Brief introduction to limited companies.pdf

8/14/2019 Brief introduction to limited companies.pdf

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Registered in England and Wales with number 8061254.Registered office: 1 Lyme Drive, Parklands, Trent Vale ST4 6NW.

Authorised and regulated by the Solicitors Regulation Authority (registration number 591677)

A brief introduction to

PRIVATE COMPANIES LIMITED BY SHARES

Verdant Legal Limited


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CONTENTS

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Paragraph Page

Part 1 How private limited companies work ........................................................................................................3

1. Introduction ................................................................................................................................................................... 32. The constitution of a private limited company ............................................................................................................... 3

2.1 Articles of association .......................................................................................................................................................... 32.2 Memorandum of association ................................................................................................................................................ 32.3 Shareholders agreement ..................................................................................................................................................... 4

3. Directors ......................................................................................................................................................................... 43.1 The role of directors ............................................................................................................................................................ 43.2 Decisions to be taken collectively by the board ..................................................................................................................... 43.3 Directors responsibilities and risks ....................................................................................................................................... 53.4 Company secretaries ........................................................................................................................................................... 53.5 Transfers of assets to and from directors .............................................................................................................................. 5

4. Shareholders ................................................................................................................................................................... 64.1 The role of shareholders ...................................................................................................................................................... 64.2 Share capital ...................................................................................................................................................................... 74.3 Different classes of share .................................................................................................................................................... 74.4 Limited liability.................................................................................................................................................................... 84.5 Ordinary and special resolutions and shareholder powers ...................................................................................................... 84.6

General meetings and voting rights ...................................................................................................................................... 9

5. Dividends ...................................................................................................................................................................... 106. Structuring the constitution ......................................................................................................................................... 117. Other company administration matters........................................................................................................................ 11

7.1 Accounts .......................................................................................................................................................................... 117.2 Other records ................................................................................................................................................................... 117.3 Statutory Books ................................................................................................................................................................ 127.4 Stationery, websites, emails and other trading disclosures ................................................................................................... 12

Part 2 Tailoring the constitution ............................................................................................................................13

1. Management of the Company ....................................................................................................................................... 131.1 Composition of the board and management ....................................................................................................................... 131.2 Conduct of the companys affairs ....................................................................................................................................... 141.3 Quorum requirements ....................................................................................................................................................... 141.4 Votes of directors and shareholders ................................................................................................................................... 151.5 Deadlock provisions .......................................................................................................................................................... 161.6 Defaulting shareholders ..................................................................................................................................................... 16

2. Reserved matters ......................................................................................................................................................... 163. Responsibility for funding and liabilities ...................................................................................................................... 17

3.1 Capital contributions and funding ....................................................................................................................................... 173.2 Guarantees ....................................................................................................................................................................... 17

4. Distribution policies ...................................................................................................................................................... 175. Transfers of shares ....................................................................................................................................................... 18

5.1 Pre-emption rights ............................................................................................................................................................ 185.2 Permitted transfers to family members and other related investors ...................................................................................... 195.3 Compulsory transfer .......................................................................................................................................................... 195.4 Expelling defaulting shareholders ....................................................................................................................................... 205.5 Drag and tag provisions .................................................................................................................................................... 21

6. Post exit restrictions ..................................................................................................................................................... 21Part 3 Shareholders powers ...................................................................................................................................22

Part 4 Directors responsibilities and risks .........................................................................................................24

1. Section 1 Strategies for managing risk ...................................................................................................................... 242. Section 2 General duties of directors under the 2006 Act ......................................................................................... 283. Section 3 Directors duties and risks during a financial crisis .....................................................................................32


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HOW PRIVATE LIMITED COMPANIES WORK

1. IntroductionA business run through a private limited company will be owned and operated by the company itself. Acompany has a legal personality which is separate from its directors and shareholders. By offering itsshareholders limited liability (discussed at paragraph 4.4 (page 8), below), it is the company that takesthe main risk in the success of the business.

The legislation which regulates most companies is the Companies Act 2006 (referred to in this note asthe 2006 Act).

This note provides general information about private companies limited by shares in England and Walesand discusses the operation, corporate structure and typical compliance issues encountered whenmanaging a private limited company. There are other types of company (such as companies limited byguarantee, or public companies) which this note does note discuss.

This is not intended to be a definitive guide and should not be used as a substitute for professionaladvice. We have lawyers equipped to deal with all legal matters which may arise in the establishmentor management of a business in the UK and would be happy to help.

Many corporate transactions or alterations to share rights can also have taxation implications. We donot advise on taxation matters and recommend that you take taxation advice from a professional taxadviser before taking any steps in a corporate transaction.

If you do have any further queries or would like to discuss this any further please do not hesitate tocontact Chris King on +44 (0) 845 519 8593 or +44 (0) 7793 916897 or [email protected].

2.

The constitution of a private limited company2.1 Articles of association

Each private limited company has articles of association. In general terms, articles govern therelationship between the shareholders and the company. The scope of the articles is generally limitedto setting out procedural matters governing directors and shareholders, the creation and transfer ofshares and the capital structure of the company.

Unless a company adopts a bespoke form of articles on its incorporation, any new companyincorporated since 1 October 2009 will automatically have as its articles a form prescribed byregulations made under the 2006 Act, named the model articles (replacing its predecessor, Table A

from that date). However, the shareholders of a company can adopt articles which are tailored to meettheir particular needs.

The articles can be changed by special resolution. More details about special resolutions are set out atparagraph 4.5 of this part 1 (page 8), below.

2.2 Memorandum of associationUntil the 2006 Act came into force on 1 October 2009, the main purpose of the memorandum ofassociation was to state the intended business of the company. The memorandum would sometimescontain certain restrictions on the type of business or activities the company was able to carry out.

However, after that date, the memorandum no longer forms part of the constitution of a company andany restrictions in the memorandum were deemed to be incorporated into the articles. Theserestrictions can be lifted by special resolution in most circumstances.


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2.3 Shareholders agreementAs a separate document to the articles, many shareholders typically enter into a shareholdersagreement which, as opposed to the articles, focuses to a greater extent on the relationship betweeneach of the shareholders.

Whilst some of the subject matter of the shareholders agreement may overlap with the articles (andtypically the company will also be a party to this document), a shareholders agreement generallycontains rights and obligations of a more commercial nature than those contained in the articles (suchas provisions governing the treatment of confidential information and business opportunities).

Whilst the articles are required to be registered at Companies House and are available for publicinspection, a shareholders agreement is a private document not to be registered. Consequently, theshareholders agreement would be the appropriate document to deal with more confidential mattersbetween shareholders and the company.

This note goes into more detail about the kind of provisions which may be contained in articles ofassociation and shareholders agreements (collectively known as equity documents) at paragraph 6 ofthis part 1 (page 11), and part 2 of this note.

3. Directors3.1 The role of directors

Although directors are appointed and removed by the shareholders, the management of a company isvested in its directors as a group and not its shareholders. Unless the articles say otherwise, a directordoes not need to be a shareholder and a shareholder does not have the automatic right to be adirector. In many limited companies, the shareholders are also directors, but these two separatefunctions should not be confused.

There is no limit on the number of directors, but in practice it is normal to have at least two.

Once appointed, a director is an officer of the company who is responsible for managing it for thebenefit of the shareholders as a whole.

3.2 Decisions to be taken collectively by the boardEach director has extensive powers to manage the business of the Company. For example, eachdirector will normally have the power to sign contracts on the companys behalf but, strictly speaking,all decisions are supposed to be taken by the directors collectively as a board.

