Company report 2018 B PDF

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Examiners’ reports 2018

Examiners’ reports 2018 LA3021 Company law – Zone B 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. Unlike last year, fewer students failed to follow the rubric of the exam paper, which required students to answer at least one question from Part A, and at least two questions from Part B. It is imperative that students are familiar with, and comply with, the instructions on the paper, but it was 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 Do the rules governing derivative claims require reform and, if so, how? General remarks This question relates to Chapter 11 of the module guide. It required discussion and analysis of the law surrounding derivative claims, found mainly in Part 11 CA 2006. It required students to explain what those rules are, to evaluate how successful they are, to identify any problems with those rules, and to suggest how they might be changed/improved. 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. Mention might be made of the Law Commission Report ‘Shareholder Remedies’ which was influential in the process of reforming the earlier common law rules on derivative actions.

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Common errors This question was often well done. A common error in weaker scripts was a failure to answer the question asked. Sometimes, essays were produced on ‘majority rule’ generally, or on the broad topic of ‘the rule in Foss v Harbottle’, instead of focusing on the derivative claim specifically. Others described the rules but made no attempt to evaluate them, or to suggest how they might be reformed and improved. 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, at least in some circumstances, the company itself is unwilling to sue. Explain the introduction of the statutory derivative claim in Part 11 CA 2006 to replace the previous common law action. Describe and explain the main elements of Part 11 and examine the conditions which must be satisfied for a shareholder to bring such a claim, including especially the claimant’s obligation to get permission to continue the claim, and 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). It 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. A good answer would ensure it not only describes, but also offers some evaluation, of the statutory regime and its application by the courts. Possible points of criticism might include the widening of the grounds on which a derivative claim can now be brought (s.260(3)), whether ‘wrongdoer control’ remains a condition, the ability of the majority to excuse a breach and thereby forestall a claim, the ability of wrongdoers to vote on an authorisation, whether courts are influenced by the views of the board in applying, for example, the ‘hypothetical director’ test, or the ‘decision of the company not to sue’. Mention might also be made of the rules governing costs/indemnity orders. Finally, good answers would include some indication of how they think the criticisms they have made of the current regime might be addressed. Poor answers to this question… did not focus on the question asked. They often spent too long talking generally around the rule in Foss and all the supposed exceptions to Foss, before eventually turning to mention, often quite briefly, derivative claims. Poorer answers would then often give a very superficial account of the statutory action, with little attempt to evaluate its rules, or to suggest improvements that might be made. Student extract Obscure, rigid, complex unyielding and old fashioned are the terms use to describe the old common law derivative action. This prompted the Law Commission in its report to recommend a new derivative procedure with more flexible and accessible criteria. This new statutory derivative procedure is contained in Part 11 CA 2006. Section 260 defines a derivative claim as proceedings brought by a member of the company in relation to a cause of action vested in the company seeking relief on behalf of the company. Has the statutory derivative procedure achieved its objective of minimising complexity and maximising accessibility or is it in need of reform? This essay will discuss the flaws in the procedure in relation to its scope, procedure and application, along with the

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logic of judicial activism and incentive to minority shareholders, the statutory derivative procedure is an unnecessary addition to company law and is indeed in need of reform. [The essay then addressed the scope of the statutory action, continuing:] The procedure to bring a claim is very restrictive. S.261 provide that the applicant must apply to court in order to obtain permission to continue it and this entails a 2 stage procedure as interpreted in Iesini. The first stage requires the claimant to establish a prima facie case that the company itself has a good cause of action which arises from a breach – s.260(3). The second stage is even more restrictive and complex as it requires the court to consider certain mandatory grounds in s.263. Then considered some of these, and how difficult they make it for the claimant to get permission. The obstacles the claimant faces do not end there. The judicial application of the derivative procedure has been very stringent. This is evident from the consideration of the hypothetical director, discussed above. This appears as a test twice, under both the mandatory and the discretionary grounds, highlighting its significance. The courts have been very reluctant to substitute their own views as to whether the hypo director would allow a claim. This is evident in the case of Iesini, where Lewison J noted that the ‘the courts are ill-equipped to take such commercial decisions’. Even in Kleanthous, Newey J was content to take into account the views of two directors of the company. Thus, Kershaw notes in his book Company law, the judges’ policy has been to pull back from actual assessment of these business considerations into the comfort zone of law’. In light of these complexities, it is not a surprise that in most cases, the courts denied granting permission. In Mission capitl v Sinclair, court heard that a hypothetical director would not attach importance to continuing the claim as the damages claimed were speculative. …Only in a handful of cases have the courts granted permission, such as Kiani v Cooper, and Stainer v Lee. [Essay continued with a detailed consideration of remedies, and how these are awarded to the company itself, not the member, and the problems over funding, noting recent cases such as Bhullar and Hook.] Thus it’s clear that the DC needs reform. This could be by removing the hypothetical director test from discretionary factors… and incentives should be created for the minority as they bring the claim for purely unselfish reasons. In conclusion, the statutory derivative claim is full of complexities and together with lack of judicial activism, fails to provide sufficient protection to minority shareholders. Thus it can be contended that it is better for a claimant to proceed under s994 which affords greater protection in terms of its scope and application. Comments on extract Interpretation of the question: good. Relevance of the answer to the question: very relevant – a well-focused answer. Substantive knowledge: excellent – shows good knowledge of the law governing derivative claims, and of the criticisms made about that law. Use of authorities: excellent. Articulation of argument: clear – had an overall argument to make.

