LEGAL PRACTICE COURSE BUSINESS LAW AND PRACTICE PRE-MODULE READING

LEGAL PRACTICE COURSE BUSINESS LAW AND PRACTICE PRE-MODULE READING LEGAL PRACTICE COURSE BUSINESS LAW AND PRACTICE PRE-MODULE READING Summer 2016LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/20 ...

LEGAL PRACTICE COURSE BUSINESS LAW AND PRACTICE PRE-MODULE READING LEGAL PRACTICE COURSE BUSINESS LAW AND PRACTICE PRE-MODULE READING Summer 2016LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 1 of 127 Contents Page Introduction 3 An introduction to this text 3 Section 1 - Considerations when Starting a Business 7 1. Why businesses are set up 8 2. Finance 8 3. Business media overview 9 4. Factors influencing the choice of business medium 17 5. Commercial risk 19 6. Multiple Choice Questions 21 Section 2 - Introduction to Company Law 23 1. Ownership 24 2. Management of companies 29 3. Constitution of a private company limited by shares 30 4. Formation of a company 33 5. Private, public and listed companies 37 6. Articles of association 40 7. Officers of a company 45 8. Duties of directors 56 9. Board and shareholder resolutions 66 10. Company procedure 73 11. Summary of main points in relation to meetings 83 12. Why is it important to follow the correct procedures? 83 13. Multiple Choice Questions 85LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 2 of 127 Section 3 - Contract Law 89 1. Introduction: Contract law in context 90 2. Key elements for formation of a contract 91 3. Terms of a contract: express and implied 98 4. Misrepresentation 99 5. How a contract comes to an end 99 6. Remedies available to contracting parties 102 7. Principal / agent relationship 105 8. Commercial contracts - specific issues 106 9. Limitation of actions and execution of agreements 111 10. Further reading 113 11. Multiple Choice Questions 114 Solutions to Self-Assessment Exercises and Multiple Choice Questions 117LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 3 of 127 INTRODUCTION Please read this. It will help. It puts what is to come into perspective. The areas covered by this workbook are as follows: Section 1: Considerations when Starting a Business Section 2: Introduction to Company Law Section 3: Contract Law These areas form the foundation required for studying Business Law & Practice (‘BLP’) in the Compulsory Modules. It should take you around 12 hours to complete the reading and exercises contained in this workbook. You are required to have completed the reading and exercises contained in this workbook prior to enrolling on the LPC. There is a Solutions Section at the end of this workbook which contains solutions to the exercises. You will be required to take a BLP Pre-Module Reading test in the early weeks of the programme. The test will take the form of multiple choice questions and will have a pass mark of 50%. You will be given further information about completion of this test upon your enrolment. You will be referring back to this workbook throughout your study of BLP, and much of its contents will be examinable for the purposes of the final assessment.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 4 of 127 Sections 1 and 2 Sections 1 and 2 are designed to give you a broad overview of fundamental corporate principles, so that when you enrol on the LPC you can ‘hit the ground running’ in the first week of your BLP module (as you will be expected to do in the first week of your training contract!). At the same time, the text is designed to be a useful sourcebook to which you can return at appropriate points on the BLP module. After starting the module, you will find it useful to re-read this text in conjunction with other materials, particularly key statutory sources such as the Companies Act 2006 (‘CA 2006’). You will receive your own copies of all relevant statutory material upon enrolment. The statutory references in this text are provided to enable you to look up the statutory provisions later in the module. Section 3 The contract law reading and exercises in Section 3 are intended to assist you in the revision and application of the contract law principles that you have already studied at degree/GDL level. On the LPC, it will be assumed that you understand the basic contractual principles. Contract law underpins many areas of business law. Every type of business entity enters into contracts in the course of trading. You will also need to understand the contractual relationships within a business itself, particularly between the owners (shareholders) and managers (directors) in a company, and between business partners in a partnership. As you will see if you take certain elective modules (e.g. Debt Finance and/or Private Acquisitions), almost every deal is based on a contract and other electives (e.g. CLIP, ITT) look at commercial contracts that clients enter in the course of trading dayto-day. The principles of contract law will also be relevant to the Civil Litigation and Property Law and Practice Core Practice Areas.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 5 of 127 The contract law reading and exercises in Section 3 are intended to assist you in the revision and application of the contract law principles that you have already studied at degree/GDL level.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 7 of 127 SECTION 1: CONSIDERATIONS WHEN STARTING A BUSINESS Legal Practice Course Learning Outcomes After completing this Section you should have an appreciation of: 1. why businesses are set up; 2. the requirement for a business to raise finance; 3. the different ways of carrying on a business, including some of the factors influencing the choice of business medium; and 4. the concept of commercial risk. Answers to the Multiple Choice Questions are at the back of the workbook.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 8 of 127 1. Why businesses are set up Businesses are generally set up to make a profit. A business generates income by selling products and/or services. In order to sell the products and/or services the business will incur certain expenses. Provided the income generated exceeds the expenses of the business it will make a profit. Once a business has made a profit a proportion of that profit is likely to be given to the owners of the business and the rest will be retained in the business in order to help it grow. 2. Finance 2.1 Why do businesses need to raise finance? A business is likely to need to raise finance for a number of reasons including the following: • to purchase premises from which to operate, stock, plant and machinery, and computer hardware and software in order to be able to manufacture and sell goods, or provide a service; • to employ staff to make the goods and/or provide the services to the customers; • to obtain advice of professional advisers from time to time, particularly accountants; and • to expand and grow, which it may do by acquiring other businesses, carrying out marketing activities and investing in new premises and equipment.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 9 of 127 2.2 How do businesses raise finance? There are four basic ways in which a business can raise money: • the owners of the business may invest in it by making contributions of capital to the business; • outside investors may be prepared to make a capital contribution to the business in order to share in its future profits; • the business may borrow money, for instance, from a bank; and • as already mentioned, a proportion of the profit that the business has generated is likely to be retained within the business to help it grow, rather than being distributed to the owners and investors in the business. 3. Business media overview There are several basic ways in which businesses can be structured. We will look at the most common of these business media in turn below. 3.1 Sole trader The simplest business medium is where a sole trader conducts business personally. • Legal status The sole trader and the business are one and the same entity and therefore the business has no legal status or identity of its own. Thus, when a contract is entered into, the sole trader will enter into it in his personal capacity and have unlimited personal liability under it.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 10 of 127 Example You open a newsagent called Daily News. Although you trade as ‘Daily News’, this is merely a name which you use to refer to the shop. There is no legal entity with that name, and each customer enters into a contract with you, in your personal capacity. • Relevant legislation Unlike partnerships or companies, there is no specific legislation regulating sole traders. They are merely subject to relevant commercial and tax legislation, accounting rules and the common law. • Liability to third parties Sole traders have unlimited personal liability to third parties. 3.2 Partnership Section 1 Partnership Act 1890 defines a partnership as "... the relation which subsists between persons carrying on a business in common with a view of profit.” This is a very wide definition since it applies irrespective of contrary intention. Your client may therefore be conducting business as a partnership without even knowing it. There are many different types of partnership. Some involve an informal association between two persons to carry on a business without any express agreement; many family businesses are run in this manner. Others are very large professional and business partnerships with many partners and an elaborate partnership deed. The most common example of this would be solicitors’ firms.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 11 of 127 • Legal status Whilst partnerships are defined by statute, they have no separate legal identity. The partnership is therefore technically unable to own property or enter into contracts. Instead, where a partnership seeks to do any of the above, it is actually the individual partners who will conduct the legal action in their own name, own the property jointly, and enter into contracts jointly. This means that if the partnership becomes insolvent, the creditors are entitled to satisfy those debts by enforcement against the personal assets of each of the partners themselves. Example You and a business associate open a newsagent called Daily News, agreeing (perhaps just orally) to share the profits. You have a partnership. Though the two partners together trade as ‘Daily News’, this is only a name they use to refer to the shop - each customer enters into a contract with the firm (i.e. both of the partners). • Relevant legislation Partnerships are governed by the provisions of the Partnership Act 1890 together with all other relevant legislation and the common law. • Liability to third parties Partners have unlimited personal liability on either a joint, or a joint and several basis determined by the nature of the liability. 3.3 Limited partnerships In a limited partnership some partners are not liable for the debts and other liabilities of the partnership. Such partners are known as ‘limited partners’ as distinct from ‘general partners’ who will have unlimitedLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 12 of 127 personal liability. A limited partnership requires the involvement of at least two partners: at least one ‘limited’ partner and at least one ‘general’ partner. Under recent proposed reforms published on 24 March 2016 (and which are due to come into force within a year), a new sub-category of limited partnership called a private fund limited partnership would be created whereby there would be a list of permitted activities that the limited partners can be involved in without being deemed to be involved in management. • Legal status Like ordinary partnerships, limited partnerships have no separate legal identity. • Relevant legislation Limited partnerships are governed by the Limited Partnerships Act 1907 together with all other relevant legislation and the common law. • Liability to third parties ‘Limited’ partners have limited liability, but only if they are not involved in the day-to-day management of the partnership. If they do become so involved, they lose their limited status and become ‘general’ partners, thereby incurring the usual unlimited personal liability.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 13 of 127 Example You and a business associate open a newsagent called Daily News and agree that a partnership structure best suits your needs. Your business associate is providing finance for the venture but will play no part in the management of the business, as such he will be the limited partner and will not be liable for the debts and other liabilities of the business while you agree to be the general partner and will have unlimited personal liability. Please note that this example is used merely to demonstrate the structure of limited partnerships. In practice they are most commonly used as a vehicle for establishing private equity and venture capital funds. 3.4 Limited liability partnership ('LLP') An LLP is a hybrid as it has the flexibility of a partnership with the added advantage of limited liability for its members. • Legal status Legally, the LLP is a body corporate and is treated as a separate legal entity from its members. The LLP may therefore own property, enter into contracts, sue and be sued in its own name. However, for tax purposes, it is treated as a partnership and the members will be taxed as partners, each being liable to pay tax on his/her share of the income or gains of the LLP. • Relevant legislation LLPs are governed by the provisions of the Limited Liability Partnerships Act 2000 together with all other relevant legislation and the common law.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 14 of 127 • Liability to third parties The liability of the members of an LLP to third parties is limited to the amount that they have agreed to pay under the terms of their partnership agreement. Example Many law firms have converted from traditional partnerships to LLP structures in recent years. 3.5 Company limited by shares • Legal status Like an LLP, a company is an artificial legal person with a separate legal identity from that of its owners. The company may therefore own property, enter into contracts, sue and be sued in its own name. The owners of shares in the company are known as shareholders or members. • Relevant legislation Companies limited by shares are governed by the CA 2006 together with all other relevant legislation and the common law. • Liability to third parties The shareholders’ liability to third parties is limited to the amount, if any, unpaid on their shares (see example at paragraph 1.5 of Section 2).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 15 of 127 Example You and a business associate want to open a newsagent called Daily News. Together you incorporate a company called Daily News Limited, in which you each hold shares. This time, each customer will enter into a contract with the company, Daily News Limited, which is a legal person in its own right. Customers will have no contract with the directors or shareholders. 3.6 Company limited by guarantee Instead of holding shares, the members of a company limited by guarantee will guarantee that if the company is ever in financial difficulties and is wound up, they will contribute a certain amount (commonly £1 each) to the funds to be distributed to creditors. The members’ liability to third parties is limited to the amount guaranteed. As these companies are relatively rare, we will not study them on the LPC. 3.7 Unlimited company This type of business medium is rare. The fundamental feature of an unlimited company is that the liability of its members is unlimited. We will not be looking at this further on the LPC. 3.8 Joint ventures A joint venture (‘JV’) is a collaborative commercial arrangement entered into by two or more parties in order to work together to pursue a common business goal. It is commonly used where one party alone would not have the resources to achieve a goal. It is not strictly a distinct type of business medium since a JV may be structured in one of several ways. The three main ways are:LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 16 of 127 1. a limited liability company (‘JVC’); 2. a partnership, limited partnership or LLP (‘Partnership JV’); or 3. a contractual co-operation agreement (‘Contractual JV’). In the UK there is no body of law which is applicable exclusively to JVs. Instead, we must look to various sources of law. Depending upon the type of vehicle chosen, company or partnership law will be relevant. • JVC The parties to the JV set up a separate limited liability company in which the objects of the JV are to be pursued, the parties each taking shares in the new company. The parties are thus shareholders in the JVC, and are likely to sign a shareholders’ agreement dealing with the establishment of the JVC and their ongoing relationship. The JVC may be owned equally by each of the participants (a ‘deadlock’ company), or it may be controlled by one or more of the participants. If the JV involves a number of parties, a limited liability company is the most suitable medium. It is the most common form chosen for JVs in the UK. • Partnership JV As we saw in paragraph 3.2, a partnership may arise without formality where two or more parties “carry on a business in common with a view of profit”. However, it is much more likely that a partnership agreement will govern the relationship between the parties. The principal advantages of using a partnership as the business medium for a JV are that there are few publicity requirements and there are possible tax advantages. The disadvantage of a partnership as the business medium for a JV is the lack of limited liability that shareholders in the Partnership JV would have, although this issue may be dealt with by the use of aLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 17 of 127 limited partnership or LLP as the JV vehicle. It is also more difficult to raise external finance or to change participants mid-stream, although a properly drafted partnership agreement should contain mechanics to allow for a change of partners without causing the dissolution of the partnership. • Contractual JV At first sight a Contractual JV may appear very like a partnership, however a Contractual JV is not governed by the Partnership Act 1890. Typically the parties simply enter into a contract (commonly known as a co-operation agreement) which will govern the parties’ rights and obligations to each other and set out how they agree to share their resources and the costs of the project. Contractual JVs are frequently used in the context of collaborative research and development projects. There may be tax advantages in structuring in this way as opposed to a formal partnership. 4. Factors influencing the choice of business medium There are clearly several structures within which to operate a business. It is therefore important to be able to recognise some of the factors which may affect your client's choice. 4.1 Set-up costs There may not be any cost in setting up in business as a sole trader or partnership, since there are no incorporation requirements. There are costs involved in incorporating a company or LLP and these will be increased by the lawyers’ fees.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 18 of 127 4.2 On-going costs Because of the principle of limited liability, companies (and, to a lesser extent, LLPs) are subject to greater regulation and disclosure requirements than either sole traders or partnerships. This increased level of regulation adds to the administrative cost of running a company and an LLP. 4.3 Liability on insolvency Partners’ and sole traders’ personal assets are at risk if the business loses money. Shareholders in limited companies or members in LLPs, however, will only be liable to contribute the amount unpaid, if any, on their share capital or capital contribution respectively. Lenders often try to circumvent this principle of limited liability by seeking personal guarantees from shareholders, directors or members of an LLP. 4.4 Tradition Many types of business, e.g. architects, accountants and law firms, are traditionally operated as partnerships. This may influence the client's choice of business medium. 4.5 Raising finance Many lenders will prefer to lend to companies since a company is subject to a higher degree of regulation and disclosure, and therefore the lender may feel comfortable that it has full information against which to measure whether the risk it is undertaking in lending to a company is large or small. In addition, companies are able to give more forms of security for borrowing than individuals or partnerships.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 19 of 127 4.6 Tax The way in which the profits of a business are taxed depends to a large extent on the business medium and many clients obtain advice on the potential tax consequences of operating via different media. This is a complex, specialist area. One fairly simple example, which you will encounter in your study of Tax Law within the BLP module, is that a company pays corporation tax on its profits whereas profits generated by a partnership are taxed in the hands of the partners. If the partners are individuals they pay income tax and capital gains tax on their share of the partnership profits. If the partners are companies they pay corporation tax on their share of the partnership profits. The Introduction to Business Tax lecture provides an overview of the tax issues arising when selecting business media. 