In order for the board validly to make decisions, the board will be required to follow certain procedureswhich would normally be set out in the articles. Typically, directors will be expected to attend ameeting to make decisions, but directors can also take decisions by circulating a written version of theresolutions to be decided upon for all directors to sign.

Typically, board meetings can only be held if a quorum1of directors is present and all directors havehad notice of the meeting. If the directors cannot reach a consensus, they may vote on the matter.Usually, each director has one vote on any matter at a board meeting and a simple majority of directorsis required to decide upon any matter.

A company may or may not have one of its directors formally appointed as chairman. If not, any oneof the directors may be chosen as chairman of any board or shareholder meeting by those present.

1The meaning of quorum is explained at paragraph 1.3 of part 2of this note, on page 14.


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The chairman presides over the meeting and may (if the articles say so) have a casting vote at adirectors meeting in the case the votes for and against a particular decision are equal.

We recommend having minutes of all board meetings signed by the chairman and keeping copies in thecompanys minute book.

3.3 Directors responsibilities and risksDirectors have extensive legal responsibilities. Many of these are of a technical nature, we recommendkeeping us informed about the companys activities so that we may advise to ensure no responsibilitiesare overlooked.

In coming to their decisions, directors have to comply with numerous statutory duties and manage theorderly administration of the company.

Part 4 of this note contains a summary of directors responsibilities and risks and our recommendationsfor managing those risks, generally.

3.4 Company secretariesPrivate limited companies may have, but are not required to appoint, a company secretary, who hasresponsibility for maintaining the companys official books and records, convening shareholders anddirectors meetings and filing returns and notices at the Companies Registry.

We also provide a comprehensive company secretarial service.

3.5 Transfers of assets to and from directorsIt is worth noting one particularly important restriction applicable to directors which commonly causes a

problem - unless appropriate planning is carried out before any such transaction is entered into.

Directors often wish to transfer assets to, or acquire assets from a company. However, if the correctprocess is not followed, the transaction may be invalidated and the directors involved may be subject topersonal liability to the company for any losses the company may suffer.

Transactions caught

The shareholders must first approve by an ordinary resolution,2the acquisition by:

a director of the company or of its holding company, or aperson connected(explained below)with such a director from the company a substantial non-cash asset(also explained below); or

the company of a substantial non-cash asset from a director or a connected person.There are certain exemptions, and rules which allow contracts to be entered into which are conditionalon the necessary ordinary resolution being passed at a later date. However, in any circumstanceswhere the directors plan to carry out such a transaction, we recommend consulting us about theprocess to be adopted before any further steps are taken.

It is worth noting that these restrictions may also catch the grant by the company of security to adirector, if the director lends secured funding to the company. This is because security is itself a non-cash asset which the director acquires from the company.

2See paragraph 4.5 of this part 1, below, on page 8, for an explanation of ordinary resolutions.


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Substantial non-cash asset

A substantial non-cash asset is one the value of which either exceeds:

10% of the companys asset value and is more than 5,000; or 100,000.It does not matter whether or not the asset is being bought at market value, or whether the companyis getting anything else which is valuable to it, in return.

Connected persons

Persons connected with a director include:

family members (spouse, civil partner or other person in an enduring family relationship; theirchildren or step children; their spouses or civil partners children or step children who live with

the director and are under the age of 18; and their parents);

bodies corporate (e.g. company or LLP) in which the director, and any person connected withhim or her, together hold more than 20% of the companys shares or voting rights;

trustees of any trust of which the director or any person connected to him or her is abeneficiary or where the trustee is entitled confer a benefit on the director and any personconnected to him or her; and

a business partner of the director or a person connected to the director.Undervalue transactions

It is also worth noting that an administrator or liquidator may apply to the court for an order avoidingany transactions (such as a transfer of assets) made at an undervalue in the two years before theadministration or liquidation if the company was then (or as a result of the transaction became) unableto pay its debts as they fell due.

Where the transaction was made with a connected person, there is a presumption that the companywas insolvent at the time, unless it can be shown otherwise.3

There is a defence where company can convince the court that it entered into the transaction in goodfaith and for the purpose of carrying on its business and at the time there were reasonable grounds forbelieving the transaction would benefit the company.

Accordingly, whenever the directors plan to carry out a transaction which may be caught by theseprovisions, we recommend that they take legal and accountancy advice at the outset, before carryingout any transactions, to avoid any problems later on.

4. Shareholders4.1 The role of shareholders

A company owns property in its own right, to which the shareholders have no legal title.

3For this purpose, the definition of connected persons is one specifically contained in the Insolvency Act 1985 and different in some respects from the oneused, above, for substantial property transactions. It includes (briefly) include directors, shadow directors, associates (within the meaning of section 435 of theInsolvency Act 1986, being certain family members, trusts for the benefit of the directors, shadow directors or their associates, partners in partnership (andtheir family members) and any associate of the company (including employees and companies under common control)


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Instead, ownership of the company is determined through the ownership of shares. Accordingly,through the companys share capital the shareholders own the company.

However, although the shareholders own the company, the law perceives shareholders as passiveinvestors, whose role is to provide investment funding to the company and who are only involved to avery limited degree in any management of the company.

4.2 Share capitalGenerally speaking, the directors may issue shares if authorised to do so under the 2006 Act, subject toany restriction contained in the articles of association, as follows:

the directors of a private company with only one class of shares may allot shares without havingto consult the shareholders;4or

where a company has more than one class of shares (more on this below), the directors will needspecific authority either in the articles or by way of shareholders resolutions to authorise shares.There are a number of technical requirements which we would be more than happy to assistwith.

For companies incorporated under any of the companies acts which preceded the 2006 Act, there maybe some additional restrictions.

Reducing the number of shares allotted can be done in certain circumstances.

A company need only have one shareholder. There is no maximum number of shareholders.

Ownership of shares determines the right to receive dividends5and to vote6at shareholders meetingsof the company.

4.3 Different classes of shareA company may issue different classes of shares, each with different rights. Rights to vote and receivedividends may differ between classes.

There are a number of different classes of share but the more common classes are ordinary andpreference shares.

Ordinary shares

Ordinary shares are the type of shares most commonly encountered in limited companies.

These shares are most commonly associated with the right to attend meetings and vote and receivedividends out of the profits of the company.

Ordinary shares may sometimes be sub-divided into different classes. Where this is done, it is typicalfor those shares to be designated by a different letter (for example A shares, B shares and so on).

Using this mechanism, the rights of ordinary shareholders in relation to the company can be adaptedextensively to suit the commercial arrangements between the shareholders. For example, each class ofshares can be given a different number of votes at general meetings, or the right to receive separatedividends for each class of share.

4Note that companies incorporated under the Companies Acts 1948 or 1985 cannot do this without passing a further ordinary resolution.5For more detail about dividends see section 5 below.6For more detail about how shareholders vote on matters, see section 4.6, below


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Each class of shares would typically only be capable of being varied with the consent of the holders ofall or a certain majority of that particular class of shares.

Generally, each ordinary share (even different classes of ordinary share) will carry an equal right to ashare in the capital (or, more simply put, value) of the company. Because of this, the value of eachordinary share will generally increase or decrease with the fortunes of the company.

However, sometimes the shares belonging to institutional investors are paid out in priority to otherclasses and some classes of share can be linked directly to specific assets within the company ringfencing shareholders rights to the proceeds of a sale of specific assets.

