Company law problem question on Director\'s duties PDF

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199033818COMPANY LAW SUMMATIVECOURSEWORK 2020/WORD COUNT: 2384Bibliography Aberdeen Railway Company v. Blaikie (1853), I, MacQ., 461, Bamford v Bamford [1970], aff’d [1970] Ch 212, CA Bray v Ford [1896] AC 44, HL Companies Act 2006 D’Jan of London Ltd, Re [1994] 1 BCLC 561 Hogg v Cramphorn [1967] Ch...

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199033818 COMPANY LAW SUMMATIVE COURSEWORK 2020/21 WORD COUNT: 2384

Bibliography 1. Aberdeen Railway Company v. Blaikie (1853), I, MacQ., 461, 2. Bamford v Bamford [1970], aff’d [1970] Ch 212, CA 3. Bray v Ford [1896] AC 44, HL 4. Companies Act 2006 5. D’Jan of London Ltd, Re [1994] 1 BCLC 561 6. Hogg v Cramphorn [1967] Ch 254. 7. Howard Smith v Ampol Petroleum Ltd [1974] AC 821, PC 8. Lexi Holdings plc (in admin) v Luqman [2009] EWCA Civ 117 9. Norman v Theodore Goddard [1991] BCLC 1028 10. Percival v Wright [1902] 2 Ch 421 11. Piercy v S Mills & Co Ltd [1920] 1 Ch 77 12. Queensland Mines Ltd v Hudson (1978) 52 ALJR 399, PC 13. Re Smith & Fawcett Ltd, [1942] Ch 304, CA 14. Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378, HL 15. Teck Corporation v Millar [1973] 33 DLR (3d) 288, BC Sup Ct 16. Terry v Watchstone Ltd [2018] EWHC 3082 (Comm) 17. West Mercia Safetywear Ltd v Dodd [1988] BCLC 250, CA.

AMBI Pvt Ltd, a British company, manufactures solar energy equipment. It supplies its products in numerous countries. Percy, its Finance director is authorised to negotiate a loan with a bank. Consequently, he approached GBX bank for the loan. Percy’s wife, Gina, is the chief executive officer of GBX bank. The bank loans AMBI Pvt Ltd £20 million at an exorbitant interest rate. In return for securing the transaction, Gina is paid a bonus of £550 000. Subsequently, AMBI Pvt Ltd decides to expand into South Africa, a country with a strong demand for solar energy. AMBI decides to operate from Sandton, Johannesburg. Mary, AMBI’s human resources director has a lavish property worth £2 million in Sandton, Johannesburg. She sells the property to AMBI for £2 million. In a different development, Percy is made aware by an anonymous email, of financial impropriety in AMBI’s corporate hospitality department. It was alleged that £5 million of the company’s funds were spent on team building exercises involving baccarat games and champagne dinners at high end casinos. Percy, who is on a 3 week holiday in Tonga decides not to interrupt his break. By the time he investigates the allegation, a further £15 million has been spent on shady transactions. Subsequently, AMBI Pvt Ltd faces serious financial problems. GMX Ltd tries to take it over. The directors of AMBI Ltd resolve to issue new shares which can be used to vote against the takeover. Advise AMBI Pvt Ltd.

The case facts have identified four issues where there are possible breaches by Pierre, Mary and the directors of AMBI Pvt Ltd., against the Director’s Duties which have been codified in the Companies’ Act 2006. These duties are outlined in Section 170 – 177 of the Act, and are based on common law and equitable principles which have effect on their responsibilities towards the company, whom they owe their duty to under the general rule 1. In examining these issues, the case laws relevant to director’s duties prior to the codification is still useful and has effect in application on the case facts. Subsequently, if the directors are found to be in breach of their general duties, they are entitled to provide remedies under Section 178, which are the same as to corresponding common law rules or the equitable principles applied.

