International Tax Law

TAX AVOIDANCE AND EVASION

What is Tax Avoidance as compared to Tax Evasion?

The classic distinction between tax avoidance and tax evasion can be attributed to Justice Oliver Wendell Homes (once an Associate Justice of the US Supreme Court).

He made the distinction in the case of Bullen –vs- Wisconsin (1916), 240,
U.S. 625 at page 630.

In the Bullen Case, Justice Oliver Wendell Holmes Stated, “when the law draws a line, a case is on one side of it or the other, and if on the safe side is none the worse legally that a party has availed himself to the full of what the law permits. When an act is condemned as evasion, what is meant is that it is on the wrong side of the line...”

The distinguishing characteristic of evasion is illegality.

If on the wrong side of the law, it is evasion.

If on the right side of the law, it is avoidance.

An author known as Emanuel Mchani defines tax avoidance as the act of structuring once affairs legally so that one is paying less taxes than he or she might otherwise pay.
Tax avoidance could involve making use of loopholes, which are inadvertent errors in the tax legislation, but more using the provisions of the law to ones advantage.

On the other hand, tax evasion is the attempt to reduce ones taxes or increase refundable credits by illegal means, e.g. making false statements about once income or deductions, or destroying records.

In the Indian case of McDowell & Co. Ltd – vs – CTO 154 ITR 148 [1985] Justice Reddy defined tax avoidance as the “art of dodging tax without breaking the law.”

It is the avoidance of tax payment without the avoidance of tax liability.

If the tax law is broken in the process of avoiding tax, it becomes tax evasion.

A classic example of a case on tax avoidance is the case of Duke of Westminster – vs – CIR [1936] AC in which it was held, “Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Act is less than otherwise would be. If he succeeds in ordering them so as to secure this result, then however unappreciative the commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity he cannot be called upon to pay increased tax.

In a House of Lords decision of 1997, Lord Noland in the case of IRC –V – Willoughby & Another [1997] distinguished tax avoidance as follows;
“The hallmark of tax avoidance is that the tax payer reduces his liability to tax without incurring the economic consequences that parliament intended to be suffered by any taxpayer qualifying for such a reduction in his tax liability.”

There is no attempt by any of the Kenyan tax legislations, to define either tax avoidance or tax evasion.


How does Tax Evasion Occur?

Broadly, tax evasion occurs when a tax payer uses fraudulent methods or deceptive behaviour to hide the actual tax liability.

Tax evasion would usually involve the following:
Failure by a taxable person to notify the tax authorities of his presence/residence or occurrence of taxable activities.
The failure to report the full amount of taxable income
The deduction claims for expenses that have not been incurred, or which exceeded the amounts that have been incurred but not for the purpose stated.
Falsely claiming tax relief (s) that is/are not due.
Failure to pay over to the tax authorities the tax properly due.
The departure from a country without paying taxes and with no intention of paying them.
Failure to report items or sources of taxable income, profits or gains, where there is a tax obligation to declare.
Transfer pricing.
  This is also a mechanism of tax evasion. A company based in a country with high rates of corporation tax could deliberately overpay for raw materials supplied by one of its subsidiaries in the low tax country where it will pay less.
  We shall expound on the issue of transfer pricing later.

How does Tax Avoidance Occur ?

  The following are examples of mechanisms employed to achieve tax avoidance:
Income splitting
  This entails the splitting of income between more than one tax payer so as to reduce the marginal tax rate.
  If one can manage to split one figure into several, the applicable marginal rate will be lower and therefore little taxable income.
  For example, if by earning Kshs. 1, 000, 000/= per month, one falls into the 30% tax rate, he can avoid tax by splitting the income into 4 individuals, if possible. The effect is, each of the individuals will have Kshs. 250, 000/= which may each fall into a lower tax rate, say 10% and thereby reducing the total payable.
  Is it plausible?
  How would it be logical to split ones income and give to others, and still retain that income as yours?
  If the income is still yours, wouldn’t it be illegal?

Thin Capitalization
  “Thin capitalization‟ is usually used to describe “hidden equity capitalization” through excessive loans.
  It is the artificial use of interest bearing debt instead of equity by shareholders with the sole primary motive to benefit from its tax advantages.  

  The loan may be provided on a market rate of interest but the size of the loan cannot be justified on bona fide business considerations.
  Such excessive interest payments constitute  hidden distributions that should be properly treated as dividend on equity capital. (i.e. equity capital is amount or capital raised by the equity owners or shareholders whereas debt capital is amount or capital obtained by way of loans).
  In case of equity capital, the shareholders would receive dividends which are taxable.
  On the other hand, in the case of debt capital or loans, the entity would be paying interest on the debt or loans, which interest would then be deducted from the income as an expense thus reducing the amount of income taxable.

Asset shifting
  This is achieved by shifting the asset producing income to another person or entity that is taxed preferentially, i.e. taxed less that the person or entity shifting the asset.
  You could transfer the asset to a charitable trust which enjoys preferential tax treatment.

                   iv. Sheltering of income
  This    is    done    by    receiving    incomes    in    tax    havens    e.g.
Switzerland and Cayman islands.
  Tax havens have lower tax rates or no tax charge at all.

  We shall later examine tax havens at length.

Income capitalization
  This means the conversion of taxable income into capital e.g. not declaring of dividends but instead converting of profits into capital to avoid non – payment of tax on dividends.

Measures Against Tax Evasion
  Generally, since tax evasion is illegal, legal penalties are used to deter tax evasion.

  However, certain measures can be used to minimize the weaknesses that are exploited by tax evaders.

  The most notable anti-evasion measures are those adopted by the European Union.

  These measures are based on the reality that tax evasion is a cross-border problem.

  These measures are as follows: Savings Tax Directive
  The EU operates by way of directives given for implementation by EU member countries.

  The EU Savings Tax Directive creates an information exchange system for tax authorizes to identify individuals who receive savings income in a member state other than his own.
  By doing so, the member states can collect data on the savings on the savings of non – resident individuals, and automatically provide this data to the authorities where the individual resides.

Savings Tax Agreements
  These are agreements entered between countries so as to assist countries in taxing citizens who have savings accounts in respective countries.

Administrative Co-operation
  This is done by strengthening administrative co-operation between member states by enabling tax authorities to benefit from exchanged data, information and experiences to better tax evasion.

Code of conduct on Business Taxation
  The code provides that the EU Member States should refrain from introducing, or amending any harmful tax measures that unfairly undermine other member state‟s revenue raising capacities.

    Iv.   Improving the exchange of information
  Rapid access to information is important in fighting tax evasion.
  More efficient methods of information exchange should be put in place.

Class should research on other measures applied against tax evasion.

 Measures against tax avoidance

Even though tax avoidance is not illegal, it nonetheless minimizes the revenue collected by government. There should therefore be ways of curbing tax avoidance. Some of the anti-avoidance approaches proposed are as follows:

Sniper approach
  This entails the enactment of specific provisions that identify with precision the type of transactions to be dealt with and prescribe against tax consequences.

Shotgun approach
  This entails the enactment of general provisions to hit broad types of avoidance practices in specific areas.

Administrative approach
  The control of tax avoidance is left to the discretion of tax authorities.
  In this case section 23 of the Kenyan Income Tax Act, gives discretion to the Commissioner of Income Tax Act to direct that adjustments be made as respects liability to tax to counteract the avoidance or reduction of liability to tax.
   This is done where the Commissioner is of the opinion that the main purpose or one of the main purposes for which a transaction was effected was avoidance or reduction to tax.

Judicial avoidance doctrines
  Courts have stated certain principles that are intended to curb tax avoidance.
  These doctrines are also known as General Anti – Avoidance Rules (GAAR).
  The main guiding principles are:

The Motive Test/Business Purpose Rule
This rule attacks tax avoidance schemes that do not have a business purpose and those artificially designed merely to avoid tax.
Under this doctrine, a transaction must have a main or predominant business purpose (i.e. commercial justification) other than tax avoidance.
The mere tax advantage cannot be acceptable business purpose; it must show a business or non – tax purposes.
Thus it must have a valid business or economic purpose other than reduction of tax liability.
If the primary purpose is something other than tax avoidance, the transaction represents acceptable tax planning.
On the other hand, if the primary purpose is to obtain tax benefits and the transaction would not be carried without those benefits, the transaction is treated as unacceptable tax avoidance.

Artificiality Test / Substance over Form Rule
The acts must be assessed according to bona fide economic and commercial substance and not the formal content.
It requires the establishment of the underlying economic reality, not what is displaced on form/paper.
Taxation will then be based on the true commercial transaction, not what is portrayed on paper.
An example is where transactions have been shown on paper to have happened but have not really happened.
In this case, courts will apply tax rules on the true position, i.e. the alleged transactions have not happened.
A company, in order to avoid tax on dividends, may label a transaction as loan with exaggerated interest when in the real sense it is equity (the company would then claim to be paying interest on loan which is deductible from the company‟s income and thus reducing the amount of tax payable, yet in the real sense it is capital equity given by a shareholder that should attract tax when dividends are paid on it).
What is appearing on form is loan with exaggerated interest but the underlying on substantive economic transaction is equity capital.
The courts would then treat such „loan‟ transaction as equity and not loan, which in that case will attract taxes on dividends therefrom.
In case of Ridge Securities – Vs – IRC, court rejected a loan with interest at over 400% per annum as a loan transaction.
The 400% interest per annum would mean that a lot of the entity‟s income would be channeled to paying huge interests on the „loan‟, and thus depleting the taxable income and denying the tax collector the true tax.











