Chapter 4

company limited by shares, the five following matters:--

1. The name of the proposed company, with the addition of the word "limited" as the last word in such name.

2. The part of the United Kingdom, whether England, Scotland or Ireland, in which the registered office of the company is proposed to be situate.

3. The objects for which the proposed company is to be established.

4. A declaration that the liability of the members is limited.

5. The amount of capital with which the company proposes to be registered, divided into shares of a certain fixed amount.

No subscriber of the memorandum is to take less than one share, and each subscriber is to write opposite his name the number of shares he takes.

These five matters the legislature has deemed of such intrinsic importance that it has required them to be set out in the company's Memorandum of Association. They are the essential conditions of incorporation, and as such they must not only be stated, but the policy of the legislature has made them with certain exceptions unalterable.

The most important of these five conditions is the third, and its importance consists in this, that the objects defined in the memorandum circumscribe the sphere of the company's activities. This principle, which is one of public policy and convenience, and is known as the "_ultra vires_ doctrine," carries with it important consequences, because every act done or contract made by a company _ultra vires_, i.e. in excess of its powers, is absolutely null and void. The policy, too, is a sound one. Shareholders contribute their money on the faith that it is to be employed in prosecuting certain objects, and it would be a violation of good faith if the company, i.e. the majority of shareholders, were to be allowed to divert it to something quite different. So strict is the rule that not even the consent of every individual shareholder can give validity to an _ultra vires_ act.

Articles of Association.

The articles of association are the regulations for internal management of the company--the terms of the partnership agreed upon by the shareholders among themselves. A model or specimen set of articles known as Table A was given by the Companies Act 1862, and is appended in a revised form to the Companies (Consolidation) Act 1908. When a company is to be registered the memorandum of association accompanied by a copy of the articles is taken to the office of the registrar of joint stock companies at Somerset House, together with the following documents:--

1. A list of persons who have consented to be directors of the company (fee stamp 5s.).

2. A statutory declaration by a solicitor of the High Court engaged in the formation of the company, or by a person named in the articles of association as a director or secretary of the company, that the requisitions of the act in respect of registration and of matters precedent and incidental thereto have been complied with (fee stamp 5s.).

3. A statement as to the nominal share capital (stamped with an _ad valorem_ duty of 5s. per £100).

4. If no prospectus is to be issued, a company must now (Companies Act 1907, s. 1; Consolidation Act 1908, s. 82) in lieu thereof file with the registrar a statement, in the form prescribed by the 1st schedule to the act, of all the material facts relating to the company. Till this has been done the company cannot allot any shares or debentures.

If these documents are in order the registrar registers the company and issues a certificate of incorporation (see Companies (Consolidation) Act 1908, sect. 82); on registration, the memorandum and articles of association become public documents, and any person may inspect them on payment of a fee of one shilling. This has important consequences, because every person dealing with the company is presumed to be acquainted with its constitution, and to have read its memorandum and articles. The articles also, upon registration, bind the company and its members to the same extent as if each member had subscribed his name and affixed his seal to them.

The total cost of registering a company with a capital of £1000 is about £7; £10,000 about £34; £100,000 about £280.

Capital.

The capital which is required to be stated in the memorandum of association, and which represents the amount which the company is empowered to issue, is what is known as the nominal capital. This nominal capital must be distinguished from the subscribed capital. Subscribed capital is the aggregate amount agreed to be paid by those who have taken shares in the company. Under the Companies Act 1900, Companies Act 1908, s. 85, a "minimum subscription" may be fixed by the articles, and if it is the directors cannot go to allotment on less: if it is not, then the whole of the capital offered for subscription must be subscribed. A company may increase its capital, consolidate it, subdivide it into shares of smaller amount and convert paid-up shares into stock. It may also, with the sanction of the court, otherwise reorganize its capital (Companies Act 1907, s. 39; Companies (Consolidation) Act 1908, s. 45), and for this purpose modify its Memorandum of Association; but a limited company cannot reduce its capital either by direct or indirect means without the sanction of the court. The inviolability of the capital is a condition of incorporation--the price of the privilege of trading with limited liability, and by no subterfuge will a company be allowed to evade this cardinal rule of policy, either by paying dividends out of capital, or buying its own shares, or returning money to shareholders. But the prohibition against reduction means that the capital must not be reduced by the voluntary act of the company, not that a company's capital must be kept intact. It is embarked in the company's business, and it must run the risks of such business. If part of it is lost there is no obligation on the company to replace it and to cease paying dividends until such lost capital is repaid. The company may in such a case write off the lost capital and go on trading with the reduced amount. But for this purpose the sanction of the court must be obtained by petition.

