corporate law november 2009 suggested answers …...corporate law november 2009 suggested answers...

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CORPORATE LAW NOVEMBER 2009

SUGGESTED ANSWERS AND EXAMINER’S COMMENTS

IMPORTANT NOTICE When reading these answers, please note that they are not intended to be viewed as a definitive “model” answer, as in many instances there are several possible answers/approaches to a question. These answers indicate a range of appropriate content that could have been provided in answer to the questions. They may be a different length or format to the answers expected from candidates in the examination. EXAMINER’S GENERAL COMMENTS Both the pass rate and general standard of the scripts was in line with previous years. Those who do well on Section A tend to pass overall, even though they perform less well when answering the Section B questions. The ability to cope with the Section B questions continues to be a major problem for many candidates. However, there were some very good scripts in which the candidates displayed a thorough knowledge of corporate law principles and cases. Some candidates appear to be reproducing „model‟ answers when attempting some of the Section B questions, perhaps relying on the published answers on the Institute‟s web site. This was true for Question 4, on minority protection, and Question 6, on charges. The effect of adopting this strategy is that the candidates‟ answers do not always deal with the issues raised in the question. Once again, it should be stressed that the key to succeeding on this paper is to revise the whole syllabus. This year, a number of candidates displayed significant knowledge gaps in the material covered by Section A. In order to maximize their full potential, candidates should ensure that they are able to identify the legal issues raised in the Section B questions and that their answers are supported with reference to decided cases and statutory provisions.

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SECTION A (Compulsory – answer all parts of this question)

1. (a) Explain how the courts use the alter ego doctrine to hold companies

criminally liable. (4 marks)

SUGGESTED ANSWER As a company is an artificial person, there are obvious difficulties in finding them guilty for crimes requiring an intention. One approach of the courts is to rely on the alter ego doctrine. This requires the court to identify a person in the company of sufficient importance that their guilty acts will be seen as those of the company itself. Such a person is treated as the company‟s alter ego (other self), and they are also sometimes referred to as the „directing mind and will‟ of the company. The difficulty with this doctrine is in establishing that the relevant person is sufficiently important. In Tesco Supermarkets v Natrass [1972] a branch manager of Tesco was held not to be sufficiently important but in DPP v Kent and Sussex Contractors Ltd [1944], a transport manager was. Similarly, in Moore v Bresler Ltd [1944] a company was convicted of tax fraud based on the acts of its company secretary and branch manager. (Credit was also given if candidates explained that the alter ego doctrine was not applied to the crime of corporate manslaughter and that this is now dealt with by the Corporate Manslaughter and Corporate Homicide Act 2007.)

EXAMINER’S COMMENTS This question was generally poorly answered. Many candidates were unable to write anything at all and only a handful of answers focused on the alter ego doctrine. Most candidates thought it was a question on lifting the veil and wrote everything that they knew on the topic.

(b) What rule was established by the case of Royal British Bank v

Turquand (1856)? (4 marks)

SUGGESTED ANSWER This case established the „indoor management rule‟ and was designed to reduce the impact of the doctrine of constructive notice. The rule states that third parties acting in good faith and without notice can assume that matters of indoor management, such as consents and appointments, have been properly complied with. So, in the case itself, the third party bank was entitled to assume that the directors had obtained the consent of the general meeting required by the articles to validate company borrowing.

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EXAMINER’S COMMENTS This question challenged many candidates who did not appreciate that the question was linked to the doctrine of constructive notice. It was not answered very well by the majority of candidates, many of whom wrote lengthy answers, of a general nature, on ultra vires. As with part (a), some candidates simply did not attempt this question.

(c) When must an annual general meeting be held in the case of a public

and a private company respectively? (4 marks)

SUGGESTED ANSWER A public company must hold an annual general meeting (AGM). Under s336 CA 2006 the AGM of a public company must be held in each period of 6 months beginning with the day following its accounting reference date. If the company changes its accounting reference date by giving the appropriate notice, the company must hold its AGM within 3 months of giving that notice. A private company is exempt from holding an AGM as s336 only applies to public companies. EXAMINER’S COMMENTS This question was reasonably well handled although some candidates did not include in their answers the private company exemption and the time limits were not always accurately stated.

(d) What are the usual advantages of owning preference shares? (4 marks) SUGGESTED ANSWER In the absence of specific provisions, the usual advantages of owning preference shares are: (i) The right to receive an annual dividend based on a fixed percentage of the

nominal value. There must be distributable profits out of which to pay the dividend but a preference shareholder will receive their dividend before any dividend is paid to the ordinary shareholders.

(ii) There is a rebuttable presumption that the dividend is cumulative, which means that if it is not paid in any one year it is carried over to the next year.

(iii) In the event of insolvency, a preference shareholder will have their capital returned to them first in preference to the other classes of shares.

Although there is no right to attend and vote at meetings, a preference shareholder does have the right to attend and vote at class meetings.

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EXAMINER’S COMMENTS This question was well answered on the whole and candidates generally scored well on it.

