English Company Law and Company Structure - Assignment Example

COMPANY LAW STUDENT NAME PROFESSOR’S NAME COURSE TITLE DATE Introduction English company law, derives most of its laws from common law practice, statutes and precedents set by the courts. The case presented requires the legal analysis of company law including insolvency, duties of a director, the role of a liquidator and winding up of a company. Question 1 Whether Customers of Telephony Ltd can recover the loan repaid to Fone4U plc to recover the 60% refunds to which they are entitled? Fone4U came up with a scheme to sell mobile telephones whereby its customers would pay a very high price but would be entitled to reclaim 60% of the price provided they applied within three days of the second anniversary of purchasing the mobile phone. Fone4U calculated that the scheme would be very profitable, but risky and formed a subsidiary company known as Telephony Ltd to operate the scheme. Fone4U being the parent company subscribed for £1 and lent £Telephony Ltd £200,000. Fone 4U in July 2012 demanded repayment of its loan of £200,000 to which Telephony repaid. The issue is whether Customers of Telephony Ltd can recover the loan repaid to Fone4U. it is interesting to state that Fone4U Plc is a public company while the Telephony Ltd is a private company. According to section 28 of the Company act, it states that a private company restricts transfer of shares, limits the number of its members to first and prohibits invitations from the public to subscribe for any shares or debentures of the company1. It is common practice for a holding company to be a public company and private subsidiary and hold shares for the parent company but no offer given for securities. It is therefore right for two separate companies to operate as a parent company and subsidiary companies. In case of public companies, where the company becomes insolvent, a shareholder can elect to sell their shares in the stock market; while on the other hand, in private company liability is limited to the shareholder in paying creditors. The first issue in the question is to determine whether the customers can recover the amount given to Fone4U is to question whether they can be called shareholders in company law. The case of Borland’s Trustee v Steel Bros & Co Ltd2 defined a share as “ the interest of a shareholder in the company measured by a sum of money, for the purpose of liability and of interest in the second”.3 In the definition, for a person to be called a shareholder, one must have a share that is paid for, it gives them an entitlement to dividends, votes, and a return of capital or interest and that there exists mutual covenants of majority control and minority protection. In this case the type of shares issued by Fone4U is capital shares since the nature of interest is payment of 60% of the cash price when the phone turns two years after purchase. The Fone4U mobile phone buyers are shareholders in Fone4U since they acquired an interest in the company by purchasing the phone and are entitled to a fair return in the capital. It is a legally established principle set in the case of Salomon v Salomon4 that a company is a separate legal entity independent from the individuals forming and creating it. Upon incorporation, a company becomes a separate legal entity from that of its members or promoters and hence a veil of incorporation is placed to protect the individuals from liability. In English law, the veil of incorporation is lifted where director’s of a company ignore the existence of the corporate veil of two companies by transferring assets from one to the other in total disregard of their duties to avoid contingent liability. The veil of incorporation is lifted in cases where a company is presumed to carry out illegal activities, it is a fraud and a sham, it is formed to evade tax amongst other reasons5. The law accords the veil of incorporation status to both the parent company and a subsidiary and they retain both their separate legal status. In the case of Adams v Cape Industries plc 6 the English company owned subsidiaries and a group of defendants were awarded damages for personal injuries. The court held that the judgment could not be enforced against the English holding company since English law recognizes the existence of subsidiary companies hence is separate legal entity. In the case of Adams v Cape Industries7 the judge justified the lifting of veil of incorporation in cases where the subsidiary is acting as an agent of the holding company, where the corporate structure is used as a façade or a sham to conceal the truth and it us a single economic entity. Who is in control in parent companies and subsidiaries is important for customers to recover. This is diminished in instances where, the subsidiary is fully in control rather than the parent company, the subsidiary carries its own account, paid tax on profits and that the creditors were its own as held in Firestone Tyre & Rubber v Lewellin (Inspector of Taxes8). Moreover, if a company is operating as a single economic entity, then the carrying on of the business amounts to a single business. In the case of DHN Food Distributors Ltd v Tower Hamlets LBC9 the court held that where the two companies are a single economic entity and that the premises and business activities were in the hands of a single group then the companies are one and the same hence both were liable. The third aspect in apportioning liability to a group of companies is when the corporate structure is used