The Enterprise Laws - Case Study Example

Company Law II Q1 The above statement re legal rules of valuation of newly issued shares of stocks of public companies and private companies is true to the extent that public companies are limited to the valuation dictated by market forces as indicated in their prices in stock exchange markets and to the extent that there are no fixed rules for valuation for newly issued shares by private companies. In the latter case, however, the statement is not absolute considering that case law on the matter indicates that the courts have given themselves wide latitude in determining company issues, including share prices, on the basis of fairness and equity. In the issuance or allotment of new shares, both public and private limited companies go through some form of valuation exercises in determining the current value of the shares. Since public companies are traded publicly in stock markets, the valuation of the newly issued shares necessarily find basis from their present share price. In this sense the public appreciation of the value of the company’s shares dictates the valuation of potential new shares justifying the observation that public companies receive “real and fair value for their shares.” On the other hand, the valuation of newly issued shares of private limited companies finds basis in the observation that “there is almost nothing controlling the minimum value to be paid for new shares” simply because, as opposed to public companies, its valuation has no defined point. What private companies have, to substitute a pre-defined basis for valuation, are valuation models that serve as their guides in determining in fixing the consideration of newly issued shares like net asset values, discounted earnings, scrap or break-up value, replacement cost and multiple of turnover. Companies are free to choose any of the above valuation models as basis for fixing the price of newly issued shares that would benefit it to the most. These valuation guides, however, are only employed to find the minimum and the ceiling values of the shares and the parties, thereafter, go through negotiations to fix the value of the shares (Valuation of Shares 2010). Share prices of public companies are controlled by market forces that affect their rise or fall and the fact that such changes in prices are out in the open for the public to see either works to the benefit or disadvantage of public companies as well as control the price of newly-issued shares by them. This is not true, however, with private companies who do not trade openly in stock market exchanges. The fact that prices of newly-issued shares of private companies have really no established and strict principles for valuation is illustrated by the case of Re Bird Precision Bellows Ltd [1986] Ch 658, where the court declared that it even it enjoys a wide discretion in determining valuation to serve the ends of justice and fairness. This is a principle likewise applied in the case of Scottish Cooperative Wholesale Society Ltd v Meyer [1959] AC 324, where the court held that it possesses a broad discretion to determine what constitutes fair price in the valuation of shares. In the case of Re Cumana Ltd [1986] BCLC 430, indicate that even the notion of fairness with respect to company matters, including share prices, is a complicated issue and highly tenuous. Fairness is dependent on the circumstances, according to the case, and since circumstances do change then it follows that even the notion of fairness is unfixed. In this case, a majority shareholder, who anticipated a major company move, created circumstances that would result in the depreciation of the prices of the company shares. The court held that in the interest of justice, the shares should be valued at a date before the majority shareholder took the step to deliberately devalue the prices of shares. These cases are but just two indications that although private companies have the option to choose any valuation model that would most benefit them, and that therefore, there really are no fixed rules for determining the prices of company shares as far as they are concerned, they are nevertheless, limited by the general rules of what is fair and equitable. Q2 (a) (i) Aye Bank plc’s floating charge ranks above Crown debts and taxes such as PAYE or VAT. This is because under the Enterprise Act 2002, the preferential status of Crown taxes and debts were eliminated, amending in effect the provisions of Schedule 6 of the Insolvency Act 1986 (Goode 2005 196). A floating charge, according to the case of Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284, is one that is placed over a class of company assets, which changes from time to time, applicable to the present and future and despite of which allows a company to carry its day-to-day business with respect to such class of assets until a definitive step is taken upon it (Cotter & Breslin 43). Put another way, a floating charge is an umbrella-like security that is not fixed upon a specific asset but upon a group of assets but nevertheless, does not interfere with the workings of the company unless such a time when it crystallizes into a fixed charge at the liquidation of the company. Aye’s debt, therefore, is classified as secured placing it beyond the ambit of the general rule of pari passu principle described under s 107 of the Insolvency Act as the distribution of company assets upon winding up in proportion to the creditors’ rights and interests in the company. On the other hand, the PAYE and VAT have ceased to be preferential debts and therefore are now treated as ordinary debts and subject to the pari passu principle. (ii) Bee Bank plc’s fixed charge should rank above that of Aye’s floating charge. The distinction between a fixed and floating charge is that while the latter is like an umbrella charge over a class of assets and transforms only into a fixed charge once the company winds up, the former is charged on a specific asset of the company from the very