Pitfalls for the unwary – the importance of following corporate formalities

If you run an owner-manager business where the shareholders are also the directors, it may be tempting to take an informal approach to corporate governance. That is to say: not following various legal formalities such as keeping board minutes or properly passing shareholder resolutions. A view might be taken that, even if legally required, these formalities do not really matter because no one is going to challenge any decisions. On that basis, jumping through the legal hoops might be considered an unnecessary expense. However, this approach can lead to significant problems when selling a business, raising finance or the liquidation of the company.

Aside from it usually being illegal not to follow the formalities, this approach can devalue your business. It’s a bit like failing to routinely maintain a house, when you come to sell it the price will be reduced to take into account the value of any necessary repairs. In a company context, it can be worse than that. Decisions might be invalid. For example, if you have attempted to change the company’s share capital (e.g. buy-back shares or issue more shares) or buy and sell things to and from your company you should have followed legally prescribed procedures. If you have not, this can lead to an expensive legal muddle in relation to your company’s share capital and share ownership and what the company itself does and does not own. Fixing this can lead to extra costs and if it is not fixed can lead to your business being worth less than you would have hoped.

It is important to appreciate, just updating the record at Companies House is highly unlikely to be enough to meet these legal requirements.

There is a body of law which says that if all shareholders unanimously consent to something happening then, regardless of whether or not the formalities are followed, that consent will be valid.  This is called the Duomatic Principle. However, this Principle does have its limits and should only be relied on as a last resort. The safest approach will be to take and follow legal advice on how to do things correctly.

If you would like further advice or assistance, please contact Victoria Spellman in our Business Services Team on 01473 611 211 or [email protected]