A

EXAMS MODULE A

1.‘The ambition of creditor protection would be defeated if, once the [capital] funds had been received, the company were completely free to return them to the members, thereby adversely affecting the creditors’ overall position vis-à-vis the company.’ (Sealy and Worthington) Discuss.

Companies Act 2006 seeks to ensure that a company’s capital is maintained in the company’s possession and, therefore, gives an accurate picture of the company’s finances. The principal anxiety of the law is that shareholders should actually pay the price of the shares in money or money’s worth and that this sum is not directly or indirectly returned to shareholders, except in accordance with the provisions of the Companies Act. The reforms established in CA 2006 seeks to deregulate the old law by removing the need for private companies to comply with measures that are unnecessarily burdensome. However, as far as public companies are concerned, much of the law is restated. Some of the differences are encountered in the reduction of capital and financial assistance regimes.

REDUCTION OF CAPITAL.

·Reduction of capital in private companies.

The simplified procedure for private companies is established in sections 642-644. For a reduction of capital, a solvency statement is required, and it must be made by the directors of the company not more than 15 days before the special resolution is passed. It shall be signed by all the directors (in other case, the company will not be unable to use this statement for the reduction of capital unless the dissenting director resigns).

This solvency statement must take into account all of the company’s liabilities and that:

a.There is no ground on which the company could then be found to be unable to pay its debts.

b.If intended to commence the winding up of the company within 12 months of the date, that the company will be able to pay its debts in full within 12 months from the winding up.

Within 15 days of the special resolution, the solvency statement must be filled to the registrar.

·Reduction of capital in public companies.

On the other hand, public companies are required to have the special resolution for the reduction of capital confirmed by the court. Sections 645-646.

An application for an order confirming the reduction shall be made to the court, including the creditors’ right to object. The court will settle a list of creditors with a view to ensuring that each one of them has consented to the reduction. If a creditor does not consent the court may, at its discretion, dispense with that creditor’s consent where the company secures the debt or claim.

The court may make an order confirming the reduction of capital on such terms and conditions as it thinks fit. However, it will not confirm the reduction unless it is satisfied, with respect to every creditor of the company entitled to object, that either their consent to the reduction has been obtained or their debt or claim has been discharged or secured. The reduction will take effecton registration of the court order confirming the reduction (and statement of capital) by the Registrar.

The policy reasons of the different treatment between public and private companies in a reduction of capital is to safeguard the interests of the creditors in the public company.

The policy with the capital maintenance regime is directed towards protecting creditors who cannot look directly towards shareholders to meet their claim (Guinness v Land Corpn of Ireland.)

2.Paradoxically, when the judges are concerned with the interpretation of the term “variation” they have not been inclined towards generosity. It may, therefore, be possible to make class rights less effective without effecting any “technical” variation of the rights themselves.’

As between shareholders of a company, there is a presumption of equality, so they will enjoy equal rights of voting and dividends when the Company is going concern and a right to participate in any surplus assets in the event of winding up. However, this presumption is rebutted if the Company issues shares carrying different class rights. The CA 2006 does not define “class rights”.

It was recognised in Andrews v Gas Meter Co [1897] that a company may issue shares with different rights attached to them (e.g. the preferential dividend rights attaching to preference shares). Such rights are known as class rights and are largely a matter of contract between the member and the company.

The judgment of Scott J in Cumbrian Newspapers determined that rights or benefits can be classified in 3 distinct categories:

1.those rights that are annexed to particular shares.

2.Rights or benefits which are confirmed on individual not qua members or shareholders.

3.Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his capacity as member or shareholder of the company.

Section 630 lays down the procedure for effecting a variation of class rights, and its aim is to protect the class rights of shareholders. Section 630 provides that class rights may only be varied:

·in accordance with the relevant provisions in the company’s articles, or

·if no such provision is made in the articles, if the holders of 3/4 in value of the shares of the relevant class consent either in writing or by special resolution (passed at a separate meeting of the holders of such shares). The company must then notify the Registrar of any variation of class rights within 1 month of the date on which the variation is made

However, Section 633 CA 2006 provides that where a variation has been affected, the holders of not less than 15 per cent of the issued shares of the class affected may apply to the court within 21 days of the resolution to have it cancelled.

Additionally, it should be taken into account the judgement in Cumbian Newspapers, as it was determined that the class rights can only be varied with the consent of the beneficiaries of such rights.

In White v Bristol Aeroplane Co Ltd [1953] C the company’s articles of association provided that the rights attached to any class of shares may be ‘affected, modified, varied, dealt with, or abrogated in any manner’ with the approval of an extraordinary resolution passed at a separate meeting of the members of that class.

The preference shareholders argued that an issue of additional shares, both preference and ordinary ‘affected’ their voting rights.

The Court of Appeal rejected the preference shareholders’ contention. Romer LJ explained that the proposal would not affect the rights of the shareholders: ‘the only result would be that the class of persons entitled to exercise those rights would be enlarged.’

In this sense, the holders of the class rights affected by the variation are protected not only with the mechanism established by law, but also with the case law provisions aforementioned.

3.‘The rules which have been developed to ensure maintenance of capital are designed to protect creditors rather than shareholders. But such creditor protection will be seriously diluted following implementation of the relevant parts of the Companies Act2006.’

Discuss.

SEE QUESTION 5

The law seeks to protect such creditors and potential shareholders by seeking to ensure through the capital maintenance doctrine that the company’s capital is not illegally returned to its existing shareholders.

4.Shareholder rights and liabilities are the incidents of the general nature of a share.’

Discuss.

Unlike partnerships, where the assets of the business are jointly owned by the partners, shareholders do not have a proprietary interest in the property of the Company.

Sealy and Worthington attribute 3 principal functions to the concept of a share:

1.It denotes the quantification of a shareholder’s financial stake in the Company and it fixes liability to contribute the company’s funding.

2.It is a measure of the shareholder’s interest in the Company as an association and his right to become a member and to exercise all rights incidental to membership.

3.It is a species of property, a chose action.

The nature of a share is a complex issue. A share is:

·a contract between the shareholder and the company

·a right of property, a chose in action (i.e. rights that can be enforced by legal action), which can be bought, sold and charged.

The classic definition of a share was delivered by Farwell J in Borland’s Trustee v Steel Bros & Co Ltd [1901]: A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders inter se in accordance with [s.33 CA 2006]. The contract contained in the articles of association is one of the original incidents of the share. A share is not a sum of money…but an interest measured by a sum of money and made up of various rights contained in the contract, including the right to a sum of money of a more or less amount.

Shareholders do not have an interest in the property belonging to the company: see Macaura v Northern Assurance Co Ltd. [1925]. Rather, their relationship is with the company – as a separate and distinct entity in its own right. A shareholder thus has rights in the company, not against it, as is the case with debenture holders. In Short v Treasury Commissioners [1948] the legal nature of a share and its monetary valuation was subjected to considerable scrutiny by the court. In this case, the government of the day purchased all of the shares in the company, valuing them on the basis of the quoted share price.

The shareholders argued that because the whole of the issued shares was being acquired the entire undertaking should be valued and the price should be apportioned between them.

It was held, however, that where a purchaser is buying control but none of the sellers holds a controlling interest, the higher price that ‘control’ demands can be ignored. The Treasury was therefore able to purchase the company for a price considerably less than its asset value.

Thus, a shareholder will have rights and liabilities which are the incident of the general nature of a share. Additionally. He may also have particular rights and liabilities by virtue of owning a particular type of class of share.

5.‘The reforms to the outmoded rules governing maintenance of share capital made by the Companies Act 2006 did not extend far enough. For example, the decision in Brady v Brady, as incomprehensible as the reasoning is, still stands.’ Discuss.

Companies Act 2006 seeks to ensure that a company’s capital is maintained in the company’s possession and, therefore, gives an accurate picture of the company’s finances. The principal anxiety of the law is that shareholders should actually pay the price of the shares in money or money’s worth and that this sum is not directly or indirectly returned to shareholders, except in accordance with the provisions of the Companies Act. The reforms established in CA 2006 seeks to deregulate the old law by removing the need for private companies to comply with measures that are unnecessarily burdensome. However, as far as public companies are concerned, much of the law is restated. Some of the differences are encountered in the reduction of capital and financial assistance regimes.

REDUCTION OF CAPITAL.

·Reduction of capital in private companies.

The simplified procedure for private companies is established in sections 642-644. For a reduction of capital, a solvency statement is required, and it must be made by the directors of the company not more than 15 days before the special resolution is passed. It shall be signed by all the directors (in other case, the company will not be unable to use this statement for the reduction of capital unless the dissenting director resigns).

This solvency statement must take into account all of the company’s liabilities and that:

c.There is no ground on which the company could then be found to be unable to pay its debts.

d.If intended to commence the winding up of the company within 12 months of the date, that the company will be able to pay its debts in full within 12 months from the winding up.

Within 15 days of the special resolution, the solvency statement must be filled to the registrar.

·Reduction of capital in public companies.

On the other hand, public companies are required to have the special resolution for the reduction of capital confirmed by the court. Sections 645-646.

An application for an order confirming the reduction shall be made to the court, including the creditors’ right to object. The court will settle a list of creditors with a view to ensuring that each one of them has consented to the reduction. If a creditor does not consent the court may, at its discretion, dispense with that creditor’s consent where the company secures the debt or claim.

The court may make an order confirming the reduction of capital on such terms and conditions as it thinks fit. However, it will not confirm the reduction unless it is satisfied, with respect to every creditor of the company entitled to object, that either their consent to the reduction has been obtained or their debt or claim has been discharged or secured. The reduction will take effecton registration of the court order confirming the reduction (and statement of capital) by the Registrar.

The policy reasons of the different treatment between public and private companies in a reduction of capital is to safeguard the interests of the creditors in the public company.

FINANCIAL ASSISTANCE

A company may not provide financial assistance for the purpose of acquiring its shares, for example by giving a gift to a third party on the understanding that the money will be used to buy the donor company’s shares, or by guaranteeing a potential purchaser’s borrowing.

A loan does not deplete a company’s net assets. This is because although funds leave the company, their loss is matched in the company’s accounts by the debt to the company that is thereby created. Thus, the prohibition on financial assistance in the 2006 Act is wider than that which would be required if the only policy in operation was to maintain the company’s share capital. But, as stressed by the policy underlying this prohibition is explained by Arden LJ in Chaston v SWP Group plc, is needing to protect shareholders and outsiders from misuse by the company of its own assets to finance the purchase of its own shares, even if the capital maintenance doctrine is not thereby infringed.

Nonetheless, there are some exceptions to the general prohibition of granting financial assistance:

·Unconditional expectations:

They mainly relate to procedures which are specifically authorised elsewhere in the Act, for example, to affect a redemption of shares or a reduction of capital.

·Conditional exceptions:

They only apply if the company has net assets and either:

a.those assets are not reduced by the giving of the financial assistance, or

  1. to the extent that those assets are so reduced, the assistance is provided out of distributable profits.

Nonetheless, the financial assistance is not prohibited:

a.if the principal purpose of the assistance is not to give it for the purpose of an acquisition of shares, or where this assistance is incidental to some other larger purpose of the company, and

b.in either case, where the financial assistance is given in good faith in the interests of the company.

The exceptions are designed to ensure that the prohibition in s.678(1) does not also catch genuine commercial transactions which are in the interests of the company. However, attempting to assess a person’s ‘purpose’ is necessarily difficult (for instance, the need to distinguish purpose from effect) because the court will need to determine whether the giving of assistance for the purpose of an acquisition of shares is an incidental part of some larger purpose.

The difficulties of assessing ‘purpose’ came to the fore in Brady v Brady [1989], which the House of Lords establishedthat in looking for some larger overall corporate purpose, it is necessary to distinguish ‘purpose’ from the reason why a purpose is formed. The commercial advantages flowing from providing the financial assistance for the acquisition of the shares may be the reason for providing it. However, the commercial advantages are a by-product of providing the assistance – they are not an independent purpose to which the financial assistance can be considered incidental.

6.‘Whether a “right” of a shareholder is deemed to be a “class right” cannot be predicted given that the law continues to be confusing.’ Discuss.

As between shareholders of a company, there is a presumption of equality, so they will enjoy equal rights of voting and dividends when the Company is going concern and a right to participate in any surplus assets in the event of winding up. However, this presumption is rebutted if the Company issues shares carrying different class rights. The CA 2006 does not define “class rights”.

It was recognised in Andrews v Gas Meter Co [1897] that a company may issue shares with different rights attached to them (e.g. the preferential dividend rights attaching to preference shares). Such rights are known as class rights and are largely a matter of contract between the member and the company.

The judgment of Scott J in Cumbrian Newspapers determined that rights or benefits can be classified in 3 distinct categories:

4.those rights that are annexed to particular shares.

5.Rights or benefits which are confirmed on individual not qua members or shareholders.

6.Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his capacity as member or shareholder of the company.

Examples of classes of shares.

·Ordinary shares.

No special rights or restrictions. 

Default category.

They rank after preference shares as regards dividends and return of capital.

One vote per share.

·Preference shares.

1.Preferential rights.

Have a right to receive a fixed amount of dividend every year

2.Cumulative element.

Cumulative dividend will be paid in any year which the company has distributable profits.

Webb v Earle (1875).

3.Restricted voting rights.

·Deferred shares.

Reflect the founders’ offer to defer their own entitlements to those other investors from whom additional capital is sought.

Will not pay a dividend until all other classes of shares have received a minimum dividend.

·Convertible shares.

A kind of share that can be convertible into other kind.

·Redeemable shares.

Shares that shall be bought back by the company at a future date.

Shares may be redeemable at the option of the shareholder or the company.

CA 2006, s 684ff.

a.Private companies.

Articles may exclude or restrict.

Redemption only out of capital.

CA 2006, s 687(1).

b.Public companies.

Articles shall authorise the redemption.

Redemption only out of distributable profits

CA 2006, s 687(2).

·Non-voting shares.

Sought to restrict the company control to the holders of the remaining shares.

Heron International Ltd v Lord Grade (1983).

·Shares with limited voting rights or enhanced voting rights.

Quin & Axtens Ltd v Salmon.

Bushell v Faith.

·Employees’ shares.

Tax benefits.

Employees share scheme. Either by distributing shares already paid up by the company either directly to the employees themselves or to trustees or them or by conferring on employees’ options to acquire shares on favourable terms.

Section 630 lays down the procedure for effecting a variation of class rights, and its aim is to protect the class rights of shareholders. Section 630 provides that class rights may only be varied:

·in accordance with the relevant provisions in the company’s articles, or

·if no such provision is made in the articles, if the holders of 3/4 in value of the shares of the relevant class consent either in writing or by special resolution (passed at a separate meeting of the holders of such shares). The company must then notify the Registrar of any variation of class rights within 1 month of the date on which the variation is made

However, Section 633 CA 2006 provides that where a variation has been effected, the holders of not less than 15 per cent of the issued shares of the class affected may apply to the court within 21 days of the resolution to have it cancelled.

Additionally, it should be taken into account the judgement in Cumbian Newspapers, as it was determined that the class rights can only be varied with the consent of the beneficiaries of such rights.

In White v Bristol Aeroplane Co Ltd [1953] C the company’s articles of association provided that the rights attached to any class of shares may be ‘affected, modified, varied, dealt with, or abrogated in any manner’ with the approval of an extraordinary resolution passed at a separate meeting of the members of that class.

The preference shareholders argued that an issue of additional shares, both preference and ordinary ‘affected’ their voting rights.

The Court of Appeal rejected the preference shareholders’ contention. Romer LJ explained that the proposal would not affect the rights of the shareholders: ‘the only result would be that the class of persons entitled to exercise those rights would be enlarged.’

7.‘Althoughsharesarefrequentlydescribedas”property”,theydonotgivetheholderany proprietaryinterestinthecompany’sassets‘.

Unlike partnerships, where the assets of the business are jointly owned by the partners, shareholders do not have a proprietary interest in the property of the Company.

Sealy and Worthington attribute 3 principal functions to the concept of a share:

4.It denotes the quantification of a shareholder’s financial stake in the Company and it fixes liability to contribute the company’s funding.

5.It is a measure of the shareholder’s interest in the Company as an association and his right to become a member and to exercise all rights incidental to membership.

6.It is a species of property, a chose action.

The nature of a share is a complex issue. A share is:

·a contract between the shareholder and the company

·a right of property, a chose in action (i.e. rights that can be enforced by legal action), which can be bought, sold and charged.

The classic definition of a share was delivered by Farwell J in Borland’s Trustee v Steel Bros & Co Ltd [1901] 1: A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders inter se in accordance with [s.33 CA 2006]. The contract contained in the articles of association is one of the original incidents of the share. A share is not a sum of money…but an interest measured by a sum of money and made up of various rights contained in the contract, including the right to a sum of money of a more or less amount.

Shareholders do not have an interest in the property belonging to the company: see Macaura v Northern Assurance Co Ltd. [1925]. Rather, their relationship is with the company – as a separate and distinct entity in its own right. A shareholder thus has rights in the company, not against it, as is the case with debenture holders. In Short v Treasury Commissioners [1948] the legal nature of a share and its monetary valuation was subjected to considerable scrutiny by the court. In this case, the government of the day purchased all of the shares in the company, valuing them on the basis of the quoted share price.

The shareholders argued that because the whole of the issued shares was being acquired the entire undertaking should be valued and the price should be apportioned between them.

It was held, however, that where a purchaser is buying control but none of the sellers holds a controlling interest, the higher price that ‘control’ demands can be ignored. The Treasury was therefore able to purchase the company for a price considerably less than its asset value.

Thus, a shareholder will have rights and liabilities which are the incident of the general nature of a share. Additionally. He may also have particular rights and liabilities by virtue of owning a particular type of class of share.

8.“The prohibition against public companies giving financial assistance serves no useful or meaningful purpose.”

“The prohibition against a company giving financial assistance for the acquisition of its own shares has generated considerable controversy since its inception in 1928. Chief among the criticisms directed at the regime are those arising from its complexity and fitness forpurpose.”

One of the key aims of the Companies Act 2006 was to liberalise company law for private companies and as a result the prohibition against financial assistance was abolished for all transactions taking place on or after 1 October 2008.

However, a public company may not provide financial assistance for the purpose of acquiring its shares, for example by giving a gift to a third party on the understanding that the money will be used to buy the donor company’s shares, or by guaranteeing a potential purchaser’s borrowing.

A loan does not deplete a company’s net assets. This is because although funds leave the company, their loss is matched in the company’s accounts by the debt to the company that is thereby created. Thus, the prohibition on financial assistance in the 2006 Act is wider than that which would be required if the only policy in operation was to maintain the company’s share capital.

But, as stressed by the policy underlying this prohibition is explained by Arden LJ in Chaston v SWP Group plc, is need to protect shareholders and outsiders from misuse by the company of its own assets to finance the purchase of its own shares, even if the capital maintenance doctrine is not thereby infringed.

The basic purpose of the prohibition (which has been a part of UK companies’ legislation since the 1920s) has remained the same: the protection of creditors against capital depletion and potentially of shareholders against inappropriate preference being given to other members. e point was put succinctly by the Court

Nonetheless, there are some exceptions to the general prohibition of granting financial assistance:

·Unconditional expectations:

They mainly relate to procedures which are specifically authorised elsewhere in the Act, for example, to effect a redemption of shares or a reduction of capital.

·Conditional exceptions:

They only apply if the company has net assets and either:

c.those assets are not reduced by the giving of the financial assistance, or

  1. to the extent that those assets are so reduced, the assistance is provided out of distributable profits.

Nonetheless, the financial assistance is not prohibited:

c.if the principal purpose of the assistance is not to give it for the purpose of an acquisition of shares, or where this assistance is incidental to some other larger purpose of the company, and

d.in either case, where the financial assistance is given in good faith in the interests of the company.

The exceptions are designed to ensure that the prohibition in s.678(1) does not also catch genuine commercial transactions which are in the interests of the company. However, attempting to assess a person’s ‘purpose’ is necessarily difficult (for instance, the need to distinguish purpose from effect) because the court will need to determine whether the giving of assistance for the purpose of an acquisition of shares is an incidental part of some larger purpose.

9.“The rights enjoyed by a shareholder may be class rights although they are not referable to particularshares.”

As between shareholders of a company, there is a presumption of equality, so they will enjoy equal rights of voting and dividends when the Company is going concern and a right to participate in any surplus assets in the event of winding up. However, this presumption is rebutted if the Company issues shares carrying different class rights. The CA 2006 does not define “class rights”.

It was recognised in Andrews v Gas Meter Co [1897] that a company may issue shares with different rights attached to them (e.g. the preferential dividend rights attaching to preference shares). Such rights are known as class rights and are largely a matter of contract between the member and the company.

The judgment of Scott J in Cumbrian Newspapers determined that rights or benefits can be classified in 3 distinct categories:

1.those rights that are annexed to particular shares.

2.Rights or benefits which are confirmed on individual not qua members or shareholders.

3.Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his capacity as member or shareholder of the company.

Additionally, the House of Lords’ decision in Bushell v Faith, where the articles gave a director weighted voting rights on a resolution to remove any director from office. The judgement noted that the right was conferred on the director/beneficiaries in their capacity as shareholders.

In this sense, the rights enjoyed by a shareholder may be class rights although they are not referable to particular shares.

10.“Thecapitalmaintenanceregimeserveslittleornopurpose.Discuss.

