Formation and Regulation of Single Member Companies

Background A single member company is a private company limited by shares or by guarantee, which is incorporated with one member, or whose membership is reduced to one person. Paul L. Davies, in the book Gower and Davies’ Principles of Modern Company Law[1], traces the concept of a single member company to as far back as the nineteenth century in the case of Salomon v Salomon [1897] A.C. 22 when he states; “……….. whilst the decision of the House of Lords at the end of the nineteenth (19th) century in Salomon v Salomon in effect allowed the incorporation of a company with a single member, the other six being bare nominees for the seventh” Indeed, single member companies have been in existence though not in the legal context. Companies have been in existence where in form, there is more than one member but in substance, it is a single member company and the other members are “shadow members” who appear on the company documents and registered as members only for the purpose of reflecting the entity as a company. With the increasing number of sole proprietorships all over the world, and the realization that these proprietorships deal with the public as much as companies do, the European Economic and Social Committee proposed the passing of a Directive that would enable formation or continuity of a single member company. In 1989, the Council of the European Community passed Directive 89/667/EEC on single member companies – refer to Directive. This Directive has been adopted by member states of the European Community, some of which have passed domestic legislation in that respect. For instance the United Kingdom passed the Companies (Single Member Private Companies Regulations 1992 S.I 1992/1699). In 1994, the European Community implemented its own Directive and passed the European Communities (Single Member Private Limited Companies) Regulations, 1994 S.I. No. 275 of 1994. This concept has also been adopted in the American jurisdiction though with some changes in respect of how they are regulated. Introduction Until 1985, it was the generally accepted position in most jurisdictions worldwide that a minimum of two people is required in order to form a private incorporated company. Although no literature exists that has been specifically designed to justify this position, there are a few arguments that seem to rest beyond debate on the matter. In spite of these arguments, however, there is an increasing tendency that favors the formation of a private incorporated company by one person particularly in Europe and the United States. Several jurisdictions now permit the formation and operation of a single-member Limited Liability Company. This paper is intended to examine the feasibility of restructuring Uganda’s company law to make room for the formation of a single member limited liability company. In this paper, the following acronyms will be used for convenience: SMLLC - Single Member Limited Liability Company LLC - Limited Liability Company. The Concept of SMLLC’s In jurisdictions that have adopted the concept, the SMLLC operates like any private company in all respects. In essence, an SMLLC is a sole proprietor doing business with the kind of protection granted to shareholders in a limited liability company. The question that arises automatically is why anyone should register himself as a LLC when he can run the business as a sole proprietor. The answer is simple – with a LLC he obtains limited liability protection, which means that for liabilities arising from the business, his personal assets cannot be touched. In fact, certain people exploit this position by contributing only their risky assets to the LLC and keeping the rest outside its scope. An additional advantage of a single-member LLC is that the interest in the company can be transferred to a beneficiary (for example, your son or next of kin), without paying gift taxes. Even after such a transfer you can continue to control the company by being appointed as ‘manager’. The Case for Reform. The proposition to allow single member companies in Uganda is supported by several sound arguments including but not limited to: The Company law of the UK on which Uganda’s company law is based has been overhauled several times. The Companies Act 2006 (UK) now allows single member companies. Modern trends are leaning towards creating new flexibility in the business sector to make room for more investment. One of the ways of doing this is by getting rid of legal requirements which have no proved efficacy in the real business world including that a limited company should have at least two members. The business public for years has been dealing with sole proprietors with remarkable ease and there seems to be no concrete justification for denying such proprietors the benefit of limited liability. Anticipated/Proposed Changes.