The first issue identified is whether the profit received by Gina, Percy’s wife amounts to an interest which must be declared. If so, it would be a breach of Section 177 2, the duty of declaration to other directors when one director is in any way directly or indirectly interested in a proposed transaction or arrangement with the company3, and must be made before the company enters into the proposed transaction or arrangement 4. Despite the absence of any personal rights under Percy in the contract, the tangible benefit given to Gina amounts to a concept of ‘more money in the marriage’. Hence, it is evident that through her direct interest in the agreement, it inevitably creates an indirect interest for Percy since she is considered as a person connected to the director as a member of his family 5. Due to Percy’s awareness of the interest 6 and the reasonable likeliness of its confliction between the parties, there is no defence for his breach especially if it were unbeknownst to the other directors 7. Thus, since Percy did not declare his indirect interest in the arrangement beforehand, he is in breach of Section 177.

1 Percival v Wright [1902] 2 Ch 421. 2 Companies Act 2006, s 177. 3 Companies Act 2006, s 177(1). 4 Companies Act 2006, s 177(4). 5Companies Act 2006, s 252(a). 6 Companies Act 2006, s 177(5). 7 Companies Act 2006, s 177(6)(a) and (b).

Thereafter, it creates a possible conflict of interest, which would breach of Section 175 8, that is the duty to avoid conflicts of a director’s personal interest with the interest of the company. In Regal (Hastings) Ltd v Gulliver9, it was ruled that regardless of whether a director was acting bona fide, as long as there was a personal profit was made, they are liable for breaching Section 175 of the CA 2006. Although it was Gina who received the profit, Lord Herschell stated in Bray v Ford10, that a fiduciary is “not allowed to put himself in a position where his interest and duty conflict”. Clearly, it is not unbeknown to him of the possible conflict of interest arising when carrying out the negotiation with his wife’s company. Thus, it is against his fiduciary duty for not avoiding the said situation as it is a “ rule of universal application” in protecting the company’s interest11.

However, under Section 175, there is an exception to this breach if the matter was authorised by the other directors. As a private company, if the company’s constitutions allow such authorisation and the matter is proposed to the directors, the duty will not have been breached 12(Section 175(5)). This will only be effective when the meeting to discuss the authorisation has met its quorum which excludes the director in breach, as well as whether the matter would have been agreed to even without the director’s vote, since their involvement cannot be used in the ratification of their own breach13. This would be sufficient even without shareholder’s approval as applied in Queensland Mines Ltd v Hudson14. According to the case facts, the company had authorised him to carry out the negotiation, however it is noteworthy that the authorisation must comply with Section 175 in consideration of any declared interests as stated in Section 180(1)(a) and (b)15. Furthermore, authorisation of members will not apply if the matter agreed upon is prejudicial to the interests of creditors16, which here, is apparent by the exorbitant interest rate set

8 Companies Act 2006, s 175. 9 [1942] 1 All ER 378, HL. 10 [1896] AC 44, HL 11 Aberdeen Railway Company v. Blaikie (1853), I, MacQ., 461, per Lord Cranworth LC. 12 Companies Act 2006, s 175(5). 13 Companies Act 2006, s 175(6). 14 Companies Act 2006, s 175 which has been applied in Queensland Mines Ltd v Hudson (1978) 52 ALJR 399, PC. 15 Companies Act 2006. 16 West Mercia Safetywear Ltd v Dodd [1988] BCLC 250, CA.

by Gina. Even so, it is important to note that this section does not apply to conflicts of interest which arise to a transaction or arrangement with the company17. The remedy for Percy’s breach against Section 175 and 177 can be found under Section 178 18 which applies the corresponding common law rule or equitable principles. Firstly, the contract for the loan granted by GBX Bank can be rescinded by AMBI Pvt Ltd because the exorbitant interest rate is not beneficial for the company. Therefore, AMBI Pvt Ltd should have the intention to set the contract aside. Another remedy would be for Gina to account for the profit she received in her bonus which arose from the conflict of interest in this arrangement. Fortunately, the breach can be ratified by shareholders through ordinary resolution if it is proven beneficial to the company, and Gina would still have to account for the profits made, because regardless of whether the company has made or loss or not, as long as there was a profit made, there is a breach of duty19. Thus, AMBI Pvt Ltd can choose to either rescind or ratify the contract with GBX Bank. Nonetheless, Gina will still have to account for the bonus of £550, 000 which she received.