The stated sum of each share is called its nominal or par value. Shares must not be allotted at a price which is less than the par value (considered in more detail below). When any company with share capital is formed the registration, documents must include a statement of capital and initial shareholdings disclosing, inter alia, the total number of the company’s shares and their aggregate nominal value (see ss.9(4)(a) and 10 CA 2006). The reasons for this disclosure and allotment were explained by Lord Halsbury LC in Ooregum Gold Mining Co of India Ltd v Roper [1892] AC 125 (Sealy and Worthington, p.382) on the basis of creditor and shareholder protection: [E]very creditor of the company is entitled to look to that capital as his security…I recognise the wisdom of enforcing on a company the disclosure of what its real capital is, and not permitting a statement of its affairs to be such as may mislead and deceive those who are either about to become its shareholders or about to give it credit. Say, for example, that a company has an authorised share capital of £100 divided into 100 £1.00 shares. If the shares issued are fully paid (i.e. paid for in full without outstanding balance due (a rare species nowadays)), every creditor and potential shareholder can safely assume that the company has received £100 by way of capital. Further, as indicated above, the law seeks to protect such creditors and potential shareholders by seeking to ensure through the capital maintenance doctrine that the company’s capital is not illegally returned to its existing shareholders. There is no minimum capital requirement for private companies. However, in practice, such companies are often incorporated with £100 share capital. Public companies, on the other hand, are required to have an allotted share capital of at least £50,000 (the prescribed euro equivalent has been fixed at €65,000) (s.763 CA 2006; the Second Company Law Directive 77/91/EEC, (1977) OJI26/1).

The former requirement that companies should have an ‘authorised’ share capital has been removed by the CA 2006. The 2005 White Paper noted that the requirement of authorised share capital should be removed because it was invariably set at a level higher than companies needed and it served no useful practical purpose. The requirement is thus replaced with the need to deliver a statement of capital on formation which has to contain, among other things, a statement of the share capital held by the subscribers and prescribed particulars of the rights attached to the shares (s.10).

Companies Act 2006 seeks to ensure that a company’s capital is maintained in the company’s possession and, therefore, gives an accurate picture of the company’s finances. The principal anxiety of the law is that shareholders should actually pay the price of the shares in money or money’s worth and that this sum is not directly or indirectly returned to shareholders, except in accordance with the provisions of the Companies Act. The reforms established in CA 2006 seeks to deregulate the old law by removing the need for private companies to comply with measures that are unnecessarily burdensome. However, as far as public companies are concerned, much of the law is restated. Some of the differences are encountered in the financial assistance regimes.

A company may not provide financial assistance for the purpose of acquiring its shares, for example by giving a gift to a third party on the understanding that the money will be used to buy the donor company’s shares, or by guaranteeing a potential purchaser’s borrowing.

A loan does not deplete a company’s net assets. This is because although funds leave the company, their loss is matched in the company’s accounts by the debt to the company that is thereby created. Thus, the prohibition on financial assistance in the 2006 Act is wider than that which would be required if the only policy in operation was to maintain the company’s share capital. But, as stressed by the policy underlying this prohibition is explained by Arden LJ in Chaston v SWP Group plc, its need to protect shareholders and outsiders from misuse by the company of its own assets to finance the purchase of its own shares, even if the capital maintenance doctrine is not thereby infringed.

Nonetheless, there are some exceptions to the general prohibition of granting financial assistance:

·Unconditional expectations:

They mainly relate to procedures which are specifically authorised elsewhere in the Act, for example, to effect a redemption of shares or a reduction of capital.

·Conditional exceptions:

They only apply if the company has net assets and either:

e.those assets are not reduced by the giving of the financial assistance, or

  1. to the extent that those assets are so reduced, the assistance is provided out of distributable profits.

Nonetheless, the financial assistance is not prohibited:

e.if the principal purpose of the assistance is not to give it for the purpose of an acquisition of shares, or where this assistance is incidental to some other larger purpose of the company, and

f.in either case, where the financial assistance is given in good faith in the interests of the company.

The exceptions are designed to ensure that the prohibition in s.678(1) does not also catch genuine commercial transactions which are in the interests of the company. However attempting to assess a person’s ‘purpose’ is necessarily difficult (for instance, the need to distinguish purpose from effect) because the court will need to determine whether the giving of assistance for the purpose of an acquisition of shares is an incidental part of some larger purpose.

11.“Determining what are and, therefore, what are not class rights is a frustrating exercise andthecaselawisconfusing.

As between shareholders of a company, there is a presumption of equality, so they will enjoy equal rights of voting and dividends when the Company is going concern and a right to participate in any surplus assets in the event of winding up. However, this presumption is rebutted if the Company issues shares carrying different class rights. The CA 2006 does not define “class rights”.

It was recognised in Andrews v Gas Meter Co [1897] that a company may issue shares with different rights attached to them (e.g. the preferential dividend rights attaching to preference shares). Such rights are known as class rights and are largely a matter of contract between the member and the company.

The judgment of Scott J in Cumbrian Newspapers determined that rights or benefits can be classified in 3 distinct categories:

7.those rights that are annexed to particular shares.

8.Rights or benefits which are confirmed on individual not qua members or shareholders.

9.Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his capacity as member or shareholder of the company.

Examples of classes of shares.

·Ordinary shares.

No special rights or restrictions. 

Default category.

They rank after preference shares as regards dividends and return of capital.

One vote per share.

·Preference shares.

4.Preferential rights.

Have a right to receive a fixed amount of dividend every year

5.Cumulative element.

Cumulative dividend will be paid in any year which the company has distributable profits.

Webb v Earle (1875).

6.Restricted voting rights.

·Deferred shares.

Reflect the founders’ offer to defer their own entitlements to those other investors from whom additional capital is sought.

Will not pay a dividend until all other classes of shares have received a minimum dividend.

·Convertible shares.

A kind of share that can be convertible into other kind.

·Redeemable shares.

Shares that shall be bought back by the company at a future date.

Shares may be redeemable at the option of the shareholder or the company.

CA 2006, s 684ff.

c.Private companies.

Articles may exclude or restrict.

Redemption only out of capital.

CA 2006, s 687(1).

d.Public companies.

Articles shall authorise the redemption.

Redemption only out of distributable profits

CA 2006, s 687(2).

·Non-voting shares.

Sought to restrict the company control to the holders of the remaining shares.

Heron International Ltd v Lord Grade (1983).

·Shares with limited voting rights or enhanced voting rights.

Quin & Axtens Ltd v Salmon.

Bushell v Faith.

·Employees’ shares.

Tax benefits.

Employees share scheme. Either by distributing shares already paid up by the company either directly to the employees themselves or to trustees or them or by conferring on employees’ options to acquire shares on favourable terms.

Section 630 lays down the procedure for effecting a variation of class rights, and its aim is to protect the class rights of shareholders. Section 630 provides that class rights may only be varied:

·in accordance with the relevant provisions in the company’s articles, or

·if no such provision is made in the articles, if the holders of 3/4 in value of the shares of the relevant class consent either in writing or by special resolution (passed at a separate meeting of the holders of such shares). The company must then notify the Registrar of any variation of class rights within 1 month of the date on which the variation is made

However, Section 633 CA 2006 provides that where a variation has been effected, the holders of not less than 15 per cent of the issued shares of the class affected may apply to the court within 21 days of the resolution to have it cancelled.

Additionally, it should be taken into account the judgement in Cumbian Newspapers, as it was determined that the class rights can only be varied with the consent of the beneficiaries of such rights.

In White v Bristol Aeroplane Co Ltd [1953] C the company’s articles of association provided that the rights attached to any class of shares may be ‘affected, modified, varied, dealt with, or abrogated in any manner’ with the approval of an extraordinary resolution passed at a separate meeting of the members of that class.

The preference shareholders argued that an issue of additional shares, both preference and ordinary ‘affected’ their voting rights.

The Court of Appeal rejected the preference shareholders’ contention. Romer LJ explained that the proposal would not affect the rights of the shareholders: ‘the only result would be that the class of persons entitled to exercise those rights would be enlarged.’

12.Are the policy considerations which underpin the prohibition against providing financial assistance for the acquisition of shares stillvalid?

One of the key aims of the Companies Act 2006 was to liberalise company law for private companies and as a result the prohibition against financial assistance was abolished for all transactions taking place on or after 1 October 2008.

However, a public company may not provide financial assistance for the purpose of acquiring its shares, for example by giving a gift to a third party on the understanding that the money will be used to buy the donor company’s shares, or by guaranteeing a potential purchaser’s borrowing.

A loan does not deplete a company’s net assets. This is because although funds leave the company, their loss is matched in the company’s accounts by the debt to the company that is thereby created. Thus, the prohibition on financial assistance in the 2006 Act is wider than that which would be required if the only policy in operation was to maintain the company’s share capital.

But, as stressed by the policy underlying this prohibition is explained by Arden LJ in Chaston v SWP Group plc, is needing to protect shareholders and outsiders from misuse by the company of its own assets to finance the purchase of its own shares, even if the capital maintenance doctrine is not thereby infringed.

The basic purpose of the prohibition (which has been a part of UK companies’ legislation since the 1920s) has remained the same: the protection of creditors against capital depletion and potentially of shareholders against inappropriate preference being given to other members. e point was put succinctly by the Court

Nonetheless, there are some exceptions to the general prohibition of granting financial assistance:

·Unconditional expectations:

They mainly relate to procedures which are specifically authorised elsewhere in the Act, for example, to effect a redemption of shares or a reduction of capital.

·Conditional exceptions:

They only apply if the company has net assets and either:

g.those assets are not reduced by the giving of the financial assistance, or

  1. to the extent that those assets are so reduced, the assistance is provided out of distributable profits.

Nonetheless, the financial assistance is not prohibited:

g.if the principal purpose of the assistance is not to give it for the purpose of an acquisition of shares, or where this assistance is incidental to some other larger purpose of the company, and

h.in either case, where the financial assistance is given in good faith in the interests of the company.

The exceptions are designed to ensure that the prohibition in s.678(1) does not also catch genuine commercial transactions which are in the interests of the company. However, attempting to assess a person’s ‘purpose’ is necessarily difficult (for instance, the need to distinguish purpose from effect) because the court will need to determine whether the giving of assistance for the purpose of an acquisition of shares is an incidental part of some larger purpose.

13.“For the modern company, there should just be one class of shares with equal rights.”

It can be said that a shareholder has rights and liabilities that are the incident of the general nature of a share. Between shareholders there is a presumption of equality. This means that they are deemed to enjoy:

·equal voting and dividend rights when the company is a going concern

·equal rights to participate in any surplus assets should the company be wound up.

This presumption of equality will be rebutted, however, where a company issues shares that carry different class rights. For example, the holders of preference shares generally enjoy:

·preferential dividend rights

·priority to a return of capital in a winding-up.

Generally, the articles of association give the company the power to issue shares ‘with such rights or restrictions as the company may by ordinary resolution determine’ (see the Model articles of association). The different classes of shares commonly issued are:

1.Ordinary shares

2.Preferential shares.

3.Redeemable shares

4.Deferred shares

5.Employees’ shares.

6.Convertible shares

7.Shares with no vote

8.Shares with limited voting rights or enhanced voting rights.

There are myriad reasons for the plurality of share classes. The company’s ordinary subscribers to ordinary shares may be reluctant to issue further ordinary shares to outsiders as means of raising additional capital because that would have the effect of diluting or destroying their control of the business. This danger arises because ordinary shares generally carry the majority of the voting rights at meetings and also entitle their holders to the lion’s share of any declared dividend. A solution, other than issuing debentures, is to issue preference shares. The attraction of this option is that it affords a company an accessible mean of raising additional capital without conferring voting rights equal to those of ordinary shareholders. Although the company will undertake to pay a preferential cumulative dividend generally fixed at a pre-determined rate, this may, in appropriate circumstances, be considered relative small price to pay for a much-needed injection of capital from which trading profits can grow.

14.‘Shareholders are afforded little protection when it comes to varying their rights.’

Discuss.

As between shareholders of a company, there is a presumption of equality, so they will enjoy equal rights of voting and dividends when the Company is going concern and a right to participate in any surplus assets in the event of winding up. However, this presumption is rebutted if the Company issues shares carrying different class rights. The CA 2006 does not define “class rights”.

It was recognised in Andrews v Gas Meter Co [1897] that a company may issue shares with different rights attached to them (e.g. the preferential dividend rights attaching to preference shares). Such rights are known as class rights and are largely a matter of contract between the member and the company.

The judgment of Scott J in Cumbrian Newspapers determined that rights or benefits can be classified in 3 distinct categories:

1.those rights that are annexed to particular shares.

2.Rights or benefits which are confirmed on individual not qua members or shareholders.

3.Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his capacity as member or shareholder of the company.

Section 630 lays down the procedure for effecting a variation of class rights, and its aim is to protect the class rights of shareholders. Section 630 provides that class rights may only be varied:

·in accordance with the relevant provisions in the company’s articles, or

·if no such provision is made in the articles, if the holders of 3/4 in value of the shares of the relevant class consent either in writing or by special resolution (passed at a separate meeting of the holders of such shares). The company must then notify the Registrar of any variation of class rights within 1 month of the date on which the variation is made

However, Section 633 CA 2006 provides that where a variation has been effected, the holders of not less than 15 per cent of the issued shares of the class affected may apply to the court within 21 days of the resolution to have it cancelled.

Additionally, it should be taken into account the judgement in Cumbian Newspapers, as it was determined that the class rights can only be varied with the consent of the beneficiaries of such rights.

In White v Bristol Aeroplane Co Ltd [1953] C the company’s articles of association provided that the rights attached to any class of shares may be ‘affected, modified, varied, dealt with, or abrogated in any manner’ with the approval of an extraordinary resolution passed at a separate meeting of the members of that class.

The preference shareholders argued that an issue of additional shares, both preference and ordinary ‘affected’ their voting rights.

The Court of Appeal rejected the preference shareholders’ contention. Romer LJ explained that the proposal would not affect the rights of the shareholders: ‘the only result would be that the class of persons entitled to exercise those rights would be enlarged.’

A successful claim was brought in Re Old Silkstone Collieries Ltd [1954]. The company’s colliery was nationalised by the government. While waiting for the final settlement of compensation, the company had twice reduced its capital by returning part of the preference shareholders’ capital investment. On both occasions the company had promised the shareholders that they would not be bought out entirely. They would retain their membership so that they could participate in the compensation scheme to be introduced under the nationalisation legislation. Subsequently, it was proposed to reduce the company’s capital for a third time by returning all outstanding capital to the preference shareholders. The effect of this would be to cancel the class completely so that the shareholders would no longer qualify for compensation.

The Court of Appeal refused to sanction the reduction, holding that the proposal amounted to an unfair variation of class rights. The preference shareholders had been promised that they would participate in the compensation scheme.

15.In Charterhouse Investments Trust Ltd v Tempest Diesels Ltd, Hoffmann J (as he then was), observedthat:

‘One must examine the commercial realities of the transaction and decide whether it can properly be described as the giving of financial assistance by the company, bearing in mind that the section is a penal one and should not be stretched to cover transactions which are not fairly withinit.’

To what extent has the ‘commercial realities’ test injected an element of flexibility into the way the modern courts approach the prohibition on the giving of financial assistance?

A public company may not provide financial assistance for the purpose of acquiring its shares, for example by giving a gift to a third party on the understanding that the money will be used to buy the donor company’s shares, or by guaranteeing a potential purchaser’s borrowing.

The basic purpose of the prohibition (which has been a part of UK companies’ legislation since the 1920s) has remained the same: the protection of creditors against capital depletion and potentially of shareholders against inappropriate preference being given to other members. e point was put succinctly by the Court

Nonetheless, there are some exceptions to the general prohibition of granting financial assistance:

·Unconditional expectations:

They mainly relate to procedures which are specifically authorised elsewhere in the Act, for example, to effect a redemption of shares or a reduction of capital.

·Conditional exceptions:

They only apply if the company has net assets and either:

i.those assets are not reduced by the giving of the financial assistance, or

  1. to the extent that those assets are so reduced, the assistance is provided out of distributable profits.

Nonetheless, the financial assistance is not prohibited:

i.if the principal purpose of the assistance is not to give it for the purpose of an acquisition of shares, or where this assistance is incidental to some other larger purpose of the company, and

j.in either case, where the financial assistance is given in good faith in the interests of the company.

The exceptions are designed to ensure that the prohibition in s.678(1) does not also catch genuine commercial transactions which are in the interests of the company. However, attempting to assess a person’s ‘purpose’ is necessarily difficult (for instance, the need to distinguish purpose from effect) because the court will need to determine whether the giving of assistance for the purpose of an acquisition of shares is an incidental part of some larger purpose.

The difficulties of assessing ‘purpose’ came to the fore in Brady v Brady [1989], which the House of Lords establishedthat in looking for some larger overall corporate purpose, it is necessary to distinguish ‘purpose’ from the reason why a purpose is formed. The commercial advantages flowing from providing the financial assistance for the acquisition of the shares may be the reason for providing it. However, the commercial advantages are a by-product of providing the assistance – they are not an independent purpose to which the financial assistance can be considered incidental.

The courts have determined in several cases the scope of commercial realities in order to determine the prohibition to provide financial assistance. In Chaston v SWP Group plc, it was cited the vision of Hoffman J in Charterhouse v Tempest Diesels “when determining the prohibition has been breached, one must examine the commercial realities of the transaction and decide whether it can properly be described as the giving of financial assistance by the company, bearing in mind that the section is a penal one and should not be strained to cover which are not fairly within it”. Arden LJ took the view that as a matter of commercial substance financial assistance was given on the facts of the case:

Section 151 (CA 2006, s.678) makes it clear that a transaction can fall within section 151 even if only one of the purposes for which it was carried out was to assist the acquisition of shares. Brady v Brady also makes it clear that an unlawful purpose is not removed by the fact that, as the judge found here, the directors were motivated by the best interests of the company. Their motivation was only a reason for their acts, not a purpose in itself.

This was approved by the Court of Appeal in Barcklays Bank plc v British and Commonwealth Holdings plc.

In MT Realisations Ltd v Digital Equipment Co Ltd [2003], that:

Each case is a matter of applying the commercial concepts expressed in non-technical language to the particular facts. The authorities provide useful illustrations of the variety of fact situations in which the issue can arise; but it is rare to find an authority…which requires a particular result to be reached on different facts.

In this respect the facts of Dyment v Boyden [2005], the Court of Appeal had to consider whether rent which was significantly greater than the market value of the premises in question constituted a breach of s.151 (s.678 CA 2006). Because of local authority rules, the transfer of shares had to be undertaken in order that the respondents no longer retained an interest in the company. The Court of Appeal held that the trial judge was right in finding that the company’s entry into the lease was ‘in connection with’ the acquisition by the appellant of the shares but was not ‘for the purpose of that acquisition’. His finding that the entry into the lease was for the purpose of acquiring the premises rather than the shares was a finding of fact with which the Court of Appeal should not interfere.

16.On its incorporation in 2009, Acme Ltd issued two different classes of shares, the Class A share and the Class B share. The company’s articles of association provided that the rights attached to the Class A share were comprised of the preferential payment of a dividend at a rate of 9% per annum. The company issued 100 shares, of which only 10 belonged to the Class Acategory.

Mr Bean, the chairman of Acme Ltd, held two of the Class A shares and ten of the Class B shares. The remaining issued share capital of the company was divided equally between the directors of the company, Alan and Charles. In July 2013, the general meeting of the company voted in favour of converting the Class A shares into Class B shares. Mr Bean refused to vote in favour of thisproposal.

Advise Mr Bean.

Section 630 lays down the procedure for effecting a variation of class rights, and its aim is to protect the class rights of shareholders. Section 630 provides that class rights may only be varied:

·in accordance with the relevant provisions in the company’s articles, or

·if no such provision is made in the articles, if the holders of 3/4 in value of the shares of the relevant class consent either in writing or by special resolution (passed at a separate meeting of the holders of such shares). The company must then notify the Registrar of any variation of class rights within 1 month of the date on which the variation is made

However, Section 633 CA 2006 provides that where a variation has been effected, the holders of not less than 15 per cent of the issued shares of the class affected may apply to the court within 21 days of the resolution to have it cancelled.

Additionally, it should be taken into account the judgement in Cumbian Newspapers, as it was determined that the class rights can only be varied with the consent of the beneficiaries of such rights.

In White v Bristol Aeroplane Co Ltd [1953] C the company’s articles of association provided that the rights attached to any class of shares may be ‘affected, modified, varied, dealt with, or abrogated in any manner’ with the approval of an extraordinary resolution passed at a separate meeting of the members of that class.

According to the provisions aforementioned, it is important to take into account whether the variation of the class of shares has been adopted in the articles. In other case, the holders of Class A shares should be adopted in a separate meeting, with the favourable vote of ¾ of the holders of such shares. In this case, Acme adopted the resolution in the General Meeting, so the procedure would not be valid.

Nonetheless, Mr. Bean would not have sufficient vote right to avoid the resolution. However, he would have the possibility to ask the court to cancel such variation, as he has more than 15% of such class rights. It shall be done within 21 days from the resolution.

17.‘The regime directed towards safeguarding class rights is not fit for purpose.’

As between shareholders of a company, there is a presumption of equality, so they will enjoy equal rights of voting and dividends when the Company is going concern and a right to participate in any surplus assets in the event of winding up. However, this presumption is rebutted if the Company issues shares carrying different class rights. The CA 2006 does not define “class rights”.

It was recognised in Andrews v Gas Meter Co [1897] that a company may issue shares with different rights attached to them (e.g. the preferential dividend rights attaching to preference shares). Such rights are known as class rights and are largely a matter of contract between the member and the company.