beginning. Between the two, it is the fixed charge which takes precedence over a floating charge when the company winds up because of the certainty of the nature of the fixed charge that is not found on a floating charge (Kothari 2006 492). This order of priority between floating and fixed charges is true whether the floating charge was made first before the fixed charge, except when the floating charge attaches with it a prohibition clause which prohibits the company from entering into an agreement which allows a security over its fixed assets and the lender in the fixed charge has knowledge of such an agreement (Clayton 2006 49). (iii) Aye’s floating charge is a secured debt and therefore does not come within the general principle of pari passu. As earlier discussed the pari passu principle, under s 107 of the Insolvency Act simply states that the company’s creditors are all placed in the same position in the sense that the company’s assets, upon liquidation, will satisfy their claims fairly and equitably in accordance to the extent of their rights and interests in the company. Aye’s charge on the private company is not in the nature of an unsecured debt but a secured one and is, therefore, not subject to the principle but enjoys a preference above them. This is because secured debts, although not strictly considered as exception to that principle, cannot be made subject to it since they are considered assets that do not belong to the company to the extent of the value of the security although the company have an equity of redemption over them (Goode 2005 189). Thus, unsecured creditors can only lay a claim to that past of the assets of Firsty Ltd, pari passu, after the company has satisfied Aye’s claim to the extent of the value of the latter’s security over Firsty. (b) The sale of the machinery is valid because it does not, in any way, injure the chances of the creditors to satisfy their claims in the event of liquidation. Transactions before actual winding up, up to 12 months before it, that are considered fraudulent are enumerated in s 206, Chapter X, Part IV of the Insolvency Act 1986 and these acts have one thing in common: they are obviously geared to fraudulently and deliberately deprive the creditors of their chances of full satisfaction of their claims. In particular and relevant to the present question is § (f) of the aforesaid provision which states that “pawned, pledged, or disposed of any property of the company which has been obtained on credit and has not been paid for (unless the pawning, pledging or disposing was in the ordinary way of the company’s business)” if done within 12 months prior to the company’s winding up is a fraudulent act and therefore punishable under the law. The second hand machinery, which was sold for a higher price than its market value, was not described as obtained on credit and unpaid and although there is no way of telling whether the transaction was done in the course of the company’s business, the transaction cannot be categorised as in fraud of its creditors because the company did not incur a loss and on the contrary, made a gain. (c) Fraudulent trading is described and defined under s 213 of the Insolvency Act 1986 (as amended) whilst wrongful trading is tackled under s 214 of the same law. The chief distinction between the two is that fraudulent trading is essentially criminal in nature because of the intent to commit deception to put at a disadvantage the claims of the company’s creditors whilst wrongful trading does not necessarily require proof of such state of mind. In addition, fraudulent trading attaches liability to members, who may be or not be directors, whilst wrongful trading applies specifically to directors. Section 213 is a very short provisions which emphasizes only the nature of fraudulent intent as a component of the act whilst s 214 prescribes certain conditions like status of the company at the time the act in issue was committed (in insolvent liquidation), or even before actual insolvent liquidation so long as that condition can be reasonably anticipated and the person who can be made liable for it (the director holding that position at the time of the commission of the act). The same provision also gives the defence for it, which is taking all the necessary steps in minimising the loss (Insolvency Act 2006). In the case of Morphitis v Bernasconi and others [2003] 2 WLR 1521, the court emphasised that an act of fraud against a creditor does not constitute fraudulent trading but the business, in its entirety, must be employed to defraud creditors. The court had an opportunity to expound on the meaning of ‘intent to defraud’ and ‘fraudulent purpose’ in the case of Re Patrick & Lyon Ltd [1933] Ch 786 and held that the phrases should be meant to refer to actual dishonesty rather than in their technical sense. In this case, the person who started his company with a very small capital and with assets that were secured with debentures in his name may not be characteristic of high-mindedness but they are certainly not indicia of dishonesty and fraud. On the other hand, wrongful trading does not necessarily include the concept of actual dishonesty in the act complained of. In the case of Re DKG Contractors [1990] BCC 903, the company was engaged in the business of ground works sub-contracting and was incorporated in 1986. The principal director employed his own machineries for the works and billed the company for them as well as for the labour of men he hired himself on site. Eventually, he became one of the company’s major creditors. Despite this, the court did not find any serious issue of dishonesty but nevertheless, he, together with another director, were found to be guilty of wrongful trading for failing to acknowledge that the company had been for a couple of years in serious trouble of bring insolvent but did not take steps to declare the company insolvent. The concept of wrongful trading, therefore, is much broader and encompassing than that of fraudulent trading because