(e) When must a disqualification order be made under the Company

Directors Disqualification Act 1986 and what, in that case, is the disqualification period? (4 marks)

SUGGESTED ANSWER Section 6 of the CDDA 1986 provides that a court must disqualify a director following a finding of unfitness. The court has no discretion under this provision and a disqualification order is mandatory. The court must be satisfied that the director is or has been a director of an insolvent company and that their conduct makes them unfit to be concerned in the management of a company. The period of disqualification is between 2 and 15 years. (Credit was also given if a candidate referred to the leading case of Re Sevenoaks Stationers [1991] in which the Court of Appeal gave guidance on how this period is to be applied:

10 years plus for „particularly serious cases‟. 6-10 years for „serious cases not meriting the top bracket‟.

2-5 years for „not very serious cases. In addition, credit was also awarded if a candidate explained that under s9A CDDA 1986, a court must make a disqualification order against a person who commits a breach of competition law and that his conduct makes him unfit to be concerned in the management of a company. The court may disqualify for up to 15 years.) EXAMINER’S COMMENTS This question produced some very long answers. The main reason for this was that candidates wrote about every situation when a director can be disqualified, rather than focusing on when a court must disqualify a director.

(f) A director is under a statutory duty to promote the success of the

company. What does this mean? (4 marks) SUGGESTED ANSWER This is dealt with in s172 CA 2006. A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. The duty is subjective and is owed to the company, reflecting the previous common law position in Percival v Wright [1902]. „Success‟ is likely to mean the long-term financial success of the company, although its exact meaning will be a matter for interpretation by the courts through case law.

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The section goes on to require that, when directors are exercising this duty, they shall have regard to a number of other stakeholders such as the company‟s employees, customers and the environment. This reflects an approach known as „enlightened shareholder value‟, which means that directors need only consider the other stakeholders to the extent that they benefit and are compatible with the interests of shareholders generally. EXAMINER’S COMMENTS Most candidates knew of this duty and were able to say something about it. The answers generally suffered from the same problem as those in Question 1(e); candidates did not focus on this duty but wrote about all of the duties. Irrelevant material attracts no credit and eats into valuable examination time.

(g) What is a derivative action, and when can such an action be brought? (4 marks) SUGGESTED ANSWER Derivative actions are now governed by statute. The relevant provisions are contained in ss260-269 CA 2006. A derivative action is defined in ss260(1) as proceedings brought by a member of a company: „(a) in respect of a cause of action vested in a company, and (b) seeking relief on behalf of the company.‟ A derivative action can only be brought „in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.‟ These actions are brought by members when the company itself is unwilling or unable to bring the action because the wrongdoers are preventing the company from commencing proceedings. They are particularly useful for remedying a breach of directors‟ duties when the directors have control of the company preventing litigation being commenced against them. EXAMINER’S COMMENTS The majority of candidates were able to explain the nature of a derivative action and scored well. However, a significant number of candidates referred to the previous common law position and did not appreciate that derivative actions were put on a statutory footing in the CA 2006.

(h) What are the legal requirements for having a company secretary in the

case of a public and a private company respectively? (4 marks)

SUGGESTED ANSWER Under s270 CA 2006, a private company is not required to have a company secretary.

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Under s271 CA 2006, a public company must have a company secretary. Under s273, the directors of a public company must take all reasonable steps to secure that the secretary has the requisite knowledge and experience to discharge the functions of the secretary. This is usually established by showing that the secretary is a member of one of a number of professional bodies and has the relevant qualifications. EXAMINER’S COMMENTS Most candidates scored well on this question, although some did not include in their answers that private companies are no longer required to appoint a company secretary. The requirements to ensure that the secretary is suitably qualified and experienced were well known.

(i) Distinguish between a secured and an unsecured creditor of a

company. (4 marks)

SUGGESTED ANSWER A secured creditor is one who has taken security over company property. In the event of non-payment, the lender will enforce the security and, in the event of winding up, will enjoy priority over other unsecured lenders. The extent of their priority will depend on the nature of the security taken. The two most common types of security are the fixed and floating charge. An unsecured creditor will not have any priority in the winding up of the company and may receive nothing in an insolvent liquidation. They will rank with the other unsecured trade creditors and, if there is not enough money to pay them all, they will rank pari passu. EXAMINER’S COMMENTS This question was well answered and nearly every candidate was able to give an example of a secured and unsecured creditor. However, there was some confusion, with a significant number of answers stating that a fixed charge holder is a secured creditor but a floating charge holder is not. Both charges give the holder security over the property of the company.

(j) Explain the potential consequences of fraudulent trading. (4 marks)

SUGGESTED ANSWER Fraudulent trading is dealt with in s213 of the Insolvency Act (IA) 1986. The provision is not limited to directors and applies to „any persons‟. Where proven, the person may be ordered by the court to make a contribution to the assets of the company. This means they will be asked to pay a sum of money to the liquidator. The court has no power to order who will receive the money and it goes into the general fund available to the liquidator to distribute in accordance with the statutory rules on the order of distribution of assets of a company on a winding up. It is also a criminal offence under s993 CA 2006.

