The main benefit of incorporation is that it limits the liability of the shareholders or owners of the company. Incorporation creates a company which is a separate legal entity, apart from the shareholders. A company may act and enter into transactions as if it were a natural person. For instance it can sign a contract and will be bound by that contract. It can sue people and be sued. The company is liable for its own actions and the shareholders will only be liable for any amount left unpaid on their shares or uncalled capital.
The benefit of limited liability and the protection it affords to shareholders is referred to as the benefit of the corpora e veil. A company lives forever. This is referred to as perpetual succession. If a company enters into a contract, it does not need to renew or vary the contract even if there is a change in its directors or shareholders. Directors act as the controllers, or brain, of the company and so have more onerous legal obligations than do the shareholders. The directors’ legal obligations or duties set minimum standards. Directors may be personally liable if those minimum standards are not met.
A company may adopt a constitution if it so chooses. The constitution contains the rules by which a particular company operates. If a company does not adopt a constitution it will be governed by the standard provisions of the Companies Act 1993. A constitution allows a company to modify, restrict or extend various provisions under the Companies Act to the extent allowed by the Act. A constitution is registered with the Companies Office. It is available for public viewing. A constitution would usually:
- Include the minimum number of directors a company should have.
- Include restrictions on share sales e.g. a pre-emptive provision requiring that the shares must be first offered to other shareholders before being sold to a third party.
- Permit insurance and indemnity for directors
- Allow company financing of share purchases.
Other corporates also have constitutional documents. In the case of an Incorporated Society these are normally called the rules while an Incorporated Charitable Trust has a trust deed.
In addition to a constitution, often a company may have an agreement between its shareholders. This agreement is a contract between the owners of the company, or shareholders, and usually contains a full description of the rights and obligations of the shareholders. Shareholders’ Agreements often contain clauses that deal with:
- The business the company is to carry out.
- Finance required by the company.
- Matters which require unanimous approval
- Administrative matters e.g. auditors, bankers, choice of accounting period, appropriate company records
- Restrictions on shareholders e.g. not to compete with the company
- Dispute resolution e.g. mediation, conciliation, alternative dispute resolution, arbitration or expert determination.
- Buy-out provisions which describe the process for shareholders to sell their shares and may include a share valuation process.
A shareholders’ agreement is particularly important in the case of a joint venture (JV) company. The shareholders’ rights and obligations should be clearly stated in the agreement. It should also provide for the mechanism to deal with disputes between the JV shareholders. This is more efficient and cost effective than leaving disputes to be dealt with by default litigation. The shareholders’ agreement must be consistent with the constitution. Unlike the constitution, the shareholders’ agreement is not registered nor is it public.