company law Q & A

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Q&A Series

Company LawFOURTH EDITION

Cavendish

Publishing

Limited

London Sydney Portland, Oregon

Jennifer James,LLB, BCLDirector of Teaching and Learning

School of Law, University of Reading


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Fourth edition first published in Great Britain 2003 by

Cavendish Publishing Limited, The Glass House,

Wharton Street, London WC1X 9PX, United Kingdom

Telephone: +44 (0)20 7278 8000 Facsimile: +44 (0)20 7278 8080Email: [email protected]

Website: www.cavendishpublishing.com

Published in the United States by Cavendish Publishing

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5804 NE Hassalo Street, Portland,

Oregon 972133644, USA

Published in Australia by Cavendish Publishing (Australia) Pty Ltd

3/303 Barrenjoey Road, Newport, NSW 2106, Australia

James, Jennifer 2003

First edition 1993

Second edition 1996

Third edition 2001

Fourth edition 2003

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic, mechanical,photocopying, recording, scanning or otherwise, without the prior permission in

writing of Cavendish Publishing Limited, or as expressly permitted by law, or under

the terms agreed with the appropriate reprographics rights organisation. Enquiries

concerning reproduction outside the scope of the above should be sent to the

Rights Department, Cavendish Publishing Limited, at the address above.

You must not circulate this book in any other binding or cover

and you must impose the same condition on any acquirer.

British Library Cataloguing in Publication DataJames, Jennifer

Company law4th ed(Q&A series)

1 Corporation lawGreat Britain

I Title

346.4'1'066

Library of Congress Cataloguing in Publication Data

Data available

ISBN 1-85941-735-3

1 3 5 7 9 10 8 6 4 2

Printed and bound in Great Britain


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v

PREFACE

Company law is less open to judicious question spotting than many others.If you are preparing for examinations, at least if you are sensible, you willensure that you have an overview of the whole subject, even if you choose toconcentrate revision in a limited number of areas. With this combinedoverview and specialised knowledge, you will be able to answer a questionwhich is principally on topic X while pointing out that you realise that minorpoints Y and Z also ariseeven if there is little that you can say on thosepoints. An overview of company law also enables you to tackle generalquestions which cut across a major part of the syllabus, for example, questionson disclosure or the distinctions between public and private (particularly

quasi-partnership) companies. When selecting specific areas for detailedrevision, it is obviously sound practice to ensure that, where topics are linked,you study both; there is little point in knowing all about the rules relating tothe fiduciary duties of directors without being equally at home with theprocedures for the enforcement of those duties.

Since no two syllabuses are identical and individual lecturers will havelaid stress on particular topics, which they will have approached in differingways, there can be no definitive list of typical examination questions.

However, in this fourth edition I have tried to produce questions which wouldbe at home on an examination paper of any university or equivalent bodyand, I hope, the Legal Practice Course. Some of the questions may demand aconsideration of the recent proposals and suggestions for reform of companylaw in key areas. To this extent, reference to the work of the Law Commissionand the Company Law Review Steering Group may be relevant. In the lightof the governments proposals inModernising Company Law(www.dti.gov.uk/companiesbill), it is also probable that a new Companies Bill will be put

before Parliament in the near future, so an awareness of its provisions willbe needed.The answers featured in this book are not meant to be model answers that

could be used to write an assessment; rather, they are the type of answerwhich a good student could hope to achieve in the course of a writtenexamination. Answers are around 2,000 words, which you should be able towrite in about 4045 minutes if you are well prepared. If you find that youcannot write this quickly, try to speed up, perhaps by using recognisedabbreviations of standard terms.

In suggesting answers to questions, I have assumed that a student ispermitted to take statutes into his/her examination. Consequently, I havenot cited anything other than section numbers as authority for propositionsunless the wording of a statute is of particular significance. If you do nothave access to the legislation, you can legitimately expect to receive somecredit for remembering the content of relevant sections.


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vi Preface

All statutory references are to the Companies Act 1985, as amended,unless otherwise indicated, and you should always indicate at the outsetif this also applies to your answers. The Companies Act is generallyabbreviated to CA, and the Insolvency Act 1986 to LA.

In common with the procedure adopted by most examiners, I havepresumed that all companies have articles identical in form to those containedin the appropriate Table A promulgated under the Companies Act 1985,unless and to the extent that the contrary is indicated.

Finally, I would like to thank Mike Ottley of the University of Greenwichfor his invaluable help in preparing the third edition of this book.

Jennifer JamesDecember 2002


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vii

CONTENTS

Preface v

Table of Cases ix

Table of Statutes xix

1 Formation of Companies and Consequencesof Incorporation 1

2 The Company and Insiders 31

3 The Company and Outsiders 63

4 The Directors 87

5 The Shareholders and their Rights 137

6 Share Capital 171

7 Loan Capital 221

8 Administering the Company 247

Index 269


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ix

TABLE OF CASES

A Company (No 002567 of 1982), Re [1983] 1 WLR 927;[1983] 2 All ER 854 43, 46

A Company (No 004475 of 1982), Re [1983] 2 WLR 381 152, 169A Company (No 007623 of 1984), Re [1986] BCLC 362 152, 168A Company (No 005287 of 1985), Re [1986] 1 WLR 28; [1986] 2 All ER 253 3A Company (No 00477 of 1986), Re [1987] BCLC 376 157, 158A Company (No 00789 of 1987), Re, ex p Shooter [1990] BCLC 384 142, 154A Company (No 005685 of 1988), Re, ex p Schwarcz [1989] BCLC 427 162A Company (No 006834 of 1988), Re, ex p Kremer [1989] BCLC 365 158A Company (No 00330 of 1991), Re, ex p Holden [1991] BCLC 597 153, 158

Aberdeen Rly Co v Blaikie Bros, HL (1854) 1 Macq 46 55, 95, 105,123, 132, 228

Adams v Cape Industries plc [1990] Ch 433; [1990] 2 WLR 657 9, 10Agnew v IRC, SeeBrumark Investments Ltd, ReAlexander Ward & Co Ltd v Samyang Navigation Co Ltd

[1975] 1 WLR 673; [1975] 2 All ER 424 59Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656 33, 38, 40, 44, 57,

75, 146, 217Allen v Hyatt (1914) TLR 444 90, 94, 103,

105, 114, 121Armagas Ltd v Mundogas SA [1986] AC 717; [1986] 2 WLR 1063 86Ashbury Railway Carriage Co v Riche (1875) LR 7 HL 653 64, 65Association of Certified Public Accountants v Secretary of State

for Trade and Industry [1997] 2 BCLC 307 13Atlas Wright (Europe) Ltd v Wright [1999] BCC 163 134

Automatic Self-Cleansing Filter Ltd v Cunninghame [1906] 2 Ch 34 52Aveling Barford v Perion [1989] 1 WLR 360; [1988] 3 All ER 1019 216, 238, 239

BCCI (Overseas) Ltd v Akindele [2001] Ch 437; [2000] 3 WLR 1423 109Bacon (MC) Ltd, Re [1990] BCLC 324 235Bahia & San Francisco Rly Co Ltd, Re (1868) LR 3 QB 584 203Bailey Hay & Co Ltd, Re [1971] 1 WLR 1357; [1971] 3 All ER 693 261Bamford v Bamford [1970] Ch 212; [1969] 2 WLR 1107 50, 51, 95, 102,

111, 175Barclays Bank Ltd v TOSG Trust Fund [1984] AC 626; [1984] 2 WLR 650 81, 86Barleycorn Enterprises Ltd, Re [1970] Ch 465; [1970] 2 WLR 898 236Barrett v Duckett [1995] BCLC 243 84, 92, 141, 193

Barron v Potter [1914] 1 Ch 895 53, 166

Barry Artist Ltd, Re [1985] 1 WLR 1305 40


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x Table of Cases

Beattie v E & F Beattie Ltd [1938] Ch 70; [1938] 3 All ER 214 35, 58, 74Bentley-Stevens v Jones [1974] 1 WLR 638; [1974] 2 All ER 653 140

Berry and Stewart v Tottenham Hotspur FC Ltd [1935] Ch 718 201Birch v Cropper (1889) 14 App Cas 525 190Boardman v Phipps [1967] 2 AC 46; [1966] 3 WLR 1009 122, 132Boston Deep Sea Fishing Ice Co v Ansell (1888) 39 Ch D 339 105Boulting v ACTAT [1963] 2 QB 606; [1963] 2 WLR 529 40, 60Brady v Brady [1989] AC 755; [1988] 2 WLR 1308 171, 212, 214, 215Brazilian Rubber Estates & Plantations Ltd, Re [1911] 1 Ch 425 98, 130Breckland Group Holdings v London & Suffolk Properties

[1989] BCLC 100 54Brightlife Ltd, Re [1987] Ch 200 225, 245British Thomson-Houston Co Ltd

v Federated European Bank Ltd [1932] 2 KB 176 74, 79Brown v British Abrasive Wheel [1919] 1 Ch 290 44, 45, 147Brumark Investments Ltd, Re (Agnew v IRC)

[2001] 2 AC 710; [2001] 3 WLR 454 223, 226, 244, 245

Burland v Earle [1902] AC 83 140Bushell v Faith [1970] AC 1099; [1970] 2 WLR 272 15, 34, 50, 53, 166

