Historical development of company law .1 The first registered companies

In document Unlocking Company Law (Page 51-55)

The approach to corporate governance taken in this book

1.4 Historical development of company law .1 The first registered companies

This book is about the law applicable to registered companies. The opportunity to create a company by an inexpensive process (registration of documents) and as a matter of right (rather than discretion or favour), has existed in England for over 160 years, since the passing of the Joint Stock Companies Act 1844. Whilst theoretically possible, it is extremely unlikely that a company would today be formed to run a business for profit by the old processes of Parliament passing a special Act or the Crown granting a Royal Charter to bring the company into existence.

The 1844 Act followed the influential report earlier that year of the first Parliamentary Committee on joint stock companies chaired by William Gladstone. Another significant feature of modern company law that can be traced back to Gladstone’s report and the 1844 Act is public disclosure of information about registered companies. Information about a company, its directors and members and annual reports and accounts must be filed at Companies House with the registrar of companies where it is available for inspection by members of the public (see Chapter 17).

When a company is registered with the registrar at Companies House, we speak about it being ‘incorporated’. The term is used in s 15(1) of the Companies Act 2006: ‘On the registration of a company, the registrar of companies shall give a certificate that the company is incorporated’. The term comes from the Latin verb ‘corporare’ which means

‘to furnish with a body’. The process of registering a company brings into existence, or

‘embodies’ a new legal person. All legal persons, registered companies included, enjoy legal rights and are subject to enforceable legal liabilities.

Significant legal benefits arise when a company owns and conducts a business rather than that business being owned and conducted mutually by a group of individuals.

Complexity is swept away regarding such questions as, who are the parties to a contract entered into in the course of the business? Who can be sued to recover money lent to the business? Who owns the property used in the business? Instead of multiple individuals (everyone who owns a part of the business or participates in management) being named as parties to a contract or litigation, a single legal person is substituted:

the company. This benefits both those owning and running the business and those with whom business is conducted. In this respect companies, unlike unincorporated business structures (on which, see Chapter 2), simplify and, therefore, facilitate the efficient conduct of business.

The use of a company to conduct a business brings the efficiency benefits outlined above but also brings with it the potential for the company to have insufficient funds to pay those to whom it owes money, its ‘creditors’. Owners, or ‘members’, of companies registered under the 1844 Act were required to contribute funds to an unlimited amount to the company to enable the company to pay its creditors. These first registered companies were what we now call ‘unlimited companies’, a term used in s 3(4) of the Companies Act 2006 to describe a company in which, ‘there is no limit on the liability of its members‘.

It is still possible to register an unlimited company but as this book is about companies Companies

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formed for profit and unlimited companies are rarely used for this purpose, little will be found about unlimited companies in this book.

1.4.2 Limited liability for company members

The question whether or not to allow companies to be registered with members, or shareholders, who are not required to contribute any sum to the company beyond the price agreed to be paid to buy shares in the company was debated throughout the first half of the nineteenth century. The main argument against allowing members limited liability was that it would encourage and facilitate even more recklessness and fraudulent activity than was increasingly rife in the growing financial and corporate services markets. Supporters argued limited liability would:

n encourage investment in companies n facilitate transferability of shares

n provide clarity and certainty as to the assets available to creditors of the company.

All of which, it was said, were essential to access capital needed to fund the growth of capital-intensive industries such as the railways and mining. Demands for limited liability finally succeeded. This was due in no small part to the fact that shortly after incorporation was made easily available, various attempts to enforce the unlimited liability system provided for in the 1844 Act proved it to be unworkable.

The Limited Liability Act 1855 was enacted and quickly replaced, along with the 1844 Act, by the Joint Stock Companies Act 1856. The 1856 Act is regarded as the first modern Companies Act although it was the next consolidating Act, adopted in 1862, that bore the modern name, ‘Companies Act’.

Limited liability was introduced to provide protection and encouragement to investors in companies and as a direct result of the difficulty of operating a system of unlimited liability of members of companies with freely transferable shares. When company shares are traded on a public stock exchange the list of members is typically long and rapidly changing which makes it difficult to track members down and enforce contributions.

1.4.3 The model company for which company law was designed

Introduction of limited liability is an example of how, in its early stages, company law developed to cater for companies with a relatively large number of shareholders and publicly traded shares. This model of ownership assumes that the owners of the company (the members or shareholders) are different individuals from the managers of the company (the directors). This separation of ownership and control gives rise to one of the key problems company law exists to regulate, namely the inclination of managers/directors to act in their own self interest rather than in the interests of the company and its owners/shareholders. It is this problem that underlies the imposition of strict ‘fiduciary’ duties on directors and extensive public disclosure obligations on companies.

In fact, today, the shares of only a tiny proportion (significantly less than 1 per cent) of registered companies are traded on a public stock exchange. Out of more than two million non-dormant registered companies, approximately 1,100 companies have shares traded on the Main Market of the London Stock Exchange and approximately 900 companies have shares traded on AIM, a market for smaller companies that is also run by the London Stock Exchange.

1.4.4 Single member and closely held companies

By far the most common type of company is a small company with a handful, if not (as is increasingly the case), a single shareholder. The directors of these companies are significant shareholders if not the sole shareholder. Separation of ownership and

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control is either not present or insignificant. These companies are sometimes referred to as ‘closely-held’ companies, referring to the small number of shareholders. The key problem company law wrestles with in closely held companies is not how to control management/the directors, but how to protect minority shareholders (who may or may not be involved in management) from the self-interested behaviour of majority shareholders.

