Corporate Law Question Answerj Nov 09

8/2/2019 Corporate Law Question Answerj Nov 09

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CORPORATE LAWNOVEMBER 2009

SUGGESTEDANSWERSANDEXAMINERSCOMMENTS

IMPORTANT NOTICE

When reading these answers, please note that they are not intended to be viewed as adefinitive model answer, as in many instances there are several possibleanswers/approaches to a question. These answers indicate a range of appropriate content thatcould 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.

EXAMINERS 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 wellwhen 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 athorough knowledge of corporate law principles and cases.

Some candidates appear to be reproducing model answers when attempting some of theSection B questions, perhaps relying on the published answers on the Institutes web site. Thiswas true for Question 4, on minority protection, and Question 6, on charges. The effect ofadopting this strategy is that the candidates answers do not always deal with the issues raised inthe 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 thematerial covered by Section A. In order to maximize their full potential, candidates shouldensure 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 companiescriminally liable. (4 marks)

SUGGESTED ANSWER

As a company is an artificial person, there are obvious difficulties in finding them guilty forcrimes 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 importancethat their guilty acts will be seen as those of the company itself. Such a person is treatedas the companys 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 sufficientlyimportant. 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 branchmanager.

(Credit was also given if candidates explained that the alter ego doctrine was notapplied to the crime of corporate manslaughter and that this is now dealt with by the

Corporate Manslaughter and Corporate Homicide Act 2007.)

EXAMINERS 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 knewon the topic.

(b) What rule was established by the case of Royal British Bank vTurquand (1856)? (4 marks)

SUGGESTED ANSWER

This case established the indoor management rule and was designed to reduce theimpact 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 properlycomplied with. So, in the case itself, the third party bank was entitled to assume thatthe directors had obtained the consent of the general meeting required by the articles tovalidate company borrowing.



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EXAMINERS COMMENTS

This question challenged many candidates who did not appreciate that the question waslinked to the doctrine of constructive notice. It was not answered very well by themajority of candidates, many of whom wrote lengthy answers, of a general nature, onultra 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 publicand 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 6months beginning with the day following its accounting reference date. If the companychanges 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 publiccompanies.

EXAMINERS COMMENTS

This question was reasonably well handled although some candidates did not include intheir answers the private company exemption and the time limits were not alwaysaccurately 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 thenominal value. There must be distributable profits out of which to pay the

dividend but a preference shareholder will receive their dividend before anydividend 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 capitalreturned 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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EXAMINERS COMMENTS

This question was well answered on the whole and candidates generally scored well onit.

(e) When must a disqualification order be made under the CompanyDirectors Disqualification Act 1986 and what, in that case, is thedisqualification period? (4 marks)

SUGGESTED ANSWER

Section 6 of the CDDA 1986 provides that a court must disqualify a director following afinding of unfitness. The court has no discretion under this provision and adisqualification order is mandatory. The court must be satisfied that the director is or hasbeen a director of an insolvent company and that their conduct makes them unfit to beconcerned 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 SevenoaksStationers [1991] in which the Court of Appeal gave guidance on how this period is tobe 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 abreach of competition law and that his conduct makes him unfit to be concerned in themanagement of a company. The court may disqualify for up to 15 years.)

EXAMINERS COMMENTS

This question produced some very long answers. The main reason for this was thatcandidates wrote about every situation when a director can be disqualified, rather thanfocusing on when a court must disqualify a director.

(f) A director is under a statutory duty to promote the success of thecompany. 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 topromote 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 bythe courts through case law.



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The section goes on to require that, when directors are exercising this duty, they shallhave 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.

EXAMINERS COMMENTS

Most candidates knew of this duty and were able to say something about it. Theanswers 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 inss260-269 CA 2006. A derivative action is defined in ss260(1) as proceedings brought bya 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 actualor 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 tobring the action because the wrongdoers are preventing the company from

commencing proceedings. They are particularly useful for remedying a breach ofdirectors duties when the directors have control of the company preventing litigation beingcommenced against them.

EXAMINERS COMMENTS

The majority of candidates were able to explain the nature of a derivative action andscored well. However, a significant number of candidates referred to the previouscommon law position and did not appreciate that derivative actions were put on astatutory footing in the CA 2006.