TAX FRAUD

Types of Tax Fraud
Tax fraud involves tax evasion which is a deliberate attempt to illegally obtain a tax benefit.
This comes in many forms including:
Forging books of accounts
Using cooked statements
Failing to register as a tax entity
Failure to furnish tax returns
Failure to pay taxes,
Failure to keep records,
Failure to withhold taxes,
Obstructing, bribing and, or impersonating a tax official
Aiding and abetting a tax crime

Actions that lead to Tax Fraud/Tax Evasion?

a) Manifest Fraud
This occurs when shipping agents illegally alter manifests prior to uploading them to the Customs Manifest Management System (MMS), thereby setting the stage for false declarations.
b) Use of fake security bonds to clear transit goods
Some importers and clearing agents use fake Customs transit bonds to clear transit goods. This happens by collusion between clearing agents, insurance companies and Customs officers.
c) Diversion/Dumping of transit goods
Transit goods are goods imported through the East African Community (EAC) region to a country outside the region. Transit goods within the EAC region are not subject to import duty. However if the consignment fails to exit the region within the prescribed period and no official extension is granted, duty becomes due (this is diversion of transit goods). Customs department secure the duty due on transit cargo through the execution of a security bond. Goods prone to diversion include sugar, petroleum, rice and motor vehicles.

d) Customs Mis-declarations
A Customs declaration is a statement showing goods being imported on which duty will have to be paid. This is done by filling in a Customs declaration form. However, some importers/clearing agents make wrong declarations with the objective of evading payment of duties or reducing the duties payable. Making a wrong declaration (i.e. mis-declaration) is a prosecutable offence.

e) Smuggling
This involves importation or export of goods secretly in violation of the law, especially without payment of duties. Recent cases include: importation of high end vehicles cleared as mattresses, baby car seats, bed sofas, toys, clothes, beach beds, shoes, belts and handbags.
f) Fraudulent cancellation of export entries
This is use of fake Customs entries as proof of export, which thereafter leading to fraudulent VAT refund claims.

g) Import/Export of prohibited or restricted goods
Prohibited goods are the goods that cannot be imported/exported into/out of the country. Restricted goods are those which must meet certain conditions before clearance through Customs.
Examples: ivory, macadamia nuts, flora and fauna etc.

h) Fake payments of import taxes
This happens when Customs entries are fraudulently posted in the Customs system and validated with fake bank payment receipts.

i) Dealing with excisable goods without a valid licence
By Law, dealers in excisable products (especially tobacco, wines and spirits) should be licensed.

j) Nil/non filing income tax returns
All individuals with income are required by law to submit Income tax returns together with accounts where applicable. The returns are due on or before the end of the 6th month after the end of accounting period. Non-submission of tax return may result into prosecution.

k) Invoice fraud
The scheme involves shell companies through which money is channeled as payments for purchase of goods while in actual sense no goods are supplied.

l) Under declaration of income
By Law, all income earned in Kenya is taxable. However, some individuals under declare their income for purposes of reducing their tax liability.

TRANSFER PRICING
Transfer price is the price that one department or division of an entity charges for the products or services supplied to another division of the same entity.
Transfer pricing is the general term for the pricing of cross – border, intra – firm transactions between related parties.
Transfer pricing as such refers to the setting of prices at which transactions occur involving the transfer of property or services between associated enterprises, forming part of a Multinational Enterprise Group (MNE Group).
Transactions between these associated entities are also referred to as “controlled” transactions, opposed to “uncontrolled” transactions between non – related entities which can be assumed to operate independently. (On “an arm‟s length basis”).
Transfer pricing is a normal incident of how MNEs must operate, and as such transfer pricing does not necessarily give rise to an avoidance or tax evasion.
However, where the pricing does not accord with applicable norms internationally or as per domestic law, issues of “mispricing”, “incorrect pricing”, “unjustified pricing” or tax avoidance or evasion, arise.
Transactions between two related parties must be based on the “arm‟s length principle” (ALP).
Under ALP, transactions within a group are compared to transactions between related entities to determine acceptable transfer prices.

Transfer Pricing Methods
How is the arm‟s length principle applied in practice in order to determine the arm‟s length price of a transaction?
Various transfer pricing methods include:
i.  Comparable Uncontrolled Price (CUP).
  This method compares the price charged for a property or service transferred in a controlled transaction to the price charged for a comparable property or service transferred in a comparable uncontrolled transaction in comparable circumstances.
Resale Price Method (RPM).
  This method is used to determine the price to be paid by a reseller for a product purchased from an associated enterprise and resold to an independent enterprise.
Cost Plus
  This method is used to determine the appropriate price to be charged by a supplier of property or services to a related purchaser.
  The price is determined by adding to the cost the supplier incurred, an appropriate gross margin so that the supplier makes an appropriate profit in light of the market conditions.
Profit – based methods
  These are the profit comparison and profit split methods
Profit Comparison Method
  This method compares the level of profit that would have resulted from controlled transactions with the profits that would have been realized by comparable uncontrolled transactions.
Profit Split Method
  This method takes the combined profits earned by two related parties from one or a series of transactions and then divides the profits so as to replicate the division of profits that would have been anticipated in an agreement made at arm‟s length.

Transfer Pricing in Treaties
As seen, the UN and OECD Model Conventions at Article 9 provides for taxation of incomes of associated enterprises.
  Article 9 is a statement of the arm‟s length principle and allows for profit adjustments if the actual price on transactions between associated enterprises differs from the price that would be charged by independent enterprises under normal market terms.
 Transfer Pricing in Domestic Law
Article 9 of the Model conventions regulates the basic conditions for adjustment of transfer pricing and advises the application of arms length principle, but does not go into the particulars of transfer.
Article 9 is not „self – executing‟ as it does not create transfer pricing regime in a country.
Transfer pricing regimes are creatures of domestic law.
Each country is required to formulate detailed legislation to implement transfer pricing rules.
In Kenya, Section 18(3) of the ITA empowers the commissioner to adjust the profits accruing to a resident person from a course of business  conducted with related non – resident persons to reflect such profit as would have accrued if the course of the business had been conducted by independent persons dealing at arm‟s length.
The Transfer Pricing Rules 2006 (TP Rules) were introduced in Kenya in 2006, to supplement the provisions of Section 18 (3) of the ITA.
The TP Rules provide guidelines to be applied by related entities in determining the arm‟s length prices of goods and services in transactions involving them and to provide administrative regulations, including the types of records and documentation to be submitted to the commissioner by a person involved in transfer pricing arrangements.

WHAT IS BEPS?
Base erosion and profit shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid.

INTRODUCTION
In September 2015, the G20 Finance Ministers called on the OECD to build an inclusive framework for the implementation of the , with the involvement of interested non-G20 countries and jurisdictions, particularly developing economies, on an equal footing
The G20 Leaders reiterated this request in their November 2015 communique, in which they strongly urged the timely implementation of the project and encouraged all countries and jurisdictions, including developing ones, to participate. The OECD/G20 BEPS package had been developed by OECD and G20 countries working together on an equal footing through the BEPS Project of the OECD’s Committee on Fiscal Affairs (CFA). In 2016, the CFA decided to extend the BEPS Project and establish the OECD/G20 Inclusive Framework on BEPS. The CFA identified an initial group of 123 countries and jurisdictions1 that might be interested in joining OECD and all G20 members2 in the Inclusive Framework on BEPS. All members of the Inclusive Framework participate on an equal footing.




WHAT IS THE INCLUSIVE FRAMEWORK ON BEPS DOING?
Inclusive Framework members are working on the implementation and updating of the OECD/G20 BEPS package. With respect to implementation, the Inclusive Framework is focusing in particular on the four minimum standards:
1.    In the areas of harmful tax practices,
2.    abuse of tax treaties,
3.    Country-by-Country reporting for the activities of Multinational Enterprises, and
4.    improving dispute resolution mechanisms.
A Peer review processes ensure the effective and consistent implementation of the minimum standards in order to achieve a level playing field and protect countries’ tax bases. These existing standards and peer review processes are currently being reviewed to ensure they remain appropriate and fit for purpose. The Inclusive Framework also provides support to developing countries to facilitate understanding and implementation of the BEPS measures. Importantly, the Inclusive Framework is also working on new measures to help ensure the international tax system can meet the challenges of increasing digitalisation of the economy. The proposals under discussion include the possibility of a new taxing right which could allocate a percentage of residual profits of MNEs to the jurisdiction of their users or customers even where, because of digitalisation, the company may not have a traditional taxing presence in that country; and a set of rules to ensure all MNEs pay at least a minimum level of taxes on their profits somewhere in the world.

WHAT IS A DIGITAL ECONOMY?
The digital economy is the result of the widespread and transformative process brought on by Information and Communication Technology (ICT). All sectors, ranging from retail, financial services to education and broadcasting and media have been transformed by ICT technologies. So much so, that the digital economy is increasingly becoming the economy itself. It would therefore be difficult, if not impossible, to ring fence the digital economy from the rest of the economy for tax purposes.

Common Tax Planning

Individuals as well as corporate entities can mitigate their tax exposure by keeping the following points in mind as they conduct their affairs.

Keeping Complete and Accurate Records

Proper record keeping enables individuals and companies, first, to support allowable deductions from their gross income.

Accurate records will also help in the event of a tax audit or other proceedings against the taxpayer.

Getting Timely, Competent Tax Advice

Working with a competent tax consultant enables individuals and corporate entities to conduct their affairs in compliance with existing tax laws.

Challenging Tax Assessments

As we shall se later, the tax statutes provide avenues for individuals and companies to challenge tax assessments made upon them by tax authorities.

At times, it turns out that the assessments by the tax authorities are on the higher side.

Compliance

Taxpayers can avoid exposure to tax problems (stiff penalties, interest, possible shutdown of business, and distractions from

usual activities) by complying with tax laws and regulations

However, it is not illegal to arrange one’s affairs in such a manner as to minimize tax burden.


TRANSFER PRICING
Transfer price is the price that one department or division of an entity charges for the products or services supplied to another division of the same entity.
Transfer pricing is the general term for the pricing of cross – border, intra – firm transactions between related parties.
Transfer pricing as such refers to the setting of prices at which transactions occur involving the transfer of property or services between associated enterprises, forming part of a Multinational Enterprise Group (MNE Group).
Transactions between these associated entities are also referred to as “controlled” transactions, opposed to “uncontrolled” transactions between non – related entities which can be assumed to operate independently. (On “an arm‟s length basis”).
Transfer pricing is a normal incident of how MNEs must operate, and as such transfer pricing does not necessarily give rise to an avoidance or tax evasion.
However, where the pricing does not accord with applicable norms internationally or as per domestic law, issues of “mispricing”, “incorrect pricing”, “unjustified pricing” or tax avoidance or evasion, arise.
Transactions between two related parties must be based on the “arm‟s length principle” (ALP).
Under ALP, transactions within a group are compared to transactions between related entities to determine acceptable transfer prices.

Transfer Pricing Methods
How is the arm‟s length principle applied in practice in order to determine the arm‟s length price of a transaction?
Various transfer pricing methods include:
i.  Comparable Uncontrolled Price (CUP).
  This method compares the price charged for a property or service transferred in a controlled transaction to the price charged for a comparable property or service transferred in a comparable uncontrolled transaction in comparable circumstances.
Resale Price Method (RPM).
  This method is used to determine the price to be paid by a reseller for a product purchased from an associated enterprise and resold to an independent enterprise.
Cost Plus
  This method is used to determine the appropriate price to be charged by a supplier of property or services to a related purchaser.
  The price is determined by adding to the cost the supplier incurred, an appropriate gross margin so that the supplier makes an appropriate profit in light of the market conditions.
Profit – based methods
  These are the profit comparison and profit split methods
Profit Comparison Method
  This method compares the level of profit that would have resulted from controlled transactions with the profits that would have been realized by comparable uncontrolled transactions.
Profit Split Method
  This method takes the combined profits earned by two related parties from one or a series of transactions and then divides the profits so as to replicate the division of profits that would have been anticipated in an agreement made at arm‟s length.