Shares.

A share is an aliquot part of a company's nominal capital. The amount may be anything from 1s. to £1000. The tendency of late years has been to keep the denomination low, and so to appeal to a wider public. Shares of £100, or even £10, are now the exception. The most common amount is either £1 or £5. Shares are of various kinds--ordinary, preference, deferred, founders' and management. Into what classes of shares the original capital of the company shall be divided, what shall be the amount of each class, and their respective rights, privileges and priorities, are matters for the consideration of the promoters of the company, and must depend on its special circumstances and requirements.

A company may issue preference shares even if there is no mention of them in the Memorandum of Association, and any preference or special privilege so given to a class of shares cannot be interfered with on any reorganization of capital except by a resolution passed by a majority of shareholders of that class representing three-fourths of the capital of that class (Companies (Consolidation) Act 1908, s. 45). The preference given may be as to dividends only, or as to dividends and capital. The dividend, again, may be payable out of the year's profits only, or it may be cumulative, that is, a deficiency in one year is to be made good out of the profits of subsequent years. Prima facie, a preferential dividend is cumulative. For issuing preference shares the question for the directors is, what must be offered to attract investors. Preference shareholders are given by the Companies Act 1907, s. 23; Companies (Consolidation) Act 1908, s. 114, the right to inspect balance sheets. Founders' shares--which originated with private companies--are shares which usually take the whole or half the profits after payment of a dividend of 7 or 10% to the ordinary shareholders. They are much less in favour than they used to be.

Promoters and promotion.

The machinery of company formation is generally set in motion by a person known as a promoter. This is a term of business, not law. It means, to use Chief Justice Cockburn's words, a person "who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose." Whether what a person has done towards this end constitutes him a promoter or not, is a question of fact; but once an affirmative conclusion is reached, equity clothes such promoter with a fiduciary relation towards the company which he has been instrumental in creating. This doctrine is now well established, and its good sense is apparent when once the position of the promoter towards the company is understood. Promoters--to use Lord Cairns's language in _Erlanger_ v. _New Sombrero Phosphate Co._, 3 A. C. 1236--"have in their hands the creation and moulding of the company. They have the power of defining how and when and in what shape and under what supervision it shall start into existence and begin to act as a trading corporation." Such a control over the destinies of the company involves correlative obligations towards it, and one of these obligations is that the promoter must not take advantage of the company's helplessness. A promoter may sell his property to the company, but he must first see that the company is furnished with an independent board of directors to protect its interests and he must make full and fair disclosure of his interest in order that the company may determine whether it will or will not authorize its trustee or agent (for such the promoter in equity is) to make a profit out of the sale. It is not a sufficient disclosure in such a case for the promoter merely to refer in the prospectus to a contract which, if read by the shareholders, would inform them of his interest. They are under no obligation to inquire. It is for the promoter to bring home notice, not constructive but actual, to the shareholders.

When a company is promoted for acquiring property--to work a mine or patent, for instance, or carry on a going business--the usual course is for the promoter to frame a draft agreement for the sale of the property to the company or to a trustee on its behalf. The memorandum and articles of the intended company are then prepared, and an article is inserted authorizing or requiring the directors to adopt the draft agreement for sale. In pursuance of this authority the directors at the first meeting after incorporation take the draft agreement into consideration; and if they approve, adopt it. Where they do so in the exercise of an honest and independent judgment, no exception can be taken to the transaction; but where the directors happen to be nominees of the promoter, perhaps qualified by him and acting in his interest, the situation is obviously open to grave abuse. It is not too much, indeed, to say that the fastening of an onerous or improvident contract on a company at its start, by interested promoters acting in collusion with the directors, has been the principal cause of the scandals associated with company promotion.

