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THE LAW OF BUSINESS ASSOCIATIONS

What is company Law?
This is a study or the interrogation of the conduct/ roles of the principles govern the
affairs r the conduct of that which he law recognizes as a company.

Section 2 (1) of the Companies Act Cap 486 Laws of Kenya states what company means as
'a company formed and registered under this Act or an existing company. This is a very
vague definition, in the statute the word company is not a legal term hence the vagueness
of the definition. The legal attributes of the word company will depend upon a particular
legal system.

In legal theory company denotes an association of a number of persons for some common
object or objects in ordinary usage it is associated with economic purposes or gain. A
company can be defined as an association of several persons who contribute money or
money’s worth into a common stock and who employ it for some common purpose. Our
legal system provides for two types of associations namely

1. Companies
2. Partnerships.
3. Upcoming is the cooperative society.

The law treats companies in company law distinctly from partnerships in partnership law.
Basically company law consists partly of ordinary rules of Common law and equity and
partly of statutory rules. The common law rules are embodied in cases. The statutory rules
are to be found in the Companies Act which is the current Cap 486 Laws of Kenya. It should
denote that the Kenya Companies Act is not a self contained Act of legal rules of company
law because it was borrowed from the English Companies Act of 1948 which was itself not
a codifying Act but rather a consolidating Act.

Exceptions to the Rules are stated in the Act but not the rules themselves. Therefore
fundamental principles have to be extracted from study of numerous decided cases some of
which are irreconcilable. The true meaning of company law can only be understood
against the background of the common law.

The sources of company Law include;

1. Kenyan Companies Law Act which is an amalgamating statute rather than a codified
statute. It is a carbon copy of the 1848 U.K Act.

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2. Substance of Common Law and equity-it contains the major principles of the Act
that have been formulated over time.

The foundation of Company Law is Pillared on two main two fundamental legal concepts

1. The concept of legal personality; (corporate personality) by which a company is

treated in law as a separate entity from the members.

2. The theory of limited liability;

Concept of legal personality

When a company is incorporated it becomes a body corporate/juristic person distinct

from its managers and members wih independen legal existence in Law and has rights
obligations capacities and incapacities.

The principle was founded in Salmon and Salmon Co In 1980 where Lord Mc Naughten
stated that;

“The co is at Law a differen person altogether from the subscribers to the memorandum”

FACTS

Mr Aron Salomon made leather boots and shoes in a large Whitechapel High Street
establishment. His sons wanted to become business partners, so he turned the business
into a limited company. His wife and five eldest children became subscribers and two
eldest sons also directors. Mr Salomon took 20,000 of the company's 20,006 shares.
Transfer of the business took place on June 1, 1892. The company also gave Mr Salomon
£10,000 in debentures (i.e., Salomon gave the company a £10,000 loan, secured by a charge
over the assets of the company).

Soon after Mr Salomon incorporated his business a decline in boot sales, exacerbated by a
series of strikes which led the Government, Salomon's main customer, to split its contracts
among more firms to avoid the risk of its few suppliers being crippled by strikes. Mr
Salomon assigned Edmund Broderip his debenture, the loan with 10% interest and secured
by a floating charge1. But Salomon's business still failed, and he could not keep up with the

1
A floating charge is a security interest over a fund of changing assets of a company or a limited liability
partnership (LLP), which 'floats' or 'hovers' until the point at which it is converted into a fixed charge, at which point

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interest payments. In October 1893 Mr Broderip sued to enforce his security. The company
was put into liquidation. Broderip was repaid his £5,000, and then the debenture was
reassigned to Salomon, who retained the floating charge over the company. Soe creditors
were not paid and went to court. The question was whether Samon and Salmon & Co were
he same and should pay the creditors. The H.C and the COA stated the were but the HOL
dissented and overruled. L. Mc Naughten stated that there should be atleast 7 perssons to
form a Co and whent hey combime they become one-The Co.(ECD Gary-Princples of
Modern Law p99- This decision opens up new vistas to Co Lawyers and the worlds of
commerce). This is because;

1. it establishes he Legaliy of he one man company

2. Establishes tha incorporation is available not only large public companies and also
partnerships but also to sole proprietors as well
3. It revealed that it was possible to a member for a member not only o limit liability
but to reduce the risk of laws by subscribing to the Co’s debentures as opposed to
shares.
4. This is the principle embodied in s16(2) as a body corporate in the certificate of
Memorandum as a legal person with a seal.

This is the same principle mentioned in Lees v Lees (1961). The one men company
is………………………….

Therefore a legal person is not always human, it can be described as any person human or
otherwise who has rights and duties at law; whereas all human persons are legal persons
not all legal persons are human persons. The non-human legal persons are called
corporations. The word corporation is derived from the Latin word Corpus which inter alia
also means body. A corporation is therefore a legal person brought into existence by a
process of law and not by natural birth. Owing to these artificial processes they are
sometimes referred to as artificial persons not fictitious persons.

CLASSIFICATION OF COMPANIES

Section 389 of the companies Act provides that “no company, association or partnerships
consisting of more than 20 persons shall be formed unless it is registered as a company
under this Act”.

the charge attaches to specific assets of the company or LLP. This conversion into a fixed charge (called
"crystallisation") can be triggered by a number of events; inter alia, it has become an implied term (under English
law) in debentures that a cessation of the company's right to deal with the assets in the ordinary course of business
leads to automatic crystallisation. Additionally, according to express terms of a typical loan agreement, default by
the chargor is a trigger for crystallisation. Such defaults typically include non-payment, invalidity of any of the
lending or security documents or the launch of insolvency proceedings.Floating charges can only be granted by
companies or LLPs. If an individual person or a partnership[1] was to purport to grant a floating charge, it would be
void as a general assignment in bankruptcy.

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There are three types of companies provided for under this section: -
(i) Chartered companies
(ii) Statutory companies
(iii) Registered companies

(i) Chartered companies

The crown in the exercise of the royal prerogative has power to create a corporation by the
grant of a charter to the person assenting to be incorporated. No such companies can be
formed in Kenya after independence and section 389 only serve as a reminder of English
origin of our companies Act.

(ii) Statutory companies

A company may be incorporated by means of a special Act of parliament. A statutory

company has no shareholders and its initial capital is provided by the treasury. It is
expected to operate according to commercial principles and to make profit. If it makes
losses and becomes unable to pay its debts, its property can be attached by its creditors but
it cannot be wound up on application of any creditor. However, the government will come
to its aid if it has no cash or other assets to pay its creditors. Examples include- Kengen,
KP&L.Co, Kenya Pipeline, Kenya Railways, KTDA, KVDA etc.

(iii) Registered companies

A registered company is formed by registration under the Companies Act. Section 2 of the
Companies Act defines a company as “a company formed and registered under this Act.”

Classification of registered companies section 4(I) classifies registered companies into:-

(a) Public company – A company formed by any seven or more persons.
(b) Private company – A company formed by any two or more persons.

A private company or a public company may be:-

(i) Limited by shares – if the liability or its members is limited by its memorandum to the
amount if any unpaid on the shares held by them.

(ii) Limited by guarantee -- if the liability of its members is limited by its memorandum to
an amount which the members have undertaken to contribute to the assets of the company
in the event of its being wound up.

(iii) Unlimited -- if it does not have any limit on the liability of its members.

PRIVATE AND PUBLIC COMPANIES

Private Company

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According to section 30(1) of the Act, a private company means a company which by its
articles:-
(a) Restricts the right to transfer its shares.
(b) Limits the number of its members to fifty not including persons who are in employment
of the company.
(c) Prohibits any invitation to the public to subscribe for any shares or debentures of the
company.

Section 30(2) provides that where two or more persons hold one or more shares in a
company jointly, they shall, for the purpose of this section, be treated as a single member.

Section 31 provides that if a private company fails to comply with any of the restrictions in
the articles, it ceases to be entitled to any privilege or exemption confessed on private
companies and thereupon the provisions of this Act shall apply as if it were not a private
company.

Privileges of a Private Company

Certain provisions of the Companies Act do not apply to a private company but are
applicable to public companies. These may be regarded as the privileges or advantages of a
private company, which are as under:-

(i) A private company may consist of only 2 members.

(ii) A private company is entitled to commence business immediately on incorporation.
(iii) A private company may allot shares without issuing a prospectus or delivering to a
registrar a statement in lieu of prospectus (Section 30 (1).
(vi) A private company is not required to hold a statutory meeting or file a statutory report
with the registrar.
(v) A private company need not have more than two directors.
(vi) Copies of balance sheet and profit and loss account filed with the registrar cannot be
inspected by the public.
(vii) A director of a private company need not hold the share qualification.
(viii) Restrictions in regard to overall remuneration do not apply to a private company.

Public Company

This is a company which is not a private company. There must be at least seven persons to
form a public company. There is no restriction as to transfer of shares. The articles of a
public company may however contain restrictions on the issue and transfer of shares.

Distinction between a Public company and a Private company

1. Minimum number of members:- For public company is seven whereas private company
is two.

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2. Maximum number of members:-

There is no limit on the maximum number in case of public company, but a private
company cannot have more than fifty members.
3. Commencement of business:-
A private company can commence business as soon as it is incorporated, whereas a public
company shall not commence its business immediately unless it has been granted the
certificate of commencement of business.
4. Invitation to public:-
A public company by issuing a prospectus may invite public to subscribe to its shares
whereas a private company cannot extend such invitation to the public.
5. Transferability of shares:-
There is no restriction on the transfer of shares incase of a public company whereas private
company by its articles must restrict the right of members of transferring the shares.
6. Number of directors:-
A public company must have at least three directors whereas private company may
have two directors.
7. Statutory meeting:-
A public company must hold a statutory meeting and file with the registrar a statutory
report, but in case of a private company there are no such obligations.
8. Name:-
The name of a private company must include the words “private ltd” at the end of its name,
but a public company has to use the words “ltd” at the end of its name.

One Man Companies

These are the companies in which one man holds virtually the whole of the share capital
with a few extra members holding the remainder who may be his relatives or nominees.
Being the largest shareholder such a person is generally the sole or the managing director
and enjoys complete control over the company. This is done to fulfill the statutory
requirements and such type of companies are perfectly valid and not illegal as established
by leading case of Saloman vs. Saloman & Co. Ltd.
STATUTORY CORPORATIONS

The difference between a statutory corporati0on and a company registered under the
companies Act is that a statutory corporation is created directly by an Act of Parliament.
The Companies Act does not create any corporations at all. It only lays down a procedure
by which any two of more persons who so desire can themselves create a corporation by
complying with the rules for registration which the Act prescribes.

FORMATION OF A COMPANY

A company comes into existence when a number of persons come together with a view to
exploit some business opportunity. These persons are called promoters. The initial step
that must be taken by promoters who are desirous of forming a company is the preparation

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of a document called memorandum of association to which at least seven of them will

subscribe their names incase of a public company and two incase of private company, as
prescribed by Section 4 of the Act.
The next step is the delivery of the memorandum to the registrar of companies together
with the following documents:-

(i) Articles of Association:-

This document contains the regulations for management of a company.

(ii) Consent to act as a director:-

If any person is appointed director of the company by the articles which are to be delivered
for registration in lieu of Table A, Form No. 209 must be delivered for registration after
being duly completed and signed by him or by his agent authorized to do so. The form is
the statutory signification of the person’s consent to act as a director.

(iii) List of persons who have consented to be directors. (Form No. 210).

(iv) Statement of the nominal share capital:-

This statement is delivered for taxation purposes pursuant to Section 39 of the Stamp Duty
Act.

(v) Declaration of compliance. (Form No. 209):-

Form No. 208 when duly completed and signed, constitutes the statutory declaration by an
advocate engaged in the formation of the company that all the requirements of the
Companies Act in respect of matters precedent to the registration of the company and
incidental thereto have been complied with.

If the aforesaid documents are correctly prepared in accordance with the provisions of the
companies Act, the registrar grants a certificate of incorporation and the company is
formed from the date of incorporation written in the certificate.

Significance of Registration

Section 389 provides that “No company, association or partnership consisting of more than
twenty persons shall be formed for the purpose of carrying on any business …unless it is
registered under this Act.” Registration is the condition precedent to the formation of a
registered company and failure to register a proposed company will mean that it does not
legally exist.

Case Law: Fort Hall Bakery Supply Co. vs. Wangoe

A plaint bearing the name “The Fort-Hall Bakery Supply Co.” filed a case against a
defendant for recovery of certain amount of money. During the hearing it was established
that the business called “Fort-Hall Bakery Supply Co.” was being carried on by a group of 45
persons and had not been registered under Companies Act. The defendant submitted that

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the action was not properly before the court since the business was illegal under Section
338.

It was held that the plaintiff could not be recognized as having any legal existence and were
incapable of maintaining the action. The court terminated the proceedings without making
any order as to costs because a non-existent plaintiff can neither pay nor receive costs.

Effect of Registration

(a) The date mentioned in the certificate of incorporation is the date from which the
company’s legal existence commences. Consequently, if an incorrect date is written in the
certificate, that date would be regarded as the actual date on which the company was
registered.
(b) The company’s registration constitutes it “a body corporate”. It becomes a legal person or
“corpora corporata” whose name is that appearing in the memorandum of association. The
certificate of incorporation is regarded as the company’s birth certificate and the date
written on it is the company’s birthday.
(c) Once the company is registered it must be treated like any other independent person with
rights and liabilities appropriate to itself.
Other forms of corporations include;

1. Chartered corporations,these fall under the Universities Act in Kenya as an

incorporation ocument
2. State corporations which are governed either
(a)By statute
(b)Order of the president. The president is enabled to form a corporation for a
specific duty e.g NASCOP & the Nyayo Commission

3. Registered Co’s include limited Liability Co’s and political parties.

4.Cooperative societies

5. Public benefit organizations-these are cooperations registered by incorporations

through the y are not companies

(Include own notes)

Nearly all statutory rules in the Companies Act are intended for one or two objects namely

1. The protection of the company’s creditors;

2. The protection of the investors in this instance being the members.

These underlie the very foundation of company law.

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LIMITED LIABILITY

Basically liability means the extent to which a person can be made to account by law in the
event of liquidation. He can be made to be accountable either for the full amount of his
debts or else pay towards that debt only to a certain limit and not beyond it. In the context
of company law liability may be limited either by shares or by guarantee.

Under Section 4 (2) (a) of the Companies Act, in a company limited by shares the members
liability to contribute to the companies assets is limited to the amount of deficit in their
shares suffices in the event of insolvency.

Under Section 4 (2) (b) of the Companies Act in a company limited by guarantee the
members undertake to contribute a certain amount to the assets of the company in the
event of the company being wound up. Note that it is the members’ liability and not the
companies’ liability which is limited. As long as there are adequate assets, the company is
liable to pay all its debts without any limitation of liability. If the assets are not adequate,
then the company can only be wound up as a human being who fails to pay his debts. The
paying up by guarantee will take effect one year into the the winding up of the company on
the amount committed to guarantee.

Under s 4(2)(c),there are no limits as to the liability of members as to their private

members as to their assets.

FORMATION AND REGISTRATION OF A LIMITED COMPANY

First in relation to registration under the Companies Act. Under s 4(1)the minimum
requirements subscribe that Both the Memorandum and Articles of Associations must each
be signed by seven persons in the case of a public company or two persons if it is intended
to form a private company. These signatures must be attested by a witness. If the company
has a share capital each subscriber to the share capital must write opposite his name the
number of shares he takes and he must not take less than one share.

a) The prerequisites therefore include;

b) The Name of the Co
c) A definition of whether it is public or prvate
d) Limited or unlimited liability
e) Limted by shares or by guarantee
f) Is there any share capital? If so,how much?

The formers of a Co are called promoters.

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THE PRIVATE Co

S 10(1) defeines a private corporation as

(1)Has a limit of the members as 50 excluding former and current employees(is it a

maximum or a minimum?)

(2)One that restricts the transfer of shares

(3)One that prohibits the public from buying shares or debentures, with a minimum
No of two members and one director.

(4)Can commence business on that day of incorporation s 177

(5) S 111 it needs no statutory meeting

(6)Has no need to publish financial statements under s 130,125,126

The Co Act was made for public Co’s and not private Co’s.

Limited & Unlimited Co

There are no unlimited Co’s in Kenya.

A limited Co is one limited by the No of shares of the members. A share is the unit from
which the share capital forming the Co is divided. A Co can be limited by shares or
guarantee or by its formers. The amount of liability in a limited Co is pegged on the
share Capital or the amount guaranteed by its masters.

Unlimited Co’s can have as many as 5 companies within it depending on the share capital.

TYPES OF REGISTERED COMPANY

Before registering a company the promoters must make up their minds as to which of the
various types of registered companies they wish to form.

1. They must choose between a limited and unlimited company; Section 4 (2) (c) of
the Companies Act states that ‘a company not having the liability of members
limited in any way is termed as an unlimited company. The disadvantage of an
unlimited company is that its members will be personally liable for the
company’s debts. It is unlikely that promoters will wish to form an unlimited
liability company if the company is intended to trade. But if the company is
merely for holding land or other investments the absence of limited liability
would not matter.

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2. If they decide upon a limited company, they must make up their minds whether
it is to be limited by shares or by guarantee. This will depend upon the purpose
for which it is formed. If it is to be a non-profit concern, then a guarantee
company is the most suitable, but if it is intended to form a profit making
company, then a company limited by shares is preferable.

3. They have to choose between a private company and a public company. Section
30 of the Companies Act defines a private company as one which by its articles
restricts
(i) the rights to transfer shares;
(ii) restricts the number of its members to fifty (50);
(iii) prohibits the invitation of members of the public to subscribe for any
shares or debentures of the company.

A company which does not fall under this definition is described as a public company.

In order to form a public company, there must be at least seven (7) subscribers signing the
Memorandum of Association whereas only two (2) persons need to sign the Memorandum
of Association in the case of a private company.

STEPS TO FORMING A COMPANY

An application for the reservation of the Co Name s19(1) through registration pending the
registrars signature for 30 days in the 1st instance whereby it shall be unavailable to others.
During his time all the other docs must be filed.

The registrar cannot registar a name that he deems ‘undesirabe’ this is a discretionary
decision. The cost of every name is 100/=

a. Memorandum of Association: this is the document in which they express inter

alia their desire to be formed into a company with a specific name and objects.
The Memorandum of Association of a company is its primary document which
sets up its external constitution and objects. It regulates transactions between
the Co and 3rd parties.

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Contents Of The Memo Of Association

Par 1-Name of the Co as per s 5(1)(a)

Par 2-A standard statement stating that the document will be situated in Kenya
Par 3-Objects and purposes of Co. It creates the objects and …..
Par 4-Liabiltiy of Co if it is limited by shares or guarantee
Par 5-Capital with which the Co proposes to be registered and the divisions of
the capital
Par 6-Desire of subscribers to see……Co
Par7-Particulars of subscribers-Name/position/profession/Shareholding
held/signature witnessed by Lawyer
Par 8-Date with which the Co shall constituted

b. Articles of Association; whereas the memorandum of association of a company

sets out its objectives and constitution the articles of association contain the
rules and regulations by which its internal affairs are governed dealing with
such matters as shares, share capital, company’s meetings and directors among
others;
S 9-13- Contains rules of internal management.
Regulate the regulation between Co and members.
S 11(1& 2),the Co may adopt the table in the 8th schedule in Table A
Most Co’s use table A with modifications.
If the Memo of Associations and Articles conflict………….
It covers the transfer,transmission and dissolution of shares;voting and the
quorum of meeting

c. Statement of Nominal Capital – this is only required if the company has a share
capital. The fees that one pays on registration will be determined by the share
capital that the company has stated. This is covered under s 23 of the stamp duty
Act. The fees shall be paid at any National Bank Branch

d. Declaration of Compliance: this is a statutory declaration made either by the

advocates engaged in the formation of the company or by the person named in
the articles as the director or secretary. It is covered under s 17(2) of the Co Act.

The effect of such an oath is that all the requirements of the companies Act have
been complied with where it is intended to register a public company, Section
184 (4) of the Companies Act also requires the registration of a list of persons
who have agreed to become directors and Section 182 (1) requires the written
consents of the Directors.
It is an affidavit as sworn evidence that all the requirements of the formation of
the Co have been met.

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e. The Notice of the situation of the Registered Office which under Section 108(1)
and 14(1) of the statute should be filed within 14 days of incorporation;

f. List of persons consented to be directors of a Co as of s 182(4). It should contain

their name,description,date of birth.

g. Particulars of Directors and Secretary which under Section 201 of the statute are
normally required within 14 days of the appointment of the directors and
secretary. The documents are then lodged with the registrar of companies and if
they are in order then they are registered and the registrar thereupon grants a
certificate of incorporation and the company is thereby formed. Section 16(2) of
the Act provides that from the dates mentioned in a certificate of incorporation
the subscribers to the Memorandum of Association become a body corporate by
the name mentioned in the Memorandum capable of exercising all the functions
of an incorporated company. It should be noted that the registered company is
the most important corporation.

h. Presentation of the docs for registration at the registrar of Co’s office.. The
process is to satisfy itself with 486. Registration and certificationof
incorporation acts as the birth certifiacate of the Co under s 16(1)

Certification under s 17(1) is evidence of the fact theat the any of the preliminaries to
incorporation are according to Law.
In Jubilee Cottton Mills v Lewis

S 16(2) states that from the date of incorporation mentioned in the certificate of
incorporation, he Co shall be a body corporate.(In law there is no fraction of the day)
Question: What if the registrar refuses to registar the Co
Answer: Application for an order of Mandamus

In R V Regisrar of Co Ex Parte Bowen

Also In R V Registrar of Co Ex Parte Moore

Question: What if the objects of the Co are scrupulous(based on illegality;against morals or

principles i.e-there is no God)

Answer: It Shall be denied according to chapter 4 the bill of rights.

See Bowman v The Secular Society L.N

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EFFECTS OF INCORPORATION

1. A corporation is a legal entity distinct from its members, capable of enjoying

rights being subject to duties which are not the same as those enjoyed or borne by
the members 16(2).

The full implications of corporate personality were not fully understood till 1897 in
the case of Salomon v. Salomon [1897] A C 22

Facts of the case

Salomon was a prosperous lender/merchant. He sold his business to Salomon and Co. Limited
which he formed for the purpose at the price of £39,000 satisfied by £1000 in cash, £10,000 in
debentures conferring a charge on the company’s assets and £20,000 in fully paid up £1
shares. Salomon was both a creditor because he held a debenture and also a shareholder
because he held shares in the company. Seven shares were then subscribed for in cash by
Salomon, his wife and daughter and each of his 4 sons. Salomon therefore had 20,101 shares
in the company and each member of the family had 1 share as Salomon‘s nominees. Within
one year of incorporation the company ran into financial problems and consequently it was
wound up. Its assets were not enough to satisfy the debenture holder (Salomon) and having
done so there was nothing left for the unsecured creditors. The court of first instance and the
court of appeal held that the company was a mere sham an alias, agents or nominees of
Salomon and that Mr. Salomon should therefore indemnify the company against its trade loss.

The House of Lords unanimously reversed this decision. In the words of Lord Halsbury
“Either the limited company was a legal entity or it was not. If it was, the business
belonged to it and not to Salomon. If it was not, there was no person and no thing at all
and it is impossible to say at the same time that there is the company and there is not”

In the words of Lord Macnaghten “the company is at a law a different person altogether from
the subscribers and 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 receive the
profits, the company is not in law the agent of the subscribers or trustee for them nor are the
subscribers as members liable in any shape or form except to the extent and manner
prescribed by the Act. … in order to form a company limited by shares the Act requires that a
Memorandum of Association should be signed by seven (7) persons who are each to take one
share at least. If those conditions are satisfied, what can it matter, whether the signatories
are relations or strangers. There is nothing in the Act requiring that the subscribers to the

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Memorandum should be independent or unconnected or that they or anyone of them should

take a substantial interest in the undertaking or that they should have a mind and will of their
own. When the Memorandum is duly signed and registered though there be only seven (7)
shares taken the subscribers are a body corporate capable forthwith of exercising all the
functions of an incorporated company.

… The company attains maturity on its birth. There is no period of minority and no interval of
incapacity. A body corporate thus made capable by statutes cannot lose its individuality by
issuing the bulk of its capital to one person whether he be a subscriber to the Memorandum or
not.”

There were several other Law Lords who decided business in the House.

The significance of the Salomon decision is threefold.

a) The decision established the legality of the so called one man company;
b) It showed that incorporation was as readily available to the small private
partnership and sole traders as to the large private company.
c) It also revealed that it is possible for a trader not merely to limit his liability to
the money invested in his enterprise but even to avoid any serious risk to that
capital by subscribing for debentures rather than shares.

Since the decision in Salomon’s case the complete separation of the company and its
members has never been doubted.

2. The company has powers to perpetual succession. If a Co is created through a

legal process,it exists in perpetuality through Law s 16(2). It can exist forever woth its
death being on winding up.

3. A Co shall have limited liability under s 4(2)(a)(b). Memebrs shall not lose assets
due to the insolvency of th Co.

4. A Co shall have the ability to own to own property under s 16(2) to hold land. The
Co has insuarance interests in its own property away from its memebrs

Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619

The Appellant owner of a timber estate assigned the whole of the timber to a company
known as Irish Canadian Sawmills Company Limited for a consideration of £42,000.
Payment was effected by the allotment to the Appellant of 42,000 shares fully paid up in
£1 shares in the company. No other shares were ever issued. The company proceeded

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with the cutting of the timber. In the course of these operations, the Appellant lent the
company some £19,000. Apart from this the company’s debts were minimal. The
Appellant then insured the timber against fire by policies effected in his own name.
Then the timber was destroyed by fire. The insurance company refused to pay any
indemnity to the appellant on the ground that he had no insurable interest in the timber
at the time of effecting the policy.

The courts held that it was clear that the Appellant had no insurable interest in the
timber and though he owned almost all the shares in the company and the company
owed him a good deal of money, nevertheless, neither as creditor or shareholder could
he insure the company’s assets. So he lost the Company.

Katate v Nyakatukura (1956) 7 U.L.R 47A

The Resondent sued the Petitioner for the recovery of certain sums of money allegedly
due to the Ankore African Commercial Society Ltd in which the petitioner was a
Director and also the deputy chairman. The Respondent conceded that in filing the
action he was acting entirely on behalf of the society which was therefore the proper
Plaintiff. The action was filed in the Central Native Court. Under the Relevant Native
Court Ordinance the Central Native Court had jurisdiction in civil cases in which all
parties were natives. The issue was whether the Ankore African Commercial Society
Ltd of whom all the shareholders were natives was also a native.

The court held that a limited liability company is a corporation and as such it has
existence which is distinct from that of the shareholders who own it. Being a distinct
legal entity and abstract in nature, it was not capable of having racial attributes.

5. The Co has the ability to sue or be sued to enforce its rights. This is part of the
Rule in Foss v Harbottle (1843)

Case Law: Foss vs. Harbottle (1843)

The claimants, Foss and Turton, were shareholders in a company ‘The Victoria Park
Company’ which was formed to buy land for use as a pleasure park. The defendants
were the other directors and shareholders of the company. The claimants alleged
that the defendants had defrauded the company in various ways and in particular
that the defendants had sold land belonging to them to the company at exorbitant
price. The claimants now asked the court to order that the defendants make good
the losses to the company.

It was held by Vice-Chancellor Wigram that since the company’s board of directors
was still in existence, and since it was still possible to call a general meeting of the
company, there was nothing to prevent the company from obtaining redress in its
corporate character, and the action by the claimants could not be sustained.

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In Foss vs. Harbottle two minority shareholders in a company alleged that its
directors were guilty of buying their own land for the company’s use and paying
themselves a price greater than its value. This act of directors resulted in a loss of
the company.

The minority shareholders decided to take action against the directors, but the
majority shareholders in a meting resolved not to take any action against the
directors alleging that they were not responsible for the loss which had occurred.

The court dismissed the suit on the ground that the acts of the directors were
capable of confirmation by the majority members and held that the proper plaintiff
for wrongs done to the company is the company itself and not the minority
shareholders and the company can act only through majority shareholders.

The rationale in that line of reasoning is that a company is a separate legal entity
from the members who compose it and as such, if any right of the company is
violated, it is the company which can bring an action through the majority.

It was held that, “If the thing complained is a thing which, in substance, the majority
of the company are entitled to do, or something has been done irregularity which
the majority of the company are entitled to do regularly or if something has been
done illegally which majority of the company are entitled to do legally, there can be
no use in laying litigation about it, the ultimate end of which is only that a meeting
has to be called, and then ultimately the majority gets its wishes.

It was also held that, it is elementary principle of law relating to joint stock
companies that the court will not interfere with the internal management of the
company, acting within their powers and jurisdiction to do so. Again it is clear that
in order to redress a wrong done to the company or to recover monies or damages
due to the company the action should prima facie be brought by the company itself”.

It is also known as “proper plaintiff principle”, which states that, in order to redress
a wrong done to a company or to the property of the company or to enforce rights of
the company, the proper claimant is the company itself, and the court will not
ordinarily entertain an action brought on behalf of the company by a shareholder.
The courts will not interfere with the general rule(majority rule) otherwise known
as the regulatory principle,proper management rule or the proper
management rule.
See further Wangari Maathai v Kenya Times.

6. Capacity of the Company to Contract/employ/fire

Lee v Lee’s Air Farming Ltd. (1961) A.C. 12

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Lee’s company was formed with capital of £3000 divided into 3000 £1 shares. Of these
shares Mr. Lee held 2,999 and the remaining one share was held by a third party as his
nominee. In his capacity as controlling shareholder, Lee voted himself as company
director and Chief Pilot. In the course of his duty as a pilot he was involved in a crash in
which he died. His widow brought an action for compensation under the Workman’s
Compensation Act and in this Act workman was defined as “A person employed under a
contract of service” so the issue was whether Mr. Lee was a workman under the Act?
The House of Lords Held:

“that it was the logical consequence of the decision in Salomon’s case that Lee and the
company were two separate entities capable of entering into contractual relations and the
widow was therefore entitled to compensation.”

7. Ability to have a common seal 16(2) to show that the CO has commissioned a
certain Act done by the Co

ADVANTAGES OF INCORPORATION

1. Capital share pooling

2. Wide capital base compared to other business associiations
3. Limited Liability – since a corporation is a separate person from the members, its
members are not liable for its debts. In the absence of any provisions to the
contrary the members are completely free from any personal liability. In a company
limited by shares the members liability is limited to the amount unpaid on the
shares whereas in a company limited by guarantee the members liability is limited
to the amount they guaranteed to pay. The relevant statutory provision is Section
213 of the Companies Act.

4. Holding Property: Corporate personality enables the property of the association to

be distinguishable from that of the members. In an incorporated association, the
property of the association is the joint property of all the members although their
rights therein may differ from their rights to separate property because the joint
property must be dealt with according to the rules of the society and no individual
member can claim any particular asset to that property.

5. Suing and Being Sued: As a legal person, a company can take action in it’s own
name to enforce its legal rights. Conversely it may be sued for breach of its legal
duties. The only restriction on a company’s right to sue is that it must always be
represented by a lawyer in all its actions.

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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 instalments. 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.

6. PERPETUAL SUCCESSION As an artificial person, the company has neither body

mind or soul. It has been said that a company is therefore invisible immortal and
thus exists only intendment consideration of the law. It can only cease to exist by
the same process of law which brought it into existence otherwise, it is not subject
to the death of the natural body. Even though the members may come and go, the
company continues to exist. As a long term business investment.

7. TRANSFERABILITY OF SHARES Section 75 of the Companies Act states as follows

“ The Shares or any other interests of a member in a company shall be moveable
property transferable in the manner provided by the Articles of Association of the
Company.” In a company therefore shares are really transferable and upon a
transfer the assignee steps into the shoes of the assignor as a member of the
company with full rights as a member. Tkes place in the new members taking the
enterprise of the old members by electing them as directors, this is the
redistribtution of shares. Note however that this transferability only relates to
public companies and not private companies.

8. Specialised or qualified management . This falls under s 177(2) to manage the direct
affairs of the Company. The advantage here is the opportunity to vote. N/B public(7)
and private(2) minimum membership

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9. Borrowing by floating charge by the Co to secure a debenture. Such a charge shal

remain dorman until it crystallizes(Illingworth v Hodson). The benefits of a floating
charge are that;

a. It enables a Co with fixed assets to borrow if it has fixed it

b. Enables the Co to use the assets as security
c. The charge does not interfere with the daily business of the Co

10. Capacity to contract, to own property invest and enhance the probability of earning
profit. It is the duty of the Co to defend its members.

11. BORROWING FACILITIES: in practice companies can raise their capital by

borrowing much more easily than the sole trader or partnership. This is enabled by
the devise of the ‘floating charge’ a floating charge has been defined as a charge
which floats like a cloud over all the assets from time to time falling within a certain
description but without preventing the company from disposing of these assets in
the ordinary course of its business until something happens to cause the charge to
become crystallised or fixed. The ease with which this is done is facilitated by the
Chattels Transfer Act which exempts companies from compiling an inventory on the
particulars of such charges and also by the bankruptcy Act which exempts
companies from the application of the reputed ownership clause. As far as
companies are concerned the goods in the possession of the company do not fall
within the reputed ownership clause. The only disadvantages are three

(i) Too many formalities required in the formation of the company

(ii) There is maximum publicity of the company’s affairs;
(iii) There is expense incurred in the formation and in the management of a
company.

In order to form a company, certain documents must be prepared whereas no such

documents need to be prepared to establish business as a sole proprietor or partnership
and throughout its life a company is required to file such documents as balance sheets and
profits and loss accounts on dissolution of the company it is required to follow a certain
stipulated procedure which does not apply to sole traders and partnerships.

DISADVANTAGES OF INCORPORATION

Non participation in management of the Co is absent to shareholders as the problem is left

to directors. This is the genesis of the Agency problem.