Transfer Pricing in Treaties
As seen, the UN and OECD Model Conventions at Article 9 provides for taxation of incomes of associated enterprises.
  Article 9 is a statement of the arm‟s length principle and allows for profit adjustments if the actual price on transactions between associated enterprises differs from the price that would be charged by independent enterprises under normal market terms.
 Transfer Pricing in Domestic Law
Article 9 of the Model conventions regulates the basic conditions for adjustment of transfer pricing and advises the application of arms length principle, but does not go into the particulars of transfer.
Article 9 is not „self – executing‟ as it does not create transfer pricing regime in a country.
Transfer pricing regimes are creatures of domestic law.
Each country is required to formulate detailed legislation to implement transfer pricing rules.
In Kenya, Section 18(3) of the ITA empowers the commissioner to adjust the profits accruing to a resident person from a course of business  conducted with related non – resident persons to reflect such profit as would have accrued if the course of the business had been conducted by independent persons dealing at arm‟s length.
The Transfer Pricing Rules 2006 (TP Rules) were introduced in Kenya in 2006, to supplement the provisions of Section 18 (3) of the ITA.
The TP Rules provide guidelines to be applied by related entities in determining the arm‟s length prices of goods and services in transactions involving them and to provide administrative regulations, including the types of records and documentation to be submitted to the commissioner by a person involved in transfer pricing arrangements.

LAW OF BUSINESS ASSOCIATIONS (COMPANY LAW)

INTRODUCTION

This course is primarily concerned with companies as defined in the Companies Act Cap 486. These are companies which are formed and registered under that Act. There are companies incorporated otherwise than under the companies Act. Some companies are formed under specific Acts of Parliament. The parastatal bodies are created under statute as bodies corporate. Most companies derive their existence through a process of registration under the Companies Act cap 486. 

EARLY FORMS OF BUSINESS ORGANISATIONS

Early forms of business organizations owing their existence to royal charter was primarily ecclesiastical bodies or public bodies such as boroughs. Trading in joint account was accomplished through types of partnerships known as the commenda and the societus…and later through the limited liability company. A commenda was a formal partnership in which one of the partners supplied capital in money or goods without personally taking part in the management of the venture. The financier advanced a sum of money to the active trader upon the understanding that he should share in the profits of the enterprise but with no liability beyond the capital advanced. The societus was a form of association which developed into the present age partnership. Each partner, being an agent of the others is liable to the full extent of his private fortune and partnership debts.

Company; the Companies Act Cap 486 Sec 2 defines a company to mean, ‘a company formed and registered under this Act or an existing company.’ This definition is vague. In legal theory the word company denotes an association of a number of persons who come together for some common object or objects. A company is an artificial legal person created by complying with the provisions of the Companies Act.

FUNDAMENTAL CONCEPTS IN COMPANY LAW

There are 2 fundamental concepts;

a.                    Legal personality

A company must be treated as a person in its own right. This separates and creates a distinction between the personalities which constitute the created entity. This concept also incorporates other aspects such as life and death. A legal person is any person human or otherwise. Non-human persons are called corporations. The word corporation derives from the Latin word corpus meaning body. These are legal persons brought into being by artificial processes of the law.

2. Limited liability

Means the extent to which a person can be called upon to account for something. A person can be called upon to pay the amount of a debt or to account for a debt up to a certain amount. In the context of company law, liability can be limited by shares or by guarantee. A share is an interest which an investor has in a particular company. Under Sec 2(4) (a) a limited liability company is one in which the liability of its members is limited by the memorandum to the amount, if any, unpaid on the share respectively held by them. This is a company limited by shares. 

The members in a company may sometimes enter into an agreement where they may contribute towards the company’s assets while they are still members to enable the company to discharge its debts. They cannot be called upon to pay more than they undertook to pay. Such a company is limited by guarantee. See Sec 4(2) (b) of the companies Act. In the event that a company does not have this guarantee or liability then it is a limited company. Sec. 4(2) (c).

 

Nearly all the principles of company law are meant for:

a.                    Protection of creditors

b.                    Protection of investors

These are the only groups of people protected by the act, however when a company is formed its activities may affect the public or employees. Whether or not companies should have the interest of the community put into account is still a matter for debate.

He procures the necessary capital alone. He gets the profits alone and equally shoulders any losses. Since a sole trader has no association in law, he is not in any way regulated by any special rules of law. 

Partnerships

Is a relationship that subsists in an association or between 2 and 20 members in a trading partnership, 2 or more profession business persons with a view to sharing profits. Firms or professional persons like lawyers, accountants and surveyors have no limitation of membership. The Partnerships Act cap 29 defines a partnership as a relation that subsists between 2 or more persons carrying on business in common with a view to profit. Under sec 389 of the companies act, “no company association or partnership consisting of more than 20 persons shall be formed for the purpose of carrying on any business that has for its object the acquisition of gain by the company, association or partnership or by the individual members thereof unless it is registered as a company under the Act.” The effect of this section is therefore to prohibit the formation of a partnership of more than 20 persons. 

In the case of; Fort Bakery-Vs-Wangui

The plaintiffs brought an action to recover certain sums of money from the defendants. During the hearing, evidence disclosed that the plaintiff were an association comprising of more than 45 people trading in partnership for gain and that their firm was not registered under the registration of business names ordinance. The counsel for the defendant thereupon submitted that the                                                                                                                                                                        action was not properly before the court. That the association was illegal as the company’s ordinance prohibited an association or a partnerships consisting of more than 20 persons formed for the purpose of business that has for its object the acquisition of gain unless it is registered as a company under the ordinance and that the court could not therefore grant relief. It was held;

a.                    That the plaintiffs could not be recognized as having any legal existence, were incapable of maintaining their action and therefore the court would not allow the action to proceed.

b.                    Since a non-existent plaintiff could not pay nor receive cost there could be no order as to cost. The suit was struck out.

See; Smith-Vs-Anderson 

Unregistered foreign companies

See; Paul gardete-Vs-republic

Partnerships are founded on mutual trust and confidence. The rights of the partners are regulated by an agreement and if this agreement is in writing it is referred to as the articles of partnerships or the partnerships deed. The provisions of the partnerships act govern whatever the partners may have left out in the partnership deed. A partnership need not be formed formally. It need not even be in writing. It can be formed orally or it may be inferred from the conduct of the parties. 

In Mohammed vs Hussein

There was a verbal partnership between the parties and it did not contain any term as to how the partnership could be dissolved. One party owned the premises on which the business was carried on but the terms of occupation by the partnership were not clear. The defendant forcibly ejected the plaintiff from the premises and refused him to take part in the management of the business. Every partner by law is entitled to take part in the management of the business. In holding that these actions terminated the partnership, the judge stated “a partnership is determinable at any moment by one partner by notice to the other. The notice need not to be in any particular form or in writing as long as it amounts to an unambiguous intimation of a final intention to dissolve the partnership. Forcible ejection and refusal to allow one partner to take part in the management of a business is a definite intimation of such intention.

Under sec 11 of the partnerships act, every partner is liable jointly with other partners for all the obligations and the debts of the firm incurred while he is a partner. 

Where an action is brought against a partnership it is one against all the partners. For this reason, where a sole trader carries his own business in a name other than his own name, he cannot commence action in that name. See; patel-vs-national contractors

LIMITED LIABILITY COMPANIES

If promoters wish to carry on business through the medium of limited liability company they must choose which one of the various types of company they wish to form. The first choice is for the promoters to consider between limited and unlimited companies. If a company is limited it could be by shares or by guarantee. If not limited it would be an unlimited company. Section 4(1) of the companies act provides “any 7 or more persons, or where the company to be formed could be a private company any 2 persons or more persons associated for any lawful purpose may by subscribing their names to a memorandum of association and otherwise complying with the requirements of this act in respect of registration form an incorporated company with or without limited liability.” If the company is a profit making concern then it is wise to have a company limited by shares. If not, then the company limited by guarantee is more suitable. The promoters must also decide whether the company is to be private or public. Sec 30 of the companies act defines a private company to mean, “a company which by its articles;

a.                    Restricts the right to transfer its shares.

b.                    Limits a number of its members to 50 not including persons who are in the employment of the company and persons who having been formerly in the employment of the company and while in that employment have continued after the determination of that employment to be members of the company.

c.                    Prohibits any invitation to the public to subscribe for any shares or debentures of the company. 

Any company which does not fall in this definition is a public company. 

REGISTRATION OF THE COMPANY

In order to secure the registration of a company the promoters must prepare and register certain documents; 

a.                    Memorandum of association-in which they express inter alia their desire to be formed in a company with a specific name and objects. They declare their intention to be formed in a company.

b.                   Articles of association- in which they set out rules for the internal management of the company. These documents are signed by at least seven or two persons where it is a public or a private company as the case may be. The signatures must be attested by a witness. The person so signing the MOA is referred to as a subscriber. If the company has a share capital each subscriber must sate opposite his name the number of shares he takes and must not take less than one share. Sec 5(4) (b) of the companies Act. 

c.                    Statement of nominal capital- this is required only in the case of a company with shared capital. It is used for the purposes of computing the stamp duty payable. 

d.                   Declaration of compliance- is a statutory declaration made either by the advocate engaged in the formation of the company or by a person named in the articles as a director or secretary to the effect that all the requirements of the companies act have been complied with. In the case of public companies, the other documents required is a list of persons who have agreed to become directors and their written consent to act as such. 

There are other documents which the law requires to be filed on incorporation. These are:

a.                    Notice of the situation of the registered office of the company under Sec 108 of the companies act. 

b.                    The particulars of the directors and the secretary under Sec 201 (4). 

These documents are lodged with the registrar of companies who scrutinizes them and on finding them in order he registers them and issues a certificate of incorporation and the company is thereby formed. Under Sec 16(2) of the Companies, from the date of incorporation mentioned in the certificate the subscribers to the memorandum together with such other persons as may from time to time become members of the company shall be a body corporate by the name contained in the memorandum capable of exercising all the functions of an incorporated company with power to own land and having perpetual succession and a common seal. Under Sec 17(1), a certificate of incorporation given by the registrar in respect of any association shall be conclusive evidence that all the requirements of this act in respect of the registration and of matters precedent and incidental thereto have been complied with and that the association is a company authorized to be registered and duly registered under the act.

CONSEQUENCES AND ADVANTAGES OF INCORPORATION

a.                    Separate legal entity

Legal personality- the most fundamental attribute of incorporation from which all other consequences and advantages flow is that the company is regarded in law as having its own legal personality, distinct and separate from its members. It is therefore capable of enjoying rights and being subject to duties. The company is a legal entity in its own right. The full implication so legal personality was never understood fully not even by the courts until the celebrated case of;

Salomon vs. Salomon and co ltd.  (1897) A.C 22 H.L. 