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Under the Company Directors Disqualification Act (CDDA) 1986, s10, a person found to have traded fraudulently under s214 IA 1986 may be disqualified for a maximum of 15 years. Section 4 of the CDDA is the equivalent provision in relation to fraudulent trading under s993 CA 2006. EXAMINER’S COMMENTS The concept of fraudulent trading was understood by almost every candidate. However, this was another question that produced unnecessarily long answers because candidates described fraudulent trading, rather than focusing on the consequences of it.

SECTION B

(Answer THREE questions from this section) 2. A Ltd (‘the company’) operates a taxi business, which is its main object as

stated in its Memorandum of Association when the company was formed in 2007. The directors and only shareholders are Emily and Jeff. The company wants to diversify and move into the business of pig farming. It has identified a piece of land, which is owned by Jeff, which it can use for pig farming. The company is proposing to finance the purchase of the land by: (i) borrowing £200,000 from its bank, which has asked the directors to

give personal guarantees in respect of the loan; and (ii) issuing 50,000 preference shares with a nominal value of £1 to

Marion, who is Jeff’s wife.

Marion will pay 75 pence each for the preference shares which are to be credited in the company’s accounts as being fully paid up.

REQUIRED

Advise Emily and Jeff on the following matters: (a) The relevance of the doctrine of ultra vires to their plans to diversify.

(7 marks)

SUGGESTED ANSWER The answer to part (a) could have been answered either applying the pre-2006 CA position or post 2006. This is because of the time when the new 2006 Act provisions came into force. In subsequent examinations only, the post 2006 law should be relied on. Pre CA 2006 answer The company has an objects clause of operating a taxi business and now wishes to diversify into pig farming. At common law, any pig farming activity would be treated as ultra vires and beyond the company‟s capacity with the result that the transactions

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would be void and unenforceable by or against the company. See Ashbury Railway Carriage and Iron Co v Riche [1875] and Re Introductions Ltd [1970]. The statutory provisions are found in ss35, 35A and 35B CA 1985. Under s35(1), the validity of an act done by a company shall not be called into question by reason of anything in its Memorandum. This provision protects both A Ltd and any third parties who enter into contracts with the company, against claims that it is ultra vires. Thus, Emily and Jeff should be advised that any pig farming contracts will be valid as between the company and third parties. Such contracts will be regarded as being within the company‟s capacity. Under s35(2), a member of a company can seek a restraining order against a proposed ultra vires act of the company. Under s35A(1), third parties dealing with the board of directors can assume that the powers of Emily and Jeff to bind the company are free of any limitation under the company‟s constitution. Under s35B, there is no duty on third parties to enquire either about company capacity or about the authority of Emily and Jeff when acting on behalf of the company. However, Emily and Jeff will be in breach of their duties as directors under s 35(3) for failing to observe the limits on their powers flowing from the Memorandum; they should have observed the object to operate as a taxi business and not to expand into pig farming. This breach of duty can be cured by ratification of the members by passing a special resolution. In addition, the company will need to pass an additional special resolution to obtain the benefit of the contract. The safest course of action for them is to alter the objects clause in the Memorandum and add pig farming to the existing objects. This can be done by special resolution under s4 CA 1985. Post CA 2006 answer Under s31 CA 2006, unless a company‟s articles specifically restrict the objects of the company, its objects are unrestricted. This now allows companies to have unlimited contractual capacity. Any previous objects contained in the company‟s memorandum will be treated as provisions of the articles under s28 CA 2006. The company has an objects clause of operating a taxi business and now wishes to diversify into pig farming. At common law, any pig farming activity would be treated as ultra vires and beyond the company‟s capacity with the result that the transactions would be void and unenforceable by or against the company. See Ashbury Railway Carriage and Iron Co v Riche [1875] and Re Introductions Ltd [1970]. The position is now governed by ss39 & 40 CA 2006. Section 39 provides that 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 company‟s constitution. Thus, Emily and Jeff should be advised that any pig farming contracts will be valid as between the company and third parties. Such contracts will be regarded as being within the

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company‟s capacity. Under s40, third parties dealing with the board of directors can assume that the powers of Emily and Jeff to bind the company are free of any limitation under the company‟s constitution. However, internally, as between the directors and the company, the directors are under a duty to act in accordance with the constitution and to only exercise powers for the purpose for which they are conferred. Pig farming is beyond the constitution and is a breach of their duties as directors under s171 CA 2006. As they are the only directors and shareholders it is unlikely that there will be any consequences for this breach, but if the company goes into liquidation, the liquidator may bring an action on behalf of the company to recover any losses arising out of pig farming activity. The safest course of action for them is to alter the constitution and either delete the objects clause or add pig farming to the existing objects. This can be done by special resolution under s21 CA 2006.

(b) Any potential liability for breaches of directors’ duties relating to their

proposal to purchase the land from Jeff, and any other requirements which need to be satisfied to ensure the validity of the transaction.

