Chapter 2: Introduction to company law
TUTORIAL QUESTIONS
1 Who controls company legislation: the states or the Commonwealth? Explain.
2 What is ASIC, and what are its functions within the Australian economy? Is it the
same as the ASX?
3 What does CLERP stand for, and what significant events have occurred as a result
of its introduction?
4 Why would we refer to a company as a fiction? Surely we can see and touch a
company… Explain why a company is a legal fiction, but a useful one.
5 Milton Friedman, a famous economist, once said the only purpose of a company was
for it to make profits for its shareholders. Many disagree with this statement and
believe that a company is a privileged body which must conduct itself for the benefit
of society, not just in the interests of shareholders. With reference to the theory of
corporations, make a comment on the various roles that could be perceived for a
company in Australia.
6 What is meant by the separate legal entity of a company from its owners and
operators? Are there circumstances in which a court may refuse to recognise this
separation? Explain.
7 Statutory piercing suggests that persons operating a company are no longer able to
hide behind the company entity. Under what circumstances might this be true? In
your answer, refer to relevant sections of the corporations legislation.
PROBLEM
1 James, a sole trader, is considering registering his business as a company. James wants
to establish limited liability for himself as a director, shareholder, and employee of
the company. Advise James on the following:
− Does the creation of a company absolutely remove him from any potential
liability for injury, loss, or contracts made by his company?
− Would James have any interaction with the ASIC or ASX if he set up a company?
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Suggested Answers
TUTORIAL QUESTIONS
1 Who controls company legislation: the states or the Commonwealth? Explain.
The ability to pass company legislation is a shared power between the states and the
Commonwealth according to the Australian constitution. Originally the states passed
company legislation, which meant that there were different rules and standards in
different states of Australia over time. The Commonwealth instituted a number of
cooperative schemes to bring law into line throughout Australia.
The Commonwealth attempted to take over the power to pass legislation but, in the
case of NSW v Commonwealth, the High Court found that the power was shared. The
Commonwealth had to make a deal with the states whereby the states permitted
the Commonwealth to pass law on behalf of the states, with a right to review this
procedure by the states at the end of the agreed period. The Corporations Act 2001 (Cth)
is legislation passed by the Commonwealth and adopted throughout Australia with the
consent of the states.
2 What is ASIC, and what are its functions within the Australian economy? Is it the
same as the ASX?
The Australian Securities and Investments Commission (ASIC) was originally known as
the National Companies and Securities Commission, and later the Australian Securities
Commission. ASIC works in conjunction with a number of related bodies, such as the
Takeovers Panel and the Australian Accounting Standards Board. ASIC advises the government on company law matters, proposes law reform, keeps a registry and record of
companies and their annual reports, conducts consumer legislation, prosecutes companies and officers for improper behaviour, and further regulates the financial sector of
Australia (hence the ‘Investments’ part of its name).
The ASX is the Australian Securities Exchange, formerly known as the Australian
Stock Exchange, which is a public listed company on which other public companies can
be listed. The ASX is not a government body but works in conjunction with ASIC and is
a self-regulator. The ASX sets standards for listed companies, in particular the principles
of corporate governance.
3 What does CLERP stand for, and what significant events have occurred as a result
of its introduction?
The Corporate Law and Economic Reform Program (CLERP) started with the First
Simplification Act, which was introduced with the intention of streamlining company
and other commercial law within Australia. The objective was to make law simpler, more
accessible and more user friendly in order to encourage business and entrepreneurship
in Australia. The first law reform allowed for the introduction of one-person companies;
successive reforms have introduced further reforms in law, now up to CLERP 9, with
significant reforms on reporting requirements imposed on officers within a company.
The latest CLERP granted the ability for members to ask questions of directors and vote
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CHAPTER 2
INTRODUCTION TO COMPANY LAW
on the remuneration of directors. Auditors now have greater responsibilities within the
company.
4 Why would we refer to a company as a fiction? Surely we can see and touch a
company… Explain why a company is a legal fiction, but a useful one.
A company is indeed a legal fiction, whereby an entity is created by legal decree. The
company has no physical entity but can own physical property and employ people to
manage and work within the company business. The legality of a company is, in a sense,
similar to that of a contract, which has no physical presence yet facilitates commercial
relations by being enforceable in a court.