Salomon was a leather merchant and a goods manufacturer. He sold his business to a company Salomon and co ltd which he had formed for sterling pounds 30,000. The company had a membership of seven being Salomon, his wife, daughter and four sons. The shares were allotted as hereunder; Salomon took 20,000 ordinary shares of sterling pounds 1 plus, a debenture worth sterling pounds 10,000 against the assets of the company. The rest owned one share of sterling pounds one each. Later, there were industrial strikes which pushed the company into insolvency and was finally wound up. The companies’ assets proved inadequate to pay the sterling pounds 10,000 worth of debenture owed to salomon together with sterling pounds 7,000 owed to unsecured creditors. Salomon took sterling pounds 10,000 before paying the creditors. The unsecured creditors sought legal action contenting that they were entitled to the assets of the company before Salomon, the debenture holder could be paid. They stated that Salomon and co ltd were really the same person with Salomon and argued that Salomon could not owe money to himself. In the high court, Upjohn J stated, “Really, I find no difference between salomon and salomon and co ltd” he decided that the unsecured creditors be paid first. Salomon appealed to the court of appeal which upheld the decision of the high court stating that the company was a mere agent of Salomon and that he must pay the sterling pounds 7,000 owed to unsecured creditors. Salomon appealed again to the House of Lords which overruled the decision of the lower courts and held; 

a.                    Salomon and co ltd is a separate and distinct entity from Salomon and any other member.

b.                    Salomon as a debenture holder (secured creditor) has a priority claim over the assets of the Salomon and co ltd before any unsecured creditors.

Lord Manhatten put the rule first, “in order to form a company limited by shares the companies act requires that a MOA should be signed by 7 persons who are each to take one share at least. If those conditions are complied with, what can it matter whether the signatories are relatives or strangers? There is nothing in the act requiring that the subscribers to the memorandum should be independent or unconnected or that they or any one of them should take a substantial interest in the undertaking or that they should have a mind of their own or that there should be anything like a balance of power in the constitution of the company. When the memorandum is duly signed and registered, though there may be only 7 shares taken, the subscribers are a body corporate capable forthwith of exercising all the functions of an incorporated company. These are strong words. The company attains maturity at its birth. There is no period of minority, nor interval of incapacity. A body corporate thus made capable by state cannot lose its individuality by issuing the bulk of its capital to one person whether he’ll be a subscriber or not. The company is at law a different person altogether from the subscribers though it may be that after incorporation the business is precisely the same as it was before and the same persons are managers and the same hands that received the profits, the company is not in law an agent or trustee for them. Nor are the subscribers liable in any shape or form except to the extent and the manner provided by the Act.”

Macaura-vs-Northern assurance co. ltd 1925 AC 619

Macaura owned a timber estate in Britain. He formed a company and sold the timber for sterling pounds 42,000 to that co. by obtaining 42,000 fully paid up shares of sterling pounds 1 each. The total was issued to macaura and his nominees. He was also an unsecured creditor for sterling pounds 19,000. He took out an insurance policy bearing his own name to secure the co. Later, most of the timber was gutted by fire and macaura went to the insurance company and claimed compensation against the fire in his own name. It was held that he as a person had no insurable interest in the estate either as a creditor or as a shareholder.

Katate-vs-Nyakatukura 1956 vol 70 ULR pg 47

The respondent sued the petitioner for the recovery of Ush 2,255 alleged to belong to the Angole African Commercial Society ltd. It was alleged that while he was a director and deputy chairman of the company the petitioner had collected various amounts of money from debtors of the company and failed to pay them over to the company or to account for them. The action was filed in the native court. The relevant statute, the jurisdiction of the native courts Act, was limited to those cases in which the parties were natives. In suing the petitioner, the respondent admitted quite frankly that he was acting on behalf of the Angole African Commercial Society ltd as their agent. The issue was whether the Angole African Commercial Society ltd was or was not a native. It was held that a limited liability company is a corporation and has existence distinct from the shareholders who hold its shares. The distinct legal entity is not capable of having racial attributes. It was not therefore a native even if all the shareholders were natives.

Lee-vs-Lees air farming co. ltd

Lee formed the respondent company for the business of aerial top dressing. It’s a method of farming from the air. The nominal capital of the company was sterling pounds 3000 divided into 3000 shares of sterling pounds one each. Lee held 2999 of the shares and the remaining one share was held by a solicitor in trust for him. Lee was therefore the beneficial owner of all the shares. He was appointed the companies director and employed at a salary as the chief pilot. He was killed in an aircraft while working for the company. His widow claimed compensation under the workmates compensation Act. The issue was whether Mrs Lee was entitled to any compensation and whether lee himself was a worker. A worker was identified as a person who entered into a contract with an employer. Had lee entered into a contract of service with the company or the company was just another face of lee. It was held that it was a logical consequence of the decision in salomon-vs-salomon that the company is separate from its members and that lee and the company were two different persons capable of establishing contractual relations between them. The deceased was therefore a workman and his widow therefore qualified for compensation.

2. Limited liability

Since a company is a corporation it has a separate legal personality and the members are not liable for the companies’ debts. In the case of a company limited by shares, a member will be liable only for the amount payable on his shares. If the company is limited by guarantee then the liability is limited to the amount guaranteed to be paid. See; insolvency bill; Sec 213(1) (a&b)

Bradley egg farm ltd-vs-Clifford 1943 vol 2 AER 348

The plaintiffs wanted their poultry to be tested for white diarrhea. They contracted with a society to carry out the test. The society official who carried out the test was negligent and as a result some of the poultry died and the plaintiff sought to recover damages from the society. The issue was, since the society did not have a separate legal existence from the members who was liable        for the negligence of the official. Was it the society or the executive committee? It was held that to make all the members liable would amount to giving the society the status of a separate legal entity which they did not have. The society was therefore not liable but the executive committee was.

3. Holding of property

Corporate personality enables the company to own property in his own name distinct from that of its members.

4. Suing and being sued

A company being a separate legal personality may seek to enforce its rights and it may also be sued for breaching its own legal duties. Unincorporated associations can sue under a representative capacity where one party represents the rest in a representative suit. At common law, a company was not allowed to appear otherwise than by an Advocate and not by an official such as a manager. See; East African roofing co ltd-vs- 1954 KLR pg 86; Order 3 Rule 4 of the civil procedure rules.

In East Africa Roofing Co. Ltd v Pandit (1954) 27 KLR 86,

Here the Plaintiff a limited liability company filed a suit against the defendant claiming certain sums of money.  The defendant entered appearance and filed a defence admitting liability but praying for payment by installments.  The company secretary set down the date on the suit for hearing ex parte and without notice to the defendant.  This was contrary to the rules because a defence had been filed.  On the hearing day the suit was called in court but no appearance was made by either party and the court therefore ordered the action to be dismissed.  The company thereafter applied to have the dismissal set aside.  At the hearing of that application, it was duly represented by an advocate.  The only ground on which the company relied was that it had intended all along to be represented at the hearing by its manager and that the manager in fact went to the law courts but ended in the wrong court.  It was held that a corporation such as a limited liability company cannot appear in person as a legal entity without any visible person and having no physical existence it cannot at common law appear by its agent but only by its lawyer.  The Kenya Companies Act does not change this common law rule so as to enable a limited company to appear in court by any of its officers.

5. Perpetual succession 

Since a company is a corporation and an artificial person it has no body, mind or soul but is dressed only on the intendment and the consideration of the law. It cannot die like a human person since it’s born by a process of law. It can only be destroyed by that process. Unless and until that process is brought into play it cannot be brought to an end and hence the company has perpetual succession and exists indefinitely.

6. Transfer of shares

Sec 70 of the companies Act provides; “the shares or rather interest of any member in a company shall be movable property transferable in the manner provided by the articles of the company” this however is subject to Sec 30 of the same Act. Shares in a company are freely transferable and the transferee steps in the shoes of the transferor as a member. Sec 30 provides that private companies should restrict the right of transfer of their shares. One must comply with the conditions under the articles in the case of private companies. 

7. Borrowing facilities

A company can borrow money much more easily than sole traders and partnerships. This is facilitated by the device of a floating charge. This is a charge which floats like a cloud over all the assets of the company from time to time falling within a generic description but without preventing the company from disposing of those assets in the ordinary course of business until something causes it to crystallize and fasten on the assets. A floating charge is an equitable security, it does not attach to any property at all as opposed to the legal charge which is attached to some particular property of the company. The company is not prevented from disposing of such a charge. Sole traders and partnerships are not allowed to do so. Under sec 43(a) of the Bankruptcy Act, anything in the possession of a bank can be attached and these provisions do not apply to a company. 

DISADVANTAGES OF INCORPORATION

These are;

• Formality
• Expense
• Publicity

In order to form a limited liability company the promoters must prepare and register certain documents. Throughout its life, a company is required to file certain documents like annual returns, balance sheets and profit and loss accounts. These are public documents and maybe examined by any member of the public on paying an examination fee. Their preparation requires the payment of money. The companies’ affairs are therefore publicized and there is no more privacy. Even in liquidation, a company must follow a particular procedure. Companies are also subject to the ultra vires doctrine which partnerships and sole proprietorships are not subject to.

Although Salomon’s case established that a company is a separate and distinguished person, there are situations where this fundamental principle of personality is ignored. In such situations the law ignores the corporate entity of the company and instead pays regard to the surrounding economic realities. These situations must be referred to as exceptions to the rule. Instances under which the corporate personality is ignored are provided for under statutes and the common law.

a.                    Under the companies Act.

Reduction in number of members- Sec 33 of this act provides, “if at any time the number of members of a company is reduced in  the case of a private company below 2 or in the case of any other company below 7 and it carries on business for more than 6 months while the number is so reduced, every person who is a member of the company during the time that it so carries on business with fewer membership and is cognizant of the fact that it is carrying on business with fewer than 2 members or 7 as the case maybe, shall be severally liable for the payment of the whole debts of the company contacted during that time and may be severally sued therefore.

Fraudulent trading- under Sec 23(1)(a), if in the course of the winding up of a company it is shown that proper books of account were not there at any time during the period of 2 years immediately preceding the commencement of the winding up or the period between the incorporation of the company and the commencement of the winding up whichever is the shorter, every officer of the company who is in default shall, unless he shows that in the circumstances in which the business of the company was started on the default is excusable, be liable for a term not exceeding 3 years.