The judgment of Scott J in Cumbrian Newspapers determined that rights or benefits can be classified in 3 distinct categories:

1.those rights that are annexed to particular shares.

2.Rights or benefits which are confirmed on individual not qua members or shareholders.

3.Rights or benefits that, although not attached to any particular shares, are conferred on the beneficiary in his capacity as member or shareholder of the company.

Additionally, the House of Lords’ decision in Bushell v Faith, where the articles gave a director weighted voting rights on a resolution to remove any director from office. The judgement noted that the right was conferred on the director/beneficiaries in their capacity as shareholders.

In this sense, the rights enjoyed by a shareholder may be class rights although they are not referable to particular shares.

Section 630 lays down the procedure for effecting a variation of class rights, and its aim is to protect the class rights of shareholders. Section 630 provides that class rights may only be varied:

·in accordance with the relevant provisions in the company’s articles, or

·if no such provision is made in the articles, if the holders of 3/4 in value of the shares of the relevant class consent either in writing or by special resolution (passed at a separate meeting of the holders of such shares). The company must then notify the Registrar of any variation of class rights within 1 month of the date on which the variation is made

However, Section 633 CA 2006 provides that where a variation has been effected, the holders of not less than 15 per cent of the issued shares of the class affected may apply to the court within 21 days of the resolution to have it cancelled.

Additionally, it should be taken into account the judgement in Cumbian Newspapers, as it was determined that the class rights can only be varied with the consent of the beneficiaries of such rights.

In White v Bristol Aeroplane Co Ltd [1953] C the company’s articles of association provided that the rights attached to any class of shares may be ‘affected, modified, varied, dealt with, or abrogated in any manner’ with the approval of an extraordinary resolution passed at a separate meeting of the members of that class.

The Shareholders’’ Rights Directive is aimed at improving shareholder participation and information rights and applies to traded companies.


EXAMS MODULE B

1.Why do stock exchanges insist on timely disclosure from the companies listed on them?

The LSE is the UK’s principal Recognised Investment Exchange (RIE) under the FSMA. As such, the FSA and the LSE work together to ensure that certain rules known as the Listing Rules are complied with. On seeking a listing on the LSE, a company has to comply with these Listing Rules.

The FSMA, S 80 specifies in considerable detail the information that must be made available to the public by a company when its shares are being listed:

·The assets and liabilities, financial position, profits and losses and prospectus of the issuer of securities.

·The rights attached to those securities.

A prospectus must be submitted to and approved by the FCA.

Nonetheless, following listing, companies are subject to a range of continuing obligations to disclosure information, necessary to maintain an orderly market and to protect investors.

A listed company must publish half-yearly reports on its activities together with profits and losses during the first six months of each financial year. Further, by way of an additional requirement to the duty to issue full annual accounts and reports, it must also publish a preliminary statement of the annual results. The Listing Rules requires a listed company to publish price-sensitive information as quickly as possible. More particularly, the following matters must be disclosed:

a.any proposed change in the company’s capital structure

b.any information received concerning substantial shareholdings

c.any information received concerning interests, or changes of interests, that directors or their spouses or children may have in the shares or debentures of the company or any other company in the same group.

These continuing obligations include also obligations with regard to the UK Code on Corporate Governance. Directors of listed companies must provide a business review, covering the development and performance of the business, which identifies the main risks and uncertainties ahead as well as the company’s operations on stakeholders. The connection between disclosure and effective corporate governance is justified in its ability to act as a management discipline, i.e. it forces management to push valuable information to shareholders and the market and allows accurate pricing of shares. It also stops management hiding bad news. As such, it addresses core corporate governance problems arising from the separation of ownership fromcontrol.

One of the consequences of listing on the LSE is that the shares of the company can be easily bought and sold. This also means that the entire listed shareholding can be bought in the listed marketplace, thus effecting a takeover of the company.

Strangely, given the importance of this area, the Companies Acts contains relatively few provisions on the regulation of takeovers the conduct of the takeover itself, which is of greatest concern to shareholders and companies, is left to the Panel on Takeovers and Mergers to govern

It is essential the disclosure of information from listed companies in order to protect not only the investors but also creditors. The implications of a company being listed are that the shares can be easily traded, and the disclosure regime is vital for:

a.maintaining market confidence

b.discouraging insider dealing

c.providing investors with accurate information on which to make investment decisions.

Additionally, the disclosure regime tries to avoid insider dealing and market abuse, which is completely prohibited.

2.‘Lenders devote considerable energy to drafting charges that will be construed by the courts as fixed rather than floating. This is particularly so in relation to charges    over bookdebts.’ Discuss.

This question requires a thorough understanding of the relevant case law together with the academic   literature.

Answers should explain the distinction between fixed and floating charges. Why do lenders want the protection of a fixed charge?

What are the problems peculiar to book debts? Candidates should discuss Siebe Gorman, Chalk v Kahn and Re New Bullas. They should also discuss in detail the House of Lords decision in Spectrum and Lord Millett’s approach in Agnew.

3.‘The disclosure principle is fundamental to the orderly operation of all capital markets.’

SEE QUESTION 1.

4.‘The Court of Appeal’s decision in Re New Bullas Trading Ltd (1994) is “fundamentally mistaken”.’

Book debts are ‘debts arising in a business in which it is the proper and usual course to keep books, and which ought to be entered in such books’: Official Receiver v Tailby (1886). It is common for a company to have debts continuously owed to it by customers for goods and services that the company has rendered.

Rather than wait for payment, a company can borrow money from creditors against the debts that remain unpaid. A question that has frequently come before the courts and has generated considerable controversy is whether a fixed charge can be created over book debts, given the changing nature of such debts.

A particularly contentious decision is that reached by the Court of Appeal in Re New Bullas Trading Ltd [1994], in which it was held that it was possible to create a combined fixed and floating charge over book debts. Here, a fixed charge was created over uncollected book debts. However, as soon as the proceeds of the debts were credited to a specified bank account, a floating charge took effect over them.

The decision in Re New Bullas attracted much criticism. In Agnew v Commissioner of Inland Revenue, Lord Millett declared New Bullas ‘to be fundamentally mistaken.’ In Agnew the debenture was so drafted as to mirror that in New Bullas, but the Privy Council held that where the chargor company is free to deal with the charged asset(s) in the ordinary course of business it must be construed as a floating charge. However, where the chargee retains control over the debts and their proceeds so as to severely restrict the company’s freedom to deal with them, as in Siebe Gorman, it will be a fixed charge. The notion of a combined charge was rejected by the Privy Council.

In National Westminster Bank plc v Spectrum Plus Ltd, the chargor, Spectrum, granted a fixed (specific) charge to the bank over its book debts. Spectrum’s account was always overdrawn and the proceeds from its book debts were paid into the account, which Spectrum drew on as and when necessary. When Spectrum went into liquidation the bank sought a declaration that the debenture created a fixed charge over the company’s book debts and their proceeds. The trial judge held, applying Agnew (above) and declining to follow Re New Bullas (above), that since the charge permitted Spectrum to use the proceeds of the debts in the normal course of business, it must be construed as a floating charge.

Re Bullas was wrongly decided even though the Privy Council in Agnew had expressed the view that the decision was mistaken:

So far as the doctrine of precedent is concerned, therefore, there is no English decision which permits this court to disregard the decision of the Court of Appeal in Re New Bullas that it is possible to have a fixed charge over book debts notwithstanding that the chargor is entitled to collect and use the proceeds of the debts, which are agreed to be subject only to a floating charge.

Further, it was held that Siebe Gorman was correctly decided given that the debenture in that case clearly restricted the company’s ability to draw on the bank account into which the proceeds of its book debts were paid. It will be recalled that Slade J had held that the charge on book debts was fixed. The Court of Appeal noted that the form of debenture used in Siebe Gorman had been followed for around 25 years and so it was inclined to hold that the form of debenture had, by customary usage, acquired meaning. Lord Phillips thus concluded that:

Slade J could properly have held the charge on book debts created by the debenture to be a fixed charge simply because of the requirements (i) that the book debts should not be disposed of prior to collection and (ii) that, on collection, the proceeds should be paid to the Bank itself. It follows that he was certainly entitled to hold that the debenture, imposing as he found restrictions on the use of the proceeds of book debts, created a fixed charge over book debts.

As expected, a seven-member House of Lords overturned the decision of the Court of Appeal and overruled Siebe Gorman and Bullas. Following the line of reasoning adopted by the Privy Council in Agnew, it held that although it is possible to create a fixed charge over book debts and their proceeds (Tailby v Official Receiver (1888)), the charge in the present case was a floating charge. Lord Scott delivered the leading speech. He stressed that the ability of the chargor to continue to deal with the charged assets characterised it as floating. For a fixed charge to be created over book debts, the proceeds must be paid into a ‘blocked’ account.

5.Critically assess the case law surrounding the issue of fixed charges over book debts.

Book debts are ‘debts arising in a business in which it is the proper and usual course to keep books, and which ought to be entered in such books’: Official Receiver v Tailby (1886). It is common for a company to have debts continuously owed to it by customers for goods and services that the company has rendered.

Rather than wait for payment, a company can borrow money from creditors against the debts that remain unpaid. A question that has frequently come before the courts and has generated considerable controversy is whether a fixed charge can be created over book debts, given the changing nature of such debts.

A particularly contentious decision is that reached by the Court of Appeal in Re New Bullas Trading Ltd [1994], in which it was held that it was possible to create a combined fixed and floating charge over book debts. Here, a fixed charge was created over uncollected book debts. However, as soon as the proceeds of the debts were credited to a specified bank account, a floating charge took effect over them.

The decision in Re New Bullas attracted much criticism. In Agnew v Commissioner of Inland Revenue, Lord Millett declared New Bullas ‘to be fundamentally mistaken.’ In Agnew the debenture was so drafted as to mirror that in New Bullas, but the Privy Council held that where the chargor company is free to deal with the charged asset(s) in the ordinary course of business it must be construed as a floating charge. However, where the chargee retains control over the debts and their proceeds so as to severely restrict the company’s freedom to deal with them, as in Siebe Gorman, it will be a fixed charge. The notion of a combined charge was rejected by the Privy Council.

In National Westminster Bank plc v Spectrum Plus Ltd, the chargor, Spectrum, granted a fixed (specific) charge to the bank over its book debts. Spectrum’s account was always overdrawn and the proceeds from its book debts were paid into the account, which Spectrum drew on as and when necessary. When Spectrum went into liquidation the bank sought a declaration that the debenture created a fixed charge over the company’s book debts and their proceeds. The trial judge held, applying Agnew (above) and declining to follow Re New Bullas (above), that since the charge permitted Spectrum to use the proceeds of the debts in the normal course of business, it must be construed as a floating charge.

Re Bullas was wrongly decided even though the Privy Council in Agnew had expressed the view that the decision was mistaken:

So far as the doctrine of precedent is concerned, therefore, there is no English decision which permits this court to disregard the decision of the Court of Appeal in Re New Bullas that it is possible to have a fixed charge over book debts notwithstanding that the chargor is entitled to collect and use the proceeds of the debts, which are agreed to be subject only to a floating charge.

Further, it was held that Siebe Gorman was correctly decided given that the debenture in that case clearly restricted the company’s ability to draw on the bank account into which the proceeds of its book debts were paid. It will be recalled that Slade J had held that the charge on book debts was fixed. The Court of Appeal noted that the form of debenture used in Siebe Gorman had been followed for around 25 years and so it was inclined to hold that the form of debenture had, by customary usage, acquired meaning. Lord Phillips thus concluded that:

Slade J could properly have held the charge on book debts created by the debenture to be a fixed charge simply because of the requirements (i) that the book debts should not be disposed of prior to collection and (ii) that, on collection, the proceeds should be paid to the Bank itself. It follows that he was certainly entitled to hold that the debenture, imposing as he found restrictions on the use of the proceeds of book debts, created a fixed charge over book debts.

As expected, a seven-member House of Lords overturned the decision of the Court of Appeal and overruled Siebe Gorman and Bullas. Following the line of reasoning adopted by the Privy Council in Agnew, it held that although it is possible to create a fixed charge over book debts and their proceeds (Tailby v Official Receiver (1888)), the charge in the present case was a floating charge. Lord Scott delivered the leading speech. He stressed that the ability of the chargor to continue to deal with the charged assets characterised it as floating. For a fixed charge to be created over book debts, the proceeds must be paid into a ‘blocked’ account.

6. “The decision of the House of Lords in Spectrum did little to clarify the issue of whether it is possible to have a fixed charge over bookdebts.”

SEE PRIOR QUESTIONS

7.“The Company Law Review recommended that registration of a charge would no longer be ‘a mere perfection requirement but would become a priority point.’  This has been endorsed by the LawCommission.”

What advantages, if any, would this bring to the registration regime?

Understandably, a creditor who is considering lending money to a company may wish to find out the extent of its indebtedness. A company is therefore required to register certain details of any charges on its assets. Section 860 of the CA 2006 specifies the categories of charge that must be registered. These include, among others:

·a charge for the purpose of securing any issue of debentures

·a charge on or on any interest in land, but not including a charge for any rent or other periodical sum issuing out of the land

·a charge on book debts of the company

·a floating charge on the company’s undertaking or property.

Part 25 of the CA 2006 lays down the registration requirements. The principal obligations are contained in ss.860 and 870 which provide that prescribed particulars of certain categories of charges created by a company, together with the instrument creating it, must be delivered to or received by the Companies Registrar within 21 days of the creation of the charge. Failure to deliver the particulars to the Registrar within the 21-day period renders the charge void against a liquidator or any creditor of the company (s.874; see Smith v Bridgend County Borough Council [2002]. If a charge has not been registered the company and every defaulting officer is liable to a fine. When a charge is registered, the Registrar must issue a certificate stating the amount secured by the charge. The certificate is conclusive evidence that the statutory registration requirements have been complied with. The charge cannot then be set aside if the particulars are incorrect.

Registration is a perfection requirement. It does not determine priority, which, depends upon the date the charge was created.

Significantly, under CLRSG proposals registration would no longer be ‘a mere perfection requirement but would become a priority point.’ Under this proposal, all that was filed would be a notice (‘financing statement’) giving particulars of the property over which the filer had taken or intended to take security and certain other details, including the name and address of the creditor from whom a person searching the register could obtain further information. The 21-day registration rule would be abandoned, as would the requirement that the charge instrument be presented with the application for registration.

Detailed rules are set out which would form the basis for a system under which the priority of registered charges would be determined by their dates of registration at Companies House. The period between creation and registration would cease to be relevant as there would be no period of invisibility. Registration would cease to be a perfection requirement and would become a priority point.

8.Is disclosure by listed companies really such a great idea? Discuss.

The LSE is the UK’s principal Recognised Investment Exchange (RIE) under the FSMA. As such, the FSA and the LSE work together to ensure that certain rules known as the Listing Rules are complied with. On seeking a listing on the LSE, a company has to comply with these Listing Rules.

The FSMA, S 80 specifies in considerable detail the information that must be made available to the public by a company when its shares are being listed:

·The assets and liabilities, financial position, profits and losses and prospectus of the issuer of securities.

·The rights attached to those securities.

A prospectus must be submitted to and approved by the FCA.

Nonetheless, following listing, companies are subject to a range of continuing obligations to disclosure information, necessary to maintain an orderly market and to protect investors.

A listed company must publish half-yearly reports on its activities together with profits and losses during the first six months of each financial year. Further, by way of an additional requirement to the duty to issue full annual accounts and reports, it must also publish a preliminary statement of the annual results. The Listing Rules requires a listed company to publish price-sensitive information as quickly as possible. More particularly, the following matters must be disclosed:

d.any proposed change in the company’s capital structure

e.any information received concerning substantial shareholdings

f.any information received concerning interests, or changes of interests, that directors or their spouses or children may have in the shares or debentures of the company or any other company in the same group.

These continuing obligations include also obligations with regard to the UK Code on Corporate Governance. Directors of listed companies must provide a business review, covering the development and performance of the business, which identifies the main risks and uncertainities ahead as well as the company’s operations on stakeholders. The connection between disclosure and effective corporate governance is justified in its ability to act as a management discipline, i.e. it forces management to push valuable information to shareholders and the market and allows accurate pricing of shares. It also stops management hiding bad news. As such, it addresses core corporate governance problems arising from the separation of ownership fromcontrol.

One of the consequences of listing on the LSE is that the shares of the company can be easily bought and sold. This also means that the entire listed shareholding can be bought in the listed marketplace, thus effecting a takeover of the company.

Strangely, given the importance of this area, the Companies Acts contains relatively few provisions on the regulation of takeovers the conduct of the takeover itself, which is of greatest concern to shareholders and companies, is left to the Panel on Takeovers and Mergers to govern

It is essential the disclosure of information from listed companies in order to protect not only the investors but also creditors. The implications of a company being listed are that the shares can be easily traded, and the disclosure regime is vital for:

d.maintaining market confidence

e.discouraging insider dealing

f.providing investors with accurate information on which to make investment decisions.

Additionally, the disclosure regime tries to avoid insider dealing and market abuse, which is completely prohibited.

9.“The current regime governing the priority of company charges is in dire need of reform.

The general rule is that security interests rank according to the order of their creation. However, a feature of the floating charge is that the company can continue to deal with the charged assets in the ordinary course of business. Therefore, a fixed charge can be created which will take priority over an earlier floating charge.

In order to protect their priority floating charge, it is possible for chargees to insert a so-called negative pledge clause in the charge. This would prohibit the chargor from creating a charge that ranks equally with (pari passu) or in priority to the earlier floating charge. Such a restriction is not inconsistent with the nature of a floating charge: Re Brightlife Ltd [1987].

However, it should be noted that the subsequent chargee will not lose priority unless he has actual notice of the negative pledge clause. Mere notice of the earlier floating charge is not sufficient: Wilson v Kelland.

Where there are competing floating charges, the governing principle is that the first in time takes priority. However, the parties may agree that the company may create a subsequent floating charge which will take priority or rank pari passu with the earlier floating charge: Re Benjamin Cope & Sons Ltd [1914].

Registration is a perfection requirement. It does not determine priority, which, depends upon the date the charge was created.

Significantly, under CLRSG proposals registration would no longer be ‘a mere perfection requirement but would become a priority point.’ Under this proposal, all that was filed would be a notice (‘financing statement’) giving particulars of the property over which the filer had taken or intended to take security and certain other details, including the name and address of the creditor from whom a person searching the register could obtain further information. The 21-day registration rule would be abandoned, as would the requirement that the charge instrument be presented with the application for registration.

Detailed rules are set out which would form the basis for a system under which the priority of registered charges would be determined by their dates of registration at Companies House. The period between creation and registration would cease to be relevant as there would be no period of invisibility. Registration would cease to be a perfection requirement and would become a priority point.

10.“The distinction between fixed and floating charges is of little relevance?” Discuss.

A company may grant a fixed charge to a creditor over certain property, such as a warehouse. Such a charge is similar to a mortgage in that the rights of the creditor (chargee) are attached immediately to the property, and the company’s (chargor’s) power to deal with the asset is restricted. The company will thus have to obtain the creditor’s consent before it deals with the charged asset. Lord Millett stated in Agnew v Commissioner of Inland Revenue [2001] that:

A fixed charge gives the holder of the charge an immediate proprietary interest in the assets subject to the charge which binds all those into whose hands the assets may come with notice of the charge.

Professor Goode has stated that a charge or security interest is a right in rem created by a grant or declaration of trust. If fixed, this implies a restriction on the debtor’s dominion over the asset or assets in question.

As its name suggests, a floating charge floats over the whole or a part of the chargor’s assets, which may fluctuate as a result of acquisitions and disposals. Corporate property that can be made subject to a floating charge includes stock in trade, plant, and book debts (receivables). The distinguishing feature of a floating charge is that the company can continue to deal with the assets in the ordinary course of business without having to obtain the chargee’s permission.

The distinction between a fixed and floating charge assumes critical importance if the company goes into liquidation because of the ranking of chargees against the general body of creditors.

In Re Yorkshire Woolcombers Association [1903] the following distinguishing features of a floating charge:

·it is a charge on a class of assets of a company present and future;

·that class is one which, in the ordinary course of the business of the company, would be changing from time to time; and

·the company may carry on its business in the ordinary way as far as concerns the particular class [charged].

In National Westminster Bank plc v Spectrum Plus Ltd [2004], Lord Phillips MR noted that:

A fixed charge arose where the chargor agreed that he would no longer have the right of free disposal of the assets charged, but that they should stand as security for the discharge of obligations owed to the chargee. A floating charge was normally granted by a company which wished to be free to acquire and dispose of assets in the normal course of its business, but nonetheless to make its assets available as security to the chargee in priority to other creditors should it cease to trade. The hallmark of the floating charge was the agreement that the chargor should be free to dispose of his assets in the normal course of business unless and until the chargee intervened.

In determining whether a charge is fixed or floating the courts will look to the substance of the matter, irrespective of what description the parties use to categorise it. In Agnew v Commissioner of Inland Revenue, it is explained that:

In deciding whether a charge is a fixed or a floating charge, the Court is engaged in a two-stage process.

1.At the first stage it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object at this stage is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets.

2.The second stage of the process is one of categorisation. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gathered from the language of the instrument, is to grant the company rights in respect of the charged assets which are inconsistent with the nature of a fixed charge, then the charge cannot be a fixed charge however they may have chosen to describe it.

In Arthur D Little Ltd v Ableco Finance LLC [2002] the company, Arthur D Little Ltd, guaranteed the liabilities of its two parent companies to Ableco by creating a charge, described as a first fixed charge, over its shareholding in a subsidiary company, CCL.