5. Commercial risk When establishing a business it is necessary, from the outset, to appreciate the concept of commercial risk. The word ‘risk’ is sometimes used interchangeably with the word ‘liability’ but the two words have different meanings. ‘Risk’ refers to the likelihood of things going wrong. ‘Liability’ is the state of being legally obliged or responsible to another party, or of owing another party money. The consequences of taking a given risk may include incurring a particular liability. The role of a lawyer includes advising your client on how to operate its business within the law: i.e. to inform it of what is and what is not permitted (and if the latter, to think creatively of other ways that your client is able to achieve what they wish, within the law). A less immediately obvious but, in practice, equally important aspect of your role is to help your client address and minimise commercial risk with legal solutions. To do this, it is necessary to understand the risks that clients face in given situations.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 20 of 127 Risk occurs in a myriad of forms throughout the business cycle of a company and is different depending on the business area. Some examples of common commercial risks include: • incurring expenditure which is unlikely to be matched by income; • agreeing to onerous contracts without a way of terminating the relationship; • taking on contractual obligations without any limitation of liability provision; • reputational risk associated with certain courses of action; • accepting unrealistic deadlines for performance; and • agreeing a course of conduct which could have disadvantageous consequences if factors outside the control of the client materialise. In business, clients constantly face choices as to whether or not to take a given commercial risk. It is necessary for a lawyer to understand the risks, to help a client spot them and to identify the possible liabilities that could confront the client if it fails to address the risks adequately. A client will almost always want to know: • What are the main elements of risk in the current proposed course of action? • What are the consequences if things do go wrong (i.e. the potential liabilities)? • What strategies can be employed to reduce or minimise these risks and potential liabilities?LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 21 of 127 6. Multiple Choice Questions 1. Which ONE of the following statements is FALSE? a) A partnership is a separate legal entity. b) A sole trader is liable for the debts of his business. c) A private limited company is a separate legal entity. d) A shareholder of a private limited company is not liable for the debts of the company. 2. Which ONE of the following statements is FALSE? a) The liability of a shareholder of a limited company is limited to the amount, if any, unpaid on their shares. b) A limited company is liable for its own debts. c) Property used by a limited company must be held in the name(s) of the majority shareholder(s) of the company. d) A limited company can sue its debtors. 3. The set up costs involved in setting up a company limited by shares are likely to be higher than those involved in setting up as a sole trader. TRUE or FALSE? 4. Which ONE of the following statements is FALSE? a) A joint venture can be structured as a partnership. b) A joint venture can be established as a limited company. c) A joint venture will always result in the formation of a separate legal entity. d) A joint venture can be structured as a purely contractual arrangement pursuant to a co-operation agreement.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 23 of 127 SECTION 2: INTRODUCTION TO COMPANY LAW Legal Practice Course Learning Outcomes After completing this Section, you should have a basic understanding of: 1. how a private company is owned; 2. shares and their key features; 3. how a company is formed; 4. the methods of, and procedures for, transacting the business of a company; 5. the content and relevance of a company’s articles of association; 6. the role and duties of directors and how they are appointed; and 7. how decisions are made within a company. Solutions to the Self-Assessment Exercises and Multiple Choice Questions are at the back of the workbook.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 24 of 127 1. Ownership The owners of the company are its shareholders, otherwise known as its members. Shareholders invest money (share capital) in the company in return for a share in the ownership of the company that is evidenced by a share certificate. Membership begins when the member’s name is entered in the company’s register of members (s.112(2) CA 2006). The first shareholders of the company are its subscribers as they subscribe to the company’s memorandum of association (see paragraph 3.2 below). A share is often described as a ‘bundle of rights’. By investing in the share capital of any company, the investor becomes a part owner of the company and will often have voting rights in shareholder meetings. There are several different types of share that a company may issue to its shareholders. Different classes of shares may carry different rights and entitlements. All rights and entitlements in relation to shares of all classes are set out in the company's articles of association (see paragraph 3.1 below). The most common type of share is known as an ordinary share. An ordinary share will usually entitle its holder to vote at shareholder meetings and to receive a share of the profits (if any). 1.1 Nominal or par value Shares in a limited company having a share capital must have a fixed nominal value. Common nominal values for ordinary shares are 1p, 5p or £1. The nominal (or ‘par’) value of a share is the minimum subscription price for that share. It represents a unit of ownership rather than the actual value of the share. A share may not be allotted/issued by a company at a discount to its nominal value, however it is not necessary for the shareholders to pay the full amount due on their shares immediately (see paragraph 1.2LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 25 of 127 below). A share may, however, be allotted/issued for more than its nominal value, and the excess over nominal value is known as the ‘premium’. The market value of a share (i.e. the amount at which a share may be traded between shareholders) will often be much higher than the nominal value of the share. 1.2 Issued, allotted, paid-up and called-up shares The amount of shares in issue at any time is known as the ‘issued share capital’. This is the amount of share capital that will be shown in the company’s accounts. A company’s issued share capital is made up of: • shares purchased by the first members of the company, known as the ‘subscriber shares’; and • further shares issued after the company has been incorporated, to new or existing shareholders. New shares can be issued at any time provided that the correct procedures (which you will learn more about later in the BLP module) are followed. ‘Allotment’ is defined in s.558 CA 2006. Shares are said to be allotted when a person acquires the unconditional right to be included in the company’s register of members in respect of those shares. The term ‘allotment’ is often used interchangeably with ‘issue’ of shares but the two have different meanings. There is no statutory definition of ‘issue’ but it has been held that shares are only issued, and only form part of a company’s issued share capital, once the shareholder has actually been registered as such in the company’s register of members, and his title has become complete. It is not always necessary for shareholders to pay the full amount due on their shares immediately. The amount paid is known as the ‘paidup share capital’. The amount outstanding can be demanded by the company at any time. Once demanded, the payment has beenLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 26 of 127 ‘called’. It is increasingly rare for shareholders of private companies not to pay-up the nominal value of their shares in full on issue. 1.3 Different classes of share A company may create different classes of share. For example, there may be two classes of ordinary share, each carrying different voting rights, or perhaps one carrying no voting rights at all. There may also be preference shares, which entitle the holder to a preferential right, such as the first claim to a dividend or the return of capital on a winding up. The rights will depend on the terms of the issue and are usually (and in some cases, must be) set out in the company’s articles of association. You will find out more about different class rights during the BLP module. Class rights may therefore be relevant when determining which shareholders can vote at general meetings and whether some shareholders have enhanced voting rights. It is also important to examine class rights where it is proposed to vary the terms of the rights attaching to a particular class of share. 1.4 Shareholders A shareholder need not be a human being. A company has a separate legal identity and can, amongst other things, own property in its own name. A company can therefore own shares in another company. Where company A owns all the shares in company B, company B will be a wholly owned subsidiary of company A. If company A owns some, but not all, of the shares in company B, company B may still be a subsidiary of company A but not a wholly owned subsidiary. You will learn about such degrees of ownership if you study the Private Acquisitions elective.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 27 of 127 Example: A Ltd owns all the shares in B Ltd. A Ltd is therefore described (for certain company law purposes) as B Ltd’s ‘parent’ or ‘holding’ company. In turn, B Ltd is A Ltd’s ‘subsidiary’. A Ltd and B Ltd together form a ‘group’ of companies. There is no limit on the number of companies that can form a group, and therefore, subsidiary companies may have their own subsidiaries too. This means that B Ltd could have its own subsidiary. In addition, there is no limit on the number of subsidiaries that a company may have, so it would be possible for either A Ltd or B Ltd to have more than one subsidiary. Here, A Ltd is the only shareholder of B Ltd. In the same way that a building belonging to A Ltd would be described as an asset of A Ltd, so shares held by companies in other companies are also considered to be assets of the company that owns them. The shares held by A Ltd in its subsidiary, B Ltd, will be shown as an asset in A Ltd’s accounts. With effect from 1 April 2016, every UK company is required to identify its ‘people with significant control’ (‘PSC’s). Broadly, this term refers to any individual (i.e. human being) who owns more than 25% of the shares or voting rights in the company; or who has the power to appoint or remove a majority of its board of directors; or who otherwise exercises ‘significant influence or control’ over the company). Every company must maintain a register of its PSCs, open to public inspection (see ss 790A - 790ZG CA 2006). The intended purpose of the PSC register is to increase transparency so as to help combat tax evasion, money laundering and terrorist financing. B Ltd A LtdLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 28 of 127 1.5 Limited liability The total nominal value of the shares held by a shareholder is equal to the total amount of that shareholder’s liability to contribute to the assets of the company if it becomes insolvent. This means that, if all the shareholder’s shares are fully paid, he will not have to contribute any further amount to the company on insolvency. This is the way in which a shareholder’s liability is said to be ‘limited’. Example If you subscribe for 10 shares of £1 each in a company, and that company later becomes insolvent and is wound up, providing you paid £10 in total when you acquired the shares, you would have no further liability to the liquidator of the company. If, however, when you acquired the shares, you only paid-up £6 of their total £10 nominal value then, if the company later becomes insolvent and is wound up, you would be liable to pay a further £4 to the liquidator. Therefore the shareholder's total liability is limited to the amount, if any, unpaid on his/her shares.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 29 of 127 2. Management of companies 2.1 Day to day management A company is an artificial person and therefore needs human agents to take decisions and act on its behalf. All companies will therefore have one or more directors who will be officers of the company. The directors are responsible for the day to day management of the company. Directors are agents of the company and their conduct is governed by statute and the common law principles of agency. They also owe fiduciary duties to the company. These duties have now been codified by the CA 2006. Together the directors of a company constitute the ‘board of directors’, often simply referred to as ‘the board’. References in CA 2006 to ‘the directors of a company’ (plural) are references to that company’s board. 2.2 Key decisions Some fundamental decisions cannot be taken by the directors but are reserved for the shareholders, for instance (i) the making of changes to the company’s constitution; (ii) the approval of certain transactions between the directors and the company (such as substantial property transactions and some loans to directors); (iii) the declaration of dividends; and (iv) the removal of directors. 2.3 Companies House All companies incorporated in England and Wales are registered at a public registry in Cardiff called Companies House. The head of Companies House is the Registrar of Companies. The company secretary (or where there is no company secretary, the directors) must ensure that the Registrar of Companies is notified when the company changes its officers, makes certain significant changes to its constitution or in certain other circumstances which you will consider during the BLP module.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 30 of 127 At least once a year, every company is required to ‘check and confirm’ that the information held on it at Companies House is up-to-date, by filing an annual confirmation statement. Before June 2016, instead of a confirmation statement, a company was obliged to file an annual return (‘AR’) to identify its directors, shareholders and registered office address as at the date of the AR. A private company may elect to hold more detailed information (equivalent to the contents of its statutory registers of members, directors, secretaries and PSCs) on a central register maintained at Companies House. Those who opt-in to the central register need not maintain their own statutory registers in-house (see ss112A, Part 2A to the Act, in particular ss.128B to 128J, 161A, ss.167A to 167E, 274A, ss.279A to 279E, 790W CA 2006). 3. Constitution of a private company limited by shares 3.1 Articles of association All companies must have articles of association (s.18 CA 2006). Under CA 2006 the articles of association form the main constitutional document of a company. The main purpose of the articles of association is to regulate the relationship between the shareholders, the directors and the company. Examples of provisions in the articles of association of a company include: • the number of directors required to transact business; • the method of appointment of directors; • the powers of directors; • how board meetings are to be conducted; • any special rights attaching to shares; • how shareholder meetings are to be conducted; and • how and to whom shareholders may transfer their shares.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 31 of 127 3.2 Memorandum of association, a company’s objects and the ultra vires rule Under s. 8 CA 2006 the memorandum has to be in the prescribed form set out below. Example of a memorandum under CA 2006 in prescribed form: COMPANY HAVING A SHARE CAPITAL Memorandum of association of Bradford Enterprises Limited Each subscriber to this memorandum of association wishes to form a company under the Companies Act 2006 and agrees to become a member of the company and to take at least one share. Name of each subscriber Authentication by each subscriber Martin Bradford Dated [date] Prior to CA 2006 the memorandum was a more complex document and formed part of the company’s constitution. Companies could set out constitutional restrictions in their memorandum and were required to include an objects clause setting out what the objects of the company were. Acting outside this statement of its objects wasLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 32 of 127 described as acting ultra vires or outside the company’s capacity (the ‘Ultra Vires Rule’). Under s.17 CA 2006 the memorandum no longer forms part of the company’s constitution - it is only required as part of the procedure to register a company at Companies House (see paragraphs 3.3 and 4.1 below). The memorandum simply amounts to a declaration on the part of the company’s subscribers (s.8 CA 2006). Companies formed under CA 2006 have unrestricted objects (s.31 CA 2006) unless the objects are specifically restricted in the company’s articles. So the Ultra Vires Rule is not applicable to a 2006 Act company unless it has chosen to insert an objects clause into its articles. For companies incorporated under the Companies Act 1985 (‘CA 1985’), s.28 CA 2006 provides that any provisions in a memorandum which exceed the very simple scope of s.8 CA 2006 must be treated as provisions of the company’s articles. This includes the objects clauses included in the memoranda of all CA 1985 incorporated companies. Under CA 2006, therefore, the objects clause of an older company continues in force, operating as a limitation on that company’s capacity unless and until the articles of such company incorporated are amended to remove its objects clause. The Ultra Vires Rule rarely causes problems in practice. The reason is that most companies today have very widely drafted objects (conferring capacity to do anything a company can do), if any. You do need to be aware of the Ultra Vires Rule, however. In practice, you may come across companies incorporated for very specific purposes, which accordingly have restrictive objects clauses. These will be the exception but, in practice, a lawyer will invariably check that a transacting company has power to contract.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 33 of 127 4. Formation of a company A client wishing to start a business through the medium of a company can either incorporate a new company from scratch or purchase an existing shelf company to conduct its business. 4.1 Incorporation from scratch In order to incorporate a new company from scratch an application must be made to the Registrar of Companies to have the new company registered at Companies House. This method was traditionally slightly slower than purchasing a shelf company (see paragraph 4.2 below). However, it is now possible to incorporate a company online and many law firms are now increasingly making use of this facility rather than using the shelf company procedure. You will look at this in more detail (and also get the opportunity to carry out an online incorporation yourself) during the BLP module. Incorporating a new company from scratch has the advantage of ensuring that the company is tailor-made to meet your client’s requirements. Under s.9 CA 2006, the following must be delivered to the Registrar of Companies for a company to be registered (if incorporating using hard copy documents rather than online): 1. a copy of the company’s memorandum; 2. an application for registration (form IN01) stating the company’s proposed name, whether the company’s registered office is to be situated in England and Wales, Scotland or Northern Ireland, whether the liability is limited and whether the company is to be private or public. (The registered office is the address at which the company can be contacted and legal proceedings can be served). The application must contain (where the company is to have a share capital) a statement of capital and initial shareholdings (s.10 CA 2006) and a statement of the company’sLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 34 of 127 proposed officers (s.12 CA 2006). If the company is to be limited by guarantee, details must be given of the guarantee (s.11 CA 2006). It must also contain a statement of compliance stating that the requirements of CA 2006 have been complied with (s.13 CA 2006); 3. articles prescribing regulations for the company (if the company does not intend to use the Model Articles (‘MA’) – see paragraph 6.3 below); and 4. the fee – the required fee for incorporation can be found on the Companies House website. Applications may take the Registrar of Companies up to five days to process, but to ensure that the company is registered on the same day as the incorporation documents are submitted, the applicant may pay a higher fee for a premium (same day) incorporation service. During your study of the BLP module, you will learn about various online services available to trainees in practice which make incorporating a new company relatively simple (and in fact, with the correct information, a trainee solicitor should be able to incorporate a new company within four hours, provided an online application is made in business hours). Once the Registrar of Companies has approved the application for incorporation of the company, the company is sent a certificate of incorporation authenticated by the Registrar’s official seal. The certificate sets out: 1. the name of the company (although this may be changed at a later date – see paragraph 4.2 below); 2. the company’s registered number. The company’s registered number will never change and must therefore be used when drafting any legal agreements to which the company is a party to ensure that the company can be correctly identified following future changes to its name; and 3. the date of incorporation.