Beruflich Dokumente
Kultur Dokumente
2009
LLB 2650021
This subject guide was prepared for the University of London External System by:
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A. Dignam, BA, (TCD), PhD (DCU), Professor of Corporate Law, Queen Mary, University of London
and
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J. Lowry, LLB, LLM, Professor of Law and Vice Dean, Faculty of Laws, University College London, University of London
This is one of a series of subject guides published by the University. We regret that owing to pressure of work the authors are unable to enter into any correspondence relating to, or arising from, the guide. If you have any comments on this subject guide, favourable or unfavourable, please use the form at the end of this guide.
Publications Office The External System University of London Stewart House 32 Russell Square London WC1B 5DN United Kingdom www.londonexternal.ac.uk Published by the University of London Press University of London 2009. Reformatted and reprinted 2010 Printed by Central Printing Service, University of London All rights reserved. No part of this work may be reproduced in any form, or by any means, without permission in writing from the publisher.
Company Law
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Contents
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.1 1.2 1.3 Company law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Approaching your study . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 The examination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
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8 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 8.1 Overview the maintenance of capital doctrine . . . . . . . . . . . . . . . 77 8.2 Raising capital: shares may not be issued at a discount . . . . . . . . . . . . 77 8.3 Returning funds to shareholders . . . . . . . . . . . . . . . . . . . . . . 8.4 Prohibition on public companies assisting in the acquisition of their own shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 83
9.2 The articles of association . . . . . . . . . . . . . . . . . . . . . . . . . . 91 The contract of membership . . . . . . . . . . . . . . . . . . . . . . . . . 93 Shareholders agreements . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Altering the articles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
Company Law 13 Dealing with outsiders: ultra vires and other attribution issues . . . . 133
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 13.1 The objects clause problem . . . . . . . . . . . . . . . . . . . . . . . . 13.3 Other attribution issues . . . . . . . . . . . . . . . . . . . . . . . . . . 135 139 13.2 Reforming ultra vires . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143
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1 Introduction
Contents
1.1 1.2 1.3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Company law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
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Introduction
This subject guide acts as a focal point for the study of Company law on the University of London External System LLB. It is intended to aid your comprehension by taking you carefully through each aspect of the subject. Each chapter also provides an opportunity to digest and review what you have learned by allowing a pause to think and complete activities. At the end of each chapter there are sample examination questions to attempt once you have completed and digested the further reading. Company law requires students to develop their existing understanding of tort, contract, equity, statutory and common law interpretation. It also provides students with new conceptual challenges such as corporate personality. This combination of development and new challenge can initially be a difficult one and the initial learning period will be greatly eased if you understand the everyday context within which company law issues affect businesses. All of the major national newspapers cover company law issues in their business sections. Keeping on top of business and general news developments will help to put your learning into context and aid your comprehension of the subject. It may even stimulate your enjoyment of company law!
Learning outcomes
By the end of this chapter and the relevant reading, you should be able to:
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approach the study of Company law in a systematic way understand what the various elements of the subject guide are designed to do begin your study of Company law with confidence.
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BERR used to be the Department for Trade and Industry (DTI). In June 2009 BERR became the Department for Business, Innovation and Skills (BIS)
Note that in this subject guide we ask you to do the essential reading after you have worked through the chapter.
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Dignam, A. and J. Lowry Company Law. (Oxford: Oxford University Press, 2008) fifth edition [ISBN 9780199232871].
This subject guide is centred on this textbook, which was written by the authors of this guide. References in the text to Dignam and Lowry are references to this textbook. It is your essential reading and so much of your study time should be taken up reading the textbook, though you will also have to study numerous case reports, complete the further reading and keep up to date with academic company law writing.
Davies, P. Gower and Davies Principles of Modern Company Law. (London: Sweet & Maxwell, 2008) eighth edition [ISBN 9780421949003].
Readings from Davies are specified in each chapter. Like Dignam and Lowry this book (Davies) is cited using just the authors name.
Pettet, B., J. Lowry and A. Reisberg Pettets Company Law: Company and Capital Markets Law. (Pearson, 2009) third edition [ISBN 9781405847308].
This text is particularly interesting as it fleshes out the interaction of company law with capital markets and securities regulation.
Sealy, L.S. and S. Worthington Cases and Materials in Company Law. (Oxford: Oxford University Press, 2008) eighth edition [ISBN 9780199298426]. Hicks, A. and S.H. Goo Cases and Materials in Company Law (Oxford: Oxford University Press, 2008) sixth edition [ISBN 9780199289851].
A statute book is a good addition to your personal company law library. These are generally updated every year and it is important that you use the most up to date version. The choice is between:
Core Statutes on Company Law. (Palgrave Macmillan) Blackstones Statutes on Company Law. (Oxford: Oxford University Press)
You are currently allowed to bring one of these into the examination. Check the Regulations for up to date details of what you are allowed to bring into the examination with you. Please note that you are allowed to underline or highlight text in these documents but you are not allowed to write notes or attach self-adhesive notelets, etc. on them. See the Regulations and the Learning skills for law study guide for further guidance on these matters.
Legal journals
A good Company law student is expected to be familiar and up to date with the latest articles and books on company law. Company law articles often appear in the main general UK legal academic journals:
Modern Law Review (MLR) Oxford Journal of Legal Studies (OJLS) Journal of Law and Society (JLS)
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It is essential that you keep up to date with developments reported in these journals. Specific dedicated company or business law journals are also very useful for company law students. The Company Lawyer, Journal of Corporate Law Studies, European Business Organisation Law Review and Journal of Business Law are among the best, combining current academic analysis of issues with updates on case law and statute. Three significant books are also drawn to your attention. We dont suggest you buy these texts but rather that you use them in a library (if you can get access to one).
Parkinson, J.E. Corporate Power and Responsibility: issues in the theory of company law. (Oxford: Clarendon Press, 1993) [ISBN 0198252889]. Cheffins, B.R. Company Law: theory and structure. (Oxford: Oxford University Press, 1997) [ISBN 0198259735]. Dignam, A. and Galanis, M. The Globalization of Corporate Governance. (Ashgate, 2009) [ISBN 9780754646259].
Parkinson (1993) examines the corporate law issues surrounding the stakeholder debate in the UK (there is more on this in Chapter 16 on corporate governance, but for now it refers to a debate about whether stakeholders, such as employees and consumers, and issues raised by environmentalists and public interest bodies should be the focus of the exercise of corporate power). John Parkinson also chaired the corporate governance group as part of the Department of Trade and Industrys (now called Department for Business, Innovation and Skills (BIS)) CLRSG Review of UK company law. His views are therefore important in understanding the CLRSG findings and the corporate governance provisions in the Companies Act 2006. The second book we would draw your attention to here is Cheffins (1997). The company law and economics school is a growing and influential one in UK company law. Knowledge of it is essential to an understanding of many of the current debates in company law. The third book, Dignam and Galanis (2009), provides a perspective on the corporate governance material used in this study guide, based around the globalisation of product and securities markets.
Other sources
Your understanding of many of the issues we will study will be aided immeasurably if you understand the context within which company law issues affect businesses. All major national newspapers cover these issues in their business sections. In an ideal world you would read these sections each day, either by buying a newspaper, reading it online or going to the library to go through them. However, we do not live in an ideal world, so a good compromise is to buy or read in a library the Saturday version of the Financial Times or view it online. It contains an update on all the weeks business and general news developments. If you can manage to do this over the academic year, it will help to put your learning into context and aid your comprehension of the course. While company law cases appear in the main law reports there are two dedicated company law reports, British Company Law Cases (BCC) (published yearly by Cronor CCH) and Butterworths Company Law Cases (BCLC) edited by D.D. Prentice, which are very useful. Online sources such as Westlaw and Lexis, which you can access through the Online Library, also carry these reports as well as unreported cases. You might also find it useful sometimes to dip into texts such as Palmers Company Law Manual (Sweet and Maxwell) or Gore-Browne on Companies (Jordans publishers) in a good law library (if you can access one). These are practitioner texts which are regularly updated and contain a wealth of up to date information.
The essential reading for most chapters will include a list of important cases that you should read and make notes on. Where additional cases are listed, you should read them if you have time to do so.
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1.3.1 Preparation
No amount of last-minute study will solve the problem of a lack of preparation. You must begin your examination preparation from the first day the course begins. Using this guide as a starting point, take careful condensed notes in a loose-leaf file of everything you read. When you have finished a section, identify and write down a list of the key points that will act as a memory trigger for you when you return to that section again. While the sample examination questions in this guide are a good way to practise, you should go beyond this and practise answering previous LLB examination questions, which are available on the External System website. Be disciplined about this exercise by pretending you are doing it under examination conditions. Give yourself only 45 minutes to answer each question, including reading and planning time. You should plan out each week of study in advance using a diary, allowing at least two hours of study for company law each week. You should also allow time for a review of the weeks work and at the end of each month allow some time for a wider review of what you have achieved that month. Remember that examinations are not intended to be an accurate assessment of your knowledge of company law. They are a test of your ability to answer certain questions on company law on one particular day in one particular year. As such you need to learn and revise constantly over that year to give yourself the best chance of performing on the day. You also need to be physically and mentally well so make sure you do not overwork; eat well and include social and physical activities in your weekly schedule. Three months before the examination you should draw up an examination revision schedule. At this point you should have been working consistently over the previous months and have a good set of notes to revise from. You will now need to decide what subjects you will revise for the examinations. This needs careful thought. Many students only revise the bare minimum number of subject areas (four the number of questions candidates must answer in the examination). However, this leaves them vulnerable to one or more of these areas not being on the paper or one or more of the areas being combined in one question. It also means the student has little choice even if all four areas they have revised come up. One or all of the questions might be very difficult while the other questions on the paper are easier. For these reasons, if you are well-prepared at this point, you should plan to revise a minimum of six areas. If you wish to be more cautious (there are still no guarantees), revise at least eight areas for the examination after carefully going over the previous examination questions. Again, include time in your examination revision schedule for practising old examination questions under examination conditions.
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It is not enough to just do this and then provide a general description of the area. You must follow the argument through to the end, identifying weaknesses and strengths but holding firm to your argument. If things are uncertain, as the law often is, then identify the uncertainty and give your substantiated opinion as to which course the law should take. All the time asking yourself: Am I answering the question? Remember as well that an essay question has a beginning (where you introduce your argument), a middle (where you set out the detail of your argument) and an end (where you conclude by repeating briefly your argument). Always follow this format, as it will help you focus on your argument.
approach the study of Company law in a systematic way understand what the various elements of the subject guide are designed to do begin your study of Company law with confidence.
Contents
2.1 2.2 2.3 2.4 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 The sole trader . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 The partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 The company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Some general problems with the corporate form . . . . . . . . . . . . . 15 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
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Introduction
Companies are the dominant form of business association in the UK. They are not, however, the only form of business association. Sole traders and partnerships also exist as specific legal forms of business. In this chapter we explore the place of the company within the various legal forms of business organisation available in the UK in order to provide some insight as to how the company has come to be the dominant form. In doing so we will consider the various forms of business organisation from the point of view of their ability to raise capital (money), their ability to minimise risk and their ability to provide some sort of clear organisational structure. We will also explore some of the general problems that the corporate form poses for businesses. In general this subject is not a course in the detailed procedural aspects of company law. Having said that, in the course of this chapter, more than any other in the guide, we will touch upon procedural matters as they arise. This is because key aspects of the procedural nature of setting up a company are very useful for understanding later chapters such as Chapter 5: Company formation, promoters and pre-incorporation contracts and Chapter 9: Dealing with insiders. Some of you may find this procedural detail off-putting, but bear with it and complete the activities. It will pay dividends in the later chapters.
Learning outcomes
By the end of this chapter and the relevant readings you should be able to:
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illustrate the differences between the major forms of business organisation in the UK describe the advantages and disadvantages of each form of business organisation explain the different categories of company demonstrate the difficulties small businesses have with the company as a form of business organisation.
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Essential reading
Dignam and Lowry, Chapter 1: Introduction to company law. Davies, Chapter 1: Types and functions of companies and Chapter 2: Advantages and disadvantages of incorporation.
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Advantages
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No legal filing requirements or fees and no professional advice is needed to set it up. You just literally go into business on your own and the law will recognise it as having legal form. Simplicity one person does not need a complex organisational structure.
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Disadvantages
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It is not a particularly useful business form for raising capital (money). For most sole traders the capital will be provided by personal savings or a bank loan. Unlimited liability the most important point to note in terms of comparing this form to the company is that there is no difference between the sole trading business and the sole trader himself. The profits of the business belong to the sole trader but so do the losses. As a result he has personal liability for all the debts of the business. If the business collapses owing money (an insolvent liquidation see Chapter 16) then those owed money by the company (its creditors) can go after the personal assets of the sole trader (e.g. his car or house) in order to get their money back.
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Activity 2.1
From the point of view of raising capital, minimising risk and providing an organisational structure, assess the merits of a sole trading concern. No feedback provided.
Advantages
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No formal legal filing requirement involved in becoming a partnership beyond the minimum requirement that there be two members of the partnership. Once there are two people who form the business it will be deemed a legal partnership. It facilitates investment as it allows two or more people to pool their resources. The maximum number of partners allowable is, since 2002, unlimited. Prior to that it was 20 unless you were a professional firm solicitors, accountants etc. If you are aware of the problems the Partnership Act can cause (see disadvantages below) then you can draft a partnership agreement to vary these terms of the Act and provide an accurate reflection of your intentions when entering the partnership. The partnership agreement can therefore be used to provide a very flexible organisational structure although this usually involves having to pay for legal advice.
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The Partnership Act 1890 can be a danger to the unwary. The broad definition of a partnership is a particular problem. For example three people going into business together without forming a company will be partners whether they know it or not. This can cause problems, as the Partnership Act 1890 imposes certain conditions for the continued existence of the partnership. If one of our three unknowing partners dies the Partnership Act will deem the partnership (even though the participants did not know they were partners) to have ended. This is the case even where a successful business is being operated through the partnership. As a result of these types of problems those who choose to be partners will usually draft a more formal arrangement called a partnership agreement specifying the terms and conditions of the partnership. The Act also entitles each partner: to participate in management to an equal share of profit to an indemnity in respect of liabilities assumed in the course of the partnership business not to be expelled by the other partners. A partnership will end on the death of a partner. If you are unaware of this when the partnership is formed, the rigidity of the Act may not reflect the intention of the partners. The partners are jointly and severally liable for the debts of the partnership. This means that each partner can be sued for the total debts of the partnership. In essence, partnerships are founded on relationships of trust. If that trust is breached then the remaining partner or partners can pay a heavy price as they must pay all the debts owed. However, if that relationship of trust is maintained then the partnership effectively reduces the risk of doing business compared to that taken by a sole trader because partners share the risk.
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Activity 2.2
From the point of view of raising capital, minimising risk and providing an organisational structure, assess the merits of a partnership. No feedback provided.
Company Law 2 Forms of business organisation Differences between public and private companies limited by shares
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Before 1992 you needed two shareholders to form a private company limited by shares. The Twelfth EC Company Law Directive (89/667) changed this requirement and the Companies Act 2006 now provides for single person private companies. Public companies still need two shareholders. In private companies investment comes either from the founding members in the form of personal savings or from a bank loan. As such, private companies are prohibited from raising capital from the general public. Public companies, on the other hand, are formed specifically to raise large amounts of money from the general public. Private companies can restrict their membership to those the directors approve of or insist that those who wish to leave the company first offer their shares to the other members. Public companies could also do this but, as their aim is to raise money from the general public, a restriction on the sale of shares would not encourage the general public to invest. Public companies have a minimum capital requirement of 50,000 (s.763 CA 2006). That capital requirement does not have to be fully paid it just needs one quarter of the 50,000 to be paid and an ability to call on the members for the remaining amount. Private companies have no real minimum capital requirements. For example a private company can have an authorised share capital of 1 subdivided into shares of 1p each. Because public companies raise capital from the general public there is a raft of extra regulations that affects their activities. This is discussed extensively in Chapter 6 on raising equity. Private companies can also adopt a more streamlined procedure for meetings by introducing written agreements instead of formal meetings. Part 13 CA 2006 is designed to recognise that often in private companies the directors and the members of the company are one and the same and so requirements for meetings, timing of meetings and laying of accounts can be suspended to streamline the operation of the private company.
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Limited liability
One of the most obvious differences between the company and other forms of business organisation is that the members of both private and public companies have limited liability. This means that the members of the company are only liable for the amount unpaid on their shares and not for the debts of the company. We will explore how this operates in some detail in the next chapter. In order to warn those who might deal with a company that the members have limited liability the word limited or Ltd must appear after a private companys name or plc after a public company (ss.58 and 59 CA 2006).
the company name the companys share capital the address of the companys registered office the objects of the company (stating what the company is empowered by the state to do) a statement that the liability of its members is limited.
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The objects of the company was once a very complex area of study for company lawyers because of the tendency of companies to change the nature of their business without changing or because they were unable to change their objects clause. Thankfully for us all it has been the subject of a largely successful and ongoing reform programme. The Companies Act 2006 provides that companies will automatically have unlimited capacity. Companies can choose to have a restrictive objects clause if they wish but in general the objects clause issue should recede further. However, it still forms an important part of company law currently because, while under the 2006 Act regime the object clause is optional, companies formed under the 1985 Act will still have an objects clause in their memorandum for some time to come. One person in the case of a private company, or two in a public company, must subscribe to the memorandum. In essence, they agree to take some shares or share in the company and become its first shareholders. Share capital in public and private companies The share capital in the memorandum is known as the nominal or authorised share capital. It represents the amount of share capital that could be issued to investors. Once an amount has been issued to investors, that amount is called the issued share capital. The memorandum will also state the amounts that the authorised share capital is subdivided into. So, for example, 100 might be subdivided into shares of 1 each. The value given to each share is known as its par or nominal value. For new companies formed under the 2006 Act a statement of capital is needed but the need to set out the authorised share capital in the memorandum is no longer necessary (s.10 CA 2006). However, it continues to act as a restriction in the articles. Shares can be fully paid, partly paid or even unpaid. With partly and unpaid shares, the shareholder can be called upon to pay for them at a later date. Shares may be also be paid for in goods and services and not necessarily in cash. We will discuss share capital extensively in Chapter 8.
A simple majority vote is where more than 50 per cent of those who vote at the general meeting agree with the resolution. In this case where more than 50 per cent vote to remove a director.
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Companies are designed as investment vehicles. Companies have the ability to subdivide their capital into small amounts, allowing them to draw in huge numbers of investors who also benefit from the sub-division by being able to sell on small parts of their investment. Limited liability also minimises the risk for investors and is said to encourage investment. It is also said to allow managers to take greater risk in the knowledge that the shareholders will not lose everything. The constitution of the company provides a clear organisational structure which is essential in a business venture where you have large numbers of participants.
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Disadvantages
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Forming a company and complying with company law is expensive and time-consuming. It also appears to be an inappropriately complex organisational form for small businesses, where the board of directors and the shareholders are often the same people (we discuss this further below).
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Activity 2.3
a. What are the advantages and disadvantages of each form of business organisation? b. With a view to recommending a particular form of business organisation to a client wishing to set up a cyber-caf, compare and contrast each of the types discussed above. c. Explain the difference between a private and a public company. No feedback provided.
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The general meeting meets once a year (this is the annual general meeting or AGM) primarily to elect the directors to the board. The directors will be a mix of professional managers (executive directors) and independent outsiders (non-executive directors); see Chapter 14. The executive directors will normally have a small shareholding but not usually a significant one. The shareholders are also provided with an annual report from the directors outlining the performance of the company over the past year and the prospects for the future (like a sort of report card on their performance). At the heart of the report are the accounts certified by the auditor (an independent accountant who checks over the accounts prepared by the directors). In between AGMs the directors run the company without any involvement by the shareholders. In a large company the board of directors will be more like a policy body which sets the direction the company goes in, but the actual implementation of that direction will be carried out by the companys employees. The directors in carrying out their function stand in a fiduciary relationship with the company. They therefore owe a duty to act bona fides (in good faith) in the interests of the company (this generally means the shareholders interests) and not for any other purpose (such as self-enrichment see Chapter 14). The employees who are authorised to carry out the companys business are the companys agents and therefore the company will be bound by their actions (see Chapter 13).
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A fiduciary is a person who is bound to act in the interests and for the benefit of another; trustees also have fiduciary duties.
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The shareholders and directors will often be the same people. The same people will also be the only employees of the company. There is no separation of ownership from control, the shareholders are the managers and therefore most of the statutory assumptions about the companys organisational structure will not hold.
These differences (in effect the requirements for meetings and accounts), which are based on a presumption of the managers being different people from the shareholders, became a burden for small companies. As a result they have been significantly altered by the CA 2006 (see below).
Advantages
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Prestige. The small businesses surveyed considered that one of the major advantages (in fact possibly the only advantage) of forming a company was that it conferred prestige, legitimacy and credibility on the venture. Limited liability. The ability of those who are behind the company to walk away from the companys debts. However for small businesses this was potentially negated by the practice of banks requiring the shareholders to provide guarantees
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Disadvantages
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Burdensome regulatory requirements (meetings, accounts, etc.). Expensive as they had to pay for professional advice to deal with the regulatory requirements.
Solutions
Historically company law has not ignored this problem and some concessions have been made. In particular, a private company could, under the old 1985 Act, adopt the simplified elective regime in s.379A CA 1985 which allowed the suspension of:
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A small private company could also adopt a written regime under the old Table A articles of association. Article 53, for example, which allowed a more informal written decisionmaking process. However, these concessions were largely seen as inadequate. The CLRSGs Final Report (Modern Company Law for a Competitive Economy: Final Report (2001), Chapters 2 and 4) recommended that the following statutory requirements be simplified for small businesses.
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As we will discuss later, the need to focus company law on the small business was a major theme (if not the major theme of the CLRSGs Final Report). As a result, the CLRSG recommended that legislation on private companies should be made easier to understand. In particular, there should be a clear statement of the duties of directors. The 2002 White Paper Modernising Company Law: The Governments Policy that followed the CLRSG Final Report, the March 2005 White Paper, the Company Law Reform Bill 2005 and the Companies Act 2006 have all carried through this focus on the quasi-partnership company with its think small first emphasis.
Minority issues
The fact that there are so few participants in a small business presents another problem for company law. That is, sometimes they disagree and if this continues, a minority shareholder can easily be excluded from the running of the company while remaining trapped within it. This occurs because company law presumes that the company operates through its constitutional organs. In order for the company to operate either the board of directors makes a decision or, if it cannot, then the general meeting can do so. It can, however, happen that a majority of shareholders holding 51 per cent (simple majority voting power) of the shares in the company could act to the detriment of the other 49 per cent. A 51 per cent majority would allow those members to elect only those who support their policies to the board. Thus the 49 per cent shareholder would be unrepresented on the board and powerless in the general meeting.
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These situations are worse in private companies where the minority shareholder often needs board approval for the sale of shares to an outsider or must offer the shares to the other members first. If the other members are obstructive then this pre-emption process can leave the minority shareholders trapped. Of course the fact that the majority holder is behaving badly will make it difficult to find a buyer willing to put themselves into a similarly weak position. Although the courts quickly came up with a limited exception to enforcing the constitutional structure (see Chapters 11 and 12) there has been a continuing tension between enforcing the constitutional structure (allowing directors to run the company unimpaired by factions among the shareholders) and protecting minority shareholders against genuinely fraudulent transactions (see Chapter 10). Eventually, a statutory remedy was introduced in s.459 CA 1985 and is now contained in s.994 CA 2006 to make it easier for shareholders to bring an action.
Activity 2.4
From the point of view of raising capital, minimising risk and providing an organisational structure, assess the merits of a registered company. No feedback provided.
Activity 2.5
Is the corporate form suitable for small companies?
Summary
The importance of this chapter is that it forms a context within which we can place the company and its success as a business form. The sole trader may be a suitable approach for informal one-person ventures, where the capital is mostly provided by the sole traders savings or a bank loan. It is unsuitable for larger organisational or investment purposes. The partnership is a very good business form which has many advantages over a company, particularly for small- and medium-sized businesses. Unfortunately it has fallen out of use as a significant business form. The increase in the number of partners allowed may go some way to increase its popularity. The company in turn has come to dominate. However the company as a form of business organisation is not without its problems. The company is designed as an investment vehicle, with limited liability for its shareholders and a clear organisational structure. It is designed for ventures where there is an effective separation of ownership from control and is therefore largely unsuitable for the majority of its users, who are small businesses. In many ways a partnership would be more suitable for an entrepreneur and less onerous for small businesses generally, especially given that limited liability is rarely a reality for these types of businesses. However, the continued use of the corporate form by small companies seems secure given the prestige attached to the tag Ltd. The Companies Act 2006 has gone some way towards meeting the needs of small businesses.
Freedman, J. Small businesses and the corporate form: burden or privilege?, [1994] 57 MLR July, pp.55584. Freedman, J. and M. Godwin Incorporating the micro business: perceptions and misperceptions in Hughes, A. and D.J. Storey, (eds) Finance and the Small Firm. (London: Routledge, 1994) [ISBN 0415100364].
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The distinction company law makes between public and private companies. The historical concessions in the elective regime in the s.379A CA 1985 and Table A, art.53. Minority protection concessions for small businesses and the fact that the CLRSG and the 2006 Act increase protection for minorities. A discussion of the CLRSGs think small first approach and its effect in the Companies Act 2006.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 2.1 2.2 2.3 2.4 The sole trader The partnership The company Some general problems with the corporate form Revision done
Contents
3.1 3.2 3.3 3.4 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Corporate personality . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Salomon v Salomon & Co . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Other cases illustrating the Salomon principle . . . . . . . . . . . . . . 24 Limited liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
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Introduction
In this chapter we explore the related concepts of corporate legal personality and limited liability. These concepts are central to developing understanding of company law and it is essential that you take time here to absorb these fundamental principles.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain what is meant by corporate legal personality illustrate the key effects of corporate legal personality in relation to liability.
Essential reading
Dignam and Lowry, Chapter 2: Corporate personality and limited liability. Davies, Chapter 2: Advantages and disadvantages of incorporation and Chapter 8: Limited liability and lifting the veil at common law.
Cases
Salomon v Salomon & Co [1897] AC 22 Macaura v Northern Assurance Co [1925] AC 619 Lee v Lees Air Farming [1961] AC 12 Barings plc (In Liquidation) v Coopers & Lybrand (No 4) [2002] 2 BCLC 364 Giles v Rhind [2003] 2 WLR 237 Shaker v Al-Bedrawi [2003] 2 WLR 922.
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The House of Lords disagreed and found that:
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the fact that some of the shareholders were only holding shares as a technicality was irrelevant; the registration procedure could be used by an individual to carry on what was in effect a one-man business a company formed in compliance with the regulations of the Companies Acts is a separate person and not the agent or trustee of its controller. As a result, the debts of the company were its own and not those of the members. The members liability was limited to the amount prescribed in the Companies Act (i.e. the amount they invested).
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The decision also confirmed that the use of debentures instead of shares can further protect investors.
Activity 3.1
Read Salomon v Salomon & Co (1897) AC 22. a. Describe the key effects of the change in status from a sole trader to a limited company for Mr Salomon. b. What are the key principles that we can draw from the case? c. Should Mr Salomon have been liable for the debts of the company?
the timber belonged to the company and not Mr Macaura Mr Macaura, even though he owned all the shares in the company, had no insurable interest in the property of the company just as corporate personality facilitates limited liability by having the debts belong to the corporation and not the members, it also means that the companys assets belong to it and not to the shareholders.
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More modern examples of the Salomon principle and the Macaura problem can be seen in cases such as Barings plc (In Liquidation) v Coopers & Lybrand (No 4) [2002] 2 BCLC 364. In that case a loss suffered by a parent company as a result of a loss at its subsidiary (a company in which it held all the shares) was not actionable by the parent the subsidiary was the proper plaintiff. In essence you cant have it both ways limited liability has huge advantages for shareholders but it also means that the company is a separate legal entity with its own property, rights and obligations (see also Giles v Rhind [2003] 2 WLR 237 and Shaker v Al-Bedrawi [2003] 2 WLR 922).
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3.3.2 Lee
Another good illustration is Lee v Lees Air Farming [1961] AC 12. Mr Lee incorporated a company, Lees Air Farming Ltd, in August 1954 in which he owned all the shares. Mr Lee was also the sole Governing Director for life. Thus, as with Mr Salomon, he was in essence a sole trader who now operated through a corporation. Mr Lee was also employed as chief pilot of the company. In March, 1956, while Mr Lee was working, the company plane he was flying stalled and crashed. Mr Lee was killed in the crash leaving a widow and four infant children. The company, as part of its statutory obligations, had been paying an insurance policy to cover claims brought under the Workers Compensation Act. The widow claimed she was entitled to compensation under the Act as the widow of a worker. The issue went first to the New Zealand Court of Appeal who found that he was not a worker within the meaning of the Act and so no compensation was payable. The case was appealed to the Privy Council in London. They found that:
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the company and Mr Lee were distinct legal entities and therefore capable of entering into legal relations with one another as such they had entered into a contractual relationship for him to be employed as the chief pilot of the company he could in his role of Governing Director give himself orders as chief pilot. It was therefore a master and servant relationship and as such he fitted the definition of worker under the Act. The widow was therefore entitled to compensation.
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Activity 3.2
Read Macaura v Northern Assurance Co [1925] AC 619 and Lee v Lees Air Farming [1961] AC 12 carefully and then write a brief 300-word summary of each case. Re-read Dignam and Lowry, Chapter 2, paras 2.22.12 and paras 2.322.44.
Summary
There are some key points to take from this chapter. First, it is important at this stage that you grasp the concept of corporate personality. If at this stage you do not, then take some time to think about it and when you are ready come back and re-read Dignam and Lowry, Chapter 2, paras 2.22.12. Second, having grasped the concept of corporate personality you also need to understand its consequences (i.e. the fact that the company can hold its own property and be responsible for its own debts).
Ireland, P. et al. The conceptual foundations of modern company law, [1987] JLS 14, pp.149165. Pettit, B. Limited liability a principle for the 21st century, [1995] CLP 124. Grantham, R.B. and E.F. Rickett The bootmakers legacy to company law doctrine in Grantham, R.B. and E.F. Rickett (eds) Corporate personality in the 20th Century. (Oxford: Hart Publishing, 1998) [ISBN 1901362833].
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 3.1 3.2 3.3 3.4 Corporate personality Salomon v Salomon & Co Other cases illustrating the Salomon principle Limited liability Revision done
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Notes
Contents
4.1 4.2 4.3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Legislative intervention . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Judicial veil lifting . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Veil lifting and tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
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Introduction
As we observed in Chapter 3 the application of the Salomon principle has mostly (remember Mr Macaura) beneficial effects for shareholders. The price of this benefit is often paid by the companys creditors. In most situations this is as is intended by the Companies Acts. Sometimes, however, the legislature and the courts have intervened where the Salomon principle had the potential to be abused or has unjust consequences. This is known as lifting the veil of incorporation. That is, the courts or the legislature have decided that in certain circumstances the company will not be treated as a separate legal entity. In this chapter we examine the situations where the legislature and the courts lift the veil.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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describe the situations where legislation will allow the veil of incorporation to be lifted explain the main categories of veil lifting applied by the courts.
