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Corporate Law June 2011

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 students in the examination. Examiner’s general comments To succeed in this exam, candidates needed to demonstrate knowledge of current, basic corporate law principles and an ability to apply those principles to the facts given in the questions. Unfortunately, most candidates did not demonstrate this knowledge and ability in their answers. Overall, the answers written by the majority of candidates indicated that they were under-prepared in terms of knowledge of the law. Answers were very general in nature, based on notions of common sense rather than reasoned application of identified legal rules and principles. Candidates regularly did not appear to read accurately either the facts of the questions or the parts of the questions that stipulated what, specifically, they were asked to do. Candidates with legal knowledge often did not apply that knowledge to the facts, thereby not answering the question. Out-of-date statements of law were expressed far too often. Candidates need to know the current law. However, there were a number of very good or excellent scripts. Candidates are urged to work through the ICSA Corporate Law recommended text to prepare themselves for the exam. It contains the knowledge needed to answer all of the questions on the exam well.

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1. With Frank‟s encouragement, his son, Gregory, registered a public limited company, Total Van Rentals plc („Total‟), of which Gregory is the sole director and owner of the 100 x £1 shares. Frank manages the company even though he is a disqualified director under the Company Directors Disqualification Act 1986.

Shortly after it was incorporated, Total purchased a fleet of vans from Wheels-for-Hire plc („Wheels‟). The contract of sale contained a term by which Total agreed not to keep the vans, or to rent them out, at, or from, premises in the south of England. The day after Total acquired the vans, Gregory registered a new company, Southern Vans Ltd („Southern Vans‟), to which he transferred all his shares in Total in return for shares in Southern Vans. Southern Vans also registered a second wholly-owned subsidiary, Quickvans Ltd („Quickvans‟). The three companies immediately underwent what Frank described as a “commercial re-organisation” in which half of the vans were transferred by Total to Southern Vans and the other half to Quickvans. The vans owned by Southern Vans are now garaged in Portsmouth, on the south coast of England, where they are rented out by Southern Vans. Wheels has not yet received the purchase price for the vans. Required

(a) Advise Wheels who may be sued to recover the purchase price of the vans and why. (9 marks) Suggested answer The contract for the sale of the vans is between the company, Total, and Wheels. Wheels can sue Total which is an artificial legal person, a corporation aggregate, separate and distinct from its shareholders and managers or directors, see ss.15 & 16 Companies Act 2006 (CA 2006). Wheels cannot sue the shareholders as shareholders of the company (Salomon v Salomon [1897]), even if Wheels is a wholly owned subsidiary of another company (Adams v Cape [1990]). Statute provides Wheels with supplementary remedies. The question states that Frank is a disqualified director. Wheels may be able to sue Frank for the price of the vans pursuant to s.15 Company Directors Disqualification Act 1986 (CDDA 1986). S.15 imposes personal liability on Frank, jointly and severally with Total, for “relevant debts” which are defined as “such debts and other liabilities of the company as are incurred at a time when [a disqualified] person was involved in the management of the company” (s.15(3)(a) CDDA 1986). Frank was clearly “involved in the management of” Total when the vans were purchased so he is jointly and severally liable with Total to pay Wheels the price for the vans. Total is a public company. It does not appear to have the required minimum share capital for a public company or to have obtained a trading certificate pursuant to s.761 CA 2006. S.767 sets out the criminal and civil consequences of a company doing business in contravention of s.761. If Total fails to comply with its obligations in connection with the transaction within 21 days of being called upon to do so (i.e. to pay for the vans), those directors of the company who were directors at the time of the transaction (i.e. Gregory), are jointly and severally liable to indemnify any other party to a transaction (i.e. Wheels) in respect of any loss or damage suffered by Wheels by reason of the company‟s failure to comply with its obligations. Accordingly, if 21 days pass after Wheels demands payment, Wheels can sue Gregory for the price. Frank may also be caught by s.767 as a de facto director.

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Examiner’s comments Disappointingly few candidates identified that the company lacked the minimum share capital and few identified the civil liability consequences of this, as set out in s.767 of the CA 2006. Although a good number of candidates noted that Frank was a disqualified director, few showed awareness of the civil consequences of this as provided for by s.15 of the CDDA 1986. Consequently, this part was answered very poorly. (b) Advise Wheels of any legal arguments that may exist to enable it to prevent the vans

being rented out in Portsmouth. (10 marks) Suggested answer The contractual promise not to rent out the vans in the south of England is given by Total to Wheels. On the facts, it is Southern Vans that is renting out the vans in the south of England. The contractual promise will be construed by the court. If the words are interpreted to be a promise by Total that neither it nor any company in its corporate group will rent out the vans in the south of England, Wheels can secure an injunction against Total and damages. This is an unlikely interpretation. If the promise is read as a promise by Total that it will not keep or rent out the vans in the south of England, any renting out by a different company (ie Southern Vans) will not fall within the language of the promise and there will be no breach of the contractual promise. The question then arises as to whether a court would, in the circumstances, ignore the separate corporate legal personality doctrine and treat the acts of Southern Vans as the acts of Total. This is sometimes called piercing the corporate veil. Candidates should have discussed the leading case examining the grounds on which, in the past, courts have been willing to ignore the separate corporate legal personality doctrine: Adams v Cape [1990]. The four grounds to be discussed and the key cases are:

Agency theory (no agency is assumed between a parent and subsidiary company, it must be established on the facts) Yukong v Rendsberg [1998]).

