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CHIEF EXAMINER COMMENTS WITH SUGGESTED ANSWERS LEVEL 6 – UNIT 1– COMPANY AND PARTNERSHIP LAW

JUNE 2019

Note to Candidates and Learning Centre Tutors:

The purpose of the suggested answers is to provide candidates and learning centre tutors with guidance as to the key points candidates should have included in their answers to the June 2019 examinations. The suggested answers set out a response that a good (merit/distinction) candidate would have provided. The suggested answers do not for all questions set out all the points which candidates may have included in their responses to the questions. Candidates will have received credit, where applicable, for other points not addressed by the suggested answers.

Candidates and learning centre tutors should review the suggested answers in conjunction with the question papers and the Chief Examiners’ comments contained within this report which provide feedback on candidate performance in the examination.

CHIEF EXAMINER COMMENTS

A number of comments have been made in previous reports but remain current. In this paper, the more successful candidates had carefully addressed the questions and topics, noting where critical analysis and application were necessary. They discussed relevant statute and case law accurately and generally provided appropriate conclusions that answered the questions posed. There were some good examples of this, which is to be encouraged.

Those candidates who achieved lower marks tended to be less focussed on what the question was asking, but rather homed in on a term or phrase in the question, without giving sufficient thought to what was being asked. This resulted in something of a regurgitation of the legal position with insufficient critical analysis in Part A and poor application to the scenarios in Part B questions. Few candidates appeared to suffer any time issues in the exam.

As with the previous exam session, there was a noticeable lack of case law referencing, across most centres and those who performed less well in particular, as noted in relation to individual questions. Case law is fundamental

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to answering questions to a good standard. Equally, some candidates gave case names but failed to outline their relevance to the topic in question.

As has been said before, candidates should be encouraged by their centres to read the questions posed and consider carefully what is being asked. In addition, candidates should be encouraged to be methodical in their answers ensuring that they address each element of the question or relevant fact. This should assist them in assuring they are correctly focussed and relevant.

CANDIDATE PERFORMANCE FOR EACH QUESTION

SECTION A

Question 1: Lifting the corporate veil – generally this question was well answered, with careful analysis of the issues and good case law referencing.

This was the second most popular question. Weaker candidates did not analyse sufficiently and/or gave little case law.

Question 2: Derivative actions and section 994 – only eight candidates answered this question but four of those produced excellent answers, comparing the two types of action, as was required by the question. The poorer answers tended to state the law on the issues, without a clear comparison.

Question 3: Company transactions with directors: only five candidates attempted this and on the whole it was poorly answered. They focussed on directors’ disclosure of interest in transactions, when there should have been discussion of the regulation of the transactions themselves (for example substantial property transactions). Only one candidate addressed this.

Question 4: Allotment of shares and insider dealing – the nine candidates answering this question produced a range of answers. The main issue was a lack of detail in the weaker answers, and especially references to statute for both parts of the question. To score highly candidates must be as specific as they can be in their references.

SECTION B

Question 1: Partnership authority – this was just the most popular question.

There were some excellent answers with careful attention to detail and good application to the facts. Statutory references were accurate and thorough. As for weaker answers, candidates did not address all the relevant statutory references. This sort of question is a good example of one where a methodical approach should be taken to cover the facts and a range of provisions in the Partnership Act 1890.

Question 2: Pre-incorporation contracts and company names – this was the third most popular question with about 21 answers. Again, answers produced results across a range and points made above apply here – the need for careful attention to detail and application to the facts, with thorough statutory and case reference – as applicable.

Question 3: Insolvency and transactions – This was the least popular question and was generally rather poorly answered. This may have been because it

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was answered late in the exam. Candidates needed to be more specific in their references and address the facts more carefully.

Question 4: Floating charges and loans to directors – Part (a) of this question asked why a floating charge was more appropriate to be taken over a company’s book debts. The better answers addressed this issue carefully, while the majority tended to rewrite a learned answer about the difference between fixed and floating charges. Candidates need to think carefully about precisely what the question is asking. The answers to (b), the regulation of loans to directors, was reasonably well answered – candidates gave adequate statutory references.

SUGGESTED ANSWERS

LEVEL 6 – UNIT 1– COMPANY AND PARTNERSHIP LAW JUNE 2019

SECTION A

Question 1

It is a well-established principle that a company has its own legal personality that is separate from that of its members or shareholders (Salomon v Salomon

& Co (1897)). Thus, there is a ‘veil of incorporation’ between the company and its members, meaning that it is the company alone that is responsible for its debts and liabilities. This applies for example to each member of a corporate group: even though a parent company owns the entire share capital of its subsidiary, it is not responsible for the contractual or tortious liabilities of its subsidiary.

However, the courts have, exceptionally and on restrictive grounds, been prepared to ‘lift’ the corporate veil, and thus disregard a company’s separate legal personality. The key case that established these grounds is Adams v Cape Industries Plc (1990), a case which involved the relationship between a parent company and some of its subsidiaries. A number of other cases, including Prest v Petrodel Resources Ltd (2013) have subsequently confirmed the Adams restrictive approach.