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Essential reading
Dignam and Lowry, Chapter 3: Lifting the veil. Davies, Chapter 8: Limited liability and lifting the veil at common law and Chapter 9: Statutory exceptions to limited liability.
Cases
Gilford Motor Company Ltd v Horne [1933] Ch 935 Jones v Lipman [1962] 1 WLR 832 D.H.N. Ltd v Tower Hamlets [1976] 1 WLR 852 Woolfson v Strathclyde RC [1978] SLT 159 Re a Company [1985] 1 BCC 99421 National Dock Labour Board v Pinn & Wheeler Ltd [1989] BCLC 647 Adams v Cape Industries plc [1990] 2 WLR 657 Creasey v Breachwood Motors Ltd [1992] BCC 638 Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447 Williams v Natural Life Health Foods Ltd [1998] 2 All ER 577 Lubbe and Others v Cape Industries plc [2000] 1 WLR 1545.
Additional cases
Re Todd Ltd [1990] BCLC 454 Re Patrick & Lyon Ltd [1933] Ch 786 Re Produce Marketing Consortium Ltd (No 2) [1989] 5 BCC 569 Trustor AB v Smallbone [2002] BCC 795 Noel v Poland [2002] Lloyds Rep IR 30 Daido Asia Japan Co Ltd v Rothen [2002] BCC 589 Standard Chartered Bank v Pakistan National Shipping Corp (No 2) [2003] 1 AC 959 R v K [2005] The Times, 15 March 2005 MCA Records Inc v Charly Records Ltd (No 5) [2003] 1 BCLC 93 Koninklijke Philips Electronics NV v Princo Digital Disc GmbH [2004] 2 BCLC 50.
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s.399 CA 2006 provides that parent companies have a duty to produce group accounts s.409 CA 2006 also requires the parent to provide details of the shares it holds in the subsidiaries and the subsidiaries names and country of activity.
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However, it was the possibility of using the corporate form to commit fraud that prompted the introduction of a number of civil and criminal provisions. These provisions operate to negate the effect of corporate personality and limited liability in:
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s.993 CA 2006 which provides a not much used criminal offence of fraudulent trading ss.213215 Insolvency Act 1986 which contain the most important statutory veil lifting provisions.
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Sections 213 and 214 differ in the way they affect the Salomon principle. Section 213 applies to anyone involved in the carrying on of the business and therefore directly qualifies the limitation of liability of members. Section 214 does not directly affect the liability of members as it is aimed specifically at directors. In small companies, directors are usually also the members of the company and so their limitation of liability is indirectly affected. Parent companies may also have their limited liability affected if they have acted as a shadow director. (A shadow director being anyone other than a professional advisor from whom the directors of the company are accustomed to take instructions or directions see Chapter 14.)
Activity 4.1
a. Explain the difference between ss.213 and 214 of the Insolvency Act 1986. b. Why was s.213 relatively unsuccessful? c. What is s.214 designed to achieve? No feedback provided.
Summary
The legislature has always been concerned to minimise the extent to which the Salomon principle could be used as an instrument of fraud. As a result it introduced the offence of fraudulent trading now contained in s.213 of the Insolvency Act 1986. The requirement to prove intent to defraud became too difficult in practice because of the possibility of a criminal offence arising and so the lesser offence of wrongful trading was introduced in order to provide a remedy where directors had behaved negligently rather than fraudulently. Thus if a director continued to trade in circumstances where a reasonable director would have stopped, the director concerned will be liable to contribute to the companys debts under s.214.
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The Court of Appeal recognised the mere faade concealing the true facts as being a well-established exception to the Salomon principle. The case of Jones v Lipman (1962) above is the classic example. There Mr Lipmans sole motive in creating the company was to avoid the transaction. In determining whether the company is a mere faade the motives of those behind the alleged faade may be relevant. The Court of Appeal looked at the motives of Cape in structuring its US business through its various subsidiaries. It found that although Capes motive was to try to minimise its presence in the US for tax and other liabilities (and that that might make the company morally culpable) there was nothing legally wrong with this.
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The court then finally considered the agency argument. This was a straightforward application of agency principle. If the subsidiary was Capes agent and acting within its actual or apparent authority, then the actions of the subsidiary would bind the parent. The court found that the subsidiaries were independent businesses free from the dayto-day control of Cape and with no general power to bind the parent. Therefore Cape could not be present in the US through its subsidiary agent. Adams therefore narrows the situations where the veil of incorporation is in effect lifted to three situations.
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Where the court is interpreting a statute or document (thus once fairness is rejected as the basis of intervention only a lack of clarity in the statute or document will allow intervention). Where the company is a mere faade. Where the subsidiary is an agent of the company.
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While there have been some notable departures from the Court of Appeals view in Adams (see Creasey v Breachwood Motors Ltd [1992] BCC 638, overruled by Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447), the Court of Appeals interpretation in Adams of when veil lifting can occur has dominated judicial thinking up until very recently. There are now signs the courts seem to be relaxing the strict approach taken in Adams (see Ratiu v Conway (2006) 1 All ER 571 and Samengo-Turner v J&H Marsh & McLennan (Services) Ltd (2007) 2 All ER (Comm) 813).
Activity 4.2
Read Dignam and Lowry, 3.103.32 then write a short answer considering the following statement. The Court of Appeals decision in Adams takes an overly cautious approach to veil lifting which does little to serve the interests of justice.
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The court then went on to find the director liable as a joint tortfeasor. (See also Koninklijke Philips Electronics NV v Princo Digital Disc GmbH [2004] 2 BCLC 50, where a company director was also held personally liable.)
Activity 4.3
Read Dignam and Lowry, 3.333.51 and consider whether involuntary creditors are adequately protected by the Adams decision.
Summary
It is important that you get a solid understanding of the issues facing the judiciary in this area. In essence the judiciary are being asked to decide who loses out when a business ends. In normal commercial situations this will be as the Companies Act intends therefore the burden falls on the creditors. However if there is a suggestion that the company has been used for fraud or fraud-like behaviour (e.g. Jones v Lipman) the courts may lift the veil. At various times, however, the Salomon principle was only a starting point and the courts would lift the veil in a number of situations if the interests of justice required them to do so. This led to great uncertainty which has been redressed by the restrictive case of Adams.
Ottolenghi, S. From peeping behind the corporate veil to ignoring it completely, [1990] MLR 338. Gallagher, L. and P. Zeigler Lifting the corporate veil in the pursuit of justice, [1990] JBL 292. Lowry, J.P. Lifting the corporate veil, [1993] JBL 41, January, pp.4142. Rixon, F.G. Lifting the veil between holding and subsidiary companies, [1986] 102 LQR 415. Muchlinski, P.T. Holding multinationals to account: recent developments in English litigation and the Company Law Review, [2002] Co Law, p.168. Lowry, J.P. and Edmunds Holding the tension between Salomon and the personal liability of directors, [1998] Can Bar Rev 467.
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profit of approximately 100,000. After that the profits declined for three years and in the last two years the company has made losses of 50,000 and 100,000. John and Amanda have grave concerns about the future of the business but, at a board meeting to discuss ceasing trading, Jim and Tom insist that things will get better. The board resolves to continue trading. Consider the implications for the board members of this decision. Question 2 Dick and his wife Bunny are owed 25,000 by Bio Ltd. Bio Ltd has refused to pay the money owed and Dick and Bunny have initiated a court action to recover the moneys owed to them. Bounce Ltd is the parent company of Bio Ltd and has recently been advised by its accountant that it could reduce its tax liability for the year 2008-2009 by removing all the assets from Bio Ltd and closing it down. Bounce Ltd has decided to follow that advice. Discuss the implications of this decision for Dick and Bunny.
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Ready to move on I can describe the situations where legislation will allow the veil of incorporation to be lifted. I can explain the main categories of veil lifting applied by the courts.
If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 4.1 4.2 4.3 Legislative intervention Judicial veil lifting Veil lifting and tort Revision done
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Notes
Contents
5.1 5.2 5.3 5.4 5.5 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Determining who is a promoter . . . . . . . . . . . . . . . . . . . . . 41 The fiduciary position of promoters . . . . . . . . . . . . . . . . . . . 41 Duties and liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Pre-incorporation contracts . . . . . . . . . . . . . . . . . . . . . . . 43 Freedom of establishment . . . . . . . . . . . . . . . . . . . . . . . . 44 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
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Introduction
In this chapter we consider the issues that arise when people (called promoters) go though the process of incorporating a company and launching its business operations. We examine their duties and the legal consequences that arise from contracts entered into by promoters on behalf of the putative company prior to its registration (termed pre-incorporation contracts).
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain when a person will be treated as a promoter describe the duties and liabilities of promoters describe the issues arising from pre-incorporation contracts assess the impact of s.51 CA 2006 on pre-incorporation contracts and the liability of promoters.
Essential reading
Dignam and Lowry, Chapter 4: Promoters and pre-incorporation contracts. Davies, Chapter 5: Promoters.
Cases
Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 Gluckstein v Barnes [1900] AC 240 Kelner v Baxter (186667) LR 2 CP 174 Phonogram Ltd v Lane [1982] QB 938 Braymist Ltd v Wise Finance Co Ltd [2002] 1 BCLC 415 berseering BV v Nordic Construction Co Baumanagement GmbH (Case 208/00) [2002] ECR I9919, ECJ Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd (Case C-167/01) [2003] ECR I10155, ECJ.
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Registering the company with Companies House. Entering into pre-incorporation contracts. In the case of public companies, issuing a prospectus. Appointing directors and finding shareholders wishing to invest in the new company.
The CA 2006 does not define the term promoter. However, the judges have, on occasions, framed tests for determining whether a persons activities relate to the promotion of a company. The classic statement in this regard was made by Cockburn CJ in Twycross v Grant (187677) LR 2 CPD 469, who said that a promoter is:
one who undertakes to form a company with reference to a given project, and to set it going, and who takes the necessary steps to accomplish that purpose and so long as the work of formation continues, those who carry on that work must, I think, retain the character of promoters. Of course, if a governing body, in the shape of directors, has once been formed, and they take, as I need not say they may, what remains to be done in the way of forming the company, into their own hands, the functions of the promoters are at an end.
The definition is necessarily broad so as to prevent persons taking steps to avoid falling within a more tightly framed proposition in order to avoid the duties borne by promoters. The breadth of the definition is a legacy of a number of nineteenth-century cases involving fraudulent schemes being perpetrated against investors. The judges responded by holding that promoters were fiduciaries by analogy with trustees (see below) and thus subject to a range of duties aimed at ensuring high standards of behaviour.
The term fiduciary is best explained by reference to the particular obligations a fiduciary owes to his or her principal. As we will see in Chapter 15, Directors duties, fiduciary obligations are obligations owed to a principal to act with loyalty and good faith in dealings which affect that person (Penner, 2008). This duty entails more than just acting honestly and fairly. Fiduciaries must act solely in the interests of the principal and must not allow their own self-interests to dictate their behaviour in any way that might conflict with the principals best interests.
For more on the fiduciary relationship, see the LLB subject guide Law of trusts, Chapter 4, The trust relationship.
Activity 5.1
Read Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218. Describe how the House of Lords reached the conclusion that the syndicate, as promoters of the new company, stood in a fiduciary position to it and outline the content of the core fiduciary duty owed by promoters.
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the company affirms the contract (Re Cape Breton Co (1885) 29 Ch D 795) the company delays in exercising its right to rescind the contract.
For rescission to be available it must be possible to restore, at least substantially, the parties to their original position unless, due to the fault of the promoter, this possibility has been lost (Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392). Finally, it should be noted that where the contract has been affirmed, the company can nevertheless sue the promoter to account for the secret profit.
Activity 5.2
Read Gluckstein v Barnes [1900] AC 240. What are the consequences of a promoter making a secret profit from a transaction with the company?
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The meaning of s.51 was considered by the Court of Appeal in Phonogram Ltd v Lane [1982] QB 938. Lord Denning MR took the phrase subject to any agreement to the contrary to mean that for a promoter to avoid personal liability the contract must expressly provide for his exclusion. The Court also held that it is not necessary for the putative company to be in the process of creation at the time the contract was entered into. In Braymist Ltd v Wise Finance Co Ltd [2002] 1 BCLC 415, an issue before the Court of Appeal was whether a person acting as agent of an unformed company could enforce a pre-incorporation contract under s.51. It was held that although the terms of the first Directive referred only to liability and not to enforcement, it did not follow that s.51 was similarly limited in scope so as to prevent enforcement of contracts made by persons on behalf of unformed companies. The words in the section and he is personally liable on the contract accordingly did not operate to negate this view. Rather the phrase merely serves to emphasise the abolition of the common law distinction between agents who incurred personal liability on pre-incorporation contracts and those who did not. The section is thus double-edged so that a party who is personally liable for the contract is also able to enforce it.
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Activity 5.3
Read Phonogram Ltd v Lane [1982] QB 938 and Braymist Ltd v Wise Finance Co Ltd [2002] I BCLC 415. Re-read Dignam and Lowry, 4.134.20. What is the policy underlying s.51 CA 2006?
Summary
The key point to understand is that promoters are fiduciaries. Where promoters fail to disclose a profit to an independent board of directors the company can require them to account for it (i.e. to disgorge the profit). Section 51 of the CA 2006 is designed to protect third parties contracting with promoters by making the promoters personally liable on pre-incorporation contracts.
Dyrberg, P. Full free movement of companies in the European Community at last, [2003] ELR 528. Green, N. Security of transaction after Phonogram, [1984] MLR 671. Griffiths, A. Agents without principals: pre-incorporation contracts and section 36C of the Companies Act 1985, [1993] LS 241. Gross, N. Pre-incorporation contracts, [1971] LQR 367. Lowry, J. Eliminating obstacles to freedom of establishment: the competitive edge of UK company law, [2004] CLJ 331. Penner, J. The Law of Trusts. (Oxford: Oxford University Press, 2008) sixth edition [ISBN 9780199540921] para 2.10. Sealy, L.S. and S. Worthington Cases and materials in company law. (Oxford: Oxford University Press, 2008) eighth edition [ISBN 9780199298426]. pp.8095. Twigg-Flesner, C. Full circle: purported agents right of enforcement under section 36C of the Companies Act 1985, [2001] Co Law 274.
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Jills sale of the kitchen to the company Geralds sale of the vans to the company Harrys transaction with British Telecom.
Both Jill and Gerald are promoters and owe fiduciary duties to the company. They are therefore precluded from making secret profits unless full disclosure of the transaction is made to an independent board which consents to the profits (Erlanger v New Sombrero Phosphate Co). However, the question states that Jill, Harry and Gerald are the sole directors. As such, are they independent? If you conclude they are not, you should discuss Salomon v Salomon. If they are also its sole members then, according to Gluckstein v Barnes, disclosure to them will not suffice either because they are not truly independent. In this situation you should argue whether Gluckstein should be distinguished if the company is private so that the scheme is not designed to defraud the investing public the court may distinguish Gluckstein on its facts. You will need to consider the companys remedies of rescission and accounting of profits (Lagunas Nitrate Co v Lagunas Syndicate). Note the circumstances in which rescission may be lost (Re Cape Breton Co) and that for rescission to be available it must be possible to restore the parties to their original position unless, due to the fault of the promoter, this possibility has been lost: Lagunas Nitrate Co v Lagunas Syndicate. Even if the respective contracts with Jill and Gerald have been affirmed, the company can nevertheless sue them to account for their secret profits. Harry has entered into a pre-incorporation contract. Because the company did not exist at the time of this contract can it be bound by it? You need to discuss Kelner v Baxter. Further, you will need to consider s.51 CA 2006, which makes a promoter personally liable unless there is an agreement with the third party, British Telecom, to the contrary (see Phonogram Ltd v Lane). For Harry to avoid liability the company must enter into a new contract with British Telecom on the same terms as that made by him (novation).
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 5.1 5.2 5.3 5.4 5.5 Determining who is a promoter The fiduciary position of promoters Duties and liabilities Pre-incorporation contracts Freedom of establishment Revision done
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Notes
Contents
6.1 6.2 6.3 6.4 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Private and public companies . . . . . . . . . . . . . . . . . . . . . . 51 Raising money from the public . . . . . . . . . . . . . . . . . . . . . . 52 Insider dealing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Regulating takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
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Introduction
Companies can raise money in a number of ways. For small companies the owners savings or bank loans usually provide the necessary finance. However as companies grow they may also wish to raise capital in the form of equity (shares) from the general public. In this chapter we will examine the legal issues surrounding raising equity from the general public.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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distinguish between raising capital for public and private companies outline the relevant methods of selling shares to the general public describe how the listing regime protects investors explain the sanctions available where insider dealing has occurred.
Essential reading
Dignam and Lowry, Chapter 5: Raising capital: equity and its consequences. Davies, Chapter 25: Public offers of shares and Chapter 30: Insider dealing and manipulation.
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Activity 6.1
Explain the differences between a private and a public company for capital raising purposes. No feedback provided.
Summary
There are several distinctions between public and private companies. Perhaps the key distinction is that private companies cannot raise funds from the general public. As a result public companies are the major vehicles for capital (equity) raising in the UK. If a public company wishes to raise large amounts of equity then it might consider applying to be listed on the LSE.
The company could offer its shares for subscription itself. This is done by issuing a prospectus and advertising in the trade or general press. An offer for sale. This is where the company has an agreement with an issuing house (a merchant bank) whereby it will allot its entire issue of shares to the issuing house. The issuing house will then try to sell the shares to its clients and the general public. The advantage of this type of sale is that the issuing house takes the risk that the shares will not sell. A placing. Here the shares may not be offered to the general public at all, but are placed with the clients of a merchant bank or group of merchant banks. The company could raise money through a rights issue. This is where new shares are offered to the existing shareholders in proportion to their existing shareholding. These pre-emption rights are conferred on shareholders by s.561 CA 2006. Once a company is listed, further capital raising is more straightforward without the complication of the initial listing process.
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Activity 6.2
a. What is a listed company? b. Why are private companies prohibited from becoming listed companies? c. What are the major forms of selling shares to the general public? d. Who has responsibility for regulating the UKs public markets? No feedback provided.
Thus the requirements aim to provide potential investors with such core information about the companys activities as will allow them to make an informed investment decision. If shares by listed companies are offered to the public a prospectus (the document issued to the public inviting them to invest in the shares) submitted to, and approved by, the FSA is required. Since 2005 and the implementation of the Prospectus Directive (Directive 2003/71/EC) in the Prospectus Regulations 2005, a single regime is now in place in Part VI of the FSMA regulating the prospectus requirements of listed and non-listed offerings.
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to investors on a fast, non-discriminatory and pan-European basis. Additionally the Transparency regime provides for criminal and civil penalties for non-compliance.
Activity 6.3
What is the listing regime trying to achieve by emphasising disclosure before and after listing?
Summary
When listing, a company has a number of possible methods of selling its shares: offering its shares itself for subscription, an offer for sale, a placing or a rights issue if already listed. The FSA is the UKs main financial regulator and is the listing authority in the UK. By necessity it works closely with the LSE to ensure that the listing regime, with its emphasis on disclosure, operates effectively.
The insider will also be guilty of an offence if they induce others to deal in pricesensitive securities on a regulated market, whether or not the insider knows the information to be price sensitive (i.e. the information would make the share price go up or down) (s.52(2)(a)). It is also an offence just to disclose price sensitive information to another person in an irregular manner (s.52(2)(a)). If found guilty a fine or imprisonment for up to seven years is possible. However the criminal standard of proof proved very difficult to achieve because of the complexity of many insider dealing situations. As a result a civil offence was introduced.
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(ii) qualifying investments in respect of which a request for admission to trading on such a market has been made, or (iii) in the case of subsection (2) or (3) behaviour, investments which are related investments in relation to such qualifying investments, and (b) falls within any one or more of the types of behaviour set out in subsections (2) to (8).
(2) The first type of behaviour is where an insider deals, or attempts to deal, in a qualifying investment or related investment on the basis of inside information relating to the investment in question. (3) The second is where an insider discloses inside information to another person otherwise than in the proper course of the exercise of his employment, profession or duties. (4) The third is where the behaviour (not falling within subsection (2) or (3))- (a) is based on information which is not generally available to those using the market but which, if available to a regular user of the market, would be, or would be likely to be, regarded by him as relevant when deciding the terms on which transactions in qualifying investments should be effected, and (b) is likely to be regarded by a regular user of the market as a failure on the part of the person concerned to observe the standard of behaviour reasonably expected of a person in his position in relation to the market. (5) The fourth is where the behaviour consists of effecting transactions or orders to trade (otherwise than for legitimate reasons and in conformity with accepted market practices on the relevant market) which- (a) give, or are likely to give, a false or misleading impression as to the supply of, or demand for, or as to the price of, one or more qualifying investments, or (b) secure the price of one or more such investments at an abnormal or artificial level.
(6) The fifth is where the behaviour consists of effecting transactions or orders to trade which employ fictitious devices or any other form of deception or contrivance. (7) The sixth is where the behaviour consists of the dissemination of information by any means which gives, or is likely to give, a false or misleading impression as to a qualifying investment by a person who knew or could reasonably be expected to have known that the information was false or misleading. (8) The seventh is where the behaviour (not falling within subsection (5), (6) or (7))- (a) is likely to give a regular user of the market a false or misleading impression as to the supply of, demand for or price or value of, qualifying investments, or (b) would be, or would be likely to be, regarded by a regular user of the market as behaviour that would distort, or would be likely to distort, the market in such an investment, and the behaviour is likely to be regarded by a regular user of the market as a failure on the part of the person concerned to observe the standard of behaviour reasonably expected of a person in his position in relation to the market.
In order to investigate a suspected market abuse the FSA has sweeping investigative powers under the FSMA. It also has a number of possible sanctions such as public censure, fines, injunctions, restitution orders and powers to vary or cancel an investment authorisation.
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Activity 6.4
Why is insider dealing illegal?
Summary
Insider dealing is where insiders in a company seek to benefit from their access to privileged confidential information by buying and selling shares which would be affected by the privileged information. As a result criminal provisions were introduced in order to deal with this problem. These provisions proved unsuccessful as the standard of proof was too difficult to achieve. Civil sanctions were introduced in the FSMA to provide a lesser offence of market abuse.
Section 219 CA 2006 contains disclosure requirements for directors salaries. The Transparency Directive requires anyone acquiring a 3 per cent holding in a company to disclose their interest to the company and again every time their interest increases or decreases by 1 per cent. Section 979 CA 2006 governs post-takeover compulsory purchase of a dissenting minority.
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Additionally, ss.895901 CA 2006 and s.110 Insolvency Act 1986 allow effective takeovers of companies in crisis and liquidation. The conduct of the takeover itself, which is of greatest concern to shareholders and companies, is left to the selfregulatory system to govern. Since 1968 the conduct of takeovers has been governed by the Panel on Takeovers and Mergers (the Panel). The Panel administers the rules on takeovers called the City Code on Takeovers and Mergers (the Code). The Panel and the Code aim to achieve equality of treatment and opportunity for all shareholders in a takeover bid. The Code, while flexible, emphasises a number of general principles. These are:
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equality of treatment and opportunity for all shareholders in takeover bids adequate information and advice to enable shareholders to assess the merits of the offer no action which might frustrate an offer is taken by a target company during the offer period without shareholders being allowed to vote on it the maintenance of fair and orderly markets in the shares of the companies concerned throughout the period of the offer.
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Until the CA 2006 the Panel was a non-statutory body but its decisions were subject to judicial review because of the public nature of its regulatory role (see R v Panel on Takeovers and Mergers ex p Datafin (1987) QB 815). However, the courts would only hear the review after the takeover was complete, thus eliminating the use of the courts in a tatical sense during the progress of a takeover bid. Prior to 2006 the Panel had no formal power to sanction but was held in great respect by the financial services sector. As a result the Panel had a number of actions it could take. First, the Panel could issue critical statements about the conduct of a bid which would alert shareholders to irregularities. Second, the Panels role was recognised by the FSA, the various selfregulatory bodies licensed by the FSA and the professional bodies. This means that the Panel could pass the matter to these bodies requesting a sanction. For example, a listed company that did not follow the Code could have the LSE remove or suspend its
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the LSE removing or suspending its listing disciplinary proceedings being brought against the companys professional advisers by their professional body.
The FSA might also withdraw its investment authorisation from any person who is the subject of an adverse ruling of the panel.
This is necessary for all those who deal in the securities market.
Marsh, J. Disciplinary proceedings against authorised firms and approved persons under The Financial Services and Markets Act 2000 in de Lacy, J. (ed.) The Reform of United Kingdom Company Law. (London: Cavendish, 2002) [ISBN 9781859476938]. Bagge, J., C. Evans, G. Wade and M. Lewis Market abuse: proposals for the new regime, [2000] X1(9) PLC 35. McVea, H. Whats wrong with insider dealing?, [1995] Legal Studies 390. Campbell, D. Note: what is wrong with insider dealing, [1996] Legal Studies 185. Morse, G.K. The City Code on Takeovers and Mergers self regulation or self protection?, [1991] JBL 509.
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The areas covered in Sections 6.1 and 6.2 above have historically provided the context for your general understanding of company law rather than being an examinable area in itself. As such the essential reading and the activities above should provide that context. Section 6.3 and 6.4 are examinable and so you should attempt the following sample question.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 6.1 6.2 6.3 6.4 Private and public companies Raising money from the public Insider dealing Regulating takeovers Revision done
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Notes
Contents
7.1 7.2 7.3 7.4 7.5 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Company charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Priority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Avoidance of floating charges . . . . . . . . . . . . . . . . . . . . . . 68 Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
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Introduction
We saw in Chapter 6 that a company raises capital by issuing shares. Another way for companies to raise money is by borrowing. In fact the majority of companies in the UK are private, with an issued share capital of 100 or less. For such companies loan capital is therefore a crucial means of financing their business activities and typically they approach high street banks for loans. Since banks are generally risk-averse, particularly since the onset of the global credit crisis, they will require security for their loans. In this chapter we therefore consider corporate borrowing by way of debentures or debenture stock and the types of charge that companies can issue to lenders as security.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain what is meant by the term debenture describe the nature of fixed and floating charges and the distinction between them explain what is meant by book debts and outline the debate surrounding the issue of granting a fixed charge over them outline the priority of charges and the statutory registration scheme describe and assess the proposals for reform.
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Essential reading
Dignam and Lowry, Chapter 6: Raising capital: debentures. Davies, Chapter 31: Debentures; and Chapter 32: Company charges.
Cases
Re Yorkshire Woolcombers Association [1903] 2 Ch 284 Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyds Rep 142 Chalk v Kahn [2000] 2 BCLC 361 Re New Bullas Trading Ltd [1994] 1 BCLC 485 Ashborder BV v Green Gas Power Ltd [2005] BCC 634 Queens Moat Houses plc v Capita IRG Trustees Ltd [2004] EWHC 868 Agnew v Commissioner of Inland Revenue [2001] 2 AC 710, PC National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41.
Additional cases
Arthur D Little Ltd v Ableco Finance LLC [2002] 2 BCLC 799 Smith v Bridgend County Borough Council [2002] 1 BCLC 77.
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7.1 Debentures
Put simply, a debenture is the document that evidences, or acknowledges, the companys debt (Levy v Abercorris Slate and Slab Co (1887) 36 Ch D 215, per Chitty J; see also Knightsbridge Estates Trust v Byrne [1940] AC 613). The definition provided by s.738 CA 2006 is far from helpful: debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. Thus a mortgage of freehold property by a company falls within the statutory definition as it is a security and a charge on its assets. A charge or security interest is a right in rem created by a grant or declaration of trust which, if fixed, implies a restriction on the debtors dominion over the asset(s) in question (Goode (2003)). Debenture stock is money borrowed from a number of different lenders on the same terms. Such lenders form a class who usually have their rights set out in a trust deed. The trustee, often a bank, represents their interests as a whole. The trust deed will generally set out the following terms.
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in rem (Latin) meaning the thing as opposed to the person (in personam)
The obligation to pay the principal sum with interest. The security, if any, that is given for the loan. The events that will trigger the enforcing of the security.
Floating charges
As its name suggests, a floating charge floats over the whole or a part (class) of the chargors assets, which may fluctuate as a result of acquisitions and disposals. Corporate property that can be made subject to a floating charge includes stock in trade, plant (ie machinery), and book debts (receivables). The distinguishing feature of a floating charge is that the company can continue to deal with the assets in the ordinary course of business without having to obtain the chargees permission. In Ashborder BV v Green Gas Power Ltd [2005] BCC 634, Etherton J reviewed the characteristics of the floating charge and examined the notion of the chargor being allowed to deal with the charged assets in the ordinary course of business. The judge noted that whether a transaction was within the ordinary course of business is a mixed
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question of fact and law and the viewpoint of the objective observer on the facts is a useful aid. A floating charge converts to a fixed charge over the assets within its scope upon the occurrence of a crystallising event such as a default on repayment or the winding up of the company.
It is a charge on a class of assets of a company present and future. That class is one which, in the ordinary course of the business of the company, would be changing from time to time. By the charge it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class [charged].
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In determining whether a charge is fixed or floating the courts will look to the substance of the matter irrespective of what description the parties use to categorise it. In this regard Lord Millett explained, in Agnew v Commissioner of Inland Revenue, that:
In deciding whether a charge is a fixed or a floating charge, the Court is engaged in a two-stage process. At the first stage it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object at this stage of the process is not to discover whether the parties intended to create a fixed or a floating charge. It is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the Court can then embark on the second stage of the process, which is one of categorisation. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gathered from the language of the instrument, is to grant the company rights in respect of the charged assets which are inconsistent with the nature of a fixed charge, then the charge cannot be a fixed charge however they may have chosen to describe it.
Lord Millett noted that Romer LJs third distinguishing feature (see above) is the classic hallmark of a floating charge. More recently, in National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41, Lord Phillips MR explained that:
Initially it was not difficult to distinguish between a fixed and a floating charge. A fixed charge arose where the chargor agreed that he would no longer have the right of free disposal of the assets charged, but that they should stand as security for the discharge of obligations owed to the chargee. A floating charge was normally granted by a company which wished to be free to acquire and dispose of assets in the normal course of its business, but nonetheless to make its assets available as security to the chargee in priority to other creditors should it cease to trade. The hallmark of the floating charge was the agreement that the chargor should be free to dispose of his assets in the normal course of business unless and until the chargee intervened. Up to that moment the charge floated.
In Arthur D Little Ltd v Ableco Finance LLC [2002] 2 BCLC 799 the chargor, Arthur D Little Ltd, guaranteed the liabilities of its two parent companies to Ableco by creating a charge, described as a first fixed charge, over its shareholding in a subsidiary company, CCL. The chargor company retained both its voting and dividend rights with respect to the shares until default. The companys administrator argued that it was a floating charge. It was held, applying Lord Milletts reasoning in Agnew, that whether or not the charge was fixed or floating is a question of law and the particular charge in issue was fixed. It did not float over a body of fluctuating assets and, notwithstanding the companys voting and dividend rights, it could not deal with the asset in the ordinary course of business: the company could not dispose of, or otherwise deal with, the shares. The asset was therefore under the control of the chargee.
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Activity 7.1
What are the principal characteristics of a floating charge and how does it differ from a fixed charge?
Summary
Whereas a fixed charge over an asset attaches immediately, a company has the freedom to continue to deal in the ordinary course of business with assets which are subject to a floating charge.