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 35 of 127 The company becomes a legal entity from the date of incorporation set out in the certificate of incorporation (s.15 CA 2006). 4.2 Purchasing a shelf company It has been more common traditionally for a solicitor to purchase a shelf company on behalf of the client than to incorporate a new company from scratch. This position is changing, as mentioned above, as a result of online incorporation services. A shelf company is one that has been set up in advance by a company registration agent or law stationer. Many firms of solicitors also operate an in-house service that sets up shelf companies for sale to clients. It is likely that you will have to make some, or all, of the following changes to the shelf company (amongst others) to meet your client’s requirements. You will learn how to implement these changes for your client during the BLP module. • Name – most shelf companies will have a name that has no connection with your client or its business (e.g. ABC 123 Limited). It will therefore need to be changed to a name selected by your client. Under s.77(1) CA 2006 a company's name can be changed by a special resolution of the shareholders or by any other means provided by the company’s articles (e.g. board resolution). • Articles – it is common for a shelf company to have been incorporated with MA (though some firms and registration agents incorporate their shelf companies with a different form of articles drafted in-house). You will need to consider whether the company’s existing articles need to be amended, in accordance with s.21(1) CA 2006, to meet the specific requirements of your client. A company may as a general rule alter its articles by special resolution.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 36 of 127 • Members, directors and the company secretary – representatives of the company registration agent will have become the first member(s) (‘subscriber(s)’ – see paragraph 1.2 above), director(s) and company secretary (if the company has one) of the company. It is therefore essential that: a) the share(s) held by the subscriber(s) is/are transferred to your client; b) your client’s representatives are appointed as director(s) and the company secretary (if there is to be one); and c) the first director(s) and company secretary (if there was one) resign from their positions. • Registered office - you may need to substitute your client’s chosen address for the first registered office in accordance with s.87(1) CA 2006. Traditionally, the greatest advantage of using the shelf company method to set up a company has been that it can be done quickly, as it avoids the need to draft and submit incorporation documentation. With the advent of online incorporation services, the difference in speed between converting a shelf company and incorporation from scratch is negligible. However conversion of a shelf company retains the advantage of being an available option all the time on every day of the year, whereas online incorporation can only take place during Companies House opening hours. Purchasing a shelf company has traditionally been regarded as the cheaper way to form a company for your client although - because your client is likely to instruct you to put changes into effect as described above - it may be that, once legal fees are factored in, the costs of the two methods are not materially different. The exceptional case would be when a client requires tailor-made articles to be drafted from scratch.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 37 of 127 5. Private, public and listed companies There are two sub-types of company limited by shares, the private limited company and the public limited company (and you can tell the difference from a company’s name). The shares of some public limited companies are listed. 5.1 Private limited company Section 4(1) CA 2006 states that “a private company is any company that is not a public company”. Private companies’ names end with the word ‘Limited’ or ‘Ltd’. The vast majority of companies in the United Kingdom are private companies, and it is this type of company that the BLP module focuses on. 5.2 Public limited company Section 4(2) CA 2006 states that a “public company is a company…whose certificate of incorporation states that it is a public company”. A public company’s name ends with the words ‘Public Limited Company’ or ‘Plc’. For practical purposes, the main difference between a public and a private company is that only public companies can offer their shares to the public, e.g. through public listing on a recognised stock exchange such as the London Stock Exchange, therefore permitting trading to take place in its shares. 5.3 Listed companies To enable a company to raise greater funds by offering shares to the public at large, a private company’s shareholders often decide to convert the company into a public limited company (‘Plc’). After converting to Plc status, a company may seek a listing of its shares on a stock exchange. Companies whose shares are listed onLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 38 of 127 the London Stock Exchange are known as ‘listed companies’ (but note that it is not the company that is listed, but its shares). Most commercial investors want to be able to deal freely in their investments, and a stock exchange listing allows them that freedom, making the company more attractive as an investment. A company must be a public company before it applies to have its shares listed on a stock exchange. However, not all public companies apply to have their shares listed. You should not therefore assume that a company whose name ends in ‘Plc’ is a listed company. 5.4 Principal differences between a private and a public company 5.4.1 Name As already mentioned the name of a private company will end in ‘Limited’ or ‘Ltd’ and the name of a public company will end in ‘Public Limited Company’ or ‘Plc’. 5.4.2 Share capital There is no requirement for a private company to have any specified minimum amount of share capital. A private company could be incorporated with just one share of 1p. In practice many companies are incorporated with a share capital of £1, that is with one share that has a nominal value of £1. A public company must have a share capital with a nominal value of at least £50,000 (or the euro equivalent), of which at least one quarter must be paid up (s.586 and s.763 CA 2006).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 39 of 127 5.4.3 Number of directors A private company need only have one director, a public company must have a minimum of two directors (s.154 CA 2006). 5.4.4 Company secretary A private company may choose to have a company secretary but it is not obliged to have one (s.270(1) CA 2006). If a private company does not have a company secretary, the directors (or any person the directors authorise) may do anything that the secretary is required or authorised to do (s.270(3)(b) CA 2006). A public company must have a company secretary (s.271 CA 2006) and the person appointed to that post must have the requisite knowledge and experience and hold one of the qualifications specified in s.273(2) CA 2006. 5.4.5 Annual general meetings A public company is required to have one annual general meeting (‘AGM’) each year (s.336 CA 2006). Private companies are no longer required to hold an AGM, although they may do so if they wish. An AGM provides members who are not directors with an opportunity to question directors, particularly on the issue of a company’s finances. You will learn more about AGMs if you study either the Equity Finance module or the Corporate Finance module. 5.4.6 Regulation Public companies are potentially able to offer their shares to the public. For this reason they are subject to a higher level of regulation than private companies. You will learn more about public companies in Lecture 3 of the BLP module.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 40 of 127 6. Articles of association 6.1 Content A company’s articles regulate its affairs and contain regulations which prescribe procedures which a company must follow when, for example, calling board and shareholder meetings, conducting meetings and appointing or removing company officers. The articles of a company are therefore effectively its rule book. Under CA 2006, the articles may also contain provisions regulating the company’s external affairs, for instance by including an objects clause (see paragraph 3.2 above). 6.2 Relationship between CA 2006 and the articles A company’s articles of association must be interpreted in the light of relevant legislation. There is considerable scope for overlap between the procedures set out in CA 2006 and those that may also be contained in the company’s articles. A company may in certain circumstances provide a procedure in its articles which is more onerous than that contained in CA 2006. Despite this you should be aware that there are some legislative provisions which override anything in a company’s articles. There are also powers available to companies by default under the provisions of CA 2006 unless the articles provide otherwise, for instance, the power of a private company to issue redeemable shares. As a solicitor you must always check both the procedures set out in the relevant legislation and in your client’s articles, and ensure that your client complies with the correct provision. For example, s.154(1) CA 2006 provides that a private company must have a minimum of one director. Company X Limited could provide in its articles that it requires three directors. Company X Limited wouldLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 41 of 127 need to comply with the three-director requirement in its articles, rather than the requirement set out in CA 2006. However, in certain circumstances the legislative provisions override matters contained in a company’s articles. An example of this would be s.321 CA 2006 (the right to demand a poll vote at a general meeting). You will be learning more about all these points later in the BLP module. 6.3 Choice of articles A company effectively has three choices as to the form of its articles: 6.3.1 MA / Table A The Secretary of State has prescribed MA for different types of company (under s. 19 CA 2006). If a new company does not register articles at Companies House, s.20(1) CA 2006 provides that the relevant MA will constitute the company’s articles in default. The court will not imply terms into the articles where the meaning is unclear. You will need to become familiar with the MA for a private limited company. A copy can be found in your statute book and will be referred to throughout the BLP module. There was a similar provision under the CA 1985. For companies incorporated under the CA 1985 the default articles were known as Table A. In practice, you may encounter older companies with Table A articles.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 42 of 127 6.3.2 Amended MA Not all of the provisions contained in the MA are suitable for all companies. Many companies therefore choose to adopt the MA as their articles, but elect to exclude, or modify the effect of, some of its provisions. 6.3.3 Tailor-made articles The third option available to your client is to instruct you to draft articles which are tailor-made for the particular company concerned. Your firm may have a precedent form of articles that you may be able to adapt for this purpose. However, generally this is a very timeconsuming process and therefore costly for your client, although the end product can often be more useful to the client in the long run. Most smaller companies will prefer to adopt MA, subject to certain amendments. 6.4 Alteration of the articles Once a company has adopted articles, it is able to alter them at any future date by special resolution (s.21(1) CA 2006). Section 22 CA 2006 permits the entrenchment of specific provisions within a company’s articles, though this occurs relatively rarely in practice. An entrenched provision of a company’s articles is one which can only be amended or repealed if specific conditions are met, or if procedures more restrictive than a special resolution are complied with. Entrenched articles can nevertheless always be amended by the agreement of all of the members, or by a court order (s.22(3) CA 2006). There is a great deal of case law relating to the alteration of a company’s articles which is outside the scope of this module. The basic rule is that, to be valid, any alteration must be made bona fide in the interests of the company as a whole.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 43 of 127 6.5 Legal effect of articles The nature of the contract established by the articles of a company is set out in s.33(1) CA 2006, which provides that the provisions in the company’s articles bind the company and its members to the same extent as if there were covenants on the part of the company and each member to observe those provisions. Whatever form the company’s articles take, therefore, they will be binding on both the company and its members. The practical effect of the predecessor to s.33(1) CA 2006 (namely s.14 CA 1985) has been the subject of a large amount of case law. The generally established rule is that the articles evidence a contract between the company and its members in their capacity as members and with respect to their rights and obligations as members (Hickman v Kent or Romney Marsh Sheep-Breeders’ Association (1915)). 6.5.1 Articles as a contract between the company and its members Courts have been willing to prevent a company infringing its members’ rights in breach of the articles by granting an injunction. Each member, acting in his capacity as a member, is similarly obliged to the company to comply with the articles. However, a member may not enforce any rights contained in the articles against the company that are not relevant to his capacity as a member. Rights contained in the articles that would probably be enforceable by members under s.33 CA 2006 would be the right to vote or the right to receive a final dividend once it has been declared (approved by a resolution of the shareholders). You will become familiar with procedures and terminology relating to declaration of dividends during the BLP module. ExampleLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 44 of 127 In Eley v Positive Government Security Life Assurance Company (1876), a member of the company who had inserted a right into the company’s articles for him to be employed as the company’s solicitor for life could not enforce this provision (under a forerunner of s.33 CA 2006) as this was not a right which he held in his capacity as a member, but rather in his capacity as the company’s solicitor. 6.5.2 Articles as a contract between the members themselves Although the courts have acknowledged that the forerunners to s.33 CA 2006 provide that the articles constitute a contract between the members themselves, as well as between the company and its members, there is conflicting authority as to whether one member may enforce the articles against another member directly (Rayfield v Hands [1960]) or only through the company itself, i.e. by requiring the company to enforce the provisions against the member (Welton v Saffery [1897]). The particular facts of Rayfield v Hands would suggest that if a member accepts a personal obligation to another member through the articles, that member can enforce the right against the other member directly. Otherwise the courts appear to be of the opinion that members will only be able to enforce provisions contained in articles through the company itself. If a member is likely to wish to enforce rights against other members, he/she should be advised to enter into a shareholders’ agreement. You will consider shareholders’ agreements on the BLP module.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 45 of 127 Self-Assessment Exercise 1 1. Under CA 2006, what is the purpose of the memorandum of a company limited by shares? 2. How many directors does a private company need to have? 3. What documentation would you need to send to Companies House on behalf of a client to incorporate a new private limited company? 4. How can a company change its articles? 5. Is a company permitted to make any change to its articles of association? 6. State one power or decision which is exercisable only by the members under the provisions of the CA 2006. 7. Officers of a company 7.1 Company secretary A company secretary's main duties are to keep the company books up to date, produce minutes of board and general meetings and make sure that all necessary filings are made at Companies House. It is not a part of his/her role to take decisions on behalf of the company, which is the domain of either the directors or the shareholders. In the past all companies were required to have a company secretary. But now under s.270(1) CA 2006 a private company is not required to have a company secretary unless the articles require it to have one. A private company can choose to have a company secretary if it wishes.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 46 of 127 If a private company does not have a company secretary, the directors (or any person the directors authorise) may do anything that the secretary was required or authorised to do (s.270(3)(b) CA 2006). A public company must have a company secretary (s.271 CA 2006). Part 12 of the CA 2006 applies to public companies and private companies that decide to have a company secretary. A public company secretary must have the requisite knowledge and experience, and one of the qualifications set out in s.273(2) CA 2006 (for example, the secretary may be a solicitor or a chartered accountant). The directors appoint the secretary and are required to check that the secretary qualifies under these provisions. 7.2 Directors 7.2.1 Number and nature of directors Under s.154 CA 2006: • a private company must have at least one director; and • a public company must have at least two directors. At least one director must be a natural person (s.155 CA 2006). This is intended to ensure that for all companies, there will always be one individual in place to aid accountability. The Government has announced that, from October 2016, all corporate directors (that is, directors which are, themselves, companies) will be prohibited subject to certain exceptions so that, as a general rule, all directors will have to be individuals. There is a minimum age limit of 16 for directors (s.157 CA 2006). The role of a director is separate from that of a shareholder however in small private companies they may be the same people.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 47 of 127 7.2.2 Executive directors An executive director is a director who has been appointed to executive office. Such a director will generally spend the majority, if not all, of his working time on the business of the company and will be both an officer and an employee of his company. Art.5 MA permits the directors to delegate specific powers to an individual director and may be used to delegate specific powers to an executive director. 7.2.3 Non-executive directors A non-executive director is also an officer of the company, but will not be an employee of the company. Non-executive directors do not take part in the day-to-day running of the company. Their role is generally to provide independent guidance and advice to the board and to protect the interests of shareholders. The term ‘non executive director’ is not defined in CA 2006. Section 250 CA 2006, which defines ‘director’ does not differentiate between executive and non-executive directors. The duties, obligations and restrictions placed on directors under the CA 2006 will apply to all directors, executive and non-executive. For the purposes of the BLP module, it is usually only necessary to bear in mind the distinction between executive and non-executive directors if you are considering their employment status. 7.2.4 Shadow directors Under s.251 CA 2006 a ‘shadow director’ is defined as a person “in accordance with whose directions or instructions the directors of the company are accustomed to act”. A person is not deemed to be a shadow director by reason only that the directors act on advice given by him in a professional capacity (s.251(2) CA 2006).