Originally in Adams, three grounds were suggested on which the veil might be lifted. Following Prest, however, it is suggested that in fact only one of these is the ‘true’ ground for veil piercing. This is where a company is a mere façade or sham, or is being used to perpetrate a fraud, reflecting earlier cases such as Gilford Motor Co v Horne (1933). The cases suggest that a company will be regarded as a sham or a façade where it is being used by the person who controls that company to ‘evade an existing obligation’ of the controller.

Jones v Lipman (1962) is a good example of a company being used as a “mere façade”, where an individual wishing to escape liability to complete a conveyancing contract transferred the property into the name of a company which he owned and controlled. If however a subsidiary is used merely to shield the parent company from a potential future obligation, then this would not constitute fraud, would not render the subsidiary a mere façade, and would not lead to the veil being lifted.

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The other situations noted in Adams and Prest where the court might intervene and produce an outcome that looked very similar to veil piercing, but which would technically not involve a true piercing of the corporate veil tend to focus on the relationship between a parent company and its subsidiary: for example, if there is either a specific statutory provision or a contractual document that requires a parent and subsidiary to be treated as a single entity. Similarly, occasionally a subsidiary may be treated as the agent of its parent company. This will not strictly involve piercing the veil, for the parent is still being treated as a separate entity. Nevertheless, as principal, it will be liable for things which its subsidiary does on its behalf. The Court of Appeal in Adams stressed, however, that courts should ordinarily only find an agency relationship between a subsidiary company and its parent where there was an express agency agreement between them. Such a relationship should not be implied merely because, for example, the parent wholly controlled its subsidiary. Earlier cases had been less restrictive than this, with the courts seemingly willing to imply an agency relationship based upon a shareholder’s control over the company (for example Re F G (Films) Ltd (1953)).

In Adams, the court also followed Woolfson v Strathclyde Regional Council (1978) in finding that the mere fact that a group of companies constitute a

‘single economic entity’ does not permit the veil to be lifted. As with the agency relationship ground above, the court in Adams took a more restrictive approach in relation to ‘single economic entities’ than in earlier cases (see for example DHN Food Distributors Ltd v Tower Hamlets London Borough Council (1976)).

The court in Adams also expressly rejected the argument that there was a further ground for veil lifting where to do so was ‘in the interests of justice’.

The court declared that whilst the three specific grounds for veil lifting that it had identified might all be said to be based on what ‘justice’ demanded, nevertheless there was a difference between the specific grounds for veil lifting (interpretation of a statute, agency, façade) and the underlying purpose for that ground. If the court accepted ‘justice’ as itself an independent ground for veil lifting, this would give too much discretion to judges to lift the veil whenever, subjectively, they thought it desirable to do so. This would inevitably create much greater uncertainty in the law.

Adams and Prest, then, require courts to adopt a restrictive approach to veil lifting. Another recent decision of the Supreme Court has also approved this restrictive approach, and the limited grounds on which the veil might be lifted, namely VTB Capital v Nutritek International (2013).

Rarely however, the courts have sought to be less restrictive than Adams, in cases where injured employees of subsidiaries have sought to sue the parent as a joint-tortfeasor. In Chandler v Cape Plc (2012), the court found that Cape, the parent, owed the employees of its subsidiaries a duty of care, because certain conditions were satisfied:

the parent company and its subsidiary operated in the same business (here the asbestos industry). Note however in Thompson v the Renwick Group Plc (2014) and Okpabi v Royal Dutch Shell Plc (2018), this condition was held not satisfied, because the parent was a “pure” holding company, merely owning shares in subsidiaries which themselves carried out all the business activities of the group;

the subsidiary’s operations must be unsafe, and the parent either must know this, or ought to know this;

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the parent must know at least as much about health and safety issues in that industry as does the subsidiary;

the employees of the subsidiary must rely on the parent company to safeguard their health and safety;

Cape had assumed a responsibility for the health and safety of its subsidiary’s employees, since it employed the manager who dealt with health and safety policy at its subsidiary.

Although Chandler identified when a parent might owe a duty of care to its employees specifically, the case of Lungowe v Vedanta Resources Plc (2017) accepted that the duty might extend to other claimants apart from employees of the subsidiary.

Whilst Chandler accepted that a parent company might owe a duty of care, it did nevertheless emphasise that parent and subsidiary are two separate legal entities and that each is responsible only for its own torts; imposing a duty of care on the parent thus does not, technically, amount to a lifting of the corporate veil.

In conclusion therefore, although there are circumstances in which the veil of incorporation may be lifted, such circumstances are rare and restricted.

Question 2

Part 11 and s994 CA 2006 offer protection of shareholder rights, particularly where the company is unwilling to take action following directors’ wrong-doing because it is itself under the control of the wrong-doers. They can be distinguished as follows.