(8 marks)

SUGGESTED ANSWER The proposal to buy the land from Jeff raises a potential breach of duty by him under ss175 and 177 CA 2006. Under s175, there is a general duty to avoid a conflict of interest and it applies in particular to the exploitation of corporate property, information or opportunity. Under 177 CA 2006, if a director is in any way, directly or indirectly, interested in a proposed transaction with the company, he must declare the nature and extent of that interest to the other directors. The declaration may be made at a meeting of the directors or may be given in writing and must be given before the company enters into the land purchases, ss177(2),(4). Jeff would not need to give the information if he was not aware of his interest or if it could not reasonably be said to be regarded as likely to give rise to a conflict of interest, ss177(5),(6). Clearly, on the facts, this is not applicable. However, no declaration is needed if the other directors are already aware of the interest and this may be relevant to Emily and Jeff. A breach of this duty will make Jeff liable for any losses incurred as a result of the breach but it may be ratified under s239 by the members by ordinary resolution. Jeff will not be allowed to vote under s239(4) and this reverses the previous law in Northwest Transportation v Beatty [1887]. The proposed purchase will also activate the substantial property transaction provisions in ss190-196 CA 2006. This is because the company will be acquiring a substantial non-cash asset from one of its directors. It is regarded as „substantial‟ as the purchase price exceeds £100,000 under s191 (2) (b).

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The land purchase will, under these provisions, require the approval of the members by ordinary resolution, s190(1). A failure to obtain the prior approval renders the land purchase contract voidable at the instance of the company. Whether or not the contract is avoided, Jeff and Emily will be liable to account for any gain made and to indemnify the company (jointly and severally) for any loss or damage as a result of the purchase. However, under s196, the members may subsequently affirm the transaction within a reasonable time period if it was entered into without initial authorisation.

(c) The legality of the issue of preference shares, and their potential

personal liability for the £200,000 loan. (5 marks)

SUGGESTED ANSWER The preference shares The proposal to issue these shares to Jeff‟s wife, Marion, infringes the no discount rule. Under s542 CA 2006, shares must each have a fixed nominal value. The no discount rule is contained in s552 CA 2006 and means that the company must receive at least the nominal value for its preference shares of £1. The directors will either need to obtain the full nominal value or reduce the nominal value of the preference shares to 75 pence. It could, perhaps, also be argued that the shares are currently only partly paid, in which case the company, or the liquidator in the case of the company‟s liquidation, could call for the unpaid amount of 25p per share from Marion. As Marion is Jeff‟s wife, Jeff is once again in a conflict of interest situation within s177 CA 2006, as issuing the shares to Jeff‟s wife is a proposed transaction (see above). He is in a conflict situation because his wife is regarded as a „connected person‟ and falls within ss252, 253 CA 2006. However, this situation is likely to fall within s177(6)(b) and so Jeff need not declare an interest as the other director, Emily, is aware that Marion and Jeff are married. The personal guarantee The directors, Marion and Jeff, have signed personal guarantees in respect of the £200,000 loan with the bank. If their company defaults on the loan they will be personally liable under the guarantee for any outstanding amounts. In effect, they will no longer enjoy the benefit of limited liability which they would otherwise have as shareholders. EXAMINER’S COMMENTS This was one of the most popular Section B questions attempted. It was not handled particularly well by the majority of candidates. The answers were often too general and lacked sufficient detail. For example, in part (b), even though the question specified that the issue was about directors duties, most candidates were unable to go logically through the statutory provisions in any detail. Instead, answers would simply say something like that „there is a breach of the no conflict rule‟, without explaining the rule,

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illustrating it with reference to decided cases and then applying it to the question. It is poor examination technique to simply list the duties of a director; the relevant duty needs to be explained and applied to the facts.

3. The shares of B plc (‘the company’) are listed on the London Stock Exchange. After a month of negotiations, a takeover bid for B plc was recently made by Z plc. Before news of the takeover bid was publicly announced, the following events took place:

(i) Trevor, the managing director of the company, told his wife, Jan,

about the takeover bid and she immediately purchased some shares in the company.

(ii) Trevor told Edward, a shareholder in the company, about the takeover

bid, and Edward also purchased some shares in the company. (iii) Trevor was approached by Jill, a shareholder in the company. She told

Trevor that she was thinking about selling her shares in the company and Trevor purchased them from Jill privately, off-market, without informing her about the takeover negotiations, for £5.00 per share.

When the takeover was publicly announced, the share price of B plc rose from £5.00 to £8.00. The takeover bid was successful after being agreed to by 90% of the company’s shareholders. REQUIRED Advise: (a) Trevor, Jan and Edward on any potential liability for insider dealing;

(10 marks)

SUGGESTED ANSWER The law on insider dealing is contained in the Criminal Justice Act 1993. The Act is entirely criminal and has no civil consequences. It applies to companies listed on a „regulated market‟ and this includes those companies listed on the London Stock Exchange. Insider dealing is a crime based on using „inside information‟ for the purpose of making a profit or avoiding a loss. The Act requires dealing in „securities‟ which are listed in Schedule 2 of the Act and includes shares. Inside information is not defined but the criteria is contained in s56 of the Act. The information must relate to particular securities (shares) or to a particular issuer of securities (a company) and not to securities or issuers generally. It must also be specific or precise, have not been made public but, if it were to be made public, it must be likely to have a significant effect on the shares price. Information relating to a takeover bid