Cade (JE) Ltd, Re [1992] BCLC 213; [1991] BCC 360 157Cane v Jones [1980] 1 WLR 1451; [1981] 1 All ER 533 36, 38Carney v Herbert [1985] AC 301; [1984] 3 WLR 1303 211, 213Cimex Tissues Ltd, Re [1995] BCLC 409 224, 244City Equitable Fire Insurance Co Ltd, Re [1925] Ch 407 26, 97, 103, 107,

130, 167, 238City Investment Centres Ltd, Re [1992] BCLC 956 127Clemens v Clemens Bros Ltd [1976] 2 All ER 268 34, 45, 112, 113, 148, 173Coleman v Myers [1977] 2 NZLR 225 90Cook v Deeks [1916] 1 AC 554 96, 106, 122, 146Cooke v Cooke [1997] 2 BCLC 28 92Cosslett (Contractors) Ltd, Re [1998] 2 WLR 131 224Cotman v Brougham [1918] AC 514 65, 71Creasey v Breachwood Motors Ltd [1993] BCLC 480 11Cumana Ltd, Re [1986] BCLC 430 153Cumbrian Newspapers Group Ltd v Cumberland and

Westmoreland Herald Ltd [1987] Ch 1; [1986] 3 WLR 26 112


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Table of Cases xi

DHN Food Distributors Ltd v Tower Hamlets LBC

[1976] 1 WLR 852; [1976] 3 All ER 462 23

DJan of London Ltd, Re [1994] 1 BCLC 561 108Dafen Tinplate Ltd v Llanelly Steel Co [1920] 2 Ch 124 33, 45, 57, 75

Daniels v Daniels [1978] Ch 406; [1978] 2 WLR 73 49, 55, 91

Dawson International v Coats Paton plc 1989 SLT 655 60, 114

Destone Fabrics Ltd, Re [1941] Ch 319 235

Dimbula Valley (Ceylon) Tea Co v Laurie [1961] Ch 353;

[1961] 2 WLR 253 199

Dixon v Kennaway & Co [1900] 1 Ch 833 201Dorchester Finance v Stebbing [1989] BCLC 498 26, 98, 108, 130

Duckwari plc (No 2), Re [1998] 3 WLR 913 135

Duomatic Ltd, Re [1969] 2 Ch 365; [1969] 2 WLR 114 258

Eagle Trust plc v SBC Securities Ltd (No 2) [1996] 1 BCLC 121 108

Ebrahimi v Westbourne Galleries Ltd [1973] AC 360;

[1972] 2 WLR 1289 60, 143, 151, 153,159, 162, 191

Eley v Positive Life Ass Co (1876) 1 Ex D 88 35, 46, 58, 59

Elgindata Ltd, Re [1991] BCLC 959 129, 142, 229

Emma Silver Mining Co v Lewis (1879) 40 LT 749 18

English and Scottish Mercantile Investment Co Ltd

v Brunton [1892] 2 QB 700 245

Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 18Estmanco (Kilner House) Ltd v GLC [1982] 1 WLR 2; [1982] 1 All ER 437 148

Euro RSCG SA v Conran (1992) The Times, 2 November 113

Flitcrofts Case (1882) 21 Ch D 519 177

Foss v Harbottle (1843) 2 Hare 189 31, 35, 49, 54, 71, 76, 84,

8789, 91, 92, 103, 109,

111, 113, 132, 138, 140,144, 145, 167, 176, 192

Framlington Group plc v Anderson [1995] 1 BCLC 475 96

Freeman & Lockyer v Buckhurst Park Properties Ltd

[1964] 2 QB 480; [1964] 2 WLR 618 73

FulhamFC v Cabra Estates plc [1994] 1 BCLC 363 60, 94


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Table of Cases xiii

IDC Ltd v Cooley [1972] 1 WLR 443; [1972] 2 All ER 162 107, 121, 123

Illingworth v Houldsworth [1904] AC 355 244

Imperial Mercantile Credit Association v Coleman (1873) LR 6 HL 189 55Introductions Ltd, Re [1970] Ch 199; [1969] 2 WLR 791 65, 71

Island Export Finance Ltd v Umunna [1986] BCLC 460 107, 123, 124

Jones v Lipman [1962] 1 WLR 832; [1962] 1 All ER 442 10, 23

Kelner v Baxter (1866) LR 2 CP 174 19Kenyon (Swansea) Ltd, Re [1987] BCLC 514 60, 169

Kuwait Asia Bank EC v National Mutual Life Nominees Ltd[1991] 1 AC 187; [1990] 3 WLR 297 25, 90, 91

Lindgren v L & P Estates Ltd [1967] Ch 572; [1968] 1 All ER 917 25

Loch v John Blackwood Ltd [1924] AC 783 151, 162, 168Lo-Line Electric Motors Ltd, Re [1988] Ch 477; [1988] 3 WLR 26 127, 241

London & Mashonaland Exploration Co Ltd v New Mashonaland

Exploration Co Ltd [1891] WN 165 113

MacDougall v Gardiner (1875) 1 Ch D 13 139, 140Macaura v Northern Assurance [1925] AC 619 5, 22

Mace Builders v Lunn [1987] Ch 191; [1986] 3 WLR 921 240Mackenzie Ltd, Re [1916] 2 Ch 450 196, 198

Macro (Ipswich) Ltd, Re [1994] 2 BCLC 354 99, 142, 229

Mahesan v Malaysia Government Officers Co-operative

Housing Society [1978] 2 WLR 444 105Melhado v Porto Allegre Rly Co (1874) LR 9 CP 503 19, 35

Movitex v Bulfield Ltd [1988] BCLC 104 132

NW Transportation Ltd v Beatty (1887) 12 App Cas 589 133, 146

Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald[1995] 3 All ER 811 13, 133, 134

New British Iron Co, Re, ex p Beckwith [1898] 1 Ch 324 59New Bullas Ltd, Re [1993] BCLC 1389; [1994] BCC 36 223, 226

Niltan Carson Ltd v Hawthorne [1988] BCLC 298 103, 135

Noble (RA) Ltd, Re [1983] BCLC 273 152, 168Norman v Theodore Goddard [1991] BCLC 1028 98, 108


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xiv Table of Cases

Northern Engineering Industries, Re [1994] 2 BCLC 704 197Nurcombe v Nurcombe [1985] 1 WLR 370; [1985] 1 All ER 65 92, 141, 212

OC Transport Services Ltd, Re [1984] BCLC 251 113, 161, 162, 173ONeill v Phillips [1999] 2 All ER 961 61, 143, 144, 15254, 156,

160, 161, 168, 169Old Silkstone Collieries Ltd, Re [1954] Ch 169; [1954] 2 WLR 77 197Ooregum Gold Mining Co of India v Roper [1892] AC 125 179Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447 10, 11, 23, 26Ossory Estates plc, Re [1988] BCLC 213 180

PFTZM Ltd, Re [1995] 2 BCLC 354 267Panama, New Zealand and Australia

Royal Mail Co, Re (1870) 5 Ch App 318 244Panorama Developments Ltd v Fidelis Furnishing

Fabrics Ltd [1971] 2 QB 711; [1971] 3 WLR 440 73, 80, 203, 254Pavlides v Jensen [1956] Ch 565; [1956] 3 WLR 224 49, 93, 144Pennell v Venida (1974) unreported 51Percival v Wright [1902] Ch 421 49, 54, 8890, 94, 102, 105,

121, 132, 139, 167, 173, 192Peso Silver Mines Ltd v Cropper (1966) 58 DLR (2d) 1 107Phonogram Ltd v Lane [1982] QB 938; [1981] 3 WLR 736 20Polly Peck International plc (No 2), Re [1994] 2 BCLC 574 127Produce Marketing Consortium Ltd (No 2), Re

[1989] 1 WLR745; [1989] 3 All ER 1 25, 129, 229

Prudential Assurance v Newman Industries[1981] Ch 257; [1980] 3 WLR 543 91, 140, 141Purpoint Ltd, Re [1991] BCLC 491 128, 228

Quin & Axtens v Salmon [1909] 1 Ch 311 15, 19, 35, 36, 52, 166

Ratners Group plc, Re [1988] BCLC 685 195Rayfield v Hands [1960] Ch 1; [1958] 2 WLR 851 33, 155, 156, 173

Read v Astoria Garage Ltd [1952] Ch 637; [1952] 2 All ER 292 46, 59Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n;

[1942] 1 All ER 378 94, 97, 106, 107, 121,123, 124, 131

Royal Bank of Scotland plc v Sandstone Properties Ltd[1998] 2 BCLC 429 203


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Table of Cases xv

Royal British Bank v Turquand (1856) 6 E & B 327 79, 81

Royal Brunei Airlines Sdn Bhd v Tan [1995] 3 WLR 64 108

Ruben v Great Fingall Consolidated [1906] AC 439 81, 202, 203Russell v Northern Bank Development Corp Ltd

[1992] 3 All ER 294; [1992] 1 WLR 588 4042

Salomon v Salomon & Co [1897] AC 22;

[189599] All ER Rep 33 3, 4, 710, 18, 23, 211

Saltdean Estate Co Ltd, Re [1968] 1 WLR 1844;[1968] 3 All ER 829 196, 197

Sam Weller Ltd, Re [1990] Ch 682; [1989] 3 WLR 923 153, 156, 191Saul Harrison & Sons plc, Re [1995] BCLC 46, 48, 142, 143, 160,

161, 168, 169

Scottish CWS v Meyer [1959] AC 324; [1958] 3 WLR 404 142

Scottish Insurance Corp v Wilsons & Clyde Coal Co[1949] AC 462; [1949] 1 All ER 1068 191, 195