Formalities during the incorporation to the winding up of the Co are time consuming and
require money. If the Co by
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Corporation tax reducing the profits uupto 30%

Inflexibity to the adoption of new measures that may be necessary and bene ficaial to the
Co due to the ultravires doctrine.Contractual obligations depend on the objects of the Co to
those reasonably incidental to the Objects.- Lord Ashbury in Ag v ………………

Too much publicity. Public Co’s have undue publicity by a registered office. postal address,
painted or affixed names in legible Roman Letters,the annual returns are open to the
public,public documnents to the registrar are open for public scrutiny. S384(1). The
winding up of Co’s is done in public.

Co’s are expensive to form,mainatain and wind up. In the formation there is the search
fee,legal fee registration fee and stamp duty. In the Life of the Co there is the registration
documents,directors allowances, auditors and auditors repors and the holding of general
meetings;Under the winding up s302 there is the liquidators remuneration,preferential
treatment s 311,debts taxes and local rates.

LIFTING THE CORPORATE VEIL (RULE IN SALOMON v SALOMON)

The general rule is that a company is a legal person and is distinct from its members. The
memebs are united to form the person we see as the company thus going behind this
person so that going behind the corpororate person so that we see the menership of the Co
is regarded as lifting the curtain, a veil, or a shield between the company and its members,
thus protecting the latter from the liability of the former. The veil is impassable as an iron
curtain.

RAISING THE CURTAIN

Part of the Co’s information is with the public but most of the pertinent information
remains with the company. To get this information, to do so will be investigate the
shareholders. To break the Co from the individual share holders would be breaking the
corporate shell. Both principles are identified by statutory and and common Law
exceptions so that this action takes place.It is institutes when the notion of legal entity is
used to defeat public convenience, justify wrong, protect fraud or defend crime the law will
regard the company as an association of persons. In these cases the law disregards the
corporate entity and pays regards to the economic realities behind the legal façade. The
court may look behind the artificial person- the company and take account of the
personalities of natural persons- the cooperators.
These cases are exceptions to the principle in Saloman v. Saloman & Co. Ltd are two-fold:
(1) Lifting by courts (common law)
(2) Lifting by statutes

(A) Lifting by courts

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L Denning In Littward Mailing Orde Stores Ltd stated that; Couts often draw aside the
veil,they often put aside the mask. They look to see the what lies behind the mask.
Legislature has shown the way by group accounts and the courts should follow suit,the
question thus becomes just how far have the courts followed suit?
(i) Determination of character

A Co is a person thus in times of war, the court will lift the veil to see whether a company is
controlled by the enemy aliens.

Case Law: Daimler Co Ltd vs. Continental Tyre & Rubber Co. Ltd (1916)
A company was incorporated in England with a capital of £25,000 in £1 shares for the
purpose of selling in England tyres made in Germany by a German company, which held the
bulk of shares in the English company. The holders of the remaining shares (except one)
and all the directors were Germans resident in Germany. The one share was registered in
the name of the secretary, who was born in Germany, but resided in England and had
become a naturalized British subject. After the outbreak of the war between England and
Germany, an action was commenced in the name of the English company on the
instructions of the secretary, for a payment of trade debt. One of the defenses was that the
company was an alien company and that payment of the debt would be trading with the
enemy.

In his judgment, Lord Parker stated:

“My Lords, the truth is that considerations which govern civil liability and rights of
property in time of peace differ radically from those which govern enemy character in time
of war. The law on the subject may be summarized in the following propositions:
(a) A company incorporated in the UK is a legal entity, a creation of law with the status and
capacity which the law confers. It is not a natural person with mind or conscience.
(b) Such a company can only act through agents properly authorized and as long as it is
carrying on business in this country through agents so authorized and residing in this
country, it is prima facie to be regarded as a friend.
(c) Such a company may, however, assume an enemy character. This will be the case if its
agents or the persons in defacto control of its affairs are resident in an enemy country or
taking instructions from or acting under the control of enemies.
(d) The character of individual shareholders cannot itself affect the character of the company
in times of peace. The enemy character of individual shareholders and their conduct may
however, be very material on the question of whether the company’s agents in defacto
control of its affairs are infact adhering to, taking instructions from or acting under the
control of enemies. This will vary with the number of shareholders who are enemies and
the value of their holdings. Given in the case the fact that the secretary held one share only
out of 25,000 shares and was the only shareholder who was not an enemy might well
suggest that he was acting under the control of, taking his instructions from, or adhering to
the enemies.

(ii) Where the company is a sham

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The court will lift the veil where the device of incorporation is used for some illegal or
improper purpose. The courts have intervened on numerous occasions and lifted the veil
in order to circumvent a fraudulent or improper design by a bunch of scheming promoters
or shareholders.

Case Law: Jones vs. Lipman

Lipman agreed to sell freehold land with registered title to the plaintiff (Jones) for £5,250.
Pending completion he sold and transferred the land to the defendant company (having a
capital £100, which he acquired and of which he and a clerk were sole shareholders and
directors), for £3000 of which 1,564 was borrowed by the defendant company from a bank
and the rest owing to him.

In an action by the plaintiff for specific performance, it was held that, the defendant
company was a cloak for Lipman.

The Lord Lawrence in his judgment stated that the defendant company is the creature of
Lipman, a device and a sham, a mask which he holds before his face in an attempt to avoid
recognition by the eye of equity. The proper order to make is an order on both the
defendants specifically to perform the agreement between the plaintiffs and Lipman.

(iii) Where the company is acting as the agent of the shareholders

The Co is not the agent or the trustee, for the subscriber in Law. However,the courts have
at times disregarded this rule so that the Co is deemed an agent of the subscriber ,that it is
necessary to know what transaction the Co has gotten itself by looking at the sunscribers
behind the mask.

This was shown in Re T.G Films Ltd

The Co had one hundred shares with 90 being held by American shareholders and 10 held
by British,all the individuals within the Co were American, it was held that the British were
simply a nominal shareholder,
Also see Smith Stone & Knight v Birmingham Corp and DHN food distributors &
Tower Hamlets Borough Councils
The court will always disregard the subsidiary Corp to
-perpetuate the fraud or
-deny the fraud
-……………..
One of the ratio decidendi in Saloman’s case was that “the company is not in law an agent of
the subscribers. Under the ordinary rules of law, a parent company and a subsidiary
company even 100% subsidiary company are distinct legal entities, and in the absence of
an agency contract between the two companies, one cannot be said to be the agent of the
other.

If a court held that a company acted in a particular instance as an agent of its holding
company the veil of incorporation would have been lifted.

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Case Law: Firestone Tyre & Rubber vs. Llewellin

An American company formed a wholly-owned subsidiary company in England to
manufacture and sell its brand of tyres in Europe. The distributors sent their orders to the
subsidiary direct and the orders were met without any consultation with the American
company. The subsidiary received the money for the tyres sold to the distributors and
after deducting its manufacturing expenses plus 5 percent, it forwarded the balance of the
money to the American company. All the directors resided in England except one who was
the president of American company and they managed the subsidiaries affairs free from
day-to-day control by the American company.

It was held that the American company was carrying on business in England through its
English subsidiary ‘acting as its agent’ and it was consequently liable to pay UK tax.

(iii) Group Enterprises

Employment by the parenting Co can be……no more than the subsidiary Co.
In Haroldworth Holdsworth v Caddies, a managing director of a holding company was
appointed to perform the duties and exercise the powers of the business of the holding
company and its subsidiaries as were assigned to him by the board of the holding company.
It was held by the House of Lords that, after being confined to the business of one of the
subsidiaries, this was not a breach of his service agreement.
The board delegates its powers to the manager,such that the subsidiary and the Co are one
and the same thing.

(iv) Ratification of Corporate Acts

This is covered in the Case of Bamford v Bamford where the the shareholders and the Co
were treated as the same thing the directors had used their powers to issue their shares in
breach of the proper purposes principle. A minority shareholder brought a dirative action
set aside but ratification defeated the action. Harman LJ Stated that directors can by making
a full and frank disclosure and calling together the general body of the shareholders,obtain
absolution and forgiveness of their sins provided the acts are not ultravires the Co and
every thing will go on as if it had been alright sinc the beginning.

Re Express Engineering, five shareholders of a Co who were also shareholders of a Co voted on

a decision to get into a contract where the Co purchased property for themselves and also
approved the the issue to themselves of securing the debentures securing payment to
them of the purchase money. This was aginst the Articles. The Co went into liquidation and
thee liquidator argued that all the directors were disqualified from voting on the purchse
and security contracts and so the he sought a declaration that the debentures were invalid.
The COA helf=d that the Co was bound by the unanimous assent of the shareholders.
(iv)Fruad/ Improper Conduct
Re Burgle Press Ltd-Haman J
S 210 Of Companies Act,

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(v)Evading the Legal Obligations

Gilford v Motor Co and another
Jones v Lipman
Yasmin Priest v Pretodel
(vi)Ascertainment of residence.
Though the CO must keep a place of residence to keep the directors from making shoddy
deals and running away. The place of residence of the Co is where the central Mgt abides,
where board meetings are made. The corporate sheel is ths pierced to know the place of
residence where the mgt abodes.
[De Beers Consolidated Mines Ltd v House]

(vii)Protection of Revenue

The courts may disregard the corporate entity of a company where it is used for tax
evasion or to circumvent tax obligation. Further, where it is desired to establish for tax
purposes in what country a company is resident the court will lift the veil and find out
where the control management is and that determines the residential status.

(B) Lifting by statutes

Courts while experiencing their inherent jurisdiction to do justice and fairness may lift a
company’s veil so as to meet the ends of justice. L Devlin in Bank Voor Henchel v Slatford
sted that the legislature can forge a sledgehammer capable of cracking the corporate
shell/lift he veil The court may lift the veil because of the following reasons:-

(i) Membership fallen below statutory minimum (Section 33)

If at any time the number of members of a company is reduced below two in case of private
company or below seven incase of public company and it carries on business for more than
six months while the number is so reduced, every member who knows of this fact will
become liable to unlimited extent for the payment of the whole debts of the company
contracted during that time. It should be noted that the section limits the members liability
to debts contracted after six months. It does not make the member liable for any debts
incurred during the six months which follow the reduction in membership.

(ii) Non-publication of a Company’s Name (Section 109 (4)

The Act requires a company’s officers and other agents to write its name on its seal, letters,
business documents and negotiable instruments. It must be in clear legible and correct
Roman alphabetical form. This is done for the benefit of third parties who might contract
with a limited company without realizing that it is a limited company. Any officer or agent
of the company who does not comply with the aforesaid statutory requirement(name of Co
is not publiched,unrepresented) shall be liable to fine not exceeding sh 1,000 and shall
further be personally liable to the holder of the bill of exchange, promissory notes, cheque

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or for goods which did not bear the company’s correct name, unless the amount due
thereon is duly paid by the company. The imposition of personal liability on the company’s
agent is what is regarded in a somewhat loose sense as “lifting the veil of incorporation”.
In such a case the misdesciption must be grave. This was held in Goldsmith Sicklemere v
Baxter where it was held that the misdemeanor was not grave. In Durham Fancy Goods v
Michael Jackson Fancy Goods td Donald J held that the Abbreviation must convey the full
meaning of the word.
It was held that Ltd describes a Co rather than identify a Co.

(iii) Group Accounts (Section 150-153)

Section 150 requires a company which has subsidiaries to lay before the company in a
general meeting accounts or statements dealing with the state of affairs and profit and loss
account of the company and the subsidiaries at the time when the company’s own balance
sheet and profit and loss account are laid before the company’s general meeting. This is
regarded in a loose sense as a case of “lifting the veil” because a holding company is obliged
to incorporate into its balance sheet the assets and liabilities of the subsidiary company as
if they were its own assets and liabilities. This is a modification of the general principle
that a company’s assets and liabilities are not a members assets and liabilities and would
not therefore be incorporated into the members own balance sheet.
S 150(2) the group accounts shall not deal with the a subsidiary of the director of the
holdinf account s of he opinion that the consolidation is impracticable,harmful to the
nusiness,expensive,no real value to members,will cause unnecessary delay in the operation
of the Co, the stements are misleading or of the accounts are so different that……………..
S 153(1) directors of a land holding Co must ensure that the financial year of the
subsidiary Co
Coincide with the financial year of the holding Coand the statement of affairs is lad before
the general meeting to show the full group accounts of the full balance sheet. The
consolidated account shall show the profit and loss account.

S 152 the stement shall stete the truth and shall show the profit and loss and the stete of
affairs as a whole and shal be treaed as one.
(iv) Investigation of company’s affairs

Section 167 gives an inspector appointed by the court to investigate company’s affairs the
power to investigate the affairs of a company’s subsidiary or holding company, if the
inspector thinks it necessary to do so for the purpose of his investigation. S 16 of the5/166
shows the circumstances through which the court may send an investigator to investigate
the holding Co.
If the investigator thinks it fit to look into the affairs of a Co or subsidiary,they shall inspect
the Co
An investigation instituted pursuant to this power would be regarded in a loose sense, as
an instance of “lifting the veil” because the order to investigate a company sufficed to
investigate the company’s member as if they were one entity.
(v) Investigation of company’s membership

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Section 173(1) empowers the registrar to appoint one or more competent inspectors to
investigate and report on the membership of any company for the purpose of determining
the true persons who are or have been financially interested in the success or failure of the
company or able to control or materially to influence the policy of the company.
S 102 shows the extent to which the the registar may appoint the investigator or on
application of members.
For the purpose of that investigation, Subsection 5 of the same section confers on the
inspector power to investigate the membership of the company’s subsidiary or holding
company for the same purpose.

(vi) Take over bids

Section 210 provides that where a scheme or contract involving the transfer of shares to
another company has been approved by the holders of not less that 9/10 in value of the
shares whose transfer is involved, the transferee company may at any timie within two
months after the making of the offer by the transferee company, give a notice to the
dissenting shareholder. The dissenting shareholder must then apply to the court within
one month from the date on which the notice was given to restrain compulsory acquisition
of his shares. The court may, in an appropriate situation, lift the veil of incorporation.

In Re Burge Press Ltd, An offer was made by a Co and was regarded as having made in
substance by the Co members. The court lifted the veil of incorporation by treating the Co
and its members as one for the purpose of acceptance of the offer.

(vii) Fraudulent trading

This requires a court order to enforce where the Co had an intent to defraud ots creditor or
any other person. If business has been carried out for any other person. The Court may do
this on the application of a creditor,contributor, official receiver or liquidator. If the Court
is convinced then it will order personal liability on all debts and liabilities
a) The disadvantage would be that such an order can only be granted if the CO is being
wound up
b) The claimant must prove the onerous burden of fraud
Section 323 provides that if the course of the winding up of a company, it appears that any
business of the company has been carried on with the intent to defraud creditors of the
company or for any fraudulent purpose, the court on application of the liquidator or any
creditor or contributory, if it thinks proper so to do, declare that any person who were
knowingly parties to the carrying on of the business in manner aforesaid shall be
personally responsible without any limitation on liability for all or any of the debts or other
liabilities as the court may direct. Under ss(3) if the Co was criminally liable then the
directors shall be imprisoned for not less than 3 years but not more than 10 years.

Ther are two types of creditors………………….

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In Re Gerald Cooperatives Ltd, f any application is made by of these persons,then then the
person shall be liable to the Co. However, if the creditor has evidence that there has been
fraud,then the monies shall in the 1st instance be…………………

In Re Miadstone Distributors Co it was held that a positive ste must be taken by the
person concerned. It can be invoked against the director, members or any other person
concerned in the fraudulent trading. The disadvantage is that the person must rove fraud
which had=s a very high burden of proof and also;
If the liquidator applies to the court any monies received are distributed to the creditors
generally and form part of of the general assets of the Co.
However,if the creditor applies directly to the court,the court may grant him actual loss or
alternatively order that the [d] pay him the actual debt.
This was the Case in Re Cyona Distributors, The difficulty of proving fraud was expressed
in Re Parreck and Lyon Ltd. Re William Leitch BrotherS Ltd the principle was invoked.
The personal liability of the person concerned is what constitutes an instance of “lifting the
veil” of incorporation.

The SUBSIDIARY Co

It is covered by s 154. If a Co is a part of the holding Co and the holding Co controls its
composition or board of directors and the holding Co holds more than half of the nominal
shares value,then It is a subsidiary. Also a Co will be a subsidiary if the Holding Co is a
subsidiary of another Co. S 29 states that a body Corporation can never be a member of the
holding Corporation as a shareholder/subscriber. A transfer of shares fro the holding Co to
the subsidiary has no effect.

There are exceptions to the rule covered in s 150-153. S 150 breaks the veil on group
accounts,s 159 talks of auditors and s 147-157 covers subsidiries . S 161 states that if a
person is disqualified from holding a position in the holding Co he is disqualified from
holding a position on the subsidiary. S 167 states…………….. S 191 states that,it is unlawful
for the Co to give a loan/guarantee/security to a director, however,a subsidiary can give a
loan to the holding Co. [These sections show the importance of having a subsidiary]

MEMORANDUM OF ASSOCIATION (The Company’s Constitution)

Primary document for the formation of every Co. Memorandum of association was
judicially defined by Lord Cairns in “Ashbury Railway Carriage Co. Ltd vs. Riche” as the
“charter” which defines the limitations of the powers of a company to be established under
the Act”.

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A company pursues only such objects and exercises only such powers as are conferred
expressly in the memorandum. A company cannot depart from the provisions contained in
its memorandum, however great the necessity may be. If it does, it would be ultra vires the
company and therefore wholly void.

The purpose of the memorandum is to enable the shareholders, creditors and those who
deal with the company to know what the permitted range of the enterprise is. It defines as
well as confines the powers of the company.

Lord Cairns in Ashbury Railway Carriage Co. Ltd vs. Riche pointed out that, the
memorandum as it were the area beyond which the action of the company cannot go;
inside that area the shareholders may make such regulations for their own government as
they may think fit.

Case Law: Ashbury Railway Carriage Co Ltd vs. Riche

A company was registered under Companies Act 1862 and the objects clause was defined
as follows:
The objects for which the company is established are to make and sell, or lend on hire,
railway carriages and wagons, and all kinds of rail plant, fittings, machinery and rolling
stock; to carry on the business of mechanical engineering and general contractors; to
purchase and sell, as merchants, timber, coal, metals and other materials and to buy and
sell any such materials on commission or as agents.

The directors agreed to purchase a concession for making railway in Belgium; and form a
company in Belgium called Societe Anonyme to work the concession and it was further
agreed that Mr. Riche commence the work. Later difficulties arose and the shareholders of
Ashbury Co. disapproved of what had been done in the matter of the railway, and required
the directors to take over the company’s interest therein and to indemnify the
shareholders. The directors, however on behalf of the shareholders repudiated the contract
for the construction of the railway, as being ultra vires the company and Mr. Riche sued the
company for damages for breach of contract.

It was held that the contract was ultra vires (beyond the powers of) the company and that
accordingly the company was not liable to Mr. Riche. Lord Cairns said that the contract was
entirely beyond the objects in the memorandum and was thereby placed beyond the
powers of the company to make the contract. If so, it is not a question whether the contract
ever was ratified or was not ratified. If it was a contract void at its beginning, it was void
because the company could not make the contract.

If every shareholder of the company had been in the room and every shareholder of the
company had said that this contract which we desire to make, which we authorize the
directors to make, to which we sanction the placing of the seal of the company, the case
would not have stood in any different position from that in which it stands now. The
shareholders would thereby by unanimous consent have been attempting to do the very
thing which, by the Act of parliament they were prohibited from doing.

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The memorandum is thus a document which sets out the external constitution of the
company and controls the relationship between the Co and 3rd parties. It is really the
foundation on which the structure of the company is based. It contains the fundamental
conditions upon which alone the company is allowed to be incorporated. S 5(1) provides
that the Memorandum shall be in English language printed and shall contain;

Contents of Memorandum

Section 5 of the Act states the following six clauses of the memorandum of association:-

(a) Name clause

(b) Registered office clause
(c) Objects clause
(d) Liability clause
(e) Capital clause
(f) Association clause
(g) Extents of the Capital ClauseSee annexures of Table B
(h)Particulars of the Shareholders Names i.e(Names of the
shareholders,descriptions,signatures)
(i)Subscription of the minimum shareholding structure
(j)Attestation of the informational dates
(k)Determination of the dates.
(a) The Name clause

The promoters of a proposed company have freedom to choose its name.

(i)Choice of Name
The choice of name must have the name Ltd if limited bu=y shares or guarantee as the last
word unless s 2(1)applies where it promotes science,Arts, religion,commerce and has no
distribution of dividends and the profits go nack intoits source.
he freedom is limited by section 19(2) of the Act which provides that “no name shall be
reserved and no company shall be registered by a name which consists of abbreviations,
initials or which, in the opinion of the registrar is “undesirable” e.g. Malaya.
S 17 of the registration Act if it is too similar to that f an existing Co,
government,presidential or municipal council and expressing partnage over any of the
above.
A name that uses the word cooperative for its users
A name likely to mislead the nationality,the race or the religion of its members
A name that suggest criminal or immoral interes
A name that is business specific and yet the company is not involved in that business.
Must not contain the surname of any oerson who is not a manager.
(ii)Reservation of Name
The registrar has the power ot reserrrve the name over a period of within 30 days
provided t is not undesirable.

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(iii)Publication of the name must be in legible Roman Print on the physical address of the
building,the common seal must have the legible ramn letters engraved
(iii) Change of name
A co May change is name suo moto or involuntarily under s 20(1). This can be done either
by

Special resolution of the shareholders(75%) with printed approval of the registrar. Such a
resolution os under s 143.
If the name is too similar to s20(2)(a)
Or if the registrar by their mistake registrars a Co that is too alike to that of another Co,that
Co may by ts own motion with the Sanctions of the registrar change its name. Such a chane
must be within 14 days.
(iv)Involuntary change
Uder s 20(2) if the name is too alike to that the registrar may within 6 months change the
name of the Co if it is under 6 weeks it must be………………….
S 70(2)(a)The high court may on its discretion order…………..the confirmation statement of
the court may order the inclusion of………….by reduced shares as an investor protection
mechanism
(v)Effect of change of name
S20(1)(4)
It has no effect on the duties and the liabilities of the Co and legal liabilities can be within
the time span.

The registrar of companies has not issued any circular explaining the criteria likely to be
used in deciding whether a proposed name is undesirable under the section. However,
corresponding to English Companies Act 1948 to which Kenya’s companies Act was
formed, regards a proposed name as undesirable if;-

(i) It is like the name of an existing company.

(ii) It is misleading for example, if the name of a company likely to have small
resources suggests that it is going to trade on a greet scale over a wide field.
(iii) It suggests some connection with the crown or members of the royal family,
for example, Queens and Princes.
(iv) It includes words which might be trademarks, unless a trade mark
clearance has been obtained.
(v) Contains the name ’Bank’ yet it does not afford itself the business of
lending and keeping money.
(vi) Proposes to be called a statutory name.

No company shall be registered by a name which is identical or which resembles the name
of an existing company. Where a company is registered by a name so similar to that of
another company that the public are likely to be deceived, the court will grant an injunction
restraining it from using that name.

Case Law: Ewing vs. Buttercup Margarine Co. Ltd

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The plaintiff, who carried on business under the trade name of the Buttercup Dairy
Company, was held entitled to restrain a newly registered company from carrying on
business under the name of the Buttercup Margarine Company Ltd on the ground that the
public might reasonable think that the registered company was connected with his
business.

However, if the company’s business is different from that of the complaining party,
confusion is not likely to arise and an injunction will not be granted.

To avoid the risk of choosing a name that ultimately turns out to be desirable, the
promoters should enquire from the registrar whether the name they intend to give the
company is “too like” that of a company already in the register of companies. After
obtaining confirmation that the name is a registerable one they should immediately make a
written application for its reservation under section 19(1) of the Act. Any such reservation
shall remain in force for a period of 30 days or such longer period, not exceeding 60 days as
the Registrar, for special reasons may allow.

Every public company must write the word “limited” after its name and every private
limited must write the word “private limited” after its name. Companies whose liabilities
are not limited are prohibited from using the word “limited”.

(b) The Registered office clause

Section 5(1) (b) provides that the memorandum of association shall state that, “The
registered office for the company is to be situated in Kenya”

The registered office clause is important for two reasons:-

(i) It ascertains the domicile and nationality of a company.
(ii) It is the place where various registers relating to the company must be kept and to
which all communications and notices must be sent. A company need not carry on its
business at its registered office
S 107,the Co must have a registered office a postal address either 14 days after
incorporation.
The purpose for a physical addres is ;
For the knowledge of where the books and registered e.g books of accounys and registers
e.g books of account,minute book of meetings,registration of members,directors charges,
debentures holders(direct or interim). It is the communicational focal point for the safe
keeping of documents.

The primary function of the registered office is to act as the company’s official address. It
provides a convenient place where legal documents, notices, and other communications
can be signed.

The following registers and documents are kept at the company’s registered office;-
(i) The register of members.
(ii) The register of directors and secretaries.

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(iii) The company’s register of charges.

(iv) The register of debenture holders.
(v) The register of directors interests in shares.
(vi) The minute books of general meeting.

The above registers and documents are subject to inspection by the following:-
(a) The company’s members can access and inspect them free of charge during business
hours for at least two hours each day.
(b) Debenture holders of the company can inspect free of charge during business hours.
(c) Any member of the public can inspect on payment of prescribed fee not exceeding Sh. 2
for each inspection.

(c) The Object clause:

Section 5(1) (c) requires the memorandum of association to state the objects of the
company.
The object clause defines the sphere of the company’s activities, the aims that its formation
seeks to achieve and the kind of activities. If anything is undertaken outside the objects
stated in the memorandum then such shall be considered ultra vires and hence not binding
the company.
The objects clause is intended to serve the following purposes:-
(a) To protect subscribers who learn from it the purpose to which their money can be
applied
(b) To protect persons who deal with the company and who can infer from it the extent of
the company’s powers.

In choosing the company’s objects, the following should be noted;

(i) The objects should not be illegal or against the general law of the country, for example,
gambling is prohibited and therefore the objects should exclude such.
(ii) The object should not include anything in contravention of the Act.
(iii) They should not include anything against public policy e.g. trading with alien enemies.

The statement Lord Cairns in 1875 in Ashbury Railway Co. Ltd vs. Riche to the effect that a
contract beyond the objects of the company in the memorandum of associations, is beyond
the powers of the company give the impression that a company has no legal power to do
anything which is not written in the memorandum. That would be a starting proposition
because, in practice, companies have to do so many things in the course of their business
that if all those things were to be written down in the memorandum, the memorandum
would be such a gigantic document that nobody would read it. The judges will not regard a
transaction undertaken by a company as ‘ultra vires’ merely because it is not written in the
company’s memorandum of association as one of the company’s objects.

They would not infact regard the transaction as ultra vires by implication if:-
(a) It was reasonably incidental to any of the objects which have been written in the
company’s memorandum.

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(b) It was undertaken for the sole purpose of effectuating, or achieving the written objects.

Doctrine of Constructive Notice

This rule regards that a person transacting business with a company is taken to be aware of
the contents of the company’s public documents such as memorandum, articles, annual
return and special resolutions.

Because the company’s registry is a “public office” the documents kept therein are
generally referred to as “public documents” since members of the public are free to inspect
them on payment of a prescribed fee.

A person transacting business with a company will be taken to have read the objects clause
in the company’s memorandum. Consequently if he concludes a contract with the company
and it turns out that the contract was for a purpose which is neither expressly nor
impliedly within the company’s objects and hence ultra vires, he is regarded as having
entered into an ultra vires contract knowingly even though he was not actually aware of its
being ultra vires. He cannot successfully sue the company for breach of the contract.

The legal justification for this rule is that since the company’s public documents in its file at
the company’s Registry are available there for inspection by any interested member of the
public he should have gone to the registry asked for the company’s file, inspected the
contents and having found the memorandum of association read the objects clause inorder
to ascertain whether the proposed contract is consistent with the company’s objects. If he
fails to do so, he will be regarded as having been aware that the contract was ultra vires.
He cannot therefore be allowed to enforce it.

The criticism that could be made against the constructive rule is its assumption that a
potential contracting party who read a company’s objects will be able to make the correct
legal conclusion regarding the vires of the proposed transaction. The fact that a perusal of
the company’s object clause does not guarantee its correct interpretation is amply
demonstrated when senior judges differ over the vires of a particular transaction. Why
should an ordinary businessman be expected to decide the matter correctly? Reading the
objects does not guarantee correct interpretation.

Remedies of the ultra vires lender

No action or suit lies at law to recover money lent to a company which has borrowed for an
ultra vires purpose. This means that the ultra vires lender cannot sue, as lender, to recover
the money he lent to the company. However, he might avail himself of one or any of the
following remedies:-
(a) If the result of the transaction is that the indebtedness of the company is not increased
because the new loan was applied in discharging an old debt, the invalid lender can be
treated as standing in place of those whose debts have been paid off.

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In Sinclair vs. Brougham, it was stated that the ultra vires lender would be entitled to rank
as creditor only to the extent to which his money was applied in discharging the intra vires
debt.

(b) If the lender can identify his money or the investment of his money in the hands of the
borrowing company, he can call for its return.

(c) If the lender cannot bring himself within any of the above prepositions he would have
no remedy except to participate in the division of the company’s surplus assets if any which
would be divisible among ultra vires creditors during company’s liquidation after all
members have received back their capital in full. The is tracing is only available are only in
equiy and ain common Law.
Conversion of of Ultravires to intervires is impossible,in [Rolled Steel Case], the High
court stated that it is important,it cannot be legitimized by ratification.

Remedies other than Tracing

(i) If a shareholder can do a derivative action to right a wrong
performed by the Co
(ii) Personal Action against the directors. If the directors Act
ultravires they represent the Co as inervires. In sch a case
they will be liable to the 3rd parties.
(iii) Subrogation- If x cannot borrow but borrows y bank cannot
recover. But Co uses the money to pay M. In equity x is
ultravires but with M is intervires,the Bank can step in the
shoes of theCo, its justification shall be present in equity.

There are two types of Ultravires

Narrow Ultravires which s the common Law doctrine of ultravires covered in s 5(1)
(c). It covers the role of capacity
This is ultravires beyond the powers of the Co as covered in [Rolled steel products
limited] as well as the Rule in Ashby’s Rly. To ascertain its use,we look at the
construction of the objects, whether the act done is expressly mentioned and not
necessarily incidental to the Co’s business.
Wider ultrevires
Abuse of the power by directors where they have acted in excess of their powers
The transaction as in the narrower sense is voidable at the option of the Co and the
directors are liable for the abuse in authority.
It is capable of being ratified by the Co at the general meeting[Bamford v Bamford]
Re David Payne Co A transaction is unenforceable of the abuse of power sinc the
other person is in abuse of power
Re Introdution Ltd/ In tourism and pig breeding v…….Bank,the p was given a loan

GRATUITOUS PAYMENT
These are charitable deeds,gifts gifts and donations.

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At common Law deeds were considered invincible unless they are mode for the
benefit of the Co. Bowen L.J IN Hutton v Westcock and Rly Co stated that the Law does
not see that there are…………… the Co was invalid.
In Park v Daily News Ltd,the court held that
In Re Lee B Eve J three pertinent questions were identified as the test for validity of
gratuitous test,they must all be fulfilled;

Is the transaction reasonably iincidental to the carrying out of business

Is ot a bonafide transaction
Is it a benefit and prospective of the Co(All the elements must be fulfilled). The court
is misinformed due to the perception was for the was for the purpose of profit.

Evans v Bros
Scientific grants were used to get future employees.
Re Halt (garage Ltd)/ Re Hastrey & Weight the business of the Co’s objects need not
be commercial but charitable & philanthropic but whatever the orgainsiers with
provided they are legal.
Kenyan Law position stands on the Hutton case through it does not apply since the
circumstancs of the jurisdiction act cannot permit under s 31(c) of the judicature Act.
This applies to inform corporate social responsibility, which determines that 2% of
profit must go into charity
The paragraph is intended to protect investers to ascertain the purpose to which their
money is taking so that they can appreciate the risk
The transactions of business with the Co and the power to transact wth the Co,the
narrower the objects, the lessor the possibility the the subscribers are exposed to risk,the
wider the objects the wider the risks
Ultra vires is a rule of capacity as shown by s5(1)(c) of the Act. The origins of the doctrine
of Ultra vires are found in are in Ashbury Rly Co v Ridge where L. Cairns stated that the
decision was too rigid to construct..
In A.g v great Eastern Rly Co, Lord Seldon stated that what is reasonable and consequential
to to intervires is incidental to the attainment or pursuit of the objects.
The legislature passed the Memeorandum of Association Act of 1890(s 8) to amend and
alter the memorandum of a Co. To go around the rule the following methods are used to
circumvent the rule;

 Amalgamation with any other Co or body of a person.

 To carry on business which may may under the existing objects fall conveniently
proximate to the businesss of the Co.

 Infalting the objets clause by listing down any conceivable object

 Incorporating the the powers of the objects of the objects(Cotman v Brogham)

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 Including an independent objects clause”Each of the forging paragraphs is an

independent object capable of being persued”(Cotman v Brogham)

 Use of subjective or objective clause to carry on any other objective which in the
opinion on the director is advantageous(Bell Houses v Gladwell)/ Rule in
Turkwards Case

N/B Under s 219,the shareholder can go to court where the substance of the Objects
changes.

(d) The Liability Clause

This clause states that the liability of the members of the company is limited.
Section 5(2) provides that memorandum of a company limited by shares or guarantee shall
state that the liability of members is limited.
Companies may either be:-
(i) Limited by shares
(ii) Limited by guarantee
(iii) Unlimited

Companies limited by shares

Section 4(2) (a) defines such a company as a company having the liability of its members
limited by memorandum to the amount, if any, unpaid on the shares held by them.

