Company report 2017 B PDF

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Examiners’ reports 2017

Examiners’ reports 2017 LA3021 Company law – Zone B Introduction The exam paper followed the same format as in previous years, save that for one question (Part A, Q4) there was a choice within the question itself. Students should refer to the Assessment Criteria to familiarise themselves with the criteria that are applied to assessed work. The best scripts tended to be those that ensured that each answer focused on the actual question being asked and the specific issues it raised. Good answers also demonstrated that the student had read around the subject and was able to apply this wider reading to the issues raised by the questions. The most common weakness was a failure to focus on the questions asked, as the specific comments below explain. Although most scripts attempted the requisite number of questions, a few scripts failed to follow the rubric of the exam paper, which required students to answer at least one question from Section A and at least two questions from Section B. Those who failed to follow the rubric usually chose to answer all questions from Section B. It is imperative that students are familiar with, and comply with, the instructions on the paper. Note that errors in student extracts, below, were present in the original extract. References to ‘CA 2006’ are to Companies Act 2006. References to IA 1986 are to the Insolvency Act 1986.

Comments on specific questions

PART A Question 1 ‘The reforms to derivative claims in Part 11 of the Companies Act 2006 have done little to improve the effectiveness of such claims.’ Discuss. General remarks This question required discussion of the new procedure for bringing derivative claims, found in Part 11 Companies Act 2006. It required students to explain what that procedure is and to explain how this ‘statutory claim’ differs from its common law predecessor. Finally, having explained the differences, the question requires a student to evaluate the impact of the changes that have been made. Have they improved the derivative claim? If so, how – in what ways? Have they failed to address outstanding problems that existed at common law?

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Law cases, reports and other references the examiners would expect you to use Relevant cases here: Prudential Assurance v Newman; Franbar Holdings v Patel; Iesini v Westrip Holdings Ltd; Kleanthous v Paphitis; Mission Capital plc v Sinclair; Wishart v Castlecroft Securities Ltd; Wallersteiner v Moir (No.2); Smith v Croft; Bhullar v Bhullar; Re Fort Gilkicker Ltd and Abouraya v Sigmund. Common errors A common error was a failure to answer the question asked. Some students simply described, in very general terms, what derivative claims are, but failed to explain in just what ways, and to what extent, the rules under Part 11 differ from the corresponding common law rules governing derivative actions. Likewise, even where students did explain changes that were made in introducing the statutory claim under Part 11, many students failed to ask whether these changes improved matters or made them worse and whether or not we can now say, in light of the changes, that the derivative claim has become effective. A good answer to this question would… explain the introduction of the statutory derivative claim in Part 11 CA 2006 to replace the previous common law action. Note the intention behind this change – improving accessibility and clarity of the law; also arguably broadening the circumstances when such claims can be brought. Note the removal of the ‘fraud’ requirement and, probably, of wrongdoer control. Note the clearer articulation of a ‘permission to continue’ requirement, in ss.262 and 263. A good answer might analyse the criteria for determining if permission is to be granted and show whether these conditions are unduly restrictive of the claimant’s ability to proceed. A good answer would offer some analysis of relevant case law, to show how the courts are interpreting and applying these criteria – whether for example they are interpreting them strictly, or more favourably towards claimants. A good answer might also try to give a sense of what proportion of claims that are started are actually given permission to continue (around 40 per cent or less). A good answer might also note continuing uncertainty within the law, especially due to the failure to replace entirely the old case law, e.g. in respect of which breaches of duty can be authorised/ratified (s.239(7)), and in respect of so-called ‘multiple’ derivative claims. Poor answers to this question… did not focus on the question asked. They spent too long talking generally around the rule in Foss, and all the supposed exceptions to Foss, before eventually turning to mention derivative claims. Poorer answers would then often give a very superficial account of the statutory action, going into little depth about the rules found in Part 11 and, worse, saying nothing about how the new rules differ from the common law rules. Finally, poorer answers usually made little attempt to evaluate the new rules or to offer an opinion about whether the new statutory action is effective. Question 2 ‘Minority shareholders cannot rely on the company’s articles of association to provide them with any protection against majority shareholders. It is unclear when the courts will enforce the articles, and it is too easy for the majority to alter the articles.’ Discuss. General remarks This question addresses the issue of minority shareholder protection but by asking, specifically, about the protection that the articles provide. The essay must focus on that. Simply writing out a pre-prepared essay on minority protection is insufficient.