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Accuracy of information: good. Clarity of expression: very good – the essay was always comprehensible. Legibility: OK Overall: a First. Question 2 ‘Two important corporate governance issues confronting listed companies today concern the composition of their boards (including their gender diversity) and excessive executive pay. The UK has tried to address these through the UK Corporate Governance Code, but this attempt has largely failed. Legislation should now be introduced to deal with these issues.’ Discuss. General remarks This question relates to Chapters 15 and16 of the module guide. It addressed the UK corporate governance regime for listed companies, and especially its regulation of board composition and executive pay. It required some discussion of how, and how well, the UK Corporate Governance Code has addressed these two issues, and whether it would be better now to have statutory rules. Law cases, reports and other references the examiners would expect you to use Of first importance here is the UK Corporate Governance Code (2016) and especially its provisions on board composition and executive pay. Mention might also be made of existing statutory provisions that also address pay (e.g. those relating to the directors’ remuneration report, found in ss.420-422A CA 2006). Reference also the Government’s current Corporate Governance Review, and its proposals on pay. Common errors The most common error is one emphasized 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 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 some specific issue. A good answer to this question would… focus on the question asked, breaking it down into the separate issues it raises. It would describe what the issue is regarding board composition – around both the proportion of non-executives, and about gender diversity. It would show how these matters are dealt with in the UK Corporate Governance Code (2016), with some knowledge of the relevant provisions. It might show how CA 2006 does not itself address either of these matters. It ought then to offer some assessment of whether the use of the Code to address board composition and gender diversity should be regarded as a success or a failure. It might mention the enforcement mechanisms behind the Code, the pressure on companies to comply, rather than to explain nonobservance, and any empirical evidence about actual levels of compliance. It should consider whether further legislation would be desirable, noting some of the theoretical arguments in favour/against soft law compared to hard law (flexibility, compliance in spirit, etc.). It would also address directors’ pay. It might note how the Code does seek to regulate such pay, partly through substantive recommendations about the make-up of remuneration packages, but more so by recommendations for the creation of

