A General Principle of English Law - Case Study Example

(a) It was established in Salomon v A Salomon & Co [1897 that 'The company is at law a different person altogether from the subscribers. Nor aresubscribers as members liable, in any shape or form, except to the extent and in the manner provided by the [Companies] Act.'2 It is a general principle of English law that it is not possible in the absence of agency, a trust relationship or wrongful trading to hold one person liable for the debts of another.3 However, like most common law principles and judicial interpretations it is a rebuttable presumption which must give way to a statement to the contrary 'in clear and unequivocal language'4 by Parliament. Under its equitable discretion the court may disregard the apparent form of limited liability personae, and focus on the actual substance. Hence there are decisions which have distinguished the apparent form of a limited company to show it for 'a device, and a sham, a maskto avoid recognition by the eye of equity.'5 This is sometimes referred to in the literature as 'lifting the veil of incorporation'. Commentators have attempted to categorise those decisions under various headings, such as agency, fraud, group enterprise, tort and so forth6. What is clear on a close reading of the cases which have distinguished Salomon is that the courts will only interfere - by lifting the veil of incorporation - where there is clear evidence of wrongdoing or where they are required to interfere by Statute. There is therefore a presumption that members of a limited company are only liable to the extent of any unpaid amount on nominal value of their shares unless 'wrongdoing' can be established. LJM Limited seems to have been incorporated for the sole intention of providing a vehicle for the directors Jean, Lynette and Lauren to unlawfully deprive W&H Limited, its shareholders and its members of its corporate assets and any retained profits from the international contract. There is authority to suggest that the courts will lift the veil to prevent evasion of an existing obligation7 and the court will grant an injunction/specific performance in that instance. For a short while it also seemed to be the case that the court would lift the veil where there was clear evidence of asset stripping. In Creasey v. Breachwood Motors Ltd [1992]8 proprietors of Breachwood Welwyn Ltd transferred that company's assets to the defendant company. The evidence indicated that the defendant company had been formed for the sole purpose of avoiding the payment of a substantial wrongful dismissal claim. Breachwood Welwyn Ltd was then struck off the company register following the procedure laid down in Section 652 of the Companies Act 1985; hence depriving the plaintiff of any redress. Robert Southwell QC, sitting as deputy High Court Judge, held that the plaintiff could present his claim for damages directly against the new company, Breachwood Motors Limited, as its sole purpose was to strip Breachwood Welwyn's assets and deprive Creasey of redress. The decision in Creasey was unequivocally overruled in Ord & Another v Belhaven Pubs Ltd [1998] by the Court of Appeal. Hobhouse L.J said: " Creasey v. Breachwood . represents a wrong adoption of the principle of piercing the corporate veil. Therefore, in my judgement the case of Creasey v. Breachwood should no longer be treated as authoritative". The Court of Appeal cited its previous decision in Adams v. Cape Industries plc [1990]9 where plaintiffs were not able to seek redress from a holding company when its subsidiary (the defendant) went into liquidation. The House of Lords have endorsed this stricter interpretation of Salomon more recently in Williams v. Natural Life Health Foods Ltd [1998]10. In that case a franchise company had already gone into liquidation by the time a misrepresentation was discovered. The plaintiff sought redress directly from the sole director of the former franchise company. Their Lordships held not only that the corporate veil was sacrosanct and should only be lifted in the most exceptional circumstances but that there was insufficient evidence that the plaintiff had relied on anything the director had said on behalf of the franchise company to justify making him personally liable. It is submitted that the rationale behind this stricter application of Salomon seems to be that in the cases mentioned the law already provides a remedy. The fact that a defendant company's assets are exhausted is not sufficiently good public policy to allow a plaintiff to seek redress in some other way. The facts before us indicate that LJM Limited has been incorporated simply to assist in stripping W&H Limited' assets. Shortly before W&H Limited became insolvent, three of the directors participated in a transaction which could be deemed to be detrimental to the company, its shareholders and its creditors, since they allowed LJM Limited to acquire W&H Limited's premises, equipment and all stock in trade at an undervalue. S238(4) IA 1986 defines a transaction at an undervalue where the company makes a gift or enters a transaction for no consideration or for significantly less consideration than the company itself provides. IA 1986, s240(1) and (2) allows the court to set aside such transactions which a) took place within the two years before the onset of insolvency and b) where the company was unable to pay its debts at the time or c) became unable to do so as a result of the transaction. The term onset of insolvency is defined in the Act as the commencement of the winding up: IA 1986, s240(3) Whilst we are told that the transaction took place at an undervalue we are not told whether it fell within the two year time limit and impacted on W&H Limited in the way prescribed by the IA 1986. There is no apparent requirement for the liquidator to establish any particular intention or motive on the part of the company in entering the transaction. It is unlikely that the directors involved will be able to rely on the statutory defence provided under IA 1986, s238(5) since