Corporate Law and Governance
Corporate Law and Governance
Question 1 Bryan, Sarah, Jason, Calvin and Rubini are interested in starting a travel agency specializing in tours around Sabah. They are keen in having an office at Damai, Kota Kinabalu and to hire a few staff. Their initial capital is RM30, 000 each. They are also planning to acquire MPV vans to cater to small groups of travelers. All of them agreed to be involved in the management of the business and to make decision together. However, they are seeking your advice as to which business structure would best serve their purpose. Advise Bryan, Sarah, Jason, Calvin and Rubini. (15 marks)
Question 2 If they have decided to form a private limited company for their business, what are the things they need to consider in incorporating a company? They would like to use Friendly Tours Sdn Bhd as the name of their business. Also, they agreed to appoint Rubini as the Managing Director of the company for 5 years. Advise them in the drafting of the Memorandum and Article of Association. (15 marks)
Question 3 In May 2013, they would like to expand their business in exporting fresh food and vegetables to Sarawak. They are not sure whether they are allowed to divert from their initial objective in travel agency business. They also would like to change their business name to Borneo Connection Sdn Bhd. In the recent meeting, Sarah was appointed as Managing Director of their business instead of Rubini as stated in the Article of Association. Advise Bryan, Sarah, Jason, Calvin and Rubini in the situations above. (15 marks)
Question 1 There are three types of business structure which are sole proprietorship, artnership and company. Choosing the right type of business structure is one of the most important choices of all for which they have to make when starting a business. Not only will this decision has an impact on their liability, it will also affect their ability to raise capital, management and decision making rights. Since there are five people who are interested in starting new business, it is important for them to compare and choose whether a partnership or company will best suit to their purpose.
According to Section 3(1) of Partnership Act 1961, a partnership is the relation which subsists between persons carrying on business in common with a view of profit. In other words, they must continuously carry on travel agency business and all partners agreed to operate the travelling business together with the intention to make profits from it. As for company, it is an artificial legal person who is bound by law to manage company. It is a separate legal entity for which its legal identity separates itself from its members, officers, employees and others who form the company.
In term of management and decision making, there are two types of partners in partnership: dormant partner who is not participate in management of the firm and managing partner who manages and makes all business decision of the firm, subject to any agreement requiring them to obtain consent of all other partners. According to the situation, all five of them are agreed to be involved in the management and to make decision together, so it is confirmed that they are all managing partners of the partnership and it is clearly set out in their written agreement.
Hence, they are entitled to manage the partnership together and they have a wider pool of skills, knowledge and experiences collectively from all partners, so they have more inputs and suggestions to a better management of the business. In decision making wise, any major decision relating to any change which will affect the nature of the partnership must obtain the consent of all partners by carrying out formal meeting. For instance, type of business carried on, admission and removal of partners, and dissolution of partnership.
Otherwise, they can freely make decision in their own or perhaps together by carrying out a less formal meeting, provided they are acted in good faith. As for a company, although only person who are appointed as director has the power to manage the company, members of the company have the definite voting rights in any major decision making. So, director has to comply with statutory requirements, which is to carry out general meetings by sending out notices of meeting to all members and must pass certain resolution from the members in order to obtain their consent and reach a decision.
Yet, the procedures in decision making in a company compared to a partnership is more tedious and time-consuming, especially when facing crucial matters to be solved in short amount of time. So, it is better to form a partnership in terms of management and decision making. As mentioned previously, partnership is not a separate legal entity and hence, they are having unlimited liability. All partners are personally and jointly responsible for all debts and obligations of the firm.
Not only it might end up with dissolution of the partnership, personal properties of partners can be seized to settle the business when the firm’s fund is insufficient to cover debts and obligations incurred during the ordinary course of the business. Unlike a company, it is a separate legal entity which separates itself from its members. As a result, only company is fully liable for debts and obligations incurred by itself while members’ liability is only limited to the unpaid amount of their shares capital, as established in case Salomon v Salomon & Co Ltd.
The creditors claimed that Salomon and his company were one and the same and they should be repaid in top priority. However, the court held that he is not liable for debts of the company due to separate legal entity. Hence, in the event of winding up, creditors cannot bring actions against members of the company to contribute more than their initial contribution in debts settlement and so, their personal assets are not affected. Therefore, it is better to form a company in term of personal liability.