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satisfies these criteria and, therefore, the information is inside information within s56 of the Act. Insiders are dealt with by s57 of the Act. To be an insider, a person must have and know that they have inside information and the information must come from an inside source. A person has information from an inside source if he has it through being, or obtained the information from, a director, employee or shareholder in a company. Trevor is an insider as he is a director of the company. Jan may be an insider as she got the information from her director husband, provided she knows that it is inside information. As a shareholder, Edward is also treated as an insider. The offences of insider dealing are contained in s52. The first offence is the dealing offence, which is the buying or selling of shares either as principal or agent. Jan and Edward have dealt by purchasing some more shares and are potentially guilty of the offence. Trevor told Edward and Jan and this may constitute the disclosure offence. Merely disclosing the information is an offence unless it is in the proper performance of the function of a person‟s employment, office or profession. Trevor purchased shares from Jill. However, these were bought privately and private sales are not caught by the Act. None of the defences in s53 or in Schedule 1 of the Act apply. Insider dealing is an either way offence and punishable by a fine and/or imprisonment. If convicted summarily, a person may be disqualified for up to 5 years and for up to 15 years if tried on indictment, s2 CDDA 1986.

(b) Jill, who wants to rescind her contract with Trevor for the sale of her

shares; and (5 marks)

SUGGESTED ANSWER Trevor purchased Jill‟s shares at a time when the take-over bid negotiations were in progress. The sale price was £5 and so Trevor has made a £3 profit per share. The problem for Jill is the case of Percival v Wright [1902] in which it was held that directors owe their duties to the company and not to individual shareholders. On similar facts, a director was held not to have broken his duty and rescission was refused. This case was recently confirmed by the Court of Appeal in Peskin v Anderson [2000] in which four members of the RAC were held not to be entitled to be informed of the possible de-mutialisation of the company and the resulting windfall that they would have received. The codification of directors‟ duties in ss170-177 of the CA 2006 appears also to confirm this position. In particular, section s172 requires directors to promote the success of the company for the benefit of its members as a whole and this is thought to codify the decision in Percival v Wright. There have been cases where the courts have found an individual duty owed to a shareholder but these have involved small companies and special circumstances. See Coleman v Myers [1977] and Allen v Hyatt [1914]. It is unlikely that Jill‟s contract will be rescinded.

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(c) the minority shareholders in the company on any rights they may have in respect of the takeover bid. (5 marks)

SUGGESTED ANSWER The minority shareholders should be advised that s983 CA 2006 applies. This provides for the right of a minority shareholder to require the offeror in a successful take over to acquire his shares. This arises because Z plc has already acquired 90 per cent of the voting shares in the company. In this situation, the minority 10 per cent holder is entitled to ask and require Z plc to buy their shares on the same terms as the offer or on any other terms as may be agreed. EXAMINER’S COMMENTS This was another popular Section B question which produced some very mixed answers. The insider dealing provisions were generally well known and applied to the facts of the question, but parts (b) and (c) were poorly dealt with. The majority of candidates struggled to identify the legal issues raised by these questions and were sometimes not attempted at all.

4. Angela, Barbara and Claire were originally partners in a hairdressing

business. They formed Hair Today Gone Tomorrow Ltd (‘the company’) in 2006 to take over the business. They are the only directors and shareholders in the company, each owning 100 shares.

The Articles of Association provide that any disputes between the company and members shall be determined by arbitration. The company quickly prospered and is still successful, but by 2007 Claire became unhappy with the way Angela and Barbara managed the business. She felt that they were taking unnecessary management risks, that they did not consult her on important matters and that they did not give her access to the company’s financial information. This caused Claire to lose interest in the management of the company, and she has not been involved in the decision-making process of the company for the last two years. As a result, Angela and Barbara removed her as a director two months ago. Claire has asked them to purchase her shares but they have refused to do so. REQUIRED Advise Claire of any statutory remedies she may rely on. (20 marks) SUGGESTED ANSWER Claire is a minority shareholder and she may be able to rely on either s994 CA 2006 and/or s122 IA 1986. The company is likely to be treated by a court as a quasi- partnership type company, in other words, an incorporated partnership. This is because it has one or more of the