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from charging or assigning debts and the company was required to pay the proceeds of collection into an account held with the bank. The debenture did not specify any restrictions on the companys operation of the account. Spectrums account was always overdrawn and the proceeds from its book debts were paid into the account which Spectrum drew on as and when necessary. When Spectrum went into liquidation the bank sought a declaration that the debenture created a fixed charge over the companys book debts and their proceeds. The Crown, however, argued that the debenture merely created a floating charge so that its claims in respect of tax owed by the company took priority over the bank. The trial judge, applying Brumark and declining to follow Bullas, held that, given the charge permitted Spectrum to use the proceeds of the debts in the normal course of business, it must be construed as a floating charge. In so holding the Vice-Chancellor also declined to follow Siebe Gorman. The bank successfully appealed to the Court of Appeal. Lord Phillips MR, delivering the leading judgment (Jonathan Parker and Jacob LJJ concurring), took the view that where a chargor is prohibited from disposing of its receivables before they are collected and is required to pay the proceeds into an account with the chargee bank, the charge is to be construed as fixed. He explained that it was not, as a matter of precedent, open to the Court of Appeal to hold that Bullas was wrongly decided even though the Privy Council had, in Brumark, expressed the view that the decision was mistaken. Further, Siebe Gorman was correctly decided given that the debenture in that case clearly restricted the companys ability to draw on the bank account into which the proceeds of its book debts were paid. The Court of Appeal noted that the form of debenture used in Siebe Gorman had been followed for some 25 years and thus it was inclined to hold that it had, by customary usage, acquired meaning. Lord Phillips observed that in Siebe Gorman:
Slade J could properly have held the charge on book debts created by the debenture to be a fixed charge simply because of the requirements (i) that the book debts should not be disposed of prior to collection and (ii) that, on collection, the proceeds should be paid to the Bank itself. It follows that he was certainly entitled to hold that the debenture, imposing as he found restrictions on the use of the proceeds of book debts, created a fixed charge over book debts.
A seven-member House of Lords, as expected, overturned the decision of the Court of Appeal and overruled Siebe Gorman and Bullas. Following the line of reasoning adopted by the Privy Council in Brumark, it held that although it is possible to create a fixed charge over book debts and their proceeds (Tailby v Official Receiver (1888)), the charge in the present case was a floating charge. Lord Scott delivered the leading judgment. He stressed that the ability of the chargor to continue to deal with the charged assets characterised it as floating. For a fixed charge to be created over book debts, the proceeds must, therefore, be paid into a blocked account (see Re Keenan [1986] BCLC 242). Lord Scott reasoned that:
The banks debenture placed no restrictions on the use that Spectrum could make of the balance on the account available to be drawn by Spectrum. Slade J in [Siebe Gorman] thought that it might make a difference whether the account were in credit or in debit. I must respectfully disagree. The critical question, in my opinion, is whether the charger can draw on the account. If the chargors bank account were in debit and the charger had no right to draw on it, the account would have become, and would remain until the drawing rights were restored, a blocked account. The situation would be as it was in Re Keeton Bros Ltd [above]. But so long as the charger can draw on the account, and whether the account is in credit or debit, the money paid in is not being appropriated to the repayment of the debt owing to the debenture holder but is being made available for drawings on the account by the charger.
Although the House of Lords has jurisdiction in an exceptional case to hold that its decision should not operate retrospectively or should otherwise be limited, it nevertheless held that in this case there was no good reason for postponing the effect of overruling Siebe Gorman.
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Activity 7.2
Read the Privy Councils opinion delivered in Agnew v Commissioner of Inland Revenue [2001] 2 AC 710. What does Agnew tell us about the classification of securities?
7.3 Priority
The general rule is that security interests are prioritised according to the order of their creation. However, as we saw above, a feature of the floating charge is that the company can continue to deal with the charged assets in the ordinary course of business. Therefore a fixed charge can be created which will take priority over an earlier floating charge. In order to protect their priority, floating chargees can insert a so-called negative pledge clause in the charge that prohibits the chargor from creating a charge that ranks equally with (pari passu) or in priority to the earlier floating charge. Such a restriction is not inconsistent with the nature of a floating charge (Re Brightlife Ltd [1987] Ch 200). However it should be noted that the subsequent chargee will not lose priority unless he has actual notice of the negative pledge clause. Mere notice of the earlier floating charge is not sufficient (Wilson v Kelland [1910] 2 Ch 306). Where there are competing floating charges the governing principle is that the earliest created takes priority. However, the parties may agree that the company may create a subsequent floating charge which will take priority or rank pari passu with the earlier floating charge (Re Benjamin Cope & Sons Ltd [1914] 1 Ch 800).
7.3.1 Registration
Understandably, a creditor who is considering lending money to a company may wish to find out the extent of its indebtedness. Companies are therefore required to register certain details of any charges on their assets. Section 860 of the CA 2006 specifies the categories of charge that must be registered. These include, among others:
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a charge for the purpose of securing any issue of debentures a charge on, or on any interest in, land (but not including a charge for any rent or other periodical sum issuing out of the land) a charge on book debts of the company a floating charge on the companys undertaking or property.
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a liquidator any creditor of the company (see Smith v Bridgend County Borough Council [2002] 1 BCLC 77).
Note that the loan is not void for want of registration of the charge, but rather the failure to register results in the lender ranking as an unsecured creditor. If a charge has not been registered, the company and every defaulting officer is liable to a fine (s.860(4)). Once registered, the charge is valid from the date of its creation. This results in what has been termed the 21-day invisibility problem (see the CLRSGs consultation
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document Registration of Company Charges (October 2000), para 3.79). This is because whenever a person checks the register it cannot be assumed that it is comprehensive because there may be a charge for which the 21-day period is still running. Section 876 also requires companies to maintain at its registered office a register containing certain prescribed particulars of all fixed and floating charges. The failure to keep such a register does not affect the validity of the charge. However, an officer of the company who knowingly authorises or permits the omission of a required entry is liable to a fine. When a charge is registered the Registrar must issue a certificate stating the amount secured by the charge. The certificate is conclusive evidence that the statutory registration requirements have been complied with. The charge cannot then be set aside if the particulars are incorrect. See, for example:
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Re Eric Holmes (Property) Ltd [1965] Ch 1052 Re CL Nye Ltd [1971] Ch 442.
Registration is a perfection requirement. It does not determine priority which, as we saw above, depends upon the date the charge was created. Creditors who ought reasonably to have searched the register will be deemed to have constructive notice of the charge (Siebe Gorman, above). Rectification of the register may be possible where the court is satisfied that the failure to register within the required period or that an omission or misstatement of any particular was accidental or inadvertent, or is not of a nature to prejudice creditors or shareholders of the company, or that on other grounds it is just and equitable to grant relief (s.873). Generally, leave to register out of time is granted by the courts subject to the rights of intervening secured creditors and provided the company is solvent (see, for example, Re IC Johnson & Co Ltd [1902] 2 Ch 101).
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7.5 Reform
7.5.1 The registration process
The CLRSG concluded that registration would no longer be a mere perfection requirement but would become a priority point. Under this proposal, which is based upon Article 9 of the United States Uniform Commercial Code, all that is filed is a notice (financing statement) giving particulars of the property over which the filer has taken, or intends to take, security and certain other details, including the name and address of the creditor from whom a person searching the register can obtain further information (the October 2000 Consultation Document, para 2.6). The 21-day registration rule would be abandoned, as would the requirement that the charge instrument be presented with the application for registration. Detailed rules are set out which would form the basis for a system under which the priority of registered charges would be determined by their dates of registration at Companies House. The period between creation and registration would therefore cease to be relevant as there would be no period of invisibility; and so registration ceases to be a perfection requirement but becomes a priority point (see the Consultation Document, para 2.8, Rule 2). The CLRSG also returned to the issue of the conclusive certificate. The Consultation Document questions whether the Registrar should be placed in the position of verifying the content of information registered. An earlier study of security interests had commented that the burden of compliance with the registration requirements should fall upon the presenters of the documentation because they were better placed to determine whether what they deliver satisfies the legislative requirements and any liability for inaccuracy in the record should lie with them (A Review of Security Interests in Property (HMSO, 1989), the Diamond Report). Accordingly, the Registrars certificate should be conclusive only as far as it is practicable for it to be so. To achieve this objective several options are explored, the most radical of which is to dispense with the requirement that the document creating the charge should be delivered to the Registrar. In its place, the requirement could be that the company only submits particulars of the charge which would include the date of its creation. Companies House would simply verify that the required particulars had been filed on time. The presenters would be fully responsible for the information appearing on the public record.
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On 2 July 2002 the Law Commission published a consultation paper, Registration of Security Interests: Company Charges and Property other than Land (No 164) (LCCP). The LCCP states that a registration scheme should perform two functions, namely to:
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provide information to persons who are contemplating extending secured lending, credit rating agencies and potential investors about the extent to which assets that may appear to be owned by the company are in fact subject to security interests in favour of other parties; and determine the priority of securities (para 12 LCCP).
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The LCCP, endorsing the views of the CLRSG, therefore provisionally proposes the introduction of an electronic notice-filing system based on the US model (see above) to replace the current registration scheme for company charges. Further, the new scheme would extend to a seller who takes purchase-money security over the particular asset purchased with the finance provided. Such a seller would have priority over all other creditors. Failing to register a financing statement will result in loss of priority over a charge that is subsequently registered. It is also proposed that a security that has not been registered will be invalid against a liquidator and an administrator. It is recommended that notice filing should be extended to cover certain quasi-security interests (i.e. transactions that secure payment or performance of an obligation). Hirepurchase agreements, conditional sales and retention of title clauses would thereby become registrable (LCCP paras 12.8012.81). In August 2004 the Law Commission followed up its earlier work with the publication of a consultative report (CR), Company Security Interests. The Commission continue to recommend notice filing on the basis that its proposals provide significant improvements and cost-savings in secured finance for companies. The use of technology can make the registration of company charges much easier, cheaper and quicker (Law Commission, Press Release, 16 August 2004). To replace the paper-based registration scheme which has been in existence for over 100 years, it is stressed that notice filing could be carried out by a secured party online. The CR sets out a range of advantages that notice filing has. These include its speed and efficiency, the fact that advance filing is permissible so that a lenders priority could be protected while negotiations continue (the proposed system is based on the principle that the first to file has priority), and that the floating charge would, in practice, disappear and be superseded by a single type of security interest having all of the advantages of a floating charge but fewer disadvantages to the lender. Notice filing has not, however, escaped criticism. It has been pointed out that the proposed scheme could lead to misleading information being on file. For example, a lender searching the register has no way of determining whether a particular registration relates to an actual transaction or to a proposed transaction that may have been aborted because negotiations broke down. Further, fewer details are available than is the case under transaction filing (Calnan, 2004). The Law Commission counters this argument with the observation that the current system requires only two additional items; the amount secured by the charge and the date it was created... (para 2.47 CR). It says that the statement of the amount secured is of little use since, unless the charge is for a fixed amount, it is most unlikely to be accurate by the time anyone searches the register. With respect to the date of creation, the CR notes that providing such a date is not possible in a system that has the advantage of allowing filing before the charge has been agreed or has attached (para 2.47). In August 2005 the Law Commission published its final report, Company Security Interests. Its principal proposals include the following.
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A new system of electronic notice filing for registering charges. Removal of the 21-day time limit thus removing the invisibility period (see clearer priority rules below). Extending the list of registrable charges so that all charges are registrable unless specifically exempted. The principal exemptions will be for some charges over registered land and over financial collateral.
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Clearer priority rules. Priority between competing charges will be by date of filing unless otherwise agreed between the parties involved (this will also remove the current 21-day period of invisibility). The distinction between fixed and floating charges will be preserved. For floating charges it will no longer be necessary to rely on a negative pledge clause to prevent subsequent charges gaining priority. It will also be unnecessary to rely on automatic crystallisation clauses. If a charge over registered land is registered in the Land Registry, it will not need to be registered in the Company Security Register. Instead, the Land Registry will automatically forward to Companies House its information about companies charges. Sales of receivables will be brought within the scheme (e.g. factoring and discounting agreements, currently a factor, will only obtain priority if it gives notice to each account debtor). The rules on charges over investment securities and other forms of financial collateral are to be clarified. The report also contains draft Company Security Regulations 2006 prepared by the Law Commission for adoption by the DTI (now BIS) under powers contained in the Companies Act 2006.
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Activity 7.3
Explain the so-called 21-day invisibility problem. What proposals for reform have been put forward to address the problem?
Beale, H. Reform of the law of security interests over personal property in Lowry, J. and L. Mistelis (eds) Commercial law: perspectives and practice. (London: LexisNexis Butterworths, 2006) [ISBN 1405710071]. Ferran, E. Principles of Corporate Finance Law (Oxford: Oxford University Press, 2008) [ISBN 9780199230518]. Capper, D. Fixed charges over book debts back to basics but how far back?, [2002] LMCLQ 246. Ferran, E. Floating charges the nature of the security, [1988] CLJ 213. Goode, R.M. Charges over book debts: a missed opportunity, [1994] LQR 592. Goode R.M. Legal problems of credit and security. (London: Sweet and Maxwell, 2003) [ISBN 0421471506]. Chapter 1. Berg, A. Brumark Investments Ltd and the innominate charge,[2001] JBL 532. de Lacy, J. Reflections on the ambit and reform of Part 12 of the Companies Act 1985 and the Doctrine of Constructive Notice in de Lacy, J. (ed.) The Reform of UK Company Law. (London: Cavendish, 2002) [ISBN 1859416934]. Gregory and Walton Book debt charges the saga goes on, [1999] LQR 14. McCormack, G. Extension of time for registration of company charges, [1986] JBL 282. Sealy, L.S. and S. Worthington Cases and materials in company law. (Oxford: Oxford University Press, 2008) eighth edition [ISBN 9780199298426]. Chapter 8. Worthington, S. Fixed charges over book debts and other receivables, [1997] LQR 562. Worthington, S. Floating charges an alternative theory, [1994] CLJ 81. Worthington, S. An unsatisfactory area of the law fixed and floating charges yet again, [2004] International Corporate Rescue 175.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 7.1 7.2 7.3 7.4 7.5 Debentures Company charges Priority Avoidance of floating charges Reform Revision done
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Notes
8 Capital
Contents
8.1 8.2 8.3 8.4 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 Overview the maintenance of capital doctrine . . . . . . . . . . . . . 77 Raising capital: shares may not be issued at a discount . . . . . . . . . . 77 Returning funds to shareholders . . . . . . . . . . . . . . . . . . . . . 78 Prohibition on public companies assisting in the acquisition of their own shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
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Introduction
In this chapter we consider a range of broadly related issues concerning the capital of a company. The underlying theme is the doctrine of maintenance of capital. This is directed towards ensuring that shareholders pay the price for their shares in money or moneys worth and that the companys capital is not illegally returned to them.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain the objectives of the doctrine of maintenance of capital state the rule proscribing shares being issued at a discount describe the rules relating to dividend payments describe the procedure for reducing capital explain the regime governing financial assistance for the purchase of shares.
Essential reading
Dignam and Lowry, Chapter 7: Share capital. Davies, Chapter 11: Legal Capital and Minimum Capital; Chapter 12: Dividends and Distributions and Chapter 13: Capital Maintenance.
Cases
Bairstow v Queens Moat Houses plc [2001] 2 BCLC 531 Re Exchange Banking Co, Flitcrofts Case (1882) 21 ChD 519 Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 Aveling Barford Ltd v Perion Ltd [1989] BCLC 626 Re Chatterley-Whitfield Collieries Ltd [1948] 2 All ER 593 Brady v Brady [1989] AC 755 Chaston v SWP Group plc [2003] 1 BCLC 675 Parlett v Guppys (Bridport) Ltd [1996] 2 BCLC 34 MT Realisations Ltd v Digital Equipment Co Ltd [2003] EWCA Civ 494 Dyment v Boyden [2005] 1 WLR 792; Carney v Herbert [1985] AC 301.
Additional cases
Guinness v Land Corporation of Ireland (1883) 22 ChD 349 Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447.
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fixed nominal value. The requirement for public companies to have a minimum share capital (50,000 or euro equivalent, currently fixed at 65,000) is retained by the 2006 Act (see ss.761 and 763).
Activity 8.1
Read Re Wragg Ltd [1897] 1 Ch 796. What approach did the Court of Appeal take towards the price a company may pay for property?
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Section 643 provides that the solvency statement must state that each of the directors has formed the opinion, taking into account all of the companys liabilities (including any contingent or prospective liabilities), that: a. as regards the companys situation at the date of the statement, there is no ground on which the company could then be found to be unable to pay its debts; and b. if it intended to commence the winding up of the company within 12 months of that date, the company will be able to pay its debts in full within 12 months of the winding up or, in any other case, the company will be able to pay its debts as they fall due during the year immediately following that date. Section 644 lays down the filing requirements in respect of a reduction of capital. Within 15 days after the special resolution is passed, the company must file with the Registrar a copy of the solvency statement together with a statement of capital and a statement of compliance. The special resolution itself must also be filed in accordance with s.30 CA 2006. The resolution does not take effect until these documents are registered (s.644(4)). If the directors make a solvency statement without having reasonable grounds for the opinions expressed in it, and that statement is subsequently delivered to the Registrar, every director who is in default commits an offence (see s.643(4); the penalties, which may include imprisonment, are set out in s.643(5)).
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companys articles. Further, a company may not purchase its own shares if as a result there would no longer be any issued shares other than redeemable shares (s.690(2)). Only fully paid shares can be purchased and they must be paid for on purchase ((s.691); payment by instalments is not, therefore, permissible (see Pena v Dale [2004] EWHC 1065 (Ch)). A company cannot subscribe for its own shares but is restricted to purchasing them from existing members (see Re VGM Holdings Ltd [1942] Ch 235). With respect to financing the purchase, a public company must use distributable profits or the proceeds of a fresh share issue made for the purpose of financing the purchase (s.692(2)). However, a private company may, as under the CA 1985, purchase its own shares out of capital (s.692(1) and s.709). As mentioned above, the main difference introduced by the 2006 Act for a private company is that the power to purchase its own shares need no longer be contained in the articles. The articles may, however, restrict or prohibit the exercise of this statutory power. Where a private company purchases its own shares out of capital, the directors are required to make a statement specifying the amount of the permissible capital payment for the shares in question. Section 714 provides that this statement must also confirm that the directors have made a full enquiry into the affairs and prospects of the company and that they have formed the opinion: a. as regards the companys situation immediately after the date on which the payment out of capital is made, there will be no grounds on which the company could then be found unable to pay its debts; and b. as regards the companys prospects for the year immediately following that date, the company will be able to continue to carry on business as a going concern and be able to pay its debts as they fall due in the year immediately following the date on which the payment out of capital is made. In forming their opinion on the companys solvency and prospects, the directors must take into account all of the companys liabilities (including contingent and prospective liabilities). Directors who make this statement without reasonable grounds for their opinion commit an offence (s.715). As an additional safeguard, s.714(6) provides that the directors statement must have annexed to it a report by the companys auditor confirming its accuracy. Further, the payment out of capital must be approved by a special resolution of the company which must be passed on the date of the directors statement or within the week immediately following (s.716). The holders of the shares in question are barred from voting on the resolution (s.717). Within the week immediately following the date of the s.716 resolution, the company must give public notice in the London Gazette (the official newspaper of record for the UK) and in an appropriate national newspaper of the proposed payment. This must also state that any creditor may apply to court under s.721 within five weeks of the resolution for an order preventing the payment (s.719). Following the purchase, the company must give notice to the Registrar. Such notice must include a statement of capital (s.708). In certain circumstances a company which purchases its own shares need not cancel them but can, instead, hold them in treasury from where they can be either sold or transferred, for example to an employee share scheme. This relaxation, which took effect on 1 December 2003, was introduced by the Companies (Acquisition of Own Shares) (Treasury Shares) Regulations 2003 (SI 2003/1116). The regulations inserted ss.162A 162G into the 1985 Act which are re-enacted in ss.724-732 CA 2006. For qualifying shares, as defined in s.724(2), to become treasury shares they must be purchased by the company out of distributable profits. There are a number of restrictions on the rights attaching to treasury shares. For example, s.726(2) states that the company may not exercise any right in respect of treasury shares. Any purported exercise of such a right is void. Further, no dividend or other distribution may be paid to the company (s.726(3)).
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8.4 Prohibition on public companies assisting in the acquisition of their own shares
8.4.1 Financial assistance
A company might wish to provide financial assistance for the purchase of its own shares by, for example, giving a gift to a third party on the understanding that the money would be used to buy the donor companys shares or, for instance, through guaranteeing a potential purchasers borrowing. This is prohibited by the Companies Act 2006. The policy underlying the prohibition is explained by Arden LJ in Chaston v SWP Group plc [2003] 1 BCLC 675:
[It] is derived from section 45 of the Companies Act 1929 which was enacted as a result of the previously common practice of purchasing the shares of a company having a substantial cash balance or easily realisable assets and so arranging matters that the purchase money was lent by the company to the purchaser The general mischief remains the same, namely that the resources of the target company and its subsidiaries should not be used directly or indirectly to assist the purchaser financially to make the acquisition. This may prejudice the interests of the creditors of the target or its group, and the interests of any shareholders who do not accept the offer to acquire their shares or to whom the offer is not made.
A loan does not deplete a companys net assets because, although funds leave the company, their loss is matched in the companys accounts by the debt to the company that is thereby created. Thus, the prohibition on financial assistance in the Act is wider than that which would be required if the only policy in operation was to maintain the companys share capital. As stressed by Arden LJ (above), it recognises the need to protect shareholders and outsiders from the company misusing its assets to finance the purchase of its own shares, even if the capital maintenance doctrine is not thereby infringed (see also the comments of Peter Smith J in Anglo Petroleum Ltd v TFB (Mortgages) Ltd [2006] EWHC 258 (Ch)).
(Prior to the CA 2006 the prohibition also extended to private companies: see s.151 CA 1985.) It is noteworthy that s.678(1) makes no reference to proof of improper intention. Breach is therefore determined objectively from the surrounding circumstances. Section 678(3) broadens the prohibition so as to cover situations where assistance is provided by a private company in order to discharge a liability incurred by a purchaser for the purpose of acquiring shares, but which, at the time the post-acquisition assistance is given, has re-registered as a public company. Section 678(1) is supplemented by s.679(1), which extends the prohibition to cover financial assistance (directly or indirectly) provided by a public company which is a subsidiary of a private company for the purpose of acquiring shares in that private company before or at the same time as the acquisition takes place. Section 679(3) extends the prohibition to cover after the event financial assistance given by a public company to its private holding company. Section 677 (together with s.683(1) and (2)) seeks to limit the scope of the meaning of financial assistance by listing certain forms or ways in which it can arise. Examples include:
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The giving of a security is illustrated by Heald v OConnor [1971] 1 WLR 497. Mr and Mrs Heald sold all of the shares in D.E. Heald (Stoke on Trent) Ltd to OConnor. The price was 35,000 but they lent him 25,000 in order to enable him to complete the purchase. The company thereby granted the vendors a floating charge over all of its assets by way of security for the loan. Thus, if OConnor defaulted, the security would be enforceable against the company. This was held to be illegal. A residual category falls within s.677(1)(d) which proscribes any other financial assistance given by a company where the net assets of the company are reduced to a material extent by the giving of the assistance, or the company has no net assets. Therefore, even if a public company were in a position to return funds to shareholders because it had distributable profits, it would not be able to provide any sort of financial assistance for the acquisition of its own shares which materially depleted its net assets. In this regard, s.677(2) and (3) state that in determining the companys net assets it is the actual value of the assets and liabilities, as opposed to their book value, that is to be applied (see Parlett v Guppys (Bridport) Ltd (1996); Grant v Lapid Developments Ltd [1996] 2 BCLC 24).
The exceptions
Section 681 contains a wide list of unconditional exceptions. Those in s.681(2) are unexceptional. They mainly relate to procedures which are specifically authorised elsewhere in the Act: for example, to effect a redemption of shares or a reduction of capital. So-called conditional exceptions are listed in s.682. They therefore only apply if the company has net assets and either: a. those assets are not reduced by the giving of the financial assistance, or b. to the extent that those assets are so reduced, the assistance is provided out of distributable profits. An example of a conditional exception is where the provision of financial assistance by the company is for the purposes of an employee share scheme, provided it is made in good faith in the interests of the company or its holding company (s.682(2)(b)), or which assists in the promotion of a policy objective such as facilitating the acquisition of the shares by an employees share scheme or by spouses or civil partners, widows, widowers or surviving civil partners or children of employees (see s 682(2)(c)). Section 678(2) and (3), however, also contain the principal purpose and incidental part of a larger purpose defences which are carried over from the 1985 Act. In essence, financial assistance is not prohibited:
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if the principal purpose of the assistance is not to give it for the purpose of an acquisition of shares, or where this assistance is incidental to some other larger purpose of the company and, in either case, where the financial assistance is given in good faith in the interests of the company.
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The exceptions are designed to ensure that the prohibition in s.678(1) does not also catch genuine commercial transactions which are in the interests of the company. However, attempting to assess a persons purpose is necessarily difficult (for instance, the need to distinguish purpose from effect) because the court will need to determine whether the giving of assistance for the purpose of an acquisition of shares is an incidental part of some larger purpose. Something is a purpose of a transaction between A and B if it is understood by both of them that it will enable B to bring about the desired result. The difficulties of assessing purpose came to the fore in Brady v Brady [1989] AC 755.
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The facts of Dyment v Boyden [2005] 1 WLR 792 (CA) provide an interesting illustration of how an allegation of financial assistance can arise. The Court of Appeal had to consider whether rent which was significantly greater than the market value of the premises in question constituted a breach of s.678 (s.151 of the 1985 Act). Because of local authority rules the transfer of shares had to be undertaken in order that the respondents no longer retained an interest in the company. The Court of Appeal held that the trial judge was right in finding that the companys entry into the lease was in connection with the acquisition by the appellant of the shares but was not for the purpose of that acquisition. His finding that the entry into the lease was for the purpose of acquiring the premises rather than the shares was a finding of fact with which the Court of Appeal should not interfere.
Section 680 CA 2006 makes breach of the prohibition a criminal offence with the company being liable to a fine and every officer of it who is in default liable to imprisonment or a fine or both. The effect of this is to make the transaction unlawful which can affect the enforceability of the underlying agreement. In Carney v Herbert [1985] AC 301, the Privy Council had to decide if the vendors of shares in A Ltd could sue the purchaser (or the guarantor thereof) for the purchase price when a subsidiary of A Ltd had provided illegal financial assistance in relation to the purchasers acquisition (by charging land owned by it as security for the purchasers promise to pay for the shares). If the agreement could not have been severed, the purchaser would have been able to keep the shares without any payment being made for them. Lord Brightman, delivering the decision of the Privy Council, stated:
as a general rule, where parties enter into a lawful contract of, for example, sale and purchase, and there is an ancillary provision which is illegal but exists for the exclusive benefit of the plaintiff, the court may and probably will, if the justice of the case so requires, and there is no public policy objection, permit the plaintiff, if he so wishes, to enforce the contract without the illegal provision.
The Privy Council therefore severed the illegal charges and allowed the vendors to sue for the purchase price.
Activity 8.2
Read Brady v Brady [1989] AC 755, [1988] 2 All ER 617. Write a short essay of not more than 300 words explaining how Lord Oliver defined the concept of larger purpose.
Summary
For financial assistance to be unlawful under s.678 CA 2006 the companys net assets must be reduced to a material extent (Parlett v Guppys (Bridport) Ltd [1996] 2 BCLC 34).
An examination of the policy concerns underlying the capital maintenance doctrine. The prohibition in s.678 CA 2006 against providing financial assistance for the acquisition of shares. You should describe what amounts to financial assistance. Note pre and post acquisition assistance. The policy underlying s.678 (see Chaston v SWP Group plc). The principal purpose exception. Analyse Brady v Brady with particular reference to Lord Olivers speech.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 8.1 8.2 8.3 8.4 Overview the maintenance of capital doctrine Raising capital: shares may not be issued at a discount Returning funds to shareholders Prohibition on public companies assisting in the acquisition of their own shares Revision done
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Notes
Contents
9.1 9.2 9.3 9.4 9.5 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 The operation of the articles of association . . . . . . . . . . . . . . . . 91 The articles of association . . . . . . . . . . . . . . . . . . . . . . . . 91 The contract of membership . . . . . . . . . . . . . . . . . . . . . . . 93 Shareholders agreements . . . . . . . . . . . . . . . . . . . . . . . . 96 Altering the articles . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
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Introduction
In Chapter 2 we briefly touched upon the constitution of the company. In this chapter we continue our examination of the companys constitutional structure with a particular focus on how corporate power is allocated internally between the general meeting and the board of directors (these bodies are often called the organs of the company).
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain the function of the articles of association describe the problems that arise with enforcing the contract of membership explain why shareholder agreements have become increasingly common describe the mechanisms for altering the articles and any restrictions on alteration.
Essential reading
Dignam and Lowry, Chapter 8: The constitution of the company: dealing with insiders. Davies, Chapter 3: Sources of company law and the companys constitution.
Cases
Salmon v Quin & Axtens Ltd [1909] 1 Ch 311 Rayfield v Hands [1960] Ch 1 Foss v Harbottle [1843] 2 Hare 461 Eley v Positive Government Security Life Assurance Co [1876] 1 Ex D 20 Punt v Symons & Co Ltd [1903] 2 Ch 506 Russell v Northern Bank Development Corporation [1992] BCLC 431 Re Duomatic [1969] 2 Ch 365 Allen v Gold Reefs Co Of West Africa [1900] 1 Ch 656 Clements v Clements Bros Ltd [1976] 2 All ER 268.
Additional cases
MacDougall v Gardiner [1875] 1 Ch D 13 Pender v Lushington [1877] 6 Ch D 70 Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915] 1 Ch 881 Puddephatt v Leith [1916] 1 Ch 200 Menier v Hoopers Telegraph Works [1874] LR 9 Ch D 350 Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 Brown v British Abrasive Wheel Co Ltd [1919] 1 Ch 290 Dafen Tinplate Co. Ltd v Llannelly Steel [1920] 2 Ch 124 Globalink Telecommunications Ltd v Wilmbury Ltd [2003] 1 BCLC 145.
Company Law 9 Dealing with insiders: the articles of association and shareholders agreements
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On incorporation the founders of a company can provide their own set of articles. If they do not, a set of model articles (historically called Table A) is provided by the Companies (Model Articles) Regulations 2008. The model articles, with some amendments, are usually adopted. Because of this, the model articles effectively provide the key legislative model for the running of the company. While companies often have very complex organisational structures, the allocation of power in the model articles between the general meeting and the board of directors is at the core of every corporate structure. It is this allocation of power that is the central function of the articles of association. As a result, even though the model articles are only a default set of rules, their almost universal adoption has meant that they form the core organisational structure of the UK registered company:
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the board of directors (the management organ) the general meeting (the members organ).
The model articles also allocate the powers of each organ. The following are the most important provisions in the articles.
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This is now contained in articles 3 and 4 of the model articles (public and private) and states:
Directors general authority 3. Subject to the articles, the directors are responsible for the management of the companys business, for which purpose they may exercise all the powers of the company.