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 48 of 127 This legislation is designed to prevent a disqualified director from getting around the prohibitions placed on him and still being involved in the running of a company, by acting behind the scenes. It is also designed to ensure that anyone who acts as a director, even if they are not technically appointed as one, is subject to the restrictions which apply to all directors. Most of the provisions in the CA 2006 imposing duties, obligations or restrictions on directors therefore apply equally to shadow directors. (See for example, ss.89, 162(6), 223, and 230 - 231 CA 2006.) It is also important to note that provisions in the Insolvency Act 1986 imposing liability for wrongful trading apply equally to shadow directors (see s.214 Insolvency Act 1986). Self-Assessment Exercise 2 Happy Caravans Ltd has run into financial difficulties. Its overdraft limit has been exceeded. Its bank manager has regular meetings with the Managing Director (‘MD’), in which the MD reports on the progress of the company. At these meetings, the bank manager makes suggestions to the MD as to how the company may continue to benefit from the bank’s financing. The MD then reports to the board and the board holds a meeting to discuss these specific proposals. So far, the directors have agreed to all the bank’s suggestions. Might the bank manager be a shadow director?LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 49 of 127 Self-Assessment Exercise 3 Jamie used to run a mail order company selling English wine, which became insolvent owing creditors substantial sums. Two old friends of his would like him to participate in a new company selling English fine cheeses by mail order, but Jamie is unable to be a director because he has been disqualified for two years. His valuable advice is needed by the board, who are old friends of his but have little experience in the food trade. Whilst Jamie has not been formally appointed, the board rarely question his advice, and usually follow it. Might Jamie be a shadow director? 7.2.5 Alternate directors Companies may provide in their articles for the appointment of alternate directors. An alternate director attends board meetings and acts in the director’s place, if the actual director is incapacitated, otherwise engaged or out of the country. An alternate director is usually either a fellow director of the company or someone who has been approved by a resolution of the board of directors. The MA do not provide for the appointment of alternate directors and, since it is now possible to hold board meetings over the telephone and to pass board resolutions by means of written resolutions, the use of alternate directors is becoming quite rare.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 50 of 127 7.3 Appointment of directors 7.3.1 Appointment of directors under CA 2006 and MA CA 2006 does not stipulate a procedure for the appointment of directors, so this is something that will be governed by the articles of the company. The MA deal with the matter simply, as follows: “17(1) Any person who is willing to act as a director, and is permitted by law to do so, may be appointed to be a director: (a) by ordinary resolution, or (b) by a decision of the directors.” As you will see on the BLP module, the second of these two procedures is easier to put into effect than the first and therefore, unless there is a particular reason for using the ordinary resolution procedure, it is usual for a board of directors to appoint its own new members. Of course, companies may not have followed the approach set out in the MA. They may instead have custom articles on this point which you must always check before advising on the appointment, retirement or removal of directors. 7.3.2 Directors’ service contracts An executive director will be an employee of his/her company. As an employee, he/she should be given a written contract of employment (otherwise known as a service contract). This contract will set out the director's terms and conditions of employment including his/her duties, remuneration package, notice provisions and the like. The effect of Art.19 MA is that the terms of an individual director’s service contract, including remuneration, are for the board toLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 51 of 127 determine. As a general rule, a director’s service agreement will only require the approval of a resolution of the board of directors. However, shareholder approval may be required for the duration of long-term service contracts. 7.3.3 Long-term service contracts Section 188 CA 2006 applies where a service contract provides for a director’s employment to have a ‘guaranteed term’ which is, or may be, longer than two years. Where s.188 CA 2006 applies, the relevant provision of the service contract requires shareholder approval. This would apply, for instance, if a director had a service contract for one year and had an option to renew the contract for a further two-year term at his/her sole discretion. You will study s. 188 in detail in due course on the BLP module. 7.3.4 What happens if approval is not obtained? If shareholder approval is not given, then the term incorporated into the service contract in contravention of s.188 CA 2006 is void under s.189(a) CA 2006. In addition, under s.189(b) CA 2006, the service contract will be deemed to contain a term entitling the company to terminate the contract at any time, by the giving of reasonable notice which will vary depending on the circumstances. All other terms of the contract may stay in force. 7.4 Directors’ authority As mentioned above at paragraph 2.1, common law principles of agency are relevant to the management of companies since a company relies upon its directors to act as its agents. The principles of agency are concerned with the circumstances in which one person (the agent) can form contracts on behalf of another person (the principal) so as to create contractual obligations enforceable against the principal by a third party. A principal is bound by acts which it has authorised the agent to do on its behalf.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 52 of 127 7.4.1 Power of directors, collectively, to act on behalf of the company The company’s articles usually give the board of directors authority to take all the day-to-day decisions concerning the operation of the company. Art.3 MA states that: “Subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.” So any third party dealing with a company would expect the board to have the power to do all acts necessary in relation to the management of the company’s business, subject to any restrictions in the company’s constitution. Does this mean that the third party must check for any restrictions on the board’s powers before transacting any business with the company? The answer is no, the third party will have the statutory protection of s.40 CA 2006, which states: “In favour of a person dealing with a company in good faith, the power of the directors to bind the company, or authorise others to do so, is deemed to be free of any limitation under the company’s constitution”. This means that provided the third party is acting in good faith it is entitled to rely on the authority of the directors acting as a board, even if the directors are actually exceeding the powers granted to them in their company’s articles.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 53 of 127 Example The articles of association of Abco Ltd contain a restriction to the effect that the directors may not commit Abco Ltd to the purchase of any new equipment having a value in excess of £30,000 without the prior approval of the shareholders. In breach of this restriction the directors enter into a contract with Equip Ltd for the purchase of new equipment costing £35,000. Provided Equip Ltd was acting in good faith, its contract with Abco Ltd will be binding on Abco Ltd as a consequence of s.40 CA 2006. The directors will still have breached their duties to Abco Ltd however and Abco Ltd will have the right to bring a claim against them (see s.40(4) CA 2006). The consequences of such a breach will be covered in more detail in the BLP module. 7.4.2 Power of an individual director to act on behalf of the company We have been looking at the powers of the board of directors but directors do not always act collectively as a board. Art.5 MA allows the board to delegate its powers to such person or committee, to such an extent and on such terms and conditions, as the directors think fit. Whether or not a third party can rely on a single director’s authority to bind the company will depend on the transaction in question and the type of authority that the director may have (express or implied). 7.4.3 Actual express authority The board of directors of a company may authorise one or more of their number to act in connection with a particular transaction, perhaps negotiating the terms of a particular transaction and/or executing documents on behalf of the company. Where this authority is given formally (usually by means of a board resolution) it is actual express authority.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 54 of 127 However directors do not always act so formally, particularly in relation to routine commercial contracts. 7.4.4 Actual implied authority Quite often the third party dealing with the director of a company will be relying on that director’s implied authority. Section 43 CA 2006 confirms that “a contract may be made on behalf of a company, by a person acting under its authority, express or implied”. A principal is liable for the acts of the agent which are within the authority usually conferred on an agent of that character. It would be normal, for instance, to expect the finance director of a company to have authority to act on the company’s behalf when dealing with the company’s accountants. Therefore, notwithstanding any express limitations on a director’s authority, if a director purports to bind the company to an act which is usual for a director to be able to do, then the company, as principal, will be bound. (This is sometimes called ‘usual’ authority because it is that which ‘usually’ attaches to the particular type of work being done by the agent.) In this connection we should consider the special situation of the managing director. It is very common for the directors of a company to appoint one of their number as a managing director. Although the role of a managing director is not set out in statute and the courts have taken differing views on the role of a managing director, it is very commonly accepted that a managing director will have the authority to act alone and bind the company on routine commercial contracts. Third parties are usually happy (and safe) to rely on the implied authority of a managing director to bind their company in the case of routine commercial contracts. This means that third parties dealing with the directors will usually be prepared to accept the signature of a single director (particularly the managing director) in connection with the sort of routine contracts thatLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 55 of 127 a company enters into on a very regular basis. However where the proposed contract is out of the ordinary and/or of significant value the third party will wish to make sure that the director it is dealing with has been granted express authority. In order to check that express authority has been given the third party will usually ask the director to produce a copy of the relevant board minute granting the authority. Self-Assessment Exercise 4 Brownlands Ltd (‘Brownlands’) is a company specialising in property sale and development. Oliver, whilst never formally appointed, acts as managing director and is referred to as the managing director on the Brownlands website. Oliver employs a team of architects to develop a site. Brownlands has now refused to pay the architects’ fees on the basis that Oliver had no authority to engage the architects on the company’s behalf. Is Brownlands liable? 7.4.5 Director acting without actual authority What happens where a director purports to enter into a transaction on behalf of the company which is neither expressly authorised nor within that director’s implied authority? It is possible for a person to have apparent (also known as ‘ostensible’) authority to act on behalf of a company (to the extent to which this is relevant for the BLP module, it will be discussed later in the course). A contract entered into on behalf of a company by a director who has apparent authority will bind the company, even if neither the board nor the shareholders wished it. In these circumstances, the director may be liable to the company (see para. 8.10 below as to the consequences of directors’ wrongful acts generally).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 56 of 127 In some circumstances, for example where a director has exceeded the scope of his authority, but his act was of benefit to the company, it may be appropriate for the company to take confirmatory action such that the director cannot at some future date be held liable to the company. This is known as ‘ratification’. If a director has exceeded the scope of his authority to act on behalf of the company, and the act was within the powers of the board of directors as a whole, then the act of that director may be ratified by a board resolution. If the act was outside the powers of the board as a whole, it can be ratified by an ordinary resolution of the shareholders. Actions by the director which are outside both his actual and any apparent authority will not bind the company. The third party may have a remedy against the director personally for breach of warranty of authority. 8. Duties of directors In the exercise of their powers, the directors must comply with their statutory duties, in particular the CA 2006 and the Insolvency Act 1986 (as amended), and those duties deriving from common law or in equity. CA 2006 provides a statutory statement of the general duties of directors. The statutory general duties are introduced by s.170 CA 2006, and then expanded in ss.171 – 177 CA 2006. The duties are based on common law rules and equitable principles and s.170(4) CA 2006 states that (although they have now replaced the equivalent common law duties) these statutory general duties should be interpreted and applied in the same way as common law rules and equitable principles. All of the statutory duties apply to directors and shadow directors. Former directors may also be covered: s.170(2) CA 2006.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 57 of 127 CA 1985 Prior to the implementation of the CA 2006, a director’s overriding duty at common law was to act bona fide in the interests of the company. In any question that a director had to consider, he should always have asked himself whether the course of conduct proposed was in the best interests of the company. If not, he could be sued by the company. A director also had a duty: • to act for the proper purpose; • not to misapply company property; and • to account for any secret profit. The statutory general duties will therefore be interpreted in line with these principles. 8.1 Duty to act within powers (s.171 CA 2006) According to this section, a director must act within his powers (i.e. in accordance with the company’s constitution), and use his powers “for the purposes for which they are conferred” – i.e. he should not use his powers for improper purposes (e.g. for personal gain). 8.2 Duty to promote the success of the company (s.172 CA 2006) This duty has been the subject of much debate. It is seen as codifying the previous common law duty requiring directors to act bona fide in the interests of the company (i.e. in the ‘best interests’ of the company). It therefore forms the central duty under the new regime.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 58 of 127 Section 172 CA 2006 stipulates that a director must act in a way which 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. In exercising this duty, a director is required to have regard to a range of matters which are set out in s.172(1) CA 2006, including: • the likely long term consequences of any decision; • employees’ interests; • the need to foster relationships with suppliers, customers and others; • the impact of the company’s operations on the community and the environment; • the desirability of the company maintaining a reputation for high standards of business conduct; and • the need to act fairly as between the members of a company. Although many of these matters were not specifically provided for under the common law, many companies would routinely consider such matters, as a necessary part of good business practice following the concept of ‘enlightened shareholder value’. (This is a term used to describe the ‘middle way’ between, on the one hand, running the company purely to maximise shareholders’ interests/profits and, on the other hand, a pluralist approach which involves acting in the interests of a wider group of stakeholders). The list of matters to be considered is not exhaustive. It is clear that the list is secondary to the duty to shareholders under s.172 CA 2006, and that the duty is owed to the company and not to the third party. Example The directors of Wilderness Oil plc are deciding whether the company ought to install a new oil pipeline. They need to haveLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 59 of 127 regard to the range of matters listed above, including the environmental implications of the pipeline, because these are mentioned in s.172(1)(d) CA 2006. However, having had regard to those matters, the directors may ultimately go ahead and install the pipeline anyway, causing a degree of environmental damage, if it promoted the success of the company to do so (under s.172(1) CA 2006). Since the introduction of the statutory duties there has been some uncertainty as to how to balance the various matters in the list, which will inevitably conflict from time to time. One fear was that companies may feel the need to respond by having more detailed board minutes to document how they have considered each area for every decision made. Another was that the new duty may lead to increased litigation. Neither fear has yet come to pass. Many companies are taking the common sense approach of ensuring board minutes clearly note that consideration has been given to the s. 172 duty when taking board decisions particularly as, with regard to significant commercial decisions, there will have been the requisite amount of research, discussion and briefing of the board to amply demonstrate consideration of the matters in s. 172(1) should the company be challenged. The courts appear to be backing this approach given the lack of significant case law on the point since these provisions came into force. 8.3 Duty to exercise independent judgment (s.173 CA 2006) This duty codifies the principle that directors must exercise their powers independently, and not fetter their discretion. They can rely on advice from others, but must make their own judgments. They cannot blindly follow others’ views without considering the interests of the company.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 60 of 127 8.4 Duty to exercise reasonable care, skill and diligence (s.174 CA 2006) The level of care, skill and diligence which a director must exercise is assessed objectively and subjectively. It is the level of skill, care and diligence which would be exercised by a reasonably diligent person with: • the general knowledge, skill and experience that may reasonably be expected of someone in his role; and • the general knowledge, skill and experience of that director. 8.5 Duty to avoid conflicts of interest (s.175 CA 2006) This duty is the first of three duties aimed at dealing with conflicts of interest which directors might experience. This duty requires a director to: “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.” This is quite widely drafted, and is said to apply “in particular to the exploitation of any property, information or opportunity”. It is no excuse for the director to say that the opportunity is not one which the company could have exploited itself. The duty is not infringed “if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest” or if the conflict arises: • in relation to a transaction with the company (i.e. a transaction between the director and the company) (s.175(3)); or • in relation to a matter which has been authorised by the directors (s.175(4)(b)).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 61 of 127 8.6 Duty not to accept benefits from third parties (s.176 CA 2006) This is the second of the three duties aimed at conflicts of interest. Under this section, a director must not accept a benefit from a third party, which is conferred by reason of his being a director, or by reason of his doing (or not doing) anything as a director. Example A director accepting a bribe, or making a profit at the company’s expense by virtue of his office, would clearly breach this duty. His conflict of interest would be obvious. However, note that the duty is not breached if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest (s.176(4) CA 2006). Note that, unlike the duty in s.175 CA 2006, the other directors cannot authorise an arrangement under this section. There is no provision allowing them to do so. However note the possibility of shareholder approval under paragraph 8.8 below. 8.7 Duty to declare interest in proposed transaction (s.177 CA 2006) This is the third of the three duties aimed at conflicts of interest. Any director who is interested in a proposed transaction with the company must declare the nature and extent of his interest to the other directors. This covers indirect interests, as well as direct interests.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 62 of 127 Example If company A is about to sign a contract with company B, and a director of company A also happens to be a shareholder in company B, he will have an indirect interest in the transaction under consideration. He stands to gain from his personal shareholding in company B, if company A signs the contract. He must therefore tell the directors of company A about his shareholding in company B, before company A signs the contract. In addition to the duty under s.177 CA 2006 to disclose interests in proposed transactions entered into by the company, directors are also required to disclose interests in existing transactions or arrangements entered into by the company (s.182 CA 2006) - a duty which arises most commonly in practice at the point when a new director joins the board. 