Single economic entity theory (emphatically rejected in Adams v Cape [1990] and demonstrated as not a valid ground in Ord v Belhaven [1998]).

Justice requires (also emphatically rejected in Adams v Cape [1990], though it seems to have been acting behind the scenes in Trustor v Smallbone [2001]).

Sham or façade theory (identified as the only basis for piercing the corporate veil by Lord Keith of Kinkel in Woolfson v Strathclyde [1978]).

Is Southern Vans “a mere façade concealing the true facts”? Note Slade LJ in Adams v Cape [1990] commenting that there is “sparse guidance” as to how to apply the test. The facts are reminiscent of Gilford Motor Co v Horne [1933], and Jones v Lipman [1962] which suggest that a court would have no problem issuing an injunction against both Total and Southern Vans if the sole purpose of setting up Southern Vans is to avoid the contractual promise. This may be countered with Ord v Belhaven [1998] and the potential for Frank and Gregory to present evidence that there was a re-organisation for bona fide commercial reasons: there are insufficient facts in the question to reach a definitive conclusion.

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Examiner’s comments

Many candidates simply treated the vans as rented out by Total rather than by Southern Vans. Few candidates discussed the potential for the courts to pierce the veil. Overall, the answers to this part were very weak. (c) If Total was to be placed into insolvent liquidation, which questions would you

advise the liquidator to ask in relation to the transfer of the vans by Total and which powers would you advise him to consider exercising in relation to the transfer of the vans?

(6 marks)

Suggested answer The liquidator should ascertain the price at which the vans were transferred out of Total and consider exercising his power to apply to the court for an order under s.238 of the Insolvency Act 1986 (IA 1986), based on the transfer of the vans at an undervalue within two years of the onset of insolvency (s.240(1)(a)). An asset is transferred at an undervalue if it is transferred in return for no consideration or consideration that is significantly less than the value of the asset (s.238(4)(b)). The liquidator should also identify all the directors, officers and managers of Total and consider applying to the court for an order against any of them (ie Gregory and Frank) based on misfeasance or breach of duty in relation to Total (IA 1986, s.212). Examiner’s comments Part (c) was approached with creativity, with candidates providing a wide range of interesting, relevant answers for which credit was given.

2. In December 2009, Ada, Ben, Dan and Carol applied to register a private company limited

by shares. Ada and Ben each subscribed for 15 x £1 shares, Dan subscribed for 25 x £1 shares and Carol subscribed for 45 x £1 shares. Ada, Ben and Dan became directors of the company. No Articles of Association were submitted with the registration application. The Registrar issued a Certificate of Incorporation. The company‟s name is Fitnow Ltd („Fitnow‟).

Fitnow commenced business in January 2010, operating a leisure centre from leased premises in Nottingham. Fitnow is extremely profitable and in its first year of operation it made £100,000 profit. Dan wishes to retain the profits and use them to purchase the premises from the landlord, who is interested in selling. Ada and Ben do not want Dan to be a shareholder in the company. They wish to distribute all of the profits by way of dividend and then remove Dan as a shareholder. If they are unable to exclude Dan, they want to dissolve the company. Carol is currently away climbing in the Himalayas. Just before she left for her extended vacation she had said, “Don‟t bother me with business while I‟m away”. Required

(a) Explain the law governing declaration of final dividends and the process Fitnow

must go through to declare and pay a final dividend. In your answer, include any meetings Fitnow may need to hold, any decisions that need to be made, any resolutions it may need to pass and give details relating to notices, quorums and voting, paying particular attention to Carol‟s rights.

(10 marks)

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Suggested answer In the absence of articles being filed on incorporation, Fitnow‟s articles will be the Model Articles (MA) for a Private Companies Limited by Shares (s.20 CA 2006). Dividends are a form of distribution, defined in s.829 of the CA 2006, and private companies may only make distributions out of profits available for the purpose (s.830 CA 2006). Profits are defined for this purpose as accumulated, realised profits, not previously utilised by distribution or capitalisation, less accumulated realised losses not written off. The question does not contain details of the basis on which the statement is made. However, as it is stated that Fitnow made £100,000 profit in its first year of operation, candidates could have assumed that these were distributable profits for the purposes of s.830 and have made reference to chapter 2 of Part 23 of the CA 2006, “Justification of distribution by reference to accounts”. The process for the declaration and payment of a dividend is set out in the Articles of Association (see MA, Articles 30-35). Essentially, a board decision is taken determining the dividend the board of directors recommends the company pay. The board recommendation is put as an ordinary resolution to the shareholders who may declare a dividend of the recommended sum (or less, but not more) (MA, Article 30). The directors may take the decision by majority vote at a meeting of directors (MA, Article 7), of which meeting, notice has been given to every director (MA, Article 9). The quorum for a meeting of directors, unless agreed otherwise, is two (MA, Article 11(2)). Alternatively, directors may take decisions outside of meetings unanimously (MA, Article 8). Ordinary resolutions of the company can be passed, by a simple majority (s.282) in one of two ways: at a meeting or by the written resolution procedure (s.281). If the resolution to declare the dividend is to take place at a meeting, at least 14 days notice of the meeting (s.307(1)) must be given to all shareholders and every director (s.310). The quorum for a meeting is two unless agreed otherwise (s.318). Voting at meetings can be by show of hands (when each member present has one vote) or by a poll (when each member present has one vote per share) (s.284(2) & (3)). Articles may provide for different voting rights (s.284(4)). If the resolution to declare the dividend is to be a written resolution (s.288), a copy of the resolution must be sent to all shareholders accompanied by a statement informing them how to signify agreement to the resolution and of the date on which the resolution will lapse if not passed. The resolution is passed when the required majority (50 per cent +1) signify their agreement to it in accordance with s.296. Shareholders have one vote per share on a written resolution (unless the articles contain alternative provisions such as relevant weighted voting rights) (s.284(1)). Here, if a resolution at a meeting were sought and Carol did not attend the meeting, Ada and Ben could still pass an ordinary resolution. Carol could appoint one of them (or any other person) to be her proxy to vote at the meeting (s.324). Alternatively, a written resolution may have been more appropriate, enabling Carol to participate. Although, again, an ordinary resolution may have been passed without her participation (s.282(2)) provided that a copy had been sent to her home address with a notice indicating how to signify agreement and the date by which the resolution was to be passed. Examiner’s comments This part was answered quite well, although few candidates provided sufficient detail to warrant a good mark. Most candidates demonstrated that they understood the framework for the declaration of final dividends.

