LEVEL 6 - UNIT 1 Company and Partnership Law SUGGESTED ANSWERS - JUNE 2015

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1 LEVEL 6 - UNIT 1 Company and Partnership Law SUGGESTED ANSWERS - JUNE 2015 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 2015 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 Companies have separate legal personality (Salomon v Salomon & Co Ltd (1897)) but can only act through human agencies. Directors have been variously described in different contexts as agents, fiduciaries, trustees of corporate assets and the directing mind behind corporate actions. The authority of the directors to act on behalf of and to bind the company is usually extremely wide and may be conferred on them either expressly by the company s articles (see, for example, the general power of management under Article 3 of the Model Articles) or by implication. It is because of this wide general power conferred on directors that ways have been devised for holding them to account for their stewardship of the company s affairs at common law, under statute and by contract. Directors fiduciary duties were originally developed over many years in a number of common law cases (see for example, Aberdeen Railway Company v Blaikie Bros (1854) on conflicts of interest). They have now been codified under the Companies Act 2006, although the equitable principles on which the common law cases were based remain relevant both to the interpretation and application of the statutory duties (s170 (4) CA 2006) and to the civil consequences of breach (s178 CA 2006). The statutory general duties are set out in Chapter 2, Part 10 CA Page 1 of 20

2 Examples include: The duty to act within powers (s171 CA 2006), i.e. a director must act in accordance with the company s constitution and only exercise powers for the purposes for which they were conferred. Generally it is for the courts to interpret the purpose for which a particular power is conferred and then to decide whether the directors have acted outside that purpose (Howard Smith Ltd v Ampol Petroleum (1974) and Hogg v Crampthorn (1966)). The duty to promote the success of the company (s172 CA 2006) is in some ways the most fundamental of the duties. A director must act in the way he considers in good faith would be most likely to promote the success of the company for the benefit of its members as a whole. Note the test is a subjective one what the directors honestly believe (in good faith) would be most likely to promote the success of the company, and not what objectively might be most likely to do so. The Courts will not generally find a breach of this duty based solely on poor business decision making. Although the interests of the members generally are paramount the section provides a long list of matters that directors are to have regard to in reaching their decisions, including such matters as the interests of the company s employees and the impact of the company s operations on the community and environment. If a company becomes insolvent the interests of the creditors as a class will become paramount (GHLM Trading Ltd v Maroo (2012)) in preference to those of the members. The duty to exercise reasonable care skill and diligence (s174 CA 2006). This contains both a subjective and objective test i.e. a director must exercise the degree of care, skill and diligence that would be expected of a reasonably diligent person with the general knowledge, skill and experience that can reasonably be expected of a person occupying that position (objective) and the general knowledge, skill and experience the director actually has (subjective).this replaced the old common law subjective test of what could be expected of directors (see Re City Equitable Fire Insurance Company Ltd (1925) and contrast Re Barings Plc (1999)). The duty to avoid conflicts of interest and duty (s175 CA 2006). A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts or may conflict with the interest of the company. The duty applies in particular to the exploitation for personal gain of any property, information or opportunity that a director obtains in his capacity as a director of the company. It is generally immaterial whether or not the company could benefit from the property, information or opportunity. Cases include Industrial Development Consultants Ltd v Cooley (1972) and, more recently, Thermascan Ltd v Norman (2011). Note that the duty to avoid conflicts of interest does not extend to transactions between the company and the director, which are instead subject to the duty of disclosure both under s177 CA (Duty to declare interest in proposed transaction or arrangement) and s182 CA 2006 (Duty to declare interest in existing transaction or arrangement). Page 2 of 20