8.8 Shareholder approval in advance Shareholders may support a director’s proposed action, and be prepared to approve it in advance, even though it would otherwise represent a breach of the general duties set out above. The statutory duties under CA 2006 are said to “have effect subject to any rule of law enabling the company to give authority, specifically or generally, for anything to be done (or omitted) by the directors … that would otherwise be a breach of duty” (s.180(4) CA 2006). This represents a continuation of the common law approach. See also ratification under paragraph 8.10 below, which amounts to shareholder approval after the event. 8.9 Duties not contained in CA 2006 As already mentioned, the new duties under CA 2006 do not entirely sweep away the old law. The CA 2006 states that the statutory general duties should be interpreted and applied in the same way asLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 63 of 127 the common law rules or equitable principles (see s. 170(4) CA 2006). In addition, directors are subject to duties under legislation other than CA 2006, for example in the Insolvency Act 1986 which you will study at the end of the BLP module. 8.10 Consequences of directors’ wrongdoing A director who has breached his duties (see para. 8.1 - 8.7) or exceeded the scope of his authority (see para. 7.4) will be personally liable to indemnify (i.e. reimburse) the company for any loss caused and to account to the company for any gain realised, irrespective of whether the company itself could have realised that gain. If so minded, the shareholders can absolve a director of liability for wrongdoing by ratifying his actions. 8.10.1 Ratifying a lack of authority Where a director has exceeded the scope of his authority the board or shareholders can ratify his action - see para. 7.4.5 above.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 64 of 127 8.10.2 Ratifying acts of negligence, default, breach of duty or trust Only the shareholders can, by ordinary resolution under s.239(2) CA 2006, ratify the following conduct of directors: • negligence; • default; • breach of duty; and • breach of trust. If a director holds shares in the company then any votes to ratify his breach which attach to shares held by him or any person connected with him (e.g. his spouse, children, parents or a company which he controls – see ss.252 and 253 CA 2006) will be disregarded under s.239(4) CA 2006. Before CA 2006 came into force, shareholders’ power to ratify a director’s actions arose at common law. Under the common law rules, certain acts cannot be ratified by ordinary resolution (see box below). It appears to be the intention to preserve this position under CA 2006, since s.239(7) CA 2006 provides that: “this section does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to acts that are incapable of being ratified by the company.”LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 65 of 127 CA 1985 Ordinary Resolution to ratify Under the previous regime before CA 2006 came into force, a breach of fiduciary duty could usually be ratified by an ordinary resolution but the following breaches are (non-exhaustive) examples of acts which could not be ratified by an ordinary resolution - although such breaches could be ratifiable by other means: • an act involving a lack of bona fides; • an illegal act; • an act done in breach of a specific procedure laid out in the company’s articles, e.g. an act requiring a special resolution (which will have to be ratified by a special resolution); and • an act involving a fraud on the minority. Informal unanimous approval Unanimous approval was effective in ratifying a breach and therefore relieving the director(s) of liability for all breaches except: ● illegal acts; ● ultra vires acts (see s.35 CA 1985); and ● acts which defrauded creditors. As stated, it appears that the above law continues to be relevant pursuant to s.239(7) CA 2006.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 66 of 127 9. Board and shareholder resolutions Since a company is an artificial person, it is unable to make decisions or carry out company business itself. Instead, decisions are made on behalf of the company by its directors and its shareholders. 9.1 Board resolutions Unless the power to take a particular decision has been delegated by the board to a particular director or committee of directors, a decision of the board of directors of a company must be taken in accordance with the procedure set out in the company’s articles of association. A decision of the board of directors of a company is known as a board resolution and a meeting of the directors is generally referred to as a board meeting (‘BM’). 9.1.1 Procedure for passing a board resolution at a BM Art.7(1) MA provides that any decision of the directors can be made by majority decision at a meeting of the directors. This is the usual procedure for directors’ decision-making.Decisions at BMs are taken by majority vote on a show of hands. For example, if there are four directors participating in the BM, at least three must vote in favour of a resolution for the board resolution to be validly passed. On the other hand if two of the directors vote for the resolution and the other two directors vote against it there will be deadlock. Art.13 MA provides that in the event of a deadlock the chairman of the BM will have a casting vote.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 67 of 127 The chairman is chosen by the directors from amongst themselves (Art.12 MA). Therefore, using the same example, if a resolution fails because there are equal votes, i.e. two for and two against, the chairman has considerable power. He can tip the balance. Furthermore, in a company with only two directors, a chairman with a casting vote is effectively able to take decisions alone. For this reason the company’s members may decide to amend the articles of association by removing the chairman’s right to a casting vote in some circumstances. 9.1.2 The quorum necessary for a valid BM The number of people required to attend a meeting in order for the meeting to be valid is known as the quorum. If a sufficient number of people attend the meeting then the meeting is said to be quorate. Art.11 MA confirms that no proposal may be voted on at a BM unless a quorum is participating in the meeting. Art.11(2) states that the quorum for a directors’ meeting may be fixed from time to time by a decision of the directors but it must never be less than two and, unless otherwise fixed, it is two. 9.1.3 Alternative procedure: unanimous decision of the directors Art. 8 MA makes provision for directors to make decisions, by unanimous agreement, without having to hold a BM. Such a decision requires all the directors to indicate to each other that they share a common view on the matter and they can indicate this “by any means” so this can include, for example, a written resolution or a telephone conversation (but note that a written record of the decision must be kept – Art.15). However since it is easy to hold a BM under the MA, in practice the prefrerred procedure for decision-making by directors is by resolution in a BM and in BLP sessions this is invariably the approach taken.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 68 of 127 9.1.4 Companies with one director The requirements in the MA as to decision-making by directors do not apply to companies with only one director. In such companies the sole director can take decisions on his own (Art.7(2) MA). 9.2 Shareholder resolutions As mentioned in Section 1 some fundamental decisions cannot be taken by the directors but are reserved for the shareholders, for instance (i) the making of changes to the company’s constitution; (ii) the approval of certain transactions between the directors and the company; and (iii) the formal declaration of dividends. A decision of the shareholders of a company is known as a shareholder resolution and a meeting of the shareholders is referred to as a general meeting (‘GM’). Shareholders’ resolutions can be passed at a GM or by means of a written resolution (see para. 10.7 below). There are two types of shareholder resolution under the CA 2006 requiring different voting thresholds. These are: • ordinary resolutions; and • special resolutions. Where the CA 2006 does not specify the type of resolution to be used then an ordinary resolution is sufficient unless the company’s articles of association require a higher majority (s.281(3) CA 2006). 9.2.1 Ordinary resolutions An ordinary resolution of the members of a company means a resolution that is passed by a simple majority (more than 50% of votes are cast in favour of the resolution) (s.282(1) CA 2006).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 69 of 127 9.2.2 Special resolutions Under s.283(1) CA 2006 a special resolution requires a majority of not less than 75%. 9.2.3 Voting on a show of hands and voting on a poll Shareholders may vote at a GM on a show of hands or on a poll. When the shareholders vote on a show of hands each shareholder who is present at the meeting will be entitled to one vote, regardless of the number of shares held by that shareholder. When the shareholders are voting on a poll, every shareholder has one vote in respect of each share held by him (s.284 CA 2006). Example (assuming all of the shareholders are present and voting at the meeting) BLP Publications Ltd Shareholder’s Name No. of shares held Anne 55 Ben 20 Cate 10 Darren 15 Total No. of shares issued 100 Voting on an ordinary resolution Voting on a show of hands - If the shareholders were to vote on a show of hands at a GM of BLP Publications Ltd then at least three of the shareholders would need to vote in favour of an ordinary resolution in order for the resolution to be validly passed as theLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 70 of 127 resolution must have the support of more than 50% of the shareholders who are present and voting at the meeting. Voting on a poll - If the shareholders were voting on a poll then Anne could pass the ordinary resolution on her own, even if the other three shareholders were to vote against the resolution, because she holds more than 50% of the total number of shares in BLP Publications Ltd. On the other hand, if Anne were to vote against the ordinary resolution the other three shareholders would not be able to pass it even if they all voted in favour of it, because, together, they only hold 45% of the shares. Voting on a special resolution Voting on a show of hands - If a special resolution were proposed at a GM of BLP Publications Ltd and the shareholders were to vote on a show of hands the resolution would be validly passed if three of the four shareholders (i.e. 75%) voted in favour of it. Voting on a poll - If the shareholders were voting on a poll Anne could not pass the special resolution on her own, but Anne and Ben together could pass the special resolution even if Cate and Darren both voted against it. As before, if Anne voted against the special resolution the other three shareholders would not be able to pass it since they hold only 45% of the shares between them. 9.2.4 The right to demand a poll vote As you will appreciate, the right to demand a poll vote is very important and will make a significant difference when the shareholders are not in agreement over a resolution. Section 321 CA 2006 sets out the conditions that must be met in order for a shareholder to be entitled to demand a poll although these conditions may be relaxed by a provision in the articles of association and in fact they are relaxed in the MA (see Art.44 MA). You may remember from paragraph 6.2 that this is an example of a situation in which the articles of association ofLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 71 of 127 a company may not include provisions more onerous than those contained in the CA 2006. 9.2.5 The right to appoint a proxy A member of a company is entitled to appoint another person as his proxy to exercise all or any of his rights to attend and to speak and vote at any GM, in his place (s.324 CA 2006) and a proxy will also have the right to demand, or join in demanding, a poll vote (s.329 CA 2006). 9.2.6 Quorum for a GM According to s.318(2) CA 2006 the quorum required for a GM is two qualifying persons and qualifying persons include proxies and representatives of corporate shareholders. As you know from paragraph 1.4, a company can hold shares in another company. In fact very many companies have corporate shareholders because they are subsidiaries within a group of companies. Section 323 CA 2006 provides that if a corporation is a member of a company, it may by resolution of its directors authorise a person or persons to act as its representative at any meeting of the company. 9.2.7 Single member companies Under s.318(1) CA 2006 where a company has only one member, one qualifying person present is sufficient to constitute a quorum for a GM.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 72 of 127 Self-Assessment Exercise 5 A company has four shareholders and an issued share capital of 100 ordinary shares. One member holds 50 shares, another holds 30 shares and the remaining two shareholders hold 10 shares each. Assume that a special resolution must be passed. How would the voting differ, depending on whether votes are taken (a) on a show of hands or (b) on a poll? Self-Assessment Exercise 6 1. What is the purpose of Art.3 MA? 2. Is the board of a company with the MA able to appoint a director? You will need your Company Law Statute book to complete this part of the exercise. Please make a note to return to this exercise after enrolment, when you will be given your Statute book. 3. Under CA 2006, which of the following decisions require board approval and which require shareholder approval? If shareholder approval is required, which type of resolution must be passed? a) Change of name (s.77(1) CA 2006) b) Relocation of registered office (s.87(1) CA 2006) c) Change of articles (s.21(1) CA 2006) d) Appointment of a director (Art.17 MA) e) Removal of a director (s.168(1) CA 2006)LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 73 of 127 10. Company procedure As you have already seen, much of the day-to-day business of a company is carried out by the directors and, where the company has a managing director (as almost all do), the managing director will have authority to enter into all routine commercial contracts on behalf of the company. From time to time however, it will be necessary for specific authority to be given to a director (perhaps in connection with the execution of documentation on behalf of the company in respect of an especially important transaction). Alternatively, a matter may need to be referred to the company’s shareholders. 10.1 Board resolutions Board resolutions can be passed, without great formality, at a BM. Example Bernard is a director of Ready Rentals Ltd (‘RRL’). He wishes RRL to contract to purchase a new fleet of rental cars. RRL’s board of directors has power to enter into such a contract without reference to RRL’s shareholders. Bernard therefore calls a BM of RRL, at which RRL’s directors review the terms of the proposed contract, resolve that RRL should enter into the contract, and authorise Bernard to sign the contract on behalf of RRL. No shareholder meeting is necessary. Art.9 MA gives the directors flexibility in regulating their meetings, providing that any director may call a BM or require the company secretary (if the company has one) to do so at any time. Therefore, the process is fairly informal and, when acting for a company, it is important to consider what the usual practice is for its directors. In the case of Browne v La Trinidad (1887) 37 ChD 1, the court held that reasonable notice of the BM was necessary, and that this wouldLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 74 of 127 be whatever notice is usual for the directors to give. Therefore, if all of the directors are in the same building, the meeting could be called almost immediately, if such notice is customary for the directors. If the directors are in various buildings or in other parts of the country, then a couple of days’ or even a couple of weeks’ notice may be required. Directors may not validly consider business unless a minimum number of directors entitled to vote are present at the time the meeting takes place. Art.11(2) MA requires a minimum of two directors to be present for the meeting to be quorate (unless the articles provide otherwise). Board resolutions are passed by majority vote on a show of hands. Each director has one vote. As we saw, the chairman may have a casting vote to prevent deadlock. 10.2 Matters to be referred to the shareholders There will need to be a referral to the shareholders of the company in the following situations: • where a matter is outside the powers of the directors and must be effected by a resolution of the shareholders; or • where a matter is within the powers of the directors but requires the prior approval of the shareholders before the directors can be authorised to act. An example of the first type of situation would be the making of amendments to a company’s articles of association. Section 21 CA 2006 provides that amendments to articles of association are to be made by a special resolution of the company’s shareholders. An example of the second type of situation would be the making of a loan to a director of the company. Under s.197 CA 2006 a company may not make a loan to a director without the prior approval of aLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 75 of 127 resolution of the shareholders. Once the shareholders have given their approval however the matter will be referred back to the Board and the Board will actually make the loan to the director, on behalf of the company. 10.3 GMs If a shareholder resolution is required then there must be a shareholders’ meeting (also referred to as a ‘general meeting’ or GM)*. It is the board’s responsibility to convene (i.e. call) general meetings. The board must decide when the GM is to take place. Section 307 CA 2006 prescribes minimum notice periods for GMs. For private companies, 14 clear days’ notice is required for the calling of a GM (and, if the company wishes to hold one, an AGM) (s.307(1) CA 2006). See paragraph 10.4 below for the meaning of ‘clear’ days. In this paragraph, the word ‘notice’ refers to a period of time (between the board’s act of convening a GM and its actually taking place). In order actually to convene the GM, the board must inform the shareholders of when (and where) it is taking place, by giving notice to the shareholders. In this paragraph, the word ‘notice’ refers to a document inviting shareholders to attend the GM, drafted in accordance with relevant provisions of CA 2006. The directors must approve the form of the notice of the GM (to confirm that it complies with the relevant statutory requirements) and then they must authorise its circulation to the shareholders. The meaning of the word ‘notice’ * Alternatively, for private companies, it is normally possible to pass a shareholders’ resolution using a written resolution procedure. This will be explained separately, in paragraph 10.7.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 76 of 127 You should note that the word ‘notice’ is used above to bear two distinct meanings and that the expression ‘notice of a GM’ can, therefore, depending on its context, refer either to: • a document sent to the shareholders by the directors, announcing that a GM will take place; or to • a period of time, which elapses between the directors’ act of calling a GM (by circulating the notice document to the shareholders) and the GM itself taking place. After the GM has taken place, a second BM will be necessary, to enable the directors to implement the matter on which the shareholders have voted. The net effect is that, if shareholder a company wishes to put into effect any change(s)/business decision(s) of a type for which shareholder approval is needed, there will be a sequence of three meetings (BM, GM, BM). This sequence is necessary to (i) allow the directors at the first BM to propose changes/business and convene a GM, (ii) obtain shareholder approval in the GM and (iii) allow the board, at the second BM, to implement the shareholders’ decision(s). There is more detail on this sequence at paragraph 10.5 below. This sequence of meetings will be referred to as a ‘GM sandwich’ throughout the BLP module. You will learn how to use this basic framework to create effective procedure plans to put your clients’ instructions into effect.