Company Law - Freshfoods Limited - Essay Example

Background Business incorporation can limit the liability of those behind the company but not when there is fraud behind the registration. The facts: Vitality plc is a manufacturer of health foods with a wholly owned subsidiary known as Organics Limited. The directors of the company are the same and the profits from Organics Limited are channelled to the directors in the form of a yearly management charge to Vitality Limited. Another company, Freshfoods Limited gets into an agreement with Organics Limited to supply Organics with raw materials for manufacturing vitamins for the vegetarian market. Freshfoods knows from the letterhead that Organics is a subsidiary of Vitality plc. In hopes of long-term trade, Freshfoods sells its products at very low prices, a loss that the company has been willing to bear for four months, knowing that once the relationship is established it can move beyond this loss leader of an introductory price. The four deliveries that Freshfoods has made to Organics over a period of four months have not been paid. As Freshfoods later finds out, three months earlier, Organics Limited stopped trading and all the products ostensibly received by the company was channelled to Wellbeing Limited, a newly incorporated company that is also a subsidiary of Vitality plc. As Freshfoods finds out, Organics has very few assets and Vitality is a secured creditor of Organics Limited. Advice to Freshfoods The core of company law is the notion of the separate personality of the company. Any such registered company has rights and obligations. As far back as the 19th century when the Joint Stock Companies Act 1844 was established there was an attempt to forestall the possibility against fraud “by insisting on full publicity and provided a Registrar of Companies to hold the public documents provided by the companies” (Lowry and Dignam 2003 15). This earlier statute, however, held members of the company liable for the debts of the company. In the Limited Liability Act 1855 the provision was made to explicitly limit the liability of the members or shareholders of a company, so as long as the company itself has money it can be sued to make good on its liabilities but “once its assets are exhausted the creditors cannot go after the members’ assets. Remember that the legal personality of the members and the company are separate. The corporate assets belong to the company and the members’ assets are their own” (Lowry and Dignam 2003 16). Since companies are not human, company law has made provision for the human element, that is, the humans who actually run the company have been provided for through agency principles and other statutory obligations and rights. Fraudulent and wrongful trading It appears that Vitality plc is hiding behind Organics to skim off money. Even though the directors of Vitality knew that Organics was not in a position to make good on its transactions and purchases from Freshfoods they went ahead anyway and took delivery. Knowing that Organics has no assets to speak of, it was “clear” to the directors that Freshfoods could not go after Organics for payment.The court is the final arbiter of whether Vitality can be held responsible and one can get a clue of the court’s thinking by looking at section 213 of the Insolvency Act 1986, which states: 213. Fraudulent trading (1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect. (2) The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company's assets as the court thinks proper. (Insolvency Act http://www.insolvencyhelpline.co.uk/insolvency-act/p04c10_1.htm#213). In simple terms, Freshfoods can sue Organic’s parent company which is really behind the perpetration of the wrongful trading. This case is actionable as a criminal offence (section 458 of the Companies Act 1985) as well as a civil offence (s. 213 of the Insolvency Act). It would have to be proven to a court, however, that the directors of Vitality plc were not acting in an honest way. Proving that the directors were not acting honestly can be difficult but it, “is wider than wrongful trading…in that it is available against ‘any persons who were knowingly parties to the carrying on of the business’ of the company” (Dine 2005 326). Instituting criminal proceedings for “fraudulent trading outside the insolvency context” (Dine 2005 326) can be a good idea to force Vitality plc to make good on what it owes Freshfoods. The court can use its discretion to lift the veil and expose members of an organization. If as section 212 of the Insolvency Act 1986 holds, it is found that the management of a company “misapplied or retained, or became accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company” (Dine 2005 326). At the very least, not informing Freshfoods that the company that they had responsibility for, had winded up, and redirecting products sent to Organics to the new company shows an intent to defraud or to escape responsibility for payment. But Freshfoods Limited also has the possibility of using the much narrower remedy of wrongful trading. “In essence it consists of continuing to trade when the company is known to be insolvent. It may, if successful, lead to the same order for a contribution as