The chargor company retained both its voting and its dividend rights with respect to the shares. The company’s administrator argued that it was a floating charge.

It was held, applying Lord Millett’s reasoning in Agnew, that it was a question of law whether or not the charge was fixed or floating.

In National Westminster Bank plc v Spectrum Plus Ltd: The object of the floating charge was to provide security to the chargee in a form that would not inhibit the chargor from continuing to carry on its business. A floating charge was not, and is not, easy to define. Initially the courts tended to analyse it as a charge coupled with a licence by the chargee to the chargor to dispose of the assets charged. Thus, in Robson v Smith [1895]

However, in Evans v Rival Granite Quarries Ltd [1910] provided the following, more accurate, description of a floating charge:

A floating security is not a future security; it is a present security, which presently affects all the assets of the company expressed to be included in it. On the other hand, it is not a specific security; the holder cannot affirm that the assets are specifically mortgaged to him. The assets are mortgaged in such a way that the mortgagorcan deal with them without the concurrence of the mortgagee. A floating security is not a specific mortgage of the assets, plus a licence to the mortgagor to dispose of them in the course of his business, but is a floating mortgage applying to every item comprised in the security, but not specifically affecting any item until some event occurs or some act on the part of the mortgagee is done which causes it to crystallise into a fixed security.

11.Does disclosure amount toaccountability?

The LSE is the UK’s principal Recognised Investment Exchange (RIE) under the FSMA. As such, the FSA and the LSE work together to ensure that certain rules known as the Listing Rules are complied with. On seeking a listing on the LSE, a company has to comply with these Listing Rules. The main initial rules cover matters such as:

·the availability of past accounts

·compliance with a minimum market capitalisation

·a minimum ‘proportion of the shares in public hands’ requirement.

Section 80 of the FSMA specifies the detailed disclosure requirements when listing, covering:

all such information as investors and their professional advisers would reasonably require, and reasonably expect to find there, for the purpose of making an informed assessment of: (a) the assets and liabilities, financial position, profits and losses, and prospects of the issuer of the securities; and (b) the rights attaching to those securities.

If a company is listing for the first time, its prospectus1 must be submitted to, and approved by, the FSA (s.84 FSMA, and the Listing Rules).

Listed companies also need to comply with the continuing obligations regime. As such, a listed company has a continuing obligation to disclose information necessary to maintain an orderly market and protect investors.

This disclosure regime is vital for:

·maintaining market confidence

·discouraging insider dealing

·providing investors with accurate information on which to make investment decisions. ç

The continuing obligations are listed in the FCA Listing Rules. A listed company must publish half-yearly reports on its activities together with profits and losses during the first six months of each financial year. Further, by way of an additional requirement to the duty to issue full annual accounts and reports, it must also publish a preliminary statement of the annual results. The Listing Rules requires a listed company to publish price-sensitive informationas quickly as possible.

Taking into account the disclosure requirements, it can be stated that the accountability documentation forms part of such disclosure, as a fundamental issue of companies to be shared with shareholders, potential shareholders and creditors.

12.‘The legal nature of security interests and the system for registration of company charges is in need of fundamental statutoryoverhaul.’

The general rule is that security interests rank according to the order of their creation. However, a feature of the floating charge is that the company can continue to deal with the charged assets in the ordinary course of business. Therefore, a fixed charge can be created which will take priority over an earlier floating charge.

In order to protect their priority floating charge, it is possible for chargees to insert a so-called negative pledge clause in the charge. This would prohibit the chargor from creating a charge that ranks equally with (pari passu) or in priority to the earlier floating charge. Such a restriction is not inconsistent with the nature of a floating charge: Re Brightlife Ltd [1987].

However, it should be noted that the subsequent chargee will not lose priority unless he has actual notice of the negative pledge clause. Mere notice of the earlier floating charge is not sufficient: Wilson v Kelland.

Where there are competing floating charges, the governing principle is that the first in time takes priority. However, the parties may agree that the company may create a subsequent floating charge which will take priority or rank pari passu with the earlier floating charge: Re Benjamin Cope & Sons Ltd [1914].

Significantly, under CLRSG proposals registration would no longer be ‘a mere perfection requirement but would become a priority point.’ Under this proposal, all that was filed would be a notice (‘financing statement’) giving particulars of the property over which the filer had taken or intended to take security and certain other details, including the name and address of the creditor from whom a person searching the register could obtain further information. The 21-day registration rule would be abandoned, as would the requirement that the charge instrument be presented with the application for registration.

Detailed rules are set out which would form the basis for a system under which the priority of registered charges would be determined by their dates of registration at Companies House. The period between creation and registration would cease to be relevant as there would be no period of invisibility. Registration would cease to be a perfection requirement and would become a priority point.

Other proposals considered by the CLRSG include implementation of a number of key provisions contained in the CA 1989 which were not brought into force. For example, an unregistered charge would also have been invalidated against ‘any person who for value acquires an interest in or right over property subject to the charge.’

In its Final Report the Steering Group recommended that: the current scheme for the registration of company charges under Part XII of the Companies Act 1985 should be replaced by a system of ‘notice filing’; the new system should encompass functionally-equivalent legal devices (commonly termed ‘quasi-security’ devices) such as hire- purchase and sales on retention of title terms; and consideration should be given to whether or not any new system should be extended to charges created by individuals and unincorporated businesses [which was outside the CLRSG’s terms of reference].

In August 2005 the Law Commission published its final report, Company Security Interests. Its principal proposals include:

·A new system of electronic notice filing for registering charges.

·Removal of the 21-day time limit.

·Extending the list of registrable charges so that all charges are registrable.

·Clearer priority rules. Priority between competing charges will be by date of filing unless otherwise agreed between the parties involved (

13.Has disclosure become even more important since the financialcrisis?

The financial crisis of 2008 brought significant criticism of the shared regulatory arrangements in the UK, as failures at the FSA, the Bank of England and the Treasury played a role in the crisis.

Eventually, extensive EU and UK institutional reform has occurred with the domestic break-up of the FSA and creation of the Prudential Regulatory Authority, the Financial Conduct Authority and the Financial Policy Committee.

At the EU level, supervision bodies were created: the European Banking Authority, European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority.

14.‘The difficulties in distinguishing between fixed and floating charges are all too apparent when the nature of a charge over book debts is inquestion.’

SEE QUESTIONS 5, 6.

15.‘ThedecisionsinSiebeGormanandReNewBullasshould not have been overruled in Spectrum. In so doing, the House of Lords severely restricted the options available tocompanies seeking to secure their borrowings.’

Book debts are ‘debts arising in a business in which it is the proper and usual course to keep books, and which ought to be entered in such books’: Official Receiver v Tailby (1886). It is common for a company to have debts continuously owed to it by customers for goods and services that the company has rendered.

Rather than wait for payment, a company can borrow money from creditors against the debts that remain unpaid. A question that has frequently come before the courts and has generated considerable controversy is whether a fixed charge can be created over book debts, given the changing nature of such debts.

A particularly contentious decision is that reached by the Court of Appeal in Re New Bullas Trading Ltd [1994], in which it was held that it was possible to create a combined fixed and floating charge over book debts. Here, a fixed charge was created over uncollected book debts. However, as soon as the proceeds of the debts were credited to a specified bank account, a floating charge took effect over them.

The decision in Re New Bullas attracted much criticism. In Agnew v Commissioner of Inland Revenue, Lord Millett declared New Bullas ‘to be fundamentally mistaken.’ In Agnew the debenture was so drafted as to mirror that in New Bullas, but the Privy Council held that where the chargor company is free to deal with the charged asset(s) in the ordinary course of business it must be construed as a floating charge. However, where the chargee retains control over the debts and their proceeds so as to severely restrict the company’s freedom to deal with them, as in Siebe Gorman, it will be a fixed charge. The notion of a combined charge was rejected by the Privy Council.

In National Westminster Bank plc v Spectrum Plus Ltd, the chargor, Spectrum, granted a fixed (specific) charge to the bank over its book debts. Spectrum’s account was always overdrawn and the proceeds from its book debts were paid into the account, which Spectrum drew on as and when necessary. When Spectrum went into liquidation the bank sought a declaration that the debenture created a fixed charge over the company’s book debts and their proceeds. The trial judge held, applying Agnew (above) and declining to follow Re New Bullas (above), that since the charge permitted Spectrum to use the proceeds of the debts in the normal course of business, it must be construed as a floating charge.

Re Bullas was wrongly decided even though the Privy Council in Agnew had expressed the view that the decision was mistaken:

So far as the doctrine of precedent is concerned, therefore, there is no English decision which permits this court to disregard the decision of the Court of Appeal in Re New Bullas that it is possible to have a fixed charge over book debts notwithstanding that the chargor is entitled to collect and use the proceeds of the debts, which are agreed to be subject only to a floating charge.

Further, it was held that Siebe Gorman was correctly decided given that the debenture in that case clearly restricted the company’s ability to draw on the bank account into which the proceeds of its book debts were paid. It will be recalled that Slade J had held that the charge on book debts was fixed. The Court of Appeal noted that the form of debenture used in Siebe Gorman had been followed for around 25 years and so it was inclined to hold that the form of debenture had, by customary usage, acquired meaning. Lord Phillips thus concluded that:

Slade J could properly have held the charge on book debts created by the debenture to be a fixed charge simply because of the requirements (i) that the book debts should not be disposed of prior to collection and (ii) that, on collection, the proceeds should be paid to the Bank itself. It follows that he was certainly entitled to hold that the debenture, imposing as he found restrictions on the use of the proceeds of book debts, created a fixed charge over book debts.

As expected, a seven-member House of Lords overturned the decision of the Court of Appeal and overruled Siebe Gorman and Bullas. Following the line of reasoning adopted by the Privy Council in Agnew, it held that although it is possible to create a fixed charge over book debts and their proceeds (Tailby v Official Receiver (1888)), the charge in the present case was a floating charge. Lord Scott delivered the leading speech. He stressed that the ability of the chargor to continue to deal with the charged assets characterised it as floating. For a fixed charge to be created over book debts, the proceeds must be paid into a ‘blocked’ account.

Candidates should conclude by assessing whether the options available to companies for secured borrowing have been restricted.

16.Why is disclosure so important to shareholders?

The LSE is the UK’s principal Recognised Investment Exchange (RIE) under the FSMA. As such, the FSA and the LSE work together to ensure that certain rules known as the Listing Rules are complied with. On seeking a listing on the LSE, a company has to comply with these Listing Rules.

The FSMA, S 80 specifies in considerable detail the information that must be made available to the public by a company when its shares are being listed:

·The assets and liabilities, financial position, profits and losses and prospectus of the issuer of securities.

·The rights attached to those securities.

A prospectus must be submitted to and approved by the FCA.

Nonetheless, following listing, companies are subject to a range of continuing obligations to disclosure information, necessary to maintain an orderly market and to protect investors.

A listed company must publish half-yearly reports on its activities together with profits and losses during the first six months of each financial year. Further, by way of an additional requirement to the duty to issue full annual accounts and reports, it must also publish a preliminary statement of the annual results. The Listing Rules requires a listed company to publish price-sensitive information as quickly as possible. More particularly, the following matters must be disclosed:

g.any proposed change in the company’s capital structure

h.any information received concerning substantial shareholdings

i.any information received concerning interests, or changes of interests, that directors or their spouses or children may have in the shares or debentures of the company or any other company in the same group.

These continuing obligations include also obligations with regard to the UK Code on Corporate Governance. Directors of listed companies must provide a business review, covering the development and performance of the business, which identifies the main risks and uncertainties ahead as well as the company’s operations on stakeholders. The connection between disclosure and effective corporate governance is justified in its ability to act as a management discipline, i.e. it forces management to push valuable information to shareholders and the market and allows accurate pricing of shares. It also stops management hiding bad news. As such, it addresses core corporate governance problems arising from the separation of ownership fromcontrol.

One of the consequences of listing on the LSE is that the shares of the company can be easily bought and sold. This also means that the entire listed shareholding can be bought in the listed marketplace, thus effecting a takeover of the company.

Strangely, given the importance of this area, the Companies Acts contains relatively few provisions on the regulation of takeovers the conduct of the takeover itself, which is of greatest concern to shareholders and companies, is left to the Panel on Takeovers and Mergers to govern

It is essential the disclosure of information from listed companies in order to protect not only the investors but also creditors. The implications of a company being listed are that the shares can be easily traded, and the disclosure regime is vital for:

g.maintaining market confidence

h.discouraging insider dealing

i.providing investors with accurate information on which to make investment decisions.

Additionally, the disclosure regime tries to avoid insider dealing and market abuse, which is completely prohibited.

The disclosure is fundamental for shareholder protection because of its ability to act as a management discipline in that it forces management to push valuable information to shareholders and allows accurate pricing of shares. It also stops management from hiding bad news.

17.Even though Public Limited Companies sell shares to the public they are still private entities where the application of transparency rules is inappropriate.’

Given that company law generally takes the view that incorporation is only gained if some transparency as to officers and accounts is provided, companies – even private ones – are generally subjected to transparency requirements. Public companies that have mass investment from the general public have even more onerous transparency requirements, justified on the basis of their potential effect on the public. A key aspect of disclosure is also shareholder protection (Company law, UK Corporate Governance Code and the Takeover Code), which has nothing to do with their private or public nature but is rather an internal protective measure.


EXAMS MODULE C

1.Albert is the managing director of Acme plc, a large pharmaceutical company. In recent years the company has enjoyed record levels of profitability. It is generally recognised that the company’s success is due to Albert’s entrepreneurial and managerial skills and his colleagues on the board have been content to turn a blind eye to his more dubious activities. The articles of association of Acme provide:

90.Remuneration of directors. The board shall fix the annual remuneration of the directors provided that without the consent of the company in general meeting such remuneration shall not exceed the sum of £1 million per annum.

91.The board may, in addition to the remuneration authorised in article 90, grant special remuneration to any director who serves on any committee of the company.

In the past 12 months the following events have occurred:

(i)Albert is paid a £1 million consultation fee for successfully guiding Acme plc through its takeover of Xon Ltd, a competing business. This payment was agreed by a special committee of the Acme plc board constituted to advise the main board on mergers and acquisitions.

(ii)Albert forms a private company, Drugco Ltd, which processes raw materials for use in pharmaceuticals. Albert places large orders on behalf of Acme plc with Drugco Ltd without informing Acme plc of his interest in Drugco Ltd. The raw materials could have been obtained from another employer at a cheaperprice.

(iii)Albert is approached by Bsquare Inc., a large US pharmaceutical company. Bsquare Inc. intends to establish a drug manufacturing plant in England and wishes to acquirethepatentwhichAcmeplcholdsonacoldandflu remedy. Bsquare Inc. pays £10 million to Albert, in return for Albert convincing the Acme plc board to vote in favour of the patent sale. The sale goes   through.

(iv)Shortly before resigning from the board of Acme plc, Albert forms another company, Zenco Ltd, and convinces a number of key Acme personnel to resign their posts and join him at Zenco Ltd.

Acme plc has recently been taken over by Xtels plc and a new board has been appointed. The details of the events outlined above have now come to the notice of the board of Xtels plc and they wish to pursue any claims they may have against Albert and his boardroom colleagues at Acme plc.

Advise the board of Xtels plc.

The classic statement on the position of directors was given by Lord Cranwoth on Aberdeen Rly Co v Blaikie Bros: “the directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is of course the duty of those agents so to act as bet to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards the principal.

However, unlike trustees, directors do not hold the legal title of property. But directors are analogous to trustees because they have the duty to manage the company’s affairs in the interest of the company. As explained in Towers v Premier Waste Management ltd (2011): “a director of a company is appointed to direct its affairs. In doing so is his duty to use his position in the company. To promote its success and to protect its interest. In accordance with equitable principles, the special relationship with the company took the form of a duty of loyalty and a duty to avoid conflict between his personal interest and his duty to the company”.

i. The central issue is the no-conflict rule and the corporate opportunity doctrine: restated in s.175. The conduct of Albert may imply a breach of the duty to avoid conflicts of interest, stablished in section 175 of the CA 2006. This duty provides:

(1) A director of a company must avoid a situation in which he has or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.

(2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity).

The fundamental objective of the duty is to curb any temptation which directors may succumb to when faced with the opportunity of preferring their own interests over and above those of the company.

An incident of the duty to avoid a conflict of interests is the so- called corporate opportunity doctrine. This ‘makes it a breach of fiduciary duty by a director to appropriate for his own benefit an economic opportunity which is considered to belong rightly to the company which he serves’

ii. The underlying rationale of the self-dealing rule which prohibits a director from being interested in a transaction to which the company was a party was explained by the House of Lords in Aberdeen Rly Co v Blaikie Bros (1854). S.177(1), provides that: ‘[i]f a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors.’

iii. In this case, it is important to determine whether the patent sale is bona fide in the interests of MLP Ltd. Section 175 establishes that directors must exercise their powers independently and not subordinate their powers to the control of others by, for example, contracting with a third party as to how a particular discretion conferred by the articles will be exercised. This is a facet of the duty to promote the success of the company laid down in s.172. Directors are not permitted to delegate their powers unless the company’s constitution provides otherwise.

The duty operates so as to prohibit directors fettering their discretion by contracting with an outsider as to how a particular discretion conferred by the articles will be exercised except, possibly, where this is to the company’s commercial benefit.

Additionally, Albert may be in breach of the duty not to accept benefits from third parties. Section 176(1) provides that a director must not accept a benefit from a third party conferred by reason of (a) his being a director, or (b) his doing (or not doing) anything as director. This duty is an element of the wider no-conflict duty laid down in s.175 and it too will not be infringed if acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. It should be noted that it applies only to benefits conferred because the director is a director of the company or because of something that the director does or does not do as director.

iv. Albert may breach article 175(3) of the CA 2006. A major concern expressed by the Company Law Review was that the case law on conflicts of duty holds the potential to ‘fetter entrepreneurial and business start-up activity by existing directors’ and that ‘the statutory statement of duties should only prevent the exploitation of business opportunities where there is a clear case for doing so’. The 2005 White Paper echoes this concern, stating that it is important that the duties do not impose impractical and onerous requirements which stifle entrepreneurial activity.

Section 175(5)(a) therefore implements the CLRSG’s recommendation that conflicts may be authorised by independent directors unless, in the case of a private company, its constitution otherwise provides. Further, s.175(6) provides that board authorisation is effective only if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid even without the participation of the conflicted directors; the votes of the conflicted directors in favour of the decision will be ignored and they are not counted in the quorum.

In this sense, Albert has noy obtained consent to execute the dealings aforementioned.

Section 178 of the CA 2006 preserves the existing civil consequences of breach (or threatened breach) of any of the general duties.

Section 178(2) provides that the statutory duties are to be regarded as fiduciary, with the exception of the duty to exercise reasonable care, skill, and diligence (Thus, the duties are enforceable in the same way as any other fiduciary duty owed to a company by its directors.

In the case of fiduciary duties, the consequences of breach may include:

·Damages or compensation where the company has suffered loss.

·Restoration of the company’s property.

·An account of profits made by the director.

·Injunction or declaration.

The liability to account arises even where the director acted honestly and where the company could not otherwise have obtained the benefit. In Murad v Al-Saraj [2005], Arden LJ explained the policy underlying such liability:

It may be asked why equity imposes stringent liability of this nature…equity imposes stringent liability on a fiduciary as a deterrent – pour encourager les autres. Trust law recognises what in company law is now sometimes called the ‘agency’ problem. There is a separation of beneficial ownership and control and the shareholders (who may be numerous and only have small numbers of shares) or beneficial owners cannot easily monitor the actions of those who manage their business or property on a day-to-day basis. Therefore, in the interests of efficiency and to provide an incentive to fiduciaries to resist the temptation to misconduct themselves, the law imposes exacting standards on fiduciaries and an extensive liability to account.

In CMS Dolphin Ltd v Simonet Lawrence Collins J subjected the issue of remedies for diverting a corporate opportunity to detailed analysis. He held that S was a constructive trustee of the profits referable to exploiting the corporate opportunity and, in general, it made no difference whether the opportunity was first taken up by the wrongdoer or by a ‘corporate vehicle’ established by him for that purpose:

I do not consider that the liability of the directors in Cook v Deeks would have been in any way different if they had procured their new company to enter the contract directly, rather than (as they did) enter into it themselves and then transfer the benefit of the contract to a new company.

The basis of a director’s liability in this situation is that, as seen in Cook v Deeks, the opportunity in question is treated as if it were an asset of the company in relation to which the director had fiduciary duties. He thus becomes a constructive trustee ‘of the fruits of his abuse of the company’s property’ (per Lawrence Collins J, above).

2.‘The codification of directors’ duties in Part 10 of the Companies Act 2006 will stultify any judicial development of the core duty of loyalty’. Discuss.

Historically, directors’ duties were developed by the courts of equity, largely by analogy with the rules applying to trustees. One of the most significant changes introduced by the CA 2006, Pt 10 was to codify these common law and equitable duties applying to directors.

Codification was recommended by the Law Commissions and the Company Law Review. The primary reason for recommending codification was to make the relevant rules clear and accessible (not only for directors but also for those affected by their decisions).

Section 170 of the CA 2006 sets out the scope and nature of the codified general duties, being:

1.Duty to act within powers.

2.Duty to promote the success of the company.

3.Duty to exercise independent judgement.

4.Duty to exercise reasonable care, skill and diligence.

5.Duty to avoid conflicts of interest.

6.Duty not to accept benefits from third parties.

