Law Study Manual 2013
Law Study Manual 2013
LAW
Professional Stage Knowledge Level
Study Manual
www.icaew.com
Law
The Institute of Chartered Accountants in England and Wales Professional Stage
ISBN: 978-085760-454-5
Previous ISBN: 978-085760-224-4
Polestar Wheatons
Hennock Road
Marsh Barton
Exeter
EX2 8RP
If you are a CFAB student, you will be gaining essential knowledge of how businesses work. As your
understanding develops you may be surprised by the variety of roles that chartered accountants take on.
To gain further insight and develop your career, I hope that you choose to continue onto the ACA
qualification.
The ACA will open doors to a highly rewarding career as a financial expert or business leader. Once you
are an ICAEW member, you will join over 138,000 others around the world who work at the highest
levels across all industry sectors, providing valuable financial and business advice. Some of our earlier
members formed todays global Big Four firms, and you can find an ICAEW Chartered Accountant on
the boards of 80% of the UK FTSE 100 companies.
As part of a worldwide network of over 19,000 students, you will have access to a range of resources
including the online student community, where you can interact with fellow students. Our student
support team is dedicated to helping you every step of the way. Take a look at the key resources
available to you on page viii.
I wish you the very best of luck with your studies and look forward to supporting you throughout your
career.
Michael Izza
Chief Executive
ICAEW
iii
iv
Contents
Introduction vii
Law viii
1. Contract formation 1
2. Termination of contract 25
3. Agency 43
4. Negligence 59
9. Partnership 183
Index 253
v
vi
1 Introduction
1.1 What is Law and how does it fit within the ACA Professional Stage?
Structure
The ACA syllabus has been designed to develop core technical, commercial, and ethical skills and
knowledge in a structured and rigorous manner.
The diagram below shows the twelve modules at the ACA Professional Stage, where the focus is on the
acquisition and application of technical skills and knowledge, and the ACA Advanced Stage which
comprises two technical integration modules and the Case Study.
If you are studying for CFAB, you will only complete the first six knowledge modules. However, you may
decide to progress to the ACA after you have completed the CFAB qualification.
Introduction vii
2 Law
2.1 Module aim
To provide students with an understanding of the principles of English law.
On completion of this module, students will be able to:
explain the nature of contractual agreements, the agency relationship and the consequences of
negligence
understand the legal implications of incorporation, including the roles of shareholders and
directors, and the main implications of insolvency law
identify instances of criminal behaviour that may be encountered by professional accountants
identify other key areas in which the law affects the role and work of the professional accountant.
3 Key Resources
STUDENT SUPPORT TEAM
T +44 (0)1908 248 250
E [email protected]
STUDENT WEBSITE
icaew.com/students student homepage
icaew.com/exams exam applications, deadlines, regulations and more
icaew.com/cpl credit for prior learning/exemptions
icaew.com/examresources examiners comments, syllabus, past papers, study guides and more
icaew.com/examresults exam results
TUITION
If you are receiving structured tuition, make sure you know how and when you can contact your tutors
for extra help. If you arent receiving structured tuition and are interested in classroom, online or
distance learning tuition, take a look at our tuition providers in your area on icaew.com/exams
ONLINE STUDENT COMMUNITY
The online student community allows you to ask questions, gain study and exam advice from fellow
ACA and CFAB students and access our free webinars. There are also regular Ask an Expert and Ask a
Tutor sessions to help you with key technical topics and exam papers. Access the community at
icaew.com/studentcommunity
THE LIBRARY & INFORMATION SERVICE (LIS)
The Library & Information service (LIS) is ICAEWs world-leading accountancy and business library. You
have access to a range of resources free of charge via the library website, including the catalogue,
LibCat. icaew.com/library
viii Law
4 Syllabus and learning outcomes
Covered in
1 The impact of civil law on business and professional services chapter
Introduction ix
(h) Identify the various statutory rights of shareholders to challenge the management 6
of the company under the Companies Act 2006 and the Insolvency Act 1986
(i) Identify the rights and duties which a member of a limited liability partnership 9
possesses
(j) Identify the ways in which a director may be appointed and removed 6
(k) Identify directors duties, explaining the consequences of any major breach 6
(l) Identify the powers of directors and in what circumstances they will bind the 6
company in a contract with third parties
(m) Identify the nature of fixed and floating charges and the procedures for 7
registering them
(n) Identify the nature and function of 8
Company voluntary arrangements
Administration orders
Receivership
Compulsory and voluntary liquidation (including relevance of secured debt)
(o) Identify the main implications of insolvency law, including: 8
The principal means of termination of companies or other business entities
The priorities on a liquidation of the distribution of assets including
rights of creditors and employees (including secured assets)
Bankruptcy and other responses to personal insolvency.
x Law
Employment law and social security law
(b) Identify who is an employee and the main legal consequences of employment 11
status
(c) Identify the key features of employment contracts and recognise circumstances in 11
which an employment contract may be terminated and the consequences arising
(d) Identify when dismissal constitutes: 11
A wrongful dismissal
An unfair dismissal
(e) Identify the circumstances where an employee can claim a statutory redundancy 11
payment
(f) Identify employers' obligations under social security law 11
Introduction xi
5 Faculties and Special Interest Groups
The faculties and special interest groups are specialist bodies within ICAEW which offer members
networking opportunities, influence and recognition within clearly defined areas of technical expertise.
As well as providing accurate and timely technical analysis, they lead the way in many professional and
wider business issues through stimulating debate, shaping policy and encouraging good practice. Their
value is endorsed by over 40,000 members of ICAEW who currently belong to one or more of the seven
faculties:
Audit and Assurance
Corporate Finance
Finance and Management
Financial Reporting
Financial Services
Information Technology
Tax
The special interest groups provide practical support, information and representation for chartered
accountants working within a range of industry sectors, including:
Charity and Voluntary sector
Entertainment and Media
Farming and Rural Business
Forensic
Healthcare
Interim Management
Non-Executive Directors
Public Sector
Solicitors
Tourism and Hospitality
Valuation
Students can register free of charge for provisional membership of one special interest group and
receive a monthly complimentary e-newsletter from one faculty of your choice. To find out more and to
access a range of free resources, visit icaew.com/facultiesandsigs
xii Law
6 ICAEW publications for further reading
ICAEW produces publications and guidance for its students and members on a variety of technical and
business topics. This list of publications has been prepared for students who wish to undertake further
reading in a particular subject area and is by no means exhaustive. You are not required to study these
publications for your exams. For a full list of publications, or to access any of the publications listed
below, visit the Technical Resources section of the ICAEW website at icaew.com
ICAEW no longer prints a Members Handbook. ICAEW regulations, standards and guidance are
available at icaew.com/regulations This area includes regulations and guidance relevant to the regulated
areas of audit, investment business and insolvency as well as materials that was previously in the
handbook.
The TECH and AUDIT series of technical releases are another source of guidance available to members
and students. Visit icaew.com/technicalreleases for the most up-to-date releases.
Introduction xiii
Auditing in a group context: practical considerations for auditors ICAEW, 2008, ISBN 978-1-
84152-628-7
The guide describes special considerations for auditors at each stage of the group audit's cycle.
While no decisions have been taken on UK adoption of the IAASB's clarity ISAs, the publication also
covers matters in the IAASB's revised and redrafted 'ISA 600 Special Considerations - Audits of
Group Financial Statements (Including the Work of Component Auditors)'. The revised publication
contains suggestions for both group auditors and component auditors.
xiv Law
The FRC Guidance on Audit Committees (formerly known as The Smith Guidance)
First published by the Financial Reporting Council in January 2003, and most recently updated in
2010. It is intended to assist company boards when implementing the sections of the UK
Corporate Governance Code dealing with audit committees and to assist directors serving on audit
committees in carrying out their role. Companies are encouraged to use the 2010 edition of the
guidance with effect from 30 April 2011.
The UK Stewardship Code
The UK Stewardship Code was published in July 2010. It aims to enhance the quality of
engagement between institutional investors and companies to help improve long-term
returns to shareholders and the efficient exercise of governance responsibilities by setting out
good practice on engagement with investee companies to which the Financial Reporting
Council believes institutional investors should aspire.
A report summarising the actions being taken by the Financial Reporting Council and
explaining how the UK Stewardship Code is intended to operate was also published in
July 2010.
Ethics icaew.com/ethics
Code of Ethics
The Code of Ethics helps ICAEW members meet these obligations by providing them with ethical
guidance. The Code applies to all members, students, affiliates, employees of member firms and,
where applicable, member firms, in all of their professional and business activities, whether
remunerated or voluntary.
Instilling integrity in organisations ICAEW June 2009
Practical guidance aimed at directors and management to assist them in instilling integrity in their
organisations. This document may also be helpful to audit firms discussing this topic with clients
and individuals seeking to address issues in this area with their employers.
Introduction xv
Reporting with Integrity ICAEW May 2007, ISBN 978-1-84152-455-9
This publication brings ideas from a variety of disciplines, in order to obtain a more comprehensive
understanding of what is meant by integrity, both as a concept and in practice. Moreover, because
this report sees reporting with integrity as a joint endeavour of individuals, organisations and
professions, including the accounting profession, the concept of integrity is considered in all these
contexts.
xvi Law
Measurement in financial services, (Inspiring Confidence in Financial Services initiative) ICAEW,
March 2008, ISBN 978-1-84152-546-4
This report suggests that more work is required on matching measurement practices in the
financial services industry to the needs of different users of financial information, despite the fact
that the financial services industry has the greatest concentration of measurement and modelling
skills of any industry. A downloadable pdf is available at icaew.com/thoughtleadership
Skilled Persons Guidance Reporting Under s166 Financial Services and Markets Act 2000
(Interim Technical Release FSF 01/08)
This interim guidance was issued by ICAEW in April 2008 as a revision to TECH 20/30 to assist
chartered accountants and other professionals who are requested to report under s166 Financial
Services and Markets Act 2000. A downloadable pdf is available at icaew.com/technicalreleases
Bringing employee personal devices into the business - a guide to IT consumerisation ICAEW,
2012, ISBN 978-0-85760-443-9
The gap between business and consumer technology has been growing over the last few years,
with the consumer market now leading in terms of ease of use and portability.
Making the most of social media - a practical guide for your business ICAEW, 2011, ISBN 978-0-
85760-286-2
This guide will enable the business manager to develop a philosophy that allies social medias
potential with the businesss objectives and capabilities, to set objectives and protect against pitfalls,
and then to take the first practical steps in a mass communications medium very different from any
that British business has encountered before.
Introduction xvii
Implementing XBRL
This booklet, produced jointly by Thompson Reuters, the Tax Faculty and the Information
Technology Faculty, is a practical guide for accountants in business and practice, and follows on
from Demystifying XBRL.
TAXline Tax Practice series of detailed briefings on current topics:
TAXline Tax Practice 27
Let property - a brief guide by Rebecca Cave (published November 2011)
TAXline Tax Practice 26
The new pension rules by Anne Redston (published July 2011)
TAXline Tax Practice 25
Tax Credits by Robin Williamson (published April 2011)
TAXline Tax Practice No 23
HMRC Powers - an overview of the new powers and penalties regime by Paula Clemett (published
October 2010)
xviii Law
CHAPTER 1
Contract formation
Introduction
Examination context
Topic List
1 The validity of a contract
2 Offer and acceptance
3 Intention to create legal relations
4 Consideration
5 The terms of the contract
6 Privity of contract
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
1
Introduction
Define a contract
Be aware of factors which might affect the validity of a contract and their consequences
Understand and apply the rules relating to offer, acceptance and the intention to create
legal relations
Understand that contract terms may be express or implied into the contract.
The specific syllabus reference for this chapter is 1a.
Syllabus links
As seen above, the issue of contract formation could be relevant in many different areas of the syllabus,
for example accounting and auditing, employment, business and financial management.
Contracts are also important in assurance; for instance, a key contract is the engagement letter between
the client and the assurance provider.
Examination context
Contract is an important part of the syllabus. Typically seven out of fifty questions relate to contract law.
Understanding the basic precepts relating to contract is vital.
You are likely to be presented with scenarios and may have to conclude whether a valid contract has
been formed. Many cases are referred to in this and later chapters. They will not be examined directly,
but illustrate points of law that could be.
In the assessment, candidates may be required to:
Recognise when a legally binding contract exists between two parties
Understand how a contract may be enforced
2 Law
1 The validity of a contract C
H
A
Section overview P
T
A valid contract is a legally binding agreement, between two parties, which agreement may be E
evidenced by writing, words or action. R
It is almost invariably the case that the two parties to a contract bring with them differing levels of
bargaining power. A contract may be made between a large retail company and an individual for
example. In such cases, the agreement is likely to be in the form of a standard form contract, prepared
by the dominant party and which the other party has no choice but to take or leave.
Generally speaking the law will not wish to restrict or interfere with the ability of contractual parties to
decide whether or not to enter into a contract and, if so, upon what terms ('freedom of contract').
However, it will often intervene where one party seeks an unfair advantage as a result of his superior
bargaining position.
Such intervention will be made by the courts or by legislation. Thus, for example, the Sale of Goods Act
implies terms into a contract which impose obligations on the business seller as to the quality and fitness
for purpose of the goods he sells. Likewise the Consumer Credit Act affords the consumer protection
where he enters into credit agreements. In respect of exclusion clauses, in which typically the stronger
party seeks to avoid liability, the Unfair Contract Terms Act (discussed in Chapter 2) may result in such a
clause being void outright or void if the court considers it to be unreasonable.
You should be aware that the European Commission has published its proposal for a new Common
European Sales Law (CESL). This is intended to be implemented at the end of 2012, notwithstanding
continuing opposition from the UK government. The CESL aims to promote trade between member
states, by creating a harmonised contract law which is designed to apply to cross-border contracts for
the sale of goods, digital content and related services. It will apply only where the parties choose to
adopt it.
In order to be valid, three essential elements of a contract must be shown to be present. These are dealt
with in detail in sections 2 4 below. Suffice it to say here that those elements are
Agreement between the parties
An intention to create legal relations
Consideration
Lack of capacity An individual must be of sound mind and Voidable at the option of the
aged eighteen or over person without capacity
Absence of free will A party should not be made to enter into a Voidable
contract other than by his own free will, ie
not by duress or undue influence
Illegality A contract should not be illegal or offend Void
public policy
Contract formation 3
Rule (in broad terms) Effect of rule not being followed
Void A void contract is not a contract at all. The parties are not bound by it and if they
transfer property under it they can generally recover their goods even from a third
party.
Voidable A voidable contract is a contract which one party may set aside. Property transferred
before avoidance is usually irrecoverable from a third party.
4 Law
Interactive question 1: Essentials of a valid contract [Difficulty level: Easy]
C
What will be the consequences of the following in relation to a purported contract between two parties? H
A
Void Voidable Unenforceable P
T
A There is clear agreement between the parties on all E
terms and they intend to create a legally binding R
agreement but there is no consideration.
B One of the parties is aged 17 1
Section overview
As noted above, the first essential element in the formation of a valid and binding contract is
agreement. This is usually analysed and understood in terms of 'offer' and 'acceptance'.
It is a matter of interpretation whether something amounts to an offer.
There are a number of rules which determine whether an offer has been validly accepted.
Contract formation 5
Worked example: Offer or invitation to treat
Ken offered to sell Leah a flick knife for 20. He also advertised the flick knives in the local newspaper
and put one on display in his shop window with a price tag on it. Will he be liable to prosecution for
'offering for sale' an offensive weapon?
He will be guilty of the offence with regard to his offer to Leah. However, the advertisement and shop
window display are not offers but invitations to treat and do not render him guilty of this offence.
An offer does not have to be made to a particular person. It may be made to a class of persons or to
the world at large.
Carlill v Carbolic Smoke Ball Co 1893
The facts: The manufacturers of a medicinal carbolic smoke ball published an advertisement by
which they undertook to pay '100 reward ... to any person who contracts ... influenza ... after
having used the smoke ball three times daily for two weeks'. The advertisement added that 1,000
had been deposited at a bank 'showing our sincerity in this matter'. Carlill read the advertisement,
purchased the smoke ball and used it as directed. She contracted influenza and claimed her 100
reward.
In their defence the manufacturers argued against this.
The offer was so vague that it could not form the basis of a contract, as no time limit was
specified.
It was not an offer which could be accepted since it was offered to the whole world.
Decision: It was a valid offer capable of acceptance. It was not vague but clear that the smoke ball
must protect the user during the period of use. Further, it was accepted that an offer could be
made to the world at large (by analogy with reward cases where it was accepted that a notice
offering a reward could be accepted by anybody).
You should note that Carlill is an unusual case in that advertisements are not usually regarded as offers.
However, it established the principle that an offer can be made to the world at large and is generally
seen as a landmark case. You should be familiar with it.
6 Law
Interactive question 2: Offer or invitation to treat [Difficulty level: Easy]
C
Bianca sees the following notice in a newspaper: H
A
'20 orthopaedic beds, 100 each' P
How would you describe this notice in terms of contract law? T
E
R
Offer Supply of information
Contract formation 7
Method of termination Consequence
Revocation by the offeror The offeror may revoke his offer at any time before acceptance either
expressly or by implication. Even if he undertakes that his offer shall
remain open for acceptance for a specified time he may nonetheless
revoke it within that time, unless he has bound himself to keep it open by
a separate contract.
Revocation initially takes effect when it is communicated to or received
by the offeree. (Note that the postal rule discussed below applies only to
acceptance and not to revocation of an offer.)
Failure of a pre- condition An offer may be 'conditional' in that it is dependent on some event
occurring or there being a change of circumstances. If that event or
change of circumstances does not occur, the offer is not capable of
acceptance.
2.3 Acceptance
The offeree's response must amount to an unqualified agreement to all the terms of the offer in
order to constitute a valid acceptance. Acceptance may be made by express words to that effect by the
offeree or his authorised agent, or it can be inferred from conduct.
Brogden v Metropolitan Railway Co 1877
The facts: For many years C supplied coal to D. D's agent sent a draft agreement to C for
consideration and the parties applied the terms of the draft agreement to their dealings, but they
never signed a final version. C later denied that there was any agreement between them.
Decision: The conduct of the parties was only explicable on the assumption that they both agreed
to the terms of the draft.
There must be some act on the part of the offeree to indicate his acceptance. An offeror cannot dictate
that his offer shall be deemed to have been accepted unless the offeree actually rejects or accepts it.
Felthouse v Bindley 1862
The facts: C wrote to his nephew offering to buy the nephew's horse, adding 'If I hear no more about
him, I consider the horse mine'. The nephew intended to accept his uncle's offer but did not reply.
Decision: C had no title to the horse as the nephew's silence could not constitute acceptance.
Similarly in Carlill's case (above), once Carlill began using the influenza product, this was a positive act
that constituted acceptance of the offer.
8 Law
Worked example: Offer and acceptance
C
In January Elle offered to buy Jane's boat for 3,000. H
A
Elle's offer of 3,000 is an offer. Many offers are in fact made by prospective buyers rather than by sellers. P
T
Jane immediately wrote a letter to Elle saying 'For a quick sale I would accept 3,500. If not interested
E
please let me know as soon as possible.' R
Jane's letter forms a counter-offer, which has the effect of terminating Elle's offer. Elle may now accept or
reject this counter-offer.
1
Elle did not see the letter until March when she returned from a business trip.
There is nothing to indicate that Jane's (counter-) offer is not still open in March. An offer may be expressed to
last for a specified time. It then expires at the end of that time. If, however, there is no express time limit set,
it expires after a reasonable time. It would not appear that the offer would have lapsed by March.
She then replied. 'I accept your offer. I trust that if I pay 3,000 now, you can wait until June for the
remaining 500.'
Elle's reply, using the words 'I accept your offer,' appears conclusive. However, it is not. The enquiry as to
variation of terms does not constitute acceptance and is more than a request for information. Elle's reply is
probably best analysed as being a new counter-offer including terms as to deferred payment.
On receiving the letter, Jane attached a 'sold' sign on the boat but forgot to reply to Elle.
By affixing a 'sold' sign, it appears that Jane accepts the revised terms as to dates for payment of the
3,500. However, the court would need to decide whether, in all the circumstances, acceptance can be
deemed to have been communicated (we will look at communication in the next section).
Contract formation 9
If the delay is attributable to the offeree's negligence, for example by stating the address
incorrectly, it will not be the case that posting amounts to acceptance.
Use of the post must have been within the contemplation of the parties, which intention can be
deduced from the circumstances and need not be express.
This is often referred to as 'the postal rule' (and applies only to acceptance, not revocation). The postal
rule will not operate where the offeror requires acceptance 'by notice in writing' as the words 'notice in
writing' must mean notice actually received by the offeror.
The law is unclear as to when an acceptance sent by e-mail becomes effective. It is not possible to say
that the communication of acceptance is instantaneous, rather it is likely to be linked to when the
offeror actually saw the e-mail or when he should have read it or might have been expected to read it.
Given the legal uncertainty as to the time of acceptance by e-mail, it is advisable for the terms of an
offer which is made online to make express provision as to the means and timing of acceptance.
Acceptance will only be effective to create agreement where the offeree is aware of the offer. Thus, if A
offers a reward to anyone who finds and returns his property and B, unaware of A's offer, returns the
property, B cannot have 'accepted' A's offer since he was unaware of it and there is no agreement.
Section overview
The intention to create legal relations is the second essential element of a valid contract. It may be
completely obvious but, if not, one of two rebuttable presumptions may be applied.
10 Law
C
The nature of the relationship Presumption
H
between the parties A
P
Social, domestic and family It is presumed that social, domestic and family arrangements are not T
intended to be legally binding unless there is clear evidence which E
points to the contrary. All circumstances will be taken into account, R
including whether husband and wife were separated at the time of
contract, the nature of the relationship between the parties and the
type of contract. For example, if the parties are a husband and wife 1
living apart or if the contract relates to property matters, the
presumption is more likely to be rebutted.
Commercial It is presumed that there is an intention to enter into legal relations
unless this is expressly disclaimed or the circumstances give a clear
contrary indication. It is not easy to rebut this presumption. In
Edwards v Skyways Ltd 1964, where D promised to make an ex gratia
payment to its employee, the argument that the words 'ex gratia'
showed that there was no intention to create legal relations failed.
Care needs to be taken during the negotiation stage as to whether a contract is intended. Use of
the words 'subject to contract' amounts to a strong presumption that no immediately binding
contract is intended.
The facts: A letter of intent set out a draft contract which was not to become effective until signed
and executed by the parties. The contract was not signed but the parties proceeded with the
project of installing two production lines in the claimants factory.
The decision: The Supreme Court held, first, that it was unrealistic to conclude that major works
would have been carried out in the absence of a contract and, secondly, that there was evidence of
an agreement and an intent to create legal relations in this case. The court made it clear that it
would not always be the case, in circumstances where works commence before a contract is
finalised, that the contract that exists between the parties contains the same terms as those in the
negotiated contract. That would be a question of fact in all the circumstances.
