Private Limited Company (England and Wales)

From Max-EuP 2012

by Heribert Hirte

1. Subject; legal sources

The private limited company is the most common form of incorporation in England and Wales, followed by the public limited company (plc). The key difference between these two corporate forms is that a private limited company may not offer its shares to the public (ss 755 and 756 Companies Act 2006).

The main source of English company law is the Companies Act 2006 (CA 2006). Other relevant legal sources include additional primary legislation, including the Company Directors Disqualification Act 1986, which disqualifies individuals in specific circumstances from being directors, and the Insolvency Act 1986 (IA 1986), which applies to insolvency proceedings (administration, insolvent liquidation) as well as the liquidation of companies, secondary legislation, European regulations, the regulations of certain bodies (eg the Financial Services Authority and the Accounting Standards Board), and case law.

2. Formation

A private limited company is formed by way of a registration process (s 9 CA 2006), upon successful conclusion of which a certificate of incorporation is issued by the registrar of companies (s 15 CA 2006).

a) Formation requirements

A private limited company may be formed by one or more individuals (s 7(1)(a) CA 2006) who subscribe their names to a memorandum of association (s 7(1)(b) CA 2006). The memorandum of association is submitted for registration together with an application which states the company’s proposed name and location (ie England and Wales, Scotland or Northern Ireland), whether liability of its members is limited, and whether the company is private or public (s 9(2) CA 2006). The application also contains a statement of capital and initial shareholdings (ss 9(4(a) and 10(2) CA 2006), a statement of the intended address of the company’s registered office, a copy of any proposed articles of association (s 9(5) CA 2006), and a statement of compliance (s 9(1) CA 2006) which confirms compliance with all of the registration requirements (s 13 CA 2006).

The memorandum of association consists of a declaration by the subscribers stating that they wish to form a company and that they agree to become members and take at least one share each (s 8 CA 2006). The Companies Act 1985 required a company to state its objects in the memorandum. This requirement no longer exists. The CA 2006 states that ‘unless a company’s articles specifically restrict the objects of the company, its objects are unrestricted’ (s 31(1) CA 2006), which codifies the widespread practice of including unrestricted objects clauses. Challenges to the validity of any act done by a company on the ground of lack of capacity by reason of anything in the company’s constitution are not recognized (s 39(1) CA 2006). In addition, for persons dealing with a company in good faith, the power of the directors to bind the company is deemed to be free of any limitation under the company’s constitution (s 40(1) CA 2006).

The CA 2006 refers to company shareholders as ‘members’. This is because the CA 2006 applies to both companies limited by shares, which have shareholders, and companies limited by guarantee, which do not have shareholders.

b) Companies House

Companies House is an executive agency of the Department for Business, Innovation and Skills (BIS) and it maintains the register of companies for England, Wales and Scotland. It is also a repository for the documents and information supplied by companies during the registration process and thereafter.

The records are public, which means that anyone can make a request to Companies House for information relating to a particular company, such as the articles of incorporation, an annual report or the names of the directors. Directors are required to file their residential address with Companies House, but they also have the choice of filing a service address (ss 163(1)(b) and 165(1) CA 2006). If directors file a different service address than their residential address, it will be protected information and kept confidential. Companies House is not responsible for the quality of the information made available to the public to the extent it is only a repository of the information provided by the founders and by the companies itself. Companies House provides an online information retrieval service at <www.companieshouse.gov.uk/>.

c) Articles of association

The articles of association form the key constitutional document of a company. They generally define the internal structure of the company and set out the share capital. With respect to the internal structure, they regulate decision-making processes and the process for the appointment of directors as well as the functions they exercise. The share capital states for each class of shares the particulars of the rights attached to the shares, the total number of shares of that class, the aggregate nominal value of shares of that class and the amount to be paid up as well as the amount (if any) to be unpaid on each share (s 10(2) CA 2006). The founders can choose to prepare articles of association specifically suited to the needs of the company or to use the model articles of association.

Model articles of association for private limited companies are found as Sch 1 to the Companies (Model Articles) Regulations 2008 and apply if (1) the company chooses not to register any articles of association or (2) it expressly adopts them.

3. Organization

a) Directors

A private limited company must have at least one director (s 154(1) CA 2006). The CA 2006 does not require directors of a private limited company to have any particular qualifications (ss 154 ff CA 2006). At least one director must be a natural person (s 155(1) CA 2006). Directors do not necessarily need to be shareholders of the company. Minors under the age of 16 and bankrupts are disqualified from being appointed as directors (s 157(1) CA 2006 and s 11 Company Directors Disqualification Act 1986, respectively).

The initial appointment of the directors of a private limited company becomes effective upon issue of the certificate of incorporation (s 16(6) CA 2006). Subsequent directors are appointed in accordance with the articles of association. New directors are generally appointed by the shareholders’ meeting or the board of directors (eg, Sch 1 Art 17 Model Articles).

A company may by ordinary resolution at a shareholders’ meeting remove a director before the expiration of his period of office, including contrary to the terms of any agreement between the company and the director (s 168 CA 2006). This right to remove a director cannot be limited through the articles of association or by agreement between the director and the company.

