LEVEL 6 UNIT 1 COMPANY AND PARTNERSHIP LAW SUGGESTED ANSWERS June Note to Candidates and Tutors:

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1 LEVEL 6 UNIT 1 COMPANY AND 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. SECTION A Question 1 As a result of the decision in Salomon v Salomon & Co [1897], that the company is an independent, separate legal entity from its members, it must operate through agents. Therefore the directors are the agents of a company and take decisions and make contracts on the company s behalf. The directors have the general power to manage the company on a day to day basis (Model Article 3). The directors are in a position of trust to the company. To hold directors accountable for the management of the company, they owe certain duties to the company. These duties can be categorised as fiduciary duties, which arise because directors are quasi-trustees of the assets of the company, and duties of skill and care which arise at common law and are an aspect of the law of negligence. These duties originally come from common law and equity and have recently been codified in sections 171 to 177 of the Companies Act Directors owe their duties to the company, not the shareholders (Percival v Wright (1902) codified by S170). In addition to these duties, the Companies Act 2006 also sets outs restrictions on directors in relation to transactions between directors and the company. These must also be considered when discussing the rules which regulate the fiduciary relationship between a director and the company. The aforementioned duties that a director is subject to are now statutory, but are still to be interpreted in the light of the old common law rules and equitable principles (section 170(4) Companies Act 2006). The duties that are owed by a director to the company include: Section 171 Duty to act within powers (Bishopsgate Investment Management Ltd v Maxwell (No.2) [1994]) Page 1 of 15

2 Section 172 Duty to promote the success of the company (Re Smith & Fawcett Ltd [1942], Item Software (UK) Ltd v Fassihi and Others [2004]) Section 173 Duty to exercise independent judgement (Fulham Football Club v Cabra Estates plc [1994]) Section 174 Duty to exercise reasonable care, skill and diligence (Re City Equitable Fire Insurance Co Ltd [1925], Norman v Theodore Goddard [1991], Re D Jan of London Ltd [1994], Secretary of State for Trade and Industry v Bairstow [2004]) Section Duty to avoid conflicts of interest (Boardman v Phipps [1967], Bhullar v Bhullar [2003]) Section 176 Duty not to accept benefits from third parties (Regal (Hastings) Ltd v Gulliver [1942], Industrial Development Consultants Ltd v Cooley [1972]) S177 Duty to declare an interest in a proposed transaction The consequences of breach of duty by a director are set out in section 178 Companies Act The legislation preserves the remedies available prior to the codification of the duties, namely as though the corresponding common law rule or equitable principle applied. In addition to the duties owed by directors to the company under sections 171 to 177, various administrative duties are also imposed upon directors by statute. These administrative duties also regulate the fiduciary relationship between directors and the company. In addition to a discussion of the general duties, a good essay should also consider the effect of some or all of the following: Criminal provisions requiring declaration of interests in contracts or transactions with the company (section 182 Companies Act 2006) The supplementary rules on transactions with directors, requiring member approval: o Service contracts (s188 Companies Act 2006) o Substantial Property Transactions (s190 Companies Act 2006) o Loans to directors (s197 Companies Act 2006) o Compensation for loss of office (s Companies Act 2006) The duties and rules outlined above have developed by reference to the law governing the duties owed by trustees, the assumption being that directors were performing a very similar function to trustees. Following the codification of the duties and rules in Companies Act 2006, it is inevitable that there is likely to be some tension between the new statutory provisions and the older case law and this might undermine the certainties of the statutory provisions. However it is important that the duties are seen as fairly open-ended. They must allow flexibility to meet changing commercial circumstances to adequately protect companies. Ultimately the aim of the rules Page 2 of 15