Similarly, calling an agreement 'a personal agreement until a fully legalised agreement, drawn up
by a solicitor and embodying all the considerations herewith stated, is signed', was held to be a
binding agreement, notwithstanding that it was obviously intended to be replaced by a more
formal contract at a later date (Branca v Cobarro 1947).
4 Consideration
Section overview
Consideration is the third essential element of a contract. Put simply, it is what each party gives or
agrees to give to the other, usually payment or a promise to do something in return.
Contract formation 11
There are three types of consideration
Executed (valid)
Executory (valid)
Past (generally invalid)
12 Law
It is presumed that each party is capable of serving his own interests, and the courts will not seek to
weigh up the comparative value (or adequacy) of the promises or acts exchanged. C
H
Thomas v Thomas 1842 A
P
The facts: By his will C's husband expressed the wish that his widow should have the use of his T
house during her life. After death, his executors (the defendants), allowed her to do so (a) in E
accordance with her husband's wishes and (b) in return for her undertaking to pay a rent of 1 per R
annum. They later said that their promise to let her occupy the house was not supported by
consideration.
1
Decision: Compliance with the husband's wishes did not constitute valid consideration (since no
economic value attached to it), but the nominal rent was sufficient consideration (even though it
could hardly be said to be adequate).
In order to be sufficient (however inadequate or tenuous), the consideration must contain some element
that can be seen as the price of the other party's promise. If all that is offered is something that the
promisee was bound to do anyway, then there is unlikely to be sufficient consideration. This can be the
case where the promisee is obliged to do something by law or under an existing contract, either with
the promisor or a third party. You should familiarise yourself with the following:
Performance of existing Not consideration unless it can be shown that some extra service over
statutory duty and above the scope of the statutory duty is also being offered.
For example, if someone agrees to pay another a sum of money for
appearing in a court, when that other person has been subpoenaed to
attend in any event, there is no consideration to support the promise to
pay.
Performance of existing Not consideration unless it can be shown that the promisee is actually
contractual duty owed to giving or doing something over and above the scope of the contractual
the promisor obligation. The facts need to be examined closely in each case to see
whether what is being done or offered is actually over and above the
existing contractual (or statutory) duty and also to ensure that the case is
not actually one of duress. It may be enough where the promisor obtains
some extra practical benefit:
Williams v Roffey Bros & Nicholls (Contractors) Ltd 1990
The facts: D subcontracted part of its work refurbishing a block of
flats to C for 20,000. During the works C found itself in financial
difficulties and D promised to pay an extra 10,300 to ensure that
the work was completed on time, but later refused to pay all of the
extra amount.
Decision: D's argument that there was no consideration for the
promise to pay 10,300 failed. It was significant that D's promise
was not made as a result of C's duress or fraud. It was considered
important that D derived the added practical benefit of not having
to engage somebody else to complete the work and also of avoiding
a penalty clause for late performance in his own contract.
Where the question concerns the waiver of all or part of a debt, the
waiver needs to be supported by consideration and the decision in
Williams v Roffey Bros is not likely to be applied (see section 4.4 below).
Performance of existing This can amount to valid consideration. Thus in Scotson v Pegg 1861, C
contractual duty owed to contracted with X to deliver cargo as X directed. X directed C to deliver it
a third party to D. D contracted with C to unload the cargo if C delivered it to D
(which he was already bound to do under his contract with X). It was
held that C's obligation owed to X to deliver the cargo to D was sufficient
consideration for D's promise.
Forbearance or waiver of Forbearance or the promise of it may be sufficient consideration if it has
existing rights some value, or amounts to giving up something of value. For example, A
might agree to forego his right to take action against B in return for B's
promise to A.
Contract formation 13
Worked example: Consideration
A crew of 30 men contracts to sail a ship from Lands End to John O'Groats for 2,000 each. During the
voyage, two crew members desert and the captain promises an additional 500 to the remaining 28 if
they will complete the voyage short-handed. Can this promise be enforced?
Solution
No. The 28 crew members are already contractually bound to complete the voyage and they would be
expected to deal with normal emergencies arising en route. The fact that they have to cover two missing
crew members does not amount to something over and above what they are bound to do anyway.
If, on the other hand, many more had deserted, so as to make the continuation of the voyage
exceptionally hazardous, then their agreement to complete for an extra 500 each would amount to
valid consideration. (Note that the position might be different in each case if it were a case of the
remaining crew members refusing to go further without extra payment.)
14 Law
Interactive question 5: Consideration [Difficulty level: Exam standard]
C
Alice owns a classic car. Alice and Barry are negotiating a deal for Barry to clean the outside of Alices car H
for her before Saturday, when she is lending her car to Claudia for her wedding. Alice will pay 10 and A
allow him to borrow the car on Sunday when Claudia is finished with it. P
T
On Thursday Alice gets mud in the car and therefore when Barry comes on Thursday to clean the car, E
she asks him to clean the inside as well. R
Barry cleans the car and asks for 15 to cover the fact that he cleaned the inside as well as the outside.
Alice refuses to pay Barry extra. She also discovers that she does not have 10 to pay him, only 5. She 1
offers him 5 and a weeks loan of the car in full settlement.
Indicate whether or not each of the following statements is true or false.
Section overview
As a general rule, the parties to a contract may expressly include in the agreement whatever
terms they choose. This is part of the principle of freedom of contract.
Terms may also be implied into the contract by the courts, by statute or by custom.
Contract formation 15
Thus if the person making the statement had special knowledge of the subject, it is more likely the
statement will be treated as a term of the contract. Likewise the courts will asses the significance of
how much time passed between the representation and the making of the contract and why the
contract omitted to incorporate the statement. (If the statement is not treated as a term of the
contract, remedies might lie in misrepresentation but not for breach of contract.)
Oral evidence will not usually be admitted to add to, vary or contradict written terms, unless it can
be shown that the document was not intended to comprise all the agreed terms.
SS Ardennes (Cargo Owners) v SS Ardennes (Owners) 1951
D contracted to take C's cargo of oranges to London 'by any route, directly or indirectly'. D's
agent gave a verbal undertaking that the vessel would sail direct from Spain to London. In fact
the ship went via Antwerp so that the oranges arrived late and a favourable market was
missed. It was held that the verbal undertaking amounted to a warranty and was admissible as
oral evidence to override the written term in the bill of lading.
In a contract entered into online, the general terms and conditions are normally in a standard form and
the other party is required to scroll through them and click accept before making the contract.
Parties to an international contract are well advised to include an express clause which specifies which
countrys law will apply to any dispute arising under its terms (usually called a choice of law or
governing law clause). In the absence of such a provision, the relevant law will be determined in
accordance with the Contracts (Applicable Law) Act 1990 (as amended, in particular to take account of
European regulation Rome I in 2008). (A governing clause may also provide for non-contractual
disputes, although this is less straightforward.)
By reference to custom But not if that would produce an inconsistency with the express terms
By statute For example by the Supply of Goods and Services Act 1982 which
implies terms that work and materials should be of satisfactory quality.
Such implied terms often override any express terms that do not offer as
much protection to the weaker party.
By the courts (1) Necessary to give business efficacy
Terms may be implied if the court concludes that the parties must have
intended those terms to apply to the contract in order to give business
efficacy to the contract.
The Moorcock 1889
The facts: The owners of a wharf agreed that a ship should be
moored alongside to unload its cargo. It was well known that at
low water the ship would ground on the mud at the bottom. At
ebb tide the ship settled on a ridge concealed beneath the mud
and suffered damage.
Decision: It was an implied term that the ground alongside the
wharf was safe at low tide, since both parties knew that the ship
must rest on it.
16 Law
(2) Implicit in the nature of the contract itself
C
The court may also imply a term, not based on the presumed intention H
of the parties, but because it is considered to be implicitly required by A
the nature of the contract used. Such an implied term may form a P
T
precedent for future contracts of the same type and parties will be
E
advised to express clear wording if such an implied term is not required. R
Liverpool City Council v Irwin 1977
The facts: A tenant in a tower block with no formal tenancy
1
agreement withheld rent, alleging that the owner of the block had
breached implied terms because (among other things) the lifts did
not work and the stairs were unlit.
Decision: It was held that since tenants could only occupy the
building with access to stairs and/or lifts, the agreement between
the parties implicitly required implied obligations on the owner's
part to maintain the common parts of the building.
6 Privity of contract
Section overview
As a general rule, only a person who is a party to a contract has enforceable rights or obligations
under it. This is the doctrine of privity of contract.
The Contracts (Rights of Third Parties) Act 1999 has had a fundamental effect on the doctrine.
The law requires that consideration must move from the promisee and only a party to a contract can
enforce it. No-one may be entitled to or bound by the terms of a contract to which he is not a party.
Where A promises B that (for a consideration provided by B) A will confer a benefit on C, then C cannot
as a general rule enforce A's promise since C has given no consideration for it.
There are a number of equitable and statutory exceptions to the privity of contract rule, for example a
person injured in a road accident may claim against the motorist's insurers under the Road Traffic Act
1972. However the two principal exceptions of which you should be aware are as follows:
Where an agent enters into a contract with a third party on behalf of his principal, the resulting
contract is actually enforceable by and between the principal and the third party. The agent cannot
enforce it.
Contract formation 17
The Contracts (Rights of Third Parties) Act 1999 provides that a third party may enforce a term
of the contract provided:
The contract expressly provides that he may; or
The term confers a benefit on him, unless it appears that the contracting parties did not
intend him to have the right to enforce it.
The third party must be expressly identified in the contract by name, class or description, but need
not be in existence when the contract is made (for example, an unborn child or a future spouse).
The Act enables a third party to take advantage of exclusion clauses as well as to enforce 'positive'
rights. The Act does not apply to employment contracts, so, for example, a customer of an
employer cannot use this Act to enforce a term of a contract of employment against an employee.
18 Law
C
Summary and Self-test H
A
P
T
E
R
Summary
Contract formation 19
20 Law
Self-test
C
Answer the following questions. H
A
1 Which one of the contracts below is a standard form contract? P
T
A A document put forward for the customer's signature by a supplier of goods in which pre- E
printed contractual terms are set out R
B A document signed by both parties to a contract in which contractual terms as negotiated
between them are set down
1
C An oral agreement to enter into relations on the basis of terms as agreed following
negotiations between the parties
D An oral agreement between two parties who have negotiated terms regarding the standards
of performance to be met by each party in the main contract
2 A new Common European Sales Law has been proposed and will be mandatory in all cross-border
contracts..
True
False
3 A valid contract is a legally binding agreement. The three essential elements of a contract are
(1) ........................................ (2) ........................................ and (3) ........................................ .
4 A voidable contract is not a contract at all.
True
False
(a) Voidable (1) The contract is valid but the parties cannot be
held to its terms
(b) Unenforceable (2) Neither party is bound
(c) Void (3) The contract is binding unless and until one party
chooses to avoid it
Offer Tender
Invitation to treat Auction
7 Fill in the blanks in the statements below, using the words in the box.
As a general rule, acceptance must be (1) ........................................ to the (2)
........................................ and is not effective until this has been done.
An (3) ........................................ is a definite promise to be bound on specific terms, and
must be distinguished from a supply of (4) ........................................ and from an (5)
........................................
A counter-offer counts as (6) ........................................ of the original offer.
Contract formation 21
8 Advertising an auction is an offer to sell.
True
False
9 Give three examples of situations likely to be invitations to treat.
.........................................................................................................................................................
.........................................................................................................................................................
.........................................................................................................................................................
10 As a general rule, silence cannot constitute acceptance.
True
False
11 Define the postal rule.
12 Give four instances when an offer is terminated.
13 Distinguish between executed and executory consideration.
14 Past consideration, as a general rule, is not sufficient to make a promise binding.
True
False
15 Consideration need not be (1) ........................................ but it must be (2)
........................................ .
16 A promise of additional reward for existing duties is not generally binding.
True
False
17 In the context of contractual considerations, payment of a lesser sum cannot be satisfaction for the
whole sum unless something is added to it, such as earlier payment, or payment by a different
method.
True
False
18 What is the name of the express clause typically incorporated into an international contract and
which specifies which countrys law will apply to any dispute under it?
......................................................
Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.
22 Law
C
Answers to Interactive questions H
A
P
T
Answer to Interactive question 1 E
R
A Void
B Voidable
C Void 1
D Unenforceable
Contract formation 23
Answers to Self-test
1 A
2 False. The proposed Common European Sales Law is intended to be voluntary and apply to sales
of goods, digital content and related services only.
3 Offer and acceptance, consideration, intention to create legal relations
4 False
5 Voidable (3)
Unenforceable (1)
Void (2)
6 Invitation to treat
7 (1) communicated (2) offeror (3) offer (4) information (5) invitation to treat (6) rejection
8 False. It is merely a statement of intention.
9 Advertisements
Exhibition of goods for sale
Circulation of a price list
10 True
11 The postal rule states that, where the use of the post is within the contemplation of both the
parties, the acceptance is complete and effective as soon as a letter is posted, even though it may
be delayed or even lost altogether in the post.
12 Rejection
Lapse of time
Revocation by the offeror
Failure of a condition to which the offer was subject
Counter-offer
13 Executed consideration is an act in return for a promise, such as paying for goods when the
shopkeeper hands them over. Executory consideration is a promise given for a promise, such as
promising to pay for goods that the shopkeeper puts on order for you.
14 True
15 (1) adequate (2) sufficient
16 True
17 True
18 Governing law clause or
Choice of law clause
24 Law
CHAPTER 2
Termination of contract
Introduction
Examination context
Topic List
1 Discharge of the contract
2 Remedies
3 Exclusion clauses in contracts
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
25
Introduction
Recognise when a contract can be said to have been frustrated and understand the
consequences of frustration
Be aware of alternative contractual remedies and the circumstances in which they might
be awarded
Recognise an exclusion clause and understand how it might be affected by the Unfair
Contract Terms Act
Specific syllabus references for this chapter are: 1a, b.
Syllabus links
You will have learnt about liabilities and provisions in your accounting paper. It is helpful to see how, in
practice, such liabilities of companies might arise.
Examination context
You should expect several questions on contract termination. They are likely to be a mixture of
application 'scenario' questions and definition questions.
In the assessment, candidates may be required to:
Identify the circumstances under which a contract can be terminated
Identify possible remedies for breach of contract
Recognise an exclusion clause and assess whether it is effective
26 Law
1 Discharge of the contract
Section overview
A contract is usually discharged by performance of the parties' obligations contained in the
contract.
Events may take place which make performance of the contract impossible or meaningless,
thereby discharging the contract by frustration.
In the absence of frustration (or other lawful excuse), non-performance will constitute breach of
the contract.
C
H
A
1.1 Performance P
Performance is the normal method of discharge of a contract: each party fulfils or performs his T
E
contractual obligations and the agreement is then ended. Although it is commonly said that complete
R
and exact performance of all the contract terms is required to discharge the contract, in fact the courts
will apply an important qualification to this rule. This is that so long as there is substantial performance
of a party's contractual obligations, that will be a sufficient discharge, although the other party will be
2
entitled to seek redress for that part of the performance that did not completely and exactly match the
contract terms.
While partial performance cannot discharge the contract as a whole, most contracts are treated as
'severable' which means that they consist of a number of obligations and can be 'severed' or discharged
through performance of only part of those obligations, leaving the remaining obligations to be
performed. For example, employment contracts usually provide for payment each week or month and
building contracts usually provide for payment at various stages of the contractor's progress. Each of
these payment dates or stages represents a point at which the contract can be severed or, effectively,
divided into smaller contracts.
If one party prevents performance, the offer of performance by the other party is sufficient discharge of
his obligations and he will be entitled to sue for damages for breach of contract, or alternatively bring a
quantum meruit (literally 'as much as he deserved') action to claim for the amount of work already
completed.
Planch v Colburn 1831
The facts: C had agreed to write a book on costumes and armour for D's 'Juvenile Library' series. He
was to receive 100 on completion. He did some research and wrote part of the book. D then
abandoned the series.
Decision: C was entitled to 50 guineas as reasonable remuneration on a quantum meruit basis.
Lawrence is not entitled to payment since he has not performed his obligations completely and
exactly.
Lawrence is entitled to receive the full contract price since he has substantially performed his part
of the contract.
Lawrence is entitled to receive the contract price less a reasonable deduction for the defects and
omissions.
Termination of contract 27
1.2 Discharge by frustration
If it is impossible to perform the contract when it is made, there is usually no contract at all. In respect
of impossibility arising after the contract has been made, the parties are free to negotiate escape clauses
or force majeure clauses (for example in respect of adverse weather or strike action in a building
contract) which will prevail if the anticipated impossibility arises.
However if, after the contract is made, performance or further performance of the contract is rendered
impossible or totally futile by some extraneous cause, for which neither party is responsible (and for
which the contract makes no provision), then the contract will be treated as discharged by frustration.
A contract will not be discharged where another mode of performance is still possible, even if that way
is more expensive and/or more difficult.
The following are examples of events or changes in circumstances where contracts have been frustrated:
Example
Destruction of the subject A hall was let to a musician for a series of concerts but before the
matter date of the first concert, the hall was accidentally destroyed by fire
(Taylor v Caldwell 1863).
Personal incapacity to perform a A drummer was contracted to perform seven nights a week in a
contract of personal service pop group. Due to ill-health the drummer was only able to
perform four nights a week (Condor v Barron Knights 1966).
Government intervention Where an outbreak of war or new legislation rendered further
performance of the contract illegal.
Non-occurrence of an event A room was let for the sole purpose of overlooking the coronation
which is the sole purpose of the procession of a King, whose illness caused the procession to be
contract postponed (Krell v Henry 1903).
(Note that the contract would not have been frustrated if the room
had been let for several days or for some other purpose also).
28 Law
Interactive question 2: Frustration of contract [Difficulty level: Easy]
Which of the following is not a correct statement of the law relating to frustration of contract?
A Parties are discharged from their contract if altered circumstances render the contract
fundamentally different in nature from what was originally agreed.
B Parties are discharged if an event, for which neither party is responsible, occurs which
renders performance impossible or futile.
C Parties who contract that something should be done are discharged if performance
becomes substantially more expensive or onerous.
D Parties who contract that something should be done are discharged if their assumption
that certain conditions (which are fundamental to the contract), would continue, proves C
to be totally false. H
A
See Answer at the end of this chapter. P
T
E
R
Termination of contract 29
If the innocent party elects to treat the contract as discharged, he must notify the other party of his
decision. This may be by way of refusal to accept further performance or refusal to perform his own
obligations. In this situation, the following applies:
He is not discharged from the contractual obligations which were due at the time of termination, but he
is discharged from his future or continuing contractual obligations and cannot be sued on them.
He need not accept nor pay for further performance.
He may be able to refuse to pay for partial or defective performance already received, unless the
contract is severable.
He can reclaim money already paid in respect of defective performance.
He can still claim damages from the defaulter.
2 Remedies
Section overview
Contractual disputes may be resolved by civil litigation in the courts or by other means.
Damages are the main remedy awarded by the courts for breach of contract and are designed to
compensate the claimant by putting him in the position he would have been in, if the contract
had been performed.
In some cases, a more appropriate remedy might be awarded, such as specific performance or an
injunction.
In this section, you will learn about the remedies available in the courts in an action for breach of
contract. However, you should be aware that the majority of contractual disputes will not reach the
courts and may be resolved by negotiation, arbitration or some other means such as mediation,
adjudication or expert determination. These alternatives to litigation are usually referred to as
alternative dispute resolution (or ADR) and are actively encouraged by the courts, even once court
proceedings have been commenced.
2.1 Damages
In a claim for damages the first issue is remoteness of damage. Here the courts consider how far down
the sequence of cause and effect the consequences of breach should be traced before they should be
ignored.
Under the rule in Hadley v Baxendale (see below) damages may only be awarded in respect of those
losses which may fairly and reasonably be considered as, either:
Arising naturally (ie according to the usual course of things) from such breach of contract, or
Such as may reasonably be supposed to have been in the contemplation of both parties, at the
time of making the contract, as the probable result of the breach.
Hadley v Baxendale 1854
The facts: C owned a mill at Gloucester. When the main crank shaft had broken, C made a
contract with D for the transport of the broken shaft to Greenwich to serve as a pattern for
making a new shaft. Owing to D's neglect, delivery was delayed and the mill was out of action
for a longer period. D did not know that the mill would be idle during this interval, simply that
he had to transport a broken millshaft. C claimed for loss of profits of the mill during the period
of delay.
Decision: Although D's failure to perform the contract promptly was the direct cause of the
stoppage of the mill for an unnecessarily long time, the claim must fail since it was not a
natural consequence of delay in transport of a broken shaft, that the mill would be out of
action (the miller might have a spare for example) and D did not know that that would be the
result.
30 Law
If the defendant can show that the chain of causation was broken and that the claimant had, in fact,
caused the loss, the defendant will not be liable. This is a question of fact, but if the claimant is unaware
of the breach, it is likely that only recklessness on his part would break the chain of causation (Borealis AB
v Geogas Trading SA 2010).
If the losses are exceptional or abnormal and not reasonably foreseeable, the defendant will be liable
only if he knew (at the time of the contract) of the special circumstances from which the abnormal
consequence of breach could arise.
Victoria Laundry (Windsor) v Newman Industries 1949
The facts: D contracted to sell a large boiler to C 'for immediate use' in their business of launderers
and dyers but were late delivering it. D was aware of the nature of C's business and had been
informed that C was most anxious to put the boiler into use in the shortest possible space of time.
C claimed damages for normal loss of profits for the period of delay and for loss of abnormal profits C
from losing 'highly lucrative' dyeing contracts which would have been undertaken, if the boiler had H
A
been delivered on time.
P
Decision: Damages for loss of normal profits were recoverable since, in the circumstances, failure to T
E
deliver major industrial equipment ordered for immediate use would be expected to prevent
R
operation of the plant. The claim for loss of special profits failed because D had no knowledge of
the dyeing contracts.
2
Interactive question 3: Remoteness of damage [Difficulty level: Exam standard]
Louise runs a homemade cake business. Cook & Co contract to sell her a large industrial oven to enable
her to expand her business by enabling her to increase cake production. Louise tells Cook & Co that she
has also been awarded a contract to bake 100 jacket potatoes daily during November and December
for a local street fair in the run up to Christmas and so needs the oven by 31 October. Cook & Co agree
to deliver the oven by 28 October. Unknown to Cook & Co, Louise has also agreed to allow Bob the
Baker to use the oven on Fridays (her day off) so that he can meet his extra customer demands over the
weekends.
Owing to a dispute between the manufacturer and Cook & Co, the oven is not delivered to Louise until
12 November. Louise is therefore unable to fulfil the jacket potatoes contract and also is unable to
increase cake production as planned. She has also lost the hire payment agreed by Bob in respect of two
Fridays.
Which one of the following statements best describes the legal position of Cook & Co?