Companies limited by guarantee

Section 4(2)(b) defines such a company as a company having the liability of its members
limited by the memorandum to such an amount as the members may undertake to
contribute to the assets of the company in the event of its being wound up.

The members can only be called upon to pay the amount guaranteed if the company is in
liquidation.

Unlimited Companies

Section 4(2) (c) defines it as a company not having any limit on the liability of its members.
Although the company is a separate legal entity, the members’ liability resembles that of
partners.

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(e) The Capital Clause

Section 5(4) (a) provides that a company having a share capital, the memorandum shall
state “the amount of share capital with which the company proposes to be registered and
the division thereof into shares of a fixed amount”.

(f) The Association Clause

This clause though not provided in Section 5 of the Act, provides that those who have
agreed to subscribe to the memorandum must signify their willingness to associate and
form a company. Seven persons are required to sign the memorandum in case of public
company whereas two for private companies.

Alteration of the Memorandum

The memorandum of association of a company being its charter, the right of the company
to alter its contents is rigidly limited by the provisions of the Act. Section 7 of the Act
provides that a company shall not alter the conditions contained in its memorandum
except in cases, in the mode and to the extent for which express provisions is made in this
Act.

(1) Change of Name

A company’s name may be changed voluntarily or compulsorily.

(a) Voluntary change of name

A company’s name may be changed voluntarily if:-

(i) A Special resolution is passed by the company for that purpose after obtaining a
written approval of the registrar (Section 20(1).
(ii) The company was inadvertently registered by a name which, in the opinion of the
registrar, is too like the name by which a company in existence is previously registered.

Although the section does not make it mandatory for the company to change its name it is
advisable for the company to take immediate steps to effect the change as soon as it
becomes aware of the situation. Any delay entails the risk of passing-off action being
instituted against it.

(iii) The minister, by license, authorizes a company to make a change in its name.

(b) Compulsory change-

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Section 20 (2) of the Act provides that within 6 months of registration with a particular
name, the registrar may direct a change in name if in his opinion the name is “too like” that
of pre-existing company. A change of name under this section may be made by ordinary
resolution.

Failure to comply with the registrar’s directive is an offence punishable by a fine not
exceeding Sh. 100 for every day during which the default continues.

After a company changes its name, it shall give to the registrar notice thereof within
fourteen days. Upon receipt of the notice, the registrar shall:-
(i) Enter the name on the register in place of the former.
(ii) Issue to the company a certificate of change of name.
(iii) Publish the change of name in the Kenya Gazette

(2) Change of Registered Office

A company may change the address of its registered office on giving proper notice to the
registrar. The new address takes effect on the entry of the address on the register but the
company has 14 days after giving due notice in which to use the new address and to
transfer the registers etc, required to be kept there before it commits any offences for using
the wrong address.

The registrar must publish in the Gazette notice of the receipt by him of notice of change in
the company’s registered office.

(3) Change of the Object Clause

Section 8 of the Act provides that a company may, by special resolution, alter the provisions
of its memorandum with respect to its objects if the alteration would enable the company: -

(a) To carry on its business more economically or more effectively.

(b) To attain its main purpose by new or improved means.
(c) To enlarge or change the local area of its operations.
(d) To carry on some business which under existing circumstances may conveniently or
advantageously be combined with the business of the company.
(e) To restrict or abandon any of the objects specified in the memorandum.
(f) To sell or dispose of the undertaking of the company.
(g) To amalgamate with any other company or body of persons.

In order to effect the proposed alterations the company’s directors would have to convene
an extraordinary general meeting of the company in order to consider and if approved,
pass a resolution that the company’s objects be altered as proposed.

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The resolution would be effective immediately it is passed if it was voted for by the holders
of at least 86% in nominal value of the company’s issued share capital or any class thereof.

When the objects are altered, a printed copy of the special resolution must be delivered to
the registrar within 14 days.

(4) Change of Capital Clause

Section 63 (1) provides that a company limited by shares or a company limited by

guarantee and having a share capital, if so authorized by its articles, may alter the
conditions of its memorandum as follows: -
(a) It may increase its share capital by new shares of such amount as it thinks expedient.
(b) It may consolidate and divide its capital into shares of larger amount than the existing
shares.
(c) It may convert all or any of its paid up shares into stock and reconvert stock into paid up
shares.
(d) It may subdivide its shares into shares of smaller amount.
(e) It may cancel shares, which at the date of passing of the resolution have not been taken or
agreed to be taken by any person and diminish the amount of its share capital by the
amount of shares so cancelled.
Section 63 (2) provides that this shall be exercised by the company in a general meeting.

ULTRA VIRES DOCTRINE

The courts have introduced 2 methods of curbing the evasion of the ultra vires doctrine.

1. The ejusdem generis rule is also referred to as the main objects rule of
construction. Here a Memorandum of Association expresses the objects of a
company in a series of paragraphs and one paragraph or the first 2 or 3
paragraphs appear to embody the main object of the company all the other
paragraphs are treated as merely ancillary to this main object and as limited or
controlled thereby. Business persons evaded this method by use of the
independent objects clause. The objects clause will contain a paragraph to the
effect that each of the preceding sub-paragraphs shall be construed
independently and shall not in any way be limited by reference to any other sub-
clause and that the objects set out in each sub-clause shall be independent
objects of the company. Reference may be made to the case of Cotman v.
Brougham [1918]A.C. 514

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In this case the objects clause of the company contained 30 sub-clauses. The first sub-
clause authorised the company to develop rubber plantations and the fourth clause
empowered the company to deal in any shares of any company. The objects clause
concluded with a declaration that each of the sub clauses was to be construed
independently as independent objects of the company. The company underwrote and
had allotted to it shares in an oil company. The question that arose was whether this
was intra vires the company’s objects. The court held that the effect of the independent
objects clause was to constitute each of the 30 objects of the company as independent
objects. Therefore the dealing of shares in an oil company was within the objects and
thus intra vires. However the power to borrow money cannot be construed as an
independent object of the company in spite of this decision.

Re Introductions (1962) W.L.R. 791

In this case the company was formed to provide accommodation and services to those
overseas visitors going to a festival in Britain. The company did this during the first few
years of existence. Later the company switched over to pig breeding as its sole
business. While so engaged it borrowed money from a bank on a security of
debentures. The bank was given a copy of the company’s Memorandum of Association
and at the material time knew that the company’s sole business was that of pig
breeding. The issue was, whether the loan and debentures were valid in view of the fact
one of the sub clauses empowered the company to borrow money and the last sub
clause was an independent object clause.

The court held that borrowing was a power and not an object. The power to borrow
existed only for furthering intra vires objects of the company and was not an object in
itself. Therefore

1. The exercise of powers which will be intra vires is exercised for the objects of the
company and is ultra vires only if used for the objects not covered by the company’s
Memorandum of Association.
2. Even an independent object clause cannot convert what are in fact powers into
objects.

2. LOSS OF SUBSTRATUM

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Where the main object of a company has failed, a petitioner will be granted an order for the
winding up of a company. Such a petitioner must however be a member or shareholder in
the company.

The object of the ultra vires rule is to make the members know how and to what their
money is being applied. This is the rationale of members’ protection.

RE GERMAN DATE COFFEE CO. (1882) 20 Ch. 169

In this case the major object of the company was to acquire a German Patent for
manufacturing coffee from dates. The German patent was never granted but the company
acquired a Swedish Patent for the same purpose. The company was solvent and the
majority of the members wished to continue in business. However, two of the shareholders
petitioned for winding up of the company on the grounds that the company’s object had
entirely failed.

The court held that upon the failure to acquire the German patent, it was impossible to
carry out the objects for which the company was formed. Therefore the sub stratum had
disappeared and therefore it was just inevitable that the company should be wound up.

Kay J. stated “where a company is formed for a primary purpose, then although the
Memorandum may contain other general words which include the doing of other objects,
those general words must be read as being ancillary to that which the Memorandum shows to
be the main purpose and if the main purpose fails and fails altogether, then the sub-stratum of
the association fails.”

This substratum rule is too narrow and cannot sufficiently uphold the ultra vires rule.
Questions are, are members or shareholders really protected? Do they know what the
objects are? The Directors may choose any amongst the many.

Secondly a member has to petition first and the court has to decide

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John Beauforte (1953) Ch.d 131

A company was authorised by its Memorandum of Association to carry on the business of

costumiers, gown makers and other activities ejusdem generis. The company decided to
undertake the business of making veneered panels which was admittedly ultra vires and
for this purpose, it constructed a factory at Bristol. The company later went into
compulsory liquidation. Several proofs of debts were lodged with the liquidator which he
rejected on the ground that the contracts which they related to were ultra vires.

Applications by way of Appeal were lodged by the 3 creditors one of whom had actual
knowledge that the veneer business was ultra vires. The 3 creditors were a firm of builders
who built the factory, a firm which supplied the veneers to the company and a firm which
had contractual debts with the company.

The courts held dismissing the applications that no judgment founded on an ultra vires
contract could be sustained unless it embodied a decision of the court on the issue of ultra
vires or a compromise on that issue. The contracts being founded on an ultra vires
transaction were void.

3. GRATUITOUS GIFTS

Can a company validly make a gift out of corporate property or asset? The law is that a
company has no power to make such payments unless the particular payment is
reasonably incidental to the carrying out of a company’s business and is meant for the
benefit and to promote the property of the company.

This issue was first decided in the case of

Hutton V Westcorp Railway Co. (1893) Ch.d

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A company sold its assets and continued in business only for the purpose of winding up.
While it was awaiting winding up, a resolution was passed in the company’s general
meeting authorising the payments of a gratuity to the directors and dismissed employees.

The court held that as the company was no longer a going concern such a payment could
not be reasonably incidental to the business of the company and therefore the resolution
was invalid. In the words of the Lord Justice Bowen said

“The law does not say that there are not to be cakes and ale but there are to be no
cakes and ale except such as are required for the benefit of the company”

The question is, suppose there is a clause in the Memorandum of Association that such
payments shall be made, is payment ultra vires? The authority that dealt with this position
was the case of

RE LEE BEHRENS & CO. [1932] 2 Ch. D 46

The object clause of the company contained an express power to provide for the welfare of
employees and ex employees and also their widows, children and other dependants by the
grant of money as well as pensions. Three years before the company was wound up, the
Board of Directors decided that the company should undertake to pay a pension to the
widow of a former managing director but after the winding up the liquidator rejected her
claim to the pension.

The court held that the transaction whereby the company covenanted to pay the widow a
pension was not for the benefit of the company or reasonably incidental to its business and
was therefore ultra vires and hence null and void.

Justice Eve stated as follows

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Whether they reneged an express or implied power, all such grants involved an expenditure of
the company’s money and that money can only be spent for purposes reasonably incidental to
the carrying on of the company’s business and the validity of such grants can be tested by the
answers to three questions:

(i) Is the transaction reasonably incidental to the carrying on of the company’s

business?
(ii) Is it a bona fide transaction?
(iii) Is it done for the benefit and to promote the prosperity of the company?

These questions must be answered in the affirmative. The question may be posed as to
whether these tests apply where there is an express power by the objects. This is one area
where the courts are still insistent that creditors’ security must be reserved.

Sometimes ultra vires can be excluded by good and clever draftsmanship

Parker v. Daily News [1962] 2 Ch.d 927

In this case the company transferred the major portion of its assets and proposed to
distribute the purchase price to those employees who are going to become redundant after
reduction in the stock of the company of the company’s business. The company was not
legally bound to make any payments by way of compensation. One shareholder claimed
that the proposed payment was ultra vires.

The court held that the proposed payment was motivated by a desire to treat the ex-
employees generously and was not taken in the interest of the company as it was going to
remain and that therefore it was ultra vires.

The Court observed as follows “the defendants were prompted by motives which however
laudable and however enlightened from the point of view of industrial relations were such as
the law does not recognise as sufficient justification. The essence of the matter was that the
Directors were proposing that a very large part of its assets should be given to its employees
in order to benefit those employees rather than the company and that is an application of the
company’s funds which the law will not allow.”

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Evans v. Brunner Mound & Co. 1921 Ch.d 359

The company carried on the business of chemical manufacturers. Its object clause
contained a power to do all such things as maybe incidental or conducive to the attainment
of its objects. The company distributed some money to some universities and scientific
institutions, which was meant to encourage scientific education and research. The
company thereby hoped to create a reservoir of qualified scientists from which the
company could recruit its staff.

The court held that even though the payment was not under an express power, it was
reasonably incidental to the company’s business and therefore valid.

This is one of the few cases where payment was recognised as being valid.

THE RIGHTS OF THE COMPANY & 3RD PARTIES UNDER ULTRA VIRES TRANSACTIONS:

These are remedies

Whether or not a contract is ultra vires depends on the knowledge of the party’s dealing
with that company. Such is the case as regards borrowing contracts. Consider the case of

David Payne & Co. (1904) 2 Ch.d 608

X was a director of company B and at the same time had some interests in company A. He
learnt that company B wished to borrow some money which it intended to apply to
unauthorised activities. He urged company A to lend the money on the security of
debentures. The issues were

(a) Whether the debentures were valid security;

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(b) Whether the knowledge of X as to the intended application of the money could be
imputed to the company.

The court held that X was not company A’s agent for obtaining such information and
therefore his knowledge was not the company’s knowledge and consequently the
debentures were valid security.

This loophole however will be applied very rarely because everybody is presumed to know
the contents of a company’s public documents. Where a contract with that company is
ultra vires, generally speaking the party dealing with that company has no rights under the
contract. The transaction being null and void cannot confer rights on the 3 rd party nor can
it impose any obligation on the company.

In many instances however, property will be transferred under an ultra vires transaction.
Such transaction cannot vest rights in the transferee and cannot divest the transferor of his
rights.

1. At common law therefore, the first remedy of a person who parts with property
under an ultra vires transaction is that he has a right to trace and recover that property
from the company as long as he can identify it.

This principle also applies to money lent to the company on an ultra vires borrowing so
long as the money can be traced either in law or in equity. The basis of this principle is that
the company is deemed to hold the money or the property as a trustee for the person from
whom it was obtained.

Therefore, if the money received is paid into a separate account, or is sufficiently

earmarked e.g by the purchase of some particular items, it can be followed and claimed by
the lender. Where tracing is impossible, because the money has become mixed with other
money, the lender is entitled in equity to a charge on the mixed fund together with the
other creditors according to the respective amounts otherwise money obtained on ultra
vires transaction generally cannot be followed once it has been spent. But if such money

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has been spent by discharging the company’s intra vires debts then the lender is entitled to
rank as a creditor to the extent to which the money has been so applied. Since the
company’s liabilities are not increased but in fact decreased, equity treats the borrowing as
valid to the extent of the legal application of such money.

2. The 3rd party has a personal right against the directors or other agents with whom
he has dealt. The rationale is that such directors or other agents are treated as quasi
trustees from which it follows that a 3rd party is entitled to a claim against them for
restitution.

TO WHAT EXTENT ARE MEMBERS PROTECTED BY THE ULTRA VIRES DOCTRINE

The intra vires creditor does not have the locus standi to prohibit ultra vires actions. Again
there is the presumption of knowledge of a company’s documents and activities. In spite of
the fact that the doctrine of ultra vires is over due for reform, it has not undergone any
reform in Kenya unlike in the United Kingdom where it has been severely eroded.

All the company can do is to alter its objects under the power conferred by Section 8 of the
Companies Act Cap 486. The effect of the Section is that a company may by special
resolution alter the provisions in its Memorandum with respect to the object of the
company.

Section 141 defines Special Resolution as a resolution which is passed by a majority of not
less than three quarters of those members voting a company’s general meeting either in
person or by proxy and of which notice has been given of the intention to propose it as a
special resolution.

Within 30 days of the date on which the resolution altering the objects is passed, an
application for the cancellation of the Resolution may be made to Court by or on behalf of
the holders who have not voted in favour of the Resolution, of not less than 15% of the

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nominal value of the issued share capital of any class and if the company does not have a
share capital, the application can be made by at least 15% of the members of the company.

If such an application is made, the alteration will not be effective except to the extent that it
is confirmed by a court. Normally a court has an absolute discretion to confer, reject or
modify the alteration.

Re Private Boarding House Limited (1967) E.A. 143

In this case, it was held that the registrar of companies is entitled to receive a notice of any
such application and to appear and be heard at the hearing of the Application on the
ground that such matters affect his record.

Under Section 8 (9) of the Companies Act Cap 486 if no application is made to the court,
within 30 days the alteration cannot subsequently be challenged. The effect of this
provision is that as long as an alteration is supported by more than 85% of the
shareholders or so long as no one applies to the court within 30 days of the resolution,
companies have complete freedom to alter their objects.

Note however, that such alterations do not operate retrospectively. Their effect relates
only to the future.

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ARTICLES OF ASSOCIATION

The Articles of association are defines in s 2(1) which states that “”

It regulates business between the Co and its members Art 9. Under Artcle 10 the Articles
must have the No of members and must define if they are limited by shares or by
guarantee.
The articles of association are the rules and regulations of a company framed for the
purpose of internal management of its affairs. The articles of association of a company are
subordinate to and are controlled by the memorandum of association.

Lord Cairns observed in this regard “The memorandum as it were the area beyond which
the action of the company cannot go; inside that area the shareholders may make such
regulations for their own government as they think fit”. The Act dies not provide for the
contents of the shares and thus the Co may under s 11 adopt all or any of the regulations
under table A. However, Table A is a sample of a table of contents for a private Co.

Section 12 of that Act provides that the articles shall be:-

(a) In English language

(b) Printed
(c) Divide into paragraphs numbered consecutively, and
(d) Signed by each subscriber to the memorandum in the presence of at least one witness,
who shall attest the signature and add his occupation and postal address.

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Contents of the Articles:

- Adoption of preliminary contracts
- Number and value of shares
- Allotment of shares
- Calls on shares
- Forfeiture of shares
- Transmission of shares
- Alteration of capital
- Share certificates
- Conversion of shares into stock
- Voting rights and proxies
- Meetings and the quorum.
- Directors and their appointments including the Managing director(107)
- Separation of powers between the AGM and the Board.
- Office of the Co secretary.
- Accounts and audit
- Winding up

Section 13(1) provides that a company may by special resolutions alter or add to its
articles. Section 13(2) provides that any alteration or addition so made in the articles shall
subject to the provisions of this Act, be as valid as if originally contained therein.

Limitations on Power to alter Articles

The following are the legal restrictions on a company’s power to alter its articles:-

(a) The alteration must not be inconsistent with the provisions of the memorandum. This
means that an alteration to include a clause, which contravenes a provision in the company
memorandum, is of no effect.
(b) Under section 13(1), an alteration which contravenes a provision in the Act is null and
void. For example, articles cannot authorize a company to purchase its own shares.
(c) The alteration of the article must be made in good faith for the benefit of the company as
a whole.
(d) The alteration of articles must not constitute a fraud on minority.
(e) Section 24 provides that no member of a company shall be bound by an alteration made
in the articles after the date on which he became a member if and so far as the alteration
requires him to take or subscribe for more shares than the number held by him at the date
on which the alteration was made, or in any way increases his liability as at the date to
contribute to the share capital.
(f) An alteration in the articles which causes a breach of contract with an outsider will be
inoperative.
(g) The alteration must not sanction anything which is illegal.

Legal Effect of Articles

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Section 22 provides that the article shall, when registered, build the company and the
members there of to the same extent as if they respectively had been signed by the
company and by each member, and contained covenants on the part of each member, to
observe all the provisions of the articles.

The effect of these provisions is to constitute through the articles of a company a contract
between each member and the company. The effect and the implications of this section
may be appreciated by considering how the articles bind:-

(a) Members to the Company and the nature of the contract

Each member of the company is bound to observe the various provisions of the articles as if
he had actually signed the same.

Case Law:

Hershell Wetton

Queen & Asteria Ltd v Salmon

Hickman vs. Kent (1957)

The articles provided for the reference of disputes between a member and the company to
arbitration, if a share holder brought an action in court against the company in connection
with a dispute between the company and himself in his capacity as a member. It was held
that the company was entitled to have the action stayed, as the articles amounted to a
contract between the company and Hickman to refer such disputes between them to
arbitration.

Astbury J defined it as; an ordinary contract that imposes obligations on the parties and
members. It is a contract between the Co and members only
The rights can only be enforced by members in their capacity as members.
That the contract is subject to the provisions of the Co Act and the Memorandum of
Assocation
That the terms are not static but dynamic within the limits of s 13(1)(2)

But a dispute between the company and a director in his capacity as a director would not
be within the terms of such articles even if the director was also a member (Beattie vs. E &
F. Beattie Ltd, 1938).

(b) Company to the Members

The company is bound to the members by the various provisions contained in the articles.
The company can exercise its rights as against any member only in pursuance of and in
accordance with the articles. Any member is entitled to sue the company to prevent any
breach of articles which would affect his rights as a member of the company. Thus where a

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right is conferred by the articles on a shareholder to vote at a company meeting, the

chairman of the meeting cannot deprive him of his right.

Case Law: Wood vs. Odessa Water Works Co. (1889)

The articles of association of the defendant company provided that “the directors may, with
the sanction of the company at a general meeting, declare a dividend to be paid in cash to
the members”. Instead of paying cash dividend to the shareholder, an ordinary resolution
was passed to give them debenture bonds. The plaintiff, a member sued the directors for
acting on the resolution. The directors were restrained from acting on the resolution on
the ground that “to be paid” mean to be paid in cash and the debenture bonds proposed to
be issued were not payment in cash.

The articles provide that the directors may with the sanction of a general meeting declare a
dividend to be paid to shareholders, prime facie that means to be paid in cash.

(c) Members Inter-se

Articles do not constitute express agreement between the members of the company. Yet
each member of the company is bound by the articles on the basis of implied contract to the
other members. The articles regulate the rights of the members’ inter-se but such rights
can be enforced only through the company. When the Articles are registered there is a
second contract between the members and other members. Sterling J in Wood v Odessa
stated that the problem is always enforceability generally it is impossible but specific
performance can be done either by;

- liquidation
Rule in Foss v Harbottle

Case Law: Ray field vs. Hands (1960)

Article II of the articles of association of Field-Davis Ltd provided: “Every member who
intends to transfer shares shall inform the directors who will take the said shares equally
between them at a fair value. Ray field, a member, sought to compel the defendants, the
three directors of the company to purchase his shares in accordance with this provision.
The court declared that they were bound to do so. The relationship here is between the
plaintiff as a member and the defendants not as directors, but as members.

(d) Company to Outsiders

Articles do not constitute any contract between the company and an outsider. An outsider
is not entitled to enforce the articles against the company for any breach of right that is
conferred on him by the articles.
Case Law: Eley vs. Positive Government Life Assurance Company (1876)
The articles of the company provided that Eley should be a solicitor of the company for life
and should not be removed from his office except on account of misconduct. He was also a
member of the company. Eley acted as a solicitor of the company for sometime but

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ultimately the company discontinued his services without any allegation of misconduct. He
sued the company for damages for breach of the contract.

It was held that the action was not maintainable because the right which he attempted to
enforce was conferred upon him in a capacity other than of a shareholder.

DOCTRINE OF INDOOR MANAGEMENT

The doctrine of indoor management is an exception to the rule of constructive notice.

According to the rule of constructive notice, a person dealing with the company is deemed
to have knowledge of the memorandum and the articles of the company. If he enters into a
transaction with the company which is ultra vires, he cannot treat the transaction as
binding on the company.

The doctrine of indoor management on the other hand argues that outsiders dealing with
the company are entitled to assume that everything had been regularly done so far as its
internal proceedings are concerned. The doctrine had its origin in a famous case, “Royal
British Bank vs. Turquand”.

Case Law: Royal British Bank vs. Turquand (1856)

The directors of the Bank issued a bond to Mr. Turquand. The articles provided that the
directors had the power to issue bond if authorized by proper resolution of the company.
No such resolution was passed. It was held that Turquand could sue on the bond as he was
entitled to assume that the resolution must have been passed. It was observed that
persons dealing with the company are bound to read the registered documents and to see
that the proposed dealings are not inconsistent therewith, but are not bound to do more.
They need not inquire into the irregularity of internal proceedings.

The doctrine is however, subject to the following exceptions:-

(a) Knowledge of irregularity: - A person who deals with the company and who has
knowledge of the irregularity in its internal management in connection with the subject
matter of his dealings cannot claim the benefit of the rule in Turquand’s case.

(b) Negligence: - A person cannot claim the benefit of the rule in Turquand in circumstances
under which he would have discovered the irregularity if he had made proper inquiries.
Further, where circumstances surrounding the transaction are suspicious, and therefore
invite inquiry, the outsider cannot claim the benefit of this rule.
(c) Forgery: - The rule in Turquand’s case will not apply where a document on which the
person seeks to rely on is a forgery.

Case Law: Ruben vs. Great Fungall Consolidated Co. (1906)

Ruben lent a company a sum of money on the security of a share certificate. The secretary
had forged the signatures of the two directors and had affixed the seal on the certificate

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without authority. The company refused to register the share certificate. Ruben claimed
damages relying on the Turquand’s rule.
It was held that he could not do so because the rule did not apply where the document was
forged.

(d) Acts outside the apparent authority: - The rule in Turquand does not apply where a
person acting on behalf of the company exceeds any actual or ostensible authority given to
him. A person who enters into a transaction with a company official who has acted beyond
official powers will not be protected by the rule in Turquand case.

Case Law: Anand Lal vs. Dinshaw & Co. (1942)

P accepted a transfer of company’s property from its accountant. Since such transaction is
apparently beyond the scope of the accountant’s authority it was void.

(e) No knowledge of the contents of the articles and memorandum of association: -

A person who has not actually read the memorandum and articles and who was not at the
time he entered into the contract, aware of their content cannot seek to rely on the doctrine
of indoor management.
The doctrine of indoor management is based on the principle of estoppels and therefore
cannot be invoked in favor of a person who has not consulted the company’s memorandum
and articles.

No one can rely and act upon something of which he was infact completely ignorant.

ALTERATION OF ARTICLES

Section 13 of the Companies Act gives the company power to alter the articles by special
resolution either by adding or reducing the Co’s terms Uder s 143 of the Co Act the
resolution must be registered. See further the provisions of s 102

This is a statutory power and a company cannot deprive itself of its exercise. Reference
may be made to the case of

Andrews v. Gas Meter Co. (1897) 1 Ch. 361

The issue herein was whether a company which under its Memorandum and Articles had
no power to issue preference shares could alter its articles so as to authorise the issue of
preference shares by way of increased capital

The court held that as long as the Constitution of a Company depends on the articles, it is
clearly alterable by special resolution under the powers conferred by the Act. Therefore it
was proper for the company to alter those articles and issue preference shares. Any
regulation or article which purports to deprive the company of this power is therefore
invalid, on the ground that such an article or regulation will be contrary to the statute. The

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only limitation on a company’s power to alter articles is that the alteration must be made in
good faith and for the benefit of the company as a whole.

In Walker v London Tramways Ltd where the question of whether all the Co’s articles were
alterable arose, it was held that; the powers to alter the Articles is subject to restriction
either in

Statutory restrictions

Judicial restrictions

(i)Statute

For alteration to occur,

(a)the general meeting must alter the articles with atleast 75% of the members in favor of
the alteration this may be dove either in person or in proxy

(b)It must not increase the liability if members………………or more shares,s13

(c)Must not be inconsistent with the Co Act

(d)Must not exceed the conditions of the memorandum

(e)Must not amend the provions of s 30 if the Co is to remain private. The alteration must
not be inconsistent with……….

(f)The holders of the class of rights to be affected require a separate meeting where in
writing 75% will support the verification. Any alteration must not deny dissenting
shareholders their right……………by a variation of class rights to apply to the court for the
variation to be reversed.

(g)Alteration must not be contrary to a court order s(211)for purposes of the protection of
the minority against oppression. S 211 provides for the winding up for the protection of the
minority.

(ii)Judicial restrictions

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The alteration may be bonafide and in the interest of the Co as a whole. It must cater for the
future but must not be too wild or extravagant.

Sidebottom v. Kershaw Leese & C0.[1920]1 Ch. 154

Director controlled share company had a minority shareholder who was interested in some
competing business. The company passed a special resolution empowering the directors to
require any shareholder who competed with the company to transfer his shares at their
fair value to nominees of the directors. The Plaintiff was duly served with such a notice to
transfer his shares. He thereupon filed an action against the company challenging the
validity of that article.

The court held that the company had a power to re-introduce into its articles anything that
could have been validly included in the original articles provided the alteration was made
in good faith and for the benefit of the company as a whole and since the members
considered it beneficial to the company to get rid of competitors, the alteration was valid.-
The provision was in good faith to beat competition.

Contrast this case with that of

Brown v. British Abrasive Wheel Co. (1990) 1 Ch. 290

Here a public company was in urgent need of further capital which the majority of the
members who held 98% of the shares were willing to supply if they could buy out the
minority. They tried persuasion of the minority to sell shares to them but the minority
refused. They therefore proposed to pass a Special Resolution adding to the Articles a
clause whereby any shareholder was bound to transfer his shares upon a request in writing
of the holders of 98% of the issued capital.

The court held that this was an attempt to add a clause which will enable the majority to
expropriate the shares of the minority who had bought them when there was no such
power. Such an attempt was not for the benefit of the company as a whole but for the
majority. An injunction was therefore granted to restrain the company from passing the
proposed resolution.

Can a Co be restrained from altering the Articles?

Yes and No, Yes because In Pant v Symar and Co,it was held that the CO cannot be
restrained because such power is provided for in statute. However, L Porter in Southern
Founders Ltd v Shirlaw stated that the Gen rule is that,the Co cannot be precluded for
altering the Articles,however,it will be in breach of contact if the court intervenes or the
where monetary award is not appropriate in the circumstances. British Mulac Syndiacate v
Appendages

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Yes, because n Peter G Ellis v Bailey it was held that provided the alteration was done in
good faith a director cannot go to court to against the alteration. The contract covers the
relevant articles as they are amended if it was based on alterable articles.

Allen v. Gold Reefs of West Africa (1900) 1 Ch. 626

In this case the company had a lien on all debts by members who had not truly paid up for
their shares. The Articles were altered to extend the Company’s lien to those shares which
were fully paid up.

The court held that since the power to alter the Articles is statutory, the extension of the
lien to fully paid up shares was valid. These were the words of Lindley L.J.

“Wide however as the language of Section 13 mainly the power conferred by it must be
exercised subject to the general principles of law and equity which are applicable to all
powers conferred on majorities and enabling them to bind minorities. It must be exercised
not only in the manner required by law but also bona fide for the benefit of the company as a
whole.”

Further reference may be made to the case of

Shuttleworth v. Cox Brothers Ltd (1927) 2 KB 29

Here the Articles of the Company provided that the Plaintiff and 4 others should be the first
directors of the company. Further each one of them should hold office for life unless he
should be disqualified on any one of some six specified grounds, bankruptcy, insanity etc.
The Plaintiff failed to account to the company for certain money he had received on its
behalf. Under a general meeting of the company a special resolution was passed that the
articles be altered by adding a seventh ground for disqualification of a director which was a
request in writing by his co-directors that he should resign. Such request was duly given to
the Plaintiff and there was no evidence of bad faith on the part of shareholders in altering
the articles.

The Plaintiff sued the company for breach of an alleged contract contained in their original
articles that he should be a permanent director and for a declaration that he was still a
director.

The court held that the contract if any between the Plaintiff and the company contained in
the original articles in their original form was subject to the statutory power of alteration
and if the alteration was bona fide for the benefit of the company, it was valid and there
was no breach of contract. Lord Justice Bankes observed as follows

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“In this case, the contract derives its force and effect from the Articles themselves
which may be altered. It is not an absolute contract but only a conditional contract.”

The question here is who determines what is for the benefit of the company? Is it the
shareholders or the Courts?

Scrutton L.J. had the following to say

“to adopt such a view that a court should decide will be to make the court the manager
of the affairs of innumerable companies instead of shareholders themselves. It is not the
business of the court to manage the affairs of the company. That is for the shareholders and
the directors.”0

EFFECT OF ALTERATION ON CONTRACT OF DIRECTORS

Sometimes the Articles may be altered in such a way that the implementation of those
articles in the altered form would give rise to breach of an existing contract between the
company and a third party and particularly so as regards contracts between companies and
their directors.

A director may hold office either

1. Under the Articles without a service contract;

Southern Foundries v. Shirlaw (1940) A.C. 701

The Plaintiff by a written contract was appointed the company’s Managing Director for 10
years. The agreement was not expressed to be subject to the Articles in any way. The
Articles provided various grounds for the removal of a director from office subject to the
terms of any subsisting agreement. The Articles further provided that if the Managing
Director ceased to be a director, he would ipso facto cease to be Managing Director. The
Company’s Articles were subsequently changed to give the Directors power to remove a
fellow director from office by notice. Such notice was given to the Plaintiff who thereupon
filed an action claiming damages from the company for breach of contract.

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It was held that since his appointment was not subject to the articles, he could only be
removed from office in accordance with the terms of his appointment and not by way of
alteration of the articles. Damages were therefore payable.

Lord Atkins said “if a party enters into an arrangement which can only take effect by the
continuance of an existing state of circumstances there is an implied undertaking on his part
that he shall be done of his own motion to put an end to that state of circumstances which
alone the arrangement can be operative.”

2. Under a contract of service which is entirely independent of the articles; or

Peter Waiganjo v Unga Ltd

Read v. Astoria Garage (1952) 1 All.E.R 922

A Company’s Articles provided that the appointment of a Managing Director shall be

subject to termination if he ceases for any reason to be a director or if the company in
general meeting resolved that his tenure of office as managing director be terminated. The
Plaintiff was appointed as the company’s Managing Director 17 years later the directors
decided to relieve him of his duties as Managing Director. The decision was subsequently
ratified by the company in general meeting. He claimed damages for wrongful dismissal.

