Company Law LA3021 Exam Paper Report 2016 ZB PDF

Preview

Summary

Download Company Law LA3021 Exam Paper Report 2016 ZB PDF

Description

Examiners’ reports 2016

Examiners’ reports 2016 LA3021 Company law – Zone B Introduction The exam paper followed the same format as in previous years. Most students complied with the ‘rubric’, answering at least two problem questions and at least one essay question. Students should refer to the Assessment Criteria to familiarise themselves with the criteria that are applied to assessed work. As in previous years, the most common weakness was a failure to answer the question asked. Too many answers – and especially those to ‘essay’ questions – read like ‘pre-prepared’ answers to a different question from the one actually asked on the exam paper. We cannot emphasise enough the importance of taking time, in the exam, to read and think about the question, working out what knowledge you have that is relevant to it and then using that knowledge to produce an essay that focuses on the actual question asked. This should always produce a better mark than regurgitating an essay that may contain more information but information which is simply irrelevant to the question asked. Note that errors in student extracts, below, were present in the original extract. All statutory references below are to the Companies Act 2006 unless you are told otherwise.

Comments on specific questions PART A Question 1 ‘A company’s articles of association provide very little protection for a minority shareholder. It is too difficult for a minority to enforce the articles, and too easy for the majority to alter them.’ Discuss. General remarks This question addresses the issue of minority shareholder protection but by asking, specifically, about the protection which the articles provide. The essay must focus on that. Simply writing out a pre-prepared essay on minority protection is insufficient. And an answer that makes no reference to the articles fails to answer the question at all. Law cases, reports and other references the examiners would expect you to use The most important statutory provision is s.33, which gives ‘contractual effect’ to the articles. The case law which interprets s.33, e.g. Foss v Harbottle, Hickman v Kent, Pender v Lushington, Rayfield v Hands, Eley v Positive Government Security Life

1

Assurance, Beattie v E and F Beattie, Salmon v Quin & Axtens. On alteration: s.21 and relevant cases e.g. Allen v Gold Reefs, Greenhalgh v Arderne Cinemas. Since the terms of the articles are also relevant if a minority tries to rely on s.994 (‘unfair prejudice’), s.994 is also worth mentioning, together with the cases which make clear that a shareholder’s chance of succeeding under s.994 does depend upon the content of the articles: see e.g. Ebrahimi v Westbourne Galleries, O'Neill v Phillips, Saul D Harrison, Re Blue Arrow, Grace v Biagioli, and Fulham FC v Richards. Common errors The most common area was a tendency to focus only on the question’s reference to ‘minority protection’ and to churn out a (probably) pre-prepared essay on that topic, without addressing at all the role the articles play in protecting a minority. A good answer to this question would… focus on the claim being made by the question: do the articles provide much protection for minorities and, in particular, is it true that it is too difficult to enforce the articles and too easy for the majority to alter them? Perhaps begin by noting that, in theory, the articles can be easily enforced under s.33. Explain how this is a ‘personal action’, that each individual shareholder is entitled to bring against either the company or even, in some cases, against fellow shareholders. Give examples of cases where this was successfully done, such as Pender, or Rayfield v Hands. All this seems to disprove the claim in the question. However, a good answer would then consider the limits on enforcement. These include the problem of ‘outsider rights’ (Eley; Beattie; Salmon) and the problem of ‘internal irregularities’ (MacDougall v Gardiner). An excellent answer would point out that the law in these areas remains uncertain and that there is a lot of academic literature addressing whether minorities can indeed use the articles to complain about breaches of ‘outsider rights’ or ‘internal irregularities’. A good answer might then address the second point made in the question, namely that it is too easy for the majority to alter the articles. It would consider s.21 and its requirement for a ‘special resolution’ and then note how easily the minority can prevent alteration. So, a minority can challenge an alteration on the ground that it is not passed ‘bona fide for the benefit of the company as a whole’. An excellent answer would consider relevant case law where the courts have applied this test – such as Allen; Greenhalgh – noting that the courts seem reluctant to uphold challenges to alterations. Other means of stopping alterations – such as invoking ‘class rights’, or using s.22 – might also be noted. Finally, although enforcing the articles under s.33 is often difficult for a minority, the articles can still be of some assistance to the minority if they try to protect themselves by suing under s.994 instead, for a breach of the articles may constitute ‘unfairly prejudicial conduct’. A good answer would note relevant cases here (Ebrahimi, O’Neill, Fulham v Richards). It would also explain how, even if a s.994 action is successful, it will usually result not in ‘enforcement’ of the articles but rather in the ‘buy-out’ of the minority. Poor answers to this question… tended, as noted above, simply to provide some discussion of how minorities protect themselves, but without mentioning the articles at all, or without considering whether the articles make a significant contribution to minority protection because of the problems over enforcement and over alteration that are mentioned in the question. Student extract The question requires to analyse how the articles of association in a company may offer protection for minority shareholders. The articles act as a constitution