A Cook & Co could not be expected to know that Louise would not have access to a
replacement oven and will not have to pay damages as a consequence
B Cook & Co were aware of the jacket potatoes contract and so are liable for that loss but
not for Louise's other losses as they were not known
C Cook & Co is liable for all Louise's losses since they were all in the course of her business
D Cook & Co are not liable for the loss due to the agreement with Bob but will be liable in
respect of the other losses.
The second issue to be considered is how much money (what 'measure of damages') is needed to put
the claimant in the position he would have achieved if the contract had been performed. This is
sometimes referred to as protecting the expectation interest of the claimant. A claimant may
alternatively seek to have his reliance interest protected; this refers to the position he would have been
in had he not relied on the contract. In such cases, he is claiming for wasted expenditure and the onus is
on the defendant to show that the expenditure would not have been recovered if the contract had been
performed.
Termination of contract 31
Anglia Television Ltd v Reed 1972
The facts: C engaged an actor to appear in a film they were making for television. He pulled out at
the last moment and the project was abandoned. C claimed the preparatory expenditure, such as
hiring other actors and researching suitable locations.
Decision: Damages were awarded as claimed. It is impossible to tell whether an unmade film will be
a success or a failure and, had C claimed for loss of profits, they would not have succeeded.
In a recent case, the court confirmed that a claim for wasted expenditure was also subject to the general
principle that an award of damages should not put a claimant in a better position than he would have
been in if the contract had been performed. Reliance damages will not be awarded regardless of the
anticipated profit to be made by the claimant, but would only be awarded where his gross profits were
likely to exceed his expenditure (Omak Maritime Ltd v Mamola Challenger Shipping Co 2010).
Generally speaking, damages will only be awarded for actual financial loss. In vary rare cases, damages
have been recovered for mental distress where that is the main result of the breach. It is uncertain how
far the courts will develop this concept.
Jarvis v Swan Tours 1973
The facts: C entered into a contract for holiday accommodation at a winter sports centre. What was
provided was significantly inferior to the description given in D's brochure. Damages on the basis of
financial loss only were assessed at 32.
Decision: The damages should be increased to 125 to compensate for disappointment and distress
because the principal purpose of the contract was the giving of pleasure.
Mitigation of loss
In assessing the amount of damages, it is assumed that the claimant will take all reasonable steps to
reduce or mitigate his loss. He is not required, however, to take discreditable or risky measures as these
are not 'reasonable'. The burden of proof is on the defendant to show that the claimant failed to take a
reasonable opportunity of mitigation.
Payzu Ltd v Saunders 1919
The facts: The parties had entered into a contract for the supply of goods to be delivered and paid
for by instalments. When C failed to pay for the first instalment on the due date, D declined to
make further deliveries unless C paid cash in advance with their orders. C refused to accept delivery
on those terms. The price of the goods rose, and they sued for breach of contract.
Decision: D had no right to repudiate the original contract, and was therefore liable in damages.
However, C should have mitigated their loss by accepting D's offer of delivery against cash
payment. Damages were limited to the amount of their assumed loss, had C paid in advance, ie
interest over the period of pre-payment. The judge commented that 'in commercial contracts, it is
generally reasonable to accept an offer from the party in default'.
Nothing 6,000
5,500 7,000
32 Law
Such a clause will be effective provided it is considered to be a genuine attempt to pre-estimate the
likely loss. This will be a question of fact. If the sum is arbitrary or excessive, it will be construed as a
penalty clause and will not be enforceable.
Ford Motor Co (England) Ltd v Armstrong 1915
The facts: D had undertaken not to sell C's cars below list price, not to sell Ford cars to other dealers
and not to exhibit any Ford cars without permission. A 250 penalty was payable for each breach
as being the agreed loss which C would sustain.
Decision: Since the same sum was payable for different kinds of loss and was considered to be
arbitrary and excessive, it was not a genuine pre-estimate of loss. It was therefore in the nature of a
penalty and unenforceable.
In Hall v Van Der Heiden 2010, on the other hand, a provision for liquidated damages of 700 per
C
week was enforceable where a contractor failed to complete refurbishment works to the claimants H
flat. The sum was considered to be a genuine pre-estimate of loss, which took into account the A
cost of alternative accommodation and could not be described as a penalty. P
T
E
Worked example: Liquidated damages R
Edith and Furaha are negotiating the terms of a contract whereby Furaha is fitting out Edith's shop.
Edith is due to open on 1 June and she has calculated that, if the shop opens late, she will lose 400 a 2
day. She therefore wants to include a clause in the contract stating that if Furaha overruns, she will pay
Edith damages of 400 per day. As this is a genuine pre-estimate of loss, it is likely that this would be
construed as an enforceable provision for liquidated damages.
2.4 Injunction
There are three types of injunction that can be granted in the court's discretion:
A mandatory injunction which is restorative in its effect. It directs the defendant to take positive
steps to undo something he has already done in breach of contract, for example to demolish a
building that he has erected in breach of contract. This is a relatively rare remedy and will only be
granted where it will produce a fair result in all the circumstances.
A prohibitory injunction which requires the defendant to observe a negative promise in a
contract.
Note that where a person enters into a contract to perform personal services for A and not to
perform them for B, an injunction may be given to enforce the negative promise, even though an
order of specific performance for the positive promise would be refused.
An asset-freezing injunction prevents the defendant from dealing with assets where the claimant
can convince the court that he has a good case and that there is a danger of the defendant's assets
being exported or dissipated.
Termination of contract 33
Worked example: Injunctions
Sophia agreed to sing at Andrew's theatre for six months and not to sing at Tim's theatre during that
period. After a few weeks, Sophia began to give three matinee performances each week at Tim's theatre.
Andrew wants to sue her for breach of contract.
Andrew would be entitled to damages. In addition he should consider seeking a prohibitory injunction,
restricting Sophia from performing at Tim's theatre, ie enforcing her promise not to do so.
(Note that had the contract stipulated that Sophia should only work for Andrew and not for anybody
else in any capacity whatsoever, an injunction would not be granted, even of the negative promise,
because that would result in her being compelled to work for him or otherwise abandon her livelihood
and starve.)
Section overview
An exclusion clause in a contract is one which purports to restrict or exclude liability for breach of
contract or negligence.
An exclusion clause must have been properly incorporated in the contract if it is to be effective.
It will be interpreted strictly against the party seeking to rely on it.
An exclusion clause in a standard form or consumer contract may be rendered void or subject to a
test of reasonableness by the Unfair Contract Terms Act 1977.
It is often the case that when a party sues the other for breach of contract, the defaulting party will
claim that his liability for breach has been restricted or excluded altogether by an exclusion clause
contained in the contract. Such clauses are very common in standard form contracts. (A standard form
contract is a contract that has been prepared by one of the parties on its written standard terms of
business, rather than one where the terms have been individually negotiated and agreed by the parties.)
34 Law
Interactive question 5: Exclusion clause [Difficulty level: Easy]
Natasha hires a car from a car rental company. On arrival at their office she is given a form, which
includes terms and conditions in small print on the back, and asked to sign it. She does so and pays the
hire charge. When she gets into the car, she happens to look in the glove compartment and sees a
document headed 'Limitation of Liability'. This states that the hire company will not be liable for any
injury caused by a defect in the car unless this is as a result of the company's negligence. While Natasha
is driving on the motorway, the airbag inflates and causes her to crash. She is badly injured. Which of
the following is correct?
Natasha's claim will be valid as she signed the form containing terms and conditions.
The claim will be invalid because the liability notice was in the car.
It is unclear whether the claim will be valid because the notice in the car may have been reinforcing C
the terms and conditions Natasha signed. H
A
See Answer at the end of this chapter. P
T
E
Once an exclusion clause can be shown to be an incorporated term, the courts will interpret any R
ambiguity in the clause against the person who relies on the exclusion.
Basically, the clause must cover the breach complained of. For example, a clause excluding liability for
'damage caused by fire' might be interpreted to mean only accidental fire and not fire caused by the 2
person's negligence.
The following case illustrates the point:
Photo Productions v Securicor Transport 1980
The facts: D agreed to guard C's factory under a contract by which D was excluded from liability for
damage caused by any of their employees. One of the guards deliberately started a small fire which
destroyed the factory and contents. It was contended that D had entirely failed to perform their
contract and so they could not rely on any exclusion clause in the contract.
Decision: There is no principle that total failure to perform a contract deprives the party at fault of
any exclusion from liability provided by the contract. In this case the exclusion clause was drawn
widely enough to cover the damage which had happened.
Termination of contract 35
Any clause that attempts to limit liability for breach of contract, where the contract is based on
standard terms or conditions, and/or where the party against whom the exclusion clause is being
used is a consumer, is void unless it can be shown to be reasonable. (In respect of contracts
between businesses, note that such exclusion clauses in bespoke contracts (ie ones where the key
terms are individually negotiated and drawn up by the parties) will be enforced as written,
provided they are properly incorporated.)
UCTA defines a consumer as someone who neither makes (nor holds himself out as making) the
contract in the course of a business, where the other party does make the contract in the course of a
business. Note that UCTA does not just operate to protect consumers; businesses may also benefit from
its provisions.
Where the statutory test of reasonableness applies, the term must be fair and reasonable having
regard to all the circumstances which were, or which ought to have been, known to the parties when
the contract was made. The burden of proving reasonableness lies on the person seeking to rely on the
clause. Statutory guidelines have been included in the Act to assist the determination of reasonableness.
By way of example, reasonableness will depend on factors such as the relative strength of the parties'
bargaining positions, whether any inducement was offered and whether the innocent party knew or
should have known of the term. In addition, the courts have considered other matters to be significant,
such as whether insurance was in place or available to the party relying on the clause and whether any
misrepresentations were made. Where the parties are of equal bargaining strength, the courts will be
reluctant to hold the exclusion clause to be unfair or unreasonable and invalid.
The Unfair Terms in Consumer Contracts Regulations 1999 provide further statutory control in
respect of consumer contracts and, in particular, terms which have not been individually negotiated.
They provide that an 'unfair term' may be declared to be void. Unlike UCTA, the Regulations only
protect individuals, not companies. You will not be examined on the Regulations.
36 Law
Summary and Self-test
Summary
C
H
A
P
T
E
R
Termination of contract 37
Self-test
Answer the following questions.
1 Which of the following is not a lawful excuse not to perform contractual obligations?
A The contract has been discharged though frustration.
B The parties have by agreement permitted non-performance.
C One party has made it impossible for the other party to perform.
D Performance has become substantially more expensive than was originally anticipated.
2 Fill in the blanks in the statements below, using the words in the box.
(1) ........................................ are a (2) ........................................ remedy designed to restore
the injured party to the position he would have been in had the contract been (3)
........................................
A loss outside the natural course of events will only be compensated if the (4)
........................................ circumstances are within the (5) ........................................ 's
knowledge at the time of making the contract.
In assessing the extent of recoverable losses, the (6) ........................................ is expected to
(7) ........................................ his loss.
A contractual term designed as a (8) ........................................ is (9)
........................................ .
3 If a party is prevented from completing performance of his obligation by the other party, he may
bring a ........................................ action to claim for the amount of work already done.
4 Name three types of event or change in current circumstances which will give rise to a contract
being frustrated.
(1) ...................................................................................................................................................
(2) ...................................................................................................................................................
(3) ...................................................................................................................................................
5 When a contract is frustrated, under the Law Reform (Frustrated Contracts) Act 1943, any monies
paid to the other party prior to frustration can be recovered but expenses incurred by that other
party cannot be recovered or offset.
True
False
6 A claimant must do all that he can to reduce the amount of the loss he suffers.
True
False
7 When anticipatory breach occurs, the injured party has two options. These are to:
(1) ...................................................................................................................................................
(2) ...................................................................................................................................................
38 Law
8 Name two types of Alternative Dispute Resolution (other than negotiation).
........................................
........................................
9 What is the rule set out in Hadley v Baxendale concerning remoteness of damage?
10 The amount awarded as damages is what is needed to put the claimant in the position he would
have achieved if the contract had been performed. What interest is being protected here?
Expectation
Reliance
C
H
11 A court will never enforce a liquidated damages clause, as any attempt to prevent the injured party
A
from pursuing a remedy through the courts is void. P
T
True E
R
False
12 Will a clause in a standard form contract which excludes or restricts liability for the following be
2
rendered void or subject to the reasonableness test under UCTA?
Void Test
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
Termination of contract 39
Answers to Interactive questions
40 Law
Answers to Self-test
Termination of contract 41
42 Law
CHAPTER 3
Agency
Introduction
Examination context
Topic List
1 Agency and agents
2 Creation of agency
3 Duties and rights of an agent
4 Authority of the agent
5 Liability of the parties
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
43
Introduction
Recognise the authority an agent has to enter contracts and instances where they may be
liable under them
Specific syllabus references for this chapter are: 1c, d, e.
Syllabus links
As outlined above, agency is the basis of partnership which we will go on to look at later in this syllabus.
Examination context
This is an important area for your exam. The sample paper contained five questions on agency law. It is
likely to be examined in the context of partnerships.
In the assessment, candidates may be required to:
Identify the methods by which agency can be created
Identify the rights and duties of agents
Recognise the authority an agent has to enter into contracts on behalf of a principal, including
actual and ostensible authority
44 Law
1 Agency and agents
Section overview
Agency is a very important feature of modern commercial life and describes the relationship that
exists where one party, the agent, acts on behalf of another, the principal.
We are concerned with the law of agency in so far as it relates to the agent purporting to enter
into a contract with a third party, on behalf of the principal.
The basic principles of agency are relevant to the actions and liabilities of (among others) partners
and company directors.
Where an agency relationships exists, the agent, by entering into a contract, establishes privity of
contract between the principal and the third party. The contract is thus enforceable both by and against
the principal and third party. Generally speaking, the agent effectively drops out of the picture and has
no rights or liabilities in respect of it, provided he has acted within his authority. It is as if the principal
had made the contract himself in the first place. The questions of authority and liability are addressed in
sections 4 and 5 below.
Section 2 describes the various ways in which an agency relationship may come into existence. The
question sometimes arises whether someone has acted as an agent or as an independent contractor in
his own right. For example, there are conflicting views (and much will depend on the circumstances) in
the case of a dealer who sells goods to a finance company which then lets them on hire-purchase: to
what extent is the dealer the agent of the finance company? (The test of whether someone is an C
employee or independent contractor in relation to employment law is considered in Chapter 11.) H
Similarly, there may be ambiguity over which party is the principal, for example in the case of someone A
P
employed by an insurance company to solicit business: is he always the agent of the insurance company
T
or can he sometimes be said to be the agent of the insured? E
R
In practice, there are many examples of agency relationships to which you are probably accustomed,
such as estate agents and travel agents. For the purposes of this course, you should appreciate, in
particular, how a director may be held to be an agent of the company and bind the company by his
3
acts and also how a partner is an agent of the partnership and may bind the firm by his acts. Directors'
authority is discussed in more detail in Chapter 6 and partnerships in Chapter 9.
2 Creation of agency
Section overview
The agency relationship is created either by mutual consent or by operation of law or by
ratification.
Express agency is created when the principal expressly appoints someone as his agent, but an
agency relationship can also be implied by the conduct of the parties.
The law may deem that an 'agency of necessity' is created in particular circumstances.
The law may provide that an ostensible or apparent agency relationship is created if the principal
holds out to a third party that the agent's authority is greater than it actually is.
Agency can be created retrospectively, through ratification of the contract.
The agent does not form contracts with third parties on his own behalf and so it is not necessary that he
has full contractual capacity. The principal, however, must have full contractual capacity.
Agency 45
2.1 Agency by consent
Consent may be express or implied. An agency can be expressly created either orally or in writing. There
is only one exception to this, which is that if the agent is to execute a deed on the principal's behalf (for
example a conveyance of land or a lease exceeding three years) then the agency must be created by
deed. Essentially this means that the agent is given a power of attorney. In commercial transactions it
is usual (but not essential) to appoint an agent in writing, so that the terms and extent of the
relationship are set down to avoid misunderstanding.
46 Law
An illustrative case is Sachs v Miklos 1948:
The facts: D agreed to store C's furniture. After a considerable time had elapsed D needed the
storage space for his own use. Unable to trace C, he sold the furniture and C sued him for
conversion. D pleaded agency of necessity in making the sale.
Decision: There was no agency of necessity since no emergency had arisen and D had sold the
furniture for his own convenience. If D's house had been destroyed by fire and the furniture left in
the open, then he would then be justified in selling it.
It is fair to say that modern day telecommunications may prevent an agent of necessity from arising very
often.
2.4 Ratification
In certain circumstances the relationship of principal and agent can be created or extended with
retrospective effect, that is, once the contract has been entered into by the agent and third party.
Ratification only validates past acts of the purported agent. It gives no authority for the future.
Thus, where A makes a contract on behalf of P at a time when A has no authority from P, P may later
ratify the contract. This will have the retrospective effect of establishing an agency as at the time the
contract was made. All parties are then in the same position as if the principal had been the original
contracting party, ie the principal may sue or be sued by the third party and the agent no longer has
any liability.
The principal may only ratify if the following conditions are satisfied:
The principal must have been in existence at the time of the agent's act. C
H
The principal must have the legal capacity to make the contract himself, both at the time the act A
was carried out and at the time of the purported ratification. P
T
The agent must, at the time of making the contract, either name or sufficiently identify the E
principal on whose behalf he is making the contract. R
The principal must ratify the contract within a reasonable time and a ratification of part of the contract
will operate as a ratification of the entire contract (ie the principal cannot just select such parts of the
3
contract as he considers to be to his advantage). In order to ratify the contract, the principal must
communicate a sufficiently clear intention of ratifying, either by express words or by conduct, such as
refusing to return goods purchased for him by an agent who lacked authority. Mere passive inactivity
will not amount to ratification.
The principal must exist at the time of the contract. Clearly Esther does exist.
The principal must have legal capacity. There is no indication to the contrary.
The agent must name or sufficiently identify the There appears to be no reason why David wouldnt
principal. tell Farouk that he is acting on behalf of Esther.
Therefore, David can go ahead and make the contract with Farouk for Esther to ratify later, if Farouk is
happy to contract with Esther. If Esther does not want the goods, she will not ratify the contract.
Agency 47
Interactive question 1: Creation of agency [Difficulty level: Easy]
A valid agency relationship can be created by:
Yes No
A Law, if it is a necessity
B Ratification
Section overview
The agent owes a number of duties to the principal.
The agent also has a number of rights.
The courts have always sought to ensure that a person does not abuse the confidence of another for
whom he is acting.
'The position of principal and agent gives rise to particular and onerous duties on the part of the
agent, and the high standard of conduct required from him springs from the fiduciary
relationship between his employer and himself. His position is confidential; it readily lends itself to
abuse. A strict and salutary rule is required to meet the special situation.' (Armstrong v Jackson
1917)
When an agent agrees to perform services for his principal for reward there is a contract between them.
However, even if the agent undertakes his duties without reward (but provided there is some
consideration to make the contract valid), he has obligations to his principal.
The law implies the following duties into any contract of agency:
Duties Explanation
Accountability An agent must provide full information to his principal of his agency transactions
and account to him for all monies arising from them.
If he accepts from the other party any commission or reward as an inducement
to make the contract with him, it is considered to be a bribe and the contract is
fraudulent. The principal who discovers that his agent has accepted a bribe may
dismiss the agent and recover the amount of the bribe from him.
Boston Deep Sea Fishing & Ice Co v Ansell 1888
The facts: A, who was managing director of the claimant company,
accepted commissions from suppliers on orders which he placed with them
for goods supplied to the company. He was dismissed and the company
sued to recover from him the commissions.
Decision: The company was justified in dismissing A and he must account to
it for the commissions.
No conflict of The agent owes to his principal a duty not to put himself in a situation where his
interest own interests conflict with those of the principal.
48 Law
Duties Explanation
Performance The agent who agrees to act as agent for reward has a contractual obligation to
perform his agreed task. (An unpaid agent is not bound to carry out his agreed
duties unless there is other consideration.) Any agent may refuse to perform an
illegal act.
Obedience The agent must act strictly in accordance with his principal's instructions insofar
as these are lawful and reasonable. Even if he believes disobedience to be in his
principal's best interests, he may not disobey instructions (unless he is asked to
commit an illegal or unreasonable act).
Skill An agent undertakes to maintain the standard of skill and care to be expected of
a person in his profession.
Personal The agent is usually selected because of his personal qualities and owes a duty to
performance perform his task himself and not to delegate it to another. (However he may
delegate in certain circumstances, for example a solicitor acting for a client
would be obliged to instruct a stockbroker to buy or sell listed securities on the
Stock Exchange.)
Confidence The agent must keep in confidence what he knows of his principal's affairs even
after the agency relationship has ceased.
Conversely, an agent has the following rights (or duties owed by the principal):
Agent Principal
Agency 49
4 Authority of the agent
Section overview
An agent's authority may be
Expressly given
Impliedly given
Ostensible or apparent on the basis of the principal's conduct.
The contract made by the agent is binding on the principal and the other party only if the agent was
acting within the limits of his authority from his principal. In analysing the limits of an agent's
authority, three distinct sources of authority can be identified:
Actual express authority
Actual implied authority
Ostensible or apparent authority
The extent of the agent's express authority will depend on the construction of the words used on his
appointment. If the appointment is in writing, then the document will need to be examined. If it is oral,
then the scope of the agent's authority will be a matter of evidence.
50 Law
Note that incidental authority and usual authority are implied because they are not expressly stated but
they are still part of an agent's actual authority.
Agency 51
The representation must be made to the third party and it must be shown that the third party relied
on the representation. If there is no causal link between the third party's loss and his reliance upon the
representation, the third party will not be able to hold the principal liable.
Where a principal has represented to a third party that an agent has authority to act but subsequently
revokes the agent's authority, he will not escape liability. The principal should inform third parties who
have previously dealt with the agent of the change in circumstances. This is particularly relevant to
partnerships and the position when a partner leaves a partnership.
True False
Section overview
As mentioned earlier, generally speaking, a contract entered into by an agent and a third party
binds the principal and the third party but not the agent, who effectively drops out of the picture.
There are, however, instances where this general rule will not apply and these are noted in this
section.
52 Law
There are particular circumstances where the agent might incur personal liability:
Under rules of trade usage
Where he adds his name as party to a negotiable instrument (depending on the facts)
Where he makes a contract under seal, unless he does so as trustee for the principal or unless the
law provides otherwise (for example, in the case of powers of attorney).
5.2 Where the agent has authority, but is not known to be an agent
In these cases, where a principal becomes known at a later date:
Either the agent or the principal may sue on the contract (but the agent's rights are subordinate to
the principal's) and
Either the agent or the principal may be sued on the contract (but the third party must choose
which one).
These rules will only apply where the agent's authority existed at the time of making the contract and
the contract cannot be said to have been intended to operate only between the contracting parties (on
the basis of their express or implied intentions).
Agency 53
Summary and Self-test
Summary
Rights Indemnity
Remuneration ('reasonable' if unspecified)
Lien
Duties Account for benefits (no bribes)
Avoid conflict
Perform task, not delegate
Obedience
Skill and care
Respect confidences
54 Law
Self-test
Answer the following questions.