The court held that on a true construction of the company’s articles the Plaintiff’s
appointment was immediately and automatically terminated on passing of the Resolution
at the general meeting since the company had expressly reserved to itself the power to
dismiss the Managing Director.

The question is, can a company be restrained by injunction from altering its articles if the
alteration is likely to give rise to a breach of contract?

Part of the answer to this question was given in the case of

British Murac Syndicate Ltd v. Alperton Rubber Co. Ltd. 1950 2 Ch. 186

By an agreement binding on the Defendant company it was provided that so long as the
operative syndicate should hold over 5000 shares in the Defendant’s company, the
Plaintiff’s syndicate should have the right of nominating two directors on the Board of the
Defendant Company. A clause to the same effect was contained in Article 88 of the
Defendant Company’s Articles of Association.

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Another Article provided that the number of directors should not be less than 3 nor more
than 7. The Plaintiff syndicate had recently nominated 2 persons as directors. The
Defendant company objected to these two persons as directors and refused to accept the
nomination and a meeting of shareholders was called for the purpose of passing a special
resolution under Section 13 of the Companies Act cancelling the article.

The court held that the defendant company had no power to alter its articles of association
for the purpose of committing a breach of contract and that an injunction ought to be
granted to restrain the holding of the meeting for that purpose.

3. Under a service contract which expressly or by implication embodies the

relevant provisions in the Articles.
Where a director holds office under the Articles without a contract of service, then his
appointment is conditional on the footing that the articles may be altered at any time in
exercise of statutory power.

If however, a director’s appointment is entirely independent of the articles then any

alterations which affects his contract with the company will constitute a breach of contract
for which the company will be liable in damages.

If a director is appointed in very general terms and without limitation of time, then the
provisions in the Articles are deemed to be incorporated in the appointment and in the
absence of any provision in the articles to the contrary, the company may dismiss him at
any time and even without notice.

Punt v. Symens & Co. 1903 2 Ch.d 506

This case had words to the effect that the company cannot be restrained but this was
overruled in the case of

British Equitable Assurance Co. v. Baily (1906) S.C. 35

Allen v. Goldreef

In this case an article was altered in such a way as to prejudice one shareholder. The article
gave a lien on partly-paid shares for debts of members. Zuccani owed money in respect of
unpaid calls on partly-paid shares but was the only holder of fully paid shares as well. The
court held that it was for the benefit of the company to recover moneys due to it and the
alteration in its terms related to all holders of fully-paid shares. The fact that Zuccani was
the only member of that class at that moment did not invalidate it.

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PROMOTERS

There is not definition for a promoter.

Bowen J in Whaleybridge Colice v Green it was stated that “ a promoter is not a term of Law
but of business identified in this world in the various things that form a Co”

Promoters do so many things that it is impracticable t to defeine what they do exactly

The Companies Act does not define the term promoter but Section 45(5) says

“A promoter is a promoter who was a party to the preparation of the prospectus.

Apart from the fact that this definition does not speak much, it nevertheless shows that the
definition is only given for the purposes of that section.

At common law the best definition is that by Chief Justice Cockburn in the case of

Twyfords – v – Grant (1877) 2C.P.D. 469

Cockburn says “a promoter is one who undertakes to form a company with reference to a
given project and to set it going and who takes the necessary steps to accomplish that
purpose.”

The term is also used to cover any individual undertaking to become a director of a
company to be formed. Similarly it covers anyone who negotiates preliminary agreements
on behalf of a proposed company. But those who act in a purely professional capacity e.g.
advocates will not qualify as promoters because they are simply performing their normal
professional duties. But they can also become promoters or find others who will. Whether
a person is a promoter or not therefore, is a question of fact. The reason is that Promoter of

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is not a term of law but of business summing up in a single word the number of business
associations familiar to the commercial world by which a company is born. This business
of getting up and forming a Co is what we call(floating it-a Co)

Lec-This is a person who comes up with the idea of Co’s and participates in the business of
forming it. Can also be any person who takes part in the formation of the Co or procuring
persons to join it as soon as it is technically formed. The person may be active or passive. The
promoter is thus the illegitimate child of the Law actively known but informally known.

It may therefore be said that the promoters of a company are those responsible for its
formation. They decide the scope of its business activities, they negotiate for the purchase
of an existing business if necessary, they instruct advocates to prepare the necessary
documents, they secure the services of directors, they provide registration fees and they
carry out all other duties involved in company formation. They also take responsibility in
case of a company in respect of which a prospectus is to be issued before incorporation and
a report of those whose report must accompany the prospectus.

Legal position of promoters.

(i)They are not agents because there is no principle in existence-Kelner v Baxter

(ii)They are not trustees because they have no beneficiaries-Omnium Electric Ltd v Baries

(iii)They are Fiduciaries sinc they are defined by the relationship with the Co rather than
Law-Erlanger v New Sombrero Phosphates. It is a relationship that is equitable and done in
good faith and confidence.

ROLE OF A PROMOTER To

His duty is to act bona fide towards the company. Though he may not strictly be an agent,
or trustee for a company, anyone who can be properly regarded as a promoter stands in a
fiduciary relationship vis-à -vis the company. This carries the duties of

(i) Disclosure and

(ii) Proper accounting particularly a promoter must not make any profit out of
promotion without disclosing to the company the nature and extent of such a
Promotion. Failure to do so may lead to the recovery of the profits by the
company.

The question which arises is – Since the company is a separate legal entity from members,
how is this disclosure effected? If a promoter fails to disclose, the Co has powers to rescind
the Contact so that it is returned to the position where it was before the performance of the
Contract.

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Erlanger v New Sombrero Phosphates Co. (1878) 3 A.C. 1218

The facts were as follows;

The promoters of a company sold a lease to the company at twice the price paid for it
without disclosing this fact to the company. It was held that the promoters breached their
duties and that they should have disclosed this fact to the company’s board of directors. As
Lord Cairns said

“the owner of the property who promotes and forms that company to which he sells his
property is bound to take care that he sells it to the company through the medium of a Board
of Directors who can exercise an independent judgment on the transaction and who are not
left under belief that the property belongs not to the promoters and not to another person.”

Since the decision in Salomon’s case it has never been doubted that a disclosure to the
members themselves will be equally effective. It would appear that disclosure must be
made to the company either by making it to an independent Board of Directors or to the
existing and potential members. If to the former the promoter’s duty to the company is
duly discharged, thereafter, it is upon the directors to disclose to the subscribers and if
made to the members, it must appear in the Prospectus and the Articles so that those who
become members can have full information regarding it.

Since a promoter owes his duty to a company, in the event of any non-disclosure, the
primary remedy is for the company to bring proceedings for

1. Either rescission of any contract with the promoter or

2. recovery of any profits from the promoter.

As regards Rescission, this must be exercised with keeping in normal principles of the
contract.

1. the company should not have done anything to ratify the action

2. There must be restitutio in intergram (restore the parties to their original position),

(b)The other remedy is the account of secret profit for the recurrence of that property
(Gluckstein v Barnes)1900 where it was held that disclosure to afew persons amounts to
disclosure and there are no duties

(c)Damages-

DUTIES OF PROMOTERS

It is the duty of the promoter to

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-Choose the Co name

-Register the Co

-Give the preliminary expenses

-Secure the services of directors

-Prepare the necessary prospectus

-Ensure that there is an independent group of directors

-Acquire the assets for the Use of Co information

REMUNERATION OF PROMOTERS

A promoter is not entitled to any remuneration for services rendered for the company
unless there is a contract so enabling him. In the absence of such a contract, a promoter
has no right to even his preliminary expenses or even the refund of the registration fees for
the company. He is therefore under the mercy of the Directors. But before a company is
formed, it cannot enter into any contract and therefore a promoter has to spend his money
with no guarantee that he will be reimbursed. It is thus unfair to burden a Co with a
contract that it did not enter into the first place.. In practice though, the promoter
remunerates himself as director.

But in practice the articles will usually have provision authorizing directors to pay the
promoters. Although such provision does not amount to a contract, it nevertheless
constitutes adequate authority for directors to pay the promoter.

Under s 80 of table A promoters cannot enforce the argument that they are entitled to
remuneration because they are not members of the Co in the 1st place. The promoter is
outside the contractual obligation of the Co. He cannot sue the Co, since at the time of the
formation of the Contract he was not a member.

Promoters can be appointed as 1st directors as they can also be given deffered/founders
shares which have the original price attached to them. They can also act as commission
agents so that they can acquire an asset, this is under the condition that they disclose such
profit. They can sell an asset to the Co and overvalue it so that they can earn profit. The
director can also overvalue an asset and the profit earned be used by earning of the shares.
They can have an opportunity to have extra shares even after the nominal value has risen.

REMEDIES AGAINST PROMOTERS

(i)Rescission of Contract. This is discretionary. Restoration of the precontractual contract is

easily lost and any delay can deny the rescission of the contract as it will be presumed that

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there was implied affirmation of the contract. Rescission will not apply where third
parties are present since intitition intergram is impossible which is the essence of
rescinding the contract.

(ii)Recovery of secret profit if the account is not disclosed . the property is not
…….rescinded. The promoter does not destroy the contract he will rather sue for damages.

(iii)Compensation.s 45(1) A third party who suffers loss wil ask for damages as remedy by
the promoters/directors/any other person who issued the prospectus.

(iv)Damages. This is always sued as an alternative remedy to damages or account of secret

profit. Issued in Re Leeds v Haley Theatres of Varies Ltd. Where the promoters made 12000
pounds profit and the CO sued for the recovery of that profit but the court granted damages
Vaugan LJ stated that,“I am clear there is a remedy in the shape of damages”

PRELIMINARY CONTRACTS BY PROMOTERS

Until a company is formed, it is legally non-existent and therefore cannot enter into any
contract or even do any other acts in law. Once incorporated, it cannot be liable on any
contract nor can it be entitled under any contract purported to have made on its. behalf
before incorporation. At this time the Co has no legal capacity to enter into a contract and
has no agents and thus cannot be the principle. This was the case in ;

Kelner v. Baxter (1886) L.R. 2 C.P. 174

In this case, A, B and C entered into a contract with the Plaintiff to purchase goods “on
behalf of the proposed Graves and Royal Alexandra Hotel Company” the goods were duly
supplied and consumed. Shortly after incorporation the company in question collapsed
and the Plaintiff sued A B and C for the price of the goods supplied.

It was held that A B and C were liable. Chief Justice Erne stated as follows:

“where a contract is signed by one who professes to be signing as agent but who has
no principal existence at the time, then the contract will hold together the inoperative
unless binding against the person who signed it. He is bound thereby and a stranger
cannot by subsequent ratification relieve him from that responsibility. When the company
came afterwards into existence, it had rights and obligations from that time but no rights or
obligations by reason of anything which might have been done before.”

To reinforce this a contract entered into with a non-existent person is void.

Newborn v. Sensolid (G.B Ltd) (1954) 1 Q.B. 45

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Here a contract was entered into between Leopold Newborn London Ltd and the Defendant
for purchase of goods by the latter. The defendant subsequently refused to take delivery of
the goods and an action was commenced by Leopold Newborn Ltd.

It was discovered that at the time the contract was entered into, the company had not been
incorporated. Leopold Newborn thereupon sought personally to enforce the contract.

It was held that the signature on the document was the company’s signature and as the
company was not in existence when the contract was signed, there never was a contract
and Mr. Newborn could not come forward and say that it was his contract. The fact was
that he made a contract for a company which did not exist.

The courts have stated that

Ratification is not possible when the ostensible principle is non-existent in law when the
contract was entered into. It can only enforceable after re-entering the contract after the
formation of the Co. If a person ets into a pre-incorporation contract in the absence of a
principle he shall be held liable.

Price v. Kelsall (1957) E.A. 752

One of the issues in this case was whether or not a company could ratify a contract entered
into on its behalf before incorporation. The alleged contract was that the Respondent had
undertaken to sell some property to a company which was proposed to be formed between
him and the Appellant. In holding that a company cannot ratify such an agreement, the
Eastern Africa Court of Appeal as then constituted O’Connor President said as follows

“A company cannot ratify a contract purporting to be made by someone on its behalf

before its incorporation but there may be circumstances from which it may be inferred that
the company after its incorporation has made a new contract to the effect of the old
agreement. The mere confirmation and adoption by Directors of a contract made before
the formation of the company by persons purporting to act on behalf of the company
creates no contractual relations whatsoever between the company and the other party to
the contract.”

However, acts may be done by a company after its formation which give rise to an inference
of a new contract on the same terms as the old one.

The question whether there is a new contract or contracts is always a question of facts
which depends on the circumstances of each individual case.

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As to whether the promoters will be personally liable on such contracts of nought might
depend on the terminology employed. In the case of

A director cannot incorporate a pre-incorporation contract as it creates no contractual

relationship between the Co and the promoter.[Nothern Sydney Investment Co and
another v Higgs and Another]

If the Co after incorporation enters into a new contract similar the previous agreement,the
new contract may be express o implied after incorporation of the new corporation and will
be enforceable

Mawagola Farmers & Growers Ltd. V Kanyanja (1971) E.A. 272

Here, prior to the incorporation of a company the promoters held public meetings at which
members of the public were asked to purchase shares in a proposed company. The
Respondents paid for the shares both before and after incorporation of the company but
the company did not allot any shares to them. Instead after incorporation, it allotted shares
to other people.

The Respondents filed actions praying for orders that the shares they paid for be allotted to
them and the company’s registered members be rectified accordingly.

The Company argued that as the Respondents had paid money for the purchase of their
shares before incorporation, their claim could only be directed against promoters because
no pre incorporation agreement could bind the company and the company could not even
after incorporation ratify or adopt any such contract.

Mustafa J.A. replied as follows:

“in order that the company may be bound by agreements entered into before
incorporation, there must be a new contract to the same effect as the old agreements. This
contract may however be inferred from the acts of the company when incorporated.”

The allotment of shares to the Respondents after the incorporation was held to be
sufficient evidence of a new contract between the company and the Respondents.
Therefore the Respondents were entitled to be allotted the shares agreed upon.

If any preliminary arrangements are made, these must therefore be left to mere
gentlemen’s agreements or otherwise the promoters might have to undertake personal
liability.

Although the principle is clear, those engaged in the formation of companies often cause
contracts to be entered into on behalf of their proposed companies.

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THE COMPANY PROSPECTUS

Although Sections 39-48 regulates the contents and issue of prospectus, they do not define
a prospectus
A prospectus is defined by Section 2 of the Act as “any notice, circular advertisement or
other invitation, offering to the public for subscription or purchase any shares or
debentures of a company”.

The definition suggests that a prospectus embrace any document, notice, circular
advertisement. What matters is not the name given to the document by its authors but its
effect on the person reading it. If the person reading the document would conclude that he
was being ‘invited’ to apply for any shares or debentures of a company, the document
would legally be a prospectus even if it is not headed so. The offer must be made to the
public.

PROSPECTUSES

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When the public is asked to subscribe for shares or debentures of a company the invitation
involves the issue of documents, which set out the advantages to accrue from an investment in
a company. This document is called a prospectus and may be issued either by the company
itself or by a promoter.

It is only in the case of a public company that a prospectus may be issued. A private
company must always raise its capital privately as required by section 30 of the Company
Act. Section 20 defines prospectuses as

“Any prospectus, notice, circular, advertisement or other invitation offering to the public
for subscription or purchase of any shares or debentured in the company”

The word invitation and offering in that definition are loosely used because when a
company issues a prospectus it doesn’t offer to sell any shares but rather invite offers from
members of the public. A prospectus is therefore not an offer but an invitation to treat. The
word prospectus is vague and uncertain when an invitation is made to the public it is a
question of fact.

The question of ‘public’ isn’t restricted to a certain section of the public but includes any
member of the general public.

Re South of England Natural Gas Co.

A newly formed company issued 3,000 copies of a document, which offered for
subscription shares in a company was headed “For private circulation only”

These copies were then circulated to the shareholders of a number of gas companies. So the
question here was this a prospectus?

It was held that this was an offer to the public and therefore constituted a prospectus.

CONTENTS OF A PROSPECTUS

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The object of a Company’s act is to compel a company to disclose in a prospectus all the
necessary information which would enable a potential investor in deciding whether or not
to subscribe for a company’s shares or debentures.

Therefore section 40 requires that every prospectus shall state the matters specified in
article 1 of the 3rd schedule to the Act and that it will also set out the report specified in part
2 of that schedule.

The provisions in that schedule are designed mainly to provide information about the
following matters

1) Who the directors are

And what benefit they will get form directorship

2) In the case of a new company what profits are being made by the promoters
3) Amount of capital required by the company to be subscribed the amount actually
received or to be received, the precise nature of consideration which is not paid in case
4) In the case of an existing company what the company’s financial record in the past.
5) The company’s obligations under any contract entered into.
6) The voting and dividend right of each class of shares.

If a prospectus includes any statement by an expert then the expert must have given
written consent to the inclusion of the statement and the prospectus must take it like he
has done so. Section 42.

Contravention of these requirements renders the company and any person who knowingly
a party to the issue of prospectus to a fine not exceeding Ksh. 10,000

Section 42 defines expert

“Including Engineer, Valuer, Accountant or any other person whose profession gives
authority any statement made by him.”

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In addition to the requirements it must be dated and the date stated therein is date of
publication of the prospectus. However there are 2 instances when a prospectus need not
contain matters set out in schedule 3 namely

i) When the prospectus is issued to existing members or shareholders of the

company.
ii) When the prospectus relates to shares or debentures uniform to previous
debentures or shares.

LIABILITY IN RESPECT OF PROSPECTUSES

If a prospectus contains untrue statements the Act subscribes both a penalty at criminal
law and also civil liability if payment of damages.

As concerns criminal liability section 46 where a prospectus includes any untrue

statements any person who authorized the issue of the prospectus is guilty of an offence
and liable to imprisonment not exceeding 2 years or a fine not exceeding 10,000 or both.
Such a fine and imprisonment unless he proves the statement was material or that he had
reasonable grounds to believe or did at the time of issue of prospectus believe the
statement true.

A statement is deemed untrue and misleading in the form and context in which it is
included.

Case

R v. Kylsant

In this case the company sustained continuous losses for 6 years between 1921-1927/

The company issued a prospectus, which in all material facts was correct. It further
specified that the dividends paid were high.

But the dividends wee being made out of abnormal profits from 1 st world war and the
prospectus was misleading in its context.

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CIVIL REMEDIES

There are 2 remedies for those who subscribe for shares as a result of misleading
statements in a prospectus.

a) Damages
b) Rescission
Section 45 provides for compensation to all persons who subscribe for shares or
debentures on the faith of prospectus for loss or damage sustained for statements included
therein.

If the statement is false to the knowledge of those who made it, it amounts to fraud and
damages recoverable from all those who made the statement intending on it to be referred
upon.

Case

Derry v. Peek

Herein, a company had power to construct tramways to be moved by animal power and
with the consent of the board of trade by steam or mechanical power.

The directors issued a prospectus stating that the company had power to use steam or
mechanical power. On reliance of this misrepresentation the plaintiff bought shares.
Subsequently the Board of Trade refused to give trade to use of steam and mechanical
power and as a result the company was wound up.

The plaintiff brought an action for deceit alleging fraudulent misrepresentation. It was held
that the defendant weren’t liable, as they had made the incorrect statement in the honest
belief that it was true.

Lord Herschell stated

“The authorities established 2 major propositions

a) In order to sustain an action for deceit there must be proof of fraud and nothing
short of that will suffice
b) Fraud is proved when it is shown a false representation is made either
i) Knowingly
ii) Without belief in its truth
iii) Recklessly not caring whether it be true or false

In order to succeed in an action for damages for fraud the plaintiff must show that the
misrepresentation was made to him or that he was one of a class of persons who were
intended to act upon it.
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2.The ordinary cause of a prospectus is for the public to become allotees of shares to a
company. Once shares have been allotted, the prospectus would’ve served its purpose and
thereafter can’t be used as a ground for filing an action for fraud in respect of shares
bought at a latter date from another source.

Case

Peek v. Gurney

The allotment of shares in the company began on July 24 th and was completed on 28th July.
In October the plaintiff bought some shares on the stock exchange. He later found that the
prospectus for July contained untrue statements and this brought an action.

The question therefore is could he sue?

It was held hat the plaintiff couldn’t base this action on the prospectus intended to be based
to the original subscribers.

The directors aren’t liable after full allotment of original shares for all subsequent dealings,
which may take place to those shares on the stock exchange.

2(a)The rule in Peek v. Gurney won’t apply where a prospectus is intended to induce not
only the original subscribers of a company’s shares but also to influence the subsequent
purchase of those shares.

Case in point

Andrews v. Mock Ford

The plaintiff alleged that the defendant sent him a prospectus inviting him to buy shares in
the company, which they knew would be a sham but the plaintiff, didn’t subscribe for the
shares.

The prospectus eventually produced a very scanty subscription and the defendant caused a
telegram to be published in the local newspaper to the effect that they struck a vein of gold
and this they alleged they confirmed the statistics in the prospectus.

The plaintiff bought shares on this basis and eventually the company wound up.

The question here is had the prospectus served its purpose?

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It was held that the prospectus intended to induce the plaintiff both to subscribe for shares
initially and also to buy them in the market thereafter. The telegram was part of the
prospectus.

Lord Justice Smith

“There was proof against the defendant a continuous fraud on their part commencing with
ascending of the prospectus to the plaintiff and culminating in the direct lie told in a
telegram which was intended by a defendant to operate in the plaintiffs mind and on the
mind of others and did operate to his prejudice and the advantage of the defendant.

In this case the function of the prospectus wasn’t exhausted and the false telegram was
brought into play by the defendant to reflect back upon and countenance the false
statement in the prospectus

The purchaser of shares induced to buy shares by the mis-statement in the prospectus has
an action for damages in negligence. He has also an action for negligent mis-statement.

Under the case of

Hedley Byrne & Co. v. Heller & Partners

All these actions are directed to the directors personally.

Rescission
As against the company a person induced to buy shares by a misrepresentation in the
prospectus may rescind the contract.

On buying shares one’s contract is with a company itself, the remedy is available only
against the company. To be entitled to this remedy it is not necessary for the purchaser of
the shares to show that the statement was fraudulent or negligent.

Even if the misrepresentation was innocent rescission lies. The right to rescind is subject to
two limitations.

a) The allotee looses the right to rescind if he shows any election to affirm the contract.
For example by attending and voting at the company’s meetings or by accepting to sell the
shares

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b) If the allotee doesn’t rescind the contract before the company is wound up he looses
the right to do so as from the moment winding up proceedings are commenced.

ORGANS OF THE COMPANY

DIRECTORS
“The directors are a body to whom is delegated the duty of managing the general affairs of
the company. A corporate body can only act through agents and it is of course the duty of
those agents so to act best to promote the interest of the corporation whose affairs they are
conducting”.

Directors are said to be the brain of the company and occupies a pivotal position in the
structure of the company, and since the directors are the brains of the company; it is only
when the brain functions that the corporation is said to function.

Board of Directors is given the powers to manage and run the company. Cap. 486 together
with the articles bestows powers to directors to manage. Members have no right to
interfere with such management; infact if members interfere; the directors have a right to
bring an action against the members to restrain them.

The directors have an express right to manage the company, but if the management want to
interfere with the Board, then they have to convene an extra ordinary general meeting and
alter the constitution of the company to allow them interfere.

“If you want to interfere in the management of the company's affairs, convene a general
meeting and alter the company’s constitution by passing a resolution obliging the directors
to act the way you want”.

Case Law: Automatic Self cleaning Syndicate Ltd vs. Cunningham (1906)
By its articles of association, the general management and control of the company was
vested in the directors, subject to regulations as might from time to time be made by extra
ordinary resolutions. In particular, the articles of association conferred on the directors the
power to sell or otherwise deal with any property of the company on such terms as they
may consider fit. The members at a general meeting passed an ordinary resolution forcing
the directors to sell certain property of the company on certain terms. The directors
refused to the effect that it was directive and therefore declined to sell.

It was held that the company’s constitution conferred upon directors the general powers to
manage the company, and in particular to decide when to sell the property of the company
and on what terms.

Notwithstanding the fact that powers to manage the company have been given to the
directors, the members have a right to intervene and take away such management: -

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(a) Where the directors are improperly using the name of the co. in litigation.
(b) If the B.O.D. itself cannot function due to one reason or another the members may
intervene.
There were two members who were also directors of the company. A conflict arose which
rendered them impossible to even communicate face to face and the only communication
was by way of memos. One member went to court petitioning for winding up under the
clause “just and equitable”. The court agreed with the application, but it was observed
that:-

“If it had been possible to have separate members from these two, the court have ordered
that they take up the management until a new team comes in”.
In another instance, (Foster vs. Foster), there was a disagreement and as a result there was
a deadlock in voting. The court said that under those circumstances where the directors
are unable to exercise powers conferred upon them by the company’s articles, the
company/members in a general meeting would take over the management and appoint a
new team.

(c) Where the directors have acted ultra vires the powers granted to them or the company
itself: - The management can ratify that which the directors did in excess of their powers.
For example, if the articles might have conferred upon them some powers but they have
exceeded the powers; in that eventuality, the management can take away those powers.

Secondly, the company did not have the kind of powers the directors exercised, and
therefore did not give them powers. In this case the members can intervene and remove
those directors.

Meaning of a Director

Under Section 2 of the Act, “A director, includes any person occupying the position of
director by whatever name called”.
“A director may be identified by the functions the person performs even though he may be
named differently, for example, Jaduong, Munene and so on.

A director may therefore be defined as, “a person having control over the direction,
conduct, management or superintendence of the affairs of a company”.

What is the position of a person occupying the position of a director but is not duly
appointed, is he still a director?

A person, who acts as a director performs the functions of a director although not duly
appointed and occupies the position of a director, is a director. This is supported by the
phrase “by whatever name called”. This does not limit the meaning. Infact it extends its
meaning to include a person who performs the functions as a director though called by
another name.

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Section 181 also supports the above case in that if a person is not validly appointed as a
director, but acts as one and the appointment is later on discovered to be defective,
anything that he has done is valid notwithstanding an irregularity in appointment of such a
person.

APPOINTMENT OF DIRECTORS

Section 177 provides that every company shall have at lest two directors while every
private companies and every other company registered before 1962 shall have at least one
director.

Under Table A, Article 75, the actual number of the directors would initially be decided
upon by the subscribers of the memorandum (promoters) and until so determined, all of
them shall be the first directors.

Table A, Article 94 empowers the company from time to time by ordinary resolution to
increase or reduce the number of its directors.

The following are the various stages of appointment of directors:-

(a) The first directors of the company.
(b) Subsequent appointment of directors.
(c) Appointment to fill a vacancy.
(d) Appointment of alternate director.
(e) Appointment of Managing Director.

(a) First Directors

Article 75 provides that the names of the first directors shall be decided in writing by the
subscribers of the memorandum of association or a majority of them.

They are usually appointed by promoters of company and normally their names are
indicated in the articles of association.
If promoters do not appoint the first director, then the tradition has been to follow the
provision in the Articles 75 of Table A, that is, people who subscribe to the memorandum of
association will become and be regarded as the first directors, until proper appointment is
done. They shall hold office until the directors are appointed at Annual General Meeting.
The articles may also provide that both the number and the names of the first directors
shall be determined in writing by the subscribers to memorandum.

(b) Subsequent Directors

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The subsequent directors are appointed by the members in general meeting beginning
from the first annual general meeting at which all the first directors retire from office and
the members are given the first opportunity to elect directors of their own choice. The
retiring directors are however eligible for election under Article 91.

At the second annual general meeting, one third of the directors are to retire from office,
the ones to retire being the ones who have been longest in office since their last election.
As between persons who became directors on the same day, those to retire shall be agreed
upon amongst themselves otherwise it shall be determined by lot. One third of the board
shall thereafter retire by rotation annually.

(c) Casual Appointment/vacancy

Articles 95 permits the board of directors to fill a vacancy in the board or to get an
additional director to join the board for practical reasons provided that the appointment
does not cause the number of directors to exceed the limit imposed by the articles. The
person appointed this way will hold office until the next annual general meeting. He will
then be eligible for re-election, but his appointment will not be taken into account when
deciding on the directors who shall retire from office.

(d) Alternate Directors

An alternate director is one appointed by another director to temporarily represent him

during his absence or inability in the Board of Directors. This power can be exercised only
if it is permitted in the articles of association. The common law rule “delegatus non potest
delegare”, states that a director has no authority to appoint an alternate director.

However where the article of association is silent about the appointment of alternate
director, a director can still appoint an alternate director.
When a director appoints an alternate director, he may indicate the powers which such an
alternate director may exercise on his behalf and those which he may not, for example, he
may participate in Board meetings and sign documents but not more than that.
He cannot hold office for a period longer than that permissible to the original director in
whose place he has been appointed.
The alternate director may be another director or an outsider. If he is a director, he would
have the vote of the absentee in addition to his own vote.

(e) The Managing Director

A Managing Director is part of the subsequent directors. It is governed by company

practice because it is always a company’s affair. The Act itself does not contain direct
provisions on the appointment of a Managing Director. It is found in the articles of
association, not the Act.

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A Managing Director who by virtue of agreement with the company, or of a resolution

passed by the company in a general meeting, or by virtue of its memorandum or articles, is
entrusted with substantial powers of management.

A director so appointed shall not whilst holding that office be subject to retirement by
rotation but his appointment shall be automatically terminated if he ceases due to any
cause, to be a director.

A Managing Director like any director can be removed at any time from office by a general
meeting irrespective of the fact that this duration of his appointment is not yet over. But
where his services have been terminated in breach of his terms, he is entitled to claim
compensation.
Managing Director receives compensation as may be determine by directors.

RESTRICTION ON APPOINTMENT

There are various restrictions which the Act imposes on appointment of directors and
these restrictions must be fulfilled for one to be appointed as director.

(1) Appointment by Articles

Section 182(1) states that a person shall not be capable of being appointed director of a
company by the articles unless, before registration of the articles, he has signed and
delivered to the registrar for registration a consent in wanting to act as a director and
either: -
(a) signed the memorandum for a number of shares not less than his qualification shares, or
(b) taken from the company and paid or agreed to pay for his qualification shares
(c) Signed and delivered to the registrar for the registration, an undertaking in writing to
take from the company and pay for his qualification shares.

These provisions do not apply to: -

(a) A company without share capital.
(b) A private company.
(c) A company which was a private company before becoming a public company.

(2) Qualification Shares

Under Section 183 (1), it shall be the duty of every director who is by the articles of the
company required to hold a specified share qualification and who is not qualified to obtain
his qualification within 2 months after his appointment or within the shorter time as fixed
by the articles.

Section 183(3) provides that the director shall vacate office if he fails to obtain his share
qualification or ceases to hold the required number of shares

Case: R vs. Camps (1962) Court of Appeal for E.A.

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The respondent, in his capacity as a director of a company, had been charged with several
offences under the companies Act. Although the directors of the company had under article
96 of the company’s articles of association duly appointed him to be the director and he
had acted as such, he never acquired the required share qualification but in a statutory
return, subsequent to his appointment, he was shown as a director which was fixed at one
fully paid up share in his own right.

Article 87 which agrees with the terms of section 183(1) of the Act provided that the office
of the director shall be vacated if a director ceased to hold the number of shares required to
qualify him for office or fails to acquire the same within 2 months after his appointment.

The court held that as the respondent had never possessed or acquired his qualifying share,
his appointment was invalid and that there were no cases for him to answer.

It was also held that the respondent was never even a de facto director and that in any
event a de facto director was not criminally liable as a director under the Company’s Act.

Against that decision, the Attorney General appealed to the High Court and the case was
dismissed but on further appeal, the High Court held that: -
(i) The word “director” in the Company’s Act includes a de facto director.
(ii) The respondent was duly and validly appointed a de jure director but he ceased to be a
de jure director two months later as he failed to acquire his share qualification within that
time.
(iii) If the respondent acted as a director after the expiration of two months from his
appointment, he was then a de facto director and he was a director for the purpose of those
sections of the Company’s Act which it was alleged he had contravened.
“Appeal allowed, acquittal set aside”.

Therefore if a director does not vacate office but continues to act as a director, he ceases to
be a de jure director and becomes a de facto director. Under Section 183(4), a de facto
director is incapable of being reappointed director of the company until he has obtained his
qualification shares and under Section 183(5), he is liable to a fine not exceeding one
hundred shilling for everyday that he acts as a director of the company.

(3) Age Limit

Section 186 provides that no person shall be capable of being appointed a director if at the
time of his appointment: -
(a) He has not attained the age of 21.
(b) He has attained the age of 70.
This provision does not apply if the company’s articles provide otherwise or a special
notice of the resolution was given to the company.

Section 142 defines “special notice” as a notice given to the company not less than 28 days
before the meeting at which the relevant resolutions are to be moved.

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(4) Undischarged Bankrupts

Section 188 provides that if a person who has been declared bankrupt or insolvent by a
competent court and who has not received his discharge, acts as a director of any company,
shall be liable to imprisonment for a term not exceeding 2 years or to a fine not exceeding
Sh. 10,000 or both.

(5) Fraudulent Persons

Section 189(1) empowers the court to make an order restraining a person from being
appointed, or act as a company’s director for a period not exceeding 5 years if: -
(a) The person is convicted of any offence in connection with the promotion, formation or
management of the company, or
(b) in course of winding up, it appears that the person had been guilty of fraudulent trading.

(6) Individual Voting

Section 184(1) provides that the appointment of directors of a company which is not a
private company is to be voted on individually, unless a motion for the appointment of the
two or more persons as directors by a single resolution was agreed upon by the meeting
without any vote against it.

A resolution moved in contravention of this provision is void under Section 184(2) even if
no objection is moved. The aim of this provision is to prevent a company’s members being
virtually forced to vote for directors who they do not want.