In Re William 1932

The company was incorporated in 1926 to acquire William’s business as a perambulator and a furniture manufacturer. The directors of the company, William and his brother appointed William as the Managing director of the company with a salary of sterling pounds 1000 per annum. Within the first 6 months the company was debited with the whole of that salary which was sterling pounds 500 more than he should have got. During that period, the company made a loss of sterling pounds 2200. During that year when the company was still in financial problems the directors paid themselves sterling pounds 250 dividends. Towards the end of 1929 to march 1930 the company was in serious financial trouble that it could not pay its debts as they fell due. In spite of this, William ordered goods worth sterling pounds 6000 which became the substance of a charge contained in a debenture held by him. Around the same time, William continued to repay himself a loan of sterling pounds 600 which he had lend the company. By mid-1930, the company with the knowledge of William owed about sterling pounds 1500 for goods supplied. The liquidator applied for William to be held personally liable under sec 3 (23) that he knew that the company could not pay debts and he was doing so fraudulently and he should personally be liable. It was held that for the company to carry on business yet William knew this was fraudulent and William was personally liable to the creditors. In the words of justice morgam, “If a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospects of the creditors receiving payment of the debt, it can generally be inferred that the company is carrying on business with intent to defraud.

Re Patrick and lion limited

Re Sayona distributers limited 1967.

Misdescription of the company-Sec 109(4) of the companies Act requires that the companies name should appear whenever it carries own business on its seal and on all business documents and letters. If an officer of a company or any person on his behalf signs or authorizes to be signed on behalf of the company any bill of exchange, promissory note, cheque or order for goods where the companies name is not stated, such officer is liable to the true owner and will also be personally liable to the holder of a bill of exchange, cheque or promissory note or order for the amount thereof unless it is paid by the company.

Sicklesmear vs buckstar 1970

Holding and subsidiary companies-It is common for a company to form a pyramid of interrelated companies, each of which in theory is a separate legal entity but in reality part of one concern is represented by the group as a whole. This is particularly the case where one happens to be the parent while the rest are subsidiary companies. A subsidiary company is defined under sec 154 of the companies act to be a subsidiary of another if that other either;

·       Is a member of it and controls the composition of its board of directors.

·       Holds more than half in nominal value of its equity share capital.

·       The first mentioned company is a subsidiary of any company which is that others subsidiary.

The accounts of the…holding company may not be a proper picture of the economic situation of the entire group thus sec 150(1) provides, “where at the end of its financial year a company has subsidiaries, accounts for statements referred to as group accounts in this act dealing as herein after mentioned with the state of affairs and the profits and loss of the company and the subsidiaries shall be laid before the company in the general meeting when the companies own balance sheets and profit and loss accounts are so laid. 

 

COMMON LAW SITUATION

Agency relationships

Logically, there is no reason why a company may not act as an agent of another, where there is an agency relationship, the courts will ignore the separate entity of each company and instead give effect to the economic reality behind the legal theory. The best example of agency relationships is where one company is a subsidiary of another. 

In smithstone & knight ltd-vs-Birmingham Corporation 1839, 

The plaintiffs were paper manufacturers in Birmingham. In the same city there was a partnership called Birmingham waste company which did business as merchants and dealers in waste paper. The plaintiffs bought off the partnership as a going concern and registered it as a company. A share capital of the new reformed company was sterling pounds 502 divided into 502 share of sterling pounds one each. The plaintiffs beneficially owned all the shares. The new reformed company carried on business which previously belonged to the plaintiffs. It occupied business premises as tenants of the plaintiff but never paid any rent. It employed no separate staff and kept no books of accounts such books being kept by the plaintiffs. Birmingham Corporation purported to acquire compulsorily the premises which the subsidiary carried on business. Thereupon, the plaintiffs claimed compensation for removal and disturbance. The issue was, who would be entitled to the compensation. Under the legislation giving the corporation the power to make a compulsory purchase order, an occupier could not claim for compensation unless it enjoyed a tenancy for a period longer than 1 year. The subsidiaries tenancy was a 1 year one. The plaintiff, the current company argued that it was really the person in occupation and therefore entitled to compensation. It was held that while the subsidiary was a separate legal entity it might be acting as the agent of its shareholders in this case a plaintiff company. Further, the occupation of the premises by the subsidiary was technical only and solely for the purposes of the plaintiff company. The plaintiff could therefore maintain a claim for compensation.

Situations where the company is formed for fraudulent purposes

Re FG films ltd 1953(1) AELR

A company was incorporated in England. Its capital was sterling pounds 100 in sterling pounds one share, 90 of which were held by the president of an American company and 10 were held by another director, a British subject. The company contented that it was the maker of a film which therefore should be registered as a British film. The court refused to agree that a film was made by the British company whose participation in it was so small as to be practically negligible. The company was merely the nominee or the agent of the USA company which had provided sterling pounds 8000 for the making of the film and which had brought the British company into existence for the sole purpose of enabling the British company to claim that the film was its own. The modest capital and its shareholding were treated by the court as evidence that the British company had been formed with a view to evading the legislation in issue.

 

Re bugle press ltd 1961 CH 270

A, B and C were the only shareholder sin a company. A held 45% of the shares and B held 45%. The remaining 10 % were held by C. A and B persuaded C to sell his shares to them but he refused to do so. A and B thereupon formed another company AB ltd which made an offer to the shareholders of ABC ltd. The offer was accepted by A and B. they then evoked the equivalent of sec 210 of the companies act which provides that if one company makes an offer to take the shares of another company and if that offer is accepted by at least 90% of the shares by buying out the shareholders then it can buy up the remaining 10%. Upon evoking sec 210. A and B took all the shares. It was held that this was a farfetched attempt to evade the fundamental rule of company law which forbid the majority shareholders from expropriating the minority. The courts will not recognize the corporate entity in such a case.

Gilford motor company ltd-vs-Horne 1935 CH 935

Jones-vs-Lipman 1962 WLR 832

Group enterprise

There is a general tendency by the courts to ignore the legal entity of various companies within a group and instead look at the economic reality of the entire group. In doing so, the courts are merely following the interpretation of the legislature under Sec 150-154 where group accounts are needed in respect of associated companies. 

Holdsworth-vs-caddies 1955 WLR 352

Residents

The issue of the residents of a company is important for taxation purposes. 

In De beers consolidated-vs-Howe 1906 AC

The appellant company was registered in South Africa. Its general meetings were always held there. Some of the directors lived in South Africa. Its meetings were held in Kimberly and in London. However a majority of the directors lived in London and most of the directors meetings were held there. Most of the chief operations of the company were controlled from London. It was held that the company was resident in the UK for purposes of taxation. Lord Lorban stated, “a company cannot eat or sleep but it can keep house and do business. We ought therefore to see where it kept house and did business. A companies’ real business is carried on where the central management and control actually resides.”

MEMORANDUM OF ASSOCIATION

Sec 5 of the companies Act requires that the memorandum of every company should be in the English language, printed and should state;

a.                    The name clause 

The name of the company with limited as the last word of the name in the case of a company limited by shares or guarantee.  Dcc 

The name clause is the first clause in the memorandum. Ltd is an accepted abbreviation of limited. 

Stacy and company-vs-Wallace 1912 vol 106 LT 544

Lord Justice Scruton decided that ltd was an accepted abbreviation for limited. 

However, where it is proved that an association about to be formed as a limited company is to promote or commerce, art, religion, charity, science or any other useful object and intends to apply its profits in the promotion of those objects and to prohibit the payment of its dividends to its members then under Sec 21 of the companies Act the minister may direct that the association may be registered as a company with limited liability without adding the word limited to its name. The name of a company can also be changed.

2. The registered copies clause

This clause shall state that the registered office of the company shall be situate in the republic of Kenya. The registrar shall be notified of the actual place after incorporation pursuant to the requirements of Sec 108 of the companies Act. This will enable the office of the registrar to know where notices and legal processes may be served on the company. It will enable members and other authorised persons to know the location of the various registers required to be kept there which must be available for inspection at specified times. The statutory books which must be kept at the registered office are;

·       The register of charges, 

·       Minute books of general meetings, 

·       Register of directors and secretaries. 

Other books may be kept are;

·       The register of members 

·       The register of directors interests in shares or debentures of the company

·       Register of debenture holders

·       The books of account.

3. The objects clause

The third and perhaps the most important clause. It states the objects for which the company is incorporated. A company is not allowed to do any activity beyond its objects or else any such activity will be deemed to be null and void, it will be ultra vires, the company. The purpose of the doctrine of ultra vires is 2 fold; 

·       It is intended to protect the investors by ensuring that they know the objects to which their money is to be applied.

·       It is for the protection of the creditors by ensuring that the companies’ assets to which they look to for the repayment of their debts are not wasted in unpaying ventures.

In Ashbury Railway and carriage company limited-vs-Riche 1875 LR pg 653

The MOA gave the association power to;

• Make and sell or lend on hire railway carriages or wagons 
• To carry on the business of mechanical engineers and general contractors.
• To purchase lease, work and sell mines, minerals and buildings.

The directors entered into a contract to purchase a concession for the construction of a railway in Belgium. The issue was whether this contract was valid and if not whether it could be ratified as the shareholders had already made to do so. It was held that since the memorandum did not contain any provision for the purchase of a concession or building of a railway the purchase was ultra vires so that even a subsequent assent of the whole body of the shareholders could not ratify it. Although mechanical contractors they could not do so. Lord Cairnes stated; “the words general contractors referred to the works which went immediately before and denoted such contracts which mechanical engineers make for the purposes of carrying on business. The contract was not in the MOA. If so, it was placed beyond the powers of the company to make the contract. It is not a question whether the contract was ratified or was not. If the contract was void at the beginning it was void because the company could not make the contract.”

Today, the doctrine of ultra vires is not as rigid as it used to be before. 

The first inroad was made in; Attorney General-vs-Eastern Railway Co. 1880 vol 5 AC 473

The company was incorporated to acquire the undertaking of two existing railway companies and to construct and run other companies. The company entered into a contract with a company to supply that other company with locomotive power for 5 years and work on carriages for 2 years. It was held that the activity in question were within the express powers of the company. Selbournd LJ stated; “the doctrine of ultra vires as explained in Ashbury’s case should be maintained. But this doctrine ought to be reasonably and not unreasonably be understood and applied. Whatever maybe adapted as incidental to or consequential upon those things that the legislature authorised ought not unless expressly held to be ultra vires.” The company can therefore undertake acts reasonably incidental to express stipulations. 

Bell houses ltd-vs-City Wall properties ltd 1966 2QB 656/vol 2 ALR 674

Re town bank 1890 44 CD 634

As per Sec 17 of the companies Act, the registrar’s certificate of incorporation is conclusive evidence that the company has stated its objects clearly. If the objects clause was to state for example that the company will do anything beneficial to the company then it need not be registered. This is a subjective clause and the company can do anything which may be ultra vires. The courts have made sure that companies do not evade this rule. The courts use several methods to control misuse of the rule;

• The Ejusdem generis rule and The main objects rule of construction
• The laws of substratum rule.