1 Fill in the blanks using the words in the boxes below.
. is the. which exists between two
persons, the ...and the agent, in which the function of the agent is to form a
.. between his . and a .
True
3
False
5 What is the best definition of ostensible authority?
(a) The authority which the principal represents to other persons he has given to the agent.
(b) The authority implied to other persons by the agent's actions.
6 An agent may disobey the instructions of the principal if he believes disobedience to be in the best
interests of the principal.
True
False
7 Name the three types of authority which an agent might have.
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
8 Provided an agent has authority and is known to be an agent, he can never have any personal
liability under the contract and only the principal can be liable.
True
False
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
Agency 55
Answers to Interactive questions
56 Law
Answers to Self-test
1 7, 1, 5, 4 (6), 3, 6 (4), 2
2 Agency by consent
Agency by estoppel
Agency of necessity
Ratification
3 (c)
4 True
5 (a)
6 False
7 Actual express authority
Actual implied authority (incidental and usual)
Ostensible or apparent authority
8 False. Generally speaking, the contract is only enforceable by the principal and the third party but
this rule is subject to a contrary intention being express or implied.
C
H
A
P
T
E
R
Agency 57
58 Law
CHAPTER 4
Negligence
Introduction
Examination context
Topic List
1 The law of tort
2 The tort of negligence
3 Professional advice and negligent misstatement
4 Defences and damages
5 Vicarious liability
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
59
Introduction
Syllabus links
Some of the issues relating to employees in this chapter will be looked at in more detail later in this
Study Manual when it focuses on employment law.
Negligent misstatement will be a relevant factor when looking at the risks an assurance firm faces and
the quality processes put into place to combat them in your Audit and Assurance Paper.
Examination context
Being an important practical issue for accountants, you might expect around five questions relating to
negligence and vicarious liability in your exam.
In the assessment, candidates may be required to:
Identify instances and consequences of negligence (particularly negligent misstatement) in a given
scenario
Identify issues and consequences of vicarious liability in a given scenario
60 Law
1 The law of tort
Section overview
The law of tort includes negligence, which is considered in detail in this chapter.
In a situation involving a breach of contract or crime, the law of tort may also be relevant.
1.1 Tort
The law of tort is a vast subject dealing with various wrongs done to an individual. The law protects
certain personal interests and where these are infringed, the law might offer redress, typically in the
form of damages or (in exceptional cases) an injunction.
Thus where personal security is infringed, for example, the torts of assault or false imprisonment might
apply and where a person's property is infringed or damaged, the torts of trespass or nuisance might
apply.
In tort, no previous transaction or contractual relationship need exist. Indeed it is quite likely that the
parties involved will be complete strangers. Where the parties are in a contractual relationship and there
has been both a breach of contract and a tort committed, the claimant may prefer to proceed in
contract rather than tort (or vice versa) for reasons associated with the measure of damages or limitation
periods. The measure of damages in contract will be such amount as would put the claimant in the
position he would have been in had the contract been performed, whereas in tort, the award will reflect
the position he would have been in had the tortious act not taken place. Broadly speaking, the
limitation period (during which an injured party must take proceedings) is six years from a breach of
contract or six years from the damage caused by the tortious act being suffered (or three years in the
case of personal injury).
Robinson v P E Jones (Contractors) Ltd 2011
The facts: Defects in two chimney flues were discovered 12 years after the contractor built a house
for Robinson. Since a contractual claim was statute-barred, Robinson sued the contractor in tort.
Decision (Court of Appeal): Where a contractual duty of care is owed, it does not necessarily follow
that a duty of care is owed in tort also. Whether or not a tortious liability arose in this case
depended on the facts and the relationship between the parties, but was excluded in any event by
a clause in the contract which restricted liability to that set out in the National House-Building
C
Council standard agreement. H
This clause satisfied the reasonableness test in UCTA and excluded any potential tortious liability for A
economic loss. The following example illustrates how the same event can easily give rise to more P
than one legal liability. T
E
R
Worked example: Tort, crime and contract breach
David is a hired chauffeur working for Estelle. He drives while drunk, crashes the car and runs over Ewan, 4
seriously injuring him and injuring Estelle slightly.
This road accident may lead to proceedings for both crime (drink driving) and tort (injury to Ewan) and
even in contract (breach of terms with Estelle).
Bad professional advice may give rise to liability both in tort and in contract. We discuss the law of tort
in relation to professional advisers in section 3 of this chapter.
Negligence 61
2 The tort of negligence
Section overview
The terms 'negligence' and 'negligent' may refer to the careless way in which an act is carried out,
or to the tort which arises when a person is in breach of a legal duty of care that he owes to
another, thereby causing that person harm or loss.
Negligence is the most important modern tort. To succeed in an action for negligence, the
burden of proof is on the claimant to prove, on a balance of probabilities, that:
The defendant owed a duty of care to the claimant to avoid causing injury, damage or loss
There was a breach of that duty by the defendant
In consequence the claimant suffered injury, damage or loss.
62 Law
Test Meaning
1 Reasonably foreseeable Was the damage reasonably foreseeable by the defendant as damage to
the claimant at the time of the negligent act or omission?
2 Proximity Is there sufficient proximity, or neighbourhood, between the parties?
3 Fair, just and reasonable Is it fair, just and reasonable that the law should impose a duty on the
defendant on the facts of the case?
4 Public policy Is there a matter of public policy that requires that no duty of care should
exist? (By way of example, the Court of Appeal has held (in 2011) that a
duty should not be owed by a surveyor to a buy-to-let investor, when
carrying out a rental valuation for a lender, on the grounds that such an
investor (unlike a simple residential purchaser) is more likely to obtain an
independent valuation.)
In applying these tests, the court is essentially looking at the relationship between the claimant and the
defendant in the context of the damage suffered. The Nicholas H case was concerned with economic
loss, but the court held that the requirements would be equally applicable in cases of physical damage
to property.
C
H
2.2 Breach of duty of care A
P
The second element that must be proven by a claimant in an action for negligence is that there was a T
breach of the duty of care by the defendant. E
R
Whether or not there has been a breach of duty is a question of fact. In certain circumstances where the
reason for the damage is not known, but it can fairly be said that it would not have occurred without
the defendant's lack of care, the claimant can argue res ipsa loquitur ('the facts speak for themselves') 4
and the court will infer that the defendant was in breach of the duty of care. It will be necessary for the
claimant to show that the thing which caused the damage was under the management and control of
the defendant. In such cases, it will then be for the defendant to prove that the cause of the injury was
not his negligence.
The standard of care needed to satisfy the duty of care is a question of law. Broadly speaking, it is the
standard of ' a reasonable man, guided upon those considerations which ordinarily regulate the conduct
of human affairs' (Blyth v Birmingham Waterworks Co 1856).
The following principles have been established by case law:
Principle Explanation
Particular skill If the defendant professes a particular skill, the standard is that of a reasonable
person with that skill, ie a reasonable accountant or reasonable electrician.
Negligence 63
Principle Explanation
Lack of skill Peculiarities or disabilities of the defendant are not relevant, so the standard for a
learner driver is that of a reasonable driver and for a trainee accountant, that of a
reasonable accountant.
No hindsight The test is one of knowledge and general practice existing at the time, not
hindsight or subsequent change of practice.
Roe v Minister of Health 1954
The facts: A doctor gave a patient an injection taking normal precautions at that time.
The drug became contaminated in a way that was not understood at the time and
the patient was paralysed.
Held: The proper test was normal practice based on the state of medical knowledge
at the time. The doctor was not at fault in failing to anticipate later developments.
Body of opinion In broad terms, a claim against a professional person will fail if he or she can point to
a body of professional opinion that supports the approach taken and which the
court considers to be reasonable.
Advantage and In deciding what is reasonable care, the balance must be struck between advantage
risk and risk. (For example, a driver of a fire engine may exceed the normal speed on his
way to the fire but not on the way back.)
Emergency If a defendant acts negligently in an emergency situation, this will be taken into
account the test is that of a reasonable man in the defendant's situation.
Vulnerability If A owes a duty of care to B and A knows that B is unusually vulnerable, a higher
standard of care is expected.
Paris v Stepney Borough Council 1951
The facts: C was blind in one eye and was employed by D on vehicle
maintenance. It was not the normal practice to issue protective goggles since the
risk of eye injury was small. A chip of metal flew into C's eye and blinded him.
Decision: There was a higher standard of care owed to C because an injury to his
remaining good eye would blind him.
64 Law
Subsequent cases have sought to emphasise the limited application of this case, however, and it remains
a difficult area of law. The courts reluctance to permit recovery of pure economic loss is largely due to
the difficulties and cost in insuring against liability that would be likely to arise as a result and also
concern that the floodgates would be opened to large numbers of claims for potentially enormous
sums.
Whether or not the damage was caused by the defendant's breach is a question of fact. Put simply, the
question is 'would the damage have occurred but for the defendant's act or omission?' If it can be
shown that actually the damage was caused by something or someone else, then there will be no
liability on the defendant's part. If something happened after the defendant's breach that caused or
contributed to the damage, then the defendant's liability will cease at that point.
Even where the claimant is able to show that the loss was suffered as a result of the defendant's breach
of duty, the court will not allow him to recover for loss that is considered too remote, or too far down
the chain of causation. This is a question of law and is part of the assessment of a damages award made
by a court. It is considered in section 4 below.
Section overview
Negligent misstatement is one aspect of the tort of negligence.
It tends to be considered separately, partly because liability stems from words rather than acts and
partly because the damage suffered is financial rather than physical.
It is obviously also of particular relevance to you as an accountant, as you will be giving
professional advice in most aspects of your work.
Where an adviser (such as an accountant, banker, solicitor or surveyor) makes a statement in some
professional or expert capacity, where it is likely that others would rely on what he said, then he may
owe a duty of care in addition to his contractual commitments. This means a potential liability in tort if
his statement, or advice, turns out to be negligently made.
As noted earlier, pure economic or financial loss (in the absence of physical damage) used not to be
recoverable unless there was a liability in contract or evidence of fraud or deceit. The neighbour
principle laid down in Donoghue v Stevenson was restricted to tortious acts or omissions that resulted in C
physical damage. H
A
The turning point came in 1963 when the landmark case, outlined below, marked a new judicial P
approach to cases involving negligent misstatement. T
E
Hedley Byrne & Co Ltd v Heller and Partners Ltd 1963 R
The facts: C was an advertising agent acting for a new client, Easipower Ltd. C requested
information from Easipower's bank, D, on its financial position. D returned non-committal replies,
which expressly disclaimed legal responsibility, and which were held to be a negligent 4
misstatement of Easipower's financial resources.
Decision: While D was able to avoid liability by virtue of its disclaimer, the House of Lords went on
to consider whether there ever could be a duty of care to avoid causing financial loss by negligent
misstatement where there was no contractual or fiduciary relationship. It decided that, had it not
been for the disclaimer, D would have been liable for negligence, having breached the duty of
care, because a special relationship did exist.
In reaching the decision in Hedley Byrne, Lord Morris said the following:
'If someone possessed of a special skill undertakes.to apply that skill for the assistance of another
person who relies on that skill, a duty of care will arise.If, in a sphere in which a person is so placed
that others could reasonably rely on his skill.a person takes it on himself to give information or advice
to.another person who, as he knows or should know, will place reliance on it, then a duty of care will
arise.'
Negligence 65
As in Hedley Byrne, cases involving negligent misstatement are usually concerned with whether or not a
duty of care exists (and perhaps also the extent of that duty) rather than questions of breach and
causation. The law has come a long way from its post-Donoghue v Stevenson stance on financial loss, but
it has evolved very much on a case by case basis, in a way that makes it extremely difficult (if not
impossible) to extrapolate clearly defined principles that dictate whether or not a duty of care exists in a
given situation.
Undoubtedly the concept of a special relationship is still helpful and the considerations outlined in The
Nicholas H case (see section 2.1) will still be relevant. What is clear is that liability can only arise where
the defendant is in the business of giving professional advice and the statement is made within that
context. He will not be liable for advice given informally or on a social occasion.
As mentioned above, it is clear from The Nicholas H case that, in applying the tests described in that
case, the courts will be examining the relationship between the parties in the context of the damage
suffered. One consequence of this is that their approach may differ depending on whether, for example,
the circumstances involve the preparation of accounts for shareholders or for a potential takeover
bidder. The Court of Appeal has recently made it clear that it will be very difficult to prove that a duty
of care is owed to sophisticated investors, who are more likely to be considered responsible for their
own actions (Springwell Navigation Corp v J P Morgan Chase Bank 2010).
Remember that, in addition to establishing that a duty of care exists and has been breached, it will be
necessary to show that the loss was caused by that breach. If, in fact, the loss was attributable to
another cause or would have been suffered in any event, an action for negligence will not succeed.
JEB Fasteners Ltd v Marks, Bloom & Co 1982
The facts: Accountants, in the knowledge that the company was seeking outside finance,
prepared accounts negligently showing overvalued stock and inflated profits. The claimant saw
the accounts and took over the company.
Decision: The claim failed on grounds of causation. It was considered that the claimant should
have known from his own enquiries that the figures were inaccurate and that the company was
taken over in order to secure the directors' expertise and not purely on the basis of the accounts.
The following cases are described in order to give you a feel for the types of situation that can arise and
the courts' approach to determining whether the professionals owe a duty of care in tort. An
understanding of the legal considerations is more important than a recall of the facts of any given case.
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Following Caparo, therefore, where an individual relies on annual audited accounts to invest in or lend
to or bid for a company, unknown to the professional who prepared them, there is no cause of action
because no duty of care exists.
Preparing a statement for general circulation, which could foreseeably be relied upon by persons
unknown to the professional for a variety of different purposes, was not sufficient to give rise to a duty
of care. On the other hand, preparing information in the knowledge that a particular person was
contemplating a transaction and would rely on the information in deciding whether or not to proceed
with the transaction would mean that a duty of care was owed.
This approach is also illustrated by James MacNaughton Papers Group Ltd v Hicks Anderson & Co 1991,
where an accountant prepared draft accounts for a company chairman but the claimant also inspected
the accounts and then took over the company. It was held that since the accounts were in draft only
and drawn up specifically for the chairman, the accountant only owed a duty of care to the chairman
and not to a potential takeover bidder.
Negligence 67
3.3 Non-takeover situations
The following two cases provide further examples of where a duty of care was said to exist, based on
the knowledge of the accountants in preparing a client's accounts:
Law Society v KPMG 2000
The facts: KPMG were retained by a firm of solicitors to prepare annual reports required by the Law
Society. The Law Society found that the solicitors had been defrauding clients and amounts had to
be made good from a compensation fund of which the Law Society was a trustee. The Law Society
sued KPMG for negligence.
Decision: KPMG owed a duty of care to the Law Society and was liable in negligence. It was just
and equitable to make KPMG liable since it was entirely foreseeable that an adverse accountant's
report could result in intervention by the Law Society for the protection of the public.
Andrew v Kounnis Freeman 1999
The facts: The defendant, Kounnis, prepared the accounts of a travel company which collapsed.
Decision: The accountant had assumed a duty of care to the CAA and was liable in negligence. A
reasonable accountant should have known that the CAA would assume the audited accounts had
been prepared with due skill and care and would rely on them in deciding whether to renew the
company's licence.
In both cases it may be said that it was reasonably foreseeable that the claimant (who could be
identified and was not one of a large class of recipients) would rely on the accounts.
3.4 Summary
As the Court of Appeal made clear in the James MacNaughton case, there is no single overriding
principle that can be applied to the complexities of every case. Rather, as you will have seen from the
cases mentioned in this chapter, there are a number of factors which the court will take into account
and some will assume a greater significance than others.
The factors with the greatest significance are:
The purpose for which the statement is made and communicated
The relationship between the professional, the recipient and any relevant third party
The state of knowledge of the professional
Whether the professional could be said to have assumed responsibility to the claimant
The size of any class to which the recipient belonged
Whether the third party was identified and known to the professional
The extent of reliance by the claimant and whether that was foreseeable
Whether it is fair and equitable (and not an offence to public policy) to impose a duty of care
It is worth noting that the increasing litigation against professionals, particularly during the takeover
boom period of the late 1980s, led accountants to find ways to limit their potential liability. KPMG, for
example, incorporated its audit practice in 1995. Several large audit firms, for example Ernst & Young
LLP, have incorporated as Limited Liability Partnerships (which are discussed in Chapter 9).
Any exclusion clause which attempts to exclude liability for negligent misstatement may be subject to
the reasonableness test in UCTA (see Chapter 2).
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3.5 Companies Act liability for auditor's report and audited accounts
In addition to any liability in tort, an auditor also commits an offence under the Companies Act 2006 if
he recklessly causes an auditor's report to contain any matter that is misleading or false to a material
extent (s 507). Such an offence is punishable by fine.
Also relevant to this question of professional liability are the following provisions of that Act:
Any provision which exempts an auditor of a company (to any extent) from, or indemnifies him
against, liability for negligence (among other things) in relation to providing audited accounts is
void (save for an indemnity for costs against successfully defending proceedings or where a liability
limitation agreement applies), s 532.
A company may enter into a liability limitation agreement with an auditor, limiting his liability for
negligence (among other things) in the course of auditing accounts to a fair and reasonable
amount, s 534.
Yes No
A She was merely a trainee and therefore the objective standard of care required
is lower.
B She was in a relationship with Daniel, therefore there is a rebuttable
presumption that she is not intending him to use her advice professionally.
C Daniel had intended to do as she advised anyway, so was not affected by her
advice.
Section overview
There are three defences of particular relevance to the tort of negligence.
The principal remedy in any case involving negligence will be an award of damages.
Negligence 69
4.1 Defences
The three defences particularly relevant to a case involving negligence are:
Defence Application
Contributory Where the defendant can show that the damage or loss suffered was partly
negligence due to the claimant's fault, the claimant's damages will be reduced by the
court in proportion to his degree of fault. For example, if a claimant would
have received 100,000 but is found to be 40% contributorily negligent, the
damages awarded will be 60,000. (Where there is concurrent liability in tort
and contract, this defence will also apply to reduce contractual liability.) The
defence is governed by the Law Reform (Contributory Negligence) Act 1945.
Volenti non fit injuria This applies where the claimant voluntarily (ie exercising free choice) agrees
(literally 'to a willing to undertake the legal risk of loss or damage at his own expense. Effectively it
person no injury is done') amounts to an agreement by the claimant to exempt the defendant from
a duty of care which otherwise would be owed. The fact that a person knows
that there is a risk, or even consents to run that risk, does not mean volenti
necessarily applies. The question is whether the claimant consented to run
the risk of having no legal redress. Where UCTA applies, volenti cannot be
raised to provide a greater exclusion of liability than the Act would allow (for
example, to relieve liability for death or personal injury).
Exclusion clauses Where there is an agreement between the parties that contains a provision
seeking to exclude or limit liability for negligence, it may be subject to UCTA.
In so far as it relates to business liability for death or personal injury caused by
negligence, it will be void. Provisions limiting liability for other types of
damage caused by negligence will be subject to the reasonable test. UCTA
specifically provides that a persons agreement to, or awareness of, the clause
does not necessarily amount to voluntary acceptance of any risk.
4.2 Damages
Damages for negligence are compensatory and are intended to put the claimant in the same position he
would have been in had he not suffered any loss. They are normally awarded in a single lump sum. As in
contractual claims, damages will not be recovered to the extent that they are considered to be too
remote. When a person commits a tort with the intention of causing loss or harm which in fact results
from the wrongful act, that loss can never be too remote.
The loss is too remote unless it can be said that the type of damage that actually did occur was
reasonably foreseeable. Provided the kind of damage suffered was reasonably foreseeable, it does not
matter that it came about in an unforeseeable way, nor that it was more extensive than could have been
foreseen.
The Wagon Mound 1961
The facts: A ship was taking on oil in Sydney harbour. Due to negligence, oil was spilled onto the
water and it drifted to a wharf 200 yards away where welding equipment was in use. The owner of
the wharf carried on working because he was advised that the sparks were unlikely to set fire to
furnace oil. Safety precautions were taken. A spark fell onto a piece of cotton waste floating in the oil,
thereby starting a fire which damaged the wharf. The owners of the wharf sued the charterers of the
ship.
Decision: The claim must fail. Pollution was the foreseeable risk, fire was not.
5 Vicarious liability
Section overview
An employer may be liable for the tortious acts of his 'employee provided there is a close
connection between the relevant act and the employee's employment.
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A principal may be liable for the tortious acts of his agent where they are committed in
furtherance of an agency relationship.
Partners in an ordinary partnership may be vicariously liable for the tortious acts of their fellow
partners where they are committed in furtherance of the partnership business.
Vicarious liability is a legal doctrine under which one person can be held legally responsible and liable
for the tortious acts of another person. Thus a person may be liable in tort in two ways:
Primarily, if he commits a tort
Vicariously, if his employee or agent commits a tort
Vicarious liability is a legal liability which may be imposed on a person even though he is himself free
from blame and in addition to the personal liability of the other person who committed the tort.
The doctrine has the advantage of providing an innocent tort victim with recourse against a financially
responsible defendant, but at the same time it does impose an additional burden on the business or
person held vicariously liable. In the context of employment, for example, this imposition of liability in
the absence of fault is a pragmatic recognition of the fact that the employer is likely to have a greater
ability to pay damages than the employee, is the best insurer against liability and is able to pass the
costs of such liability, or potential liability, to his customers. It has far less to do with any argument that
the employer should accept losses alongside the benefits of the employee's work or that he was careless
in selecting the employee.
Negligence 71
to look after the children, and the torts committed were in his work time, in the place where he was
employed and while he was carrying out his employed duty to care for the children.
Whether this close connection between the employees tort and his employment exists must be
decided by the court on the facts of each case. Two further cases in which the test has been applied
since the Lister case are:
Dubai Aluminium Co Ltd v Salaam and ors 2002
The facts: A, a solicitor, drafted bogus agreements.
Decision: The drafting of agreements of this nature (but for a proper purpose) would be within the
ordinary course of business for a solicitor. Therefore the dishonest acts were sufficiently closely
connected to the course of his business for his employers to be vicariously liable for those acts.
Attorney General v Hartwell 2004
The facts: A police constable in the British Virgin Islands was on duty when he went to a restaurant
where his partner worked as a waitress. He fired several shots at his partner and her male
companion. One shot hit a British tourist, who sustained serious injuries.
Decision: The Privy Council found that the Attorney General (as the representative of the
Government of the British Virgin Isles) was not vicariously liable for the personal injury sustained by
the British tourist. The acts of the policeman were not closely connected to his employment, and in
fact had nothing to do with his police duties. He was pursuing a personal vendetta.
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Summary and Self-test
Summary
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Negligence 73
Self-test
Answer the following questions.
1 In tort no previous transaction or contractual relationship need exist.
True False
3 There are two/three/six essential elements for a negligence claim to be successful. They are
................................ ................................ ................................