The directors are responsible for making decisions for the company and usually collectively exercise the power to act on behalf of the company by acting as a board of directors. It is often provided in the articles of association that the board of directors may delegate powers to individual directors or that a managing director may be appointed and assigned management functions (eg Art 5 Sch 1, Model Articles). Even if delegated to an executive committee, the power of the directors may still always be exercised by the board of directors (Huth v Clarke (1890) 25 QBD 391).

It is established under English company law that a person dealing in good faith with a company is entitled to assume that internal procedures have been followed (Royal British Bank v Turquand (1856) All ER Rep 435). This principle, called ‘indoor management’, was codified in s 35A of the Companies Act 1985, which referred to the ‘board of directors’. However, s40(1) of the CA 2006 only refers to the ‘directors’. The consequences of this amendment are as yet unclear, as it may be argued that each individual director now has unlimited power to commit the company or, conversely, that the reference to directors in the plural is intended to exclude individual directors acting alone and without authority to bind the company. This issue will require determination by the courts.

Directors are subject to a number of duties which can be broadly divided into two categories: fiduciary duties and duties of care, which are codified in ss 171–179 CA 2006. However, the principles developed by the courts with respect to these duties remain relevant and continue to apply (Gore-Browne on Companies, ch 15 Directors’ Duties, part 1). Directors’ duties also apply to shadow directors, who are persons in accordance with whose directions or instructions the directors of the company are accustomed to act (s 251 CA 2006), which depending on the circumstances may include dominant shareholders, parent companies and occasionally also dominant banks.

Under existing case law, the fiduciary duty of directors means that they have a duty ‘to act bona fide in the best interest of the company’ (Smith and Fawcett Ltd [1942] Ch 304 at 306). The interest of the company is generally considered to be the interests of the shareholders. New s 172 CA 2006 modifies the existing equity principle by stating that a director must act in the way he considers, in good faith, most likely to promote the success of the company for the benefit of its members as a whole, thus confirming that the duty of the directors is to promote the interest of the company and not any collateral purpose. The Act also recognizes that directors are under certain circumstances required to consider or act in the interest of creditors of the company, eg if the company is insolvent (s 172(3) CA 2006 and Lonrho Ltd v Shell Petroleum Ltd [1980] 1 WLR 627).

It is well established that directors are not only liable for breaches of fiduciary duties, but also for breaches of their duty of care (Re City Equitable Fire v Insurance Co [1925] Ch 407). Section 174 CA 2006 expressly refers to liability based both on the general knowledge, skill and experience expected of a director and the general knowledge, skill and experience of a particular director, thus incorporating both objective and subjective considerations for the purpose of establishing negligence.

Directors are required to keep detailed company registers and to inform Companies House on a regular basis of any change to the registers. The company may be subject to sanctions, including in particular circumstances being struck off the company register. Directors are personally liable for any failure to comply with their duty to notify the registrar in accordance with CA 2006 (eg s 167(4) and (5) CA 2006 with respect to any change relating to directors). The appointment of a company secretary, who traditionally played an important role in the performance of these administrative duties, is no longer required for private limited companies (s 270 CA 2006).

Insolvency law protects creditors of English private limited companies. Section 123(1) IA 1986 provides that a company is deemed unable to pay its debts if a creditor with a valid debt exceeding £750 required the company to pay the sum due and the company neglected for a period of three weeks to pay it to the creditor. Any disposition of the company’s property and any transfer of shares or alteration to the status of the company’s members made after the commencement of the winding up are void unless approved by the court (s 127 IA 1986).

During the liquidation of a company, the liquidator can take proceedings directly against directors for wrongful trading. Wrongful trading is considered to have occurred where at some time before the commencement of the winding up of the company, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation but continued to trade nonetheless (s 214(2) IA 1986). Additionally, the liquidator can bring damages claims against the directors for fraudulent trading (s 213 IA 1986). Fraudulent trading requires that the directors operated the company with the intention to defraud the company’s creditors. In cases of fraud by directors on creditors, an indemnification claim under s 423 IA 1986 is available, which may in certain circumstances be brought directly by the injured creditors.

b) Shareholders’ meetings and shareholders’ resolutions

The primary organ of English companies is the shareholders’ meeting, which decides on changes to the articles of association and can place extensive limitations on the company’s internal as well as external relationships. It can take over the operation of the company at any time or adopt resolutions affecting the manner in which it operates. The requirements for the shareholders’ meetings and the shareholders’ resolutions in a private limited company were simplified in the CA 2006 (ss 281 ff). An annual shareholders’ meeting must be called at least once in each financial year. This requirement is explicit for public limited companies (s 336 CA 2006) and implicit for private limited companies, as directors will need to submit their annual report to members (ss 415 ff CA 2006) or may seek reappointment. The shareholders’ meeting is generally called by the board of directors. Shareholders may also call a meeting (s 303 CA 2006).

The annual shareholders’ meeting for private limited companies may be held through written resolutions (ss 288 ff), a procedure allowing for the shareholders’ meeting to be replaced by a written resolution signed by all the members.

