The establishment of a legal entity that is detached from the individual entities of the individuals for the purposes of conducting business as a group is known as incorporation. 1 It is a simple and voluntary act which is ideal for small enterprises that is an alternative to forming a company that is limited by guarantee or a co-operative. With the incorporation of a company come certain advantages and responsibilities as defined by the Australian Law. The individuals who chose to form an incorporated association are not entitled to use the profits accrued in the process of conducting the business for personal gain.
There are advantages of not incorporating an organization: The organization can be dissolved as there are no statutory obligations. The unincorporated association is not open to public scrutiny since the financial statements. Appointment of a public officer is not necessary as is the case of incorporated organization. The organization does not have legal liabilities since it is difficult to sue an unincorporated organization.
The incorporation of an organization gives the organization certain advantages. Once a company is incorporated, it can enter into contracts with other organization since the legal framework for such dealings is present. The company also has continuity because the resignation or departure of an individual does not mark the end of the company. It can accept gifts in addition to acquisition of grants from the government. The company also has the right to purchase and sell property.
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Advantages of Incorporating the Business
For an incorporated business, the property that has been acquired for the purposes of the business is the regarded as a separate entity that is detached from the individuals. This would be advantageous for Nicola and May since this puts the business interests ahead of their personal interests. Should any of them decide to leave the business; the assets accrued for the business do not necessarily have to be handed to the party that has left since they are registered under the name of the business. 2
One of the key benefits of incorporation is limited liability. According to s515-529 the liability of shareholders is limited to the value of the shares they own in the business even when the company is dissolved. 3 If an organization is unincorporated, the members of the association are held personally liable for anything for which, if the association were a company, the company would be liable. However if the organization is incorporated, an insurance policy which covers the organization is responsible for the legal liability. This means that Nicola and May will not have personal legal liabilities as long as they have an insurance policy that covers their business. 4
An incorporated company can only be compelled to pay its creditors to the extent of its assets and its capital. They are also legally obliged to pay for the unpaid shares. If the directors of the company have acted in good faith and in the interest of the company, then their assets (in this case Nicola and May’s personal assets) are protected from the creditors of the company.
Incorporation of a business makes it possible for the business to acquire grants from the government. This is even made easier by the fact that the organization owns assets as a separate legal entity thus it is possible for these assets to act as security for the loans or grants. For a business with plans for expansion such as Nicola and May’s business, this will go a long way in the facilitation of their expansion. In addition to that, Nicola and May can accept gifts for their bookshop since they shall become a legal entity once they are incorporated. 5
The incorporation of a business protects the business name. If another business entity attempts to register a business under the same name, the relevant authorities can stop such attempts. This gives the business a unique identity that the clients can easily associate with.
Disadvantages of Incorporation
There are certain advantages that come as a result of the incorporation. Having an incorporated business opens the business up to legal suits. Nicola and May can enter into legal contracts. The breach of a contract would therefore be the responsibility of the incorporated business to bear. For an unincorporated business the legal suit is directed to individual members of the organization. Having a legal suit directed to the company as a legal entity can have serious implications on the company’s image. It could lead to the public boycotting the products of the company. 6
In relation to ownership of land and property, the company as a legal entity reserves the right of ownership. This presents a challenge since the expansion of the company means that there is inclusion of new parties. However the new entrants are not entitled to the property of the company which may lead to discontent and dissensions.
For an incorporated company, conducting business in other states means that they have to register in that state. This is an expenditure that varies from one state to another with the cost of registering a business in the northern territory being $65 dollars and that of the southern territory being $200. 7 For a business that is still in its infancy, this extra cost can be detrimental to their financial margins depending on the number of states that the company is operating in. The registration of the business also implies that the name of the business needs to be registered.
Recommendations on the type on incorporation for Nicola and May’s bookshop
A limited liability company would be a suitable venture for Nicola and May. This is a type of incorporated company that protects the directors of the company from personal liability. It is headed by a Managing director who makes the key decisions about the company but the other members of the company have a say in the day to day running of the company. This company has several advantages: it allows for favorable tax treatment since there is no limit to the number of members but the company is taxed as a sole proprietorship. The allocation of the profits and the losses would be dependent on the individual percentage of ownership of Nicola and May. A limited liability company allows for Nicola and May to incorporate other members into the company. This is beneficial to the new members since they can enjoy fringe benefits such as signing up on a retirement benefit scheme. The new members of the company are also protected from personal liability. For Nicola and May, a limited liability company is beneficial since it would allow them to take up insurance based on their pro rata share of their limited liability company shares.
There are three forms of this type of companies (limited) namely:
1. Those limited by shares s112 (1) such that the liability of the shareholders is limited to the value of their share even if the company goes bankrupt or is dissolved s516.
2. Those limited by guarantee where members are liable to a certain fixed amount should the company be dissolved. This applies to companies that don’t have share capital.
3. Those limited by both guarantee and shares- these are a mixture of the two above and are relatively rare due to the potential of prolonged dispute in the event of dissolution. 8
Based on these subtypes I would recommend a cooperation limited by shares.