................................ ................................ ................................
4 When the court applies the maxim res ipsa loquitur, it is held that the facts speak for themselves
and the defendant does not have to prove anything, since the burden of proof is on the claimant.
True False
5 What was the leading case on negligent misstatement that allowed recovery of non-physical
damage?
6 Which of the following would prevent a claim for negligence from being successful?
(a) The claimant followed a course of action regardless of the acts of the defendant.
(b) The defendant caused the harm to the claimant.
(c) The defendant was not yet fully qualified.
(d) The parties were proximate and the harm suffered was reasonably foreseeable.
(e) An intervening act broke the 'chain of causation'.
(f) The duty of care was restricted by public policy.
7 'A public company's auditors owe no duty of care to the public at large who rely on the audit
report in deciding to invest.'
This is the decision from Caparo.
True False
8 Name four of the matters to be taken into account by the Court in considering cases of
professional negligence.
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
9 In order for the employer to be vicariously liable the tort must have been committed:
(1) .................................................................................................................................................
(2) .................................................................................................................................................
10 If an agent is liable in tort, the claimant may enforce the vicarious liability of the principal only
where he is unable to recover sufficient damages from the agent.
True False
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
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Answers to Interactive questions
C
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Negligence 75
Answers to Self-test
1 True
2 C
3 Three: Duty of care
Breach of that duty
Consequential damage, injury or loss
4 False. Res ipsa loquitur means 'the facts speak for themselves' and will lead to an inference that the
defendant was in breach of the duty of care.
5 Hedley Byrne v Heller 1963
6 (a), (e), (f)
7 True
8 The purpose for which the statement was made and communicated
The relationship between the parties
The size of any class to which the recipient belonged
The state of knowledge of the maker
The reliance by the recipient
Whether the professional assumed responsibility
9 (I) By an employee
(2) The employee must have been acting in the course of his employment (in a way that had a
close connection with the scope of his employment).
10 False. The principals liability is in addition to the agent's liability and exists regardless of the agents
ability to satisfy the claimant.
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CHAPTER 5
Companies: the
consequences of
incorporation
Introduction
Examination context
Topic List
1 Characteristics of a company
2 Types of company
3 Formation of a company
4 A company's name
5 Articles of association
6 Administrative consequences of incorporation
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
77
Introduction
To know the procedure for forming a company, what constitutes a company's constitution
and how it can be altered
Syllabus links
As companies are fundamental in the business world, this chapter is relevant to most papers in your
syllabus. Elsewhere, you will study the audit of companies, corporation tax, financial companies,
managing companies and preparing company accounts, for example.
Examination context
A large proportion of your exam will relate to company law, as set out in this chapter and Chapters 6, 7
and 8. You might expect around 12 questions to address the areas covered by this chapter.
In the assessment, candidates may be required to:
Identify the procedure required to form a registered company and identify the advantages and
disadvantages of off-the-shelf companies
Demonstrate an understanding of corporate personality and recognise the circumstances when the
veil of incorporation can be lifted
Identify the administrative consequences of incorporation including requirements regarding
statutory books, accounts, meetings and the role of a company secretary
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1 Characteristics of a company
Section overview
A company has a separate legal identity from its members and is, in law, a person in its own right.
This is one of the fundamental cornerstones of company law.
The liability of the members of a company for the debts of the company may be limited. The
liability of the company itself is always unlimited.
The 'veil of incorporation' said to be drawn between the company and its members may be lifted
in certain circumstances.
For the purposes of this study manual, a company is an entity registered under the Companies Act 2006
('CA'06') or any earlier Companies Act.
The single largest piece of legislation ever made, the CA'06 is intended to be a comprehensive code of
company law, restating and replacing most of the relevant companies legislation that went before it
(principally the Companies Acts 1985 and 1989) and also introducing new law. Many of the changes in
law were designed to lighten the regulatory and bureaucratic burden on companies (simplifying
decision-making processes and capital maintenance provisions, for example), although it remains to be
seen whether the burden may actually be increased in some areas, such as communication with
nominated holders and the new duty on directors to promote the success of the company (which could
lead to differences in the way they conduct their business).
Subject to some very minor restrictions, the Act is now in force. References to the Act are to this
statute and section numbers are given for ease of reference only (the exam will not require you to know
section numbers).
1.2 Liability
As mentioned above, one of the key consequences of the fact that the company is distinct from its
members is that its members may enjoy limited liability. This means that, in the event of business
failure, the members will only be asked to contribute identifiable amounts to the assets of the business,
even though they are, essentially, the ones who own the business. Not surprisingly, most companies are
registered with limited liability.
It is important that you understand that the company itself, on the other hand, is liable without limit
for its own debts. In an unlimited company, there is no limit on the company's or the members'
liability. Thus, the question of limited liability is important when a limited company is unable to satisfy
all its debts.
The amounts that members may be required to pay, in the event of a winding up, depend upon the
type of limited company, as follows:
Company limited by Any outstanding amount of the nominal value of any share which has not
shares been paid either by the original or a subsequent holder of the shares. If the
member's shares are fully paid, there is no further liability to contribute.
Any premium (over the nominal value) that was agreed to be paid for the
share will also be owed to the extent that it has not been paid, unless the
shareholder at the time is not the original shareholder (since the amount of
premium is a debt that does not pass with the shares).
Company limited by The amount they guaranteed to pay in the event of a winding up.
guarantee
A company, as a separate legal entity, may also have liabilities in tort and crime. However, it is currently
extremely difficult to prosecute a company successfully for a criminal offence.
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COURTS
Situation where the veil might
be lifted Examples
To reveal national identity Re F G Films Ltd 1953: An English company was formed to make an
English film. In fact the staff and finance were American, the film 5
was produced in India and there were neither premises nor
employees in England. The veil was lifted to expose a 'sham'
company with the result that the marketing and other advantages
available to British films were not available in this case.
82 Law
2 Types of company
Section overview
Public companies are companies limited by shares and registered as public companies.
Private companies may be unlimited, or limited by shares or guarantee.
Public companies may re-register as private and vice versa.
Limited companies may re-register as unlimited and vice versa.
Liability Description
Limited by shares Liability is limited to the amount of the nominal value, if any, unpaid on
(public or private) members' shares held by them (including any premium payable by the current
owner in respect of them).
Limited by Liability is limited to such amount as the members undertake to contribute to
guarantee (private the company's assets in the event of it being wound up.
only)
A company limited by guarantee cannot be registered with a share capital. A
company limited by guarantee is often a charity or trade association, ie a non-
commercial organisation that aims to keep income and expenditure in balance
but has the members' guarantee as a form of reserve capital in case of
insolvency.
Unlimited There is no limit on the members' liability. They can be compelled to contribute
(private only) as much as may be necessary to pay the company's debts in full.
An unlimited company does not need to file annual accounts, subject to certain
conditions (for example, that it is not a subsidiary or a parent of a limited
company (s 448)).
C
2.2 Public and private companies H
A
A public company is a limited company expressly registered as a public company under the Act. Only a P
small proportion of companies are public companies. T
E
A private company is any registered company (limited or unlimited) that is not stated to be a public R
limited company. Most private companies are small to medium enterprises in which some, if not all,
shareholders are the directors.
5
The principal differences are that a public company is subject to more stringent rules and regulation
than private companies and that only a public company can offer its securities to the public. The
principal features of public and private companies can be summarised as follows (at the same time
illustrating the differences between them):
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In addition, special rules apply to quoted companies with regard to publication of details on the
company website and directors' remuneration reports.
A private company may apply to the Registrar of Companies to be re-registered as a public company (or
a public company as a private company) provided certain conditions and procedures are satisfied (ss 90-
101).
3 Formation of a company
Section overview
There are a variety of documents required to form a company.
Companies can be bought 'off the shelf'.
Promoters make business preparations for a new company.
Document Description
Memorandum of A memorandum in the prescribed form stating that the subscribers (a) wish to
association form a company and (b) agree to become members of the company and, in
the case of a company with a share capital, agree to take at least one share
each. It must be authenticated by each subscriber.
Application This must state
The company's proposed name (which is subject to certain rules designed
to prevent the company misleading the public regarding its identity and/or
activities) C
H
Whether the liability of the members is to be limited and, if so, whether by A
shares or guarantee P
T
Whether the company is to be private or public E
R
Whether the registered office is to be in England and Wales or Wales or
Scotland or Northern Ireland
The intended address of the registered office (the registered office is the 5
address for delivery of legal documents which may need to be served on a
company and also where company registers must or may be kept (see
section 6)).
Articles of association may also be submitted, but if none is supplied, the default articles will apply (see
section 5 below).
If the Registrar is satisfied that the registration requirements of the Act have been complied with, he will
register the documents and issue a certificate of incorporation, naming and describing the company
and giving its date of incorporation and registered number.
This certificate is conclusive evidence that the company is registered in accordance with the Act and is a
body corporate. If irregularities in formation procedure or an error on the certificate are later discovered,
it is nonetheless valid and conclusive (Jubilee Cotton Mills Ltd v Lewis 1924).
Note that a public company also needs to obtain a trading certificate before it can commence
trading. It must submit:
An application stating (amongst other things) that the nominal value of the company's allotted
share capital is not less than the 'authorised minimum' and
A statement of compliance (s 762).
Any transaction in contravention of this provision will render any company officer in default liable to a
fine but the transaction will remain valid. Failure to obtain a trading certificate within a year of
incorporation may result in a compulsory winding up (s 122 Insolvency Act 1986).
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3.3 Promoters and pre-incorporation contracts
In addition to the person who takes the procedural steps to get a company incorporated, the term
'promoter' includes anyone who makes business preparations for the company. However a person who
acts merely in a professional capacity in company formation, such as a solicitor or an accountant, is not
on that account a promoter.
A promoter owes certain duties to the company:
A general duty to exercise reasonable care and skill
A fiduciary duty to disclose any personal interest in a transaction and, sometimes, to account for
monies received. Generally speaking, any profits which he makes from promoting the company
and fails to disclose must be surrendered to the company. However, if he discloses them and the
company gives consent, he may retain any legitimate profits.
In the case of a public company, disclosure is made through the listing particulars or prospectus.
Disclosure in a private company should be to existing and prospective members or to the board of
directors, provided it is independent of him.
Since a company has no capacity to enter into contracts prior to its coming into existence, if a promoter
makes a contact on the company's behalf prior to incorporating (a 'pre-incorporation contract'), the
following will apply:
The company cannot ratify the contract since it did not exist when the contract was made (Kelner
v Baxter 1866)
The company is not bound by it even after incorporation and even if it has derived some benefit
from it (Re National Motor Mail Coach Ltd, Clinton's Claim 1908)
The company cannot enforce the contract against the third party unless the promoter and third
party have given rights of action to the company under the Contracts (Rights of Third Parties) Act
1999
The contract takes effect (subject to any agreement to the contrary) in the same way as one made
with the promoter and he is personally liable on it (s 51).
A promoter can avoid potential liability, most usually by
Not making contracts until the company has been incorporated, or
Using an off-the-shelf company, or
Agreeing a draft only with the third party on the basis that the company, once formed, will enter
into the agreed form with the third party.
Where a promoter is already liable on a pre-incorporation contract, he may be able to arrange for the
company to novate the contract (ie enter into a new contract on identical terms), in which case he
should also secure the third party's consent to the promoter thereupon being released from personal
liability.
Note that giving rights to the company under the Contracts (Rights of Third Parties) Act 1999 does not
also remove a promoter's liability since the Act provides that the original parties remain liable on the
contract.
A promoter usually incurs expenses in preparations, such as drafting legal documents, made before the C
H
company is formed. He cannot legally claim any remuneration or indemnity for his services or expenses A
but, in practice, will generally arrange that the first directors, of whom he may be one, agree that the P
company shall make such payment to him. T
E
R
Interactive question 3: Pre-incorporation contracts [Difficulty level: Exam standard]
Imran is in the process of setting up a new company, Silver Stumps Ltd. Before submitting the
5
application for registration, he enters into a contract on behalf of the company with Greenfields plc for
the purchase of a cricket ground on the banks of the River Avon. Shortly after the company is registered
and a certificate of incorporation issued, Silver Stumps Ltd finds that it is unable to raise sufficient funds
and so fails to complete on the purchase on the due date.
4 A company's name
Section overview
There are rules which restrict a company's freedom to choose any name.
A company's name may be changed either through the company's choice or as directed by the
Registrar.
A company's name must be disclosed in accordance with the Act.
The Act sets out rules which provide for certain company names to be prohibited, for a name to be
changed and requiring disclosure of a company's name and business name (exceptions are set out in
ss 60-62).
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Interactive question 4: Formation of company [Difficulty level: Exam standard]
What are the documents that must be delivered to the Registrar on formation of a private company
limited by shares?
See Answer at the end of this chapter.
5 Articles of association
Section overview
Every company is required to have articles of association ('articles') and model articles apply where
a company does not register its own.
Articles prescribe regulations governing the management of the company's affairs, the rights of
the shareholders and the powers and duties of the directors.
Articles form part of the constitution of a company and bind the company and its members.
Articles may be altered by the company in general meeting.
A company's articles form part of its constitution, along with all special resolutions and other relevant
resolutions and agreements (s 17). Sometimes a power conferred on a company by the Act is expressed
to be subject to any restriction or prohibition contained in the company's articles (for example, the
power of a private limited company to reduce its capital). Where the Act prohibits something permitted
by the articles, the Act will prevail.
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In particular, a company is required to keep the following company records:
A register of members
A register of directors and (if applicable) company secretaries
A register of directors' residential addresses (this information is 'protected information' and must
not be made available for public inspection.)
Copies of directors' service contracts and indemnity provisions restricting directors' liabilities
Records of resolutions and minutes (for a period of ten years)
Directors' statement and auditor's report
A register of charges and copies of charges
In addition, a company is required to give copies of the company's articles, and certain other documents
of constitutional importance, free of charge upon request (s 32). A company is not required to keep a
register of debenture holders but, if it does, it must comply with the provisions concerned with its
availability for inspection (s 743).
Accounting records 'Adequate accounting records' that are sufficient to show the company's
(s 386) financial position at any time with reasonable accuracy, including:
Daily entries of income and expenditure
Record of assets and liabilities
(If applicable) statements of stock and stocktakings
Annual accounts (s 393) ie a balance sheet and profit and loss account. Consolidated group accounts
are normally required where the company is a parent company.
The accounts must give a 'true and fair view' of the company's financial
position in respect of its financial year. Notes to the accounts must deal with
employee numbers and costs and directors' benefits.
The accounts must be approved by and signed on behalf of the board of
directors.
Directors' Report (s 415) In respect of the financial year, the
Names of directors
Principal activities of the company
Statement that the auditor is not unaware of any relevant audit
information
A recommended dividend and business review, (including principal risks and
uncertainties facing the company) are usually included although not always
(for example small companies).
(A consolidated report should be produced where group accounts are
prepared). The directors' report must be approved by and signed on behalf
of the board of directors.
Directors' Remuneration This applies to quoted companies only and is subject to the members'
Report (s 420) approval.
Auditor's Report (s 495) Where accounts are audited (see section 6.4 below) the report must
Identify the accounts audited and the financial reporting framework
applied in their preparation
Describe the scope of the audit
State that, in the auditor's opinion, the accounts give a true and fair
view of the company's financial affairs
State that the directors' report is consistent with the accounts
Annual return (s 885) The return must state the date to which it is made up and contain
information including
The address of the company's registered office
Prescribed particulars of the directors and any company secretary
The type of company and its principal business activities
The address(es) of where the register of members and any register of
debenture holders may be inspected (if not kept at the registered office)
A statement of capital and prescribed particulars concerning the members
and the shares in the company
The return must be signed by a director or secretary and delivered to the
Registrar within 28 days of the return date (usually the anniversary of the
date of incorporation).
Non-compliance with these provisions may render the company and any relevant officer liable to a fine
and, in some cases, imprisonment.
92 Law
A company's accounts and reports must be publicised in compliance with the Act, including filing them
at the Registry within 9 months (private company) or 6 months (public company) after the end of the
relevant accounting reference period.
You should be aware that a less stringent regime applies to small and medium-sized companies (for
example, they may file 'abbreviated accounts'). Broadly, these are private companies which comply with
two or more of the following requirements (s 382):
Small Medium
Turnover 6.5m 25.9m
Balance sheet 3.26m 12.9m
Employees 50 250
Summary
94 Law
Self-test
Answer the following questions.
1 Define a company.
2 What was the name of the case that is generally cited as establishing the principle of corporate
personality?
3 An unlimited company has unlimited liability. A limited company has limited liability.
True
False
4 Give three examples of where the courts might lift the veil of incorporation.
5 Give three examples of where statute provides for the veil of incorporation to be lifted.
6 Is it true that a company is not required by law to have a company secretary?
7 What is the minimum share capital for:
8 List ten examples of how public companies differ from private companies.
... ...
... ...
...
...
...
9 If a public company does business or borrows before obtaining a trading certificate from the
Registrar, the transaction is
A Invalid and the third party cannot recover any loss
B Invalid but the third party can recover any loss from the directors C
C Valid and the directors are punishable by a fine H
A
D Valid but the third party can sue the directors for liquidated damages P
T
10 The memorandum of association for a company limited by shares records the subscribers'
E
agreement and intention in respect of three matters. Name them. R
5
11 What is an off-the-shelf company and what is its significance in company formation?
True
False
(2) A promoter should avoid personal liability by utilising the Contracts (Rights of Third Parties)
Act 1999 and giving rights of enforcement to the company as third party.
True
False
13 A company cannot be registered unless it submits a copy of its articles of association when
applying for registration
True
False
True
False
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
96 Law
Answers to Interactive questions
1 A company is an entity registered under the Companies Act 2006 or any earlier Act.
2 Salomon v Salomon & Co Ltd 1897.
3 False. Any company has unlimited liability for its debts. In a limited company, the liability of the
members (not the company) is limited to the amount outstanding on their shares or the amount of
any guarantee.
4 Where a subsidiary company can be regarded as an agent of the holding company.
To reveal the true national identity of a company.
Where the company is a quasi-partnership.
Where a company is a sham.
5 Where a public company trades without a trading certificate.
In cases of fraudulent or wrongful trading.
Where a director carries on business when he is disqualified.
Where directors form a new company with a name identical or similar to that of an insolvent
company.
6 This is true in the case of private companies but a public company must have a company secretary.
7 (1) 0
(2) 50,000
8 See table in section 2.2 of this chapter.
9 C
10 Their wish to form a company
Their agreement to becoming members of the company
Their agreement to subscribe for at least one share each
11 It is a dormant company available for purchase by those wishing to set up a company. It avoids the
usual formation formalities and the problems associated with pre-incorporation contracts do not
arise.
12 (1) False, since the company was not in existence at the time of the contract.
(2) False. The Act provides that the original parties remain liable on the contract.
13 False. Where articles are not registered, model ('default') articles prescribed by the Secretary of
State will apply.
14 By special resolution, unless there is provision for entrenchment, in which case unanimous consent
or a court order is required.
15 The Act
16 Register of debenture-holders.
17 Adequate accounting records, that are sufficient to show the company's financial position at any
time with reasonable accuracy, including daily entries of income and expenditure, a record of
assets and liabilities and (if applicable) statements of stock and stocktakings.
18 True (although not if the company is an investment or banking company).
98 Law
CHAPTER 6
Introduction
Examination context
Topic List
1 Directors
2 Members
3 Majority rule and minority protection
4 Meetings and resolutions
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
99
Introduction
To know how directors are appointed and removed and to understand their role in the
management of the company
Syllabus links
The issue of a director's authority to bind the company relates to agency, which you studied in Chapter
3.
You will come across references to the members of a company passing resolutions in many areas of
company law, including insolvency and in relation to share capital. This chapter explains how such
resolutions come to be passed, whether in general meeting or otherwise.
Examination context
You should expect exam questions on each of the learning objectives stated.
In the assessment, candidates may be required to
Identify the various statutory rights of shareholders to challenge the management of the company
Identify the ways in which a director may be appointed and removed
Identify directors' duties and explain the consequences of any major breach
Identify the powers of directors and in what circumstances they will bind the company in a
contract with third parties
Recognise how members can influence the management of a company through meetings and
resolutions, including the members' right to requisition a meeting
100 Law
1 Directors C
H
A
Section overview P
T
The directors of a company manage the company's business. E
R
The Companies Act 2006 and a company's articles of association together dictate who can and
cannot be a director and how directors are appointed and removed.
The Act and company articles also determine the extent of a director's powers and his authority to 6
bind the company.
Directors owe a number of duties to the company and face potential civil and criminal liability in
the event of breach.
References to 'the Act' and section numbers refer to the Companies Act 2006 ('CA'06') unless otherwise
stated. Section numbers are given for reference only.
Non-executive ie a director (appointed or otherwise as above) who does not have a particular
director function but generally just attends board meetings. Directors duties apply to
non-executive directors in the same way as to executive directors.
Many directors of public companies are non-executive and it is generally
regarded as a great strength for a company to have a board consisting of both
executive and non-executive directors. They are seen as helpful in contributing
an independent view to the board's deliberations and ensuring the continuing
effectiveness of the executive directors and their management of the company's
affairs.
A company normally appoints a chairman of the board of directors who also
acts as chairman at general meetings. He is usually regarded as a non-executive
director.
Managing director The articles usually provide for the directors to appoint one or more of their
(MD) number to be managing director(s), charged with carrying out day-to-day
management functions.
A director's actions are valid even if his appointment is subsequently found to have been defective or
void (s 161).
Any change in the directors of a company should be recorded in the company's register of directors
and notified to the registrar within 14 days.
102 Law
Interactive question 1: Directors [Difficulty level: Easy]
C
(1) Which of the following terms describes a person in accordance with whose directions or H
instructions the directors are accustomed to act? A
P
A Alternate director T
B Shadow director E
C De facto director R
D Non-executive director
(2) Which of the following accurately states the requirements for the removal of a director? 6
A Special resolution with ordinary notice
B Ordinary resolution with special notice
C Ordinary resolution with ordinary notice
D Special resolution with special notice
See Answer at the end of this chapter.
Section 1 of the Company Directors Disqualification Act 1986 provides that a court may formally
disqualify any person from being (without leave of the court) a director (including a shadow director),
liquidator, administrator, receiver or manager of a company's property or in any way directly or
indirectly being concerned or taking part in the promotion, formation or management of a company.
Disqualification is considered at section 1.8 below.
In addition, the articles may provide that a director must vacate office if he becomes bankrupt or of
unsound mind, or if he is absent from board meetings for, say, 6 consecutive months and the directors
resolve that he should vacate office on that account.
Interactive question 2: Resolution for removal of director [Difficulty level: Exam standard]
A company has three members who are also directors. Each holds 100 shares. Normally the shares carry
one vote each, but the articles state that on a resolution for a director's removal, the director to be
removed should have 3 votes per share. On a resolution for the removal of Jeremy, a director, Jeremy
casts 300 votes against the resolution and the other members cast 200 votes for the resolution. Has
Jeremy validly defeated the resolution?