Claims under Part 11 of the Companies Act 2006 (CA 2006), known as derivative claims, are brought by members on behalf of the company for any breach of duty (s260) and not merely for ‘fraud on the minority’. The ground for bringing a claim must involve an act or omission involving negligence, default, breach of duty or breach of trust by a director. This contrasts with a claim under s994 that may be brought in respect of any conduct of the company’s affairs that is ‘unfairly prejudicial’ to the interests of members. Any member bringing a derivative claim must also obtain the court’s permission to continue it. S263 identifies the factors to be considered in the granting of such permission. The court must refuse permission when the company has given authority before the act or has ratified after the act. This reasserts the rule giving the majority the power to deny the minority the right to continue their claim (although in the case of ratification, that majority must not include the wrongdoer or those connected with her: s239). Note however the case of Cullen Investments Ltd v Brown (2015) where the High Court held that a shareholder authorisation of a director’s breach of duty could only be valid if the director had given full and frank disclosure of the said breach.

Additionally, permission must not be given where a ‘hypothetical director’

acting to promote the success of the company (under s172 CA 2006) would not continue the claim: relevant considerations here include the costs of the action, the prospects of its success, the ability of the director to satisfy any order made against her, and the harm that might be caused to the company’s business by continuing the claim against the director – all of which are commercial considerations, upon which a court may be ill-equipped to judge (Iesini v Westrip Holdings Ltd (2009). Consequently, the courts have in fact

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been reluctant to rely on this bar to permission to continue. They have said that only if ‘no reasonable director’ would continue the claim should the courts refuse permission on this ground (Iesini). This may seem helpful to the minority, but this ‘hypothetical director’ test reappears as one of the discretionary factors the court must take into account where no mandatory bar requires the court to refuse its permission for continuation. When applying this discretionary factor, the courts have accepted arguments (and even from the directors of the company who are the alleged wrongdoers) that continuing the action would not be in the company’s best interests: see eg Kleanthous v Paphitis (2011).

Finally, the court must also ask if the member bringing the claim would instead have a personal cause of action in respect of the wrong complained of. In several cases, the courts have used this discretionary factor to rule that the member would be better off bringing a claim for unfair prejudice under s994:

see eg Franbar Holdings v Patel (2008) and Mission Capital v Sinclair (2008).

It would therefore appear that the courts consider the unfair prejudice remedy as a better solution for the minority.

Occasionally, however, it may be that the member does not actually wish to leave the company as they believe the company has good prospects and they and their investment are better protected by remaining shareholders (Wishart v Castlecroft Securities Ltd (2010)).

Finally, a shareholder bringing a derivative claim can ask the court to order that the company must indemnify the claimant shareholder against any legal costs the shareholder may be ordered to pay (if, say, she loses the derivative claim) (Wallersteiner v Moir (No 2) (1975)).

By contrast, under s994, an individual member may complain to the court where ‘the company’s affairs have been conducted in a manner that is unfairly prejudicial’ to the interests of the members generally or some part of them including his own. The courts have interpreted the ‘interests of the members’

broadly: such interests could be based on the formal rights of the shareholder – under provisions of the CA 2006, or the company’s own constitution – but also on understandings which were never recorded in the articles. These have been referred to both as ‘legitimate expectations’ (Re Saul D Harrison & Sons plc (1995)) and as ‘equitable considerations’. One of the earliest cases to establish this judicial approach is Ebrahimi v Westbourne Galleries (1973). In O’Neill v Phillips (1999), Lord Hoffmann stressed that the task of the court is to give effect to the parties’ own understanding, and not to override what the parties had themselves agreed. Indeed the court will take into account what may be very informal agreements. Further, the courts have generally accepted that interests enjoyed in a capacity other than as a member could also be enforced under s994: see eg Gamlestaden Fastigheter AB v Baltic Partners Ltd (2007).

A further illustration is the recent case of Re CF Booth Ltd (2017): here excessive remuneration was paid to directors who represented the majority shareholders, alongside a refusal to pay dividends to shareholders, apparently motivated by a desire to acquire the minority shareholder’s shares. The court found that such behaviour amounted to unfairly prejudicial conduct.

Another level of protection under s994 lies in the range and effectiveness of the remedies available to the court. Under s996, the court can make any order it sees fit to remedy the unfair prejudice including the purchase of the

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petitioner’s shares. This is by far the most common remedy sought by minorities, and awarded by the courts, which have also generally insisted that a fair price be paid for the shares (i.e. not discounted for being a minority holding): (Re Bird Precision Bellows (1986); O’Neill v Phillips (1991)).

Unlike in a derivative claim, it is generally not possible for a shareholder who brings a claim under s994 to get an order that the company must indemnify any legal costs the shareholder may incur.