3 The statutory general duties are owed by the director to the company (s170 (1) CA 2006). This reinforces the common law rule, sometimes known as the rule in Foss v Harbottle (1843) or the proper plaintiff rule i.e. that in an action for breach of duty the proper plaintiff is the company itself and not individual shareholders or even the body of shareholders generally. One of the consequences of this rule is that it may be difficult to enforce claims for breach of duty where the company is managed by wrong-doers who will be reluctant to compel the company to take action against themselves. This is particularly so where directors have been given wide general powers of management. Shareholders can of course dismiss directors by ordinary resolution using the statutory powers in s168 CA 2006; or, if the articles permit, require the directors to take or refrain from taking any specified action. See for example the reserve power in Article 4 of the Model Articles that permits shareholders to give such directions by special resolution, although this does not invalidate prior actions of directors. There are however more direct ways in which shareholders can enforce claims against delinquent directors either by bringing a derivative claim under Part 11 CA 2006 or petitioning the court for an order on the grounds of unfair prejudice under Part 30 CA A derivative claim is a claim derived from a cause of action vested in the company and brought on behalf of the company. A derivative claim may only be brought in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust of a director. It involves a two stage process in which the shareholder must first establish a prima facie case and then seek permission to continue the claim as a derivative claim. The court has a wide discretion as to whether to grant permission, but must take into account a number of statutory considerations including whether the act or omission complained of gives rise to a cause of action that a member could pursue in their own right e.g. under s994 CA 2006 in respect of unfair prejudice. In certain circumstances permission to continue the claim as a derivative claim must be refused - for example, if the Court is satisfied that a person acting in accordance with s172 (duty to promote the success of the company) would not seek to continue the claim. An unfair prejudice claim under s994 CA 2006 is potentially much wider in scope and can be brought in any circumstances where it is alleged the company s affairs are being conducted in a manner that is unfairly prejudicial to the interests of the members generally or some part of its members. Page 3 of 20

4 Question 2 a) The characteristics of a fixed charge are: It is a charge over a specific asset such as land or plant and machinery It may encompass both present and future assets If the chargor wishes to sell the asset, the charge must either be released or (if permitted by the terms of the charge) the asset sold subject to the charge The charge may be either legal or equitable. Generally speaking legal charges vest legal title to the charged asset in the chargee. An equitable charge will vest only equitable title to the asset, although equity binds the conscience of the borrower and will therefore enforce any formalities that may need to be complied with against the borrower. One of the key requirements for creation of a fixed charge is that it gives the lender sufficient control over the charged asset, otherwise it will be a floating charge and not fixed (National Westminster Bank plc v Spectrum Plus Limited and Others (2005)). The characteristics of a floating charge are: It is a charge over a generic class of assets of a company both present and future such as stock or book debts (Re Panama, New Zealand and Australian Royal Mail Co (1870)). Only a company or a Limited Liability Partnership can create a floating charge. The composition of the class of assets will change from time as the company is free to deal with them in the ordinary course of its business Until the charge crystallises, the company remains free to deal with the charged assets without reference to the chargee (Re Yorkshire Woolcombers Association Ltd (1903)). At common law a floating charge will automatically crystallise on the occurrence of certain events such as the making of a winding up order, the appointment of a receiver or administrator or the company ceasing to carry on business. In addition the charge document will normally specify events that will trigger crystallisation such as the creation or attempted creation of a security interest over any of the charged assets in favour of a third party. The principal advantage of a fixed charge from the lender s perspective is that he retains a high degree of control over the charged asset as the chargor is not free to sell or otherwise deal with the asset without the chargee s consent. This also makes it easier for the chargee to value the charged asset and to measure it against the borrower s liability. The other reason lenders will normally prefer to take a fixed charge is that on the chargor s insolvency a fixed charge ranks ahead of a floating charge so that the holder of a fixed charge will be paid out before the holder of a floating charge gets anything. Note that a charge that was a floating charge when created will be treated as such on insolvency. Page 4 of 20

5 One of the potential weaknesses of an instrument expressed to create a fixed charge however it is that it may not have the intended effect. What matters is not the form of words used to describe the charge but the substance of the charge itself. This has been particularly demonstrated in cases involving attempts to create a fixed charge over book debts and bank accounts. The leading case on this is Re Spectrum Plus Ltd (2005) where the House of Lords held that, although in theory it would be possible to create a fixed charge over book debts, in fact only a floating charge had been created because the lender did not retain sufficient control over the sums received and the operation of the account into which they were paid. The principal advantage of a floating charge is that it is a commercially flexible form of security that enables the borrower to deal with the charged assets without reference to the lender so long as the charge remains uncrystallised. From the lender s perspective this may be seen as a disadvantage but it does give the lender the opportunity to take some form of security over assets such as stock and book debts that might not otherwise be amenable to a fixed charge. A holder of a qualifying floating charge (i.e. one created in accordance with Schedule B1, paragraph 14, Insolvency Act 1986) is entitled to appoint an administrator in defined circumstances affecting the chargor s solvency. This may help to protect the interests of the lender (and other creditors). As mentioned above, on insolvency a holder of a floating charge will rank behind the holder of a fixed charge for payment on a distribution of the proceeds of sale of assets in a winding up. Floating charge holders also rank for payment behind the expenses of winding up and payment of preferential creditors and a proportion of the proceeds remaining for distribution to floating charge holders has to be ring-fenced for payment to unsecured creditors. Note there are no restrictions on who may create a fixed charge but only companies and limited liability partnerships can create floating charges. b) Registration of a charge is effected by delivering a statement of particulars with the Registrar of Companies at Companies House, known as a s859d Statement of Particulars (s859d CA 2006). The statement of particulars must be in the prescribed form and contain the information required by s859d and, where the charge is created or evidenced by an instrument, be accompanied by a certified copy of the instrument (s859a and 859D CA 2006). With very limited exceptions, practically all types of charge may now be registered (fixed and floating). The period allowed for delivery is 21 days from the day following the date of creation of the charge (s859a (4) CA 2006). Registration may be effected by the company or any person interested in the charge ; this obviously includes the charge holder who in practice will be most concerned to see that the charge is properly registered (for the reasons given below). Page 5 of 20