Concurrently with the adoption of the contract for the acquisition of the property which is the company's _raison d'être_, the directors have to consider how they will best get the company's capital subscribed. Down to the passing of the Companies Act 1900 the usual mode of doing this was to issue a prospectus inviting the public to subscribe for shares. After the act of 1900 the prospectus fell into general disuse. In the year 1903, out of a total of 3596 companies which registered, only 358 issued a prospectus, the directors preferring, it would seem, to place the share capital through the medium of brokers, financial agents and other intermediaries rather than run the risk of incurring, personally, liability under the stringent provisions for disclosure contained in the act (s. 10). Of late the prospectus has, however, returned into favour. Under the act of 1907, incorporated in the Consolidation Act 1908 (s. 82), a company, if it does not issue a prospectus, must file a statement of all the material facts relating to the company.

Prospectus.

A prospectus is an invitation to the public to take shares on the faith of the statements therein contained, and is thus the basis of the agreement to take the shares; there therefore rests on those who are responsible for its issue an obligation to act with the most perfect good faith--_uberrima fides_--and this obligation has been repeatedly emphasized by judges of the highest eminence. (See the observations of Kindersley, V.C., in _New Brunswick Railway Co._ v. _Muggeridge_, 1860, 1 Dr. & Sm. 383, and of Lord Herschell in _Derry_ v. _Peek_, 1889, 14 A. C. 376.) Directors must be perfectly candid with the public; they must not only state what they do state with strict and scrupulous accuracy, but they must not omit any fact which, if disclosed, would falsify the statements made. This is the general obligation of directors when issuing a prospectus; but on this general obligation the legislature has engrafted special requirements. By the Companies Act 1867, it required the dates and names of the parties to any contract entered into by the company or its promoters or directors before the issue of the prospectus, to be disclosed in the prospectus; otherwise the prospectus was to be deemed fraudulent. This enactment was repealed by the Companies Act 1900, but only in favour of more stringent provisions incorporated in the Consolidation Act of 1908. Now, not only is every prospectus to be signed and filed with the registrar of Joint Stock Companies before it can be issued, but the prospectus must set forth a long and elaborate series of particulars about the company--the contents of the Memorandum of Association, with the names of the signatories, the share qualification (if any) of the directors, the minimum subscription on which the directors may proceed to allotment, the shares and debentures issued otherwise than for cash, the names and addresses of the vendors, the amount paid for underwriting the company, the amount of preliminary expenses, of promotion money (if any), and the interest (if any) of every director in the promotion or in property to be acquired by the company. Neglect of this statutory duty of disclosure will expose directors to personal liability. For false or fraudulent statements--as distinguished from non-disclosure--in a prospectus directors are liable in an action of deceit or under the Directors' Liability Act 1890, now incorporated in the act of 1908. This act was passed to meet the decision of the House of Lords in _Peek_ v. _Derry_ (12 A. C. 337), that a director could not be made liable in an action of deceit for an untrue statement in a prospectus, unless the plaintiff could prove that the director had made the untrue statement fraudulently. The Directors' Liability Act enacted in substance that when once a prospectus is proved to contain a material statement of fact which is untrue, the persons responsible for the prospectus are to be liable to pay compensation to any one who has subscribed on the faith of the prospectus, unless they can prove that they had reasonable ground to believe, and did in fact believe, the statement to be true. Actions under this act have been rare, but their rarity may be due to the act having had the effect of making directors more careful in their statements.

Allotment of shares.

Before the passing of the Companies Act 1900, it was a matter for directors' discretion on what subscription they should go to allotment. They often did so on a scandalously inadequate subscription. To remedy this abuse the Companies Act 1900 (Companies (Consolidation) Act 1908, s. 85) provided that no allotment of any share capital offered to the public for subscription is to be made unless the amount fixed by the memorandum and articles of association and named in the prospectus as "the minimum subscription" upon which the directors may proceed to allotment has been subscribed and the application moneys--which must not be less than 5% of the nominal amount of the share--paid to and received by the company. If no minimum is fixed the whole amount of the share capital offered for subscription must have been subscribed before the directors can go to allotment. The "minimum subscription" is to be reckoned exclusively of any amount payable otherwise than in cash. If these conditions are not complied with within forty days the application moneys must be returned. Any "waiver clause" or contract to waive compliance with the section is to be void.

An allotment of shares made in contravention of these provisions is irregular and voidable at the option of the applicant for shares within one month after the first or statutory meeting of the company (Companies (Consolidation) Act, s. 86). Even when a company has got what under the name of the "minimum subscription" the directors deem enough capital for its enterprise, it cannot now commence business or make any binding contract or exercise any borrowing powers until it has obtained a certificate entitling it to commence business (Companies (Consolidation)