To conclude, a derivative claim under Part 11 is one brought on behalf of the company while a s994 claim is a personal claim. The grounds on which a derivative claim can be brought are arguably narrower than under s994. The procedure for bringing a derivative claim is more complex, involving a two stage permission process, and there are more potential bars to bringing a claim than under s994. Finally, the sanctions available to the Court under s994 are extremely wide including ordering a purchase of the complainant’s shares at fair value.

Question 3

This question centres on various sections of the CA 2006, and in particular sections 177, 182, 188 and 190 and Model Article 14. The underlying principles here are avoidance of conflicts of interest between directors’

personal interests and their duties to the company and transparency through disclosure of interests.

Sections 177, 182 and Model article 14 address these principles.

Prior to the CA 2006, such a transaction was voidable at instance of the company (Aberdeen Railway Co v Blaikie Bros (1854)). However in the precursor to the Model Articles, regulation 85 of Table A Articles did provide for a mechanism, albeit a complicated one, to contract out of this principle.

Currently, under s177 a director must declare an interest, whether direct or indirect, in a transaction with the company of which he is a director. Provided that disclosure is made, the contract is not voidable. The disclosure must be made before the contract is entered into (s177(4), and this could for example be at a board meeting or by specific written notice.

Exceptions do exist however, in s177(5) and (6), to the requirement to disclose the interest. No disclosure is required, for example, if the other directors are already aware (or ought to be aware) of the proposed transaction, or if it could not be expected to give rise to a conflict, or if it relates to the approval of a director’s service contract.

S177 relates to a civil law duty to disclose. S182 should also be mentioned which imposes a criminal liability if a director does not disclose a transaction that has already been entered into. As with s177(6), there is no need to disclose if the other directors are already aware of the transaction (or if disclosure has already been made under s177).

The duty to disclose under s177 exists in addition to the duty to avoid conflicts of interests between a director’s personal interest and his duty to the company. Directors are under a general duty to avoid conflicts of interests under s175 CA 2006. However, it should be noted that conflicts arising in

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relation to a transaction with the company are specifically excluded from s175 (see s175(3)). Model Article 14 (MA 14) instead deals with the potential conflict arising where there is with an actual or proposed transaction or arrangement with the company in which a director is interested. Such a director is prohibited from counting in the quorum for or voting on approval of such a transaction.

Companies can however expressly exclude this article, or an ordinary resolution can be passed disapplying the article. As with s177, MA 14 also provides exceptions such as when the director is subscribing for shares in the company.

In addition to the rules under section 177 and MA 14, in certain circumstances shareholder approval is also required when a director is to enter into a transaction with a company.

Firstly, directors’ service contracts: Normally only board approval is required of a service contract but where that agreement contains a fixed term of over two years, then the shareholders must approve that term by ordinary resolution, which can be in general meeting or by written resolution (s188 CA 2006). In either case the shareholders must be given the opportunity to review a memorandum of the proposed service contract. If appropriate approval is not obtained, then the fixed term is void, and the contract is deemed terminable on reasonable notice.

Secondly, under s190 CA 2006, if a director or a person connected with him, such as his parent, spouse or child (s252 CA 2006), enters into a transaction with the company, such as the sale or purchase of an asset, that transaction must be approved by the shareholders when the transaction:

(i) relates to a non-cash asset (s1163);

(ii) is substantial – ie it is for more than £100,000 or is less than

£100,000 but more than £5,000 and over 10% of the company’s net asset value.

The relevant approval is by ordinary resolution (ie a simple majority). The approval could be given by passing a resolution in general meeting, or by a members’ written resolution. Moreover, it would appear that informal, but unanimous, approval may also suffice (NBH v Hoare (2006)).

If approval is not given, then the contract is voidable at the instance of the company. Moreover, any director of the company who authorised the transaction is liable to account to the company for any gain made.

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Question 4(a)

Directors possess wide powers to run a company, but certain restrictions do exist to prevent directors from allotting shares without limit and thereby potentially diluting existing members’ shareholdings.

The starting point is s549 CA 2006 which states that directors can allot shares, but only if authorised to do so. This requirement for specific authority is lifted however in relation to private companies with one class of shares under s550 CA 2006. The section effectively gives automatic authority to allot, as long as there is no provision to the contrary in the company’s articles of association.

However, if the company is a public one or has more than one class of shares, authority is required under section 551 CA 2006. Shareholders must approve the granting of authority to the directors (note it is not approval of the actual allotment) by ordinary resolution in general meeting. The written resolution alternative could be used. Such an approved authority is subject to a maximum length of five years, and the resolution for approval must also state the maximum number of shares that directors could allot.

However, even if s550 applies, if directors propose to allot equity securities (ie ordinary shares or shares with voting rights for example) they must first offer them to existing shareholders, under s561 CA 2006. These are statutory pre-emption rights and can help to prevent dilution of voting rights.

However, these rights can be disapplied again under the CA 2006 ss 567, 569, 570 and 571. Generally, if a company has included a disapplication of pre- emption rights into its articles, then directors do not have to offer new equity securities to existing shareholders before offering them to anyone else.