7.Duty to declare an interest in a proposed or existing transaction or arrangement.

This codification supersedes the older case law. But those cases remain relevant to the interpretation of the new statutory provisions where those codified duties are formulated in a way that quite faithfully reflects the older case law. The rules set out in the CA 2006 are expressed at a sufficiently high level of generality so as to be capable of judicial development within their terms.

The Law Commissions examined the case for restating directors’ duties in statute. Arguments against this were founded on loss of flexibility, while those in favour saw advantages in terms of certainty and accessibility. The Commission’s conclusion was that the case for legislative restatement was made out and that the issue of inflexibility could be addressed by (i) ensuring the restatement was at a high level of generality by way of a statement of principles and (ii) providing that it was not exhaustive, that is, while it would be a comprehensive and binding statement of the law in the field covered, it would not prevent the courts inventing new general principles outside the field.

Company Law Review viewed these sections as the key ‘scoping’ provisions:

·Section 170(3) makes it clear that while the general duties are ‘based on certain common law rules and equitable principles’, the statutory restatement has ‘effect in place of those rules and principles’. In other words, the restatement replaces them.

·Section 170(4) directs the courts to interpret and apply the general duties having regard to the pre-existing case law.  Much of this case law, of course, developed by analogy with the duties of trustees and other fiduciaries and so it seems that the intention here is to maintain the relationship of the law on directors’ duties with its wider equitable origins.

Although the courts are given no legislative assistance for determining when or to what extent the pre-existing jurisprudence can be harnessed as an aid to interpreting the statutory restatement, nevertheless s.170(4) seems to be directed towards facilitating the continued development of    the duty by the courts.

3.‘It is difficult to see how the policy objectives which underpinned the Company Law Review are reflected in the statutory statement of directors’ duties contained inthe Companies Act 2006, Part 10.’

A concern of both equity and common law courts was to develop a corpus of rules designed to prevent directors abusing their considerable powers. The policy objective is based on prophylaxis and the result is a formidable body of reported decisions in which the judges have been developing the contours of directors’ duties.

Confronted with this body of law, the Company Law Review (CLR), in line with its objectives of maximizing clarity and accessibility, recommended that the duties of directors should be codified by a way of statutory restatement. Thus, the general duties of directors appear in Part 10 of the CA. Company Law Review viewed these sections as the key ‘scoping’ provisions:

·Section 170(3) makes it clear that while the general duties are ‘based on certain common law rules and equitable principles’, the statutory restatement has ‘effect in place of those rules and principles’. In other words, the restatement replaces them.

·Section 170(4) directs the courts to interpret and apply the general duties having regard to the pre-existing case law. Much of this case law, of course, developed by analogy with the duties of trustees and other fiduciaries and so it seems that the intention here is to maintain the relationship of the law on directors’ duties with its wider equitable origins.

The Law Commissions examined the case for restating directors’ duties in statute. Arguments against this were founded on loss of flexibility, while those in favour saw advantages in terms of certainty and accessibility. The Commission’s conclusion was that the case for legislative restatement was made out and that the issue of inflexibility could be addressed by (i) ensuring the restatement was at a high level of generality by way of a statement of principles and (ii) providing that it was not exhaustive, that is, while it would be a comprehensive and binding statement of the law in the field covered, it would not prevent the courts inventing new general principles outside the field.

Although the courts are given no legislative assistance for determining when or to what extent the pre-existing jurisprudence can be harnessed as an aid to interpreting the statutory restatement, nevertheless s.170(4) seems to be directed towards facilitating the continued development of the duty by the courts.

Nonetheless, it is noteworthy that the issue of restating directors’ duties in statutory form caused considerable controversy and generated a widespread debate.

In its Final Report, the Steering Group recommended a legislative statement of directors’ duties for three principal reasons:

1.To provide a greater clarity on what it is expected to directors and to make the law more accessible, it would help the standards of governance and provide authoritative guidance and clarification of issues such as “scope” in a way that reflects modern business needs and wider expectations of responsible business behaviours.

2.To enable defects in the common law to be corrected in important areas.

3.To make developments of the law in this area more predictable.

The government accepted the proposals and it is clear that the approach taken by the CLR shaped the framing of Part 10 of the CA.

4.Acme Ltd.’s principal business activity is commercial property development. It specialises in designing and building business parks around the UK. It has five directors, Oliver, Fagin, Dodger, Nancy and Marlow. Each of the directors holds 20 per cent of the company’s issued share capital.

While attending a party in Brighton one weekend, Oliver sees a large plot of industrial land for sale which he thinks would make an ideal business park. Fagin is visiting a potential site on behalf of AcmeLtdwithanestateagent,BillSykes,whoishisbrother.

During the visit Bill Sykes tells Fagin of an opportunity to invest in Formula One car racing which he says will bring great returns.

At the next board meeting of Acme Ltd, Oliver tells his colleagues of the site he has seen near Brighton but goes on to add that he thinks the asking price is too much and that the site is located on the wrong side of the city. Dodger, Acme Ltd.’s finance director, expresses the concern that the finances of the company are in such a poor state anyway that it should not invest in acquiring new sites foratleast12months.Allofthedirectorsagreetothisstrategy.

Oliver incorporates a new company, Dickens Ltd, which acquires the plot of land in Brighton for £250,000. Fagin borrows £1 million from UpBeat Bank plc and invests the whole sum in Formula One racing as recommended by his brother, Bill Sykes. The site acquired by Dickens Ltd is now worth £750,000. Fagin’s investment in Formula One racing has quadrupled in value. It has recently emerged that Nancy and Marlow are directors of Acorn Ltd, a competitor of Acme Ltd.

Advise Acme Ltd.

According to the case afore described he directors of the company may have breached their duties. The statement that a director of a company owes his duties to the company (170(1)) may seem to state very obvious. In defining the term “company”, some assistance was provided in Greenhalgh v Arderne Cinemas Ltd [1951]: ‘the phrase “the company as a whole” does not…mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body.

Further, the Report of the Second Savoy Hotel Investigation concluded that it was not enough for directors to act in the short-term interests of the company alone. Regard must be taken of the long-term interests of the company. In other words, the duty is not confined to the existing body of shareholders but extends to future shareholders.

The conduct of Oliver may imply a breach of the duty to avoid conflicts of interest, stablished in section 175 of the CA 2006. This duty provides:

(1) A director of a company must avoid a situation in which he has or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.

(2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity).

The fundamental objective of the duty is to curb any temptation which directors may succumb to when faced with the opportunity of preferring their own interests over and above those of the company.

An incident of the duty to avoid a conflict of interests is the so- called corporate opportunity doctrine. This ‘makes it a breach of fiduciary duty by a director to appropriate for his own benefit an economic opportunity which is considered to belong rightly to the company which he serves’

In the case of Fagin, who invests in the property that visited on behalf of the company for his own benefit, influenced by his brother, the real estate agent, may breach article 175(3) of the CA 2006. The underlying rationale of the self-dealing rule which prohibits a director from being interested in a transaction to which the company was a party was explained by the House of Lords in Aberdeen Rly Co v Blaikie Bros (1854). S.177(1), provides that: ‘[i]f a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors.’

Lastly, for the case of Nancy and Marlow, who are directors of a competing company, may breach article 175(3) of the CA 2006. A major concern expressed by the Company Law Review was that the case law on conflicts of duty holds the potential to ‘fetter entrepreneurial and business start-up activity by existing directors’ and that ‘the statutory statement of duties should only prevent the exploitation of business opportunities where there is a clear case for doing so’. The 2005 White Paper echoes this concern, stating that it is important that the duties do not impose impractical and onerous requirements which stifle entrepreneurial activity.

Section 175(5)(a) therefore implements the CLRSG’s recommendation that conflicts may be authorised by independent directors unless, in the case of a private company, its constitution otherwise provides. Further, s.175(6) provides that board authorisation is effective only if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid even without the participation of the conflicted directors; the votes of the conflicted directors in favour of the decision will be ignored and they are not counted in the quorum.

In this sense, none of the directors has obtained consent to execute the dealings aforementioned.

5.‘The accountability of corporate management for wrongful trading, fraudulent trading and “unfitness” can be easily avoided. As such, these grounds offer little deterrent to the unscrupulous director.’

The Insolvency Act 1985 introduced “unfitness” as a ground for disqualification of directors. This is also contained in CDDA 1986, which provided that the court shall disqualify a director if it is satisfied that:

a.That he has been a director of a company that at any time become insolvent; and

b.That his conduct as a director of the company makes him unfit to be concerned in the management of the company.

The policy was explained in Re Sevenoaks Stationers (Retail) Ltd [1991] as being to ‘to protect the public, and in particular potential creditors of companies, from losing money through companies becoming insolvent when the directors of those companies are people unfit to be concerned in the management of a company.’

Civil liability for fraudulent trading is imposed by s.213 of the 1986 Act. This provides that if in the course of the winding-up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the court, on the application of the liquidator, may declare that any persons who were knowingly parties to the carrying on of the business in that manner are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper. The meaning of fraud for the purposes of s.213 has been defined as requiring ‘real dishonesty involving, according to current notions of fair trading among commercial men at the present day, real moral blame’: Re Patrick and Lyon [1933].

Continuing to trade while the company is insolvent is not sufficient to establish liability. In Morphitis v Bernasconi [2003], the Court of Appeal, while accepting that fraudulent trading can occur even though only one creditor has been defrauded, nevertheless stressed that to find fraud there must be clear evidence of fraudulent intent on the part of the directors in carrying on the business of the company. Liability did not arise under s.213 just because it might appear to the court that any creditor of the company had been defrauded.

Actual dishonesty must be proved: Welham v DPP [1961]. However, allowing a company to trade knowing that it is unable to meet all of its debts as they fall due may amount to sufficient evidence of dishonest intent: R v Grantham [1984].

A clear example of fraudulent intent appears from the facts of Re William C Leitch Brothers Ltd [1932], in which the liquidator sought declarations that the director of the company had been knowingly a party to carrying on the business of the company with intent to defraud its creditors and he was therefore personally liable for all the company’s debts. [I]f a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud.

Similarly, in Re Gerald Cooper Chemicals Ltd [1978] it was held that accepting advance payment for the supply of goods from one creditor where the directors knew that there was no prospect of the goods being supplied and the payment returned amounted to fraud committed in the course of carrying on business.

Regarding the wrongful trading, it has been seen that s.213 requires proof of dishonest intent so that directors who carry on business recklessly do not fall within its scope. To address this loophole and following the recommendations of the Cork Committee (Cork Committee Report, Cmnd 8558, Ch. 44), s.214 of the Insolvency Act 1986 introduced the concept of ‘wrongful trading’.

Like fraudulent trading, s.214 only applies where the company is in liquidation. It provides that a liquidator of a company in insolvent liquidation can apply to the court to have a person who is or has been a director of the company declared personally liable to make such contribution (if any) to the company’s assets as the court thinks proper for the benefit of the unsecured creditors.

6.‘Despite the fact that the courts have said that disqualification is not a punishment, in truth the exercise that is being engaged in is little different from any sentencing exercise.

The Company Directors Disqualification Act 1986 seeks to protect the general public against abuses of the corporate form. The effect of a disqualification order is that a person shall not, without the leave of the court:

be a director of a company, or a liquidator or administrator of a company, or be a receiver or manager of a company’s property or, in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company, for a specified period beginning with the date of the order.(Section 1(1)).

A disqualified person cannot, therefore, act in any of the alternative capacities listed. For example, a disqualified director cannot participate in the promotion of a new company during the disqualification period: Re Cannonquest, Official Receiver v Hannan [1997]. Nor can he be ‘concerned’ or ‘take part in’ the management of a company by virtue of acting in some other capacity, such as a management consultant: R v Campbell [1984].

The 1986 Act draws a distinction between discretionary orders of the court and mandatory disqualification for unfitness.

Discretionary orders

Persons convicted of an offence

Section 2 provides that the court may, in its discretion, issue a disqualification order against a person convicted of an indictable offence in connectionwith the promotion, formation, management, liquidation or striking off of a company, or with the receivership or management of a company’s property.

The offence does not have to relate to the actual management of the company, provided it was committed in ‘connection’ with its management. The maximum period of disqualification is:

a.five years where the order is made by a court of summary jurisdiction

b.15 years in any other case (s.2(3)).

Persistent breaches of the company’s legislation

The court may disqualify a director where it appears that he has been persistently in default in complying with statutory requirements relating to any of the following concerning the Registrar:

·any return, account or other document to be filed with, delivered or sent

· notice of any matter to be given (s.3(1)).

Persistent default will be presumed by showing that in the five years ending with the date of the application, the person in question has been convicted (whether or not on the same occasion) of three or more defaults (s.3(2)).

Fraud

The court may make a disqualification order against a person if, in the course of the winding-up of a company, it appears that he:

·has been guilty of an offence for which he is liable (whether he has been convicted or not) under s.458 of the Companies Act (fraudulent trading)

·has otherwise been guilty, while an officer or liquidator of the company or receiver or manager of its property, of any fraud in relation to the company or any breach of his duty as such officer, liquidator, receiver or manager (s.4).

The maximum period for disqualification is 15 years. Where a person has been found liable under ss.213 or 214 of the Insolvency Act 1986 (respectively the fraudulent trading and wrongful trading provisions) the CDDA gives the court discretion to disqualify such person for a period of up to 10 years.

Disqualification after investigation of the company

Section 8 provides that if it appears to the Secretary of State from a report following a DTI investigation that it is expedient in the public interest that a disqualification order should be made against any person who is, or has been, a director or shadow director of any company, the Secretary of State may apply to the court for a disqualification order. The court can disqualify such a person for up to 15 years if it is satisfied that his conduct in relation to the company makes him unfit to be concerned in the management of a company.

This power has been used where, following a DTI investigation, it was apparent that a director had abused his power to allot shares in order to retain control of the company: Re Looe Fish Ltd [1993].

Mandatory disqualification orders for unfitness

Section 6(1) of the CDDA 1986 provides that the court shall make a disqualification order against a person in any case where it is satisfied that he is or has been a director of a company which has at any time (whether while he was a director or subsequently) become insolvent and his conduct as a director of that company makes him unfit to be concerned in the management of a company.

The minimum period of disqualification is two years and the maximum period is 15 years (s.6(4)). In contrast with the other grounds for disqualification noted above, s.6 is restricted to directors or shadow directors, including de facto directors.

The policy underlying s.6 was explained by Dillon LJ in Re Sevenoaks Stationers (Retail) Ltd [1991] as being to ‘to protect the public, and in particular potential creditors of companies, from losing money through companies becoming insolvent when the directors of those companies are people unfit to be concerned in the management of a company.’

An insolvent company is defined as including a company which goes into liquidation at a time when its assets are insufficient to meet the payment of its debts, liabilities and liquidation expenses (s.6(2)).

An application under s.6 must be brought by the Secretary of State if it appears to him that it is expedient in the public interest that a disqualification order should be made against any person (s.7(1)).

7.“Section 172 of the Companies Act 2006 raises the spectre of directors being called to account for unpopular commercialdecisions.”

Section 172 reasserts the notion of the primacy of shareholders while recognising that well-managed companies operate on the basis of ‘enlightened shareholder value’. According to this approach, directors, whilst ultimately required to promote shareholder interests, must take account of the factors affecting the company’s relationships and performance.

This duty has two elements.

1.A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.

2.In doing so, he should have regard (amongst other matters) to the factors listed in above. This list is not exhaustive, but highlights areas of particular importance which reflect wider expectations of responsible business behaviour.

The question of what will promote the success of the company is one for the director’s good-faith judgment. This aligns the duty with the position long taken by the courts that, as a general rule, their role is not to interfere in the internal management of companies. In discharging this duty, directors are bound to exercise reasonable care, skill, and diligence (s.174).

Section 172(1) restates Lord Greene MR’s formulation of the duty in Re Smith & Fawcett Ltd: ‘Directors must exercise their discretion bona fide in what they consider (not what a court may consider) is in the interests of the company…’

The determination of good faith is partly subjective in that the court will not substitute its own view about a director’s conduct in place of the board’s own judgment. In Regentcrest plc v Cohen [2001] Jonathan Parker J observed ‘the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue, therefore, relates to the director’s state of mind’.

However, in determining whether the duty has been discharged an objective assessment is also made. In Charterbridge Corporation Ltd v Lloyd’s Bank Ltd [1970], Pennycuick J stated that the test for determining whether this duty has been discharged ‘must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.’

8. “Unfitness’ as a ground for disqualification is too vague a term. The policy underlying the Company Directors Disqualification Act 1986 would be better met if the grounds for such an order were listed in the statute with greaterprecision.”

Section 6(1) of the CDDA 1986 provides that the court shall make a disqualification order against a person in any case where it is satisfied that he is or has been a director of a company which has at any time (whether while he was a director or subsequently) become insolvent and his conduct as a director of that company makes him unfit to be concerned in the management of a company.

The minimum period of disqualification is two years and the maximum period is 15 years (s.6(4)). In contrast with the other grounds for disqualification noted above, s.6 is restricted to directors or shadow directors, including de facto directors.

The policy underlying s.6 was explained by Dillon LJ in Re Sevenoaks Stationers (Retail) Ltd [1991] as being to ‘to protect the public, and in particular potential creditors of companies, from losing money through companies becoming insolvent when the directors of those companies are people unfit to be concerned in the management of a company.’

An insolvent company is defined as including a company which goes into liquidation at a time when its assets are insufficient to meet the payment of its debts, liabilities and liquidation expenses (s.6(2)).

An application under s.6 must be brought by the Secretary of State if it appears to him that it is expedient in the public interest that a disqualification order should be made against any person (s.7(1)).

Section 6 provides that the court must be satisfied that the director’s conduct ‘makes him unfit to be concerned in the management of a company.’ This has been construed as meaning unfit to manage companies generally, rather than unfit to manage a particular company or type of company.

In determining whether a person’s conduct renders him unfit to be a director, s.9 CDDA 1986 directs the court to take into account two kind of matters:

1.Those matters which are generally applicable

·misfeasance or breach of any fiduciary or other duty by the director (para. 1)

·the degree of the director’s culpability in concluding a transaction which is liable to be set aside as a fraud on the creditors (paras. 2 and 3)

·the extent of the director’s responsibility for any failure by the company to comply with the numerous accounting and publicity requirements of the CA 2006 (paras. 4 and 5).

2.Those which are applicable only where the company has become insolvent

·the extent of the director’s responsibility for the causes of the company becoming insolvent (para. 6)

·the extent of the director’s responsibility for any failure by the company to supply any goods or services which have been paid for, in whole or in part (para. 7).

In Re Lo-Line Electric Motors Ltd [1988] Sir Nicholas Browne-Wilkinson VC said that while ordinary commercial misjudgement is not in itself sufficient to establish unfitness, certain conduct would be sufficient to justify disqualification. Examples of such conduct include conduct:

·which displays ‘a lack of commercial probity’

·which is grossly negligent

·which displays ‘total incompetence’.             

An interesting recent decision is Secretary of State for Trade and Industry v Swan (No. 2) [2005], in which Etherton J subjected the responsibilities of a non-executive director, against whom an application for disqualification under s.6 had been brought, to detailed consideration. N, a senior non-executive director and deputy chairman of the board and chairman of the audit and remuneration committees of Finelist plc, together with S, the company’s CEO, were disqualified for three and four years respectively. N’s reaction upon being informed by a whistle-blower of financial irregularities (‘cheque kiting’) going on within the group was held to be entirely inappropriate. He failed to investigate the allegations properly, nor did he bring them to the attention of his fellow non-executive directors or to the auditors. The judge held that N’s conduct fell below the level of competence to be expected of a director in his position and he was therefore ‘unfit’ to be concerned in the management of a company.

9.“The Companies Act 2006, Part 10, has done little to further the objectives of simplifying the common law and correcting itsdeficiencies.”

SIMILAR TO QUESTION 2

A concern of both equity and common law courts was to develop a corpus of rules designed to prevent directors abusing their considerable powers. The policy objective is based on prophylaxis and the result is a formidable body of reported decisions in which the judges have been developing the contours of directors’ duties.

Confronted with this body of law, the Company Law Review (CLR), in line with its objectives of maximizing clarity and accessibility, recommended that the duties of directors should be codified by a way of statutory restatement. Thus, the general duties of directors appear in Part 10 of the CA. Company Law Review viewed these sections as the key ‘scoping’ provisions:

·Section 170(3) makes it clear that while the general duties are ‘based on certain common law rules and equitable principles’, the statutory restatement has ‘effect in place of those rules and principles’. In other words, the restatement replaces them.

·Section 170(4) directs the courts to interpret and apply the general duties having regard to the pre-existing   case law. Much of this case law, of course, developed by analogy with the duties of trustees and other fiduciaries and so it seems that the intention here is to maintain the relationship of the law on directors’ duties with its wider equitable origins.

The Law Commissions examined the case for restating directors’ duties in statute. Arguments against this were founded on loss of flexibility, while those in favour saw advantages in terms of certainty and accessibility. The Commission’s conclusion was that the case for legislative restatement was made out and that the issue of inflexibility could be addressed by (i) ensuring the restatement was at a high level of generality by way of a statement of principles and (ii) providing that it was not exhaustive, that is, while it would be a comprehensive and binding statement of the law in the field covered, it would not prevent the courts inventing new general principles outside the field.

Although the courts are given no legislative assistance for determining when or to what extent the pre-existing jurisprudence can be harnessed as an aid to interpreting the statutory restatement, nevertheless s.170(4) seems to be directed towards facilitating the continued development of    the duty by the courts.