(h) What are the legal requirements for having a company secretary in thecase 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, thedirectors of a public company must take all reasonable steps to secure that thesecretary has the requisite knowledge and experience to discharge the functions of thesecretary. This is usually established by showing that the secretary is a member of one of anumber of professional bodies and has the relevant qualifications.

EXAMINERS COMMENTS

Most candidates scored well on this question, although some did not include in theiranswers that private companies are no longer required to appoint a company secretary.The requirements to ensure that the secretary is suitably qualified and experienced werewell known.

(i) Distinguish between a secured and an unsecured creditor of acompany. (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 enjoypriority over other unsecured lenders. The extent of their priority will depend on the natureof the security taken. The two most common types of security are the fixed and floatingcharge.

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 unsecuredtrade creditors and, if there is not enough money to pay them all, they will rank pari

passu.

EXAMINERS COMMENTS

This question was well answered and nearly every candidate was able to give anexample of a secured and unsecured creditor. However, there was some confusion, with asignificant number of answers stating that a fixed charge holder is a secured creditor but afloating charge holder is not. Both charges give the holder security over the property ofthe 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 notlimited to directors and applies to any persons . Where proven, the person may be orderedby the court to make a contribution to the assets of the company. This means they will beasked to pay a sum of money to the liquidator. The court has no power to order who willreceive the money and it goes into the general fund available to the liquidator todistribute in accordance with the statutory rules on the order of distribution of assets of acompany 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 tohave traded fraudulently under s214 IA 1986 may be disqualified for a maximum of 15years. Section 4 of the CDDA is the equivalent provision in relation to fraudulent tradingunder s993 CA 2006.

EXAMINERS COMMENTS

The concept of fraudulent trading was understood by almost every candidate. However, thiswas another question that produced unnecessarily long answers because candidatesdescribed 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 asstated in its Memorandum of Association when the company was formed in

2007. The directors and only shareholders are Emily and Jeff. The companywants to diversify and move into the business of pig farming. It has identified apiece of land, which is owned by Jeff, which it can use for pig farming. Thecompany 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 toMarion, who is Jeffs wife.

Marion will pay 75 pence each for the preference shares which are to be

credited in the companys 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 CAposition 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 reliedon.

Pre CA 2006 answer

The company has an objects clause of operating a taxi business and now wishes todiversify into pig farming. At common law, any pig farming activity would be treated asultra 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 RailwayCarriage 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 ofanything 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 betweenthe company and third parties. Such contracts will be regarded as being within thecompany s capacity.

Under s35(2), a member of a company can seek a restraining order against a proposedultra vires act of the company.

Under s35A(1), third parties dealing with the board of directors can assume that thepowers of Emily and Jeff to bind the company are free of any limitation under thecompany 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) forfailing to observe the limits on their powers flowing from the Memorandum; they shouldhave observed the object to operate as a taxi business and not to expand into pigfarming. This breach of duty can be cured by ratification of the members by passing aspecial resolution. In addition, the company will need to pass an additional specialresolution to obtain the benefit of the contract.

The safest course of action for them is to alter the objects clause in the Memorandum andadd pig farming to the existing objects. This can be done by special resolution under s4CA 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 todiversify into pig farming. At common law, any pig farming activity would be treated as ultravires and beyond the company s capacity with the result that the transactions would bevoid and unenforceable by or against the company. See Ashbury Railway Carriage andIron Co v Riche [1875] and Re Introductions Ltd [1970].

The position is now governed by ss39 & 40 CA 2006. Section 39 provides that thevalidity of an act done by a company shall not be called into question on the ground oflack of capacity by reason of anything in the company s constitution. Thus, Emily andJeff should be advised that any pig farming contracts will be valid as between thecompany 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 underthe company s constitution.

However, internally, as between the directors and the company, the directors are under aduty to act in accordance with the constitution and to only exercise powers for thepurpose 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 andshareholders it is unlikely that there will be any consequences for this breach, but if thecompany 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 requirementswhich 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 ofinterest and it applies in particular to the exploitation of corporate property, informationor opportunity.

Under 177 CA 2006, if a director is in any way, directly or indirectly, interested in aproposed transaction with the company, he must declare the nature and extent of thatinterest to the other directors. The declaration may be made at a meeting of thedirectors or may be given in writing and must be given before the company enters into theland 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 relevantto Emily and Jeff.

