Unit 1: Company and Partnership Law SUGGESTED ANSWERS JANUARY 2011 Note to Candidates and Tutors: The purpose

e of the suggested answers is to provide students and tutors with guidance as to the key points students should have included in their answers to the January 2011 examinations. The suggested answers do not for all questions set out all the points which students may have included in their responses to the questions. Students will have received credit, where applicable, for other points not addressed by the suggested answers. ILEX is currently working with the Level 6 Chief Examiners to standardise the format and content of suggested answers and welcomes feedback from students and tutors with regard to the helpfulness of these Suggested Answers. Students and tutors should review the suggested answers in conjunction with the question papers and the Chief Examiners reports which provide feedback on student performance in the examination. SECTION A Question 1 (a) As a result of the Enterprise Act 2002 an administrative receiver may only be appointed by the holder of a floating charge created before 15 September 2003. In relation to floating charges created after this date, even those which purport to allow the appointment of an administrative receiver, only an administrator may be appointed. An administrator may also be appointed by the court under an administration order, or by notice by the company, its directors or creditors. The function of an administrator is to carry out the objectives of administration, which are primarily to rescue a company in financial difficulty to enable it to survive as a going concern. If this is not possible then the procedure should be used to achieve a solution for the creditors which would be better than what would be achieved if the company were to be wound up. If this too is impossible then the procedure should be used for the purpose of maximising the returns to the secured and preferred creditors of the company (Sch B1 Insolvency Act 1986, para 3). In Oldham v Kyrris & Others [2004] it was established that the administrator does not owe a common law duty of care to unsecured creditors in relation to his conduct of the administration. In contrast to the purpose of the administrator, an administrative receiver is appointed by a floating charge holder and his primary duty is to realise the security of the debenture holder who appointed him (s.29 (2) IA1986).
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(b) A debenture is a document which either creates a debt or acknowledges it (Levy v Abercorris [1887]). This is echoed in the statutory definition of s.738 Companies Act 2006 which provides that a debenture is debenture stock, bonds and any other securities of a company, whether or not constituting a charge on the assets of the company. Fixed charges are legal or equitable charges over specific identifiable assets. A company cannot deal with a charged asset without the consent of the chargor. A fixed charge can be created over present and future assets. In the case of future assets, the asset must be sufficiently described so as to be identifiable when it is eventually acquired. A floating charge is an equitable charge and was first recognised in Re Panama (1870). The most commonly accepted definition is that of Romer LJ in Re Yorkshire Woolcombers (1903), which is that it is a charge over a class of assets which change over the ordinary course of business and which, until crystallisation, the company can treat as uncharged. Until a crystallising event occurs the charge will float over the charged class of assets (Illingworth v Holdsworth [1904]). Events which trigger crystallisation include the winding up of the company, the appointment of an administrative receiver, the sale or disposal by the company of a substantial part or the whole of its assets, and the cessation of the business of the company (Re Woodroffes Musical Instruments [1985]). In addition, the specific terms of the charge may provide for automatic events of crystallisation such as provision for a lender to give notice of crystallisation (Re Brightlife [1987]). A series of recent cases highlighted the difficulty in taking a fixed charge over book debts (Siebe Gorman v Barclays [1979], Re New Bullas Trading [1994], Brumark [2000], Re Spectrum Plus [2005]). The House of Lords, in Re Spectrum Plus, held that whilst it may be possible in theory to take a fixed charge over book debts, it may not be possible in practice due to the level of control over the asset necessary to give rise to a fixed charge. It does not matter what the parties have called the charge. The court will look at the intention of the parties and the level of control exercised by the lender. In Re Spectrum there was insufficient control as the borrower was not restricted in the operation of the account. In terms of priority a registered fixed charge will take priority over a registered uncrystallised floating charge. Question 2 Once a company has received payment for the shares which it issues, that consideration cannot be returned to the members except in the proper course of a distribution of assets in a winding up. The creditors of the company are entitled to assume that the capital of the company is maintained whilst any of them is owed money by the company (Trevor v Whitworth [1887]). It was held in the case of Ridge Securities v Inland Revenue Commissioners [1964] that a company can only lawfully deal with its assets in furtherance of it objects and that any voluntary disposition of assets its ultra vires. In Aveling Barford Ltd v Perion Ltd & Ors [1989] the court found that a sale of an asset at an undervalue to a