A No, the articles are invalid insofar as they purport to confer extra votes.
B Yes, the proceedings and articles are valid.
C Yes. Whilst the articles are invalid and the voting is therefore 200 to 100 in favour, a special
resolution is required and the necessary 75% majority has not been obtained.
D No. A director is not entitled to vote on a resolution for his own removal.
See Answer at the end of this chapter.
Statutory (general) The directors are statutorily bound to exercise powers only 'for the purpose for
which they are conferred' (see section 1.5 below).
Statutory (specific) For example alteration of the articles and reduction of capital need a special
resolution, which the directors must secure from the shareholders in general
meeting before they can act. Directors' actions which expressly require members'
approval are detailed in section 2.3 below.
Articles For example the articles may set a maximum amount that the directors are
entitled to borrow, any greater amount needing approval of the company in
general meeting. (As to whether such a restriction will be effective against a third
party, see section 1.4 below.)
Members The members can exercise control over the directors' powers
By passing a special resolution to alter the articles, thereby re-allocating the
powers between the board and the general meeting
Ultimately by removing directors from office
The directors' powers are vested in them as a collective body and are exercised by the directors in
board meetings. Generally speaking, it is considered sufficient if the directors are in communication with
each other, usually by telephone, rather than necessarily being in one place at the same time and
articles may make such provision. Equally, even if the directors are assembled together, there can be no
board meeting if any of the directors object to a meeting being held in those circumstances.
Authority Explanation
Express Binding
Implied Binding. Managing directors, and to some extent other executive directors (such
as sales directors or finance directors), are much more likely to bind the company by
their actions, since greater powers are usually delegated to them. Thus a managing
director has implied usual authority to make general business contracts on behalf of
the company (in addition to any actual authority given to him by the board).
There is little guidance from statute or case law, on the other hand, on what
authority might be deemed to attach to non-executive directors or directors in
lower or middle management, but it will not be as wide ranging as that attaching to
a managing director. (Indeed such case law as there is suggests that it is very limited
indeed.)
Ostensible Binding. If the board permits a director to behave as if he were a managing director
or give the impression that he is one, that director will have the apparent or
ostensible authority to enter into all commercial contracts relating to the business
as a managing director would have and to bind the company in respect of them.
It might be helpful to revise the principles of agency outlined in Chapter 3 and in particular the case of
Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd 1964 in respect of managing directors. Where
a director would have authority but for a restriction placed on it, the position is governed by s 40. This
provides that 'in favour of a person dealing with a company in good faith, the power of the directors to
bind the company or authorise others to do so, is deemed to be free of any limitation under the
company's constitution (s 40).
104 Law
Note in particular:
C
The section relates to any transaction or dealing between the company and a third party (ie not H
just to contracts) A
P
The other party is deemed to be acting in good faith unless the contrary is proved (and will not T
be deemed to be acting in bad faith just because he knows of the limitation) E
R
The limitations to be disregarded include any imposed on the directors by resolution or
agreement of the members.
Section 41 provides that s 40 will not apply where the person dealing with the company is a director or 6
person connected with a director. In such cases, the transaction becomes voidable at the instance of the
company and that party is liable to account for any gain and to indemnify the party against any loss.
Duty Explanation
106 Law
Duty Explanation
C
To exercise ie the care, skill and diligence that would be exercised by a reasonably diligent person H
A
reasonable with P
care, skill and T
The general knowledge, skill and experience that may reasonably be expected of a
diligence E
person performing his functions as director R
(s 174)
His actual general knowledge, skill and experience
Thus it is no excuse for a director to say that he lacked expertise if a reasonable director 6
in his position would have that expertise. Further more, his actual expertise may result
in a higher standard than that of the reasonable director. The courts have held, for
example, that a director who signs an insurance proposal without reading it may be
liable in negligence.
An executive director with expertise in a particular area, or even a non-executive
director who is qualified or experienced in a relevant discipline, will be expected to
show a higher standard of care than simply attending board meetings. Even someone
with no commercial or business experience or qualification is required (by the Act) to
demonstrate the care that may be expected of a person fulfilling his directors role.
Simply attending board meetings and not attending to the company's interests in
between meetings is unlikely to be sufficient (unless it can be shown that a director's
failure to prevent a fellow director's wrongdoing did not cause or contribute to the loss
suffered).
Lexi Holdings plc (in administration) v Luqman 2009
The facts: Two sisters and their brother were directors of a company. The brother had
convictions for offences of dishonesty in the past. The sisters knew this but played no
part in the company, demanded no explanations from their brother of his business
dealings and did not advise the other directors, auditors and the bank of his
convictions. The brother took nearly 60m in fictitious loans, false facility letters and by
misappropriation of company funds.
Decision: The Court of Appeal held that the sisters were, or ought to have been, aware
of various matters in relation to the fraud perpetrated on the company by their brother.
As a result, they were liable as they were in breach of their fiduciary and common law
duties of care owed to the company.
To avoid A director must avoid a situation in which he has or can have a direct or indirect
conflict of interest that conflicts or possibly may conflict with the interests of the company or
interest another duty. This duty is particularly applicable to the exploitation of any property,
(s 175) information or opportunity, (regardless of whether the company could actually take
advantage of it) but is expressly stated not to apply to any conflict arising in relation to
a transaction or arrangement with the company (where ss 177 and 182 apply, see
below). The duty is not infringed if the matter has been authorised by the directors.
This may happen
In a private company, provided the company's constitution does not invalidate
such authorisation
In a public company, provided the company's constitution expressly allows such
authorisation
In each case, the relevant director cannot be counted towards a quorum and his votes
will not be included in determining whether the authorisation is given.
If such authorisation is given there is no need for further approval by the members
unless the company's constitution so provides.
If the case falls within the statutory provisions for matters requiring members' approval
(and these provisions are satisfied), then the director does not also need to comply with
this duty.
Not to A director must not accept a benefit from a third party by reason of his
accept
Being a director or
benefits from
third parties Doing (or not doing) anything as director
(s 176) Unless the acceptance of the benefit cannot reasonably be regarded as likely to give rise
to a conflict of interest.
If the case falls within the statutory provisions for matters requiring members' approval (and
these provisions are satisfied), then the director does not also need to comply with this duty.
To declare Provided the director is, or ought reasonably to be, aware of the situation, he must declare
interest in the nature and extent of any such interest (direct or indirect) to the other directors,
proposed unless it cannot reasonably be regarded as likely to give rise to a conflict of interest.
transaction
The notice may be made
or
arrangement At a board meeting
(s 177)
By notice in writing or
By a general notice, ie that he has an interest in the third party and is therefore to
be regarded as interested in any transaction or arrangement with that third party (in
which case he should take reasonable steps to ensure that such general notice is
brought up at the next board meeting).
Provided such declaration is made, there is no need for approval by the members or
the board, unless the company's constitution so provides or unless it is an arrangement
between a director and the company for the transfer of a substantial non-cash asset
(see section 2.3 below).
(Note that a specific duty exists likewise in relation to existing transactions or
arrangements as soon as is reasonably practicable (s 182). This duty applies also to
shadow directors (s 187). Breach of this specific duty is punishable by fine.)
A person may continue to be subject to the duties in ss 175 and 176 even after he ceases to be a
director, in certain circumstances (s 170 (2)).
One or more of the general duties may overlap, in which case each will apply. For example, taking a
bribe from a third party would contravene the duty not to accept benefits from third parties (s 176). It
might also amount to a failure to promote the success of the company for the benefit of its members (s
172) and/or a failure to exercise independent judgment (s 173).
Solution
Xavier is under a duty to avoid any situation in which he has an interest that, even potentially, conflicts
with the company's interests, even if the company is not actually prejudiced as a result (it may even fair
better as a result). However, this duty does not apply to a conflict of interest arising in relation to a
transaction with the company, as is the case here. The relevant duty, with which Xavier must comply, is
a duty to disclose his interest to the other directors pursuant to s 177. He should make such disclosure
at a board meeting or in writing. He could provide a general disclosure of the nature and extent of his
interest in the firm, so that he is to be regarded as interested in any transaction with it. Such general
notice should be given at a board meeting or brought up at the next meeting following it. If he fails to
do so, the contract will be voidable at the instance of the company and he could be liable to indemnify
the company against any loss.
108 Law
1.6 Breach of directors' duties
C
A director in breach of any of the duties imposed on him may be required to make good any loss H
suffered by the company, including accounting for any secret profits. Any contract entered into A
between the company and a director may be rendered voidable by the director's breach of duty. Any P
T
property taken by the director from the company can be recovered if it is still in his possession. It may E
be recoverable from a third party unless that third party required it for value and in good faith. R
Where the breach has not yet occurred or is continuing, an injunction might be an appropriate remedy.
If another director, or directors, is or are also in breach then their liability will be joint and several. In the 6
absence of any breach, however, a director will not be jointly liable with another who is in breach.
Legal action in respect of a breach of directors' duties is most likely to be pursued under s 260 (see
section 3.3 below).
The articles of a company may impose more onerous requirements on its directors. They cannot,
however, dilute the duties except to the extent that is permitted by certain provisions. For example:
s 173: that a director will not be in breach of the duty to exercise independent judgement if he
has acted in a way authorised by the constitution
s 175: some conflicts of interest by independent directors may be permitted, subject to the
constitution
s 180 preserves any rule of law that would otherwise be a breach of duty.
Any ratification of conduct amounting to negligence or other breach of duty by a director (or former
director or shadow director) must be made by an ordinary resolution of the members, disregarding the
votes of that director and any member connected with him (s 239).
Note that any provision to exempt a director from or indemnify him against liability for breach of duty
or negligence (or default or breach of trust) is void (s 232), save that a company may provide insurance
and qualifying indemnity in respect of third parties.
In any proceeding for negligence, default, breach of duty or breach of trust against an officer of the
company (or auditors), the court may relieve him of any liability if it considers that he acted honestly
and reasonably and that, having regard to all the circumstances of the case, he ought fairly to be
excused (s 1157).
Re D'Jan of London Ltd 1993
The facts: D, a director of the company, signed an insurance proposal form without reading it. The
form was filled in by D's broker. An answer given to one of the questions on the form was incorrect
and the insurance company rightly repudiated liability for a fire at the company's premises in which
stock worth some 174,000 was lost. The company became insolvent and the liquidator brought
this action under s 212 of the Insolvency Act 1986 alleging D was negligent.
Decision: In failing to read the form D was negligent. However, he had acted honestly and ought
therefore to be partly relieved from liability. The fact that D owned a 99% shareholding was relevant,
as the risk he took might have been seen as more unreasonable if he had owned a lower stake in the
company. (This case was brought on a provision from CA 1985 in line with s 1157 CA 06.)
Grounds
110 Law
Grounds
C
A disqualification order must Where a person has been a director of a company which has at any H
A
be made, for a minimum of 2 time become insolvent (whether while he was a director or P
years and a maximum of 15 subsequently) and his conduct as a director of that company makes T
years: him unfit to be concerned in the management of a company. (The E
courts may also take into account his conduct as a director of other R
companies, whether or not these other companies became insolvent.)
Directors can be disqualified under this section even if they take no
active part in the running of the business. In uncontested cases, and 6
where it is considered expedient in the public interest, the Secretary of
State may accept a disqualification undertaking instead of seeking a
disqualification order (ie an undertaking that the director will not act
as a director etc or be concerned in the management etc of a
company).
Note that a bankruptcy order made against a person automatically disqualifies him from acting as a
director of a company or being concerned in the management or promotion of a company (s 11).
Offences for which directors have been disqualified include the following:
Insider dealing
Failure to keep proper accounting records
Failure to read the company's accounts
Loans to associated companies on uncommercial terms to the detriment of creditors
The courts' approach has been to view 'ordinary commercial misjudgement' as insufficient to justify
disqualification.
Re Uno, Secretary of State for Trade and Industry v Gill 2004
Facts: A group consisting of two furniture companies carried on trading while in serious financial
difficulties, while the directors tried to find a way out of the situation. Uno continued to take
deposits from customers for furniture to fund its working capital requirements.
Decision: The directors were not disqualified for acting in this way as their behaviour was not
dishonest or lacking in commercial probity and did not make them unfit to manage a company.
They had been trying to explore realistic opportunities to save the businesses and were not to
blame for the eventual collapse of the businesses and the subsequent loss of customers.
A lack of commercial probity, or gross negligence or total incompetence, however, might render
disqualification appropriate.
Secretary of State for Trade and Industry v Thornbury 2008
Facts: A director failed to carry out any further investigation after receiving verbal assurances from
other directors regarding the financial status of the company. The company was in breach of its
statutory obligations to pay HMRC.
Decision: Although the director had not been dishonest, it had not been reasonable for him to leave
matters in the other directors' hands to such a degree. He was held to be unfit to be concerned in
the management of a company and disqualified for two years.
Note that recent guidance from the Office of Fair Trading has signalled a greater willingness to
disqualify directors of companies which are in breach of competition law. It seems that a directors
active involvement in the breach will no longer be required. Rather, a director may face disqualification
if it can be shown that he had reasonable grounds to suspect a breach but failed to take steps to prevent
it, or even where he did not know of the breach but should, in all the circumstances (including his own
skill and experience) have known of it.
Breach of a disqualification order can result in a fine and/or imprisonment.
The following circumstances may result in the court imposing a lower period of disqualification in
mitigation:
Lack of dishonesty
Loss of director's own money in the company
2 Members
Section overview
Shareholders, being members of a company with a share capital, effectively own the company.
The members exercise control over the directors where required by law and the company's
articles.
Any subscriber of a company's memorandum and any person entered on the company's register of
members is a member of the company. A single member limited company must include a statement on its
register that there is only one member. Subject to limited exceptions, a company cannot be a member of
its holding company. Where a member owns shares in a company, he is called a 'shareholder'.
112 Law
To be sent a copy of annual accounts and reports
To require directors to call a general meeting C
To appoint a proxy H
A
A member may be entitled, under the company's articles, to nominate another person to exercise all or P
T
any of those rights in place of him.
E
Subject to any contrary provision in the company's articles, a company may send communications in R
electronic form, provided the member has agreed (generally or specifically).
A member of a listed company who holds shares on behalf of another person may nominate that other 6
person to enjoy information rights, ie the right to receive a copy of all communications required to be
sent to members, including accounting reports (s 146). Such information can be provided electronically
unless a request is made for hard copies.
A member may take action to enforce personal rights of membership for example the right to vote
(Pender v Lushington 1877) or receive a due dividend. Note that this is not a derivative action, on behalf
of the company, but a personal action.
Matter requiring
Notes Consequences of breach
approval
Service contracts Approval is required if the service contract The provision is void and the
(s 188) provides for a director's employment to be a contract is thereafter
guaranteed term of two years or more (ie deemed to include a term
not terminable by the company in a lesser entitling the company to
period or only in specified circumstances). terminate it at any time on
giving reasonable notice.
A written memorandum setting out the
proposed contract must be provided to the
members prior to the resolution being passed.
Substantial property Approval is required for any arrangement The company faces no
transactions (s 190) where a director is to acquire from the liability for failure to obtain
company (or the company from the approval. The transaction is
director) a substantial non-cash asset, ie voidable at the instance of
one (or more) whose (aggregate) value the company except in
specified circumstances,
Exceeds 10% of the company's asset
unless the members give
value and is more than 5,000 or
approval within a reasonable
Exceeds 100,000 period.
The section does not apply to transactions The director (and possibly
permitted under a relevant service contract others) is liable to account to
or to payments for loss of office. the company for any gain
and to indemnify the
There are other exceptions applicable to company against any loss or
group companies, companies in winding up damage.
or administration and to transactions on
recognised investment exchanges.
Loans to directors etc Approval is required for any loan by a The transaction is voidable
(s 197) company to a director or for any guarantee at the instance of the
or security by a company in connection company, except in specified
with a loan made by another party to a circumstances, unless it is
director. A written memorandum setting approved by the company
out the details of the transaction proposed within a reasonable period.
must be given to the members.
There are similar There are exceptions for The director (and possibly
provisions dealing with Expenditure on company business, others) is liable to account to
quasi-loans to directors defending proceedings or regulatory the company for any gain
and loans and quasi- action or investigation and to indemnify the
loans to persons company against any loss or
connected with directors, Minor transactions or ones in the damage.
credit transactions ordinary course of business
(public companies only) Intra-group transaction
and transactions related
to any of the above Money-lending companies
Payments for loss of Approval is required for payments or The payment is held on
office (s 217) benefits to be made on loss of office or trust for the company.
retirement.
Any director who authorised
A written memorandum of the proposed the payment is liable to
payment (or other benefit) must be sent to indemnify the company for
all members. any loss.
There are exceptions for small payments and
payments in discharge of legal obligations.
('Small payments' are currently those of 200
or less, although the Secretary of State does
have power to increase this figure.)
Note that the general duties still apply even if one of these provisions applies (s 180) so that, for
example, the directors should only approve a loan to a director if they are confident that it will not
offend the duty to promote the success of the company. On the other hand, if members' approval is
obtained under one of these provisions (or an exception applies so that approval is not needed) then
the duties to avoid conflicts of interest and not to accept benefits from third parties (ss 175 and 176)
will not apply (s 180), (but the other duties will still apply). For example, if a director fails to obtain
authorisation from the directors or members for a loan in respect of legal defence costs, he will not be
acting in breach of his duty to avoid conflicts of interest.
Section overview
Generally speaking the company is controlled by the will of the majority. If the minority objects to
the majority's actions, the basic rule is that it has no recourse because the company is the proper
claimant.
However, the minority is given the right by statute to object in certain circumstances.
Any member may also bring an action against the directors (on behalf of the company) for breach
of duty or negligence against the directors.
Any member may apply to the court for relief where the affairs of the company have been
conducted in an unfairly prejudicial manner.
Any member may, as a last resort, petition the court to wind up the company on the ground that
it is just and equitable to do so.
114 Law
Furthermore, unlike directors, members may exercise their votes in their own interests and are not
required to act for the benefit of the company. Generally speaking, if the minority is unhappy with a C
decision made by a majority, it has no recourse: the company (being a separate legal person) is the H
A
proper claimant with the action vested in it. This is sometimes referred to as 'the rule in Foss v
P
Harbottle'. T
Foss v Harbottle 1843 E
R
The facts: A shareholder (Foss) sued the directors of the company alleging that the directors had
defrauded the company by selling land to it at an inflated price. The company was by this time in a
state of disorganisation and efforts to call the directors to account at a general meeting had failed. 6
Decision: The action must be dismissed.
The company as a person separate from its members is the only proper claimant in an action to
protect its rights or property.
The company in general meeting must decide whether to bring such legal proceedings.
A minority can, however, take action in certain cases, in particular:
Where statute specifically provides for a minority to have a particular power or to apply to the
court for example. The permitted minority is normally measured by being a minimum number of
members or by members holding a specified percentage of the company's share capital or voting
rights (see 3.2 below).
A derivative action for negligence, breach of duty, default or breach of trust by the directors under
s 260 (see section 3.3 below).
A derivative action in respect of unfairly prejudicial conduct by the majority under s 994 (see 3.4
below).
To petition the court for the company to be wound up on the grounds that it is just and
equitable to do to so (see 3.5 below).
Note too that a minority member may also pursue a personal action to enforce his rights of
membership.
Subject Required
Variation of class rights Holders of 15% of class of shares (or 15% of members where no
share capital) can apply to court for cancellation (s 633)
Company meeting Can be requisitioned by holders of (usually) 10% of company's
paid up capital with voting rights (or 10% of voting rights where
no share capital) (s 303)
Notice of members' resolutions Must be given by company on requisition of members holding
5% of voting rights (s 292)
Payment out of capital by private Any member (or creditor) can apply to court to prohibit the
company for the redemption or transaction (s 721)
purchase of its shares
Registration of limited company Can be prevented by individual members
as unlimited
116 Law
The following are examples of conduct that has been held to be unfairly prejudicial in contravention of
the identical provision in earlier legislation (s 459 CA 1985): C
H
Exclusion and removal from the board where the company was one in which the director had a A
legitimate expectation of being involved in management, ie a quasi-partnership company. P
T
Re Bird Precision Bellows Ltd 1986 E
R
The facts: A minority with 26% of the shares suspected the MD of this 'quasi-partnership'
company of concealing bribes paid to secure contracts. When the DTI refused to investigate
the minority was removed from the board. They claimed that this unfairly amounted to 6
prejudicial conduct.
Decision: The claim was allowed as it was a 'quasi-partnership'.
Improper allotment of shares, for example, an allotment by a majority shareholder simply to
increase his holding
Making an inaccurate statement to shareholders, for example misleading them by recommending
acceptance of a bid by another company which the directors owned
Diversion of a company's business to a director-controlled company
Actions brought claiming that the following matters constituted unfairly prejudicial conduct failed:
Failure by a parent company to pay the debts of a subsidiary
Non-compliance with the Stock Exchange rules, the City Code and the Cadbury Code.
Failure by a fellow director and majority shareholder to increase the petitioner's shareholding
(see O'Neill v Philips 1999 below)However, where the excluding party has made a reasonable offer
to buy out the shares of the excluded shareholder, the exclusion is unlikely to be regarded as
unfairly prejudicial (provided the shares are properly valued and without applying a discount to
reflect the fact that it is a minority shareholding).
Whatever the reason for the application, the complaint must be based on prejudice to the member as a
member and not as an employee, nor as an unpaid creditor.
O'Neill v Phillips 1999
The facts: P owned a 75% shareholding, although O managed the company (following P's decision
to take a less active role in the affairs of the company) and, at P's suggestion, took 50% of the
profits. The possibility of increasing O's shareholding to 50% was discussed but never acted upon.
When business declined, P resumed control. He demoted O to the position of branch manager and
withdrew his profit share. However, O remained a director. O claimed unfair prejudice for the
withdrawal of his profit share and the alleged repudiation of an agreement to increase his
shareholding.
Decision: The House of Lords held that there was no firm agreement to increase O's shareholding
and so he had no legitimate expectation of such action that the law would enforce. It was
considered quite fair that P should retain a majority shareholding and exercise control in the way
he did. Lord Hoffman did say (obiter) that if there had been an actual agreement in O's favour, his
capacity as member (and not just as employee) might have founded a claim since he had invested
time and money in the company.
The courts will not generally intervene in cases of dispute about management (even bad management)
save possibly where it results in serious financial damage to the company and the minority's interests. A
breach of company law will not necessarily mean that there is unfairly prejudicial conduct. However,
where company law has been fully complied with, it may be said that relief under s 994 is unlikely to be
given unless there are equitable considerations that make it fair in all the circumstances. The provision
cannot simply be invoked by shareholders when they do not like the way a company is run.
Re A Company 1983
The facts: The petitioners' grievance was the directors' refusal to put forward a scheme of
reconstruction or a proposal to purchase their shares (by the company). The directors were
preoccupied with plans for diversification of the business.