Alternatively, the pre-emption rights can be disapplied by special resolution (and a 75% majority). Again, such a resolution could be passed in general meeting or in writing.

Finally, note that directors must exercise any power they are given to allot shares for ‘the purpose for which the power was conferred’ (s171). It would be for the court to determine for what purpose the directors were empowered to allot shares. Cases such as Howard Smith v Ampol Petroleum (1974) suggest the court would likely find that the purpose for which directors were empowered to allot shares was only to raise more capital for the company.

In conclusion, at first sight there appears to be significant restriction on directors’ power to allot shares, but the ca 2006 has introduced a number of means of lessening such restrictions.

4(b)

This question raises the issue of insider dealing, which is a criminal offence under the Criminal Justice Act 1993 (CJA). The primary offence is committed if an individual who has information as an insider deals in price affected securities on a regulated market (s52 (1) CJA). There are also the secondary offences of encouraging another person to deal in securities that are price affected securities knowing or having reasonable cause to believe that the dealing would take place (s52(2)(a) CJA); and, disclosure of inside information by an individual otherwise than in the proper performance of his office, employment or profession to another person (s52(2)(b) CJA)

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There are a number of elements to these offences. First, the primary offence can only be committed by an individual. Second, the dealing must take place on a “regulated market”. Regulated markets include the Main Market of the London Stock Exchange and the Alternative Investment Market. For the purposes of the CJA, a person “deals” in securities if he acquires or disposes of securities as principal or agent or procures another person to do so including, as here, through his agent or broker (s55 CJA).

Information is “inside information” if it:

• Relates to particular securities or a particular issuer of securities

• Is specific or precise

• Has not been made public and

• If it were made public would be likely to have a significant effect on price.

Securities are “price affected” if the information relating to them is “inside information” and the inside information is “price sensitive information” if the information would, if made public, be likely to have a significant effect on the price of the securities (s56 CJA). The CJA provides a non-exhaustive list of what is meant by information being “made public” including where it is published in accordance with the rules of a regulated market for the purpose of informing investors and their advisers (s58 CJA).

The individual must have the information as an “insider”. This will be so if the information is “inside information” and the individual knows that it is inside information and he has it from an inside source (s57 CJA). He will have the information from an inside source if he has it through being a director, employee or shareholder himself or he has access to the information through his employment, office or profession or the direct or indirect source of the information is through one of those channels. It therefore covers both direct and indirect sources of information.

There are a number of statutory defences contained in s53 and special defences in Schedule 1 CJA. These defences include not expecting the dealing at the time to result in a profit; believing on reasonable grounds that the information had been disclosed widely enough to ensure that those dealing would not be prejudiced by not having the information; and dealing in good faith in the course of business as a market maker.

Penalties are a fine or imprisonment for a maximum of 7 years. A director may also be made the subject of a banning order under the Company Directors Disqualification Act 1986 disqualifying him from holding office as a director.

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SECTION B

Question 1(a)

As this business is run as a partnership, the liability of the firm in relation to the printer depends primarily on the law of agency as applied by s5 PA 1890.

Further, if the partnership is found to be liable, all the partners (Kevin, John and Navpreet) would be jointly liable under s9 PA1890 and severally under the Civil Liability (Contributions) Act 1978.

Initially Kevin’s actual authority to bind the partnership should be considered.

Actual authority can be divided into two limbs: express and implied. The former can derive from a partnership agreement for example. We are told that the partnership agreement here contains a provision restricting the incurring of debts to £3,500, without the consent of the other partners. It would appear therefore Kevin did not have express actual authority and has breached this provision of the agreement. In addition, the other partners had no knowledge of the purchase.

In terms of actual implied authority, this can arise as a result of course of dealings between the partnership and a third party. Here we are told there have been no such previous dealing which suggests Kevin did not have implied authority. Further, under s7 PA 1890 where partner uses the firm’s credit for purposes not connected with the firm’s ordinary course of business the firm is not bound unless the partner is specifically authorised. In this case it seems that the printer is for the business, but its 3D capability is beyond the needs of the partnership. In addition, Kevin was not specifically authorised.

Although Kevin therefore did not have actual authority, it is however necessary to turn to the apparent authority that could arise under section 5 PA 1890.

S5 PA 1890 provides that every partner is an agent of the firm for the purpose of the business of the partnership; further, a partner acting in the usual way for the purpose of carrying out business of the kind carried on by the firm will bind the firm unless the partner concerned has no authority to act, and the third party either knows he has no authority or does not know or believe him to be a partner.

Each element of s5 should be considered in turn in relation to Kevin’s purchase of the printer. First, was he acting in the usual way for the purpose of carrying out business of the kind normally carried out by the firm? It is apparent from caselaw that this test is not restricted to the actual business of the firm but may extend to other activities which are incidental to it. However, a printer would appear to be something needed for the business.

