The Case for Incorporation: Benefits and Criticisms

CORPORATION LAW
A business can be organised in various forms as decided by the owners, depending on the
various decision criteria such as the nature of the business, availability of funds, size of
operations and others. Some of the chief forms of business organisations is the corporations,
partnership entities, sole proprietorships, joint ventures, trust and others. Each of the above
mentioned form of business affects the management functions, liability of the owners, the
manner of the payment of taxes and other incidental business tasks. The essay is aimed at
evaluating the statement that “The case for incorporation is overstated.” The work will shed
light on the various aspects of corporation such as the corporate personality, the limited
liability principles, cost of set up in the corporation and various related concepts. The first
section of the work will highlight the benefits or the reasons, which makes the establishment
of corporation popular. This would be followed by the criticism of incorporation of the
companies. The criticism would be counter argued in light of the available measures in the
law and regulations, which guard the ownership and rights of shareholders, and a conclusion
will be presented.
A corporation is a statutory creation. The supporters of the creation of corporates state a
number of benefits of the company form of business operation, which are explained as
follows. One of the prime benefits of formation of a corporation is the “Separate Legal
Identity.” A company as referred above is registered under a statute of the state where the
head office is located and is regarded as an artificial independent member in the eyes of the
law, as represented and managed by the board of directors. By separate identity it is meant
that everything ranging from the company’s bank account to tenders and contracts in the
name of company to ownership of the assets is separate and distinct from the members in the
eyes of the law. Two of the most widely known case laws in this regard are that of Salomon v
Salomon & Co Ltd 1and Lee v Lee’s Air Farming Ltd2. In context of Australia, the formation
and management of a corporation is governed by the Corporations Act, 2001 (Cth)3. Further
the companies are required to abide by the rules and regulations established by the Australian
Securities and Investments Commission (ASIC). The governing body ASIC is established for
the purpose of registration, enforcement, investigation of the issues and the overall
governance and oversight of the companies.
Other major benefits are stated bellow in the formation of corporation. The owners or the
shareholders of a company enjoy limited liability in corporation unlike in the sole
1 Salomon v A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22
2 Lee v Lee’s Air Farming Ltd [1960] UKPC 33
3 Corporations Act 2001 (Cth)
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CORPORATION LAW
proprietorship and partnership forms of businesses. This is in addition to the perpetual
existence. By this, it is meant that as a shareholder, the only obligation of the shareholders is
to pay the remaining amount of the unpaid shares, and there is no requirement to pay for the
contractual obligations, debts, negligence, or wrongful acts of the corporation. As opposed to
the above, the partnership business makes the partners individually liable for the debts of the
firm. Further to state, the company creation also enjoys the benefit of collection of large-scale
amount of capital; this is because in sole proprietorship and partnerships, the owners, which
are limited, contribute the capital. The public companies are required to have a minimum one
shareholder and there is no upper ceiling to the number of members. In contrast to this, in the
partnership structure, there is an upper limit of 20 for the maximum number of partners in a
firm. Thus, as compared to the sole proprietorships and partnerships, a large amount of
capital can be invested in the company. While a company can be created with a minimum one
member, a partnership requires a minimum of two members. Further, to add the benefits of
formation is that the company employs professional managers and directors to manage and
oversee the day-to-day and other strategic functions.
In addition to the above, the other benefits and operations include the power to issue and
cancel the shares in the company, issue of debentures as an alternative source of capital, ease
in transferring the ownership of shares, distribution of the company’s property among the
members and others. Thus, due to the above-mentioned benefits, the corporations are
regarded as superior to the other forms of business organisations.
However, in spite of the above-mentioned advantages, the case of corporation is regarded as
overstated in the light of some of the below listed disadvantages. The prime disadvantage of
formation of a corporation is that the same are complex and costly to operate. Right from the
incorporation of the company, there are required a number of documents to be filed with the
regulators such as the articles and memorandum of association, financial statements,
Directors’ report, annual returns, auditor’s report and other documents. In order to draft and
file the above documents, the corporates hire the service of accountants, lawyers, company
secretary and other such professionals. Further, the operation of a corporation is a costly
affair. For instance, a company is required to hold shareholders and directors meetings on
annual basis followed by the preparation of the minutes and other such compliance
procedures as stated in the Corporations Act. In contrast to this, the operations of a sole
proprietorship and partnerships are easy and less funds consuming. There lie minimum
compliance and the disclosure requirements right from the application of name, restriction on
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CORPORATION LAW
the objects and powers of the company, restriction on the alteration of the of the rules,
appointment of officers and likewise internal and external matters.
In addition, the criticism in the formation of corporation is stated to be that the corporate
personality and limited liability principles are both less secure and are often utilised by the
directors to carry out the fraudulent activities. As the ownership is separate from
management, there are chances of misuse of properties and money of the corporation,
stemming from the conflict of interest among the directors who are chiefly attributed to
manage the affairs of the company.
The Corporations Act prescribes the four main general duties of the directors in sections 180
to 1844 to ensure that the company is managed fairly and in a legitimate manner. These duties
are on the lines of acting with due diligence, in good faith, taking care while discharging the
managerial functions, not to make improper use of power and information obtained during
the course of management of the company. As stated in the case of ASIC v Sino Australia Oil
and Gas Limited5, a director would be held personally liable if he does not act in a fairly
responsible manner. Further in order to safeguard the money and interest of other
stakeholders, additional duties are prescribed in various other sections. For instance, section
588G6 requires the directors to ensure that company does not engage in the insolvent trading
practices. Further section 3447 ensures that the company engages into due compliance with
the financial reporting requirements. This is in addition to section 199,8 where proper
maintenance of financial books and records is mandated. Further section 2089 mandates the
directors to disclose the personal interests to the market10. In addition, it is required to lodge
the information as and when needed by the ASIC under Section 188.11 Also, section 67412
makes it mandatory for the directors of the company to make continuous disclosures of
information that may affect the share prices of the company. Thus, the above additional
duties in the various parts of the Corporation Act ensure that the rights of the stakeholder as a
whole remain intact in the complex business operations of the company.
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5 ASIC v Sino Australia Oil and Gas Limited (provliqapptd) [2016] FCA 42
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10 Corporations Act, 2001, s208
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