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connected company, whist dressed up as a genuine commercial transaction, was an unlawful distribution which breached the rules of capital maintenance. Statute has however developed a number of ways in which a company may lawfully reduce its capital. Ss.641-643 sets out the procedure to be followed whereby a private limited company may reduce its capital, requiring, inter alia, a special resolution of the members. In addition, any company may reduce its capital where the reduction is approved by the court under s.641 and ss.645649. It is possible that the capital of a company be reduced incidentally. This will occur where, as a remedy to unfair prejudice under s.994, the court orders (under s.996) the company to buy out the claimants shares. This will have the effect of reducing the companys capital. s.658 sets out a general prohibition against a company voluntarily acquiring its own shares, which reinforces the general principle of maintenance of capital. This too is subject to exceptions. s.684 gives companies the power to issue redeemable shares on the condition that there are no restrictions in the articles, the companys share capital does not exist solely of redeemable shares and that the shares can only be redeemed if fully paid. They must be redeemed either out of distributable profits or the proceeds of a fresh issue of shares or out of capital. Any premium should be credited to the share premium account. A further exception to s.658 is that a company may purchase its own shares subject to certain conditions. The right to purchase shares is subject to any restriction in the articles (s.690(1)), shares may only be purchased if fully paid, shares may not be purchased if the only remaining shares would be redeemable and /or treasury shares (s.690(2)) and the shares can only be purchased out of distributable profits, the proceeds of a fresh issue of shares or out of capital. In Acatos & Hutcheson v Watson [1995] it was held that a company who wished to purchase a company whose sole asset was a shareholding in the purchaser was not prohibited from doing so by the predecessor of s.658. Private companies should effect an off market purchase, following the procedure in ss.694-700, including obtaining a special resolution of the members. Should a private company effect a redemption or a buy back out of capital, it must follow the procedure set out in ss.709-723, whereby the directors must make a solvency statement, the members must approve the payment by special resolution, dissenting members should be given the opportunity to apply to court for cancellation of the resolution and notice must be placed in the London Gazette. Question 3 A new form of legal entity, the Limited Liability Partnership (LLP), came into being on 6 April 2001 under the Limited Liability Partnerships Act 2000 (LPA2000). The Limited Liability Partnership Regulations 2001 (LLPR2001) provide for the application, where appropriate, of company and insolvency law to LLPs. As a body corporate the LLP exists as a legal person separate from its members. A third party will usually contract with the LLP itself rather than with an individual member of the LLP. Should a member of an LLP be negligent in the work that he carries out for a client there will generally be two possible causes of action: in
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contract and in tort. Because the LLP will be a separate legal entity with which the client has contracted only the action in tort is potentially available against the member. The LLPs existence as a separate legal entity makes it more akin to a company than a partnership. A company too is a separate legal entity (Salomon v Salomon [1897]). In the case of a private limited company the liability of its members for the companys debts is limited to the paid up value of their shares. The liability of a member of an LLP for its debts is limited to the amount which has been agreed between the members. Only a company can raise capital by issuing shares. A company can also raise capital by granting a floating charge. LLPs can also grant floating charges but partnerships cannot. In contrast, the partners in a partnership face unlimited liability in respect of the debts of the partnership. S.9 Partnership Act 1890 (PA1890) provides that every partner is liable jointly for the debts of the partnership incurred whilst he is a partner. The Civil Liability (Contribution) Act 1978 (CL(C)A) now provides that judgment against one partner does not bar later against another jointly liable partner. Liability for wrongful acts and omission by a partner is joint and several with his co-partners where the firm as whole is liable (s.12PA1890). An indemnity may be available under CL(C)A. The LLP has unlimited capacity. This means that an LLP can do anything that a natural person could do. It has the ability to enter into contracts and hold property and will continue in existence in spite of any change in membership. The position of a private limited company differs in that its capacity may be limited by its objects clause if it has one. The taxation position differs according to the chosen business medium. Despite being more akin to a private limited company an LLP is, like a conventional partnership, subject to the income tax regime. Each member in the case of an LLP or partner in the case of a partnership is treated as a notional sole trader and is liable to pay income tax on their own share of the profits of the LLP