QUALIFICATIONS OF A DIRECTOR

There is no requirement in the Act that a director must hold shares, but more frequently,
the articles provides that no person shall act as a director unless he holds certain number
of shares or stock.
If the articles of association contain a provision that the qualification of a director shall be
holding a specified number of shares, then Section 183 provides that:-

(i) Each director must acquire and retain such qualification shares within two months after
his appointment or such a shorter time as may be fixed by Articles.
(ii) The warrant payable to bearer will not count for the purpose of qualification shares.
(iii) If he fails to acquire qualification shares within 2 months he automatically ceases to be a
director.
(iv) He cannot be reappointed director unless he has obtained his qualification shares.
(v) If he acts as a director after expiry of 2 months without taking qualification shares, he is
liable to a fine up to Sh. 100 for everyday until he stops acting.

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Retirement Age

Every director is required to retire from office shortly after 70 years and no one should be
reappointed after that age-but this does not apply where the appointment is made or
approved in Annual General Meeting after a special notice has been given.

It does not apply to private companies unless they are subsidiaries of public company. The
act also fixes the minimum age and states that no person is capable of being appointed as a
director if at the time of his appointment, he has not reached or attained the age of 21.
Bankruptcy also disqualifies any person from holding office as a director.

Effects of Disqualification

Whether a director holds qualification shares or not, the company will be bound to third
parties for the acts of such directors until the effect in appointment or qualification is
disclosed.

POSITION OF DIRECTORS

(a) Directors as agents

The directors are elected representatives of shareholders. They are in the eyes of law
agents of the company and the general principles of agency regulate in most cases, the
relationship between the company and its directors.

The directors are more than agents- they have in certain matters, independent powers.
They are not bound to consult shareholders in all maters. Power vested with directors,
they and they alone can exercise these powers.

(b) Directors are not personally liable as agents

Where the directors of a company act on its behalf, they are personally liable for contracts
which they make provided they act within the scope of their authority and they do not
make contracts in their personal names.
It was held that “whenever an agent is liable, directors would be liable, where the principal
would be liable; the liability is the liability of the company”.

The directors are personally liable when:-

(i) The contract is in their names
(ii) They use the company name incorrectly e.g. by omitting the words Ltd & Plv. Ltd.
(iii) The contract is signed in such a way that it is not clear whether it is the agent or
principal who signed it.
(iv) They exceed the powers given to them by memorandum and articles of association.
(c) Directors as Employees

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Although directors are agents of the company, they are not employees or servants of the
company for being entitled to privileges and benefits which are granted under the
company’s Act to employees but there is nothing to prevent a director from being a servant
of the company under a special contract of service, which he may enter into with the
company.
Palmer’s statement gives an insight into this matter. He states that, “Directors are not as
such employees of the company or employed by the company nor they are servants of the
company or members of its staff. A director can, however hold salaried employment or an
office in addition to that of his directorship which may for this purpose make him an
employee or servant and in such a case, he would enjoy any right given to employees as

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such but his directorship and his rights through that directorship are quite separate from
his rights as employee”.

(d) Directors as Trustees

Directors are treated as trustees of the company’s property and money and of the powers
entrusted to them.

Directors are the trustees of the company’s money and property in the sense that they must
account for all the company’s money and property to refund to the company any of its
money or property which have been impropriety paid, that is, not to pay dividends out of
capital. Company property includes confidential information and beneficial contracts
meant for the company.

The following points in regard to confidential information are worth noting:-

(i) The information itself must be confidential- nothing public.
(ii) The information must have been communicated to the directors or it has reached them
in circumstances obliging them to treat it as confidential.
(iii) The directors must have made an unauthorized use of that information, for example,
converting it to their own use.

The court went a length to explain and define the scope of directors’ duties with emphasis
on the protection of company’s property:-
(i) A director as a fiduciary is under an obligation not to profit himself personally from the
property of the company. More so in a situation where his interest is likely to conflict with
those of the company to which he is appointed a director.
(ii) Directors as fiduciaries, if they use the property of the company thereby making profits,
must be honest enough to account for this profit to the company.
“Men who assume the complete control of the company’s business must remember that
they are bound to protect the property of the company. They are not at liberty to sacrifice
the interests which they are bound to protect, and while ostensibly acting for the company,
divert in their own favor business which should properly belong to the company they
represent”.

Incase director s are guilty of a distinct breach of duty of which they took to secure the
contract which was meant for the company, whatever benefit they must have obtained
must be regarded as being held by them on behalf of the company.

Directors are however not trustees in the real sense of the word because they are not
vested with the ownership of the company’s property. It is only as regards some of their

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obligations to the company and certain powers that they are regarded as trustees of the
company.

The directors are really only quasi trustees because:

(i) They are not vested with the ownership of the company’s property.
(ii) Their functions are not the same as those of trustees.
(iii) Their duties of care are not as onerous as those of trustees.

True position of directors according to Jessel, M.R. in Forest of Dean Coal Mining Company,
observed that, “Directors have sometimes been called as trustees or commercial trustees
and sometimes they have been called managing partners, it does not matters much what
you call them so long as you understand what their real position is, which is that they are
really commercial men managing a trading concern for the benefits of themselves and of all
the shareholders. They stand in a fiduciary position towards the company in respect of
their powers and capital under their control”.

DIRECTORS REMUNERATION

For technical reasons the directors are not regarded as employees of the company of which
they are directors. They therefore have no right to be paid their services unless there is a
provision for payment in the articles.

Table A, Article 76 provides that “remuneration of the directors shall from time to time be
determined by the company in general meeting”.

Provided the resolution has been passed, the remuneration is payable whether profits are
earned or not.

The remuneration payable to the directors of a company is determined by the articles of

the company or by a resolution passed by the company in general meeting.

The directors have no right to be paid for their services and cannot pay themselves or each
other or make presents to themselves out of the company’s assets unless authorized to do
so by the instrument in writing, for example, articles or by shareholders at a properly
convened meeting.

If directors are not entitled to remuneration and they pay themselves remuneration out of
company’s funds, they may be compelled to restore it even though they acted in good faith
and honestly believe that the payment was permissible.

Directors may be paid traveling, hotel and other expenses properly incurred by them in
attending company’s business. In the absence of such a provision, a salaried director is not
entitled to expenses incurred by him as they are usually covered by his remuneration.

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The remuneration payable to director is a debt from the company, and a director may sue
the company for non-payment.
Incase of absence or inadequacy of profits, it can be paid out of profits with approval of the
company.

Powers of Directors

The powers of directors are usually set out in the articles, and quite frequently there is a
clause entrusting the management of the company’s affairs in the hands of directors and
possess the following powers which enables them to carry out their functions:-
(a) To enter into contracts on behalf of the company.
(b) To engage or dismiss employees.

The directors’ powers may be restricted by the articles, for instance, some certain acts shall
not be done by them unless they first obtain the sanction of the company in general
meeting.
Where such provisions exist in the articles, failure to obtain the sanction may render the
company not bound by the acts and the directors then become personally liable to the third
parties.

If a director has an interest in any contract which is being considered by the company he
must usually declare his interest when the contract is being discussed.

A director is said to have declared his interest not when he states that he has an interest
but when he states what his interests are.
The disclosure should be made at the time the contract in question comes before the Board
of Directors for discussion.
Disclosure is only valid if it is made to sufficient number of directors who are themselves
not interested in the contract. In a case of three directors, if two are interested and declare
to one who is not, it is invalid. This is because the directors who are interested are
incapable of voting in the issue and since they are a majority, there is no quorum to which
the disclosure is made. Quorum in this case means sufficient number of directors who are
not interested in the contract.

Legal effect for directors for non-disclosure of interest

The consequences are two fold:-

(i) Statutory consequences.
(ii) Common Law consequences.

At common law, the contract itself becomes avoidable at the option of the company, that is,
the company can decide to continue with the contract or not or repudiate. If the director in
question has made secret profits on that contract, he must refund the same to the company.

In statutory consequences under Section 200(4), such directors shall be liable to a fine not
exceeding Sh. 2,000.

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ASSOCIATE DIRECTORS

A company may appoint one or some of its employees to its board of directors. Such
appointment is primarily intended to provide employees with a forum where they can
express their views on the company’s operations, programmes or policies. Employees who
are appointed are usually called “associate directors”.

CORPORATE DIRECTOR

Although the statutory restrictions on appointment of directors tend to suggest that only a
natural person can be appointed as director, in practice it is not so. Holding companies
appoint themselves directors of subsidiary companies with a view to securing and
maintaining complete control of the subsidiaries. This has been made possible by the fact
that there is no provision in the Act which prohibits the practice.
The body corporate would appoint a natural person whom it has formally authorized to
attend board meetings on its behalf.

DISQUALIFICATION OF DIRECTORS

Table A, Article 88 provides that the office of director shall be vacated if the director: -

(i) He has ceased to be a director by virtue of Section 183, that is, he has failed to take-up
prescribed shares within two months of his appointment or under Section 186 which lays
down the minimum and the max age for directors.
(ii) He becomes bankrupt.
(iii) He becomes prohibited from being a director by reason of any order made
under Section 189 (restraining fraudulent persons from managing a company).
(iv) He becomes of unsound mind
(v) He resigns his office by notice in writing to the company.
(vi) He is absent without permission for more than 6 months from meetings of directors
held during that period.
Regarding resignation, it was held in Premier Cinema Co. vs. Ennion that a verbal notice of
resignation which is given to and is acceptable by the general meeting is effective and
cannot be withdrawn. This is because the general meeting would be deemed to have
amended the company’s articles by deleting the words “in writing”. But if an oral notice of
resignation is given to and accepted by the board of directors, it would be invalid since the
directors cannot legally alter the company’s articles of association.

Regarding absence from board meetings, it should be noted that it does not say that the
director in question shall vacate office if he “absents himself”. Such would disqualify the
director if the absence in question was voluntary. The office would be termed vacated if
the director has not been in office even if on medical grounds as per McConnell’s claim.

A person may also cease to be a director for other reasons as follows: -

(i) Death.

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(ii) Retirement by rotation under articles.

(iii) Dissolution of the company.

VACATION/REMOVAL OF DIRECTOR

A director may leave office either by vacation or by removal.

(a) Vacation

This is the voluntary quitting by a director. It can happen any time during the directors
tenure of office for any reason such as ill health, age, agreement with the Board of
Directors, bankruptcy, ceases to hold qualification shares, of unsound mind, is convicted by
the court of an offence involving moral turpitude absents himself from meetings, restrained
by the court from being a director and so on.

(b) Removal of Directors

Removal means being forced to quit the position of a director. A director can be removed
by:-
(i) Operation of law
(ii) Company itself

If a director is in breach of his statutory qualification, the consequence is that the law
operates immediately to remove him. Secondly, when the company goes into liquidation,
the directors ceases to hold office.

Section 185(1) provides that a company may by ordinary resolution remove a director
before expiration of his period of office, not withstanding anything in the articles or in any
agreement between him and the company. A company may remove a director by ordinary
resolution after giving a notice.

It is vital to note that Section 185 requires that the company observe the rules of natural
justice which insists that a man shall not be condemned unheard. The company must send
a copy to the director concerned who is entitled to speak in his defence.
A removed director may claim compensation for the loss of office.

Compensation for Removal

Section 185(6) provides that nothing in the section shall be taken as depriving a removed
director of compensation or damages payable to him in respect of termination of his
appointment as a director.

This provision would enable a managing director to sue the company for damages for
wrongful dismissal if the effect of his removal as a director was to prematurely terminate
his appointment and was inconsistent with the contract.

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COMPENSATION FOR LOSS OF OFFICE

(a) Section 192(1) makes it unlawful for a company to make to a director any payment by
way of compensation for loss of office, or consideration for or in connection with his
retirement unless the particulars of the proposed payment are disclosed to the members
and approved by the company in a general meeting. This is necessary because the
directors when negotiating the terms of the proposed settlement would be dealing with
one of their own and might as a consequence give inadequate consideration to the interests
of the company.
(b) Section 193 provides that it shall not be lawful to transfer any part of the undertaking or
property for the purpose of making any payment to a director by way of compensation for
loss of office or on retirement unless particulars are disclosed to the members of the
company and approved by the company in a general meeting.
(c) If a payment is made to a director as compensation for loss of office or on his retirement,
he must take reasonable steps to ensure that the particulars of the proposed payment are
included in or sent with any notice of the offer given to the share holders. If this is not done,
the director holds the payment on trust for the persons who have sold their shares as a
result of the offer.
(d) Section 194 imposes a duty on directors to disclose payments for loss of office, made in
connection with transfer of shares in a company. This section provides that such payment
should be proposed with a transfer as a result of:-
(i) An offer made to the general body of shareholders.
(ii) An offer made by or on behalf of some other body corporate with a view to the
company becoming its subsidiary or a subsidiary of its holding company.
(iii)An offer made by or on behalf of an individual with a view to his obtaining the right to
exercise or control of not less than 1/3rd of the voting powers at the general
meeting.

Loans to Directors

Section 191(1) renders unlawful any loan made by a company to a director. It is also
unlawful for the company to guarantee or secure a loan given to a director by any other
person. These restrictions do not apply to:-
(i) A private company, or
(ii) A subsidiary company whose director is its holding company or
(i) Payments made to a director to meet expenses incurred or to be incurred for the
purpose of the company, or to enable him to perform his duties, or
(ii) A loan by a money lending company of a bank in ordinary course of business.
Loans to them must be disclosed in the account laid before the general meeting.

DUTIES OF DIRECTORS

The duties of director are usually considered under two broad categories, namely: -
(i) Duties of care, skills and diligence.
(ii) Fiduciary duties.

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(1) Duty of Care, Skill and Diligence

Directors should carry out their duties with reasonable care and exercise such degree of
skill and diligence as is reasonably expected of persons of their knowledge and status. The
directors are not liable for mere errors of judgment.

Case Law: Brazilian Rubber Plantation Estates Ltd (1911)

In this case, the directors of the company decided that the company should invest in some
rubber estates in Brazil. They accordingly issued a prospectus inviting members of the
public to come forward and subscribe for the shares and debentures of the company, the
purpose of invitation being to raise money from the subscription in order to finance the
rubber estate project.
In the prospectus they declared to the prospective investors that the project in question for
which subscription were being invited was viable or had potential success. Soon after
subscription the project turned out to be a failure and the company was wound up.

The subscribers brought an action against the directors for inserting a misleading/false
statement in the prospectus upon which they had relied or acted upon to their detriment.
In their defense, the directors claimed that they had acted in good faith.

It was held that the directors were not liable because they had made an error of judgment
about viability of the project and in making the judgment, they had applied the care and
skill that men of experience were expected to apply.

Where a director makes an error of judgment, he will be absolved from any liability so long
as the judgment he made or decision he took and considering all surrounding
circumstances came from past experiences and knowledge which he had; but if a director
fails to exercise due care expected of him in the exercise of his duties, he is guilty of
negligence.

Standard of Care

The standard of care, skill and diligence depends upon the nature of the company’s
business and the circumstances of the case.
The standard of care depends upon:-
(i) The type and nature of work.
(ii) Division of powers between directors and other officers.
(iii) General usages and customs in that type of business.
(iv) Whether directors work gratuitously or remuneratively.

Case Law: City Equitable Fire Insurance Co. Ltd

The directors of insurance company left the management of the company’s affairs almost
entirely in the hands of B, the managing director. Owing to B’s fraud, a large amount of
company’s assets disappeared. B and the firm in which he was a partner had taken a huge
loan from the company and the cash at the bank or in hand included £7,300 in the hands of

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the company’s stockbrokers, in which B was a partner. The directors never inquired as to
how these items were made up.

It was held that the directors were negligent, though the articles protected them from
liability.

Romer therefore observed that “in ascertaining the duties of a director, it is necessary to
consider the nature of the company’s business and the manner in which the work of the
company carried out amongst the directors and other company officials”.

In Dovey vs. Cory, a director was held not liable for negligence merely because he had
failed to verify false information regarding the company’s accounts which he had been
given by the company’s manager and managing director.
The court stated, “The business cannot be carried on upon principles of mistrust. Men in
responsible positions must be trusted by those above them, as well as by those below them
until there is reason to distrust them. We agree that care and prudence do not involve
distrust”.

(2) Fiduciary Duties

As fiduciaries, directors must -

(a) Exercise their powers honestly and bona fide for the benefit of the company as a
whole. But if for example the power to issue further shares is exercised by the directors,
not for the benefit of the company but simply and solely for their personal aggrandizement
and to the detrimental of the company, the court will interfere and prevent the directors
from doing so.

(ii) Not to place themselves in a position in which there is a conflict between their duties
to the company and their personal interests. They must not make any secret profit out of
their position and if they do, they have to account for it to the company.

Case Law: Cook vs. Deek (1916)

Three directors of a company obtained a contract in their own names, under the
circumstances which made it breach of trust by them, and constituted themselves trustees
of the contract of the company. By their votes as holders of ¾th of the shares, they induced
the company to pass a resolution declaring that it had no interest in the contract.

It was held the directors were liable to account to the company for the profit they made on
the contract as in equity, it belonged to the company.

Case Law: Regal Hastings Ltd vs. Gulliver (1942)

R. Co. Ltd owned one cinema and wanted to buy two others with a view to selling the three
together. It formed a subsidiary company to buy the two cinemas. It was however unable
to provide the necessary finances. As such, its directors themselves subscribed for some of

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the shares in the subsidiary company. The cinemas were acquired and the shares in R Co.
Ltd and the subsidiary sold at a profit.

It was held that the directors must account to R. Co. Ltd for the profit they made because it
was through the knowledge and opportunity they gained as directors of R.Co. Ltd, that they
were able to obtain the shares.

Case Law: Burland vs. Earle (1902)

Burland, a director of a company, bought a property for £21,564 at a public auction. He
subsequently sold it to the company for £60,000. The shareholders brought an action
against Burland for restoring the profit made by him out of resale of the property to the
company.

It was held that Burland was not liable to pay to the company the profit made by him
because there was no evidence whatsoever of any mandate to Burland to purchase on
behalf of the company, or that he was in any sense a trustee for the company of the
purchased property.

But where a director is under mandate to purchase some property for the company, he is in
a sense a trustee for the company of the purchased property. If he purchases the property
in his own name and then sells it to the company at a higher price thus making a profit, he
is liable to account to the company the profit earned.

(3) Duty of Disclosure

Except with the consent of Board of Directors, a director or his relative or any firm in which
he is a member or a director, shall not enter into any contract with the company for the
sale, purchase or supply of goods. Even in case of urgent necessity contracts, consent must
be obtained. It is the duty of the director to disclose to the Board the nature of his interest
in any contract or arrangement entered into

(4) Duty to act honestly

A director must not act in manner trying to make personal gain out of a transaction in the
name of the company.

(5) Meetings of the Board

A director is not bound to attend all meetings, but he should obviously attend as many as
possible.

(6) Delegation of Authority

A director has duty not to delegate his functions except to the extent authorized by the act
or the constitution of the company.

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Can a director be liable for the mistakes of his colleagues?

A director absented himself from Board meetings for 20 years and during this period, his
colleagues paid dividends out of capital. The shareholders brought an action against this
particular director arguing that by absenting himself, he was acting negligently because
had he been attending the meetings, he would have discovered that dividends were being
paid out of capital.

It was held that this director was not negligent in absenting himself unless there were
circumstances warranting non-abstention.

Exceptions to this Rule

Whether a director must attend a Board meeting or not is a question of fact. His
compulsory attendance depends on the exigencies of the company’s life. If he is a member
of committee of the Board, he must attend or is reasonable expected to attend meetings of
that committee to deliberate on issues at hand because by being placed in that committee,
his input is considered important.

If a director is so expected to attend but he fails, then such a director is negligent.

Can a director be allowed to delegate?

The directors are bound by the principle “delegates no potest delegata”, that is, a delegate
cannot sub-delegate- even then, the exigencies of business allow a director at times to
delegate his duties, though he cannot delegate all his duties.

However, at times a director can rely on other officers in the company to perform those
duties. He shall not be held negligent in such cases once he is satisfied that the various
officers of the company are manning those duties property, and he shall not be held liable
for negligence in such cases.

INSIDER DEALING

Insider dealing is understood to cover situations where a person buys or sells securities
when he is in possession of confidential information which affects the value of those
securities. Furthermore the confidential information in question will generally be in his

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possession because of some connection which he has with the company whose securities
are to be dealt in. He may be a director or a professional advisor.

Section 33 of Capital Markets Authority Act (Cap 485 A) prohibits insider dealing. The
objective of this prohibition is to promote and facilitate the development of an orderly, fair
and efficient capital market in Kenya.

The section imposes criminal penalties and gives statutory right to an aggrieved
shareholder to claim compensation if he suffers loss from the transaction, under Section
34(3). If the person guilty under Section 33 profited from the offence, but those harmed
cannot practically determine the compensation payable, it shall be made to Investor
Compensation Fund established under Section 18(1) of the Act.

Section 33(9) provides that a person is connected with a company if he occupies a position
that may reasonable be expected to give him access to “price sensitive information” by
virtue of:-
(i) Any professional or business relationship existing between himself and that body
corporate, or
(ii) His being an officer or a substantial shareholder in that body corporate, or in a related body
corporate.
Section 33(5) prohibits “a connected person” from communicating that information to any
other person whom he knows or has reason to believe, will make use of the said
information to deal in listed securities.

The object of Section 33(5) is to prevent a connected person from “tipping” another person
with the intention that the person “tipped” shall deal or cause another person to deal in the
relevant securities.

Section 33(12) provides that any person in contravention of Section 33 shall be guilty of an
offence and shall be liable to a fine not exceeding Sh. 500,000 or Sh. 1,500,000 for a body
corporate. These fines are to be doubled on any subsequent conviction.

LIABILITY OF DIRECTORS

(1) Liability to Outsiders

Directors are not personally liable to outsiders if they act within the scope and powers
vested in them. The general rule is that wherever an agent is liable, those directors would
be liable, but where liability would attach to the principal only, the liability is the liability of
the company.
The directors would be personally liable to third parties in the following cases:-
(i) They contract with outsiders in their own personal capacity.
(ii) They contract as agents of undisclosed principal.
(iii) When the company is ultra vires the company.

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In default of statutory duties, directors shall be personally liable to third in the following
cases:-
(i) Misstatement in prospectus
(ii) Irregular allotment
(iii) Failure to repay application money if the minimum subscription is not subscribed.

(2) Liability to the Company

The directors shall be liable to the company in the following cases:-
(i) Where they have acted ultra vires the company, for example, they have applied the funds of
the company to objects not specified in the memorandum or when they pay dividends out
of capital.
(ii) When they have acted negligently –negligence may give rise to liability, there need not be
fraud.

(iii) Where there is a breach of trust resulting in a loss to the company, they are bound to make
good the loss.

(iv) Misfeance: - Willful misconduct or willful negligence.

(3) Criminal Liabilities

The act provides penalties by way of fine or imprisonment particularly when directors omit
to comply with or contravene certain provisions of the Act.

COMPANY MANAGEMENT

A company being an artificial person cannot manage its own affairs and the articles of
association of every registered company have provisions regarding the delegation of
powers pertaining to the company’s management. Since companies do not have a physical
existence, no soul nor a body of its own, it cannot act by itself, but rather through human
beings who act as agents, that is, directors.

Table A, Article 80 provides that “the business of the company shall be managed by the
directors”.

Directors Duties

Firstly there are 3 preliminary positions

a) Whereas director’s authority to bind the company depends on the acting collectively
as a Board, the duties to the company are owed by each director individually. These duties
are owed to the company and the company alone and not to individual shareholders.

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Case

Percival v. Wright

Certain shareholders wrote to the company’s secretary asking if he knew anyone willing to
buy their shares.

Negotiations took place and eventually the company’s chairman and two other directors
bought the plaintiffs shares at 12 pounds 10 shillings per share.

The plaintiff latter discovered that prior to and during their negotiations for sale the
chairman and the Board of Directors had been approached by a 3 rd party with a view to
purchase the entire company’s assets at more than 12 shillings.

The plaintiff brought an action to set aside share sales on the ground that the directors
owed them a duty to disclose negotiations with a 3rd party.

It was held that the directors aren’t agents for individual shareholders and didn’t owe them
a duty to disclose.

Therefore the same was proper and couldn’t be set aside.

b) However if the directors are authorized by the members to negotiate on their behalf
for example on potential purchase then the directors would be in a position to be agents for
such members and owed a duty to them accordingly.

Case

Allen v. Hyall

c) These duties except where expressly stipulates in the Company Act aren’t restricted
to directors alone but apply equally to any official of a company who is authorized to act as
agents and in particular to those acting in a managerial capacity.
This is particularly so as regards to fiduciary duties.

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Director’s duties proper

These fall into 2 broad categories

i) Duties of care and skill in the conduct of a company’s affairs and

ii) Fiduciary duties of loyalty and good faith

Duties of care and skill

The director’s duty and skill were summed up by Justice Romer in the case of

Re City Equitable Fire Insurance

Here the directors of an insurance company left the management of the company’s affairs
almost entirely to the Managing Director.

Owing to the managing directors fraud a large amount of the company’s funds disappeared.

Certain items appeared in the balance sheet under the heading: “Loans at call or short
notice” or “Cash in bank or in hand”

The directors didn’t inquire how these items were made up. If they had inquired they
would have found the loans were chiefly to the managing director himself and to the
company’s general manager and the case in bank and hand included some 13,000 pounds.
In the hands of a firm of stock brokers at which the managing director was partner

On the company’s winding up an investigation on its affairs disclosed a shortage of its funds
at more than 1.2 m pounds incurred mainly due to the delinquent fraud of the managing
director for which he was convicted and sentenced. The other directors had all along acted
in good faith and honestly but the liquidator sought to make them liable for damages.

It was held that the directors were negligent. Justice romer states the directors duty and
care and skill as follows.

“A director needn’t exhibit in the performance of his duties a greater degree of skill than
may reasonably be expected from a person of his knowledge and experience.”

This proposition describes the standard of skill exhibited in actions undertaken by

directors. The test is partly objective and subjective because a reasonable man would be
expected to have knowledge of the director with his experience.

Re Brazilian Rubber and Plantations Estates Ltd.

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A company had 5 directors and one of them confessed that he was absolutely ignorant of
business. The 2nd one was 75 years old and very deaf and the 3rd agreed to be a director
because he saw one of his friends name in the roll. The other 2 were fairly able
businessmen.

The directors caused a contract to be entered between the company a certain syndicate for
purchase of a rubber plantation in Brazil.

The issued prospectus contained false statements about the acreage of the plantation, the
type of trees e.t.c.
The information contained therein was given to the directors by a person who had an
original option to purchase that property he had never been to Brazil and the debtor was
based on his own imagination. The directors caused the company to purchase.

It was held that the conduct didn’t amount to gross negligence.

Neville L.J.,

“It has been laid down that so long as they act honestly directors can’t be made responsible
in damages unless they are guilty of gross negligence.

A director’s duty required him to act with such care as is reasonably expected from him
having regard to his knowledge and experience.

He isn’t bound to bring any special qualifications to his office. He may undertake
management of a rubber company in complete ignorance of anything connected to rubber
without incurring responsibility from mistakes resulted from such ignorance while if he is
acquainted with rubber business he must give the company the advantage of his
knowledge while transacting the company’s business.

He isn’t bound to take any definite part in the conduct of the company’s business in so far
as he undertakes it he must use reasonable care.

Such reasonable care must be measured in the care an ordinary man might be expected to
take in the same circumstances of his own behalf.

ii) A director isn’t bound to give continuous attention to affairs of his company.

His duties are of an intermittent nature to be performed at periodical board meetings and
at meetings of any committee of the board on which he is placed. He isn’t bound to attend

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all such meetings though he is to attend whenever in the circumstances he is reasonable

able to do the same.

Case

Re Denham & Co.

Here a company was incorporated in 1973 under the articles3 directors were appointed.
Namely Denham, Taylor and Crook. The 4th was appointed later.

The articles conferred on Denham supreme control of the company’s affairs. He was given
power to override decisions of the General Meeting and the Board of Directors. He was
responsible for declaring dividends and he managed the company’s affairs entirely alone
without consulting the other directors.

Between 1874-1877 a dividend of 18% p.a. was recommended and paid and the total
amount paid was 21,600 pounds. In 1880 the company went into liquidation and an
investigation revealed that money paid as dividends were paid not out of profit but out of
capital

Thereafter Denham became bankrupt, Taylor died and his estate was worthless. Denham
became a man of straw. The third party was of no means. The directors addressed their
claims to Crook who had property. Crook argued that since formation of the company he
hadn’t attended meetings and couldn’t be held accountable for any fraudulent statements
in the company’s balance sheet.

It was held that a director isn’t bound to attend all meetings and isn’t liable for misfeasance
committed by his co-directors at board meetings at which he was never present.

Case

Marquis of Butes
In this case the director didn’t attend board meetings for 38 years. He was held not liable.

iii) In respect of all duties which having regard to all exigencies of business and
articles of association may properly be left to some other official. A director in the absence
of grounds for suspicion will not be liable in trusting that other official to perform that
other duty honestly.

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Dovey v. Cory

In this case a bank sustained heavy losses by advances made improperly to customers.

The irregular nature of advances was concealed by means of fraudulent balance sheets,
which were the work of the general manager and the chairman in assenting to payment of
dividends out of capital, and those advances on improper securities were done on the
advice of the general manager and chairman

It was held that the reliance placed on the co-director by the general manager and
chairman was reasonable.

He wasn’t negligent and was therefore not liable for not having discovered the fraud as he
wasn’t in the absence of circumstances of suspicion bound to examine the company’s books
to see if the balance sheet is correct..

It may be said therefore that the duties of care and skill appear to be negative duties.

II) Fiduciary Duties

The directors fiduciary duties are divisible into 4 sub categories

a) The directors must always act bonafide in what they consider and not what the
court may consider to be the best interest of the company. In this context the term
company means the company will be continued as a going concern thereby balancing long
term views against short term interest of existing members.

b) The directors must always exercise their powers for the purpose for which they
were conferred and not for extraneous purposes even if the latter are considered to be in
the best interest of the company. For example the directors are invariably empowered to
issue capital and this power should be exercised for raising more funds when the company
requires it. Hence it will be a breach of directors duties to issue company’s share for the
purpose of entrenching themselves in the company’s affairs.

Case
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Punt v. Symons

In this case the directors issued shares with the object of creating a sufficient majority to
enable them pass a special resolution depriving the shareholders special rights conferred
upon them by the company’s articles.

It was held that the power of a kind exercised by the directors in this case is power to be
exercised for the benefit of the company.

Primarily this power is given to them for the purpose of raiding capital for the purpose of
the company.

Therefore a limited use of shares to persons who are obviously meant and intended to
secure the necessary statutory majority in a particular interest wasn’t a fair and bonafide
exercise of the power.

Case

Piercy v. Mills & Co.

In this case a company had 2 directors they fell out of favour with majority of the
shareholders who were thereupon threatened with reelection and election of 3 others to
the board.

The directors issued shares with the object of creating sufficient majority to enable them
resist the election of the 3 additional directors who election would have put the 2 directors
in the minority of the board.

It was held that the directors aren’t entitled to use their powers for issuing shares merely
for the purpose of maintaining their control or the control of themselves and friends of the
affairs of the company or even merely for the purpose of defeating the wishes of the
existing majority of shareholders.

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The plaintiff and his friends held a majority of shares in the company and as long as that
majority remained they were entitled to have their wishes prevail in accordance with a
company’s regulation/

Therefore it wasn’t open for the purpose of defeating the wishes if the majority to issue the
shares in dispute.

In those circumstances where the directors have breached their duty in the exercise of
proper purpose the shareholders may forgive them by ratifying their actions.

Case

Hugg v. Cramphorn Ltd.

In this case the company had 2 classes of shares ordinary and preference.

Each share carried out one vote. The power to issue company shares was vested in the
directors. They learnt that a take over bid was to be made to the shareholders in the
bonafide belief that acquisition control of the prospective take over bidder won’t be in the
interest of the company or staff. The directors decided to forestall this move.

They attached 10 votes to each of the preference shares and allotted them to a trust, which
was controlled by chairman of the board and one of his partners in the audit department
and an employee of the company to enable the trustee to pay for the shares. The directors
provided them with an interest free percent loan out of the company’s reserve fund.

An action challenged by the plaintiff who was an associate of the take over bidder and
registered holder of 50 ordinary shares in the company was started.

After finding that it was improper for the directors to attach such special voting rights the
courts stood over the action in order to enable a General Meeting to be held and debate
whether or not to ratify the directors actions. The General Meeting ratified the action.

Case

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Bamford v. Bamford

There were similar facts but a meeting was held before proceeding to court and at that
meeting ratified the director’s action.

Question here is whether a decision of a general meeting could cure the irregularity?

It was held that if the allotment was done in bad faith it was voidable at the instance of the
company because it was a wrong done by the company with the right to recall allotment
has the right to approve it back and forgive breach of duty.

They mustn’t fetter their discretion to act for the company for example the directors can’t
contract either among themselves or with 3 rd parties as to how they will vote at future
board meetings.

However where they have entered into a contract on behalf of the company they may
validly agree to take such further action at board meetings as may be necessary to carry out
such a contract.

VARIATION OF CLASS RIGHTS

Although the Companies Act recognises the existence of class of shareholders, it does not
define the term ‘class’ the best definition is found in the case of

Sovereign Life Assurance Co. v. Dodd (1892) 2 QB 573

In that case Bowen L.J. stated as follows: “The word Class is vague it must be confined to
those persons whose rights are not dissimilar as to make it impossible for them to concert
together with a view to their common interest.”

Under Article 4 of Table A where the Share Capital is divided into different classes of
Shares, the rights attached to any class may be varied only with a consent in writing of the

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holders of three quarters of the issued share of that class or with assumption of a special
resolution passed at a separate meeting of the holders of the shares of that class.

However, under Section 25 (2) if the rights are contained in the Memorandum of
Association and if the Memorandum prohibits alteration of those rights, then class rights
cannot be varied.