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characteristics identified by Lord Wilberforce in Ebrahimi v Westbourne Galleries Ltd [1973]. These are: (i) that the relationship between the members and directors is built on mutual trust and confidence and is likely to be satisfied where the business was originally carried on as a partnership; (ii) that there is an agreement or understanding that all of the members will participate in the management of the company; and (iii) that there is a restriction in the company‟s constitution on the transfer of a member‟s shares. The jurisdiction under s122 IA 1986 Section 122(1) (1) (g) IA 1986 provides that a company may be wound up by the court if it is of the opinion that it is just and equitable to do so. The facts have some similarity with the Ebrahimi case. In that case, Ebrahimi, who was a shareholder and director, was removed by the other two shareholders by passing an ordinary resolution under what is now s168 CA 2006. The House of Lords treated Westbourne Galleries Ltd as an incorporated partnership. They held that although they had the legal right to remove Ebrahimi under s168, the exercise of this right was subject to equitable principles and removing him was unfair and they granted a winding up order. Claire may seek to rely on this remedy but it is a drastic remedy and is limited by s125(2) IA 1986. This provides that the just and equitable remedy will not be available if there is another, alternative, remedy available to the petitioner which they are unreasonably refusing to pursue. The alternative remedy is contained in s944 CA 2006 which may be available to Claire but could also include any reasonable offer to buy her shares, but the others have refused to do this. The jurisdiction under s994 CA 2006 This provision provides a remedy for a member when „the affairs of the company are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members‟. A petition under s994 may be combined with a petition to wind up the company on the just and equitable ground. In Re R A Noble & Son (Clothing) Ltd [1983], Slade J said that a member can bring himself within the provision if they can show the value of their shareholding has been seriously diminished or at least jeopardized by the conduct complained of. However, this is not a condition, so Claire may still be able to rely on the provision even though the company is still successful. Claire feels that the other two directors have taken unnecessary management risks. Commercial misjudgment on its own does not amount to unfairly prejudicial conduct; it must be gross and over a prolonged period to fall within the scope of s994, See Re Macro (Ipswich) Ltd [1994]. The leading case on s944 is O‟Neill v Phillips [1999]. In this case, Lord Hoffman said that it is not enough that the company is a quasi partnership because „fairness‟, as used in the section, usually requires some breach of the terms on which the member had agreed that the affairs of the company should be conducted. The terms are contained in the constitution of the company but may also be found in some wider, equitable, agreement or understanding. Claire should argue that there was an agreement or understanding that she would continue to be a director and not be removed from office.

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Some of the cases refer to this as a „legitimate expectation‟. See Re Saul D Harrison & Sons plc [1995]. In Phoenix Office Supplies Ltd v Larvin [2002], the Court of Appeal applied the O‟Neill decision and held that a petitioner must prove fault on the part of the respondents. The fact that Barbara and Angela have refused to buy Claire‟s shares is not sufficient to invoke the remedy. Here, however, Claire may rely on her removal as a director and their refusal to give her access to the company‟s financial information. The fact that Claire is complaining about being removed as a director will not be a bar to her relying on s994. In Re a Company [1986], Hoffmann J said that, in a small company, a member‟s interests as a member may include a legitimate expectation that he will continue to be employed as a director and a dismissal will be treated as unfairly prejudicial conduct to his interests as a member. However, one difficulty Claire may face in relying on s994 is that a petitioner must not be the cause of her own problems. It seems that Claire was dismissed only after she lost interest in the management of the company. In Re R A Noble & Son (Clothing) Ltd [1983], the judge refused to grant a remedy under s944 in similar circumstances because, although the conduct (removal of a director who had lost interest) was prejudicial, it could not be considered unfair. Instead, the court granted a winding up order under s122 IA 1986. The remedies for unfairly prejudicial conduct are contained in s996 CA 2006. The court can make any order it thinks fit but the usual remedy is a share purchase order with no discount being applied to reflect the fact that Claire is only selling a minority holding. Where will dispute be heard? Arbitration clauses in a company‟s articles of association have been the subject of a number of cases. The issue is whether the company or Claire can rely on the clause and insist on arbitration rather than court proceedings to determine their dispute. The articles constitute a contract between the company and its members under s33 CA 2006. In Hickman v Kent or Romney Marsh Sheepbreeders‟ Association [1918] an arbitration clause was enforced by the company against a member. However, in Beattie v E & F Beattie Ltd [1938], the court refused to allow a shareholder who was also a director to rely on an arbitration clause when he was complaining about a dispute with his company relating to the failure to account for company money in his capacity as a director. Directors are treated as outsiders and beyond the scope of s33. See Eley‟s Case [1876], where a company secretary was treated as an outsider. For the purposes of relying on the arbitration clause, Claire should argue that her dispute is in her capacity as a member and that, as a member, she has the right to have the articles observed. See Salmon v Quinn & Axtens Ltd [1909].

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EXAMINER’S COMMENTS There was a disappointing approach to this question and many candidates were unable to identify the statutory protection offered by s122 IA 1986 and s994 CA 2006. The majority of those that did were unable to provide any real detail about these remedies. The derivative action was explained better and in more detail but any remedy obtained goes to the company and so Claire would be better off relying on s994 CA 2006 – unfairly prejudicial conduct. The arbitration clause in the articles was sometimes not dealt with at all.