or the partnership. On the other hand a private limited company will pay corporation tax on its profits. Different tax rates apply, and there are different reliefs and allowances available for both income and corporation tax. If the members of an LLP decide to enter into an LLP Agreement then that agreement, as is the case with a partnership agreement, is not a public document. This contrasts with the constitutional documents of a private limited company, which are public documents. Whilst the members of an LLP enjoy the less formal management structure and meeting arrangements of a conventional partnership, they must comply with a number of the formalities required of private limited companies by company law. These include: the formation of an LLP requires registration; changes in membership must be notified to the Registrar of Companies; accounts and an annual return must be filed; a register of charges must be kept, etc. Question 4 Following the enactment of s.31 CA2006 it is no longer necessary for a company to have an objects clause, in which case the capacity of the company will be unlimited. A company may however choose to restrict its objects in which case
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the objects clause will be contained in the companys articles of association. The objects clause of companies incorporated prior to CA06 are deemed to be part of the articles of association and no longer the memorandum, and the existing clause will continue to limit the companys capacity (unless the articles are amended by special resolution under s.21). The ultra vires doctrine to be discussed below will therefore continue to be of relevance to the majority of companies for some time to come. In Ashbury Railway Carriage and Iron Co Ltd v Riche [1875] the House of Lords held that a contract which was outside the objects clause of the company was ultra vires and therefore void. The House of Lords later expanded on this in the case of Cotman v Brougham [1918] in which it was held that the purpose of the objects clause is to give members the security of knowing what his capital would be used for and to give third parties the security of knowing that he could enforce a contract against a company. In order to avoid contracts being found to be outside a companys objects clause draftsmen attempted various solutions including drafting long form objects clauses, using Cotman clauses in which sub clauses stand independently of each other, and Bell Houses clauses (Bell Houses Ltd v City Wall Properties [1966]) where the objects clause would be followed with the statement that the company could in addition carry on any other trade or business whatsoever. s.9(1) European Communities Act 1972, which was later incorporated into s.35 CA1985 provided that where a person dealt with a company in good faith, any transaction decided upon by the directors would be within the capacity of the Company. The current provision is s.39CA06 which provides that: the validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the companys constitution. This extends the operation of s.35 to ensure that neither party can avoid liability on the ground that a transaction is ultra vires, and it extends it to corporate gifts in addition to contracts. In terms of the internal effects of an ultra vires transaction, we must look at s.40CA06. S.40(4) states that the right of a member to bring proceedings to restrain the doing of an action that is beyond the power of the directors is not affected. Such action must however be taken before the transaction becomes binding. Once that is the case a member may still seek to hold a director liable for breaching their duty under s.171 (s.40(5)). Turning to the authority of directors to act on behalf of the company the articles of association give them wide powers to manage the company (Art 3 Model Articles). However if a third party the board misused their power then a contract would be voidable at the option of the company (Rolled Steel Products Ltd v British Steel Corporation [1985]). The situation may also arise where the authority of the directors may be expressly limited by its articles or as discussed above where the objects clause limits the capacity of the company. In such cases third parties may be unaware of such limitations. The third party would be protected by s.40 which provides that the power of directors to bind the company is deemed to be free of any limitation under the constitution of the company where a third party is dealing in good faith with the company. It also provides that good faith is to be presumed. A third party is not required to make enquiries as to any limitations on the powers of the directors. This provision means that the directors can bind the company even where they do not have the authority to do so. The operation of S.40 was illustrated in the case of Smith v Henniker-Major & Co [2003]. The case of EIC Services Ltd v Phipps [2005] held