6 On delivery of a statement of particulars within the 21 day period the Registrar must give a certificate of registration to the person who delivered the charge particulars; such a certificate is conclusive evidence that the charge has been properly registered within the period allowed for delivery (s859i (6) CA 2006). The system of registration is now voluntary but the consequences of failure to register are that the charge is void as regards any security provided by it against a liquidator, administrator or other creditor of the company. Any underlying debt however remains enforceable and will become immediately due and payable if the security is rendered void for failure to register or failure to do so within the 21 day period (s859h CA 2006). Question 3 It is a long standing principle of company law, derived from the common law, that companies must maintain their capital for the benefit of creditors (Trevor v Whitworth (1887)). In other words, the money subscribed by shareholders for their shares cannot be returned to them except after payment of all the company s creditors in a winding up or in one of the ways permitted by the Companies Act The rationale for the rule is that, unlike a general partnership where the individual partners remain personally liable for the debts of the partnership, shareholders have limited liability. As a result they cannot be made liable for the debts of the company beyond the amount they have agreed to pay for their shares. The amount of a company s called up share capital therefore has to be maintained as a fund of last resort to protect the interests of creditors. Although the common law principle established in Trevor v Whitworth remains, it has now been overlaid with a substantial gloss of statutory regulation, some of which serves to re-enforce the rule and some of which provides statutory conditions for departing from it. The regulations affecting public companies are markedly stricter than those applicable to private companies, reflecting their generally larger size and creditors exposure to financial risk. The following are examples of ways in which statutory regulations reinforce the maintenance of capital principle: By providing a general statutory prohibition on companies purchasing their own shares (s658 CA 2008), breach of which is subject to criminal sanctions, although this rule is now subject to a number of statutory exceptions referred to below. By restricting the way in which companies (public and private) can pay dividends. Essentially a company wishing to pay a dividend can only do so out of its accumulated realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated realised losses, so far as not previously written off in a reduction of capital or re-organisation duly made (s830 CA 2006). The distribution must be justified by reference to the company s last annual accounts. If a company makes an unlawful distribution then any member who knows or has reasonable grounds for believing the distribution is made in contravention of the statutory rules is Page 6 of 20

7 liable to repay it and the directors may be liable for breach of duty (Bairstow v Queen s Moat Houses plc (2002) and It s a Wrapp (UK) Limited v Gula (2006)). By prohibiting public companies from providing financial assistance for the purchase of their own shares both at the time of the purchase and subsequently (s678 CA 2006). The prohibition extends to subsidiaries of public companies giving financial assistance for the purchase of shares in their holding company and to public company subsidiaries giving financial assistance for the purchase of shares in their private holding companies (ss678 and 679 CA 2006). Financial assistance is broadly defined and includes financial assistance given by way of gift, guarantee, security or indemnity and by way of loan and any other financial assistance that has the effect of materially reducing the net assets of the company (s677 CA 2006). There are various exceptions, both conditional and unconditional, to the general rule and breach of the prohibition is a criminal offence. By regulating the issue of share capital in various ways: Shares must have a fixed nominal value (s542 CA 2006) and a company may not issue its shares at a discount to their nominal value (s580 CA 2006). In theory at least, this ensures that companies receive the full nominal amount for their issued shares. Shares can however be issued partly paid, although public companies may not allot shares unless at least one quarter of the nominal value and the whole of any premium is paid up (s586 CA 2006); and most modern articles prohibit the issue of partly paid shares altogether (see for example Article 21 of the Model Articles for Private Companies). Companies may allot shares at a premium to their nominal value. However the amount of any premium must be credited to a share premium account (s610 CA 2006) which is treated for most purposes as part of the paid up share capital and can only be reduced in the same way and subject to the same safeguards that the share capital can be reduced. Public companies, formed as such, may not commence in business or borrow unless they have an authorised minimum share capital i.e. the nominal value of its allotted share capital must not be less than 50,000 (s CA 2006). Private companies re-registering as public companies are subject to a similar requirement. Shares can be issued for a non-cash consideration but in the case of public companies they may not allot shares as fully or partly paid for a consideration other than cash unless the consideration for the allotment has been independently valued (s593 CA 2006). There are two principal statutory exceptions to the maintenance of capital rule: First a company may reduce its share capital in one of the ways permitted by Chapter 10, Part 17, CA That is, in the case of a private company, by special resolution supported by a solvency statement and for both public and private Page 7 of 20