Secretary of Sate for Trade and Industry v Laing [1996] 2 BCLC 324 186

Secretary of State for Trade and Industry v Deverell[2001] Ch 340; [2000] 2 All ER 365 145, 267

Secretary of State for Trade and Industry v McTighe (No 2)[1996] 2 BCLC 477 128

Secretary of State for Trade and Industry v Taylor[1997] 1 WLR 407 127, 128

Selangor United Rubber Estates v Cradock (No 2) [1968] 1 WLR 319 108

Sevenoaks Stationery (Retail) Ltd, Re

[1991] Ch 164; [1990] 3 WLR 1165 126, 127, 241Sheffield Corp v Barclay [1905] AC 392 201

Sidebottom v Kershaw Leese [1920] 1 Ch 154 33, 45, 147Siebe Gorman v Barclays Bank [1979] 2 Lloyds Rep 142 224, 225, 244, 245

Simmonds v Heffer (1983) The Times, 25 May 71

Smith & Fawcett Ltd, Re [1942] Ch 304; [1942] 1 All ER 542 94, 201Smith v Croft (No 2) [1988] Ch 114; [1987] 3 WLR 405 55, 92, 141, 146

Southard & Co Ltd, Re [1979] 1 WLR 1198; [1979] 3 All ER 556 23Southern Foundries (1926) Ltd v Shirlaw

[1940] AC 701; [1940] 2 All ER 445 40, 44, 58

Swabey v Port Darwin Gold Mining Co Ltd (1889) 1 Meg 385 58

Swaledale Cleaners Ltd, Re [1968] 1 WLR 1710; [1968] 3 All ER 619 201


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xvi Table of Cases

Thomas Marshall (Exporters) Ltd v Guinle[1979] Ch 227; [1978] 3 All ER 193 124

Trevor v Whitworth (1887) 12 App Cas 409 178, 204Trustor AB v Smallbone (2001) The Times, 30 March 11

Underwood Ltd v Bank of Liverpool [1924] 1 KB 775 74, 80Unisoft Group Ltd (No 3), Re [1994] 1 BCLC 609 267

Victor Battery Co Ltd v Currys Ltd[1946] Ch 242; [1946] 1 All ER 519 213

Virdi v Abbey Leisure Ltd [1990] BCLC 342 158

Wallersteiner v Moir [1974] 1 WLR 991; [1974] 3 All ER 217 91, 149Wallersteiner v Moir (No 2) [1975] 2 WLR 389 54Webb v Earle (1875) LR 20 Eq 556 191Welton v Saffery [1897] AC 299 38, 41, 44, 155Whaley Bridge Printing Co v Green (1880) 5 QBD 109 18Wharfedale Brewery Co Ltd, Re [1952] Ch 913 192William Jones & Sons Ltd, Re [1969] 1 WLR 146;

[1969]1 All ER 913 197Winkworth v Edward Baron Developments Ltd

[1986] 1 WLR 1512; [1987] 1 All ER 114 91Wragg Ltd, Re [1897] 1 Ch 796 150, 176, 179, 211

Yenidje Tobacco, Re [1916] 2Ch 426 151Yeovil Glove Ltd, Re [1965] Ch 148; [1964] 3 WLR 406 231, 234Yorkshire Woolcombers Association Ltd, Re [1903] 2 Ch 284 224, 226

Yukong Line Ltd of Korea vRendsburg Investment Corp of Liberia (No 2)[1998] 1 Lloyds Rep 322; (1997) 141 SJLB 212 10, 11, 23, 26


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xvii

Companies Act 1862 4,37Companies Act 1948 37, 98, 108Companies Act 1980 37

Companies Act 1985 2, 8, 26, 37, 64,66, 110, 145, 168,

221, 24955,258, 261, 264, 266

Pt X 119, 136s1 3, 12, 32, 37, 178s 1(3A) 14s 2 3, 12, 32,

37, 64, 178

s 2(1)(b) 254s 2(1)(c) 13, 64s 2(3), (4) 5s 2(5) 5, 14s 3A 13, 66, 67, 69, 71s 3A(b) 66s 4 14, 38, 43, 48, 66s 5 14, 38, 43, 205s 8 12, 32, 54s 9 19, 33, 34, 36, 39,

40, 44, 50, 52, 53,5759, 75, 88,

137, 139, 145, 172,186, 217, 259

s 14 15, 19, 20, 3236,58, 59, 74,

155, 156, 173s 17 34s 24 9ss 2534 13s 35 13, 24, 66, 71, 73,

75, 76, 233s 35(1) 66, 67, 69,

70, 75, 76s 35(2) 67, 70, 76s 35(3) 24, 67, 7072, 76s 35A 74, 78, 80, 81, 85,

86, 135, 233s 35A(1) 70, 81, 86s 35A(2) 81, 86s 35A(2)(b) 70s 35A(5) 70, 71s 35B 81s 36C 20

s 42 39, 43ss 5355 259s 54 205

s 79 151ss 80116 6ss 8096 95s 80 50, 87, 101,

110, 174, 187s 80A 101, 111, 174, 187s 89 50, 101, 174,

175, 187s 91 101, 111, 174

s 92 101, 175s 94 174, 187ss 99115 9s 99 14, 150, 176,

179, 189, 211s 100 176, 179, 185, 211ss 101, 102 179s 103 8, 150, 179s 106 179

s 111A 30s 112 101, 176, 179, 180s 113 102, 180s 114 102s 117 195s 118 9, 179s 121 14, 110, 147, 166,

172, 174, 186, 194s 121(2)(a) 41

ss 12528 6ss 12527 38, 112, 113s 125 113s 125(3) 145, 198s 125(5) 198s 127 197, 198s 135 6, 14, 40, 180, 182,

195, 205, 206, 218ss 136, 137 182

s 142 259s 143 6, 180, 204,

205, 217s 143(1) 203s 143(2) 206s 143(3) 205s 151 180, 21114, 219

TABLE OF STATUTES


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xviii Table of Statutes

s 152 219s 153 211, 212, 215s 153(1) 212

s 153(2) 212, 214s 154 213, 219s 155 212, 213,

215, 219s 156 182, 220ss 15981 205s 160 209, 218s 162 150, 208, 209, 218ss 164, 168, 169 209, 218

ss 170, 171 209, 218s 173 182, 209, 218s 175 209, 219ss 176, 177 182, 219s 182 200, 201, 211s 183 201s 186 201, 202ss 198200 255ss 202, 20406, 209 256ss 21162A 6ss 211, 217, 218 256s 221 248s 226 249s 232 134ss 233, 234 250s 235 251ss 238, 241 249

ss 242, 242A 248s 245 249s 249A 7ss 249B, 249C, 250 251ss 252, 253 249ss 26381 180s 263 218ss 282310 6s 282 16, 88, 93, 119

ss 283, 286 200, 253s 291 83s 293 93s 303 26, 48, 50, 53, 58, 78,

83, 89, 137, 139, 151,157, 162, 166, 184, 260

s 303(5) 26, 78

s 309 48, 101, 111ss 31148 6s 312 216

s 317 55, 87, 95, 105, 133,134, 136, 239

s 319 50, 95, 134,135, 136, 165

ss 32022 135s 320 6, 55, 56, 86, 87,

95, 13436, 239s 322 56, 103, 239s 322A 70, 86, 135, 147

s 322A(5) 70ss 33046 116, 135ss 33042 87s 330 6, 95, 11618,

134, 153, 219, 220s 330(1), (2) 116, 117, 135s 330(4) 118, 136s 331 116, 135s 331(2) 117s 331(4) 118ss 33238 117, 136s 332 118s 334 118, 220s 335 118, 153s 337 117, 136s 338 117, 118s 338(2), (3), (6) 117s 341 153, 220s 341(5) 116s 346 116, 135, 239ss 34862 6s 349(4) 5, 9, 21s 351 254ss 352, 353 200, 254s 359 201s 359(1) 201s 359(3) 202s 361 201s 363 256s 365 257ss 36684 6s 366 258s 366A 168, 259s 368 48, 168, 259


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Table of Statutes xix

s 379A 6, 174, 187,251, 252

s 380 259ss 381A81C 5s 381A 16, 217, 252, 260ss 381B, 381C 260s 382A 252ss 38394A 6ss 384, 385, 385A, 386 251s 391 251, 260ss 391A, 393 251

s 395 16, 223, 230s 395(1), (2) 243s 399 259ss 42527 171s 425 213ss 42830F 110, 171s 459 3, 6, 14, 16, 19, 31, 34,

36, 42, 46, 48, 49, 51,57, 60, 61, 87, 92, 99,

100, 103, 110, 113, 137,138, 140, 14244,

148, 149, 15154, 156,157, 15962, 16669,

173, 174, 18994,199, 217, 229, 262

s 461 113, 154, 156, 157,162, 169, 191, 199, 205

s 713 257s 727 115, 118s 741 23, 84, 86, 134, 145s 741(2) 266s 744 221, 238Sched 4 249Tables AG 37Table A 32, 53, 54, 78, 88,

119, 133, 146, 198, 252

Art 24 200Art 32 41, 110, 172, 174, 186Art 34 195Art 35 208, 218Art 37 259Art53 39Art 64 88, 119