A resolution adopted without a formal vote by shareholders is only valid if adopted when all the members are present (eg adopted on the basis that no objection to the resolution was raised). This simplified procedure for passing resolutions is called the unanimous consent doctrine and presents an alternative to both the written resolution and the formal resolution procedures (s 281(4) CA 2006).

Shareholders’ resolutions require a simple majority (ordinary resolution) or, in special cases (eg changes to the articles), a three-quarters majority of the votes cast (special resolutions) (ss 282, 283 CA 2006). The concept of the extraordinary resolution no longer exists under the Act.

c) Minority shareholders protection

Minority shareholders may take legal proceedings in the name of the company (derivative action, actio pro societate) typically against a defrauding director who is protected by the majority shareholders or against majority shareholders who benefited personally from assets of the company. This type of proceeding is, however, considered exceptional under common law because of the rule established in Foss v Harbottle (1843) 2 Hare 461 which provides that either the shareholders as a whole or the board of directors are entitled to take action against the wrongdoing of a director. The right to bring a claim was recognized for individual shareholders but only in very restricted circumstances. Derivative actions by minority shareholders will now be governed by ss 260 ff of the CA 2006, which allow, among other things, a claim originally brought by the company to be continued by the minority shareholders where there is an appropriate cause of action (s 262 CA 2006).

Minority shareholders may also petition a court for relief pursuant to s 994 CA 2006 if the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members.

4. Share capital

The articles of association will provide the mechanism for the allotment of shares, the rights and privileges associated with each type or class of shares, any restrictions on the transfer of shares and the conditions under which payment of the unpaid portion of a share should be made in cases where this applies.

The allotment of shares is ‘the appropriation to a person of a certain number of shares’ (Re Florence Land & Public Works Co (Nicol’s Case) (1885) 29 Ch 421). Shares are issued when the entire process of application, allotment, payment (which can be partial) and registration is completed (National Westminster Bank plc v IRC [1995] 1 AC 119).

Shares can be paid for in cash or by way of non-cash consideration. With respect to public limited companies, non-cash consideration must be assessed by an independent person (s 593 CA 2006). This requirement does not apply in connection with non-cash consideration for shares in private limited companies.

Under English company law, there is a general prohibition against cross-holding of shares between a mother company and its subsidiary (s 136 CA 2006). Further, a private limited company must not acquire its own shares, whether by purchase, subscription or otherwise, except in accordance with the provisions of the CA 2006, eg for the purposes of capital reduction (s 658 CA 2006).

According to the CA 2006, a company’s shares must not be allotted at a discount (s 580 CA 2006). For example a debt of £500,000 converted into shares of par value of £1,000,000 would be prohibited (Re Mercantile Trading Co (Schroeders’s Case) (1871) LR 11 Eq 13 (HL)).

Prior to redeeming shares the company must ensure solvency tests are satisfied (ss 642 and 643 CA 2006).

Shares in a private limited company are generally traded by private agreements between sellers and buyers. The transfer of shares of a private limited company does not require notarization. Agreements may exist between shareholders of a private limited company limiting the transferability of shares to third parties.

5. Other creditor and investor protections

The various disclosure obligations, such as the obligation to maintain up-to-date registers of members and directors (ss 113 and 162 CA 2006), constitute a source of information for creditors and investors. Anyone can obtain details from Companies House, where annual returns are submitted (s 856 CA 2006) and which contain among other things information about the capital and shareholders of the company. In the case of an insolvency filing and the appointment of a liquidator, creditors are normally informed through notices in the main English daily newspapers.

A private limited company may grant security interests (charges) to creditors over the company’s assets. A charge might be an encumbrance over a specific asset (fixed charge) or a floating charge against a class of assets (eg the trading stock of the company). The company may not dispose of a secured asset without the permission of the holder of the security interest (charge). With a floating charge, the private limited company may freely dispose of individual assets as part of its daily activities and the creditor’s rights do not attach to specific assets until a contractually agreed event takes place, upon which the floating charge is transformed into an encumbrance over one or more specific assets (the floating charge ‘crystallizes’).

Literature

Geoffrey Morse (ed), Palmer’s Company Law, looseleaf (25th edn, 1992); Lord Millet and Alistair Alcock (eds), Gore-Browne on Companies, 2 vols (50th edn, 2004); Horst Eidenmüller (ed), Ausländische Kapitalgesellschaften im deutschen Recht (2004); Sir Roy Goode, Principles of Corporate Insolvency (3rd edn, 2005); Marcus Lutter (ed), Europäische Auslandsgesellschaften in Deutschland (2005); Heribert Hirte and Thomas Bücker (eds), Grenzüberschreitende Gesellschaften (2nd edn, 2006); Geoffrey Morse and others (eds), Palmer's Company Law: Annotated Guide to the Companies Act 2006 (2007); Paul Davies, Gower and Davies’ Principles of Modern Company Law (8th edn, 2008).

Retrieved from Private Limited Company (England and Wales) – Max-EuP 2012 on 06 December 2022.

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