Shareholders reserve power 4. (1) The shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action. (2) No such special resolution invalidates anything which the directors have done before the passing of the resolution.
certain qualifications (i.e. the memorandum) and specifically the objects of the company and any other articles restricting directors powers special resolutions, directions from the shareholders and the Companies Act.
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Although the power to run the company is subject to qualifications, it is important to note that the board is the primary power-wielding organ of the company. In Howard Smith Ltd v Ampol Petroleum Ltd (1974) Lord Wilberforce summed up the position:
[t]he constitution of a limited company normally provides for directors, with powers of management, and shareholders, with defined voting powers having power to appoint the directors, and to take, in general meeting, by majority vote, decisions on matters not reserved for management... it is established that directors, within their management powers, may take decisions against the wishes of the majority of shareholders, and indeed that the majority of shareholders cannot control them in the exercise of these powers while they remain in office.
It is common, for example, to restrict the boards ability to borrow up to a certain amount without shareholder approval
The power delegated to the board derives from the total power the company actually has, thus the power they wield is always limited by the objects clause. It is also worth noting that the discretion is, of course, tempered by the very practical fact that s.168 CA 2006 allows the majority of the members to remove the board. Thus the board cannot stray too far from the shareholders wishes if they are to keep their jobs. The board is also given, by virtue of articles 30 (private) and 70 (public), the power to decide whether to distribute any surplus profits to the shareholders in the form of dividends. Although technically the general meeting declares the dividend it cannot do so unless the board recommends a dividend. This may not seem like a significant power but it is a very important independent management power exercised by the board. The shareholders cannot therefore get any income from their shareholding unless the directors allow it.
Company Law 9 Dealing with insiders: the articles of association and shareholders agreements
s.420 CA 2006) also require that each directors pay package be put to the general meeting for a vote. The general meeting is also empowered by s.21 CA 2006 to alter the articles if three-quarters of the members (by a special resolution,) vote in favour of the resolution. Thus in effect the members can alter the internal rules by which the companys power is allocated.
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Activity 9.1
a. What is the function of the articles of association? (No feedback provided.) b. Get a copy of the model articles and read through it. Try to identify what it is that each article is trying to achieve.
Summary
The articles of association form a core part of company law as they allocate corporate power between the management and the shareholder organs. It is an area where the reform driver of think small first has been particularly successful.
This rather odd statutory contract was introduced in the nineteenth century to automatically bind the shareholders and the company together to observe the constitution of the company (see Hickman v Kent or Romney Marsh Sheep-Breeders Association (1915) 1 Ch 881). It is an odd contract, as it can be varied without the consent of all the parties to it by special resolution. It also binds future members. It does, however, have a key advantage far beyond just the observation of the constitution. When new members join the company by buying shares, the constitution will automatically bind them to observe the pre-existing constitution.
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As such, it removes the possibility of re-negotiating the rules every time a new shareholder arrives. This facilitates the development of the share market as the shares are more transferable where they come with a fixed set of rights. However, as we will discover below, unlike a normal contract the operation of the s.33 contract is surrounded by a great deal of uncertainty.
Voting rights. Share transfer rights. A right to protect class rights. Pre-emption rights. The right to be registered as a shareholder. The right to obtain a share certificate. The right to enforce a dividend that has been declared. The right to enforce the procedure for declaring the dividend. The right to have directors appointed in accordance with the articles. Other procedural rights such as notices of meetings.
Company Law 9 Dealing with insiders: the articles of association and shareholders agreements
While this offers a good overview of the characteristics of personal rights in the articles the case law on the matter is still somewhat confused (see the contrasting views in MacDougall v Gardiner (1875) 1 Ch D 13 and Pender v Lushington (1877) 6 Ch D 70).
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9.3.4 Reform
The CLRSGs Final Report (July 2001 paras 7.347.40) recommended clarifying the s.14 issues by allowing all the articles to be enforceable by the members against the company and each other unless the contrary was provided. The courts would also be able to strike out trivial actions. These same recommendations are present in the Governments Consultative Document March 2005 (para 5.1). However, strangely, the CA 2006 simply reworded the old problematic s.14 of the CA 1985. Thus after nearly a decade of examining the failings in the area the Government seems content to ignore the CLRSG and its own White Papers to leave the issues in this area unresolved.
Activity 9.2
Why is the enforcement of the s.33 contract so complex?
Summary
The s.33 contract fulfils a useful function. It ensures that all the members (even future ones) and the company are bound to observe the constitution. It is an unusual contract in that:
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it binds future parties who cannot renegotiate it it can be continually altered by special resolution.
As a result, not all the parties to the contract have to agree to the alteration yet will be bound by the new terms. However it is the enforcement of the statutory contract that has exercised much judicial and academic thought. Can it be enforced by a member against another member? Can a member enforce it against the company? Are all the articles, even outsider articles, enforceable? Unfortunately the Companies Act 2006 leaves these questions unresolved.
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Company Law 9 Dealing with insiders: the articles of association and shareholders agreements
The exercise of a members votes generally may also be subject to a bona fides qualification. In Clements v Clements Bros Ltd [1976] 2 All ER 268 Foster J declined to recognise the ability of a majority shareholder to authorise an allotment of shares, the motive behind the share allotment being to dilute the voting power of the minority shareholder plaintiff. Foster J considered that the majority shareholder was not entitled to exercise her vote in any way she pleases. He based his decision on what he termed equitable considerations and thus the mala fides (bad faith) element of the allotment precluded it from ratification (see also Menier v Hoopers Telegraph Works (1874) LR 9 Ch D 350 and Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286). However, in general the courts are extremely reluctant to overturn a decision of the general meeting on the grounds of a lack of bona fides, doing so in only a small number of cases (see Brown v British Abrasive Wheel Co Ltd [1919] 1 Ch 290 and Dafen Tinplate Co Ltd v Llannelli Steel [1920] 2 Ch 124).
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Activity 9.3
a. What are the main advantages and disadvantages of a shareholders agreement? b. Are there any restrictions on a shareholders ability to exercise his votes as he wishes?
Summary
As a result of the uncertainty surrounding the s.33 contract, shareholders have formed contractually binding agreements which the courts have been willing to enforce. The only real complication with these agreements is where the company is a party to the agreement and some or all of the agreement is contrary to a statutory provision. In such a case the company cannot contract out of its statutory obligation. Alteration of the companys constitution normally occurs by special resolution. However, sometimes the courts have allowed more informal processes to stand. There may also be restrictions on the ability of shareholders to vote if a statutory obligation is affected or a minority shareholder is disadvantaged.
Wedderburn, K.W. Shareholders rights and the rule in Foss v Harbottle, [1957] CLJ 194. Ferran, E. The decision of the House of Lords in Russell v Northern Bank Development Corporation Limited, [1994] CLJ 343. Prentice, G.N. The enforcement of outsider rights, [1980] 1 Co Law 179. Gregory, R. The section 20 contract, [1981] 44 MLR 526. Drury, R.R. The relative nature of a shareholders right to enforce the company contract, [1986] CLJ 219. Goldberg, G.D. The enforcement of outsider rights under section 20 (1) of the Companies Act 1948, [1972] MLR 362. Goldberg, G.D. The controversy on the section 20 contract revisited, [1985] MLR 158.
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Roy, John, Sarah and the company are also the only parties to a shareholders agreement in which all the parties agree not to increase the share capital of the company without the agreement of all the parties to the shareholders agreement. Roy has recently returned from holiday and found that during his absence there had been a board meeting which approved the purchase of a large tract of land for development purposes worth 100,000. The board also proposes funding the purchase by increasing the share capital of the company. Roy is very unhappy about these developments and wishes to stop them. Advise him about his options.
Company Law 9 Dealing with insiders: the articles of association and shareholders agreements
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 9.1 9.2 9.3 9.4 9.5 The memorandum The articles of association The contract of membership Shareholders agreements Altering the articles Revision done
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Notes
10 Class rights
Contents
10.1 10.2 10.3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shares and class rights . . . . . . . . . . . . . . . . . . . . . . . . . 102 103
Classes of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 Variation of class rights . . . . . . . . . . . . . . . . . . . . . . . . . 105 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
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Introduction
In this chapter we consider the nature of a share and the interest that a shareholder has in the company. We go on to examine how the capital of a company may be divided into various classes carrying with them different rights for their holders. Finally, we consider how the company may vary the rights attaching to a class of shares.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain the legal nature of a share describe the various classes of shares describe how class rights attaching to shares are determined outline the procedure for varying class rights.
Essential reading
Dignam and Lowry, Chapter 9: Classes of shares and variation of class rights. Davies, Chapter 19: Controlling members voting, pp.663-674 and Chapter 23, The nature and classification of shares.
Cases
Borlands Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 Scottish Insurance Corp Ltd v Wilson and Clyde Coal Co Ltd [1949] 1 All ER 1068 Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Herald Newspapers and Printing Co Ltd [1987] Ch 1 White v Bristol Aeroplane Co Ltd [1953] Ch 65 Greenhalgh v Arderne Cinemas Ltd [1946] 1 All ER 512.
Additional cases
Re National Telephone Co [1914] 1 Ch 755 Macaura v Northern Assurance Co Ltd [1925] AC 619.
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We saw in Chapter 3 that shareholders do not have an interest in the property belonging to the company (see Macaura v Northern Assurance Co Ltd [1925] AC 619); rather their relationship is with the company as a separate and distinct entity in its own right. A shareholder thus has rights in the company not against it as in the case of debenture holders (see Chapter 7). In Short v Treasury Commissioners [1948] 1 KB 116 (affirmed by the House of Lords [1948] AC 534) the legal nature of a share was subjected to considerable examination by the court in relation to its valuation. The Government purchased all of the shares in the company, valuing them on the basis of the quoted share price. The shareholders argued that because the whole of the issued shares were being acquired then the entire undertaking should be valued and the price apportioned between them. It was held, however, that where a purchaser is buying control but none of the sellers holds a controlling interest, the higher price that control demands can be ignored. The Treasury was therefore able to purchase the company for a price considerably less than its asset value.
See further, Sealy, L.S. and Worthington, S., Cases and Materials in Company Law. (Oxford: Oxford University Press, 2008) 8th edition [ISBN 9780199298426] pp.42648).
Activity 10.1
Explain the nature of a share.
Summary
An important feature of a share is that it represents the yardstick for measuring the members interest in the company. For example, it determines the voting rights of the holder at general meetings and the right to participate in surplus capital in the event of the company being wound up. Finally, a share is a species of property (a chose in action) that can be purchased, sold, bequeathed and mortgaged.
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Rights or benefits which are annexed to particular shares, such as dividend rights, and rights to participate in surplus assets on a winding up. Where the articles provide that particular shares carry particular rights, these are class rights for the purposes of s.125 CA 1985 (see now s.630 CA 2006). Rights or benefits that, although contained in the articles, are conferred on individuals who are not qua members or shareholders but, for ulterior reasons, are connected with the administration of the companys affairs (see Chapter 9). Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his or her capacity as member or shareholder in the company.
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capacity of members.
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On the facts of the case it was held that provisions in the articles which gave the claimant a pre-emptive right over the transfer of shares in the defendant company, together with the right to nominate a director to its board so long as it held 10 per cent of the ordinary shares, were class rights. Scott J said:
A company which, by its articles, confers special rights on one or more of its members in the capacity of member or shareholder thereby constitutes the shares for the time being held by that member or members a class of shares for the purposes of section 125. The rights are class rights.
In determining the scope of class rights the courts have developed certain rules of construction. For example it is presumed that any rights attaching to a share are exhaustive (i.e. comprehensive) (see Re National Telephone Co [1914] 1 Ch 755). However, preference shares are presumed to be entitled to a cumulative dividend even if the terms of issue are silent on the matter (Webb v Earle (1875) LR 20 Eq 556).
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Activity 10.2
Explain what is meant by class rights.
The company must then notify the registrar of any variation of class rights within one month from the date on which the variation is made (ss.637 and 640). Although the CLRSG had recommended that the consent of 75 per cent of the holders of the class affected should be a statutory minimum, notwithstanding any less onerous procedure contained in the companys articles, this was removed from the Companies
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First, if, and to the extent that, the company has adopted a more onerous regime in its articles for the variation of class rights, for example requiring a higher percentage than the statutory minimum, the company must comply with the more onerous regime. Second, if and to the extent that the company has protected class rights by making provision for the entrenchment of those rights in its articles (see s.22 CA 2006), that protection cannot be circumvented by changing the class rights under s.630.
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It should be noted that the statutory procedure is supplemented by the common law requirement that the shareholders voting at a class meeting must have regard to the interests of the class as a whole (British America Nickel Corpn v MJ OBrien Ltd [1927] AC 369, Viscount Haldane; and Re Holders Investment Trust [1971] 2 All ER 289, Megarry J).
Activity 10.3
Why is it important to identify a class right?
Grantham, R.B. The doctrinal basis of the rights of company shareholders, [1998] CLJ 554. Ireland, P. Company law and the myth of shareholder ownership, [1999] MLR 32. MacNeil, I. Shareholders pre-emptive rights, [2002] JBL 78. Polack, K. Company law class rights, [1986] CLJ 399. Rixon, F. Competing interests and conflicting principles: an examination of the power of alteration of articles of association, [1986] MLR 446. Sealy, L.S. and S. Worthington, Cases and Materials in Company Law. (Oxford: Oxford University Press, 2008) Chapter 9. Worthington, S. Shares and shareholders: property, power and entitlement (Part I), [2001] Co Law 258.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 10.1 10.2 10.3 Shares and class rights Classes of shares Variation of class rights Revision done
11 Majority rule
Contents
11.1 11.2 11.3 11.4 11.5. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
The rule in Foss v Harbottle the proper claimant rule . . . . . . . . . . 111 Forms of action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 Derivative claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 The statutory procedure: Part 11 of the CA 2006 . . . . . . . . . . . . . 116 The proceedings, costs and remedies . . . . . . . . . . . . . . . . . . 118 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 120
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Introduction
As we saw in Chapter 3, a consequence of the Salomon doctrine is that a company can sue in its own right to vindicate a wrong done to it. Thus, whenever a wrong has been committed against the company, the proper claimant is the company itself. However, a company is a metaphysical person and as such it must act through its organ of management (the directors) and the decision to bring legal proceedings is generally vested in the board (see the model articles of association for private and public companies, article 3 (directors general authority) respectively, at http://www.berr.gov.uk/files/file45533.doc). But what if the wrongdoers are the directors themselves who, controlling the company, prevent it from seeking legal redress against them? In this chapter we consider how the law seeks to solve this problem by permitting minority shareholders, in certain exceptional circumstances, to bring a derivative action on the companys behalf. It is worth bearing in mind here when examining this issue that there is a tension between the theory of corporate personality and majority rule. As a result this is a conceptually difficult and technical topic that requires concentrated study. Given its complexity, you will need to read and reflect on these conceptual tensions. Dont be put off if you do not understand the topic immediately take a break and then re-read the material. You will find that patiently working through the chapter perhaps several times will pay dividends.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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describe the rule in Foss v Harbottle (the proper claimant rule) and the policies that underlie it describe and critically assess the exceptions to the rule in Foss v Harbottle describe the various types of shareholder actions outline the difficulties which confront a shareholder who seeks to initiate litigation when a wrong has been done to the company by those in control assess the statutory procedure for bringing a derivative claim.
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Essential reading
Dignam and Lowry, Chapter 10: The principle of majority rule. Davies, Chapter 17: The Derivative claim and personal actions against directors.
Cases
Foss v Harbottle (1843) 2 Hare 461 Edwards v Halliwell [1950] 2 All ER 1064 MacDougall v Gardiner (1875) 1 ChD 13 Estmanco (Kilner House) Ltd v GLC [1982] 1 WLR 2 Wallersteiner v Moir (No 2) [1975] 2 QB 273 Prudential Assurance Co Ltd v Newman Industries Co Ltd (No 2) [1980] 2 All ER 841; [1982] Ch 204 CA Smith v Croft (No 2) [1988] Ch 114 Johnson v Gore Wood & Co [2001] 1 All ER 481 Ellis v Property Leeds (UK) Ltd [2002] 2 BCLC 175 Giles v Rhind [2001] 2 BCLC 582.
Additional cases
Mumbray v Lapper [2005] EWHC 1152 (Ch) Re Downs Wine Bar [1990] BCLC 839 Day v Cook [2002] 1 BCLC 1 Walker v Stones [2001] 2 WLR 623 CA Shaker v Al-Bedrawi [2002] EWCA Civ 1452.
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it prevents a multiplicity of legal proceedings being brought in respect of the same issue if minority shareholders were permitted to initiate such proceedings there could be hundreds of actions it upholds the principle of majority rule: if the majority of shareholders do not wish to pursue an action then the minority is bound by that decision. (For a particularly clear explanation of the tension between the rule in Foss v Harbottle and corporate personality, see Sealy, L.S. and S. Worthington Cases and Materials in Company Law. (2008) pp.50002).
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It should be noted that the model articles of association for private and public companies (see article 3) place the management of companies into the hands of their directors and the decision whether to sue a third party who has committed a wrong against the company or, on the other hand, to defend an action brought against the company falls within the remit of the board. Consequently, even where the directors do not hold a majority of shares (as is common in large private companies and public companies) the shareholders cannot generally direct them to sue or defend an action (Breckland Group Holdings Ltd v London and Suffolk Ltd (1988) 4 BCC 542). In essence, the rule in Foss v Harbottle is a procedural device. As explained by Jenkins LJ in Edwards v Halliwell [1950] 2 All ER 1064, it has two limbs.
i. The proper plaintiff in an action in respect of a wrong done to a company is prima facie the company itself. ii. Where the alleged wrong is a transaction which might be made binding on the company and all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company is in favour of what has been done, then cadit quaestio (in other words, the majority rule).
In Foss v Harbottle (1843) 2 Hare 461 the claimants were two shareholders in the Victoria Park Company. They brought an action against the companys five directors and promoters, alleging that the defendants had misappropriated assets belonging to the company and had improperly mortgaged its property. The claimants sought an order to compel the defendants to make good the losses suffered by the company. They also applied for the appointment of a receiver. It was held that the action must fail. The harm in question was suffered by the whole company, not just by the two shareholders. It was open to the majority in general meeting to approve the defendants conduct. To allow the minority to bring an action in these circumstances would risk frustrating the wishes of the majority. A clear application of the rule that illustrates how it fits with the principle of majority rule is MacDougall v Gardiner (1875) 1 ChD 13. The chairman of the Emma Silver Mining Co had adjourned a general meeting of the company without allowing a vote to be taken on the issue of adjournment as requested by a shareholder, MacDougall. He therefore brought an action claiming first, a declaration that the chairman had acted improperly and second, an injunction to restrain the directors from taking any further action. The Court of Appeal held that the basis of the complaint was something that in substance the majority of the shareholders were entitled to do and there was no point in suing where ultimately a meeting has to be called at which the majority will, in any case, get its way. Against this background Lord Davey in Burland v Earle [1902] AC 83 formulated what has become a classic statement of the rule.
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(See also Mozley v Alston (1847) 1 Ph 790; Gray v Lewis (1873) 8 Ch App 1035; Re Downs Wine Bar [1990] BCLC 839.)
Activity 11.1
Consider the key differences between private companies and public companies. Do you think the relationship between the board of directors and the shareholders may depend upon the size of the company? No feedback provided.
Activity 11.2
Read MacDougall v Gardiner (1875) 1 Ch D 13. Upon what basis did Mellish LJ reach the conclusion that the Rule in Foss v Harbottle operated to defeat the claim? When, in his view, may a minority sue?
Personal actions
Mellish LJ explained in MacDougall v Gardiner, (above) that where the right of a shareholder has been infringed by the majority, he can sue. Here, the injury or wrong in question is not suffered by the company as such, but by the shareholder personally. Therefore, the anxiety underlying Foss v Harbottle does not arise. A shareholders rights can arise by virtue of a contract, for example, under the companys constitution or a shareholders agreement. Thus, where a dividend is declared but not paid, a shareholder can sue for payment by way of a legal debt. See, for example, Wood v Odessa Waterworks Co (1889) 43 Ch D 636 (Ch D)).
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Recently the no reflective loss principle has been subjected to considerable judicial scrutiny. For example, in Ellis v Property Leeds (UK) Ltd [2002] 2 BCLC 175, the Court of Appeal held that the bar on such claims applies equally where the claimant is suing qua director as to when he sues qua shareholder. It will also trigger to prevent a claim brought qua creditor or employee and the fact that a company is in administrative receivership does not prevent it from pursuing any claim for wrongdoing (see Gardner v Parker [2004] EWCA Civ 781, in which the Court of Appeal also stressed that the bar is an obvious consequence of the rule against double recovery). However, the prohibition can be circumvented where the shareholder is able to bring a claim qua beneficiary of a trust of shares of which the wrongdoer is trustee (see Walker v Stones [2001] 2 WLR 623, CA; Shaker v Al-Bedrawi [2002] EWCA Civ 1452). A further example of a successful claim for reflective loss is afforded by Giles v Rhind [2001] 2 BCLC 582. The company was insolvent due to a former directors breach of certain duties (not to compete or misuse confidential information). Both duties were also express terms in a shareholders agreement to which the defendant and claimant were parties. Although the company had initiated an action against its former director, the administrative receivers discontinued it when the defendant director applied for a security of costs order. In effect, the defendant had, by his breach of duty, rendered the company incapable of seeking legal redress against him. The claimant sought to recover losses to the value of his shareholding, loss of remuneration and loss of the value of loan stock. The Court of Appeal, in placing considerable emphasis on the fact that the defendants own wrongdoing had, in effect, disabled the company from suing him for damages, found that this situation had not confronted the House of Lords in Johnson v Gore Wood & Co (above). Given that the duties in question were expressly provided for in the shareholders agreement it was held that the claimant could pursue his claim for breach of the agreement, including his losses in respect of the value of his shareholding. The claims for loss of remuneration and losses of capital and interest in respect of loans made by him to the company did not, in any case, fall within reflective losses. Thus, in Giles v Rhind (No 2) [2003] Ch 118, the court awarded a substantial sum by way of damages.
Activity 11.3
Try to summarise Lord Binghams three propositions in Johnson in simple language. No feedback provided.
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Summary
In Johnson v Gore Wood & Co the House of Lords explained that the reason for disallowing the shareholders claim for reflective loss is that if a member could sue there would be a risk of double recovery. As pointed out by Arden LJ in Day v Cook [2002] 1 BCLC 1, the members claim is trumped by the companys. Thus, for a shareholder to bring a personal claim for a loss it must be shown that there was breach of a duty owed personally to him or her and that a personal loss was suffered which is separate from any loss suffered by the company.
Activity 11.4
Read Giles v Rhind [2003] 1 BCLC 1. What was the issue that came before the Court of Appeal in this case which had not been addressed by the House of Lords in Johnson v Gore Wood & Co?
Where the act complained of is illegal or is wholly ultra vires the company. This has now been put on a statutory footing by s.40 CA 2006. However, note that this right is lost once the contract is concluded (see s.40(4); see further, Chapter 13, below). Where the matter in issue requires the sanction of a special majority, or there has been non-compliance with a special procedure.
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Where a members personal rights have been infringed. Where a fraud has been perpetrated on the minority and the wrongdoers are in control.
Attempts to add a fifth exception where it would be in the interests of justice to relax the rule were roundly rejected by the Court of Appeal in Prudential Assurance v Newman (No 2) [1980] 2 All ER 841. Wedderburn in his frequently cited article, Shareholders rights and the rule in Foss v Harbottle [1957] CLJ 194 and [1958] CLJ 93, has argued that in reality there is only one true exception, namely the fourth exception in Jenkins LJs list. He reasons that the first two are not exceptions because the rule is directed towards preventing a minority from challenging acts that can be legitimised by a simple majority and conduct falling within these first two grounds cannot be sanctioned by an ordinary majority. The third so-called exception covers a wrong by the company and not a wrong to the company. We now turn to the true exception to the rule.
In Daniels v Daniels [1978] Ch 406, Templeman J expressed the view that the term fraud should extend to cases of self-serving negligence. He said that the fraud on the minority principle would be satisfied: where directors use their powers intentionally or unintentionally, fraudulently or negligently in a manner which benefited themselves at the expense of the company. But note that negligence per se is not sufficient. In Pavlides v Jensen [1956] Ch 565 Danckwerts J accepted that the forbearance of shareholders extends to directors who are an amiable set of lunatics. In this case, although the directors were negligent, they did not derive any personal benefit. Contrast the common law position with the reforms introduced by the CA 2006, Part 11 (below).
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[their] votes should be disregarded if, but only if, the court is satisfied either that the vote or its equivalent is actually cast with a view to supporting the defendants rather than securing benefit to the company.
Summary
To fall within the exception to the rule in Foss v Harbottle the minority shareholder must establish fraud on the part of the wrongdoers (a non-ratifiable breach) and wrongdoer control. If a majority of the independent minority shareholders decide not to support the action, the individual shareholder will not be able to initiate proceedings. Davies concludes that this development, together with the antipathy shown towards individual shareholders who initiate actions (see, for example, the Court of Appeals refusal to endorse the public spirit of the plaintiffs in bringing the action in Prudential Assurance v Newman (above)), would seem to suggest that the derivative action is now seen as a weapon of last resort (see Davies, Chapter 17: The enforcement of directors duties, p.463).
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a person acting in accordance with s.172 (duty to promote the success of the company) would not seek to continue the claim; or where the claim arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company; or where the complaint arises from an act or omission that has already occurred, that act or omission was authorised before it occurred, or has been ratified since it occurred.
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These factors represent a total bar to a derivative claim proceeding. The requirement that the court should take into account the importance that a director, acting in accordance with the duty to promote the success of the company, would attach to the claim appears to dispense with the old common law prerequisite of wrongdoer control. The list of factors to be taken into account for determining the refusal of permission is supplemented by s.263(3). This sets out the factors which the court must, in particular, take into account when exercising its discretion to grant permission to continue a derivative claim. These factors are: a. whether the member is acting in good faith b. the importance that a person acting in accordance with s.172 (duty to promote the success of the company) would attach to pursuing the action c. whether prior authorisation or subsequent ratification of the act or omission would be likely to occur d. whether the company has decided not to pursue the claim e. whether the shareholder could pursue the action in his own right. Section 263(4) goes on to add the requirement, as laid down in Smith v Croft (No 2) (above), that the court shall have particular regard to any evidence before it as to the views of members who have no personal interest in the derivative claim. There will need to be a factual enquiry into whether or not the breach is likely to be ratified. In practice the courts will probably adjourn the permission hearing in order for the question of ratification to be put to the company. Provision is also made for a member of the company to apply to the court to continue a derivative claim originally brought by another member but which is being poorly conducted by him or her. Section 264 provides that the court may grant permission to continue the claim where the manner in which the proceedings have been commenced or continued by the original claimant amounts to an abuse of the process of the court, the claimant has failed to prosecute the claim diligently and it is appropriate for the applicant to continue the claim as a derivative claim. Similarly, by virtue of s.262, where a company has initiated proceedings and the cause of action could be pursued as a derivative claim, a member may apply to the court to continue the action as a derivative claim on the same grounds listed in s.264. This addresses the situation where directors, fearing a derivative claim by a member, seek to block it by causing the company to sue but with no genuine intention of pursuing the action diligently. In assessing the statutory reforms it is noteworthy that there is little or no change of emphasis in terms of formulation. The focus of the rule laid down in Foss v Harbottle and its jurisprudence was on prohibiting claims unless one of the exceptions to the rule was satisfied. The statutory language similarly proceeds from the rather negative standpoint that the court must dismiss the application or claim in the circumstances specified in ss.261(2), 262(3), 263(2)(3) and 264(3). The modern case law, though decided prior to the 2006 Act, suggests that the mandatory requirement for permission cannot be dismissed as a mere technicality. It reflects the real and important principles that the Court of Appeal reaffirmed in Barrett v Duckett and underlines the need for the court to retain control over all the stages of a derivative
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action (see Portfolios of Distinction Ltd v Laird). Against the background of the statutory criteria for granting permission to continue the claim, the decision in Jafari-Fini v Skillglass [2005] EWCA 356, is of interest. The Court of Appeal upheld the judges refusal to allow the derivative claim to continue. Chadwick LJ explained that the company itself would not benefit from the action and the claimant shareholder had alternative avenues open to him, specifically a personal claim. A major deterrent against speculative claims is, of course, costs. Although CPR, r.19.9E enables the court to order the company to indemnify the member, in practice such an order will rarely be granted where permission is denied. Finally, it is also noteworthy that the law on ratification has been tightened and the votes of the wrongdoers will no longer be counted on such ordinary resolutions (although such members may be counted towards the quorum and may participate in the proceedings; see further, ss.175 and 239 CA 2006).
In Smith v Croft (No 2) (above), decided under the old RSC (Rules of the Supreme Court), Walton J held that the shareholders personal means to finance the action was a relevant factor to be taken into account by the court in determining the need for an indemnity. The judge also added that even where the shareholder is impecunious, he should still be required to meet a share of the costs as an incentive to proceed with the action with due diligence.
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Summary
If you have understood the rationale underlying the Rule in Foss v Harbottle, together with the fundamental principles of company law that underpin it, you clearly understand the proper claimant rule. If at this stage you still have difficulties understanding this area dont worry it is a notoriously difficult topic. If you are still having difficulties, re-read Dignam and Lowry, Chapter 10 before going on to read the other sources listed in Useful further reading below. Also, as you reflect on the rule, bear in mind that the judges do not see themselves serving as appeal tribunals for the benefit of dissenting minority shareholders (Carlen v Drury (1812) 1 Ves & B 154; see Dignam and Lowry, para 10.3). The statutory procedure at least sets out the steps to be followed in an accessible way. We await the case law it will generate with interest, particularly with respect to how the judges will exercise their discretion in granting (or refusing) permission to continue the claim.
Lord Wedderburn Shareholders rights and the rule in Foss v Harbottle, [1957] CLJ 194 and [1958] CLJ 93. Boyle, A.J. The new derivative action, [1997] 18 Co Law 256. Ferran, E. Litigation by shareholders and reflective loss, [2001] CLJ 245. Law Commission Consultation Paper No 142. Law Commission Report No 246. Drury, R.R. The relative nature of a shareholders right to enforce the company contract, [1986] CLJ 219. Prentice, D.D. Shareholder actions: the rule in Foss v Harbottle, [1988] LQR 341. Sealy, L.S. Problems of standing, pleading and proof in corporate litigation in Pettet, B.G. (ed.) Company law in change. (London: Stevens & Sons, 1987) [ISBN 0420477500]. Sullivan, G.R. Restating the scope of the derivative action, CLJ [1985] 236. CLSRG Developing the Framework, para 4.127; Completing the Structure, paras 5.865.87; Final Report, para 7.46.
outline the new statutory procedure discuss what the rule in Foss v Harbottle is and identify its purpose (Edwards v Halliwell and MacDougall v Gardiner) assess the case law surrounding the exceptions to the rule and consider, against this background, whether the judges, in exercising their discretion under Part 11 CA 2006, are likely to open the floodgates of litigation or whether they are likely to adopt a strict approach towards granting permission to continue the claim.
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You should conclude by considering the vexed question of costs. What incentive is there for bringing an action on behalf of the company?
