LEVEL 6 UNIT 16 THE PRACTICE OF COMPANY & 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. Question 1 (a) The question is looking at the potential liability of partners. As a basic premise, every partner in a firm is jointly liable for all of the debts of the firm incurred whilst he is a partner (s9 Partnership Act 1890). Despite the wording of s9 Partnership Act 1890, by virtue of the Civil Liability (Contribution) Act 1978, partners are now effectively jointly and severally liable for the debts of the firm. Will the Partnership be bound under s5 Partnership Act 1890? This requires the application of the following test: 1) Is the act related to business of the kind carried on by the firm? Objective test: yes - the purchase is from a supplier at a toy trade fair. 2) Would Jason usually be expected to have authority? Objective test: a partner is usually expected to have authority to buy goods related to the Partnership. 3) Does company know or believe Jason to be a partner? Subjective test: on the facts, there is no reason for the supplier to question this; Jason s attendance at the event was in his capacity as a partner. 4) Does the other party to the contract know or believe Jason to have no authority? Subjective test: again, there is no reason, on the facts, for the other party to know of the lack of authority. The firm, and therefore the partners, will be liable for a debt if incurred by someone (in this case Jason Hudson) acting on behalf of the firm with authority. The limitation placed on Jason, and all the other partners by virtue of the partnership deed, clause 7.1.6, will not be binding on the other party to the contract unless that party has knowledge of the restriction in accordance with s8 Partnership Act 1890. There is nothing on the facts to suggest this, and therefore the firm could be liable. Page 1 of 6
By applying the above tests, it is clear that Jason did not have actual authority, as his ability to incur liabilities on behalf of the firm is capped at 10,000 and he has spent considerably over this sum. In this instance the firm is only liable if the seller can rely on s5 Partnership Act 1890. Given the nature of the business of the Partnership it is likely that the purchase of the toys, even if they are not of the required ethical standard, would be regarded as an act for carrying on in the usual way the business of the Partnership. Therefore the firm is liable. In terms of liability for the order, Jason is bound under privity of contract. All the current partners, will be bound jointly under s9 Partnership Act 1890. (b) Both Elizabeth Watson and Michaela Sinclair, as partners, will not be able to expel Jason Hudson, as a partner, from the Partnership unless the right to do so has been expressly agreed between the partners (s25 Partnership Act 1890). Accordingly the partners will have to look to the terms of the Partnership Agreement, and see if it gives a power of expulsion in the light of Jason s past behaviour. Clause 20 of the partnership deed is relevant here. Jason has incurred a debt for any single transaction over the limit set by the partnership deed of 10,000 (clause 7.1.6). This arguably amounts to a serious breach of the terms of the agreement or any duty which has as its object or effect the material disadvantage of the partnership, giving a power of expulsion (clause 20.1.1). Jason can only be expelled if two thirds of the other partners vote to expel him (Clause 18.3). This would require both Elizabeth and Michaela to be in agreement. The expulsion will not terminate the partnership as regards the other partners (clause 2.1) who can buy out Jason s interest (clause 21). The procedure by which the partners can effect the expulsion of Jason in accordance with the partnership deed is as follows: Jason must be served with 14 clear days notice of his proposed expulsion (clause 18.1) together with a statement of the grounds for the expulsion (clause 18.3) the meeting itself must be quorate (clause 18.3) Jason must be given opportunity to be heard at the meeting (clause 18.3) two thirds of the other partners must vote for expulsion (clause 18.3) notice of expulsion must then be given within 3 months of becoming aware of the breach or ground for expulsion (clause 20.1). Question 2 (a) Elizabeth Watson may be appointed a director of W&S Toys Limited ( the Company ) either by the directors in a Board Meeting or by members in a General Meeting by Ordinary Resolution in accordance with Article 17(1) Model Articles. To appoint by General Meeting, directors will need to call a GM on 14 clear days notice or short notice (s307 CA 2006 and Article 48 Model Articles). Alternatively, the Company could use the written resolution procedure under s288-300 Companies Act 2006. However, Elizabeth is also to be awarded a director s service contract of five years. As this is for a fixed term exceeding two years, the term must be Page 2 of 6
approved by an ordinary resolution of the company (s188 Companies Act 2006). A copy of the proposed agreement or a memorandum of its terms, including the term which requires members approval, must be available for inspection by the members of the company at the company s registered office for not less than 15 days (s188(5) Companies Act 2006). Alternatively if a written resolution is used the memorandum should be attached to it. If such a term is granted before the members approval is obtained, it is void and the agreement terminable at any time by the company on giving reasonable notice (s188(5) Companies Act 2006). Accordingly, as an ordinary resolution is required, the appointment and approval of the contract should be deferred to a General Meeting of the company. Elizabeth need not declare her interest in the grant of her service contract by virtue of s177(6)(c) Companies Act 2006 but should be advised to do so as a matter of good practice. Elizabeth may not however vote or be counted in the quorum at the board meeting called to approve her service contract (Article 14 Model Articles). Administration: a number of documents will need to be prepared, namely, Board Meeting minutes and resolutions (first to decide on the appointment and the terms of the