Preference shares

The rights of preference shares can be different from company to company, but typically, preferenceshares are fixed-income shares. Unlike ordinary shares, they do not normally participate in the successof the company and are therefore seen as a less risky form of investment. Often, preference shareswill be entitled to an automatic dividend of a percentage of nominal value of, or the amount paid up on,those shares and will be paid out ahead of the ordinary shareholders.

Usually if the there are insufficient profits to pay the dividend, the preference dividend will continue toremain payable and the unpaid amount of dividends will accumulate until eventually paid. Generally, allunpaid amounts of preference dividend must be paid in full before dividends on ordinary shares can bepaid.

Often preference shares carry no voting rights, or can vote only in very limited circumstances.

Often, preference shares will be redeemable, either by the company, or by the shareholder who ownsthem (or both).

Accordingly, the preference shares, in practice, tend to be structured more like debt funding than the

equity funding which ordinary shares represent.

4.4 Limited liabilityIn general terms, the liability of shareholders of a company is limited to the nominal value of the sharesallotted to them. Shares may be issued partly paid or nil-paid, which leaves the shareholder with anoutstanding commitment to pay the balance due when called upon. Persons to whom shares areallotted pay with cash or other assets of a value no less than the nominal value of the shares.

The key benefit of the limited company, therefore, is that it provides a vehicle by which its investorsmay limit their liability to a fixed financial sum, being the amount they are prepared to invest into, andthus risk in, the business of the company.

Of course, there are certain exceptions to the rule of limited liability. Landlords of commercialpremises, on leasing property to the company, and banks, on lending money to the company,sometimes require personal guarantees from the shareholders (but even where shareholders have togive such guarantees, limits on the maximum amount of them can often be negotiated) and, if ashareholder is also a director, there are a range of situations when directors can incur specific liabilitiesfor breaches of their duties, or can be liable for their negligence.7

4.5 Ordinary and special resolutions and shareholder powersA limited range of matters require the specific approval of the shareholders. Shareholders decisionsare typically reached either in a general meeting8or by shareholders who hold the requisite number of

7For more information on the risks which may affect directors, and means of managing those risks, see part 4of this note.8For more details on general meetings, see section 4.6.


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voting rights signing a written resolution to resolve the matter in question.

There are two types of corporate resolutions which the shareholders can pass - ordinary resolutions andspecial resolutions. Ordinary resolutions can be passed by the shareholders holding at least a majorityof voting rights and special resolutions can be passed by the shareholders holding 75% or more of thevoting rights.

An ordinary resolution is generally required for any item of routine business where the 2006 requiresthe approval of the matter by the shareholders in a general meeting. Typical examples include:

payment of a final dividend; capitalisation of reserves; approval of the acquisition by a director of property belonging to the company (or vice versa;

or

appointment or removal of a director.The situations when special resolutions are required are set out in the 2006 Act. Typical examplesinclude:

alteration of the articles; change of name; reduction of share capital; disapplication of statutory pre-emption rights when issuing shares; approval of certain purchases by a company of its own shares; or approval of the winding-up of the company.It is also worth noting that, generally speaking, by ordinary resolution, the shareholders can require, orauthorise, the directors to carry out any act or do any lawful thing in connection with the companysbusiness or assets and it has become common practice for banks, for example, to require shareholdersresolutions to approve the entry into financial facilities to ensure that their funding has been given thegreatest possible authority by the company that it can give.

Accordingly, whilst shareholders are not to be involved in the day to day management of the business,through the mechanism of shareholders resolutions, the shareholders can exercise a substantialinfluence over the companys affairs. A table listing the most prominent shareholders rights (and whatdegree of ownership/voting control triggers those rights) is at part 3 of this note.

4.6 General meetings and voting rightsOrdinarily, general meetings are called by the directors, although there are circumstances whenshareholders can require the directors to call a general meeting, and call a general meeting themselvesif the directors fail to do so.9

Ordinarily, private limited companies (whose shares are not traded on a regulated market) are nolonger subject to the requirement to hold an annual general meeting and can call general meetings on14 days notice,10 except for resolutions to remove the auditors or a director, or appoint an auditor

9A very brief summary of this right is explained in part 3. It is a power open to shareholders holding 5% in nominal value of shares having the right to vote atgeneral meetings.10In calculating notice, the date on which the notice is sent out and the date of the meeting are excluded. This is known as the clear days rule.


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other than a retiring auditor, which are subject to special rules about notice, which we can assist with ifnecessary.

At a meeting, the matter is proposed to the shareholders, who then vote on the issue.

Each share will have a certain voting rights, which are usually set out in the articles. How a matter isdecided may differ depending on whether the matter is decided on a show of hands or on a poll.

The default position under typical articles is that, if the vote is decided on a show of hands, eachshareholder hasjust one vote. However, if the matter is decided on a poll, the default position is thateach shareholder has one vote per share.

A poll can normally be demanded by the directors, the chairman, two shareholders with the right tovote at the meeting, or one shareholder with 10% or more of the voting rights at the meeting (but therights of shareholders to demand a poll can be extended by agreement).

If the matter is decided by way of a written resolution under the 2006 Act (which is a commonalternative to having a general meeting and simply requires the circulation of a written resolution to the

members) each shareholder effectively has the same number of votes as if the matter had beendecided on a poll taken at a meeting,11being one vote per share.

The number of votes each share carries can be changed and this is discussed in more detail atparagraph 1.4 of part 2 (page 15) of this note. Note that the rights should only be changed byagreement with shareholders. Changing the rights of minority shareholders, for example, to removetheir rights to vote or receive a fair proportion of dividends against their wishes may give them the rightto issue legal proceedings against the company and/or its directors.12

5. DividendsA company may distribute some or all of its profits to its shareholders as dividends.

If a companys articles are silent on the point, directors would be entitled to declare all dividends (finaland interim) without the need for shareholder approval.

However, most articles set out that directors can pay interim dividends, but that the final dividends forthe year must be recommended by directors but declared by shareholders by way of ordinaryresolution. If there is any doubt about the application of any procedure, we can assist.

The default position is that dividends are normally paid to the ordinary shareholders in an amountproportionate to their shareholding.

However, the articles can be drafted so as to allow the directors to pay to each class of shares, or

sometimes, to each ordinary shareholder. This is often used as a mechanism for tax planning, or toreflect a profit share arrangement within the company.

Certain shares can be put in place with very specific rights to dividends, such as preference shares(mentioned above at paragraph 4.3, page 7). These shares will often automatically be entitled to afixed dividend each year, paid ahead of the other shareholders.

The company can only pay a dividend (whether to the ordinary or preference shareholders) if there areprofits available, which are normally determined by reference to the companys statutory accounts. Ifthere are profits left over from the previous year, but no profits in the present financial year, thedirectors may still be able to pay a dividend.

11In practice, written resolutions are worded in such a way that signing them constitutes a vote in favour of, and not signing them constitutes a vote against,the resolution.12The rights shareholders may have are mentioned in more detail in section 2 of part 3 of this note, on page 31 of this note.


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If a dividend is declared or paid and there are insufficient profits, the directors are jointly and severallyliable to the company for the full amount of the overpayment. Any member who receives anunauthorised dividend and knows or ought to know it is unauthorised, must repay the dividend to thecompany.

6.

