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Advantages

There are numerous advantages to forming a limited liability company as your trading entity. First, the effect of limited liability is to remove any personal shareholder liability should the company get into difficulties trading. If the company is unable to meet its obligations, it is the individual creditors affected that must bear this loss. A risk to bear in mind however is that a director of the company may be ordered to meet the shortfall in an insolvent liquidation to the extent that failure to keep accounting records can be shown to have led to the liquidation.

Secondly, there is flexibility associated with the capital structure of any company as it is recognised that a company's situation cannot be expected to remain static. There is an ability to do the following with ease:

1. vary the rights of shareholders in relation to dividends or control;
2. expand the size of the company;
3. conveniently separate ownership and management;
4. change the effective control and ownership of the entity without interfering with the essential identity of the organisation; and
5. the death of a party (i.e. a shareholder) does not necessitate a need for change as it would in a partnership.

Disadvantages

There are various costs of incorporating a company and also costs of ongoing administration. Under the Companies Act 1993 (the ‘Act'), there are certain requirements that must be carried out. These requirements include keeping accounting records, retaining company records, preparing and filing annual returns, preparing financial statements, and appointing an auditor.

Duties placed on directors can be quite onerous. For example, directors must act in good faith and in the best interests of the company. It needs to be borne in mind that this duty is owed to the company and not to individual shareholders. Related to the duty of good faith is the duty requiring directors to exercise their powers for a proper purpose. Again, this is a duty owed to the company rather than to individual shareholders.

Directors have a duty of loyalty which is a duty both ‘not to profit from the company' and ‘not to place [themselves] in a position where the company's interests and [their] own personal interests conflict' (Holden v Architectural Finishes Limited (1996) NZCLC 260, 976). This duty is provided for in the Act and under the general law, although the position under the general law is far more demanding on directors and therefore a more popular choice for anybody wishing to hold directors to account.

The Act requires that directors exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but not limited to, the nature of the company; the nature of the decision; and the position of the director and the nature of responsibilities undertaken by them.

There can be problems associated with minority shareholders. If there is a fundamental change to the nature of the company's activities and the rights enjoyed by a class of shareholders, an objecting shareholder does not have to accept the majority decision. In certain circumstances, an objecting minority shareholder that has the right to vote in a general meeting may require the company to purchase their shares. This right may be triggered where alterations are made to the constitution that change the main activities of the company; major transactions; and alterations to the rights enjoyed by a class of shareholders.

Although there is greater flexibility associated with the capital structure of any company, there is also a greater degree of regulation which effectively creates a level of inflexibility when contrasted to other forms of entities. A limited liability company is unable to contract out of various provisions in the Act.

Taxation considerations for a company

A company must file tax returns and pay income in New Zealand in respect of the company's worldwide taxable income at the company tax rate of 30%. Unless a company is a Loss Attributing Qualifying Company (LAQC), tax losses cannot be attributed to the shareholders. If a company is a LAQC, losses are passed on to the shareholders in proportion to their shareholding.

Losses may be carried forward in a limited liability company only if there has been at least 49% continuity of shareholding as set out in the Income Tax Act 2007. There is an ability for tax losses of one company in a group to be offset against the income of other companies within the same group.

Formation of a company

There are several steps that must be undertaken when forming a company. First, the applicant must apply to reserve a name. If there is to be limited liability of shareholders, the name of the company must end with the word ‘Limited' or the words ‘Taipui (Limited)'.

Secondly, directors and shareholders need to be appointed. Both shareholders and directors are required to provide written consent. The directors will be responsible for the day to day management of the company, and the shareholders will contribute the initial capital, as well as being required to approve any major transactions. Unless altered by constitution, a major transaction refers to a transaction of 50% or more of the company's assets.

There are certain restrictions in relation to who can be directors. A director must be a natural person over the age of 18. They cannot be an undischarged bankrupt, nor can they be subject to an order made under the Protection of Personal and Property Rights Act 1988. A director cannot be a person who is prohibited under any other statutory provisions, which includes being convicted of a crime involving dishonesty in the five years prior to acceptance of the appointment as a director.

Companies can either be bound purely by the Act, or can alter some obligations under the Act. Alterations to the company's obligations can be done in two ways. First by way of a Company Constitution. Many companies have constitutions as the default rules in the Act which otherwise apply may be unsuitable.

The Act is drafted in such a way that it suits large, widely held companies; however the majority of companies in New Zealand are small, closely held companies.

Secondly, shareholders can alter their obligations to each other by way of a Shareholders Agreement. This is a private document that often stands alongside a constitution in a small, closely held company. Shareholders Agreements are used as a way of supplementing any constitution or the default rules in the Act and can confer rights or obligations on shareholders acting in other capacities which cannot be provided for in a constitution. Shareholders Agreements also reduce the inherent uncertainty arising from the default position of majority rule as a Shareholders Agreement can provide for how and when votes are cast.

Conclusion

Once a company is formed any existing business can be transferred. There will be a number of things to consider as every situation is different, and we suggest that you obtain professional advice at this point.

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