8 companies by special resolution confirmed by an order of the court (s641(1) CA 2006). The CA 2006 specifies a number of circumstances in which a company may reduce its share capital, such as reducing or extinguishing the liability on any of its share capital that is not paid up or cancelling any share capital that is lost or unrepresented by available assets, but also provides a more general power to reduce its share capital in any way. Whatever the circumstances, a primary consideration will be the interests of creditors and the solvency of the company following the reduction. A solvency statement, required for private companies, is a statement by each of the directors that they are satisfied at the date of the statement that there is no ground on which the company could be found to be unable to pay its debts and they have formed the opinion the company will be able to pay its debts in full for the next 12 months. In the case of a court confirmed reduction creditors are entitled to object and the court may not make an order confirming the reduction unless it is satisfied that every creditor entitled to object has either consented to the reduction or his claim has been discharged or secured (s643 CA 2006). Second, notwithstanding the general prohibition on companies purchasing their own shares (s658 CA 2006), they can issue redeemable shares and purchase their own shares, subject to the provisions of Chapters 3 and 4, Part 18 CA Generally speaking redemption and buy-back of shares must be financed out of distributable profits or the proceeds of a fresh issue of shares made for the purpose. In that way the existing capital of the company is protected. Private companies however can redeem or purchase shares out of capital subject to the provisions of Chapter 5, Part 18 CA This provides a number of safeguards for creditors. The redemption or purchase must be financed first out of any available profits and only the balance (the permissible capital payment ) can be paid out of capital; the directors must make a declaration of solvency supported by an auditor s report and the permissible capital payment must be sanctioned by special resolution of the shareholders. Page 8 of 20

9 Question 4 a) The liability of partners for the debts and liabilities of the firm is governed by the law of agency as applied by s5 Partnership Act 1890 (PA 1890). The provisions of s5 are further qualified by s8 PA 1890 which provides that if there is agreement between the partners that any restriction shall be placed on their power to bind the firm, no act done in contravention of such agreement is binding on the firm with respect to any person having notice of the agreement. As with the law of agency, in order for the agent to bind the principal he must be acting within authority. The authority of the agent may be actual authority created by agreement between the principal and his agent and may be conferred expressly (e.g. in a written partnership agreement) or by implication. Where an agent occupies a particular position (e.g. a bank manager) and is exercising powers normally associated with that position he may be considered by a third party to be acting within his usual or implied actual authority. An agent acting with actual authority will always bind the principal. Alternatively the authority may be what is termed apparent or ostensible authority which arises where the agent is held out as having authority. Where a third party acts on this apparent authority, for example by entering into a contract with the principal s agent, the principal is estopped from denying the authority of the agent even though it may exceed his actual authority. There are a number of key elements for the s5 liability to be incurred: First the partner in question must be carrying on business of the kind carried on by the firm. The meaning of this phrase has been considered in number of cases. It will extend beyond the immediate business of the firm to other activities that may be considered incidental to it. In the case of solicitors it will extend to giving investment advice (Polkingbourne v Holland (1934) and giving undertakings that the firm holds funds for a client (United Bank of Kuwait Ltd v Hammoud (1988)). There are however limits to what will be considered the normal scope of the business. In JJ Coughlan Ltd v Ruparelia and Others (2003), a case concerning a solicitor involved in a fraudulent investment scheme, it was held that the motive of the solicitor was irrelevant but having regard to the abnormal and incredible nature of the scheme itself, it could not objectively be considered as part of the normal business of a solicitor. Second, for liability to attach to the firm the business must be carried on in the usual way. Whether or not this is the case will depend on the nature of the business and whether the partner can be said to be acting within his usual authority in relation to the act in question. For this purpose the courts have drawn a distinction between the usual authority of partners in trading and nontrading partnerships. Thus partners in trading partnerships will have implied authority to bind the firm by buying and selling the firm s goods and borrowing money in the firm s name. Even if there is express agreement between the partners prohibiting such acts they will bind the firm unless the third party has actual notice of the prohibition (s8 PA 1890). By contrast, partners in non- trading partnerships, such as Page 9 of 20