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 77 of 127 Example: RRL’s directors consider that RRL should change its articles. The directors have no power to do this by themselves – it can only be done by shareholders (s.21(1) CA 2006). A GM is therefore necessary, for a shareholder vote. Before the GM can take place, RRL’s directors must call the GM. RRL’s directors will take this step at a BM. Therefore a BM will take place, followed by a GM. After the GM, another BM will be necessary as it is the board’s responsibility to ensure that the shareholders’ decision is implemented and that all necessary follow-up action is taken. In this example, the CA 2006 requires the company to register its new articles at Companies House. Overall sequence of meetings: BM, GM, BM. 10.4 Clear days’ notice Section 360(1) CA 2006 states that the clear day rule applies to s.307(1) CA 2006 and in counting the days of the notice period, the day of the meeting and the day the notice is given are both excluded. Section 1147 CA 2006 provides a default rule whereby if the notice is posted (or sent by e-mail), it is deemed to be served 48 hours after posting (or 48 hours after the time sent by e-mail).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 78 of 127 Self-Assessment Exercise 7 1. How much notice is required to convene a BM? 2. 14 clear days’ notice is required for a GM, the notice is to be posted and today’s date is 1 September. The company has MA articles. When is the earliest date the meeting can take place if the notice is posted today? 10.5 Sequence of meetings in more detail In the normal course of events, the process of holding a GM called by the board will involve four distinct stages. 1. A BM is held to decide on the issues to be considered at the GM, to resolve to convene the GM, to approve the form of notice for the GM and authorise its circulation. The notice of the GM will set out the wording of the resolutions to be put before the shareholders. The notice of the GM is then circulated to the shareholders by the company secretary (if the company has one) or by the directors. 2. On the day appointed the GM will take place and the shareholders will vote on the resolutions set out in the notice. 3. A further BM will be held and the directors will be informed as to how the shareholders voted at the GM and whether the resolutions were passed. The directors will then authorise the company secretary (if there is one) or one of the directors, to deal with the post-meeting matters. 4. The post-meeting matters will then be carried out by theLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 79 of 127 company secretary (if the company has one). This means that copies of the relevant documents will be filed at Companies House and the company’s internal records (minute books and registers) will be brought up-to-date. This sequence of events is important and you will revisit it again and again during the BLP module, examining in more detail exactly what happens at each stage of the process. 10.6 Short notice of GMs GMs may be called on short notice if agreed by the members. Section 307(5) CA 2006 provides for a private company that the short notice must be agreed to by a majority in number of the members who together hold shares with a nominal value of not less than 90%** of the total nominal value of the shares which give the right to attend and vote at the GM. Therefore, where companies have few shareholders, it is often possible for meetings to be held at short notice. If all the shareholders are available at the time the directors decide to convene a GM, the following sequence of events may be possible. 1. A BM is held to resolve to convene the GM, to approve the form of notice for the GM and the form of consent to short notice, and authorise their circulation to the shareholders. The notice of the GM and the form of consent to short notice are then given to the shareholders who indicate their agreement for the GM to be held on short notice by signing the form of consent to short notice. The BM is then adjourned to enable the GM to take place. 2. The GM takes place immediately following the adjournment of the BM and the shareholders vote on the resolutions set out in the notice. 3. The BM is then reconvened. The directors are informed as to ** This percentage may be increased to up to 95% by a provision in the company’s articles of association but there is no such provision in the MA.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 80 of 127 how the shareholders voted and they authorise one of their number to take the relevant action and deal with the postmeeting matters. 4. The post-meeting matters will then be carried out. All this can be dealt with in well under an hour. Public Companies You should be aware that the notice requirements for GMs are different for public companies. You will learn about this if you study either the Equity Finance module or the Corporate Finance module. 10.7 Written resolution procedures for private companies 10.7.1 Board resolutions Art.8(2) MA allows directors to take decisions in the form of a directors’ written resolution provided the prescribed procedure is followed. As explained in para. above, this is uncommon in practice. 10.7.2 Ordinary and special resolutions Under s.281 CA 2006 only private companies may pass a shareholders’ resolution by way of a written resolution. Section 282(2) CA 2006 states that a written ordinary resolution can be passed by a simple majority of the total voting rights of eligible members (i.e. the same voting threshold required for an ordinary resolution if passed at a GM on a poll vote with no shareholders abstaining). Sections 283(2) and (3) CA 2006 state that a written special resolution must state it is a special resolution and can be passed by a majorityLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 81 of 127 of members representing not less than 75% of the total voting rights of eligible members (i.e. the same voting threshold required for a special resolution if passed at a GM on a poll vote with no shareholders abstaining). Section 284(1) CA 2006 states that, where a company has a share capital, every member has one vote in respect of each share held by him when voting on a written resolution. Sections 288 - 300 CA 2006 contain the general provisions applying to written resolutions, for example how directors or members can propose a written resolution. Section 288(2) CA 2006 provides that resolutions to remove a director or auditor from office may not be passed by way of written resolutions (because, as we shall see in the BLP module, these decisions require ‘special notice’, the aim of which is to allow the director or auditor time and opportunity to mount a defence). Auditors are entitled to copies of some communications supplied to members, including written resolutions, and to receive notice of GMs that members are entitled to receive; to attend any GM; and to be heard at any such meeting on any part of the business that concerns him as an auditor. See s.502 CA 2006. Written resolutions need to be passed in accordance with a procedure complying with that set out in CA 2006, regardless of any provisions in a company’s articles. You will consider the procedure - which must conform to a basic ‘sandwich’ structure similar to that described in para. 10.3 - in more detail during the BLP module. Written resolutions must be recorded in the minute books in the same way as minutes of a GM. 10.8 Post-meeting - dealing with documentation Copies of all resolutions affecting the company’s constitution must be sent to the Registrar of Companies within 15 days of being passed.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 82 of 127 All special resolutions must be filed, and thus form part of a company’s constitution (ss. 17(b) and 29(1)(a) CA 2006), as do a few particular ordinary resolutions specified by the relevant provisions of the CA 2006. You will encounter these ordinary resolutions later in the BLP module. Copies of any amended articles must also be filed (s.26(1) CA 2006), together with various company forms. The CA 2006 refers in numerous places (e.g. s.87(1) CA 2006) to requirements for notice of certain events and/or decisions to be given to the Registrar of Companies. The directors will also be responsible for updating the statutory books, e.g. the registers of members and directors, and the BM and GM minute books. If the company has a company secretary he/she will update the statutory books.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 83 of 127 11. Summary of main points in relation to meetings When dealing with meeting procedures, always consider the following: 1. Who transacts the business - board or shareholders? 2. Call - how, and by whom, must the meeting be called? 3. Notice - how much notice is required to be given and to whom? 4. Quorum - what quorum is required? 5. Agenda - what is on the agenda for the meeting and is it in the correct order? The notice of a GM which is given or sent to members must describe in sufficient detail the business to be transacted in order for members to decide whether they wish to attend or not (s.311(2) CA 2006). Further, if a special resolution is proposed, the notice must specify that the resolution is to be passed as a special resolution and set out the text of the resolution (s.283(6)(a) CA 2006). Whilst there is no requirement to do so, in practice the wording is set out in full for ordinary resolutions too. 6. Voting - who is entitled to vote and how? 7. Post-meeting - what documentation must be dealt with? 12. Why is it important to follow the correct procedures? If the correct procedures are not followed, then resolutions purportedly passed at meetings may be invalid. For example, if written notice for GMs is not given in the proper form to all those entitled to it, then any resolutions are invalid, unless the error is accidental. Similarly, if a meeting is not quorate, then resolutions will not be validly passed, nor will they be valid if the incorrect type of resolution is used. There may also be criminal sanctions. For example, ss.248(3) and (4) CA 2006 state that if a company fails to record minutes of meetings in the relevant statutory books, every officer in default is liable to a fine.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 84 of 127 It is also important to remember that solicitors are often called on by the company client, director client or shareholder client to advise on the correct procedures to be followed when transacting company business. If you are negligent and cause loss, then there could be actionable negligence claims against your firm.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 85 of 127 13. Multiple Choice Questions 1. Which one or more of the following documents must be filed at Companies House, following a GM to amend a company’s articles? Choose as many items as apply. (a) Copy of a special resolution (b) Copy of the amended articles (c) Copy of the GM minutes (d) Copy of an ordinary resolution 2. Shareholders in a company are also known as: (a) Partners (b) Directors (c) Members (d) Employees 3. Major decisions affecting the company (such as the power to remove a director and the power to change the company’s name) will be taken by: (a) The partners (b) A committee of directors (c) The board of directors (d) The shareholdersLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 86 of 127 4. Which ONE of the following statements is TRUE? (a) Directors owe a duty to their company to exercise their powers only for the purposes for which they are conferred. (b) The directors’ general duties under CA 2006 apply to shadow directors, but never apply to former directors. (c) The directors’ duties and obligations are regulated purely by the articles of their company. (d) The directors’ duties and obligations are regulated purely by the articles and their service contracts. 5. Which ONE of the following statements is TRUE? (a) The court will imply terms into the articles where the meaning is unclear. (b) The articles form a binding contract as between the company and each of the members, and as between each of the members themselves. (c) The articles form an agreement which is only enforceable by the company against the members and vice versa.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 87 of 127 6. Bill, Paul, Simon and Ben are all shareholders of Magic Music Limited (‘Magic’). They have recently decided to rebrand Magic as they feel that the company’s name is outdated. As part of the rebranding they will need to change Magic’s name. They each hold the following number of shares in Magic: Shareholder Number of Shares Held Bill 28 Paul 48 Simon 20 Ben 4 Magic’s Articles of Association do not deal with changes to Magic’s name and Magic intends to deal with the change of name at a forthcoming GM. Which ONE of the following statements is TRUE? (a) If only Bill and Paul voted in favour of the resolution on a show of hands then it could be passed; (b) On a poll the resolution could be passed if only Bill and Paul voted in favour of it; (c) On a poll the resolution could be passed if Bill, Simon and Ben all voted in favour of it; or (d) On a show of hands all of the shareholders would need to vote in favour of the resolution in order for it to be passed.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 88 of 127 7. The directors of Perfect Pastries Limited (‘Perfect’) would like to call a GM on short notice. Perfect has six shareholders. Which ONE of the following statements is CORRECT? (a) If members holding the majority in nominal value of the issued shares in Perfect vote in favour of the meeting being held on short notice then it will be possible for it to be held on short notice; (b) If 3 of the members holding together at least 90% in nominal value of the issued shares in Perfect vote in favour of the meeting being held on short notice then it will be possible for it to be held on short notice; (c) If the majority in number of the shareholders vote in favour of the meeting being held on short notice then it will be possible for it to be held on short notice; or (d) If 4 of the members holding together at least 90% in nominal value of the issued shares in Perfect vote in favour of the meeting being held on short notice then it will be possible for it to be held on short notice.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 89 of 127 SECTION 3: CONTRACT LAW Legal Practice Course Learning Outcomes After completing this Section, you should have: 1. revised your understanding of some of the contract law principles that you studied during your degree/GDL, including the following: a) the key elements which must exist for the formation of a contract; b) the ways in which a contract can come to an end; c) the remedies available to contracting parties; d) the principal/agent relationship; and 2. a basic understanding of some of the issues affecting commercial contracts. Solutions to the Self-assessment Exercises and Multiple Choice Questions are at the back of the workbook.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 90 of 127 1. Introduction: Contract law in context On the LPC, it will be assumed that you understand the basic concepts of formation and termination of contracts, together with the obligations which exist between parties and the remedies available should such obligations fail to be met. Contract law underpins many areas of business law. Every type of trading entity (sole trader, partnership, LLP and company) enters into contracts in the course of its business to buy and sell goods and/or services. During certain BLP sessions you will practise the skill of drafting, with a focus on drafting terms for a variety of commercial contracts, and you will look at contract law in further detail if you study certain electives such as Commercial Law and Intellectual Property or International Trade and Transactions. The BLP module introduces certain types of occasional transactions which most businesses undertake from time to time, such as borrowing money from a bank or purchasing a subsidiary. If you go on to study the Private Acquisitions and/or Corporate Finance and/or Debt Finance elective modules, you will see that every deal is based on a contract. In partnerships, you already know that there is usually a partnership agreement setting out partners’ rights and their obligations to each other. You also know that, according to statute (s.33 CA 2006), a company’s constitution, forms a contract between the company and its shareholders, and between the shareholders themselves. Again, it is important that you understand the relevant contractual relationships. Businesses may appoint agents to sell or distribute their goods or services. Within a company or a partnership, particular directors or partners may be given authority to act as agents of the business and cause it to enter into contracts. To understand the extent of such authority and its effect on both the business and the specificLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 91 of 127 individual, you require prior knowledge of some basic elements of agency, which is a branch of contract law. 2. Key elements for formation of a contract There are three fundamental elements in any simple contract. They are: 1. Agreement – the parties must have reached, or be deemed to have reached, agreement. This is usually established by identifying a clear offer from the offeror, which has been unconditionally accepted by the offeree. 2. Intention and capacity – the parties must have intended, or be deemed to have intended, to create legal relations, and they must also be capable of making a contract. 3. Consideration – according to the terms of the agreement, some advantage must move from each party to the other. In any transaction where one of these elements is missing, there is no contract. 2.1 Agreement An agreement may be made in any manner whatsoever, provided that the parties are in communication with each other. Whether or not an agreement has been reached, and if it has, the terms of that agreement, are established by looking at the intention of the parties. The intention of the parties is gathered from the express terms of the contract. Also, where necessary, the conduct of the parties is taken into account. The court is not concerned with the inward mental intent of the parties, but rather with what a reasonable man would say was the intention of the parties, having regard to all the circumstances (‘objective test’). The presumed intention may or may not be the same as the actual intention.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 92 of 127 2.2 Offer and acceptance In order to discover whether agreement was reached between the parties, it is usual to analyse the negotiations in terms of offer and acceptance. Many negotiations are too complicated to lend themselves to an easy analysis of this kind, but the courts will try to discover whether, at any time, one party can be said to have accepted the firm offer of the other. The offer must take the form of a promise or undertaking by the offeror to be contractually bound in the event of unconditional acceptance being made. Upon acceptance, the terms of the offer become the terms of the contract made by that acceptance. The offer must, therefore, be clear, complete, certain and final. An offer must be distinguished from a mere invitation to treat. An invitation to treat is a first step in negotiations, which may, or may not, be a prelude to a firm offer by one of the parties. You should be familiar with the concept of an invitation to treat from your studies to date. Self-Assessment Exercise 8 Compile a list of three examples of invitations to treat. The acceptance of the offer must be unqualified and must correspond exactly with the terms of the offer. It will not be easy to determine offer and acceptance in all transactions yet the court will always examine the communications between the parties to discover whether, at any one time, one party may be deemed to have assentedLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 93 of 127 to all the terms, express and implied, of a firm offer by the other party. An assent which is qualified in any way does not take effect as an acceptance. For example, where goods are offered at a certain price, an assent coupled with a promise to pay by instalments is not an acceptance. 2.3 Counter-offers Where an offeree makes a counter-offer, the original offer is deemed to have been rejected and cannot be subsequently accepted. If, on receipt of an offer, the offeree requests the offeror to inform him whether he would be prepared to add a term to the offer, the offeree’s request may be construed as a request for further information. In this event, since there has been no counter-offer, the original offer remains open. Where a counter-offer is accepted, then its terms and not the terms of the original offer become the terms of the contract. Difficulties can occur when an offer is made on the standard terms of the offeror and the purported acceptance is made on the standard terms of the offeree. If these terms are different in any way, the offeree has in fact made a counter-offer. In these circumstances it may be difficult to assess when, or if, any actual acceptance has been made. This process is often referred to as the ‘battle of the forms’ (see paragraph 8.3 below). 