Company report 2018 A PDF

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Examiners’ reports 2018

Examiners’ reports 2018 LA3021 Company law – Zone A Introduction The exam paper followed the same format as in previous years. Students should refer to the Assessment Criteria to familiarise themselves with the criteria that are applied to assessed work. As in past years, the best scripts always focused on the actual questions being asked, and the specific issues they 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 stick to the question, as the specific comments below explain. Compared with last year, fewer students failed to follow the rubric of the exam paper, which required candidates to answer at least one question from Part A, and at least two questions from Part B. It is imperative that students are familiar, and comply, with the instructions on the paper, but good to see that almost all students did so. 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 ‘Insofar as the non-executive directors of listed companies are concerned, the provisions of the UK Corporate Governance Code are much more effective than section 174 of the Companies Act 2006 in ensuring that such directors diligently and carefully perform their proper role in the company.’ Discuss. General remarks This question relates to Chapter 15 of the module guide. It required a comparison between two areas of regulation which both try to ensure that non-executive directors work hard (diligently) and competently in the way they run the company. These two areas are, first, the UK Corporate Governance Code and, second, s.174 CA 2006. Both needed to be discussed, and some relevant comparisons made.

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Law cases, reports and other references the examiners would expect you to use UK Corporate Governance Code (2016 version). Case law on s.174, such as Re City Equitable Fire Insurance Co. Ltd (1925) Ch. 407; Lexi Holdings (in liq) v Luqman [2009] 2 BCLC 1; Regentcrest plc v Cohen (2001) 2 BCLC 319. Common errors The most common error was a failure to stick to the question asked. As in previous years, too many students still seemed to have prepared a ‘standard’ essay on the history of the UK Corporate Governance Code, and were determined to regurgitate that essay regardless of what the question actually asked. 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 lot of answers, as a result, had very little to say about the director’s duty of care and skill under s.174, and even many better answers, that did mention s.174, just described what it said, but made no attempt to compare that provision’s effectiveness with the effectiveness of the Code. A good answer to this question would… explain how the UK Corporate Governance Code addresses non-executive directors – especially in terms of the proportion of such directors on boards, and in terms of the role such directors are to play, their monitoring of executives, their contribution towards the company’s strategy, etc. It would also describe s.174 CA 2006. It might explain how the section does define the standard of care skill against which directors are judged (a mixed objective/subjective test), but does not expressly define what role/activities directors must carry out. It would compare these two methods of addressing a NED’s diligence and competence. A good answer might consider how the Code only indirectly addresses competence, although it does at least define a role for NEDs. Moreover, by specifying recommendations for NEDs’ independence, it perhaps increases the likelihood, a little, that NEDs will actually fulfil this role. A good answer might also compare the relative effectiveness of the enforcement of the Code, and the enforcement of s.174. It could note that the Code is ‘soft’ law, only applies to listed companies, and is supported only by the ‘comply or explain’ principle. All that said, compliance seems to be relatively high – at least in terms of the rules on composition and independence. By contrast, s.174 is legally enforceable – but note the comparative dearth of actions for breach of duty. A good answer might note the possibility of enforcement through a derivative claim – but again, observe that derivative claims are also relatively rare. 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 specific issues, and the specific ‘claim’, which the question focuses upon. Student extract [The answer began with a short account of the history of the UK Corporate Governance Code and then continued:] Perhaps the most substantial instrument that seeks to achieve this accountability is the UK Corporate Governance Code. It is now issued by the Financial Reporting Council (FRC). Its latest version is from 2016. Its key recommendation is to include independent non-executive directors (NEDs) to the main board, the idea being that the NEDs would bring some objectivity to board decisions. …

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Examiners’ reports 2018

It continues to focus on the structure, composition and role of the board, whilst its emphasis is on ensuring a substantial proportion of NEDs who are required to monitor their executive colleagues. One interesting change that was introduced in the 2012 Version of the Code was a recommendation that the company’s annual report should include a description of the board’s policy on diversity, including gender, any measurable objectives set out for implementing the policy and progress on the objectives. Moreover, Lord Davies published his review on the proportion of women on the board. It was shown that in October 2015, 26% of the 100 top quoted companies (FTSE 100) were women members up from 12.5% in 2011. Furthermore, the Walker Review suggested that institutional shareholders should engage more with the companies they invest in. And Fund managers should be encouraged to comply, or explain nom-compliance, with a Stewardship Code, overseen by the FRC in the same way as the Corporate Governance Code. [There then followed a short summary of the Stewardship Code, and a discussion of short-termism and the steps being taken to address that.] In November 2016, the DBEIS published its much heralded Green Paper on Corporate Governance Reforms. S174 enshrines the importance of the wider interest groups. According to s174 the duty of care skill and diligence is an integral part of the company law to ensure that directors perform their duties with care and skill. In the Green Paper, the Government is exploring new ways to connect the board with interest groups to build on the existing governance activities. The options include increasing influence over executive pay, strengthening the voices of stakeholders. Comments on extract Interpretation of the question: reasonable – the student sees that there are two issues in the question – but does not seem to appreciate the need to draw comparisons. Relevance of the answer to the question: the first part, which is not extracted above, went through the history of the Code, which was not directly relevant to the question. Its relevance then improved, as it embarked on a reasonable discussion of the actual provisions of the Code. But it failed to stick to the question, wandering away from competence and diligence, and with very little to say about s.174 and no real comparisons between the two regimes. Substantive knowledge: rather weak: the knowledge of the Code seemed reasonable, but little analysis of whether the Code is effective in ensuring competence and diligence. Very little knowledge of s.174. Articulation of argument: the answer did not really build up an argument. It didn’t compare the two regimes, and so could not really make an argument whether one was better than the other in ensuring directors’ competence and diligence. Accuracy of information: OK. Clarity of expression: it was generally clearly expressed. The points being made were clear and comprehensible – but they were not the points needed to provide a good answer. Legibility: good Overall: this was a bare pass.