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(b) Discuss whether Ada and Ben will be able to exclude Dan as a shareholder of the company.

(10 marks) Suggested answer Assuming that Dan is unwilling to sell his shares voluntarily, Ada and Ben may consider amending the Articles of Association to introduce a compulsory expropriation provision. S.21 of the CA 2006 provides that a company can alter its articles by passing a special resolution. A special resolution requires 75% support, so Ada and Ben will need Carol to support such an amendment. The courts have introduced a limitation on the power to amend the articles, explained in Allen v Gold Reefs of West Africa Ltd [1900]: the power to amend the articles must be exercised bona fides for the benefit of the company as a whole. This test is very difficult to apply. It is essentially a subjective test of honesty with an objective floor (Shuttleworth v Cox Bros [1927]). Three cases dealing with the introduction of compulsory expropriation provisions should have been discussed: Sidebottom v Kershaw, Leese and Co Ltd [1920]; Brown v British Abrasive Wheel Co Ltd [1919] and Dafen Tinplate v Llanelly Steel Co (1907) Ltd [1920]. Essentially, it is unlikely that a company will be permitted to introduce a bare expropriation provision. A bad temper is not grounds to exclude a shareholder so, unless Ben and Ada can both enlist Carol‟s support and identify a condition of expropriation that can be defended as making the expropriation exercisable to protect the interest of the company, it is unlikely that they will be able to remove Dan as a shareholder. Examiner’s comments Very few candidates discussed altering the articles. Many candidates appeared to misread the question and wrote about how to remove a director rather than a shareholder. (c) Discuss whether Ada and Ben will be able to secure the winding up of the company. (5 marks) Suggested answer Ada and Ben own only 30% of the company between them. This gives them what is sometimes called “negative control” in that they can prevent the passing of special resolutions but they do not have the power to pass either an ordinary resolution or a special resolution. The circumstances in which a company can be voluntarily wound up are set out in s.84 of the IA 2006. A special resolution is required, which requires 75% of the votes cast on the resolution. Ada and Ben cannot secure a special resolution without the support of Carol. The circumstances in which a company can be wound up by the court are set out in s.122. The key ground relevant here is that it is just and equitable that the company should be wound up (s.122(1)(g)). The persons who can apply for winding up are set out in s.124 which does not include a shareholder, but the court has been willing to interpret the term “contributory” (defined in s.79) to include a shareholder, to enable shareholders to make applications for a winding up under s.122 (Re Rica Gold Washing Co Ltd [1879]). A decision by Ada and Bill that they do not want to be in business with Dan is not a sufficient basis for the court to order a winding up. The approach of the court is set out in Ebrahimi v Westbourne Galleries Ltd [1973] in which Lord Wilberforce emphasised the equitable nature of the jurisdiction and the undesirability of defining categories or headings under which cases must be brought before the court will be prepared to grant a winding up. Candidates were required to identify the right to apply for a winding up, notwithstanding the limited language of s.122, the equitable nature of the jurisdiction, the leading case on exercise of

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the court‟s discretion, and the fact-intensive nature of such an application, noting that inadequate facts are given in the question. Examiner’s comments Many candidates wrote generally about the availability of winding up without applying that knowledge to the facts of the question. Few discussed the approach of the courts to its jurisdiction to wind up on a “just and equitable” basis.

3. Outings Ltd („Outings‟) was incorporated on 1 March 2011. Its articles contain a clause

stating that its board of directors has no power to enter into any contract committing the company to pay any sum in excess of £500,000 in aggregate. It has three directors: Omar is the finance director, John is the production director and Ursula is the marketing director. Laurence is the company secretary.

The following events have taken place: (i) On 15 February 2011, Omar signed a two year lease for the rental of offices from

Landlets LLP („Landlets‟). He had added his signature to the lease above the printed words “For and on behalf of Outings Ltd”. The offices are currently occupied by Outings, which is paying the monthly rent.

(ii) On 15 April 2011, ten high-specification laptops arrived at Outings‟ offices with an

invoice for £50,000 from Atop plc („Atop‟). Laurence admits to having agreed over the phone to purchase them on behalf of Outings when cold-called two weeks earlier. Atop‟s salesman had followed-up the conversation with an email to Laurence which had commenced:

“To: Company Secretary of Outings Ltd This email confirms our agreement reached on the telephone earlier today for ten laptops for the members of the board of directors …”

(iii) On 15 May 2011, Ursula signed a contract with Service plc („Service‟), on behalf of

Outings, for the purchase of £275,000 of promotional materials for each of two years. The lawyers of Service had checked the articles of Outings and advised Service‟s sales manager to structure the contract in this way to make it appear to be a smaller commitment than it actually was.