The firm could escape liability if it can be shown that the dealership did not either know or believe Kevin to have been a partner. This is the first time the partnership has had any dealings with the printer supplier, but the order was made on the partnership’s headed paper which should include all the names of the partners. Therefore, the printer dealer would have seen Kevin’s name as a partner. It is unlikely also that the supplier would have seen the partnership agreement and the restriction.

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In summary therefore, it seems likely that the partnership will be liable to pay for the printer. However, the partnership could require Kevin to indemnify the partnership as he has breached the partnership agreement restriction.

1(b)

Section 17(1) partners are only liable for debts when they are members of the partnership. However, liability could arise if Mina is held out as a partner before she joins under s14 PA 1890. She must be knowingly held out by the others for example or hold herself out as a partner. Therefore, she should not allow her name to be added to the letterhead or website until she formally joins.

(c)

Under s17(2) a partner not liable for debts incurred after he ceases to be liable. He must however ensure that section 36 PA 1890 is complied with. First unless and until specific notice is given to those who have previously dealt with the partnership, they can treat apparent members of the old firm as still being members applies though. In addition, notice of the change, ie John’s retirement, should be placed in the London Gazette. This will constitute notice to those who have not previously dealt with the firm.

Question 2

The issues to discuss here relate to the renting of the refrigeration unit and the proposals for the company and trading names.

Firstly, if Jason enters into a contract to rent the unit before the company is incorporated, then this contract will be a ‘pre-incorporation contract’.

Ordinarily, a person entering into a contract on behalf of a company acts as the company’s agent, and it is accordingly the company which is liable on that contract, not the agent. With a pre-incorporation contract, however, this cannot be the case, for at the date of the contract there is no company in existence to act as principal. Rather, as s51 Companies Act 2006 makes clear, the position is that the promoter, here Jason, is personally liable in respect of the contract. Thus, he would be personally liable to pay the rent and to comply with all the other obligations of under the agreement.

This rule is, by s51, made subject to any ‘agreement to the contrary’. In other words, it is possible for Jason, when he enters into the contract on behalf of the company he is forming, to expressly agree, with Coolways, the other party to that contract, that Jason as promoter will not be personally liable under the contract. However, in Phonogram Ltd v Lane (1981), the court made clear that any such ‘agreement to the contrary’ must be expressly and clearly included within the contract. The court would not imply any such agreement to the contrary. In that case, the promoter signed the contract ‘for and on behalf of Fragile Management Ltd’ (the name of the company being incorporated). The court held that these words were insufficient to amount to an agreement excluding the personal liability of the promoter.

Thus, if Jason were merely to add some additional words to his signature to indicate he signs purportedly as an agent for the company being formed, that will not be sufficient to exclude his personal liability. It must be shown that

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there is actually an agreement between him and Coolways excluding his personal liability.

Whilst s51 makes clear that the promoter will incur a personal liability under the contract, it does not make clear whether the promoter will be entitled personally to enforce the contract: does the promoter take the benefits, as well as the burdens, of the contract? The point was, however, settled in the case of Braymist Ltd v Wise Finance Co Ltd (2002). The Court of Appeal held that s51 provides both remedies for, but also imposes obligations on, a party who enters into a contract with a company that has not yet been formed, and those obligations can be enforced by the person purporting to act as agent of the unformed company. So, Jason would also be able to enforce the contract against Coolways.

What might Jason do therefore to protect himself against personal liability?

One thing is, as noted above, to enter into an ‘agreement to the contrary’ with Coolways. Another option would be for Jason to enter into a contract with the company once it is incorporated, whereby the company promises to perform the obligations under the contract with Coolways, and to indemnify Jason against his liability under that contract. This is however an incomplete solution, for it depends upon the ability of the company to perform these obligations (such as to pay the rent, and so on). If the company is unable to do so, say because it becomes insolvent, then Coolways will still be able to sue Jason personally, and his right of indemnity against the company will be of little value. A better solution is a contract of novation – ie a new contract not only with the company but with Coolways too, under which the company agrees to perform on the same terms as in the original contract, and under which Coolways releases the promoter, Jason, from his previous personal liability.

The difficulty with the preceding suggestion is that, once Coolways has the benefit of a contract with Jason, there is perhaps no obvious reason why she would agree to enter into a contract of novation which releases Jason from his personal liability. A way around this would be for Jason to include a term in the original contract that his liability will cease at some point in the future if the company is incorporated and if the company agrees to take over the Jason’s liability. Again, however, Coolways would have to agree to the inclusion of this term. Clearly, this solution is close to the idea of an

‘agreement to the contrary’ that is provided for in s51 itself (see above) although this solution has the disadvantage of creating (albeit temporary) personal liability for Jason.

Finally, since the problem of personal liability arises because of the time gap before the formation of the company, one way around the problem is simply to create the company as quickly as possible. To this end, Jason could use a shelf company to have available a company immediately (although the acceleration of the incorporation process at Companies House achieves now a similar effect).

