Company Law Problems - Research Paper Example

Company Law Problems Question The ment that "The legal rules on consideration for new shares ensure that public companies receive real and fair value for their shares, unlike the position for private companies where there is almost nothing controlling the minimum value to be paid for new share" is only true to the extent that public companies, and the price of shares they issue or will issue in the future, are dictated by the prices reflected on stock market exchanges where trading of their shares take place. When it comes to private companies, however, the statement is not entirely true because despite the fact that private companies are not confined by prices seen overtly by the public in stock market exchanges, as they do not trade in them, nor by the fact that they are guided by acceptable valuation models in pricing new issued shares, they are nevertheless, restricted by the notion of fairness that may intervene in the form of court decisions. Public quoted companies determine considerations to newly issued stocks by the very prices reflected and accessible to the public in stock market exchanges where they trade. Such prices are held hostage to the basic principle of supply and demand. Thus, when shares of public companies are in demand and are being traded heavily, its prices go up and the opposite is true: if instead of buying, there is a dominant mood of selling company shares in the stock market, company shares go down. There is no escape to this since IPOs are governed and regulated by securities laws and agencies. This gives rise to a justification of the aforementioned statement that prices of newly issued shares reflect their true value in the market. On the other hand, and on the contrary, private companies are virtually free to choose any basis for pricing newly-issued shares. This, according to the book Auditing: Principles and Practice, valuation of assets, including shares for that matter, may be made in any of the following ways although non-exclusively: cost price valuation, in which the basis of pricing is the original price at which the shares were first issued, including all charges appurtenant to it; market value or net realizable value, which is the prevailing price of the shares in the market; cost of replacement, or valuation based on the prices of similar assets; break-up or scrap value, is valuation based on the probable value of the asset when it becomes unserviceable, and; book value, when shares, or company assets, are valued on the basis of their original price subtracted with its depreciation value (Kumar & Sharma 163-164). Yet, the freedom of private companies to set the price on newly-issued shares is not absolute as evinced by a chain of case law handed down by the English courts. In Re Company (No. 007623 of 1984) [1986] BCLC 362, the court held that the fair value of the shares of an employee must reflect the fact of frustration suffered by him by when the company did not upheld its promise to base his salary on its profitability. Although the case did not directly tackle share valuation, it hinted that the court gives itself discretion to rule on share values and that there is therefore no definite rule upon which to base share prices. In Re Elgindata Ltd [1991] BCLC 959, the court went to the other side of the fence by holding that the diminished value of the company’s shares did not necessarily stem or resulted from unfair prejudice proven. In the case Scottish Cooperative Wholesale Society Ltd v Meyer [1959] AC 324, the court directly upheld itself as possessed of the broad powers to make the determination whether the price of company shares is fair or not. All these cases indicate that there is no fixed rule in the valuation of company assets or shares simply because even the court can exercise the power to determine them on the vague basis of fairness, a notion which is in itself unstable and circumstances-dependent. Question #2 (a)(i) The Crown debts PAYE and VAT will both take inferior positions as regard Aye bank plc’s floating charge. A floating charge was defined by the court in the case of Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284 as “a charge on a class of assets of the company which includes present and future assets, and; the composition of the charge is not fixed – it changes from time to time in the ordinary course of the company’s business.” By this definition, it is evident that a floating charge is a security representing a company’s debts to another. Crown debts on the other hand, takes the classification of unsecured debts, as opposed to floating charges, by virtue of the fact that they are not charged upon any of the assets of the company. Previously, Crown debts are preferential debts in accordance with Schedule 6 of the Insolvency Law 1986 but the passage of the Enterprise Act 2002 had changed all that as it specifically amended and deleted such classification, relegating it to the position of ordinary unsecured debts. (Mason 2006 210). According to the book The Credit Controller’s Desktop Guide, the following is the order of priority in the satisfaction of company creditors at the time the company’s winding up and liquidation: “the expenses of the liquidation; preferential debts; debts that are secured by floating charges; ordinary debts; interest on preferential and ordinary debts” (Mason 2006 209). It is