3 which regulate the fiduciary relationship between a director and his company is to provide a check against abuse by directors but not be so rigid as to prevent dealings between directors and the company and to permit the directors to keep any benefits arising. Question 2 (a) Salomon v Salomon & Co [1897] is arguably the leading case in company law. Mr Salomon formed a limited company to take over his existing leather business. There were seven shareholders of the new company, Salomon & Co Ltd: Mr and Mrs Salomon and their five children. Mr Salomon and two of his sons were also the directors. In return for the business, the company paid Mr Salomon a combination of cash, shares in the company and a debenture secured by a floating charge on the company s assets. Less than a year later, the company was in financial trouble and a liquidator was appointed. As a floating charge holder, Mr Salomon sought to enforce his security. This would have meant that all other trade creditors of the company received nothing. The liquidator argued that the company was a mere alias for Mr Salomon and therefore he should be responsible for paying all the debts. The House of Lords held that the company was a separate and distinct person from its shareholders and directors. The debenture was perfectly valid. The fact that a company s shares are held by someone does not mean that person will be treated as the company or as having primary responsibility for the company s debts. The principle was established that, providing a company is correctly incorporated, the shareholders are distinct from the company itself. This principle is recognised in S16(2) Companies Act 2006 which defines a registered company as a body corporate. Therefore Lord Halsbury s statement means that where there is a company it will be a legal entity in its own right, its assets are its own and do not belong to the company s members (Macaura v Northern Assurance [1925]). The principle of separate legal personality has been question and ignored by the courts in certain circumstances. In these cases the company and its shareholders and/or directors have been treated as one. This disregard for the tradition principles of company law is known as piercing the veil of incorporation. It is important to note that piercing the veil of incorporation is the exception rather than the rule. Examples of where the courts has considered piercing the veil include: Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd [HL 1916], Gilford Motor Co Ltd v Horne [1933] and Jones v Lipman [1962], Smith Stone & Knight Ltd v Birmingham Corporation [1939], DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976], Woolfson v Strathclyde [1978], Adams v Cape [1990], Ord v Bellhaven Pubs Ltd [1998], Polly Peck International plc Re (No. 3) [1994]. Page 3 of 15

4 The cases decided since in recent years indicate that the principle of separate legal personality remains a cornerstone of English company law and Lord Halsbury s statement from the end of the nineteenth century still remains true. (b) A company will be formed or promoted by someone. This person is known as a promoter. Until the promotion process is completed upon incorporation of the company by the Registrar of Companies, the company does not exist. Any contract entered into before a company is incorporated is a pre-incorporation contract. The promoter cannot be considered at law as an agent as there is no principal. Therefore a company cannot be a party to, and therefore liable on, any contract made or purported to be made on its behalf before it came into existence (section 51 Companies Act 2006). This is because it does not have the capacity to enter into a contract at that time. Any contract entered into prior to the date of incorporation of the company is deemed to be between the third party and the promoter. This effect cannot be avoided by the agreement being entered into by the promoter either on behalf of or as the company. The effect of preincorporation contracts were considered in Kelner v Baxter [1866] and Phonogram Ltd v Lane [1981]. Therefore, the promoter will be liable for any termination costs or breach of contract claim subject to any agreement to the contrary. This provisio is included in section 51 Companies Act In order for a promoter to be released from liability, after incorporation of the company the contract in question should be novated, and the company should enter into a second /new contract (or deed of novation) with the third party on the same terms as the pre-incorporation contract. Alternatively the pre-incorporation contract can include a cessation of liability clause providing that the promoters liability shall cease if, when the company if formed, it enters into a replacement contract with the third party. Both arrangements have the same effect. Question 3 Where two or more persons carry on business in common with a view to profit, they are acting as a partnership (section 1 Partnership Act 1890). A partnership need not necessarily be recognised as such by the parties since the existence of a partnership depends on whether or not the definition contained in section 1 of the Partnership Act 1890 applies. One of the main advantages of a partnership is the lack of formality; however to the extent that section 1 is satisfied the partners will be subject to the provisions of the Partnership Act 1890, unless they agree otherwise. Although a partner has no definable role other than under the terms of a partnership agreement, entered into voluntarily by all the partners, he does have certain responsibilities towards his fellow partners and correspondingly certain rights against his fellow partners which arise as a result of the existence of the partnership relationship. Arguably partners have a fiduciary relationship to each other. Page 4 of 15