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that s.40 covers bilateral transactions and not internal arrangements of the company such as bonus issues. SECTION B Question 1 The facts suggest that the Company may have entered into a transaction at an undervalue in relation of the sale of the vans to Bismarck Limited. S.238 Insolvency Act 1986 provides that where there has been a transaction at an undervalue, a liquidator may apply to the court for the transaction to be set aside. A transaction at an undervalue is one where the company transfers property for either no consideration or consideration which is significantly less than the consideration which was given by the Company. In Phillips v Brewin Dolphin Bell Lawrie [2001] the House of Lords adopted a flexible interpretation of consideration based on commercial reality. In this case it could be argued that the consideration received (14,000) was significantly less than the consideration paid by the Company in November 2009 (36,000) s.240 IA provides that a transaction at an undervalue may only be set aside if it was made within two years of the commencement of winding up and at the time it was entered into the Company was unable to pay its debts or became so as a result of the transaction. The transaction in question was made in Feb 2010 and is therefore within this time limit. The insolvency of the Company is presumed where the transaction is in favour of a connected person. The definition of connected person is set out in s.249 and includes as is the case on the facts, associates of the company which includes (s.435) companies where the same person has control of both companies. There is a potential defence available which is that the transaction was entered into in good faith for the purposes of the business and there were reasonable grounds for believing that it would benefit the company. The facts suggest that in paying the overdue invoices, the Company may have preferred Mary Rose Limited. S.39 IA provides that a transaction may be set aside if its effect was to prefer one creditor over another. A preference is given if the company does anything which improves a persons position in the event of an insolvent liquidation. An example of a preference is seen in Re M Kushler [1943] where an overdraft secured by a personal guarantee of a director was repaid. In order for a preference to be set aside it must be established that it was influenced by a desire to prefer (Re MC Bacon [1990]). Payment made in response to pressure from a creditor will therefore not be a preference. It is possible that this may have been the case given that the recipient is a major supplier of the Company. If the preference is given to a connected person the desire to prefer will be presumed (Re Exchange Travel (Holdings) Ltd [1996]). In order to be set aside, the preference must have been made within 6 months of the commencement of winding up proceedings unless the preference is given to a connected person in which case the time limit is extended to two years. The company must also have been insolvent at the time of giving the preference or became so as a result of the preference. As there is nothing to suggest that Mary Rose Ltd is connected with the Company the relevant limit will be 6 months.
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There is potential for the liquidator to bring an action against the directors personally for wrongful trading under s.214 IA. A director will be guilty of wrongful trading if the company has gone into insolvent liquidation and at some time before the commencement of the winding up they knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation. The test is both objective and subjective and can be seen at work in Re Brian D Pierson [1999]. The court will consider both the general skill and experience that might reasonably be expected of a director and the actual skill and experience possessed by the director in question. In this case we are not told about the directors actual skill and experience but on the objective test it would have to be decided whether they ought reasonably to have known they would not avoid insolvent liquidation given that the company has traded at a loss for a number of years, given that the lender had obvious concerns and given that they lost several major contracts. There is a defence to s.214 where a director can show that he took every step which ought to have been taken with a view to minimising the potential loss to the companys creditors. Whilst the directors here did inject some cash into the business this did not seem to have significant impact and could not be said to be taking every step to minimise loss to the creditors. Where wrongful trading is established the court can order that the director is liable to contribute to the extent that the assets were depleted by his conduct. Question 2 (a) Whilst it is not a requirement in the formation of a partnership that there is a partnership agreement in place, in the absence of such an agreement, as is the case on the given facts, the relevant provisions of the Partnership Act 1890 will apply as the default provisions. s.24(1) provides that: all partners are entitled to share equally in the capital and profits of the business and must contribute equally towards the losses whether of capital or otherwise sustained by the firm. As there is no partnership agreement the profits of the business must be shared on this basis and must therefore be shared equally despite Baljits contention that she contributed more capital. S.24(5) deals with the management of the partnership and states that: every partner may take part in the management of the business. Whilst this provision is subject to any agreement between the partners there is no such agreement here, so Baljit cannot exclude Aysha from having a say in the management of the business. (b) The definition in s.20PA is relevant to the issue of ownership of property. It provides that all property brought into the partnership or acquired on account of the firm will be regarded as partnership property. In order to apply s.20 there are three tests to ascertain if property is partnership property. These are: was the property originally brought into partnership stock?