2

Examiners’ reports 2016

of the company that sets out guidelines, rules, regulations and laws by which the company will be governed. Hence it may be easy to assume articles of association providing clear cut provisions for the protection of minority shareholder interests. However in practice it does not happen so. Even though directors are appointed by shareholders, they have more authority in terms of governing and altering the articles, since they will be the primary decision makers in the company. Even if directors are acting unjustly towards the minority, they can only be removed under s.168. [The essay then noted how directors might breach their duties to the company, which harms minorities and then continued.] In terms of protection of minorities, they have a better provision under ss.213 and 214 of Insolvency Act where in the account of just and equitable ground a company would be wound up. [The essay then continued to explore a fair number of cases relevant to the winding up of companies, such as Ebrahimi, Re German Date, Yenidje Tobacco, etc.] Comments on extract Overall, this was a very weak essay, which received a fail mark. The main difficulty is that it simply did not answer the question set. It read as if the student had come prepared to write on a winding up of the company, not on the enforcement of the articles and chose to do that, notwithstanding that the question was clearly about the articles. Interpretation of the question and relevance of the answer: this was very poor. The answer began in a way that suggested the writer appreciated it was about enforcement of the articles and was going to focus upon that. However, the bulk of the answer – about three-quarters of it – was not about the articles at all but about a winding up of the company. Substantive knowledge: very weak. Even in that small part of the essay which did address the effectiveness of the articles in protecting minorities, no mention was made about how the articles can be enforced (s.33). And no mention was made of the alteration of the articles, save to say that directors can alter the articles, which is simply wrong (see s.21). The knowledge of the winding up regime was better, although the wrong section number was quoted (it is s.122(1)(g), not ss.213 and 214). Use of authorities: this was better on the winding up part of the essay. Unfortunately, as noted, this was not what the question asked about. And on the issue the question did ask about – enforcement of the articles – no authorities were mentioned. Accuracy of information: as noted already, too many basic errors, e.g. suggesting directors can alter the articles. Clarity of expression: OK. Legibility: good. Question 2 ‘Attempts to improve the accountability of large companies through the appointment of more independent non-executive directors have been a failure. It would be much better to require such companies to include, on their board, directors who are chosen by a wider range of stakeholders, and whose role is to promote the interests of those stakeholders.’ Discuss.

