Single Member Company (SMC)

SINGLE MEMBER COMPANY (SMC) SINGLE MEMBER COMPANY (SMC) [A critical analysis with common law background] By Rehmat Ali Civil Judge, Lahore Introduction The word "company" has no strict legal meaning;1 however, in legal theory, the term implies an association of a number of people, for some business purpose or similar objects.2 English law provides two main types of organizations for such associations: partnership and companies, although the term "company" is colloquially applied to both, the modern lawyer regards companies and company law as distinct from partnership and the law of partnership. Partnership law, which is now largely codified in Partnership Act, is based on law of agency; each partner becoming an agent of others, and it therefore affords a suitable framework for an association of a small body of persons having trust and confidence in each other.3 Company is described as a body of persons associated for the purpose of business.4 Since the inception of corporations, it is synonymous to multi-members, working on behalf of the company. Thus, keeping in view this rule, a "partnership" and an "individual" can be termed as company, so the concept of polarity in company has no meaning. Idea of a Single Member Company (SMC) seems to create a special atmosphere for business activities irrespective of its proper sense. If a single member wants to form a company, it means that he is creating an artificial person, in order to share the responsibility of risk(s), if any. Why there is need for creation of an artificial person in presence of a natural person? This object can be considered as the entire theme of incorporation and limited liability. It is general law that if any person commits wrong he will be responsible for that, but in case of incorporation the management of the company is carried out by natural persons and liability is shifted to company being separate legal entity. This principle may be considered to be against natural law. The concept of an SMC5 has been introduced in the Companies Ordinance (XLVII) 1984, in the year 2002 by amendment. We have to consider whether these amendments are in light of evolutionary growth of company law in Pakistan? After creation of Pakistan the old Companies Act, 1913 was implemented in letter and spirit. This Act remained in force till the enforcement of Companies Ordinance, 1984. This Ordinance is off shoot of the Law Commission headed by the I. I. Chundrigar6 and after his death headed by the Sharif Ud Din Pirzada. But at same time India succeeded to make company law in 1956.7 In India one committee called Bhaba Committee and three commissions8 were setup to look into corporate affairs and to make recommendations for reformation in company law in country. In UK, Board of Trade, Committees and commissions have contributed a lot for development of company law9. In Pakistan we see only one commission for legislation of company law. Company law in Pakistan is not a result of trials and errors in the field of corporate practice, but it is fixed type of statute with borrowed principles, that is why there is no separate corporate practice. On same lines the idea of SMC has been introduced in Companies Ordinance, 1984, without any public awareness and proper discussion. The object of this article is to analyze the scheme of the existing statute and new amendments; Whether SMC is another tool to escape from risk by the capitalists? What can be the maximum benefits by SMC to individual and society as well? Whether the new amendments are in disagreement with existing corporate law? Whether this notion is misuse of separate entity of the company? Whether idea of SMC is more useful and beneficial for the promotion of small industries and for documentation of economy? Since 1998, UK has implemented the Council Directive 89/667; the Company law was amended to enable the use of companies for small, one-person, businesses. Since 1 July 1998 it has been possible to form a company having single member/director. Likewise in Australia law regarding SMCs has been introduced. In Pakistan, a single person can form a private limited company which may be limited by shares or guarantee10. Such single-member companies need to have only one director.11 Before going ahead it is necessary to have glance at the history of development of company law on this subject. In United Kingdom (UK) the concept of company law, developed in order to facilitate the ancient mode of trade called partnership". Indeed the concept of partnership is very old phenomena developed over the centuries by trader(s)/merchant(s). The most important point is that why company law developed and on what foundation it was laid down? In the case of partnership concerns the liability of partners is unlimited, so in order to avoid the unlimited liability the concept of limited liability emerged. Generally this aspect was favorable to the business community. In 1844 the provision of unlimited liability was introduced in Joint Stock Company Act 1844. Soon after that Companies Limited Liability Act 1855 was passed and word "Limited" became part of company's name. In case of Salomon v A. Salomon Co.12 the matter was, whether Salomon was personally liable to creditor or the company. The matter was resolved by mouse of Lords that company possesses a separate legal identity distinct from its members, so liability is not against Salomon but it is against the company. Emphasis was made on incorporation and its legal formalities. Company was declared as separate legal person as against natural person, having rights and liabilities under the law, though its