obvious, therefore, that as between an ordinary and unsecured debts such as Crown debts and secured debts such as floating charges, the latter, and in this case Aye’s floating charge, takes a higher order of priority in debt satisfaction than the former. (a)(ii) Bee’s fixed charge rates a higher ranking than that of Aye’s floating charge in the order of priority of debt satisfaction at the company’s winding up and liquidation. A fixed charge, as distinguished from the notion of general and unspecific nature of floating charges such as that held by Aye, is one that is secured over a specific asset of the company like a building or machinery of the company. Although both kinds of charges are considered secured claims and places them in a better position than unsecured claims, their rankings are not on the same level because fixed charges occupy a higher priority of claim satisfaction than that of the floating charge. During liquidation, for example, the assets covered by the fixed charge may be sold and its proceeds applied directly to the claim of the fixed charge holder. The class of assets over the floating charge holder may also benefit from the sale of this class of assets but he shares it with other claimants which may have higher priority in claiming than him (Bender & Ward 2002 1350). (a)(iii) Aye bank plc occupies a higher priority of debt satisfaction vis-à-vis unsecured claimants. Thus, when the class of assets covered by the floating charge of Aye will be sold during the liquidation stage of the winding up of Firsty Ltd, Aye’s claims will have to be satisfied first before the unsecured claimants are satisfied theirs. Aye’s floating charge is categorised as secured and therefore constitutes an exception to the Pari Passu principle laid down in section 107 of the Insolvency Act. That provision states that “subject to the provisions of this Act (Insolvency Law 1986) as to preferential payments, the company’s property in a voluntary winding up shall be on the winding up be applied in satisfaction of the company’s liabilities pari passu and, subject to that application, shall (unless the articles otherwise provide) be distributed among the members according to their rights and interests in the company” (section 107, Chapter V, Insolvency Law 1986). What the Pari Passu Principle provides, in essence, is that all unsecured debts should be given equal treatment in accordance with the extent of their claim against the company, a principle consistent with the pro rata standard. Aye’s floating charge, however, is of a higher priority than that of unsecured claimants because “any type of security puts a lender in a better position than the unsecured creditors” (Bender & Ward 2002 135). (b) The contract of sale between Bad Ltd and the buyer of the second-hand machinery is valid as to the liquidator of the company. Selling the second-hand machinery over its market value does not harm the company or its creditors and on the contrary, benefits them unless the transaction was attended by fraud on the part of the company against the buyer but there is no allegation to that effect in the problem. What the UK law on insolvency seeks to prevent is the conduct of fraudulent acts that are deliberately made to diminish the chances of claimants to satisfy their credits either in anticipation of insolvency liquidation or during the stage itself. The liquidation process is protected, as a government policy, against property dispositions that are aimed to either advantage or disadvantage some them through statutory provisions (Anderson 2008 292), that can be found, inter alia, in the Insolvency Law 1986. The case of Re M C Bacon Ltd [1990] BCLC 324, although not necessarily reflecting the same condition as the problem at hand, nevertheless show that even transactions, superficially considered disadvantageous to the company, cannot be readily assailed as a fraudulent act out to deny creditors their potential claims against the company. In this case, the turn of events caused a company serious financial trouble but the directors decided to continue trading. In 1986, although it was already obvious that the company is insolvent a bank granted it an overdraft facility secured by a debenture. Soon thereafter, the company voluntarily went through insolvency liquidation process, and was unable to satisfy all claims of its unsecured creditors. The liquidator sued on the ground that the transaction with the bank was undervalued. The court disagreed. It held that the act of the directors was clearly motivated by their desire to keep the company going and that the grant of debenture to the bank did not amount to a parting of its assets nor did they undervalued the company’s assets because the agreement of security did not act to diminish or exhaust the company assets, which are the essence of a fraudulent transaction as prescribed under the Insolvency Law 1986. (c) The chief difference between a fraudulent trading and a wrongful trading is, in the words of author Stephen Tully, wrongful trading is “conceptually broader than fraudulent trading and seems to have been introduced in order that the provision might allow for creditors’ interests to form a basis of decision even in the absence of actual dishonesty” (Tully 2007 118). What Tully simply wants to point out is that the provision concerning fraudulent trading under section 213 of the Insolvency Law 1986 clearly imputes