Apart from that, they are planning to acquire several MPV vans in order to support their business but apparently their initial capital contribution which is totaling RM150, 000 is merely sufficient to acquire one or two second-hand MPV van. So, in term of raising capital, partnership’s fund is raised through capital contribution by all partners. If they wish to raise more capital by admitting more partners into the business but prior to admission, they must dissolve the partnership and form a new partnership consisting old and new members again, and perhaps their previous written agreement must be re-wrote.
However, continuous admission of new partner may not be the solution if they wish to expand the business as the amount of capital contribution from each partner may not collectively big enough to do so. As for company, a private limited may normally issue shares or debentures to family, friends or employees by way of a private arrangement while a public limited may invite public to subscribe for its shares or debentures. Also, a private limited may convert to public limited by passing special resolution to raise more capital.
Despite the risk of being a new business and compilation of statutory procedures, the amount of capital raised may be relatively more than the amount of capital contributed by each partners in the partnership. Therefore, it is better to form a company in term of raising capital and business expansion. Furthermore, partnership is not a separate legal entity and it can be easily dissolved upon the death, retirement, or new admission of any partner. Hence, partnership’s duration of existence is uncertain and has a finite lifespan.
Meanwhile, since company is a separate legal entity, it has the characteristic of perpetual succession. In other words, despite any changes occur in its membership, they should not worry about dissolution of the company as it is has an infinite lifespan and exists perpetually until it is legally wound up or deregistered. As such in case Re Noel Tedman Holdings Pty Ltd, a husband and wife who were the only directors and members of the company were killed in an accident but the court held that the company is not affected by the accident and would continue to exist.
Therefore, it is better to form a company in term of duration of existence. In conclusion, compared to a partnership, they are recommended to form a company in terms of limited liability of members, easier to raise more capital and its perpetual succession. Question 2 When they have chosen to form a private limited company, they should appoint a promoter to assist them in formation of company by performing secretarial services. Firstly, the promoter must conduct name search on the availability of proposed company’s name.
Next, incorporation documents such as Memorandum of Association (hereinafter referred as MA), Articles of Association (hereinafter referred as AA), statutory declarations and any prescribed forms must be lodged with Registrar of Companies’ (hereinafter referred as ROC) within three months from the date of approval of the company’s name. Upon submission of documents and payment of fees, ROC will issue certificate of incorporation to them. In MA, they need to state the name clause, registered office, object clause, share capital clause and liability clause.
While setting out name clause, they need to apply name search to ROC to check on the availability of their company’s intended name which is Friendly Tours Sdn Bhd. However, care must be taken where they should not register their company in a name that in opinion of ROC is undesirable or unaccepted by the Ministers, and also confusingly similar to the name of an existing company. In addition, they must include ‘Sendirian Berhad’ or the abbreviation ‘Sdn Bhd’ in their company’s name as it is a private limited company.
Once they obtain bona fide approval from ROC, the name is reserved for three months from the date of approval. Next, they should set travel agency business which tours around Sabah as their company’s principal object clause and from thereafter it defines their company’s legal capacity when entering into any contract. Yet, in order to expand their company’s legal capacity and evade ultra vires act, they are advised to draft their object clause in widest possible terms by including many conceivable forms of activities, either dependent or independent to company’s principal object clause i. e. ravelling business, and each of it should be regarded as a separate and independent object in its own paragraph.
Furthermore, they have to state the amount of company’s initial authorized share capital, which is RM150, 000 and its division into shares of a fixed amount, which can be 150,000 ordinary shares of RM1 per share. They can increase or decrease their authorized share capital in future by passing ordinary resolution. Also, their liability as a member in the company also must be stated, which is limited to the unpaid amount on their share capital, to protect their personal assets in the event of winding up.
Other information such as company’s registered office which located at Damai, Kota Kinabalu, subscribers clause and association clause must also be stated in MA. As a private limited company, it is open for them to decide whether to adopt its own AA which meets company’s requirements, adopt Table A of Fourth Schedule as its AA or a combination of Table A articles with specific articles designed to meet company’s requirements. However, under Section 30(2) of Companies Act 1965, Table A will be AA of their company if they failed to register its articles upon registration.
Any further alteration of AA is required to pass special resolution under some conditions. In drafting of AA, information such as appointment and removal of directors should be included in AA. To be appointed as a director, Rubini must be a natural person which is at least 18 years old and not being disqualified from being a director. Since they are forming a private limited company, they are allowed to name Rubini as Managing Director of the company and state a five years term of office in AA provided she is not 70 years old and above.