a sham or a façade. In Jones v Lipman10 vendor wishing to evade a specific performance order in a contract for sale of land created a company by third parties and conveyed the land to the company. The court held that the acquisition of the company and the conveyance was a mere cloak or sham to evade his liabilities under the contract. It is crucial to question the intention of Fone4U in creating Telephony Ltd is its subsidiary and retaining its control over the directors. The reason for creation of Telephony Ltd was prompted by the fact that the business was a risky venture and therefore Telephony Ltd was created to limit the liability of Fone4U to its customers who were also its main shareholders. The evasion of corporate liability also warrants the lifting of the corporate veil in cases where directors of a company transfer the assets of one company to the other company without giving regard to their duties as directors in order to avoid issues of contingent (Ridley, 2009 ). In the case of Re H and others11 the court held that if there is evidence of a company’s intention to fraudulently evade their duties, then the veil of incorporation will be lifted. In insolvency law as stated in the case of Liquidator of West Mercia Safetywear Ltd v Dodd12, the court stated that it requires directors to consider the creditor’s interests as insolvency approaches despite no such duty being owed to creditors. It is prudent to understand whether it was prudent for the directors to pay Telephony Ltd the debt owed knowing fully that the company was falling into insolvency. It is established in precedent that the failure or non-payment of an undisputed debt is evidence of a company’s inability to pay its debt as held in the case of Taylor Flooring Ltd v M& H Plant Hire (Manchester) Ltd13. This means that on the instance that the company became insolvent, then the company was unable to pay its debt and the hasty payment of Fone4U was to assert that the company had a secured interest in light of the decision in Salomon v Salomon & Co14. According to the Insolvency Act 1986 at section 127 the dispositions of property belonging to the company, transfer of shares or alteration to the company’s status made after commencement of a winding up proceeding is void unless the court declares otherwise. The precedent set by courts in relation to creditors clearly dictates that creditors can only recover by proving their debts in the collective windup process15. The dictum stated in the case of Re Wilshire Iron Co. ex parte Pearson16 clearly stated that this prevents alienation and dissipation of property such that it injures the person’s interested in the assets of that company. It is therefore crucial to state that the repayment of the £200,000 to Fone4U before the issuance of a winding up order goes against the provisions of the law. The nature of the existence of the two companies Fone4U and that of the Telephony Ltd is that of a parent company and a subsidiary company. It can be reasonably assumed that the two companies carried own the same business activity such that one could not delineate their separate existence since Telephony Ltd only existed solely to shield Fone4U from any risk. In understanding whether or not the customers can recover then the simple questions that need to be answered are in the case of Smith, Stone and Knight v Birmingham17. The identified six questions are who was carrying on the business? Whether the profits were treated as those of the parent company? Was the parent company the head and brain of the trading venture ? Did the parent company play a role in deciding what should be done and how much the investment to be made in the business? Did the parent company make a profit based on its skill and direction? Was the parent company in effectual and constant control?18. Fone4u was carrying on the business, while Telephony Ltd took the risks of Telephony Ltd. The profits of Telephony Ltd were treated as the profits of Fone4U and therefore the brain of the trading venture between the two companies was Fone4U. The parent company Fone4u maintained a significant control over Telephony Ltd even directing the directors of Telephony Ltd to continue trading as long as possible despite knowing that the scheme was wholly unprofitable and would be insolvent. Moreover Fone4U played the role in directing Telephony Ltd on the amount to be invested £200,000 due to its constant control of the company. The customers can however not recover the amount £200,000 but can recover the sums when it is returned to Telephony Ltd and subject to a winding up petition, then the customers can get the amount upon proving their debts as creditors. Despite lifting the veil of incorporation since Telephony Ltd was incorporated as a tool to evade liability, customers cannot recover their debts but subject to a winding up order. Question 2 Whether the liquidator can recover the loan repaid to Fone4U? The issue clearly foreshadows the dilemma the courts had in the decision of Salomon v Salomon19 in the view of a company as a separate legal entity and lifting of the veil of incorporation.English company law presents a dilemma in the payment of creditors in relation to their debts owed to company. The main issue is whether the debt was secured? The question before the court in Salomon v Salomon & Co Ltd20 was whether a one-man company could lend money to the company and take security over its assets in return and thereby ensuring the individual has a priority over the other creditors of the