10 professional firms, do not have implied authority to borrow or pledge the firm s property. There is one major qualification to s5 PA 1890 in that if a partner has in fact no authority and the person with whom he is dealing does not know or believe him to be a partner, then his acts will not bind the firm. As regards contracts, s9 PA 1890 provides that every partner is jointly liable for all debts and obligations of the firm incurred while he is a partner and after his death, his estate is severally liable while they remain unsatisfied. Section 10 PA 1890 further provides that the firm will be liable for loss or damage caused by the wrongful acts and omissions of any partner acting in the ordinary course of the firm s business or with the authority of his co-partners. The effect of this seems to be that the firm will not be liable for wrongful acts and omissions where a partner is acting without the actual authority of his copartners and which falls outside the scope of his apparent authority. In Dubai Aluminium Co Ltd v Salaam and Others (2003) the House of Lords stated that the words any wrongful act or omission used in s10 should not be confined to common law torts but could extend to a dishonest breach of trust. The fact of dishonesty (in this case the drafting of fraudulent contracts by a partner in a firm of solicitors) did not of itself mean his co-partners could escape liability on the basis the act was outside the ordinary course of the firm s business (c.f. the decision in JJ Coughlan Limited v Ruparelia and Others (2003)). Liability of the partners for wrongful acts or omissions for which the firm is liable is joint and several (s12 PA 1890). b) Generally speaking a retiring partner is not liable for the debts and obligations of the firm incurred after he has ceased to be a partner. A retiring partner remains liable for the debts and obligations of the firm incurred while he was a partner (s17 (2) PA 1890). However, he may be discharged from such liabilities by a novation agreement to that effect between the retiring partner (1), the continuing partners (2) and the creditor(s) (3) (s17 (3) PA 1890), or be indemnified against such liabilities by the continuing partners. A retiring partner may however be made liable for debts incurred after he has ceased to be a partner under the doctrine of holding out i.e. where there has been some representation or holding out that a person is a partner he will be estopped from denying it. Under s14 PA 1890 a person who represents himself or allows himself to be represented as a partner in a firm is liable to anyone who has on the faith of such representation given credit to the firm whether or not the representation was made with the knowledge or consent of the person giving it. Liability under s14 only extends to contractual liability and not to liability in tort. Further, where a person deals with the firm after a change in its constitution he is entitled to treat all apparent members of the old firm as still being members of the firm until he has notice of the change (s36 (1) PA 1890). Page 10 of 20

11 The requirement for notice can be satisfied in one of two ways. For creditors who have previously dealt with the firm and knew the person to have been a partner actual notice is required (s36 (1) and (3) PA 1890). For creditors who had no previous dealings with the firm a notice in the London Gazette will suffice (s36 (2) PA 1890). Finally a partner who dies or becomes bankrupt or retires from the firm not having been known by the creditor to be a partner in the firm, will not be liable for debts contracted after his/her death, bankruptcy or retirement (s36 (3) PA 1890). The additional protections a retiring partner should seek therefore are: Covenants from his co-partners not to be held out as a partner following his retirement including contractual obligations to remove his name from the firms letterheads and stationery; An indemnity from the continuing partners in respect of any successful claim being brought for debts incurred after he has ceased to be a partner. SECTION B Question 1 a) There are two principal potential advantages that would result from incorporation: i. Separate legal personality limited liability companies, unlike sole traders and general partnerships, are legal entities in their own right with legal personality separate from their members (Salomon v Salomon & Co Ltd (1897)). This means, for example that a company owns its own property, enters into contracts in its own name and is liable for its own debts. ii. Limited liability the liability of the members/shareholders of a company limited by shares is limited to the amount, if any, unpaid on their shares. The liability of the company itself is unlimited but, unlike sole traders and partnerships who are personally liable without limit for the debts and liabilities of their business, the personal assets of the shareholders are not generally exposed to risk beyond what they have agreed to pay for their shares. There are circumstances in which the courts have been willing to lift the so-called corporate veil so as to hold shareholders/directors personally liable for the debts and liabilities of a company. These are however extremely rare and are generally confined to those instances identified in Adams v Cape Industries plc (1990) i.e.: Where the company is a mere façade that has set up to avoid pre-existing obligations (Gilford Motor Company v Horne (1933) and Jones v Lipman (1962)) Pursuant to a contractual or statutory requirement that companies belonging to the same group of companies be treated as a single economic unit (DHN Food Distributors Ltd v Tower Hamlets London Borough Council (1976) although the correctness of this decision has been doubted and Page 11 of 20

