Exam 2016, questions and answers PDF

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Examiners’ reports 2016

Examiners’ reports 2016 LA3021 Company law – Zone A 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 ‘UK company law still has a “one size fits all” approach. Its rules do not distinguish sufficiently between large companies and small ones.’ Discuss. General remarks This question raised a perennial issue within UK company law: does it distinguish sufficiently between different sizes of company and their different needs? The question suggests it does not do so and answers ought to try to reach a conclusion whether that is true. However, no answer could possibly examine company law in its entirety. Students can be selective, choosing just some areas of company law to find examples of how the law either does, or fails to, distinguish differently sized companies.

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Law cases, reports and other references the examiners would expect you to use CA 2006, picking examples where it does, or does not, distinguish between differently sized companies, 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 A failure to focus on the question. Many essays considered only if the company was good for business. This question was different, asking if company law in the UK distinguishes sufficiently between different sizes of company. Some essays tended to ask only whether company law deals well with small companies. Whilst they partially answered the question, they were also incomplete, for the question required one to address how well companies of both sizes are served by UK company law. A good answer to this question would… perhaps begin by explaining the major differences between large and small companies. Larger companies will typically have more shareholders, who are likely to have less involvement in running the business and therefore be more vulnerable to misbehaviour by the company’s executives. The larger company may need to raise more capital from the public, may need a more professional board and more board accountability and so on. The smaller company, by contrast, is likely to have fewer shareholders and be run more informally. Too much regulation can be more burdensome. There may well be no real ‘separation of ownership and control’, so that its owners – shareholders – will also be its directors and managers and will be in charge of managing the company on a daily basis. It will more often encounter disputes between majority and minority shareholders and will therefore need better minority protection. Insolvency will be a greater risk, requiring robust creditor protection and insolvency procedures. A good answer would then turn to consider whether UK company law reflects these differences, with rules that treat large and small companies differently. A good answer would probably limit itself to picking just some areas of company law as examples. Examples of areas where the law does seem to distinguish between different-sized companies include rules on accounts/audit and rules on shareholder disputes that treat ‘quasi-partnerships’ differently. Elsewhere, company law offers different rules for private and for public companies and these differences also tend to correspond to companies of different sizes. So, there are different rules about capital maintenance, raising capital, about company secretaries, number of directors, availability of written resolutions, about directors authorising conflicted transactions, and so on. And the model articles now distinguish between private and public companies. Some of these differences are quite longstanding, but they were added to by the Companies Act 2006 and its emphasis on ‘Think Small First’. Finally, ‘listed companies’ are subject to a separate group of rules because of their listed status. However, there are lots of examples of where the law treats private public and private companies alike. Generally, for example, the duties of directors do not differ according to the size of the company. The model articles still assume a distinction between owners and directors and company law generally allocates different decision-making powers either to shareholders or to directors.

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Poor answers to this question… often failed to answer directly the question asked, perhaps addressing only the small company or (less often) only the large company. Other poor answers tried to address both types of company but offered too few examples of how company law does, or does not, distinguish between differently sized companies. It is acceptable to be selective in the areas of company law one draws on for this question but an essay will be considered as demonstrating insufficient knowledge, if its mentions only one or two areas of law to demonstrate how UK law deals with differently sized companies. Question 2 ‘The UK has been very successful in addressing the composition of boards of directors, including the proportion of independent non-executive directors, and the proportion of female directors. However, it has entirely failed to control the excessive pay that directors award themselves.’ Discuss. General remarks This question addresses issues usually discussed under the rubric of ‘corporate governance’. It required, however, students to look at a number of very specific issues within this broad topic. The first concerns the composition of boards, and specifically the proportion of independent non-executive directors (‘NEDs’), and of female directors. The second is the control of directors’ pay. The question is drafted as a couple of arguments/claims about these issues – that the UK has dealt well with the composition issue but has failed to deal with the pay issue. While there are arguably no ‘right answers’ here – so that one very good essay might strongly agree with these claims and another equally good essay might just as strongly disagree with them – it is good for a student to try to reach a conclusion as to whether on balance, he or she agrees or disagrees. It gives a sense of ‘closure’ to the essay. Law cases, reports and other references the examiners would expect you to use On the proportion of NEDs, the UK Corporate Governance Code and its predecessors. On ‘Gender Diversity’, the work of the Davies Review. On directors’ pay, the ‘Say on Pay’ rules in the Business, Enterprise and Regulatory Reform Act 2013; 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. 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 above, dealing with the composition of boards, and the control of directors’ pay. A good answer to this question would… focus on the question asked, breaking it down into the separate issues it raises. It would describe how the UK has dealt with board composition. It might note that company law itself does not address this issue. However, under successive corporate governance codes and, now in the UK Corporate Governance Code (2014), it recommends that at least half the board of listed companies (excluding the chairman) be independent NEDs. A good answer would explain this is only a recommendation of good practice, is ‘enforced’ only through the ‘comply or explain’ mechanism but seems to be largely observed by listed companies.

