Avoid mistakes when setting up your business

By Scott Moran, Partner

First published in The Press & The Dominion Post, 07 April 2008

A limited liability company is the most popular form of business structure chosen by small, medium and large enterprises in New Zealand.

The New Zealand Companies Office is a world leader in providing the business community with real time online access to the Companies Register, which enables the incorporation and maintenance of companies online. This ‘do-it-yourself’ access helps companies reduce set-up and compliance costs.

In this article, I outline five of the most common mistakes that directors, particularly of companies with a small number of shareholders, tend to make when administering their companies.

Lack of a Constitution

It is not compulsory to have a constitution. As a result many companies do not adopt a constitution. Although the Companies Act contains default provisions that apply to the governance and administration of a company, there are many powers and rights that can only be exercised if provided for in a constitution. For example, without a constitution a company may not buy back its own shares, finance share purchases, restrict the sale of its shares to third parties or insure its directors.

Maintaining Addresses

If a business moves location or if a director or shareholder changes address important communications can be missed. It is very important that the Companies Office database is updated upon any change. This is particularly important when the relevant address is the registered office of the company.

Not only is it a requirement of the Companies Act to maintain these accurate details, but it is important to ensure that all legal notices are received. It is all too common to have legal documents served at outdated registered office addresses, which result in companies being subject to litigation or liquidation when the directors were unaware of the proceedings.

Another consequence is the company failing to receive Annual Return reminders. When these are not filed, the Registrar of Companies moves to strike these companies off. It is often only when the company comes to finance or sell its assets that the directors are made aware of the fact that the company has been struck off. Although a company can be restored, the time and cost in doing so can be considerable.

Issuing an Insufficient Number of Shares

A company is able to incorporate with only one share. While this may appear clean and convenient upon incorporation, when a business expands and seeks additional shareholders, or seeks to more effectively manage its shareholding, additional shares will need to be issued.

The issue of additional shares can present problems if a company is subject to covenants that do not allow share issues. To issue shares, directors need to complete resolutions and certificates that certify the shares are being issued for fair value. This process can become involved with company valuations often required.

As shares may be issued for no consideration upon incorporation, it is often advisable to issue a large number of shares early to retain maximum flexibility later.

Understanding Director’s Duties

It is not often understood that the role of a director differs to that of a sole trader. The duties owed by a director to the shareholders and creditors of a company are wide ranging. The duties include exercising rights for the benefit of the company itself (not necessarily the director’s personal interest), to not incur obligations on behalf of the company that it may be unable to reasonably meet, ensuring the company meets the solvency test set out in the Companies Act when entering certain transactions and to generally not act in contravention of the Companies Act or the company’s constitution.

It is therefore important that a director understands his or her role and his or her duties. Breach of these duties can result in personal liability for losses suffered by others as a result of a failure to meet these duties.

Execution of documents

There is a widely held belief that one director with a witness can correctly sign a document on behalf of a company. This is correct if a company has only one director. However, if there is more than one director then, unless the constitution of the company provides otherwise, two directors must sign deeds on behalf of a company.

In summary, although there is no doubt that ease of access to the Companies Office Register has many benefits, directors and shareholders of companies need to be informed so they do not fall victim to some of the common traps.

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