This post is part of Investigating Companies: A Do-It-Yourself Handbook. Read, download or purchase the whole book here.
In the UK, companies are formed and regulated under the Companies Act, the most recent version of which was passed in 2006. Companies are also governed by a host of laws, regulations and codes, in particular the Insolvency Act 1986 and, for publicly-quoted companies, the UK Corporate Governance Code (see section 3.7 for finding individual legal cases and specific legislation and regulations). When people create, or, in the jargon, ‘incorporate’ a company, they set up a body with certain legal characteristics:
SEPARATE LEGAL ENTITY
When a company is incorporated, it takes on its own ‘legal personality’, distinct in the eyes of the law from its shareholders, directors and employees. This means companies have legal rights and duties, and can enter into legal relationships – they can sue or be sued, own property, enter into contracts, and claim rights to a fair trial, privacy and freedom of expression. Companies can be prosecuted for wrongdoing under criminal legislation in the UK but, as they cannot be jailed, the main punishment available is a fine.
SHARES AND SHAREHOLDERS
All profit-making companies have a certain number of shares (a ‘share capital’) that give their owners (the ‘shareholders’) the right to vote on a range of issues, including the direction of the company’s business – usually on the principle of one share one vote – and the right to receive ‘dividend’ payments from the company’s profits, and a share of its worth if it is wound up. The number of shares issued by a company is normally decided by a shareholder vote.
If shareholders, who are also called ‘members’, sell their shares, the rights and benefits from the shares are transferred to the new owners. See section 3.1 for how to find out who a company’s shareholders are, and section 2.6 for dividends.
LIMITED LIABILITY AND THE ‘CORPORATE VEIL’
The personal liability of shareholders in the majority of UK companies is limited to the value of their investment in the company. This means that if a company becomes insolvent, its shareholders lose what their shares cost, but are not personally liable for the company’s debts. Lenders, suppliers or staff owed money and wages have a right to the company’s cash and possessions ahead of the shareholders but they have no claim on the shareholders’ personal wealth. This principle also means that the company, but not its shareholders, is responsible for criminal or civil claims brought against it. It has proven very difficult to ‘pierce the corporate veil’ that is provided by incorporation. Even if a company is convicted of, say, corporate manslaughter, its shareholders will not normally be held personally liable. However, in certain limited cases, directors or employees may be prosecuted if they are personally responsible for criminal behaviour while working for the company.
Note that some companies are set up to be unlimited companies. As the name suggests, the legal liability of their shareholders is not limited to the cost of their shares and they are personally liable for its debts in the event of insolvency.
Perhaps unsurprisingly, most companies in the UK are limited. There are certain financial, legal and administrative reasons why investors may set up an unlimited company. They may be confident there is a low risk of insolvency, or they may want to avoid the disclosure requirements for limited companies (unlimited companies do not have to publish annual accounts, for example).
CORPORATION OR COMPANY? What’s the difference between a corporation and a company? Most of the time, the terms can be used interchangeably – all companies are incorporated and therefore are technically corporations. The word corporation tends to be used for big companies that operate in different countries, often further described as multinational or transnational corporations. ‘Corporation’ also includes other incorporated legal entities, such as town councils or the City of London corporation.
Shareholders often delegate the day-to-day management of the company to directors (many people, of course, both own and run companies and, in this case, the shareholders may also be directors). In the UK, employees are not allowed to vote on company resolutions or the hiring and firing of directors, as they are in some other countries.
Unlike shareholders, directors are not protected by the corporate veil. They can be fined for breaches of certain duties under relevant legislation, or disqualified from holding directorships for a period. In certain limited cases, they may also be charged with criminal offences in relation to the operation of a company.
Directors must act within the powers granted by the company’s Articles of Association and any Memorandum of Association, and are bound by certain legal responsibilities – known as ‘fiduciary duties’. Section 172 of the UK Companies Act sets out that a director “must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”.
Although the act says a director must “have regard” to a number of other matters, including the interests of the company’s employees and the impact of its operations on the community and the environment, the key measurement of “success” is most-often seen as the profitability of the company.
The Directors’ Duties briefing by the Taylor Wessing law firm, free to read online, gives further details. See page 67 for how to find out who the directors of a company are.
In general, the bigger the company, the more directors it will have.
– The Chief Executive Officer (CEO) is the director in overall charge of the management of the company. Also known as the Managing Director or Chief Executive.
-The Chief Operating Officer (COO) is responsible for the day-to-day running of the company’s work and the Chief Financial Officer (CFO) is in charge of financial planning and reporting.
– Non-executive directors are not responsible for the day-to-day running of the company but their role is typically to oversee its overall operations and governance. They sit on the company’s board of directors and in large companies are often senior corporate or political figures who add to the company’s reputation and connections.
– The chairman or chairwoman of the board may be an executive or non-executive director, and may hold some other office with the company.
In practice, the more diversified the ownership of a company, the more power the directors may have. Companies that publicly-list their shares may have hundreds or thousands of shareholders and few with enough shares to influence the direction of the business on their own, which may give the directors more influence than if they had to answer to only one or two shareholders.
This can give directors the opportunity to prioritise their own, or their employees’, interests over those of the shareholders (by proposing inflated salaries or bonuses, for example).
In the UK, companies pay corporation tax on their profits. Shareholders may then have to pay tax on any dividends they receive and employees have to pay personal income tax and national insurance on their wages. VAT is added on to the price of many products and services.
Tax regulations are notoriously complicated and regularly change, so check the HMRC website for up-to-date rules and rates.
Some companies try to pay as little tax as possible, often by shifting their profits to countries with low tax rates. See section 2.6 for how to find out how much tax a company is paying.
When companies stop doing business they go into liquidation, their assets and property are distributed and they cease to exist. The most common reason for the winding up of a company is insolvency through lack of cash, meaning it cannot pay its debts on time.
In this case, creditors – the people the company owes money to – may commence insolvency proceedings against it, or the directors may choose to instigate the winding up process themselves.
There are various insolvency procedures available and creditors may prefer to avoid liquidation if they can achieve a better outcome from a company’s rescue. These include a company voluntary arrangement or administration. These types of procedures may give the company more time to pay off its debts, or may enable some of them to be reduced or extinguished.
If liquidation becomes inevitable, an appointed ‘liquidator’ will adjudicate creditors claims and collect and distribute the company’s possessions accordingly. There are various claims that can be brought against directors if there is evidence of wrongdoing on their part.
If the company has not run into trouble but has chosen to stop doing business voluntarily (after a resolution has been passed by shareholders), its assets are redistributed to creditors, and whatever is left goes to the shareholders.
Directors then file for its dissolution, after which it is struck off the register of companies at Companies House.
INCORPORATION: A VERY BRIEF HISTORY
Pre-1600: Concept of ‘incorporation’ develops to provide independent legal identity for non-commercial institutions, such as hospitals, monasteries and colleges, so they can exist independently of their founders.
1600: East India Company, a forerunner of the modern multinational, established by Royal Charter to pursue trade in the “East Indies” (South and East Asia).
1844: Joint Stock Companies Act allows companies to register themselves without a specific charter.
1855: Britain passes the Limited Liabilities Act – becoming the first country to limit the liability of the members of certain companies to the value of their shares.
1856: New Joint Stock Companies Act simplifies the administrative procedure allowing incorporation of limited liability companies and forms the basis of future UK company law.
2006: Most recent Companies Act, based on the principles of the 1856 act.
See Corporate Watch’s Corporate Law and Structures report for a more detailed history