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It would then turn to the issue of gender equality. It would note the historical gender imbalance on UK boards and the creation of the Davies Review to examine this. It would note the recommendations of that Review, its target of 25 per cent female board membership by 2015, the changes to the UK Corporate Governance Code in support of that target and the target’s apparent achievement. It would then address the issue of directors’ pay. This is a large topic. It might note attempts to deal with pay through the creation of board ‘remuneration committees’ and evidence that such committees have tended to increase, rather the decrease, pay levels. It would note more recent efforts to encourage shareholders to play a greater role, through ‘Say on Pay’ rules and generally encouraging more shareholder engagement, e.g. through the Stewardship Code. Finally, a good answer would offer some brief conclusion. 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 in the business/financial press. 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 noted above. 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; pre-prepared essays that give an answer to a different question from the one asked will get little credit. Question 3 Explain the legal effect of: a) provisions in a company’s articles of association which restrict the objects of the company; and b) provisions in a company’s articles of association which limit the authority of its directors. General remarks This addressed a topic that has come up often before, namely the capacity of the company (ultra vires) and the authority of directors. In the past, it has been asked as a problem question and students have often answered such problem questions well. However, here the topic was addressed as an essay question. Changing the ‘angle’ of the question in this way did not significantly change the legal knowledge required to answer it. However, it did help to differentiate between those good students who clearly understood the legal rules and principles relating to this topic and could use them to answer an essay-style question and those who ‘learnt’ the rules but lacked real understanding of them. Law cases, reports and other references the examiners would expect you to use For part (a): ss.31 and 39 CA 2006. Case law on the ultra vires doctrine (e.g. Ashbury Carriage Co v Riche; Bell Houses; Re Introductions); ss.33 and 171 CA 2006. For part (b): the rules on directors’ authority; ss.40 and 41 CA 2006; Freeman and Lockyer v Buckhurst Properties; Hely Hutchinson v Brayhead Ltd; ss.33 and 171 CA 2006.

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Common errors Unfortunately, many answers either failed to address the question, or else showed a lot of confusion about the topic of ultra vires and directors’ authority and the relevance of provisions in the articles in respect of those topics. Quite a lot of answers seemed to focus on the reference to ‘provisions in the articles’ and wrote an answer just about the effect of the articles, in general, without mentioning the company’s objects (and the ultra vires doctrine) or directors’ authority. Even where an essay did focus on questions of a company’s objects, and directors’ authority, answers tended to discuss only what is sometimes called the ‘external issue’, that is the impact of articles on a contract entered into with an outsider in breach of such a articles (see below). However, a full answer requires discussion not just of this external issue but also of the ‘internal’ consequences of such articles – their relevance to personal actions brought to enforce the articles under s.33 and their relevance to the directors’ duty under s.171 (to observe the terms of the constitution). See below. A good answer to this question would… take each part of the question in turn. Starting with a), a constitutional provision restricting the company’s objects would displace the default rule that otherwise applies under s.31, giving a company unlimited capacity. So, a restriction on objects would restrict the capacity of the company. But so what? Historically, such a restriction would have meant that transactions by the company beyond that capacity would have been ultra vires and thus ‘void’ and unenforceable: Ashbury, Bell Houses, Introductions, etc. Now, however, this ‘external’ consequence of a company acting beyond a restriction on its objects has been abolished: s.39. So, externally, a restriction on the company’s objects has no legal effect. However, a restriction on objects continues to have ‘internal’ legal consequences. If a shareholder learns her company is intending to enter into a contract beyond the objects, but has not yet done so, she can bring a personal action against the company, under s.33, to enforce the articles and stop the company entering into the contract in the future. Moreover, even if the directors have already made the company enter into such a contract, so that it is now too late for the shareholder to use s.33 to prevent the company doing so, still the directors will thereby have breached their duties under s.171. It would, however, be for the company to enforce such a breach. While a derivative action might be brought, it is probably unlikely a shareholder would be given permission to continue such an action. So, to summarise, a good answer would demonstrate that a provision in the articles restricting the company’s objects now has little ‘external’ effect (on contracts already entered into with third parties) but still has lots of ‘internal’ effects. A good answer would then turn to part b), limits on the authority of directors. It would show how such a limit again has little external effect (because of s.40, which allows a third party to enforce a contract, even if entered into in breach of a constitutional limit on the directors’ authority). However, such a limit has the same internal effects as discussed above. A shareholder who learns that directors intend to act beyond their authority, as limited by the constitution, could use s.33 to prevent them doing so in the future, provided she acts before any contract has been entered into by the company. The directors’ acting beyond a constitutional limit on their authority puts them in breach of their duties under s.171 CA 2006 (a duty owed to, and enforceable by, the company itself).