118 Law
Decision: An order for liquidation on this ground may only be made 'in the absence of any other
remedy'. As the parties had agreed in principle that there was an alternative to liquidation the C
petition must be dismissed. H
A
Orders have been made for winding up in the following situations: P
T
Where the company was formed for an illegal or fraudulent purpose. E
R
Where there is a complete deadlock in the management of its affairs.
Re Yenidje Tobacco Co Ltd 1916
6
The facts: Two sole traders merged their businesses in a company of which they were the only
directors and shareholders. They quarrelled bitterly, refused to speak to each other and conducted
board meetings by passing notes through the hands of the secretary. One sued the other for fraud
and he petitioned for compulsory winding up.
Decision: 'In substance these two people are really partners' and by analogy with the law of
partnership (which permits dissolution if the partners are really unable to work together) it was just
and equitable to order liquidation.
Where the directors deliberately withheld information so that the shareholders had no
confidence in the company's management.
Section overview
Decisions affecting the existence, structure, and constitution of a company are reserved to the
company in general meeting, rather than the directors.
Certain matters to be carried out by the directors also require a decision in general meeting.
A decision of a company in general meeting is only valid and binding if the meeting is properly
convened by notice and if the business of the meeting is fairly and properly conducted. Therefore
the statutory rules on notice, quorum, proxies and voting need to be followed.
The decision may need to be passed by an ordinary or a special resolution (depending on the
subject matter).
Private companies are permitted to pass written resolutions, which means that they do not need
to hold general meetings except in very limited circumstances.
There are also rules governing class meetings and single member companies.
120 Law
Interactive question 9: Notice periods [Difficulty level: Easy]
C
In a public company, what percentage of the voting rights or nominal value of shares with voting rights H
must consent to a notice period of less than 14 days? A
P
A For a general meeting B For an AGM T
E
51% R
75%
90% 6
95%
100%
Required
Type of
majority of the Business Rules
resolution
votes cast
122 Law
Records
C
As noted earlier, every company must keep the following records for ten years (s 355) and available for H
inspection by members. A
P
Copies of all resolutions passed otherwise than at general meeting T
Minutes of all general meetings E
Details of decisions by sole member companies R
Quoted companies must also publish on a website the results of polls at general meetings (s 341).
6
Summary
124 Law
C
H
A
P
T
E
R
Public company
Private company
True
False
4 Name TWO ways which indicate that the power of the directors is subject to the will of the
members in general meeting.
.................................................................................................................................................
.................................................................................................................................................
5 List SIX of the general duties imposed on directors by CA'06.
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
6 The test of whether a director exercised reasonable care, skill and diligence is partly objective, ie
the standard reasonably to be expected of someone performing his role as director, but also partly
subjective if having regard to his actual general knowledge, skill and experience would require a
higher standard.
True
False
7 The offences of wrongful trading and fraudulent trading only apply when a company goes into
insolvent liquidation and may give rise to a personal liability on the part of a director.
True
False
8 In what circumstances might the Secretary of State accept a disqualification undertaking instead of
seeking a disqualification order?
Where the director has been in persistent default of company law filing requirements
126 Law
Matter Consequence of breach
C
H
A
P
T
E
R
11 State the rule in Foss v Harbottle.
12 What are the THREE possible actions available to a minority who is unhappy with the action of the
6
majority?
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
13 Under what TWO circumstances is a public company required to call a general meeting?
.................................................................................................................................................
.................................................................................................................................................
14 Name THREE instances when a written resolution cannot be used.
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
15 Where special notice is required, how many days' notice must be given?
7 days
14 days
21 days
28 days
16 If the voting on a show of hands results in 58% in favour of a resolution and voting on a poll results
in 61% in favour, which result counts?
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
128 Law
Answer to Interactive question 7
C
B Elizabeth and Jane could consider a derivative action, under s 260 CA'06. Under the common law, H
prior to the Act, they would be unlikely to succeed. The facts of this case resemble those of Pavlides A
v Jensen 1956 where it was held that mere negligence did not justify a minority action to protect P
the company's rights since, in the absence of fraud, the sale could legitimately be approved by a T
E
majority of the shareholders. However, the new statutory provision covers negligence by the R
directors and so a remedy may be given. It remains to be seen how the courts will interpret and
apply s 260.
6
Answer to Interactive question 8
B 10% is required (5% is sufficient if the last meeting was over 12 months previously)
D The company secretary has no power to call a meeting
1 A public company must have at least 2 directors. A private company must have at least 1 director.
2 A shadow director is someone in accordance with whose directions or instructions the directors are
accustomed to act.
3 False. Special notice is required but only an ordinary resolution is needed.
4 Alteration of the articles requires special resolution
Reduction of capital requires special resolution
Borrowing power may need ordinary resolution
Directors' office is subject to members power to remove by ordinary resolution
5 To act within the company constitution and to exercise their powers only for the purposes for
which they were conferred
To promote the success of the company
To exercise independent judgement
To exercise reasonable care, skill and diligence
To avoid conflicts of interest
Not to accept benefits from third parties
To declare any interest in a proposed transaction or arrangement
6 True
7 False. Fraudulent trading applies whether or not a company has been or is in the course of being
wound up. It is true, however that the commission of both offences can lead to a personal liability
to contribute to the company's debts.
Service contracts Provision is void and contracts deemed to include provision for
termination on reasonable notice
Substantial property Contract is voidable, director liable to account for any gain and
transactions indemnify against any loss
Loans to directors etc Contract is voidable, director liable to account for any gain and
indemnify against any loss
Payments for loss of Payment is held on trust for the company, director liable to indemnify
office for any loss
11 In order to redress a wrong done to a company or its property or to enforce its rights, the proper
claimant is the company itself and not a member or members of the company.
12 Derivative action under s 260 (if majority represented by directors)
Derivative action under s 994 for unfairly prejudicial conduct
Petition for the winding up of the company on the just and equitable ground (s 122 IA '86)
13 An AGM every year
Wherever its net assets are half or less of its called up share capital
14 In a public company
To remove an auditor
To remove a director
130 Law
15 28 days
C
16 The vote on a poll. If a poll is taken, the result of the previous show of hands is disregarded.
H
A
P
T
E
R
Companies: finance
Introduction
Examination context
Topic List
1 Shares
2 Share capital
3 Loan capital and charges
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
133
Introduction
To understand the key types of shares in a company, including the procedures for the
issue, payment and transfer of shares
To identify different types of share capital and know how share capital can be altered
To recognise fixed and floating charges and to know the rules relating to their registration
and priority
Syllabus links
In the previous chapter, you learned about companies limited by shares and this chapter now explores
the financing of such companies. You will learn about loans and charges over companies' assets and, in
the next chapter, consider further what happens when a company defaults on such arrangements.
Examination context
You can expect around four or five questions on the subject matter of this chapter on your exam paper.
In the assessment, candidates may be required to:
Identify the procedures for the issue of shares, including issues at a premium and pre-emption
rights
Identify aspects of capital maintenance including reduction of capital, redemption and purchase of
a company's own shares, financial assistance for the purchase of a company's own shares and
distribution of profit.
Identify share transfer requirements and disclosure requirements
Identify the nature of fixed and floating charges and the procedures for registering them
134 Law
1 Shares
Section overview
The most common types of share are ordinary shares and preference shares. A company may also
issue redeemable shares (which may take the form of ordinary or preference shares).
Shares which have certain rights not enjoyed by other shares in the company are grouped in a
class and are said to have class rights.
Generally speaking, shares may be allotted provided authority is given in the articles or by
ordinary resolution and they must first be offered to existing shareholders in proportion to their C
existing holdings. H
A
Shares must be paid for in money or money's worth. They can be issued at a premium but not, as P
a general rule, at a discount. T
E
Shares are generally freely transferable and may be transferred in a paper or paperless format. R
A share is a transferable form of personal property, carrying rights and obligations, by which the interest
of a member of a company limited by shares is measured. A member of a company who holds one or 7
more shares is a shareholder. References to 'the Act' are to the Companies Act 2006 unless otherwise
stated.
Share Feature
Ordinary Ordinary shareholders have an automatic right to have their capital repaid and to
participate in the distribution of profit, when the company is wound up, provided the
company has surplus assets once creditors have been satisfied.
Dividends are payable to ordinary shareholders only according to declarations made by
the directors and they are not cumulative (whereas dividends payable on preference
shares are normally cumulative).
It is the ordinary shareholders who are normally offered the benefit of rights issues and
bonus issues.
All ordinary shareholders have statutory pre-emption rights (see section 1.4 below).
Preference Preference shareholders also have a right to have their capital repaid on a winding up
(unless the articles provide otherwise). If there is a surplus after repayment of capital,
ordinary and preference shareholders will share equally. Where preference shares are
expressed to carry a priority or preferential right to return of capital, the amount paid
up on each preference share is to be repaid before anything is repaid to ordinary
shareholders. In these circumstances, however, if there is a surplus after repayment of
capital, the preference shareholders will have no right to share in that surplus.
Typically preference shares will carry a prior right to a fixed dividend, in which case
It is not a right to compel payment of a dividend, simply to receive a dividend at the
specified rate before any other dividend is paid or declared.
The right to receive a preference dividend is deemed to be cumulative unless the
contrary is stated.
On liquidation, the preference shareholders cease to be entitled to any unpaid
preference dividends unless
A dividend has been declared though not yet paid when liquidation commences
and
The articles (or other terms of issue) expressly provide that in a liquidation
arrears are to be paid in priority to return of capital to members
Holders of preference shares have no entitlement to participate in any additional
dividend over and above their specified rate unless that is expressly provided.
Preference shares are usually expressed not to carry a right to vote (or only in
specified circumstances, such as failure to pay the preference dividend, variation of
their rights or a resolution to wind up). If there is no express provision, they carry the
same voting rights as ordinary shares.
Preference shareholders do not have rights of pre-emption unless they are specifically
conferred by the company's articles of association or terms of issue of the shares.
Redeemable A redeemable share is one which is issued on terms that it can be bought back by the
company at the option of the company or the shareholder (see section 2.4 below).
136 Law
Greenhalgh v Arderne Cinemas Ltd 1946
The facts: The company had two classes of ordinary shares, 50p shares and 10p shares. Every share
carried one vote. A resolution was passed to subdivide each 50p share into five 10p shares, thus
multiplying the votes of that class by five.
Decision: The rights of the original 10p shares had not been varied since they still had one vote per
share as before.
Reason Explanation
Exceptions The Act provided that the provisions do not apply to allotments of
Bonus shares
Securities to be wholly or partly paid up otherwise than in cash
Securities relating to an employees share scheme
Exclusions A private company may exclude all or any of the provisions in its articles, either
generally or in relation to allotments of a particular description
Disapplication Directors of a private company with only one class of shares may be authorised
to allot equity securities as if s 561 did not apply by either
The articles or
Special resolution
Where directors are given authority by the company to allot shares, they may
also be given the power to allot equity securities as if s 561 did not apply by
either
The articles (where a general authority is given) or
Special resolution
138 Law
More specifically (s.552), a company is prohibited from applying any of its shares or capital money in paying
any commission, discount or allowance to any person in consideration of his subscribing for shares (or
procuring subscriptions or agreeing to subscribe or procure subscriptions). This prohibition applies
regardless of how the shares or money are to be applied, whether in addition to the purchase price of
property acquired by the company or the contract price of work to be carried out for the company or in
being paid out of the nominal purchase money or contract price or otherwise.
There is one exception, however, which entitles a company to pay a commission to someone who agrees
to subscribe or to procure subscriptions for shares, provided the company's articles contain the relevant
authority and provided the commission paid does not exceed 10% of the issue price of the shares or the
amount authorised by the articles, whichever is less.
That amount so transferred may be used to write off the expenses of the issue of those shares and any
commission lawfully paid on the issue. The account may also be used to pay up new shares to be
allotted to members as fully paid bonus shares. There are also special rules for group reconstruction
relief and merger relief, which relieve companies from the requirement to transfer any premium to a
share premium account. Thus if an acquiring company secures at least 90 per cent of the equity capital
of another company as consideration for an allotment of its shares, any premium obtained from the
excess of the other company's assets over the nominal value of its shares need not be transferred to the
share premium account.
Otherwise, the share premium account is treated as part of the company's paid up share capital and is
subject to rules on the reduction of capital set out in the Act. For example, a company cannot distribute
part of its share premium account
As a dividend
To write off expenses incurred in connection with the formation of the company, nor
To write off expenses incurred in connection with an issue of debentures
Rule Explanation
Generally speaking, where an allotment is made in contravention of these provisions, the allottee is
liable to pay an amount equal to the nominal value of the allotted shares together with interest. He may
apply to the court for relief from such liability and the court may grant relief where it considers it just
and equitable to do so.
Yes No
140 Law
voting rights, until the transfer is registered and his name is entered on the register of members. He is
also entitled to such information as he may reasonably require as to the reasons for the refusal (but he is
not entitled to minutes of directors meetings). Where the company fails to comply with these
provisions, it and its officers are guilty of an offence punishable by a fine.
There is no requirement for certification where shares are transmitted by operation of law, for example
where a bankrupt member's trustee in bankruptcy or a deceased member's personal representative
becomes entitled to the member's shares.
Listed shares
Securities may be transferred without a written instrument.
CREST Co Ltd is a private company owned by a number of firms connected with all sections of the
equities market. The company is currently the approved operator of an electronic system which enables
C
shareholders to hold and transfer their securities without the need for written instruments of transfer. H
Under the CREST system, a member appoints a custodian broker to hold his shares under a customer A
agreement, which provides for the broker to deal with the shares only in accordance with the P
shareholder's directions. Any transfer of shares is normally completed in three days. T
E
Regulations under the Act (made by either the Treasury or the Secretary of State) may provide that R
companies may be required (rather than just permitted) to adopt such a paperless holding and transfer
of shares (s 785). Such regulations might impose such a requirement in relation to particular types of
company or security or provide for the company to pass an ordinary resolution to that effect. 7
You should be aware that there are very detailed rules for the disclosure of substantial interests in the
relevant share capital (essentially voting shares) of public companies. For example, in the case of
companies listed on the Official List or AIM, issuers are obliged to publish their total share capital and
voting rights at the end of each calendar month in which a change has occurred. A shareholder must
notify the issuer (by completing a notification form) where his percentage of voting rights reaches 3% of
the total voting rights of the company, and each 1% thereafter. It follows that this threshold may be
reached even where a shareholder does not actually deal in the shares. He is therefore obliged to make
the notification within two trading days of when he became or should have become aware of the
notifiable change. These provisions are set out in the Disclosure and Transparency Rules (published by
the Financial Services Authority).
2 Share capital
Section overview
The capital which is invested in a company limited by shares by shareholders is called its share
capital.
A company's share capital can be increased and altered in a number of ways, but there are strict
controls on any reduction of capital.
In certain circumstances a company may acquire its own shares, by redemption or purchase, and
private companies may be permitted to fund such an acquisition out of capital.
Private companies may give financial assistance for the acquisition of their shares but public
companies are prohibited from doing so, save in certain circumstances.
Dividends represent a return on capital invested and, generally speaking, must be paid out of
distributable profits only.
It is a fundamental principle of company law that limited companies should utilise their share capital
only for the purposes of the business and should not be allowed to diminish or return any part of that
capital to the detriment of company creditors or minority shareholders. This maintenance of capital
principle is upheld by various provisions in the Act which limit capital reduction schemes, restrict the
freedom of a company to purchase its own shares and give financial assistance to aid share purchases,
strictly control the circumstances in which capital may be used for the redemption and purchase of
shares, as well as restricting the scope for making dividend payments and utilising payments of share
premiums.
Term Meaning
A company A company that has power under its constitution to issue shares (s 545)
having a share
capital
Issued or allotted Shares that have been issued or allotted as the case may be (s 546) (including
share capital shares taken by the subscribers on the formation of the company).
A company need not issue all its share capital. Any part of it not issued is called
unissued share capital.
Called-up share So much of the share capital as equals the aggregate amount of the calls made on
capital its shares plus share capital that is paid up without being called and share capital to
be paid at a specified future date under the articles or terms of allotment of the
relevant shares (s 547).
Equity share The issued share capital excluding any part of it that, neither as respects dividends
capital nor as respects capital, carries any right to participate beyond a specified amount in
a distribution (ie usually a companys ordinary share capital, since preference shares
usually carry a right to a fixed return).
Loan capital Loan capital describes the company's borrowed money.
142 Law
A private company may reduce its capital by special resolution supported by a solvency statement
given by all of the directors in a prescribed form (within 15 days prior to the resolution being
passed) confirming the company's ability to pay its debts over a period of twelve months (s.643).
This method is only permissible where there is at least one member remaining who holds a non-
redeemable share (so that a private limited company cannot reduce its share capital to nothing
without the court's approval)
A copy of the resolution and a statement of capital, together with a copy of the solvency statement or
court order must be filed with the Registrar.
If the net assets of a public company are (or fall to) half or less of the company's called up share capital,
the directors must call a general meeting in order to consider whether any steps need to be taken to
deal with the situation.
Members' liability is reduced accordingly following a permitted reduction in capital. Any reserve arising C
from a reduction of capital may be treated as a realised profit for the purposes of distributions. H
A
P
T
2.3 Other alteration of share capital E
R
A company may, however, increase or alter its share capital as follows and in each case must give notice
to the Registrar of the alteration, accompanied by a statement of capital, within one month:
Alteration Rule 7
(Note that a company's share capital may also be altered as a result of a redenomination from one
currency to another (s 622). Such a redenomination may also result in a reduction of capital in order to
round up or down nominal values in the new currency. If such a reduction is needed, it must not
exceed 10% of the nominal value of the reduced allotted share capital and a special resolution is
required.)
144 Law
Where shares are redeemed or purchased out of a company's profits, the amount by which the
company's issued share capital is diminished when shares are cancelled must be transferred to the
capital redemption reserve. That reserve is treated as part of the company's paid up share capital,
except that it may be used to pay up new shares to be allotted to members as fully paid bonus shares.
Public Private
company company
Section overview
A company may choose to raise loan capital rather than share capital. A debenture is the
document that records the terms of any loan.
A company may enter into a fixed or floating charge by way of providing security for its
borrowing.
The lender or debentureholder is then a secured creditor and will rank in priority to unsecured
creditors in any liquidation of the company.
Charges need to be registered.
146 Law
Like shareholders, debentureholders own transferable company securities which are usually long-term
investments in the company and the procedure for issue and transfer of shares and debentures is very
similar.
There are however important differences:
From the investor's standpoint, debenture stock is often preferable to preference shares since the former
offers greater security and yields a fixed income.
From the company's standpoint, raising capital by borrowing has obvious advantages but it has to bear
in mind also the disadvantages of the rate of interest payable and, in particular, the liability imposed by
any charge which is created in order to secure the loan.
A charge is an encumbrance upon real or personal property granting the holder certain rights over that
property, usually as security for a debt owed to the charge holder. The most common form of charge is
by way of legal mortgage, used to secure the indebtedness of borrowers in house purchase transactions.
In the case of companies, charges over assets are most frequently granted to persons who provide loan
capital to the business. A charge secured over a company's assets gives to the creditor (called the
'chargee') a prior claim over unsecured creditors (and may give him priority over other secured
creditors) to payment of his debt out of those assets. Charges are of two kinds, fixed and floating.
148 Law
3.5 Comparison of fixed and floating charges
A fixed charge is normally the more satisfactory form of security since it confers immediate rights over
identified assets. However, a floating charge has some advantage in being applicable to current assets
which may be easier to realise than fixed assets subject to a fixed charge. If for example a company
becomes insolvent, it may be easier to sell its stock than its empty factory.
The principal disadvantages of floating charges are as follows.
The holder of a floating charge cannot be certain until the charge crystallises (often through the
company failing) which assets will form his security.
Even when a floating charge has crystallised over an identified pool of assets the chargee may find
himself postponed to the claim of other creditors as follows.
C
A judgment creditor or landlord who has seized goods and sold them may retain the
H
proceeds if received before the appointment of the debentureholder's receiver (s 183 IA). A
P
Preferential debts (for example remuneration and holiday pay owed to employees) may be T
paid out of assets subject to a floating charge unless there are other uncharged assets E
available for this purpose (ss 40 and 175 IA). R
The holder of a fixed charge over the same assets will usually have priority over a floating
charge on those assets even if that charge was created before the fixed charge (see below).
7
A creditor may have sold goods and delivered them to the company on condition that he is to
retain legal ownership until he has been paid (a Romalpa clause).
The Enterprise Act 2002 also introduced a clause into the Insolvency Act 1986 stating that a
'prescribed part' of the company's net property will be available to unsecured creditors,
regardless of any charges over that property. This introduces an element of 'proportionality'
for unsecured creditors. The amount of money that is to be so prescribed, or 'ring-fenced', is
set by the Secretary of State.
As noted above, a floating charge may become invalid automatically if the company creates the
charge to secure an existing debt and goes into liquidation within a year thereafter (s 245 IA); the
period is only six months with a fixed charge.
150 Law
Summary and Self-test
Summary
C
H
A
P
T
E
R
2 Which of the following are rights of preference shareholders (unless excluded by the articles)?
A The right to receive a dividend is cumulative.
B If the company goes into liquidation, preference shareholders are entitled to claim all arrears
of dividend from the liquidator.
C
C As well as rights to their preference dividends, preference shareholders can share equally in H
dividends payable to ordinary shareholders. A
P
D Preference shareholders have a priority right over ordinary shares for the return of their T
capital. E
R
E Preference shareholders have equal voting rights to ordinary shareholders.
3 What is meant by 'called-up share capital'?
7
4 What is the majority of the relevant class required to consent to a variation of class rights?
51% 75%
90% 100%
5 What minimum percentage of shareholders in a class may apply to the court for a variation of class
rights to be cancelled?
5% 10%
15% 20%
6 Where authority to allot shares is given to directors in the company's articles, what type of
resolution is required to vary or renew that authority given that it results in an alteration of the
articles?
7 Fill in the blanks in the statements below.
A ........................................ issue is an allotment of additional shares to existing members in
exchange for consideration payable by the members.
A ........................................ issue is an allotment of additional shares to existing members where
the consideration is effectively paid by using the company's reserves.
8 Do rights of pre-emption apply in the following cases?
A At a discount? Yes No
True False
11 When a company receives an instrument of transfer, it must register the transfer or give notice of
refusal within what time period?
12 Name two ways in which a private company may lawfully reduce its share capital.
.................................................................................................................................................
.................................................................................................................................................
13 Name THREE ways in which a company's share capital can be altered (but not reduced).
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
14 What type of resolution is required to authorise the redemption of shares?
15 Name three safeguards that are required for a private company to be authorised to redeem or
purchase its shares out of capital.
16 What restrictions, if any, apply to a private company providing financial assistance for the purchase
of its shares?
17 Can a private company purchase its own shares where they are partly paid up, provided it has
sufficient distributable profits?
18 Fill in the blanks in the statements below.
A public company cannot make a distribution if it would reduce the company's net assets to below
the aggregate of its ........................................ and ........................................