service agreement, then to hold the required General Meeting to approve the term, and finally a subsequent Board Meeting to authorise the execution of the service contract), Notice of General Meeting and minutes, and the necessary Ordinary Resolution. The proposed agreement or a memorandum of its terms will need to be prepared, and letters noting the declaration of interest on the part of the director, updating of the registers of directors and Form AP01 to be completed and filed with the Registrar. (b) Elizabeth Watson may be removed from office by an ordinary resolution of the shareholders notwithstanding any contrary provision in any agreement between her and the company (s168 Companies Act 2006). The proposed service contract will not therefore prevent Elizabeth s removal as a director before the term of that contract has come to end. However, the right of the company to remove her as a director will be without prejudice to any claim for compensation that Elizabeth might have if her removal constitutes a breach of her service contract (s168(5)). Special Notice of any such proposed resolution must be given to the company at least 28 days before the meeting. Elizabeth is entitled to protest her removal by speaking at the meeting called to consider the resolution to remove her and to make written representations to the meeting (s169 Companies Act 2006). She can be protected in the following ways: include a Bushell v Faith clause in the Articles to give her enhanced voting rights in the event of a resolution to remove her or to amend or remove the Bushell v Faith clause from the Articles (or the Bushell v Faith clause might also be prevented from amendment or removal by a provision for entrenchment, under s22 Companies Act 2006) amend Article 18 Model Articles to reduce the circumstances in which a director would be disqualified from holding office by a clause in a separate shareholders agreement which requires parties to that agreement to vote against any resolution to remove her as a director. Page 3 of 6
The articles of association may be amended by Special Resolution (s21 Companies Act 2006), with a copy filed at Companies House (s30 Companies Act 2006), together with a reprinted copy of the amended articles of association (s34 Companies Act 2006). Question 3 (a) This will be a substantial property transaction. The Partnership assets are owned jointly by the Partners (clause 12.2 of the Partnership Deed). The partners will all have been appointed directors of the Company prior to the transfer of the business of the partnership by her (and her fellow partners) to the company. Under s190 CA 2006 a company may not acquire from a director and a director may not acquire from the company, a substantial non-cash asset unless the arrangement is either first approved, or made conditional upon being approved, by a members ordinary resolution. In this instance, the Company is to acquire from three of its directors, Elizabeth, Michaela and Jason, various non-cash assets that consist of the Partnership assets. A non-cash asset is any property or interest in property other than cash (s1163 CA 2006). Under s191 CA 2006 a non-cash asset is substantial in relation to the company if its value exceeds 10% of the company s net asset value and is more than 5000 or its value exceeds 100,000. The Company is a shelf company that is yet to trade (and the investment from 3PPP is yet to be made). At most the Company will only have issued the two subscriber shares. The net assets of the Company are effectively nil. The transfer of the partnership business will therefore be substantial in value. Accordingly, the acquisition requires the approval of members by ordinary resolution. If members approval is not obtained the transaction will be voidable at the instance of the company. Directors who authorise the transaction without members approval will be liable to indemnify the company for any loss or damage which results from the transaction. However, of the Company s four directors at this point, three will be interested in the transaction and will therefore be required to declare their interest under s177 CA 2006 (unless all the other directors are already aware of their interests (s177 (6) (b) CA 2006) which is the case here). The three directors who are still partners in the Partnership are unable to vote on the transaction when they, as directors, resolve that the contract should be made with themselves (Article 14 Model Articles). The directors interests in the contract are direct and material and they conflict with the interests of the company they are the sellers whose interests must, by definition, be in conflict with the buyer s interests. They cannot vote so under Article 14(1) Model Articles they cannot count in the quorum and as a result, when they come to vote on this contract in the directors meeting a quorum will not be capable of being secured as all directors are caught by Article 14 Model Articles. Therefore quorum will not be achieved. Quorum for a directors meeting is two under Article 11 of the Model Articles. Without a quorum business cannot be validly conducted at board meetings. Note, although s177 Companies Act 2006 and Article 14 Model Articles applies in relation to a directors meeting each shareholder is free to vote at the general meeting according to their own personal interest. The solution is therefore to first seek an ordinary resolution under Article 14(3) Model Articles to disapply the articles (either generally or for this single Page 4 of 6
