Elimination of the Memorandum of Association
Types of Companies
Single Member Companies
No-Par Value Shares
Concept of 'Shareholder' Changed
Shareholders' Rights to Purchase Shares
Fundamental and radical changes in Sri Lankan company legislation are expected once the proposed company law reform in the draft companies act is passed by the legislature. The draft act, which was to come into operation in 2000, may now come into force early in 2001; the delay is a result of the swearing in of a new cabinet.
Some of the most significant changes in the law as envisaged by the new Companies Act are set down below.
The proposed act would mean that the only paperwork required for incorporating a company would be a single form setting out the central characteristics of the company. This, as well as the necessary consents, could be completed by an ordinary business person. Standard articles of association would apply unless it is desired to modify or eliminate the model articles. Accordingly, the process of incorporation of a company will become easier and reliance on professional assistance will decline correspondingly.
With these changes it is likely that the incorporation of companies, particularly small private companies actively engaged in business, is likely to increase. This is in keeping with the government's avowed intention that the private sector should be the engine of economic growth in Sri Lanka.
Elimination of the Memorandum of Association
Another part of the proposed new Companies Act involves the elimination of the memorandum of association. As a result, the object clause would also disappear, which in turn would cause the abolition of the doctrine of ultra vires. This has been part of company law in Sri Lanka since the doctrine of a corporate personality and the creation of the company as a separate legal entity was introduced into the law.
The legal rationale for the doctrine of ultra vires was best explained by Lord Cairns in the judgment of the House of Lords in the case of Ashbury Railway Carriage and Iron Company v Riche ((1875)LR7HL 653). The first reason given for the application of the doctrine to a company, was that the company's objects clause which was required by statute to be stated in the memorandum of association, was treated as conferring specific statutory powers outside which the company could not act even with the unanimous consent of its members.
The second reason given by the House of Lords was that there was an implied covenant to comply with the conditions in the company's memorandum of association, and that therefore any activity which was not authorized by the objects clause should not be permitted.
In Sri Lanka however, the current position is that the covenant referred to by the House of Lords is a statutory provision. It is not legally implied.
The doctrine that a company should not venture outside the scope of its object clause, originates from the legal requirement that the objects clause must be stated in the memorandum of association of the company.
The new provisions will permit a company that has not set out its objects in the articles of association to have the same freedom to contract as a natural person. It will be able to carry on or undertake any business or activity, perform any act or enter into any transaction.
In the case of a company which has set out its objects in the articles, the effect will be to validate transactions even though they are beyond the company's objects as set out in the articles. However, the liability of the company's directors for loss caused by engaging in activities beyond the objects set out in the articles, would remain. The right of individual members of the company to obtain injunctive relief to restrain the company and it's directors from engaging in transactions and activities beyond the scope of it's objects would also be preserved.
These provisions, together with the elimination of the memorandum of association, effectively do away with the ultra vires doctrine and the difficulties created by it for businesses. They will have the salutary effect of encouraging and promoting the formation of companies. The realization that the ultra vires doctrine is a legal principle which has little use to the modern company has resulted in its modification or abandonment in several countries. In this context, the statement of Lord Devlin in the case of Kum v Tat Bank Ltd (1971 1 Lloyd's Report 444) is particularly appropriate:
"The function of the commercial law is to allow, so far as it can, commercial men to do business in the way they want to do it and not to require them to stick to forms that they may think to be outmoded."
The proposed Companies Act sets out three different types of companies that may be formed. They are:
- limited companies;
- unlimited companies; or
- companies limited by guarantee
A limited company may be incorporated as a private company or as an offshore company
The act provides that the name of every limited company other than a listed company shall end in the word 'limited' or the abbreviation. Every private company must have in its title, 'private limited' or this abbreviation. This is also the case for every limited company which is a listed company, with the words 'public limited company' or the abbreviation.
One of the changes intended by the proposed Companies Act is that a private limited company will no longer require a minimum of seven members. It is difficult to find a rational basis for having a minimum of seven members.
A major change to be introduced by the proposed Companies Act is the establishment of single member companies.