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Poor answers to this question… made the mistakes noted above under ‘common errors’. So, many addressed only the ‘external’ effects of relevant provisions in the articles, without considering the internal effects. Student extract (a) Pursuant with s.32 of the Companies Act, the company’s objects are unrestricted unless it chooses to specify as object in its articles of association. In the latter case, the company will be entitled to perform only those types of activities which are ascertained in its articles. Consequently, if a company chooses to changes [sic] it without introducing amendments to the articles of association, this may be a breach of the company’s articles as ‘ultra vires’ and a violation of the terms upon which its shareholders set up the business. However, with respect to the transactions with third parties, the latter will be protected by s39 of the Companies Act . . . the validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s constitution. (b) Likewise, any limitation of authority of directors does not affect the validity of transactions with a person who is acting in good faith. Pursuant to s.40 of the Companies Act the powers of the directors to act without such limitations as a rebuttable presumption in favour of such a person who is not bound to enquire on directors powers. What is more, he shall not be regarded as acting in bad faith by reason only of his knowing that such an act is beyond the powers under the company’s constitution. Thus the standard is very high with exception of those cases when a party to a transaction is a director or any person connected to him as ascertained in s41 Companies Act. With respect to members of the company, they however have the right to bring proceedings to restrain the doing of such action. In addition, any director who acts beyond the limits breaches his duty to act within powers, specified in s171 Companies Act. Comments on extract Interpretation of the question: this was OK – the answer suggested the student understood the question being asked. Relevance of the answer to the question: again, OK, the answer did focus on the question asked and the student divided their answer clearly between the two halves of the question. Substantive knowledge: rather limited. The student had the basics, in terms of the two main provisions that are relevant, namely ss.39 and 40 CA 2006. However, the answer starts a little badly by mentioning the wrong provision (s.32, instead of s.31). Moreover, in relation to the first part of the answer, on ultra vires/objects clauses, the answer addresses only the ‘external’ effects of a restriction on the company’s objects clauses. It is very short, and says nothing about the internal effects – it does not consider whether/when shareholders can enforce such a provision under s.33, nor the relevance (of a restriction on the company’s objects) to the directors’ duties under s.171. For part b), the answer is longer, and shows a little more knowledge, picking up on the right of shareholders to enforce the provision (but again not actually mentioning s.33) and noting s.171. Use of authorities: none included – so again rather weak here. Articulation of argument: it flowed along quite coherently but the essay was very short and so points were not really fully/clearly explained.

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Accuracy of information: generally what was said was accurate, apart from the mistake over a section number (31/32). Clarity of expression: OK. Legibility: good. Question 4 ‘A well-drafted duty of care and skill for directors should spell out clearly the activities which directors must undertake in order to contribute towards the running of the company, but should also ensure that directors are free to take reasonable commercial risks. Unfortunately, section 174 of the Companies Act 2006 achieves neither of these goals.’ Discuss. General remarks This question focused on the director’s duty of care and skill. It had two parts to it. The first part was ‘normative’, asking students to discuss what a good duty of care and skill would look like. The second part was ‘descriptive’, asking whether the current v...