LEVEL 6 UNIT 16 PRACTICE OF COMPANY & PARTNERSHIP LAW SUGGESTED ANSWERS - JUNE 2011

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1 LEVEL 6 UNIT 16 PRACTICE OF COMPANY & PARTNERSHIP LAW SUGGESTED ANSWERS - JUNE 2011 Note to Candidates and Tutors: The purpose of the suggested answers is to provide students and tutors with guidance as to the key points students should have included in their answers to the June 2011 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 students may have included in their responses to the questions. Students will have received credit, where applicable, for other points not addressed by the suggested answers. Students and tutors should review the suggested answers in conjunction with the question papers and the Chief Examiners reports which provide feedback on student performance in the examination. Question 1 Coopers Solutions Limited (CSL) CSL may purchase Jack Boyle s shares by undertaking a buy back of shares. The basic principle is that a company limited by shares cannot acquire its own shares s658 Companies Act The reason for the general prohibition is that it is part of the body of legislation designed to preserve the share capital of companies. However, there are exceptions to basic principle; namely that a company limited by shares may purchase its own shares (subject to any prohibition or restriction in the articles) (s690 Companies Act 2006) provided: the shares are purchased using distributable profits or the proceeds of a fresh issue of shares issued for that purpose or, if the company is private, out of capital) (s692(1) and (2) Companies Act 2006); that where the buy back is to be off market, which would be the case if the company is a private company, the terms of the contract by which the company is to purchase its shares are first approved by special resolution of the company before the contract is made (s696 Companies Act 2006). Given the reluctance of the other shareholders to purchase Jack s shares, it is unlikely that they will wish to subscribe for new shares or see the sale of new shares to an outsider. Consequently the consideration for all the shares, 300,000 will have to be funded by distributable profits. However, as the company has only 250,000 of distributable reserves (profits), this is insufficient for the purchase and the remaining sums (i.e. 50,000) will have to be funded by the use of capital. Page 1 of 7

2 A private company limited by shares (i.e. CSL) may buy its own shares using capital (s709 Companies Act 2006) provided: capital is only used to the extent distributable profits are insufficient to satisfy the consideration to be paid by the company (s710 Companies Act 2006); the directors and auditors make a statement that the company can carry on as a going concern (s714); the payment out of capital is first approved by special resolution of the company (s716 Companies Act 2006); members who did not vote for the resolution, or creditors, have five weeks from the passing of the resolution to object to the court (s721) and the payment must not be made during that period (s723); and a notice must be placed in the London Gazette and either the creditors must be informed or the notice must also be place in a national newspaper (s719); the right to use capital is subject to any prohibition or restriction in the company s articles. In addition, the company will need to be authorised by the articles to undertake the procedure. As CSL has adopted the Model Articles, Article 36 Model Articles permits the purchase by a company of its own shares and the use of capital for that purpose. Since CSL has adopted the model articles for private companies it may, with the requisite authorities, acquire Jack s shares. This will require two special resolutions, firstly to buy the shares and secondly to use capital partly to fund the acquisition. The company is to purchase Jack s shares at a premium to their nominal value but this can be paid out of distributable profits as the premium is 150,000, a sum less than the distributable reserves available to be used. (b) The procedural requirements: To buy back shares: Inspection of the contract or a memorandum of its terms (s696 Companies Act 2006) (note time-scales) and board approval of terms; The special resolution to buy back is void if it would not have been passed if the vendor had not voted (s695 Companies Act 2006); Return to registrar of companies within 28 days of purchase (s707 Companies Act 2006) and amend the register of members; Preservation of contract and inspection facilities for 10 years at registered office s702 Companies Act To use capital: Directors statement in prescribed form with auditor s report annexed (s714 Companies Act 2006); Special resolution to be passed within a week following the making by the directors of their declaration; The directors declaration and the auditor s report must be available for inspection at the general meeting at which the special resolution is passed; Page 2 of 7

