is not necessarily where the company is but where its members are. The veil has to be lifted so that the location of the members can be ascertained.  In Debeers Consolidated Mines Co. v. House (1906) The company was registered in S. Africa where its general meetings were held. Some of its directors lived in South Africa and some board meetings were held there as well. However, majority of the directors were Britons resident in Britain.  The company’s affairs were controlled and managed from London.  The question was whether the company was a resident of the UK for purposes of tax.  The court held that it was resident in London.  Lord Loveburn stated:

“A company cannot act or sleep but it can keep house and do business.  A company resides for purposes of income tax where its real business is carried on.  The real business is carried on where the central management and control actually abides.’

1. Group Enterprises

Many cases have been decided where the court has held that a parent company is the same entity as its subsidiary and vice versa.  There is no basic principle governing when this decision will be reached.  The decisions are based on the circumstances of each case.

In Harold Holdsworth & Co. Ltd v. Caddies the respondent (caddies) was the appellant’s Managing Director and an agreement between himself and the company stated:

‘…. he shall perform the duties and exercise the powers in relation to the business of the company and the business of its existing subsidiary companies, which may from time to time assigned to or vested to him by, the board of directors of the company.’

After some time the board resolved that he should confine his attention to one of their subsidiaries only.  He refused to do so and brought an action for damages for breach of contract.

The court held that there was no breach due to the fact that in the circumstances of the case, the director of the parent company could make decisions of the management of any of its subsidiary companies as if the parent company and subsidiary company were one entity.

1. Determination of character/enemy character

As an artificial person a company has no actual character.  It is neither friend nor foe.  It can be neither loyal nor disloyal.  In order to ascertain a company’s ‘character’ courts have lifted the veil of incorporation and taken a look at the character of its members and managers. These are the persons who lend a company its character. A company is regarded as having an ‘enemy character’ if its members or managers are enemies of the state or ‘alien enemies’.  If this is the case, the company is said to be an enemy of the country it is operating in.

In Daimler Co. Ltd V ContinentalTyre and Rubber Co. (Great Britain) Ltd the continental tyre co was formed in Britain to sell German made tyres. The bulk of the co shares were held by the German co. which manufactured the tyres. The remaining shares except one, were held by a German resident in Germany. All directors were Germans resident in Germany. After the outbreak of the 1st world war, the Continental tyre co. instituted proceedings against the appellant (Daimler) to enforce a trade debt. The defendant denied liability and argued that the debt was unenforceable as enforcing it amounted to trade with an alien enemy. This defense was rejected. However on appeal the House of Lords lifted the veil of incorporation and disallowed the action as the company was an alien enemy by reason of its members and managers of the co. In the words of Lord Parker:

“A company incorporated in the UK is a legal entity, a creation of law with the status and capacity which the law requires. It is not a natural person with mind or conscience. It can be neither loyal nor disloyal. It can neither be friend nor enemy. Such a co. may however assume an enemy character. This would be the case if its agents or the person in de facto control of its affairs whether authorized or not are resident in an enemy country or wherever resident are adhering to the enemy or taking instructions from or acting under the control of enemies. A person knowingly dealing with the company in such a case is trading with the enemy.”

• Distinction between companies and other forms of business associations

Distinction	Sole trader	Partnership	Company	Co-operative
Formation	Register as self–employed	Deed of partnership drawn up	Register with Registrar of Companies.	Register with Registrar of cooperatives
Number of shareholders/partners/members	one	Two or more	One or more	Ten or more
Member’s control	sole	Depends on deed	Decision making at shareholder level is based on number of shares held and voting powers attached to each share.	Decision making at members level is usually based on one member-one-vote principle.
Liability of shareholder, partners or members	Unlimited (personal property of shareholder may be at risk)	Unlimited (personal property of shareholder may be at risk)	Limited to investment placed into business. (corporate veil rule-of-law applies)	Limited to investment placed into business. (corporate veil rule-of-law applies)
Governance	By owner (appointed by owner)	Shared responsibility (agreed by partners)	Board of directors (elected at an AGM by the shareholders)	Committee of management and management team (elected at an AGM by the members)
Investment	Mainly personal funds	Partners’ finance	Shareholders’ finance, issuing of shares.	Mainly from owners’ finance, government assistance and pooling of limited personal resources.
Accounts and audit	No strict accounting or audit required. Records not available for public inspection.	No strict accounting or audit required. Records not available for public inspection.	Accounting and audit requirements (depending on legislative thresholds). Accounts open for public inspection (also in abridged format).	Accounting and audit requirements (depending on legislative thresholds). Accounts open for public inspection (also in abridged format).
Profit Distribution	Withdrawn by owner	Distributed to partners according to profit sharing	Distributed by way of dividends to shareholders in proportion to their number of shares.	Distributed by way of patronage to members in proportion to the volume of business or other transactions done by them with the society. Usually limited dividends paid to shareholders in proportion to their number of shares.
Continuity	If owner dies or retires business may go out of existence unless sold by heirs.	Partnership dissolved on death, retirement or bankruptcy.	Perpetual existence. Shareholders and their company are legal and distinct entities.	Perpetual existence. Members and their cooperative are legal and distinct entities.
Winding-up	Usually business is closed and net assets (if any) are distributed to owners	Usually business is closed and net assets (if any) are distributed to owners	Usually company is liquidated and net assets (if any) are distributed to shareholders according to % shareholding.	Usually a co-operative is liquidated and the net assets (if any) are distributed on winding-up according to the principle of disinterested distribution, that is to say to another co-operative pursuing similar aims or general interest purposes.

 

LIMITED COMPANIES AND PARTNERSHIPS COMPARED

Section 3 of the Partnership Act defines a partnership as a relationship between two or more persons carrying on business together with the view of making profit. The partnership can be distinguished from a limited company as follows:

1. Formation: a company undergoes elaborate legal procedures to come into existence, for example, a company requires registration with the registrar of companies whereas for a partnership registration is not compulsory.
2. Legal personality. A company has legal personality and is distinct from its members whereas a partnership has no legal personality and is made up of the members who compose it.
3. The minimum number of members in a partnership is two and a maximum of twenty whereas the minimum number in a private company is two and maximum of fifty. In a public company minimum of seven and an unrestricted maximum.
4. Transferability of shares. Shares in a company are freely transferable whereas a partner cannot transfer his shares without consent of the other partners.
5. Scope of business. The scope of business of the company is limited to the object clause of the memorandum of association whereas scope of business of a partnership is not restricted.
6. The business of the company is run by the board of directors whereas every member of a partnership firm is involved in the business of the firm.
7. Partners are agents to each other in the carrying of business of the firm, whereas members of a limited company are not agents to each other.
8. An act of the parties. For example, agreement, notice etc, render the partnership dissolved whereas dissolution of the company requires elaborate legal procedures.