The legal entity of the company is important because it allows for investors (shareholders) to invest in a company’s business, which thereby gives them limited liability.
The format of the company allows for an accumulation of capital and independent
management, and further facilitates ease of transfer of ownership in the company
through a transfer of shares.
5 Milton Friedman, a famous economist, once said the only purpose of a company was
for it to make profits for its shareholders. Many disagree with this statement and
believe that a company is a privileged body which must conduct itself for the benefit
of society, not just in the interests of shareholders. With reference to the theory of
corporations, make a comment on the various roles that could be perceived for a
company in Australia.
There are a variety of views on what a company actually is. Some see the company
as simply a device to enable commerce and entrepreneurship with safety in numbers;
the only purpose of the company is to make money for the people who have risked
their capital. In the process the company creates jobs and produces goods and services
required by the general community.
Others, however, view the company as a privilege; that is, the state has granted
limited liability and certain concessions to those who operate a company. In return, a
company has some social responsibility. Companies in their activities actually affect
many others within the community; for example, through the use of the roads and
protective services, pollution, etc. A company therefore has a wider responsibility to
all stakeholders in the company: shareholders, managers, workers, the community, and
consumers. They cannot just do what they like, but instead must be good citizens.
6 What is meant by the separate legal entity of a company from its owners and
operators? Are there circumstances in which a court may refuse to recognise this
separation? Explain.
Anybody in Australia can register a company, a separate legal entity which can hold an
enterprise and conduct business in Australia. A company is recognised as an entity in its
own right and with an ability to own property, employ people, and enter into contracts.
People are more willing to invest in a company because they have limited liability
provided by the company, which lessens the risk for investors. The Salomon v Salomon
case established that, in the event of insolvency, the owner/operator within a company
is indeed a separate entity from the insolvent company, and can in fact be a creditor!
See Lee v Lees Air Farming also.
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If, however, a company is created for improper purposes, or the company’s entity is
misused—to avoid tax, for example—then a court may refuse to recognise the separate
entity of the company. This is called piercing the veil of incorporation; in other words, looking behind the company facade to see what is actually going on with the use of a company.
7 Statutory piercing suggests that persons operating a company are no longer able to
hide behind the company entity. Under what circumstances might this be true? In
your answer, refer to relevant sections of the corporations legislation.
Statutory piercing refers to the process whereby legislation is passed which effectively
holds individuals liable, along with the company, for a wrongdoing. Where an individual
does something deemed to be fraudulent, negligent, wrong, or not deserving of the
protection of the corporate entity, the individual will be liable to compensate another
party, or further suffer fines and penalties. In Australia there are various statutes, such as
tax legislation, environmental legislation, and records keeping legislation, which ensure
that individuals will be liable along with the company without the protection of a
separate legal entity.
Section 588G, which holds directors liable for insolvent trading in a company, is an
example of statutory piercing within the Corporations Act 2001 (Cth). A director cannot
claim the separate entity of a company as a defence.
PROBLEM
1 James, a sole trader, is considering registering his business as a company. James wants
to establish limited liability for himself as a director, shareholder, and employee of
the company. Advise James on the following:
− Does the creation of a company absolutely remove him from any potential
liability for injury, loss, or contracts made by his company?
− Would James have any interaction with the ASIC or ASX if he set up a company?
James can register a company, even with just himself as the shareholder and director.
On transferring his business into the company, the company becomes the owner and
operator of the business and James can become the shareholder, director and employee
of the company with a separate legal entity and, consequently, limited liability. If the
company is appropriately managed then James has nothing to fear. The company may
need capital and, if James attempts to borrow, he may find that a creditor will ask for
personal guarantees from him.
James may still be personally liable for wrongs; for example, allowing the company
to trade while insolvent under s 588G. Various other statutes may make him liable if he
has been negligent or if he has contributed to an injury or loss.
James will probably not have a listed company and therefore no contact with the
ASX. James will have to register the company with ASIC; he will need to send in an
annual return each year and pay an annual fee on behalf of the company. The annual
return ensures that the company keeps its records up to date with ASIC. ASIC can
demand various information from James as director (and presumably secretary), including, for instance, financial reports. James will need to ensure that ‘his’ company complies
with legislative requirements as to records, accounting, and meetings (if required). His
company will also be subject to implied law imposed by corporations legislation.
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