it renders directors liable for acts that are not strictly classifiable as dishonest. The case of Re Produce Marketing Consortium Ltd [1989] 5 BCC 569 was the first case on wrongful trading. The court found liable two directors who allowed the company to drift into a state of graduated and gradual insolvency without acting upon it and putting it into liquidation. The directors were ordered to give £75000 to the company. (d) The fixed charge is not open to challenge because there is no clear showing that the company is going into a state of insolvency very soon. First, the provision on wrongful trading is applicable only to a situation of insolvent liquidation; second, wrongful trading is applicable only when previous to such insolvent liquidation, the director or directors can reasonably foresee that the company would inevitably fall into insolvency in the future and; third, the person liable is a director at the time the act in issue was committed. In the present problem, Dee Ltd is not in a state of insolvent liquidation as this is not alleged in the problem and although the problem states that the company had met difficulties from time to time, it does not clearly state that there was reasonable prospect that the company was heading for insolvency. In the case Re Continental Assurance Co of London plc [2007] 2 BCLB 287, the board of directors of a company conducted a crisis meeting to consider the company’s prospects. The board decided there was no reason to declare a state of insolvency and the company continued in its usual business, but soon thereafter, the company went into insolvent liquidation. The liquidator sued the directors for wrongful trading for failing to declare a state of insolvency even after having gone through the crisis meeting, where they could have arrested the company’s freefall by declaring insolvent liquidation then and there. The Court disagreed on the ground that the facts proven did not show that a reasonable prospect that there was no way out for the company other than an insolvent liquidation at the time of the crisis meeting. (e) The floating charge is not open to challenge by the liquidator because it does not constitute an act that would be inimical to the interest of creditors nor constitute an act within the ambit of Malpractice before and during Liquidation in Chapter X of the Insolvency Act 2006 (as amended). Although the Companies Act 2006 makes a company officer liable for sanctioning or allowing the omission of charges in the company’s register of charges as laid down in s 891 of the said law, this does not does not constitute concealment of debt due from the company under s 206(a) of the Insolvency Law because the omission took place more than 12 months before the commencement of the company’s winding up nor does the omission necessarily signify deliberate intent to deceive the creditors since the charge was properly registered in the Companies House and may have been merely unwittingly omitted. In addition, the company was able to comply with requirements of a Companies Act 2006 provision requiring the registration of charges with the Registrar of the Companies House, a more important registration because it allows the public the opportunity to view and find out the charges affecting the company. This is the more important registration because unless such charge is registered with the said agency, the charge is deemed void as against the liquidator and creditors with respect to the assets covered by such unregistered charge and in addition, the holder of such unregistered charge is placed in the same category as unsecured creditors which will subject them to the pari passu principle (Clayton 2006 50). The fact of registration of such a charge is also deemed, for all intents and purposes, a notice of its existence (Judge 81). In addition, any complaint that may be filed by the liquidator on account of this transaction the secretary cannot be faulted under sections 213 and 214 of the Insolvency Law 1986 considering that fraudulent trading attaches only liabilities to members and wrongful trading only against company directors. In the case of Re Maidstone Building Provisions Ltd [1971] 3 All ER 363, the court held that the company’s secretary was not liable for any wrongdoing, like incurring debts even though the company is on the brink of insolvency, under the Insolvency Law despite the fact that she had knowledge of the fraud. Knowledge alone is not sufficient to convict the person under the said law but active participation will and being a “party to the carrying on of the business” implying that the person must be a director of the company. References: (2010). Valuation of Shares. Complete Formations. http://www.completeformations.co.uk/companyfaqs/shareholders/valuaion_of_shares.html Clayton, P. (2006). Forming a Limited Company: A Practical Guide to Legal Requirements and Procedures, 9th Edition, Kogan Page Publishers. Companies Act 2006. Cotter, A. & Breslin, J. (2003). Banking & Corporate Financial Services. London: Routledge Cavendish. Enterprise Act 2002. Goode, R. M. (2005). Principles of Corporate Insolvency Law, 3rd Edition, London: Sweet & Maxwell. Insolvency Law 1986. Judge, S. (2008). Q & A: Company Law 2008 and 2009. Oxford University Press. Kothari, V. (2006). Securitization: The Financial Instrument of the Future. Singapore: John Wiley and Sons. Morphitis v Bernasconi and others [2003] 2 WLR 1521. Re Bird Precision Bellows Ltd [1986] Ch 658. Re Continental Assurance Co of London plc [2007] 2 BCLB 287. Re Cumana Ltd [1986] BCLC 430. Re DKG Contractors [1990] BCC 903. Re Maidstone Building Provisions Ltd [1971] 3 All ER 363. Re Patrick & Lyon Ltd [1933] Ch 786. Re Produce Marketing Consortium Ltd [1989] 5 BCC 569. Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284. Scottish Cooperative Wholesale Society Ltd v Meyer [1959] AC 324. The Insolvency Rules 1986. Wood, P. (2007). Comparative Law of Security Interests and Title Finance, 2nd Edition, London: Sweet & Maxwell. Read More