COMPANY LAW 101 – WHAT DIRECTORS AND SHAREHOLDERS NEED TO KNOW
So you’ve incorporated a company, but you’re not sure exactly what it all means. What is the effect of incorporation? What does ‘limited liability’ mean? Does it exclude all potential personal liability? What are the obligations of directors and shareholders? Company law can be a challenge for business people. Here is a brief practical explanation of company law basics from Atticus Legal, Company & Business Lawyers Hamilton.
Company Incorporation – the first steps
Firstly, assuming the company is trading, you or your accountant will need to obtain an IRD number for the company and GST registration, if appropriate. This is not automatic. The Companies Office website now makes it easy to arrange this at the time of incorporation using a simple step-by-step online process. Be aware that special rules and requirements apply to ‘Look Through Companies’ (see below).
You should diary ahead to the first annual return due date specified in the Company Summary issued on incorporation, and to subsequent anniversary dates, to ensure that the annual return is filed with the Companies Office in the time required. You can file annual returns online. If you want to have your accountant deal with this then you should specifically agree that with him/her. In any event, we recommend that you ensure that the address and email on record at the Companies Office (for both the company and you as a director) remains current, so that you can be notified by the Companies Office if any such filing is overdue. Failure to file an annual return when due can lead to the company being removed from the Companies Register by the Companies Office. Such removed companies can be reinstated but at a cost, so it’s better to ensure the company is not removed in the first place.
Limited Liability and Personal Guarantees
Ongoing company law matters to be aware of:
(1) A company is a legal entity in itself, separate from its shareholders and directors. The consequence of this is that, subject to certain exceptions, the shareholders and directors are not personally liable for the company’s debts. However, this does not apply to company creditors to whom the directors and/or shareholders have given a personal guarantee. In addition, where the company has issued shares at an ‘issue price’ which remains unpaid then the shareholders are liable to contribute that amount to the company. The unpaid issue price, if any, represents their ‘limited liability’. The expression ‘limited liability company’ refers to the shareholders’ liability being limited as described above, not to any limitation on the liability of the company itself.
In order to minimise personal liability for the company’s debts/obligations, we recommend that directors and shareholders avoid signing personal guarantees of the company as far as possible. The company’s bank and landlord will inevitably want personal guarantees (perhaps secured over your home, in the case of a bank facility) and that’s a commercial fact of life. However, try to avoid signing personal guarantees to others such as suppliers to the company. They may ask you repeatedly for this, but often they will give up and supply your company without a guarantee, especially where a credit account is not involved and the company is paying the supplier regularly. Beware the personal guarantee ‘embedded’ in a supplier’s terms of trade that you are asked to sign. You need to look carefully at these terms of trade and keep copies.
There are also other instances where personal liability can arise; for example, on the part of directors in the case of ‘reckless trading’ where the company is insolvent or nearing insolvency or where the directors authorise a ‘distribution’ by the company (eg. a dividend) in circumstances where the company does not satisfy the ‘solvency test’ (see below).
(2) To ensure you have the benefit of limited liability you should:
i. Make sure the company letterhead (and other day-to-day company communications and documents such as quotes, invoices, receipts, etc) shows the correct full name of the company (with or without ‘trading as …’);
ii. Ensure that the company’s bank accounts are in the correct company name;
iii. Make sure that when you sign something on behalf of the company (eg. a letter or quote) that you identify the capacity under which you are signing – eg. write ‘director’ after your signature or ‘as director’ or similar.
This is important as failure to disclose the correct company name on relevant documentation can legally result in you being personally liable in respect of the contract or transaction concerned.
(3) Company law gives directors the legal responsibility for day-to-day management of the company in accordance with the Companies Act and the company’s constitution, if any. Shareholders are not entitled to intervene in the directors’ management decisions, but do have certain rights and powers reserved to them under the Companies Act; for example, to approve matters such as changes to the constitution of the company and any issue of shares which would affect the voting/distribution rights of existing shares.
Company law requirements – Solvency Test and Company Dividends
(4) Company profits and losses, for legal and tax purposes, are separate from those of the individual directors and shareholders, except where a company is registered with the IRD as a Look Through Company. Company profits can be distributed, when the solvency test allows, by way of dividends to shareholders. Depending on the tax paid by the company, ‘imputation credits’ can be attached to those dividends so they are not taxed twice. Tax losses can, subject to certain shareholder-continuity rules, be carried forward and offset against future company taxable income. Shareholder-continuity rules also apply to the carry forward of the company’s imputation credits. There are other ways of having the company return funds to shareholders, such as full/part repayment of any current account debt owed by the company to shareholders and share buy-backs. These matters should be discussed with your lawyer and accountant.
The Companies Act requires directors to certify that the company satisfies a statutory solvency test in certain circumstances – eg. directors authorising a dividend or other company distribution to shareholders. The solvency test is explained in our Atticus Legal information sheet on directors’ duties, available on our website.
(5) Directors have certain duties and obligations to the company and sometimes to shareholders and creditors as well. In some cases, directors can become personally liable for failure to perform those duties. See our Atticus Legal information sheets, on our website, on directors’ duties and company records and registers to be kept by the directors.
(6) As noted above, shareholders are generally only personally liable to the company for the amount remaining unpaid by way of issue price on their shares. However, shareholders will be liable to repay any loans or advances made to them from time to time by the company – eg. current account advances. Shareholders (and directors) can also be required to refund dividends if the solvency test was not properly assessed and certified by the directors when they authorised dividend payments.
Pre-emptive Rights (first rights of refusal)
(7) The constitution of the company, if any, typically requires any shareholder who wishes to sell or transfer his or her shares to first offer them to the other existing shareholders in accordance with the ‘pre-emptive rights’ (first right of refusal) procedure in the constitution. A constitution will also set out various rules and requirements for company governance and administration. We recommend that a company put in place a constitution, including pre-emptive rights, generally where there are two or more shareholders.
We also recommend that a separate ‘shareholders agreement’ be put in place where there are two or more arms-length shareholders – eg. to specify what obligation each shareholder has to contribute to company funding requirements, both initially and ongoing, and other important matters. Sometimes a constitution alone is not enough. Again, this should be discussed with your lawyer and accountant.
If you would like more specific information about directors’ duties or the statutory records the law requires the directors to keep, please see our Atticus Legal information sheets on these subjects on our website.
WANT TO KNOW MORE ABOUT COMPANY LAW? Just ask Atticus Legal, Experts in Business & Company Law Hamilton
CALL ANDREW SMITH, the owner of Atticus Legal for expert professional advice on any of the matters referred to in this information sheet.
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Disclaimer: The information contained in this information sheet is, of necessity, of a general nature only. It should not be relied upon without appropriate legal advice specific to your particular circumstances.
This information sheet is copyright © Atticus Legal, May 2016.