The Ejusdem generis rule

This is where the MOA expresses the objects of the company in a series of paragraphs and one paragraph or the firs second and third paragraphs appear to embody the main objects of the company and the other paragraphs will be treated as merely ancillary tool. These main objects. However not withstanding these rules, the business community has invented the independent objects rule of interpretation. This is a situation where the promoter’s state at the bottom of the memorandum that each of the objects is independent and each of the sub clauses should be treated as equally important. The leading authority on this aspect of interpretation is

Cottman-vs-Bravam 1918 AC 514

The company was formed to acquire certain rubber and tobacco estates. The objects clause 8 contained giving the power to promote and form companies and to deal in the stocks and shares of such companies.; clause 12; giving a general power to deal in the stocks and shares clause 30; which provided;

• That the objects specified in any clause were not to be strictly construed by reference to the contents of any other sub-clause.
• That no object should be construed a subsidiary or ancillary to any other entry in the objects clause.

The company underwrote shares in another company dealing in oil which went into liquidation and it was placed in the list of contributories. It applied to be struck off that list on the ground that the entire transaction was ultra vires. The House of Lords concluded however that the underwriting transactions were authorised by clauses 8 and 12 which by clause 30 had to be given primary effect, a separate and independent objects. As per Lord Parker, the result was; “a modern memorandum of association with its multi-various objects of lists and powers specified as objects and its clauses designed to prevent any specified object being read as ancillary to any other object. 

However, the independent objects clause cannot turn powers into objects.

See; Introductions ltd-vs-The National Provincial Bank 1969 2 WLR 791

 

The laws of substratum rule

Under this rule if the main object of the company fails then the rest of the objects also fail. Such an object is the substratum meaning the main object of the company and if the main object fails then the company is subject to winding up;

In Re German date coffee co. ltd 1882 Vol 20 CH 1969

The major object of the company was to acquire a German patent to manufacture coffee from dates. The German patent was not granted and the company obtained a Dutch patent for the same purpose. Two shareholders petitioned the court for a winding up order on the grounds that the companies’ objects had failed. It was held that the substratum of the company had failed and it was not possible to carry out the objects for which the company was formed and therefore it was just an equitable for the company to be wound up. See Sec 219 of the companies Act

Re Jon Beauforte London ltd 1953 CH 131

There are areas where the doctrine of ultra vires is vigorously imposed. This is mainly in the field of gratuitous payments. A company cannot defectively make gratuitous payments unless these are made for the benefit of the company.

In Hutton-vs-WestCorn Railway company 1883 23 CH 18864

The company had disposed of all of its undertakings and was no longer a going concern as trading body. It existed only for the purposes of winding up. In its general meeting it resolved to expend part of the purchase money on gratuitous payments to directors and other officials. It was held that since the company was no longer a going concern, the resolution was invalid. Lord Justice Bowen stated, “The law does not say that there are to be no cakes and ale except such as are required for the benefit of the company. Charity has no business to sit with the board of directors.”

Re Lee behrels 1832 2CH 836 

Re Ray

Nyali ltd-vs-AG 1957 1AER 646

Remedies to ultra vires transaction victims

Whether a contract is ultra vires or not will depend on the knowledge of the party dealing with the company

Re David Payne 1904 2CH 608

X, who was interested in company B learned in his own private capacity that company B which had general borrowing powers proposed to borrow a loan for purposes outside its business. It induced company A to make a loan to company B which used the money as proposed. The money was borrowed in the security of a debenture. Was this debenture valid? The money was borrowed for a purpose outside the objects of the company yet the directors knew this. The court held that where a company has a general power of borrowing for its own purposes and where the company borrows within the limits of that power the person who lend the money is not bound to enquire for what purpose the borrowing company is to apply the money so borrowed. The director’s private knowledge could not be imputed in the company. Romer LJ held; “where you have a limited company with a MOA authorizing the company to embark on a series of transactions and among those purposes you find the power to borrow generally for the purposes of the company, I take it to be clear beyond controversy that when the money is being borrowed within the limits of the power of borrowing, the person who lend the money is not bound to enquire to what purpose the borrowing company is about to apply the money so borrowed.” 

In respect to property transferred under an ultra vires transaction since the effect of ultra vires is to render the whole transaction null and void it follows that the purchaser shall not acquire any rights in such property. This also applies to any money lend to the company on an ultra vires borrowing. So long as the money can be traced in law or in equity the lender is still entitled to a charge on the mixed fund proportionate to his own share if there are other claimants. The directors are treated as trustees and the money is treated as trust money. A third party may also bring a personal action against the directors with whom he has dealt with. The third parties have an equitable claim against them for specific restitution.

What reforms to ultra vires

In 1945 in England, the cohen committee proposed that as regard 3^rd parties a company should have all the powers of a natural person and the objects clause in the memorandum should operate only as a contract between the company and the members regarding the scope of the authority vested in the directors. This recommendation overlooked the fact that 3^rd parties dealing with the company will still be presumed to have constructive knowledge of the companies’ public documents and they will be presumed to know when the directors exceed their authority. In 1962, the Jenkins committee recommended that even the constructive notice rule should be abolished so that even the actual knowledge of the memorandum of articles should not deprive a 3^rd party of the right to renounce a contract if he reasonably failed to appreciate that this precluded the company or its officers from entering into the contract. The constructive notice rule has now been abolished I England but it still remains the law in this country. In order to avoid the ultra vires rule, the objects clause may be amended by the company. Sec 8 of the Companies Act empowers the company by special resolution to alter or add to its objects so long as 85% of the shareholders of the issued share capital support a proposed alteration companies can easily alter their objects clauses and thereby avoid the trap of ultra vires.

4. The nominal capital clause

States the nominal capital to which the company wishes to be registered and the division thereof into shares of fixed amounts. 

5. Liability clause

States that the liability of the members shall be limited or as the case may be.

ARTICLES OF ASSOCIATION

 

The articles of association is one of the important documents relating to the companies constitution. Sec 9 of the Companies Act states that a company limited by guarantee must register with the registrar articles of association prescribing articles for the company. Under sec 10 the articles of a private company should state the number of members with which the company proposes to be registered. A company limited by shares may or may not register articles of association. The articles so registered may adapt all or any of the regulations in schedule one table a of the companies act. Table A is the model form of articles of association for a company limited by shares. It is in two parts; part one is designed for public companies and part two for private companies. In registering its articles of association a company may take one or three options;

a.                    It may adopt table A in full.

b.                    It may adopt table A subject to amendments 

c.                    It may register its own set of articles and exclude table A altogether. 

Sec 12 requires that the articles must be

i.In the English language

ii.Printed

iii.Divided into paragraphs numbered consecutively

iv.Dated

v.Signed by each subscriber to the memorandum of association in the presence of at least one witness who should attest the signatures and add his occupation and address.

Whereas the MOA confers powers in the company the articles determines how such powers shall be exercised. In other words they regulate how the internal affairs of the company shall be managed. Among other things the articles deals with;

i.The issue of shares, 

ii.Alteration of the share capital, 

iii.Transfer of shares, general meetings, 

iv.Voting rights, 

v.Appointment of directors, 

vi.Payment of dividends, 

vii.Accounts, winding up and other miscellaneous matters. 

The articles also provide the dividing line between the powers of the shareholders and those of the directors.

The juridical effect of the articles.

Under Sec 22 of the Companies Act, subject to the provisions of the Act, when the memorandum and the articles are registered they bind the company and the members as if they had been signed and sealed by each member and contain covenants on the part of each member to observe all the provisions. This section has been interpreted to mean that once the articles have been registered, they constitute a contract between the company and each individual member. 

Hickman-vs-Kent/Romney marsh sheep breeders association ltd 1951 1CH881

The articles of the company provided for the reference of a dispute between a member and the company to arbitration. A dispute arose between Hickman who was a shareholder and the company. Hickman filed a court action against the company. The company contented that the court acti on was premature since Hickman was bound under the articles to refer the matter to arbitration. The company applied for the action to be stayed. It was held that the company was entitled to have the action stayed as the articles mounted to a contract between the company and Hickman to refer disputes between them to arbitration. The court decided as per Justice Asberry that;

a.                    No article can constitute a contract between the company and a third party.

b.                    No right merely purporting to be given by an article to a person whether he’s a member or not in a capacity other than that of a member as for instance; solicitor, promoter or director can be enforced against a company.

c.                    Articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the comgpany. It is a basic rule that the articles do not confer rights upon an outsider or upon a member in a capacity other than that of a member for example as a director.

Eli-vs-Positive government security life assurance company ltd 1876 vol 1

The articles provided that the plaintiff should be the companies’ solicitor for life removable only for misconduct. He became a solicitor and a member. Later the company terminated his employment. He sued the company for breach of the contract contained in the articles. It was held that the articles would function as an agreement between the members to appoint the plaintiff or a direction to the directors to appoint him but the articles did not of themselves constitute a contract between the plaintiff in his capacity as a solicitor and the company. This is so because articles confer rights only to members of a company and not third parties.

Wood-vs-Odessa water works company 1889 vol 42 CHD636

Reifill-vs-h 1960 CH pg 1

ALTERATION OF THE ARTICLES 

Sec 13 of the Companies Act empowers a company by a special resolution to alter or add to its articles. Any such alteration or addition is as valid as if it was originally contained in the articles. Special; resolution is defined in Sec 141 of the Act  as a resolution supported by ¾ of the members voting either in person or by proxy at a general meeting of which 21 days’ notice of the intention to propose a resolution as a special resolution has been given.

Andrews-vs-Gas Knitter company ltd 1897 CH 361

The issue was whether the company which under its memorandum and articles had no power to issue preference shares could alter its articles so as to authorize the issue of such shares by way of increased capital. It was held that in so far as the companies’ constitution depends on the articles of association it was clearly alterable by a special resolution under powers conferred by the Act. 

The power to alter the articles is a statutory power and the company cannot deprive itself of the right to exercise that power. Although companies have power to alter the articles there are limitations to this power. A resolution to alter the articles of a company must not;

• Be inconsistent with any statute.
• Exceed the conditions contained in the memorandum.
• Increase the liability of a member or require him to take more shares unless he agrees to do so in writing. See. Sec 24 of the Companies Act.
• Remove the restrictions contained in Sec 30 if the company is to remain a private company.
• The variation of the articles must not conflict with Sec 74 of the Companies Act as to the rights of the shareholders affected by a variation of class rights to apply to the court for a cancelation of the variation. 
• The resolution must be not inconsistent with an order of the court made under Sec 211 of the companies act dealing with cases of oppression by the majority of the minority a company.
• The alteration of the articles must be in good faith and for the benefit of the company as a whole.