3

General remarks This question addresses ‘accountability’ in large companies – a topic often discussed under the rubric of ‘corporate governance’. It required, however, students to look at two specific issues within this broad topic. The first is the use of non-executive directors (‘NEDs’) to improve accountability in large companies (and whether trying to do that has been ‘a failure’). The second is whether things would be better if more directors were chosen by a company’s ‘stakeholders’ and if those directors were required to promote the interests of stakeholders (rather than, say, just of shareholders). Law cases, reports and other references the examiners would expect you to use The literature explaining what NEDs are, and evaluating their effectiveness, including the UK Corporate Governance Code (2014). The literature which addresses the merits of ‘stakeholding’, including the use of stakeholder-appointed directors. No specific article or book or report would be seen as essential but to get a good mark, some reference to some of this wider literature is highly desirable. Common errors The most common error is one that has been emphasised in previous years’ examiners reports: too many students appear to have prepared a ‘standard’ essay on corporate governance, which simply recites the history of the UK Corporate Governance Code. Questions on the topic of corporate governance, such as this one, tend to be much more focused, requiring discussion of a specific aspect or issue(s) – in this case, the two issues identified under ‘general remarks’ above. A good answer to this question would… perhaps begin by noting why ‘accountability’ is seen as important and problematic in larger companies – and therefore, why ‘corporate governance’ in such companies enjoys so much attention. As Berle and Means pointed out last century, there is often a separation between ownership and control, leaving shareholders more vulnerable to misbehaviour by their executives. Moreover, because of their size and power, such companies can also significantly impact on the welfare of other stakeholders, such as employees, consumers and neighbours. A good answer might then address the first issue identified, namely whether the use of NEDs to improve accountability has really been a failure. It would explain what NEDs are, the role they are given and any evidence we have about their effectiveness. This might include both more ‘theoretical’ arguments about the strengths and weaknesses of NEDs and any empirical evidence about, say, whether they improve corporate profitability. The increased reliance on NEDs in the UK, as evidenced by the provisions of the UK Corporate Governance Code, might be noted. However, this would only be a small part of the answer. There would be no need to provide a lengthy, pre-prepared, summary of the whole history of different Codes of Practice in the UK and their recommendations about the proportion of NEDs a company should have. A good answer would then turn to the second – stakeholding – issue in the question. There is, of course, not necessarily a ‘right’ answer on this but a good answer would note relevant arguments around this question. As with any issues within the topic of corporate governance, the literature here is voluminous. A good answer would refer to some relevant literature beyond the subject guide and main textbook. Moreover, since corporate governance focuses on larger companies and policy issues that are ‘in the public eye’, a good answer might include relevant news stories reported on in the business/financial press.

4

Examiners’ reports 2016

Poor answers to this question… tended simply to set out a discussion of the history of the Combined Code/UK Corporate Governance Code, with little attempt to examine the issues of the success or failure of NEDs, or whether things would be better, or even worse, if we had a bigger dose of ‘stakeholding’ – including having some directors chosen by stakeholders. It is worth emphasising once again that questions on the exam paper are very carefully drafted, so as to focus on particular and specific, issues. Answers must address those issues; pre-prepared essays that give an answer to a different question from the one asked will get little credit. Student extract The corporate governance codes for many years have tried to implement the non-executive directors on boards in order to bring a much more independent and diverse say into the boardroom. This much was emphasised in the corporate governance debate and put forward by several reports such as Hampel Report, The Stewardship Report and implemented in the Corporate Governance Code in 2010 and 2014. Thus what was expected by this was to improve the decisions made by boards who would have many more non-executives directors (NEDs) …who can bring innovative and independent decisions from their side. Thus, the appointment of NEDs was to bring an outsourced independence who can make quality decisions on behalf of the company … but without being influenced by the day to day politics of the management. [The essay then went to note that most companies seem to comply, but not fully, with the NED requirements and then continued.] Therefore, moving forward to the idea that directors must come from a wider range of stakeholders may be a huge step in recognising stakeholder interests. Thus directors who are chosen by a range of stakeholders, such as creditors, banks, interested NGOs, environmental groups, labour representatives and suppliers, may create a vast diversity in the boardroom. Dodd argues that companies have a great social responsibility in making decisions. Having a board with such stakeholder representatives may create a much more diverse board and may also reflect in the company’s success. As Freeman describes stakeholders as groups or individuals who have an interest in the accomplishment of the company’s mission, such stakeholders may have a greater impact if they are able to be on the board and make decisions collectively. It would for sure enhance the value of the company and the stakeholders position in the social and economic structure. [The essay continued to note the potential advantages of stakeholding and then some of the problems in implementing a stakeholder approach to corporate governance, with lots more references, throughout the essay, to relevant reading.] Comments on extract Overall, this was a strong essay that achieved a good 2.1. Interpretation of the question: good. The student clearly understood what the question was asking, identified the two parts of the question and stuck to them. Relevance of the answer to the question: again, good. The student focused on what the question actually asked. The essay proceeded logically, first addressing the effectiveness of NEDs and then turning to the stakeholding issue. Substantive knowledge: very good on the stakeholding issues. On the NED issue, it began well, with a clear understanding of what has been expected of NEDs to date