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 11.1 11.2 11.3 11.4 The rule in Foss v Harbottle the proper claimant rule Forms of action Exceptions to the proper claimant rule The statutory procedure: Part 11 of the CA 2006 Revision done
Contents
12.1 12.2 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
Winding up on the just and equitable ground . . . . . . . . . . . . . 123 Unfair prejudice s.994 CA 2006 . . . . . . . . . . . . . . . . . . . . Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 132
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Introduction
In this chapter we examine the statutory rights of minority shareholders. What rights do they have? How can they enforce them and against whom? What remedies are appropriate and available? You should bear in mind that minority shareholders in an owner-managed private company often depend upon the way the company is run for their living; such shareholders frequently work for the company and participate in its management. As a result the stakes can be extremely high when a minority dispute occurs in such a company.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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describe the range of statutory remedies available to minority shareholders explain the just and equitable winding up remedy state the main grounds for a just and equitable winding up describe the scope of the unfair prejudice remedy describe the remedies available under the unfair prejudice provision.
Essential reading
Dignam and Lowry, Chapter 11: Statutory shareholder remedies. Davies, Chapter 20: Unfair prejudice.
Cases
Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 Virdi v Abbey Leisure Ltd [1990] BCC 60 Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360 Re City Branch Group Ltd [2004] EWCA Civ 815 Re Ghyll Beck Driving Range Ltd [1993] BCLC 1126 Re Elgindata Ltd [1991] BCLC 959 Phoenix Office Supplies Ltd v Larvin [2002] EWCA Civ 1740 Re Macro (Ipswich) Ltd [1994] 2 BCLC 354 Re London School of Electronics Ltd [1986] Ch 211 Re Saul D Harrison & Sons plc [1995] 1 BCLC 14 CA ONeill v Phillips [1999] 1 WLR 1092 Re Sam Weller & Sons Ltd [1989] 5 BCC 810 Anderson v Hogg [2002] BCC 923 Grace v Biagioli [2006] 2 BCLC 70 Richardson v Blackmore [2006] BCC 276 Re OC (Transport) Services Ltd [1984] BCLC 251 Irvine & Ors v Irvine [2006] EWHC 1875 (Ch) Re Bird Precision Bellows Ltd [1984] Ch 419.
Additional cases
Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426 Re a Company (No 00477 of 1986) [1986] BCLC 376 Re Blue Arrow plc [1987] BCLC 585.
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The basis of the business association was a personal relationship and mutual confidence (generally found where a pre-existing partnership has converted into a limited company). An understanding that all or certain shareholders (excluding sleeping partners) will participate in management. There was a restriction on the transfer of members interests preventing the petitioner leaving.
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Lord Wilberforce stressed that the court was entitled to superimpose equitable constraints upon the exercise of rights set out in the articles of association or the Companies Act. He went on to say that the words just and equitable are:
a recognition of the fact that a limited company is more than a mere legal entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure
It should be noted that Lord Cross stressed that petitioners under s.122(1)(g) IA 1986 should come to court with clean hands. If a petitioners own misconduct led to the breakdown in relations relief will be denied.
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The following are illustrations of the grounds which will support a petition under s.122(1)(g). i. The companys substratum has failed The petitioner will need to establish that the commercial object for which the company was formed has failed or has been fulfilled (see Re German Date Coffee Co (1882) 20 Ch D 169; Virdi v Abbey Leisure Ltd [1990] BCLC 342; Re Perfectair Holdings Ltd [1990] BCLC 423). ii. Fraud The remedy will enable shareholders to recover their investment where the company was formed by its promoters in order to perpetrate a fraud against them (see Re Thomas Edward Brinsmead & Sons [1887] 1 Ch 45). iii. Deadlock If the relationship between the parties has broken down with no hope of reconciliation, the court may order a dissolution (see Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426). iv. Justifiable loss of confidence in the companys management Winding up may be ordered where there is a lack of confidence in the competence or probity of its management, provided the company is, in essence, a quasi-partnership (see Loch v John Blackwood Ltd [1924] AC 783). v. Exclusion from participation in a small private company where there was a relationship based on mutual confidence A classic example is the case of Ebrahimi v Westbourne Galleries (above).
Activity 12.1
Read Re a Company (No 004415 of 1996) [1997] 1 BCLC 479. Why did the court strike out the winding up petition?
Activity 12.2
Read Virdi v Abbey Leisure Ltd [1990] BCLC 342. Why was winding up under s.122(1)(g) IA 1986 considered to be an appropriate remedy?
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Although, as will be seen, s.996 provides for a range of remedies, petitioners generally seek an order requiring the respondents, who are usually the majority shareholders, to purchase their shares. The courts have adopted a flexible approach towards what constitutes the companys affairs. Thus, in Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360, the Court of Appeal held that the failure of a parent company (Soundcraft Electronics) to pay debts due to its subsidiary (in which the petitioner was a minority shareholder) constituted acts done in the conduct of the affairs of the company. In Re City Branch Group Ltd [2004] EWCA Civ 815, the Court of Appeal held that an order under s.994 could be made against a holding company where the affairs of a wholly-owned subsidiary have been conducted in an unfairly prejudicial manner and the directors of the holding company are also the directors of the subsidiary. See also, Re Phoneer Ltd [2002] 2 BCLC 241; Gross v Rackind [2004] 4 All ER 735, CA; Re Legal Costs Negotiators Ltd [1999] 2 BCLC 171, CA.
Interests
Although the petitioner must be a shareholder in order to bring the action, the conduct which forms the basis of his complaint need not affect him in his capacity as a member. For example, exclusion from the management of the company, which is conduct affecting the petitioner qua director, will suffice (ONeill v Phillips [1999] 1 WLR 1092). The use of the term interests is expansive in effect, thereby effectively avoiding the straitjacket which terminology based on the notion of rights would impose on the scope of the provision (Re Sam Weller & Sons Ltd [1989] 5 BCC 810; see also Re a Company (No 00477 of 1986) [1986] BCLC 376). In Ebrahimi v Westbourne Galleries, Lord Wilberforce recognised that in most companies, irrespective of size, a members rights under the articles of association and the Companies Act could be viewed as an exhaustive statement of his or her interests as a shareholder. However, as we saw above, he went on to list three situations in which equitable considerations could be superimposed. 1. Where there is a personal relationship between shareholders which involves mutual confidence. 2. Where there is an agreement that some or all should participate in the management. 3. Where there are restrictions on the transfer of shares which would prevent a member from realising his or her investment. This element of Lord Wilberforces speech received extensive consideration by the House of Lords in ONeil v Phillips [1999] 1 WLR 1092, in which it was concluded that for the purposes of s.994 the court can apply equitable restraints to contractual rights.
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Re Ghyll Beck Driving Range Ltd [1993] BCLC 1126 is an excellent example of a s.994 case. A father and son, along with two other people, incorporated a company to operate a golf range. They were each equal shareholders and directors. Within six months of the companys existence the relationship between the parties had become acrimonious due mainly to disagreements over business strategy which left the petitioner feeling isolated. Following a fight between the father and the petitioner the business was managed without consulting him. It was held that the petitioner had been unfairly excluded from the management of the company when from the start it had been anticipated that all four would participate in managing the business. The court therefore ordered the majority to purchase the petitioners shares on the basis that the affairs of the company had been conducted in a manner unfairly prejudicial to his interests. However, it should be noted that s.994 does not mean that the judges administer arbitrary justice without reference to the commercial relationship that exists between the parties. Indeed, Lord Wilberforce had recognised in Ebrahimi that the starting point for the court was always to look to the agreement between the parties, for example, as contained in the articles. In Re a Company (No 004377 of 1986) [1987] BCLC 94, the majority, including the petitioner, voted for a special resolution to amend the companys articles so as to provide that a member, on ceasing to be an employee or director of the company, would be required to transfer his or her shares to the company. To remedy a situation of management deadlock, the petitioner was dismissed as director and was offered 900 per share. When he declined this offer the companys auditors valued his shares in accordance with the pre-emption clauses. He petitioned the court under s.459 (now s.994) to restrain the compulsory acquisition of his shares, arguing that he had a legitimate expectation that he would continue to participate in the management of the company. Hoffmann J held that there could be no expectation on the part of the petitioner that should relations break down the article would not be followed. The judge stressed that s.994 could not be used by the petitioner to relieve him from the bargain he made. Further, in Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, Hoffmann LJ laid down guidelines for determining unfairness. He stressed that fairness for the purposes of s.994 must be viewed in the context of a commercial relationship and that the articles of association are the contractual terms which govern the relationships of the shareholders with the company and each other. The first question to ask, therefore, is whether the conduct of which the shareholder complains was in accordance with the articles of association. See also Re Posgate & Denby (Agencies) Ltd [1987] BCLC 8; Re Blue Arrow plc [1987] BCLC 585; Strahan v Wilcock [2006] EWCA Civ 13.
Summary
The interests of members include rights derived from the companys constitution or statute or a shareholders agreement or some general equitable duty owed by the directors to the company. A member will also have an interest in maintaining the value of his or her shares, as was shown in Re Bovey Hotel Ventures Ltd July 31, 1981 (unreported) cited by Nourse J. in Re R.A. Noble & Sons (Clothing) Ltd [1983] BCLC 273. Further, as seen in Re Ghyll Beck Driving Range Ltd, a members interests may also encompass the expectation that they will continue to participate in management (see also Re a Company (No 003160 of 1986) [1986] BCLC 391; Re a Company (No 004475 of 1982) [1983] Ch 178).
Unfair prejudice
The petitioner must establish that the conduct in question is both prejudicial (in the sense of causing prejudice or harm) to the relevant interests and also unfairly so (Re a Company, ex p Schwarcz (No 2) [1989] BCLC 427, per Peter Gibson J). In Re Ringtower Holdings plc (1988) 5 BCC 82, Peter Gibson J stated that the test is unfair prejudice, not of unlawfulness, and conduct may be lawful but unfairly prejudicial The notion of unfairness was considered by the Jenkins Committee (Cmnd. 1749, 1962) to be a visible
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Examples of unfair prejudice include the following.
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Exclusion from management, which is a typical s.994 complaint (see Re XYZ Ltd (No 004377 of 1986) [1987] 1 WLR 102; Re Ghyll Beck Driving Range Ltd (above); Brownlow v GH Marshall Ltd [2001] BCC 152; Phoenix Office Supplies Ltd v Larvin [2002] EWCA Civ 1740). Mismanagement (breach of the directors duties of care and skill) (see Re Elgindata Ltd [1991] BCLC 959; and Re Macro (Ipswich) Ltd [1994] 2 BCLC 354). Excessive remuneration taken by the directors and the failure to pay dividends (see Re Sam Weller & Sons Ltd [1990] Ch 682; Re a Company (No 004415 of 1996) [1997] 1 BCLC 479; Re Cumana Ltd [1986] BCLC 430; Anderson v Hogg [2002] BCC 923; Grace v Biagioli [2006] 2 BCLC 70). Breach of fiduciary duties the case law shows that s.994 may be used to obtain a personal remedy despite the rule in Foss v Harbottle (see Re London School of Electronics Ltd [1986] Ch 211; Re Little Olympian Each-Ways Ltd (No 3) [1995] 1 BCLC 636). See also, Re Baumler (UK) Ltd [2005] 1 BCLC 92; Re Cumana Ltd [1986] BCLC 430, CA. It should be noted that in Re Baumler (UK) Ltd, George Bompas QC (sitting as a Deputy Judge of the High Court) observed that in the case of a quasi-partnership company, a breach of duty by one participant may lead to such a loss of confidence on the part of the innocent participant and breakdown in relations that the innocent participant is entitled to relief under s.996 of the CA 2006 (see below). The judge noted that, in effect, the unfairness lies in compelling the innocent participant to remain a member of the company.
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Summary
In Re Saul D Harrison and ONeill v Phillips Lord Hoffmann took the opportunity to inject content into the concept of fairness. He reaffirmed the sanctity of the s.33 contract (see Chapter 9 of this guide). The House of Lords stressed that the remedy did not confer on the petitioner a unilateral right to withdraw his capital. In order to succeed under s.994 a petitioner will need to prove either a breach of contract (including the s.33 contract) or breach of a fundamental understanding which, although lacking contractual force, makes it inequitable for the majority to go back on the promise. See also, Re Guidezone Ltd and the comments of Auld and Jonathan Parker LJJ in Phoenix Office Supplies Ltd v Larvin.
Activity 12.3
Read Re Macro (Ipswich) Ltd [1994] 2 BCLC 354. a. What was the principal allegation of the petitioners? b. How did Arden J approach the issue of assessing whether the conduct was unfairly prejudicial? c. What remedy was sought?
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12.2.2 Remedies
Section 996(1) CA 2006 provides that the court:
may make such order as it thinks fit for giving relief in respect of the matters complained of.
authorise civil proceedings to be brought in the name and on behalf of the company by such person or persons and on such terms as the court may direct; require the company not to make any, or specified, alterations in its articles without the leave of the court; provide for the purchase of the shares of any members of the company by other members or by the company itself and, in the case of a purchase by the company itself, the reduction of the companys capital accordingly.
Note the width of the courts powers under s.996(1) (compare the winding up remedy, above). In Re Phoneer Ltd, the petitioner sought a winding up order on the just and equitable ground and the respondent cross-petitioned for winding up under s.994. Roger Kaye QC, granting a winding up order since both parties obviously desired it, noted that section 996 enables, but does not compel, the court to make an order under that section. Although the respondent held 70 per cent of the shares, the judge felt that on the facts of the case justice is served by ordering the winding up of the company on the basis of a 50/50 split. The court can fashion a remedy to the wrong done: see Re A Company ex parte Estate Acquisition & Development Ltd [1991] BCLC 154. Section 996(2) specifies certain remedies available (see above). The most common remedy sought is that under s.996(2)(e) (purchase of shares). Indeed, in Grace v Biagioli [2005] EWCA Civ 1222 , the Court of Appeal affirmed the view that there is a presumption in favour of a buyout order for successful unfair prejudice petitions.
Valuation of shares
Valuing shares in quoted companies is a fairly straightforward exercise because reference can be made to their market price. For unquoted companies and the vast majority of s.994 petitions fall within this category the valuation exercise is a far more difficult undertaking. The court has a wide discretion to do what is fair and equitable in all the circumstances of the case and under the Civil Procedure Rules the court is expected to adopt a vigorous approach towards share valuation (North Holdings Ltd v Southern Tropics Ltd [1999] BCC 746). In Re Bird Precision Bellows Ltd [1984] Ch 419, affirmed by the Court of Appeal [1985] 3 All ER 523, the court reviewed the approach to be adopted towards valuing shares. It was stressed that the overriding objective was to achieve a fair price and that normally no discount would be applied given that the petitioner is an unwilling vendor of what is, in effect, a partnership share (i.e. the shares will be valued on a pro rata basis according to the value of all the issued share capital). If, however, the shareholding is acquired by way of an investment a discount may, in the circumstances, be fair so as to reflect the fact that the petitioner has little control over the companys management (see the speech of Lord Hoffmann in ONeill v Phillips; see also, Profinance Trust SA v Gladstone [2002] 1 BCLC 141, CA). In Irvine & Ors v Irvine [2006] EWHC 1875 (Ch), the High Court decided that, for the purposes of a buyout ordered following a successful petition under s.994 CA 2006, a shareholding of 49.96 per cent was to be valued as any other minority holding. It held
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that no premium should be attached to the shares simply because the buyer was the majority shareholder who would gain control of the whole of the issued share capital. The court also held that, where the parties had agreed a method for valuing the shares that made no distinction between the various assets of the company, the valuation of the cash surplus held by the company was also to be subject to the minority discount and was not to be treated as having been notionally distributed to the shareholders prior to the buyout order. See also Richardson v Blackmore [2006] BCC 276; Re OC (Transport) Services Ltd [1984] BCLC 251.
Lowry, J. Mapping the boundaries of unfair prejudice in J. de Lacey (ed.) The Reform of UK Company Law. (London: Cavendish, 2002). Lowry, J. Reconstructing shareholder remedies: The Law Commissions Consultation Paper No. 142., [1987] Co Law 247. Lowry, J. Stretching the ambit of s.459 of the Companies Act 1985: the elasticity of unfair prejudice, [1995] LMCLQ 337. Prentice, D.D. The theory of the firm: minority shareholder oppression: sections 459461 of the Companies Act 1985, [1988] OJLS 55. Reisberg, A. Indemnity Costs Orders Under s.459 Petitions [2004] Comp Law 116. Reisberg, A. Shareholders Remedies: In Search of Consistency of Principle in English Law [2005] European Business Law Review 1063. Riley, C. Contracting out of company law: s.459 of the Companies Act 1985 and the role of the courts, [1992] MLR 782.
You should read this volume of the Company Lawyer because it is devoted to reviewing the Law Commissions reform proposals.
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the exclusion from management the remedies available under s.996 CA 2006 the enforceability of rights provided by the articles of association.
You must examine the elements of the unfair prejudice remedy. In considering the approach of the court towards s.994 petitions you will need to discuss, in particular, Lord Wilberforces speech in Ebrahimi v Westbourne Galleries Ltd, Lord Hoffmanns speech in ONeil v Phillips and the decision in Re Saul D Harrison. More particularly the focus of the claim will centre on exclusion from management, which is a typical s.994 complaint (Re Ghyll Beck Driving Range Ltd), and mismanagement (breach of the directors duties of care and skill) (Re Elgindata Ltd and Re Macro (Ipswich) Ltd). Finally, your answer should address the range of remedies available under s.996 with emphasis given to buyout orders, together with how the court may value Colins shares (Re Bird Precision Bellows Ltd and ONeill v Phillips).
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 12.1 12.2 Winding up on the just and equitable ground Unfair prejudice ss.994 and 996 CA 2006 Revision done
Contents
13.1 13.2 13.3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
The objects clause problem . . . . . . . . . . . . . . . . . . . . . . . 135 Reforming ultra vires . . . . . . . . . . . . . . . . . . . . . . . . . . 136 Other attribution issues . . . . . . . . . . . . . . . . . . . . . . . . . 139 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 143
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Introduction
As we discussed briefly in Chapter 9, companies were at one time conferred with the power in their constitutional documents to carry out certain specific functions (the objects) by a specific statute or grant from the Crown. The objects clause was a necessary part of the constitutional documents of early charter and statute companies as they were formed to carry out certain functions by a specific charter or statute. However, as the registered company opened up corporate status to ordinary businesses, a particular problem arose. These registered companies were also required to have specific purposes (objects) in their memorandum but were much more likely to change the nature of their business over time. This was both a problem for companies who legitimately wished to change the nature of their business and for outsiders who were dealing with the company and were in danger of having unenforceable contracts because the company was acting outside its powers. Over time the courts became somewhat flexible about the issue but eventually statutory intervention was needed to solve the remaining problems. The chapter also considers how responsibility is attributed to the company for tortious and criminal actions.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain why the objects clause issue has caused such difficulty describe the effect of the legislative reform process on the ultra vires issue discuss the recommendations of the CLRSG and the reforms in the Companies Act 2006 as they impact on ultra vires issues explain why attribution in other areas was and is similarly problematic.
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Essential reading
Dignam and Lowry, Chapter 12: The constitution of the company: dealing with outsiders. Davies, Chapter 7: Corporate actions.
Cases
Ashbury Carriage Company v Riche [1875] LR 7 HL 653 Re Jon Beauforte (London) Ltd [1953] Ch 131 Re Introductions Ltd v National Provincial Bank [1970] Ch 199 Royal British Bank v Turquand [1856] 6 E & B 327 Campbell v Paddington [1911] 1 KB 869 Lennards Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 Tesco Supermarkets Ltd v Nattrass [1971] 2 All ER 127 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500.
Additional cases
Re German Date Coffee Co [1882] 20 Ch D 169 Freeman & Lockyer v Buckhurst Park Properties Ltd [1964] 2 QB 480 McNicholas Construction Co Ltd v Customs and Excise Commissioners (2000) STC 553 P & O European Ferries Ltd [1990] 93 CrApp R 72 (CA) MCI WorldCom International Inc v Primus Telecommunications Inc [2004] 1 BCLC 42 EIC Services Ltd v Phipps [2004] 2 BCLC 589 Morris v Bank of India [2005] 2 BCLC 328.
Company Law 13 Dealing with outsiders: ultra vires and other attribution issues
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Some examples
In Re Jon Beauforte (London) Ltd [1953] Ch 131 the companys objects stated that it was to carry on a business as gown makers but the business had evolved into making veneered panels. No change had been made to the objects clause to reflect this change. A coal merchant had supplied coal to the company which was ordered on company notepaper headed with a reference to the company being a veneered panel maker. The coal merchant was deemed because of constructive notice to know of the original objects clause and because of the headed notepaper to have actual notice of the change in the business. As a result the transaction was ultra vires and void. In Re Introductions Ltd v National Provincial Bank (1970) Ch 199 the case concerned a company incorporated in 1951, around the time of the Festival of Britain, with the specific object of providing foreign visitors with accommodation and entertainment. After the Festival was over the company diversified and eventually devoted itself solely to pig breeding, which the original framers of the objects had not considered (naturally enough). The company had granted National Provincial Bank a debenture (see Chapter 7) to secure a substantial overdraft which had accumulated prior to its eventual insolvent liquidation. The company was held to have acted ultra vires and therefore the transaction was void and the bank could not enforce the debenture or even claim as a normal creditor in the liquidation (see Chapter 17 on the statutory liquidation procedure). As a result of cases like this it was generally agreed that only legislative intervention could solve the problem in the long term.
Activity 13.1
a. Read Re German Date Coffee Co [1882] 20 Ch D 169. Do you consider this a harsh application of the ultra vires doctrine? b. Read Re Jon Beauforte (London) Ltd (1953) Ch 131 and Re Introductions Ltd v National Provincial Bank (1970) Ch 199. Write a 300 word summary of each.
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Summary
The issue of ultra vires stems primarily from a historical hangover from charter or statute companies. At first the courts applied the doctrine strictly to registered companies, despite the harshness of its effect. Over time, however, the courts began to loosen their interpretation of the objects clause where they could. They also began to accept very widely drafted objects clauses. However, as we have seen, problems occasionally still arose which had a drastic effect on the outsiders ability to enforce a contract. Statutory reform was needed.
Under the CA 1985 the memorandum formed part of the companys constitution. Now however, s.8 of the CA 2006 has reduced the memorandum of association to a more limited function. The memorandum is now a simple document providing certain basic information and key declarations to the public which state that subscribers wish to form the company and agree to become members taking at least one share each. The subscribers to the memorandum are those who agree to take some shares or share in the company, thus becoming its first members. If the application to the Registrar is successful the subscribers become the first members of the company and the proposed directors become its first directors. To eliminate any remaining problems with the objects clause the CLRSG, in the Final Report (July 2001 para 9.10) and the Consultative Document (March 2005, Chapter 5), proposed that companies be formed with unlimited capacity. The CA 2006 partly implements the recommended approach. Companies registered under the 2006 Act have unrestricted objects unless a company chooses to have an objects clause stating what it is empowered to do (s.31 CA 2006). If a company does chose to have an objects clause, and for companies formed under the previous Principal Acts in 1948 and 1985 with an objects clause (unless these companies now remove their objects clause (s.31(2) CA 2006)), the objects clause forms part of the articles of association (s.28 CA 2006). As most companies currently in existence were formed under principal Companies Acts that required an objects clause, this change will only really affect companies newly incorporated under the CA 2006. For companies already in existence with an objects clause, that clause still operates to restrict them and will now become part of their articles of association (s.28 CA 2006). In recognition of the fact a large number of companies will still have an objects clause, s.35 CA 1985 has been replaced by an almost exact replica in s.39 CA 2006 which states:
(1) The validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the companys constitution.
Company Law 13 Dealing with outsiders: ultra vires and other attribution issues
As a result of the reform process, what were traditional ultra vires actions became a question of whether the required internal authority to transact was given to those who transacted with the outsider.
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The section had the effect of protecting outsiders who deal either directly with the board or those authorised to bind the company. It is worth noting that the section set the standard of bad faith fairly high as sub-s.2(b) specifically allowed third parties to have knowledge that the transaction was irregular. As a result it implied that active dishonesty might be required in order to qualify as bad faith (see EIC Services Ltd v Phipps [2004] 2 BCLC 589). To further emphasise the lower good faith requirement subs.2(c) set a presumption of good faith. The section also contained a similar provision to s.35 allowing shareholders to prevent an imminent irregular transaction and protected insiders who deal with the company, which the indoor management rule did not. However, s.322A CA 1985 was also introduced as an amendment to the CA 1985 by the CA 1989 and s.35A was subject to it. That section provided that a transaction between the company and a director or a person connected to him (family etc.) which exceeded the powers of the board was voidable at the instance of the company. Section 35B CA 1985 also attempted to deal with the issue of constructive notice. It states:
[a] party to a transaction with the company is not bound to enquire as to whether it is permitted by the companys memorandum or as to any limitation on the powers of the board of directors to bind the company or authorise others to do so.
This was intended to act in tandem with s.711A CA 1985 to abolish the concept of constructive notice for corporations. However, s.711A has never been implemented and so only s.35B deals with constructive notice (s.40 CA 2006 (see below)).
(a)
(b) a person dealing with a company is not bound to enquire as to any limitation on the powers of the directors to bind the company or authorise others to do so, is presumed to have acted in good faith unless the contrary is proved, and is not to be regarded as acting in bad faith by reason only of his knowing that an act is beyond the powers of the directors under the companys constitution.
The references above to limitations on the directors powers under the companys constitution include limitations deriving (a) from a resolution of the company or of any class of shareholders, or from any agreement between the members of the company or of any class of shareholders.
(b) (4)
This section does not affect any right of a member of the company to bring proceedings to restrain the doing of an action that is beyond the powers of the directors. But no such proceedings lie in respect of an act to be done in fulfilment of a legal obligation arising from a previous act of the company.
Company Law 13 Dealing with outsiders: ultra vires and other attribution issues
(5) (6) This section does not affect any liability incurred by the directors, or any other person, by reason of the directors exceeding their powers. This section has effect subject to section 41 (transactions with directors or their associates), and section 42 (companies that are charities).
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Additionally s.322A CA 1985 (connected persons) is also replicated in a new section (s.41 CA 2006).
Activity 13.2
Have the reforms described above solved the ultra vires problem for companies?
Activity 13.3
a. How did the 1989 reforms attempt to deal with the remaining ultra vires problems? b. Describe the different types of authority that can be conferred by a company. c. Explain how the indoor management rule works. d. Describe the latest reforms in this area. No feedback provided.
Summary
The issue of ultra vires in the context of companies, while once a significant danger, has largely been dealt with by statutory reform. Further reform as a result of the work of the CLRSG has followed in due course in the CA 2006. The area remains an important one in the context of company law as it offers a very good illustration of how authority is conferred on the company and legitimately exercised by its agents who deal with the outside world.
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As a result, if one individual can be identified who can be said to be essentially the companys alter ego and that individual has the required fault, then the fault of that individual will be attributed to the company. The attribution of responsibility here is very different than through vicarious liability in tort, where the company is responsible for the actions of another. The individuals fault here is attributed to the company because the law treats the individual and the company as the same person. There is, however, a central problem with the alter ego theory in that it required the identification of a single individual in what was often a complex corporate organisational structure. This was often not possible unless a very small company was at issue. The theory has been particularly problematic in attributing criminal responsibility to companies, especially when attempting to determine the companys mens rea or guilty mind. In Tesco Supermarkets Ltd v Nattrass [1971] 2 All ER 127 Tesco was charged with an offence under the Trade Descriptions Act 1968. They had advertised goods at a reduced price but sold them at a higher price. In order to avoid conviction Tesco had to show that they had put in place a proper control system. Tesco argued that they had and that the manager of the store had been at fault. The court considered whether the manager was acting as an organ of the company. Lord Reid found that:
[a] living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these; it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company.
Respondeat superior (Latin) the superior is responsible. This is the doctrine that an employer is responsible for things done by his or her employees as part of their employment.
In this case the manager who was at fault was not the guiding mind and therefore Tesco could not be liable for his action. Subsequently the application of the organic theory has effectively acted as an immunity from criminal prosecution for large complex corporate organisations where it is impossible to identify a single individual responsible for the companys action.
Company Law 13 Dealing with outsiders: ultra vires and other attribution issues
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Activity 13.4
Read Lord Hoffmanns judgment in Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 and prepare a 300-word summary on his view of the corporate attribution issue.
Summary
Attributing law designed to apply to humans to the corporate form has continued to be a difficult task. Vicarious liability in tort has proved an elegant solution, but where fault or intention is necessary the courts have yet to find a similarly elegant solution. The Meridian case has certainly moved things forward from the difficulties created by the alter ego or organic theory. However, the courts failure to find a way of attributing crimes of violence to the corporate form has instigated a statutory reform process which is still under way.
Ferran, E. The reform of the law on corporate capacity and directors and officers authority, Parts 1 and 2, [1992] Co Law 124 and 177. Hannigan, B. Contracting with individual directors in Rider, B.A.K. (ed.) The Corporate Dimension. (Bristol: Jordan Publishing, 1998) [ISBN 0853084769]. Poole, J. Abolition of the ultra vires doctrine and agency problems, [1991] Co Law 43. Munoz Slaughter, C. Corporate social responsibility: a new perspective, [1977] Co Law 313. Sullivan, B. [2001] Corporate killing some government proposals, Crim L Rev 31.
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Sean is one of the major shareholders in Robin Ltd and although he approved the appointment of Ranjid he is very concerned by the plans of the new managing director. Sean comes to you for advice. Advise him concerning the issues raised in this question. Question 2 The objects clause of Ram Ltd provides that: a. The business of the company shall be the construction of churches and all other forms of religious accommodation. b. The company may make whatever borrowings and charge whatever of its assets as the directors may consider desirable. Although never formally appointed managing director, Brian, to the knowledge and with the full agreement of his co-directors, Bernice and Camilla, carries out the day-to-day management of Ram Ltd. Brian, acting on behalf of Ram Ltd, agreed that the company would manufacture and supply 5,000 deck chairs for the Brighton Local Authority beachfront. To finance this operation he borrowed 50,000 from Y Bank plc to enable Ram to purchase the machinery to carry out this agreement. The loan was evidenced by a debenture which was signed on Rams behalf by Brian and Bernice. Owing to serious mismanagement the company incurred considerable losses and with only 1,000 deck chairs completed was found to be hopelessly insolvent and put into compulsory liquidation. Advise the liquidator.
Company Law 13 Dealing with outsiders: ultra vires and other attribution issues
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 13.1 13.2 13.3 The objects clause problem Reforming ultra vires Other attribution issues Revision done
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Notes
Contents
14.1 14.2 14.3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 Categories of director . . . . . . . . . . . . . . . . . . . . . . . . . . 150 Disqualification of directors . . . . . . . . . . . . . . . . . . . . . . . 151 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
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Introduction
The first part of this chapter considers the relationship between the board of directors and the general meeting. It then goes on to outline the various categories of director, their appointment and removal. It also discusses the Company Directors Disqualification Act 1986 (CDDA 1986) relating to the disqualification of unfit directors.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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define the term director explain the role of the board of directors and its relationship with the general meeting describe the various categories of director explain the process for awarding remuneration describe how the general meeting can remove a director from the board explain how directors can be disqualified from holding office.
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Essential reading
Dignam and Lowry, Chapter 13: Corporate management. Davies, Chapter 10, Disqualification of directors; and Chapter 14: The board.