intent and deliberateness on the part of perpetrators, members of the company, in acting upon company assets to deceive its creditors whilst the same intent and deliberateness are absent in section 214 of the aforesaid law which specifically attaches liability to company directors, acting as such at the time of the trading in issue. Thus, the specificity of intent in the fraudulent trading provisions gives it a narrower and limited perspective vis-à-vis the broader view that the provision on wrongful trading that does not prescribe any mens rea on the part of the actor. (d) The liquidator cannot challenge the fixed charge on the ground of fraudulent trading or on the ground of wrongful act. The reason for this is that fraudulent trading requires that the director must have intentionally acted to deceive the company’s creditors, which is not evident here. Although the company was said to have been confronted with times of financial difficulties, these periods seemed intermittent and did not constitute one clear proof that the company was on the verge of insolvency. Neither do the facts of the problem indicate that the company had the creditors in mind when he executed the fixed charge. What is evident here that was also evident in the case of Re M C Bacon Ltd [1990] BCLC 324, was that the director had wanted to keep the company’s business prospects going. In that case, the court decided that the defendant was not guilty of fraud. The problem at hand is not similar to the situation in the case Re William Leitch Brother (No 1) [1932] 2 Ch 71, where the court found the defendant director guilty of fraudulent trading when he borrowed a sum of money when the company was already heavily indebted and the company was clearly heading towards insolvency. In this case, the court used the subjective test of what the director knew at the time he entered into the transaction and not what a reasonable director would have known at the time of the transaction. In this case, Dee Ltd was not evidently on the verge of insolvency at the time the fixed charge was executed. Similarly, the case would fail under the wrongful trading prohibition of the Insolvency law 1986 because there was no reasonable prospect at the time the fixed charge was executed that the company was heading for insolvency liquidation. In Re Produce Marketing Consortium Ltd [1989] 5 BCC 569, a case of wrongful trading, the directors of the company were adjudged guilty of wrongful trading because they had allowed the company to drift into insolvency for several years without doing the necessary thing to do of declaring an insolvency liquidation, in the process causing more potential damage to the company creditors than was necessary. (e) The liquidator has no ground for invalidating the execution of the floating charge in favour of Zed Bank because the act was not evidently motivated by the desire to deceive the company’s creditors in accordance with section 213 of the Insolvency Law as evidenced by the registration of the instrument with the Registrar of Companies. As was held in the case of Re M C Bacon Ltd [1990] BCLC 324, no company asset was diminished or depleted by the mere act of attaching a charge over it for the purpose of securing a debt because the company does not part with any of its assets, thus, such a situation is not tantamount to an act of fraud. Neither can the same come within the ambit of wrongful trading because the prospects of the company at the time the charge was executed cannot be said to be reasonably heading for insolvency liquidation. In the case Re Purpoint Ltd. [1991] BCLC 491, the court declared that the director was not necessarily guilty of wrongful trading simply because he allowed the company to initiate business notwithstanding that he had entertained doubts even at the outset regarding critical factors such as sufficient capitalisation and assets that were merely bought from loans or acquired on a hire basis purchase, because there was no showing that a reasonable director in his stead would have outright concluded that the company would surely flounder under such conditions. Although in the present case, the non-entry of the particulars of the charge in the company’s register is punishable under the Companies Act 2006, it does not come within the ambit of punishable acts under the insolvency act as it does not constitute fraudulent, wrongful trading or even concealment considering that the act took place more than the 12 months period. References: Anderson, H. (2008). Directors Personal Liability for Corporate Fault, Kluwer Law International. Bender, R. & Ward, K. (2002). Corporate Financial Strategy, 2nd Edition, Oxford: Butterworth-Heinemann. Kumar, R. & Sharma, V. (2006). Auditing: Principles and Practice, New Delhi: PHI Learning Pvt. Ltd. Companies Act 2006. Enterprise Act 2002. Insolvency Law 1986 (as amended). Insolvency Rules 1986. Mason, R. (2006). The Credit Controllers Desktop Guide, 3rd Edition, Thorogood Publishing. Re Company (No. 007623 of 1984) [1986] BCLC 362. Re Elgindata Ltd [1991] BCLC 959. Re M C Bacon Ltd [1990] BCLC 324. Re Purpoint Ltd. [1991] BCLC 491. Re William Leitch Brother (No 1) [1932] 2 Ch 71. Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284. Scottish Cooperative Wholesale Society Ltd v Meyer [1959] AC 324. Tully, S. (2007). Research Handbook on Corporate Legal Responsibility, UK: Edward Elgar Publishing. Read More