Use of the registered limited company as a corporate structure by sole-trader businessmen gathered pace in the 1890s. This development was legally contentious.

Whereas the Companies Act 1862 required a company to have a minimum of seven shareholders, businessmen satisfied this requirement by issuing one share each to members of their families, or to other individuals to hold the share on trust for the benefit of the businessman. They thereby created, in fact if not in law, a company owned and controlled by a sole member.

In the seminal case of Salomon v A Salomon and Co Ltd [1897] AC 22 (HL), creditors of just such a company challenged this practice as an abuse of the Companies Act 1862 registration process. They were successful both at first instance and in the Court of Appeal.

It took an appeal to the House of Lords for the judges to clarify that the Companies Act 1862 permitted the registration of a company owned and controlled, in effect, by a single shareholder who could not be sued to recover the debts of the company and whose liability to contribute funds to the company was limited. It is interesting to reflect how different company law might be today if the strident judgments of the members of the Court of Appeal, firmly set against endorsing limited liability for sole traders ‘hiding’

behind registered companies, had not been appealed and overturned by the House of Lords.

Introduction in the Companies Act 1907 of the distinction between ‘private’ and

‘public’ companies (for the current distinction see Table 2.1) was evidence of acceptance by the legislature that:

n the registered company was not the sole preserve of companies with publicly traded shares; and

n not all laws developed with companies with publicly traded shares in mind were appropriate for closely held companies.

The 1907 Act requirement for public companies to disclose their annual balance sheets, for example, was not considered appropriate for private companies. Private companies were not required to disclose annual accounts until 1967.

By 1911, two out of every three of the 50,000 companies registered were private companies. The preponderance of private companies is even more emphasised today. By 2012, 99 out of every 100 registered companies were private companies (the percentage that are public companies is in fact 0.3 per cent).

A simplified company template to allow single member companies to save on transaction costs and unnecessary formalities was proposed by the Reflection Group on the Future of EU Company Law in its report in April 2011 (see 1.5.4 below) and BIS sees consideration of the need for a new corporate form for single person businesses as an area on which to focus. The BIS website states: ‘At present there are hundreds of thousands of limited companies that are owned and run by a single person, and that person has to comply with extensive rules designed to balance the interests of multiple shareholders and directors’.

1.4.5 Twentieth century developments

Until the UK joined the European Union in 1973, company law was periodically reformed and consolidated following a review and report by a committee established for the purpose by the government department responsible for trade, now the Department for Business Innovation and Skills (BIS). The main committees, reports and resulting legislation are set out in Table 1.1 below.

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Committee Year of report Amending Act Consolidating Act

Loreburn Committee 1906 (Cmnd 3052) Companies Act 1907 Companies

(Consolidation) Act 1908

Wrenbury Committee 1918 (Cd 9138) Companies Act 1929

Greene Committee 1926 (Cmnd 2657)

Cohen Committee 1945 (Cmnd 6659) Companies Act 1948

Jenkins Committee 1962 (Cmnd 1749) Companies Act 1967

Companies Bill 1973 (lapsed)

Table 1.1 Pre-European Union (1900–1973)

Following UK membership of the European Union, company law continued to be subject to in-depth national reviews (see Table 1.2 below). Significant reforms were made in the 1980s in the specialised areas of securities regulation (financial services law) and insolvency law. These areas of law were restructured, with relevant parts of company law being carved-out, reformed and relocated in the Financial Services Act 1986 (since replaced by the Financial Services and Markets Act 2000), the Insolvency Act 1986 and the Company Directors Disqualification Act 1986 (an Act that provides for the disqualification of directors from participating in the management of another company in a range of circumstances). In contrast, notwithstanding the consolidation and partial re-writing of disparate statutes resulting in the Companies Act 1985, reform of core company law was neither fundamental nor structured.

Changes to core company law in the period 1973–2006 occurred piecemeal, mainly in response to European Union initiatives (see section 1.5 below). The result was unacceptable. Company law increasingly lacked coherence and contained obvious conceptual inconsistencies, many arising from the obligatory implementation of a number of rules and principles set out in EU company law directives that did not sit comfortably with UK company law.

Company law reviews, reforms and consolidations excluding EU initiatives

Reform initiative Year Act

Bullock Committee (Employee representation)

1977 (Cmnd 6706) None

Cork Committee (Insolvency law) 1982 (Cmnd 8558) Insolvency Act 1985

Insolvency Act 1986 Gower Review (Financial services

law/securities regulation)

1982 (Cmnd 9125) 1984 (Cmnd 9125)

Financial Services Act 1986

Law Commission (Shareholder remedies)

Consultation Paper No 142 Report No 246

None

Law Commission (Directors’ duties) Consultation Paper No 153 Report No 261/173

None

Table 1.2 Post-European Union (1973–1998)

Not until 1998 was a root and branch review of company law announced with a clear commitment from the Government to enact a Companies Act fit for purpose in the twenty-first century. To the surprise of many onlookers who doubted that parliamentary time would be committed to such, relatively speaking, apolitical legislation, the Government honoured its commitment with the enactment of the Companies Act 2006. The Company Law Review, which resulted in the enactment of the Companies Act 2006, is examined in section 1.6 below.

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CHAPTER 1 INTRODUCTION TO COMPANY LAW

In document Unlocking Company Law (Page 51-55)