3 The special resolution to use capital is void if it would not have been passed if the vendor had not voted; Note the publicity requirements and the time limit within which the purchase must be made. Question 2 There are two aspects to consider in relation to Diana failing to disclose, at a board meeting at which only two directors, including her, were present, a personal interest which she had in a transaction decided on by that board meeting; namely those arising under the Civil (s177 Companies Act 2006) and Criminal (s182 Companies Act 2006) obligation to disclose interest in company transactions. Civil obligation: The basic requirement is that Diana should have declared to the directors an interest in proposed transaction (s177 Companies Act 2006). Note that declaration can, but need not, be made at a board meeting. The consequence of breaching s177 Companies Act 2006 is the same as a breach of the equivalent common law/equitable rule, i.e. the equitable rule of no-conflict rule as set down by Aberdeen Railway Company v Blaikie Bros [1854]. Under this equitable rule, the contract becomes voidable at the election of the company and the director becomes liable to account for any profit she makes on the contract. Criminal obligation: The criminal obligation/requirement arises under s182 Companies Act The requirement/obligation requires that a director acts within powers, namely: Article 11 Model Articles: quorum for board meeting is two persons; Article 14 Model Articles: not to be counted as part of quorum if the director has or is interested in a transaction; s171 Companies Act 2006: the directors must act within powers, including within company s constitution; contract becomes voidable if excess of powers; s40 Companies Act 2006: those dealing with the company may entitled to assume that there is no limit on the authority of the directors to bind the company or to delegate responsibility to conduct the dealing, i.e. the requirement of good faith by third party. Consequently, the directors who attended the meeting and voted exceeded their powers since Diana could not vote and therefore could not count in the quorum (Article 14 Model Articles). There is no quorum when directors decision is taken as only one could vote. In addition, even though the matter had come up for discussion previously and it was likely that the transaction would be entered into, there was the non-disclosure of interest to directors. As such, the transaction is voidable at the election of the company unless the other party can rely on s40 Companies Act 2006 which would require it to have dealt in good faith. Page 3 of 7

4 (b) The proposal to pay off Ewan Hutchings debt and for Ewan to then replay the company amounts to a loan to a director. The relevant law is s197 Companies Act 2006, which prohibits a company from entering into any loan guarantee in connection with a loan made by any person to one of its directors, unless approved by a shareholders ordinary resolution. A quasi-loan is a payment made to a third party to satisfy an obligation or liability of a director owed to that third party by a company (s199(1) Companies Act 2006). Section 197 Companies Act 2006 requires that, in addition to obtaining member consent, a written memorandum setting out the nature of the transaction or arrangement, the amount and purpose of the loan and the extent of the company s liability connected with it must be made available to members before they give their approval by way of ordinary or written resolution. This will be a loan to a director so prohibited unless there is an exception. The most applicable is the s207 Companies Act 2006 exception, provided the proposed loan is less than 10,000. However, as the loan is for 13,500 the exception will not apply and an ordinary resolution of the shareholders will be required. In any event the decision to grant the loan is a directors decision. Ewan, in any event must disclose interest (s177 Companies Act 2006) and cannot vote on matter (Article 14 Model Articles) so cannot count in quorum (Article 14 Model Articles). Question 3 The potential consequences of acquiring from Sykes Limited the freehold office for 270,000 is that it could be held to be a transaction at undervalue. Where, at the relevant time, a company has entered into a transaction in which the company (i.e. Sykes Limited) receives, as in this instance, significantly less consideration than that provided by the company itself (i.e. the property is valued), the transaction may be held to be one at an undervalue and the court must make an order to restore the position (s238 Insolvency Act 1986), unless there is defence of good faith with reasonable grounds for believing that the transaction would benefit the company. The time at which a company enters into a transaction at undervalue is a relevant time if the transaction is entered into within two years of the onset of insolvency in the case of a transaction at undervalue. Applying the facts, the sale would be at an undervalue and it is difficult to see how it would benefit the company, as the company, Sykes Limited, is seeking to sell a property valued at 320,000 for 275,000. In addition there is some doubt as to good faith, given that the proceeds are to be used to reduce debt to various creditors of Sykes Limited to stave off statutory demands. Consequently, the transaction may well be set aside if Sykes Limited goes into liquidation within the relevant time the company is deemed unable to pay its debts within the meaning of s123 Insolvency Act Sykes Limited may be Page 4 of 7