management is carried out by the natural persons. Moreover attribution of separate legal entity has been recognized by the courts of law13, which can never be equal to a natural person e.g. some courts have the view that directors are trustees towards the creditors, shares-holder, etc and some considered their duties as of care and skill under common law. In this context Professor Gower has divided the duties of directors in to two categories firstly "Fiduciary duty" and Secondly, duty of "care and skill".14 It is worth mentioning here that business community always prefer common law duties of directors, rather duties under equity (fiduciary duty). Rationale behind is that in case of Equity the principles of trust, followed by the Chancery Courts will be applicable. These principles laid down that, directors are the trustees of company and the members etc. These rules are not favorable to business community. That is why; they are not ready to discharge their duties under equitable principles.15 In Salomon v Salomon and Co. Ltd. (1897), although Salomon's case is cited in courts to this day, but this rule is not of universal nature, yet it is subject to criticism from some quarters. For example, Kahn-Freund called the decision as "calamitous"(catastrophic) in his article.16 Later in that same article, the author also called for the abolition of private companies. Lord Denning has righty said "Our system of company law has only been in existence for some 120 years. It is the universal medium of business. Most merchants and most traders are now limited liabilities companies. Not in England but also in countries overseas. The law, however, has let down a curtain which conceals the going on of the directors and managers of the company. Beneath this curtain all sorts of fraud can be perpetrated---on the customers, on creditors, and on shareholders."17 Limited liability, single member company and social responsibility of SMC Defining Limited Liability; simply stated, limited liability means that shareholders are not liable for debts incurred in the operation of a company and at winding up stage. Thus, shareholders' losses are limited to the amounts invested and guarantees given by them i.e. the amounts originally invested in the company at the time of the stock purchase. In other words limited liability means liability of the members only to the extent of their unpaid share. When the business was carried out in shape of partnership then liability of the partners were unlimited, all their personal assets were held liable to the satisfaction of claim of third party. This situation was not favorable to the business community, and then a device, in shape of limited liability, was introduced to provide opportunity for conducting risk-free business without fear of personal liability. The company being a separate legal person is also under other obligations to perform its environmental, social and economic responsibilities. The object of the company should be to promote business, contribution to sustainable development and called for a new, social and environmental role for business in a global economy. A company for all intents and purposes is very easily defined "it is the kind of legal entity or corporate body which is brought into being by the registration procedures laid down by the company law." Its creation is evidenced by the issuance of certification of incorporation the registrar companies.18 Just like natural person, after fulfilling the mandate of law. Rights and liabilities of a person are determined in context of his status, qualification and role, which he is under obligation to perform towards the society. Same case is with the corporation, which, being operational, has to take profit from the people. In this view of the matter corporations also have social, economic and environmental responsibility towards the society. The issue is what sort of duties can be performed by the SMC in the society? In case of listed company having seven or more directors along with other management has more social linkage with reference to its volume of business and number of persons as compared to SMC. The visible object behind the SMC is to boost the economic activities in the country with manageable risk. In this way single member will not be responsible to anybody in the company management. There is no question of quorum of meeting single man is performing one man show. The culture of one man show is mostly disliked by the majority of people. This lack of accountability of single director may cause serious issues with reference to his social, economic as well as environmental responsibilities. It is worth mentioning that in order to monitor the activities of the SMC more officials are required for this purpose. It may be stated that SMC have limited role in developing the healthy corporate activities. Scheme of Companies Ordinance, 1984 and new amendments Section 15 of Companies Ordinance, 1984 provides; Mode of forming a company;---(1) "Any 2[three] or more persons associated for any lawful purpose may, by subscribing their names to a memorandum of association and complying with the requirements of this Ordinance in respect of registration, form a public company and any 3[one,] or more persons so associated may, in like manner, from a private company".19 The above mention section amended to extent of number of members from two members to one member without any specific name of the company. It is also worth mentioning here that there is no definition of SMC in the definition clause of Companies Ordinance, 1984.20 Section 47 of Companies Ordinance, 1984 provides; Liability