A breach of this duty will make Jeff liable for any losses incurred as a result of thebreach but it may be ratified under s239 by the members by ordinary resolution. Jeff will notbe 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 inss190-196 CA 2006. This is because the company will be acquiring a substantial noncashasset from one of its directors. It is regarded as substantial as the purchase price exceeds100,000 under s191 (2) (b).



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The land purchase will, under these provisions, require the approval of the members byordinary resolution, s190(1).

A failure to obtain the prior approval renders the land purchase contract voidable at theinstance of the company. Whether or not the contract is avoided, Jeff and Emily will beliable 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, themembers may subsequently affirm the transaction within a reasonable time period if it wasentered into without initial authorisation.

(c) The legality of the issue of preference shares, and their potentialpersonal 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 thenominal value for its preference shares of 1. The directors will either need to obtain thefull 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 casethe company, or the liquidator in the case of the company s liquidation, could call for theunpaid amount of 25p per share from Marion.

As Marion is Jeff s wife, Jeff is once again in a conflict of interest situation within s177CA 2006, as issuing the shares to Jeff s wife is a proposed transaction (see above). He isin a conflict situation because his wife is regarded as a connected person and fallswithin ss252, 253 CA 2006. However, this situation is likely to fall within s177(6)(b) andso 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 bepersonally liable under the guarantee for any outstanding amounts. In effect, they willno longer enjoy the benefit of limited liability which they would otherwise have asshareholders.

EXAMINERS COMMENTS

This was one of the most popular Section B questions attempted. It was not handledparticularly well by the majority of candidates. The answers were often too general andlacked sufficient detail. For example, in part (b), even though the question specified thatthe issue was about directors duties, most candidates were unable to go logicallythrough the statutory provisions in any detail. Instead, answers would simply saysomething 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 poorexamination technique to simply list the duties of a director; the relevant duty needs tobe 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 Zplc. Before news of the takeover bid was publicly announced, the followingevents 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 thecompany.

(ii) Trevor told Edward, a shareholder in the company, about the takeoverbid, and Edward also purchased some shares in the company.

(iii) Trevor was approached by Jill, a shareholder in the company. She toldTrevor that she was thinking about selling her shares in the companyand Trevor purchased them from Jill privately, off-market, withoutinforming her about the takeover negotiations, for 5.00 per share.

When the takeover was publicly announced, the share price of B plc rose from5.00 to 8.00. The takeover bid was successful after being agreed to by90% of the companys 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 isentirely 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 aprofit 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 ofsecurities (a company) and not to securities or issuers generally. It must also be specificor precise, have not been made public but, if it were to be made public, it must be likelyto 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 theAct.

Insiders are dealt with by s57 of the Act. To be an insider, a person must have andknow that they have inside information and the information must come from an insidesource. 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 theinformation from her director husband, provided she knows that it is insideinformation. As a shareholder, Edward is also treated as an insider.

The offences of insider dealing are contained in s52. The first offence is the dealingoffence, 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 theoffence. 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 thefunction 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. Ifconvicted summarily, a person may be disqualified for up to 5 years and for up to 15 yearsif tried on indictment, s2 CDDA 1986.

(b) Jill, who wants to rescind her contract with Trevor for the sale of hershares; and (5 marks)

SUGGESTED ANSWER

Trevor purchased Jill s shares at a time when the take-over bid negotiations were inprogress. The sale price was 5 and so Trevor has made a 3 profit per share. Theproblem for Jill is the case of Percival v Wright [1902] in which it was held that directorsowe their duties to the company and not to individual shareholders. On similar facts, adirector 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 fourmembers 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 confirmthis position. In particular, section s172 requires directors to promote the success of thecompany 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 ashareholder 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 havein respect of the takeover bid. (5 marks)

SUGGESTED ANSWER

The minority shareholders should be advised that s983 CA 2006 applies. This provides forthe right of a minority shareholder to require the offeror in a successful take over to acquirehis shares. This arises because Z plc has already acquired 90 per cent of the votingshares in the company. In this situation, the minority 10 per cent holder is entitled toask and require Z plc to buy their shares on the same terms as the offer or on any otherterms as may be agreed.

EXAMINERS 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 thequestion, 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 notattempted at all.