2.4 Methods of acceptance The acceptance of an offer must (in most cases) be communicated to the offeror. The method of communication of the acceptance can have a bearing on when acceptance is deemed to have taken place. Where post is deemed to be the proper means of communication, the acceptance takes effect from the moment the letter of acceptance is properly posted (‘Postal Rule’). The Postal Rule applies even whenLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 94 of 127 the acceptance is delayed or lost in the post. Remember, however, that the Postal Rule applies only to letters of acceptance, not to letters revoking an offer. Revocation of an offer must be received in order to be effective. Although there is no authority which precisely deals with this point, it appears that the Postal Rule may be displaced if the acceptance is incorrectly addressed, the rationale being that the offeree, by his own carelessness, has lost the benefit of the Postal Rule. It is always open to the offeror to redress the imbalance of the Postal Rule by requiring actual communication of the acceptance to him. Where an acceptance is made by an instantaneous mode of communication, actual communication is required and the Postal Rule does not apply. The rationale for this exception to the Postal Rule is that if an acceptance is made by telephone, the offeree will know at once that the acceptance has not been communicated and will be able to rectify the position by making a proper communication. This situation can be differentiated from a communication by post, where the offeree may not know that the letter of acceptance has gone astray until it is too late to make another communication. The established principles of case law can be utilised in relation to more technologically advanced methods of communication. For instance, if an acceptance is sent by fax, the sender will generally know at once that the fax has not been communicated. If, however, the message is received in such a form that it is almost entirely illegible, the sender is unlikely to be aware of this and such an acceptance may well be effective. It is suggested that a similar interpretation, based on the knowledge of the sender, should prevail in relation to other forms of instantaneous communication such as telephone answering machines, e-mail and the internet. You will consider this issue if you study the Commercial Law and Intellectual Property elective.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 95 of 127 Self-Assessment Exercise 9 Are the following invitations to treat, offers or acceptances? 1. A flyer for a year’s subscription to the Times for £80? 2. A spontaneous letter requesting a yearly subscription to the Times with a cheque for £80? 3. A response to the flyer with a cheque for £80? 2.5 Termination of an offer An offer may come to an end by rejection, revocation or lapse. In each case, the offer loses its legal effect and becomes incapable of acceptance. A rejection does not take effect until it is actually communicated to the offeror, as only then will the offeror know that he is free from the offer. An offeror may revoke his offer at any time before acceptance but, once a valid acceptance has been made, he is bound by the terms of his offer. An offer cannot be revoked after acceptance. In other words, no unilateral withdrawal is possible once the contract is formed. Furthermore, the revocation is effective only upon actual notice of it reaching the offeree. An offer may lapse and thus become incapable of acceptance by passage of time, by the death of one of the parties, or by the non-LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 96 of 127 fulfilment of a condition precedent. In relation to the passage of time, this can either be the passage of a period prescribed by the offeror, or where there is no prescribed period, where acceptance is not made within a reasonable time. The concept of conditions precedent is considered in further detail at paragraph 8.6 below. 2.6 Intention to be bound The intention to create legal relations is an essential element in the formation of a contract. Where no intention to be bound can be attributed to the parties, there is no contract. The test of intention is objective. The courts seek to give effect to the intentions of the parties, whether expressed or presumed. A broad distinction can be made between agreements of a commercial kind and agreements of a domestic kind. The ordinary common sense presumption is that in a commercial or business agreement, the parties intend that the agreement should be legally binding. If a party to a business agreement wishes to assert that legal relations were not intended when the agreement was entered into, the onus is on him to rebut the presumption and the burden of doing so is a heavy one. The expression ‘subject to contract’ creates a strong inference that the parties do not intend to be bound until the execution of a formal contract. Acceptance ‘subject to contract’, prima facie, is not binding. In a sale of land, it is usual to express tentative preliminary agreement to be ‘subject to contract’, so as to give the parties an opportunity to reflect or to seek legal or other advice before entering into a binding contract. The expression ‘subject to contract’ has received judicial recognition for this purpose. But if any other form of wording is used, care must be taken to show legally that the parties did not intend to create a legally binding agreement. There is a difference between aLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 97 of 127 tentative agreement which is not binding and a provisional agreement which may be binding. In cases of social, family or other domestic arrangements, the presumption is that there is no intention to create legal relations. The presumption can be rebutted, and the question of whether the presumption is rebutted will be resolved by examining the circumstances of each case and the language used by the parties. 2.7 Consideration Consideration is the principal essential ingredient of enforceability of agreements. Consideration need not be adequate; the inadequacy of the price is immaterial to the existence of a binding contract. Consideration, however, must have some value, usually expressed as being something of ‘value in the eyes of the law’. It matters not how small that value is, so long as it is worth something. Execution of a contract by deed ensures that a binding obligation is created even when there is no consideration. You will look at this further in the BLP module. 2.8 Breach of contract Where a party neglects or refuses to honour a contractual obligation, there is a breach of contract. A breach by one party causes a right of action to accrue to the other party. The usual remedy for breach of contract is damages (i.e. putting the aggrieved party in the position he would have enjoyed had the contract not been broken). In certain special circumstances, the court may order the contract-breaker to carry out his contractual promise specifically (specific performance). The equitable remedy of specific performance will not be awarded where damages will suffice.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 98 of 127 3. Terms of a contract: express and implied The terms of a contract are its contents and these determine the extent to which the parties are in agreement. Accordingly, the terms of a contract define the rights and obligations arising from the contract. Contractual terms may be express or implied. Express terms are express statements made by the parties and by which they intended to be bound. There is a general presumption that the parties have expressed, orally or in writing, every material term which they intend should govern their contract. But there are circumstances where terms which have not been expressed by the parties are implied into the contract by the law or on the facts. An implied term is binding to the same extent as an express term. A term is implied in fact to give effect to the presumed but unexpressed intentions of the parties. In order to discover the unexpressed intention of the parties, the courts may take notice of trade customs, the conduct of the parties, a course of dealing between the parties and the need to give ‘business efficacy’ to a contract. In relation to business efficacy, it is important to note that no term will be implied to give the contract efficacy unless the implication arises inevitably. This means that a term will not be implied merely on the grounds that such an implication will transform the agreement into a businesslike arrangement, but that, without the implied term, the arrangement would be so unbusinesslike that sensible people could not be supposed to have entered into it. A term implied in law, either by the courts or by statute, is in principle effective regardless of the intention of the parties. Parties may seek to ‘contract out’ of a term implied in law, by including an express term to that effect. The extent to which they can do so effectively depends on application of relevant law to the facts. For example, in all contracts for the sale of goods, a term is implied by law (under s. 14 Sale of Goods Act 1979) that the goods must be of satisfactory quality.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 99 of 127 In a scenario where parties to a particular sale of goods contract have agreed an express term which excludes the s.14 implied term, a question arises as to which, of the implied term and its express exclusion, should prevail. To answer that question, it is necessary to apply provisions of the Unfair Contract Terms Act 1977 to the facts. 4. Misrepresentation Misrepresentation is an untrue statement of fact or law which one party (‘A’) makes to another party (‘B’) and which induces B to enter into a contract with A. To make a claim for misrepresentation, the misrepresentation must be material (except if the misrepresentation is fraudulent), it must be fact or law, it must be untrue and it must have induced B to enter into the contract. Misrepresentation can be classed as innocent, fraudulent or negligent. There are various remedies for misrepresentation which may include rescission (i.e. putting the parties back into their original position) or damages (see paragraph 2.8 above). The remedy available will depend on the type of misrepresentation that has occurred. As well as the requirements to prove a claim for misrepresentation as noted above, an additional bar to claiming for misrepresentation is a clause known as an entire agreement clause. This type of clause is aimed at excluding liability for misrepresentation. If you study the Private Acquisitions elective module, you will also look at this clause further. 5. How a contract comes to an end Every contractual obligation gives rise to a corresponding contractual right. Thus, where the obligation of one party is discharged, the corresponding right of the other party is extinguished. Where allLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 100 of 127 obligations arising under a contract are discharged and all rights thus extinguished, the contract is discharged. A contract might be discharged in one of the four ways dealt with in turn below: performance, agreement, breach, or frustration. 5.1 Performance A contractual obligation is discharged by the complete performance of the undertaking. The promisee is entitled to the benefit of complete performance exactly according to the promisor’s undertaking. Where the promisor is unable or unwilling to give more than partial performance, the general rule is that there is no discharge. The practical effect of this rule is that where a contract provides for payment by one party after performance by the other, no action to recover payment may be maintained until the performance is complete. However, the entire performance rule, like every good rule, is subject to a number of exceptions. For example, where one party has rendered only partial performance of the contractual obligations, it is possible that the other party, rather than reject the work done, might accept that part of the performance. However, it should be noted that such an acceptance of partial performance is at the discretion of the other contracting party. 5.2 Agreement A contractual obligation may be discharged by agreement, either by a subsequent binding contract between the parties or by operation of a term of the original contract.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 101 of 127 5.3 Breach The usual remedy for breach of contract is an award of compensatory damages (so most breaches do not terminate the contract). However, in certain circumstances, the injured party may treat the contract as having been repudiated by the breach. In such cases, the injured party is discharged from further liability under the contract and may sue for damages (see paragraph 6.1 below). 5.4 Frustration Frustration may be raised as a defence to an action for breach of contract. The defence would be used where something happens after the contract is formed that makes performance of the contract impossible. Frustration may occur in the following circumstances: 1. Impossibility – where the contract becomes impossible to perform due to the total or partial destruction of some object necessary to the performance of the contract; 2. Supervening illegality – where a change in the law or state intervention renders any attempted performance illegal; or 3. Non-occurrence of an event – where an event fundamental to the contract does not occur, the contract may be frustrated despite the fact that it is still physically possible to carry out the contract. It should be noted, however, that the doctrine of frustration should be applied within very narrow limits. Furthermore, it is usual in practice for the terms of any commercial contract to provide agreed consequences for supervening unforseen events (for example, a ‘force majeure’ clause). Therefore the doctrine of frustration rarely affects businesses in practice.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 102 of 127 6. Remedies available to contracting parties 6.1 Conditions and warranties The traditional view is that each term of a contract, express or implied, is either a condition or a warranty, depending upon its importance with regard to the purpose of the contract. The question of whether a term is a condition or a warranty becomes significant in cases of breach of contract. According to the traditional approach, the distinction between a condition and a warranty is that a condition is an important term ‘going to the root of the contract’, whereas a warranty is a less important term not going to the substance of the contract. As a general principle, if a promisor breaks a condition in any respect, however slight, the other party has a right to elect to treat himself as discharged from future obligations under the contract and to sue for damages immediately. If he does not exercise the right to elect to treat the contract as at an end, he will remain bound by the contract but can sue for damages with respect to the other party’s breach. If, on the other hand, a promisor breaks a warranty in any respect, the only remedy available to the other party is to sue for damages, i.e. there is no right to treat the contract as at an end. The parties to the contract are free to classify the relative importance of the terms of their contract. However, even where the parties describe a term as a condition, it is open to the court to hold that the parties could not have intended the term to have this effect. Self-Assessment Exercise 10 Explain the consequences of a breach of condition.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 103 of 127 What does it mean when the time for performance of a contractual obligation is said to be ‘of the essence’? It is worth noting at this point that you will come across meanings being given to the terms ‘warranty’ and ‘condition’ other than those mentioned above during the BLP module. For example, in a commercial contract you may come across conditions precedent (see paragraph 8.6 below), some (or all) of which may not necessarily be intended to take effect as a ‘condition’ with the consequences for breach as mentioned above. You may also come across a warranty in the form of a statement of fact which one party to a contract requires to be made to it by the other in a binding manner – such a term may be either a ‘condition’ or a ‘warranty’ (in terms of the meanings given to these terms above) depending on its importance. It is always therefore going to be necessary to look at the context in which the term is used, rather than just the name given to the term by the parties. You will look at these types of warranties (together with indemnities) on the BLP module and also in more detail if you study certain electives, such as Private Acquisitions or Commercial Law and Intellectual Property. 6.2 Innominate and intermediate terms The traditional distinction between conditions and warranties is no longer regarded as exhaustive. Case law has held that there are many terms which at the outset are neither conditions nor warranties, but are of an innominate or intermediate nature. A minor breach of such a term will only amount to a breach of warranty, but a serious breach will allow the innocent party to terminate the contract and claim damages. This represents a more flexible approach, and allows the court a good deal of leeway when dealing with cases where the purported innocent party is attempting to use a trivial breach in orderLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 104 of 127 to extract themselves from a contractual agreement which is no longer commercially advantageous. 6.3 Remedies The law has developed a range of remedial responses where a breach of contract occurs. The successful claimant will only be granted one remedy (though more than one may be pleaded). For example: 1. Unliquidated damages – these are assessed on the compensatory principle with the idea being to make good the claimant’s losses and nothing else. The purpose of damages as a remedy is to put the claimant into the position he would have been in had the contract not been breached. Entitlement to unliquidated damages is subject to the rule in Hadley v Baxendale (remoteness) and the duty to mitigate loss. 2. Liquidated damages – where contracting parties make a genuine pre-assessment of the loss that would flow from any particular breach and stipulate accordingly in their contract that this sum shall be payable in the event of a breach. Where the sum inserted in the clause is intended as a punishment of the contract-breaker and is not connected with the amount of loss which could be contemplated by the parties at the time of contracting (in accordance with the principles applicable to unliquidated damages), the sum is a penalty. A penalty clause is void and in the event of a breach, the injured party may bring an action for unliquidated damages. 3. Equitable remedies – specific performance, injunctions.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 105 of 127 Self-Assessment Exercise 11 The purpose of damages as a remedy for breach of contract is stated above. Think back to your previous study of the law of tort: what is the corresponding purpose of damages in tort? Is this the same as for breach of contract? In practice, breach of a given contract does not invariably give rise to application of the common-law rules set out in this paragraph 6. Parties to a contract are free to agree their own provisions as to the consequences of breach which displace the general rules, and this is often done in commercial contracts. For example, on the BLP module you will encounter terms in a loan agreement which expressly specify ‘events of default’ and their consequences. 7. Principal / agent relationship You should already be aware that if an agent enters into a contract on his principal’s behalf, it is as if the contract were made between the principal and the third party. We have already looked at the common law principles of agency when considering the director’s power, as an agent of his company, to bind the company (see paragraph 7 of the Company Law Section). These principles apply to all forms of agency as follows:LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 106 of 127 1. if the agent acts within his actual authority (express or implied), the principal is bound; 2. if the agent acts outside of his actual authority but within his apparent (or ostensible) authority, the principal is bound; and 3. if the agent acts outside of his actual and apparent authority, the principal is not bound but he can ‘ratify’ the agent’s acts. In practice, businesses selling goods sometimes appoint agents to find customers, negotiate sales and/or enter into contracts with customers on their behalf. In these situations, the Commercial Agents Regulations 1993 (as amended) have a considerable impact. These regulations imply a number of key terms into certain agency agreements. In particular, the principal has an obligation to make a one-off payment to the agent on termination of the agency, in recognition of the agent's contribution to the business and which has nothing to do with any breach of contract. There are also far-reaching ‘default’ rules regulating, for example, not only the agent's rights to remuneration but also the dates on which it is payable, which will apply unless the parties expressly agree otherwise. It should be noted that these regulations have no effect on the application of common law agency principles, as outlined in this document. 8. Commercial contracts - Specific issues Below are some of the contractual issues business lawyers need to be aware of which can affect the drafting and negotiation of commercial contracts. 8.1 Heads of terms Heads of terms (which are also known as ‘memoranda of understanding’) are used in many corporate and commercial transactions in order to outline the agreed intentions of the parties prior to the negotiation of a formal contract. They are commonly intended to be non-binding (except for one or two clauses) and thereLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 107 of 127 will be express provision to this effect. Heads of terms are usually used to set out the framework for future negotiations. On the BLP module, you will see that negotiations for a loan facility between prospective lenders and borrowers similarly begin, usually, with a heads of terms document called the ‘term sheet’. Even though heads of terms are not legally binding, they often carry a substantial amount of moral force and are often negotiated before lawyers become involved. 