In Allen-vs-The Gold reeves of West Africa. 1900 1CH656

The company had by its articles given itself a lien on all the shares which were not fully paid for. The company sought to extent the lien to all the shares by an alteration of the articles. It was held that the company was entitled to extent the lien by an alteration of the articles in exercise of the statutory power. Lord Linley stated; “Wide however as the language of section 13(a), the powers conferred by it must like all other powers be exercised subject to those general principles of law and equity which are applicable to all powers conferred on the majority and enabling them to bind minorities. It must be exercised not only in the manner required by law but also bonafide (in good faith)

See; Shuttleworth-vs-Coxbrothers 1927 vol 2QP pg 4

Sidebottom-vs-Casua & company 1920 1 CH 154

Brown-vs-British abrasive wheel company 1919 1 CH 290

 

Sometimes the articles may be altered in such a manner that the implementation in their altered form may lead to a breach of contract. Such is particularly the case as it regards contracts of service between companies and their directors and servants. Can a company alter its articles in such a way as to dismiss a director from office? A director may hold office in one of three ways. He may hold office either;

a.                    Under the articles without any contract of service.

b.                    Under a service contract which is entirely independent of the articles.

c.                    Under a service contract which expressly or by implication embodies the relevant provisions of the articles.

Where a director holds office under the articles without a service contract then his service is conditional that the articles may be altered at any time in exercise of the statutory power. If however the director’s appointment is entirely independent of the articles then any alteration which affects his contract with the company will constitute a breach of contract in respect of which the company will be liable in damages. 

In Southern Foundries (1926) Ltd v Shirlaw 1940 AC 701

The plaintiff was by a written contract appointed managing director of the company for a period of 10 years. The agreement was not expressed to be subject to the articles in any way. The original articles set out grounds upon which the office should be vacated subject to the terms of any subsisting agreement. The articles also provided that should the managing director seize to be a managing director then he should also seize ipso facto to hold office as managing director. As a result of some company to the organization, new articles were subsequently to be adapted one of which recommended the removal of any director by notice. Pursuant to this article, the company purported to remove the plaintiff from his office of director with the result that his appointment as managing director was also terminated. There was a contract independent of the articles. The plaintiff brought an action for breach of contract. It was held that he was entitled to damages for a breach of contract. Lord Atkins stated, “If a party enters into an arrangement which can only take effect by exercise of an existing state of circumstances, the law is that there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that state of circumstances under which the arrangement can be operative.” 

Vs- northern railport company ltd 1962 WLR 1038             

Read-vs-astoria garage ltd. 1942 CH 637

Punt-vs-symons 1903 2CH 506

British murac syndicate-vs-Alperton rubber co ltd 1915 Vol 2CH 186

 

Variation of class rights

Classifieds in company law recognizes existence of classes of shareholders in the company. Bowen LJ in sovereign life assurance company ltd-vs-Dold 1892 2QB 513 defined the word class. He stated; “the word class is vague. It must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view of common interest.” The term relates to those persons whose rights are similar to the extent that they can consolidate them together. In the case itself it was held that policy holders whose rights had matured were a different class from those whose policies are not mature. 

Art 4 of table A provides that where the share capital is divided into different categories of shares, the rights attached to any class may be varied with the consent in writing of the holders of ¾ of the issued shares of that class or with the sanction of a special solution passed at a separate general meeting of the holders of the shares of the class.

See sec 74 and 5(2) of the Companies Act.

 

COMPANIES ORGANS AND OFFICERS

Since the company is an artificial person it can only act through the agency or natural persons. The decisions of the majority of the members of the company in the general meetings is deemed to be the decision of the company. In practice, it is impossible for the company’s day to day position to be attended to by all the members and this rule had to be changed. The constitution of the company provides for a board of directors which delegates powers of management to a managing director. For this reason companies have two main organs;

• General meeting and 
• The board of directors.

The authority to exercise the companies’ powers is delegated to the directors acting as a board. 

 

THE BOARD OF DIRECTORS.

Under Section 177 every public company must have at least 2 directors and every private company must have at least 1 director. In practice, the first directors of a company are appointed by;

a.                    Being named in the articles of association.

b.                   In the manner laid down in article 75 of table A which states that the names of the 1^st directors shall be determined in writing by the subscribers to the memorandum of association or the majority of them. Until such determination, the 1^st signatures to the MOA, shall be the 1^st directors.

In the case of a public company with a share capital section 182 requires that a person may not be appointed as a director by the articles unless on registration of the articles;

i.He has signed and delivered to the registrar a consent in writing to act as a director.

ii.Signed the memorandum for a number of shares not less than his qualification if any.

iii.Taken from the company or paid or agreed to pay for his qualification shares.

iv.Signed and delivered to the registrar an undertaking to take from the company and pay for his qualification shares if any.

v.Made and delivered to the registrar a statutory declaration that the number of shares not less than the qualification are registered in his name.

After the initial appointment it is usual for an annual retirement of directors and the filling of vacancies at the annual general meeting. Under Sec 185, a director can be removed by an ordinary means of removal embodied in the articles. Subject to any modification or exclusion of Table A, article 88 requires that the office of director to be vacated if the director;

a.                    Seizes to be a director by virtue of section 183 relating to share qualification or section 186 relating to removal on attainment of the age of 70 years. 

b.                    If he becomes bankrupt or makes any arrangement of composition of his creditors an undischarged banker is not allowed to work as a director without leave of the court.

c.                    Becomes prohibited from being a director by an order under Sec 189 which empowers the court to restrain the person from managing the company.

d.                    Of an unsound mind.

e.                    Resigns from his office by a notice in writing.

f.                     Absents himself without permission from directors meetings for more than 6 months.

The director in a company need not be natural person. A company can be a director in another company.

 

Division of powers between the general meeting and the board of directors.

Until the end of the 19^th century, it was generally assumed that the general meeting was the company and the directors were merely agents for the company. Although this view else way for a long time it was modified on the advent of the 20^th century. The earliest authority on the relationship between these two is 

Automatic self-cleansing filter syndicate-vs-Cunningham 1906 2CH pg 94

The court of appeal made it clear that the division of powers between these two in the case of registered companies entirely depends on the articles of association. Where the powers have been vested on the board by the articles then the general meeting cannot interfere with the exercise of those powers. In this case, the companies relevant articles provided that subject to such regulations as might be made by extra ordinary resolution the management of the company shall be vested in the directors who might exercise all the power of the company which were not by statute expressly required to be exercised by the company in the general meeting. Another article expressly empowered the directors to deal with any property of the company on such terms and conditions as they might deem fit. At the general meeting of the company a resolution was passed by a simple majority of the shareholders directing the board to sell the company’s assets on specified terms. The directors were of the opinion that a sale on those terms was not of benefit to the company and therefore declined to carry out the sale. Were the directors bound to carry out the directive of the general meeting?

It was held that the articles constituted a contract by which the members had agreed that the directors and the directors alone shall manage the affairs of the company. Unless and until the powers vested in the directors were reduced by an extra ordinary alteration of the articles they could ignore the resolutions of the general meeting on matters of management. They were therefore entitled to refuse to carry out the sale agreement adapted by an ordinary resolution of the general meeting. 

The division of the powers between the general meeting and the board of directors in respect to the company’s management is found in article 80 of table A which states; “the business of the company shall be managed by the directors who may exercise all such powers of the company as are known by the Act or these regulations required to be exercised by the company in the general meeting.”

In Quinn Axtens -vs-Salmon 1909 AC 442

It was established that whether the formula contained in article 80 is employed as invariably is in practice the general meeting cannot interfere with the decision of the directors unless they are acting contrary to the provisions of the Act or the articles. The companies two managing directors who were A and S held between them the bulk of the companies ordinary shares. One of the articles provided that the companies business should be managed by the directors who might exercise all the powers of the company subject to such regulations as shall not be existent with the provisions of the articles or as might be prescribed by the company in the general meeting. Another article provided that no resolution of a meeting of the directors having for its object the acquisition or letting of certain premises should be valid if either A or S descended. The directors resolved to acquire and to let certain properties but S descended. An extra ordinary general meeting was held at which the shareholders by a majority passed similar resolutions. Upholding the court of appeal the House of Lords held that the shareholders resolution were inconsistent with the articles and granted an injunction to restrain the company from acting. 

Shaw and sons ltd-vs-Shaw 1935 2QB 213

Scott-vs-Scott 1943 1ALER

The general meeting retains the ultimate control but only to amend the articles thereby taking away the directors power and also through its power to remove the directors from office and appointing new ones. Unless any of these actions is taken the directors can if they so wish disregard the wishes and instructions of the members in all matters not specifically preserved by the Act or the articles to the general meeting. The old idea that the general meeting is the company and the directors are merely agents or servants of the company servient to the general meeting is no longer a law.

Exceptions to the general rule

a.                    Litigation

Although the general meeting cannot restrain the directors from conducting litigation in the name of the company the general meeting can institute proceedings on behalf of the company if the directors neglect or refuse to do so. This situation changes if the directors know that they are the ones in the wrong. In 

 

Marshalls Valve Gear Co. Ltd-Vs-Manning waddle and company ltd 1909 1CH 267

Marshalls was the majority shareholder and the managing director of the plaintiff company which was formed to exploit an invention which he had patented. On the board he was out voted by the other three directors who were interested in the defendant company. The latter was infringing on the plaintiffs patent and Marshalls in spite the opposition of his co-directors instituted the action to obtain an injunction to restrain the infringement. It was held that as the majority shareholder he had a right to bring the action.

Grant. Vs. United  Kingdom …Railways 1888 Vol 40 CH135

Bamford. Vs. Bamford 1969 2WLR 1107.

2. Where there is a deadlock in the management of the board so that the board cannot function in any material respect, then the power to do so reverts back to the general meeting.

Barron. Vs. potter 1914 1CH 895

The company’s articles provided that the number of directors should not be less than 2 or more than 10 under the quorum for the directors for transacting business should be 2 years after the company’s’ incorporation, the company had 2 directors, Mr. Potter as chairman and managing director and colonel Barron.  Colonel Barron refused to attend any board meeting with Mr. Potter. The companies’ affairs came to a standstill. The only solution would have been to appoint additional directors but the power to do so was vested by the articles in the board of directors. There was therefore no board meeting. It was held that where the articles give the board of directors the power of appointing additional directors and owing to differences between the directors no board meeting could be held then the company had the power of appointing additional directors at the general meeting.

 

DIVISION OF POWERS BETWEEN THE BOARD OF DIRECTORS AND THE MANANGING DIRECTOR.

Art 107 of table A allows director to appoint one or more of their number to the office of managing director, for such period and on such terms as they may think fit. The main duty of a managing director is to exercise some or all of the directors’ powers of management. This is sanctioned by art 109 which authorises the board to delegate to a MD all their powers. The wording of art 109 suggests that the board of directors may effectively divest itself of its powers to the managing director.