Nonetheless, it is noteworthy that the issue of restating directors’ duties in statutory form caused considerable controversy and generated a widespread debate.

In its Final Report, the Steering Group recommended a legislative statement of directors’ duties for three principal reasons:

1.To provide a greater clarity on what it is expected to directors and to make the law more accessible, it would help the standards of governance and provide authoritative guidance and clarification of issues such as “scope” in a way that reflects modern business needs and wider expectations of responsible business behaviours.

2.To enable defects in the common law to be corrected in important areas.

3.To make developments of the law in this area more predictable.

The government accepted the proposals and it is clear that the approach taken by the CLR shaped the framing of Part 10 of the CA.

10.“The tests for determining whether or not an individual is a shadow director are confusing and the company’s legislation should, therefore, be more prescriptive in thisregard.”

In order to evade the duties which directors are subject to, a shareholder might avoid a formal appointment but still direct the board’s decision-making. In this case, the shareholder may be classified as a ‘shadow director’ and will be subject to the statutory and common law obligations of directors

Section 251(1) of the CA 2006 defines a shadow director as ‘a person in accordance with whose directions or instructions the directors are accustomed to act’ (see also s.22(5) CDDA 1986). Those who provide professional advice are expressly excluded, but a professional person may be held to be a shadow director if his conduct amounts to effectively controlling the company’s affairs: Re Tasbian Ltd (No. 3) [1993].

In Re Hydrodam (Corby) Ltd [1994] BCC 161, Millett J considered the definition contained in s.251(1). He took the view that in determining whether or not an individual is a shadow director, four factors are relevant:

·The de jure and de facto directors of the company are identifiable.

·The person in question directed those directors on how to act in relation to the company’s affairs or was one of the persons who did.

·The directors did act in accordance with his instructions.

·They were accustomed so to act.

Millet J explained that a pattern of behaviour must be shown ‘in which the board did not exercise any discretion or judgment of its own but acted in accordance with the directions of others.’ However, merely controlling one director is not sufficient; a shadow director must exercise control over the whole board, or at least a governing majority of it.

11.“The distinction between de jure, shadow and de facto directors is no longer relevant.”

Executive and non-executive directors

Executive directors are full-time officers who generally have a service contract with the company. The articles will normally provide for the appointment of a managing director, sometimes called a chief executive, who has overall responsibility for the running of the Company.

Non-executive directors are normally appointed to the boards of larger companies to act as monitors of the executive management. Typically, they are part-time appointments.

De facto directors

A de facto director is one who has not been formally appointed but has nevertheless acted as a director: Re Kaytech International plc [1999]. The issue of whether or not an individual is a de facto director generally arises in relation to disqualification orders under the Company Directors Disqualification Act 1986 (CDDA). The courts have formulated guidelines for determining the issue. In Re Richborough Furniture Ltd [1996] BCC 155, Lloyd J stated that emphasis should be given to the functions performed by the individual concerned. In Secretary for State for Trade and Industry v Jones [1999], Jacob J stated that the essential test is whether the person in question was ‘part of the corporate governing structure’. The key test is whether someone is part of the governing structure of a company in that he participates in, or is entitled to participate in, collective decisions on corporate policy and strategy and its implementation.

Shadow directors

In order to evade the duties which directors are subject to, a shareholder might avoid a formal appointment but still direct the board’s decision-making. In this case, the shareholder may be classified as a ‘shadow director’ and will be subject to the statutory and common law obligations of directors

Section 251(1) of the CA 2006 defines a shadow director as ‘a person in accordance with whose directions or instructions the directors are accustomed to act’ (see also s.22(5) CDDA 1986). Those who provide professional advice are expressly excluded, but a professional person may be held to be a shadow director if his conduct amounts to effectively controlling the company’s affairs: Re Tasbian Ltd (No. 3) [1993].

Therefore, if a person comes within the definition of a shadow director, they should look to act in accordance with the duties imposed on de jure directors, as failure to do so may result in liability. This was resolved by the case of Vivendi SA and anor v Richards and anor [2013], in which the High Court held that a shadow director will typically owe fiduciary duties in relation at least to the directions or instructions that he gives to the de jure directors. More particularly, the court held that a shadow director will normally owe the duty of good faith (or loyalty) when giving such directions or instructions.

12.Does the statutory language in Part 10 of the Companies Act 2006 adequately capture the totality of the duty of loyalty as developed in the case law?

The classic statement on the position of directors was given by Lord Cranwoth on Aberdeen Rly Co v Blaikie Bros: “the directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is of course the duty of those agents so to act as bet to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards the principal.

However, unlike trustees, directors do not hold the legal title of property. But directors are analogous to trustees because they have the duty to manage the company’s affairs in the interest of the company. As explained in Towers v Premier Waste Management ltd (2011): “a director of a company is appointed to direct its affairs. In doing so is his duty to use his position in the company. To promote its success and to protect its interest. In accordance with equitable principles, the special relationship with the company took the form of a duty of loyalty and a duty to avoid conflict between his personal interest and his duty to the company”.

The core fiduciary duty of loyalty to which company directors are subject forms part of the general duties of directors which now appear in Chapter 2 of Part 10 of the Companies Act 2006. The statutory restatement is set at a fairly high level of generality and in part seeks to reform the common law upon which it is based. As a means of assessing the scope of the reformulated duty of loyalty found in s.172 of the Act, it is instructive to view the provision against the policy considerations underlying the Government’s decision to place the general duties of directors on a statutory footing and, more generally, the wider objectives underpinning the company law reform project which, after eight years of consultations, culminated in the 2006 Act.

Both the 2002 and 2005 White Papers accepted that directors’ general duties should be codified, and the Government sought to settle the matter of whether the restatement should be exhaustive by noting that it will so drafted as to “enable the law to respond to changing business circumstances and needs.” It is stressed that the restatement will leave scope for the courts to interpret and develop its provisions in a way that “reflects the nature and effect of the principles they reflect.”

Perhaps more than any other of the duties contained in Part 10, the framing of the fundamental duty of loyalty generated considerable debate both during the CLR’s consultations and when the Companies Bill was going through Parliament. The statutory formulation has two elements:

1.First, s.172(1) begins by stating that a “director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole…” The provision thus aligns the interests of the company with its members “as a whole”. While the Explanatory Notes which accompany the Act see this as codifying the common law position, there is, in fact, a point of departure from the classic formulation of the duty by Lord Greene M.R. in Re Smith & Fawcett Ltd. He noted that directors “must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interests of the company”.

2.The second element of the duty is that in promoting the success of the company a director should “have regard (amongst other matters)” to the non-exhaustive factors listed in subsection (1):

(a)  the likely consequences of any decision in the long term,

(b)  the interests of the company’s employees,51

(c)  the need to foster the company’s business relationships with suppliers, customers and others,

(d)  the impact of the company’s operations on the community and the environment

(e)  the desirability of the company maintaining a reputation for high standards of business conduct, and

(f)  the need to act fairly as between members of the company.

To gain some insight into the meaning of this provision it is instructive to consider the CLR’s deliberations on how best the duty of loyalty should be formulated. Although the CLR recognised the merits of a stakeholder approach it did not recommend its adoption as such but opted for a modified model whereby the core duty of directors would be founded upon the need to promote “enlightened shareholder value”. Under this approach, directors, whilst ultimately required to promote shareholder interests, must take account of the factors affecting the company’s relationships and performance. The CLR took the view that the duty should be formulated in such a way as to remind directors that shareholder value depends on successful management of the company’s relationships with other stakeholders.

A concern of both equity and common law courts was to develop a corpus of rules designed to prevent directors abusing their considerable powers. The policy objective is based on prophylaxis and the result is a formidable body of reported decisions in which the judges have been developing the contours of directors’ duties.

Confronted with this body of law, the Company Law Review (CLR), in line with its objectives of maximizing clarity and accessibility, recommended that the duties of directors should be codified by a way of statutory restatement. Thus, the general duties of directors appear in Part 10 of the CA. Company Law Review viewed these sections as the key ‘scoping’ provisions:

·Section 170(3) makes it clear that while the general duties are ‘based on certain common law rules and equitable principles’, the statutory restatement has ‘effect in place of those rules and principles’. In other words, the restatement replaces them.

·Section 170(4) directs the courts to interpret and apply the general duties having regard to the pre-existing case law. Much of this case law, of course, developed by analogy with the duties of trustees and other fiduciaries and so it seems that the intention here is to maintain the relationship of the law on directors’ duties with its wider equitable origins.

The Law Commissions examined the case for restating directors’ duties in statute. Arguments against this were founded on loss of flexibility, while those in favour saw advantages in terms of certainty and accessibility. The Commission’s conclusion was that the case for legislative restatement was made out and that the issue of inflexibility could be addressed by (i) ensuring the restatement was at a high level of generality by way of a statement of principles and (ii) providing that it was not exhaustive, that is, while it would be a comprehensive and binding statement of the law in the field covered, it would not prevent the courts inventing new general principles outside the field.

Although the courts are given no legislative assistance for determining when or to what extent the pre-existing jurisprudence can be harnessed as an aid to interpreting the statutory restatement, nevertheless s.170(4) seems to be directed towards facilitating the continued development of the duty by the courts.

Nonetheless, it is noteworthy that the issue of restating directors’ duties in statutory form caused considerable controversy and generated a widespread debate.

In its Final Report, the Steering Group recommended a legislative statement of directors’ duties for three principal reasons:

4.To provide a greater clarity on what it is expected to directors and to make the law more accessible, it would help the standards of governance and provide authoritative guidance and clarification of issues such as “scope” in a way that reflects modern business needs and wider expectations of responsible business behaviours.

5.To enable defects in the common law to be corrected in important areas.

6.To make developments of the law in this area more predictable.

The government accepted the proposals and it is clear that the approach taken by the CLR shaped the framing of Part 10 of the CA.

13. ‘Creditors are inadequately protected by the wrongful or fraudulent trading provisions.’

Civil liability for fraudulent trading is imposed by s.213 of the 1986 Act. This provides that if in the course of the winding-up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the court, on the application of the liquidator, may declare that any persons who were knowingly parties to the carrying on of the business in that manner are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper. The meaning of fraud for the purposes of s.213 has been defined as requiring ‘real dishonesty involving, according to current notions of fair trading among commercial men at the present day, real moral blame’: Re Patrick and Lyon [1933].

Continuing to trade while the company is insolvent is not sufficient to establish liability. In Morphitis v Bernasconi [2003], the Court of Appeal, while accepting that fraudulent trading can occur even though only one creditor has been defrauded, nevertheless stressed that to find fraud there must be clear evidence of fraudulent intent on the part of the directors in carrying on the business of the company. Liability did not arise under s.213 just because it might appear to the court that any creditor of the company had been defrauded.

Actual dishonesty must be proved: Welham v DPP [1961]. However, allowing a company to trade knowing that it is unable to meet all of its debts as they fall due may amount to sufficient evidence of dishonest intent: R v Grantham [1984].

A clear example of fraudulent intent appears from the facts of Re William C Leitch Brothers Ltd [1932], in which the liquidator sought declarations that the director of the company had been knowingly a party to carrying on the business of the company with intent to defraud its creditors and he was therefore personally liable for all the company’s debts.  [I]f a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud.

Similarly, in Re Gerald Cooper Chemicals Ltd [1978] it was held that accepting advance payment for the supply of goods from one creditor where the directors knew that there was no prospect of the goods being supplied and the payment returned amounted to fraud committed in the course of carrying on business.

Regarding the wrongful trading, it has been seen that s.213 requires proof of dishonest intent so that directors who carry on business recklessly do not fall within its scope. To address this loophole and following the recommendations of the Cork Committee (Cork Committee Report, Cmnd 8558, Ch. 44), s.214 of the Insolvency Act 1986 introduced the concept of ‘wrongful trading’.

Like fraudulent trading, s.214 only applies where the company is in liquidation. It provides that a liquidator of a company in insolvent liquidation can apply to the court to have a person who is or has been a director of the company declared personally liable to make such contribution (if any) to the company’s assets as the court thinks proper for the benefit of the unsecured creditors.

14.‘The courts have had the opportunity to develop rules relating to the care, skill and diligence with which a director should discharge the duties of his office, but they have failed to do so satisfactorily. The Companies Act 2006 Part 10 has improved on that, but the problem remains an insoluble one, inherent in the very nature of the role of the director.’

Section 174 gives statutory effect to the modern judicial stance taken towards the determination of the standard of care expected of directors. It provides:

(1) A director of a company must exercise reasonable care, skill and diligence.

(2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with—

(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and

(b) the general knowledge, skill and experience that the director has.

In Re D’Jan of London Ltd [1993], Hoffmann LJ, applying s.214(4) of the Insolvency Act 1986, held a director negligent and prima facie liable to the company for losses caused as a result of its insurers repudiating a fire policy for non-disclosure. The director had signed the inaccurate proposal form without first reading it.

The effect of s.174 is that a director’s actions will be measured against the conduct expected of a reasonably diligent person. This is therefore an objective test. However, subjective considerations will also apply according to the level of any special skills the particular director may possess.

Thus, a director cannot take a passive role in the management of the company. This is also the case in small, private owner-managed companies (termed quasi-partnerships) where a spouse or son assumes the role of director without ever expecting to play a pro- active part in the affairs of the company. In Re Brian D Pierson (Contractors) Ltd [2001], the court refused to countenance such symbolic roles:

The office of director has certain minimum responsibilities and functions, which are not simply discharged by leaving all management functions, and consideration of the company’s affairs to another director without question, even in the case of a family company…One cannot be a ‘sleeping’ director; the function of ‘directing’ on its own requires some consideration of the company’s affairs to be exercised.

Further, in Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry v Griffiths [1998] 2 BCLC 646, Lord Woolf stated:

The collegiate or collective responsibility of the board of directors of a company is of fundamental importance to corporate governance under English company law. That collegiate or collective responsibility must however be based on individual responsibility. Each individual director owes duties to the company to inform himself about its affairs and to join with his co-directors in supervising or controlling them.

Additionally, in Re City Equitable Fire Insurance Co ltd, Romer J added 3 guiding principles for the determination of the directors’ duty of care:

1.Need not to exhibit greater degree of skill than may reasonable be expected from a person in his knowledge and experience.

2.It is not bound to give continuous attention to the affairs of his company. Intermittent nature to be performed at a periodical board meetings’ and committees of the board.

3.A director is, in the absence of grounds of suspicion, justified in trusting that official to perform such duties honestly.

15.‘Any attempt to define the duties of directors more clearly would involve the risk that, since it would be impossible to define such duties exhaustively, there would be inevitable lacunae which might well make it more difficult to determine in any particular set of circumstances what these dutiesare.’

Historically, directors’ duties were developed by the courts of equity, largely by analogy with the rules applying to trustees. One of the most significant changes introduced by the CA 2006, Pt 10 was to codify these common law and equitable duties applying to directors.

Codification was recommended by the Law Commissions and the Company Law Review. The primary reason for recommending codification was to make the relevant rules clear and accessible (not only for directors but also for those affected by their decisions).

Section 170 of the CA 2006 sets out the scope and nature of the codified general duties, being:

1.Duty to act within powers.

2.Duty to promote the success of the company.

3.Duty to exercise independent judgement.

4.Duty to exercise reasonable care, skill and diligence.

5.Duty to avoid conflicts of interest.

6.Duty not to accept benefits from third parties.

7.Duty to declare an interest in a proposed or existing transaction or arrangement.

This codification supersedes the older case law. But those cases remain relevant to the interpretation of the new statutory provisions where those codified duties are formulated in a way that quite faithfully reflects the older case law. The rules set out in the CA 2006 are expressed at a sufficiently high level of generality so as to be capable of judicial development within their terms.

The Law Commissions examined the case for restating directors’ duties in statute. Arguments against this were founded on loss of flexibility, while those in favour saw advantages in terms of certainty and accessibility. The Commission’s conclusion was that the case for legislative restatement was made out and that the issue of inflexibility could be addressed by (i) ensuring the restatement was at a high level of generality by way of a statement of principles and (ii) providing that it was not exhaustive, that is, while it would be a comprehensive and binding statement of the law in the field covered, it would not prevent the courts inventing new general principles outside the field.

Company Law Review viewed these sections as the key ‘scoping’ provisions:

·Section 170(3) makes it clear that while the general duties are ‘based on certain common law rules and equitable principles’, the statutory restatement has ‘effect in place of those rules and principles’. In other words, the restatement replaces them.

·Section 170(4) directs the courts to interpret and apply the general duties having regard to the pre-existing   case law.  Much of this case law, of course, developed by analogy with the duties of trustees and other fiduciaries and so it seems that the intention here is to maintain the relationship of the law on directors’ duties with its wider equitable origins.

Although the courts are given no legislative assistance for determining when or to what extent the pre-existing jurisprudence can be harnessed as an aid to interpreting the statutory restatement, nevertheless s.170(4) seems to be directed towards facilitating the continued development of the duty by the courts.

16.Arthur, Beatrice and Charles are the directors of Dynamic Development plc, a company whose main objects are to engage in the business of computer software development and ‘any other business which, in the opinion of the directors is in the interest of the company’. None of the directors hold any shares in thecompany.

In November 2012 the company was approached by Fred, a computer games software designer, who wished to sell one-half of his interest in certain products which he has designed but not yet launched on the market. At a meeting attended by all three directors and Fred the possibility of such a joint venture was discussed but rejected by the company on the grounds that given the volatile nature of consumer demand and the fast-changing nature of the computer games market, the venture was too risky. In January 2013 Fred approached Arthur, Beatrice and Charles with a view to obtaining their personal involvement in the venture. Arthur declined but Beatrice and Charles accepted Fred’s invitation. They incorporated a new company, Zenco Ltd, with Beatrice and Charles each holding one-half of the issued share capital in the company; they were also its two directors. This arrangement was not disclosed to Dynamic Developmentplc.

In April 2014 Dynamic Development plc was taken over by Pro-Computers plc and Arthur, Beatrice and Charles were replaced as directors by nominees of Pro-Computers. The new board has now learned of the Zenco Ltd project and that the initial investment made by Beatrice and Charles has tripled in value to £250,000.

Advise Dynamic Development plc.

According to the case afore described, Beatrice and Charles may have breached their duties. The statement that a director of a company owes his duties to the company (170(1)) may seem to state very obvious. In defining the term “company”, some assistance was provided in Greenhalgh v Arderne Cinemas Ltd [1951]: ‘the phrase “the company as a whole” does not…mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body.

Further, the Report of the Second Savoy Hotel Investigation concluded that it was not enough for directors to act in the short-term interests of the company alone. Regard must be taken of the long-term interests of the company. In other words, the duty is not confined to the existing body of shareholders but extends to future shareholders.

The conduct of such directors may imply a breach of the duty to avoid conflicts of interest, stablished in section 175 of the CA 2006. This duty provides:

(1) A director of a company must avoid a situation in which he has or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.

(2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity).

The fundamental objective of the duty is to curb any temptation which directors may succumb to when faced with the opportunity of preferring their own interests over and above those of the company.

An incident of the duty to avoid a conflict of interests is the so- called corporate opportunity doctrine. This ‘makes it a breach of fiduciary duty by a director to appropriate for his own benefit an economic opportunity which is considered to belong rightly to the company which he serves’

In the case of Beatriz and Charles, who invested in the products from Fred, and incorporated a company as shareholders and directors, may imply a breach article 175(3) of the CA 2006. A major concern expressed by the Company Law Review was that the case law on conflicts of duty holds the potential to ‘fetter entrepreneurial and business start-up activity by existing directors’ and that ‘the statutory statement of duties should only prevent the exploitation of business opportunities where there is a clear case for doing so’. The 2005 White Paper echoes this concern, stating that it is important that the duties do not impose impractical and onerous requirements which stifle entrepreneurial activity.

Section 175(5)(a) therefore implements the CLRSG’s recommendation that conflicts may be authorised by independent directors unless, in the case of a private company, its constitution otherwise provides. Further, s.175(6) provides that board authorisation is effective only if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid even without the participation of the conflicted directors; the votes of the conflicted directors in favour of the decision will be ignored and they are not counted in the quorum.

In this sense, none of the directors has obtained consent to execute the dealings aforementioned.

Additionally, it is important to state that section 170(2) establishes that the duty to avoid conflicts of interest, continue to apply after the person ceases to be a director of the company. In this sense, despite being removed from directors, Charles and Beatrice still be liable.

17.‘The disqualification regime for company directorshas proved to be inadequate. Too many “unfit” directors continue to get away with abusing the privilege of limitedliability.’

The Company Directors Disqualification Act 1986 seeks to protect the general public against abuses of the corporate form. The effect of a disqualification order is that a person shall not, without the leave of the court:

be a director of a company, or a liquidator or administrator of a company, or be a receiver or manager of a company’s property or, in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company, for a specified period beginning with the date of the order.(Section 1(1)).

The 1986 Act draws a distinction between discretionary orders of the court and mandatory disqualification for unfitness.

Discretionary orders

Persons convicted of an offence

Section 2 provides that the court may, in its discretion, issue a disqualification order against a person convicted of an indictable offence in connectionwith the promotion, formation, management, liquidation or striking off of a company, or with the receivership or management of a company’s property.

Persistent breaches of the company’s legislation

The court may disqualify a director where it appears that he has been persistently in default in complying with statutory requirements relating to any of the following concerning the Registrar:

·any return, account or other document to be filed with, delivered or sent

· notice of any matter to be given (s.3(1)).