5 When addressing the issue of the extent to which partners in an unlimited partnership can be bound by their fellow partners, one must have regard to the law of agency and the Partnership Act Transactions which may affect a partnership and the individual partners generally involve contracts. Contracts may be made by all of the partners acting collectively (i.e. they take a decision together and are all bound) or by just one of the partners. It is the second scenario when a partner can bind other partners. Section 5 of the Partnership Act 1890 provides that every partner is an agent of the firm and his other partners for the purpose of the business of the partnership. It goes on to state that the acts of every partner who does any act for the carrying on in the usual way business of the kind carried on by the firm of which he is a member binds the firm and his partners. It is clear from section 5 that the firm (which given that a partnership has no legal existence separate from that of the partners means the partners themselves) will be bound by the act of a partner provides that it falls within his usual authority i.e. when (1) he is carrying on in the usual way (Higgins v Beauchamp [1914]) (2) business of the kind carried on by the firm (JJ Coughlan Ltd v Ruparelia and others [2003]). Therefore if the partners have expressly instructed one of the partners to represent the firm in a particular way, the partner will have express actual authority and bind his fellow partners. The partners may also be liable for actions of an individual fellow partner which were not actually authorised but may have appeared to an outsider to be authorised. This liability derives from application of agency law and the fact that a partner may have apparent or ostensible authority. However, section 5 contains exception to this general rule that one partner can bind the others. The exception is that a partner will not be able to bind the other partners of the firm if the partner acting has no authority to act for the firm in the particular matter, and the person with whom he is dealing either knows that he has no authority, or does not know or believe him to be a partner. Therefore the knowledge or belief of the third party dealing with the partner will affect the ability of the partner to bind his fellow partners. It will be a subjective test as to the knowledge of the third party. If a partner has bound the other partners, what does this mean for those innocent partners? Pursuant to section 9 of the Partnership Act 1890, each partner in the firm will be jointly liable with the other partners for all the debts of the firm whilst he is a partner, therefore meaning that unlimited liability is imposed on each partner. Section 3 of the Civil Liability Contribution Act 1978 provided that judgement against one partner does not bar later action against another partner. Therefore in the event that one partner has bound all the others, a third party will have the right to sue any or all of the partners for the whole amount of the debt. This is obviously a significant risk for a partner in a partnership, he may be sued for the whole amount of the debt incurred by another partner without his knowledge. A prudent partner would want to counteract this risk by inserting an indemnity in the partnership agreement and/or relying on sections 1 and 2 of the Civil Liability Contributions Act Page 5 of 15

6 In addition to section 5 of the Partnership Act 1890, partners in an unlimited partnership could also be bound by contracts in respect of which they have not been a party to the negotiations for by virtue of sections 14 and 36 of the Partnership Act Pursuant to section 14 where a third party has relied on a representation that a particular person was a partner in a firm, the third party might be able to hold that partner liable for the debt. This liability is different to section 5 as it likely to affect a partner when they have retired from the firm before the contract was made and the contract is being made with someone that the firm has not previously dealt with. The retired partner will have been held out as still being a partner of the firm and the third party will have relied on that representation when entering into the contract. Section 36 provides what must be done by a partner on leaving a partnership to reduce liability. When a partner leaves the partnership, he must give notice of his leaving since otherwise since otherwise he may become liable under section 36 for the acts of his former partners done after he leaves the firm, if the third party is unaware of the fact that he has left. The partner must give actual notice to all those who have dealt with the firm prior to him leaving (section 36(1)) and place an advertisement in the London Gazette as notice to all those who did not deal with the firm prior to the date of the partner s departure (section 36(2)). The only times these notices are not required and the leaving partner will escape liability is when the reason for ceasing to be a partner is death or bankruptcy. The principle upon which section 36 is based is that, unlike section 14, it does not depend on the third party having relied on some representation at the time of the transaction. Rather the third party is given the right to assume that the membership of the firm remains unchanged until notice is given. In conclusion a partner in an unlimited partnership can be bound by the actions of his fellow partners. An exception to this is provided for in section 8 of the Partnership Act 1890: if it has been agreed between the partners that any restriction shall be placed on the power of any one or more of them to bind the firm, no act done in contravention of the agreement is binding on the firm with respect to persons having notice of the agreement. Question 4 When a company receives debt finance i.e. borrows money, the lender will require the company to enter into a loan agreement. The lender will usually insist on the company giving it a right of recourse against the assets of the company in the event that the loan is not repaid on time. This right of recourse is security for the loan. Where security has been given the loan agreement will constitute a debenture (S738 Companies Act 2006/Levy v Abercorris (1887)). When considering the security to be granted, a company should be advised that there may be a number of forms of security it can grant over its assets. Where a company has property, it can offer it to a lender to take a charge by way of legal mortgage (section 87 Law Property Act 1925) over the property. This type of security is also known as a legal mortgage and is arguably the best form of security available to a lender. The charge by way of legal mortgage, unlike mortgages of all assets other than land, will not transfer legal title to a Page 6 of 15