Next, there is an issue as to whether the property Mary sold to AMBI Pvt Ltd has been approved by shareholders since it holds a substantial value. This falls under Section 190 20 where an arrangement between the company and one of its directors requires the consent of shareholders by ordinary resolution during a general meeting, when the transaction of a non-cash asset being bought or sold by the company is deemed ‘substantial’, that is, a value over £100,000 21. It is evident here that Mary’s property is considered ‘substantial’ by its selling price of £2 million. Withal, it was both a property which she had interest in and was in existence at the time the transaction took place, as ruled in Terry v Watchstone Ltd22. Assuming that there was no shareholder approval, she would be in breach of Section 190. However, it can be argued that since shareholder approval is vital in examining is benefits for AMBI Pvt Ltd, it is safe to say that Mary was acting bona fide in the arrangement as she sold the property at its fair market 17 Companies Act 2006, s 175(3). 18 Companies Act 2006. 19 Regal (Hastings) Ltd. V Gulliver [1967] 2 AC 134. 20 Companies Act 2006. 21 Companies Act 2006, s 190(a) – (b) 22 [2018] EWHC 3082 (Comm).

value considering the company’s demand for property in South Africa when the transaction took place. Considering the said facts, the remedy for this issue is to void the contract at the company’s instance and have Mary liable for the sales made. However, since Mary had clearly “acted honestly and reasonably”23 by selling her property at a fair market value, it shows that she has taken into regard to the circumstances of the situation. Hence, members of AMBI Pvt Ltd should consider ratifying the transaction in retrospect24 as it was made in the company’s best interest considering their wish to expand in that area. Thus, under Section 1157 of the CA 2006, Mary is not in breach of Section 190.

Subsequently, the next issue concerns Percy eluding the alleged misappropriation of funds, which is a possible breach of Section 17425 – the duty to exercise reasonable care, skill and diligence when carrying out the functions of a director. This composite obligation is measured by a dually objective and subjective test, that is, by examining what a reasonably diligent director would have done in such circumstances and whether the involved director’s actions were reasonable considering their general knowledge, skill and experience as a director 26, which was developed by Hoffman LJ in the cases of Norman v Theodore27and Re D’Jan28. In applying this dually objective and subjective test to the case facts, Percy’s choice to ignore the allegations he was informed of is unreasonably diligent as a Finance director who should be concerned of any misappropriations and issues involving the company’s funds. In Lexi Holdings29, two directors were held liable for not informing their auditors regarding the misappropriations happening which they were aware of, causing the company to fall insolvent. Similarly, Percy’s failure to inform the company and investigate the matter has led to AMBI Pvt Ltd losing a total of £20 million. Thus, considering his relevant knowledge, skills as the Finance Director, prioritizing his holiday over the matter does not comply with Section 115(7) as a defence as it is not a reasonable nor honest action30. The appropriate remedy for this breach is available in Section 23 Companies Act 2006, s 1157(1). 24 Companies Act 2006, s 196. 25 Companies Act 2006. 26 Companies Act 2006, s 174(2)(a) and (b). 27 Norman v Theodore Goddard [1991] BCLC 1028. 28 D’Jan of London Ltd, Re [1994] 1 BCLC 561. 29 Lexi Holdings plc (in admin) v Luqman [2009] EWCA Civ 117. 30 D’Jan of London Ltd, Re [1994] 1 BCLC 561.

178(1) under claims for damages and compensation. It is worth mentioning that remedies under Section 178(2) is not applicable here due to the Section’s different nature as a fiduciary duty. Therefore, Percy will have to pay £20 million for the loss suffered due to his incompetence for breaching Section 174.