company. The decision in this case held that a member of a company acting in good faith is entitled to hold the company’s debenture and that every creditor is entitled to hold any security. This decision however fails to take into consideration the economic and practical realities. In the circumstances of Fone4U one can argue that Fone4U advanced the loan to Telephony Ltd was to avert the risks and therefore one can say they are secured creditors. In this case, the application of the doctrine laid down in Salomon v Salomon & Co despite having overreaching implications on the separate legal entity of a company, it does not diminish drawing aside of the veil in cases of fraud. In Fone4U, created the subsidiary company Telephony Ltd was to evade their existing legal obligations to its shareholders or customers then the legal obligation exists prior to incorporation, then the use of the corporate structure would be considered as to evade and hence pierce it.21 In this case one needs to determine whether a liquidator can overturn prior transactions when directors in anticipation of liquidation pay off debts owed to the company The Insolvency Act 1986 states that a company is in breach of its duty if it permits certain transactions within a specified period before liquidation. A liquidator can apply to the court to seek an order that restores the parties into the position they would have been in of the transaction had not been carried out challenged under sections 239 of the Insolvency Act 1986 The Insolvency Act 1986 section 239 states that preference in relation to winding up order is given if a person is one of the creditors of the company and whether the company took the chance. Better still, did anything whose consequence would have the effects of restoring that person to a position in which in the event of insolvent, then the person would have been in a better position if the transaction had not been done. In the case of Telephony Directors, they sought to pay Fone4u in such a way that would disadvantage the Telephony Ltd shareholders without paying due regard to the effects of the transactions. In the event that the liquidator can recover from Fone4U, the liquidator needs to challenge the legality of the transactions. The liquidator needs to prove to the court that the company was influenced in giving a preference over the company’s shareholders to that of Fone4U. The liquidator needs to show that the parent company Fone4U had influence over the transactions in order to attain preferential treatments. For the purposes by section 239 of the Insolvency Act 1986, the definition of ‘connected’ is very wide and includes a transaction with directors or a major shareholder. In this case, the directors of Telephony Ltd effected the transaction since Fone4U demanded the repayment of the loan in July and the liquidator was appointed in August 2012. The time limits imposed by the Insolvency Act for challenging a preferential transaction are six months prior to the date of formal insolvency for unconnected parties, and two years prior to that date for connected parties. In the case of Fone4U and Telephony Ltd, the transaction is a month prior to the date of formal insolvency and therefore the liquidator can challenge the reversal of the transaction. The liquidator must prove the desire to prefer Fone4U as opposed to other creditors and shareholders. In company law, there is an obligation for, directors to seek proper legal advice before declaration of dividends or repayment of their loan accounts when a company becomes insolvent and is likely to proceed into compulsory liquidation as long as the payments are not deemed to be preferential. In the case, the liquidator can recover the loan repaid to Fone4U by Telephony Ltd upon filing a proceeding to prove that the repayment of the loan was a preferential transactions to place Fone4U in a better position as opposed to its other directors. At the same time the transactions falls within the six months period prior to formal liquidation rendering the transaction irreversible. Question 3 Whether the liquidator of telephony can take proceedings for wrongful trading against Mayo, Charles, Sandra or Fone4U? The Company’s Act 2006 at section 171 states that a director has the duty to act within his powers according to the Constitution of the company and exercise his powers according to the powers conferred. A director’s duty is to promote the success of the company in a way that he considers his actions to be in good faith not only to benefit the company but also the interest of the members. As held in the case of Regenstcrest plc (in liq) v Cohen22 that directors must act in what they consider as right and not what they think is right in relation to its members. It is questionable whether the directors of Telephony Ltd were acting in the best interest of the company or that of its parent company Fone4U hence in breach of their duties under company law. In the case of Bishopsgate Investment Management Ltd v Maxwell (No. 2)23 the court clearly stated that it is a breach of fiduciary duty to act in bone fide in the interest of the company and not for the proper use in transfer of stock whereby the company was a trustee of the company. The directors of Telephony ltd were in breach of their fiduciary duties since they failed to act in order to foster interests of Telephony Ltd but that of Fone4U and disregarded the principle of separate legal entity whereby group companies are protected by the doctrine. The Act requires that a