Second, as far as the choice of name is concerned, the company’s name must end in ‘Ltd’. The name cannot be identical with the name of an existing registered company, and s66 CA 2006 specifies that certain small variations in names are insufficient to make one corporate name different from another.

In Jason’s case, he may also need to get permission to use ‘Bedford’ in the company’s name, as it suggests a connection with a local authority. He could therefore just drop Bedford from the name.

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It would be possible to change the company’s name at a later stage under s26 CA 2006. A shareholders’ special resolution would be required in general meeting or by written resolution. Companies House would also have to be informed of the change of name.

In addition, if Jason decides to use a different trading or business name, he will have to comply with disclosure obligations such as stating on his business stationery where the company’s registered office is.

Even if Jason succeeded in registering the company with the name he wants, he should check if there are any other businesses with similar names. He would want to avoid any ‘passing off’ action if the name under which the company trades suggests it is carrying on someone else’s business.

Question 3

Lucy could consider taking the following action:

It would appear from the facts that the directors may fall foul of s214 Insolvency Act 1986 (IA). Lucy could apply to the court for a declaration that any of the directors is or are liable to make such contribution to the assets of the company as the Court thinks proper (s214(1) IA). If the application is successful, then the amount to be awarded will be calculated on a

‘compensatory’ basis, i.e. to reflect the depletion in the company’s assets caused by the wrongful trading; see Re Produce Marketing Consortium Ltd (No2) (1989).

Section 214 applies in circumstances where a company has gone into insolvent liquidation and at some point, before the commencement of the winding up the directors knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. If the director can satisfy the court that he took every step with a view to minimising the potential loss to creditors, the Court may not however make a declaration (requiring the director to contribute to the company’s assets) (s214(3) IA).

It is necessary to establish the facts a director ought to know or ascertain, the conclusions he should reach, and the steps he ought to take, i.e. those which a reasonably diligent person would have known, ascertained, reached or taken:

i) having the general knowledge, skill and experience that could reasonably be expected of a person carrying out similar functions; and

ii) the general knowledge, skill and experience the director has (s214(4) IA).

These are respectively objective and subjective tests. Applying them to the HC directors, Bridget, as she is young and inexperienced, would be judged objectively. Alan, on the other hand is as a qualified accountant, so would be judged subjectively and therefore would be expected to conclude, before Bridget, that the company had no reasonable prospect of going into insolvent liquidation. We have no specific information about Simon. Therefore, on the facts, he would be judged objectively.

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The question here is at what stage, if at all, the directors ought to have concluded on this basis that there was no reasonable prospect of the company avoiding insolvency.

The company certainly appeared to be in serious financial difficulties by 2018 although we do not have precise figures. The directors continued to trade for almost a year afterwards despite a continuing deterioration in its financial position as a result of paying increased prices for the cotton. In addition, the directors appear to have taken a rather relaxed approach to managing the company in the early part of 2019, when they all went skiing. In addition, they have not held a board meeting since then, suggesting that they have not taken every step to minimise the loss to creditors. (Re Brian D Pierson (Contractors) Ltd (1999)).

Besides possibly being in breach of s214 IA 1986, the directors may also have been in breach of some of their general duties as directors. In particular, they do not appear to have been fulfilling their statutory duties to promote the success of the company, and to exercise due skill and care (ss 172 and 174 CA 2006).

Next, a floating charge created at a ‘relevant time’ before the onset of insolvency is invalid except to the extent that it is given for new consideration (s245 IA 1986). In other words, it is void to the extent that it is given for a pre-existing debt.

In the case of a charge created otherwise than in favour of a person connected with the company, the relevant time is 12 months ending with the onset of insolvency which in the case of company going into liquidation is the date of the commencement of the winding up.

Here, it appears the charge was created to secure an existing debt, the overdraft facility with Eastern Bank, and that it was created within the relevant time (about 5 months prior to insolvency) as there is no reference to new consideration being given. There is no suggestion that Eastern Bank is a connected person in relation to HC. Because the charge is not given to a connected person, it is invalid only if the company was unable to pay its debts at the time of the charge’s creation or became unable to do so as a result of the creation of the charge. However, this certainly seems to be the case here.

Lucy could therefore apply for the floating charge to be declared void.

In relation to the sale of the vehicle, Lucy could call for this to be set aside on the grounds that it was the sale of an asset at an undervalue under section 238 Insolvency Act 1986 (IA 1986).

A transaction at an undervalue occurs if at a ‘relevant time’ the company enters into a transaction with a person for no consideration or for a consideration the value of which in money or money’s worth is considerably less than the consideration provided by the company (s238(4) IA). The vehicle was sold for only just over half its value, so should satisfy the undervalue element.