Cases
Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34 Secretary of State for Trade and Industry v Tjolle [1998] BCC 282 Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch) Re Kaytech International plc [1999] BCC 390 Yukong Line Ltd of Korea v Rendsburg Investments Corpn of Liberia (No 2) [1998] BCC 870 Re Hydrodam (Corby) Ltd [1994] BCC 161 Bushell v Faith [1970] AC 1099 Re Cannonquest, Official Receiver v Hannan [1997] BCC 644 Re Sevenoaks Stationers (Retail) Ltd [1991] Ch 164 Re Polly Peck International plc (No 2) [1994] 1 BCLC 574 Re Grayan Building Services Ltd [1995] Ch 241 Re Lo-Line Electric Motors Ltd [1988] Ch 4.
Additional cases
John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113) Barron v Potter [1914] 1 Ch 895 Unisoft Group Ltd (No 2) [1993] BCLC 532.
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14.1 Directors
14.1.1 Defining the term director
As we saw in Chapter 3, companies are artificial legal entities and as such they must operate through their human organs. The management of the company is vested in the board of directors, who are expected to act on a collective basis, although the articles may and in large companies generally do provide for delegation of powers to smaller committees of the board or to individual directors. It should be borne in mind that in small private companies the same individuals may wear a number of hats: as directors, workers and shareholders. In large companies, however, there is generally a clear division between the board and the shareholders (although it should be borne in mind that even here directors will often receive shares as part of their remuneration package). The Companies Act 2006 does not define the term director beyond stating in s.250 that the term includes any person occupying the position of director, by whatever name called. Thus, whatever title the articles adopt to describe the members of the companys board (for example, governors), the law will nevertheless view them as directors. Section 154 lays down the minimum number of directors that companies must have: two for public companies and one for private companies.
See also Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89; and John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113. As indicated above, article 3 (directors general authority) of the model articles of association for private and public companies, (see http://www.berr.gov.uk/files/ file45533.doc; see also the 1985 Table A, article 70) confers on the board virtual managerial autonomy. Article 3 provides:
Directors general authority Subject to the articles, the directors are responsible for the management of the companys business, for which purpose they may exercise all the powers of the company.
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The power of the general meeting is limited to certain matters such as the right to alter the articles (s.21); share capital (ss.617 and 641); and to delegate authority to allot shares (ss.549 and 551). If shareholders disapprove of a director they can remove him from office by ordinary resolution (s.168 CA 2006, see 14.1.5below). However, executive power will revert to the general meeting where the board of directors is deadlocked so that it is incapable of managing the company (Barron v Potter [1914] 1 Ch 895).
Summary
Directors are not mere delegates or agents of the general meeting but are under a duty to act bona fide in the interests of the company as a whole (see Chapter 15). Article 3 confers extensive managerial powers on directors, who can thus pursue a course of action different from that prescribed by a bare majority of shareholders. However, the general meeting can remove a director by ordinary resolution (s.168 CA 2006).
Activity 14.1
Read Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89. To what extent can a controlling shareholder dictate how directors should act?
Summary
Sections 154-167 CA 2006 govern the appointment and registration of directors. The principal requirements for appointment are:
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every private company is to have at least one director, and every public company to have at least two (s.154) 16 is set as the minimum age (as in Scotland) for a director to be appointed (s.157) the appointment of a director of a public company is to be voted on individually, unless there is unanimous consent to a block resolution (s.160) the acts of a person acting as a director are valid notwithstanding that it is afterwards discovered that there was a defect in his appointment, that he was disqualified from holding office, that he has ceased to hold office, or that he was not entitled to vote on the matter in question (s.161, replacing s.285 of the CA 1985). (See the construction given to the provision in Morris v Kanssen [1946] AC 459, Lord Simonds.)
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Activity 14.2
Read Guinness plc v Saunders [1990] 2 AC 663. a. What were the material terms of the companys articles of association? b. Why did the House of Lords order Mr Ward to repay the company the 5.2m awarded him by way of remuneration?
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While the power contained in s.168 cannot be removed by the articles, it is possible for a director to entrench himself by including in the articles a clause entitling him to weighted voting in the event of a resolution to remove him. In Bushell v Faith [1970] AC 1099 the articles provided that on a resolution to remove a particular director, his shares would carry the right to three votes per share. This meant that he was able to outvote the other shareholders who held 200 votes between them. In other words, the ordinary resolution could be blocked by him. The House of Lords approved the clause. Lord Upjohn reasoned that: Parliament has never sought to fetter the right of the company to issue a share with such rights or restrictions as it may think fit. He went on to state that in framing s.168 (s.303 CA 1985) all that Parliament was seeking to do was to make an ordinary resolution sufficient to remove a director and concluded that: Had Parliament desired to go further and enact that every share entitled to vote should be deprived of its special rights under the articles it should have said so in plain terms by making the vote on a poll one vote one share. Nowadays, however, while weighted voting clauses are commonly encountered in private companies of a quasipartnership nature, they are expressly prohibited by the LSE Listing Rules.
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the de jure and de facto directors of the company must be identifiable the person in question directed those directors on how to act in relation to the companys affairs or that he was one of the persons who did the directors did act in accordance with his instructions they were accustomed so to act.
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Millet J explained that a pattern of behaviour must be shown in which the board did not exercise any discretion or judgment of its own but acted in accordance with the directions of others. However, merely controlling one director is not sufficient; the shadow director must exercise control over the whole board or at least a governing majority of it (Re Lo-line Electric Motors Ltd [1988] Ch 477; Unisoft Group Ltd (No 2) [1993] BCLC 532).
Activity 14.3
Read Secretary of State for Trade and Industry v Deverell [2001] Ch 340. What was the courts approach to the determination of whether or not the respondent was a shadow director?
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Fraud
The court may make a disqualification order against a person if, in the course of the winding up of a company, it appears that he: a. has been guilty of an offence for which he is liable (whether he has been convicted or not) under s.993 CA 2006 (fraudulent trading), or b. has otherwise been guilty, while an officer or liquidator of the company or receiver or manager of its property, of any fraud in relation to the company or of any breach of his duty as such officer, liquidator, receiver or manager (s.4). The maximum period for disqualification is 15 years (s.4(3)). Where a person has been found liable under s.213 or s.214 of the Insolvency Act 1986 (respectively the fraudulent trading and wrongful trading provisions, see Chapter 16 of this guide), the CDDA 1986 gives the court a discretion to disqualify such person for a period of up to 10 years.
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misfeasance or breach of any fiduciary or other duty by the director (para 1) the degree of the directors culpability in concluding a transaction which is liable to be set aside as a fraud on the creditors (paras 2 and 3) the extent of the directors responsibility for any failure by the company to comply with the numerous accounting and publicity requirements of the Companies Act 2006 (paras 4 and 5).
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Those matters to which regard is to be had when the company is insolvent are listed in Part II of Schedule 1 and include:
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the extent of the directors responsibility for the causes of the company becoming insolvent (para 6) the extent of the directors responsibility for any failure by the company to supply any goods or services which have been paid for, in whole or in part (para 7).
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In Re Lo-Line Electric Motors Ltd [1988] Ch 477 Sir Nicholas Browne-Wilkinson V-C said that while ordinary commercial misjudgment is not in itself sufficient to establish unfitness, conduct which displays a lack of commercial probity or conduct which is grossly negligent or displays total incompetence would be sufficient to justify disqualification (see also Re Dawson Print Group Ltd [1987] BCLC 601; Secretary of State for Trade and Industry v Ettinger, Re Swift 736 Ltd [1993] BCLC 896).
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In Secretary of State for Trade and Industry v Swan (No 2) [2005] EWHC 603, Etherton J subjected the responsibilities of a non-executive director, against whom an application for disqualification under s.6 had been brought, to detailed consideration. N, a senior non-executive director and deputy chairman of the board and chairman of the audit and remuneration committees of Finelist plc, together with S, the companys CEO, were disqualified for three and four years respectively. Ns reaction upon being informed by a whistle-blower of financial irregularities (cheque kiting) going on within the group was held to be entirely inappropriate. He failed to investigate the allegations properly. Nor did he bring them to the attention of his fellow non-executive directors or to the auditors. The judge held that Ns conduct fell below the level of competence to be expected of a director in his position and he was, therefore, unfit to be concerned in the management of a company.
Activity 14.4
Read Secretary of State for Trade and Industry v TC Stephenson [2000] 2 BCLC 614. What were the allegations made against the director by the Secretary of State? What was the decision of the court?
Summary
The courts will look for abuses of the privilege of limited liability as evidenced by capricious disregard of creditors interests or culpable commercial behaviour amounting to gross negligence. Non-executive directors who lack corporate financial experience may rely on the advice and assurances provided by the companys accountants although they should be vigilant and raise objections whenever they have concerns about the financial operation of the company.
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Axworthy, C.S. Corporate Directors who needs them?, [1988] 51 MLR 273. Bradley, C. Enterprise and entrepreneurship: the impact of director disqualification, [2001] JCLS 53. Finch, V. Disqualification of directors: a plea for competence, [1990] MLR 385. Hicks, A. Disqualification of directors 40 years on, [1988] JBL 27. Lowry, J. The whistle-blower and the non-executive director [2006] Journal of Corporate Law Studies 249. Milman, D. Personal liability and disqualification of company directors: something old, something new, [1992] NILQ 1. Sullivan, G.R. The relationship between the board of directors and the general meeting in limited companies, [1977] 93 LQR 569.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 14.1 14.2 14.3 Directors Categories of directors Disqualification of director Revision done
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Notes
15 Directors duties
Contents
15.1 15.2 15.3 15.4 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Directors duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 161
The restatement of directors duties: Part 10 of the CA 2006 . . . . . . . 163 Relief from liability . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 Specific statutory duties . . . . . . . . . . . . . . . . . . . . . . . . Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 183
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Introduction
In this chapter we consider the duties of directors and Part 10 of the CA 2006, which sets out the equitable and common law duties of directors by way of statutory restatement. In addition, we will consider certain other statutory duties of directors aimed at addressing specific types of abuses. We will also examine the scope of the courts discretion to relieve directors from liability for breaches of duty. In considering the fiduciary duties of directors you should bear in mind the work you did for the Law of trusts in Part I of the LLB (see in particular Chapter 17 of that subject guide, Breach of fiduciary duty).
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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discuss the fiduciary position of directors discuss the content and scope of the duties of directors restated in Part 10 of the CA 2006 explain the authorisation process describe the principal transactions with directors that require the approval of members explain the courts discretion to relieve directors from liability describe the specific statutory duties of directors.
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Essential reading
Dignam and Lowry, Chapter 14: Directors duties. Davies, Chapter 16: Directors duties and Chapter 17: The derivative claim and personal actions against directors.
Cases
Percival v Wright [1902] 2 Ch 421 Allen v Hyatt (1914) 30 TLR 444 Gething v Kilner [1972] 1 WLR 337 Peskin v Anderson [2001] BCLC 372 Multinational Gas and Petrochemical Co Ltd v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 Re Smith & Fawcett Ltd [1942] Ch 304 Fulham Football Club Ltd v Cabra Estates plc [1994] BCLC 363 Extrasure Travel Insurances Ltd v Scattergood [2002] All ER (D) 307 (Jul) (Ch D) Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 Teck Corporation Ltd v Millar [1972] 33 DLR (3d) 288 Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378, [1967] 2 AC 134n Cook v Deeks [1916] 1 AC 554 Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443 Bhullar v Bhullar [2003] EWCA Civ 424 Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200 Guinness plc v Saunders [1990] 2 AC 663 Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald (No 2) [1995] BCC 1000 Re DJan of London Ltd [1993] BCC 646
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Re Duckwari plc [1997] 2 BCLC 713 Re Duckwari plc (No 2) [1999] Ch 268 Re Duckwari plc (No 3) [1999] 1 BCLC 168.
Additional cases
Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2003] 2 BCLC 153, Ch D Thorby v Goldberg (1964) 112 CLR 597 Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1478 Norman v Theodore Goddard [1991] BCLC 1028 Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549 Tito v Waddell (No 2) [1977] Ch 106.
ensuring the restatement was at a high level of generality by way of a statement of principles; and by providing that it was not exhaustive: ie while it would be a comprehensive and binding statement of the law in the field covered, it would not prevent the courts inventing new general principles outside the field.
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The hallmark of the Law Commissions approach was their regard for the wider economic context in which company law, particularly that regulating directors, operates. It is asserted that in regulating the enterprise, the law should operate efficiently, promoting prosperity (LCCP para 2.8). More particularly, it is recommended that the law should move towards a general principle of meaningful disclosure, and that approval rules should be seen as the exception (Law Com No 261 and 173, para 3.72). The CLRSG proposed that the duties of directors should be restated and to this end the general duties owed by a director of a company to the company are set out in Part 10 CA 2006. We will examine each restated duty in turn. The Final Report of the CLRSG accepted the case for codification for two principal reasons.
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First, directors should know what is expected of them and therefore such a statement will further the CLRs objectives of reforming the law so as to achieve clarity and accessibility. Second, the process of formulating such a statement would enable defects in the present law to be corrected in important areas where it no longer corresponds to accepted norms of modern business practice.
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The CLR thought that this was particularly so with respect to the duties of conflicted directors. Before we begin our examination of directors duties, we first consider the important question of to whom are the duties owed?
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Activity 15.1
Read Coleman v Myers [1977] 2 NZLR 225. What were the special circumstances that led the court to distinguish Percival v Wright and hold that the directors owed fiduciary obligations to the shareholders?
Summary
The general principle at common law, and now carried forward by s.170 CA 2006, is that directors owe their duties to the company and not to the shareholders.
the duty to act within powers (s.171) the duty to promote the success of the company (s.172) the duty to exercise independent judgment (s.173) the duty to exercise reasonable care, skill and diligence (s.174) the duty to avoid conflicts of interest (s.175) the duty not to accept benefits from third parties (s.176) the duty to declare interest in proposed transaction or arrangement (s.177)
The duty to declare interest in an existing transaction or arrangement is laid down by s.182. You should read each of these sections of the Act in full.
This section restates the duty requiring a director to exercise his powers in accordance with the terms upon which they were granted (ie to comply with the companys constitution), and do so for a proper purpose (ie a purpose for which power was conferred).
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For the purpose of paragraph (a), the companys constitution is defined in s.17 CA 2006 as including the companys articles of association, decisions taken in accordance with the articles and other decisions taken by the members, or a class of them, if they can be regarded as decisions of the company. The importance of directors appreciating the purposes of the company as detailed in the constitution is critical if they are to fulfil the duty laid down by s.172 to promote the success of the company (see 15.2.2 below). The articles of association may increase the burden of the duties by, for example, requiring directors to obtain shareholder authorisation for their remuneration packages. However, the articles may not dilute the duties except to the extent expressly provided for in the relevant provisions. In this regard, s.173 (duty to exercise independent judgment (see 15.2.3 below)) provides that a director will not be in breach if he has acted in accordance with the constitution. As we will see, s.175 (duty to avoid conflicts of interest (see 15.2.5 below)) provides that a director will not be in breach where, subject to the constitution, the matter has been authorised by independent directors. Paragraph (b) of s.171 codifies the proper purposes doctrine formulated by Lord Greene MR in Re Smith & Fawcett Ltd [1942] Ch 304, where he stated that directors must not exercise their powers for any collateral purpose. The facts of Extrasure Travel Insurances Ltd v Scattergood [2002] All ER (D) 307 (Jul) (ChD) afford a clear illustration of a power (the power to deal with corporate assets) being exercised for an improper purpose. More generally, however, the issue of whether directors have used a power for a proper purpose arises in relation to their authority to issue shares. If shares are allotted in exchange for cash where the company is in need of additional capital the duty will not be broken. But where directors issue shares in order to dilute the voting rights of an existing majority shareholder because he or she is blocking a resolution supporting, for example, a takeover bid, then the duty will be breached (see Hogg v Cramphorn [1967] Ch 254). In Piercy v S Mills & Co Ltd [1920] 1 Ch 77 the court set aside a share issue on the basis that this was done simply and solely for the purpose of retaining control in the hands of the existing directors. The Privy Council in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 subjected the content of the duty to thorough scrutiny. The directors allotted shares to a company which had made a takeover bid. The effect of the share issue was to reduce the majority holding of two other shareholders, who had made a rival bid, from 55 to 36 per cent. The two shareholders sought a declaration that the share allotment was invalid as being an improper exercise of power. The directors argued, however, that the allotment was made primarily in order to obtain much needed capital for the company. It was held that the directors had improperly exercised their powers:
it must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority, or creating a new majority which did not previously exist. To do so is to interfere with that element of the companys constitution which is separate from and set against their powers.
Lord Wilberforce stressed that the court must examine the substantial purpose for which a power is exercised and must reach a conclusion as to whether that purpose was proper or not (see also Extrasure Travel Insurances Ltd v Scattergood; Criterion Properties plc v Stratford UK Properties LLC [2003] BCC 50). The power to issue shares may be exercised for reasons other than the raising of capital provided those reasons relate to a purpose benefiting the company as a whole; as distinguished from a purpose, for example, of maintaining control of the company in the hands of the directors themselves or their friends (Harlowes Nominees Pty Ltd v Woodside (Lake Entrance) Oil Co (1968) CLR 483). Further, it has been held that it may be in the companys interest for directors to forestall a resolution accepting a takeover offer by issuing shares. In Teck Corporation Ltd v Millar [1972] 33 DLR (3d) 288 the British Columbia Supreme Court held that an allotment of shares designed to defeat a takeover was proper even though it was made against the wishes of the existing shareholder and deprived him of control. Berger J stressed that, provided the
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Activity 15.2
Read Lord Wilberforces opinion delivered in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821. What steps should the court go through when determining whether or not an exercise of power by directors was for an improper purpose?
Summary
The proper purposes doctrine restated in s.171 is an incident of the central fiduciary duty of directors to promote the success of the company (s.172, see 15.2.2 below). The power of directors to issue shares (ss.549-551 CA 2006), may be exercised for reasons other than the raising of capital provided those reasons relate to a purpose benefiting the company as a whole.
This non-interventionist policy (the internal management rule) was explained by Lord Eldon LC in Carlen v Drury (1812) 1 Ves & B 154, who said: This Court is not required on every Occasion to take the Management of every Playhouse and Brewhouse in the Kingdom.
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In Item Software (UK) Ltd v Fassihi [2005] 2 BCLC 91, Arden LJ, having noted that the fundamental duty [of a director] is the duty to act in what he in good faith considers to be the best interests of his company, concluded that this duty of loyalty is the time-honoured rule (citing Goulding J in Mutual Life Insurance Co of New York v Rank Organisation Ltd [1985] BCLC 11). The determination of good faith is partly subjective in that the court will not substitute its own view about a directors conduct in place of the boards own judgment. In Regentcrest plc v Cohen [2001] 2 BCLC 80, Jonathan Parker J observed the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue, therefore, relates to the directors state of mind (see also, Extrasure Travel Insurances Ltd v Scattergood (above)). However, in determining whether the duty has been discharged an objective assessment is also made. In Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62, Pennycuick J stated that the test for determining whether this duty has been discharged must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company. Thus, in Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald (No 2) [1995] BCC 1000, the companys sole director resolved at a board meeting in which he and the company secretary were the only attendees, that his service contract should be terminated and that 100,892 be paid to him as compensation. It was held that he was not acting in what he honestly and genuinely considered to be in the best interests of the company but rather was acting exclusively to further his own personal interests. (See also Knight v Frost [1999] 1 BCLC 364; Ball v Eden Project Ltd [2002] 1 BCLC 313, Laddie J; Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244.)
It is therefore made clear that the review is an integral part of the duty of loyalty. In informing the members about the directors performance of this duty, s.417(4) states that the review must give a balanced and comprehensive analysis. To achieve this, subsection (6) requires the use of key performance indicators (KPIs) relating to financial matters and to environmental and employee matters. Although the particular KPIs used are left to the discretion of the directors, they must be effective in measuring the development, performance or position of the business.
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The recognition of the existence of directors duties to creditors has received the endorsement of the House of Lords. In Winkworth v Edward Baron Development Co Ltd [1986] 1 WLR 1512, Lord Templeman explained that directors owe a fiduciary duty to the company and its creditors, present and future, to ensure that its affairs are properly administered and to keep the companys property inviolate and available for the repayment of its debts (see also, Lonhro Ltd v Shell Petroleum Co Ltd [1980] 1 WLR 627 HL, at 634 per Lord Diplock).
Standing to sue
The question of standing to sue to enforce this duty (locus standi) arose in Yukong Line Ltd of Korea v Rendsburg Investment Corpn of Liberia (No 2) [1998] 2 BCLC 485 in which it was pointed out that creditors have no standing, individually or collectively, to bring an action in respect of any such duty. Toulson J held that a director of an insolvent company who, in breach of duty to the company, transferred assets beyond the reach of its creditors owed no corresponding fiduciary duty to an individual creditor of the company. The appropriate means of redress was for the liquidator to bring an action for misfeasance (s.212 Insolvency Act 1986). Notwithstanding the logistical issue of locus standi raised by Toulson J, the question of directors duties to creditors again emerged in two recent decisions of the Companies Court. In Re Pantone 485 Ltd [2002] 1 BCLC 266, Richard Reid QC, sitting as a deputy judge in the High Court, observed that:
In my view, where the company is insolvent, the human equivalent of the company for the purposes of the directors fiduciary duties is the companys creditors as a whole, i.e. its general creditors. It follows that if the directors act consistently with the interests of the general creditors but inconsistently with the interest of a creditor or section of creditors with special rights in a winding up, they do not act in breach of duty to the company.
Again, in Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2003] 2 BCLC 153, it was held that a resolution of the board of directors passed without proper consideration being given by certain directors to the interests of creditors would be open to challenge if the company had been insolvent at the date of the resolution. Leslie Kosmin QC, sitting as a deputy judge in the High Court, stated that in relation to an insolvent company, the directors, when considering the companys interests, must have regard to the interests of the creditors. The court was required to test the directors conduct by reference to the Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch 62 test (i.e. could an honest and intelligent man, in the position of the directors, in all the circumstances, reasonably have believed that the decision was for the benefit of the company). In the case of insolvent companies the test is to be applied with the benefit of the creditors substituted for the benefit of the company. Section 172(3) also makes express reference to any enactment. In this respect, it should be noted that section 214 of the Insolvency Act 1986 provides that a liquidator of a company in insolvent liquidation can apply to the court to have a person who is or has been a director of the company declared personally liable to make such contribution to the companys assets as the court thinks proper for the benefit of the unsecured creditors. The liquidator must prove that the director in question allowed
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the company to continue to trade, at some time before the commencement of its winding up, when he knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation.
Activity 15.3
Read Extrasure Travel Insurances Ltd v Scattergood [2002] All ER (D) 307 (Jul), Ch D. Where a company is a member of a group, in whose interests should the directors act?
(a) (b)
This provision restates the principle developed in the case law that directors must exercise their powers independently and not subordinate their powers to the control of others by, for example, contracting with a third party as to how a particular discretion conferred by the articles will be exercised. This is a facet of the duty to promote the success of the company laid down in section 172. Directors are not permitted to delegate their powers unless the companys constitution provides otherwise. The duty operates so as to prohibit directors fettering their discretion by contracting with an outsider as to how a particular discretion conferred by the articles will be exercised except, possibly, where this is to the companys commercial benefit. In Fulham Football Club Ltd v Cabra Estates plc [1994] BCLC 363, four directors of Fulham football club agreed with Cabra, the clubs landlords, that they would support Cabras planning application for the future development of the clubs ground rather than the plan put forward by the local authority. In return for this undertaking, Cabra paid the football club a substantial fee. The directors subsequently decided to renege on this promise and wanted to give evidence to a planning enquiry opposing the development. They argued that their agreement with Cabra was an unlawful fetter on their powers to act in the best interests of the company. The Court of Appeal rejected this argument. It was held that:
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the agreement with the landlords was part of a contract that conferred significant benefits on the company the directors, in giving their undertaking to Cabra, had not improperly fettered the future exercise of their discretion.
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In fact, it was not a case of directors fettering their discretion because they had exercised it at the time they gave their undertaking. The Court drew a distinction between:
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directors fettering their discretion, which is a clear breach of duty directors exercising their discretion in a manner which restricts their future conduct; this is not a breach of duty.
Neil LJ endorsed the view of Kitto J in the Australian case Thornby v Goldberg (1964) 112 CLR 597 stating:
There are many kinds of transaction in which the proper time for the exercise of the directors discretion is the time of the negotiation of a contract and not the time at which the contract is to be performed... If at the former time they are bona fide of opinion that it is in the interests of the company that the transaction should be entered into and carried into effect I see no reason in law why they should not bind themselves.
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(a) (b)
In Re DJan of London Ltd [1993] BCC 646, Hoffmann LJ, applying s.214(4) of the Insolvency Act 1986, held the director negligent and prima facie liable to the company for losses caused as a result of its insurers repudiating a fire policy for non-disclosure. The director had signed the inaccurate proposal form without first reading it. The effect of s.174 is that a directors actions will be measured against the conduct expected of a reasonably diligent person. This is therefore an objective test. However, subjective considerations will also apply according to the level of any special skills the particular director may possess. The focus on objective assessment can also be seen in cases brought under the Company Directors Disqualification Act 1986 (see Chapter 14, above), particularly in relation to where directors delegate their powers. Inactivity on the part of directors is no longer acceptable. Therefore little weight is given to any contention to the effect that the director was unaware of a state of affairs because he had trusted others to manage the company (see Re Landhurst Leasing plc [1999] 1 BCLC 286). Thus, a director cannot take a passive role in the management of the company. This is also the case in small private owner-managed companies (termed quasi-partners) where a spouse or son assumes the role of director without ever expecting to play a pro-active part in the affairs of the company. In Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275 the court refused to countenance such symbolic roles:
The office of director has certain minimum responsibilities and functions, which are not simply discharged by leaving all management functions, and consideration of the companys affairs to another director without question, even in the case of a family company One cannot be a sleeping director; the function of directing on its own requires some consideration of the companys affairs to be exercised.
Further, in Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry v Griffiths [1998] 2 BCLC 646, Lord Woolf stated that:
The collegiate or collective responsibility of the board of directors of a company is of fundamental importance to corporate governance under English company law. That collegiate or collective responsibility must however be based on individual responsibility. Each individual director owes duties to the company to inform himself about its affairs and to join with his co-directors in supervising or controlling them.
Activity 15.4
Read Foster Js judgment in Dorchester Finance v Stebbing [1989] BCLC 498. Were the non-executive directors (NEDs) held liable for signing blank cheques and leaving them with Stebbings, the executive director? Was a lower standard of care required of two of the defendants because they were NEDs? Was the fact that they were qualified accountants material?
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This encompasses the significant body of case law spanning over a century or so which the provision codifies. See Re Lands Allotment Co [1894] 1 Ch 616 and JJ Harrison (Properties) Ltd v Harrison [2002] 1 BCLC 162, confirming that a director holds the proceeds made from a breach of fiduciary duty as a constructive trustee. The fundamental objective of the duty to avoid conflicts of interest is aimed at curbing any temptation directors may succumb to when faced with the opportunity of preferring their own interests over and above those of the companys. As explained by Lord Herschell in Bray v Ford [1896] AC 44:
It is an inflexible rule of a court of equity that a person in a fiduciary position is not, unless otherwise expressly provided, allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is a danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect.
A modern formulation of this duty was delivered by Millett LJ in Bristol and West Building Society v Mothew [1998] Ch 1:
The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his beneficiary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict...
The classic decision on this aspect of the fiduciary obligation is Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378, [1967] 2 AC 134n. Regal owned a cinema and its directors wished to acquire two additional local cinemas and sell the whole undertaking as a going concern. They formed a subsidiary company in order to take a lease of the other two cinemas but the landlord was not prepared to grant the subsidiary a lease on these two cinemas unless the subsidiarys paid-up capital was 5,000. The company was unable to inject more than 2,000 in cash for 2,000 shares and so the original arrangement was changed. It was decided that Regal would subscribe for 2,000 shares and the outstanding 3,000 shares would be taken up by the directors and their associates. Later, the whole business was sold by way of takeover and the directors made a profit. The purchasers of Regal installed a new board of directors and the company successfully brought an action against its former directors claiming that they should account for the profit they had made on the sale of their shares in the subsidiary. Lord Russell of Killowen stated that the opportunity and special knowledge to obtain the shares had come to the directors qua fiduciaries and having obtained these shares by reason of the fact that they were directors of Regal, and in the course of the execution of that office, are accountable for the profits which they have made out of them. Lord Russell went on to add that:
the rule of equity which insists on those, who by use of a fiduciary position make a profit, being liable to account for that profit, in no way depends on fraud, or absence of bona fides; or upon such questions or considerations as whether profit would or should otherwise have gone to the plaintiff
The liability arises from the mere fact of a profit having, in the stated circumstances, been made.
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See also Bhullar v Bhullar, Re Bhullar Bros Ltd [2003] EWCA 424; Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1478. On post-resignation breaches (s.175(4)) see Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200. In this regard in Peso Silver Mines v Cropper [1966] 58 DLR (2d) 1, the board of Peso was offered the opportunity to buy a number of mining claims. Some of these were located on land which adjoined the companys own mining territories. The board bona fide declined the offer because:
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of the then financial state of the company there was some doubt over the value of the claims.
Later, the companys geologist formed a syndicate with the defendant and two other Peso directors to purchase and work the claims. When the company was taken over, the new board (as in Regal (Hastings)) brought an action claiming that the defendant held his shares on constructive trust for the company. The claim was unsuccessful. It was held that the decision of the directors to reject the opportunity had been made in good faith and for sound commercial reasons in the interests of the company. See also, Laskin Js approach towards the issue of determining liability in Canadian Aero Service Ltd v OMalley [1973] 40 DLR (3d) 371.
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Recent decisions have made it clear that the general fiduciary obligations of a director do not prevent him from:
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making the decision, while still a director, to set up in a competing business after his directorship has ceased taking preliminary steps to investigate or forward that intention provided he did not engage in any actual competitive activity while his directorship continued.
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Island Export Finance Ltd v Umunna [1986] BCLC 460. Balston Ltd v Headline Filters Ltd [1990] FSR 385. Framlington Group plc v Anderson [1995] 1 BCLC 475. Coleman Taymar Ltd v Oakes [2001] 2 BCLC 749.
A director may utilise confidential information or know-how acquired while working for the company after he departs but not trade secrets (see Dranez Anstalt v Hayek [2002] 1 BCLC 693; CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704). It is worth noting that s.175(4)(a) recognises that unexpected situations can arise where a conflict exists, but that conflict alone does not necessarily constitute a breach by directors. As explained by Lord Goldsmith, (see Official Report, 6/2/2006; coll GC289):
Once you know that you are now in a situation of conflict, you will have to do something about it, but you are not in breach simply because it happened when, as is set out in subsection (4)(a), it could not, reasonably be regarded as likely to give rise to the conflict.