5. Happy Haulage Ltd (‘the company’) is a company whose business is

transporting goods by road. Its only director is Heather, who is married to Simon, and they are the only shareholders. Heather habitually does what Simon tells her to do in relation to the management of the company. The company is in compulsory liquidation and the liquidator, Edward, has discovered the following facts and seeks your advice:

(a) The main cause of the company’s insolvency was a fire which

destroyed its entire fleet of vehicles. The company’s insurers have legitimately refused to indemnify it for the value of the vehicles because Heather failed to disclose material facts when she signed the insurance proposal form without bothering to read it. (7 marks)

SUGGESTED ANSWER By failing to read the insurance proposal before signing it, Heather may be in breach of her duty to exercise reasonable care, skill and diligence under s174 CA 2006. This requires a director to achieve the standard of a reasonable diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and the general knowledge, skill and experience that the director has. This introduces an objective standard but also takes into account any skills and experience the director personally has and the director will be judged by the higher of the two standards. Much will depend on the skill, qualification and experience Heather has but, regardless of this, a reasonable director might be expected to read important documents such as insurance forms before signing them. The facts are similar to the case of Re D‟Jan (of London) Ltd [1999] in which it was held a director was in breach of the previous common law duty of care when they signed an insurance form without reading it. However, the court went on to excuse the director from breach of duty under what is now s1157 CA 2006. This requires the court to find that the director acted both honestly and reasonably. The case is generally considered to be a generous application of the provision If there has been a breach of the duty in s174, Heather may be personally liable for the resulting losses of the company. The liquidator, Edward, has the power to commence

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litigation in the name of the company against directors for breaches of duty by virtue of s212 IA 1986. (b) Heather and Simon transferred the remaining assets of the company

to another company, Alpha Ltd, in which Heather is the sole director and shareholder. This was done six months ago, on legal advice, in order to put the assets beyond the reach of the company’s creditors. (7 marks)

SUGGESTED ANSWER Transferring the assets of the company to Alpha Ltd, which is owned and controlled by Heather, may amount to a transaction at an undervalue. This is dealt with in s238 IA 1986. A transaction at an undervalue is one where the company either gives away its property for no consideration or receives significantly less consideration than it has provided. The liquidator must establish that the company was insolvent at the time of the transaction and that it occurred within 2 years of the presentation of the winding up order being presented to the court. This should not be problem for Edward as the transfer was done six months ago. The court has wide powers to order the transfer of property to correct the situation. An alternative claim may lie under s423 IA 1985, on the basis that the transfer is a transaction defrauding creditors. Under this provision, there is no need to show that the company was insolvent and there are no time limits. The liquidator will have to show that the transaction was entered into for the purpose of putting assets beyond the reach of the company‟s creditors. It makes no difference that it was done on legal advice. In Arbuthnot Leasing Ltd v Havelet Leasing Ltd (no 2) [1990], a company‟s business assets were transferred to an off-the-shelf company shortly before it went into receivership. This was done on legal advice and the court ordered the reversal of the transaction. A further possibility is to ask the court to lift the veil of incorporation of Alpha Ltd as it is a façade for the activities of Heather. A case in point is Re Trustor AB v Smallbone [2001] – company funds were transferred without authority by a director from company A to company B, a company he owned and controlled. Both company B and the director were jointly and severally liable to repay the money.

(c) Simon is currently subject to a three-year disqualification order after

his previous company, Happy Hauliers Ltd, went into liquidation. (6 marks)

SUGGESTED ANSWER Simon is the subject of a disqualification and under s1 CDDA 1986 he is, therefore, prohibited from being, without leave of the court, directly or indirectly involved in the formation or management of a company. Although Simon is not a de jure director of the

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company, he may be regarded as a shadow director as Heather habitually follows his instructions. See s251 CA 2006 and Re Hydrodan (Corby) Ltd [1994]. Shadow directors are also subject to the CDDA 1986 provisions. Acting whilst disqualified is likely to be regarded as falling within the „serious‟ bracket laid down in Sevenoaks Stationers Ltd [1991] and may result in a further disqualification period for Simon in excess of 10 years. Acting as a shadow director whilst disqualified may also mean Simon is personally liable for the debts of the company under s15 CDDA 1986. Acting as a shadow director may also mean that Simon is subject to the provisions in ss216, 217 IA 1986 dealing with the re-use of company names. The choice of the name Happy Haulage Ltd may be a prohibited name under ss216, 217 IA 1986. Under these provisions, a director of an insolvent company is prohibited from using any name or similar name by which the company was known in the 12 months prior to insolvency. The prohibition lasts for 5 years unless the court grants leave to use it. It can be argued that the names Happy Haulage and Happy Hauliers are similar. Breach of the provisions can result in Simon, as a shadow director, being personally liable for the debts of the new company. A breach is also a criminal offence. A good example is provided by the case of Ad Valorem Factors Ltd v Ricketts [2003] in which the Court of Appeal held that the names Air Component Ltd and Air Equipment Ltd fell within the provisions. EXAMINER’S COMMENTS The issues raised by this question were often identified but not sufficiently developed in the answers. However, the responses to this question were generally adequate but lacked the detail and authority to attract the higher marks.

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6. "A specific charge, I think, is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined; a floating charge, on the other hand, is ambulatory and shifting in its nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp".