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board ‘remuneration committees’. It might again note the theoretical arguments about the likely effectiveness or otherwise of such committees, and any empirical evidence about the impact of such committees on the level/composition of pay. A good answer would also note that, in contrast to composition/diversity concerns, there is already a body of hard law that does address remuneration, largely around the issue of shareholder ‘Say on Pay’ rules. A good essay would explain these, and again consider whether, and if so how, more legal rules might be desirable. A very good answer might also show some awareness of the latest recommendations emanating from the Government’s current Corporate Governance Review, say with regard to greater disclosure of pay ratios. 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, especially with regard to board composition and pay, whether those rules have worked well in regulating board composition and pay, and whether reliance on more statutory rules, with the force of law, might work better. Question 3 ‘Compare the regime for removing directors, under section 168 of the Companies Act 2006, with the regime for disqualifying directors under the Company Directors Disqualification Act 1986.’ General remarks This question relates to Chapter 14 of the module guide. It requires the comparison of two areas of company law that have some similarities, but work in very different ways. Both areas needed to be addressed, and comparisons drawn. This required students to engage in some analysis – merely describing the two regimes (under s.168, and CDDA 1986) was insufficient. Law cases, reports and other references the examiners would expect you to use Cases relevant to the interpretation of s.168 (e.g. Bushell v Faith. Section 168(5) on the right to compensation for removal. Other financial implications of removing directors under s.168 (e.g. the director’s right to claim that removal is unfairly prejudicial conduct, under s.994 CA 2006); attempts to limit the amount of compensation payable (e.g. s.188 restricting long service contracts). 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 The most common error was a failure to draw comparisons between the two different areas mentioned. Students generally did a better job at describing how s.168 works, and how CDDA 1986 operates, than they did in then comparing these two regimes. A good answer to this question would… Describe, and then compare, the two regimes referred to. It would explain what s.168 addresses – the removal from office of a director by the company’s shareholders. It would explain how s.168 is an empowering provision, designed to facilitate (a) majority (of) shareholders in removing a director they no longer wish to remain on the board. It is designed to address the ‘agency problem’ between shareholders and directors. It is a mandatory provision, but is subject to a number of limitations. Relevant to mention here are the right of directors to speak in their defence (s.169), and the contractual limits which may arise (notwithstanding the ‘mandatory’ nature of the section). These contractual limits include: the insertion of

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‘weighted voting’ provisions in the articles, the existence of long-service contracts, which can make exercising the power of removal expensive (s.168(5)) and quasicontractual legitimate expectations of participation in management, which can form the basis of challenge under s.994 CA 2006 or s.122(1)(g) IA 1986. It would then explain the disqualification regime under CDDA 1986. It should note how, in contrast to s.168’s empowering of private actors – shareholders – to reduce their agency costs, CDDA is a system of public regulation designed to provide public (and perhaps especially creditor) protection. It might describe the procedure for disqualifying under the Act, and say a little about the wide range of grounds on which disqualification can be ordered. Some concentration on the s.6 ground would probably be appropriate. The essay might also note the different consequences that follow from disqualification under CDDA, compared to removal under s.168. Poor answers to this question… Tended not to compare the two regimes. Weakest answers simply described one regime in any detail, and then say very little about the other, and nothing on comparisons between them. Better answers did at least describe both regimes, but even then, gave little analysis of how the regimes are similar or dissimilar. Question 4 Is the registered company a good legal form through which to run a small business? Do any of the rules of company law need to be changed, to serve better the distinctive needs of smaller businesses? General remarks This question relates to Chapters 2 and 16 of the module guide, but could draw examples from many other areas of company law covered by other chapters of the Guide. It raises two different – but connected – questions. The first is about the strengths (or weaknesses) of the registered company as a ‘business vehicle’, especially for small businesses. The second raises the long-discussed question whether UK company law is well suited for, specifically, smaller businesses. Law cases, reports and other references the examiners would expect you to use Relevant provisions from CA 2006, or from IA 1986, that create the main advantages of the company for businesses, such as those dealing with legal personality (s.16 CA 2006), limited liability (s.74 IA 1986), and so on. Provisions in CA 2006 which show how far company law does, or does not, try to treat smaller companies differently (e.g. provisions on company meetings, accounts, directors and their duties, company secretaries, derivative claims, raising and maintenance of capital, shareholder rights; the Model Articles. Mention also relevant areas of case law, such as those dealing with the unfair prejudice regime, where courts have developed distinctive rules for the ‘quasi-partnership’. Consider the Modern Company Law Review, and its emphasis on ‘Think Small First’. Common errors Generally, the answers to this question were quite good. If there were errors, it was often in failing to deal with the second issue noted above – whether UK company law is well designed for the needs of the smaller business. A good answer to this question would… perhaps address each of the two sentences in turn. As to the first, it might begin by identifying some of the features of the corporate form that are attractive to any business – limited liability, perpetual succession, ease of raising finance, ease of leaving the business and selling ones investment, a clear management structure, rules governing the rights of investors inter se, etc. A good answer might then ask how far these features are indeed necessary for, or realised in the case of, smaller

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businesses. It could also note some of the offsetting disadvantages, such as costs of formation, disclosure obligations, and a degree of regulatory burden. As to the second part of the question, a good answer might then develop the analysis of the differences between larger and smaller businesses to identify the different regulatory needs they have, and then to explore whether company law currently reflec...