The Companies Act 2006, the largest piece of legislation to have been enacted by parliament has made significant changes to how companies are established and run in the UK. The Companies Act 2006 aims to:
1. Ensure improved regulation and a “think small first approach”.
2. Make the process of setting up and running a company easier.
3. Provide increased flexibility for the future.
4. Increase shareholder involvement and long-term investment culture.
The 2006 Act has more clearly defined directors’ duties and also made directors more accountable to their shareholders for failure to carry out these duties. The “think small first approach” means that the effect of the 2006 Act on private companies is mainly deregulatory, on the other hand for public companies (whose shares are publicly traded) the new legislation will in many cases impose further burdens.
Companies are classified by reference to two criteria:
1. The liability of their members
2. The public/private distinction
Classification by reference to the liability of the members. A registered company may take one of three forms:
1. An unlimited company
2. A company limited by shares
3. A company limited by guarantee
Once a company has been incorporated it has a separate legal entity independent of is owners, meaning the company is able to own property and enter into contracts with other businesses. It is therefore the company that is principally responsible for debts, losses and contractual claims, as opposed to individual shareholders.
Sole traders and partners in a partnership, on the other hand, are personally liable to meet all their business’ liabilities that have been incurred. Therefore if a business runs into debts in excess of their assets and the partners or sole trader cannot pay them off, this will result in the failure and liquidation of the business.
According to the CA 2006 a company is defined as having “limited company” if the liability of its members is limited by its constitution Such a company may have its liability limited by shares or by guarantee. A company limited by shares is the most common business structure currently deployed and in particular private limited companies account for the majority registered in the UK for companies “limited by shares”.
A company is limited by its shares if the members’ liability is limited to the amount unpaid on the shares that they hold. This means if a shareholder holds fully paid shares they cannot be called upon to account for any shortfall suffered by the company. If the company fails then the most the shareholders stand to lose is the value of their investment, whereas a sole trader or a partnership, in contrast, stand to lose their personal estates.
The concept of limited liability places a considerable limitation on the remedies available to a creditor of a failing company.Â Creditors have therefore devised strategies in dealing with limited companies aimed at reducing the effect of limited liability. A common practice now for some creditors is to seek personal guarantees of the company’s liabilities from directors and shareholders, which has effectively cancelled out the advantages of limited liability.
Regardless of the risk of having to provide personal guarantees, there are still further advantages of running a limited liability company, as opposed to the other business mediums:
– When the business is up and running the need to provide personal guarantees generally extends only to voluntary creditors such as finance companies, banks and landlords for a commercial lease.
– In cases where a business is newly established, it is rare that suppliers of goods or services will require personal guarantees in order for the company to obtain credit.
– Customers/consumers are also unlikely to ask for personal guarantees in respect of the goods or service supplied to them.
– Therefore any other potential claims (e.g. personal injury from defective goods) will fall directly on the company.
Where a business is run through the medium of a sole trader or a partnership, all of the above liabilities are the direct responsibilities of the owner(s) of the business.
Disadvantages of limited liability
Shareholders in a limited liability company face a much higher level of statutory regulation and control when compared to the other business mediums.Â The CA 2006 imposes substantial regulatory and reporting obligations and even criminal sanctions on members or companies in default of certain obligations.
One of the key areas under heavy regulation is the companies finances, in particular its accounts. The CA 2006 requires that every company must keep adequate records, further:
– The accounts are subject to an independent audit.
– Must be filed together with additional certain supporting documents (e.g. a director’s report).
– Are subject to certain time limits within which they must file with the registrar.
– Management ensuring compliance with the regulation is time consuming and costly.
– Fees for auditors and others involved in the audit also make this a costly process for the company.
The above does not apply to sole traders or partnerships, as their accounts are not required to be filed or audited.
Another of the company’s reporting obligations involves information they are required to make available to the general public. Such information is usually accessed by an individual making an application direct to the company in question, examples of which include:
– Documentation submitted on the initial formation of the company, (e.g. articles of association)
– The annual accounts and the directors’ statement
– Company officers appointed on formation or later
– Company updates e.g. changes in shareholders/company officers, and annual accounts
– Any mortgages, debentures and charges recorded in the charges register.
It follows that a considerable amount of information concerning the structure, financing and performance of a company is required to be made available to anyone who wishes to view it, even actual or potential competitors of the business. This amounts to little or no privacy for the company in conducting its affairs. Conversely, this disadvantage is not shared by a sole trader or a partnership.
A further and final disadvantage of a limited liability company may be the formality that is required in decision making, for example a simple task such as changing the company name or constitution can require:
– The shareholders having to set up a general meeting.
– The meeting being carried out in accordance with the CA 2006.
– The shareholders passing a resolution and this being recorded in writing.
– A copy of this resolution, along with further supporting documents must then be filed the registrar of companies.