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See also, the joint judgment of Rich, Dixon and Evatt JJ in Furs Ltd v Tomkies (1936) 54 CLR 583. It is noteworthy that the statutory statement of directors duties does not follow the common law position. Self-dealing is removed from the realms of directors fiduciary duties and replaced with a statutory obligation to disclose an interest. Section 175(3) makes it clear that the duty to avoid conflicts of interest contained in s.175(1) does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. Rather, self-dealing falls within s.177(1). This provides that: [i]f a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors. In similar terms s.182 applies to cases where a director has an interest in a transaction after it has been entered into by the company. The provisions do not apply to substantial property transactions, loans, quasi-loans and credit transactions which require the approval of the companys members (ss.190 203, see 15.3 below). Sections 177 and 182 reflect the common practice that companies articles of association generally permitted directors to have interests in conflict transactions provided they were declared to the board. The reason why the common law tolerated such relaxation of the rule was explained by Upjohn LJ in Boulting v Association of Cinematograph Television and Allied Technicians [1963] 2 QB 606:
It is frequently very much better in the interests of the company... that they should be advised by someone on some transaction, although he may be interested on the other side of the fence. Directors... may sometimes be placed in such a position that though their interest and duty conflict, they can properly and honestly give their services to both sides and serve two masters to the great advantage of both. If the person entitled to the benefit of the rule is content with that position and understands what are his rights in the matter, there is no reason why he should not relax the rule, and it may commercially be very much to his advantage to do so.
The principal distinction between the two statutory provisions is that, whereas breach of s.177 carries civil consequences (s.178), breach of s.182 results in criminal sanctions (s.183). More particularly, s.178 states that the consequences of breach (or threatened breach) of ss.171-177 are the same as would apply if the corresponding common law
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rule or equitable principle applied. This is subject to the proviso introduced by s.180(1) that, subject to any provision to the contrary in the companys constitution, if s.177 is complied with, the transaction is not liable to be set aside by virtue of any common law rule or equitable principle requiring the consent of members. The question has arisen as to whether disclosure has to be made at a formal meeting of the board. In Lee Panavision Ltd v Lee Lighting Ltd [1992] BCLC 22 and Runciman v Walter Runciman plc [1992] BCLC 1084 it was held that informal disclosure to all members of the board would suffice. In MacPherson v European Strategic Bureau Ltd [1999] 2 BCLC 203 each of the shareholders and the directors knew the precise nature of others interest so that there was, in effect, unanimous approval of the agreement. The court therefore held that:
[n]o amount of formal disclosure by each other to the other would have increased the others relevant knowledge.
However it should be noted that the board has to be given precise information about the transaction in question (Gwembe Valley Development Co Ltd v Koshy [2000] BCC 1127), affirmed by the Court of Appeal [2003] EWCA Civ 1478.
damages or compensation where the company has suffered loss (see Re Lands Allotment Co [1894] 1 Ch 616, CA; Joint Stock Discount Co v Brown (1869) LR 8 Eq 381) restoration of the companys property (see Re Forest of Dean Coal Co (1879) 10 Ch D 450; JJ Harrison (Properties) Ltd v Harrison [2002] 1 BCLC 162, CA) an account of profits made by the director (see Regal(Hastings) Ltd v Gulliver)
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injunction or declaration (see Cranleigh Precision Engineering Ltd v Bryant [1965] 1 WLR 1293.) rescission of a contract where the director failed to disclose an interest (see Transvaal Lands Co v New Belgium (Transvaal) Land & Development Co [1914] 2 Ch 488, CA).
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Presumably the rules developed for establishing the liability of accessories (for example, in the case of receipt of property pursuant to a breach of fiduciary duty, or dishonest assistance of such a breach) will be applied notwithstanding that the breach may be of a duty which is now statutorily defined and imposed. The liability to account arises even where the director acted honestly and where the company could not otherwise have obtained the benefit (Regal (Hastings) Ltd v Gulliver; IDC v Cooley). In Murad v Al-Saraj [2005] EWCA Civ 959, Arden LJ explained the policy underlying such liability:
It may be asked why equity imposes stringent liability of this nature... equity imposes stringent liability on a fiduciary as a deterrent pour encourager les autres. Trust law recognises what in company law is now sometimes called the agency problem. There is a separation of beneficial ownership and control and the shareholders (who may be numerous and only have small numbers of shares) or beneficial owners cannot easily monitor the actions of those who manage their business or property on a day to day basis. Therefore, in the interests of efficiency and to provide an incentive to fiduciaries to resist the temptation to misconduct themselves, the law imposes exacting standards on fiduciaries and an extensive liability to account.
In Coleman Taymar Ltd v Oakes [2001] 2 BCLC 749, Robert Reid QC, sitting as a Deputy Judge of the High Court, stated that a company is entitled to elect whether to claim
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damages (equitable compensation) or an account of profits against a director who, in breach of duty, makes a secret profit.
However, even though the profit may arise out of the use of position as opposed to the use of trust property, the judges more typically resort to the language of the constructive trust as the means for fashioning a remedy (see Boardman v Phipps [1967] 2 AC 46, although, Lord Guest excepted, all of their Lordships spoke of the defendants liability to account). In A-G for Hong Kong v Reid [1994] 1 AC 324, Lord Templeman explained that Boardman demonstrates the strictness with which equity regards the conduct of a fiduciary and the extent to which equity is willing to impose a constructive trust on property obtained by a fiduciary by virtue of his office. In JJ Harrison (Properties) Ltd v Harrison [2002] 1 BCLC 162, CA, a director usurped a corporate opportunity by acquiring for his own benefit development land owned by the company. At the time of valuation he failed to disclose that planning permission was forthcoming which, once granted, would greatly inflate its value. The company, having unsuccessfully applied for planning permission a couple of years earlier, was unaware that local authority policy in this respect had changed. The director purchased the land from the company in 1985 for 8,400. Having obtained planning permission through, to add insult to injury, use of the companys resources, he then resold part of it for 110,300 in 1988 and the rest in 1992 for 122,500. The director resigned and the company sought to hold him liable as a constructive trustee. Chadwick LJ, citing Millett LJ in Paragon Finance plc v DB Thackerar & Co (1999), said:
It follows from the principle that directors who dispose of the companys property in breach of their fiduciary duties are treated as having committed a breach of trust that, a director who is, himself, the recipient of the property holds it upon a trust for the company. He, also, is described as a constructive trustee.
In the CMS Dolphin Ltd v Simonet, Lawrence Collins J subjected the issue of remedies for diverting a corporate opportunity to detailed analysis. He held that S was a constructive trustee of the profits referable to exploiting the corporate opportunity
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and, in general, it made no difference whether the opportunity is first taken up by the wrongdoer or by a corporate vehicle established by him for that purpose.
I do not consider that the liability of the directors in Cook v Deeks would have been in any way different if they had procured their new company to enter the contract directly, rather than (as they did) enter into it themselves and then transfer the benefit of the contract to a new company.
The basis of a directors liability in this situation is that, as seen in Cook v Deeks, the opportunity in question is treated as if it were an asset of the company in relation to which the director had fiduciary duties. He thus becomes a constructive trustee of the fruits of his abuse of the companys property (per Lawrence Collins J, above).
Activity 15.5
Read Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378, [1967] 2 AC 134n What is the basis of the liability of the directors in this case? Who brought the claim?
long-term service contracts (s.188) substantial property transactions (s.190) loans, quasi-loans and credit transactions (ss.197214) payments for loss of office (ss.215 222).
The policy underlying the requirement of shareholder approval of these specified transactions was explained by Carnwath J in British Racing Drivers Club Ltd v Hextall Erskine & Co [1997] 1 BCLC 182. He stressed that the possibility of conflicts of interests in these circumstances is such that there is a danger that the judgment of directors may be distorted and so it ensures that the matter will be... widely ventilated, and a more objective decision reached. Section 180 thus sets out, in part, the relationship between the general duties of directors and these more specific provisions contained in Part 10, Chapter 4 of the Act. Section 180(1) provides that if the requirement of authorisation is complied with for the purposes of s.175 (see s.175(4) and (5), above), or if the director has declared to the other directors his interest in a proposed transaction with the company under s.177, these processes replace the equitable rule that required the members to authorise such breaches of duty. This is made subject to any enactment (for example, the above transactions contained in Chapter 4 of Part 10) or any provision in the companys articles which require the authorisation or approval of members. Thus, the companys constitution can reverse the statutory change and can insist on certain steps being taken requiring the consent of the members in certain circumstances. In that event, that provision would have to be given effect to. That is the consequence of the change of approach and therefore a change of approach to the appropriate consequence of there not being members approval in particular cases because it would no longer be required (see Official Report, 9/2/2006; coll GC337). Section 180(3) states that compliance with the general duties does not remove the need for the approval of members to the transactions falling within Chapter 4 CA 2006. Further, s.180(2) provides that the general duties apply even though the transaction falls within Chapter 4, except that there is no need to comply with ss.175 or 176 where the approval of members is obtained. Section 180(4) preserves the common law position on prior authorisation of conduct that would otherwise be a breach of the general duties. Thus, companies may, through their articles, go further than the statutory duties by placing more onerous requirements on their directors (e.g.
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See Re Duomatic Ltd [1969] 2 Ch 365; Parker & Cooper Ltd v Reading [1926] Ch 975; EIC Services Ltd v Phipps [2003] 1 WLR 2360; Euro Brokers Holdings Ltd v Monecor (London) Ltd [2003] 1 BCLC 506, CA.
It is therefore necessary for directors to comply with every duty that may be triggered in any given situation. For example, the duty to promote the success of the company (s.172) will not authorise the director to breach his duty to act within his powers (s.171), even if he considers that it would be most likely to promote the success of the company.
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the officer has acted honestly and reasonably having regard to all the circumstances of the case, he ought fairly to be excused on such terms as the court thinks fit.
A classic illustration of the way the provision might be used is Re Welfab Engineers Ltd [1990] BCLC 833. The directors of a company which had been trading at a loss sold its main asset for the lower of two competing bids on the understanding that the company would continue to be run as a going concern. Shortly afterwards the company went into liquidation. The liquidator brought misfeasance proceedings against the directors. It was held that the directors had not acted in breach of duty in accepting the lower offer but, even if they had, it was a case in which relief would be granted under s.1157. Hoffmann J took the view that the directors were motivated by an honest and reasonable desire to save the business and the jobs of the companys employees. Another example is Re DJan of London Ltd. You will recall that the director in question incorrectly completed a proposal form for property insurance. The insurers subsequently repudiated liability on the policy when the company claimed for fire damage. The director had signed the proposal without reading it. Hoffmann LJ thought that it was the kind of mistake that could be made by any busy man. In granting the director partial relief from liability, the court noted that he held 99 of the companys shares (his wife held the other). Therefore the economic reality was that the interests the director had put at risk were those of himself and his wife. The judge observed that it may seem odd that a person found to have been guilty of negligence, which involves failing to take reasonable care, can ever satisfy the court that he acted reasonably. Nevertheless, the section clearly contemplates that he may do so. It follows that conduct may be reasonable for the purposes of s.1157, despite amounting to lack of reasonable care at common law. In Re Duckwari plc (No 2) (above), the point was made obiter that a director who intends to profit by way of a direct or indirect personal interest in a substantial property transaction could not be said to have acted reasonably and therefore would be denied relief under s.1157. See also: Re Brian D Pierson (Contractors) Ltd [1999] BCC 26; Re Simmon Box (Diamonds) Ltd [2000] BCC 275; Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549.
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It permits a company to enter into a contract which is conditional on member approval. This implements a recommendation of the Law Commissions (s.190). The company is not to be liable under the contract if member approval is not forthcoming (s.190(3)). It provides for the aggregation of non-cash assets forming part of an arrangement or series of arrangements for the purpose of determining whether the financial thresholds have been exceeded so that member approval is required (s.190(5)). It excludes payments under directors service contracts and payments for loss of office from the requirements of these clauses (s.190(6)). This implements a recommendation of the Law Commissions. It provides an exception for companies in administration or those being wound up (s.193).
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In Re Duckwari plc [1997] 2 BCLC 713, the company had acquired a non-cash asset from a person connected with one of its directors for 495,000. Four years later in 1993, following the collapse of the property market, the property was valued for the purpose of the proceedings at 90,000. It was no longer possible to avoid the transaction and so the company sought an indemnity for its losses. It was held that irrespective of whether the transaction is or can be avoided, the director or connected person and any other director who authorised the transaction will be liable to account to the company for any profit or loss sustained as a result of the breach of s.190 CA 2006 (see Re Duckwari plc (No 2) [1999] Ch 253 and Re Duckwari plc (No 3) [1999] 1 BCLC 168).
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The effect of a breach of ss.197, 198, 200, 201 or 203 is that the transaction or arrangement is voidable at the instance of the company (s.213(2)). Further, regardless of whether the company has elected to avoid the transaction, an arrangement or transaction entered into in contravention of the provision renders the director (together with any connected person to whom voidable payments were made and any director who authorised the transaction or arrangement) liable to account to the company for any gain he made as well as being liable to indemnify the company for any loss or damage it sustains as a result of the transaction or arrangement (s.213(4)). A director who is liable as a result of the company entering into a transaction with a person connected with him has a defence if he can show that he took all reasonable steps to secure the companys compliance with ss.200, 201 or 203. The Act does not define loan, although s.199 does define the term quasi-loan and related expressions (see s.199).
Conaglen, M. The content and function of fiduciary loyalty, [2005] LQR 452. Davies, P. and J. Rickford, An Introduction to the New UK Companies Act [2008] ECFR 49. Edmunds, R. and J. Lowry The continuing value of relief for directors breach of duty, [2003] MLR 195. Ferran, E. Company Law Reform in the UK [2001] Singapore Jrnl of International and Comparative Law 516 Finch, V. Creditor interests and directors obligations in Sheikh, S. and W. Rees Corporate Governance & Corporate Control. (London: Cavendish, 1995) [ISBN 1874241481]. Finch, V. Company directors: who cares about skill and care?, [1992] MLR 179. Grantham, R. The unanimous consent rule in company law, [1993] CLJ 245. Lowry, J. Regal (Hastings) fifty years on: breaking the bonds of the ancien rgime, [1994] NILQ 1. Lowry, J. and R. Edmunds The corporate opportunity doctrine: the shifting boundaries of the duty and its remedies, [1998] MLR 515. Lowry, J. Self-dealing directors constructing a regime of accountability, [1997] NILQ 211. Penner, J. The Law of Trusts. (Oxford: Oxford University Press, 2008) [ISBN 9780199540921].paras 2.1014. Prentice, D. The corporate opportunity doctrine, [1974] MLR 464. Sealy, L. S. The director as trustee, [1967] CLJ 83. Worthington, S. Corporate governance: remedying and ratifying directors breaches, [2000] LQR 638. Worthington, S. The duty to monitor: a modern view of the directors duty of care in Patfield, F. M. (ed.) Perspectives on Company Law: 2. (London: Kluwer Law International, 1997) [ISBN 9041106782]. Worthington, S. Reforming directors duties, [2001] MLR 439. Berg, A. The company law review: legislating directors duties, [2000] JBL 472. White Paper: Modern Company Law For a Competitive Economy: Developing the Framework, (2000) DTI, March. Developing Directors Duties [1999] CfiLR (special edition devoted to the Law Commissions report on directors duties (Nos 261 and 173) and the DTIs fundamental review of core company law).
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Keay, A. The duty of directors to take account of creditors interests: has it any role to play, [2002] JBL 379. Payne, J. A re-examination of ratification, [1999] CLJ 604. Sealy, L. S. Bona fides and proper purposes in corporate decisions, [1989] Monash Univ LR 265. Law Commission and the Scottish Law Commission, Company Directors: Regulating Conflicts of Interests And Formulating A Statement Of Duties (Nos 261 and 173, respectively).
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Bhullar v Bhullar. The fact that Arthur was a party to the boards decision to reject Freds offer, together with the fact that he declined Freds personal invitation might point to the boards decision being made in accordance with s.172. On the information you are given it is difficult to reach a firm conclusion in this regard, but it is an issue that must be addressed. You will also need to discuss s.175(5)(b) as the company is a plc. You must reach a conclusion on the issue of liability. This shows the Examiner that you have thought about the issues. One final point in this regard: you should mention that the claim is being brought by Dynamic Development plc because breach of fiduciary duty is a wrong against the company (see Chapter 11 of the subject guide) and the proper claimant rule therefore applies (see now Part 11 of the CA 2006). Finally, discuss s.1157 CA 2006. It is a belt and braces provision so that inevitably defendant directors will argue for relief from liability. Note that the court may relieve the defendants in whole or in part.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 15.1 15.2 15.3 15.4 Directors duties Revision done
The restatement of directors duties: Part 10 of the CA 2006 Specific statutory duties Relief from liability
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Notes
16 Corporate governance
Contents
16.1 16.2 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186
Introducing corporate governance . . . . . . . . . . . . . . . . . . . 187 The debate in the UK . . . . . . . . . . . . . . . . . . . . . . . . . . 189 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 194
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Introduction
This chapter examines the corporate governance debate in the UK. It is an extremely important area. Students are not only expected to be up to date with current corporate governance issues but are expected to have a detailed knowledge of the history and theory that informs the corporate governance debate. This chapter provides an overview but, as with other areas of this course, students need to engage with the further reading to build up a detailed knowledge of this area.
Learning outcomes
Having completed this chapter and the relevant reading you should be able to:
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describe the main historical periods in the development of the modern company explain the various corporate theories that influence the corporate governance debate illustrate the current trends in corporate governance writing form your own view of what the main purpose of a company should be.
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Essential reading
Dignam and Lowry, Chapter 15 Corporate governance I: corporate governance and corporate theory and Chapter 16 Corporate governance II: the UK corporate governance debate.
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Activity 16.1
Provide some examples from your study of company law that illustrate the key points of the various corporate theories.
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First, corporations are very powerful and therefore have an enormous effect on society. Thus a narrow accountability to shareholders is insufficient to protect societys interests. Second, some, like Parkinson (1995), argue that the assumption that shareholders have a moral claim to primacy by virtue of their property rights is plainly incorrect. If shareholder primacy is to be justified it must be on other grounds. Third, the moral claims of others (stakeholders) either outweigh the shareholders claims or at are at least equal to them when it comes to allocating primacy.
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However, these moral claims seemed overwhelmed by the efficiency-based arguments of the government and the private sector in the 1980s. In response, by the early 1990s a two-fold approach was emerging in the corporate governance literature. First, it was still morally right to include stakeholders in the decision-making process and, second, it could be justified on competitive grounds. For example, contented employees are more productive, the business entity benefits through lower transaction costs because of higher levels of trust and a greater sense of community, and so ultimately the economy and society benefits.
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Pay has continued to be a corporate governance problem, as the central conflict of interest in a board deciding on its own pay has remained despite the creation of remuneration committees. As a result the government introduced a requirement in August 2002 (the Directors Remuneration Report Regulations 2002, (SI 2002/1986)) that all listed companies must present a remuneration report to their general meeting for consideration. The vote is advisory only and so does not affect the contractual validity of the directors contracts. It is, however, intended to give shareholders a direct voice as to levels of acceptable pay. The Work Foundation often produces figures on directors pay and its website is worth monitoring (www.theworkfoundation.com See, in particular, Life at the top: The labour market for FTSE-250 chief executive.) Additionally, since the advent of the credit crisis in Autumn 2008, a significant concern has arisen that the structure of pay within listed companies had a role in encouraging risk which in turn almost led to the collapse of the global financial system. As a result, in 2009 shareholders have been voting against the remuneration packages of a number of high profile companies. A third committee called the Hampel Committee reported in 1998 and, while offering nothing new to the accountability issues, provided an opportunity to combine the Cadbury and Greenbury recommendations into one single code called the Combined Code. The Hampel Committees importance lies in that fact that its failure to meaningfully engage in the corporate governance debate antagonised the government into putting corporate governance firmly on its reform agenda within the ambit of the CLRSG.
Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes. The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company
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the businesss development and performance during the financial year the companys (or groups) position at the end of the year the main trends and factors underlying the development, performance and position of the company (or group) and which are likely to affect it in the future.
In doing this, the directors would have to consider if it is necessary to report on a range of factors that may be relevant to the understanding of the business, including, for example, environment, employee and social and community issues. (DTI Guidance on the OFR and changes to the directors report (January 2005).) The controversy surrounding the OFR focused on the potential increase in personal liability that directors may have for forward-looking financial information. In response, somewhat remarkably, the then Chancellor, Gordon Brown, announced on 28 November 2005 that the OFR would be repealed from 12 January 2006. (See the Companies Act 1985 (Operating and Financial Review) (Repeal) Regulations 2005, SI 2005/3442.) This ill-thought out repeal was complicated further by the fact that the European Accounts Modernisation Directive (Directive 2003/51/EC) requires a fair business review (FBR) to take place. As a result the BIS guidance now runs as follows.
The Business review requires a balanced and comprehensive analysis of the development and performance of the company during the financial year and the position of the company at the end of the year; a description of the principal risks and uncertainties facing the company; and analysis using appropriate financial and non-financial key performance indicators (including those specifically relating to environmental and employee issues). Companies producing a business review must disclose information that is material to understanding the development, performance and position of the company, and the principal risks and uncertainties facing it. This will include information on environmental matters and employees, on the companys policies in these areas and the implementation of those policies. Moreover, key performance indicators must be used where appropriate (including those specifically relating to environmental and employee issues). Similarly, companies producing a business review will need to consider disclosing information on trends and factors affecting the development, performance and position of the business, where this is necessary for a balanced and comprehensive analysis of the development, performance and position of the business to describe the principal risks and uncertainties facing it, or to provide an indication of likely future developments in the business of the company.
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In essence, having repealed the OFR, the DTI then stated that while an Operating and Financial Review is no longer required there is still a requirement to produce a fair business review which is very similar to the OFR. The requirement for the business review based on the guidance above is now contained in s.417 CA 2006. See the guidance at: http://www.berr.gov.uk/whatwedo/businesslaw/corp-govresearch/page21369.html The collapse of the US company Enron in 2002 (you can find out more about this on the website: http://specials.ft.com/enron/FT3GIIYBNXC.html) spurred the government into announcing a review of the role of non-executive directors in UK companies. The review was carried out by Derek Higgs, who consulted widely and produced a final report in January 2003. Its key recommendation was to provide a good definition of independence for non-executives, which was adopted by the LSE. A non-executive director will now only be considered independent when the board determines that the director is independent in character and judgment and there are no relationships or circumstances which could affect, or appear to affect, the directors judgment. Such relationships and circumstances arise where the director:
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is or has been an employee of the company has or had a business relationship with the company is being paid by the company other than a directors fee and certain other payments has family ties to the company or its employees holds cross-directorships or has significant links with other directors through involvement in other companies or bodies represents a significant shareholder has served on the board for 10 years.
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The Higgs independence criteria have subsequently been adopted by the London Stock Exchange. (http://www.berr.gov.uk/whatwedo/businesslaw/corp-governance/ higgs-tyson/page23342.html).
Activity 16.2
Read Chapters 15 and 16 of Dignam and Lowry and then consider the following. The committees on corporate governance have been an amazing success. We know this not only because of the domestic improvements in corporate governance they have brought about but because similar systems have been adopted by international agencies and other jurisdictions around the world. Do you agree with the above statement? Explain your views.
Berle, A. and G. Means, The modern corporation and private property. (New York: Harcourt, 1932; revised edition, 1968) (New Brunswick, NJ; London: Transaction Publishers, paperback edition 1991 [ISBN 0887388876]). Dodd, E. For whom are corporate managers trustees?, [1932] Harvard Law Review 1145. Berle, A. For whom are corporate managers trustees: a note, [1932] Harvard Law Review 1365. Dignam, A. and M. Galanis, The Globalization of Corporate Governance. (Ashgate, 2009) xxiv and p.458. Jensen, M. and W. Meckling Theory of the firm: managerial behaviour, agency costs, and ownership structure, [1976] 3 Journal of Financial Economics, 305. Coffee, J. The rise of dispersed ownership: the roles of law and the state in the separation of ownership and control, [2001] Yale LJ 1, pp.2529.
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Parkinson, J.E. Corporate power and responsibility: issues in the theory of company law. (Oxford: Oxford University Clarendon Press, 1993) [ISBN 0198259891]. Cheffins, B.R. Company Law: Theory and Structure. (Oxford: Oxford University Press, 1997) [ISBN 0198764693]. Wedderburn, K.W. The social responsibilities of companies, [1982] Melbourne University LR 1. Wedderburn, K.W. Companies and employees: common law or social dimension?, [1993] LQR 220. Wheeler, S. (ed.) A Reader on the Law of the Business Enterprise. (Oxford: Oxford University Press, 1995) [ISBN 0198764693]. Riley, C.A. Controlling corporate management: UK and US initiatives, [1994] LS 244. Pettet, B. Towards a competitive company law, [1998] Co Law 134. Dignam, A. A principled approach to self-regulation? The report of the Hampel Committee on Corporate Governance, [1998] Co Law 140. Dignam, A. and M. Galanis Australia inside/out: the corporate governance system of the Australian listed market, [2004] Melbourne University Law Review Vol 28 (December, 2004), No 3, pp.623653. Finch, V. Board performance and Cadbury on corporate governance, [1992] JBL 581.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 16.1 16.2 Introducing corporate governance The debate in the UK Revision done
Contents
17.1 17.2 17.3 17.4 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196
Liquidating the company . . . . . . . . . . . . . . . . . . . . . . . . 197 The liquidator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 Directors of insolvent companies . . . . . . . . . . . . . . . . . . . . 201 Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 203
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Introduction
In this chapter we consider the various ways in which a company can be wound up. A principal anxiety of the law is to ensure the most equitable treatment possible of all the creditors. You will have noted from previous chapters that many key issues of company law come to the fore during the liquidation process. You should revise Chapter 7: Raising capital: debentures and Chapter 15: Directors duties before embarking on the material below.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
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explain the ways in which a company may be wound up describe the powers and duties of the liquidator describe the order in which creditors are paid discuss the liabilities of directors of insolvent companies.
Essential reading
Cases
Re London and Paris Banking Corp (1874) LR 19 Eq 444 Measures Bros Ltd v Measures [1910] 1 Ch 336 Silkstone and Haigh Moore Coal Co v Edey [1900] 1 Ch 167 Stead, Hazel & Co v Cooper [1933] 1 KB 840 Coutts & Co v Stock [2000] 1 BCLC 183 Re J Leslie Engineers Co Ltd [1976] 1 WLR 292 Re Produce Marketing Consortium Ltd [1989] BCLC 520.
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The members may decide to wind up the company even though it is flourishing this is termed voluntary winding up. The creditors may force the dissolution of a company where it is insolvent (i.e. it cannot pay its debts) this is termed compulsory winding up. It is in the public interest to wind up a company.
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if a creditor, to whom a sum exceeding 750 is owed, has served on the company at its registered office a written demand, in the prescribed form, requiring the company to pay the debt and the company has for three weeks thereafter neglected to pay; or
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It should be noted in relation to the third category that a company will be deemed to be insolvent where the value of the companys assets is less than the amount of its liabilities (s.123(2) IA 1986). However, if the debt is disputed on bona fide grounds the court will not allow the petition to proceed. Thus, if a creditor presents a petition in order to pressurise the company into paying a debt, the amount of which is genuinely disputed as being excessive, the court may dismiss the petition with costs (Re London and Paris Banking Corp (1874) LR 19 Eq 444). However, if the petition proceeds a creditor who is owed 750 or more will be entitled to a winding up order although the court may refuse to make an order if the petition is not supported by the majority of creditors (s.195). If the court does make an order to wind up the company it is made in favour of all the creditors, not just the petitioner, and the Official Receiver is appointed as liquidator. At this point, if the Official Receiver finds that the realisable assets of the company are insufficient to cover the expenses of the winding up and that the affairs of the company do not require further investigation, he or she may apply to the Registrar of Companies for the early dissolution of the company. Such an application is then registered by the Registrar and three months after the date of the registration of the notice the company is dissolved. But, if there are sufficient funds to cover the expenses of the liquidation the Official Receiver has the power to summon separate meetings of the companys creditors and contributories for the purpose of choosing a person to be liquidator of the company in his or her place (s.136(4)). Once the liquidator has completed his function (see below), s.205 provides that when he has filed his final returns or the Official Receiver has filed a notice stating that he considers the winding up to be complete, the Registrar of Companies shall register those returns or the notice forthwith. At the end of the period of three months beginning with the day of that registration the company is dissolved (s.205(2)).
Activity 17.1
Read British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758. What emerges from the British Eagle decision as the overarching purpose of liquidation?
Activity 17.2
Read Finch, V. Corporate Insolvency Law: Perspectives and Principles. (Cambridge: Cambridge University Press, 2009) Chapter 2. [ISBN 9780521701822] What are the objectives of the liquidation regime?
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may be exercised only with the sanction of the court or the liquidation committee; and those which are exercisable without the need to obtain such sanction. For example, the liquidator must obtain the appropriate sanction before exercising his power to bring or defend proceedings in the name and on behalf of the company and to carry on the business of the company so far as may be necessary for its beneficial winding up (s.167(1)(a), Sch.4, Part II). No such sanction is required, however, for the liquidator to sell company property or to raise money by providing security on company assets (s.167(1) (b), Sch.4, Part III). Although, as we have seen, the liquidators main role is to secure that the companys assets are got in and distributed to the creditors (s.143), he also, along with the court, polices the end of the company to ensure insiders do not take advantage of the companys genuine creditors. As such the liquidator is empowered by s.238 IA 1986 to apply to court to set aside any transactions at an undervalue which may have occurred in the two years preceding the winding up. Sometimes in the lead-up to liquidation the company will attempt to put certain creditors in preferred positions to ensure that they get paid (often the creditors in question are in fact directors of the company who may have personally guaranteed a loan to the company). Section 239 allows the liquidator to apply to court to have such a preferment set aside. Insiders may also enter into extortionate credit arrangements which bind the company. If this occurs within three years of the winding up, s.244 again provides for the liquidator to apply to the court to set the transaction aside. The liquidator in a voluntary solvent liquidation, while he has the same duties of good faith as a liquidator in a compulsory liquidation, has a very different role. In a voluntary solvent liquidation the liquidator simply gathers together the assets, pays the liabilities and distributes any surplus to the members. In a compulsory liquidation the liquidator will also carry out this function but usually without any chance that the asset value will exceed the companys liabilities. Thus the liquidators main function will be to determine the priority in which creditors will receive payment. The liquidator will also police the years immediately before the insolvency for any irregular transactions that might be challengeable.
Activity 17.3
Read Re Grays Inn Construction Co Ltd [1980] 1 WLR 711. What factors should be taken into account by the court when deciding whether to validate a post-winding up disposition of property?
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17.4 Reform
In Chapter 15 we considered the state of the case law suggesting that directors may owe duties to creditors where the company is insolvent. In this regard you should note s.172(3) of the CA 2006.
Activity 17.4
a. What are the three ways of bringing a companys existence to an end? b. Where a company is wound up voluntarily, can the creditors appoint a liquidator? c. What are the three grounds given in s.123(1) of the Insolvency Act 1986 for deeming a company to be insolvent? d. In an insolvent liquidation, which creditors are given preference over ordinary debts? e. In a voluntary liquidation, what happens to any surplus assets? No feedback provided.
Finch, V. Corporate insolvency law: perspectives and principles. (Cambridge: Cambridge University Press, 2009) [ISBN 9780521701822. Goode, R.M. Principles of corporate insolvency law. (London: Sweet & Maxwell, 2005) [ISBN 9780421930209]. Report of the Review Committee on Insolvency Law and Practice (Cork Committee Report), Cmnd 8558. Cooke, T.E. and A. Hicks Wrongful trading predicting insolvency, [1993] JBL 338.