Structuring the constitutionDifferent issues are raised by different numbers of shareholders, each of whom may have differentshareholdings, interests and degrees of influence. For example:

a company owned by a single shareholder/director may want maximum possible flexibility tomanage the affairs of the company;

one of the shareholders (in a company with multiple shareholders) may have seniority, or wishto protect the value of a large investment in the company. Accordingly, that shareholder mayrequire certain enhanced powers and protections;

two equal shareholders should decide how they will resolve any deadlock between them; a company which is effectively a partnership (often referred to as a quasi partnership by

company lawyers) may want the power to expel members under certain situations;

it is usually worth adopting a procedure dealing with the transfer shares; if shares are to be allotted to employees or executive directors it may be important to reserve a

power to force them to transfer their shares if they cease to be employed by the company forany reason; or

a company in which the main shareholders hope to achieve an exit may want the power tocompel minority shareholders to sell their shares if an offer to buy the company is received.

Part 2 of this note discusses various options which shareholders might take in order to achieve themost appropriate constitutional structure. Of course, it would be a matter of tailoring the constitutionaldocuments to reflect the shareholders requirements and also to take into account the compliancematters which may need to be provided for, and which are briefly described in part 4.

7. Other company administration matters7.1 Accounts

All UK companies (unless dormant) must produce annual accounts containing a profit and loss accountand a balance sheet. There are a number of complicated rules about how detailed a companysfinancial statements must be, and whether or not they need to be audited. Your companys accountantshould be able to advise on all these matters.

The accounts must be shown to and approved by the shareholders. Typically, accounts are filed onlineby your accountants, but we can assist with filings where necessary.

7.2 Other recordsEach company must file a range of up-to-date information at Companies House, including the accountsand details of any changes to the constitution, share capital, directors or the registered office.

In addition, once a year every company must file an annual return showing these details. Allinformation filed at Companies House is available for inspection by the public.


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We offer a comprehensive company secretarial service where we can attend to filing. Please let usknow if you would like more information about this.

7.3 Statutory BooksEvery company is required to keep the following:

7.3.1 Registers of:(a) members;(b) directors and secretaries;(c) directors interests; and(d) charges.

7.3.2 Copies of any directors service contracts;7.3.3 Minute books containing minutes of all board and general meetings; and7.3.4 Accounting records.If we incorporate a company for you, we will prepare a set of statutory registers for you.

We offer a comprehensive company secretarial service where we maintain the statutory registers forcompanies on their behalf. Please let us know if you would like more information about this.

7.4 Stationery, websites, emails and other trading disclosuresA company must ensure the following details are on all letterheads, emails and other communications,its website and all official publications:

Its full name; Its country of registration and registered number; and Its registered office address.The companys name must also be displayed in a prominent place at the companys places of businessor where it keeps its records for inspection.

Companies should also have terms of use and a privacy policy complying with data protection rules ontheir websites, which we can assist with.


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TAILORING THE CONSTITUTION

This part of the note outlines some of the most important matters to be considered when tailoring a companysconstitution to the needs of the shareholders. We hope that it may assist shareholders or prospectiveshareholders to consider the range of protections available to them.

The discussion is not necessarily exhaustive and we would recommend a further discussion to enable us to drafta constitution which most appropriately reflected your requirements.

In order create a constitution with all the provisions discussed below, the company would have to adopt newarticles of association and the company and shareholders would have to sign a shareholders agreement.Because of the inevitable overlap and interplay between the shareholders agreement and articles, the belowdiscussion does not differentiate between the two documents. Some forms of protection will requirecomplimentary provisions in both documents and the documents tend to dovetail.

A shareholders agreement will offer its parties far greater security and control over the company than can beachieved solely through the articles. However, such protection is not always necessary for every company and

we would advise as appropriate on review.

In any event, we recommend that the shareholders take accountancy, tax advice and possibly independentfinancial advice about the best structure to implement, prior to making any major constitutional changes.

1. Management of the CompanyAll aspects of equity documents govern the management of the company. However, certain provisionsdirectly prescribe the procedures for taking decisions and allocating responsibility for managementfunctions. These provisions are discussed in this section.

1.1 Composition of the board and managementRepresentative directors

A shareholder does not have an automatic right to be appointed as a shareholder.

However, particularly where the parties expect to be involved in the management of the business, theshareholders may want an entrenched right to appoint themselves or one (or more representatives) tobe directors.

Often the shareholders want to limit the ability to remove a director from office. This is discussed atmore detail in paragraph 1.4 (page 15).

Swamping rights

In certain circumstances, a key investor may want the power to appoint any number of directors to theboard and/or exercise an enhanced number of votes, effectively taking control of the company. This isa fairly common right for institutional investors and is typically exercisable when the company breachesthe terms of its funding agreements with the bank or is in financial difficulty.

Committees

The agreement can provide for more complicated layers of management, with senior managementpresiding over a number of committees (for example, it is common to have an audit or remuneration

committee).

In professional partnerships, there are often several classes of partner (such as full equity, fixedequity (with limited management involvement but a fixed investment in the firm) and salaried (who aresimply employees)) with varying degrees of responsibility.


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It is becoming popular to convert partnerships and LLPs to limited company status, and it is possible tostructure the constitution to reflect the varying powers and responsibilities, with for example, a seniorboard consisting of the senior partners. We provide bespoke advice to professional partnerships whowish to incorporate or alter their constitution.

1.2 Conduct of the companys affairsDealings between shareholders, compliance and oversight

It is worth spelling out key duties of the company, the members and directors, including obligations ofgood faith and integrity which may not necessarily apply as between the shareholders of a limitedcompany.

In addition responsibility for compliance matters can be allocated, such as keeping proper records,maintaining insurance and conducting financial controls.

The documentation can enhance the rights of shareholders beyond the general law position, giving

e.g.:

access to board minutes, financial documents and records which are not normally available to aperson in his or her capacity as a shareholder; and

rights to (or send professional adviser to) attend and observe directors meetings.1Financial controls

Perhaps, more importantly, the equity documentation can put in place:

procedures for preparation and approval of annual accounts (note that, in the case of privatecompanies, approval by the shareholders is no longer a statutory requirement);

provisions for the creation and approval of annual budgets and business plans; and requirements for the preparation of regular management accounts and other financial

information.

1.3 Quorum requirementsQuorum means the minimum number of directors (in the case of a board meeting) or shareholders (inthe case of a general meeting of shareholders) who must be present at the meeting to make itsproceedings valid.

The quorum requirements for board and shareholders meetings can be tailored to ensure, for example,that, in order for board decisions to be valid:

a sufficient number of board members must be involved in any decision; the representative director of a particular shareholder must be present at board meetings;

and/or

Similarly, the quorum requirement for shareholders meetings can be set so that certain shareholders or

1 Institutions sometimes find this useful as a means of gaining representation at board meetings without the formality of appointing a director with theattendant responsibilities and potential liabilities that would otherwise go with that office.


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their proxies2must be present for their proceedings to be valid.

We would also suggest including default provisions so that if a member consistently failed to attendmeetings, certain quorum restrictions could fall away at adjourned meetings.

1.4 Votes of directors and shareholdersDirectors

How directors take decisions at board meetings is discussed in paragraph 3.2 of part 1 (page 4).

In most companies, each director will have one vote at each board meeting (regardless of the numberof shares anyone has).

However it is worth considering whether a director who is (or who represents) a major investor shouldbe given multiple votes on some, or all issues.