The act, provides that: "a company may have one shareholder only, if that shareholder is a body corporate, and where the single shareholder is a natural person the nominee shall be a body corporate; otherwise, a company shall have not less than two shareholders."
Therefore, a limited company can have a single shareholder only where such a shareholder is a body corporate. If the single shareholder is a natural person, a body corporate must be the nominee of such person. No distinction is made here between private companies public companies.
The traditional objection to single member companies has been that a fundamental attribute of corporate personality is that a corporation is a legal entity distinct from its members, with rights and duties different from those which its members enjoy or are subject to. It would be meaningless and unnecessary to give a natural person corporate personality. It is further argued that it would put creditors at undue risk by giving a natural person limited liability.
The proposal contained in the draft Companies Act would legally recognize the de facto existence of single shareholders. As stated by Gower, the decision of the House of Lords in Salomon v Salomon in 1897, finally established "the legality of the 'one-man' company and showed that incorporation was as readily available to the small private partnership and sole trader as to the large public company".
The proposals in the draft act would only result in the establishment of single shareholder companies in which the single shareholder is a body corporate, due to the requirement that where the single shareholder is a natural person, the nominee shall be a body corporate. It is indeed difficult to find a rational basis for the nominee being a body corporate.
A far-reaching and radical change in existing company legislation is being sought by the proposed Companies Act. It provides that "no share shall have a nominal or par value".
The present act requires the amount of the share capital with which the company proposes to be registered and the division of this into shares of a fixed amount, to be stated in the memorandum. Thus, each share has a nominal or par value. This prevents the issue of no-par value shares.
The proposal to introduce no-par value shares is one step towards the elimination of one of the fundamental principles of existing company law, namely the doctrine of capital maintenance. One of the arguments put forward to support the issue of no-par value shares is that the nominal value of a share need not bear any relation to its true value, even at the time of its first issue. It is also the case that, after the company has been in existence for some time, the nominal value rarely bears any relation to the true value. Accordingly, neither the nominal capital or the issued capital has any relation to the net assets of the company and is of no value in determining the credit-worthiness or the financial status of the company.
It is also argued that in the case of par value shares, dividends being expressed as a percentage of the nominal value of such share, gives a misleading impression of the value of that dividend. It therfore seems that no-par value shares would render the actual position more readily intelligible to ordinary, unsophisticated investors and would protect them from being misled.
No-par value shares are permitted in the United States and Canada. In the United Kingdom, the Jenkins Report of 1962 recommended the issue of preference and ordinary shares of no-par value. However, there is no likelihood of their being introduced since nominal par values are required under the EC Directives.
Concept of 'Shareholder' Changed
In the present Companies Act a shareholder is understood to mean only a person whose name appears in the share register. In the proposed act this definition would also include a person who is entitled to have his or her name registered in the share register even if registration has not taken place. This would effectively mean that a person entitled to be a shareholder could exercise all rights of a shareholder without his or her name being registered. Thus a company wrongfully refusing or negligently failing to record a person's name on the share register could not deprive him or her of their rights as a shareholder. It will, however, raise some uncertainty as to who the shareholders of a company are at any given moment of time.
Shareholders' Rights to Purchase Shares
The proposed act sets out certain circumstances under which a shareholder can compel a company to purchase his or her shares. This is an entirely new concept in Sri Lankan law. It means that shareholders who are in the minority and therefore unable to affect the fate of their shares, can now insist on these shares being bought.
The proposed act gives statutory recognition to derivative actions for the first time. A court may, on the application of a shareholder or director of a company, allow proceedings to be brought in the name and on behalf of the company. It may also allow intervening proceedings, to which the company is a party, for the purpose of continuing, defending or discontinuing the proceedings.
The proposed act gives power to court to make an order restraining a company (or a director of a company) that proposes to engage in conduct that would contravene the articles of the company or the provisions of the act. It is significant that there is no necessity for a shareholder or director to hold any minimum percentage of shares in the company to make such an application and obtain an order under these provisions. This could give rise to action being brought against a company which may hamper the smooth functioning of the company.
For further information on this topic please contact Simon Senaratna at Simon & Associates by telephone (+94 1 38 19 06) or by fax (+94 1 38 19 07) or by e-mail ([email protected]).
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