director exercises independent judgment according to section 173 and that the action is authorized by the constitution of the company. Mayo despite knowing the implications of the actions of Fone4U to continue trading, he opted to resign without using his independent judgment to inform Fone4U the implications of their actions. Further section 174 requires that a director of a company exercise reasonable care, skill and diligence in relation to carrying his duties and function in relation to the company. Moreover, section 175 of the Act requires that a director has a duty to avoid conflicts of interest that my conflict with the interest of the company. Section 172 (3) of the Company Act 2006 requires the directors of the company in certain circumstances to consider or act in the interests of creditors of the company. The introduction of section 172 (3) of the Companies Act clearly reflects the provisions of section 214 of the Insolvency Act 1986 that the liquidator could make a director to make a contribution to its assets. If there was no reasonable prospect of avoiding insolvency the director failed to take a step to minimize the potential loss to the creditor’s of the company.24 The directors of Telephony Ltd failed to ascertain the implications of the transactions in relation to giving preference to its creditors as opposed to its shareholders. The Insolvency Act 1986 at section 213 (1) clearly states that if in the course of winding up a company it appears that the business was carried on with the intention to defraud its creditors or any other person, the corporate veil is lifted. Moreover section 213 of the Insolvency Act 1986 compels the liquidator to declare that person’s who knowingly carried out the business in such a manner make contributions to the company’s assets. Section 214 of the Insolvency Act 1986 defines wrongful trading as “ if in the course of winding up of a company, it becomes insolvent liquidation, and at some time before the commencement of winding up proceedings, persons within the company knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into liquidation”. The person liable for wrongful trading needs to have been a director of the company at that particular time. The role of a liquidator in winding up proceedings is to assess the asset pool in order to distribute it to the creditors and where some transactions that are less than six months old are preferential, then the liquidator can reverse these transactions. A claim of wrongful trading would succeed if the liquidator can prove that the directors acted in contravention of their duties without necessarily having intention to defraud. It is reasonable to state that in the instance that a company’s financial standing is at risk of going into liquidation, the directors are required to stop trading at this point. Fone4U having known the unprofitability of the scheme asked the directors of Telephony Ltd to continue trading. In the case of Produce Marketing Consortium Ltd (No 2)25 the company drifted to insolvency, but the two directors failed to put the company into a status of liquidation at the right time and the court held that each of them to contribute £75,000 to the debts of the company. In this case, the court placed liability on the director’s for wrongful trading. In the case of Re Purpoint Ltd26 that in understanding wrongful trading, then one must recognize the existence of the point of no return where insolvency is inevitable. In the case it was held that Meredith the director was warned of the company’s debt but continued trading. The directors of Telephony Ltd knew of the impending insolvency and hastily paid the loan with the intention of shielding Fone4U from any loss in case of winding up petition. The directors of Telephony Ltd Mayo, Charles and Sandra are liable for wrongful trading to Telephony Ltd since having known that the company is most likely to become insolvent they acted in the best interest of its parent company as opposed to the interest of Telephony Ltd and that of its shareholders. Just like in the case of Produce Marketing Consortium Ltd (No 2) the directors can be personally liable for the debts of the company and contribute to the assets and liability of the company to repay its shareholders. Fone4U is liable for wrongful trading, since being the parent company, it retained significant control over the activities of Telephony Ltd and even instructed the directors Mayo, Charles and Sandra to continue trading knowing very well that the scheme was unprofitable and insolvency was inevitable. REFERENCES Company Law Act 2006 Davies, A. 2012, Gower and Davies Principles of Modern Company Law, 9 th edn, Sweet & Maxwell, London Hicks & Goo, 2008, Cases and Materials on Company Law, Macmillan, Palgrave. Insolvency Act 1986 Mayson, S. French, D. & Ryan, C. 2010, Company Law, Oxford University Press, Oxford. Morse, G. 2006, Partnership Law, Oxford University Press, Oxford. Ridley, A. 2009, Key Facts: Company Law, Hodder Education, London. Cases Adams v Cape Industries plc (1990) Ch 455 Bishopsgate Investment Management Ltd v Maxwell (No. 2) [1994] 1 All ER 261 Borland’s Trustee v Steel Bros & Co Ltd 1901 DHN Food Distributors Ltd v Tower Hamlets LBC (1976) Firestone Tyre & Rubber v Lewellin (Inspector of Taxes) [1957] 1 WLR 464. Jones v Lipman [1962] 1 WLR 832 Regenstcrest plc (in liq) v Cohen [2001] 2 BLC 80 Re H and others (1996) Re Purpoint Ltd [1991] BCC 121 CD Salomon v Salomon [1895] 2 Ch 325 West Mercia Safetywear Ltd v Dodd [1988] BCLC 250 Read More