8.2 Letters of comfort One of the most common areas in which letters of comfort are given are loan finance transactions where, for example, a parent company may be seeking to provide ‘comfort’ to a bank that its subsidiary will be able to make loan repayments. In such a letter, the parent may make representations as to the subsidiary’s past or future performance, or it may state that its policy is to make sure that all subsidiary companies are able to service their bank debt. You already know that for a binding contract to arise an intention to create legal relations must exist, and that in business agreements this intention is presumed. However, there has been a lot of debate through case law as to whether such letters enable a bank to sue the parent company as a result of the subsidiary’s default. This remains a grey area, and whether or not a legal obligation has arisen will always depend on the facts of the case in question. You will learn more about letters of comfort if you study the Debt Finance elective module. 8.3 Battle of the forms We have already looked at offers and counter-offers in paragraphs 2.2 and 2.3 above. One common situation in which counter-offers arise is in the ‘battle of the forms’. This is where the parties each attempt to contract on their own standard terms. For example:LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 108 of 127 1. a buyer sends an order form to a supplier with its standard terms and conditions of purchase on the back; and 2. in response, the supplier sends an acknowledgement of the order with its standard terms and conditions of supply on the back. In the above case there has been no acceptance of the buyer’s offer by the supplier. Instead, the supplier has made a counter-offer on its own terms and conditions. This often means that the ‘last shot in the battle’, i.e. whoever sends their terms last, prevails. However, this approach is by no means a safe way of ensuring that a party’s terms prevail and caution must always be advised. It is far safer for the parties to agree unequivocally what terms will apply. The Court of Appeal case (Hertford Foods Limited v LIDL UK GmbH [2001] EWCA Civ 938) has made the situation even more unclear. In that case the court declined to follow the ‘last shot’ doctrine, as it concluded that on the facts the standard terms of neither party applied, and therefore the contract was governed by the general law. 8.4 Contracts (Rights of Third Parties) Act 1999 (the ‘Act’) The Act confers rights on parties who were not parties to the original contract and therefore amends the principles of the doctrine of privity of contract. The Act provides that a third party may enforce the terms of a contract where either (i) the right to enforce is given to the third party by an express provision in the contract, or (ii) where a term purports to confer a benefit on a third party unless, on the proper construction of the contract, the parties did not intend the third party to have that right.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 109 of 127 In order to avoid inadvertently providing rights to third parties, it is possible for a contract to specifically state that, save for express provisions, third party rights are excluded. Where third parties are provided with rights pursuant to the Act, these are the same as the rights which the third party would have had, had that third party been a party to the original contract. 8.5 Assignment and novation The issue of assignment and novation often arises when a party to a contract is seeking to transfer its rights and obligations under that agreement to a third party. If you study the Debt Finance elective module, you will examine how lenders use novation and assignment to transfer their interests in loans to other lenders, or use other contractual mechanisms to produce a commercially similar result. If you study the Private Acquisitions elective module, you will examine how these are used in relation to business sales. With assignment, only the benefit (rights) of an agreement can be assigned and not the burden (obligations/liabilities). This means that when a contract is said to have been assigned, it is in fact only the benefit that has transferred; the original party retains the obligations/burden. An assignment is a bipartite agreement between the assignor and the assignee and can be affected without the consent (or even knowledge of) the other party to the contract. Contracts often expressly state whether or not assignment is permitted. An assignment can be legal or equitable. For a legal assignment, s.136 Law of Property Act 1925 requires that the assignment is:LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 110 of 127 ● absolute (i.e. unconditional) – the whole and not just part of the benefit must be transferred; ● in writing and signed by the assignor; and ● notified in writing to any person(s) against whom the assignor could enforce the assigned rights. If any element is missing (in practice often notice is missing), the assignment is likely to be equitable. Novations, on the other hand, allow both the benefit and the burden to be transferred, with the effect that the third party ‘steps into the shoes’ of the party that he is replacing. Novations are tripartite agreements between the original parties to the contract and the third party, and require the consent of all. 8.6 Conditions precedent Usually found at the start of an agreement, conditions precedent are stipulated criteria or conditions that must be met before the agreement, or certain parts of the agreement, can come into force. Example Your client is looking to purchase a company that runs a nightclub. The music and entertainments licence for the club is about to expire and your client believes that there may be some difficulty in obtaining a new licence. In this case your client will not want to proceed with the purchase of the company until the licence has been granted. Your client can either wait to see what the outcome of the licence application is, or he can enter into the purchase agreement with completion conditional upon the licence being granted.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 111 of 127 Entering into a contract with completion occurring at a later date is known as ‘exchange’. At the point of exchange the fundamental obligation to complete the transaction arises, subject to the satisfaction of any conditions precedent, with the remaining provisions of the agreement coming into force at completion. You will study conditions precedent further if you study the Private Acquisitions elective module. 9. Limitation of actions and execution of agreements 9.1 Limitation Periods The Limitation Act 1980 provides that the basic limitation periods within which a claim must be brought are: 1. Contract - 6 years from the date on which the cause of action accrued; 2. Deed – 12 years from the date on which the cause of action accrued; 3. Tort (other than a claim for personal injuries and death) - 6 years from the date on which cause of action accrued; and 4. Personal injuries and death - 3 years from the later of either: a) the date on which the cause of action accrued, or b) the date of the claimant’s ‘knowledge’. 9.2 Execution of agreements There are generally two types of contract: • a simple contract/agreement under hand (i.e. an agreement which is not intended to take effect as a deed); and • a deed.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 112 of 127 Generally, a contract will take the form of an agreement under hand unless it has to take the form of a deed for one (or more) of the following reasons: • it is a document which is required to be executed as a deed (e.g. certain transactions relating to land, certain mortgages of property, or the grant of a power of attorney); • it is desirable to have a limitation period for an action arising from the contract of twelve years (a deed) rather than six years (an agreement under hand); or • it is questionable whether a party to the document is providing valuable consideration. If a document takes the form of a deed, the document will be binding even if valuable consideration is not given. A duly authorised person can execute a simple contract/agreement under hand on behalf of each party. In the case of a company, this would usually be by a director authorised by a board resolution. However, a company’s articles should always be checked in order to ensure that there are no further requirements relating to the execution of documents. If the party is an individual, the individual can simply sign the agreement without the signature being witnessed. In the case of a partnership, the agreement can be entered into by one or more of the partners (you will remember that a partnership cannot enter into contracts on its own behalf as it is not a separate legal entity). Each individual partner can sign in his/her own name including a reference to the partnership and the status of the partner as such. In relation to deeds, the following requirements must be met: • the deed must make it clear on its face that it is a deed;LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 113 of 127 • the deed must be delivered; and • the deed must be executed properly. In the case of a company, a deed is properly executed if it is signed by two authorised signatories (who must be directors or, if the company has one, the company secretary), or if its common seal is used. A company is also able to execute a deed by the signature of a single director in the presence of a witness (s.44 CA 2006). In the case of an individual, the individual needs to sign the deed and have his or her signature witnessed. In the case of a partnership, an individual partner does not have authority to execute a deed on behalf of a partnership unless the authority has expressly been conferred by deed. Deeds should therefore be executed by all partners unless one or more partners is given a power of attorney to execute deeds on behalf of the partnership. This authority can also be conferred by the partnership deed. The signature of the partner(s) should also be witnessed. In practice, it is important to ensure that contracts have been properly executed, and it is usually left to a trainee to ensure this. You will learn about how to select the appropriate form of execution clause during one of your drafting skills SGSs, which will be taught as part of the BLP module. 10. Further reading If you require further guidance in relation to the principles of contract law you should read the relevant sections of Treitel “The Law of Contact”.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 114 of 127 11. Multiple Choice Questions 1. A breach of which of the following types of term could entitle the innocent party to repudiate the contract? 1. An innominate term; 2. A condition; 3. A warranty; 4. A minor term. (a) 1 only; (b) 2 only; (c) 1, 3 and 4; (d) 1 and 2. 2. Which of the following statements is correct? 1. The parties to a social or domestic arrangement are presumed not to have intended the arrangement to be legally enforceable; 2. The parties to a commercial transaction are presumed to have intended the arrangement to be legally enforceable. (a) 1 only; (b) 2 only; (c) Both 1 and 2; (d) Neither 1 nor 2.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 115 of 127 3. A sign in a shop states “Goods will not be exchanged nor will refunds be made”. Vera complains that the goods she bought in the shop are not of satisfactory quality under s.14 of the Sale of Goods Act 1979 and claims a refund. Which ONE of the following statements is correct? (a) The sign is an express term so Vera is not entitled to a refund. (b) A term that goods be of satisfactory quality cannot be displaced because it is implied by statute so Vera is entitled to a refund. (c) To determine whether or not Vera is entitled to claim a refund you would apply the Unfair Contract Terms Act 1977. (d) The sign is not a term of the contract under the doctrine of privity of contract. 4. What must an injured party do when the other party to the contract commits a fundamental breach? (a) He must either treat the contract as discharged or affirm it as still in force; (b) He must treat the contract as discharged at once; (c) He must continue with his own obligations if he wants to claim damages; (d) He must seek an injunction if he wants to claim damages.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 117 of 127 Solutions to Self-Assessment Exercises And Answers to Multiple Choice QuestionsLPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 119 of 127 Section 1: Considerations when Starting a Business Section 1 Multiple Choice Questions 1. (a) A partnership is not a separate legal entity. Rather, it is the partners who own the partnership property and/or enter into contracts, either individually or jointly. 2. (c) Property of the company is owned by the company itself. It is not true that it needs to be in the name of the majority shareholders. 3. TRUE - the set up costs involved in setting up a company limited by shares will be higher as there will be legal costs incurred in dealing with the company’s constitutional documents etc as well as incorporation fees due to Companies House. No formalities at all are required for an individual to set up in business as a sole trader. 4. (c) A joint venture may be structured as a partnership or simply via purely contractual arrangements – in neither of these scenarios will a separate legal entity be formed.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 121 of 127 Section 2: Introduction to Company Law Self-Assessment Exercise 1 1. The principal function of a memorandum of a company limited by shares is to state that the subscribers wish to form a company under CA 2006 and have agreed both to become members and to take at least one share each. 2. A private company needs to have one director (s.154(1) CA 2006) unless the company’s articles provide otherwise. The one director must be a natural person. 3. The company’s memorandum and articles, the registration documents (required by s.9 CA 2006), the compliance statement (s.13 CA 2006) and a fee. The articles do not need to be sent to Companies House if the MA are being used. 4. The company must obtain permission from its shareholders to make the change to its articles. The company’s shareholders must agree to the change by special resolution (s.21(1) CA 2006). Therefore at least 75% of the votes cast at the meeting must agree to the change. 5. No. Any change made to a company’s articles must be made bona fide in the interests of the company as a whole. 6. Here are a couple of suggestions: • power to change the company’s articles (s.21(1) CA 2006); • power to remove a director (s.168(1) CA 2006).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 122 of 127 Self-Assessment Exercise 2 Section 251(2) CA 2006 will protect the bank manager from falling into the definition of a shadow director as long as he is simply advising the board in a professional capacity. However, he should be careful to avoid taking any part in the actual decision-making process. All decisions must be taken by the board collectively, in a manner that is in accordance with the directors’ duties under CA 2006, including the s.172 CA 2006 duty to promote the success of the company. Self-Assessment Exercise 3 Jamie will be deemed to be a shadow director if he has a real influence in the company's affairs, even if his friends do not seek his advice on every aspect of running the business. If Jamie is deemed to be a shadow director he will be acting in breach of his disqualification order, which is a criminal offence. Self-Assessment Exercise 4 Yes. Oliver has the apparent authority of a managing director. Brownlands has held him out on its website as its managing director even though he has never been formally appointed, and the architects acted in reliance on that. Therefore Brownlands is bound to pay the architects’ fees. Self-Assessment Exercise 5 a) On a show of hands, at least 75% of the shareholders can pass the resolution. Therefore three of the four members must vote in favour of the resolution. b) On a poll vote, the 50% shareholder voting together with the 30% shareholder would be able to pass the special resolution, as this would amount to more than 75% of the votes.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 123 of 127 Self-Assessment Exercise 6 1. Art.3 MA gives the board, collectively, authority to make decisions and take action on behalf of the company. It states that the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company. A reference in the MA to ‘the directors’ (plural) can be read as a reference to ‘the board’. 2. Yes, under Art.17(1)(b) MA. Note also that directors may be appointed by the shareholders by ordinary resolution (Art.17(1)(a) MA). 3. a) Change of name s.77(1) CA 2006 – special resolution, which is a type of shareholder resolution (n.b. this is subject to checking the articles of the company in question, as the section provides that a change of name can be done“by other means provided for by the articles”, which could include a board resolution). b) Relocation of registered office – board resolution. Section 87(1) CA 2006 makes no reference to any type of resolution. Therefore, the board can make the decision, using the powers conferred upon it by MA3. As a general rule, if CA 2006 makes no reference to a decision being made by a ‘resolution’, then shareholder approval is not required and the decision can be made by the directors. c) Change of articles s.21(1) CA 2006 – special resolution , which is a type of shareholder resolution. d) Appointing directors – 2 methods: Art.17 MA states either the members may appoint a director by ordinary resolution, which is a type of shareholder resolution, or the directors may appoint a director by board resolution.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 124 of 127 e) Removing directors – s.168(1) CA 2006 states that a company has the right to remove a director by ordinary resolution, which is a type of shareholder resolution. Self-Assessment Exercise 7 1. Only ‘reasonable’ notice is required pursuant to the case of Browne v La Trinidad (N.B. the MA provide in Art.9 that “(1) Any director may call a meeting of directors”). 2. The earliest day the meeting can be held is 18 September. This is because the notice is posted. The notice is posted on 1 September and it is deemed served on 3 September. Start counting the 14 days on 4 September. The 14 day period is therefore 4 to 17 September inclusive. The earliest day the meeting can be held is the next day, 18 September.LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 125 of 127 Section 2 Multiple-Choice Questions 1. (a) and (b). Minutes (for either GM or BM) are never filed at Companies House. They are kept with the statutory books of the company. A special resolution is required in order to amend a company’s articles of association pursuant to s.21(1) CA 2006, not an ordinary resolution. 2. (c) Shareholders are also known as ‘members’. 3. (d) The shareholders take the important decisions and the examples given are reserved for them by CA 2006. 4. (a) Directors owe a duty to their company to exercise their powers only for the purposes for which they are conferred (s.171(b) CA 2006). 5. (b) The articles form a binding contract between the company and each of the members, and as between the members themselves. 6. (b) Section 77 CA 2006 provides that a company can change its name by special resolution. A special resolution requires the approval of 75% or more of the votes (s.283(1)). A vote taking account of the members’ shareholdings is known as a ‘poll’. Bill and Paul together hold 76% of the votes on a poll (and only 50% of the votes on a show hands). 7. (d) There are two elements to the consent required for short notice and these are that approval must given by: • the majority in number of the members of the company (so that, out of six shareholders, a minimum of four must consent); who • together hold at least 90% in nominal value of the issued shares of the company (s.307(5) CA 2006).LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 126 of 127 Section 3: Contract Law Self-Assessment Exercise 8 Your list could include: advertisements of goods for sale; display of goods for sale in a shop; invitations to tender; or auction sales. Self-Assessment Exercise 9 1. Invitation to treat. 2. Offer. 3. Offer. Self-Assessment Exercise 10 The breach allows the innocent party to treat the contract as repudiated (the innocent party is entitled to terminate the contract and/or claim damages). Alternatively, the innocent party can choose to affirm the contract and treat the breach as a breach of warranty (the remedy being damages only). The addition of wording stating that ‘time is of the essence’ means that a provision will be construed as a condition rather than a warranty (and means that if the obligation is not performed on time, the other party is entitled to terminate the contract and claim damages). In the absence of such an express provision, the innocent party can only claim damages and cannot terminate the contract. Self-Assessment Exercise 11LPC: BUSINESS LAW AND PRACTICE PRE-MODULE READING LAW SCHOOL 5/25/2016 1:32:00 PM Page 127 of 127