Required Advise Outings:

(a) Whether or not Landlets is bound by the lease, and to whom, and whether or not

Outings can enforce the lease, should it wish to. (8 marks) Suggested answer The lease was signed before Outings was incorporated: it is a pre-incorporation contact. At common law, a company is not bound by a pre-incorporation contract as an agent cannot bind a non-existent principal (Kelner v Baxter [1866-67]; Newborne, v Sensolid [1954]). S.51 of the CA 2006 changes the common law by providing that a pre-incorporation contract is binding on the person purporting to act for the company or as agent for it, subject to any agreement to the contrary. There does not appear to be any agreement to the contrary on the

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facts, so the lease is binding on Omar. Omar is not only bound by the lease but can enforce the lease against Landlets (Braymist v Wise Finance Co Ltd [2002]). If Outings wishes to be a party to the lease, ratification is inadequate to adopt a pre-incorporation contract (Re Northumberland Avenue Hotel Co [1866]). Novation is required for Outings to replace Omar as a party. Novation can be inferred from the conduct and transactions of the parties after the contract has been entered into and Outings has come into existence (Re Northumberland Avenue Hotel Co [1866]), but is not found lightly and is not a unilateral act by Outings. Essentially, the parties have to have agreed to enter into a new contract with Outings substituted for Omar. Here, paying the rent will not be enough as it is likely to have been paid on the mistaken belief that the company is a party to the lease. It is very unlikely that Outings will be able to enforce the lease without the agreement of Landlets to novate it. Examiner’s comments Question 3 was the most popular question. In relation to part (a), most answers recognised the pre-incorporation nature of the contract. However, not many answers cited s.51 and many candidates appeared to be basing their answers on the common law cases. The potential to novate was generally noted but not developed. (b) Whether or not Outings is bound by the contract with Atop. (7 marks) Suggested answer Outings will only be legally bound by a contract if it is entered into by an agent of the company authorised to enter into such contracts. An agent‟s authority may be actual (express or implied), or ostensible (Freeman Lockyer v Buckhurst Park [1964]). The power of the company to enter into contracts is vested in the board of directors collectively (Model Articles for Private Companies Limited by Shares, (MA) Article 3). The board may delegate its powers, ie grant authority to individuals (MA, Article 5). This delegation is often takes place by individuals being appointed to roles within the company and may result from authority being cascaded down through layers of management. A company secretary may have express authority granted to him. In the absence of a clear statement setting out his authority, he has limited authority to bind the company to contracts. Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971], the leading case on the authority of a company secretary to bind the company, establishes that a company secretary has ostensible authority to bind the company to matters concerned with administration. As this is such a matter, the company secretary will almost certainly be held to have ostensible authority and Outings will be bound. Examiner’s comments This question was answered satisfactorily. (c) Whether or not Outings is bound by the contract with Service, which is a major

financial burden which it cannot afford, and, if it is bound, what legal remedies it may be able to obtain, if any.

(10 marks)

Suggested answer The contract with Service is beyond the powers of the board of directors as the articles state that the board may not commit the company to more than £500,000 and the contract is a commitment to £550,000. At common law, the board cannot authorise Ursula to enter into such a contract. S.40 CA 2006 “fixes” the shortcoming in the authority of the board in most cases. Candidates should have set out and applied to the facts the conditions to be satisfied for s.40 to

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operate. Service must be a person (Smith v Henniker Major [2002]) (yes), dealing with the company (s.40(2)(a)) Smith v Henniker Major [2002]) (yes), in good faith s.40(20(b) (Wrexham v Crucialmove [2008]). The behaviour of the lawyers of Service may take Service out of the realm of acting in good faith, which would mean that s.40 does not apply. At common law, Service could not rely on Turquand’s Case as it has knowledge of the articles and its actions indicate that it knew that no internal process had been gone through to authorise Ursula. Even if s.40 operates, it simply removes the limit on the power of the board. It is still necessary to determine whether or not Ursula, as an individual, has actual or ostensible authority. No evidence of express actual authority is presented in the question. Ursula is the marketing director who can be expected to have been implicitly authorised to enter into marketing contracts so implied actual authority may be arguable (Hely Hutchison v Brayhead Ltd [1968]) in conjunction with the language in s.40 to the effect that the power of the directors to authorise others to bind the company is deemed to be free of any limitation. Ostensible authority is almost certainly not available as the conditions in Freeman Lockyer v Buckhurst Park [1964] cannot be satisfied because Service knew that Ursula did not have authority to bind the company, so cannot have relied on any representation to the contrary made by the company. Examiner’s comments Few candidates discussed s.40 in their answers and a significant number did not discuss agency and its foundations. Many candidates appeared to assume that the company was bound and focussed exclusively on Ursula‟s potential liability to the company.

4. Wool 4U plc („Wool 4U‟) is a successful textile manufacturing company, the shares of

which are traded on the London Stock Exchange. Wool 4U was initially registered in 1960 as a private company limited by shares. In 2000, it was re-registered as a public limited company, at which time it retained the objects clause in its original Memorandum of Association, which states, “the objects of the company are to manufacture and sell woollen cloth”.