Fraud

The court may make a disqualification order against a person if, in the course of the winding-up of a company, it appears that he:

·has been guilty of an offence for which he is liable (whether he has been convicted or not) under s.458 of the Companies Act (fraudulent trading)

·has otherwise been guilty, while an officer or liquidator of the company or receiver or manager of its property, of any fraud in relation to the company or any breach of his duty as such officer, liquidator, receiver or manager (s.4).

Disqualification after investigation of the company

Section 8 provides that if it appears to the Secretary of State from a report following a DTI investigation that it is expedient in the public interest that a disqualification order should be made against any person who is, or has been, a director or shadow director of any company, the Secretary of State may apply to the court for a disqualification order. The court can disqualify such a person for up to 15 years if it is satisfied that his conduct in relation to the company makes him unfit to be concerned in the management of a company.

Mandatory disqualification orders for unfitness

Section 6(1) of the CDDA 1986 provides that the court shall make a disqualification order against a person in any case where it is satisfied that he is or has been a director of a company which has at any time (whether while he was a director or subsequently) become insolvent and his conduct as a director of that company makes him unfit to be concerned in the management of a company.

The minimum period of disqualification is two years and the maximum period is 15 years (s.6(4)). In contrast with the other grounds for disqualification noted above, s.6 is restricted to directors or shadow directors, including de facto directors.

The policy underlying s.6 was explained by Dillon LJ in Re Sevenoaks Stationers (Retail) Ltd [1991] as being to ‘to protect the public, and in particular potential creditors of companies, from losing money through companies becoming insolvent when the directors of those companies are people unfit to be concerned in the management of a company.’

An insolvent company is defined as including a company which goes into liquidation at a time when its assets are insufficient to meet the payment of its debts, liabilities and liquidation expenses (s.6(2)).

An application under s.6 must be brought by the Secretary of State if it appears to him that it is expedient in the public interest that a disqualification order should be made against any person (s.7(1)).

Section 6 provides that the court must be satisfied that the director’s conduct ‘makes him unfit to be concerned in the management of a company.’ This has been construed as meaning unfit to manage companies generally, rather than unfit to manage a particular company or type of company.

In determining whether a person’s conduct renders him unfit to be a director, s.9 CDDA 1986 directs the court to take into account two kind of matters:

3.Those matters which are generally applicable

·misfeasance or breach of any fiduciary or other duty by the director (para. 1)

·the degree of the director’s culpability in concluding a transaction which is liable to be set aside as a fraud on the creditors (paras. 2 and 3)

·the extent of the director’s responsibility for any failure by the company to comply with the numerous accounting and publicity requirements of the CA 2006 (paras. 4 and 5).

4.Those which are applicable only where the company has become insolvent

·the extent of the director’s responsibility for the causes of the company becoming insolvent (para. 6)

·the extent of the director’s responsibility for any failure by the company to supply any goods or services which have been paid for, in whole or in part (para. 7).

In Re Lo-Line Electric Motors Ltd [1988] Sir Nicholas Browne-Wilkinson VC said that while ordinary commercial misjudgement is not in itself sufficient to establish unfitness, certain conduct would be sufficient to justify disqualification. Examples of such conduct include conduct:

·which displays ‘a lack of commercial probity’

·which is grossly negligent

·which displays ‘total incompetence’.             

An interesting recent decision is Secretary of State for Trade and Industry v Swan (No. 2) [2005], in which Etherton J subjected the responsibilities of a non-executive director, against whom an application for disqualification under s.6 had been brought, to detailed consideration. N, a senior non-executive director and deputy chairman of the board and chairman of the audit and remuneration committees of Finelist plc, together with S, the company’s CEO, were disqualified for three and four years respectively. N’s reaction upon being informed by a whistle-blower of financial irregularities (‘cheque kiting’) going on within the group was held to be entirely inappropriate. He failed to investigate the allegations properly, nor did he bring them to the attention of his fellow non-executive directors or to the auditors. The judge held that N’s conduct fell below the level of competence to be expected of a director in his position and he was therefore ‘unfit’ to be concerned in the management of a company.

18.Directors have significant managerial discretion and, as a consequence, scope for abuse. However, Part 10 of the Companies Act 2006 has introduced effective and satisfactory measures to mitigate this risk.’

Historically, directors’ duties were developed by the courts of equity, largely by analogy with the rules applying to trustees. One of the most significant changes introduced by the CA 2006, Pt 10 was to codify these common law and equitable duties applying to directors.

Codification was recommended by the Law Commissions and the Company Law Review. The primary reason for recommending codification was to make the relevant rules clear and accessible (not only for directors but also for those affected by their decisions).

Section 170 of the CA 2006 sets out the scope and nature of the codified general duties, being:

1.Duty to act within powers.

2.Duty to promote the success of the company.

3.Duty to exercise independent judgement.

4.Duty to exercise reasonable care, skill and diligence.

5.Duty to avoid conflicts of interest.

6.Duty not to accept benefits from third parties.

7.Duty to declare an interest in a proposed or existing transaction or arrangement.

Section 178 of the CA 2006 preserves the existing civil consequences of breach (or threatened breach) of any of the general duties. Although an attempt was made to codify the remedies available for breach of directors’ duties, this proved to be a very difficult exercise and eventually it became ‘too difficult to pursue’ (according to the Explanatory Notes to the Bill that became the CA 2006).

(1) The consequences of breach (or threatened breach) of sections 171 to 174 are the same as would apply if the corresponding common law rule or equitable principle applied.

(2) The duties in those sections (with the exception of section 174 (duty to exercise reasonable care, skill and diligence)) are, accordingly, enforceable in the same way as any other fiduciary duty owed to a company by its directors.

Section 178(2) provides that the statutory duties are to be regarded as fiduciary, with the exception of the duty to exercise reasonable care, skill, and diligence, which is not considered to be a fiduciary duty. Thus, the duties are enforceable in the same way as any other fiduciary duty owed to a company by its directors.

In the case of fiduciary duties, the consequences of breach may include:

·Damages or compensation where the company has suffered loss: Re Lands Allotment Co [1894] 1 Ch 616, CA; Joint Stock Discount Co v Brown (1869).

·Restoration of the company’s property: Re Forest of Dean Coal Co (1879) 10 Ch D 450; JJ Harrison (Properties) Ltd v Harrison [2002]

·An account of profits made by the director: Regal (Hastings) Ltd v Gulliver

·Injunction or declaration: Cranleigh Precision Engineering Ltd v Bryant [1965].

·Rescission of a contract where the director failed to disclose an interest: Transvaal Lands Co v New Belgium (Transvaal) Land & Development Co [1914].

Presumably, the rules developed for establishing the liability of accessories will be applied notwithstanding that the breach may be of a duty which is now statutorily defined and imposed.

The liability to account arises even where the director acted honestly and where the company could not otherwise have obtained the benefit: Regal (Hastings) Ltd v Gulliver.

In Coleman Taymar Ltd v Oakes [2001] 2 BCLC 749, Robert Reid QC, sitting as a Deputy Judge of the High Court, stated that a company is entitled to elect whether to claim

·damages (equitable compensation), or

·an account of profits against a director who in breach of duty makes a secret profit

However, even though the profit may arise out of the use of position as opposed to the use of trust property, the judges more typically resort to the language of the ‘constructive trust’ as the means for fashioning a remedy. In A-G for Hong Kong v Reid [1994] 1 AC 324 Lord Templeman explained that Boardman ‘demonstrates the strictness with which equity regards the conduct of a fiduciary and the extent to which equity is willing to impose a constructive trust on property obtained by a fiduciary by virtue of his office.’

In CMS Dolphin Ltd v Simonet Lawrence Collins J subjected the issue of remedies for diverting a corporate opportunity to detailed analysis. He held that S was a constructive trustee of the profits referable to exploiting the corporate opportunity and, in general, it made no difference whether the opportunity was first taken up by the wrongdoer or by a ‘corporate vehicle’ established by him for that purpose:

I do not consider that the liability of the directors in Cook v Deeks would have been in any way different if they had procured their new company to enter the contract directly, rather than (as they did) enter into it themselves and then transfer the benefit of the contract to a new company.

The basis of a director’s liability in this situation is that, as seen in Cook v Deeks, the opportunity in question is treated as if it were an asset of the company in relation to which the director had fiduciary duties. He thus becomes a constructive trustee ‘of the fruits of his abuse of the company’s property’ (per Lawrence Collins J, above).

19. ‘The regime governing the removal from office and the liabilities of directors who persistently commit wrongs against the company and/or its creditors is    ineffective.’

SEE QUESTION 18


EXAMS MODULE D

1.‘While shareholders remain passive we are always going to have a problem with managerial discretion’. Discuss.

From a theoretical perspective the fact that management and shareholders are separate creates the central agency problem that both the main theories (aggregate theory and realist theory).

The agency problem relates to the fact that if the shareholders take no part in the running of the company, mechanisms have to be devised to ensure that management do not abuse their discretion.

The realist theory argues that the company was no fiction but had a real existence; it does not depend on the state or its members to exist. The corporation is formed by shareholders but becomes something distinct at that moment: a real thing with its own interests and aims. There is a separate existence of the corporation: because of the corporation has its own interests, it can justify a departure from a shareholder.  It assumes the managers are purely neutral technocrats who have no interest on their own and make decisions in the best interests of the company.

Realist theorists such as Dodd, on the other hand, view the agency issue as an essential way to ensure that   management can run the company for the benefit of all. The problem has remained an issue for shareholders and the community and was partly addressed in the report of the DTI Company Law Review Steering Group as part of the reforms leading to the CA 2006.

The aggregate theory recognises the company as an institution formed by the aggregation of private contracting individuals. This is, members come together to pool their investment on terms they have agreed. The aggregate theory places the focus of managerial discretion firmly on the shareholders.

Aggregate theorists such as Berle and Jensen would advocate focusing on legal mechanisms that focus management power on shareholders.

The steering group formulated the concept of ‘enlightened shareholder value’ to deal with the stakeholder aspects of the    agency problem. This forms the basis of s.172 of the Companies Act 2006 and the business review (formerly the Operating and Financial Review).

2.Have the corporate governance committees been a success?

It is important, for the answering of this questions, to examine the recommendations made by the committees regarding the corporate governance.

The Cadbury Committee

The Cadbury Committee was established by the Financial Reporting Council, the London Stock Exchange and the combined accounting bodies. Its 1992 report on the Financial Aspects of Corporate Governance focused entirely on shareholder/board accountability mechanisms. The report was an industry attempt to address some of the accountability concerns expressed about UK-listed companies. Although fairly narrowly focused, it succeeded in identifying the lack of managerial accountability at the heart of most UK-listed companies. The key recommendations of the Cadbury Committee were:

·the introduction of non-executive directors to the main board

·the creation of sub boards dominated by non-executives. The idea was that these non-executive directors would bring some objectivity to board decisions.

·Cadbury also recommended that a committee structure should be put in place to improve:

a.accountability in the appointment of directors

b.the pay (remuneration) of directors

c.the audit processes. 

However, as we will see, its failure to define what independence in the context of non-executives meant would become a problem some 10 years later, as companies regularly appointed ex-executive directors and friends of board members as non-executives.

The Greenbury Committee

By 1995 the Greenbury Committee was formed to report on directors’ pay. The Greenbury Committee:

·Identified that there is an inherent conflict of interest in directors deciding on their own pay

·Recommendedan enhanced disclosure regime for directors’ paya non-executive-only remuneration committee.

Unfortunately, the open disclosure regime recommended by Greenbury only succeeded in providing a reference point for managers to negotiate higher salaries, as they could point to higher salaries in other, similar companies to justify higher pay claims. Pay has continued to be a corporate governance problem, as the central conflict of interest in a board deciding on its own pay has remained despite the creation of remuneration committees.

The Higgs Review (2003)

The review was carried out by Derek Higgs, who consulted widely and produced a final report in January 2003. The key recommendation of the Higgs Review was to provide a good definition of independence for non-executives.

A non-executive director will now only be considered independent when the board determines that:

9.the director is independent in character and judgment and

·there are no relationships or circumstances which could affect, or appear to affect, the director’s judgment.

Such relationships and circumstances arise where the director:

is or has been an employee of the company

has or had a business relationship with the company

is being paid by the company other than a director’s fee and certain other payments

has family ties to the company or its employees

holds cross-directorships or has significant links with other directors through involvement in other companies or bodies

represents a significant shareholder

has served on the board for 10 years. T

The Higgs recommendations aim to ensure that non-executives function properly in their monitoring role by emphasising their independence. Thus, they may finally begin to act to improve the accountability of managers. The core recommendations of the Higgs Review have been adopted by the London Stock Exchange and have also been influential in many other jurisdictions around the world where stock exchanges are present.

The financial crisis and corporate governance

In the aftermath of the financial crisis that engulfed the global economy in 2008, Sir David Walker considered that:

the boards of big banks did not understand the scale of the risks their organisations were running

non-executives of big banks did too little to rein in the excesses of the executive directors

·shareholders in banks also failed to curb reckless gambling by financial institutions, and that the owners did not ‘exercise proper stewardship’

·bankers were paid in a dangerous way which encouraged them to speculate imprudently.

His solutions to these significant problems were as follows.

·Financial institutions should form a risk committee, separate from the audit committee, to monitor all substantial transactions and stop a transaction if it was deemed too risky. The committee should be chaired by a non-executive director (NED).

·Currently NEDs devote too little time to their role (20–25 days currently, often for pay of more than £100,000 a year). Bank and financial institution NEDs need to devote 30–36 days each year to the role. They also must be properly trained and scrutinised closely by the FSA to ensure that they can hold executives to account.

·The chairmen of banks or other financial institutions similarly devote too little time to their roles and should commit no less than two-thirds of their time to the business. The chairman should have significant and relevant ‘financial industry experience’ and should face re-election by shareholders every year.

·The remuneration committee should set the pay of executive directors and ‘high end’ individuals below board level. ‘High end’ individuals are those ‘who as executive board members or other employees perform a significant influence function for the entity or whose activities have, or could have, a material impact on the risk profile of the entity’. The pay of these ‘high end’ employees should be disclosed (anonymously) in the annual report in bands ranging from ‘£1 million to £2.5 million, in a range of £2.5 million to £5 million and in £5 million bands thereafter’.

·Bonuses or any element of performance pay should have time delays of several years, up to five years, or enough time to assess that the transactions that engaged the bonus or performance pay did indeed benefit the bank in the way intended.

·The board and the FSA should monitor more closely the selling activities of major shareholders to understand what had triggered the sales.

·Institutional shareholders and fund managers should be more engaged with the companies that they invest in.

Although there were myriad governance failings in the banks that led to the financial crisis in 2008 an interesting feature of the aftermath was the concern that boards of banks engaged in a sort of dangerous group think among men from similar background ds and experience which led to their demise. This brought a wider focus to gender inequality on boards. In 2011 Lord Davies produced a report entitled ‘Women on Boards’, exploring the problem inherent in having so few women represented on UK boards. As a result, listed companies have increased gender disclosure requirements, policy obligationson gender board balance and a non-binding gender target of 25 per cent women on FTSE 100 boards. By 2015 this target was achieved and subsequently raised to 33 per cent.9

3.Why is the ‘agency’ problem such a big issue, both theoretically and practically, for company law?

From a theoretical perspective the fact that management and shareholders are separate creates the central agency problem that both the main theories (aggregate theory and realist theory).

The agency problem relates to the fact that if the shareholders take no part in the running of the company, mechanisms have to be devised to ensure that management do not abuse their discretion.

The realist theory argues that the company was no fiction but had a real existence; it does not depend on the state or its members to exist. The corporation is formed by shareholders but becomes something distinct at that moment: a real thing with its own interests and aims. There is a separate existence of the corporation: because of the corporation has its own interests, it can justify a departure from a shareholder.  It assumes the managers are purely neutral technocrats who have no interest on their own and make decisions in the best interests of the company.

Realist theorists such as Dodd, on the other hand, view the agency issue as an essential way to ensure that   management can run the company for the benefit of all. The problem has remained an issue for shareholders and the community and was partly addressed in the report of the DTI Company Law Review Steering Group as part of the reforms leading to the CA 2006.

The aggregate theory recognises the company as an institution formed by the aggregation of private contracting individuals. This is, members come together to pool their investment on terms they have agreed. The aggregate theory places the focus of managerial discretion firmly on the shareholders.

Aggregate theorists such as Berle and Jensen would advocate focusing on legal mechanisms that focus management power on shareholders.

The steering group formulated the concept of ‘enlightened shareholder value’ to deal with the stakeholder aspects of the    agency problem. This forms the basis of s.172 of the Companies Act 2006 and the business review (formerly the Operating and Financial Review).

4.‘Given the evident corporate governance failures within the financial services industry and the subsequent crisis in financial markets since October 2008, it is time to abandon the use of self-regulating committees on corporate governance and impose a statutory framework.’

It is important, for the answering of this questions, to examine the recommendations made by the committees regarding the corporate governance.

The Cadbury Committee

The Cadbury Committee was established by the Financial Reporting Council, the London Stock Exchange and the combined accounting bodies. Its 1992 report on the Financial Aspects of Corporate Governance focused entirely on shareholder/board accountability mechanisms. The report was an industry attempt to address some of the accountability concerns expressed about UK-listed companies. Although fairly narrowly focused, it succeeded in identifying the lack of managerial accountability at the heart of most UK-listed companies. The key recommendations of the Cadbury Committee were:

·the introduction of non-executive directors to the main board

·the creation of sub boards dominated by non-executives. The idea was that these non-executive directors would bring some objectivity to board decisions.

·Cadbury also recommended that a committee structure should be put in place to improve:

d.accountability in the appointment of directors

e.the pay (remuneration) of directors

f.the audit processes.  

However, as we will see, its failure to define what independence in the context of non-executives meant would become a problem some 10 years later, as companies regularly appointed ex-executive directors and friends of board members as non-executives.

The Greenbury Committee

By 1995 the Greenbury Committee was formed to report on directors’ pay. The Greenbury Committee:

·Identified that there is an inherent conflict of interest in directors deciding on their own pay

·Recommendedan enhanced disclosure regime for directors’ paya non-executive-only remuneration committee.

Unfortunately, the open disclosure regime recommended by Greenbury only succeeded in providing a reference point for managers to negotiate higher salaries, as they could point to higher salaries in other, similar companies to justify higher pay claims. Pay has continued to be a corporate governance problem, as the central conflict of interest in a board deciding on its own pay has remained despite the creation of remuneration committees.

The Higgs Review (2003)

The review was carried out by Derek Higgs, who consulted widely and produced a final report in January 2003. The key recommendation of the Higgs Review was to provide a good definition of independence for non-executives.

A non-executive director will now only be considered independent when the board determines that:

·the director is independent in character and judgment and

·there are no relationships or circumstances which could affect the director’s judgment.

Such relationships and circumstances arise where the director:

is or has been an employee of the company

has or had a business relationship with the company

is being paid by the company other than a director’s fee and certain other payments

has family ties to the company or its employees

holds cross-directorships or has significant links with other directors through involvement in other companies or bodies

represents a significant shareholder

has served on the board for 10 years. T

The Higgs recommendations aim to ensure that non-executives function properly in their monitoring role by emphasising their independence. Thus, they may finally begin to act to improve the accountability of managers. The core recommendations of the Higgs Review have been adopted by the London Stock Exchange and have also been influential in many other jurisdictions around the world where stock exchanges are present.

The financial crisis and corporate governance

In the aftermath of the financial crisis that engulfed the global economy in 2008, Sir David Walker considered that:

the boards of big banks did not understand the scale of the risks their organisations were running

non-executives of big banks did too little to rein in the excesses of the executive directors

·shareholders in banks also failed to curb reckless gambling by financial institutions, and that the owners did not ‘exercise proper stewardship’

·bankers were paid in a dangerous way which encouraged them to speculate imprudently.

His solutions to these significant problems were as follows.

·Financial institutions should form a risk committee, separate from the audit committee, to monitor all substantial transactions and stop a transaction if it was deemed too risky. The committee should be chaired by a non-executive director (NED).

·Currently NEDs devote too little time to their role (20–25 days currently, often for pay of more than £100,000 a year). Bank and financial institution NEDs need to devote 30–36 days each year to the role. They also must be properly trained and scrutinised closely by the FSA to ensure that they can hold executives to account.

·The chairmen of banks or other financial institutions similarly devote too little time to their roles and should commit no less than two-thirds of their time to the business. The chairman should have significant and relevant ‘financial industry experience’ and should face re-election by shareholders every year.

·The remuneration committee should set the pay of executive directors and ‘high end’ individuals below board level. ‘High end’ individuals are those ‘who as executive board members or other employees perform a significant influence function for the entity or whose activities have, or could have, a material impact on the risk profile of the entity’. The pay of these ‘high end’ employees should be disclosed (anonymously) in the annual report in bands ranging from ‘£1 million to £2.5 million, in a range of £2.5 million to £5 million and in £5 million bands thereafter’.

·Bonuses or any element of performance pay should have time delays of several years, up to five years, or enough time to assess that the transactions that engaged the bonus or performance pay did indeed benefit the bank in the way intended.

·The board and the FSA should monitor more closely the selling activities of major shareholders to understand what had triggered the sales.

·Institutional shareholders and fund managers should be more engaged with the companies that they invest in.