(a) What is a quorum for meetings of directors and members?
The quorum for directors meeting is two directors which must always be present (in every meeting) unless otherwise determined by the directors as per s248F. This is because for a person to become a director of a corporation, they should be appointed to that office by at least another director who might also serve another role as a member. For a members’ meeting the quorum that must be present in all meetings is two members as per s249T. 9
(b) How can directors be removed from their position by the members?
The removal of a director from office by the members can be done through voting at the annual general meetings (AGM) despite what is stipulated in the company’s constitution or the contract between the company and the director. This is done under s203D by a resolution reached by shareholders in the AGM. The company Act under s203D (2) (3) requires the director to be removed be given a minimum 2 month notice after the resolution so that s/he can represent himself/herself to members. 10 In a proprietary company the director can be removed under s203C and if the director is a representative of a certain category of creditors or shareholders then he/she can only be removed after another director has been elected to replace him. If the company has members that hold a majority of the shares in the company, they have the powers to remove the director from office. Other directors in their capacity as members of the company can also remove a director from office. If there is a breach of contract in the removal of the contract the contract does not protect the director from removal but provides rights for compensation or damage or action for oppression (s232)
(c) If the members want to rely on the replaceable rule in s 254D, what change must be made to the constitution and what procedure must be followed to implement that change?
Replaceable rules are those regulations in the Company Act that can be replaced or modified by the changes in the company’s constitution made by a special resolution of members s135 (2). These rules regulate the management and administration of companies and were introduced in 1998. The s254D is the “ Pre-emption for existing shareholders on issue of shares in proprietary company”. 11 This section of the Company Act provides that directors of a proprietary company should give the current shareholders the first priority in acquiring shares of a particular category (proportional to the number of shares held) prior to issuing shares of that particular category. The directors must provide the shareholders with a statement containing the terms of the offer which should include the number of shares on offer and the period for which the offer remains open. If the shareholders fail to take some or all the shares then the directors have the power to issue these shares as they find fit. The fourth clause allows the company (members) to empower the directors to issue particular category of shares without considering the current shareholders. This fourth clause requires the passing of a special resolution in a general meeting thus this involves a change of the constitution to allow the directors to disregard the provision of the first clause. 12
In order to implement the said change in the directors must call for a meeting by giving at least a 21 days’ notice. The notice must state the purpose of the meeting including the proposed resolution. 75% of the members entitled to vote have to vote in favor of the resolution in order for the change to be effected. In some circumstances the resolution may be passed by circulating a document containing the resolution to all members with voting powers. In this latter case all the members must sign in favor of the resolution in order for the resolution to be passed. Following the passing of the resolution the directors then give the shareholders a statement containing the terms of the share issue. 13
According to Section 181 (1) of the Australian Corporations Act, the director of the company is obliged to act in good faith and in the interests of the company. 14 The personal interests of the company must be kept separate from the company’s interest therefore Max is legally obliged to protect the companies interests. In light of this, Clare can sue Max since he fired her on the basis of personal interests and not necessarily in the interests of the company.
In addition to that, Clare has a cause to sue Max for failure to exercise care and diligence towards the company. This is because he fires her in spite the fact the law requires that an incorporated company should have a company secretary who advises the company on legal matters. In this case once Clare is fired, the company’s interests are jeopardized since there is no one to advice on legal matters. Should this go on for a prolonged period, the company might end up running into legal battles based on the failure by Max to exercise care for the company by firing Clare.
The director of the company is also legally obliged to ensure that the company to ensure that the company documents are signed by at least two of the company directors in addition to the company secretary. 15 In this case, Clare has been acting in this capacity but Max suddenly terminates her services due to their personal differences. Just as s203D (2) requires that the directors being removed be given notice the same should apply to other staff. Clare can sue the company for being dismissed without notice. If Clare was formerly a share holder within the company she is entitled to making a decision regarding what goes on in the company. Her opinion regarding termination of her services was not sought. This constitutes neglect of the shareholders interests by Max and Angus thus Clare has the right to contest the matter in a court of law.
Replaceable Rules. 2002. http://www. incorporator. com. au/14/ReplaceableRules-FullVersion. pdf (accessed September 7, 2011).
austlii. June 18th, 2011. http://www. austlii. edu. au/au/legis/cth/num_act/2011. html (accessed September 6th, 2011).
Australian Securities and Investment Commission. Company Resolutions. June 30, 2011. http://www. asic. gov. au/asic/asic. nsf/byheadline/Company%20resolutions? opendocument (accessed September 7, 2011).
French, Drek. Model articles for association of companies. London: Oxford University Press, 2009.
Queensland, Real Estate Institute of. Memorandum and articles of association. Queensland: Sydney, 2003.
Slater, A. H. Australian proprietary company articles : a practical guide with precedents . Canberra: Bond University Publishers, 1992.
Ciro T, and Symes C. Corporations Law in Principle 8th Edition. Thompson Reuters, 2009.
Tomasic, Roman, Stephen Bottomley, and Rob McQueen. Corporations Law in Australia. Malbourne: The Federation Press, 2001.