Art 70 15, 18, 25, 48, 49,5255, 71, 78, 79,

83, 84, 88, 89, 93, 109,137, 139, 159, 166

Arts 8494 133Art 85 55, 95, 105, 133, 228

Companies Act 1989 37, 221ss 25, 27 251Sched 11 251

Company DirectorsDisqualification

Act 1986 126, 129s1 125, 240ss 26 125s6 126, 127, 240,

241, 266ss 8, 10 125Sched 1 126, 241

Criminal Justice

Act 1993 12022Enterprise Act 2002 264

Financial Services andMarkets Act 2000 2730s 79 27s 80 28s 80(1), (4) 28

s 82 28s 84 27s 90 28, 29Sched 10 28, 29

Insolvency Act 1986 10, 129, 208,222, 229, 230, 239,

246, 264, 265

s 76 182, 209, 210, 219s 122(1) 100, 207s 122(1)(g) 16, 19, 57, 60,

84, 87, 137, 151,155, 157, 159, 162,

167, 168, 19092, 265s 123 207, 265


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xx Table of Statutes

s 125 168s 125(2) 151s 143 228

s 175 240ss 21315 9s 213 5, 24, 266s 214 5, 24, 26, 97, 98,

115, 128, 130, 139,228, 229, 233, 266

s 214(1) 24s214(4) 25, 128, 229ss 23841 230

s 238 223, 23739s 239 100, 208, 223,

235, 240, 243s 240 235, 238s 245 208, 225, 230,

233, 235, 239,240, 243, 245

s 245(2) 234, 235s 245(3) 234ss 249, 435 238Sched 6 234

Limited LiabilityPartnerships Act 2000 68

Misrepresentation Act 1967

s 2(1) 30

Stock Transfer Act 1963 201Supply of Goods and

Services Act 1982 98, 130, 167


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1

CHAPTER 1

FORMATION OF COMPANIES

AND CONSEQUENCESOF INCORPORATION

Introduction

Questions are rarely set solely upon the rules relating to the formation of

companies. However, in tackling questions on the consequences ofincorporation, some appreciation of the rules of formation (and the differingtypes of company) is appropriate. Factors which might influence the decisionto incorporate, the effects of incorporation and lifting the veil are commonareas for questions. Questions involving lifting the veil generally requiresome form of critical analysis rather than a mere recitation of decisions.Another, broader type of question regularly encountered involves adviceabout incorporation and running of companies and possible types ofinvestment in a company either in general or for specified persons (generallya brilliant but unbusinesslike inventor, his aware brother-in-law and adoddery relative of means). Material relating to formation should also beincorporated in questions relating to the different legal regime applicable topublic and private (particularly quasi-partnership) companies and generalquestions about disclosure.

The law relating to promoters and pre-incorporation contracts can beregarded as part of the formation of a company. Questions on promoters may

be linked with the liability of directors and a question could combine a pre-

incorporation contract with a post-incorporation contract. However, theincreasing use of off-the-shelf companies for small private companies renderspromoters and pre-incorporation contracts of diminishing importance. Somecourses may require students to be familiar with methods of raising capitalsuch material is likely to form a small part of a problem or be examined bymeans of a simple essay which merely demands a competent recitation of fact;

but, obviously, every question setter has their own hobbyhorse(s).

Checklist

Students should be familiar with: how a company can be formed and the differing types of company; advantages and disadvantages of incorporation;


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2 Q & A on Company Law

effects of incorporation; circumstances in which the separate legal personality of the company will

be disregarded, both at common law and by statute (particularlyfraudulent and wrongful trading); promoters, particularly their duties and rights; liability for pre-incorporation contracts.Students should be aware that related issues which could be linked toquestions based on this area include: the distribution of power within a company; enforcement of the articles of association;

liability and/or protection of directors/investors, includingdisqualification of directors;

restructuring of share capital.

Question 1

Do the advantages of incorporation really compensate for the bureaucracy

involved in running a company?

Answer plan

A question such as thisa variant on the very well-worked theme of theadvantages and disadvantages of incorporationcan only be tackled by

someone who knows the material, and should only be tackled by someonewho is desperate! It is very difficult to score high marks on such aquestion, since there is little scope for anything but a neat summary of theadvantages of incorporation and a further summary of the bureaucraticrequirements alluded toa rare question where a list might be beneficial.It should be noted, however, that the wise student does not comment onthe dullness of the question.

Answer

Incorporation of an existing or projected enterprise (not necessarily abusiness) can be achieved either by forming a company from scratch incompliance with the procedures laid down in the Companies Act 1985 or

by buying a pre-existing company off-the-shelf (the latter procedure


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Formation of Companies and Consequences of Incorporation 3

accounts for about 60% of formations). In either case, the company willrequire a memorandum of association (s 1), which must contain certain

information (s 2) and articles of association, although the Company LawReview Steering Group (1999) has proposed that the memorandum andarticles should be replaced by a single registration form and constitution.The content of the articles, which are the companys internal rules, can bedetermined by the founders of the company, but, if none is registered, theappropriate form of Table A will automatically apply (s 8) if the companyis limited by shares. The advantage of purchasing an off-the-shelfcompany is that the company already exists and there is no delay betweendeciding to form a company and the company coming into existence

through the registration process; there is merely a transfer ofshareholding. This obviates the problem of pre-incorporation contractsand the possibility of having stationery printed bearing a name which, bythe time the company is registered, has been taken by another company.However, an off-the-shelf company would not have been formed with thespecific requirements of the promoters in mind and alterations of thememorandum or articles might be required. Indeed, problems can arisewhen the new shareholders of the company fail to make the necessary

amendments. For example, in Re A Company (No 005287 of 1985)(1986), ashareholder who wished to use s 459 to bring an action against his fellowshareholders was denied locus standi when it was discovered that theshares in the company, which had been purchased off-the-shelf, had never

been transferred to the purchasers. For most people interested in forming(or buying) a company, the appropriate form of company will be a privatecompany limited by shares (s 1).

The UK has traditionally had more companies than other European

countries of comparable size (there are almost one and a half million atpresent). What are the attractions of incorporation? The principal advantageof incorporation, from which a variety of benefits flow, is that a company isa distinct legal entity with rights and duties independent of those possessed

by its shareholders, directors and employeesit is a legal person. Inconsequence, for example, business conducted in the name of a registeredcompany is separate from the personal affairs of the human beings who actfor the company, and separate also from the affairs of any other business

that those human beings may conduct on behalf of another registeredcompany. Corporate personality was created by statute in the first half ofthe 19th century, but the full significance of this provision was not appreciateduntil the famous case of Salomon v Salomon & Coin 1897.

In Salomon,S converted his existing, successful business into a limitedcompany, of which he was the managing director. S valued his business at39,000 (an honest but optimistic valuation) and received from the


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company, in discharge of this sum, cash, a debenture (an acknowledgmentof debt) and 20,001 1 shares out of the issued share capital of 20,007. Ss

wife and five children each held one of the remaining issued shares (sevenbeing the minimum number of shareholders at that date), probably as hisnominee. The company went into insolvent liquidation within a year withno assets to pay off the unsecured creditors. The issue for the courts waswhether S was liable for the companys unpaid debts. The House of Lords,reversing the Court of Appeal, held that the company had been properlyformed and was a legal person in its own right, separate from S,notwithstanding his dominant position within the company. The companywas not Ss agent and, consequently, Ss liability was to be determined

solely by reference to the Companies Act 1862. The Act required ashareholder to contribute to the debts of a company only where he heldshares in respect of which the full nominal value had not been paid. S hadpaid for his shares in full by transferring the business to the company, sohe had no liability to the creditors of the company. Thus, the Salomoncaseestablished that legal personality would be recognised even when oneshareholder effectively controlled the company and had fixed the value ofthe assets used to pay for his shares.

The effects of separate legal personality are many and include thefollowing: a company can sue and be sued in its own name; a company has perpetual succession. A company cannot die simply

because all its shareholders are dead, although it can be wound up orstruck off the Register by the Registrar of Companies if it appears to bemoribund. Because a company exists unless and until it is wound up orderegistered, property, once transferred to the company, remains theproperty of the company, to do with as it pleases. There are no deathduties to pay on the property because the company does not die and nocosts are incurred in transferring the legal title to the property on a changeof shareholder or director;

the shareholders, directors and employees are not liable for criminal ortortious acts committed by the company, although they may incur personalliability concurrent with that of the company. For example, a companymight, through the combined acts or omissions of several employees,

establish and operate an unsafe system of work which caused the deathof an employee. The company would be liable but an individual directoror employee would not be liable unless he was personally negligent orthe company was acting as an agent or employee of that individual;

the shareholders, directors and employees are not liable on (nor can theyenforce) contracts entered into by the company. As with criminal and


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tortious liability, an individual may incur personal liability concurrentwith that of the company if he also enters into the contract. Furthermore,

when the company acts as the agent of a shareholder or director (or anemployee, but this is a rare event), the individual is liable under the normalrules of agency;

a company may be formed with limited liability (s 2(3)). Limited liabilityallows the members of a company to limit their responsibility for acompanys debts. Liability may be limited to a predetermined sum, payableon winding up (a company limited by guarantees 2(4)), or to the nominalvalue of the shares held, unless this sum has been paid by the current or aformer shareholder (a company limited by sharess 2(5)). Since most

shares are issued fully paid, shareholders have, effectively, no liability forthe companys debts;

where a company has transferable shares, ownership of the company canbe split or transferred without affecting the company itself;

formation of a company may bring financial benefits. For example, acompany can raise money to create floating charges and, perhaps, tominimise the tax liability of shareholders.