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Section 245 IA 1986, whereby the liquidator of an insolvent company can avoid floating charges (see Chapter 7 of this guide). Whether or not Helen is liable for wrongful trading see IA 1985, s.214. Particular reference should be made to Re Produce Marketing Consortium (No 2). You will need to discuss Salomon v Salomon [1897] AC 22 and Adams v Cape Industries plc [1990] 2 WLR 657 (see Chapters 3 and 4) in order to explain that a parent company (Pear Ltd) is not liable for the debts of its subsidiary (Sub Ltd). However, if Pear Ltd is a shadow director of Sub Ltd (see Chapter 14 of this guide and particularly Secretary of State for Trade and Industry v Deverall [2001] Ch 340), the assets of Pear Ltd may be liquidated to meet the claims against Sub Ltd. Whether Helen can be disqualified as a director under the Company Directors Disqualification Act 1986 (see Chapter 14). Particular reference should be made to the degree of culpability required before the court will disqualify a director. In Re Lo-Line Electric Motors Ltd [1988] Ch 477 Sir Nicholas Browne-Wilkinson V-C said that while ordinary commercial misjudgment is not in itself sufficient to establish unfitness, conduct which displays a lack of commercial probity or conduct which is grossly negligent or displays total incompetence would be sufficient to justify disqualification.
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If you ticked need to revise first, which sections of the chapter are you going to revise?
Must revise 17.1 17.2 17.3 17.4 Liquidating the company The liquidator Directors of insolvent companies Reform Revision done
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Notes
Feedback to activities
Contents
Chapter 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 Chapter 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 Chapter 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 Chapter 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 Chapter 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Chapter 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 Chapter 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211 Chapter 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211 Chapter 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212 213 213 214 215 216 218 218
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Chapter 2
Activity 2.1
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Activity 2.2
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Activity 2.3
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Activity 2.4
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Activity 2.5
Small businesses seem to have been particularly ill-served by the corporate form. At the heart of this has been the difference between company laws presumption that the shareholders do not exercise day-to-day control of the business and the reality in a small business that shareholders often do exercise day-to-day control. The elective regime in the CA 1985 and Table A did try to simplify matters, but from the 1994 Freedman study we know that the only real advantage perceived by small businesses from forming a company was the legitimacy it conferred on the business. The reform process leading to the Companies Act 2006 identified this as a significant problem and the 2006 Act attempts to redress this imbalance by removing the presumption that ownership is separated from control in order to make the corporate form a better model for small businesses.
Chapter 3
Activity 3.1
a. Mr Salomons personal liability for the debts of the business had changed completely from unlimited liability as a sole trader to limited liability as a shareholder in the company. Not only was Mr Salomon not liable for the debts of the company but he had also, as managing director of the company granted himself a secured charge over all the companys assets. As a result if the company failed not only would Mr Salomon have no liability for the debts of the company but whatever assets were left would be claimed by him to pay off the companys debt to him. b. There is really one central principle we can draw and two minor ones. The central principle is that the company is a separate legal personality from its members and therefore legally liable for its debts. This brings us to the minor principles. The first being that once the technicalities of the Companies Act are complied with, a oneperson company can have the benefits of corporate legal personality and limited liability. The second is that debentures can be used effectively to further shield investors from losses. c. This is really a matter of your own personal opinion. It is useful, however, to work out what you think about this issue as it will help you deal with other areas of company law where the Salomon decision has implications.
Activity 3.2
The key point here for your further understanding is that a share is in no way a representation of the fractional value of the companys property. The company as a separate legal entity owns its own property and there is no legal connection between a share in the company and the companys property. That is the case even where (as in Macaura and Lee) the shareholder owns all the shares. Shareholders generally
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benefit from this (although not Mr Macaura) because it facilitates limited liability as the company also owns its own debts (see also Woolfson v Strathclyde Regional Council [1978] SC 90).
Chapter 4
Activity 4.1
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Activity 4.2
You will have noted from your reading that from the 1960s until the 1990s there was little consistency in the way the senior judiciary approached difficult cases where veil lifting was an option. In 1985 the Court of Appeal in Re a Company [1985] BCLC 37, Ch.D could draw on cases such as Wallersteiner v Moir [1974] 1 WLR 991 to argue that the court can use its power to lift the corporate veil if it is necessary to achieve justice, irrespective of the legal efficacy of the corporate structure under consideration. Equally, four years later the Court of Appeal in National Dock Labour Board v Pinn & Wheeler Ltd [1989] BCLC 647 could draw on cases such as Woolfson v Strathclyde RC [1978] SLT 159 to argue for a strict interpretation of the Salomon principle. In short there was little consistency or certainty in a very important area of company law. This, it seems, is what the Court of Appeal seeks to address in Adams by narrowing the categories of veil lifting and eliminating any concept of veil lifting in the interests of justice. Instead, narrow categories have been created which are somewhat elusive. It does indeed seem an overly cautious approach which does little to serve the interests of justice. However there are suggestions in cases such as Ratiu v Conway (2006) 1 All ER 571 that the courts are becoming a bit more flexible in their interpretation of veil lifting issues.
Activity 4.3
Involuntary creditors (generally, in this context, the victims of personal injury by the company) are in a vulnerable position when it comes to the application of the Salomon principle. Normal creditors have at least a way of calculating the business risk and charging more or monitoring in order to protect themselves. Involuntary creditors cannot do so and so if, for example, a parent company remains protected from the tortious activities of its subsidiary by the Salomon principle, involuntary creditors can suffer badly. Thankfully the courts seem to realise this and draw a subtle distinction between commercial torts (negligent misstatement) where Salomon is strictly applied and personal injury actions where a more flexible approach has been taken (see Lubbe and Others v Cape Industries plc [2000] 1 WLR 1545).
Chapter 5
Activity 5.1
The House of Lords reasoned that Erlanger, as representing the syndicate, had undertaken to act on behalf of the yet unformed company. We saw from the brief extract taken from Lord Cairns LCs speech (para 4.2), that promoters possess considerable power in determining the shape of a new companys management and supervision. Given the vulnerability of companies to abuse by their promoters, the law has responded by holding them subject to the rigour of the core fiduciary duty of loyalty. In effect, this prohibits promoters from placing themselves in a position where their personal interests might conflict with those of the putative company. Thus, although promoters are not prohibited from selling their own property to the company, they can only do so having made full disclosure to an independent board of directors.
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Activity 5.2
It is important to note that on the facts the promoters did not disclose to an independent board of directors the profit they made on selling property owned by them to the company. Lord Macnaghten, examining the conduct of Gluckstein, against whom the action was brought, stressed that where a person who plays many parts (i.e. being a promoter and then subsequently a director of the company) announces to himself in one character what he has done in another character, this cannot be described as disclosure in its proper sense. Indeed, there was no disclosure to the intended shareholders at all; they were thus victims of a deception. Consequently, where promoters make a secret profit during the promotion process they will be jointly and severally liable to account for that profit to the company.
Activity 5.3
The policy underlying s.51 is to protect third parties who contracted in the belief that they were dealing with registered companies. It makes pre-incorporation contracts legally enforceable as personal contracts with promoters unless their personal liability has been unequivocally excluded. The question of whether the promoter could enforce the contract he is personally liable on has now been resolved by the Court of Appeal.
Chapter 6
Activity 6.1
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Activity 6.2
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Activity 6.3
By emphasising continual disclosure by listed companies, before and after listing, the FSA and the LSE wish to achieve a number of aims.
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Where the company is listing for the first time disclosure provides the potential investor with enough information to decide whether to invest or not. Where the company is already listed the disclosure regime is designed to ensure that information is fairly distributed. If this was not the case large shareholders would have greater access to information than small ones.
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Activity 6.4
The answer to this question is not as straightforward as it may seem. There are those who believe that insider dealing should be allowed as it enables insiders to send signals about impending actions by companies much quicker than the disclosure regime (see McVea (1995)). However, the prevailing view on why it is illegal is that it is morally reprehensible and has very damaging effects on the investing publics confidence in the marketplace (see Campbell (1996) on why insider dealing is outlawed).
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Chapter 7
Activity 7.1
A floating charge is a creature of equity. It attaches to assets for the time being. The hallmark of a floating charge is that the company can continue to deal with the charged assets in the ordinary way without obtaining the chargees consent (Re Yorkshire Woolcombers Association, Romer LJ). As its name suggests, it floats over the class of assets charged and it will only attach as a fixed charge upon a crystallising event such as a default in making a loan repayment. A fixed charge is a mortgage (legal or equitable) that is generally granted over identifiable assets not commonly traded in the day-to-day operations of the company it attaches to specific assets of the company, for example, land. The holder of a fixed charge will have rights in rem over the assets (see Agnew v Commissioner of Inland Revenue). Fixed chargees rank above floating chargees in respect of their priority in a liquidation (see Chapter 16 of this subject guide). Floating charges may be challenged under the Insolvency Act 1986, s.245 (see section 7.4 of this guide).
Activity 7.2
In Agnew Lord Millett explained that, unlike a floating charge where the company continues to have the freedom to deal with the assets subject to the charge, a fixed charge creates an immediate proprietary interest in the assets in favour of the holder and therefore the company cannot deal with its assets without committing a breach of the terms of the charge. He stressed that the classification of a security as a fixed or floating charge was a matter of substance rather than drafting. If the chargor was free to deal with the charged assets and could withdraw them from the ambit of the charge without the consent of the chargee, then the charge must be viewed as a floating charge. From the chargees perspective, if the charged assets were not under its control, whereby it could prevent their dissipation without its consent, then the charge cannot be viewed as a fixed charge. The critical test was whether the company could continue receiving the book debts and to use them in its business and whether it had the unrestricted right to deal with the proceeds of book debts paid into its bank account. Note that Lord Millett states that Re New Bullas was wrongly decided because the company was left in control of the process by which the book debts were extinguished and replaced by different assets that were not the subject of a fixed charge and were at the free disposal of the company. That was clearly inconsistent with the nature of a fixed charge.
Activity 7.3
Section 874 of the CA 2006 states that certain charges will be void if not registered within 21 days of their creation. Once registered the charge is valid from the date of its creation. This gives rise to a 21-day invisibility period because whenever a person checks the register it cannot be assumed that it is comprehensive because there may be a charge for which the 21-day period is still running. Under the reform proposals put forward by the CLRSG and the Law Commission the 21-day registration rule would be dispensed with altogether. The period between creation and registration would therefore cease to be relevant and, consequently, there would be no period of invisibility. If adopted by the government, registration will no longer be a perfection requirement but becomes a priority point as between competing chargees.
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Chapter 8
Activity 8.1
Lindley LJ stressed that notwithstanding Ooregum, there is no rule preventing a private company purchasing property or services at any price it thinks proper. Thus, provided a company acts honestly, a contract that provides for it to pay for goods or services by fully paid-up shares is valid and binding both on the company and its creditors. Unless the transaction can be attacked on the basis of, for example, fraud, the value of the consideration received by the company in return for its shares cannot be enquired into.
Activity 8.2
Lord Oliver rejected both the trial judges and the Court of Appeals view that larger purpose could embrace avoiding liquidation and preserving the companys goodwill and the advantages of an established business. He noted that purpose is in some contexts a word of wide content and in attaching meaning to it for the purposes of s.153 CA 1985 (now ss.678-682) the mischief against which s.151 (now s.678) seeks to address must be borne in mind. It is therefore necessary to distinguish between a purpose and the reason why a purpose is formed. Larger does not mean more important and reason is not the same as purpose. On the facts of the case, Lord Oliver concluded that the scheme was framed for the best of reasons but to say that the larger purpose of Bradys financial assistance is to be found in the scheme of reorganisation itself is to say only that the larger purpose was the acquisition of the Brady shares on their behalf. Larger purpose cannot be found in the benefits likely to flow from the financial assistance and therefore the acquisition was not a mere incident of the scheme devised to break the deadlock it was the essence of the scheme itself.
Chapter 9
Activity 9.1
a. No feedback provided. b. The articles have historically assumed a situation where there are potentially large numbers of people involved in a business venture. As such it provides a very clear set of rules designed to allocate power between the board and the general meeting, the board having responsibility for the day-to-day running of the company and the general meeting having a supervisory function. This has historically been both a strength and a weakness: a strength in that companies that match the statutory presumption of large numbers of participants can function effectively according to its division of powers; a weakness in that small companies with few participants find its formal division of power inappropriate. The supervisory role of the general meeting has also been diminished in very large companies by shareholder apathy. The separating out of private and public company articles, thus providing appropriate rules, should go some way to resolving this weakness.
Activity 9.2
The s.33 contract is an unusual one but that alone does not explain why enforcing it has been such a complex issue. It seems that all the enforcement issues touch upon a central question in company law. That is, when can an individual member sue in the context of a corporate activity? As we will see in Chapter 11 the general rule in Foss v Harbottle (1843) 2 Hare 461 states that only the company itself can sue to right a wrong to the company. When the judiciary have been deciding on s.33 issues this general principle seems to loom large in their thoughts. As a result, some of the judiciary hold firm to the belief that only the companys organs can enforce the constitution. Others have taken the view that to apply the general rule in Foss v Harbottle is inappropriate in
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the context of s.33 as it would allow the majority to defeat the intention of the section, which is to ensure the constitution is enforceable. Thus the individual shareholders must be allowed to sue to enforce the constitution. While the CLRSG has recognised that shareholders should be able to do so in its recommendations the CA 2006 has done little to change the confusion.
Activity 9.3
a. The key advantage of a shareholders agreement is the certainty of enforcement against the other parties to the agreement. The courts have continually shown that they will enforce such agreements. A shareholder can also identify who he wishes to contract with. For example, if he wishes to contract for other shareholders votes he can identify a shareholder with the right percentage of votes and then enter into an agreement with the other shareholder to exercise his votes in a particular way. It is also private. The disadvantage of a shareholders agreement is that once a party to a shareholders agreement sells his shares, the new owner has no obligations under the shareholders agreement. This is in contrast to the way the s.33 contract operates to bind future shareholders to the companys constitution. Adding the company to the shareholders agreement may also be a disadvantage as there are statutory restrictions on its ability to contract. b. As we have discussed above there are certain restrictions on the shareholders ability to vote. First, alterations of the articles cannot conflict with any statutory provisions. Second, sometimes the courts (particularly where minority shareholders are disadvantaged) will impose equitable restriction on the majority shareholders votes.
Chapter 10
Activity 10.1
A share represents the members financial stake in the company as an association and delimits the extent of the shareholders liability to the company. If the share is partly paid the shareholder owes the company the difference between the price actually paid and its nominal or par value plus any premium (see Chapter 8). In fact, nowadays most shares are fully paid and so the holder has no further liability to contribute to the companys capital in the event of it becoming insolvent. Unlike partners in a partnership, shareholders do not own corporate assets but rather ownership is vested in the company itself: Macaura v Northern Assurance Co Ltd [1925] AC 619.
Activity 10.2
Where rights are annexed to particular shares, such as the right to receive dividends at a specified rate or to receive a return of capital on winding up, they are class rights. Obviously, if a company has issued only one class of shares ordinary shares there are no class rights as such, only shareholder rights. In Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Herald Newspapers and Printing Co Ltd [1987] Ch 1, Scott J explained that where a companys articles confer special rights on one or more of its members in the capacity of member or shareholder the rights are class rights.
Activity 10.3
The significance of identifying a right as a class right is that it cannot be varied by the company without going through the procedure laid down in ss.630-634 CA 2006. A proposal to vary class rights requires the consent of the class concerned. Class rights therefore have greater protection than a right conferred just by the articles, because the articles of association can be altered by a special resolution of the company (s.21 CA 2006).
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Chapter 11
Activity 11.1
No feedback provided.
Activity 11.2
The judge explained that if the substance of a complaint relates to something that the majority of the company are entitled to do, or if the complaint concerns some irregularity which the majority can legitimately do regularly then there is no point in suing, because ultimately a general meeting will be called at which the majority will get its own way. Mellish LJ went on to add, however, that if the majority abuse their powers and deprive the minority of their membership rights then the minority can sue (see Chapter 9 of this guide and s.33 CA 2006, the statutory contract).
Activity 11.3
No feedback provided.
Activity 11.4
Briefly, the facts were that the company was insolvent due to a former directors breach of certain fiduciary duties not to compete or misuse confidential information. Both duties were also express terms in a shareholders agreement to which the defendant and claimant were parties. Although the company had initiated an action against its former director, the administrative receivers discontinued it when the defendant director applied for a security of costs order (i.e. a court order requiring the company to demonstrate its ability to comply with the courts decision on costs). In effect, the defendant had, by his breach of duty, rendered the company incapable of seeking legal redress against him because it lacked the means to fund the litigation. The claimant sought to recover losses to the value of his shareholding, loss of remuneration and loss of the value of loan stock. The issue for the court was whether these were recoverable by him given the decision in Johnson v Gore Wood & Co. The Court of Appeal, in placing considerable emphasis on the fact that the defendants own wrongdoing had, in effect, disabled the company from suing him for damages, found that this situation had not confronted the House of Lords in Johnson. Given that the duties in question were expressly provided for in the shareholders agreement, it was held that the claimant could pursue his claim for breach of the agreement including his losses in respect of the value of his shareholding. The claims for loss of remuneration and losses of capital and interest in respect of loans made by him to the company did not, in any case, fall within reflective losses. In summary, the decision means that if a company is rendered incapable of suing a wrongdoer by the wrongdoing in question, a shareholder who also has a claim may bring proceedings for his own losses, including losses (termed reflective losses) attributable to the diminution in value of his shares.
Chapter 12
Activity 12.1
The petitioners argued that the majority shareholders who were also the directors had run three companies for their own benefit in that they claimed excessive remuneration while paying low dividends to non-director shareholders. On the facts the court considered that the petitioners had an arguable claim for relief under s.994 and that an order requiring the respondents to purchase the petitioners shares at a fair price to be determined by the court would be more appropriate than destroying the company by ordering its winding up.
Activity 12.2
The Court of Appeal held that the petitioner was not acting unreasonably in refusing to accept a valuation of his shares by the companys auditor, as provided in the articles,
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given that his shares might be discounted in circumstances where a discount was inappropriate. Balcombe LJ took the view that it would be just and equitable to ignore the articles of association and allow the petition to proceed. The converse of the decision in Virdi is that if an offer to purchase a petitioners shares is fair, the petitioner will be acting unreasonably in seeking a winding up order rather than seeking relief under s.994 CA 2006.
Activity 12.3
a. The evidence of the events giving rise to the claim spans a period of some 40 years. The petitions were brought against two associated companies, Macro (Ipswich) Ltd and Earliba Finance Co Ltd. The petitioners alleged that the conduct of the companies sole director, Mr. Thompson, (T), amounted to mismanagement which unfairly prejudiced their interests as members. At the time of the petition T was 83 years of age. He was described as a patriarchal figure and engaged in serious disagreements with the petitioners. It is noteworthy that of the three petitioners, one was Ts son and the other two were his nephews. Central to the mismanagement allegation was the complaint that Ts laissez faire style of management left the companies vulnerable to the dishonesty and neglect of his employees at Thompsons, an estate agency business which managed a substantial number of rental properties owned by the company. The petitioners alleged that Thompsons employees received secret commissions from builders, the costs of which were passed on to the companies, and that they took key money from new tenants. It was successfully argued that the substantial financial losses suffered were due to Ts mismanagement which unfairly prejudiced the petitioners. b. Arden J stated that the question of whether any conduct was unfairly prejudicial to the interests of the members has to be judged on an objective basis. First it has to be determined whether the action of which the complaint is made is prejudicial to members interests and, second, whether it is unfairly so. c. In granting relief, the court took the view that rather than appoint the petitioners to the board, which they had contended had been their expectation, T would be ordered to purchase his sons shares in Macro and Earliba.
Chapter 13
Activity 13.1
a. This case probably represents the harshest interpretation of the ultra vires doctrine and perhaps illustrates best the danger ultra vires posed to companies. In this case the companys object was to acquire and develop a German patent for producing coffee from dates. The company failed to get the German patent but obtained a Swedish one instead. Despite the fact the company had a thriving business based on the Swedish patent it was wound up by the court because it could not achieve its strictly stated object. b. Re Jon Beauforte and Re Introductions Ltd are further good examples of the problems thrown up by the ultra vires issue and the need for legislative intervention.
Activity 13.2
The statutory reforms have the combined effect of making it easier for companies to change their objects and of providing saving provisions for outsiders. This means that there are very few remaining ultra vires problems. Most of the criticism of the reforms has focused on the complexity of the solutions provided for what seems a relatively simple problem. The CLRSG in its Final Report (July 2001) (para 9.10) recognised this and recommended that any company formed under a new companies act should have unlimited capacity whether or not it chooses to have an objects clause. This was partly implemented in the CA 2006.
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Activity 13.3
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Activity 13.4
Lord Hoffmann viewed the organic theory of the company as largely unhelpful. Instead he considered that if a rule of law requires the court to determine the act or a state of mind of a person, and that rule was intended to apply to companies as well, the court can construct a special rule to test whether something can be attributed to the company. For example the court may not be limited to looking at the directing mind and will of the company but rather could also examine the state of mind of the individual responsible for the matter at hand, no matter what level they were at in the company.
Chapter 14
Activity 14.1
Buckley LJ explained that a person who holds all of the shares in a company is not entitled to control its business. Directors are not the servants of shareholders and so they are not bound to obey their directions given as individuals. Nor are directors the agents of shareholders, bound to follow orders given by their principals. But where the articles of association entrust directors with control of the company, such control can only be removed by amending the articles in accordance with the statutory procedure laid down by s.21 CA 2006 which requires a special resolution.
Activity 14.2
a. Article 90 provided that the board shall fix the annual remuneration of the directors subject to the proviso that without the consent of the general meeting such remuneration shall not exceed 100,000. Article 91 went on to confer on the board the power to grant special remuneration, in addition to ordinary remuneration, to any director who serves on any committee or who gives special attention to the business of the company. b. Mr Ward was a member of a committee set up by Guinnesss board of directors to guide the company through a takeover bid it had made for another company, Distillers. He had been paid a fee of 5.2m for his services which had been agreed by the committee. Lord Templeman, construing the language of the articles of association, found that they did not confer on the committee the power to pay remuneration to one of its own members. He said that Article 91 draws a contrast between the board and a committee of the board. The board is expressly authorised to grant special remuneration to any director who serves on any committee. It cannot have been intended that any committee should be able to grant special remuneration to any director, whether a member of the committee or not.
Activity 14.3
In reversing the trial judges finding that the respondents were not shadow directors within the statutory definition, Morritt LJ, having reviewed the case law, laid down five propositions. i. The definition of a shadow director is not to be too narrowly construed given that the purpose of the CDDA 1986 is to protect the public. ii. Although the purpose of the legislation is to identify those, other than professional advisers, with real influence in the corporate affairs of the company, it is not necessary that such influence should be exercised over the whole field of its corporate activities. iii. Whether any particular communication (by words or conduct) from the alleged shadow director is to be classified as a direction or instruction must be objectively ascertained by the court in the light of all the evidence.
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iv. Non-professional advice may come within the statutory description: the proviso excepting advice given in a professional capacity assumes that advice generally is or may be included. The concepts of direction and instruction do not exclude the concept of advice because all three share the common feature of guidance. The critical factor is whether the person has real influence over the companys affairs. v. Although it is sufficient to show that in the face of directions or instructions from the alleged shadow director the properly appointed directors (or some of them) cast themselves in a subservient role or surrendered their respective discretions, this is not necessary in all cases. Such a requirement would be to put a gloss on the statutory requirement that the board are accustomed to act in accordance with such directions or instructions.
Activity 14.4
H, as a non-executive director of the company, was signatory to the companys cheque account. The companys accounts, which H looked to when assessing the companys financial position, were prepared by professional accountants. The company went into liquidation and the Secretary of State applied for an order under s.6 CDDA 1986 on the basis that H had caused the company to operate a policy of not paying Crown monies and had failed to keep himself properly informed of the companys financial position. The grounds of the application were that beginning in June 1995 the company had ceased making National Insurance and PAYE payments. Also, the fact that the company was in arrears of VAT was apparent in the management accounts for February and April 1995. It was alleged by the Secretary of State that H either knew the payments were not being made or ought to have realised they were not being paid because he had not been requested to sign any cheques in respect of such payments. Further, H had signed a number of cheques to pay another directors sons school fees thereby allowing that director to breach his fiduciary duties by misusing company funds for his own personal use. H had questioned the propriety of these payments but had been assured by the accountants that they would be treated as part of that directors remuneration and would be properly reflected in the accounts as such. Notwithstanding the accountants advice H had refused to sign additional cheques for school fees and he had reported these payments to the board. The Secretary of States allegation that H had failed to keep himself properly informed of the companys financial health was rejected. Merely being a signatory to the companys cheques was not sufficient to make the director personally responsible for any policy of not paying Crown monies. H was entitled to rely on the assurances of the accountant that the finances of the company were being properly managed. The court held, taking Hs lack of experience in operating corporate finances together with his non-executive status, that he was entitled to rely on the accountants to prepare the accounts and on their assurances that the finances were being properly run. A cheque signatory is not a Finance director and is therefore not expected to possess such expertise. With respect to the cheques for school fees, H had acted on the advice of the accountant and had reported the payments to the board.
Crown monies: National Insurance, PAYE (employees income tax) and VAT (sales tax) are all collected by companies on behalf of the government and paid over at set intervals.
Chapter 15
Activity 15.1
In Coleman v Myers the board of a family company had recommended to the shareholders a takeover offer by a company controlled by one of the defendant directors. The court held that in a small private company where the minority shareholders habitually looked to the directors for advice on matters affecting their interests, a duty of disclosure arose which placed the directors in a fiduciary relationship with the shareholders. Woodhouse J stated that while it is impossible to lay down a general test as to when the fiduciary duty will arise, the following factors will be material to the courts determination: dependence upon information and advice, the existence of a relationship of confidence, the significance of some particular transaction for the parties and the extent of any positive action taken by or on behalf of the director or directors to promote it.
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Activity 15.2
Lord Wilberforce stated that the court should: i. consider the nature and scope of the power whose exercise is in question (in this case, a power to issue shares) ii. identify the limits within which it may properly be exercised iii. identify the substantial purpose for which it was actually exercised iv. having given credit to the bona fide opinion of the directors and accepting their judgment as to matters of management, determine whether the substantial purpose (point iii, above) fell within a legitimate purpose determined according to point ii, above. v. If the substantial purpose is proper, the exercise of the power will not be set aside because some other improper, but merely incidental, purpose was also achieved.
Activity 15.3
In Extrasure the directors had transferred company funds to another company in the group to enable it to pay a creditor who had been pressing for payment. It was held that the directors had acted without any honest belief that the transfer was in the interests of the transferor company. The decision clearly illustrates that where the company is one of a number in a group structure the directors must act bona fide in the interests of that company. This is, after all, a straightforward application of the decision in Salomon (see Chapter 3 of this guide) that each company is a separate legal entity. There may be situations, however, where acting in the interests of the group furthers the interests of the particular company. For example, if a subsidiary company is owed money by its parent company which is in financial difficulty the failure on the part of the directors to take action to recover its debts may be in the interests of the subsidiary if, on balance, it would be adversely affected by the liquidation of the parent company (see Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360).
Activity 15.4
All three of the directors (the executive and the two NEDs) were held liable to make good the companys losses and, while the judge noted the accountancy experience of the NEDs, their professional qualifications were not material to his finding. The court found the NEDs negligent in allowing Stebbings to do as he pleased. You should note Foster Js finding that the NEDs not only failed to exhibit the necessary skill and care in the performance of their duties as directors, but that they failed to perform any duty at all.
Activity 15.5
The directors were liable notwithstanding that:
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the company was financially incapable of purchasing the necessary shares they had used their own money they had acted honestly.
As Lord Russell pointed out, the liability to account for any profit does not depend upon fraud or absence of bona fides, the liability arises from the mere fact of a profit having, in the stated circumstances, been made. The fact that the purchasers of the company in effect got a reduction on the purchase price they had agreed was irrelevant to the issue of liability. The decision illustrates that the liability of directors in this respect is founded upon their trustee-like status thus, like trustees, directors will hold any secret profit (i.e. a profit not disclosed to and ratified by the shareholders) on constructive trust. The new board caused the company to bring the claim against its former directors. As we saw in Chapter 11, the proper claimant rule requires the company to bring proceedings for redress when a wrong has been committed against it.
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Chapter 16
Activity 16.1
This is a good way for you to bring company law to life a bit more by thinking about how various aspects of company law can be categorised. As a general guide, mandatory company law rules, such as minimum capital requirements which override any private agreements between contracting parties, sit easier with concession theory, where state interference is more easily justifiable. Default rules, such as the articles of association which apply in the absence of any agreement to the contrary, and enabling rules, such as the company registration procedure, which provide a framework for private parties to carry out certain functions sit easier with aggregate theory. Additionally the common laws protection of managerial discretion seems to have some resonance with corporate realism. Company law, as you will note, is not in reality dominated by any one theory but is a mix of all three.
Activity 16.2
This is a provocative statement and you must agree or disagree with it. Do not sit on the fence as a strong argument on one side or the other is the only way to deal with it. The statement is interesting given that until recently it was generally agreed that corporate governance had improved. Given the collapse of the financial services sector in the UK and US over the course of 2008-9 corporate governance failure is once more at the top of the reform agenda. While it is true that the committees have been a great export success, with many countries adopting their recommendations, this may not be the success it might have seemed. It now seems that the reason why these recommendations are particularly palatable for the global business community is that they are not particularly onerous. If you have not already read Dignam and Lowry, Chapter 15, please do so now.
Chapter 17
Activity 17.1
The primary purpose of liquidation is to ensure, as far as possible, that all creditors receive fair treatment, so if there is any scheme put in place which prevents this the court will set it aside. Thus, the House of Lords held that the pari passu principle of distribution (by which is meant that the free assets of the company are distributed pro rata among unsecured creditors) is mandatory to the extent that a creditor cannot, by contract, obtain a better position than that which the pari passu principle permits.
Activity 17.2
The objectives of the IA 1986, which implements the recommendations of the Report of the Review Committee on Insolvency Law and Practice (Cork Committee Report, 1982, (Cmnd 8558)), are:
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to maximise the return to creditors where the company cannot be saved to establish a fair system for the ranking of competing claims by creditors to provide a mechanism by which the causes of the companys failure can be identified and those guilty of mismanagement can be made answerable.
The compulsory winding up procedures and the powers of a liquidator and the court to police the winding up seeks to achieve these objectives.
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Activity 17.3
Buckley LJ explained that there may be circumstances where it is beneficial, both to the company and to the unsecured creditors, that the company be allowed to dispose of some of its property after the petition has been presented. However, he stressed that in considering whether to make a validating order the court should ensure that the interests of the unsecured creditors are not prejudiced. Where an application is made in respect of a specific transaction this may be susceptible of positive proof. But, whether or not the company should be permitted to carry on business generally is more speculative and will depend on whether a sale of the business as a going concern will be more beneficial than a break-up realisation of the assets. Buckley LJ concluded by saying that, although the court will be disinclined to consent to any transaction which has the effect of preferring a pre-liquidation creditor, nevertheless the court would be inclined to validate a transaction which would increase, or has increased, the value of the companys assets, or which would preserve, or has preserved, the value of the companys assets from harm which would result from the companys business being paralysed
Activity 17.4
No feedback provided.
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Notes
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