5 close to the onset of insolvency, which is the date of the presentation of the petition for the administration order or the date of the commencement of the winding up (s240 Insolvency Act 1986). Note also that the directors of Capio Renovations Limited should be aware of their general duty to exercise reasonable care, skill and diligence (s174 Companies Act 2006); which they may breach if they proceed where they know or ought to know that the transaction is subject to challenge as a transaction at an undervalue. (b) The transfer of the land owned by the Edwards to the new company Capio Renovations Limited will be a substantial property transaction. As such, a company may only enter into an arrangement with a director, where it is to acquire from a director, or the director is to acquire from the company, a non-cash asset exceeding in value a specified sum if the arrangement is either first approved or conditional upon being approved by a members ordinary resolution (s190 Companies Act 2006). In this instance, the new company is to acquire from the Edwards non-cash assets (Seymour Industrial Park) from two of its directors (i.e. Charles Edwards and Stuart Edwards). The asset is substantial as it exceeds 5,000 and is equal to or more than 10% of the company s asset value. As the company will be new, its assets will (presumably) be limited to the paid up share capital on incorporation, i.e. the nominal value of the subscriber shares. Clearly the value of the Seymour Industrial Park being transferred will be in excess of one-tenth of its asset value. Accordingly, the acquisition requires the approval of members by ordinary resolution. If members approval is not obtained the transaction will be voidable at the instance of the company. Directors who authorise the transaction without members approval will be liable to indemnify the company for any loss or damage which results from the transaction. In addition, as the Edwards will be interested in the transaction; this will require a disclosure of interest under s177 Companies Act 2006 and Article 14 Model Articles. Neither Charles Edwards or Stuart Edwards will be permitted to vote at the directors meeting on this matter is considered nor count in the quorum. Quorum for a directors meeting is two under Article 11 of the Model Articles. Without a quorum business cannot be validly conducted at board meetings. [Note, the application of s177 Companies Act 2006 and Article 14 Model Articles applies in relation to a directors meeting, each shareholder is free to vote at the general meeting according to their own personal interest.] The solution is therefore to seek an ordinary resolution under Article 14(3) Model Articles to disapply the articles (either generally or for the single transaction) and so allow the directors to vote on the transaction at directors meeting despite the fact that they are interested. Page 5 of 7

6 Question 4 (i) (ii) (b) On the assumption that the proposed business venture between Jack Boyle and Capio Renovations will be established as a company, the tax implications for Jack Boyle in respect of his salary (assuming Jack Boyle is appointed as a director of this new company) and any dividend received: Remuneration under a service agreement is income taxable to income tax. Taxable under Income Tax (Trading and other Income) Act 2005 (ITTOIA 2005) on the PAYE scheme, tax is deducted at source by the employer, i.e. the company. Jack s income tax liability will be calculated by taking his income, deducting his personal allowance and then applying the income tax rates. The basic rate (20 percent) and, in the event that her income exceeds these thresholds as a result from income from other sources, the balance will be taxed at the higher rate of 40 percent or highest rate of 50 percent. Any dividends paid to Jack will amount to taxable income, taxable under Part 4 IT(TOI)A 2005 and subject to a basic rate of income tax of 10 per cent, a higher rate of 32.5 per cent, and highest rate of 42.5 percent. Payments received by Jack will be treated as a payment after deduction of the lower rate; i.e. he will receive the dividend net of 10 per cent tax, representing 90 per cent of the gross figure. In order to calculate the gross dividend, it is necessary to gross up the net dividend. This will then be used to calculate Jack s aggregate statutory income. Dividends will be taxed after earned income and savings income. It is likely that the higher or highest rate of tax will apply to the dividends received by Jack. Tax implications for Company in respect of any dividends the directors may declare are that they are paid by the company in full without deduction of income tax. The payment received by a shareholder as a dividend is treated as a payment after deduction of tax at the ordinary rate, even though no tax is actually deducted by the company. UK recipients are entitled to a tax credit equivalent to one-ninth of the dividend, i.e. 10 per cent of the dividend. Jack Boyles s potential liability for the debts of the company: Jack will be liable up to the nominal value of his shares, this is obviously dependent on how much he is proposing to invest in the company, i.e. a minimum value may be the value of the freehold commercial warehouse that he is proposing to transfer to the company. As a director, Jack will be at risk of being held liable for fraudulent or wrongful trading (ss213 & 214 Insolvency Act 1986 respectively). For fraudulent trading, it would have to be established the company was permitted to trade whilst insolvent with the intention of defrauding creditors. For wrongful trading, both the objective and subject test would Page 6 of 7

7 need to be satisfied; i.e. that as a director Jack as such had the general knowledge, skill and experience and should he have been aware that the company was trading whilst insolvent. The risk is that Jack could be required to contribute to the company s assets, and in the case of fraudulent trading risks criminal offence. As a consequence, she then may possibly be in breach of his fiduciary duty to the Company and liable to contribute to the assets of the company, s212 Insolvency Act Jack may also possibly be held in breach of the new directors duties under s174 Companies Act Jack, in the event of default by the Company in relation to the loan he is proposing to make, will also have lost this sum; subject to whether this has been secured and has been registered. If the loan is secured but the charge is unregistered, then it is void against the administrator/ liquidator. Page 7 of 7