There are drawbacks to separate legal personality, in that the property of thecompany, not being that of the members, cannot be insured by a memberand the company cannot claim on an insurance effected by a person onproperty which he then owned but subsequently transferred to the company(see Macaura v Northern Assurance (1925)). Moreover, the assets of thecompany are the property of the company and a shareholder, even acontrolling shareholder, cannot simply help himself to the companys cash.In addition, there is a limited number of situations where Parliament or thecourts have decreed that corporate personality should be ignored. Forexample, where the directors have engaged in fraudulent or wrongful trading,they incur liability to creditors (ss 213 and 214 of the Insolvency Act 1986).Section 349(4) imposes liability upon an officer of the company who hassigned company cheques, etc, on which the name of the company does notappear in full.

But what bureaucratic drawbacks are there to incorporation? In returnfor the advantages of incorporation, Parliament requires the observation ofmandatory rules on the operation of a company. These rules are lengthy and

complex and there can be no doubt that, in most companies, manyadministrative rules, for example on the conduct of meetings, are largelyignored. Perhaps in recognition of the widespread lack of use of some of therules, the government has recently sought to reduce the administrative

burden on companies, especially smaller companies, by the insertion of newsections into the 1985 Act. Sections 381A-81C permit a private company to


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dispense with meetings and pass resolutions by unanimous writtenagreement. Section 379 A permits a private company to elect to disregard

certain requirements of the Companies Act if all the shareholders agree eitherin person or by proxy.Such reforms are small measures, and even if the suggestions of the

Company Law Review Steering Group (1999 and 2000) on certainadministrative aspects of the formation and running of companies wereadopted, there is still an immense amount of law imposing obligations uponcompanies, shareholders and directors which would not apply to a sole traderor to a partnership or a limited liability partnership. These obligations fallinto five broad groups:

(a) Much of company administration is subject to statute (ss 34862) andthere are rules as to the qualification of directors and the companysecretary (ss 282310). The conduct of meetings of shareholders ordirectors is subject to statutory control (ss 36684), although many ofthese rules are ignored in small companies.

(b) The power of the directors, who in smaller companies will almostcertainly be majority shareholders, are limited, in that certain things

cannot be done while others can be done only with the agreement of theshareholders. Many of these constraints on directorial power relate tothe ability of the directors to benefit themselves (ss 31148). For example,s 330 provides that the directors cannot lend the companys money to adirector (there are innumerable exceptions) and s 320 restricts the abilityof a director to engage in substantial property transactions with hiscompany. The power of the directors to raise capital by the allotment ofshares is restricted (ss 80116).

(c) The ability of the directors or shareholders to do as they wish with theshares of the company is restricted, so that, for instance, the share capitalof the company cannot be reduced without the approval of the court (s135) and a company cannot buy its own shares (s 143, but there areexceptions). The wishes of minority shareholders may have to be takeninto account (ss 12528 and 459) despite the wishes of the majority.

(d) The major statutory requirement which imposes a continuing burdenrelates to company accounts. The financial results of the company must

be presented to the shareholders in a balance sheet and profit and loss

account (ss 22162A). The length and technicality of the accounting rulesmean that company accounts must, in effect, be prepared by a qualifiedaccountant and a company must have its accounts checked (audited) bya qualified accountant (ss 38494A). All companies must send theiraccounts to the registrar of companies, where they are open to publicinspection, although small and medium sized companies, as defined by


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the Act, can elect to send an abridged version instead. The obligation ofa company to produce audited accounts in compliance with the Act

imposes an annual financial burden on a company, which is muchresented by many companies. Recently, small companies (defined in s249A) have been either wholly (for those with a turnover of less than90,000) or partially exempted from the statutory audit unless membersholding at least 10% by value of a class of shares require the company toobtain an audit.

However, there can be little doubt that a number of British businesspeoplethink that the bureaucratic drawbacks are more than outweighed by the

benefits of incorporation.

Question 2

In forming a company, its shareholders may seek to minimise the liabilityof the company and themselves to creditors. To what extent, if at all, dothe courts endorse this practice?

Answer plan

This question requires: discussion of whether shareholders and companies can minimise their

liability to shareholders; and a discussion of the case law in this area.While questions on lifting the veil are fairly common, such questions(including this one) are not well answered by saying that there are a largenumber of cases where the courts will lift the veil and then listing them. Aquestion such as this calls for effective deployment of the relevant cases anda critique of those cases.

Answer

The fundamental attribute of corporate personality is that the company is alegal entity distinct from its membersa company is a legal person.Corporate personality was created by statute in the first half of the 19thcentury, but the full significance of this provision was not appreciated untilthe famous case of Salomon v Salomon & Coin 1897.


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In Salomon,S converted his existing, successful business into a limitedcompany of which he was the managing director. S valued his business at

39,000 (an honest but wholly inaccurate valuation) and received from thecompany in discharge of this sum, cash, a debenture and 20,001 1 sharesout of the issued share capital of 20,007. Ss wife and five children each heldone of the remaining issued shares (seven being the minimum number ofshareholders at that date), probably as his nominee. The company went intoinsolvent liquidation within a year, with no assets to pay off the unsecuredcreditors. The issue for the courts was whether S was liable for the companysunpaid debts. The House of Lords, reversing the Court of Appeal, held thatthe company had been properly formed and was a legal person in its own

right notwithstanding the dominant position of S within the company. Thecompany was not Ss agent, and consequently, Ss liability was to bedetermined solely by reference to the Companies Act 1985. S had paid forhis shares in full (by transferring the business to the company) and so hisliability to creditors was exhaustedthe full nominal value had been paid.Prior to Salomon it had been suggested that the owner-managed type ofcompany could not be treated as a separate legal person from its owner(s),

but Salomons case established that, in the absence of fraud, legal personality

would be recognised even when one shareholder effectively controlled thecompany and had fixed the value of the assets used to pay for his shares(note now the valuation requirements for non-cash consideration for sharesin public companies: s 103).

While not mandatory, the majority of companies are formed with limitedliability. This does not mean that the liability of the company is limitedit isliable for all its debts. However, if a company is insolvent it has no money tosatisfy creditors, and the creditors will look elsewhere for satisfaction of their

debts. If a company is formed as a limited company, it means that theshareholders (even controlling shareholders and others engaged in themanagement of the company) can restrict their liability for the debts of thecompany which the company cannot pay. Most companies are limited byshares so that a shareholder who owns shares is liable only to the extent thathe or a previous owner of those shares has not paid the nominal value ofthose shares to the company. Since, in practice, most shares have a lownominal value (generally 10 pence or 1) and it is paid when the shares are

first issued, the amount which a shareholder has to contribute on theinsolvency of the company is nothing. Of course, if a company is required tohave a large share capital, then the company will at least have received alarge sum during its lifetime, which may mean that it has fewer unsatisfieddebts. Unfortunately, company law does not require private companies tohave more than one share, so a private company might have as little as 1 pshare capital. Even public companies are not required to have a large share


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capital (since s 118 provides that public companies must have a share capitalof at least 50,000, of which at least a quarter must have been subscribed for

in cash). In addition, the rules relating to the payment for shares (ss 99115)allow private companies to sell their shares for non-cash consideration, whichmay be (as in Salomon) worth less than the nominal value of the shares allottedprovided the consideration is not wholly illusory. The rules are slightlystricter for public companies so that, for example, they must have non-cashconsideration professionally valued. If a company is in financial difficulty itmay be able to restructure itself (with court approval), which has the effectof discarding debts; but could it move all of its assets to a new subsidiaryknowing that it is about to be found liable for large amount of compensation

for some disease to which it has exposed its workforce? Certainly, Parliamenthas not prohibited companies from setting up subsidiaries (probably whollyowned) which undertake risky enterprises on behalf of the parent company.If the risky enterprise fails, the holding company is unaffected and can ignoreany debts of the subsidiary, while if it succeeds, the profits can be transferredto the holding company. Thus, in Adams v Cape Industries plc(1990), a UK

based company was not liable to pay damages to employees employed by asubsidiary company operating in South Africa who had been negligently

exposed to asbestos and were now suffering from asbestosis. Indeed, it issound business practice to ring-fence risk in this way. Parliament hasdetermined that the benefits of encouraging entrepreneurial activityoutweigh the disadvantages of permitting undercapitalised companies tooperate.

Parliament has in a very limited number of cases restricted the effect ofincorporation. Is there any theme behind these exceptions which mightindicate areas in which the courts should lift the veil of incorporation? And,

perhaps more importantly, do these exceptions indicate that the courts oughtto be more willing to lift the veil to protect creditors? There are a number ofminor provisions. For example, s 24 makes a person who is the remainingshareholder after a six month period in which a public company has hadless than two shareholders, jointly and severally liable for the companysdebts. Section 349(4) imposes liability upon an officer of the company whohas signed company cheques, etc on which the name of the company doesnot appear in full. However, the most important provisions are those relating

to fraudulent or wrongful trading and the special rules for groups. Sections21315 of the Insolvency Act 1986 impose liability for the debts of a companywhere a person has engaged in fraudulent or wrongful trading (wrongfultrading is limited to directors). The rules on group accounts are immenselycomplicated, but broadly they are designed to ensure that the accounts ofassociated companies are looked at as a whole to provide a true and fairview. What can we discern as the concern of Parliament in providing


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exceptions to Salomons case? Is it clear, for example, that an element ofwrongdoing or impropriety should disqualify a person from the manifold

benefits of corporate personality (particularly that of limited liability)?The courts have been willing to lift the veil of incorporation where acompany has been used to avoid the existing liability of an individual. Suchcases may be called cases where the corporate form is a mere faade or asham but the description changes with the years. For example, in Jones vLipman(1962), the owner of land contracted to sell it to the claimant but thentransferred the land to a company which he controlled. When the claimantsought completion of the sale, the vendor said that he could not complete

because he no longer owned the property; the court allowed the claimant to

bring a claim against the company which had been set up simply to avoidthe vendors existing legal obligation. Similarly, in Gilford Motor Co Ltd v

Horne(1933) H had worked for the claimant company and was contractuallybound not to compete with it after leaving the company. Hs wife set up acompany which competed with Gilford and this company employedH.Gilford successfully sought an injunction against H and the new company.In both of these cases the courts imposed liability on the companies and socan hardly be said to have ignored corporate personality. A more common

situation is where a companys controlling shareholders remove corporateassets from the company, leaving the company unable to satisfy its debtsin such a case should the shareholders be ordered to return the assets or bepersonally liable for the unsatisfied claims of creditors? The courts havecontinued to adhere to the decision in Salomonand have been reluctant todisregard corporate statutes and treat the shareholders as directly responsiblefor the debts of the company or require them to return assets.