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Examiners’ reports 2017

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 Relevant cases here might include some of: Hickman v Kent or Romney Marsh Sheep-Breeders' Association; Pender v Lushington; Welton v Saffery; Rayfield v Hands; Eley v Positive Government Security Life Assurance; Beattie v E and F Beattie; Salmon v Quin & Axtens; MacDougall v Gardiner; Allen v Gold Reefs of West Africa; Shuttleworth v Cox Bros; Greenhalgh v Arderne Cinemas; Citco Banking Corp NV v Pusser’s Ltd; Brown v British Abrasive Wheel Co; Sidebottom v Kershaw, Leese & Co Ltd; Dafen Tinplate Co v Llanelly Steel Co; Cumbrian Newspapers Group Ltd v Cumberland and Westmorland Herald Newspaper and Printing Co Ltd. Since the articles can also be relevant if a minority relies on s.994, s.994 is also worth mentioning, including cases that 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, Re Saul D Harrison, Re Blue Arrow, Grace v Biagioli and Fulham FC v Richards. Common errors The most common error was a tendency to focus only on the question’s reference to ‘minority protection’, and to churn out a (possibly) pre-prepared essay on that topic, without addressing the role the articles play in protecting a minority and, specifically, whether it is true that they cannot be enforced and can too easily be altered. A good answer to this question would… note the continuing uncertainty over key aspects of the ‘statutory contract’, created by s.33 CA 2006. One area of doubt/controversy concerns the enforcement of ‘outsider rights’. A good answer would discuss some of the relevant case law that illustrates the lack of consistency in the cases, and might note academic attempts to explain or resolve such inconsistencies. A second area of uncertainty concerns the courts’ refusal, sometimes, to enforce those breaches of duty which are labelled as ‘mere internal irregularities’, where the breach of the articles is said to be only a wrong to the company to be resolved by the operation of majority rule. Again, a good answer would note the apparently conflicting case law, such as Pender, and MacDougall, and again might note academic attempts to resolve this controversy. On the alteration point, a good answer would analyse how easily the majority can alter the articles. It would reference s.21 and analyse the judicial policing of alterations through the requirement that they be passed ‘bona fide for benefit of the company as a whole’. A good answer would explore the judicial construction and application of this test, through the relevant case law. It is generally applied as a subjective test and the requirement of ‘benefit of the company as a whole’ has been construed as a rather easily satisfied requirement to avoid discrimination. A good answer might note a stricter approach in ‘expropriation’ cases, as well as the ability of well-advised minorities to prevent future alteration through the use of s.22 CA 2006 or the creation of ‘class rights’. 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), and explain how a successful s.994 action usually results not in ‘enforcement’ of the articles (but in a ‘buyout’).

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Poor answers to this question… tended to discuss minority protection generally but saying little specifically about the articles, or whether the articles do make a significant contribution to minority protection. Student extract The question suggests that minorities are not well protected by a company’s articles of association, due to uncertainties of enforcement and the ease of alteration. The suggestion has weight, considering enforcing the s.33 CA 2006 contract is plagued by three unresolved hurdles: whether a member may enforce against another member; whether shareholders can enforce as an insider and whether it will be considered a personal right. As for alterations, the courts have interpreted the test of alteration to include a good faith requirement but case law has shown us that challenges on such bona fides by the minority has been rarely successful. Give that statutory protection of minorities have demonstrated to be difficult to raise, the articles should be strengthened in terms of enforcement and alteration. It is unsurprising that Lord Wedderburn in his 1957 article on Foss v Harbottle, laments the protection given to minority shareholders. S.33 provides that the company’s constitution binds the company and the members as covenants … however in a situation where the member wishes to sue another member to enforce his s.33 rights inter se, the position is extremely unclear. Hickman v Kent provides that the literal interpretation of s.33 would mean there is no direct right of enforcing s.33 against shareholders by shareholders. But, Rayfield v Hands has held that s.33 may bind shareholders inter se. This is supported by Prentice who prefers this route of enforcement in the interests of avoiding multiplicity of actions. The Company Law Reform Steering Group, in Developing the Framework 2002, has recommended for the confusion in the law to be clarified to allow for greater protection for minorities. However, s.33 merely reproduces its counterpart in CA 1985. … The second uncertainty which often faces shareholders is whether the right in question will be interpreted as an insider or an outsider right. This confusion has spawned a long line of academic dissent and attempts of reconciliation, leaving minorities unclear as to what their rights actually are. The starting point is Ely v Positive Government, which defines an inside right as a right common to all. Hence, individual rights would be excluded from s.33 enforcement. However, in Salmon v Quin and Axtens, the courts held that a right of a director could be enforced if it was framed in a way to require the courts to enforce ‘a shareholder’s right tangentially affecting his right as a director’. This line of argument has been later used in Beattie causing confusion to the neat way of discerning an outsider or insider’s right in Ely. [The essay then looked at the academic debate around the insider/outsider rights issue, and the work of the CLRSG. It continued with a detailed look at the personal rights/mere internal irregularities uncertainty and finally provided a detailed examination of the case law dealing with alterations to the articles.] Comments on extract Interpretation of the question: excellent – the student understood precisely what they were being asked to discuss.