Then, they should ensure that the company has at least two directors including Rubini who shall be named in AA as the first directors of the company and will hold office until the first Annual General Meeting where they will automatically retire (except Rubini in this situation). If they adopt Articles 64, 66 and 67 of Table A, retiring directors may be reappointed and the company may increase or decrease the number of directors in a general meeting by ordinary resolution.
Furthermore, board of directors may have the power to appoint anyone as a director either to fill in casual vacancy or addition to existing board members if they adopt Articles 68 of Table A. Also, they have rights as members of the company to remove a director by ordinary resolution before his term of office expires. Yet, it is always subjected to company’s AA such as a provision is provided not to remove a director. They should also include the duties and powers of being a director, for example Rubini must greatly exercise her duties of care, skill and diligence.
Other officers such as company secretary and auditor must be appointed at least one in the company and his legal position and duties must be clearly set out in company’s AA. In addition, they should include rights of various classes of shareholders in terms of company’s profitability, repayment of capital, transfer of shares, and decision making process. Detailed information regarding share capital should be clearly furnished such as methods of issuance of shares, transfer of shares, share buyback and reduction of capital.
For debenture holders’ protection, they may need to state rules relating any fixed or floating charges attaching to specific properties as a security to creditors in case of unable to repay any loan or borrowing. Notices and procedures to meeting and winding up also must be stated in AA. Apart from that, they must insert restrictions as contained in Section 15(1) of Companies Act 1965 into MA and AA as a result of being a private limited company. For instance, it restricts its members’ rights to transfer shares.
It also cannot have more than 50 members. The company, too, cannot raise capital by a way of offering shares and debentures to public or the public deposit money with the company. In a nutshell, they will receive certificate of incorporation upon successful registration of the company. Certificate of incorporation signifies that their company has been duly registered on date mentioned in it and restrictions in Section 15(1) of Companies Act 1965 will be effective.
Besides, incorporation may bring forth effect that the company is a body corporate with the powers of an incorporated company, where it may sue or be sued in its own name, has a perpetual succession, may own property and the liability of its members may be limited. Question 3 During commencement of business, the company may wish to expand its business, change its name or alter provisions relating internal management. The company is permitted to do so by altering MA and AA by virtues of Section 21 and 31 of Companies Act 1965.
MA is allowed to be altered to the extent and in the manner which is provided by the Act under Section 21 of Companies Act 1965. Meanwhile, Section 31 of Companies Act 1965 states that articles in AA may be altered or added by special resolution and become valid as if originally contained in the articles despite subjected to few limitations. The first issue arises in this question is whether the company is allowed to divert their initial objective in travel agency business and expand their business in exporting fresh food and vegetables.
Upon incorporation, the legal capacity of the company is defined by object clause which has been stated in MA and it is not allowed to enter into any contract with third party, of which the purpose goes against its object. Otherwise, such act by the company is deemed to be an ultra vires act. Hence, the contract cannot be ratified by the company and considered as void contract which is shown in case Ashbury Railway v Riche. The company entered into a contract to build a railway station in Belgium for which the purpose went against their object clause of making, selling and hiring railway carriages.
The court held that the contract was considered as void as it was beyond the legal capacity of the company to undertake it. So, in their situation, the company is not supposed to enter into any contract including exporting fresh food and vegetables because their legal capacity is only limited to travel agency business which tours around Sabah. However, Section 20 of Companies Act 1965 has provided that even an ultra vires contract is still valid if it has been executed despite company’s lack of capacity to enter into it.
Meanwhile, if the contract has yet to be executed, minority shareholders may file for injunction to restrain company from performing the contract. Nevertheless, it is for the company’s best interest to evade the purpose of ultra vires doctrine by altering its object clause under Section 28 of Companies Act 1965. In case Bell House Ltd. v City Wall Properties Ltd. , defendant refused to pay procuration fee to company on the ground that the contract was made outside company’s object clause.
However, there was such clause in MA which allowed company ‘to carry on business or any trade whatsoever in opinion of board of directors be advantageously carried on by the company in connection with or ancillary to any of the above business or the general business of the company’. Although there was no relationship with main object clause, the court held that it was within plaintiff’s legal capacity due to the bona fide opinion of board of directors.