7 lender, but will provide it with rights equivalent to those under a 3000 year lease and will allow a lender to sell the factory if the borrowing company defaults under the loan agreement or the security documents. A company can also give a fixed and/or floating charge over other assets. A fixed charge is a charge on a specific asset owned by the company which it cannot deal with at all unless the charge holder i.e. the lender, consents. By way of example, to the extent that there is any heavy equipment in a property which is charged by way of legal mortgage (discussed above) it is likely to constitute a fixture and therefore would be covered by the charge by way of legal mortgage over the property. If not, a fixed charge should be taken as for the freestanding equipment. The holder of a fixed charge is in a strong position. In the event that the company defaults on the loan the lender would be entitled to appoint an LPA Receiver under the fixed charge. The LPA Receiver would be entitled to take possession of the charged assets and deal with them for the benefit of the charge holder. A floating charge, in contrast, is a charge on a class of assets, usually those which are not covered by a fixed charge i.e. the current assets i.e. the company s undertaking and stock, raw materials (Re Panama, New Zealand and Australian Royal Mail Co (1870), Re Yorkshire Woolcombers (1904)). It is therefore possible for a company to still grant security when they have no more assets to offer by way of legal mortgage or fixed charge over assets which are constantly changing. It is the company s ability to still deal with the assets which is the primary characteristic of a floating charge. A floating charge will crystallise on the company: going into receivership, liquidation; ceasing to trade; or on the occurrence of an event specified in the debenture. On crystallisation the floating charge becomes a fixed charge. A qualifying floating charge holder (a lender who has the benefit of a floating charge created after 15 September 2003) can appoint an administrator without petitioning the court or apply to the court for an order that its own administrator replace one proposed or appointed by the company s directors. An additional asset for security is book debts i.e. the lender takes security over money which is owed to the company. In theory, a fixed or a floating charge could be taken over the book debts (Re New Bullas (1994); Re Spectrum Plus Ltd (2005), although following the decision in re Spectrum Plus Ltd) it is difficult to create a fixed charge in practice. This is because book debts would need to be paid into a blocked account over which the company had control for a fixed charge to be created (following Re Spectrum Plus Limited in the House of Lords). It is established that a charge over book debts constitutes a floating charge as the company will need freedom to withdraw cash from its account in times of very tight cash flow. This is similar to the requirement to be able to deal with stock. From the lenders point of view, before entering into a loan and taking security, despite the protection afforded to third parties by sections 39 and 40 of the Companies Act 2006, a lender should be advised to review the borrowing company s constitution to ensure that it has the capacity to borrow and grant charges and there are no restrictions on the directors to do the same. Whilst a lender, subject to dealing in good faith, would have the protections under sections 39 and 40 of the Companies Act 2006, it is prudent to check the ability of the directors to enter into a loan agreement and grant the security. Page 7 of 15