THE COMPANY SECRETARY

Sec 178 of the Companies act requires every company to have a company secretary. The secretary must not be the sole director. If anything is required to be done by a director and the secretary it cannot be done by the same person acting as both. Under Sec 177, a private company should have at least one director while a public company must have at least 2 directors. The secretary is appointed by the board and not by the general meeting. Generally speaking his duties are managerial or administrative. The traditional view is that he does not normally have authority to enter contract s on behalf of the company. In 

 

Barnett Hoares and Co. vs. London Tramways co ltd 1887 18QP 815

Lord Escher stated, “a secretary is a mere servant. His position is that he is to do what he is told and no person can assume that he has any authority to represent anything at all.”

In the past, the secretary has been treated as a subordinate servant without authority to commit the company over his action except the engagement of clerical staff. In;

Panorama investments. Vs. Fidelis furnishing fabrics ltd 1971 2QP 711

It was held that where a company secretary ordered self-driven cars, for his own purposes but ostensibly for the business purposes of the defendant company who were his employers, the defendant was liable to the car hire company. 

Lord denning stated, “But times have changed, a company secretary is a much more important person than he was in 1887. He is an officer of the company with an extensive duties and responsibilities. This appears not only in the modern companies act but also by the role which he plays in the day to day business of a company. He is no longer a mere clerk, he regularly makes representations on behalf of the company and enters into contracts on its behalf which come within the day to day running of the company so much that he may be held out as having authority to do such things on behalf of the company. He is certainly entitled to sign contracts connected with the administrative side of the companies’ affairs such as employing staff and ordering cars etc. all such matters now come within the ostensible authority of the company secretary.”

Salmon LJ described a company secretary as the chief administrative officer of the company. It is the secretary’s responsibility to ensure that all the companies’ documentations are in order, that the relevant returns have been made and the companies’ registers have been properly maintained. The companies articles also provides that the company seal should be affixed in his presence.

THE ORGANIC THEORY

In respect of the law of agency as applied to company law, the company is bound by the activities of its officers. However, there are situations in which the law refuses to recognize the concept of vicarious liability and instead insists on personal fault as a prelude to liability. For certain purposes the courts have elected to treat the actions of certain officers in the company as those of the company itself. This position sprung from the words of Viscount Haldel in 

Lennards Carrying co ltd. vs. Asiatic Petroleum co. ltd 1915 Ac 705

Under the relevant section of the merchant shipping Act the owners of any sea going vessel were not liable for any loss which occurred without their personal fault or privity. Lennard was the MD of the company. He knew that the ships boilers were faulty and he let the ship out to sea. As a result of a fault in the boilers the ship was destroyed and the cargo of the Asiatic Petroleum co ltd was destroyed. Could the company escape liability? It was held that since Lennard was the MD his knowledge was the company’s and the company was deemed to have known that the ship was unseaworthy and the company could not escape liability. The knowledge of the MD must be visited upon the company which was therefore liable.

Viscount Haldel stated, “my Lords, a corporation is an abstraction, it has no mind of its own anymore that it has a body of its own. Its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent but who is really the directing mind and will of the corporation. If Mr. Lennard was the directing mind of the company then his actions must unless a corporation is not to be liable at all have been an action which was of the company itself within the meaning of the section.”

Bolton Engineering Co ltd. vs. Graham and sons 1957 1 QP 159.4

 

WINDING UP

The rules relating to winding up are specifically set out in the companies act. Section 212 of the act provides that the winding up may be either;

a.                    Voluntary

b.                    By the court

c.                    Subject to the supervision of the court.

Voluntary winding up

The circumstances in which a company may be wound up voluntarily are set out in sec 217 of the companies act. A company may be wound up voluntarily;

• When the period if any fixed for the duration of the company expires or the event if any occurs, the occurrence of which the articles provide that the company is to be wound up and the company in the general meeting passes a resolution requiring the company to be wound up voluntarily.
• If the company resolves by a special resolution that the company should be wound up voluntarily. 

Generally companies do not always provide for a period within which they will be wound up. Those in need of protection are creditors and the minority shareholders. To protect these groups, sec 276 requires that where it is proposed to wind up a company voluntarily the directors of the company must make a declaration to the effect that they have made a full inquiry into the affairs of the company and having done so have formed the opinion that the company will be able to pay up its debts in full within such period not exceeding 12 months from the commencement of the winding up. Where this declaration is made, there is no need to involve the creditors in the winding up. The declaration will suffice as a guarantee that the company will pay its debts. If the directors are unable to make this declaration, then the winding up will be constituted as creditors winding up. The creditors then appoint a liquidator and a committee to take care opf their interests.

 

By the court

Winding up pursuant to a court order to that effect is the common type of winding up. Sec 218 of the companies act gives the high court jurisdiction to wind up any company registered in Kenya. The circumstances under which the company may be wound up are given in sec 219 of the companies act. These are situations in which;

• The company has by special; resolution resolved that the company be wound up by the court.
• Default is made by the company in delivering to the registrar the statutory report or in holding the statutory meeting.
• The company does not commence business within one year from incorporation or suspends its business for a whole year.
• The number of members is reduced in the case of a private company below 2 and in the case of a public company below 7.
• If the company is unable to pay its debts.
• The court is of the opinion that it is just an equitable that the company should be wound up.
• In the case of a company incorporated outside Kenya, and carrying on business in Kenya, winding up proceedings have been taken against it in the country of its incorporation or any other country in which it has established a place of business.

Who may present a winding up petition?

Under sec 231, an application for the winding up of a company should be by a petitioner presented either by the company itself or by a contributory. A creditor will normally present a winding up petition where the company is unable to pay up its debts. The company’s inability to pay up its debts is defined in sec 220. The company is deemed to be unable to pay up its debts if;

• A creditor to whom the company is indebted in a sum exceeding KES 1000 only, demands payment from the company and three weeks elapse before the company has paid that sum or secured it to the reasonable satisfaction of the creditor.
• Execution is issued on judgement, against the company in favour of the creditor is returned unsatisfied.
• If it is proved to the satisfaction of the court by any other method that the company is unable to pay its debts. Insolvency is inability on the part of the company to pay its debts as and when they fall due. Winding up may not be resorted to where the company disputes the debt. In 

Re Ghelani 1957 EA 197

It was held that it is for the company to show that the debt is disputed on substantial and bonafide grounds and the onus of establishing this rests with the company. 

See Sec 213, 214, 221, 222

COMMON GROUNDS FOR WINDING UP

There are common grounds for winding up by the courts;

• Where the company is unable to pay its debts
• Where the court is of the opinion that it is just and equitable to wind up a company. The courts have exercised this power under various cases.

a.                    Where the substratum of the company has failed; Re German date coffee company ltd

b.                    Where a member has been expelled from office or excluded form participation in the management of the company. 

In Re Westbourne galleries ltd 1973 AC 390 the profits of the company were paid to the directors as salaries and the petitioner was expelled from the company without a dividend. It was held that it was just and equitable that the company be wound up.

• Minority protection- a petitioner who can show that he has lost confidence in the ability or determination of the existing management to conduct the companies’ affairs, in the proper manner will be entitled to a winding up order. There must be a continuous disaffection on the part of the directors or officers in relation to the companies’ business which has justified the petitioner in lacking confidence in their management. 

In Locke vs John blackwood 1924 AC 783

A company was registered in Barbados as a public company in order to carry on the testators business and to divide the profits between member of his family entitled under his will to share them, the managing director who had the majority of the voting rights together with the co-director omitted to hold a general meeting or to submit accounts or recommend payment of dividends. By failing to do so they laid themselves open to the suspicion that their object in so failing was to put the petitioner in ignorance of the companies’ position and affairs and to buy the petitioners shares at another value. It was held that in the circumstances of the case, regard being heard to the domestic character of the company, the petitioners were entitled to the winding up order as it was just and equitable

• Where there is a deadlock which may arise where the shares are divided equally between 2 members who have become irreconcilable with the result that the business of the company can no longer be carried on.

In Re Yenije tobacco co ltd 1916 2CH 1964 

Weinberg and Rothmann stated separately as tobacconists and cigarette manufacturers. I 1914, they agreed to amalgamate their business and in order to do so formed a private company in which they were the only shareholders and directors. Under the companies’ articles they had equal voting powers and one director was to form a quorum. Any disputes were to be referred to arbitration. In 1915, differences arose between the parties, where they became so hostile that neither of them could speak to the other. Information from one to the other was passed through the company secretary. Weinberg petitioned for the company to wound up on the ground that it was just and equitable. It was held that this was a partnership. There was need for dissolution and since there was a deadlock it was just and equitable that the company be wound up. In the words of Warring J, “although they are carrying this business by means of machinery of a limited liability company, in substance they are partners. The litigation in substance is the dissolution of the partnership and we should not be unduly bound by matters of form if we treated either the relation between them as other than that of partners or the litigation other than an action brought by for the dissolution of the partnership against the other.

Consequences of winding up

The consequences of a winding up order dates back to an earlier date than when the order was made. The earlier date is called the date of commencement of winding up which is the date of the presentation of the winding up petition. Once a court makes a winding up order, a copy of that order must forthwith be handed over by the company to the registrar of companies. The consequences of winding up are;

a.                    Any disposition of the companies property, transfer of shares, alteration in the status of the members after the commencement of winding up is null and void unless the court otherwise orders. See Sec 224 of the companies act. Once a company goes into liquidation, the whole purpose of exercise is to collect the companies’ assets, pay its debts and distribute its assets to the members. The object of sec 224 is to freeze corporate business from the time the petition is presented so that the companies’ assets may not be wasted during the period that may lapse before the petition is heard. The court may sanction the transaction in the ordinary course of business otherwise the filing of a petition may be ill-founded and cripple the companies’ businesses. 

b.                    Where the company is wound up by the court, any attachment, distress or execution put in force against the companies’ assets after the commencement of the companies winding up is void. Sec 225 of the companies act. This may be validated by the courts order under section 228 whose purpose is to ensure that where a company goes into liquidation the assets are administered for the benefit of the creditors. The section provides that where a winding up order has been made or a provisional liquidator has been appointed no action can be taken nor proceedings be taken against the company except by way of leave of the court and subject to such terms as the court may impose.

c.                    On a winding up order being made, section 236 provides that the official receiver by virtue of his office becomes the provisional liquidator and he continues to act as such until he or another person is appointed the liquidator.

d.                    Upon the appointment of the liquidator, the powers of the directors seize and they become functus officio. 

e.                    On a winding up order being made, the servants of the company are ipso facto (by virtue of the fact of winding up) dismissed but the servant who continues to discharge the same duties and receives the same wages as before may be deemed to have entered into a contract of service with the liquidator. 

END