an order under the fraudulent trading provisions. As with fraudulent trading, an application may only be made by the liquidator” (Dine 2005 326). To make matters clear, once a company has gone into insolvent liquidation, as seems to be the case with Organics, wrongful trading can be applied against a person or those people who prior to the liquidation was a member or director of the company and was aware or ought to have been aware that the company would not escape the insolvency and yet continued to trade. “But the declaration is not to be made if the court is satisfied that the person concerned thereupon took every step with a view to minimising the potential loss to the company’s creditors as, on the assumption that he knew there was no reasonable prospect of avoiding insolvent liquidation, he ought to have taken” (Davies 2003 196). If the directors of Vitality plc had notified Freshfoods three months ago regarding the financial position of Organics Limited they may have saved themselves from the possibility of having to bear the consequences for their subsidiary. What the court would seek to address are the following: Should the director have realised there was no reasonable prospect of the company avoiding insolvent liquidation and, once that stage has been reached, did the director take all the steps he or she ought to have taken to minimise the loss to the company’s creditors, especially, no doubt, by seeking to have the company cease trading? Both these judgments will depend heavily on the facts of particular cases: what sort of company was involved, what were the functions assigned to or discharged by the director in question, what outside advice was taken and what was its content? (Davies 2003 197) The case of R v Grantham [1984] points to a strong possibility that Freshfoods can get redress. This is because in that case, the court upheld a direction made to the jury that they could convict a person of fraudulent dealing if a person took part in running a business “if they were satisfied that he had helped to obtain credit knowing that there was no good reason for thinking that funds would become available to pay the debts when they became due or shortly thereafter” (Davies 2003 196). Even if some of the members involved in Vitality plc were to present themselves merely as shadow directors, this would not take away the responsibility they. It is very clear from section 214 of the Insolvency Act that shadow directors, which include people other than professional advisers who may give advice to the directors, can also be implicated. This is significant because the directors of Vitality plc may have hired someone else to manage Organics and thus they could claim that they were not responsible for ordering the products from Freshfoods Limited. It must be noted that “The degree of control exercised by parent companies may vary from detailed day-to-day control to virtual independence, with many variations in between In the case Re Produce Marketing Consortuim Ltd. [1989] 1 W.L.R. 745 the does not excuse a director or shadow director who fails to carry out his or her duties. It would not be enough for such a person to make declarations of honesty. But the effect of s. 214, at least in the case of Produce Marketing Consortium was compensatory rather than punitive. At this point, Freshfoods is concerned about recovering its funds, so the main thrust is to get back such money. Produce Marketing Consortium is significant in that it was the first reported case that was decided using the Insolvency Act 1986, s 214, which deals with wrongful trading. In that case, David and Murphy, the two directors had not continued to ply their importing trade in fruit importation even when it had become clear at some point that they could not avoid becoming insolvent. The presiding judge, Knox J, held them liable for wrongful trading, noting in his summation the following: “There is no question but that they were directors at all times and that PMC [the company] has gone into insolvent liquidation. The issue is whether at some time after 27 April 1986 and before 2 October 1987, when it went into insolvent liquidation, they knew or ought to have concluded that there was no reasonable prospect that PMC would avoid going into insolvent liquidation” (Sealy 2001 621). It may be found that likewise, the directors of Vitality plc may indeed have known about the status of Organics Ltd prior to its winding down and that they may indeed have deliberately sought to go through the winding down process in order to defraud Freshfoods and possibly some other companies. Freshfoods has a reasonably good prospect of being able to recover positive judgment if it takes action against Vitality plc as the parent company of Organics Limited. Bibliography Davies, Paul L. 2003. Gower and Davies’ Principles of Modern Company Law, UK: Thomson – Sweet and Maxwell. Dine, Janet. Company Law. 5th edition. UK: Palgrave Macmillan. Lowry, John and Dignam, Alan. 2003. Company Law, London, UK: LexisNexis Butterworths. “Insolvency Act.” http://www.insolvencyhelpline.co.uk/insolvency-act/p04c10_1.htm#213 (March 13, 2007) Sealy, LS. 2001. Cases and Materials in Company Law, Seventh edition. UK: LexisNexisButterworths. Read More