transaction) and so allow the three directors to vote on the transaction at directors meeting despite the fact that they are interested. Once passed, quorum will be achieved for the Board Meeting first to table the purchase by the Company of the Partnership assets, and to seek approval of members by ordinary resolution. (b) A director is not ordinarily liable for contracts entered into by the company. However by virtue of s214 Insolvency Act 1986 the court may hold that any person is liable to make such contribution to the company s assets as the court thinks proper if the company goes into insolvent liquidation; at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation; and that person was a director of the company at that time. The criteria against which a director s knowledge and actions is measured is the knowledge possessed and the action that would have been taken by a reasonably diligent person, having both the general knowledge, skill and experience to be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and the general knowledge, skill and experience that that director actually has (s214(4) Insolvency Act 1986). If the directors continue to trade and in the process increase the liabilities of the company, the company may then become unable to pay its trade creditors, i.e. its debts. A company is deemed to be unable to pay its debts, inter alia, if a creditor for more than 750 has served a statutory demand and remains unpaid for three weeks or if it is proved to the satisfaction of the court that it is unable pay its debts as they fall due (s123 Insolvency Act 1986). In the event that the company is unable to pay its debts, creditors may petition the Court for the compulsory winding up of the company on the ground that it is unable to pay its debts (s122(1)(f) Insolvency Act 1986). If such circumstances do occur, the directors may be guilty of wrongful trading under s214 Insolvency Act 1986. There is a defence to wrongful trading but only if the director concerned can prove to the satisfaction of the court that after he concluded there was no reasonable prospect of the company avoiding going into insolvent liquidation, he took all reasonable steps to minimise the loss to the company s creditors. If found guilty of wrongful trading the court may, on application of the liquidator, order the delinquent directors to make such contribution to the assets of the company as it thinks proper. Question 4 (a) The directors of the company must be authorised to allot shares (s549-551 CA 2006). s550 CA 2006 provides that where a private company, such as in this instance, has only one class of shares (classes of shares defined in s629 CA 2006) the directors may exercise any power to allot shares, except to the extent that they are prohibited by the company s articles. However, as the proposal includes the allotment of preference shares, the directors will need to be authorised under s551 CA 2006. In addition, to attach the rights to the preference shares, the articles will need to be amended by special resolution (s21 CA 2006). To allot the new shares to the private equity house, 3PPP, the company will first need to create the preference shares and then authorise the directors to allot all the shares, in accordance with s551 CA 2006. Page 5 of 6
As the company is proposing to allot the ordinary shares ( equity securities, under CA 2006) for cash, the existing members should be offered the shares first (s561 CA 2006), in proportion to their existing holdings. Given that this investment will only take place once the transfer of the partnership business has been completed, Elizabeth, Michaela and Jason will be the existing shareholders at this point. Clearly, then, the allotment of the ordinary shares to 3PPP does not comply with s561. However, since, presumably, the existing shareholders agree to the allotment of the new ordinary shares to 3PPP, those shareholders will simply need to waive their pre-emption rights. Alternatively, a member s special resolution disapplying the pre-emption rights could be sought under s570 CA 2006. Any member who objects to the issue may attempt to bring an action under s994 CA 2006, unfair prejudice. Given the circumstances, it is likely that the members will be willing to waive their pre-emption rights. The preference shares being allotted to 3PPP will not be equity securities (as they do not fall within the definition in s560 CA 2006) and therefore that allotment will not be subject to rights of pre-emption for the existing members. (b) The procedure for the allotment of new shares is first to call a board meeting to resolve to seek the members permission for the directors to allot a minimum of 2,500,000 ordinary shares of 1 each and 1,000,000 preference shares of 1 each. The members general meeting may be called on 14 days notice or on short notice procedure (s307 CA 2006 and Article 48 Model Articles). Alternatively, the Company could use the written notice procedure under s288-300 CA 2006. The members will vote on the ordinary resolution granting directors power to allot shares (ss549 and 551 CA 2006) and the special resolution (s21 CA 2006) amending the company s Articles to include the rights attached to the preference shares. On the assumption that the shareholders have waived their rights and therefore no special resolution is required disapplying pre-emption rights, the meeting will close. The board meeting will then re-convene. The board will then receive and resolve to allot new shares following receipt of the applications from the current directors at the agreed price. All the current directors will have to declare their interest under s177 CA 2006 in relation to the allotment of shares at the board meeting. Although, since all directors can reasonably be assumed to be aware of the other s interest, they will be exempt under s177(6)(b) CA 2006. In this instance, Article 14 Model Articles does not apply as the director s conflict of interest arises from a proposed subscription for shares and they are thereby not prevented from voting on board meeting resolutions relating to the allotment (Article 14(4)(b)). Administration: the directors will then need to resolve to allot the shares and affix the company s seal to the share certificates, update the register of allotments and members and prepare minutes of the board meeting and members meeting. The members will formally notify the Company of their interest in the shares (s113 CA 2006). A statement of capital will need to be sent to the Registrar together with the s21 and s551 resolutions, amended articles of association and Form SH01 of the allotment of shares for non-cash consideration. The sum representing the nominal value of the preference shares, 1,000,000, and the ordinary shares, 2,500,000 will be credited to the Called up share account (s580 CA 2006). Page 6 of 6