A. FORMATION The formalities requisite to incorporation have several implications. They affect, among other things, the ease and tempo with which a company may be incorporated. In view of the need to strike a balance between making this process easier thereby increasing investment and ensuring that creditors in particular and the public in general are protected, the following changes are recommended: The Companies Act should be amended to allow a single person to form a limited liability company. This change should also encompass situations where the number of members in a limited company falls to one or where an unlimited company with only one member becomes a limited company. Thus, (a) Every person who wishes to incorporate a limited liability company as the sole member thereof should be required to have a specified minimum capital.[2] (b) An individual seeking to incorporate a limited company should be required to file a statement that the company has only one member. This should be in addition to all the usual filing requirements. Provisions should be put in place to specifically ensure that Ugandan citizens are given sufficient investment opportunities in comparison to non citizens. In 1989, the Council of the European Community passed Directive 89/667/EEC on single member companies – refer to Directive provisions which have been put in place to incorporate SMMLCs. Article 2(1) Directive 89/667/EEC. Regulation 3(1) European Communities (Single Member Private Limited Companies) Regulations 1994, SI 275 of 1994 & Regulation 2(1) of the Companies (Single Member private Limited Companies) Regulations 1992 SI 1992 No. 1699 – all provide for formation of a Private Limited Company by one person. In the Ugandan context therefore, the amendments made to the UK Companies Act of 1985 (providing for SMMLCs) would be relevant and applicable to our Companies Act since it is similar to the UK one. If we were to adopt the amendments made by the UK to incorporate single member companies in their law, amendment would be made to section 3(1) of the Companies Act Cap. 110 to provide for incorporation of such a company with a proviso that the existing rules of law on requirements of incorporation would apply to the single member company with such modifications that would be necessary for such a company.

B. REGULATION 1. Meetings (a) General Meetings All power exercisable by a company in general meetings under the companies Act should be exercisable in case of a single member company, by a sole member without the need to hold a meeting. Thus any matter to be done, decided by a company in general meeting or decided by resolution are satisfied, in case of a single member company, by decision of the member which is drawn up in writing and notified to the company. These notifications/resolutions must be recorded by the company and retained in book form or other suitable means.[3] Resolutions to which sec. 141, 142 and 143 of the Companies Act Cap 110 applies (special resolutions) should be registered/notified to the registrar of companies within 15days. Every single member company should be required to hold meetings in similar fashion as other companies for matters concerning the removal of an auditor or for non- appointment of an auditor. In the case of a company limited by shares or guarantee and having only one member, one qualifying person present at a meeting would be quorum.[4] The sole member would exercise the powers of the general meeting. Where the sole member takes any decision that (a) may be taken by the company in general meeting and (b) has effect as if agreed by the company in general meeting, he must (unless that decision is taken by way of a written resolution) provide the company with details of that decision. It should be provided that if a person fails to comply with this requirement he commits an offence which should attract a heavy fine. (b) Annual General Meetings The sole member of a SMLLC may decide, to dispense with the holding of an AGM. The decision should have effect for the year in which the decision is made and subsequent year but should not have effect on any liability already incurred by reason of default in holding an AGM. It is open to the Sole member of the company to require the holding of an AGM in a particular year by notice to the company not later than at least 3 months before the end of the year. If such a notice is given then the provisions of Section 133 of Cap 110 should apply in respect to the calling of the meeting. Where a decision to dispense with the holding of AGMs for SMLLC is in force then the requirement in Cap 110 to lay balance sheet (Section 149), profit and Loss Accounts (Section 148) , auditor’s report (sec.156), directors’ report (Sec. 157) ( compliance with sec.158) before the AGM shall be satisfied where the accounts and reports are sent to the sole member. These should be sent not less than 21 days before the would-be date for the AGM. 2. Directors The directors or managers of the SMLLC may include the single owner. It should be a requirement of the law that the sole member of the company names, at the time of incorporation, the persons that are going to be charged with the running of the company viz, Directors (and a Board of Directors), Secretary and other company officials. 