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Question 2 ‘The rules on the maintenance of capital, the regime for disqualifying directors, and the provisions of sections 213 and 214 of the Insolvency Act 1986, together ensure that creditors are well protected.’ Discuss. General remarks This question relates to Chapters 8, 14 and 17 of the module guide. It was quite a broad ranging question, asking you to demonstrate knowledge and understanding of three related areas of company law (capital maintenance, disqualification, and ss.213/4 IA 1986), and also to analyse those three areas to decide how effectively they protect creditors. Law cases, reports and other references the examiners would expect you to use On capital maintenance, relevant case law includes: Ooregum Gold Mining Company v Roper; Trevor v Whitworth; Re Halt Garage (1964) Ltd; Chaston v SWP Group plc; Brady v Brady. On disqualification, examine the Company Directors Disqualification Act 1986 and relevant case law, such as: Re Sevenoaks Stationers; Re Lo-Line Electric Motors. On sections 213/4 IA 1986, relevant case law includes: Re Produce Marketing Consortium; Brooks v Armstrong. Common errors Missing out one of the three areas set out in the question and describing the rules, but saying nothing to analyse how effectively those rules protect creditors. A good answer to this question would… examine the rules governing the three areas of creditor protection which are mentioned, and then evaluate their effectiveness. Regarding capital, these require, inter alia, disclosure of the amount of share capital raised, restrictions on issuing shares at a discount, restrictions on public companies on valuation of non-cash consideration and restrictions on undertakings in return for shares. As to maintenance of capital, note rules regarding restrictions on distributions, capital reductions, share buybacks, and financial assistance for the acquisition of shares. Explain how these rules protect creditors, ensuring companies disclose to creditors how much capital has been raised, actually do raise the amount claimed and preserve that capital within the company. Explain the limits to these rules: no minimum capital for private companies; private companies not required to value non-cash considerations; rules don’t prevent loss of capital in the ordinary course of trading; liberalisation of buyback rules for private companies; etc. Explain ss.213/214 IA 1986. Show requirements that must be satisfied for a liquidator to bring proceedings successfully under each provision. Explain limits on effectiveness of s.213, notably the requirement to show dishonesty. Contrast this with the ‘negligence based standard’ that underpins s.214. Explain who these provisions can be used against (anyone for s.213; only directors/shadow directors for s.214), and the consequences of a successful action, including who gets the fruits of an action. A good answer might note longstanding problems over funding such actions, and liquidators’ apparent reluctance to bring them, and note the introduction of s.246ZD IA 1986 (by SBEEA 2015) allowing the sale of actions by liquidators. On disqualification, explain how disqualification might promote creditor protection. A good answer would probably focus on the s.6 ground – unfitness – explaining its meaning, and the number of successful cases brought each year. Perhaps address the meaning of unfitness, controversy over whether mere incompetence