Wool 4U has six directors, two of whom are non-executive directors („NEDs‟). One of the NEDs, Molly, retired as Chief Executive Officer of Lamb-u-Like Ltd („Lamb-u-Like‟), a sheep farming company, two years ago, having worked in sheep farming for 45 years. She continues to be a NED of Lamb-u-Like, in which she has a 20% shareholding. All of the Wool 4U directors are aware of Molly‟s professional history and her current directorship and interest in Lamb-u-Like. At a recent meeting of the Wool 4U board, a board resolution was proposed that the company enter into a five year contract for the purchase of a minimum of £30,000 of wool per annum from Lamb-u-Like. Molly attended this board meeting. Although she commented favourably on the benefits of the agreement for Wool 4U, she did not vote on the resolution, which was approved by the other five directors. The directors have since discovered that the price of wool under the contract is significantly higher than at least two alternative suppliers. Required Advise Wool 4U:

(a) On the relevance, if any, to the company of the doctrine of ultra vires and the status

and relevance of the company‟s objects clause. (11 marks)

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Suggested answer Candidates were required to describe the doctrine of ultra vires and discuss any relevance it may have to the company. The ultra vires doctrine is the doctrine that a company‟s legal capacity is limited by its constitution and specifically by its objects clause. This doctrine now has no relevance to non-charitable registered companies, regardless of when they were registered or whether or not they have an objects clause. S.39 of the CA 2006 states 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”. Accordingly, the doctrine has no relevance to Wool 4U. Candidates should have proceeded to discuss the status and relevance of the company‟s objects clause. A company is no longer required to have an objects clause but any company registered before the registration provisions of the CA 2006 came into effect (1 October 2009) was required to have an objects clause in its memorandum. From that date, the objects clause of such a company is treated as a provision of its articles (s.28 CA 2006). Here, the objects clause is treated as a provision of Wool 4U‟s articles. Consequently, the objects clause is relevant in four respects: (i) It may underpin liability of the directors for breach of duty. The articles are an important

part of the company‟s constitution (s.17 CA 2006). Directors owe a duty to the company to act in accordance with the constitution and only exercise powers for the purposes for which they are conferred (s.171 CA 2006). Accordingly, any director causing the company to act outside its objects will be in breach of his or her duty to the company.

(ii) It may result in a contract with the company being void, although the potential for this is slight. At common law, the board of directors has no authority to bind the company to a contract outside the objects of the company. S.40 CA 2006 will over-ride this absence of authority in most but not all cases.

(iii) The shareholders can seek an injunction preventing the directors from acting beyond their powers, ie inconsistently with the objects clause (a power preserved by s.40(4) CA 2006)

(iv) If the object of the company becomes impossible, this may satisfy the court that the company should be wound up on the ground that it is just and equitable to do so (IA 1986 s.122(1)(g)).

On the facts, the agreement with Lamb-u-Like is in pursuit of the objects of the company. Examiner’s comments Part (a) produced incomplete and often out-of-date answers. Few candidates identified the effect of the CA 2006 on the objects clause of an existing company, which is an important issue. Some candidates discussed expressly how ultra vires might be relevant in relation to the transaction outlined in the problem and confined themselves to this pursuit. This was perhaps an understandable approach, although the question required a more general discussion. (b) On the potential liability of Molly to the company on the facts stated above. (8 marks) Suggested answer The fact that she is a director of a company with which Wool 4U may contract technically places Molly in a conflict of interest position and in breach of s.175(1) CA 2006, unless the situation (of her being a director and 20% owner of Lamb-u-Like) “cannot reasonably be regarded as likely to give rise to a conflict of interest” (s.175(4)(a)). Alternatively, if the articles of Wool 4U include provision authorising the directors to do so, the directors may authorise Molly‟s dual directorships (s.175(5)(b)), provided that Molly must not be counted towards the quorum and that her vote at the meeting, at which the matter is authorised, must not be counted in determining whether or not it has been authorised (s.175(6)).

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The real conflict of interest arises in relation to the contract with the company, which is not governed by s.175 (see s.175(3)) but is governed by ss.177 and 190. S.190 requires substantial (as defined in s.191) property transactions between a director or a person connected with a director (as defined in ss. 252-254) and the company to be approved in advance by shareholders. This does not appear to have occurred. The civil consequences of contravention are set out in s.195. The contract is for purchase of in excess of £100,000‟s worth of wool (minimum 5 x £30,000), therefore, it is a substantial property transaction (s. 191). Molly owns 20% of the contracting party, Lamb-U-Like, which is therefore connected to her (ss. 252 & 254(2)(a)). Molly is liable to account to Wool 4U for any gain she directly or indirectly makes and to indemnify the company for any loss or damage resulting from the contract (ss.195(3) & (4)). (The contract may be voidable, but the bona fides of Lamb-u-Like Ltd may preclude this (see s.195(2)). S.177 is not important as, even if no formal declaration has been made, the other directors were aware of Molly‟s interest in Lamb-u-Like so there is no breach of that section (s.177(6)(b)). Given Molly‟s comments at the board meeting about the contract, breaches of ss. 172 and 174 could arguably be made out. When she commented, she should have been acting in the way she considered in good faith would be likely to promote the success of Wool 4U (s.172) and should have exercised reasonable care and skill (s.174). In practice, remedies for these breaches would not need to be pursued, as the company would be able to secure adequate remedies using s.190. Examiner’s comments No more than one or two answers to this question identified the s.190 requirement. Many candidates referred to s.175 without referring to, or considering, s.175(3). (c) On the potential liability of the other directors to the company on the facts stated

above. (6 marks)

