Law relating to Company

Advantages of a Company ;
01. The Limited liability Company is a concept of English
law. After the Industrial Revolution in England in Seventeenth
Century, as business expanded, it was soon realized that
conducting business by (i) sole trading or (ii) by partnership was
not sufficient. These methods had a number of disadvantages.
For instance, sole trading or partnerships could not raise enough
capital. Secondly, only a few persons could be actively involved
in such business. Thirdly and more importantly, both sole
Traders and partners incurred personal/individual liability if the
business failed. On the other hand, the concept of a limited
liability Company did not face these disadvantages, A Company
through the issue of shares, could raise a large amount of capital
and because of the concept of limited liability, the Share Holders
Were not personally liable for the debts of the Company except
to the extent of the value of their shares.
02. Another great advantage of a Company is that it is
perpetual. This means that it does not matter if the
individual human owner (shareholders) come in and
then leave the Company either voluntarily or
because of death. All that a Company need to do
such a case is to make a note in its share register.
The Company continues and its business is
undisturbed until the Company itself decides to
cease doing business by a winding-up or liquidation.
02. The act of becoming a Company, in the formal
sense is called, incorporation. On incorporation, the
Company becomes a separate “legal person”. Thus a
Company can enter into Contracts even between
itself and the natural persons who established it. It
can also sue and be sued.
This important principle that a Company is a
separate legal entity from its shareholders was
judicially established over a hundred years ago in
1897 by England’s highest Court, the House of Lords
in the famous case of Salomon Vs. Salomon (1897)
AC 22.
• Here, Salomon was a boot and shoe manufacturer.
After trading in his own name (as a sole proprietor) for
nearly 30 years, he incorporated his business into a
limited liability Company. His wife and children were
given one share each in the Company while all the
balance shares were in his own name. As security for
the shares in the Company, he obtained debentures
from the company. Subsequently, the Company went
bankrupt. On the Company’s winding up it was found
that it’s remaining assets were insufficient to satisfy
both debenture holders of the Company and its trade
creditors. The trade creditors argued that since
Salomon- the principal share holder, was the debenture
holder, his rights should not have priority because
Salomon and the Company were truly the same person
since he & his wife and children owned the Company.
• That being so, he could not owe money to himself.
The Court however held that Salomon’s Company
was a separate legal entity from Salomon-although
he owned almost 99% of the shares. Accordingly,
the debentures the Company had issued to
Salomon was a secured debts which should gain
priority over the unsecured debts owed to the trade
creditors. Thus Salomon’s claim should prevail over
that of the third party trade creditors.
• This important decision which is called the Salomen
Principal, has never been doubted ever since – and
has been applied in modern times.
• In Lee Vs. Lee’s Air Farming Ltd. (1961) AC 12
Mr. Lee was the Managing Director of a small
Company that operated air planes. He owned all the
shares of the Company except one share. He also
piloted the Company’s planes. While piloting a
plane he died and his widow claimed workmen’s
compensation Insurance. The insurance Co. argued
that since the Company was owned by Lee, he
could not also be a ‘worker’ in the same Company
and denied liability.
• Held
• That the Company and Lee were separate and the
widow’s claim for insurance compensation was
upheld.
• This provides that a Company is separate from its
share holders and staff.
• It was also accepted as good law and applied by the Sri
Lankan Court in Trade Exchange (Ceylon) Ltd. Vs. Asians
Hotel Corporation (1981) SLLR 67; In that case, 95% of
the shares of a Hotel Company (The Asian Hotels
Corporation) were held by a government corporation.
The Supreme Court of Sri Lanka held that the Company
and its shareholders were distinct legal entities and
that the Company did not become an agent of the
Government even though almost all the shares (95%)
were held by a Government corporation.
• Another striking illustration of a Company’s separate legal
existence lies in the fact that person in control of a
Company may do a wrong or commit a loss to the Company
in the belief that no action can be taken against them by
the Company because they are part of its management.
The correct position, however, is that a Company can sue
its own employees and its directors if they have caused any
loss to the Company by their actions.
• For example, Regal (Hasting) Ltd. Vs. Gulliver (1942) 1 All ER
378; The directors of R Co. Ltd. bought shares in a
subsidiary Company knowing that when such a subsidiary
Co. was sold they(the Directors) would make a substantial
profit. The Company sued the directors and the Court held
that the Directors must return such profits as they had
made use of their position as directors to make a private
profit for themselves.
• Lifting the corporate veil
• There are situations where the Courts will look
behind what is called the ‘veil’ or ‘mask’ of
incorporation to ascertain whether a Company is
really different from its major share holders.
• Judicial Decisions show that one of the clearest
justification for lifting the corporate veil is where a
majority share holders or ‘one man’ company is
attempting to commit a fraud or engage in
improper conduct.