for carrying on business with less than 21[three] or, in the case of a private company, two members;---If at any time the number of members of a company is reduced, in the case of a private company22 [other than a single member company], below two, or in the case of any other company, below23 [three], and the company carries on business for more than six months while the number is so reduced, every person who is a member of the company during the time that it so carries on business after those six months and is cognizant of the fact that it is carrying on business with fewer than two members or 24[three] members, as the case may be, shall be severally liable for the payment of the whole debts of the company contracted during that time, and may be sued there for without joinder in the suit of any other member. The idea of misuse of the concept of separate entity and device to exploitation and to avoid the risk The above mention section 47 explains the situation in case of reduction of member of the company; it may be able to continue its function to certain time. After expiring of the time, the members will be severally responsible for the payment of whole debs of the company contracted during that time. It is some sort of check on the management of the company against the misuse of authority. This was the proper time to set forth the method for SMC. Despite of this fact SMC has been excluded from this mechanism. Furthermore, no method has been evolved for this purpose, which shows the intention of legislature. In this way this amendment seems to be transplanted in the Ordinance. It is to some extent miss-matching with scheme of existing company law. Nomenclature of company law and practical managerial functions depicts the plurality of company rather singularity. It is also a fact that nobody can oppose the single director, in any meeting so it is like sole proprietorship but in guise of legal person along with risk free venture. In Pakistan still we have no corporate litigation as a separate field because banking and corporate practices have no visible distinction. At the same time from other point of view, it is considered as documentation of the economy and may help the small local industry to be flourished. The basic problem we are facing in the country is deficiency of small industry which is considered as the back bone of economy of any country. If the government wants to flourish the economic activities then it has to make all-out efforts for creating and developing corporate culture in the country, so this purpose can be achieved through small industries and healthy corporate activities in shape of regulation of SMC. Procedure of meeting and voting by the members under section 160 of Companies Ordinance, 1984. This section provides the holding of general meetings of the companies and the quorum. In case of SMC it is amended and quorum of single member made sufficient to carry on routine company affairs.25 In case of SMC, any company official can be associated, in conducting of general meeting or other legal activities without any material powers, affecting the business interest of the director (owner) of company but just to witness the proceedings. It means that there should be a person who may object the arbitrary acts of single member. If there is mismanagement in company it cannot be checked by the same person. There is a famous rule of natural justice that" no one is judge in his own cause". Same is case with single member who have to take decisions for running of corporate affairs. Who will judge the honesty and transparency of single member company? It is fact that single member has its own capital and energy for flourishing his business, but it should be kept in mind that he is a member of family, society and country as well and he has some environmental, social and economic responsibilities. With this point of view he cannot be allowed to get undue benefits in guise of separate legal entity. Whatever the case may there should be mechanism for checking the corporate affairs of single member company. The possible method can be, the official website having all the information regarding the corporate activities of SMC. It should be monitored only by authorized official of the concerned department. This object can also be fulfilled by using the video link conferences as to monitor the activities of the companies. The apprehension is that, in absence of positive and active monitoring of the activities of SMCs, there will be deterioration in the development and economic growth in the country. Section 174 of Companies Ordinance, 1984 provides; [174. Minimum number of directors of a company.---(1) Notwithstanding anything contained in any other law for the time being in force,- (a) Every single member company shall have at least one director; (b) every other private company shall have not less than two directors, and (c) every public company other than a listed company shall have not less than three directors, appointed and elected in the manner provided in this Ordinance. (2) every listed company shall have not less than seven directors to be elected in a general meeting in the manner provided in this Ordinance.] This section provides the numbers of directors which are requirement of law for incorporation of company. Now in Pakistan a single member can incorporate a company. Section 204-A of Companies Ordinance, 1984 provides; 204-A. Certain companies to have secretaries26 [and share registrars] (1) A listed company shall have a whole time secretary and a single member company shall have a secretary possessing such qualification as may be prescribed] [(2) Listed companies shall have an independent share registrar possessing such qualifications and performing such functions as may be specified by the Commission Section 305 of Companies Ordinance, 1984 provides; Circumstances in which company may be wound up by Court.