they are unlikely to be able to convincingly establish that the W&H Limited entered into the transaction in good faith, for the purpose of carrying on its business and that there were reasonable grounds for believing it would benefit the company. In determining whether a transaction at an undervalue falls within the defence, it has been said that: 'persons should be just before they are generous and that debts must be paid before gifts can be made.'11 Under s238, IA 1986, there does not appear to be any discretion for the court to order reimbursement to the parties prejudiced by the transaction since the court is required to restore the pre-transaction position.12 Generally the property will be returned to the pool of company assets. In cases such as Creasey - specifically debt avoidance - is covered by s423(1)(a) or (c) IA 1986. to obtain redress the plaintiff in Creasey would have had to sought leave to restore the dissolved company to the register, and to bring substantive proceedings against the defendant company. Where the defendant company had no funds, s423(1)(a) or (c) IA 1986 could be used to return funds to the defendant company. On the facts it would appear that the liquidator has a strong case against LJM Limited for seeking restitution of W&H Limited's premises, equipment and all stock in trade acquired at an undervalue assuming that the transaction falls within the two year limitation period. (b) Directors owe both a fiduciary duty to an organisation and also a duty of care and skill. The fiduciary duties of directors are not defined by Statue but generally directors are required to act bona fide in the best interests of the company and not to exercise their powers for any collateral purpose.13 As we shall see Statue has made some of these duties absolute requirements. The test for establishing the 'best interests of the company' is based on the directors' subjective opinion: the court will not substitute its own opinion, unless the decision made is such that no reasonable man could consider it to be bona fide in the interests of the company.14 It has been said that the duty is owed to the company and not to shareholders or creditors, present or future.15 However there have been statutory inroads on the common law presumption under the Insolvency Act (ss212-214, ss238-240) and Schedule 1 of the Companies Directors Disqualification Act 1986. The directors' powers to dispose of company assets and any procedural requirements will be detailed in the Articles. At common law directors must not use their powers for an improper purpose; this is assessed objectively16. The directors appear to have been motivated to ensure LJM Limited obtained valuable assets as cheaply as possible, rather than to ensuring that W&H Limited obtained the best consideration for its assets. As it appears that this transaction fails the 'proper purpose' test, then the court may set the transaction aside. Directors must not place themselves in a position where there is a real possibility17 that their duty to the company and their personal financial interests conflict,18 unless authorised by the Articles of Association.19 There is no acceptable defence to the no-conflict rule nor will the court enquire into the merits of the transaction.20 Any contract made under such a breach is voidable but the company loses this right where the company delays in rescinding the contract, a bona fide purchaser at value intervenes or it is not possible to restore the pre-contract situation.21 There is also an absolute statutory duty to disclose any interest - even where the Articles permit directors to contract out of the no-conflict rule. Where a director does not make full disclosure to the board of any direct or indirect interest in a contract, transaction or arrangement, then the court can impose a fine under s317 Companies Act 1985. s317 is only concerned with disclosure and not with the validity of any contract, transaction and arrangement; that is a matter for construction of the Articles. There is also a duty under S320 CA 1985 to obtain approval by resolution in a general meeting for any substantial property transaction which involves a director or any connected person. This approval must be obtained in addition to the s317 CA 1985 duty to disclose an interest as well as any requirements in the Articles. Further, where the directors have a material interest then a note must be added to the accounts under s232 CA 1985. There are exceptions to the s320 CA 1986 requirement such as the value of the asset, intra-group transactions and disposal at winding up. A director may also enter such a transaction in his/her capacity as a member. However, on the facts none of these exceptions apply to Jean, Lynette and Lauren particularly since more than 10% of W&H Limited's assets have been stripped by the three directors. Whilst the transaction is voidable22 Jean, Lynette and Lauren remain liable to account for any gains however made and to indemnify the company for any loss or damage which results from the arrangement or transaction.23 Their common law liability will be in addition to the statutory liability.24 S322A also limits the circumstances in which a transaction of this nature can bind the company, making these transactions voidable. It may be possible for Ryan to show that he was not involved in the transaction, but certainly Jean, Lynette and Lauren will have no defence as it is clear that they have made no attempt to ensure the company's compliance with the Companies Act and they were aware of the relevant circumstances which contravened the s320 CA 1985 provision. On the facts Jean, Lynette and Lauren have made a paper profit by selling W&H Limited's property at an undervalue to LJM Limited. As directors, Jean, Lynette and Lauren have a duty not to make a profit which results from knowledge obtained from their position within W&H Limited. There is no acceptable defence to making a profit in such circumstances, such as bona fides or that W&H Limited may have benefited.25 Jean, Lynette and Lauren will