3. Office of the Company Secretary It is our opinion that a single member company should have a company secretary. Under the Companies Act Cap. 110, a private company can have a director who is also the secretary provided that director is not the sole director. With single member companies, it is highly likely that the sole member would appoint himself as company director and the sole director. There is need, in such an instance, to have a different person appointed as company secretary since such a sole director may not adequately perform all the duties of the two offices. However, where a sole member appoints other people as members of the Board of Directors, then one of the directors can take up the role of company secretary. In United Kingdom, the requirement that private companies should have a company secretary was removed. The duties carried out by the company secretary can now be done by the directors. It is upon the directors to decide whether they may appoint a company secretary or not as they are no longer obligated to do so – see Gower & Davies Principles of Modern Company Law, 7th Edition at p.298. 4. Returns The same requirements as to annual returns should apply to single-member companies. Every single-member company should be required to file a return whenever the number of its members rises to more than one, stating that fact and giving particulars of the new shareholder(s). This will, in effect, change the status of the company. 5. Shares The same rules of law relating to shares in a private company should apply to a sole member company. 6. Capital maintenance There should be a legal requirement for the directors and the sole member of the company to ensure at all times that its capital does not go below the minimum capital requirement referred to above. This is intended to provide some level of protection for the company’s creditors. 7. Contracts Contracts with a single member company may be executed as provided by the existing law subject to any necessary modifications. However, certain contracts require special attention such as: Contracts with sole members who are also directors where a private company limited by shares or by guarantee having only one member enters into a contract with the sole member who is also director of the company, the company should, unless the contract is in writing, ensure that the terms of the contract are either set out in a written memorandum or are recorded in the minutes of the first meeting of the directors of the company following the making of the contract. Thus in the event that such a contract is not written and recorded it should be unenforceable as against the company but enforceable against the sole owner. This to give protection to the creditors of the company 8. Changing to a Single- Member Company A private company limited by share or guarantee registered with two or more subscribers to its memorandum of association in accordance with Cap 110 may become a single- member company on such a date as the number of members and all the shares in the company are transferred and registered in the name of a sole person. Particulars of this change should be notified to the registrar of companies within 30days after the date within which the number of members is reduced to one. 9. Changing from a Single- Member company. A company which is incorporated as or becomes a single-member in accordance with Cap 110 or this suggested amendment shall cease to become a single-member on such a date as the number of member increases to more than one. Particulars of this change should be notified to the registrar of companies within 30days after the date from which the number of members increased to more than one. the EEC Law & UK Law and laws of other jurisdictions which adopted the EEC Directive, provide that the fact of members reducing to one, date on which the number reduced to one and the identity of the sole member should be notified in writing in the prescribed form to the Registrar of Companies within 28 days after the date on which the number of members is reduced to one – see R.5(2) & (3) SI 275/1994, R.4(1) & (3) of Schedule to SI 1992/1699. The law further provides that in the event that the number of members in the single member company increases, this should be notified to the Registrar of Companies – refer to R.6 SI 275/1994, r.4(2) of the Schedule to SI 1992/1699. The effect of legalizing formation of one-man companies is that the provision in the law making members of a private company, who after six months subsequent to the reduction of members below the statutory number continue carrying on business liable to pay the debts incurred was repealed – refer to R.3 SI 1992/1699 & r.7 of SI 275/1994. Similarly, if the Ugandan Law were to be amended to provide for single member companies, the aforementioned provisions would be relevant and applicable and should be adopted with necessary modifications putting the Ugandan circumstances into context. Legal and Socio-Economic Implications of Reform Capital requirements Attaching minimum capital requirements to the incorporation of a limited company by a single person might eliminate a considerable portion of local business participants from investment. However, a convincing counter argument would be that such ‘small investors’ would still have available to them the option of pooling their resources to incorporate a limited liability company which they can later break away from as their capital increases to each of the individuals to incorporate a limited company on his/her own. Incorporation The formalities, expense and other rigors of incorporation in Uganda are already a considerable hindrance to local investment because of the low levels of literacy and high levels of poverty. Making it possible for a single person to incorporate a limited company and hiring skilled persons to run it might loosen the grip on the wider population. The minority who are wealthy but illiterate are likely to invest in sole member companies (some of which would take the form of educational