Additionally, Percy is in a possible breach of Section 172 of the CA 2006 – the duty to act in good faith to promote the success of the company and the members of the company, while having regard to other stakeholders. Liability is proven if the directors were found by courts to not be acting bona fide in the interests of the company 31. However, it is difficult to prove liability as it is a fully subjective test. Hence, it is preferable that the claim is made under Section 174.

Lastly, issuing new shares to tackle the takeover by GMX is a feasible breach of Section 171 of the CA 2006 – the duty for directors to act in accordance to the company’s constitution and only exercise their powers for purposes they are conferred. The ‘substantial purpose’ test derived from Howard Smith v Ampol Petroleum Ltd32 determines whether the substantial purpose of the allotment of shares was proper and was exercised for a proper purpose. Here, the director’s consideration of the company’s interest is open to review by courts. In applying the substantial purpose test to the case facts, AMBI Pvt Ltd allotted new shares to augment voting rights against the takeover bid, which is considered improper as it affects the constitutional rights of the company’s members33. Though their motives were bona fide in protecting the company from a takeover, but this does not act as a defence because the sole purpose for issuing new shares should only be to raise capital for the company34. In Teck Corporation v Miller35, the issue of shares was considered to be for proper purposes since they intended to prevent having damage caused to the company by a takeover. Though motive was ruled to be irrelevant in Hogg v Cramphorn36, if proven that it was not an abuse of power but protection for the interests of the 31 Re Smith & Fawcett Ltd, [1942] Ch 304, CA. 32 [1974] AC 821, PC. 33 Howard Smith v Ampol Petroleum Ltd [1974] AC 821, PC. 34 Re Smith & Fawcett Ltd, [1942] Ch 304, CA. 35 [1973] 33 DLR (3d) 288, BC Sup Ct. 36 Hogg v Cramphorn [1967] Ch 254.

company then it is deemed a proper use of director’s power. Unlike in Bamford37, the allotment of shares to stall a takeover which was potentially beneficial was ruled improper for obstructing a prospective opportunity for the company. Similarly, knowing that AMBI Pvt Ltd is suffering financial difficulties, stalling the takeover is considered improper as it could prove beneficial to the company, especially in raising capital. However, if they are deemed to have acted “honestly and reasonably” under section 115738 by courts, directors can have their liability reduced, which is unlikely due to the similarity of case facts with Bamford39. Hence, proving that the directors of AMBI Pvt Ltd have breached their duty under section 171 of the CA 2006. Nonetheless, to remedy this problem, section 178 allows members to resolution to set aside the shares, which is possible if those who bought the shares are noticed of the breach. This was held in Piercy v Mills40 where courts set aside the shares issued for improper purpose.

Summarizing the evaluation above, Percy is likely to be in breach of sections 174, 175 and 177 of the CA 2006 since he did not declare his interest in the loan interest which conflicted with the company. Additionally, he is negligent for not informing of the misappropriation of funds which led to the company losing £20 million, considering his position as the Finance director. Subsequently, the directors of AMBI Pvt Ltd are in breach of section 171 of the CA 2006 for exercising their power for an improper purpose when they issued new shares to stall a takeover bid. Lastly, Mary is not in breach, specifically under section 190 of the CA 2006 as it is evident that the transaction was done bona fide as she sold her property which was simultaneously in demand by the company and at a fair market value.

37 Bamford v Bamford [1970], aff’d [1970] Ch 212, CA. 38 Companies Act 2006. 39 Bamford v Bamford [1970], aff’d [1970] Ch 212, CA. 40 Piercy v S Mills & Co Ltd [1920] 1 Ch 77.

FEEDBACK You managed to identify the main breaches (but note almost all students did in this time around). At the same time, I have the following concerns on your substantive discussion. Loan - Note whether it is a good idea to argue ss 175 & 177 at the same time, especially given you are well aware of 175(3). Substantial property transaction - Here you will also need to consider s 177.

Financial impropriety - Look fine. Share issuance - Also look fine. Sturcture - it will be even better if you use some headings. But the current structure is clear enough.

Overall - it is a good response to the question, especially your consideration of remedies looks well thought out when compared to most of other essays....