---A company may be wound up by the Court [(i) if the company ceases to have a member.]27 Amendments in law and their compatibilities with existing scheme of Enactment. The single member shall now be able to enjoy the privilege of limited liabilities as envisaged under the provision of the Companies Ordinance. Moreover, the benefit of having a status of a company shall also be availed by such a single member. For the purpose of having a second person in a meeting and have sound documentation, an SMC shall be under obligation to appoint a company secretary. The SMC shall have all the rights and privileges as well as obligations and liabilities as other private company has. The transformation of sole proprietorship into SMC will, of course, help in documentation of economy. At the same time, the most important issue is the concept of. company is attached with more than one member, not with the single person. Entire scheme of law is revolving around this idea of plurality but the introduction of SMC in the Ordinance is not compatible with the entire existing scheme of company law because there are serious issues regarding meetings, quorum, management and other plural functions of company cannot be performed properly. The best solution is to make separate legislation keeping in view single member responsibility. Benefits of SMC to individual and the country Pakistan being a developing economy is mostly dependent upon the agriculture sector. With this background it is need of the day to promote the small/cottage-industry in the country. It has multi-fold benefits on overall economy and well-being of the people. Following are some of the benefits of the same; (1) It will provide solid support to other indigenous industries in the country in shape of raw material and furnished goods. (2) It will, fulfil the local needs of the people and there would be less imports and maximum exports, which is considered best tool for foreign exchange. (3) There would be maximum jobs opportunities in the country and also utilization of local resources. (4) Local manufacturing will be encouraged and country will be on the way to prosperity and self-reliance. (5) There are chances of disputes inter se the members, directors in private companies. But in case of SMC there will be no stranger in company and there would be no dispute. Business of a sole proprietor should not be disturbed with his death as employees would continue operating it while heirs settle their claims for taking over the firm (6) There would be no restrictions on the business of a single-member company. All the individuals having their own business in the form of trade, industry, agriculture, advisory role or any other provisions could form a company and could be benefited from the new concept. Despite of all above mentioned benefits of SMC, there was no awareness of merits of the single-member company. It is the need of the day to introduce and popularize the concept in the larger interest of business and trade. The single-member firms would also be allowed to be listed on the stock exchanges as SMC.28 One could get the certificate of incorporation after filing the prescribed registration documents with the Registrar of Companies. This concept is more beneficial in the developed countries, but in Pakistan it would probably take time to become helpful for uplifting the economy. Conclusion Pakistan came into existence in 1947 and prior to that, we used to follow law laid down by the British. There is great evolutionary development in UK but in Pakistan we borrow the principles of corporate laws from different countries particularly England. In India, there is separate corporate practice, entirely different from banking. It provided a method of feedback regarding the practical hardships in the corporate field. It further motivated the legislature to make amendments in law. Now at this time the mother statute of Indian Companies Act, 1956 is amended at large scale. Apart from all there is no doubt that Companies Ordinance cover most of corporate aspects but it is not a complete and updated law as compare to other countries. In case of SMC law has been legislated to provide that a single individual or person may form a company just by subscribing to memorandum of association but at the same time it is also necessary to provide certain mechanism for the proper implementation of law, checks and balances on the SMC and there maximum benefits for country. The transformation of sole proprietorship into SMC will, of course, help in documentation of economy. The most important issue is the concept of company is attached to more than one member not with any single person. The entire scheme of law is revolving around this idea but introduction of SMC in the Ordinance is not compatible to the entire existing scheme of company law. Meetings, quorum, management and other plural functions of the company cannot be performed properly. The best solution is to make separate legislation keeping in view single member responsibility and joint businesses. It is another aspect that SMC be given certain privileges and incentives, keeping in view the betterment of small industry. There should be assurance of non-exploitation in the name of any company whatsoever. SMC should be treated as separate legal entity but liability of single member should be under certain qualifications.