In private equity investments, enhanced voting rights for directors may also be coupled with swampingrights (discussed under paragraph 1.1, above) and exercisable specifically where the company breachesthe terms of its funding agreements with the bank or is in financial difficulty.

Shareholders and weighted voting rights

The general position about shareholders votes is discussed in paragraph 4.6 of part 1(page 9).

Shares can be given unequal voting rights, or their rights can be enhanced only in specific situations,and of course, the company is free to issue shares without any voting rights at all.

For example, the shareholders may:

create two classes of ordinary share with unequal voting rights, generally (but this isuncommon because the shareholders with more to invest will normally hold more shares andownership of a greater number of shares is what normally determines the voting rights atshareholder level); or

more commonly, provide for enhanced voting rights only in a narrow range of situations. Themost common provision of this nature is one which protects a director from being removed, bygiving their appointing shareholder the requisite number of votes necessary to defeat anyproposal to remove that director from the board.

It is worth noting that section 168 of the 2006 Act makes it clear that a company can always remove adirector by ordinary resolution, regardless of what the articles or any agreement says. Accordingly, aclause which simply says that a director cannot be removed will not be effective. However, it ispossible to give the appointing shareholder enough votes to defeat such a resolution and, generally, togive shares unequal voting rights.

Depending on the nature of the investment being made, we may sometimes recommend that thispower to effectively prevent the removal of a representative director falls away from a defaultingshareholder (discussed in more detail at paragraph 1.6, below, page 16).

2A proxy is a substitute who is appointed to attend a shareholders meeting and vote at it on a shareholders behalf. Proxies can be given authority to voteas they choose, or told to vote in a certain manner. Sometimes, shareholders appoint the chairman of the meeting as their proxy (and would normally be freealso to direct how the chairman was to exercise their votes).


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1.5 Deadlock provisionsThis is potentially a problem if two members have equal voting power and they cannot agree on amatter. Deadlock provisions can cater for all situations, or be limited to matters of fundamentalimportance to the company and can provide, by way of example, the following solutions to a deadlock:

1.5.1 providing for a rotating chairman with a casting vote on decisions (note that the chairman of ashareholders meeting is now prohibited from holding the casting vote); or

1.5.2 providing (by a number of different procedures) for one of the shareholders to exit from thecompany.

There are various other possible solutions and we are happy to discuss this in more detail.

1.6 Defaulting shareholdersThe equity documents can provide sanctions against a shareholder who commits a serious breach of

the agreement or his or her other obligations to the company or commits some other act of seriousmisconduct. The documentation would normally define such a person as a defaulting shareholder.

It is worth considering the situations in which the shareholders and/or company wish to be in a positionto take action against a defaulting shareholder.

Not all companies provide any special rights for dealing with defaulting shareholders. However, inprofessional partnerships, for example, these provisions can be very important.

These provisions can be used to suspend the rights of (for example, the right to appoint arepresentative director, to allow the shareholders to consider removal of a defaulting shareholdersrepresentative), or expel, defaulting shareholders.3

We would also recommend having a service contract which should cover the circumstances in which adirectors employment and directorship with the company may lawfully be ended.

2. Reserved mattersOne of the crucial provisions of the shareholders agreement is a list of matters which the company isrestricted from carrying without approval of all, or at least a suitable majority of, shareholders. Theseprovisions protect the shareholders interests in key aspects of the business and are a key tool inprotecting the interests of minority shareholders. These may include things like the following (althoughthe list is not exhaustive):

2.1.1

any change to the articles, share capital of the company or the companys business;

2.1.2 entering into major contracts;2.1.3 any declaration of dividends or changes to agreed dividend policies;2.1.4 appointment or removal of directors (although these provisions, in particular, should be tailored

to suit the requirements of each company4) or senior employees;

2.1.5 expelling shareholders (if applicable);2.1.6 buying or selling any business, or major assets, or entering into major capital commitments;

3More about expulsion of defaulting shareholders is discussed at paragraph 5.4, below, page 20.4For details about representative directors, see paragraph 1.1, above, page 13.


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2.1.7 entering into financial facilities or negotiating new borrowings with any lender, or entering intomajor security obligations; or

2.1.8 entering into major litigation.It is very normal to set certain financial levels below which approval is not needed, to allow the boardto function at a certain level without needing to refer back to the shareholders.

3. Responsibility for funding and liabilities3.1 Capital contributions and funding

It is worth considering how the shareholders propose to fund, e.g. working capital and further fundingand when it may be necessary to call on the members to provide further funding, and any limits on theextent of further funding and any conditions on that funding (e.g. all lending to the company to be byway of secured loans or, perhaps, certain shareholders may agree to make a fixed loan contribution).

3.2 GuaranteesBanks, landlords and sometimes other creditors require the directors and/or shareholders to givepersonal guarantees by which the directors will pledge their own money and personal assets as securityfor debts of the Company to that creditor.

In practice, the liability under guarantees is not always shared equally or fairly (for example, theshareholders may want liability under guarantees to be shared in line with the way shareholders haveagreed to fund the company). It is rare for the creditor to accept a sharing arrangement which mightweaken the security it is demanding in any way. However, as between the shareholders, theshareholders agreement can provide for whatever sharing agreement they wish.

In addition, the equity documentation can put a contractual onus on shareholders to seek a release ofthe terms of any guarantees given by one of them should he or she exit from the company.

We recommend taking legal advice prior to signing any personal guarantee or indemnity.

4. Distribution policiesThere is no obligation on the company to pay dividends. It may be worthwhile setting out adistribution policy to ensure that the parties cooperate to ensure that profits are distributed to themembers in a consistent manner.

More sophisticated planning can be achieved if the companys constitution provides that each

shareholder may receive different levels of dividends (otherwise, dividends are typically paid equally oneach share).

It is generally the case that dividends are taxed more favourably than salary. Therefore, particularlyfor owner managed businesses, or where the rewards open to staff are performance based, it may,subject to tax advice, prove beneficial for each of the company and members to receive some of theirpay as dividends rather than salary.

Provisions in any agreement must be carefully drafted in order to comply with taxation rules so thatany intended tax benefits are not disrupted by the drafting we recommend taking tax advice on anydividend policy you may wish to implement.


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5. Transfers of sharesPerhaps the most important provisions to consider are restrictions on the transfer of shares. Withoutsome sort of restriction on the transfer of shares, they are freely transferrable to anyone. There aremany reasons why the shareholders may prefer control of the company to remain with a select group

of individuals, or otherwise impose a range of conditions for approval on new members.

Many companies which are not advised do not contain any restriction on transfer, or contain out ofdate restrictions which should be modernised to reflect changes brought about by the 2006 Act.

Many companies which do have some sort of restriction contain an article simply permitting directors torefuse to register a transfer of shares, typically without giving reasons. Under section 771(1) of the2006 Act, if the directors do refuse to register a transfer, whether not the articles of the company sayotherwise, they must now give reasons for that refusal.

A dissatisfied transferor or transferee can attack the directors decision if he or she can show that theyexercised their discretion for an improper purpose, failed to act in good faith in a manner that promotes

the success of the company as a whole, or for a reason outside the grounds for rejecting transferswhich are specified in the articles. Accordingly, the current law gives a greater the scope was the casein the past for dissatisfied transferors or transferees to mount legal challenges to a refusal to register.

Separately to that, private companies may have a limited market for minority shareholdings and pre-emption provisions (discussed below) are a common way of providing the fairest process for managingthe exit of a shareholder from a company.