8 All the security discussed above (except arguably the assignments over book debts) falls within section 860(7) of the Companies Act 2006 as those types of charges that are registrable. This means that the prescribed particulars of each security document (i.e. the debenture) must be registered with the Registrar of Companies within 21 days of the date of creation of the charge. Failure to do so within the time limit will make it void against other creditors and/or a liquidator or administrator of the company (section 874 Companies Act 2006). Pursuant to section 860(1) Companies Act 2006, it is primarily the company s responsibility to register the charge, however it is often the lender that undertakes the registration as it is the lender who suffers in the event of non or late registration. Section 860(2) provides that any party with an interest in the charge may affect the registration. Any charge by way of legal mortgage must also be registered at HM Land Registry to give priority over any subsequent mortgagee. The registration acts as notice to them and to any subsequent purchaser of the property. A lender should be aware that a fixed charge will take priority in order of creation. It is possible for creditors to enter into a deed of priority to alter this order, however this would have to be commercially negotiated. Furthermore, a fixed charge will take priority over a floating charge on the same assets. A lender will require a negative pledge to be granted in respect of a floating charge to protect their interest. SECTION B Question 1 (a) Before the transfer of shares from Damien to his daughter can be considered for registration by the directors, section 770(1) Companies Act 2006 means that Northern Glaziers must check that the proper instrument of transfer has been delivered i.e. the articles may specify form of transfer, and Model Article 26 (which applies in this case) allows any usual form. Any form which complies with Schedule 1 Stock Transfer Act 1963 must be accepted. The ability of directors of Northern Glaziers to refuse registration will be set out in the company s articles, here Model Article 26(5), which gives directors an unfettered discretion to refuse to register the transfer to Damien s daughter. The directors need to make sure they have correctly exercised any discretion given i.e. actively exercised discretion (Re Inverdeck Ltd [1998]), exercised in the interests of the company and power to refuse used for proper purpose. A failure to act means that directors will lose right of refusal (Re New Cedos Engineering Co Limited [1994]).If the directors refuse the transfer the refusal should be noted in the board minutes, giving reasons, and the Damien s daughter (who would have sought approval of the transfer) should be notified within two months (sections 771(1)(b) and 771(2) Companies Act 2006). The directors are under a duty to provide her with reasons for any refusal: sections 771(1)(b) and 771(2) Companies Act Damien should be told that if the directors wrongly refuse to register the transfer, their decision may be challenged by application to the court under section 125 Companies Act Page 8 of 15

9 (b) When issuing new shares, the directors of Northern Glaziers must have regard to the following: Any restrictions on Northern Glazier s authorised share capital Under the Companies Act 2006 the concept of authorised share capital ( ASC ) has been abolished, the ASC is no longer stated in a company s memorandum (section 8 Companies Act 2006). As Northern Glaziers was incorporated in 2005 i.e. pre 1 October 2009, section 28 Companies Act 2006 means that any ASC requirement of Northern Glaziers will become a restriction in the company s articles. The company s constitution needs to be checked to see if there is still an ASC. If there is, this can be removed by the shareholders passing an ordinary resolution. The requirements for directors authority to allot relevant shares pursuant to S549 Companies Act 2006 Subject to any restriction in the company s articles, no authority to allot will be required if the company has only one class of shares (section 550 Companies Act 2006) From the facts it appears that Northern Glaziers has only ordinary shares. As it has model articles there are no restrictions on the directors authority to allot shares, therefore the directors can take advantage of section 550. The only requirement is as a company incorporated pre 1 October 2009, Northern Glaziers must activate the provision under section 550 by an ordinary resolution under the transitional provisions if it has not already done so. Pursuant to Model Article 21, Northern Glaziers must only issue shares which are fully paid up. Pre-emption Rights When allotting equity securities (defined in section 560 Companies Act 2006) the directors must consider the existing shareholders pre-emption rights under section 561 and/or the articles. There are exceptions under S Companies Act 2006, for example where shares are to be allotted other than wholly for cash (section 565 Companies Act 2006), but these do not appear to apply here. As the company has model articles, the directors are only concerned with statutory pre-emption rights. The directors of Northern Glaziers must either comply with the pre-emption procedure under section 561 and 562 Companies Act 2006, alternatively the pr-emption rights can be disapplied by special resolution under section 570/571 Companies Act 2006 or waived by each shareholder. In addition to the statutory requirements set out above, following the issue of the shares, Companies Act 2006 requires the directors to complete both internal and external paperwork. In particular, the directors are required to file a return of allotment (SH01) with the Registrar of Companies (section 555 Companies Act 2006) and register the allotment in the company s internal registers and issue a share certificate (sections 554/769 Companies Act 2006) and credit the share premium account. Page 9 of 15