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does/should suffice. The consequences of disqualification should be noted, including in terms of typical disqualification periods, and the possibility of securing leave to act whilst disqualified. Some mention might also be made of the introduction of ‘compensation orders’ under CDDA 1986. Poor answers to this question… tended to write about only one, or two, of the areas mentioned, or discussed the areas very superficially. Poor answers also tended to be too descriptive, with no attempt to analyse the law’s effectiveness. The question asks you specifically about how well it protects creditors. You must come up with an answer to that. Question 3 ‘Derivative claims are an ineffective means of enforcing directors’ duties. It would be better if the law allowed any shareholder to bring a personal action, for her own benefit, against a director who has breached her duties to the company.’ Discuss. General remarks This question relates to Chapter 11 of the module guide. It requires discussion of two ‘claims’ made by the question. First, is it true that derivative claims are ineffective? Second, would it be better to permit each shareholder to bring a personal action? It’s important to understand what the question means when it talks about shareholders bringing a personal action against the director – see below. Law cases, reports and other references the examiners would expect you to use Relevant cases on derivative claims include: 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. On a personal action against a director, relevant case law includes: Sharp v Blank; Peskin v Anderson; Giles v Rhind. Common errors Students tended to be much better at discussing derivative claims than discussing the personal action against a director. On the latter, many students discussed an action under s.994. That is not, strictly speaking, a personal action against a director. However, some credit was usually given for such discussion, since these are certainly ‘personal actions’. A good answer to this question would… explain the nature of a derivative claim, and the purpose behind it - permitting a shareholder to sue a director for breach where the company itself is unwilling to sue. It would describe the main rules governing the statutory derivative claim in Part 11 CA 2006, showing the conditions which must be satisfied for a shareholder to bring such a claim. It might note that some of these conditions have been relaxed in the new statutory derivative claim, compared to the old common law action, such as the abandonment of the requirement to demonstrate ‘fraud’, and perhaps the requirement to show wrongdoer control. It would also note, however, how the claimant must still secure permission to continue the claim, and would analyse the criteria (in s.263(2) and (3)) that the courts apply in deciding whether or not to give such permission. Such analysis should include some discussion of the relevant case law, such as Iesini, Franbar, Kleanthous, Singh, Wishart etc. to show how the courts actually apply the statutory criteria – whether for example the courts 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 (less than half).

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A good answer might also note some of the more practical problems that undermine the effectiveness of derivative claims – especially the ‘collective action’ problem, the risk of ‘free riding’, the lack of an effective incentive for any individual shareholder to sue, and so on. That could provide a good link into the second part of the question, asking whether the derivative claim should be replaced with personal actions against directors for breach of their duties. A good answer might say something about how UK company law currently deals with such actions – that they are effectively precluded, both through the rule that the duties of directors are owed to the company alone (Percival v Wright; s.170(1)) and by the rule that precludes a personal action for ‘reflective loss’. The reasons for UK law’s current restrictions on such personal actions might be considered and evaluated – such as avoiding the ‘floodgates’ problem of multiple actions from a single breach of duty; ensuring some sharing amongst all shareholders of whatever money a director has (where the director cannot afford to fully compensate for the harm she has caused, and multiple personal actions would result in those who sue first securing full compensation, but those who sue later receiving nothing); upholding ‘majority rule’; ensuring the normal priority of creditors is protected (and perhaps link this to the criticism of the decision in Giles v Rhind). Poor answers to this question… tended only to address derivative claims, with nothing to say about personal claims against directors. Those that did address personal claims tended just to describe s.994, and the case law on that. But an action under s.994 is not, strictly speaking, an action against a director. Moreover, note that the question is not asking ‘can a shareholder bring a personal action against a director?’ but rather ‘should a shareholder be able to bring a personal action against a director?’ It needs some discussion of the pros and cons of allowing such personal claims. Student extract Under s260, a member may bring a derivative claim in respect of any claim a member may have against a director in order to seek relief on behalf of the company. The general rules is that because a company has its own rights and liabilities in law, it alone should be the one to sue for wrongs done to it (Foss). . … The one notable exception to Foss is when there is wrongdoer control. This means that the very persons who are wrongdoers and who should be sued are in charge of deciding whether or not the company should litigate (Burland v Earle). In such a case, the court will consider under sections 263 whether or not to allow a derivative claim by a member instead. One of the reasons a company may also not be able to sue is if the wrongdoers have deprived it of the funds to litigate (Giles v Rhind). In such a case, although a member may then claim, there will be little point in enforcing directors’ duties because the company is itself on the verge of being wound up. The lack of certainty over who pays for a derivative claim also deters altruistic litigation for the company – a successful claimant has no lien for costs on assets recovered in a claim. Directors may forestall a derivative claim by bring a company claim with no intention of genuinely pursuing it. S262 then helps a member to turn that claim into a derivative claim provided the section’s criteria are met.

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[There was then a very brief mention of the criteria the courts must apply in deciding whether to give permission.] Thus derivative claims cannot be said to be wholly ineffective. Comments on extract Interpretation of the question: very poor – the student chooses to answer only part of the question. They are interpreting the question as ‘are derivative claims effective?’ The question clearly has much more to it than that. Relevance of the answer to the question: it started well, with a reasonable discussion of derivative claims. Even had the question been only about that, however, the answer was a little superficial, providing little real analysis of precisely how effective such claims are. But then it failed to deal at all with the second part of the question, regarding the merits of allowing a shareholder to sue personally. Substantive knowledge: OK on derivative claims (but more needed on the way the permission rules are applied by the courts). No apparent knowledge at all about personal actions against directors. Use of authorities: weak – no real discussion of case law. Articulation of argument: in relation to the effectiveness of derivative claims, there was at least a basic argument. But no argument developed in respect of the second part of the question. Accuracy of information: OK on derivative claims. Clarity of expression: good. Legibility: good. Overall: a Fai...