Setting up a business under English law

Unlike many legal systems, English law has never developed a comprehensive code of company law. Instead, the relevant law is found partly in cases decided according to the principles of common law and equity and partly in statutes. Between 1985 and 1986, a series of statutes was passed to consolidate many previous statutes. The most important of these was the 1985 Companies Act.

If you want to set up a business under English law, the first question to consider is whether or not to form a limited company (or corporation). A corporation is a kind of artificial legal entity, with the right to sue and be sued. It may consist of a single person, or several persons, but in each case it has a legal identity separate from these individuals. The members of a limited company have limited liability. This means that if the business has difficulties, the members can be made to pay its debts only up to a certain limit. Normally this limit is the amount unpaid on shares they hold (limited by shares), or the amount they have guaranteed to contribute to company assets (limited by guarantee). The company's liability itself is not limited; as long as the business has money or assets, creditors may sue. But they cannot sue the members as individuals beyond their stated limits.

Selling shares is one of the ways in which companies raise capital. A share is ownership of a proportion of the company, and thus the right to a proportion of any profit it makes (dividend). Shareholders cannot insist on the payment of a dividend every year, since this is up to the directors to decide. But if they are dissatisfied with the management of the company, as members they have the right to remove the directors. The more shares a member holds, the more voting rights he will have in general meetings.

Another way for a company to raise capital is by issuing debentures, or bonds, in return for loans. Debentureholders are entitled to an annual payment of interest, and this is not linked to the company’s profits and losses. In general, they have the right to sell their debentures back to the company (that is, call in their loan), or sell them on to someone else. If possible, the lender will make sure his loan is secured by a charge over a company asset, so that he will have the right to take company property should there be no money to repay him.

A limited liability company is not the only way to run a business. A single person may operate as a sole trader, and even if he employs many people, he alone is responsible for management and, thus, for any debts. Another way to run a business is for two more people to form a partnership in which they share management, profits, and liability to debts.

Unlike members of a company, partners may find their personal property is at risk if they are sued by creditors. It is also possible to form an unlimited company. Since members’ liability is unlimited this is, in effect, similar to a partnership.

If the advantage of forming a company is that it offers members some protection in case of bankruptcy, the disadvantage is that there are many regulations to observe in setting it up and running it. Under English law, there must be a minimum of two people, and they must sign a document called a memorandum of association, which must be filed with the national registrar of companies. The memorandum contains the name of the company, its objects, whether it is limited by shares or guarantee, and the amount of share capital. There are some restrictions on the choice of name: for example, the registrar will not accept a name that is the same or very similar to a company already registered, since this could confuse consumers and clients.

The objects clause of the memorandum is very important because a company may not engage in activity beyond its registered objects. Such activity is said to be ultra vires — outside its capacity. It used to be the case that both the company and its clients lost the right to remedies for breach of contract over an ultra vires transaction. The purpose of the doctrine was to stop company assets from being used for unauthorized activities. However, partly because of pressure to conform to European Community law, it is now possible for someone contracting with the company on ultra vires matters to be protected, provided the matter was authorized by the company’s directors. In any Case, companies usually draft very wide objects clauses to include any activities that the business is likely to be engaged in now or in the future.

1. What is the first question to consider if you want to set up a business under English law? Is there something else to be taken into account?

2. What does “limited liability” mean? Limited by shares? Limited by guarantee? Do you know any other forms of business?

3. What are the main ways for a company to raise capital? Can you think of some others?

4. What regulations should be observed in setting up and running a business?

5. What kind of information does the memorandum contain?

6. Why is the objects clause very important? What is ultra vires?

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