10 Question 2 The two main actions falling to be considered are (1) a wrongful trading claim against Sadlers directors and (2) a claim against Block for repayment of a preference. Wrongful trading By section 214 Insolvency Act 1986, a liquidator can apply to the court for an order that a director or former director contribute to the company s assets if the company has gone into insolvent liquidation and that person knew or ought to have concluded that there was no prospect of the company avoiding insolvent liquidation. A director is required to take into account the facts which should be known by a reasonably diligent person (a) in his position and (b) taking account of his skill and knowledge. The information available to the company s directors included (1) the failure of Bradley, a very substantial debtor in circumstances in which it should have been clear that there was no prospect if recovering the money that it owed, and (2) the numerous demands from trade creditors, many of which the company was clearly unable to meet. All of the directors may well have known that there was no prospect that the company could avoid liquidation. They should have taken account of the company s continuing financial deterioration, particularly noting Bradley and other debtors failure to pay. Bradley s failure left it with overall net liabilities, the company was insolvent on a balance sheet test. Perhaps Chris and James should have realized this at the latest when Michael resigned on 7 January. Michael, as an accountant, will be held to a higher standard and is even more likely to have breached his duty. Section 214(3) Insolvency Act 1986 makes it a defence for a director to show that he took every step with a view to minimising the loss to the company s creditors. There is no sign that any of the directors did this. Michael s resignation will not help him, it does nothing to help the creditors and by the time he resigned Michael, more than the others, should have realised that the company might not be able to continue to trade. The contribution which a court will order under section 214 is a compensatory order, to place the company back in the position in which it would have been if the directors had not breached their duty (Re Produce Marketing Consortium Ltd (No.2)[1989]. Preference By section 239 Insolvency Act 1986 where a company goes into liquidation and has within the relevant time given a preference to any person, the liquidator can apply for an order restoring the position to what it would have been had the company not given the preference. A company gives a preference if it does anything which would place a creditor in a better position on insolvent liquidation than it would otherwise have been. That is what has happened with the payment to Blocks. Page 10 of 15

11 On the assumption that Blocks was not a connected person, the relevant time is six months before the commencement of the liquidation. The preference was given three months before the petition and so this time limit is met. Also the company must have been unable to pay its debts at the time of the preference or as a result. This requirement is satisfied because the company was balance sheet insolvent at the time of the preference. However by section 239(5) there is no preference unless the company giving it was influenced by the desire to prefer the creditor. There is no presumption of a desire to prefer where (as seems to be the case here) the preference was not to a connected person. In Re MC Bacon No 1 (1990) it was held that a payment made in order to prevent a creditor from petitioning the winding up of the company was actuated by a desire to continue trading and not a desire to prefer. That would seem to be the case here, and so it is unlikely that an order would be made in respect of the payment to Blocks. Fraudulent trading Under section 213 Insolvency Act 1986, the liquidator could claim fraudulent trading against the directors of Sadlers but a court will not make such a finding unless there is real moral blame on the part of the directors, tantamount to running the business with the deliberate intention of defrauding creditors. Misfeasance/Breach of duty In addition to the above claims, the liquidator may also be able to claim against the directors personally under section 212 Insolvency Act 1986 for a breach of duty. Question 3 (a) When giving consideration as to whether a director can be removed from office, a company must have regard to the termination of a director as an employee under the terms of his service contract and the removal of the director from the board of directors. The facts identify that Temple s lawyers are negotiating a settlement with Kasit in respect of the termination of his service contract, however his service contract does not include a provision allowing the company or a shareholder to force Kasit off the board. As the company has model articles and nothing on the facts suggested that any of the grounds in Model Article 18 exist, the other directors are unable to remove Kasit from the board. Therefore Kasit must be removed by the shareholders. Section 168 Companies Act 2006 provides that a director can be removed from office by the shareholders passing an ordinary resolution, provided that special notice is given to the company of the intention to move such a resolution. The requirements for special notice are set out in S312 Companies Act clear days notice (under S360 Companies 2006) must be given to the company (to the directors as agent of the company) by ABC. Therefore ABC must give special notice to the directors of Temple of its intention to remove Kasit. If, after having received the special notice, the directors call a general meeting to Page 11 of 15