ALLOTMENT OF SHARES

An allotment, legally, is the company’s acceptance of an offer to buy its shares. It is

governed by the following rules of the common law relating to contract:-

(a) Where a company issues a prospectus, the issue is an invitation to treat but not an offer: - It
is not regarded as an offer because if it was regarded as an offer, every application made
pursuant thereto would constitute an acceptance and the company would be contractually
bound to allot all the shares applied for. If the shares were oversubscribed, the company
would be sued by the applicants who were not given the shares they had applied for. When
applications are made, they constitute offers, and hence the company cannot be sued
because there is no contract between them and the company.

(b) The company’s, acceptance must be unconditional: - If the application was made for 10
shares and 5 were allotted, allotment would be a counter-offer which the allottee could
reject. But whenever the issue is oversubscribed companies invariably prepare application
forms which contain a clause to the effect that the applicant “agrees to accept” such number
of shares as the company in its absolute discretion may allot to him.

(c) The acceptance must be communicated to the applicant:-This means that the allottee must
actually receive the letter of allotment so that he is aware of the allotment. If the letter of
allotment is lost in transit there would be no binding contract. If the applicant authorizes
the company to communicate the acceptance by post, there would be a binding contract the
moment the letter of acceptance is posted.

Case Law: Dunlop vs. Higgins (1849)

‘A’ applied for the shares of a company. The company accepted the offer. The allotment
letter was delayed in the post. ‘A’ repudiated the allotment.

It was held that the contract was complete when the allotment letter was posted.

(d) The allotment must be made within a reasonable time:-If there is undue delay in the
allotment the offer lapses.

Case Law: Ramsgate Victoria Hotel Co. vs. Montefiore (1866)

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X applied for shares on June 28. Shares were allotted on November 23. X refused to take
them. It was held that the offer had lapsed and X was not liable to pay for them.

Section 49 (1) provides that no allotment shall be made of any share capital of a company
offered to the public for subscription unless the amount stated in the prospectus as
minimum amount, which in the opinion of directors must be raised by the issue of share
capital and the sum payable on application for the amount so stated has been paid to and
received by the company.

Section 50 (1) provides that a company having a share capital which has not issued a
prospectus, or which has issued a prospectus but has not proceeded to allot the shares, the
company shall not make a first allotment of its shares unless it has delivered a statement in
lieu of prospectus to the registrar at least 3 days before the allotment.

Section 50 A (1) provides that a company having a share capital shall not allot any of its
shares to a body corporate which is not a company formed and registered under this Act
without prior consent in writing of the Treasury to such allotment, and any allotment made
without such consent shall be void.

Requirement of Allotment

(i) Public company must file a prospectus or a statement in lieu of prospectus before making
the first allotment.
(ii) Minimum subscription: – No shares which are offered to the public can be allotted until
the minimum subscription stated in the prospectus has been subscribed and the amount
payable on application has been received in cash.
(iii) Application money: - The money payable on application for each share shall not be less
than 5% of the nominal value of the shares. If the minimum subscription is not subscribed
within 60 days after the issue of prospectus, all money received from applicants must be
returned forthwith.
(iv) If the prospectus states that the application has been or will be made to the stock exchange
for permission for the shares or debentures offered thereby to be dealt in on stock
exchange, then the permission must be applied before the third day after the issue of the
prospectus, failing to which the allotment would be void.

Irregular Allotment

An allotment of shares is considered irregular if it contravenes the provisions of Section 49

or Section 50. Section 49 prohibits allotment unless minimum subscription is received.

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Section 50 prohibits allotment in certain cases unless statement in lieu of prospectus is

delivered to the registrar.

In case it contravenes these two sections, it becomes voidable at the instance of the
applicant within one month after holding of statutory meeting of the company and not
latter.

Where the director contravenes the provisions of Section 49 and Section 50, he must
compensate the company and the allotee respectively for any loss, damage or costs which
the company or allotee has incurred. But no proceedings to recover any such loss, damage
or costs may be commenced after the expiry of two years from the date of allotment.

COMMENCEMENT OF BUSINESS

A public company which has issued a prospectus cannot commence business or exercise
any borrowing powers unless:-
(a) The minimum subscription has been raised.
(b) Every director has paid to the company on each of the shares taken,
or contracted to be taken by him and for which he is liable to pay cash.
(c) No money is or may become liable to be repaid to applicants for any
shares or debentures which have been offered for public subscription by reason of any
failure to comply or obtain permission for the shares or debentures to be dealt in on any
stock exchange.

If the minimum subscription was not raised, the company can only commence business if:-
(a) There has been delivered to the registrar for registration a statement in lieu of
prospectus.
(b) Every director of the company has paid to the company on each of the shares taken.
(c) There has been delivered to the Registrar for registration a statutory declaration in Form
No. 212 by the secretary that condition (b) above has been complied with.

The registrar shall, on delivery to him of the relevant form, or statement in lieu of
prospectus, certify that the company is entitled to commence business.

Issue of Shares at Discount

A company issues shares at a discount when shares are issued at a price less that the face
value.
Section 59 of the Act permits a company to issue the shares at a discount if:-
(i) The shares to be issued must be of a class already issued.
(ii) Such issue is authorized by a resolution passed in general meeting.
(iii) The resolution specifies the maximum rate of discount.
(i) Not less than one year has elapsed since the company was entitled to commence
business. This provision obviates the risk of hasty or premature issue at a discount.

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(ii) The issue is sanctioned by the court.

(iii) The issue is made within one month after the court’s sanction.

Issue of Shares at a Premium

A company is free to sell its shares at a premium, that is, at a price higher than nominal
value. The premium received on issue of shares must be transferred to “Share Premium
Account”, under Section 58 (1).
Subsection 2 of the Act provides that the share premium account may be used for the
following purposes:-
(i) For issuing to the members as fully paid bonus shares, the unissued shares of the
company.
(ii) For writing off preliminary expenses of the company.
(iii) For writing off expenses, commission or discount on the issue of shares or debentures of
the company.
(iv) For providing for the repayment of premium payable on redemption of redeemable
preference shares or debentures.

Note: Dividend cannot be paid out of share premium account as this will amount to
reduction of capital without the confirmation of the court, and hence ultra vires the
company.

ALTERATION OF CAPITAL

A company is empowered by section 63 to alter the provision of its memorandum which

relates to its authorized capital.

The power is exercisable if:-

(i) The articles confer the authority to alter its capital.
(ii) The company holds a general meeting for the purpose of altering the capital.
(iii) The alteration is authorized by an ordinary resolution.

Mode of Alteration

Section 63(1) provides the various modes of altering its capital:-

(a) Increasing its share capital by issuing new shares.

(b) Consolidate and divide all or any of its share capital into shares of larger amount than the
existing ones.
(c) Convert all or any of its fully paid up shares into stock or reconvert that stock into fully
paid up shares of any denomination.
(d) Subdivide its shares into shares of smaller amount than is fixed by the memorandum.

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(e) Cancel the shares which have not been taken by any person and diminish the amount of
its share capital. This mode of alteration is called “diminution” of capital.

Under Section 63, no alteration of capital can be valid unless:-

(i) It is authorized by the articles of association.
(ii) It is approved by the company at a general meeting.

Increase in Share Capital

The nominal share capital of a company may be increased by ordinary resolution of the
company in the general meeting. The articles usually contains authority to allow the
company to increase its capital, but incase it does not allow, they must be altered by special
resolution to this effect.

Under Section 65, where a company has increased its share capital beyond the registered
capital, notice must be given to the registrar within 30 days from the date of passing such a
resolution. Otherwise, the directors and the company knowingly permitting the default
will be liable to a fine of Sh. 100.

Reduction of Capital

The law regards capital of a company as something sacred. No action resulting in a

reduction of capital of a company should be permitted unless the reduction is effected:
(i) Under statutory authority or by forfeiture.
(ii) In strict accordance of the procedure set out in the articles of association. Any
reduction contrary to this principle is illegal and ultra vires.
The general rule is that it is illegal for a company to reduce its capital because such a
reduction would be tantamount to reducing the security available to the company’s
creditors. However section 68(1) authorizes a company to reduce its capital if:-
(a) The company’s articles authorize it to do so. If the articles do not confer the authority the
can be amended by the inclusion therein of the requisite authority.
(b) The company passes a special resolution to that effect.
(c) The court confirms the proposed reduction. This is required to protect the interest of the
company’s creditors.
Reduction of capital may be effected in several ways:-
(i) Where redeemable preference share are redeemed.
(ii) Where shares are perfected for non payment of calls.
(iii) Where un issued shares are cancelled.
(iv) Reduction of liability on any of its shares in respect of share capital not paid-up.
(v) Cancel any paid up share capital which is lost or is unrepresented by the available assets,
that is, “diminution”. For example, some of the capital may, in fact have been lost or
diminished, for instance, Sh. 100 shares may represent asset of Sh. 50.
(vi) Pay off any paid up share capital which is in excess of the wants of the company.

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Section 68 gives the company the power to reduce its share capital in any way but
specifically mentions ways in which the reduction of capital may be effected in order to
extinguish or reduce the liability on shares not fully paid.

Under Section 69 where a company has passed a resolution for reduction of capital, it must
apply to the courts for an order confirming the reduction. Where the reduction of share
capital involves diminution of liability for unpaid capital or return to any shareholder of
any paid up share capital, the courts may allow all creditors to object to reduction.

The court will settle a list of company’s creditors and hear their objection and the court will
confirm such a reduction if they are satisfied that:-
(i) The creditors’ consent to reduction has been obtained.
(ii) Their debts have been discharged.
(iii) Their debts have been secured by the company.

Liability of Members on Reduction

On reduction of capital, the members of a company whether present or past are not liable
beyond a certain limit. The liability of members is limited to the difference if any between
the amount of the share as fixed by the minute and the amount paid. However, in certain
cases, the liability of the members will not be reduced even though there has been a
reduction of capital. If the company is unable to pay the claim of any creditor entitled to
object who was ignorant of the proceedings for reduction or of their nature and effect and
who was not entered on the list of creditors, then:-
(i) Every member of the company at the date of the registration of the order for reduction
will be liable to contribute for the payment of that claim an amount not exceeding the
amount which he would have been liable to contribute if the company had commenced to
be wound up on the day before that registration.
(ii) If the company is wound up, the courts, on application of such creditor and upon proof of
his ignorance of the reduction, may accordingly settle a new list of contributories who
could be forced to pay as if they were ordinary contributories in a winding up.

Maintenance of Capital

The issued share capital of a company limited by shares is the primary security for the
company’s creditors. A limited company by its memorandum declares that its capital is to
be applied for the purpose of the business. The creditors give credit to a company because
of .
capital and therefore the capital of the company should not be “watered down”. Many
provisions in the Act attempt to prevent capital being watered down such as making it

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illegal for a limited company to issue shares at a discount unless provision of Section 59 is
complied with.

Purchase of Own Shares

According to a leading case Trevor vs. Whitworth, it is illegal for a limited company to
purchase its own shares. Such a purchase, if permitted would constitute an indirect
reduction of the paid up capital. It is presumed that whenever a company buys its shares it
would do so by utilizing its paid up capital.

Despite the rule in Trevor v Whitworth, a company may purchase or acquire its own shares
in the following cases:-
(a) where it is a purchase of redeemable shares,
(b) where the shares are purchased pursuant to a court order under Section 211 (2) on
application by oppressed members and
(c) where the shares are forfeited for non-payment of a call.

REDEMPTION OF SHARES

Section 60(1) empowers a company limited by shares to issue preference shares which are
at the option of the company liable to be redeemed, if the articles authorize such issue. It
however provides that: -
(a) No such shares shall be redeemed except out of profits of the company which would
otherwise be available for dividend or out of the proceeds of a fresh issue of shares made
for the purposes of the redemption.

(b) No such shares shall be redeemed unless they are full paid.

(c) The premium if any payable on redemption must have been provided for out of profit of
the company or out of company’s share premium account.
(d) Where any such shares are redeemed otherwise than out of a fresh issue, there shall, out
of profits which would otherwise have been available for dividend, be transferred to a
reserve fund to be called “Capital Redemption Reserve Fund”, a sum equal to the nominal
amount of the shares redeemed.

DIVIDENDS

Dividends are the profits of trading divided among the shareholders in proportion to their
shares.

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The basic rule is that “dividends must not be paid out of capital”.

Declaration and Payment

There is no provision in the Act dealing with payment of dividends but it is governed by the
articles of association failing which the provisions of Table A apply as follows: -
(i) Articles 114:-The Company in a general meeting may declare dividends but no
dividend shall exceed the amount recommended by the directors. No dividend can be
declared if the directors have recommended none.

(ii) Articles 115:-The directors may from time to time pay to the members such interim
dividends as appear to the directors to be justified by the profits of the company. A
resolution passed at a general meeting directing the director to pay interim dividends is
invalid (Scott vs. Scott)

(iii) Article 116:-No dividend shall be paid otherwise than out of profits. Because the
word “profits” is ambiguous, this provision be understood to mean “dividends must not be
paid out of capital”. Provided dividends are not paid out of capital it does not matter from
whatever it is paid.

(iv) Article 120:-Any general meeting declaring dividends may direct payment of such
dividend wholly or partly by the distribution of specific assets and in particular shares-
dividend in kind.

(v) Article 121:-Any dividend payable in cash in respect of shares may be paid by cheque
or warrant sent through the post directed to the registered address of the holder.

(vi) Article 122:-No dividend shall bear interest against the company. At common law the
declaration of a dividend creates a single contract debt due from the company to the
shareholder which will be time barred in six years from the date of declaration.

Case Law relating to Dividends:

Losses in precious years need not be provided for. A dividend can be paid if there is a
profit on the current year’s trading.

Profits of previous years can be brought forward and distributed even if there is a revenue
loss in the current trading year.

Losses on fixed assets in the current year need not be made good by provision for
depreciation before treating a revenue profit as available for dividend.

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Unrealized profits on revaluation of assets can be distributed by way of a dividend or used

to pay a bonus issue.

Dividends must not be paid out of capital.

SHARE CAPITAL

In commercial parlance, the word “capital” is generally used to denote the amount by
which the assets of a business exceed its liabilities. However, in legal parlance, the word
“capital” is used to denote the amount of money which a company raises from a sale of its
shares.

Types of Capital

(a) Nominal or Authorized Capital

This is the capital that is stated in the memorandum pursuant to Section 5(4) (a) of the Act.
It is authorized in the sense that, once the memorandum of association is registered, the
company can take immediate steps to raise the capital from the public without applying for
a permit. It is nominal because it is calculated on the basis of nominal or book value of the
shares.

(b) Issued Capital

It is that position of the nominal capital which has been issued by the company. It is also
known as subscribed or allotted capital. It may be equal or less than nominal capital but
cannot exceed it.

(c) Paid-up Capital

It is that part of issued capital, which has been paid-up by the share holders. It may be
equal to or less than the issued capital but cannot exceed it.

(d) Called-up Capital

It is that amount of issued capital which the company has asked its shareholders to pay by
means of calls.

(e) Uncalled capital

This is the amount which remains unpaid on shares. The company may at any time, call
upon the shareholders to pay the uncalled capital in accordance with the provisions of the
articles.

(f) Reserve capital

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Section 62 of the Act defines reserve capital as that portion of the issued but uncalled- up
capital of a limited company, which the company’s members by special resolution, have
resolved that the company shall not call up unless and until it is in liquidation. It is to be
called up only for purposes of liquidation. As soon as a resolution is passed, the capital is
put on reserve and the directors’ power under the articles to make calls on shares will not
be exercisable in respect of that capital, unless the company is wound up. It is referred to
in Section 62 as “the reserve liability” of a limited company.

Methods of Public Issue

(a) Prospectus Issue

Under prospectus issue, the company sells the shares directly to the public rather than
selling them through intermediaries.

Company---->Sells shares to--->Public

The company issues a document generally called a prospectus. As a precaution against
unsuccessful issue, the company may underwrite the issue.

(b) Placing

A placing occurs if the company instead of selling its shares directly to the public arranges
with a broker to sell them on its behalf.

Company---> Broker --->sells the shares to---> Public

(Acts as the company’s agent)
A placing may be “private placing” if the broker ‘places’ them with his clients instead of the
general public.

(c) Offer for Sale

An offer for sale is an arrangement whereby a company sells the whole of its shares to an
“issuing house” and the issuing house then resells the shares to the general public, usually
at a profit.

pany---> Sells shares to----> Issuing House---> Resells shares to Public

The issuing house issues a document called “offer for sale”.

(d) Offer by Tender

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An “offer by tender” occurs if a company writes tenders for its shares and resells them to
the highest bidder. This is done with a view to obtaining the best price possible for the
shares. Under this method, the company fixes a minimum price for the shares and accepts
the highest tendered price above the minimum price.

(e) Rights Issue

This occurs when a company which has been trading for sometime makes an offer to the
existing members to buy shares of a new issue in proportion to the number of shares they
hold.

The existing members, rather than the public, are thereby given a ‘right’ to buy new shares.
A member who does not want to keep the shares will have a right to sell them straight
away if he accepts the company’s offer.

(f) Bonus Issue

It is a method by which a company instead of paying a cash dividend to its members retains
the cash but issues new shares to the members. The company thereby increases the
nominal capital and acquires the cash it needs for business expansion.

This method can only be used if the articles make a provision for it because the general rule
at common law is that dividends are payable in cash (Wood vs. Odessa Waterworks
Company).

(g) Conversion Issue

Occurs either during a re-organization of a company’s capital structure or when two or

more companies amalgamate. What usually happens is that holders of one type of shares
(preference shares) are offered the right to convert them into shares of another type in the
same company e.g. ordinary shares, or in the case of amalgamation, the shares of another
company.

COMPANY MEMBERSHIP

Although Section 28 bears the words, definition of a member, the section does not define a
member; rather it states the ways in which a person may become a member of a company
as follows:-
(a) By subscribing to the memorandum of association of the company.
(b) By agreeing to become a member of the company.
Section 28(1) provides that the subscribers to the memorandum shall be deemed to have
agreed to become members of the company and on its registration shall be entered as
members in its register of members. When Section 28(1) is read in conjunction with
Section 5(4) (b), it binds a subscriber of a company having a share capital to take at least

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one share, suggesting that a subscriber automatically becomes a shareholder on the

company’s registration.

Section 28(2) provides that every other person who agrees to become a member of a
company, and whose name is entered in the register of members, shall be a member of the
company. This implies that a person who agrees to become a member of the company does
not actually become one until his name is entered in the register of members. This section
makes the placing of the name of a shareholder on the register a condition precedent to
membership. “Registration is essential for membership”.

HOW TO BECOME A MEMBER

A person may become a member of the company in any of the following ways:-

(a) Membership by Subscription

Every subscriber to the memorandum is deemed to have agreed to become its members
and on its registration must be put on the register of members.

(b) Membership by qualification shares (compliance with Section 182(2)

An agreement to become a member may occur if a person who has consented to be a

director gives the statutory undertaking to take and pay for his qualification shares. Section
182(2) declares such a director to be in the same position as if he had signed the
memorandum.

(c) Membership by Allotment

An allotte membership commences from the moment his name is entered in the company’s
register of members.
(d) Membership by Transfer

A ‘transfer’ occurs if shares are bought from a company’s shareholder rather than from the
company itself. The purchase of shares constitutes the agreement to become a member
and the membership commences from the moment the transferee’s name is entered in the
register of members.

(e) Membership by Transmission

A transmission is a legal process by which ownership of shares in a company changes

automatically when the registered holder dies or becomes bankrupt.

Table A, Article 29 provides that “in the case of death of a member, the personal
representatives of the deceased where he was a sole holder shall be the only person
recognized by the company as having any title to his interest in the shares. If the personal

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representatives elects or decided to be registered himself as a holder of the shares, the

election constitutes the agreement to be a member”.

Article 30 provides that a bankrupt member’s shares in a company will be transmitted to

his trustee according to rules in bankruptcy law. If the trustee elects or decides to be
registered as the holder of the shares, the election constitutes the agreement to be a
member and the provision of Subsection 2 of Section 28 become applicable.

(f) Membership by Estoppels

A person who, without having agreed to be a company’s member, is aware that his name is
wrongly entered in its register of members but takes no steps to have his name removed
there from, may be estopped from denying his apparent membership to somebody who
relied on it and extended credit to the company.

Cessation of Membership

A person’s membership of a company may cease or come to an end in either of the

following ways: -
(a) When a person transfers his shares: -The transferor ceases to be a member as soon as the
transferee is registered.

(b) When a person’s shares are validly forfeited by the company: -Table A, Article 33 provides
that a member’s shares may be forfeited if the member fails to pay any call. Article 37
provides that a person whose shares have been forfeited shall cease to be a member in
respect of the forfeited shares. He therefore ceases to be a member if all of the shares
previously held by him are forfeited.

(c) When a person makes a valid surrender of his shares of the company:- A person’s
membership will come to an end if he surrenders all his shares to the company with the
approval of the directors. If the surrender is void, the membership does not come to an end
even if the member’s name is removed from the register.

(d) When a person dies, his ownership of a company’s shares will come to an automatic end
by virtue of the provision of the law of succession.
Table A, Article 24 provides that, in case of death of a member the personal representatives
of the deceased shall be the only persons recognized by the company as having any title to
his interest in the shares.

(e) When a person is declared bankrupt, his ownership of company’s shares will come to an
end under the provisions of the Bankruptcy Act, which vest a bankrupt property in his
trustee.

(f) Redemption of redeemable preference shares: - If a member’s entire holding consists

exclusively of redeemable preference shares and all these shares are redeemed by the

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company under Section 60 of the Act, he will cease to be a member from the date on which
his name is removed from the register of members.

(g) When a company sells shares under its lien: - A company, like an unpaid seller under the
sale of Goods Act, has a right of lien on its shares as security for the balance of their price.
Table A, Article 11 gives the company “a first and paramount lien” on every unpaid share.
If the company sells all the shares held by a member, the membership will come to an end
from the moment the buyer’s name is entered in the register of the company.

Article 12, gives the company power to sell “any shares on which the company has a lien”.

(h) Repudiation by an Infant: - An infant member has a common law right to repudiate his
membership of a company if there has been a total failure of consideration because the
shares have become worthless.

Case Law: Steinberg vs. Scala (Leeds) Ltd.

Miss Steinberg, an infant, purchased 500 £ 1 shares from the defendant company. She paid
Sh. 10 on each share and being unable to meet some calls, repudiated the contract while
she was still a minor and claimed: -
(a) Rectification of the register of members to remove her name there from and thereby
relieve her from liability on future calls.
(b) Recovery of the money already paid.

It was held that: -

(a) She was entitled to rescind and so was not liable for future calls, but
(b) She was not entitled to recover the money already paid because there had not been a total
failure of consideration. She had got the thing for which the money was paid, namely the
shares. Although she had not yet received any dividends on the shares, the shares had
some value.

(i) Liquidation: - Company liquidation terminates membership of all former members from
the moment it becomes a member. The members technically become “contributories”.

Who may be a Member?

The general rule is that any person who is competent to contract may be a member. A
contract to purchase shares is like any other contract and both the contracting parties must
be competent to enter into a contract.

The membership rights of some categories of persons are as follows: -

(a) Minor/Infants

An infant is any person who has not attained the age of 18 years. A minor has a common
law right to enter into a contract to buy shares in a company, and thereby become a
member of the company. The contract is however avoidable at his option, and he may

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avoid it at any time during his infancy or within a reasonable time after attaining the age of
18 years.

Although the infant has a right to repudiate the contract, he would only be entitled to get
back the amount already paid if there has been a total failure of consideration because the
shares have become valueless.

Case Law: Palaniappa vs. Official Liquidator (1942)

A father as a guardian of his minor daughter applied for the shares of a company. Shares
were allotted to the daughter describing her as a minor. The company went into
liquidation and the father was placed under the list of contributories.

It was held that neither the father nor the minor are liable as contributories.

A company’s articles may, however, restrict membership of the company to adults only in
which case an infant would not become a member of the company.

(b) A corporation

A corporation, whether registered or not, can become member of another company, if so

authorized by its articles. But a company cannot be a member of itself. A company cannot
purchase its own shares because it involves reduction of capital, which is not permissible
under Section 29(1).

(c) Personal Representatives

On member’s death, his personal representatives would be entitled to be registered as a

member of the company unless the company’s articles provide otherwise.

REGISTER OF MEMBERS

Section 112(1) requires every company to keep a register of its members and prescribes
the contents of the register as follows: -

(i) The names and postal address of the members.

(ii) A statement of the shares held by each member.
(iii) The amount paid or agreed to be considered as paid on the shares of each member.
(iv) The date at which each person was entered in the register as a member.
(v) The date at which any person ceased to be a member.

Section 122(2) requires the register of members to be kept at the registered office of the
company.

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Section 115(1) provides that the register of members shall be open during business hours
to the inspection of any member without charge, and of any other person on payment of a
fee, not exceeding Sh. 2 for each inspection as the company may prescribe.

Section 117 permits a company, on giving a notice by advertisement in some newspaper

circulating in Kenya to close the register of the members for any time or times not
exceeding in the whole 30 days in each year. The purpose is to keep the register static so
that members’ holdings may be extracted as at a particular date for the purpose of
computing dividends.

LESSON 9

COMPANY SHARES

Shares

A share is an interest of a shareholder in a definite portion of the capital. Shares measure

rights of a shareholder to receive a certain amount of profit of the company while it is a
going concern, and to contribute to the assets of the company when it is going to be wound
up.

A share is, therefore, the interest of a shareholder in the company measured by a sum of
money, for the purpose of liability in the first place, and of interest in the second, but also
consisting of a series of mutual covenants entered into by all shareholders inter se in
accordance with Section 22.

A share is not a sum of money, but an interest measured by a sum of money and made up of
various rights contained in the contract.
A person who acquires a share in a company automatically becomes subject to the
obligations imposed by the Company’s Act, the company’s memorandum of association and
the company’s articles of association. He also becomes entitled to the rights similarly
conferred.

Corporate shares: - These are shares created by the company for issue to its employees.
They are therefore, shares that serve special purpose.

They are usually given to employees to win their cooperation in management.

These shares don’t carry any voting rights but have the right to earn dividends.

Deferred/Founder shares: - These are shares given or issued to the founders as a reward
for their services. They are few and carry a right of residual profit when other
shareholders have been paid.

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Even then, founders don’t like being given these shares because they prefer to be given
preferential shares which are of course cumulative and participating in nature.

Stocks

A stock is one unit of a company’s capital comprising several number of shares put together
e.g. a company may decide that every ten shares shall converted to constitute one stock so
that instead of members buying shares they buy stocks each one of which represents ten
shares.

When a company decides to consolidate its shares into stocks, consolidation does not alter
the par value indeed the total value of the shares comprised in one stock becomes the value
of the stock they constitute.

The conditions under which shares may be converted into stocks or vice versa Under
Section 64 and Section 63

(i) It must be the type of company that is allowed to convert its shares. Only companies
registered as “limited” are allowed to convert.
(ii) Conversion can be undertaken if only the Articles of Association of a Company contain
express provision to that effect, but where the articles are silent, the company cannot
undertake such conversion. However, if the company wishes to do so, it must first alter the
articles to make a provision for conversion.
(iii) Only the company itself can take a decision to convert shares into stocks. Directors of a
company do not have the authority in law to make this decision.
(iv) The shares to be converted must only be those which are fully paid for by the members.
(v) Where a company has taken a decision to convert shares into stocks, that company must
give a notice of conversion to the registrar of company within 30 days from the date the
resolution was made.
(vi) After the shares have been converted into stocks and have been issued to stockholders any
share certificate they had should be substituted with stock certificate but not stock
warrants.

Distinction between Shares and Stocks

Shares Stocks

1. 1. A share is a distinct individual

unit of capital in a company and 1. Stock is not divided into
shares can be bought and sold in equal parts/denomination
whole units. and subject to articles, may
2. be bought or sold in any
convenient subdivisions.
3. 2. Under Companies Act, shares are
required to be distinguished.

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2. Stocks bear no distinguishing

features.

3. 3. A company can issue shares 3. A company cannot issue

directly. stock directly; rather it can
only convert its fully paid
shares into stock.

Shareholder’s Obligating

The primary obligation of shareholder is to observe the provisions of the Company’s Act as
well as the provisions of the company’s memorandum and articles. Incase of a company
limited by shares, he is under obligation to pay, when called upon to do so, the amount if
any, unpaid on the shares he holds.

Shareholders Rights

The rights conferred to shareholders by the Act include: -

1. Section 8(2), to object to a proposed alteration of the company’s objects.
2. Section 74(1), to apply to the court for cancellation of a proposed variation of the rights
attached to a particular class of shares.
3. Section 89(1), to inspect without fee the register of holders of debentures of the
company.
4. Section 106(1), to inspect without fee copies of the instruments creating charges and the
company’s register of charges.
5. Section 115(1), to inspect without fees the register of members.
6. Section 132(1), to require the directors to convene an extraordinary general meeting of
the company.
7. Section 132(3), to convene an extraordinary general meeting of the company if the
directors fail to do so.
8. Section 136(1), to appoint a proxy to attend a meeting
9. Section 158(1), to receive a copy of every balance sheet together with a copy of the
auditors report
10. Section 211(1), to apply for a court order in cases of oppression.
11. Section 221(1), to apply to the court for the winding up of the company.

Rights conferred by memorandum and articles of association: -

(a) Income rights- Dividends
(b) Capital rights-return of capital on a winding up or authorized reduction of capital
(c) Attendance of meeting and voting.

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CLASSES OF SHARES

The classes of shares, which can be created and issued by a company, are not prescribed by
the Company’s Act. They depend on the provisions of the company’s constitution, usually
the articles of association.

Legally, therefore, a company may create any type of or class of shares it pleases, but in
practice the following are the classes of shares generally issued by companies: -
(a) Ordinary shares
(b) Preference shares

Ordinary shares

The word “ordinary” as used in relation to shares, has no legal meaning but was adopted to
denote a share, which has no special rights attached to it. Ordinary shareholders have
residual rights of the company.

Preference shares
A preference share must satisfy the following two conditions: -
(i) It shall carry a preferential right as to the payment of dividend at a fixed rate.
(ii) In the event of winding up, these must be a preferential right to the repayment of the
paid up capital.

Types of Preference Shares

(i) Cumulative and non-cumulative preference shares
(ii) Participating and non-participating preference shares
(iii) Convertible and non-convertible preference shares
(iv) Redeemable and non-redeemable preference shares, Section 60(1).

TRANSFER OF SHARES

Section 75 provides that the shares of any member in a company “shall be movable
property transferable in manner provided by the articles of the company”.

According to Table A, Article 24 provides that the directors may decline to register the
transfer of a share not being fully paid share to a person to whom they shall not approve
and they may also decline to register the transfer of a share on which the company has a
lien.

Where articles are framed with some limitations on the discretionary power of refusal, it
follows on plain principle that if the directors go outside the matters which the articles say
are to be the matters and the only matters to which they are to have agreed, the directors
will have exceeded their powers. If the directors wrongfully exercise their power of
refusal, the transferee may apply to the court for rectification of the register and the entry
of his name therein.

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In case of private companies which have adopted Table A, Article 24 provides that the
directors may in their absolute discretion and without assigning any reason therefore,
decline to register any transfer of any share, whether or not it is a fully paid share.
Provided that the directors exercise their discretion bonafide and within a reasonable time
they cannot be ordered by the court to register a transfer of shares which they have
declined to register. The directors’ power of refusal must be exercised within a reasonable
time from the receipt of the transfer which according to Section 80(1) is 60 days from the
date on which the transfer is lodged with the company.

Effect of Transfer

Unless shares are being transferred as a gift, a transfer is a contract of sale which is effected
through the agency of a stock broker who is a member of the Nairobi Stock Exchange. The
property in the shares is however not vested in the transferee unless and until his name is
entered into the company’s register of members pursuant to section 28(2) of the Act.

In the interim period, the effect of the transfer is as follows:-

(i) If the shares are partly paid, and a call is made, the transferor is legally liable and must
pay the amount required and then seek an indemnity from the transferee.
(ii) If dividends are declared and paid the transferor is the person who, according to the
company’s records is entitled to them. He would however hold the dividends on trust for
the transferee, unless the shares were bought “ex-dividend” or “ex-all”.
(iii) If a meeting of a company is convened and the transferor decides to attend the meeting,
his right to vote or otherwise will depend on whether he has fully paid for the shares.
(a) If he has been fully paid for the shares, he must vote as the transferee directs. In such a
case he is regarded as the transferee’s trustee.
(b) If not fully paid up, he would have a prima facie right to vote in respect of those shares.
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Labels: company law, law of business associations

THE COMPANY’S LIEN

A lien is the right to retain possession of a thing until a claim is satisfied. Incase of a
company, lien on a share means that the member would not be permitted to transfer his
shares unless he pays his debt to the company.
Table A, Article 11 may give the company “a first and paramount” lien on the shares of its
members, either in respect of amounts payable on the shares or any amount due from the
member of the company. The right of lien is not inherent but must be clearly provided for
in the articles.

The lien does not however confer a power to sell the property retained. Consequently, if
the company wishes to be able to enforce its lien by selling the relevant shares, without a
court order, it must insert a suitable clause in the articles.

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Table A, Article 12 gives the company power to “sell”, in such a manner as the directors
think fit, any shares which the company has a lien subject to specified conditions.

Since the shares are not physically in possession of the company it appears proper to
regard the company’s lien as an “equitable lien” which does not arise until the registered
shareholder incurs a debt to the company.

Case Law: Bradford Banking Co. vs. Briggs & Co. (1886)
A member deposited his share certificate with the bank as an equitable mortgage of the
shares to secure a loan to him by the bank. The bank gave notice to the company of its
interest as mortgage. Later, this member became indebted to the company.

It was held that as the company had prior notice of the bank’s mortgage, its lien was
postponed to the mortgage since the company’s claim under the lien arose after the bank’s
notice was received.