5

and why they have been appointed in increasing numbers. But the essay was a bit brief and superficial in examining their effectiveness. It did not have much to say about the ‘theoretical’ concerns about whether NEDs are really able to make a difference and did not refer to any empirical evidence about whether NEDs do, in practice, seem to improve the performance of their companies. Use of literature: excellent. The student managed to communicate the fact they had read widely around the topic, understood the literature they had read and could see how it was relevant to the argument/analysis the student developed. Articulation of argument: very clear – logically structured. Accuracy of information: very good again – no obvious errors in what was written. Clarity of expression: good. Legibility: good. Question 3 ‘Many small companies are more like partnerships. In small companies, there is a close personal relationship between their shareholders, all of whom expect to manage the company, and expect the company to come to an end if the relationship breaks down. Unfortunately, UK company law does not reflect these expectations.’ Discuss. General remarks This was a question about how well UK company law deals with the different needs of small companies. This general topic has featured in past exam papers. However, this question was not simply asking students to write all they know about the differences between large and small companies. Rather, it required a focus on certain, specific attributes of small companies and whether UK company law reflects these specific attributes. Law cases, reports and other references the examiners would expect you to use The law dealing with the rights of shareholders in smaller companies and the remedies available to shareholders in such companies when their relationships have broken down. Section 994 CA 2006; s.122(1)(g) Insolvency Act 1986; case law interpreting those provisions, especially Ebrahimi v Westbourne Galleries; O’Neill v Philllips. Common errors As with other essay-style questions, the most common error was a failure to focus on, and therefore to answer, the question set. Too many students wrote all they knew about the law’s treatment of small companies, without focusing on the points being made in the question, which needed to be addressed directly. A good answer to this question would… begin by identifying the issues or ‘sub-questions’ that are raised here. These might be: first, a) are small companies at all like partnerships and, in particular, do shareholders have the ‘close relationships’, and the ‘expectations’ (participate in management, company will terminate if the relationship breaks down) that the question suggests? And secondly, b) does UK company law reflect these expectations – and if so, how exactly? A good answer might start with (a) (whether small companies are like partnerships, etc.). It might note that there are 3.5 million companies in the UK and over 99 per cent are private. Many – most – of these are very small. With so many companies, it is difficult to generalise about them all. But what we see from cases dealing with small companies is that very often such companies are more like partnerships. There is often no separation of ownership and control. All shareholders expect to be directors. Because shareholders

6

Examiners’ reports 2016

are also involved in managing the company – they are not ‘sleeping investors’ – the shareholders have a close working personal relationship. This is reflected in ‘pre-emption provisions’ in the articles, to control the risk of strangers joining the company. The term ‘quasi-partnership’ – defined in Ebrahimi - has become commonly used in UK company law to describe companies that are, legally, companies but which in reality share these attributes of a partnership. What is perhaps less clear is whether shareholders, even in a quasi-partnership, also expect the company to come to an end if the relationship between shareholders breaks down. That is a very drastic response. Perhaps shareholders expect some less destructive step to be taken – say only that some shareholders would buy out ...