Suggested answer S.190 is the most straightforward solution here: s.195(4)(d) renders all five of the other directors jointly and severally liable with Molly to indemnify the company. A discussion of the duties under ss.172 and 174 is more appropriately placed here as the directors under consideration participated in the company‟s decision to buy, ie were clearly acting in the role of managers of Wool 4U‟s business. The correct test for each duty should be identified and the behaviour of the directors tested against it. S.172 invites discussion of the extent to which the test is subjective or objective (Re Smith & Fawcett [1942] contrast Charterbridge Corporation v Lloyds Bank Ltd [1970]) and s.174 a discussion of the objective nature of the test, the CA 2006 having changed the law (from Re City Equitable Fire Insurance Co Ltd [1925]) and made it more demanding of directors (confirming Re D’Jan (of London) Ltd [1994]). S.173 is also of interest here and discussion of the appropriateness of relying on Molly‟s expertise in the circumstances is creditworthy.

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Examiner’s comments Discussion of ss. 172 and 174 was often superficial in answers to part (c), with most candidates not applying the law to the facts. For Question 4 as a whole, the general nature of the discussion of directors‟ duties was marked and, given the central importance of the topic, very disconcerting.

5. Infamy Ltd („Infamy‟) was formed in January 2007 to acquire the celebrity promotion

business that Peter and Stacey had owned and operated in partnership together for four years. Peter and Stacey had each subscribed for 50% of the shares in the company and became its directors. Shortly after its formation, Infamy was invited to bid for a profitable three year contract with Celeb TV plc („Celeb TV‟). Peter and Stacey knew that they needed to bring in someone with television presence so they approached Terry, a well known television show host, to discuss the possibility of him becoming part of the contract team.

Negotiations between Peter, Stacey and Terry resulted in Terry becoming a director of Infamy alongside Peter and Stacey. He also became owner of 20% of the shares of the company, with Peter and Stacey owning 40% each. All three agreed to each of them having a four-year service contract, commencing 1 May 2007. Infamy‟s bid was successful and it entered into a three year contract with Celeb TV. Its income trebled in the first year of the contract and profits would have been high but for each of the directors receiving remuneration at a level approximately three times that of comparable marketing professionals. Its distributable profits were consequently low and it did not pay any dividends. Before the contract with Celeb TV expired, Infamy successfully negotiated a new contract for a further three years. On the day the new contract was signed, 1 June 2010, Peter wrote to Stacey stating that she had been removed from the board and enclosed a cheque for six months‟ pay in lieu of notice of termination of her service contract. Infamy continues to earn very high income from the Celeb TV contract, pays very high remuneration to its directors and does not pay dividends. Required Advise Stacey on:

(a) The validity of her removal from the board. (5 marks) Suggested answer Ss. 168 and 169 of the CA 2006 govern removal of directors in addition to specific provisions in the articles (which may not formally contradict the power in s.168 but weighted voting rights can effectively work around it: Bushell v Faith [1970]). No specific provisions in the articles are referred to in the question, therefore, candidates should have assumed that none were relevant. S.168 provides that the company may, by ordinary resolution at a meeting, remove a director. The written resolution procedure cannot be used (see also s.288(2)). Peter & Terry have 60% of the votes between them, sufficient to pass an ordinary resolution, but there is no evidence that a shareholders‟ meeting has been held. Special notice of a proposed resolution to remove Stacey should have been given to the company at least 28 days before the meeting. 14 clear days‟ notice should have been given of the meeting (to all shareholders).

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S.169 sets out a director‟s rights; to receive a copy of the special notice, have representations sent to shareholders, and to address the meeting. The correct procedure has not been gone through, so the removal is ineffective. If Peter and Terry wish to remove Stacey, she can be removed subject to the correct procedure being adhered to. Consequently, she has little to gain from taking the procedural points, except time. Candidates should have noted that, even if Stacey‟s removal is in accordance with the CA 2006, her removal may form part of the evidence to support a petition under s.994 based on conduct unfairly prejudicial to her interests. Examiner’s comments Part (a) was answered satisfactorily. (b) Her rights under her service contract with the company. (5 marks) Suggested answer S.168(5) provides that removal as a director pursuant to s.168 does not prejudice Stacey‟s entitlement to compensation for early termination of her service contract. However, s.188 governs directors‟ long-term service contracts. If a term in a director‟s service contract provides for the contract to be for two years or more, the term must be agreed to by the company unless it has been approved “by resolution of the members”. There is no evidence of such a resolution having been passed. If this means that s.188 has not been complied with, the consequence, set out in s.189, is that the contract remains binding on the company but the provision setting out the four year term is void to the extent of the contravention. Also, the contract is deemed to contain a term entitling the company to terminate the contact at any time by giving reasonable notice. Stacey is therefore entitled to payment in lieu of reasonable notice (which is a matter of fact and six months may be sufficient). It may be argued that s.188 has been complied with based on Re Duomatic Ltd [1969] as the shareholders unanimously agreed Stacey‟s service contract. Examiner’s comments Significantly less than half of candidates identified the relevance of s.188. Of those that did, very few candidates appeared aware of the consequences of its breach, with many answers simply stating that the contract was void. (c) Any legal claim she might be able to bring on behalf of the company and the