Therefore, based on their situation, the company can widen the scope of object clause by adding such clause into their MA in order for them to expand their business in exporting fresh food and vegetables. Apart from that, notices must be sent out to all members within 21 days of the general meeting and the company must pass a special resolution from members who attend and vote at the general meeting. Then, if there is no objection to the alteration within 21 days after passing of resolution, the company has to lodge with ROC within 14 days in order for the alteration to come in effective.
The second issue arises is whether the company can alter its name in MA from Friendly Tours Sdn Bhd to Borneo Connection Sdn Bhd. Prior to alternation, the company must conduct name search and apply to ROC to check on availability of its proposed new name which is Borneo Connection Sdn Bhd. It must also ensure that the new name is not undesirable or unacceptable in the opinion of ROC or similar to the name of an existing company. Once it obtains approval from ROC, the new name will be automatically reserved for 3 months and the company must perform steps to change its name within the reservation period.
Then, under Section 23(1) of Companies Act 1965, the company must provide notice of 21 days to all members of the general meeting and pass a special resolution from members who attend and vote at the general meeting. Upon that, ROC will only re-issue certificate of incorporation under the new name i. e. Borneo Connection Sdn Bhd and effects are taken into place. However, the company remains the same legal entity as the change of name will not affect any rights or liabilities of the company. In the third situation, Sarah was appointed as the Managing Director of the company instead of Rubini as stated in AA.
Firstly, the first issue arises is regarding validity of naming Rubini as Managing Director in AA. Section 123 of Companies Act 1965 has stated that a person shall not be named as a director or proposed director in MA or AA or company’s prospectus but this section is not applicable to a private limited company. So, it is valid to name Rubini as the Managing Director. Assuming Rubini’s term of office is not stated in AA, she will hold office until the next Annual General Meeting where she will retire automatically and may be re-elected for next appointment.
However, there is also a possibility where members of the company may remove Rubini as Managing Director by ordinary resolution before her term of office expires. Hence, Rubini should be given special notice of 28 days of the general meeting where she is proposed to be removed. Yet, based on the situation, she was not given any notice regarding removal of her position and Sarah was directly appointed as the Managing Director and therefore, it brought up straight to the next issue on whether Sarah is eligible to be appointed as Managing Director.
The person must be a natural person who at least 18 years old and above, has consented to appointment and not being disqualified from being a director can be appointed as a director. So, it is assumed that Sarah has fulfilled the criterion and she can be appointed as the Managing Director. Upon successful appointment of Sarah as the Managing Director, it brought up the key issue on whether the contract between Rubini and the company is in breach.
Section 33(1) of Companies Act 1965 has explained that MA and AA perate as a contract which only binding the company and its members, and members amongst themselves, but not between the company and outsiders. Generally, director is merely an officer but not a member of the company and so, he is considered as an outsider. Since he is not privy to the contracts, he cannot enforce any rights that MA or AA purport to confer upon them. However, Rubini has been validly named as the Managing Director of the company in AA and so, she has a valid contract between the company and herself.
Therefore, she can enforce her rights against the company if the company fails to observe provisions in AA. This situation is supported by the case Southern Foundries v Shirlaw. Shirlaw sued for breach of contract because he was removed by Federation Foundries which altered the articles of Southern Foundries to give them power to remove Shirlaw before his ten years term of office was expired. The court held that an alteration of the articles was not amounted to a breach of contract but their act on altered articles was deemed to be and, therefore, Shirlaw was only entitled to damages.
From the case, judge of the case has laid down the general principles where a company is not precluded from altering its articles so as to give itself to act upon altered articles, but acting on altered articles is construed as a breach of contract. Moreover, no injunction can be granted to prevent the adoption of the new articles but damages was the only remedy for breach of contract. In Rubini’s situation, there is a breach of contract as the company appointed Sarah as the Managing Director instead of her who has been stated in AA and it was assumed that the alteration of articles was in progress.
Yet, she cannot re-enforce her appointment since she cannot prevent company from altering its AA as it is given the power to do so under Section 33(1) of Companies Act 1965. So, she can only obtain damages for wrongful dismissal. In conclusion, the company is allowed to expand its business scope and change its name to a new name as long as it passes special resolution. However, Rubini was only entitled to damages as a result of wrongful dismissal because she cannot restrain the company from performing alteration in articles.
University/College: University of Chicago
Type of paper: Thesis/Dissertation Chapter
Date: 1 November 2016
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