Accordingly, we generally recommend that companies consider the following, all discussed below:

pre-emption provisions governing the process by which shares must be offered to othershareholders within the company;

permitted transfer provisions governing certain situations when transfers can take place outsideof the pre-emption procedure; and

compulsory transfer provisions, which are particularly relevant to quasi-partnership companiesand private equity investments.

It is also worth considering including specific restrictions on:

transfers to outsiders - for example, family companies may consider a requirement that anynew incoming member must be specifically approved by the shareholders, or some class ofthem; and

a sale of shares during an initial period, in order to incentivise the shareholders to commit, fora limited period, to the company, perhaps tying those restrictions into bad leaver provisions,discussed at paragraph 5.3, below (page 19).

5.1 Pre-emption rightsOffer of shares to be made by shareholder

Generally speaking, pre-emption rights will require any shareholder who wishes to sell shares to offerthem to the other shareholders (or sometimes, to specific shareholders, or perhaps even back to thecompany).

There is a wealth of options for pre-emption provisions, and indeed, they can be substantially adaptedto suit the requirements of the shareholders. We recommend that companies consider adopting pre-emption procedures covering such things as:


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to which shareholders, and by whom, shares must be offered; whether the company should be given the opportunity to purchase its own shares (subject to

certain technical conditions which must be satisfied);

how the price is to be determined (we would normally recommend that if there is a dispute asto price, the question is referred to an independent accountant);

the specific valuation procedures which are to apply if shares are to be valued independently(for example, giving the accountant freedom to determine an appropriate market value5;basing the price on the net assets; or opting for more specific valuation policies);

whether the shareholder offering to sell his or her shares is to be entitled to withdraw the offerif he or she does not like the results of the valuation (and whether he or she should pay thecosts of the valuation in such circumstances);

whether a shareholder who wishes to sell shares must offer all (rather than simply a portion) ofthe shares held by him or her under the procedure (particularly relevant to partnership

companies or private equity investments); and

similarly, minimum, or total, transfer conditions, making any sale conditional on offers havingbeen received for all, or a specific proportion, of the offerees shares.

Note that, if a company chooses to adopt specific tax efficient plans to reward its employees withshares, such as a share incentive plan, there are specific tax rules which apply and which determineprecisely how any pre-emption procedures must operate. We would be more than happy to assist withthese.

5.2 Permitted transfers to family members and other related investorsCompanies often decide to adopt pre-emption procedures (discussed below). However, they may alsowish to provide for a number of situations when the pre-emption procedures do not apply.

For example, provisions could be included allowing:

institutional investors to be able to transfer their shares freely (although, depending on thecircumstances, such investors may be limited to being able to transfer their shares only towithin their group or to another institutional investor);

corporate shareholders to transfer their shares to another company within their group; a certain majority of shareholders to agree, on occasion, to suspend the pre-emption rights to

allow shares to be transferred to e.g. an incoming manager or partner; and/or

transfers to family members or family trusts without any need to apply any pre-emptionprovisions. These provisions allow shareholders to structure their shareholdings tax efficientlybut can still be drafted in a way that family members to whom shares are transferred may alsobe required to join in with any sale of the family member who originally transferred shares tothem.

5.3 Compulsory transferWithout specific provisions in the equity documents (usually the articles) the shareholders do not havethe right to compel a shareholder to sell his or her shares.

5This is the basis we would normally suggest, generally on a pro-rata basis, without a discount on the basis that the shares represent a minority holding, or apremium for any majority holding.


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However, for many companies, it may be important to include provisions which, for example:

facilitate the expulsion of shareholders in a quasi-partnership company (particularly defaultingshareholders); or

enable the company to require employees and directors shares to be offered for sale ondeparture; or

enable the company to remove a disgruntled shareholder; or enable the company to buy the shares of a shareholder in specific circumstances, such as the

bankruptcy or death of a member, or an attempt to transfer the shares in breach of thearticles.

Typically, the right to force a compulsory sale will be time limited. Often the time limits are in theregion of 6 to 12 months from the relevant triggering event.

Compulsory transfer provisions can require a sale under a pre-emption procedure similar to that

discussed at paragraph 5.1, above (page 18) or, in the right circumstances, sometimes to new,incoming shareholders, approved by the board.

Good leaver/bad leaver

Most commonly, shares will be offered under a pre-emption procedure at a price to be agreed, or indefault of agreement, at a market value determined by an accountant.

However, in certain circumstances, a shareholder may be required to sell his or her shares for less thanmarket value. These circumstances most commonly arise in companies with an institutional investor.The purpose of these provisions is to incentivise senior management to make the company realise thevalue of the investors investment, by providing financial consequences if that senior manager leaves

the company before that investment has been realised.

In order to protect the continuity of the company, it may also be worth considering a substantialdiscount for the shares of a shareholder who becomes bankrupt, as technically the title to his or hershares may fall into the hands of his or her trustee in bankruptcy, and the company may want to beable efficiently to protect itself against losing control of a portion of its membership in that event.

Accordingly, provisions in the articles can be introduced which distinguish between a good leaver anda bad leaver. A good leaver will be offered market value for his or her shares, and a bad leaver willreceive a discounted market value. Any discount is usually time limited and will reduce progressivelyover time, to recognise the value added over time by the senior manager since the investment tookplace.

Good leaver will usually mean leaving employment on grounds of death, disability, unfair orconstructive dismissal. Bad leaver will usually mean leaving in circumstances justifying his or hersummary dismissal. These definitions can be tailored substantially to suit the requirements of thecompany.

It is worth noting that it the investor is often given the discretion to relax or modify the effect of theseprovisions under certain circumstances.

5.4 Expelling defaulting shareholdersCompulsory transfer provisions would normally extend to the situations when a defaulting shareholder

is removed, and where necessary, can be specifically tailored to the requirements of the company.

This may be particularly appropriate in professional partnerships.


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It is worth noting, however, that for various technical reasons, we do not recommend that any badleaver provisions are included solely to penalise defaulting shareholders or acting as an alternative toseeking damages for any breach by a defaulting shareholder. The limited reasons why a company can

justify adopting bad leaver provisions are described at 5.3, above.

5.5 Drag and tag provisionsThe intention of many shareholders is to sell their company at some point in the future for a gain. It isoften a condition of investments made by institutional investors, that if they find a buyer for thecompany in the future, the investor can compel a sale of the whole of the company.

Similarly, the minority shareholders may wish that, if the majority investor has negotiated a sale with athird party, they should be given the opportunity to take part in that sale, thus giving them the comfortthat they too could realise their own investment in the company.

Accordingly:

drag along provisions can be included in the articles, which provide that, if a certain majorityof the shareholders wish to sell their shares to a genuine third party purchaser, they canrequire the remainder of the shareholders to sell at the same price as per share to that thirdparty purchaser; and

tag along provisions set out that if a certain majority of the shareholders are proposing to selltheir shares to a genuine third party purchaser, the remainder can require a proposedpurchaser to buy all the shares in the company at the same price per share as has been offeredto the majority.

This has the advantage of making the company more readily marketable and prevents a small minorityfrom obstructing a sale which a requisite majority approves.

6. Post exit restrictionsIt is worth considering including post-exit restrictions protect the companys business by restricting aformer shareholder from carrying out activities in competition with the company for a period of timeafter that shareholder exits from the company.

Whilst a director will owe a duty of confidentiality to the company and will have certain obligationswhich may prevent them from exploiting business opportunities even after leaving the company, a clearcontractual obligation will provide far greater clarity to the parties about how they expect to berestricted should they exit, and is generally more straightforward to enforce.