Although there were myriad governance failings in the banks that led to the financial crisis in 2008 an interesting feature of the aftermath was the concern that boards of banks engaged in a sort of dangerous group think among men from similar background ds and experience which led to their demise. This brought a wider focus to gender inequality on boards. In 2011 Lord Davies produced a report entitled ‘Women on Boards’, exploring the problem inherent in having so few women represented on UK boards. As a result, listed companies have increased gender disclosure requirements, policy obligationson gender board balance and a non-binding gender target of 25 per cent women on FTSE 100 boards. By 2015 this target was achieved and subsequently raised to 33 per cent.9

5.Whydoestheseparationofownershipfromcontrolcausesuchproblemsforcompany law?

Over the course of the 20th century, there was a changing in practice and social phenomena which judges were quick to recognize. In listed companies share ownership is now more widespread and the attention of shareholders, both private and institutional, is, by large, focused upon investment returns rather than upon monitoring directorial conduct. The general meeting in larger companies, particularly through the use of proxy voting (where shareholders do not attend the meeting but instead send in written vote or, more usually, assign their votes to the board to exercise as it wishes) often becomes more than a forum for rubber-stamping boardroom decisions.

This shift of power from those who own the company to those who control it was identified by Berle and Means in their pioneering empirical study. They argued that one of the consequences of the separation of ownership from control, taken together with the dispersion of share ownership, was that shareholders could no longer control the direction of the company. Although directors in the companies surveyed had functional control, they had relatively small personal shareholdings. A large dispersed shareholding in turn has neither the means nor the initiative to monitor these new powerful managers

The principal concerns in large public companies is their investment returns, while the focus of the directors is centred on the power over the enterprise. If shareholders disagree with the directors’ management of the company, the only realistic option is to sell their shares and leave.

6.What lessons can we learn about the ‘agency’ problem from the financial crisis that unfolded in Autumn2008?

From a theoretical perspective the fact that management and shareholders are separate creates the central agency problem that both the main theories (aggregate theory and realist theory).

The agency problem relates to the fact that if the shareholders take no part in the running of the company, mechanisms have to be devised to ensure that management do not abuse their discretion.

The realist theory argues that the company was no fiction but had a real existence; it does not depend on the state or its members to exist. The corporation is formed by shareholders but becomes something distinct at that moment: a real thing with its own interests and aims. There is a separate existence of the corporation: because of the corporation has its own interests, it can justify a departure from a shareholder.  It assumes the managers are purely neutral technocrats who have no interest on their own and make decisions in the best interests of the company.

Realist theorists such as Dodd, on the other hand, view the agency issue as an essential way to ensure that   management can run the company for the benefit of all. The problem has remained an issue for shareholders and the community and was partly addressed in the report of the DTI Company Law Review Steering Group as part of the reforms leading to the CA 2006.

The aggregate theory recognises the company as an institution formed by the aggregation of private contracting individuals. This is, members come together to pool their investment on terms they have agreed. The aggregate theory places the focus of managerial discretion firmly on the shareholders.

Aggregate theorists such as Berle and Jensen would advocate focusing on legal mechanisms that focus management power on shareholders.

The steering group formulated the concept of ‘enlightened shareholder value’ to deal with the stakeholder aspects of the    agency problem. This forms the basis of s.172 of the Companies Act 2006 and the business review (formerly the Operating and Financial Review).

Between 2009 and 2016 a number of key reports and reforms have taken place to the financial crisis and the Walker Report in particular. In 2010, the FRC produced its Stewardship Code, which enhances the quality of engagement between institutional investors and companies to help improve long term returns to shareholders and the efficient exercise of governance responsibilities. The Code goes on to outline that institutional investors should:

·Publicly disclose their policy on how they will discharge their stewardship responsibilities.

·Have a robust policy on managing conflicts of interest in relation to the stewardship and this policy should be publicly disclosed.

·Monitor their investee companies.

·Establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholders value.

·Be willing to act collectively with other investors where appropriate.

·Have a clear policy on voting and disclosure of voting activity.

7.Corporatetheoryallowsustoworkoutsolutionstotheoccasionalproblems that arise in companylaw. ‘

SEE QUESTION 9

8.ThefinancialcrisishasillustratedthefailureoftheCorporateGovernance codes. ‘

In the aftermath of the financial crisis that engulfed the global economy in 2008, Sir David Walker considered that:

the boards of big banks did not understand the scale of the risks their organisations were running

non-executives of big banks did too little to rein in the excesses of the executive directors

·shareholders in banks also failed to curb reckless gambling by financial institutions, and that the owners did not ‘exercise proper stewardship’

·bankers were paid in a dangerous way which encouraged them to speculate imprudently.

His solutions to these significant problems were as follows.

·Financial institutions should form a risk committee, separate from the audit committee, to monitor all substantial transactions and stop a transaction if it was deemed too risky. The committee should be chaired by a non-executive director (NED).

·Currently NEDs devote too little time to their role (20–25 days currently, often for pay of more than £100,000 a year). Bank and financial institution NEDs need to devote 30–36 days each year to the role. They also must be properly trained and scrutinised closely by the FSA to ensure that they can hold executives to account.

·The chairmen of banks or other financial institutions similarly devote too little time to their roles and should commit no less than two-thirds of their time to the business. The chairman should have significant and relevant ‘financial industry experience’ and should face re-election by shareholders every year.

·The remuneration committee should set the pay of executive directors and ‘high end’ individuals below board level. ‘High end’ individuals are those ‘who as executive board members or other employees perform a significant influence function for the entity or whose activities have, or could have, a material impact on the risk profile of the entity’. The pay of these ‘high end’ employees should be disclosed (anonymously) in the annual report in bands ranging from ‘£1 million to £2.5 million, in a range of £2.5 million to £5 million and in £5 million bands thereafter’.

·Bonuses or any element of performance pay should have time delays of several years, up to five years, or enough time to assess that the transactions that engaged the bonus or performance pay did indeed benefit the bank in the way intended.

·The board and the FSA should monitor more closely the selling activities of major shareholders to understand what had triggered the sales.

·Institutional shareholders and fund managers should be more engaged with the companies that they invest in.

To reflect wider concerns about UK corporate governance, a new version of the Combined Code on Corporate Governance was also produced in May 2010 and is now called the UK Corporate Governance Code. The code was updated again in 2012, 2014 and 2016.

One of the most important developments triggered by the Financial Crisis occurred in October 2010, when BIS launched a review of ‘corporate governance and economic short-termism’.This resultedin the appointment of John Kay and eminent Oxford economist to examine key issues related to investment in UK equity markets and its impact on the long-term performance and governance of UK quoted companies. In February 2012, Kay produced the interim review, which provided a wide range of evidence that British companies were subject to damaging short-term pressures, particularly from shareholders. It then went on to set out ideas for to how to correct this problem, including changes to long-term focused directors’ duties, dual class voting and tax incentives to encourage long-term shareholding, and reduced financial disclosure to encourage managers to plan for the longer term. However, of these interim suggested solutions the final report, when it appeared in July 2012, contained only a significant recommendation on removing quarterly disclosure. The report’s other main focus, in terms of solving the short-termism problem, was to target the investment chain. This target focused on encouraging trust, providing long-term incentives for asset managers, and introducing fiduciary standards of care for those in the investment chain while also encouraging good practice focused on long-term investing. On remuneration for executives, the review refreshingly recommended ultra-long-term share incentives to ensure a focus on the very long term. Again, these are significant recommendations, but where shareholders were concerned the final report focused on encouraging a form of enhanced shareholder ‘stewardship’ based on trust, respect, engagement and understanding, which should not only include engagement with matters of corporate governance but strategic issues as well.

Although there were myriad governance failings in the banks that led to the financial crisis in 2008 an interesting feature of the aftermath was the concern that boards of banks engaged in a sort of dangerous group think among men from similar backgrounds and experience which led to their demise. This brought a wider focus to gender inequality on boards. In 2011 Lord Davies produced a report entitled ‘Women on Boards’, exploring the problem inherent in having so few women represented on UK boards. As a result, listed companies have increased gender disclosure requirements, policy obligationson gender board balance and a non-binding gender target of 25 per cent women on FTSE 100 boards. By 2015 this target was achieved and subsequently raised to 33 per cent.

9.Does corporate theory influence company law?

The concession or fiction theory implies that the formation of companies was a concession from the state in that either the Crown or Parliament granted the advantages of corporate personality through a grant or specific Act of Parliament. This theory describes incorporation as a concession granted or a legal fiction created by the state because of the public good being carried out by the business.

As a result, the purpose of the company contained some element of public interest, for example to build a railway, canal or telegraph network or to develop trade within the British Empire.

The state is central to its existence and the company therefore only exists and is legitimised because it serves the public good. This theory makes it relatively easy to justify the imposition of corporate regulations aimed at promoting the public interest.

However, although companies are still formed by the state today, the advent of the registered company with its essentially private nature caused a decline in the use of concession theory. The state gave up the ability to set the objectives of a corporation. This was now done by private individuals and framed in terms of their own private needs.

The realist theory argues that the company was no fiction but had a real existence; it does not depend on the state or its members to exist. The corporation is formed by shareholders but becomes something distinct at that moment: a real thing with its own interests and aims. There is a separate existence of the corporation: because of the corporation has its own interests, it can justify a departure from a shareholder.  It assumes the managers are purely neutral technocrats who have no interest on their own and make decisions in the best interests of the company.

Realist theorists such as Dodd, on the other hand, view the agency issue as an essential way to ensure that   management can run the company for the benefit of all. The problem has remained an issue for shareholders and the community and was partly addressed in the report of the DTI Company Law Review Steering Group as part of the reforms leading to the CA 2006.

The aggregate theory recognises the company as an institution formed by the aggregation of private contracting individuals. This is, members come together to pool their investment on terms they have agreed. The aggregate theory places the focus of managerial discretion firmly on the shareholders.

Aggregate theorists such as Berle and Jensen would advocate focusing on legal mechanisms that focus management power on shareholders.

Concession theory, for example, can be observed in the objects clause ultra vires issues. It means that, if the object clause of a company stated that the business was to run a furniture shop, Parliament was deemed to have conferred powers to run a furniture shop but no other type of business. Creditors and shareholders were therefore protected as management could not take their funds and use them for any other purpose.

Aggregate theory is influential in the way directors are legally focused on shareholders and in agency cost-reducing measures such as disclosure or the Corporate Governance codes.

Realist theory, however, can be seen in the fact the company is a separate legal entity and in the fact the judges give a wide discretion to directors. Similarly, section 172 of the Companies Act 2006 is heavily influenced by realist theory.

In short, theory does influence company law but no one theorydominates.

10.Have Non-Executive Directors been a successful answer to the agencyproblem?

First, it is important to take into account the concept of a NED: they are normally appointed to deports of larger companies to acts as monitors of the executive management. They are typically part time appointments. The corporate governance committees view NEDs as holding the potential to perform a monitoring role over their executive brethren, ensuring that they act strictly in the interest of the company.

It is important, for the answering of this questions, to examine the recommendations made by the committees regarding the corporate governance.

The Cadbury Committee

The Cadbury Committee was established by the Financial Reporting Council, the London Stock Exchange and the combined accounting bodies. Its 1992 report on the Financial Aspects of Corporate Governance focused entirely on shareholder/board accountability mechanisms. The report was an industry attempt to address some of the accountability concerns expressed about UK-listed companies. Although fairly narrowly focused, it succeeded in identifying the lack of managerial accountability at the heart of most UK-listed companies. The key recommendations of the Cadbury Committee were:

·the introduction of non-executive directors to the main board

·the creation of sub boards dominated by non-executives. The idea was that these non-executive directors would bring some objectivity to board decisions.

·Cadbury also recommended that a committee structure should be put in place to improve:

g.accountability in the appointment of directors

h.the pay (remuneration) of directors

i.the audit processes. 

However, as we will see, its failure to define what independence in the context of non-executives meant would become a problem some 10 years later, as companies regularly appointed ex-executive directors and friends of board members as non-executives.

The Greenbury Committee

By 1995 the Greenbury Committee was formed to report on directors’ pay. The Greenbury Committee:

·Identified that there is an inherent conflict of interest in directors deciding on their own pay

·Recommendedan enhanced disclosure regime for directors’ paya non-executive-only remuneration committee.

Unfortunately, the open disclosure regime recommended by Greenbury only succeeded in providing a reference point for managers to negotiate higher salaries, as they could point to higher salaries in other, similar companies to justify higher pay claims. Pay has continued to be a corporate governance problem, as the central conflict of interest in a board deciding on its own pay has remained despite the creation of remuneration committees.

The Higgs Review (2003)

The review was carried out by Derek Higgs, who consulted widely and produced a final report in January 2003. The key recommendation of the Higgs Review was to provide a good definition of independence for non-executives.

A non-executive director will now only be considered independent when the board determines that:

·the director is independent in character and judgment and

·there are no relationships or circumstances which could affect, or appear to affect, the director’s judgment.

Such relationships and circumstances arise where the director:

·is or has been an employee of the company

·has or had a business relationship with the company

·is being paid by the company other than a director’s fee and certain other payments

·has family ties to the company or its employees

·holds cross-directorships or has significant links with other directors through involvement in other companies or bodies

·represents a significant shareholder

·has served on the board for 10 years.

The Higgs recommendations aim to ensure that non-executives function properly in their monitoring role by emphasising their independence. Thus, they may finally begin to act to improve the accountability of managers. The core recommendations of the Higgs Review have been adopted by the London Stock Exchange and have also been influential in many other jurisdictions around the world where stock exchanges are present.

This should clearly show it is designed to focus on shareholder – rather than stakeholder – concerns about how companies are run. As such, stakeholders are not particularly a   focus of the code and so it is unlikely to be concerned with stakeholder issues.

Overall problems with NEDs have persisted, for example suspicions about their lack of independence, pay has not been restricted by their activities, and in the collapse of the banks in the financial crisis NEDs seemed incapable of monitoring them.

The Walker Report (2009)

It has the aim to examine corporate governance in the UK banking industry and make recommendations, including in the following areas: the effectiveness of risk management at board level, including the incentives in remuneration policy to manage risk effectively; the balance of skills, experience and independence required on the boards of UK banking institutions; the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees; the role of institutional shareholders in engaging effectively with companies and monitoring of boards; and whether the UK approach is consistent with international practice and how national and international best practice can be promulgated.

Among other of the solutions proposed by Sir David, as to increase the NEDs devotion in the company up to 30-36 days each year to the role.

11.Is there a theory that completely explains the major issues that arise in companylaw?

SEE QUESTION 9.

12. ‘A grounding in corporate theory is essential if future company law reforms are to be successful.’

SEE QUESTION 9.

13.What principles underpin the UK corporate governance code?

The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company.  The first version of the UK Corporate Governance Code (the Code) was produced in 1992 by the Cadbury Committee.

The Code is a guide to a number of key components of effective board practice. It is based on the underlying principles of all good governance: accountability, transparency, probity and focus on the sustainable success of an entity over the longer term.

The Code has been enduring, but it is not immutable. Its fitness for purpose in a permanently changing economic and social business environment requires its evaluation at appropriate intervals.

The new Code applies to accounting periods beginning on or after 17 June 2016 and applies to all companies with a Premium listing of equity shares regardless of whether they are incorporated in the UK or elsewhere.

The code is entirely principle-based, and so they should go through the principles and their importance:

1.Leadership

Every company should be headed by an effective board which is collectively responsible for the long-term success of the company.

There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.

The chairman is responsible for leadership of the board and ensuring its effectiveness on all aspects of its role.

As part of their role as members of a unitary board, non-executive directors should constructively challenge and help develop proposals on strategy.

2. Effectiveness

The board and its committees should have the appropriate balance of skills, experience, independence and knowledge of the company to enable them to discharge their respective duties and responsibilities effectively.

There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board.

All directors should be able to allocate sufficient time to the company to discharge their responsibilities effectively.

All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.

The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties.

The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.

All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance.

3. Accountability

The board should present a fair, balanced and understandable assessment of the company’s position and prospects.

The board is responsible for determining the nature and extent of the principal risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal control systems.

The board should establish formal and transparent arrangements for considering how they should apply the corporate reporting, risk management and internal control principles and for maintaining an appropriate relationship with the company’s auditors.

Financial Reporting Council 5

4.Remuneration

Executive directors’ remuneration should be designed to promote the long-term success of the company. Performance-related elements should be transparent, stretching and rigorously applied.

There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration.

5. Relations with shareholders

There should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.

The board should use general meetings to communicate with investors and to encourage their participation.

14.Has company law any theoretical   grounding?

The concession or fiction theory implies that the formation of companies was a concession from the state in that either the Crown or Parliament granted the advantages of corporate personality through a grant or specific Act of Parliament. This theory describes incorporation as a concession granted or a legal fiction created by the state because of the public good being carried out by the business.

As a result, the purpose of the company contained some element of public interest, for example to build a railway, canal or telegraph network or to develop trade within the British Empire.

The state is central to its existence and the company therefore only exists and is legitimised because it serves the public good. This theory makes it relatively easy to justify the imposition of corporate regulations aimed at promoting the public interest.

However, although companies are still formed by the state today, the advent of the registered company with its essentially private nature caused a decline in the use of concession theory. The state gave up the ability to set the objectives of a corporation. This was now done by private individuals and framed in terms of their own private needs.

The realist theory argues that the company was no fiction but had a real existence; it does not depend on the state or its members to exist. The corporation is formed by shareholders but becomes something distinct at that moment: a real thing with its own interests and aims. There is a separate existence of the corporation: because of the corporation has its own interests, it can justify a departure from a shareholder.  It assumes the managers are purely neutral technocrats who have no interest on their own and make decisions in the best interests of the company.

Realist theorists such as Dodd, on the other hand, view the agency issue as an essential way to ensure that   management can run the company for the benefit of all. The problem has remained an issue for shareholders and the community and was partly addressed in the report of the DTI Company Law Review Steering Group as part of the reforms leading to the CA 2006.

The aggregate theory recognises the company as an institution formed by the aggregation of private contracting individuals. This is, members come together to pool their investment on terms they have agreed. The aggregate theory places the focus of managerial discretion firmly on the shareholders.

Aggregate theorists such as Berle and Jensen would advocate focusing on legal mechanisms that focus management power on shareholders.

Concession theory, for example, can be observed in the objects clause ultra vires issues. It means that, if the object clause of a company stated that the business was to run a furniture shop, Parliament was deemed to have conferred powers to run a furniture shop but no other type of business. Creditors and shareholders were therefore protected as management could not take their funds and use them for any other purpose.

Aggregate theory is influential in the way directors are legally focused on shareholders and in agency cost-reducing measures such as disclosure or the Corporate Governance codes.

Realist theory, however, can be seen in the fact the company is a separate legal entity and in the fact the judges give a wide discretion to directors. Similarly, section 172 of the Companies Act 2006 is heavily influenced by realist theory.

In short, theory does influence company law but no one theorydominates.

15. ‘The UK Corporate Governance code does very little to address shareholder or stakeholder concerns about how companies are run.’

It is important, for the answering of this questions, to examine the recommendations made by the committees regarding the corporate governance.

The Cadbury Committee

The Cadbury Committee was established by the Financial Reporting Council, the London Stock Exchange and the combined accounting bodies. Its 1992 report on the Financial Aspects of Corporate Governance focused entirely on shareholder/board accountability mechanisms. The report was an industry attempt to address some of the accountability concerns expressed about UK-listed companies. Although fairly narrowly focused, it succeeded in identifying the lack of managerial accountability at the heart of most UK-listed companies. The key recommendations of the Cadbury Committee were:

·the introduction of non-executive directors to the main board

·the creation of sub boards dominated by non-executives. The idea was that these non-executive directors would bring some objectivity to board decisions.

·Cadbury also recommended that a committee structure should be put in place to improve:

j.accountability in the appointment of directors

k.the pay (remuneration) of directors

l.the audit processes. 

However, as we will see, its failure to define what independence in the context of non-executives meant would become a problem some 10 years later, as companies regularly appointed ex-executive directors and friends of board members as non-executives.

The Greenbury Committee

By 1995 the Greenbury Committee was formed to report on directors’ pay. The Greenbury Committee:

·Identified that there is an inherent conflict of interest in directors deciding on their own pay

·Recommendedan enhanced disclosure regime for directors’ paya non-executive-only remuneration committee.

Unfortunately, the open disclosure regime recommended by Greenbury only succeeded in providing a reference point for managers to negotiate higher salaries, as they could point to higher salaries in other, similar companies to justify higher pay claims. Pay has continued to be a corporate governance problem, as the central conflict of interest in a board deciding on its own pay has remained despite the creation of remuneration committees.

The Higgs Review (2003)

The review was carried out by Derek Higgs, who consulted widely and produced a final report in January 2003. The key recommendation of the Higgs Review was to provide a good definition of independence for non-executives.

A non-executive director will now only be considered independent when the board determines that:

·the director is independent in character and judgment and

·there are no relationships or circumstances which could affect, or appear to affect, the director’s judgment.

Such relationships and circumstances arise where the director:

·is or has been an employee of the company

·has or had a business relationship with the company

·is being paid by the company other than a director’s fee and certain other payments

·has family ties to the company or its employees

·holds cross-directorships or has significant links with other directors through involvement in other companies or bodies

·represents a significant shareholder

·has served on the board for 10 years.

The Higgs recommendations aim to ensure that non-executives function properly in their monitoring role by emphasising their independence. Thus, they may finally begin to act to improve the accountability of managers. The core recommendations of the Higgs Review have been adopted by the London Stock Exchange and have also been influential in many other jurisdictions around the world where stock exchanges are present.

This should clearly show it is designed to focus on shareholder – rather than stakeholder – concerns about how companies are run. As such, stakeholders are not particularly a   focus of the code and so it is unlikely to be concerned with stakeholder issues.