• Jones Vs. Lipman (1962) 1 ALL ER 442
• Lipman Contracted to sell his house to Jones. Later,
he changed his mind and did not want to sell. To
achieve this objective, he transferred the ownership
of his house to a Company which he controlled and
then told Jones “Sorry, the house is no longer
mine”. But the Court held, that his transfer of the
house to the Company was a ‘sham’. The Court gave
an order both against Lipman and the Company
that the house be sold to Jones as earlier agreed.
• Main provisions of the new Companies Act No. 7 of 2007
• Types of Companies Permitted
(a)Limited Company Public Company
Private Company
Off-Shore Company
(b)Unlimited Company: is one in which the liability of
members is unlimited.
(C)Company limited by Guarantee: In a Company limited by
guarantee the liability of the members is restricted to the
amount each has undertaken to contribute to the assets of
the Company in the event of dissolution or liquidation.
• Incorporation
• Application on Form 1
• Adopt a model Article or annex a set of Articles
• Form 18
• Form 19
• Major transactions of a Company
• Of special importance are the provisions of the new
Act relating to what are called “major transactions”.
These provisions contained in Section 185 are for
the benefit of the share holders to protect them
from an irresponsible Board of Directors.
• A Company cannot enter into any major transaction
unless such transaction is-
(a) Approved by special resolution
(b) contingent on approval by special resolution
(c) Consent to in writing by all the share holders of the
Company or
(d) A transaction which the Company is expressly
authorized to enter into by a provision in its Articles
which was included in it at the time the Company was
incorporated.
The provisions contained in Sec. 185 in respect of major
transactions will not apply to Private Companies acting
with unanimous shareholder approval.
• What is a major transaction?(See Sec. 185)
• The acquisition of, or an agreement to acquire, whether
contingent or not, assets of a value which is greater
than half the value of the assets of the Company before
the acquisition.
• The disposition of, or an agreement to dispose of,
whether contingent or not, the whole or more than
half the value of the assets of the Company.
• A transaction which has or is likely to have the effect of
the Company acquiring rights or interests or incurring
obligations or liabilities of a value which is greater than
half the value of the assets before the acquisition or,
• A transaction, or series of related transactions which
have the purpose or effect of substantially altering the
nature of the business carried on by the Company.
• Public Notice
• A Company must, within thirty (30) working days of
its incorporation under the Companies Act, give
public Notice of its incorporation., specifying the
name and the number of the Company and the
address of the Company’s registered office.
• Company Name and changes thereof
• Restrictions on Company Names
• It cannot use a name that is identical to an existing
Company. This issue is overcome by getting the name
approved earlier.
• The Company name cannot, without the approval of
the consent of the Minister in charge, use words such
as,
(i) President or ‘Presidential’
(ii)Municipal or other local authority or suggesting
connection with any society or body incorporated by
Act of Parliament.
(iii)’Co-operative’ or ‘Society’
(iv)’National’, ‘State’ or ‘Sri Lanka’ or similar words.
• Change of Name
• Any change of a Company’s name must conform to
following;
❖ Prior name approval from Registrar of Companies
❖ Only by special resolution with the Registrar’s prior
approval
❖ Notice to the Registrar-Form 3
❖ Registrar’s certificate under Sec. 8(3)b
❖ Not to affect rights and obligations or pending legal
proceedings.
❖ Public notice to be given normally by news paper
advertisement.
• Directors of Companies under new Companies Act
• Directors of Companies, their appointments,
qualifications, disqualifications, Duties, removal
• The main persons who control and manage a
company are its Directors. Collectively the Directors
are called the Board(See Sec. 184) The chief
executive of the Company, sometimes also called
the Managing Director, is normally a member of the
Board. A public Company must have at least two
directors and any other company at least one.
Qualifications of Directors
• The following are disqualified to be a director;
• A person who is under eighteen years old.
• A person who is an undercharged insolvent.
• Has been convicted of any offence under the
Companies Act which is punishable by
imprisonment.
• Has been convicted of an offence involving
dishonest or fraudulent acts.
• Is adjudged insolvent under the Insolvency
Ordinance.
• A Court of law can also disqualified a director
under Sec. 213 of the Act.
• Appointment, Removal and vacation of office
(i) The first directors; Directors named in the
application for incorporation or in the
amalgamation proposal will continue as a Director
until he ceases to be such a director in accordance
with the provisions of the Act.
(ii) Subsequent Directors; can be appointed by
ordinary resolution of shareholders unless the
Articles otherwise provide.
(iii) Removal; Subject to the provisions in the Articles a
director may be removed from office by ordinary
resolution passed at a general meeting called for
that purpose.
(iv) Vacation or Cessation of Office; The office of
Director of a Company will be vacated if the
Director,
(a) resigns or vacates his office in accordance with
Sections 207(2) and 210(2)
(b) is removed from office in accordance with the
provisions of the Act or the Articles of the
Company.