For transactions at an undervalue, the ‘relevant time’ is the period of two years ending with the onset of insolvency (s240(1)(a) IA). This period applies irrespective of whether the transaction is with a ‘connected person’. This transaction took place just under two years prior to liquidation. However, at that time the company must also be unable to pay its debts or become so as

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a result of the transaction (s240(2) IA). This is however presumed where the company enters into the transaction with a connected person, as here, unless the contrary is proved. ‘Connected person’ is defined in s249 IA 1986 as a director or an associate which includes a director’s parent, as here.

Whether a company is unable to pay its debts is to be ascertained by the tests contained in s123 IA. These include where it is proved to the satisfaction of the court that the value of its assets is less than the value of its liabilities including contingent and prospective liabilities (s123(2) IA). We do not have precise information on this, but the facts suggest that the company was in financial difficulties, and it did go into liquidation only eight months later.

It is a defence and the court may not make an order under s238 if it is satisfied the company entered into the transaction in good faith and for the purpose of carrying on its business and that at the time it did so there were reasonable grounds for believing the transaction would benefit the company (s238(5) IA).

On the facts it seems unlikely this test would be satisfied as there seems to be no proper motive for the company selling the unit or for believing it would benefit the company.

Question 4(a)

Two types of charge are possible: fixed and floating, but the most appropriate would be the floating charge for the following reasons.

There are difficulties with creating a fixed charge over a company’s book debts – ie the debts owed to the company and payments received in respect of such debts. Creation of a fixed charge over book debts is in theory feasible, but the decision in Re Spectrum Plus Ltd (2005) makes this difficult. The key issue revolves around whether the lender has sufficient control over the charged assets to give rise to a fixed charge and whether the borrower is able to use the moneys received to carry on the business. The House of Lords in Spectrum overruled previous cases (Siebe Gorman (1979) and Re New Bullas (1994)), holding that for a fixed charge to be created over book debts a lender must exert a high degree of control over the charged assets – for example requiring the borrower to pay sums received into a specified account, and from which the borrower could withdraw sums only with the consent of the lender.

The issue here is that imposing such requirements on the borrower under a fixed charge would fetter effective carrying on of the business.

A floating charge would be more suitable as SFC would retain control of the assets without having to seek consent of lender each time it needed to deal with book debts.

In terms of the nature of a floating charge, only a company or an LLP can create one. The charge is created over a generic class of assets (such as the stock in trade or book debts of the company): Re Panama, New Zealand and Australian Royal Mail Co (1870). In other words at the date of its creation, the charge does not attach to specific items within that class of assets. It will attach to particular assets only when it ‘crystallises’ into a fixed charge:

Illingworth v Holdsworth (1904). This means that until crystallisation, the chargor company is free to deal with the assets under the charge without reference to the charge (Re Yorkshire Woolcombers Association Ltd (1903)), thus maintaining control over how to deal with these assets. Hence the preference over a fixed charge in this case.

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Other points to note about a floating charge include that it will be a ‘qualifying floating charge’ (ie one created after 15 September 2003), giving the charge holder (here Douglas) the right to appoint an administrator over the company, in the event for example that the company faces financial difficulties and is unable to repay the debt owed. Such administrator will have rights to take control over the company’s undertaking to protect the interests of the charge holder.

Douglas would also enjoy a degree of priority over other, in particular unsecured, creditors regarding the proceeds of sale of the assets subject to the charge. However, this priority, and thus creditor protection, can be restricted, in two ways. First, it can be restricted by rules governing the registration and priority of different charges over the same asset. We are told that SFC has already granted a fixed charge to HSG Bank. A floating charge ranks behind a fixed charge over the same asset. However, it seems that the existing fixed charge is only over SFC’s office premises and is not over the book debts. Douglas should still ensure that the floating charge is registered at Companies House (s859A(4) CA 2006) to get protection against subsequent floating charges. Second, the priority Douglas will enjoy will also be restricted by rules in IA 1986 which are designed to ensure a fairer treatment of unsecured creditors.

4(b)

A company is permitted to grant a loan to a director, but only if that loan is first approved by the company’s shareholders (s197 CA 2006), by ordinary resolution. This could be done in general meeting or by written resolution.

Certain exceptions to the requirement to obtain shareholder approval do exist (ss 204 to 209 CA 2006), and the most relevant to consider here is found in s204 CA 2006, which states that approval is not required where a director is provided with funds when he incurs expenditure for company purposes or to fulfil his duties. In addition, the funds may be provided so that the director may avoid incurring such expenditure, as is the case with SFC and Ben.

However, this exception only applies where the funds provided, in this case the loan, is less than £50,000. Here of course the proposed loan is £75,000 and thus will require shareholder approval. No other exceptions would be relevant to the proposed loan to Ben.

If such approval is not obtained, then the loan is voidable at the instance of the company (s213 CA 2006), unless restitution of the money is no longer possible. Further the relevant director, Ben would be liable to account for any profit made or to indemnify the company for any loss incurred.

It is worth noting that, following Ciro Citterio v Thakrar (2002) and Guinness v Saunders (1990), a constructive trusteeship does not arise in relation to any assets acquired by the director using funds provided by a company.

References

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