Oral Transfer

Section 77 of the Act provides that, not withstanding anything in the articles of association
of a company, it shall not be lawful for the company to register a transfer of shares unless a
proper instrument of transfer has been delivered to the company.

This means that an oral transfer of shares is illegal and void.

In Re: Greene, the judge explained that the primary object of the section was to “scotch”
the then prevalent practice of registering oral transfers of shares to the great detriment of
the revenue. Its current effect is to enforce payment of the stamp duty that is payable on
the transfer of shares. If the company registers oral transfers, the transferee would not
acquire title to those shares and the transferor would be deemed to remain the registered
holder of the shares.

Forged Transfer

An instrument of transfer of shares on which the signature of the transferor is forged is

called a forged instrument, and any transfer based on such instrument is called a forged
transfer.

A transfer is usually forged after a person steals another person’s share certificate with the
intention of having the relevant shares registered in his name so that he may thereafter
transfer them to a third party.

The first thing that a company should do when an instrument of transfer is tendered is to
inquire into its validity. The company should sent a notice to the transferor at his address
and inform him that such a transfer has been lodged and that if no objection is made before
a specified day it would be registered.

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Because the transferor’s forged signature on the transfer is wholly inoperative, the
consequences of such transfer are as follow: -
(i) A forged transfer is a nullity and cannot affect the title of the shareholder whose
signature is forged. If a company transfers shares under a forged instrument of the
transfer, the true owner can compel the company to have his name restored in the register
of members.
(ii) If a company has issued a share certificate under a forged transfer and he has sold the
shares to an innocent person, the company is liable to compensate such a purchaser if it
refuses to register him as a shareholder. In such a case, he can claim damages from the
company on the grounds that he acted on the share certificate of the company.
(iii) If the company has been put to loss by reason of the forged transfer, it can claim an
indemnity from the person presenting the transfer for registration even though he is quite
innocent of the forgery.

Transfer Advice

In order to minimize instances of forged transfers, some companies in Kenya issue a

“Transfer Notice” or “Transfer Advice” to the registered holder to the effect that a transfer
of his shares has been presented for registration.

However, if the registered holder ignores the ‘notice’, he is not estopped from later
asserting that the transfer was not signed or authorized by him.

Blank Transfer

A transfer signed by the transferor, but with a blank for the name of the transferee is called
a blank transfer. In a blank transfer, neither the transferee’s name and the signature nor
the date of sale, are filled in the transfer form. The transferee is at liberty to sell it again
without filing his name and signature to a subsequent buyer. The process of purchase and
sale can be repeated any number of times with the blank deed and ultimately when it
reaches the hands of one who wants to retain the shares, he can fill his name and date and
get it registered in the company’s books.

The facility of blank transfer has often been used for illegal purposes particularly to avoid
taxes.

MORTGAGE ON SHARES

A shareholder who intends to borrow money on the security of his shares may do so by
way of legal or equitable mortgage on his shares.

(a) Legal mortgage

This entails the transfer of shares to the lender as a security for repayment of an old debt.
As long as the mortgagee remains a registered shareholder, he is entitled to all dividends

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and he is entitled to vote, unless it is agreed between the lender and borrower that
dividends will be paid to the latter.

A legal mortgagee is for a period when the contract is still in force, a member of the
company.

In order to effect a legal mortgage of shares, the legal ownership of shares must be
transferred to the lender by the registration of a form of transfer with the company
concerned.

Dividends paid to the lender during the currency of the loan as the registered holder of the
shares are payable by him to the borrower unless the loan agreement provides that they
will be applied towards reduction of the loan. The voting rights exercisable in respect of
the shares will depend on the provisions of the loan agreement.

(b) Equitable mortgage

This is effected by a deposit of share certificate by the borrower with the lender as a
security for the loans, with or without delivery of a blank transfer. Incase the borrower
fails to repay the loan the mortgagee may fill the blank transfer form and dispose the
shares.

There are no legal formalities prescribed for an equitable mortgage which can therefore be
created quite informally. Anything done by the lender and the borrower which shows an
intention to mortgage the shares will suffice.
The common options for equitable mortgage are:-

(i) To deposit the share certificate with the lender without executing a transfer: -
If the borrower fails to repay the loan as agreed between him and the lender, the lender
must apply to court for an order for sale of the shares.
Alternatively the lender may apply for an order of fore closure which would vest the
ownership of the shares in him absolutely.

(ii) To deposit the share certificates plus a blank transfer with the lender.

A blank transfer is one which is signed by a named transferor but does not specify the
transferee. On default by the borrower, the lender has an implied authority to sell the
shares and to enter the name of the purchaser in the transfer as the transferee. In Deverges
vs. Sandeman Clark Co., it was observed that no court order is required in order to effect
the sale.

Priorities

If a person who has borrowed money on the security of an equitable mortgage by a

fraudulent misrepresentation, induces the company to issue him with another share

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certificate and uses the certificate to sell the shares to a bonafide purchaser for value who
then obtains registration, that purchaser will have a priority over the mortgage.

Share Certificates

Section 82(1) provides that within 60 days after the date on which a transfer is lodged with
a company, the company must have ready for delivery, a certificate of the shares
transferred.

Section 82(3) provides that a person aggrieved by the company’s failure to issue a share
certificate may serve the company with a notice requiring the company’s compliance with
the section. If the company does not do so within 14 days after the service of the notice he
may apply to the court for an order directing the company and the officer responsible to
issue the certificate with such time as the court may specify. The costs of application shall
be borne by the company or the officer of the company who was responsible for the default.

In Re: Bahia & San Francisco Railway Co., the judge described the share certificate as a
“declaration by the company to all the world that the person in whose name the certificate
is made out and to whom it is given, is a shareholder in the company, and it is given by the
company with the intention that it shall be so used by the person to whom it is given and
acted upon in the sale and transfer of shares”.

SHARE WARRANTS

Section 85(1) provides that a company limited by shares, if so authorized by its articles
may, with respect to any fully paid up shares, issue under its common seal a warrant
stating that the bearer of the warrant is entitled to the shares therein specified.

Section 114(1) provides that on the issue of a share warrant, the company shall strike out
of its register of members, the name of the member then entered therein as holding the
shares specified in the warrant as if he had ceased to be a member. The company shall then
enter in the register the fact that the issue of the share warrant, a description of the shares
included in the warrant and the date of issue.

Section 114(2) provides that the bearer of the share warrant shall be entitled on
surrendering it for cancellation to have his name entered as a member in the register of
members.
The share warrant is a “warranty” that the bearer is the holder of the shares specified
therein. Secondly it is a negotiable instrument which is transferable by simple delivery and
a bonafide transferee for value of the warrant is not affected by any defect in the title of the
transferor.

FORFEITURE AND SURRENDER OF SHARES

Forfeiture

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If a shareholder having been called to pay any call on his shares fails to pay, the company
has two remedies against the shareholder:-
(i) To sue him for the amount due.
(ii) To forfeit the shares.

Forfeiture means losing the right of ownership of the shares as a penalty for some act.
Forfeiture for non payment can be instituted if special powers are given by articles to the
directors to do so.
The company may forfeit shares of a shareholder for non payment of some call if the
following conditions are satisfied:-
(i) In accordance with articles: - Forfeiture must be authorized by articles of the company.
(ii) Notice prior to forfeiture: - Under Section 34, the notice is required to name a day/date on
or before which the payment is to be made, and to state that in the event of non-payment,
the shares will be liable to be forfeited.
(iii) Resolution of the Board: - If the defaulting shareholder does not honor the notice, the
directors must pass a resolution forfeiting such shares. If this resolution is not passed, the
forfeiture is invalid.
(iv) Good faith: - The directors must forfeit the shares in good faith and for the benefit of the
company.

Effects of Forfeiture

(i) A person whose shares are forfeited ceases to be a member in respect of the forfeited
shares.
(ii) Forfeited shares may be cancelled, sold or re-allotted on such terms and in such manners
as the directors deem fit.

DEBENTURES

Section 2 of the Act defines a debenture as including debenture stock, bonds and any other
securities of the company, whether constituting a charge on the assets of the company or
not.

A debenture is a document given by a company as evidence of a debt to the holder usually

arising out of a loan and most commonly secured by a charge.

According to Palmer, the word ‘debenture’ signifies “any instrument under seal evidencing
a deed, the essence of it being the admission for indebtedness”. In other words, debenture
is a document creating or acknowledging an indebtedness of the company which may or
may not be secured.

Debentures are usually issued by a resolution of the Board of Directors under powers
conferred by the company’s articles of association. Table A, Article 79 provides that, the
directors may exercise all the powers of the company to borrow money and to issue
debentures, debenture stock and other securities”.

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Charges Securing Debentures

A company can issue secured and unsecured debentures. If the debentures are not secured
by the assets of the company, the debenture holders position is that of an unsecured
creditor. Secured debentures are issued by creating a charge on the assets of the company.

The term “charge” means an interest. It may either be a specific (fixed) charge or a floating
charge.

(a) Fixed Charge

A fixed charge is created in respect of a definite and ascertained property and this prevents
the company from dealing with that property without the consent of debenture holders. In
the event of winding up of a company, debenture holder secured by a specific charge is in
the highest ranking class of creditors. Where there are a number of specific charges on the
same property, their priority is determined by the general rules relating to priority of
charges.

(b) Floating Charge

A floating charge is an equitable charge which does not fasten on any ascertained or
definite property and as such can deal with any of its assets in the ordinary course of
business.

Lord Gower defined a floating charge as “a charge which floats like a cloud over the whole
assets from time to time falling within the generic description”.

The consent of the debenture holders is not necessary for the company to deal with its
assets.

Characteristics of a floating charge

The characteristics of a floating charge have been ably stated by Romer in Re: Yorkshire
Wool Combers Association Ltd (1903) that: -
(i) It is a charge on a class of assets present and future.
(ii) The class is one which changes from time to time in the ordinary course of the
company’s business.
(iii) Is contemplated by the charge that, until some event occurs which causes the charge to
crystallize, the company may use the assets charged in the ordinary course of its business.

Distinction between Fixed and Floating Charge

“A specific/fixed charge is one that fastens on ascertained and definite property or

property capable of being ascertained and defined; a floating charge on the other hand is
ambulatory and shifting in its nature, hovering over and so to speak floating with the
property which it is intended to affect, until some event occurs or some act is done which

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causes it to settle and fasten on the subject of the charge within its reach and grasp”,
according to Illingworth vs. House worth (1904).

Crystallization of Floating Charges

A floating charge may crystallize or become fixed in any of the following ways:-
(i) When the company ceases to carry on business.
(ii) When the company defaults and the debenture holders take steps to enforce their
security, either by appointing a receiver or applying to court to do so.

Case Law: Government Stock and Other Securities vs. Manila Railway Co. (1897)
The debentures created a floating charge. After three months, interest become due, but the
debenture holders took no steps. The company then made a mortgage of a specific part of
its property. The House of Lords held that the mortgage has no priority. It was observed
that “it is of essence of floating charge that it remains dormant until the undertaking
charged ceases to be a going concern, or until the person in whose favor the charge is
created intervenes. As long as he does not intervene the business will be carried on. Mere
default does not cause crystallization and that the debenture holders must intervene by
taking steps to enforce their security”.

(iii) When the company goes into liquidation.

(iv) When the receiver is appointed.

Priority of Charges

The priority between charges is as follows:-

(a) Legal fixed charges rank according to their order of creation.
(b) If an equitable fixed charge (i.e. an informal mortgage created by a deposit of title deeds or
share certificate to the lender) is created first and a legal charge over the same property is
created later, the legal charge takes priority over the equitable charge.
(c) A floating charge will be postponed to a later fixed charge over the same property.

The floating charge would however have priority over the fixed charge if: -
(i) The floating charge contained a clause prohibiting the company from creating fixed
charges with priority over it.
(ii) The holder of a fixed charge actually knew about the prohibition.

(d) If two floating charges are created over the general assets of the company, they will rank
in the order of creation.
(e) If a company creates a floating charge over a particular kind of assets, for example book
debts, the charge will rank before an existing floating charge over the general assets

LESSON 11

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MAJORITY RULE (Foss vs. Harbottle, 1843)

Supremacy of the majority is the fundamental principle of company law. Generally,

majority members are entitled to exercise powers of the company and control its affairs. A
group of persons controlling ¾ of the votes would have a complete control of the company,
and a little more than half the votes would give considerable influence allowing control
over appointments to the Board.

The Act lays down certain matters, which have to be decided by shareholders at a general
meeting by simple majority, whereas certain more important matters can be decided by a
special majority of ¾ of the shareholders. Therefore, it is obvious the administration of a
company goes with the majority rule.

The principle of majority rule was recognized in Foss vs. Harbottle (1843). It is also known
as “proper plaintiff principle”, which states that, in order to redress a wrong done to a
company or to the property of the company or to enforce rights of the company, the proper
claimant is the company itself, and the court will not ordinarily entertain an action brought
on behalf of the company by a shareholder.

Case Law: Foss vs. Harbottle (1843)

The claimants, Foss and Turton, were shareholders in a company ‘The Victoria Park
Company’ which was formed to buy land for use as a pleasure park. The defendants were
the other directors and shareholders of the company. The claimants alleged that the
defendants had defrauded the company in various ways and in particular that the
defendants had sold land belonging to them to the company at exorbitant price. The
claimants now asked the court to order that the defendants make good the losses to the
company.

It was held by Vice-Chancellor Wigram that since the company’s board of directors was still
in existence, and since it was still possible to call a general meeting of the company, there
was nothing to prevent the company from obtaining redress in its corporate character, and
the action by the claimants could not be sustained.

In Foss vs. Harbottle two minority shareholders in a company alleged that its directors
were guilty of buying their own land for the company’s use and paying themselves a price
greater than its value. This act of directors resulted in a loss of the company.

The minority shareholders decided to take action against the directors, but the majority
shareholders in a meting resolved not to take any action against the directors alleging that
they were not responsible for the loss which had occurred.

The court dismissed the suit on the ground that the acts of the directors were capable of
confirmation by the majority members and held that the proper plaintiff for wrongs done
to the company is the company itself and not the minority shareholders and the company
can act only through majority shareholders.

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The rationale in that line of reasoning is that a company is a separate legal entity from the
members who compose it and as such, if any right of the company is violated, it is the
company which can bring an action through the majority.

It was held that, “If the thing complained is a thing which, in substance, the majority of the
company are entitled to do, or something has been done irregularity which the majority of
the company are entitled to do regularly or if something has been done illegally which
majority of the company are entitled to do legally, there can be no use in laying litigation
about it, the ultimate end of which is only that a meeting has to be called, and then
ultimately the majority gets its wishes.

It was also held that, it is elementary principle of law relating to joint stock companies that
the court will not interfere with the internal management of the company, acting within
their powers and jurisdiction to do so. Again it is clear that in order to redress a wrong
done to the company or to recover monies or damages due to the company the action
should prima facie be brought by the company itself”.

Basis of the Rule

(1) The right of the Majority Rule

The court has said in some of the cases that an action by a single shareholder cannot be
entertained because the feeling of the majority of the members has not been tested and
that they may be prepared to waive their right to sue.

(2) The Company is a Legal Person

The court has also said from time to time that since a company is a person at law, the action
is vested in it and cannot be brought by a single member.

(3) The prevention of multiplicity of Actions

This situation could occur if each individual member was allowed to commence an action in
respect of a wrong done to the company.

(4) The court’s order may be made ineffective

The court’s order could be overruled by an ordinary resolution of members in a subsequent

general meeting.

Case Law: MacDougall vs. Gardiner (1875)

The articles empowered the chairman with the consent of the members in a meeting to
adjourn a meeting and also provided for taking a poll if demanded by the shareholders.
The adjournment was moved and declared by the chairman.

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A shareholder brought an action for a declaration that the chairman’s conduct was illegal.
It was held that the action could not be brought by the shareholder. If the chairman was
wrong, only the company could sue.

Lord Melish said that if the thing complained of is a thing which in substance the majority
of the company are entitled to do, there can be no use in having litigation about it, the
ultimate end of which is only that a meeting has to be called and then ultimately the
majority gets its wishes.

Advantages of the Rule in Foss vs. Harbottle

(i) Recognition of separate legal personality of a company. If a company has suffered some
injury, then it is not the individual members, rather it should be the company to seek
redress.
(ii) It preserves the right of the majority to decide how the affairs of the company shall be
conducted. It is the wish of the majority to prevail.
(iii) Multiplicity of futile suits can be avoided, that is, if every member were permitted to sue
everyone who has injured the company through a breach of duty, there would be enormous
waste of time and money.
(iv) Litigation at the suit of a minority is futile if majority do not wish it.

Exceptions to the Rule in Foss vs. Harbottle (Protection of the Minority)

It is clear from Foss vs. Harbottle rule that it is the majority rule that prevails in the
company management. Such powers may be misused to exploit the minority shareholders
and to serve personal ends. This may be clear in case of private companies where few
individuals own majority of shares.

Palmer rightly pointed out that, “a proper balance of rights of majority and minority
shareholders is essential for the smooth functioning of the company”.
To curtail the power of the majority, the following exceptions have been admitted as
follows:-
(i) Acts which are ultra vires or illegal

Foss vs. Harbottle will apply only when the act done by the majority is one which the
company is authorized to do by its memorandum.
No simple majority of members can confirm or ratify an illegal act, not even if all the
shareholders are willing to do so. Incase of ultra vires acts, even a single shareholder can
restrain the company from committing those acts by filing a suit of injunction. Majority
rule will not prevail where the act in question is illegal.

(ii) Acts supported by insufficient majority

For certain acts, it might require ¾th majority. The rule in Foss vs. Harbottle cannot be
invoked by a simple majority if the act requires special majority. If the requirements of

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special majority are not fulfilled, any shareholder can restrain the company from acting on
resolutions.

Case Law: Edwards vs. Halliwell (1950)

A trade union had rules which were the equivalent of the articles of association, under
which any increase in members’ contributions had to be agreed by a 2/3rd majority in a
ballot of members. A meeting decided by a simple majority, to increase the subscriptions
without holding a ballot. The claimants as a majority of members applied for a declaration
from the court that the resolution was invalid.

It was held that the rule in Foss did not prevent a minority of a company from suing
because the matter about which they were suing was one which could only be done or
validly sanctioned by a greater than simple majority.

(iii) Where the act of majority constitutes a fraud on the minority

A resolution would constitute a fraud on minority if it is not bona fide for the benefit of the
company as a whole. Similarly, an action of the majority which discriminates between
majority shareholders and minority could constitute a fraud of majority. A special
resolution would be liable to be impeached if the effect of it were to discriminate between
the majority shareholders and minority shareholders, so as to give the former advantage of
which the latter were deprived.

The rule in Foss would create grave injustice if the majority were allowed to commit
wrongs against the company and benefit from those wrongs at the expense of the minority,
simply because no claim could be brought in respect of the wrong.

Case Law: Cook vs. Deek (1916)

The directors of a Railway Construction company obtained a contract in their own names
to construct a railway line. The contract was obtained under circumstances which
amounted to breach of trust by the directors who then used their voting powers to pass a
resolution of the company declaring that the company had no interest in the contract.

It was held that the benefit of the contract belongs in equity to the company and that the
directors would benefit themselves at the expense of the minority. It is tantamount to
majority oppressing the minority. In case of breach of duty of this sort, the rule in Foss did
not bar the claimants’ claim.

Case Law: Brown vs. British Abrasive Wheel Co. (1919)

A company required further capital. The majority who represented 98 percent of the
shareholders, were willing to provide this capital but only if they could buy up the 2
percent minority. The minority would not agree to sell and so the majority shareholders
proposed to alter the articles to provide for compulsory acquisition under which 9/10 th of
shareholders could buy out any shareholders.

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Lord Asbury held that the alteration of the articles would be restrained because the
alteration was not for the benefit of the company. The rule in Foss did not bar the
claimant’s claim.

(iv) Where it is alleged that the personal membership rights of the plaintiff
shareholder has been infringed

Such individual rights include the right to attend meetings the right to receive dividends
the right to insist in strict observance of the legal rules; statutory provisions in the
memorandum and articles. If such a right is in question, a single shareholder can on
principle, defy a majority consisting of all other shareholders.

Thus, where the chairman of a meeting at the time of taking the poll ruled out certain votes
which should have been included, a suit by a shareholder was held to be validly filed.
Where the candidature of a shareholder for directorship is rejected by the chairman, it is an
individual wrong in respect of which the suit is maintainable.

(v) Where there is breach of duty

A minority shareholder can bring a suit against the company where there is a breach of
duty by the directors and majority shareholders to the detriment of the company.

Case Law: Daniels vs. Daniels (1978)

A company on an instruction of the two directors (husband and wife), having majority
shareholding sold the company’s land to one of them, (the wife) at a gross under value. The
minority shareholders brought an action against the directors and the company.
It was held that minority shareholders had a valid cause of action.

(vi) Oppression and Mismanagement

Where there is oppression of minority or mismanagement of the affairs of the company,

Foss vs. Harbottle does not apply.

Oppression refers to an act performed in a burdensome, harsh and wrongful manner. A

shareholder can bring an action against the management of the company on the grounds of
oppression and mismanagement.

LESSON 12

COMPANY MEETINGS AND PROCEEDINGS

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Class Meeting

Meaning of Company Meeting

Ordinarily, a meeting may be defined as assembly of people for lawful purpose or coming
together of at least two people for the same reason.

A Co. meeting may be defined as, “a conference or coming together of at least a quorum of
members in order to transact either the ordinary or special business of the company”.
Therefore, a meeting can no more be constituted by one person than it could if no
shareholders at all had attended.

Although the word meeting is not defined in the Companies Act, in Sharp vs. Dawe (1876),
a meeting was defined as, “an assembly of people for lawful purpose or the coming together
of at least two persons for any lawful purpose”.

Meetings are divided into: -

(a) Public Meetings: - Those meetings which consider maters of public concern and to which
all members of the public have access, subject to physical limitations of the place where the
meeting is held or conditions imposed by any law.
(b) Private Meetings: - Those attended by people who have a specific right to attend, for
example, Committees of golf club or members of a registered company. Therefore
company meetings fall under this category.

Role of Company Meetings

Since a company is an artificial person, it cannot act on its own. It is the directors, elected
representatives of shareholders who are vested with the powers of control and
management of the company. Since directors must work as a team, meetings are held
frequently. It is at these meetings that matters relating to the company business are
decided.

Similarly shareholders meetings are also important as it is here that shareholders can look
after their interest by exercising the powers conferred on them by statute. These meetings
provide an opportunity to shareholders to come together and take decisions for their
welfare by controlling the Board of Directors and their activities.

CLASSIFICATION OF MEETINGS

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(a) STATUTORY MEETING (Section 130)

Every company limited by shares and every company limited by guarantee and having a
share capital shall within a period of not less than one month and not more than three
months from the date of the of commencement of business, hold a general meeting called
statutory meeting. This meeting is held once during the lifetime of the company.

A private company, an unlimited company or a company limited by guarantee having no

share capital, is not required to hold a statutory meeting. The notice convening this
statutory meeting must be given at least 21 days before the meeting, and must specifically
state that the meeting is a statutory meeting.

Objects of the Statutory Meeting

The object of this meeting is to afford the shareholder an early opportunity of obtaining
material information as to the circumstances of the company’s promotion and also its
immediate prospects.

According to Palmer, “the object of the statutory meeting is to put the shareholders of the
company at as early a date as possible in possession of all the important facts relating to
the new company”.

The members have a statutory right to discuss any matters relating to the formation of the
company or arising out of the statutory report whether previous notice has been given or
not. The other object include: -
(i) To put members of the Co. in possession of all the important facts relating to the company,
for example, what shares have been taken up, what money has been received, what
contracts have been entered into and what has been spent on preliminary expenses.
(ii) To provide the members an opportunity of meeting and discussing the management
methods and prospects of the company.
(iii) To approve the modification of the terms of any contract named in the prospectus.

Statutory Report

The law accordingly requires that the directors send a report known as statutory report to
every member of the company at least 14 days before the date of the meeting. However, if
all the members entitled to attend and vote at the meeting agree, the report can be
forwarded less than 14 days before the meeting.

Contents of the Statutory Report

The report contains all the necessary information relating to the informational aspect of
the company, as follows: -

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(i) Total shares allocated: – Distinguishing shares allocated as fully or partly paid up
otherwise than in cash, and stating shares partly paid up, the extent to which they are so
paid up and in either case the consideration for which they have been allocated.
(ii) Cash received: – The total amount of cash received by the company in respect of shares
allocated.
(iii) An abstract of receipts and payments made there out up to the date of the report, and
an account or estimate of the preliminary expenses.
(iv) Directors and auditors: - The memos and addresses and occupations of the directors,
auditors and managers and secretary and changes that have occurred to such names,
addresses and occupations since the date of incorporation of the company.
(v) Particulars of any contract and the modification or the proposed modification of any
contract which is to be submitted for the approval of the members at the meeting.
(vi) The extent to which the underwriting contracts have not been carried out and reasons
therefore.
(vii) The arrears, if any, due on calls from any directors and the manager.
(viii) The particulars of any commission or brokerage paid or to be paid to any director or to
the manager in connection with the issue or sale of shares or debentures of the Co.

The statutory report must be certified as correct, by not less as two directors one of whom
shall be the Managing Director if any. The auditors of the company shall also certify as
correct regarding the shares allotted, cash received in respect of any shares and the
receipts and payments of the company. A certified copy of the report shall be delivered to
the registrar for registration immediately after the same has bean sent to the members of
the company.

Procedure at the Meeting

At the commencement of the meeting, the board shall place a list showing the names,
addresses and occupations of the members of the company and the number of shares held
by them. The list shall remain open for inspection by members during continuance of the
meeting. The members present at the meeting may discuss any matter relating to the
formation of the company or arising out of statutory report.

But the meeting cannot pass any resolution on any item or on a subject of which notice has
not been given by the Act.

Section 130 (8) provides that the meeting may adjourn from time to time and at any
adjourned meting, a resolution can be passed after due notice in accordance with the
articles has been given so that if the company at the original meeting wishes to pass a
resolution and sufficient notice has not been given, it can resolve to adjourn for the
necessary period in order to allow notice to be given.

The adjourned meeting is treated as if it is an original meeting for the purpose of

transacting business.

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Effects of Non-Compliance

If default is made in complying with Section 130, every director of the company who is
knowingly and willfully guilty of the default, or in the case of the company, every officer of
the company who is in default, is liable to fine up to Sh. 1,000 shillings.

In addition, default in delivering the statutory report or in holding the statutory meeting is
one of the grounds for petition for winding up order against the company.

The court ordinarily does not take such serious view of default. So instead of making a
winding up order, Section 222 (3) provides that the courts may direct the report to be
delivered or the meeting to be held and order the costs to be paid by the persons in default.

(b) ANNUAL GENERAL MEETING

Every company must in each year hold, in addition to any other meeting, Annual General
Meeting. The notice conveying the meeting must specify that it is a notice of the Annual
General Meeting.

The first Annual General Meeting must be held within 18 months from the date of
incorporation, meaning that the Co. is not required to hold an Annual General Meeting in
the year of incorporation or in the next year.

For example, a company incorporated on October 1, 2004 may hold it Annual General
Meeting by April 1 2006 and then no other meeting will be necessary either in 2005 or
2006. Similarly, if a company is incorporated in January 1, 2005, it may hold its Annual
General Meeting within 18 months, that is, by July 1, 2006. If the meeting is held say in
June 2006, the company need not hold any other meeting in the year 2005 and 2006.

Every Annual General Meeting must be held during business hours and on working days.

The registrar may, for any special reason, extend the time for holding any Annual General
Meeting by any given period; but no extension of time is granted for holding the first
Annual General Meeting.

There should be at least one Annual General Meeting per year and as many meetings as
there are years.

Case Law: Sree Meenakshi Mills Co. Ltd vs. Assistant Registrar of Co. AIR (1938)
The Annual General Meeting of a company called in December 1934 was adjourned and
held in 1935 March. The next meeting was held in January 1936, no other meeting being
held in 1935. The company was prosecuted for failure to call the Annual General Meeting
in 1935. The company argued that it did hold a meeting in the year 1935, but it was held by
court that the meeting of March 1935 was the adjourned meeting of 1934.

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If default is made in holding an Annual General Meeting, a member may apply to the
registrar of companies to call or direct the calling of such meeting.

Default in accordance with provision of Section 131 or in complying with any directions of
the registrar, renders the company and its officers who are in default liable to a fine up to
Sh. 2,000.

Requirements of Notice

Proper length of notice must be provided by statute or articles. Section 133 of the Act
provides that minimum notice required for company meetings, other than the adjourned
meeting is as follows: -
(a) In case of Annual General Meeting, 21 days notice in writing is given.
(b) In case of a meeting other than AGM or a meeting of passing a special resolution, 14 days
notice in writing and 7 days in case of unlimited company.

Any provision contained in the articles shall be valid in so far as it provides for the calling
of a meeting by a short notice than it is provide by this section.

Ordinary Business of Annual General Meeting

The normal business transacted at an Annual General Meeting depends upon the articles.
Article 52 of Table A provides that the ordinary business of such a meeting shall be:-
(i) The declaration of dividends.
(ii) The consideration of accounts.
(iii) The election of directors in place of the retiring.
(iv) Appointment of and fixing of the remuneration of auditors.

Any business which is not defined as “ordinary business” of an Annual General Meeting is
known as special business.

Section 148 of the Act provides that at the Annual General Meeting, the directors of a
company must lay before the company the Profit and Loss Account.

The proceedings at the meeting are commenced by the chairman, who usually makes a
speech on the company’s affairs and any other circumstances of interest to the company
and also answers questions from the members if any. After this, he initiates or proposes a
motion relating to the adoption of accounts and payments of dividends if any.

The next item of business deals with the proposal for election or re-election of directors.
Section 184 must be complied here. This section stipulates that if single resolution is
passed for election or re-election of more than one director of a public company, such a
resolution is invalid unless resolution was previously passed that all the directors
concerned can be elected by a single composite resolution.

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Thirdly, a motion regarding the remuneration of the company’s auditors is proposed. This
is obligatory.

Although the appointment of auditors must be made at this Annual General Meeting, they
are automatically re-elected, provided they are qualified without any resolution to that
effect, unless: -
(a) They have resigned, or
(b) They are unwilling to act, or
(c) A resolution has been passed expressly providing that they shall not be reappointed
(d) Other auditors in their place have been appointed.

Role of an Annual General Meeting

(i) It is only at an Annual General Meeting that shareholders can exercise any control over
the affairs of the company. They can confront the directors, their elected representatives at
least once a year.
(ii) They also get an opportunity to discuss the affairs and review the working of the
company.
(iii) They can put necessary measures to protect their interests, for example, they may refuse
to re-elect a director whose actions and policy they disapprove.
(iv) They can also take up any matter of the company for discussion.
(v) Appointment of auditors is done in this meeting.
(vi) Annual accounts are also presented for consideration.
(vii)Dividends are declared.

(c) EXTRA –ORDINARY MEETING (Section 312)

A statutory meeting and an Annual General Meeting are called ordinary meetings. Every
other meeting of the company which is not the above is an “extra ordinary meeting”.

Extra ordinary meetings can be convened either by the directors whenever they think fit or
on the requisition of members of the company, under Article 49.

Where directors think fit to convene a meeting, they do so by resolution passed at a duly
convened and constituted meeting of the Board. Article 52 of Table A, states that all
business that is transacted at extra ordinary meeting shall be deemed as special.

The extra ordinary general meeting may be convened:-

(a) By Board of Directors on its own or on the requisition of the members.
(b) By the requisitionists themselves on the failure of Board of Directors to call the meeting.

Extra-ordinary meeting convened by Board of Directors:-

(a) On its own:– The BOD may call an extra ordinary meeting whenever some special
business is to be transacted which in the opinion of the Board of Directors, cannot be
postponed till the next Annual General Meeting.

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(b) On requisition of members: - The requisite number of members of a company may ask for
an extra ordinary general meeting to be held. The Board of Directors shall proceed to call
such a meeting. The requisition for such a meeting by the members shall be signed:-
(i) In case of company with share capital holders of not less than 10% of the paid up capital
of the company having a right of voting in regard to the matter of acquisition.
(ii) In case of company with no share capital, by members representing not less than one
tenth of the total voting power in regard to the matter of requisition.

A requisition signed by one of the joint owners of the shares has the same force and effects
as if it has been signed by all of them.

The requisition shall set out all matters for consideration on which the meeting is called
and shall be deposited in the registered office of the company. The directors are required
to convene such a meeting within 21 days from the date of deposit of the requisition, but if
the fail to do so, the requisitionists themselves may convene the meetings, as nearly as
possible in the manner required by the company’s articles for convening the meeting,
under Section 132.

The company must compensate the requisitionists for any reasonable expenses incurred
and may repay out of sums payable by the company to such directors as were in default.

Notice

Unless the meeting is called to pass a special resolution, the requisite notice for an extra
ordinary general meeting is 14 days (Saturdays, Sundays, Public holidays are not
included). In case of unlimited company, 7 days notice is required, but where special
resolution is required, 21 days.

(d) CLASS MEETINGS

Class meetings are generally held for obtaining the consent of a particular class of
shareholders for altering their rights and privileges or for the conversion, of one class into
another, for instance, there may be a meeting of preference shareholders for varying their
rate of dividend.
Prima facie, a class meeting should be attended by the members of the class in order that
the discussion of the matter which the meeting has to consider may be carried
unhampered.

The presence of a number of persons with conflicting interests would render it impossible
for the members of the class to adequately discuss the matter from their point of view.

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And if the presence of the outsiders is retained in spite of the ascertained wish of the
constituents of the meeting for their exclusion, it cannot be said that a separate meeting of
the class had been fully held. But where the constituents of the meeting meet together and
no one infact raised any objection to the presence of strangers or outsiders within the same
four walls, there is no reason why their meeting should be a perfectly good meeting, as per
Carruth vs. Imperical Chemicals Industries (1937).