Lord Macnaghten in Illingworth v Houldsworth (1904) AC 355 at 358. REQUIRED In the light of the above statement, and with reference to decided cases and statutory provisions, compare a fixed and floating charge as a suitable form of security from a lender’s point of view. (20 marks)

SUGGESTED ANSWER A fixed charge, also known as a specific charge, may either be legal or equitable in nature and is usually granted over the company‟s fixed assets. An example is a legal mortgage over the company‟s factory to secure a loan. The lender will have a security interest over the property immediately after the charge is created. Crucially, the company is not allowed to deal with the charged asset without the lender‟s consent. A floating charge is equitable in nature and is taken over the company‟s fluctuating assets such as stock in trade or book debts. The essential characteristics of a floating charge were identified by Romer J in Re Yorkshire Woolcombers Assoc [1902] as:

(i) a charge over a range or class of assets; (ii) which changes from time to time; and (iii) which does not allow the company to deal with the asset without the consent of

the lender.

When the case reached the House of Lords it was reported as Illingworth v Houldsworth [1904], from which the quote in the question was taken. Lord Macnaghten offered his own description of a floating charge whilst not disagreeing with that given by Romer J. Subsequent cases (usually in connection with charges over a company‟s book debts expressed to be fixed) have established that it is the third characteristic that is the badge of a floating charge. See Siebe Gorman v Barclay‟s Bank [1979]. The degree of control needed where the charge is over book debts is currently very much a live issue. The House of Lords, in National Westminster Bank plc v Spectrum Plus Ltd [2005], recently decided that Siebe Gorman was wrongly decided as there was insufficient control by the lender over the company‟s bank account for the charge to be fixed. One way to ensure control, and thus create a fixed charge, is for the lender to insist on a „blocked account‟, whereby collected book debt money is paid into a designated account which cannot be operated without the lender‟s consent. A floating charge may not be considered a suitable form of security from a lender‟s point of view for the following reasons:

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(i) In a winding up, the rights of a floating charge holder are postponed to the rights of the fixed charge holder, the expenses of winding up and the preferential creditors. Fixed charge holders are paid first and for this reason a first fixed charge is the best form of security from a lender‟s point of view.

(ii) As between a fixed and floating charge, a fixed charge has priority regardless of

the date of creation. This problem may be overcome in relation to fixed charges by the use of a „negative pledge‟ but this will require actual notice of the subsequent lender. Wilson v Kelland [1910].

(iii) Judgment creditors, landlords who have levied distress for rent prior to

crystallization, and owners of goods subject to retention of title clauses also take priority over floating charges.

(iv) The lender will not know the value of the floating charge until the lender

defaults and the charge is then said to crystallise, when it becomes a fixed charge over whatever assets subject to the charge are left. However, this does not mean that the floating charge goes to the top of the list of creditors for the purpose of priority.

(v) The crystallising events are uncertain, particularly with regard to automatic

floating charges. (vi) The floating charge may be set aside as a preference under s239 of the

Insolvency Act 1986 subject to a maximum „look back‟ period of 2 years. (This is also true of fixed charges).

(vii) The floating charge may be set aside, in certain circumstances, under s245 IA

1986. Essentially, this will be the case where the company grants a floating charge to secure an existing debt and the company goes into liquidation within 2 years. The charge will be valid to the extent that the company grants new money. Re Destone Fabric Ltd [1941]. Fixed charges are subject to this potential attack by the liquidator.

The Enterprise Act 2002, which amended the Insolvency Act 1986, has severely reduced the attractiveness of taking a floating charge because the remedy of a floating charge holder, namely, to appoint an administrative receiver, is restricted, essentially, to where the company issues secured debentures that are held by trustees on behalf of the debenture holders, where the amount raised is at least £50m and the debentures are traded on a regulated market. Instead, the floating charge holder is expected to appoint an administrator, who will have the interests of the collective body of creditors in mind. The new regime applies to floating charges created on or after 15th September 2003. The holder of a floating charge created before this date can choose between the appointment of an administrative receiver or an administrator. Due to the advantages of a fixed charge over a floating charge, the parties may be tempted to attach the label „fixed charge‟ to their security in order to try and gain the necessary status of a fixed charge. However, the label the parties give to the charge will not be conclusive. See Re Armagh Shoes Ltd [1982] and Re Brightlife Ltd [1987].

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A floating charge is a less attractive form of security when compared to a fixed charge. In light of the above developments, it remains to be seen whether the floating charge will survive as a major form of security interest. (Credit was also given if candidates explained that a prescribed percentage of the floating charge assets must now be set aside to pay the company‟s unsecured creditors. The prescribed percentage is:

50 per cent of the first £10,000; 20 per cent of the remainder; up to a maximum of £600,000.

The prescribed percentage rule does not apply:

where the company‟s net property is less than £10,000; or where the costs of distribution to the unsecured creditors would be

disproportionate to the benefits).

EXAMINER’S COMMENTS This question was well answered by most candidates. The differences between the two types of charge were known by nearly every candidate together with the relevant authorities. However, some very long answers were written and the material was not always relevant. A number of candidates wrote lengthy descriptions about debentures, which was not required. Some candidate also wrote all they knew about debentures and charges instead of focusing on the question set.

The scenarios included here are entirely fictional. Any resemblance of the information in the scenarios to real persons or organisations, actual or perceived, is purely coincidental.

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