4. Angela, Barbara and Claire were originally partners in a hairdressingbusiness. They formed Hair Today Gone Tomorrow Ltd (the company) in2006 to take over the business. They are the only directors and shareholders inthe 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 Clairebecame unhappy with the way Angela and Barbara managed the business. Shefelt that they were taking unnecessary management risks, that they did notconsult her on important matters and that they did not give her access to thecompanys financial information. This caused Claire to lose interest in themanagement of the company, and she has not been involved in thedecisionmaking process of the company for the last two years. As a result, Angelaand 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 2006and/or s122 IA 1986.

The company is likely to be treated by a court as a quasi- partnership type company, inother 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 builton mutual trust and confidence and is likely to be satisfied where the business wasoriginally carried on as a partnership; (ii) that there is an agreement or understandingthat 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 itis of the opinion that it is just and equitable to do so. The facts have some similarity with theEbrahimi case. In that case, Ebrahimi, who was a shareholder and director, was removed bythe other two shareholders by passing an ordinary resolution under what is now s168 CA2006. The House of Lords treated Westbourne Galleries Ltd as an incorporatedpartnership. They held that although they had the legal right to remove Ebrahimi unders168, 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 bys125(2) IA 1986. This provides that the just and equitable remedy will not be available ifthere is another, alternative, remedy available to the petitioner which they areunreasonably refusing to pursue. The alternative remedy is contained in s944 CA 2006which may be available to Claire but could also include any reasonable offer to buy hershares, 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 interestsof its members generally or of some part of its members . A petition under s994 may becombined 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 bringhimself 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 isnot 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 takenunnecessary management risks. Commercial misjudgment on its own does not amount tounfairly prejudicial conduct; it must be gross and over a prolonged period to fall withinthe 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 saidthat it is not enough that the company is a quasi partnership because fairness , as usedin 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 inthe constitution of the company but may also be found in some wider, equitable,agreement or understanding. Claire should argue that there was an agreement orunderstanding 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 & Sonsplc [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 factthat 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 togive 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 toher relying on s994. In Re a Company [1986], Hoffmann J said that, in a smallcompany, a member s interests as a member may include a legitimate expectation that hewill continue to be employed as a director and a dismissal will be treated as unfairlyprejudicial conduct to his interests as a member.

However, one difficulty Claire may face in relying on s994 is that a petitioner must notbe 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 circumstancesbecause, although the conduct (removal of a director who had lost interest) wasprejudicial, 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 courtcan make any order it thinks fit but the usual remedy is a share purchase order with nodiscount 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 andinsist on arbitration rather than court proceedings to determine their dispute.

The articles constitute a contract between the company and its members under s33 CA2006.

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 & FBeattie Ltd [1938], the court refused to allow a shareholder who was also a director to relyon an arbitration clause when he was complaining about a dispute with hiscompany relating to the failure to account for company money in his capacity as adirector. 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 herdispute is in her capacity as a member and that, as a member, she has the right to have thearticles observed. See Salmon v Quinn & Axtens Ltd [1909].



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EXAMINERS COMMENTS

There was a disappointing approach to this question and many candidates were unableto 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 obtainedgoes 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 istransporting goods by road. Its only director is Heather, who is married toSimon, and they are the only shareholders. Heather habitually does whatSimon tells her to do in relation to the management of the company. Thecompany is in compulsory liquidation and the liquidator, Edward, hasdiscovered the following facts and seeks your advice:

(a) The main cause of the companys insolvency was a fire which

destroyed its entire fleet of vehicles. The companys insurers havelegitimately refused to indemnify it for the value of the vehiclesbecause 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 thegeneral knowledge, skill and experience that may reasonably be expected of a personcarrying out the functions carried out by the director in relation to the company, and thegeneral knowledge, skill and experience that the director has. This introduces anobjective 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 asinsurance forms before signing them.

The facts are similar to the case of Re D Jan (of London) Ltd [1999] in which it was held adirector was in breach of the previous common law duty of care when they signed aninsurance form without reading it. However, the court went on to excuse the director frombreach of duty under what is now s1157 CA 2006. This requires the court to find that thedirector acted both honestly and reasonably. The case is generally considered to be agenerous application of the provision

If there has been a breach of the duty in s174, Heather may be personally liable for theresulting 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 s212IA 1986.