Rights of Minority

Although the articles may allow the variation of class rights with the consent of a specified
proportion of class shareholders, the minority of that particular class of shareholders has a
valuable right to object.

Section 74 stipulates that the holders of not less than 15% of the issued shares of the class,
being persons who did not consent to the resolution or abstained or did not vote at all, may
object within 30 days to the alteration approved by the majority of the class.

The court must disallow the variation if it is not satisfied it would unfairly prejudice the
shareholders of a class, but if not satisfied, then it will confirm the variation. A letter of the
court confirming this must be sent to the registrar within 30 days. If memorandum or
articles of the company do not provide For the variation of class of rights and it is desired
that The variation be effected, then this must be done under Section 207 which gives power
to the company to compromise with its creditors, or any class of them.

Meeting of the Board

The company is entitled to the combined wisdom of the directors and the directors are
required to meet together as a board; and directors must meet as frequently as possible.
These are known as board meetings. It is at these meetings that vital matters relating to the
company are discussed and decided upon.

Meetings of Committees of Directors

In a large company where directors are many, it is often necessary to delegate certain
matters to committees of their number. But this power must be provided by the articles.
By so doing, the full board will probably not need to meet more frequently.

REQUISITES OF A VALID MEETING

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A meeting can validly transact any business if the following requirements are satisfied:-

(i) Proper authority.

(ii) Proper notice.
(iii) Quorum must be present.
(iv) Chairman must preside.
(v) Minutes of the meeting must be kept.
These are explained below: -

(i) Proper Authority-

A meeting to be valid must be convened by a proper authority. It is the Board of Directors
who has the authority to call a meeting, be it statutory, annual or extra ordinary. If the
Board do not #all the meeting the members of the company may call the meeting.
Even if the meeting of the Board at which it is resolved to call a General Meeting is not
properly constituted, the general meeting called by the Board can act.

(ii) Proper Notice

The second requirement of a valid meeting is that all those who are concerned with the
business of the meeting and are entitled to attend, are communicated of the date, time,
place and business of the meeting. Such communication is called notice.

The length of notice required by Section 133 for calling a general meeting is 21 days.
Section 133, since statutory, overrides any provision in the articles for a shorter notice, but
articles can validly provide for longer notice than that laid down by statute.

The meeting can however be called by giving a shorter notice in the following cases:-

(a) In case of an Annual General Meeting, by the consent of all the members entitled to attend
and vote.
(b) In case of any other meeting, by the consent of the members holding not less than 5% of
paid- up capital of the company or not less than 95% of voting power.

If members agree to accept a shorter notice, a resolution to that effect must be recorded in
the minutes of the meeting with sufficient details of voting.

Case Law: Bailey, Hay & Co. Re (171)

The notice of a meeting for theVoluntary winding up of a company was short by one dAy.
All thefive members attended. ThE necessary resolution was passed by the votes of two
members, the other three ab3tained from voting. It was held that the resolution was
validly passeD with the unanimous assent of all the members and those who abstained
were treated as having acquiesced in the winding up.

Omission to give Notice

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Deliberate omission to give a notice even to one member may invalidate the meeting. An
accidental omission or non-receipt of notice by any member doeS not inValidatE the
proceedings at the meeting. “AccidentAl loss –not deliberate”.

Case Law: Mussel white vs. CH Mussel white & Sons Ltd (1962)
M sold shares inM Ltd to D. The payment was to be made by D to M by instalments. M was
to remain on the register of members until the last instalment was paid. Before the last
instalment was paid, an annual general meeting was held, but M did not receive the notice
of the meeting as the directors erroneously believed that M was no longer a member.

It was held that the failure to give notice was not incidental and the meeting held without
notice was void.
Contents of the Notice;-

(i) Specify the date, place and hour of the meeting.

(ii) Statement of the business to be transacted/agenda, with sufficient details.

Special Notice

Certain powers which are exercisable by members by ordinary resolution or special

resolution, requires “special notice”.

A special notice is required for the following resolutions:-

(i) Removing a director.
(ii) Authorising a director who is over 70 years.
(iii) Appointment of an auditor.
(iv) Providing expressly that a retiring auditor shall not be appointed.

(iii) Quorum

Quorum means the minimum number of members who must be present in order to
constitute a valid meeting. The quorum is generally stated by articles.

Articles 53 Table A provides that no business shall be transacted at any general meeting
unless a quorum is present at the time the meeting proceeds to business.
Three persons/members present in person shall be quorum.
Thus those members who intend to vote by proxy are not taken into account when
determining whether or not a quorum is present.
Where no provision is made as to quorum in the articles, Section 134 (c) prescribes two
members in case of private company and in other cases three.
If the articles provide that proxies be included in quorum, then it can be counted.

Rule: If no quorum is present, there is no meeting and any business conducted is invalid.
Unless otherwise provided in the articles, if within half an hour from the time
appointed for holding a meeting of the company, a quorum is not present the meeting:-
(a) If called upon by the requisition of members stand dissolved

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(b) Other cases stand adjourned to the same date in the next week at the same time, as the
directors may determine.

Note: If the quorum is not present at the adjourned meeting, then the present members
shall be quorum.

Quorum should be present at the time the meeting proceeds to business not present
throughout or at the time of voting.

SHARP VS. DAWES RULE

One person, except in exceptional cases cannot constitute a quorum. The word “meeting”
prima-facie means a coming together of more than one person. Strictly speaking therefore,
one shareholder cannot constitute a meeting. This is Sharp vs. Dawes rule.

Case Law: Sharp vs. Dawes (1876)

A general meeting of a company was called for the purpose of making a call. Only one
shareholder attended. The business of the company was carried through including a call on
the shareholders. Dawes was sued for the call he failed to pay. In his defence, Dawes
argued that the call had not been validly made at a general meeting. It was held that one
person could not constitute a meeting.

Meltish L.J. said, “according to ordinary English language, a meeting could no more be
constituted by one person than a meeting could have been constituted if no share holder at
all had attended. No business could be done at such a meeting.

Re. Sanitary Carbon Co. (1877) appeared to lend support to the above decision as it was
held that a meeting of a company attended by one shareholder only was not validly
constituted, even though that shareholder held the proxies of all other members.

Therefore, as a general rule, one individual alone does not constitute a meeting even if
he/she represent two or more members, for example, by being both a member and a proxy
for another member.

(iv) Chairman
The chairman:-
(i) Conducts a meeting.
(ii) He is the presiding officer.
(iii) Keeps order and conducts the meeting.
(iv) Must give members present a reasonable chance to discuss any proposed resolution.
(v) Should not adjourn the meeting without the consent of the members.

(v) Minutes of the Meeting

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Section 145 of the Act states that every company must keep minutes containing a fair and
correct summary of all proceedings of general meetings and directors in books kept for that
purpose.

The term “minutes” means official record of all the meetings of a company. These are
summary of the business transacted, decisions and the resolutions arrived at the meeting.

Any minute purporting to be signed by the chairman of a meeting is evidence of the

proceedings of the meeting in which it relates.

LESSON 13

PROXIES
A proxy is an authority to represent and vote for another person at a meeting. It is also an
instrument appointing a person as a proxy. The person so appointed is known as a proxy.

A proxy is not entitled to act contrary to the instructions of the appointer. Notice calling a
meeting must contain the right to attend and speak at the meeting. The right to appoint a
proxy is provided under Section 136 and any clause purporting to take away this right is
void.

Voting and Poll

Voting by show of hands: - Questions arising in a general meeting are to be decided in the
first instance by show of hands. On a show of hands, each member has one vote
irrespective of the number of shares, and a proxy cannot vote unless the articles otherwise
provides.

Since voting by show of hands does not always reflect the true interests of a member upon
a “value” basis, a provision has been made in Section 137 by virtue of which, except on the
question of election of chairman or an adjournment of meeting, the members have a
statutory right to demand that a poll be taken.
The demand for a poll may be made effective:-
(i) By the chairman.
(ii) By not less than five members having the right to vote at the meeting.
(iii) By a member representing not less than 1/10th of the total voting rights.

Vote by show of hands is not an accurate method f ascertaining the wishes of the members
of the company because the votes of those voting by proxy are not counted. Also it does not
pay due regard to the wishes of a member holding a large number of shares since he/she
has only one vote on a show of hands method.

A poll is more proper and effective means of arriving at the wishes of all the members. A
poll may be demanded before or on the declaration of the result of the voting on a show of
hands.

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RESOLUTIONS

Decisions of the company are made by resolutions of its members passed at meetings of
members. A proposal when passed and accepted by the members becomes resolution.
There are three kinds of resolutions:-
(i) Ordinary resolution
(ii) Special resolution
(iii) Resolutions requiring a special notice

(i) Ordinary Resolution

This is one passed by members at a general meeting by a simple majority of members

entitled to vote therein. Simple majority means that the votes cast either by show of hands
or on a poll in favour of a particular proposal including the casting vote of the chairman,
exceeds the votes cast against it. Votes may be cast by members in person or by proxy.
A proper notice should be given, that is, 21 days notice.

For example, in a general meeting of a company, out of 1,000 members entitle to vote, only
700 were present. Of the 700, 251 members vote in favour of a resolution, 250 against it
and 199 abstained from voting. The resolution was passed by a simple majority.

Ordinary resolution is necessary for the following among other purposes:

(i) To authorise the issue of shares at discount – Section 59.
(ii) To increase the share capital.
(iii) To appoint an auditor.
(iv) To appoint directors.
(v) To declare dividend
(vi) To approve accounts
(vii) To wind up voluntarily where provision to that effect is provided by articles

Extra ordinary Resolution

This is one which has been passed by a majority of not less than ¾th of such members, as
being entitled to do, vote in person or where proxies are allowed, vote by proxy at a general
meeting of which notice specifying the intention to propose the resolution as extraordinary
has been duly given. This resolution is not in Kenya.

(ii) Special Resolution

A resolution shall be a special resolution, says the Act, Section 141 when:-
(i) The intention to propose the resolution as special resolution has been duly specified in
the notice.

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(ii) The notice required under the Act, of 21 days has been duly given
(iii) The votes cast in favour of the resolution by members entitled to vote either in person or
by proxy are not less than three fourths of such members as being entitled to vote in
person or by proxy, where proxies are allowed.
The votes may be cast either by show of hands or by poll.

Special resolutions are the most vital part of the mechanism of the company. It is by and
through this instrument that the companies carry out vital administrative and executive
acts. The aim of passing special resolution is to ensure that every important change shall be
made only after due deliberations and with the sanction of the greater body of
shareholders of the company.
The articles may provide certain types of business that requires special resolutions as
follows:-
(i) To alter the objects of a company- Section 8.
(ii) To alter the articles – Section 13.
(iii) To change the name of the company – Section 20.
(iv) To create new reserve liability – Section 62.
(v) To alter the provisions of the memorandum for changing the place of registered office
from one state to another.
(vi) To reduce share capital of a company – Section 69.
(vii) To appoint inspectors to inspect or investigate the affairs of the company - Section 166.
(viii) To resolve that a company be wound up by order of the court -Section 271.
(ix) To institute members’ voluntary winding up – Section 280.
(x) To authorise the liquidator to accept shares in consideration for the sale of company’s
sharers.

(iii) Resolutions requiring “Special Notice”

This resolution requires a special notice to be given to the members. A resolution requiring
a special notice may be passed by the members at a general meeting by a simple majority
or ¾th majority.

A special resolution, for which special notice will be invalid, unless 28 days notice before
the meeting at which the resolution is to be moved, is given to the company by a member.
Special notice is required by the Act in the following matters:-
(i) A resolution at an Annual General Meeting appointing as an auditor a person other
than a retiring one- Section 60.
(ii) A resolution at an Annual General Meeting to provide that a retiring auditor shall not be
appointed.
(iii) A special resolution to appoint a director who is over any applicable age limit.
(iv) A special resolution to remove a director before the expiry of his period of office or to
appoint another director in place of the removed director – Section 185(2).

LESSON 14

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ACCOUNTS AND AUDITORS

Under Section 148 of the Act, directors must lay before the company once a year, Profit and
Loss Account and Balance Sheet. Incase of non-profit making organization, an Income and
Expenditure Statement.

The law insists that the accounts must cover the period, incase of first accounts, the period
starting from the incorporation, and subsequent/preceding accounts made up to a date not
earlier than nine moths before the date of the meeting (for company having interest
abroad, twelve months).

Failure by a director to comply with Section 148 may attract the following penalties:-
(i) Imprisonment for a term not exceeding 12 months.
(ii) A fine not exceeding Sh. 10,000, or both.

Provided that:-
(i) The proceeding against a person in respect of an offence under this section consisting
of a failure to take reasonable steps to secure compliance by the company.
(ii) The offence was committed willfully.

Appointment of Auditors

To safeguard the interests of shareholders, the Companies Act provides for the
appointment of auditors. Auditors are servants of shareholders and their duty is to
examine the affairs of the company on their behalf at the end of the year and report to them
what they have found out.

Under Section 159, every company is required to appoint an auditor at each Annual
General Meeting, failure to appoint at this meeting will cause members to make an
application to the registrar to appoint the auditor.

The rule of thumb is that a retiring auditor is to be reappointed without any resolution
being passed at the meeting unless:-
(i) He is not qualified for re-appointment.
(ii) A resolution has been passed appointing someone else instead of him.
(iii) A resolution has been passed that he shall not be re-appointed.
(iv) He has expressed in writing his unwillingness to be re-appointed.

Under Section 159(6), a casual vacancy of auditors can be filled by directors.

No person other than a retiring auditor may be appointed at an Annual General Meeting
unless a special resolution has been given and a copy of it has been sent to the retiring
auditor forthwith.

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The retiring auditor is usually entitled to be heard or to make representations in writing

and circulated among the members. The company must state in the notice that the
representation has been made and sent a copy of the representation to each member.

If a copy of representation is not sent, the retiring auditor may request that they may be
read at the meeting.

Disqualification for appointment as an Auditor

A person is not qualified to be an auditor unless:-

(i) He is a member of one or more professional bodies specified in first column of the
schedule to the Accountants Act or
(ii) He is authorized by the registrar to be appointed as having similar qualifications
obtained outside, that is, U.K., South Africa or India.
(iii) He has practiced in Kenya as an accountant before 26th May 1959.
(iv) He has been appointed and practiced before 26th May 1959 as an auditor of an existing
company.

The following persons are not qualified for appointment:-

(i) An officer/servant of the company.
(ii) A person who is a partner or in the employment of an officer or servant of the company.
(iii) A body corporate.
(iv) A person disqualified for appointment as auditor of subsidiary or holding company.

Remuneration of Auditors

It may be fixed by the company in an Annual General Meeting.

Incase of auditor appointed by directors to fill on casual vacancy or registrar in the event of
a company failing to appoint one, his remuneration is governed by provisions of Section
159(7), which empowers directors and registrars to fix such remuneration.

POSITIONS OF AUDITORS

(i) Auditors as gents of Members

Auditors are agents of shareholders even where they are not appointed by them and their
duties are to examine the affairs of the company on their behalf and report to them what
they have found out.
Apart from any social contract, an auditor is not an agent of the company.
His certificate on the Balance Sheet is not an acknowledgment of the company’s
indebtedness. But if he is negligent in the performance of his duties and this result in loss to
the shareholders, he is liable to the shareholders; but this liability would not extend to
third parties with whom no contractual relationship exists.

(ii) Auditors as officers of the Company

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Since they are normally liable for default in the performance of their duties, they are
regarded as officers.

(iii) Auditor as Employee of the Company

The nature of the relationship between an auditor of the company is that of a professional
man and a client, rather than that of an employer-employee, but for certain reasons, he is a
company officer.

RIGHTS AND POWERS OF AUDITORS [Section 162(4)]

(i) Right to access of books, accounts and vouchers:-

The phrase book does not limit the scope, rather includes all books whether statutory,
statistical or memorandum.

(ii) Right to attend Annual General Meetings of the company.

(iii) Right to be heard, particularly on any part of the business which concerns him as an
auditor.

DUTIES OF AUDITORS

(i) They must acquaint themselves with their duties as laid down by the Act and Articles.
(ii) They must report to the members on the accounts laid down before the company in the
general meeting.
The auditor is to give information in direct and express terms. Auditors occupy a fiduciary
position in relation to the shareholders and in auditing the accounts maintained by the
directors; and they must act in the best interest of the shareholders.
(iii) Duty of care: - Auditors must be honest and must exercise reasonable skill and care;
otherwise they may be sued for damages. An auditor was described as a “watchdog but not
a blood hound”. Thus, the auditors must be alert and careful and ascertain the company’s
true position.
(iv)The auditor has a duty to advice either directors or shareholders as to what they ought to
do. He is not concerned with the policy of the company, whether the company is ill-
managed or well managed.

London and General Bank

The greater part of the company’s capital was advanced as loans upon securities which
were insufficient and difficult to realize. For several years, the auditors pointed out to the
directors the unsatisfactory nature of these securities and the auditors report to the
members on the Balance Sheet date only stated, “The value of the asset as shown in the
Balance Sheet is dependent on realization”. On the faith of this Balance Sheet, dividends
were declared, which were really out of capital. It was held that it was the duty of the
auditors to ascertain the true position of the company and to report to the shareholders.
The auditors had failed in this duty and were liable.

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Liability of Auditors

They are liable for negligence, particularly in complying with the provision of the Act.

LESSON 15

COMPROMISE, ARRANGEMENT, RECONSTRUCTION AND AMALGAMATION OF

COMPANIES

The term compromise means settlement of a dispute by mutual concession. In a

compromise, the parties intend to settle a dispute between them by a give and take
arrangement.

Arrangement is wider in scope and includes a reorganization of the share capital of the
company by the consolidation of shares of different classes or by division of shares or by
both methods.

Under Section 207, a company can enter into compromise or arrangement with its
creditors or members without going into liquidation and the following procedure is
adopted:-
(i) Application to court.
(ii) Meeting of creditors: - The court may order a meeting of creditors or members of any
class of them to be called.
(iii) Approval of the scheme:- Any compromise or arrangement shall be binding on all the
creditors or members and also on the company or in the case of a company which is being
wound up, on the liquidators and contributories if:-
(a) The scheme is approved by majority in number representing ¾ in value of
creditors/members.
(b) The scheme is sanctioned by the court.
(iv) Copy of court’s order to be filled by the registrar.
(v) In default of the above requirements, every officer of the company shall be punishable
with a fine which may extend up to Sh. 100 for each copy in respect of which default is
made.

Reconstruction and Amalgamation

Reconstruction occurs when a company transfers the whole of its undertaking and
property to a new company consisting substantially of the same shareholders.

The object of reconstruction is to re-organize capital and variations of the right of

investors.

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Amalgamation is the blending of two or more existing company so as to form a third entity
or one company is absorbed into and blended with another company.

It implies creation of a new company by a complete consolidation of combining units.

Under amalgamation, none of the existing company retains its entity.
A reconstruction/amalgamation may take the following forms:-
(i) By scheme of arrangement.
(ii) By sale of undertaking.
(iii) By sale of shares.
(iv) By amalgamation.
Sale of undertaking: - This involves a sale of the undertaking as a going concern. Incase of
sale, some vital provisions must be addressed to facilitate reconstruction and
amalgamation as follows:-
(i) The transfer of property and liabilities of a transferor company.
(ii) The allotment/appropriation by the transferee company of any shares, debentures, and
so on in that company which under the compromise/arrangement are to be allotted.
(iii) The continuation by the transferee company of any legal proceedings pending against
the transferor.
(iv) The provision to be made for any person who within such time and in such manner as
the court directs, dissent from the compromise/arrangement

Sale of shares: - If the offer to acquire shares is made, then the shareholders have the
option to approve the offer within 4 months. Approval should be made by 9/10 in value of
the shares or 90% of the value of shares. These shares exclude shares already held by the
transferee company or its subsidiaries.

Once 90% of majority approves for the transfer, the transferee company gets the right to
acquire the shares of the dissenting shareholders within 2 months after the expiry of the
above 4 months, the transferee company should give a notice to shareholders that it
desires to acquire the shares within one month from the date of the notices. The dissenting
shareholders may apply to the court but if no application is made to the court, the
transferee company gets the final right and also becomes bound to acquire those shares on
the terms on which the shares of other shareholders are to be transferred.

When an application is made to the court by a shareholder that the terms are not fair, the
onus is upon the applicant to establish his allegation. The court will attach considerable
weight to the fact that a large body of shareholders has accepted the offer.

Sometimes, the transferee company does not feel it necessary to serve notice on the
dissenting shareholders. It is quite content that its offer has been accepted by nearly all the
shareholders in the transferor company and the minority of the remaining members can do
nothing to stop implementing its policies so long as it does not oppress them.

LESSON 16

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WINDING UP OF COMPANIES

The Companies Act Cap. 486 does not define the term winding up or liquidation, however it
uses them interchangeable, hence we assume them as synonymous.

Winding up, means a process of putting an end to the life of a company. It is a proceeding
by means of which a company is dissolved and in the course of such dissolution its assets
are collected and its debts are paid off out of the assets of the company or from
contributions by its members, if necessary. If any surplus is left, it is distributed among the
members in accordance with their rights.

Winding up or liquidation is the process by which the management of the company’s affairs
is taken out of its directors’ hands, its assets are realized by the liquidator and its debts are
paid out of the proceeds of realization.

Modes of Winding Up

There are three modes:-

(i) Compulsory winding up by the court.
(ii) Voluntary winding up:-
(a) Members’ voluntary winding up.
(b) Creditors’ voluntary winding up
(iii) Winding up under the supervision of the court.

(i) COMPULSORY WINDING UP BY THE COURT (Section 219)

This is also known as compulsory winding up.

This may occur in the following circumstances:-

(a) Special resolution of the company: - If the company has by special resolution
resolved that it may be wound up by the court, the court may pass a winding up order. The
power of the court in such a case is discretionary. The court may refuse to order winding
up where it is opposed to public or company’s interest.

(b) Default in holding statutory meeting or in delivering the statutory report to the
registrar: - If a company defaults in delivering a statutory report to the registrar or in
holding the statutory meeting, the court may order winding up of the company either on
the petition of the registrar or on the petition of a contributory. The petition must not be
filed before expiry of 14 days after the last day in which the statutory meeting ought to
have been held. However, the court may instead of making a winding up order, direct the
statutory report to be delivered or that a meeting shall be held.

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(c) Failure to commence or suspension of business: - Where a company does not

commence its business within one year from its incorporation, or suspends its business for
a whole year, the court may order for is winding up.
The court exercises power in this case only if the company has no intention of carrying on
its business or if it is not possible for it to carry on its business.

Case Law: Orissa Trucks and Enamel Works Ltd (1973)

A company’s business remained suspended for 10 years, its capital had been embezzled
and its major contributor, the Orissa government refused further help. It was held that the
company should be wound up.

Where the suspension of business is temporary or can be satisfactorily accounted for, the
court will refuse to make an order.

If a company has not begun to carry on its business within a year from its incorporation, or
suspends its business for a whole year, the court will not wind up if:-
(i) There are reasonable prospects of the company starting business within a reasonable
time.
(ii) There are good reasons for the delay, that is, the suspension of business is
satisfactorily accounted for and appears to be due to temporary causes.

Case Law: Middleborough Assembly Rooms Company (1880)

A company suspended its business for more than 10 years due to depression in trade. A
shareholder presented a petition for the winding up of the company a year later. 4/5th in
value of the shareholders opposed the petition. The company intended to continue its
operations when trade prospects improved. The petition was dismissed.

(d) Reduction of members below Minimum: -In the case of a private company
below two members and a public company below seven members

If the company carries on business for more than six months while the number is reduced,
every member who is cognizant of the fact that it is carrying out business with members
fewer than the statutory minimum, will be severally liable for the payment of the whole of
the debts of the company contracted after six months.
This is an area in the company where corporation veil is lifted.

(e) Inability to pay debts: - That is,

(i) A creditor to whom the company owes more than Sh. 1,000 has left at the registered office,
demand under his hand for the payment of the sum due, and the company has for 3 weeks
thereafter reflected to honor the sum.
(ii) Execution or other process in favor of the creditors of a company is returned unsatisfied in
whole or in part.
(iii) If it is proved to the satisfaction of the court that the company is unable to pay its debts.

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The court will not prove whether assets exceed liabilities, rather whether the company is
unable to meet its current demands.

(f) Just and equitable: - This is when the court is of the opinion that it is just and
equitable that the company should be wound up. This clause gives the court very wide
powers to order winding whenever the court considers it just and equitable to do.

The following are the instances where the court can issue a winding up order under the
clause, “just and equitable”: -
(a) Where there is a deadlock in management.
(b) Where it is impossible to carry on the business of the company except at a loss.
(c) Where the company has engaged in illegal business.
(d) Where the object for which the company is formed is impossible of further pursuit.
(e) Where the minority is being disregarded or oppressed.
(f) Where there is lack of confidence in directors.
(g) Where the company has been conceived and brought forth in fraud.

Just and Equitable clause

The court must be over-cautious before admitting a petition for winding up on the just and
equitable clause. It should be allowed as a last resort.

Just and equitable clause depends upon the facts of each case. The court may order winding
up under this clause when:-
(a) The substratum of the company is gone

Substratum of a company is said to have disappeared only when the object for which it was
incorporated has substantially failed or when it is impossible to carry on business except at
a loss, or the existing assets are insufficient to meet the existing liabilities.

Before the court makes a winding up order under this, the court should consider the
interest of shareholders as well as creditors.

The substratum of a company disappears when:-

(i) The subject matter is gone.

Case Law: Pirie vs. Stewart

A shipping company lost its only ship, the remaining assets being a paltry sum of £363.
Majority shareholders filed a petition for winding up but minority shareholders opposed
this and desired to carry on business.
It was held that it was just and equitable that the company be would up.

(ii) When the main object of the company has substantially failed or become impractible

Case Law: German Date Coffee Company (1882)

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The object clause of the German Date Coffee Company stated that it was formed for a
German patent which would be granted for making a partial substitute for coffee from
dates and for acquisition of incidental there and also other inventions for similar purposes.
The German patent was never granted but the company did acquire and work on a Swedish
patent and carried on business at Hamburg where substitute for coffee was made from the
dates, but not under the protection of a patent.
A petition was filed by two shareholders that the main object could not be achieved, and
therefore it was just and equitable that the company should be wound up.

(iii) The company carries on business at a loss and there is no reasonable hope that the
object of trading can be attained: - Where majority shareholders are against it, the court
cannot order a company to be wound up merely because it is making a loss.

(iv) Where the existing and probable assets of the company are insufficient to meet its
existing liabilities. Where the company is totally unable to pay off creditors and there is
increasing burden of interest and deteriorating state of management and control of
business owing to sharp differences between shareholders, the court will order winding up.

(b) When the management is carried on in such a way that the minority is
disregarded or oppressed: - This is prejudicing the interests of minority shareholders by
majority shareholders.

Case Law: Re Garnets Mining Company Ltd (1977)

The petitioner was Mrs. Beth Wambui Mugo. She wanted the company to be wound up on
the “just and equitable” ground. Her reasons were as follows:-
(i) That the affairs of the company were being conducted in a manner which was
oppressive to her. Despite her 50% shareholding, she was treated at most times as
decorating figure because she was excluded from both the company and board meetings,
but nevertheless expected to sign or approve most of the resolutions. When she suggested
transferring her shareholding, she was out voted.

(ii) The substratum of the company had gone and that the company had no alternative
business to engage in. A company had been incorporated to “mirie rubbis”. This business
collapsed because Mugo influenced the government to withdraw the mining license as a
way of revenging against the Greek directors.

(iii) Because of the differences between her and the rest of the Greek members, the
management of the company had broken down completely and consequently there was
loss of confidence and proximity in each other to the extent that the company could no
longer be managed at all
It was held that though Mugo (petitioner) was partly to blame for sabotaging the business,
she was entitled to this order under Section 215.

(c) Where there is deadlock in management of the Company: - When shareholding

is equal and there is a case of complete deadlock and there is no hope or possibility of
smooth and efficient continuance of the company as commercial concern.

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Case Law: American Pioneer Leather Company (1918)

There were only three directors and shareholders in a private company. One of them left
the country and the remaining two quarreled among themselves and as a result there was a
complete deadlock.
It was held that it was just and equitable that the company be wound up.

Case Law: Yenidje Tobacco Company Ltd (1916)

A and B were the only shareholders and directors of a company with equal rights of
management and voting powers. After a time, they become bitterly hostile to each other
and disagreed about the appointment of important servants of the company. All
communications between them were made through the secretary as they were not in
speaking terms with each other. The company made large profits in spite of the
disagreement.

It was held that there was complete deadlock in management and the company was
ordered to be wound up.

(d) When the company was formed to carry out fraudulent or illegal business, or
when the business of a company becomes illegal.

Case Law: Brinsmead (Thomas Edward) & Sons (1897)

Thomas Edward and two of his sons were employed by John Brinsmead & Sons Ltd in the
business of piano manufacturing. They left John Brinsmead & Sons Ltd and started a
company called Thomas Edward Brinsmead & Sons Ltd for carrying on similar business.
They were restrained by a court injunction from using the name Brinsmead on the ground
of fraud. A petition for compulsory winding up of the company was presented.

Held that the company was formed to carry out fraud and, therefore, it was just and
equitable to be wound up.

(e) In the case of a company incorporated outside Kenya and carrying on

business in Kenya, winding up proceedings have been commenced in respect of it
either:-
(i) In the country of incorporation.
(ii) In any country in which it has established place of business (Section 219).

Who may Petition for Compulsory Winding Up?

The following persons can file a petition:-

(a) The company: - A company may itself file a petition for winding up after it has passed a
special resolution. The directors have no powers to present a petition for winding up.
(b) Creditors: - The word creditor here refers to every person having a pecuniary claim
against the company, whether actual or contingent, and such a person is competent to file a
petition for the winding up of the company.

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Disputed debt: – A creditor whose debt is disputed cannot get a winding up order. The
court may either order the petition or stand over until the validity of the debt can be
determined, or may dismiss a petition.
(c) Petition by any contributory: - Section 214 defines a contributory as any person liable to
contribute to the assets of the company in the event of its being wound up. It however
includes all persons who at the date:-
(i) are members of the company or,
(ii) have been members within a year immediately proceeding that date.
(d) By official receiver.
(e) By Attorney General in consequence of a report of inspectors upon the company’s affairs.

Consequence of Winding up Order

(i) Official liquidators are appointed.
(ii) The powers of directors are terminated and
(iii) The company’s servants are “ipso facto” dismissed.
A receiver is not under any obligation to discharge debts even though incurred after the
date of his appointment, unless he exceeded his authority or expressly accepted or agreed a
personal liability.

(ii) VOLUNTARY WINDING UP

Voluntary winding up means winding up by members, or creditors without interference by

the court. They are left to settle their affairs without going to the court. They may,
however, apply to the court for any directions, if and when necessary.

A company may be wound up voluntarily when:-

(a) The period fixed by articles for the duration of the company has expired or an event upon
which the company is to be wound up has happened and the company in a general meeting
has passed an ordinary resolution.
(b) If the company for whatever reason, has passed a special resolution to wind up
voluntarily.

Types of Voluntary Winding Up

(a) Members’ voluntary winding up.

(b) Creditors’ voluntary winding up.

(a) Members voluntary winding up

In a voluntary winding up of a company, if a declaration of its solvency is made, it is a

members’ voluntary winding up. The declaration shall be made by majority of directors at
a meeting of the Board that they have made a full inquiry into the affairs of the company
and that having done so, they are of the opinion that:-

(i) The company has no debts.

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(ii) That it will be able to pay debts in full within 12 months from the date of commencement
of the winding up.

Declaration of solvency: - This should be done before the general meeting passing
the resolution for winding up and not after the general meeting. It is a solemn
declaration of solvency made by a director that the company is solvent and able to
pay all its debts in full within a period of 12 months.

(b) Creditors’ voluntary winding up

Where the declaration of solvency is not made, the winding up is referred to as creditors’
winding up. It is presumed that the company is insolvent. In such a case, a company must
call a meeting of creditors on the same day or the following day after the meeting, at which
resolution for winding up is to be made or proposed. The directors must lay before the
creditors the position of the company.

(iii) WINDING UP SUBJECT TO SUPERVISION OF COURT

Section 304 provides that when a company has passed a resolution to wind up voluntarily,
the court may order the continuation of voluntarily winding up subject to their supervision
on any terms.

The liquidator will continue to exercise all powers subject to the restrictions laid down by
the courts. A petition for the winding up of the company subject to the supervision of the
courts may be presented by any person entitled for the compulsory winding up, but before
the court refuses or makes a supervision order, they must call a meeting for ascertaining
the wishes of creditors and contributories.

The court will usually be called to supervise a voluntary winding up if there is a substantial
dispute between the company and creditors, especially where they disagree over the
appointment of a liquidator.

Distinction between Voluntary winding up and Compulsory Winding up.

(a) Declaration of solvency is a must in members whereas it is not necessary in creditors

winding up.
(b) Mode of discharging liabilities incase of winding up: - The company must pay all costs,
charges and expenses property incurred in the winding up including liquidation costs.
These expenses rank in priority to other claims. If assets are insufficient to satisfy all the
liabilities, the courts may make any order as to the payment of those costs and charges as
they deem fit.
(c) Then, preferential creditors must be paid under Section 311. The following preferential
creditors must be paid in priority:-
(i) All government and local rates payable within 12 months before the date of winding up.

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(ii) All government rent not more than one year.

(iii) Wages and salaries of any servant for services rendered during four months
proceeding relevant period not exceeding Sh. 4,000.
(iv) All amounts due in respect of any compensation under workmen’s compensation,
which has occurred before the relevant date.
(d) Finally, proceeds left may be given to shareholders and if any portion remains unclaimed, it
goes to the public trustee as “Bona vacantia”, that is, ownerless property.

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