institutions)[5] thereby providing employment the poorer majority. This, however, is not guaranteed to deal with the time-honored social predicament presented by poverty and illiteracy in Uganda. Liability The combination of no minimum capital requirements and limited liability could be an invitation to trading at the expense of creditors. Accordingly, in the absence of ex ante minimum capital requirement, there should be developed some ex post controls on those who get into trade without sufficient money of their own or at their disposal to secure their liability to creditors. It is completely clear that a single member company is needed in all the economies. However, there is no doubt that it could be dangerous, especially for creditors when shares are in the hands of one member. Therefore it is prudent that the shareholder has to pays in all the share capital or must pay the minimum required and provide security for the remaining amount. This is the position in Germany in a bid to protect prospective creditors who have to deal with a SMLLC Piercing the corporate veil Piercing the corporate veil may raise more questions under SMLLCs than it would under the ordinary limited liability company. Should the sole member be responsible in any case or should the law define the situations of liability? Who will be responsible to creditors - the sole member or somebody else? Definitely piercing the veil is a concept meant to protect the creditors but the veil should be pierced only if there is a notion of abuse. In such an instance the responsibility should be borne not only by the sole member, but also by the board of directors. Where the company has one director who is not the owner of the company, such a person should be responsible along with the sole member. Tax revenue It can be reasonably forecast that legalizing the formation of sole member companies will widen the threshold of investment resulting in growth in the private sector. This would naturally translate in a wider tax base and thus more revenue for the Government. On the other hand, however, one can rightly anticipate increased litigation arising from instances of liability to creditors. The real extent of the implications of such trends can only be told by time. Taxation A single member company may be taxed as a sole proprietorship. The profits of the LLC should be added to the other income of the interest holder. Thus the profits and losses should be reported to his/her personal tax returns. Thus this would call for the amendment of Income Tax statute to incorporate these changes (American Jurisdiction). However, the English jurisdiction has maintained corporate tax even on these SMLLCs. The question thus lies on which position will increase the tax base in Uganda. Is it when SMLLC business is taxed as a proprietorship or as a company applying rates like of any other corporation? Should the sole owner be given an option to choose whether the single-member company should be treated as a sole proprietorship for tax purposes or to be taxed a any other body corporate under tax statutes. In some states in US, an SMLLC can elect whether to be taxed as proprietorship or as a corporation. Under our current tax regime any company would be taxed on its earnings at a corporate level and shareholders are taxed on any distributed dividends. Transitional Provisions There should be provisions to smoothen the progress of the reform. Examples of such provisions may include: a) Those relating to conduct which may be punishable under the new law/amendment which is not punishable under the current law. b) Those relating to companies whose membership falls below the required number of members immediately before the coming into force of the new legal regime. c) Standard forms should be put in place for; (i) Incorporation of a single member company (ii) Notification of a multi-member company changing to a single-member company. (iii) Notification of a single-member company changing to a multi-member company The Minister may be given power to make by Statutory Instrument such transitional provisions and savings as he considers necessary or expedient in connection with the commencement of any provision made by or under the new law/amendment. Conclusion In all jurisdictions, Company Law recognizes companies as entities distinct from the members/shareholders and minimum guidelines are set down on how such entities should be operated subject to each company’s Articles of Association. Company Law provides for general rules of law that must be complied with by every company and such rules should be applicable to single member companies. In conclusion therefore, our considered opinion is that single member companies can be regulated like the existing companies are being regulated subject to any necessary modifications and alterations that are peculiar to such companies. Regard should be placed on the form, liability of a single member to its creditors and to what extent should a sole owner (especially a corporate entity) of a SMLLC be allowed to form other SMLLCs [1] 7th Edition at page 4. [2] See Part III of the Financial Institutions Act, Cap. 54. [3] In most European and American jurisdictions, there is an option to use electronic means. [4] For the purposes of this provision a “qualifying person” should be taken to mean (a) an individual who is a member of the company, (b) a person authorised to act as the representative of a corporation in relation to the meeting or (c) a person appointed as proxy of a member in relation to the meeting. Cf S. 135, Cap.110. [5] This theory is fortified by the current steady increase in the number of private schools and universities in Uganda.