Protecting your Company from Disputes and Break-Ups

Like the loaf of bread you ate for breakfast, company formation has become a commodity. The last company you formed probably cost a fraction of the price your grandfather paid for his – not just in real terms but in actual money!

Since the advent of the internet and electronic filing, bucket shops have sprouted offering company formation with lower prices and more choices. But if you consider what forming a company actually means, you’ll realise that many entrepreneurs are walking blindly into a potentially costly and devastating trap that can ruin their health and finances.

Let’s start with the basics of registering a limited company

Limited company - a legal entity that is created by filing documents at Companies House, the UK’s official registry. This type of company has a separate and distinct identity from its owners, known as shareholders or members. The “limited” in limited company means members are not liable for the company’s debts, unless someone signs a personal guarantee.

Members and directors - members own shares in the company and appoint directors to run the company on their behalf. In most SMEs they are the same people, especially at the start. The directors have to act in the best interest of the members over and above any personal considerations.

Articles - the company has a constitution known as the Articles, continue reading to discover why this is where it gets interesting.

The truth about default articles

Companies formed prior to 1st October 2009 had to submit their own articles to Companies House along with their application. Since this date the Companies Act 2006 in an attempt to simplify company law created “default articles”. It was no longer mandatory to submit articles with your application to register the company, you simply tick a box and use the default set as prescribed by the Act.

Initially people flocked down this route, lured by bucket shops with affordable prices. It soon became clear that the legislators, in spite of widespread consultation, had in their haste to “think small first” botched their reform. If you take a quick look at the changes, you’ll wonder how 118 clauses managed to shrink down to 53!

You can read more about the deficiencies of model articles on my website.

Beware of the limitations of default articles

The limitations of default articles mainly affect companies with more than one person as director or shareholder, but no company knows at the start how many people will be involved as the company grows. Problems only come to light once it is too late to prevent them and the overwhelming majority of SME owners never consult their articles until faced with a dispute.

As a company director, you are acting in a position of responsibility with legal sanctions for failure, sometimes within criminal law. It is necessary to choose company formation agents who know what they are doing.

My company, Formations Direct, is a member of ACRA (Association of Company Registration Agents). As a member of this professional body, Formations Direct carries professional indemnity insurance and work to the highest professional standards, ensuring that staff are actually knowledgeable in the field of company formation. Many ACRA members, like us at FD, employ professionally qualified staff such as accountants or solicitors.

Shareholder disputes and company break-ups

Often the dispute takes on the subtle guise of an unsuitable shareholder; typically one working member is not pulling their weight, has lost interest in the business or has an irreconcilable conflict of interest. People are surprised to learn that they cannot simply confiscate that person’s shares. Once they have paid for their shares they are theirs – for keeps. You cannot simply transfer the business into another company and leave. This is a breach of your duty as a director to act in the best interests of all the shareholders.

Unless your articles contain some provisions for a break-up of the company or there is a separate shareholders’ agreement, the solicitors are going to clear up nicely - you could find yourself spending years in and out of court instead of focusing on building your business.

These are fundamental matters and can be practically addressed by a robust set of articles and a separate document between members detailing the responsibilities of each and the course of action to take if not fulfilled. It won’t necessarily prevent disputes or disagreements but it should provide a pathway to resolution, and can often make people think twice prior to acting foolishly. It is advisable to seek legal advice on drawing up such a document or at the very least, purchasing one online if you are worried about costs.

A commercial solicitor would charge for a comprehensive shareholders’ agreement the small extra fee charged for an appropriate set of articles by an ACRA member. This is a worthwhile investment, for peace of mind alone if nothing else.

Norman Younger BA(Hons) FCCA is a company formation agent and equity partner in a firm of accountants specialising in helping start-ups. Business int...
Norman is spot on in regards to these pre-prepared articles for your company, it may seem like a time saver, but can place you into tricky situations once you wish to customise it. It really pays to consult an expert accountant each and every time you are forming a company, not only to find out if that is the best business structure for you in the first place, but also on how to do it properly. Don't be fooled by low costs or you will end up with a low cost solution. It's your company, you should decide what is best for it based on the expert advice given to you!
    • N
    • January 19th, 2012

    Quite correct to mention that a limited company may not even be the best structure for a business. At Formations Direct we find that whenever we try to talk people out of buying a company they say "thank you" but I really do want one.

    This actually leads to a point that I make quite often - the need to insure against financial disaster. So, even if it may not be the best tax framework, it could save your bacon by being a limited company.

    Again, one has to look at the whole picture and weigh up the risks of what you are trading in , to come to a decision and there is no substitute for professional advice.
  • O
  • February 21st, 2012
thank you for your post

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