Such restrictions are only enforceable if they go no further than is necessary to protect legitimatebusiness interests and protect the trade connection and confidential information of the company.

Typical restrictions, widely considered to be enforceable would include the following covenants, alwaystime limited (the rule of thumb is that restrictions of over 12 months are progressively harder toenforce, but we recommend you take specific advice when considering including these provisions in anydocument before you consider enforcing them) would include restrictions against the formershareholder:

setting up in competition with the company and seeking business from its customers (or,potentially more controversial, dealing with customers);

interfering with key suppliers; or seeking to entice, or employing, employees, directors or shareholders of the company to a

competing business.


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SHAREHOLDERS POWERS

% shareholding or voting rights Section of the2006 Act (orother statute, if

different)

Any restrictions

Any shareholding

The right to ask a court to call a general meeting s 306

Right not to be unfairly prejudiced s 994

Right to apply to court to wind up the company,on grounds that it is just and equitable to do so

s 122(1)(g) of theInsolvency Act

1986

The right to a share certificate s 769

The right to have the shareholders name enteredon the register of members

s 113

The right to a copy of the annual accounts s 431

The right to inspect minutes of general meetingswithout charge

ss. 358

The right to inspect the register of members andindex of members names without charge

s 116(1)(a)

The right to require a copy of the register ofshareholders within 10 days of the request(subject to a charge)

s 116(2)

The right to inspect the register of directorsservice contracts without charge

s 229(1)

Right to inspect the registers of directors andcompany secretaries

ss. 162(5) & 275(5)

5% of voting rights

Right to require the company to circulate astatement of not more than 1,000 words aboutthe business to be dealt with at the meeting

s 314(1) The request must be received bythe company at least one weekbefore the meeting to which itrelates

5% in nominal value of shares having the right to vote at general meetings1

Right to require the directors to call a generalmeeting

s 303(2)(a) This can be exercised by sendingwritten notice to the company

1Note that this may be different to the more straightforward percentage of voting rights if, for instance, certain shares carry more votes than others.


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Right to call a meeting at the companys expense s 305(1) Can only be exercised if thedirectors fail to call a generalmeeting pursuant to section 303within 21 days from the date theyreceive a request from the relevantshareholders

10% in nominal value of shares having the right to vote at general meetings

The right to refuse consent to short notice of ageneral meeting

ss. 307(4) (6),2006 Act

(Note that the company change itsarticles to give the right as low as5%)

Right to demand a poll at a general meeting s 321(2)(b)

10% in nominal value of the issued share capital (voting or otherwise)

The right to require the companys accounts to beaudited s 476

More than 25% of voting rights

The power to block a special resolution s 283

More than 50% of the voting rights

The power to pass an ordinary resolution 282 A court may have the power to setaside a resolution of the memberswhere the votes have been used to

defraud the minority or for acorrupt purpose.

75% of voting rights

The power to pass a special resolution s 283 Again, a court may set aside aresolution where the votes havebeen used to defraud the minorityor for a corrupt purpose


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DIRECTORS RESPONSIBILITIES AND RISKS

As well as the list of general duties set out in the 2006 Act, directors owe other duties under variety of otherlaws and regulations, such as insolvency and health and safety legislation.

This part outlines some of the more important duties and typical strategies for deal with the risks involved.

This part is split into three sections:

1. Strategies for managing risk;2. General duties of directors under the 2006 Act; and3. Directors duties and risks during a financial crisis.Whist it is important to understand the duties and risks, we consider that the first step is to adopt strategies tomanage risk. Whilst the consequences of a breach of duties can be severe for directors, with adequate

protective measures, procedures and processes in place and an understanding of the risks, there is no typicalrisk which is not capable of being managed.

This is why we have placed the strategies for managing risk at section 1. We hope that they are useful andwould be happy to discuss them in more detail.

Section 1

Strategies for managing risk

Consider theinsurance options

General insurance

The basic position is that a director will not be personally liable for a negligent actcommitted by the company, or more to the point, a companys employee, during thecourse of the business.

Whilst, under these circumstances, the company is also liable, it is also worth notingthat a director or employee who has negligently (or intentionally) caused loss to anythird party is probably also be personally liable (but the director or employee will rarelybe pursued on the basis that the company will normally be expected to have betterfinancial strength and insurance cover).

We therefore recommend that each company consults with insurance brokers toensure that it has in place appropriate types of cover to cover the kinds of risk that the

company may face (e.g. product or professional liability).

Directors & Officers liability insurance (D&O insurance)

D&O insurance also covers directors in respect of the personal financial consequencesof any wrongful or unlawful acts whilst acting as directors of the company. A goodpolicy should cover most, if not all of the risks described in section 2. They cansometimes cover some of the costs and certain aspects of personal liability which mayarise if the company becomes insolvent (but this will depend on the terms of thepolicy).

D&O insurance is not available against the financial consequences of criminal acts by adirector.

A companys payment of premiums for D&O insurance is a taxable benefit in kind for


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the director.

However, since the insurance normally benefits both the company and the director,the premium is generally apportioned between the company and the director to arriveat the taxable amount.

Whilst we cannot advise on specific insurance policies, we can put you in touch withindependent brokers who can.

Ensure thecompanysconstitutionappropriately dealswith all relevantcompliance issues

We recommend reviewing the articles of the company to determine whether:

the provisions governing the calling of meetings are appropriate, workable andthat meetings are properly convened and quorate when called;

provisions to allow directors to authorise conflicts of interest (discussed in moredetail in section 2, below);

provisions to allow, if necessary, directors to hold multiple directorships on theboards of different companies, without thereby inadvertently breaching dutiesto the company;

provisions to allow the acceptance of corporate hospitality from third partiesand other benefits, as appropriate;

a formal indemnity to allow a company to pay a directors defence costs indefending proceedings for breach of duty (but this will be on the basis that heor she repays the costs if unsuccessful); and

formal permission to the company to obtain and pay for D&O insurance.Allocateresponsibility forcompliance

Except, perhaps, for the smallest size of company, where delegation to specificdirectors or departments is not necessarily feasible, we recommend delegatingresponsibility for financial and legal oversight to someone of sufficient seniority withinthe business.

Perhaps the most important aspect is financial management. Responsibility for puttingin place and monitoring checks and controls should be delegated to a specificindividual who, or department which, is in a position to police issues and who report tothe board as a whole on a regular basis.

Responsibility for maintaining accounting and corporate records and for statutorynotification and filing obligations should be delegated to specific individuals, such as

accounting or company secretarial staff (and in that regard, we provide acomprehensive company secretarial service).

Responsibility for complying with court orders or undertakings should also bedelegated to a particular person or department.

It is worthwhile taking into account the particular risks which affect the business andspending time setting up processes to manage and oversee risks to ensure that anypersons or departments whose activities carry the greatest risk of breach areconsistently monitored. So, for example, the company should be in a position tomonitor compliance with key contracts and funding agreements.


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Hold regular boardmeetings

It is important to hold regular board meetings to ensure the directors are kept up todate have appropriate input into decisions. As mentioned below, it is crucial to ensurethat the directors are kept as up to date as possible about what is going on.

It is also important to establish and audit trail of the companys decisions, particularlyto demonstrate compliance with directors duties.