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Was the property acquired on account of the firm? Was the property acquired for the purposes of the partnership and in the course of the partnership business. The case of Miles v Clarke [1953] illustrates the difficulty in ascertaining ownership of property where there is no written partnership agreement, as is the case here. Essentially the ownership of property is a question of fact. There must be some evidence of the partners intention to treat the property as part of the capital of the business. In Davis v Davis [1894] it was held that there was no intention to hold the property as partnership property on the basis that the existing workshops used were not held as partnership property despite the partners being co-owners of the workshops. On the facts we would need to ascertain the intentions of the parties in relation to the garage. This means looking for evidence as to how the parties treated the garage. For example, did the partnership pay rates in relation to the garage? Did the partnership pay to insure the garage? Is there any agreement transferring the garage to the partnership? Did the partnership pay any rent for the use of the garage, etc? (c) Where no fixed term has been agreed for the duration of the partnership then it is a partnership at will. A partner may retire from a partnership at will at any time merely by giving the other partners notice of their intention to retire (s.26PA1890). S.17(2) provides that a retiring partner remains liable for the debts of the partnership incurred up to the date of their retirement. Aysha would be liable for any debts incurred by the partnership until the date of her retirement. Under s.17(3) she will have the option to be discharged from those liabilities by novation which is a tripartite agreement between herself, the remaining partners and the creditors of the partnership. A novation agreement must be supported by consideration or else executed as a deed. S.36 sets out the notice requirements which must be complied with on her retirement. A notice should be placed in the London Gazette, and actual notice of her retirement should be given to existing customers of the partnership. Aysha should also take steps to ensure that she is not held out to be a partner under s.14 (1), despite having retired from the firm. Such steps could include ensuring her name is removed from the firms stationery. Question 3 (a) Olga has been removed from her office as director by Miquita and Nathan. A director can be removed from office by ordinary resolution of the members under s.168CA06. As Olga holds 33% of the issued share capital she would not be able to block such a resolution. However the Companys articles of association may contain what is known as a Bushell v Faith clause, named after the 1970 case. In that case weighted voting rights were given to a director under threat of removal which allowed the director to defeat a resolution to remove him from office.