procedural steps and conditions she would need to satisfy. (6 marks) Suggested answer The proper claimant for actions to enforce the rights of the company is the company (Foss v Harbottle [1843]). The statutory exception to this is contained in s.260 of the CA 2006 which allows Stacey to bring a derivative action for the benefit of the company if she can establish “ …negligence, default, breach of duty or breach of trust by a director of the company” (s.260(3)). The only potential breach of duty is payment of excessive remuneration, which is not easy to establish as a breach. Even if a prima facie case of breach of duty can be made out against Peter and Terry, Stacey would need court permission to continue (s.263(2)), which must be refused if either (i) on the balance of probabilities, a director acting in accordance with s.172 would decide not to pursue the claim; or (ii) the breach/breaches have been authorised/ratified. Even if this hurdle were cleared, the court must take a number of factors into account in

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determining whether or not to give permission to continue (see s.263(3) and identify the six factors listed). The most important factor is the final factor, s.263(3)(f), “whether the act or omission in respect of which the claim is brought gives rise to a cause of action the member could pursue in his own right rather than on behalf of the company”. This leads into part (d), as Stacey probably has a claim under s.994 and is unlikely to obtain permission to continue a s.260 claim. Examiner’s comments Candidates did not appear to read part (c) precisely enough, as the answers indicated that they did not identify the significance of the language “on behalf of the company”, i.e. that this part of the question called for analysis of the availability of a derivative claim under s.260 of the CA 2006. (d) Any other legal petitions she may be able to make and the remedy she might expect

to secure. (9 marks) Suggested answer As a member/shareholder, Stacey may petition the court under s.994 of the CA 2006 for, “ … such order as [the court] thinks fit for giving relief in respect of the matters complained of” (s.996 CA 2006). The conduct complained of can be; (i) a breach of personal rights of Stacey (but it is hard to see any clear-cut breach of Stacey‟s strict rights); (ii) a wrong to the company (the payment of excessive remuneration is potentially a breach of directors‟ duties, but the case is not strong); or even (iii) something less than a breach of strict legal rights. Even if otherwise lawful, equity will not permit to go un-remedied the exercise of strict legal rights which undermine equitably enforceable expectations. Stacey will need to argue that the company‟s affairs have been conducted in a manner that is unfairly prejudicial to her “interests” in this broader sense. The application of this equitable jurisdiction is seen where the relationship of the parties is essentially that of partners and one is removed from management (as here – Stacey has been removed as a director, and it is no answer that her removal was strictly in accordance with the CA 2006). It has also been exercised where company profits are paid out as excessive remuneration and no dividends are paid in a quasi-partnership company in which one person has no service contract and is unable to exit the company by selling their shares (again, as here). Candidates should have discussed the general jurisdiction, including identifying the Ebrahimi factors: Ebrahimi v Westbourne Galleries Ltd; Re Saul D Harrison and O’Neill v Phillips) and should focus particularly on Re Cumana Ltd [1986] (payment of excessive remuneration to directors) and Re Sam Weller & Sons Ltd [1990] (non-payment of dividends). In relation to remedies, although the powers of the court are very broad under s.996, a buy-out of the petitioner‟s shares in the company by the majority shareholder is the usual remedy sought and awarded: Grace v Biagioli [2006]. Here, it is not wholly clear whether a discount or pro-rata price is appropriate. If Stacey can show that even with the introduction of Terry, the management was understood to be mutually undertaken and to involve her, she may be able to secure an order that her shares be bought at a pro-rata valuation: Re Bird Precision Bellows. Stacey may also consider petitioning the court for an order to wind up the company based on the just and equitable ground (IA 1986 ss. 124 and 122(1)(g)). Her ability to make an application under s.994 is not sufficient ground to deny a winding up order and the court will ask: is the shareholder acting reasonably in seeking an order? (Re a Company (No 001363 of 1988) ex parte S-P).

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Examiner’s comments Many answers confused legal action taken by or on behalf of the company in order to secure a remedy for the company (on the one hand) with legal action by a shareholder to secure a personal remedy for the benefit of the shareholder (on the other hand). Consequently, ss. 260 and 994 CA 2006 were not dealt with well. Discussion of the conditions to be satisfied before a court would be prepared to grant a remedy on a s.994 petition was very poor.

6. Yetty plc („Yetty‟) was incorporated on 1 July 2008. On 2 July 2008, Rich Bank plc („Rich

Bank‟) granted the company an overdraft facility of up to £200,000. In order to secure the sum overdrawn from time to time, Rich Bank insisted upon, and was granted: a fixed charge over Yetty‟s freehold offices, a charge (expressed to be a fixed charge) over Yetty‟s book debts and a floating charge over all the assets and the business of Yetty. Also on 2 July 2008, Zorba, one of the directors, lent the company £50,000.