Both Adams v Cape Industries plc (1990) (mentioned above) and Yukong

Line Ltd v Rendsburg Investment Corp (No 2)(1998) are clear authority for theproposition that where a company and its shareholders arrange its affairs inorder to avoid potential liability (that is, liability that could arise) and in sodoing transfer assets out of the hands of the company, there can be no claimupon those assets and no liability imposed on the shareholders. This appearsto be the case even where the liability is imminent and will arise. For example,in Yukong, the company had entered into a chartering agreement with Rwhich it broke, leaving it liable to pay damages for breach of contract. On

the day of breach and shortly thereafter, but before R had commencedproceedings against the company, its assets were transferred to anothercompany. The court refused to allow R to claim that sum of money from thetransferee or bring a claim against the director-shareholder who hadauthorised the transfer (he might have been liable to Yukong for breach offiduciary duty owed to Y or under the Insolvency Act 1986). A similarapproach can be seen in Ord v Belhaven Pubs Ltd(1998), in which the claimant,


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O, had entered into a 20 year lease of a public house owned by the defendant(B). O was now alleging breach of contract and misrepresentation on the

part of B. B was part of a group of companies which owned hotels and publichouses, and subsequent to Os claim the group was restructured andownership of the property leased by O was transferred from B to anothercompany in the group, leaving B with no assets to satisfy any judgmentwhich O might obtain. O sought to extend his claim to Bs parent companyand the other company which had taken over Bs activities and assets. Thecourt rejected Os claim, finding that the restructuring was a genuinecommercial decision and not one designed to defeat Os claim (even if itseffect was to make any judgment against B valueless). In the absence of some

impropriety, the court would not lift the veil and allow O to bring a claimagainst the shareholder which had removed the asset from B or the newowner of that asset. Both Yukongand Ordrejected the earlier case of Creaseyv Breachwood Motors Ltd(1993), in which the director-shareholders transferredall the assets of the company to another company which they controlled inorder to ensure that if Cs legal claim against the company succeeded it wouldhave no funds to meet the judgment. Perhaps it is possible to reconcile thesecases by treating Creaseyas a case where there was no legitimate commercial

reason for the transfer of assets, unlike the situation in Ord. However, thisexplanation does not apply to Yukong,where the sole reason for the transferseemed to be to ensure that the company would not have to meet Rs legalclaim if it was successful. Subsequently, in Trustor AB v Smallbone(2001), thecourt took the view that the veil of incorporation will not be lifted simply

because justice would suggest that it should be done. If the courts are to liftthe veil, whether to protect creditors or others, there must, in the absence ofstatutory grounds, be such impropriety in the use of the company to justify

the court disregarding an action which is otherwise legally effective.The attitude of the courts can be summarised thus: where a defendant has used a company to evade his obligations (to a

creditor or another), the company can be ordered to comply with theobligation;

if the company has at the behest of its controlling shareholders organisedits affairs to avoid potential liabilities (or even, arguably, existing liabilities),then neither the directors nor the shareholders are liable in the absence of

impropriety. Simply avoiding ones debts is not sufficient to constituteimpropriety, it seems.

Note

A student could expand upon the policy reasons underpinning corporate personalityand limited liability and might comment on the economic entity theory, even thoughthis is now largely discredited.


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Question 3

Laura, a talented designer, and her husband, Bernard, are running a smallbusiness engaged in the printing and selling of silk scarves and ties. Theyare seeking to expand the business and have persuaded Lauras parentsto provide funds for expansion. Lauras parents do not wish to participatein the day to day running of the business, nor do they need an incomefrom their investment, but they would like to be consulted on major mattersof policy and to be able to recover their capital in the future. Laura andBernard wish to retain control of the business but want to give Lauras

brother, Mark, who works for them, greater involvement in the business.Laura and Bernard have decided to form a company in which they willown the majority of shares and be directors. They seek your advice abouthow to structure the company and to accommodate the wishes of Laurasparents, Mark and themselves.

Answer plan

Again, a fairly typical question which might apply to many small familybusinesses. The answer should address the specific concerns of thoseinvolved, rather than be a general description of company formation. Sincethe decision to incorporate has been taken, there is no need to consider theadvantages and disadvantages of incorporation.

Answer

Laura (L) and Bernard (B) wish to incorporate their existing business. Theappropriate form of company will be a private company limited by shares (s1). L and B may choose to establish a new company; the company will requirea memorandum of association, which must contain certain information (s 2)and articles of association, before it can be registered by the Registrar ofCompanies. The Companies Bill (draft) recommends that there should be asingle documentthe constitution. The content of the articles, which can becalled the companys internal rules, can be fixed by the founders of thecompany, but, if none is registered, the appropriate form of Table A willapply (s 8). Alternatively, they may choose to buy a pre-existing companyoff-the-shelf. The advantages of an off-the-shelf company are that thecompany becomes theirs immediately, without going through the registrationprocess; all that is required is a transfer of shareholding, but such a companywould not have been formed with their specific requirements in mind and


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alterations of the memorandum or articles might be required. Perhaps themost important things for L and B to grasp are that their company is a separate

legal person and that, by establishing it, they can no longer treat the businessas entirely their own affair. To take an extreme example, they must, asdirectors, formally approve any contracts they enter into with the company(see Re Neptune (Vehicle Washing Equipment) Ltd (1995), in which the onlydirector was required, formally, to inform himself of his interest in a contractentered into by the company).

Turning to the mechanics of formation, the memorandum must give thename of the company, which must appear on the companys seal, businessletters, cheques, etc, and be affixed outside all places of businessbrevity

reduces printing costs. The final word of the companys name must beLimited (which can be abbreviated to Ltd). There are restrictions upon thenames which can be used (ss 2534). The principal restriction is that theircompany cannot have the same name as an existing company. Consequently,if their name is Smith, Smith Ltd is unlikely to be acceptable. Indeed, a namewhich has been registered may, within 12 months of registration, be directedto be changed by the Secretary of State if it is too similar to the name of anexisting company or is misleading (see Association of Certified Public

Accountants v Secretary of State for Trade and Industry(1997), where the courtheld that the name suggested companys members possessed a level ofqualification which was not in fact required). Other names are banned if thename would be a criminal offence or be offensive. Yet further names can beused only if the Secretary of State gives permission, for example, namessuggesting a connection with local or central government. It is possible tochange the name of the company at a later date, if need be.

The memorandum requires the company to state whether its registered

office is in England and Wales or in Scotland. Finally, s 2(1)(c) requires thecompany to state the objects of the company. This provision, whereby thecompany sets out what it intends to do, is of diminishing importance. L andB would probably adopt s 3A and register the objects of the company as

being to carry on any trade or business whatsoever. Ls parents might wishto restrict the companys business to the existing trade, rather than see theirmoney being expended on new schemes; limiting the memorandum wouldprovide some protection for their investment (if they became shareholders),

in that they could seek to restrain activities not sanctioned by the objectsclause (s 35). However, the draft Companies Bill would abolish therequirement for private companies to have an objects clause so that a privatecompany would have unlimited capacity. The effect of s 35 is that ashareholder can only restrain contemplated acts, and not those already legally

binding on the company. It might be better for Ls parents to have a contractwith L and B which determines what the money can be used for. If the


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directors (likely to be L and B) overstep the objects clause in their dealingson behalf of the company, Ls parents could sue them for breach of directors

duty, but, in a company like this, prevention rather than cure is more apposite.The objects of the company can, in any case, be changed (ss 4 and 5) but ashareholder with a 15% shareholding in any class of share has locusto objectto the change, although the change may still be sanctioned by the court.

Section 2(5) of the memorandum requires a statement of the amount ofthe companys share capital, how the share capital is divided up and thevalue of each share. This valuethe nominal valueis an arbitrary figurewhich does not necessarily bear any relation to the asset value of the companyor its earning potential. The minimum nominal value of a share is one penny

and, at present, a company must have at the outset at least two shareholders(other than a private company limited by shares or guarantee, which cannow be formed by one person (s 1(3A)). Thus, the company could have twoone penny shares and L could buy one and B the other. These two shareshave to be paid for in cash. Two shares creates a rather inflexible sharestructure and most private companies have a share capital of 100 or 1,000divided into 1 or 10 p shares. L and B could give M a stake in the business

by allotting shares to him. If L and B wish to retain control of the company,

they need to ensure that their shareholding is at least 50% plus one vote(sufficient to pass an ordinary resolution) or, preferably, 75% (sufficient topass a special resolution), although M might not regard less than 25% as avery worthwhile shareholding in the company. Ls parents could also begiven shares in the company but, unless they had a majority, which wouldnot suit L and B, they would have no effective control over their investment.As shareholders, Ls parents would have to be notified of meetings and wouldhave locusunder s 459 to raise the issue of unfair prejudice, etc.