Meetings should be minuted to record:

matters discussed; instructions given; decisions reached; any professional advice given to the board and any such advice taken into

consideration in making decisions; and

directors voting for and against proposals.The contents of the minutes should:

reflect careful and considered decision making; and be agreed by all directors.

Make sure thedirectors knowwhat is going on

Although particular responsibilities are delegated to certain directors, each director hasa general responsibility for any breach by the company of its obligations and aresponsibility to monitor compliance as a whole.

It is therefore important that those with responsibility for each aspect of thecompanys business or affairs provide regular and structured reports to the board.

Directors should ensure that they receive a satisfactory flow of relevant information.

In particular, regular management accounts, preferably setting out a profit and lossaccount, and details of creditors and debtors and, ideally, a balance sheet, areparticularly important. Protection against certain liabilities (particularly those whichmay arise on the brink of, or during, insolvency) can only be based on the data whichthey provide.

Take professional

advice wherenecessary

Professional advice will be required on the structure of corporate transactions in order

to ensure that they comply with all relevant legal and regulatory provisions. It willalmost always be necessary to take advice from both solicitors and accountants insuch circumstances.

Professional advice which is sought on significant issues should be available:

to directors at first hand; in writing; and if necessary at board meetings.Directors should:

ask their advisers to clarify anything which is not completely clear; and


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make it clear if whenever they are relying on their advisors advice.Consider appointingnon executivedirectors

As a company grows, it may be worthwhile considering appointing a non-executivedirector who can help to ensure that an objective and independent view is taken ofthe companys affairs.

The non-executive director may be in a better position to take an objective view of theinterests affected by a companys actions.

Non-executive directors should ideally be wholly independent of the company.

Carefully reviewyour companysannual accountsand anymanagementaccounts

A companys statutory accounts are the primary source of information forshareholders. The directors careful consideration of the draft and of anyrecommendations or reservations made by any accountants or auditors is thereforecrucial

Coping with a financial crisis

Involveprofessionaladvisers at an earlystage.

It is important to keep the companys accountant or auditors closely involved and toseek the advice of lawyers and insolvency practitioners who may provide guidance andrange of options to deal with the situation.

Ensure that youobtain adequatefinancialinformation.

Have reliable financial information prepared to determine whether continuation of thebusiness is viable.

If appropriate, obtain professional advice to conduct an independent review and togive advice about asset values.

Make sure that allrelevant people areaware of thecompanysproblems

The entire board should be alerted to difficulties as they arise. This will be more easilymanaged if the company has regular board meetings although not all importantinformation can necessarily wait until the next board meeting.

We recommend the early supply of full information to the companys bankers andother major creditors to help obtain their support as far as possible.

Maintain fullrecords of all

decisions taken

Whilst we recommend taking full minutes of meetings and records of decisions in anyevent, it becomes more crucial if the company is on the verge of insolvency.

If an insolvent liquidation occurs and an action is brought against the directors forwrongful trading, it is vital that they have an adequate record of steps which they tookto minimise potential loss to creditors.


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Section 2

General duties of directors under the 2006 Act

What the duties are about

The directors duties set out in the 2006 Act replace a number of common law rules and equitable principles onwhich they are based. Where more than one duty applies at any time, the directors must comply with eachapplicable duty.

A list of the main statutory duties is set out below:

Duty Explanation

Promote thesuccess of thecompany

Section 172

A director must, in good faith, promote the success of the company for the benefit ofits members as a whole. In doing so, the director must have regard (among othermatters) to the:

likely consequences of any decision in the long term; interests of the companys employees; need to foster the companys business relationships with suppliers, customers

and others;

impact of the companys operations on the community and the environment; desirability of the company maintaining a reputation for high standards of

business conduct; and

need to act fairly as between the members of the company.The duty is subject to any law requiring directors in certain circumstances to consideror act in the interests of the creditors of the company, such as when the company isinsolvent, or nearing insolvency.

Success is not defined. The government stated that success in this context wouldusually mean long-term increase in value for commercial companies, and that this isgenerally a matter for the directors good faith judgment.

The obligation to have regard to the listed factors is subordinate to the overarchingduty to promote the success of the company for the benefit of its members as a whole

but at least some regard must also be had to the listed factors. The list of factors isnot exhaustive and all relevant circumstances must be considered in each case.

Each director owes the duties only to the company, even where the duty expects himor her to take into account of other things or people.

Act within powers

Section 171

Each director must act in accordance with the companys constitution (in particular,the articles of association) and must only exercise his or her powers for their properpurpose.

Under previous case law covering this area, courts have approached the duty by firstascertaining the purpose for which the power was conferred, and then determining

whether that was the directors main purpose when exercising the power.

If the directors main purpose was not the purpose for which the power wasconferred, it will not matter if he or she exercised the power in good faith or in the


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belief that it would promote the success of the company for the benefit of themembers as a whole.

Examples of use of powers for a purpose which is not proper include:

giving away assets of the company for no consideration to his own privatefamily company of which he was a director;

issuing shares clearly made with the object of creating enough voting power toalter the companys articles; and

issuing shares to one takeover bidder and not another, to ensure the defeat ofone of the takeover bids.

Exerciseindependentjudgement

Section 173

Directors must not restrict their freedom to make independent decisions.

The duty will not be infringed by a director acting in accordance with an agreemententered into by the company that restricts the future exercise of the directors

discretion or in a way authorised by the companys articles.

At the time that this section was enacted, the then government stated that this dutywould not prevent directors relying on advice, as long as the directors exercise theirown judgment in deciding whether or not to follow the advice in question. Indeed,bearing in mind the range of other duties, we recommend seeking advice wherever itseems appropriate to do so.

Exercise reasonablecare, skill anddiligence

Section 174

A director must exercise the care, skill and diligence which would be exercised by areasonably diligent person with both:

the general knowledge, skill and experience which may reasonably be expectedof a person carrying out the functions carried out by a director of the company(the objective test); and

the general knowledge, skill and experience that the director actually has (thesubjective test).

The objective test therefore sets out a minimum standard of care, but if the director inquestion has specialist knowledge, a higher, subjective standard applies when his orher specialist skill is called upon.

Avoid conflicts ofinterest

Section 175

A director must not, without the companys consent, allow any conflict, or possibleconflict, between the duties he or she owes the company and either his or her

personal interests or other duties he or she owes to a third party.

The duty does not relate to any transaction or arrangement with the company butinstead relates specifically to the exploitation by the director of any property,information or opportunity which properly belongs to the company.

If there is a conflict, the shareholders can authorise it by ordinary resolution.However, we can also amend the articles for companies to allow independent boardmembers to authorise conflicts, in accordance with the 2006 Act, which can simplifymatters if a conflict arises.

The most obvious situation where an issue may arise is for directors who sit onmultiple boards. We can assist with amendments to the articles and otherdocumentation (as necessary) to permit multiple directorships and deal with otherissues, such as the appropriate management of confidential information between


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multiple directorships.

Do not acceptbenefits from thirdparties

Section 176

Directors must not accept any benefit (including a bribe) from a third party which heor she receives because of his or her being a director, or doing or not doing anythingas a director.

The duty will not be infringed if the acceptance of the benefit cannot reasonably beregarded as likely to give rise to a conflict of interest. Benefits conferred by thecompany, its holding company or subsidiaries, and benefits received from a personwho provides the directors services to the company, are also excluded.

It is possible to adopt, and we recommend adopting, provisions in the ar

Brief introduction to limited companies.pdf

Documents

Transcript of Brief introduction to limited companies.pdf