Yetty began to experience financial difficulties. In April 2009, the board of directors created and registered a floating charge over all of the company‟s assets and business in favour of Zorba, to secure the £50,000 loan he had previously made to the company. In January 2010, Voltan plc („Voltan‟) lent £75,000 to Yetty in return for a fixed charge over the freehold offices and a floating charge over Yetty‟s book debts. Unable to service its debts, Yetty went into liquidation in June 2010. It owed £200,000 to Rich Bank on the overdrawn current account, £75,000 to Voltan, £50,000 to Zorba, £30,000 to HM Revenue & Customs and £50,000 to unsecured trade creditors. The freehold offices were sold for £175,000. The liquidator collected £75,000 of outstanding book debts and the company‟s remaining stock was sold for £25,000. The liquidator‟s expenses were £50,000 and the preferential debts were £25,000. The liquidator has confirmed that all charges were registered with the Registrar of Companies. Required Advise the liquidator:

(a) On the validity and order of priority of each of the charges. (13 marks) Suggested answer Each charge should be dealt with in turn. As the question states that all charges were registered with the Registrar of Companies, registration is not an issue for lengthy discussion (see s.860(7) CA 2006 for types of charges that need to be registered). Rich Bank‟s fixed charge against the offices is a valid fixed charge, securing £200,000. As it is first in time, it takes priority in relation to all charges against the offices, fixed or floating. Rich Bank‟s charge expressed to be a fixed charge against the book debts is unlikely to be a fixed charge but will operate as a floating charge. Whether a charge is a fixed or floating charge is a question of substance, not form. The requirements for a charge to be a fixed charge should be set out, including discussion of the importance of control of the property by the holder of a fixed charge and the practical requirements to establish control where the charged property is book debts (discussed in Re Spectrum [2005] and Agnew v IRC (Re Brumark Investments Ltd) [2001]).

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Rich Bank‟s floating charge over all the assets and business of Yetty is a valid floating charge and as it is first in time it takes priority in relation to all other floating charges against the assets and business, except the floating charge against the book debts (which is in favour of Rich Bank anyway). If it contains any language permitting the subsequent grant of floating charges taking priority over it (Re Automatic Bottle Makers Ltd [1926]), the situation may be different. Language permitting subsequent floating charges over specific assets to take priority over an „all assets and business‟ floating charge is not uncommon. If such language is present, subsequent fixed charges over assets within the class „all assets and business‟ will take priority (Re Castell & Brown Ltd [1898]). The floating charge granted to Zorba is ineffective to secure the £50,000 lent by Zorba. Zorba is a director of the company and is therefore a connected person for the purposes of the IA 1986, s.245. The „relevant time‟ for the purposes of s.245 is therefore the two years ending with the onset of insolvency which, on the facts, covers the entire life of the company. S.245 provides for a floating charge created at a relevant time to be invalid except to the extent of (for the purposes of these facts) money paid to the company at the same time or after the creation of the charge. We are not told that any money was so paid, so the floating charge does not secure any sum, and clearly does not secure the £50,000 paid to the company in July 2008. Voltan‟s fixed charge over the freehold offices is a valid fixed charge against the offices, securing £75,000. As it is the second in time fixed charge, it is second in line in priority against the offices, behind Rich Bank‟s fixed charge. It takes priority over any floating charges, whenever created (Re Castell & Brown Ltd [1898]). Voltan‟s floating charge over Yetty‟s book debts is a valid floating charge, securing £75,000. It is second in time, and therefore second in line in priority behind Rich Bank‟s floating charge against the book debts (Re Benjamin Cope & Sons Ltd [1914]). Examiner’s comments Many candidates identified the basic rules of priority in relation to one or more fixed charges, one or more floating charges or a mixture of both but applied these rules poorly to the facts of the question. Far too many candidates did not appear to read the statement that all charges had been properly registered and therefore proceeded to treat various charges as invalid due to non-registration. Some candidates identified the idea that a charge is not fixed merely because it is labelled as such. Very few candidates identified the s.245 argument in relation to Zorba's charge, although some discussed it being a preference under s.239. (b) How the proceeds of the various assets should be distributed. (12 marks)

Suggested answer The liquidator must respect the order of horizontal priority of charges against particular property and is required to distribute the proceeds in accordance with the statutory order of distribution (IA 1986 ss.115, 175, 176A and schedule 6). The freehold property subject to the fixed charges is technically outside the statutory order of distribution. Rich Bank is entitled to all the proceeds of sale of the freehold property (£175,000) and is still owed £25,000. The assets to be distributed by the liquidator are £100,000, made up of £75,000 proceeds of the book debts and £25,000 stock proceeds. This sum is distributable in the following order:

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Payment £ £

Liquidator‟s expenses 50,000 leaves 50,000

Preferential creditors 25,000 leaves 25,000

Set aside the prescribed part for unsecured creditors*

8,000 (50% x £10,000 + 20% x £15,000)

leaves 17,000

Floating charge holders 17,000 to Rich Bank**

leaves 0

Unsecured creditors 3,000 of prescribed part to HMRC

5,000 of prescribed part to others

leaves 0

* Further to IA 1986 s.176A as introduced by the Enterprise Act 2002 and as calculated in accordance with the IA 1986 (Prescribed Part) Order 2003. Note that no floating charges were created before 15 September 2003 so no debts secured by floating charges are payable before the prescribed part is deducted. ** Rich Bank‟s floating charges take priority over the floating charge of Voltan.

Examiner’s comments Many candidates did not appear to understand that holders of fixed charges have property interests in the charged assets and, therefore, that the assets are not available to the liquidator until the charge has been released following payment of the underlying secured debt. Most candidates did not demonstrate knowledge of the statutory order of distribution applied by a liquidator. In particular, quite a lot of candidates answered that Crown debts rank as preferential. Very few candidates demonstrated knowledge of the prescribed part to be set aside for unsecured creditors. Candidates also tended to simply list the order of distribution without working out the maths and explaining how much various creditors would receive.

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.