12 the principle that companies in a group should be treated as a single economic unit was expressly rejected in Adams; and Where a company acts as agent for its shareholders (Re FG Films Ltd (1953)) Despite the reluctance of the courts to lift the corporate veil, directors/shareholders may be liable in tort if a duty of care can be established on the basis of the principles laid down in Hedley Byrne v Heller & Partners Ltd (1964) and the director/shareholder concerned had assumed a high degree of personal responsibility to the plaintiff for the act complained of (Williams and Another v Natural Life Health Foods Ltd and Another (1998)). In the case of Ibrahim and Amy therefore, although incorporation would protect them from liability in contract (on the basis none of the veil lifting exemptions identified in Adams would be likely to apply) they might still be personally liable in the tort of negligence. b) A private company limited by shares is formed by the process of registration prescribed by the Companies Act 2006 (CA 2006). This involves delivering to the Registrar of Companies a number of documents and a fee. The documents are: The memorandum of association this is a document in prescribed form signed (or otherwise authenticated ) by one or more persons stating that the subscribers wish to form a limited liability company and agree to be members of it (s8 CA 2006) An application for registration (s9 CA 2006) which must state or contain: the company s proposed name Whether the company s registered office is to be situated in England or in Wales the liability of the members is to be limited by shares the company is to be private a statement of capital and initial shareholdings a statement of the company s proposed officers (directors and secretary, although a private company need not have a secretary) the company s registered address a copy of the company s proposed articles (to the extent these are not the default model articles prescribed by s20 CA 2006) a statement of compliance that the requirements of the Act have been complied with. Page 12 of 20

13 The statement of capital must state the total number of shares to be taken by the subscribers on incorporation, the aggregate nominal value of the shares and for each class of share, the rights attaching to them, the total number of shares and the aggregate nominal value. If the Registrar is satisfied that the registration requirements have been complied with he must issue a certificate of registration which is conclusive evidence that the requirements of the Act have been complied with. The effect of registration is that the subscribers and such other persons as agree to become members are a body corporate (s16 CA 2006). If they wish to keep substantially the same name as the partnership name, they would need to check that there is no existing company using that name, since a company may not be registered with the same name as an existing company (s66 CA 2006). Furthermore, their company name must end in Limited or Ltd (s59 CA 2006). They might also consider whether it would be easier and cheaper for them to acquire an off the shelf company rather than forming one from scratch. This would involve acquiring a ready-made company from an incorporation agent for a fee; the incorporation agent would transfer the shares to Ibrahim and Amy, appoint them as directors then resign its own position as director and change the address of the registered office. c) This asked how Ibrahim and Amy could implement their existing partnership arrangements in the new company. This would need to be reflected in the share structure and the articles of association. A company must have articles prescribing regulations of the management of the company (s18 CA 2006); it must either file its own articles or the Model Articles prescribed by s20 CA 2006 will apply. The articles form part of the company s constitution and create a contractually binding agreement between the company and each member and between the members themselves (s33 CA 2006 and Rayfield v Hands (1958)) and Hickman v Kent or Romney Marsh Sheep Breeders Association (1915)). The rights attaching to the company s shares, including rights as to income, capital and voting covered by the existing partnership agreement, would normally be set out in the articles. In order to implement their existing arrangements which although equal in management and voting are different regarding rights to income and capital - it would be advisable for them to register their own articles. Ibrahim and Amy may also want to enter into a shareholders agreement to cover other matters they might not wish to make public. Page 13 of 20