Assuming that L and B are the principal shareholders, they may choose topay for the shares by transferring the business to the company or by agreeingto work for the companythis is perfectly acceptable (s 99). Assuming thatthe value of the business is to exceed the modest nominal value currentlyencountered, L and B may be owed money for the business by the company.This debt could be secured by debenture, giving, in theory, L and B priorityover other creditors on winding up. Indeed, by incorporating, L and B appearto have removed their personal assets from the perils of the companys

insolvency. In practice, the benefits of limited liability do not exist for foundersof small private companiesthe banks which form the major creditor formost businesses require personal guarantees (often secured on the directorshomes) from directors, etc, before extending the company credit. The sharestructure of a company can be changed: see, for example, ss 121 (alterations)and 135 (reduction). Since L and B are the promoters of the company, thearticles should reveal any profits which they have made on incorporation.


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Turning to the articles of association, the main issue is the extent to whichTable A should be adopted. Most private companies amend Table A and in

such cases it is safest to draft a self-contained set of articles for the company,lest there be any doubt about what rules have been adopted. Commonamendments are to insert a restriction upon the transferability of thecompanys sharesin this case, L and B will not want M or any othershareholder transferring shares to outsiders, to vary the rules on quorumsat meetings and the maximum number (and age) of directors. It is in thearticles that L and B might choose to insert a provision permitting Ls parentsto block changes of policy. This could be achieved in one of two ways. Lsparents could be given weighted voting rights (approved by the House of

Lords in Bushell v Faith(1970)) in respect of certain transactions. For example,Art 70 of Table A, which most companies adopt, vests the running of thecompany in the directors, subject to directions given by special resolution.If Ls parents are given weighted voting rights, they can ensure that they canalways issue directions. Such a clause should be protected against alteration.Alternatively, Ls parents could be given a right to veto in the articles(protected against alteration), which, by virtue of s 14, gives them acontractual right of veto if they are shareholders.

The difficulty with the latter approach is that the ability of shareholdersto enforce the contract which is contained in the articles is uncertain. Thetraditional view is that a shareholder can enforce the articles only insofar asthe relevant article creates a membership right, that is, a right attaching toeach and every share which relates to the holding of shares. This view derivesfrom the first instance decision of Astbury J in Hickman v Kent or Romney

Marsh Sheepbreeders Association (1915) and would appear to preclude theenforcement of a right vested only in Ls parents. However, powerful

arguments have been raised against this interpretation of the s 14 contract.Lord Wedderburn in particular relies heavily upon the House of Lordsdecision in Quin and Axtens v Salmon(1909), where a shareholder was heldto be entitled to enforce an article which required his consent to the sale ofcompany land, to advance the view that a shareholder has a personal rightto require the company to act in accordance with its articles. Variations onLord Wedderburns argument would restrict the shareholder to having aright to ensure that the appropriate corporate body carries on the affairs of

the company. The uncertainty surrounding the s 14 contract makes this routean uncertain one for Ls parents. Either of these proposals would limit L andBs ability to run the company as they wished. A freestanding shareholderagreement would provide a contractual means of restraining L and Bs actionseven if it did not bind the company.

Since L and B are forming a private company, they should be informed ofthe provisions for written resolutions (s 381 A) allowing decisions to be made


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by written agreement without the need to call a meeting, and electiveresolutions permitting a company to exempt itself from some of the formal

requirements of the Acts.If L and B are to be the first directors of the company (only one is requiredby laws 282), no further directors are required, although there is no reasonwhy M could not be invited to be a director. The proceedings of the directorswill be governed by the articles. All directors are subject to the usual rulespertaining to directors duties. These duties which derive from equity, thecommon law and statute are immensely complex and the directors should

be advised of the need to seek proper legal advice before entering intotransactions. The company would almost certainly be classified as a quasi-

partnership company (even if M becomes a shareholder-director) and anyserious breakdown in the relationship of the three principals could lead to apetition for just and equitable winding up under s 122(1)(g) of the InsolvencyAct 1986a parallel provision would operate if the business had been runas a partnership. Further, attempts to exclude Ms participation in thecompany, or attempts to block L/s parents exercising any right to consultationand/or veto, could be unfair prejudice and consequently in breach of s 459.

The final question to be addressed is how to protect the financial stake

being provided by Ls parents. Ordinary shares in a private company are notreadily marketable and offer no protection against insolvency; they are notan appropriate choice. Preference shares are subject to the same handicaps,although redeemable shares would guarantee a return of capital if thecompany was still a going concern. The best solution would appear to be asecured loan, preferably redeemable at a fixed date, in their favour. Obviously,the company must have an asset of sufficient value to stand as security forthe loan and a specified asset subject to a fixed charge is more likely to

guarantee repayment than a floating charge. A charge on the assets of thecompany must be registered (s 395).

Note

Some discussion of shareholder agreements would be useful if time permitted.


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Question 4

Archie, Brian and Colin, who are all self-employed plasterers, agree tocombine their businesses and to operate as a company, Cornice Ltd. Adocument is prepared which states: It is hereby agreed that all expensesincurred by Colin in the formation of Cornice Ltd shall be repaid fromcompany funds within 12 months of the date of incorporation of thecompany. It is signed: For and on behalf Cornice Ltd, as agents only,Archie and Brian.

Upon advice by an accountant, Colin duly formed Cornice Ltd and its

shares were divided equally among the three participants, who all becamedirectors. The articles of the company provide that: Any person who hasincurred expenses in connection with the formation of the company shall

be entitled to reimbursement of those expenses by the company. Afterformation, Brian signed a cheque, bearing the name Cornice, in favourof the accountant for his advice in connection with the formation; thischeque has not been paid. It has also emerged that Archie made a profitfrom the incorporation, which he did not reveal to Colin. Colin protested

about the failure to pay the accountant and Archies undisclosed profitand Archie and Brian then resolved not to reimburse him for his expensesand agreed to take no action to recover the profit from Archie.

Advise Colin and the accountant.

Answer plan

Three principal issues arise in this question:(a) whether Colin can initiate proceedings to recover the profit made by

Archie;(b) whether Colin has any claim for the expenses which he incurred in

forming the company, either against the company or against Archie andBrian;

(c) whether the accountant has any claim against the company or Brian forhis services.

Answer

The law is a little hazy as to who is a promoter, it is a question of fact in allcases; there is no doubt that Archie, Brian and Colin are the promoters ofCornice Ltd. They are the people who decided to form the company, who set


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it going and who organised the registration, all of which are factors indetermining whether a person is a promoter (see Emma Silver Mining Co vLewis

(1879) andWhaley Bridge Printing Co v Green

(1880)). In contrast, despiteany help he may have provided, the accountant is not a promoter if he merelyacted in a professional capacity (Re Great Wheat Polgooth Co(1883)).

A promoter owes certain obligations to the company which he is formingessentially, a duty of good faith in all dealings with the incipient corporation.This is because promoters are in a position of total dominance over thecompany and there is much scope for them to profit from the promotion.The courts have had to determine whether a promoter cannot derive a profitfrom the promotion or whether to allow the retention of profit in certain

cases. The courts have adopted the second view. In Erlanger v New SombreroPhosphate Co(1878), the House of Lords held that a promoter could keep anyprofit he made out of the promotion, provided that full disclosure was madeto an independent board of directors.

While still valid, this test is almost impossible to satisfy. Promoters ofprivate companies, as in this case, are likely to become the first directors andhave a continuing involvement with the company; there is no independent

board. Consequently, the courts have treated disclosure to the members as

full disclosure (Salomon v Salomon(1897)), provided that the initial membersdo not intend to bow out once disclosure has been achieved.

A has not made full disclosure of his profit to all shareholders and, even ifthis is an indirect profit, he has broken the duty which he owes to thecompany. That indirect profit making is a breach of duty is well illustrated

by Gluckstein v Barnes(1900), in which the promoters sold property (Olympia)to a company they were promoting, which profit was duly disclosed. Thepromoters did not reveal that, prior to their acquisition of Olympia, they

had acquired certain debts (for less than face value, since it was generallythought that they would never be paid) secured on the property. Prior totransferring the property to the company, they arranged for these debts to

be paid and the profit they made when the debts were discharged was notdisclosed. The promoters were required to repay this profit to the company.