(b) Heather and Simon transferred the remaining assets of the company

to another company, Alpha Ltd, in which Heather is the sole directorand shareholder. This was done six months ago, on legal advice, inorder to put the assets beyond the reach of the companys creditors.

(7 marks)

SUGGESTED ANSWER

Transferring the assets of the company to Alpha Ltd, which is owned and controlled byHeather, 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 forno consideration or receives significantly less consideration than it has provided.

The liquidator must establish that the company was insolvent at the time of thetransaction 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 thetransfer 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 atransaction 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 showthat the transaction was entered into for the purpose of putting assets beyond the reachof 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 assetswere 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 afaade 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 werejointly 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 hisinstructions. 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 forSimon in excess of 10 years.

Acting as a shadow director whilst disqualified may also mean Simon is personally liable forthe debts of the company under s15 CDDA 1986.

Acting as a shadow director may also mean that Simon is subject to the provisions inss216, 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, 217IA 1986. Under these provisions, a director of an insolvent company is prohibited fromusing 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 useit. 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 theCourt of Appeal held that the names Air Component Ltd and Air Equipment Ltd fell withinthe provisions.

EXAMINERS COMMENTS

The issues raised by this question were often identified but not sufficiently developed in theanswers. However, the responses to this question were generally adequate but lackedthe 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 ascertainedand definite property or property capable of being ascertained and defined; afloating 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 toaffect until some event occurs or some act is done which causes it to settle andfasten 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 andstatutory provisions, compare a fixed and floating charge as a suitable form

of security from a lenders point of view. (20 marks)

SUGGESTED ANSWER

A fixed charge, also known as a specific charge, may either be legal or equitable innature and is usually granted over the company s fixed assets. An example is a legalmortgage over the company s factory to secure a loan. The lender will have a securityinterest over the property immediately after the charge is created. Crucially, thecompany 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 hisown 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 badgeof a floating charge. See Siebe Gorman v Barclay s Bank [1979]. The degree of controlneeded where the charge is over book debts is currently very much a live issue. The Houseof Lords, in National Westminster Bank plc v Spectrum Plus Ltd [2005], recently decidedthat Siebe Gorman was wrongly decided as there was insufficient control by the lenderover the company s bank account for the charge to be fixed. One way to ensure control, andthus 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 withoutthe lender s consent.

A floating charge may not be considered a suitable form of security from a lender s point of viewfor the following reasons:



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(i) In a winding up, the rights of a floating charge holder are postponed to therights 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 firstfixed 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 bythe 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 tocrystallization, and owners of goods subject to retention of title clauses also takepriority over floating charges.

(iv) The lender will not know the value of the floating charge until the lenderdefaults and the charge is then said to crystallise, when it becomes a fixedcharge 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 purposeof priority.

(v) The crystallising events are uncertain, particularly with regard to automaticfloating charges.

(vi) The floating charge may be set aside as a preference under s239 of theInsolvency 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 IA1986. Essentially, this will be the case where the company grants a floating

charge to secure an existing debt and the company goes into liquidation within2 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 potentialattack by the liquidator.

The Enterprise Act 2002, which amended the Insolvency Act 1986, has severely reduced theattractiveness 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 thedebenture 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 anadministrator, who will have the interests of the collective body of creditors in mind. Thenew regime applies to floating charges created on or after 15 th September 2003. Theholder of a floating charge created before this date can choose between theappointment of an administrative receiver or an administrator.

Due to the advantages of a fixed charge over a floating charge, the parties may betempted to attach the label fixed charge to their security in order to try and gain thenecessary status of a fixed charge. However, the label the parties give to the charge willnot 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. Inlight of the above developments, it remains to be seen whether the floating charge willsurvive as a major form of security interest.

(Credit was also given if candidates explained that a prescribed percentage of thefloating charge assets must now be set aside to pay the company s unsecured creditors. Theprescribed 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).

EXAMINERS COMMENTS

This question was well answered by most candidates. The differences between the twotypes of charge were known by nearly every candidate together with the relevantauthorities. However, some very long answers were written and the material was notalways relevant. A number of candidates wrote lengthy descriptions about debentures,which was not required. Some candidate also wrote all they knew about debentures andcharges 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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Corporate Law Question Answerj Nov 09

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