12 consider the resolutions before the 28 days then notice is deemed to have been properly given even though the 28 day period has not been complied with (section 312(4)). Note that section 288(2) Companies Act 2006 prohibits the passing of this resolution as a written resolution. It should be noted that Temple is obliged under section 169(1) Companies Act 2006 to send a copy of the intended removal resolution to Kasit once it has been received from ABC. Kasit is then entitled to make written representations against his removal and attend and speak at the general meeting to remove him (section 169 Companies Act 2006). Kasit can request that his representations it circulated to members together with the notice for the meeting (or, if too late, that it be read out at the meeting) under sections 169(3) and (4). As the rest of the board agree with Temple s proposal, the board will call a general meeting to pass the required ordinary resolution in accordance with sections 302 and 307 Companies Act The resolution to remove Kasit requires the support of a simple majority of the shareholders of Temple. As Temple owns 52% of the shares, it will be able to pass the ordinary resolution to remove Kasit even if other shareholders were opposed. Such an attempt to remove Kasit may be defeated if Kasit were a shareholder and the articles contained weighted voting rights (Bushell v Faith [1969]) or there is any arrangement contained in a shareholders agreement to support a director subject to such a vote. This should be checked. Assuming there are none, ABC and Temple will succeed in removing Kasit from the board of directors of the company. (b) Section 31 of the Companies Act 2006 states the revised position on objects clauses: Unless a company s articles specifically restrict its objects, its objects are unrestricted. Therefore any company that is incorporated after 1 October 2009 will have unlimited capacity and the doctrine of ultra vires will not apply to such a company, unless a restriction is imposed on its objects in the articles of association. For existing companies (i.e. those incorporated before 1 October 2009, in this case Temple), the objects clause previously set out in the memorandum is now deemed to be in the company s articles of association (section 28 Companies Act 2006). The ultra vires doctrine will still continue to have effect for Temple as it has an objects clause. Pursuant to section 39 of the Companies Act 2006, the validity of an act done by a company vis a vis outsiders shall not be called into question on the ground of lack of capacity by reason of an objects clause. Further, section 40(1) Companies Act 2006 further provides that, in favour of a person dealing in good faith (i.e Sunseeker Limited), the power of the directors to bind the company shall be deemed to be free of any limitation in the company s constitution. Therefore, to the extent that Kasit has entered into a contract and it cannot be shown that Sunseeker Limitedacted in any other than good faith, Temple cannot avoid liability on the ground that the contract is outside its objects. In most cases, it seems that for existing companies the objects clause will have little (if any) relevance. The third party is protected and the external effects of the ultra vires doctrine have effectively been abolished. Page 12 of 15

13 Nevertheless, even though Temple may be bound as regards the third party, directors are still obliged to act within their powers (S171 Companies Act 2006) and the articles (which include any object clause) form a contract between the shareholder and the company. Therefore the doctrine is still preserved internally. Temple could bring an action against Kasit for acting outside of his authority and in breach of duty. It appears that Kasit did not have actual authority to enter into the contract. Temple may be able to argue that it is not bound by the contract if it was outside Kasit s apparent authority (Hely-Hutchinson v Brayhead Ltd [1968]). The basis of apparent authority is that Temple is estopped from denying Kasit s authority to bind the company in a contract with Sunseeker. In order to bind the company, Sunseeker would show that it relied on a representation (which could be a failure to correct a mistaken impression) that Kasit was acting with the company s authority. If this were the case, Temple would be bound. Question 4 For the previous three years, Vivienne has successfully run her landscape gardening business as a sole trader. Now that she intends to change her own role within the business and invite two of her employees, Samira and Martin, to expand their own, Vivienne would like advice on converting the business either into a partnership or a private limited company. When advising a client on choosing the correct form of business medium it is helpful to compare partnerships and private companies by reference to general factors. For the purposes of this comparison, we will consider a partnership pursuant to the Partnership Act Formalities in setting up There are no formalities in setting up an unlimited partnership. The only requirement is that section 1 of the Partnership Act 1890 will be satisfied (which on our facts it will). In essence a partnership is an inexpensive business medium to set up and continue. However, Vivienne should have a formal partnership agreement prepared to deal with ownership of the business, division of profits and decision making. The expense of drafting the agreement may be at least equal to the cost of incorporating a company. A private limited company must be incorporated under the Companies Act Vivienne will need to form, or purchase off the shelf, a company of which she will be, possibly along with Samira and Martin depending on the agreement reached, the directors and shareholders. The company will then acquire the landscape gardening business from Vivienne, probably in return for shares in the company. Management structure With a partnership, no management structure is imposed. All partners have a right to take part in the management of the partnership, but are not obliged (section 24(5) Partnership Act 1890). Pursuant to section 24(8) Partnership Act 1890 all matters except the introduction of a new partner (section 24(7)) and a change in the nature of the partnership business which both require unanimity, are decided by majority. If all three were partners, then Vivienne could be outvoted on decisions which require majority vote. Vivienne may be prepared for Page 13 of 15