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Relevance of the answer to the question: again, excellent. The answer focused clearly on the question asked and the issues it raised. Substantive knowledge: also excellent. The student had an extremely detailed and accurate knowledge of the different issues raised by reliance on the articles as a source of minority protection. The knowledge covered not only the underlying problems but also the case law that adds to the confusion in this area and academic commentary. Use of authorities: excellent: the student cited all the most relevant authorities and generally showed a good understanding of the decisions reached by the courts, and the significance of those decisions for the development of the law. Articulation of argument: it flowed clearly and was very well structured and coherent. The division/structure of the essay was logical. It was clear what the student was arguing, and the material was well ordered and assembled to support the student’s argument. A good conclusion emphasised and clarified the argument that had been put forward. Accuracy of information: generally, very good. Clarity of expression: excellent – very clearly explained. Legibility: good. Overall, the essay got a clear first. Question 3 ‘The rules and principles set out in the UK Corporate Governance Code are well designed to improve accountability in listed companies. However, their enforcement is a major problem. Such rules and principles should therefore be codified in a new Companies Act, and each shareholder should be given a personal right to enforce those rules and principles against any listed company in which they own shares.’ Discuss. General remarks This question addressed the UK corporate governance regime for large companies. It required, however, a discussion of a specific issue with regard to that regime, namely the effectiveness of the UK Corporate Governance Code. It asked whether it is true that the content of the Code is well designed but its enforcement is problematic. It then required students to discuss a possible reform, based on codifying the Code into a statute, and giving each shareholder a personal right to enforce its provisions. Students had to address these different issues raised by the question. An answer that merely wrote generally about the history of the Code, without addressing the specific points raised – the quality of its content, the ease with which it can be enforced, whether the proposed reform was attractive – would not be answering the question asked. There is no ‘right answer’ to the issues raised by the question. One very good answer might agree strongly with the suggestions made in the question, while an equally good answer might just as strongly disagree with them. But the important point is that any good answer would focus on them and address them specifically. Law cases, reports and other references the examiners would expect you to use Students need to refer to the UK Corporate Governance Code (2016). They would need to refer to relevant literature that has evaluated that Code, and especially its

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‘comply or explain’ mechanism, and any evidence of the extent to which companies are forced to comply with its provisions. Refer also to the Stewardship Code (2012). 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 and such students seem determined to regurgitate that answer regardless of what the question actually asks. 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. A good answer to this question would… describe the UK Corporate Governance Code, and explain, briefly, the rules/principles it contains. It would evaluate whether these are indeed well designed to promote accountability, perhaps focusing upon the rules on board composition, board structure, and the role of boards/NEDs. It might then consider what mechanisms exist to enforce the Code, focusing on the comply or explain system that underpins it, and the extent to which this encourages companies to comply. It might then address the suggestion of codification, backed by a personal right to enforce. On codification, it might consider what might be gained thereby – say in terms of greater specificity in the drafting of rules, democratic input/legitimacy, etc. – and what might be lost, in terms of lack of flexibility, speed of updating, box ticking and so on. Giving shareholders a personal right to enforce might increase enforcement but replaces the sentiment of the market with individual shareholder preferences and also loses the ‘democracy’ of majority rule. Why should a single shareholder be allowed to enforce the Code, if a majority of shareholders are happy for the company not to follow one of its provisions? 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 explain what the rules and principles making up the Code say, why those rules and principles were chosen, whether they are well designed to improve accountability in listed companies. Nor would they address specifically the enforcement of the Code and its ‘comply or explain’ mechanism, or offer any analysis of whether this works well or badly, as the question suggests. Finally, they often failed to consider the suggestion in the question regarding codifying the Code in a statute and giving each shareholder a personal right to enforce those rules. Student extract The UK Corporate Governance Code, published by the FRC, an independent regulator for corporate reporting and governance, is the Code of Best Practice applying to public companies listed on the Stock Exchange. This essay will consider the Code’s origin, its principles and its self-regulatory system to demonstrate how far it encourages and enforces good corporate governance. [There then followed a brief summary of the history of the Code and then continued]: The Code is an example of ‘soft law’. It does have the force of a statue, but works on a comply or explain basis. Listed companies are obliged to make a compliance statement and to explain to shareholders if they are noncompliant and why. The Code indicates best practice of corporate governance in a number of areas, including – Leadership, accountability, effectiveness, remuneration, relations with shareholders – each consisting of

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a main and supporting principles. The code will be explored to demonstrate how it encourages and enforces good corporate governance. [The essay then went through a selection of the Code’s rules or principles, explaining their content and their significance. It then continued:] However admirable its principles, the Code is valuable only if it enforces good corporate governance, which is doubted, as there are no penalties for failure to comply with its provisions. For example, companies such as Marks and Spencer plc and Stuart Rose allowed the same person to hold chief executive and Chairman roles. Nevertheless, it seems that the ‘comply or explain’ requirements impose just enough pressure and directors are aware that, if the Code is seen to be failing, more rigid regulations might well take its place. The self-regulatory system has the benefit of flexibility, both by allowing alterations to be made to the Code...