be personally liable to account for the profits made. Whilst it is possible for W&H Limited in general meeting to ratify such a profit by unanimous agreement of the shareholders this is unlikely to be forthcoming given that Ryan is unaware of the transaction. Awarding the overseas contract to their new company is straight-forward misappropriation of W&H Limited's corporate opportunity, since this would be considered a company asset. Jean, Lynette and Lauren have acquired the contract for LJM Limited whilst purporting to be acting in their capacity as directors on W&H Limited's behalf.26 This was clearly a maturing business opportunity for W&H Limited, and exploiting the opportunity was their primary motivation in setting up LJM Limited; therefore it was not open for the directors to take the overseas contract on their own account.27 As such Jean, Lynette and Lauren may be deemed constructive trustees of the opportunity and in that instance following from Cook v Deeks [1916]28 the courts will not allow them to ratify depletion of the trust assets by ratification in a general meeting. Further, LJM Limited may also be liable as a constructive trustee since it knowingly participated in the directors' breach of trust to W&H Limited. In addition LJM Limited has received W&H Limited's corporate assets and appears to have notice of the breach of trust.29 LJM Limited cannot claim to be a bona fide purchaser of value in obtaining the assets. S212 IA 1986 provides a summary procedure under which an action for breach of a fiduciary duty may be commenced. Any person with sufficient interest30 may apply to the court to examine the conduct of a director31 to determine whether they have misapplied or retained or become accountable for money or other company property, or been guilty of any misfeasance or other breach of duty to the company, including negligence. Where this is established by the evidence the court can order the person to repay, restore or account for the company property or to make contribution to the assets of the company of such sum as the court thinks just. Further, if the court is satisfied that as directors Ryan, Jean, Lynette and Lauren are unfit to be concerned in the management of a company it is required to make a disqualification order against that person under the Company Directors Disqualification Act 1986 ss6-7 (CDDA 1986). S9(1) and Schedule 1 CDDA 1986 requires the court to give regard to culpability in determining whether an individual is unfit such as breaches of duty, failure to comply with procedural requirements under the Companies Act, responsibility for the insolvency, entering into transactions at an undervalue or giving voidable preferences to creditors. The section has quite draconian implications and is not lightly applied. In Re Lo-Line Electric Motors Ltd [1988]32 Vice-Chancellor Browne-Wilkinson said: 'ordinary commercial misjudgement is in itself not sufficient to justify disqualification. In the normal case, the conduct complained of must display a lack of commercial probity althoughin an extreme case of gross negligence or total incompetence disqualification could be appropriate.' There are restrictions on who may apply to have a director disqualified; the court may disqualify the directors of W&H Limited's if they are found liable for wrongful trading then the court may use its initiative to disqualify them. The maximum period of disqualification is 15 years. Once disqualified a director is automatically personally liable for debts incurred by companies operating under his/her direction during the period of disqualification.33 In conclusion, with the exception of the no-conflict duty Jean, Lynette and Lauren cannot exclude personal liability for breach of their fiduciary duty toward W&H Limited by anything contained within the Articles of Association34. The Articles can provide for waiver of the no-conflict duty - usually under Article 85. If the Articles did provide for the directors to contract out of the no-conflict duty, then they would only be able to rely on the waiver where they could show that they had followed any procedural requirements to the letter.35 On the facts before us there does not appear to be any provision in the Articles to waive the no-conflict duty; W&H Limited does not appear to have ratified the transactions; nor does there appear to have been any attempt at full disclosure in general meeting by the directors involved. While the transaction remains voidable the court can set it aside and/or require the director(s) to account for any gains made under such a transaction. Word count: 2747 (including 143 words of quotations) Bibliography Farrar, J., Furey, N and Hannigan, B. Farrar's Company Law. 3rd Edition. Butterworths. French, D. (2001). Blackstone's Statutes on Company Law. 4th Edition. Blackstone Press Limited. Pettet, B. (2005). Company Law. 2nd Edition. Longmans. Ridley, A. (2002). Company Law: Key Facts. Hodder & Stoughton. Rose, F. (2001). Company Law in a Nutshell. Sweet & Maxwell. Sealy, L. (2001). Cases and Materials in Company Law. 7th Edition. Butterworths. Cases Aberdeen Railway Co v Blaikie Brothers [1854] 1 Macq 461 Adams v. Cape Industries plc [1990] Ch 433 Boardman v Phipps [1967] 2 AC 46 Cook v Deeks [1916] 1 AC 554 Creasey v. Breachwood Motors Ltd [1992] BCC 638 Dimbley & Sons Ltd v National Union of Journalists [1984] 1 WLR 427 Freeman v Pope [1870] 5 Ch App 538 Gilford Motor Co Ltd v. Horne (1933) Ch 935 Guinness plc v Saunders [1990] 2 AC 663 Hely-Hutchinson v Brayhead Limited [1968] 1 QB 549 Island Export Finance Ltd v Umunna [1986] BCLC 460 Jones v Lipman [1962] 1 All ER 442 Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Limited [1983] Ch 258 Re Lo-Line Electric Motors Ltd [1988] Ch 477 Regal (Hastings) Limited v Gulliver [1967] 2 AC Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 Salomon v A Salomon & Co [1897] AC 22 Shuttleworth v Cox Bros & Co (Maidenhead) Limited [1927] 2 KB 9. Vatcher v Paull [1915] AC 372 Williams v. Natural Life Health Foods Ltd [1998] 2 ALL ER 577 Read More