14 this to happen on some decisions, but it is likely that she would want to retain control over major business decisions. This arrangement could be included in a partnership agreement specifying that major decisions required unanimity. In a company, the directors have the powers of day to day management (Model Article 3), however the articles of association of the company and the Companies Act 2006 require a number of major decisions to be taken by, or at least, approved by the shareholders. These include removal of directors (section 168 Companies Act 2006), change of the company s articles of association (section 21 Companies Act 2006) and approval of substantial property transaction between directors and the company (section 190 Companies Act 2006). It appears that Vivienne would hold the vast majority of the shares in the company and would therefore have the power to veto any major decision. However Vivienne should also consider being a director as well as a shareholder, even though she does not want to participate in the business full time. As a director she would receive notice of board meetings (Model Article 9) and would be aware of what decisions were being taken in the company. Assuming that Samira and Martin were also directors, Vivienne should be aware that as decisions of directors are taken by majority (Model Article 7), she could be outvoted (a casting vote as the Chairman under Model Article 13 would not help). Therefore she must be careful in the articles of association to delegate to the directors only those powers she wishes them to exercise, retaining for the share shareholders in general meeting such powers as she wishes to be able to control herself i.e. amend Model Article 3. Liability for debts Vivienne does not intend to participate in the business everyday going forward. However as a partner (albeit a semi sleeping partner) she would be liable without limit for all debts of the business section 9 Partnership Act 1890). Assuming that Samira and Martin became partners, this would mean that Vivienne would be fully liable to outsiders for Samira and Martin s actions. Vivienne could insist that the partnership agreement contained a provision that she would be liable to a contribution from her fellow partners (or rely on section 1 Civil Liability (Contribution) Act 1978, but if they are unable to contribute (noting their current financial positions) Vivienne is liable without limit. Therefore Vivienne could be liable for a matter which is not her own fault. If the landscape gardening business was incorporated, Vivienne would sell her business to the company in return for shares. She may be the only shareholder, depending on whether Samira and/or Martin also invested to give them an incentive. Vivienne s liability is limited (sections 3(1) and 3(2) Companies Act 2006, so assuming that the shares are fully paid (Model Article 21 would require this), Vivienne s liability would be limited to her investment i.e. the value of the business and not her entire personal wealth. Vivienne should have regard to the potential liability of directors of a private limited company. Unlike partners, directors are not normally personally liable for the debts of the company. They may incur personal liability in certain situations, e.g. acting in breach of duty (sections 170 to 178 Companies Act 2006), wrongful trading (section 214 Insolvency Act 1986); piercing the veil of Page 14 of 15

15 incorporation, however a directorship is likely to be less risky for Vivienne than becoming a partner. Raising finance In the event that Vivienne wishes to raise money in the future to grow the business, she could consider either loans or capital. A person lending money to a business will usually seek security for repayment of the loan. Companies and partnerships can both create fixed charges over their assets as security. However only a company can create a floating charge (Bill of Sale Act 1832). Although the floating charge is an inferior form of security compared with a fixed charge it allows the company to use its stock as security for borrowing. Therefore a company would allow Vivienne greater scope than a partnership for raising loan finance. If Vivienne sought further investment she could invite investors to introduce capital by investing in the company as a shareholder with the additional benefit of limited liability (section 3 Companies Act 2006). If she converted her business to a partnership, a person introducing capital would become a partner and accept unlimited liability for all the debts of the partnership incurred after he becomes a partner. The equity investment (with limited liability) and greater options in respect of security, appear to make a company more attractive for this factor. Page 15 of 15