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S.217 allows for a director to receive a payment for loss of office if it is approved by the shareholders. Alternatively Olga may be able to bring an action for breach of contract as seen in the case of Southern Foundries v Shirlaw [1940]. (b) Pursuant to s.550, as the company is a private company and has only one class of shares, the directors may allot shares without recourse to the members. It is also possible that authority to allot shares has been given to the directors by the articles of the Company. Under s.561 where a company proposes to allot equity securities for cash they must first offer them to existing members pro rata their shareholding. The procedural requirements for making the offer are set out in s.562. Equity securities are defined by s.560 and include ordinary shares. The company may have disapplied the pre emption rights in its articles (s.570) if the directors are generally authorised to allot shares, or they may be disapplied by special resolution of the Company. In order to have passed a special resolution Olga would have had to vote in favour of it. (c) Ordinary shares carry no contractual right to receive a dividend. Dividends can only be paid if there are profits available for distribution, as defined by s.830CA06. In the event that there are such available profits in this case then the correct procedure should be followed. Art 30 of the model articles provides that it is for the directors to recommend the payment of a dividend and the level of such dividend. It is then for the shareholders to approve the payment of the dividend by ordinary resolution. As Olga is no longer a director she will not have a say in the decision to recommend a dividend to the shareholders. (d) Olga may be able to pursue an action for unfair conduct under s.994. A member may petition the court for relief against unfair prejudice resulting from some specific act or omission done or threatened by the company or from the general conduct of the affairs of the company. In ONeill v Phillips [1999] the House of Lords indicated that an unfair prejudice action could be based on the unlawful conduct of the companys affairs or on inequitable considerations (ie on lawful conduct which is inequitable). The case of Ebrahimi v Westbourne Galleries [1973] considered inequitable conduct and found that in appropriate cases the court will subject the exercise of legal rights to equitable principles. In some cases (eg Quinlan v Essex Hinge Co Ltd [1996]) the court has found there to be a quasi partnership. In such a case the conduct may affect the petitioner in their capacity as director as well as a shareholder, so removal from the board may be unfairly prejudicial conduct. s.996 provides that the court may make such order as it thinks fit. As in the case of Grace v Biagioli [2005] an order that the minority shareholders shares be bought out is often the most practical order and is therefore the most common order to remedy unfair prejudice.

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Question 4 Applying the definition provided in Twycross v Grant [1877] (one who undertakes to form a company with reference to a given project and to set it going , and who takes the necessary steps to accomplish that purpose) Erika, Fred and Gulbir are clearly promoters of the new company. They are said to be in the process of incorporating it, further, they have sourced suppliers for the purpose of the company and developed a recipe to be used by the company. The Newco is not yet incorporated therefore it has not come into existence. It was held in Jubilee Cotton Mills v Lewis [1924] that a company is incorporated on the date stated on its certificate of incorporation. If the promoters enter into the contract with the supplier it will be a pre incorporation contract. S.51CA06 applies to pre incorporation contracts and provides that subject to any agreement to the contrary, the promoter will be personally liable for the contract. It can be seen in the case of Kelner v Baxter [1866] that a promoter cannot purport to act as an agent of the company at this stage as no company yet exists. The case of Phonogram v Lane [1981] illustrates the operation of s.51 (in relation to an equivalent provision) in conferring personal liability on the promoter. It also established that it is irrelevant that the third party knew the company was not yet incorporated. Correspondingly the promoter will also have a right to enforce the contract. This was established in the case of Braymist v Wise Finance Co Ltd [2002]. If the promoters wish to proceed with the contract then they should attempt to limit their exposure to liability. A company cannot ratify a contract made on its behalf before incorporation (Kelner v Baxter, Natal Land & Colonisation Co v Pauline Colliery Syndicate [1904]). However, there a number of ways in which a promoter may transfer liability to a company. Following incorporation the company with the consent of the promoter and the third party may enter into a contract of novation with the third party. In order for this to be effective there must be an element of renegotiation on the part of the company (Re Northumberland Avenue Hotel Co [1886]). Alternatively, draft contracts may be used. The contract would become operative on incorporation. Another possibility is to include a cessation of liability clause, as permitted by s.51. The promoters liability will cease on incorporation when the company offers to contract with the third party. A promoter stands in a fiduciary position. It was seen in the case of Leeds & Hanley Theatre of Varieties [1902] that a promoter owes a duty of care to the unincorporated company. Further, a promoter owes a duty not to make a secret profit. It was seen in the case of Erlanger v New Sombrero Phosphate Co [1878] that where a promoter made a secret profit without disclosing it the contract could be rescinded. If a promoter discloses that he is to make a secret profit then he may be permitted to retain the profit. However the company may require him to either rescind the contract or as was seen in the case of Gluckstein v Barnes [1900], to account for the profits.

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