14 Question 2 The starting point should be to decide whether or not Joel and Mike are carrying on a business together as partners. Partnership is defined as the relation that subsists between persons carrying on business in common with a view of profit (s1 PA 1890). A written agreement is not necessary provided the s1 definition is satisfied. There are a number of key elements to this definition. First, there must be two or more persons carrying on a business in common. Business is defined fairly widely by s45 PA 1890 as including every trade, occupation or profession. Section 2 PA 1890 provides a number of rules for deciding whether a partnership exists. Thus, co-ownership whether in the form a joint tenancy, tenancy in common, joint property, common property or part ownership does not of itself create a partnership. For the most part however, these provisions are indicative only and not determinative of the existence of a partnership. A business may consist of a single venture or, perhaps more frequently, a series of continuing activities. Khan and Another v Miah and Another (2001) There must however be more than mere agreement to form a partnership (Ilott v Williams (2013)). The concept of a business being carried on in common also implies some shared responsibility for decision making, in contra-distinction from the employer employee relationship where ultimately the employee must act in accordance with his employer s instructions. Second, there must be an intention to carry on business with a view of profit i.e. a profit motive. Section 2 (3) PA 1890 provides that the receipt by a person of a share of profits is prima facie evidence that he is a partner but does not of itself make him a partner. In effect it is only one of several factors that must be taken into account. The sharing of profits is nonetheless a strong indicator of the existence of a partnership and is one of the factors that distinguish partnership from other forms of business relationship such as employer and employee. Applying the above to the scenario in question, it would seem there are very strong grounds for concluding that Joel and Mike are working in partnership in particular, the shared responsibility for decision making and the participation in profits. The fact that there is no written agreement means that their relations will be governed by the PA 1890, save to the extent of any contrary oral agreement or a contrary agreement can be inferred from a course of dealing between them. Page 14 of 20

15 Under s25 PA 1890 a partner cannot be expelled by his co-partners unless there is express agreement for them to be able to do so. Mike s purported dismissal of Joel is therefore mis-conceived. Joel is not an employee and cannot be dismissed in that way. Relations between partners are governed by s24 PA This provides that every partner is entitled to take part in the management of the business (s24 (5)). Further, any difference arising as to ordinary matters may be decided by a majority but no change may be made in the nature of the partnership business without unanimous consent of all the partners (s24 (8)). The PA does not specify what is meant by ordinary business or what would constitute a change in the nature of the partnership business. A properly drafted partnership agreement would of course set out the voting majorities required on specific issues. Here the proposal to open a new bike repair shop probably does not amount to a change in the nature of the business it is not for example, a proposal to alter the type of business carried on or to make fundamental changes to the constitution of the business. Joel and Mike would therefore have an equal say in the matter resulting in deadlock if their differences cannot be resolved. In terms of dealing with this deterioration in their relations therefore, the options available to Joel are: Try to repair relations with Mike and enter into a written partnership agreement setting out their respective rights and responsibilities Dissolve the partnership if relations have completely broken down. The partnership could be dissolved either by mutual consent or by notice given by either partner to the other. This is a partnership at will i.e. where no fixed term has been agreed upon for the duration of the partnership. In such circumstances any partner may bring the partnership to an end by giving notice to the other partners of his intention to do so (s26 PA 1890). Termination by notice is also provided by s32(c) PA 1890 which provides that a partnership for an undefined time may be terminated by any partner giving notice to the other partners of his intention to dissolve. Note that the Courts have distinguished the two sections by limiting the scope of s26 to those situations where the agreement is silent on the question of termination (Moss v Elphick (1910)). The consequences of termination would be that the partnership property would be sold and the proceeds applied in paying the debts and liabilities of the partnership and any balance of income and capital would be distributed among the partners equally in the absence of evidence to the contrary; here there is contrary evidence as Mike contributed initial capital (ss39 and 44 PA 1890). Page 15 of 20

16 Question 3 There are a number of transactions which the liquidator might seek to challenge: i) Wrongful trading (s214 Insolvency Act 1986 (IA)) The liquidator may apply to the court for a declaration that the directors (or any of them) is 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). The section 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. For this purpose there is a two-fold test of the facts a director ought to know or ascertain and 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) The Court may not however make such a declaration if it is satisfied the director concerned took every step with a view to minimising the potential loss to creditors (s214 (3) IA). 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. Clearly the Company was balance sheet insolvent by 31 March 2014 (on the basis its current assets were insufficient to meet its current liabilities) but the directors continued to trade for almost a year afterwards despite a continuing deterioration in its financial position. The decisions taken at the board meeting in June 2014 seem to fly in the face of the evidence. ii) Fraudulent Trading (s213 IA) Note that if in the course of winding up it appears that the business was carried on with intent to defraud creditors (or for any other fraudulent purpose) the Court may order any person knowingly concerned to make such contribution to the company s assets as the court thinks proper (s213 IA). Any director concerned may also be liable to disqualification under the Company Directors Disqualification Act 1986 (CDDA). On the facts there is no evidence of any fraudulent intent. (iii) Transaction at an undervalue (s238 IA) Page 16 of 20