While there may be no doubt that A has broken his duty to the company,can C do anything about it? The duty is owed to the company and thecompany appears to have resolved to do nothing about As action. Since a

company is an abstraction, a person acting on behalf of the company mustinitiate litigation. By virtue of Art 70 of Table A, this power is vested in theboard, who, in this case, have decided not to sue. C, as a shareholder, cannotforce the company to sue A, nor has he the power to sack the board; but hemay be able to bring a derivative action on behalf of the company allegingfraud by the controlling shareholders. However, given the inauspicious startto the joint venture, he might be better advised to seek a just and equitable


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winding up under s 122(1)(g) of the Insolvency Act 1986 or bring an actionfor unfair prejudice (s 459) on his own account and seek to be bought out of

the company.Cs next cause for complaint is the failure to obtain reimbursement for theexpenses which he incurred in the course of promotion. A promoter is notentitled to reimbursement from the company unless he can establish a validcontract to pay. Is there such a contract? The document signed by A and Bpurports to bind the company to reimburse C, but the case of Kelner v Baxter(1866) has long established that a company cannot be bound by a contractentered into prior to its incorporationthe company did not exist at therelevant time, so it cannot contract. In Kelner,the promoters ordered wines

and spirits on behalf of a hotel company they were forming. The goods werenot paid for by the company; nor could they be recovered, since they had

been consumed. The company was not liable on the contract, although thepromoters were. Nor can the articles be said to ratify the pre-incorporationcontract: Kelner v Baxteralso held that a principal which did not exist at thetime that its agent purported to act on its behalf cannot ratify the acts of theagent. If the company was to enter into a new contract with C post-incorporation, he could sue on the new contract, but he would have to show

that he had provided consideration which was not past.C may seek to rely on the provision in the articles authorising the

reimbursement of promotion expenses. This article plainly authorises thedirectors to pay these expenses if they choose, but it almost certainly doesnot entitle C to demand payment. Section 14 provides that the articles of thecompany bind the company and its members. The wording of the sectionseems tolerably clearthe articles create a contract between the companyand its members. Since a contract existseven if a rather odd one, in that it

can be altered by one party (s 9)it would seem that C could sue on thearticles and obtain his due. Unfortunately, the courts have interpreted the s14 contract rather oddly. The traditional view is that a shareholder can enforcethe articles only insofar as the relevant article creates a membership right,that is, a right attaching to each and every share and which relates to theholding of shares. This view derives from the first instance decision of Astbury

J in Hickman v Kent or Romney Marsh Sheepbreeders Association (1915) andwould appear to preclude the enforcement of a right which, while vested in

all shareholders (and others), does not relate to the ownership of shares.What constitutes a membership right is far from clear, but it seems clear thata reimbursement of promotion expenses does not fall into this category(Melhado v Porto Allegre Rly Co(1874)). However, powerful arguments have

been raised against Astburys interpretation of the s 14 contract. LordWedderburn in particular relies heavily upon the House of Lords decisionin Quin and Axtens v Salmon(1909), where a shareholder was held entitled to


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enforce an article which required his consent to the sale of company land, toadvance the view that a shareholder has a personal right to require the

company to act in accordance with its articles. Variations on LordWedderburns argument would restrict the shareholder to having a right toensure that the appropriate corporate body carries on the affairs of thecompany. The conventional view seems likely to be applied to a case such asthis and C would not be reimbursed.

C would, however, be able to bring an action against A and B personallyfor the reimbursement of his expenses. Section 36C provides that acontract which purports to be made by or on behalf of a company at atime when the company has not been formed has the effectas one made

with the person purporting to act for the company as agent for it, and he ispersonally liable on the contract accordingly. The courts have interpretedthis section (and its forebears) purposively and there seems little doubtthat A and B will be liable. Phonogram Ltd v Lane (1982) illustrates theoperation of the section. L had entered into a contract with the claimant on

behalf of a company he was forming to manage a rock group (Cheap,Mean and Nastyunknown to me, I admit!) and had receivedapproximately 12,000 on behalf of the intended company to aid his

endeavours. The company was never formed and, even though it wasaccepted that the money had not necessarily benefited L personally, hewas liable to reimburse the claimant.

The final issue concerns the accountant who has not been paid. Obviously,the accountant must establish some legal right if he wishes to bring an actionto recover the sum due. First, he could seek to sue the company on the pre-incorporation contract, but this will not succeed, because: it is not clear that he was contracting with the company rather than with

C personally; even if he was contracting with the company, the company, as we have

seen, is not liable on a pre-incorporation contract.Secondly, he could sue the company as the drawer of the cheque and, if thecompany fails to pay, he might be able to seek a winding up order, althoughit is unlikely that the sums would justify this. He could not sue the companyon the provision in the articles which seems to authorise the payment of

incorporation expenses, because he is not a shareholder and is not a party tothe s 14 contract. Indeed, even if he was a shareholder, he would face thesame difficulties as C in enforcing what appears to be a non-membershipright. If a court was prepared to disregard the conventional view on the s 14contract and hold that all the articles constituted contractual rights (or that amember had a right to have the articles complied with), he would still haveto depend upon C suing on his behalf (unless he was a shareholder). If C


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sued on behalf of the accountant, the rules of privity would seem to providethat any damages payable to C would reflect Cs loss and not that of the

accountant (if C has to reimburse the accountant, his losses might berecoverable).Thirdly, he could sue Brian as the signatory of a company cheque which

does not bear the full name of the company. Section 349(4) states that anyperson who signs a cheque on behalf of a company on which the name ofthe company does not appear in fullB signed on behalf of Cornice and notCornice Ltdis personally liable on the cheque. While the omission of Ltdseems minor and there is no question of the accountant being misled as tothe status of the body with which he was dealing, the law is strict. The

omission of & in the name of a company has triggered the section and,while the courts feel that claims under this provision may be whollyunmeritorious, they have left it to Parliament to amend the law. If theaccountant sues B under this provision, B is entitled to an indemnity fromthe company, provided that it is solvent.

Both C and the accountant should be able to recover their money, providedthat A and B are solvent. One cannot see much future for Cornice Ltd,however.

Question 5

Rendell Ltd has a number of wholly owned subsidiaries, including BarbaraLtd and Vine Ltd. The directors of Rendell Ltd are also directors of thesetwo subsidiaries.

Land belonging to Barbara Ltd is being compulsorily purchased by thegovernment for a road widening scheme; the amount of compensationhas not yet been agreed.

Vine Ltd, while originally engaged in house building, has incurred hugelosses in speculative property dealings which were entered into by themanaging director of the company without the knowledge of the otherdirectors, who took no active part in its management. The creditors ofVine are pressing Rendell to pay its subsidiarys debts. Without furthersupport from Rendell Ltd, Vine Ltd will go into insolvent liquidation.

Advise Rendell Ltd and its directors.


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Answer plan

A number of issues arise. They can be split into those affecting the holdingcompany and those affecting its directors.Rendell Ltd are seeking:

to obtain the best possible compensation for the land acquisition; to escape liability for the debts of Vine Ltd; to avoid the speculative building contracts; to pursue all or some of the directors of Vine in respect of the losses

already incurred.

The directors of Rendell are trying: to escape any liability for their actions and inactions as directors of

Vine Ltd.

Answer

Rendell wishes to maximise the compensation payable in respect of the road

widening scheme which affects Barbara Ltd, and to minimise its losses inrespect of its subsidiary, Vine Ltd.

(a)Barbara Ltd

Barbara Ltd is a wholly owned subsidiary of Rendell Ltd but, as a registeredcompany, it is a separate legal person from its shareholder. Traditionally, a

shareholder has no legal interest in the property of the company. Thus, inMacaura v Northern Assurance(1925), a shareholder was unable to claim on apolicy of insurance which he had effected on certain of the companys assetsand which had been destroyed by fire; one cannot insure anothers propertyand the assets belonged to anotherthe company. Thus, the amount payablefor the road widening scheme would seem to be limited to an appropriatesum under the legislation necessary to compensate Barbara Ltd for its loss.However, the forfeiture of the land may also have an adverse affect upon

other companies within the Rendell Ltd group, resulting in greater loss thanthat which is payable to Barbara Ltd.Can Rendell Ltd claim that the veil of incorporation cloaking Barbara Ltd

can be torn aside, so that Rendell and Barbara are treated as one company forthe purposes of compensation? There are some circumstances in which a courtwill ignore the separate legal personality of a company. This disregard ofcorporate legal status may be required by statute or, in exceptional cases, be


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decreed by the courts. One statutory situation is pertinent. The statutes whichpermit compensation for persons whose real property is subject to a compulsory

purchase order allow a court to disregard the separate legal personality ofindividual companies within a group and consider the effect of the order onthe business of the group as a whole. An example very similar to the facts ofthis case arose in DHN Food Distributors v Tower Hamlets LBC(1976).

(b)Vine Ltd

The situation in respect of this subsidiary is more complex:Turning to the first issue, is Rendell liable for the debts of its subsidiary?

Once again, the existence of the corporate veil shields the shareholder, Rendell,from the attentions of the disgruntled creditors of Vine Ltd. The situation issimilar to that in Salomon v Salomon & Co(1897), in which S, who had convertedhis existing, successful business into a limited company of which he was themanaging director and principal shareholder, was found not to be liable forthe companys unpaid debts. This strict adherence to the separation of company(Vine) and its shareholders (Rendell) causes loss to creditors but, as yet, thisposition has not been ameliorated by the courts (see the somewhat caustic

comment on this by Templeman LJ in Re Southard & Co Ltd(1979)). Hence,unless there is some reason to disregard the corporate personality of Vine,the creditors have no call upon Rendell. Grounds for lifting the veil includewhere a company is being used to conceal some fraudulent purpose, as, forexample, inJones v Lipman(1962), where the defendant sought to evade a

binding contract of sale between himself and the claimant by conveying thesubject matter of the contract to a company he controlledthe corporate statusof the transferee was disregarded by the court.

However, where the claimants right of action is against a company inthe first place, the veil cannot be lifted so as to enable the claimant to bringproceedings against a person who controlled the company but who is nototherwise liable to the claimant (Yukong Line Ltd v Rendsburg Inv

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