(c) becomes disqualified from being a director in
terms of the provisions of Sec. 202
(d) dies
• Age limit of a Director;
This is now fixed at seventy. However, he or she can be
re appointed after reaching 70 if such reappointment is
done at an annual general meeting of the Company.
• Validity of acts of directors and delegation of their
powers
• As regards validity, the acts of a person as a director
will be valid notwithstanding the fact that:-
(a) A person’s appointment was defective; or
(b) the person is not qualified for such appointment

As regards delegation, Sec. 186 permits the Board

of Directors to delegate their powers as provided
for therein subject to any restrictions in the Article
of Association of the Company.
Duties of Directors
• To act in good faith and in the best interests of the
Company( Sec. 187)
• To comply with the Act and Company’s articles of
association.(Sec. 188)
• Not to act in a manner which is reckless or grossly
negligent but to exercise the degree of skill and care
that may reasonably be expected of a person of his
knowledge and experience.( Sec. 189)
• To rely on and use information and advice received
from others only if he knows that such reliance is
not unwarranted and if he is not put on notice after
making adequate inquiries. (Sec. 190)
• To make disclosure of interests. (Sec. 192)
• Not to use Company information(Sec. 197)
• To disclose share dealing.(Sec. 200)
• To approve remuneration and other benefits for
directors only as provided for in Sec. 216.
• Not to give loans or provide guarantee or security
to a director unless permitted under Sec. 217.
• To act as provided for in Sec. 219 in the event of a
situation of insolvency.
• To call an extra ordinary general meeting if it
appears that there will be serious loss of
capital.(Sec. 220)
 Doctrine of Ultra- Vires in Company Law
• The term ultra-virus is a Latin term which means
“beyond the powers”. If a person acts beyond the
authority or powers conferred on him, he is said to
be acting ultra-virus. This principle or doctrine of
ultra-virus was not confined to Company law. It
applies to several other areas of law. It applies in
the law of Agency and in the law of partnership
where for example, an agent exceeds the powers
given to him by the principal or a partner exceeds
the powers given to him in the partnership Deed.
• Under the old English law and even under our
Companies Act of No. 17 of 1982, the Ultra Vires
rules applied to Companies. For example, bankers
who lent to Companies always ensured that the
object of the borrowing was within the Companies
Memorandum of Association.
• However, the new Companies Act No. 7 of 2007 had
done away with this Ultra Vires rule. The new Act
does not also require a Company to have a
Memorandum of Association. It only requires
Articles.
• The leading English Case on the Ultra Virus rule in
Company is Asbury Railway Carriage Co. Ltd. Vs.
Richie(1875)LR 7 HL 653;
• A Company was formed to make, sell or hire railway
carriages and wagons. The directors of the
Company contracted to purchase a concession for
running a railway service in Belgium. Next, the
Company entered into a contract with a person
called Richie to construct a railway to operate the
service. This contract was also ratified and approved
by all the members of the Company. Later the
Company repudiated the contract and Richie sued
the Company for breaking the Contract.
• In their defence, the Company’s lawyers took a legal
argument that since originally the Company was not
empowered by its memorandum to operate a
railway system, the Company’s contract with Richie
was ultra vires and therefore the Company was not
bound by it.
• The House of Lords upheld this argument. The
Court noted that there was no moral justification in
the argument because the Company was denying
that it had the power to do something which it
actually did. But legally the argument was justified.
The contract with Richie to build a railway was
outside the powers given in the Company’s
memorandum. Thus the Directors of the Company
had no authority to enter into such a Contract.
• The subsequent ratification of this contract by all
the Company’s members also was not sufficient
because a contract that is ultra virus cannot be later
ratified.
• The “Indoor Management” Rule in Company Law
• Another rule of practical importance in Company law
which is connected to the Ultra virus doctrine, and still
applies (unlike the Ultra virus rule) is what is called the
“indoor management” rule. This rule originated from a
well known English case named Royal British Bank Vs.
Turquand(1856) 6 E & B 327.
• According to this rule, which is popularly referred to as
the Rule in Turquand’s case, outsiders (third parties)
dealing with a Company can assume that the
Company’s business activities and transactions are
being properly and duly performed and are not bound
to enquire whether the Company’s internal
management has been regular.
• In the Terquand case, a Company had borrowed
2000 pounds from the Plaintiff bank and as security
given the bank a bond signed by two directors.
When the bank sued to recover the unpaid loan, it
was argued that no resolution had been passed by
the Company to borrow that money from the bank
and therefore the bank could not recover.
• In rejecting this argument, it was held that because
power to borrow money was not inconsistent with
the general powers of the Company, the bank was
entitled to assume that the necessary resolution
had been passed.