17 The writing off of the director s loan may amount to a transaction at an undervalue enabling the liquidator to apply to the Court for an order restoring the position to what it would have been if the transaction had not been entered into. A transaction at an undervalue occurs if at a relevant time the company enters into a transaction with a person by making a gift to that person or 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) Where the company enters into a transaction with a connected person the relevant time is the period of two years ending with the onset of insolvency (s240 (1) (a) IA). At that time the company must also be unable to pay its debts or become so as a result of the transaction (s240 (2) IA). 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). On the facts it seems likely that this test would be satisfied. A person is connected with the company for this purpose if he is, inter alia, a director of it (s249 (5) IA). 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 writing off the loan or for believing it would benefit the company. (iv) Avoidance of Floating charge (s245 IA) 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. 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. In this case it appears the charge was created to secure an existing debt and that it was created within the relevant time as there is no reference to new consideration being given. Where 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. This clearly seems to be the case here. Page 17 of 20

18 Question 4 a) Shareholders and Directors resolutions required Shareholders resolutions i. Substantial Property Transaction (s190 CA 2006) The proposed purchase by the Company of the storage warehouse from Red Star is a substantial property transaction within s190 CA 2006 and requires the prior approval of shareholders or must be made conditional on such approval. Section 190 (1) (b) provides that a company may not enter into a transaction under which the company acquires or is to acquire a substantial non-cash asset from a person connected with a director of the company unless the arrangement has been approved by the members of the company or is conditional on such approval being obtained. The warehouse is a non-cash asset i.e. any property other than cash (s1163 CA 2006) An asset is substantial if its value exceeds more than 100,000 (s191 (2) (b) CA 2006) here it is valued at 1 million The Company is proposing to acquire a substantial non-cash asset from a person (Red Star) connected with a director of the Company (Paul Brown) (s190 (1) (b) CA 2006) Red Star is connected with Paul because it is a body corporate with which he is connected (s252(2)(b) CA 2006) For this purpose Red Star is deemed to be connected with Paul as he is interested in more than 20% of the equity share capital of Red Star (ss 252 and 254 CA 2006). The proposed purchase therefore requires approval by ordinary resolution of the Company; alternatively a contract could be entered into conditional on such approval being obtained. ii. Appointment of Carolyn as a director The Company has Model Articles for Private Companies. Article 17 MA provides that directors may be appointed either by ordinary resolution of the shareholders or by a decision of the directors. If the former, an ordinary resolution will be required; in view of the proposed long term service contract this may be the simplest solution. iii. Long term service contract Under s188 CA 2006 the award of a director s service contract for a guaranteed term of more than two years must first be approved by ordinary resolution of the shareholders. Here the guaranteed term is three years i.e. the contract cannot be terminated by the Company before the expiry of the three year fixed term. Directors resolutions required: Page 18 of 20

19 To approve the appointment of Carolyn as a director of the Company, unless appointed by the shareholders. To approve, subject to shareholder consent: The terms of the proposed service contract with Carolyn The proposed purchase of the warehouse from Red Star and the terms of the proposed contract To convene a general meeting of the shareholders for the purpose of passing the above resolutions (s302 CA 2006); alternatively, to approve the circulation of written resolutions for approval by eligible shareholders (s288 (3) (a) CA 2006). To authorise a director or director and secretary on behalf of the Company to execute the contracts for the purchase of the warehouse and the service agreement. To instruct the Company Secretary to file Form AP01 (Notice of appointment of a director) at Companies House and to make the necessary entries in the Company s Register of Directors (s162 CA 2006) and Register of Directors Residential Addresses (s165 CA 2006). b) Procedural Steps The board of the Company should meet. Any director may call a meeting by giving notice to the other directors or instruct the Company Secretary to give notice. Notice of the meeting should specify the date, time and place of the meeting but it need not be in writing; if it is anticipated that all directors participating in the meeting will not be in the same place, the notice should specify how they are to communicate with each other (MA 9). The quorum for a directors meeting is two unless fixed at any higher number by the directors (MA 11). Decisions at a meeting are taken by majority vote or, if no meeting is held, by unanimous decision of all eligible directors i.e. those who would have been entitled to vote at a meeting (MAs 7 and 8). If the votes are equal the Chairman has a casting vote (MA 13). If a proposed decision involves a transaction in which a director is interested he/she should declare his/her interest (s177 CA 2006). He/she will also be barred from voting or being counted in the quorum (MA 14) unless Article 14 is disapplied or the decision involves a permitted cause. On the facts, this would apply to Paul, at least in relation to the SPT, and possibly to Carolyn if she is appointed by the board at the beginning of the meeting. She is not obliged to declare her interest in her proposed service contract (s177 (6) (c) CA 2006), although it may be good practice for her to do so. Page 19 of 20