19 Which of the following are correct statements about the relationship between a company's
ordinary shares and its debentures?
A Debentures do not confer voting rights, whilst ordinary shares do.
B The company must pay interest on debentures and dividends on ordinary shares.
C A debentureholder takes priority over a member in liquidation.
20 What are the principal characteristics of a floating charge?
21 Company law requires a company to maintain a register of charges and to make it available for
inspection by the public, not just members and creditors.
True False
7 days 21 days
14 days 28 days
24 What particulars of a charge must the Registrar be sent when the charge is registered?
25 What main remedies are available to a secured debentureholder to enforce his security?
Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.
154 Law
Answers to Interactive questions
1 False. The company may decide not to pay any dividend, or may be unable to because it does not
have any distributable profits. What the preference shareholders have is a right to receive their
dividends before other dividends are paid or declared.
2 A and E are implied rights; the others have to be stated explicitly.
3 A company's called-up share capital is so much of the share capital as equals the aggregate amount
of the calls made on its shares plus share capital that is paid up without being called and share
capital that is to be paid at a specified future date.
4 75%. A special resolution of the relevant class or written consent from at least 75% in nominal
value of the issued shares of that class.
5 The holders of at least 15% of the issued shares of the class in question (who have not themselves
consented to the variation)
6 An ordinary resolution, even though an alteration in the articles takes place (which would normally
require a special resolution). Remember that authority to allot need not be given in the articles, it
can be given by ordinary resolution.
7 A rights issue is an allotment of additional shares to existing members in exchange for
consideration payable by the members.
A bonus issue is an allotment of additional shares to existing members where the consideration is
effectively paid by using the company's reserves.
8 A No
B Yes
C No
D No
9 A At a discount, no
B At a premium, yes
C Otherwise than for cash, yes. However note that the non-cash consideration must be
independently valued in the case of a public company
10 True
11 Two months
12 By a special resolution approved by the court
By a special resolution supported by a directors' solvency statement
13 Allotment of more shares
Subdivision
Consolidation
14 An ordinary resolution
15 A directors' statement
An auditors' report
A special resolution
Public notice of the proposed payment
16 None
17 No, a company can only purchase its own shares when they are fully paid
18 Called-up share capital and undistributable reserves
19 A and C are correct. Whilst the company has a contractual duty to pay interest on debentures,
there is no necessity for it to pay dividends on shares. B is therefore incorrect.
156 Law
20 A floating charge can be described as:
A charge on a class of assets, present and future
Which class is in the ordinary course of the company's business changing from time to time
Until the holders enforce the charge, the company may carry on business and deal with the
assets charged
21 True
22 A, C and D are true. As the charge does not attach to the asset until crystallisation, B is untrue.
23 21 days
24 A copy of the charge
The date that the charge was created C
H
The amount of the debt which it secures A
The property to which the charge applies P
The person entitled to it T
E
25 Take possession of the asset subject to the charge and sell it R
Appoint a receiver of it
Introduction
Examination context
Topic List
1 Administration
2 Receivership
3 Company Voluntary Arrangements
4 Liquidation
5 Individual voluntary arrangements
6 Bankruptcy
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
159
Introduction
Syllabus links
Chapter 5 addressed how a company is formed. This chapter looks at the termination of a company by
winding-up and dissolution (but also compulsory voluntary arrangements and administration, which are
both designed to avoid termination). In discussing the rights of secured and unsecured creditors, it also
follows Chapter 7 where you studied debentures and company charges.
Examination context
The legal issues discussed in this chapter could be examined in conjunction with other areas of company
law, for example the incorporation of a company, fraudulent and wrongful trading and financing by
loan capital. You might be asked to advise on appropriate courses of action available to members or
creditors in a scenario involving a company in financial difficulties. An awareness of personal bankruptcy
and individual voluntary arrangements may be needed in the context of discussing partners liabilities.
In the assessment, candidates may be required to:
Identify the nature and function of administration, receivership and company voluntary
arrangements
Identify the principal means of termination of companies, including voluntary and compulsory
winding-up
Describe the priorities on a liquidation of a distribution of assets, including the rights of creditors
and employees
Identify the main implications of bankruptcy and individual voluntary arrangements
When a company is in financial difficulties, there are several courses of action open to its members and
creditors. Some are aimed at rescuing the company as a going concern, others are aimed at bringing
the life of the company to an end, whether insolvent or not. Thus administration is designed to rescue
the company as a going concern or, at least, to secure a better result for the company's creditors as a
whole than would be likely on a winding-up. A secured creditor may appoint a receiver to realise the
charged assets and satisfy the debt secured. Company voluntary arrangements are also designed to
rescue the company and prevent it from being wound up. Liquidation, on the other hand, is the act of
terminating the company's life and winding up its business.
160 Law
1 Administration
Section overview
Administration is relevant where a company is in financial difficulties but not necessarily insolvent
or close to insolvency.
Administration results in a moratorium on actions against the company.
An administration order is an order of the court which puts an insolvency practitioner in control of
the company, principally to insulate the company from its creditors and with a view to rescuing
the company as a going concern.
Company Ordinary Apply to the court and show Cannot appoint in specified
resolution that circumstances, including where
the company is already in
Directors (this is the Majority The company is or is
liquidation or administration or
most usual type of decision likely to be unable to pay
where applications are pending.
appointment) its debts and
Otherwise must give five days'
An administration order prior notice to any QFCH. Must
is reasonably likely to file at the court
achieve the purpose of
administration Notice of the intended
appointment and actual
Must give notice of
appointment
application to QFCH (below)
who may intervene
Timescale Event
Within 7 days File notice of his appointment with the Registrar of Companies
Require any of the company's officers and employees to provide a statement of
affairs (who have 11 days to comply with any such request)
162 Law
Timescale Event
Within 8 weeks Submit a statement of his proposals for achieving the aim of administration to
The Registrar
The company's creditors
The company's members
Within 10 weeks Hold a creditors' meeting (unless he considers there to be insufficient property to
make a distribution to unsecured creditors over and above the 'ring-fenced asset
distribution' set out in the Act and 10% creditors do not require one
regardless).
The creditors may either accept the proposals or reject them (in which case the
court may make any order it sees fit, including the termination of the
administrators appointment).
One year after The administrator's appointment is terminated unless extended by the court or
appointment (once only) by a prescribed majority of the creditors.
2 Receivership
Section overview
A secured creditor with a charge over land usually has the power to appoint a receiver in the event
of the borrower's default.
A receiver will realise the charged asset in order to pay off the chargeholder's debt.
With some exceptions, administrative receivers can no longer be appointed by floating
chargeholders.
The term 'receiver' has, somewhat confusingly, come to be used to denote two types of office, one of
which was virtually abolished by changes made to the Insolvency Act 1986 by the Enterprise Act 2002,
whilst the other remains.
164 Law
2.2 Fixed charge receiver
The term 'receiver' may also indicate a 'non-administrative receiver' or 'LPA receiver' (so-called because
such receivers were traditionally appointed under the Law of Property Act 1925). The scope for these
receivers was not curtailed by the Enterprise Act 2002 and, on the contrary, some commentators report
rising activity in the receivership market.
A receiver may be appointed by the holder of a fixed charge over land in the event of the borrower's
default. His role is to collect rent and/or sell the property. Unlike liquidators, administrators and trustees
in bankruptcy, a receiver does not need to be a qualified insolvency practitioner and, in practice, will
often be a surveyor or other property specialist. Although his main concern is to realise the property for
the benefit of the lender, he also owes a duty of care to the borrower to act prudently and to have
regard to his interests (but not to go to extensive lengths to enhance the value of the property before
selling it, by pursuing planning applications or renewing leases, for example).
The appointment of a receiver may provide a relatively quick and inexpensive remedy for a lender and
may be attractive where a straightforward exercise of his power of sale is not appropriate. Although the
appointment of a receiver is often followed by liquidation, it is quite possible for the company to remain
solvent and to continue in business once the receiver has performed his duties and vacated office. The
appointment of a receiver will normally cause floating charges to crystallise and become fixed charges
(although they are ranked as floating charges on a winding up, since they were created as such).
Section overview
Company Voluntary Arrangements (CVAs) were introduced by the Insolvency Act 1986 and are
intended to avoid a company being wound up.
A CVA is an agreement between the company and its creditors, which sets out how the
companys debts are to be paid and in what proportions.
A company is entitled to continue trading for the duration of the CVA.
A CVA may comprise either one or both of a composition of debts (where the company agrees to pay
a limited proportion of its total debt, eg 60p in the pound) or a scheme of arrangement (where the
company agrees to pay its debts over a defined period, typically 3-5 years). A CVA may result in one or
more creditors taking an interest in the company by way of a debt-equity swap.
3.2 Moratorium
By important changes introduced by the Insolvency Act 2000, where the directors of a small company
wish to propose a CVA, they may apply for a short moratorium, during which they can prepare and
submit a proposal to their creditors. (This gave small companies the significant advantage of a
breathing space which, otherwise, was only available by entering into administration.)
Prescribed documents must be submitted to the court, including the proposed CVA, a statement of the
companys affairs and confirmation that the nominee believes the proposal to have a reasonable
prospect of being approved and implemented. Once these documents are filed, a moratorium of 28
days will come into effect, subject to extension of up to two months with the agreement of both the
members and creditors meetings. The existence of the moratorium must be advertised and stated on
all business documents. It should also be notified to the Registrar of Companies.
Generally speaking, no winding up or other insolvency proceedings can be commenced during the
moratorium period. Nor can security over the companys property be enforced, or any legal process
undertaken. Any winding up petitions presented prior to the moratorium will be stayed and a floating
charge cannot crystallise during the moratorium. The company cannot requisition or hold any meeting
without the consent of the nominee or court and it can only sell property (other than in the ordinary
course of its business), or pay off pre-moratorium debts, with the approval of the nominee or creditors
committee (if there is one) and, if the property is charged, the consent of the charge-holder or court.
The nominee must monitor the companys affairs during the moratorium and the moratorium will be
terminated if the nominee withdraws his consent to act, provided he does so properly and on specified
grounds.
166 Law
4 Liquidation
Section overview
Winding up, or liquidation, is the process of terminating the life of a company and is carried out
by a liquidator.
A company is most likely to be wound up where it has become insolvent.
Liquidation may proceed as a members' voluntary winding up (where the company is solvent) or
as a creditors' voluntary winding up.
Alternatively, liquidation may be imposed compulsorily on the company by the court.
The liquidator is bound to realise the company's assets and apply the proceeds in a particular
order, including distributing any surplus to contributories once creditors have been satisfied.
This is a statutory declaration that the directors have made full enquiry into the affairs of the company
and are of the opinion that it will be able to pay its debts in full, together with interest (at the applicable
8
rate), within a specified period not exceeding 12 months. It is a criminal offence punishable by fine or
imprisonment for a director to make a declaration of solvency without having reasonable grounds for it.
The declaration must
Be made by all the directors or, if there are more than two, by a majority of them
Include a statement of the company's assets and liabilities as at the latest practicable date before
the declaration is made.
The declaration must be:
Made not more than five weeks before the resolution to wind up is passed and
Delivered to the registrar within 15 days after the meeting (s 89 IA '86).
The company may appoint a liquidator by passing an ordinary resolution to that effect. If the liquidator
later concludes that the company will be unable to pay its debts, he must call a meeting of creditors and
lay before them a statement of assets and liabilities (s 95 IA '86).
In a members' voluntary winding up the creditors play no part, since the assumption is that their debts
will be paid in full. However, a members' voluntary liquidation may become a creditors' voluntary
liquidation where the liquidation process is not progressing to the satisfaction of the company's
creditors.
Ground Explanation
That the company is unable to A creditor must (in petitioning on the grounds that the company is
pay its debts (s 122 (1)(f)) unable to pay its debts) show either
That he is owed more than 750 and has served on the company
at its registered office a written demand for payment and the
company has neglected, either to pay the debt or to offer
reasonable security for it within 21 days, or
That he has attempted to enforce a judgment against the company
by execution on the company's property but it has failed to satisfy
the debt, or
168 Law
Ground Explanation
That, taking into account the contingent and prospective liabilities
of the company, it is unable to pay its debts as they fall due or that
its assets are less than its liabilities.
That it is just and equitable to This ground is usually relied on by a member who is dissatisfied with
wind up the company the directors or controlling shareholders over the management of the
(s 122(1)(g)) company (for example, where there is management deadlock or
where relations within a quasi-partnership break down). It must be
shown that no other remedy is available.
(This provision was discussed in Chapter 6.)
A members petition to wind up the company on the grounds that it is just and equitable to do so, will
only be considered if the company is solvent (otherwise he has nothing to gain from it) and he has been a
registered shareholder for at least six of the last 18 months prior to the petition (subject to some
exceptions).
The BIS (Department for Business, Innovation and Skills) may petition for the compulsory winding up of
a company
If a public company has not obtained a trading certificate within one year of incorporation
Following a report by BIS inspectors that it is in the public interest and just and equitable for the
company to be wound up.
On a compulsory winding up, the court will usually appoint the Official Receiver (an officer of the court)
as liquidator, although he may be replaced by an insolvency practitioner at a later date. The Official C
H
Receiver must investigate (s 132) the causes of the failure of the company, and generally, its
A
promotion, formation, business dealings and affairs. P
T
The liquidation is deemed to have commenced at the time (possibly several months earlier) when the
E
petition was first presented, with the following consequences: R
Any disposition of the company's property and any transfer of its shares subsequent to the
commencement of liquidation is void unless the court orders otherwise.
8
Any legal proceedings in progress against the company are halted (and none may be commenced)
unless the court gives leave.
Any seizure of the company's assets after commencement of liquidation is void.
The employees of the company are automatically dismissed and the liquidator assumes the powers
of management previously held by the directors.
Any floating charge crystallises.
The assets of the company may remain the company's legal property but under the liquidator's
control, unless the court orders the assets to be vested in the liquidator.
The business of the company may continue, but it is the liquidator's duty to continue it with a view
only to realisation, for instance by sale as a going concern.
Transaction Explanation
Charges Charges not registered within 21 days are void against the liquidator and creditors (and
the chargee becomes an unsecured creditor)
Transactions A transaction 'at an undervalue' is a gift or a If at the time of the
at an transaction in the two years prior to liquidation (or undervalue or preference
undervalue administration), by which the company gives the company was unable to
consideration of greater value than it receives, for pay its debts, or became so
instance a sale at less than full market price (s 238 IA by reason of the transaction
'86), unless the company enters into it (save in the case of a
170 Law
Transaction Explanation
You will recall that if the liquidator can show that the directors are guilty of wrongful or fraudulent
trading the court may order that they be personally liable for some or all of the company's debts (ss C
213, 214 IA '86). H
A
P
Interactive question 2: Avoidance of charges [Difficulty level: Exam standard] T
E
Trading Ltd has recently begun a process of liquidation (in February 2007) following resolutions by the R
members and creditors to wind up the company. Archibold and Duke, the two directors, have been
researching insolvency on the internet and it has led them to be concerned over a number of
transactions entered into by Trading Ltd over the past few years. They advise you that Trading Ltd has 8
actually been unable to pay its debts since April 2006.
They ask for your advice as to whether the following transactions might be avoided by the liquidator.
Priority Explanation
1 Costs Including the costs of getting in the assets, liquidator's remuneration and all
costs incidental to the liquidation procedure
2 Preferential debts Employees' wages (for a prescribed period and subject to a prescribed
maximum)
Accrued holiday pay
Contributions to an occupational pension fund
These rank equally
3 Floating charges Subject to ring-fencing (see below)
4 Unsecured A certain percentage of assets is 'ring-fenced' for unsecured creditors where
ordinary creditors there is a minimum fund for distribution of 10,000, namely 50% of the first
10,000 of floating charge realisations and 20% of the floating charge
realisations thereafter (subject to a prescribed maximum)
5 Deferred debts For example dividends declared but not paid and interest accrued on debts
since liquidation
6 Members Any surplus (meaning that the company is in fact solvent) is distributed to
members according to their rights under the articles or the terms of issue of
their shares.
Note that secured creditors with fixed charges (and indeed floating charges) may appoint a receiver to
sell the charged asset, passing any surplus to the liquidator. In the event of a shortfall they must prove
for the balance as unsecured creditors. Note, however, that a floating charge holder who faces a
shortfall on his secured debt (which is therefore treated as unsecured) cannot share in the ring fenced
part available to unsecured creditors.
Buffers Ltd has an issued share capital of 5,000 1 shares and is in compulsory liquidation. The
liquidator has a fund of 8,500 available for distribution and needs to distribute the fund to settle the
following claims so far as possible:
The directors declared a dividend of 10p, six months ago but it has not been paid.
The liquidation costs, including remuneration, amount to 2,500
Moneylender plc had a floating charge over the company's stock in trade which has now
crystallised and the value is 4,000
The company's employees have been paid, with the exception of some accrued holiday pay worth
1,200
Mr Staples, the local stationery supplier is an unsecured creditor and is owed 830.
It is clear that there will not be a surplus for distribution to the members.
A Which debt will be discharged first?
B Will Mr Staples receive all of the money owed to him?
C Will the members receive the dividend?
D Do the ring-fenced provisions apply?
See Answer at the end of this chapter.
172 Law
Following dissolution of a company (by whatever means) its property vests in the Crown as bona
vacantia (s 1012 CA '06), which means that there is no known person entitled to it. However the Crown
has the power to disclaim it, in which case any interested person may apply to the court to have the
property vested in them on such terms as the court sees fit.
Section overview
An individual voluntary arrangement ('IVA') is an arrangement available to an individual (including
sole traders and partners) to reach a compromise with his creditors, with the aim of avoiding
bankruptcy.
IVAs are governed by the Insolvency Act 1986 and supervised by licensed insolvency practitioners.
Sole traders and partners may well wish to pursue the option of an IVA in order to protect the survival of
their business. An IVA normally provides for the debtor to pay reduced amounts towards his total debt
over a period of, usually, five years. Once approved, an IVA binds all of the debtors creditors and none
may pay petition for bankruptcy.
Advantages
For the individual The sole trader is permitted to continue in business and to operate a
normal bank account (but without an overdraft facility)
There is flexibility in drawing up the proposals to suit his personal and
financial circumstances
He does not suffer the restrictions that would be imposed by bankruptcy,
for example not being able to act as a director of a limited company
Details of IVAs are not published in the press as details of bankruptcy are
For the creditor It is essential that an IVA is considered as it is likely to give greater
satisfaction to creditors than bankruptcy would
The costs of administering an IVA are significantly less than bankruptcy,
thus enabling a higher return to creditors
6 Bankruptcy
Section overview
A person may become bankrupt either by petitioning the court himself or by his creditor
petitioning the court for bankruptcy.
Bankruptcy is effectively the equivalent for a sole trader or partnership (or other individual) of a
compulsory winding up in the case of a company.
It should be considered as a last resort after IVAs.
174 Law
The reason for this provision (which does not apply where a creditor petitions for bankruptcy) is to
discourage bankruptcy, in favour of an IVA, where there is this level of value in the estate as against the
total debt.
Where a creditor petitions for bankruptcy, he will be able to show that the debtor is unable to pay his
debts, if he can show that
He has served a statutory demand on the debtor that has not been satisfied or set aside within 21
days or
His attempts to enforce a judgment order have not been satisfied.
The creditor may present a petition within the three week period following service of a statutory
demand where the value of the property is likely to be diminished significantly during that period. In
such cases an interim receiver is appointed, rather like a provisional liquidator. However, if a bankruptcy
order is made, the debtor becomes an undischarged bankrupt and the order is advertised in the
Gazette and in a local and/or national newspaper.
Also from the date of the order, the Official Receiver is appointed to administer the bankruptcy and to
act as trustee of the bankrupt's estate, unless an insolvency practitioner is appointed to act as trustee
(which is likely where the estate is sufficient to pay his fees and the creditors). The Official Receiver must
investigate the debtors financial affairs and must report to his creditors, and may report to the court. He
will also give notice of the bankruptcy order to local authorities, utility suppliers, the land registry and
any other relevant bodies or organisations. He must act to maximise the funds available to satisfy the
creditors and then pay creditors with provable debts in a prescribed order, similar to the compulsory
winding up of a company. If there is insufficient money available to pay all unsecured creditors, the
trustee in bankruptcy will declare a dividend, ie so many pence in the pound, so that the creditors
receive part-payment of their debts. C
H
A
P
6.2 The effect of bankruptcy T
E
Regardless of who petitions the court, once a bankruptcy order is made, the debtor becomes an
R
undischarged bankrupt and is subject to a number of personal restrictions, for example
He cannot act as a director of a company or an insolvency practitioner
8
He faces criminal liability for failure to provide information or co-operate with the Official Receiver
by handing over his property, for example
Under ICAEW rules, he may not practise as a chartered accountant
From the date of the petition, any payment of money or disposition of property is void unless approved
by the court. The court may stay any action against the debtor from the date of the petition and,
generally speaking, the bankrupt can no longer be sued by his creditors once the order is made. There
are exceptions however, for example a secured creditor can still enforce his security.
Most importantly, the bankrupt's estate automatically vests in the trustee in bankruptcy as soon as he is
appointed and, from the time the order is made, the Official Receiver act as receiver and manager of the
estate and must protect it pending the appointment. Such vesting occurs automatically and does not
need any written contract or transfer of rights or property.
Note that the bankrupts 'estate' is defined to exclude
Such tools of the trade and other items as are necessary for use personally in his employment,
business or vocation
Such clothing and household provisions as are necessary to satisfy the basic domestic needs of the
bankrupt and his family
Property held by the bankrupt on trust for another person
Certain tenancies protected in some way by legislation
The estate is vested subject to the rights of secured creditors.
Debt Explanation
1 Costs The costs of realising the estate, the remuneration of the trustee and
incidental expenses
2 Pre-preferential As provided by certain statutory provisions, for example funeral
debts expenses where the bankrupt is deceased
3 Preferential debts Remuneration of employees (for a prescribed period and subject to a
prescribed maximum)
Sums payable in connection with occupational pension schemes
Accrued holiday pay
4 Ordinary debts Where the fund is insufficient to pay all unsecured creditors they rank
equally
5 Interest Creditors may prove for interest up to the date of bankruptcy (and
therefore only if all preferential and ordinary creditors have been paid
in full)
6 Postponed debts For example a debt owed to the bankrupts spouse
7 Surplus Any surplus is returned to the bankrupt (this is of course unlikely)
Once the trustee has completed the distributions, he reports to the creditors who will usually release
him from his trusteeship.
176 Law
Company voluntary
arrangement
Nominee
Summary and Self-test
Approval of
creditors and
members
Moratorium
(small companies
only)
Continue trading
177
E
P
8
C
R
H
178 Law
Self-test
Answer the following questions.
1 Who may apply to the court for an administration order but cannot appoint an administrator out of
court?
2 What must an administrator do
A Within 7 days?
B Within 8 weeks?
C Within 10 weeks?
3 What does CVA stand for?
4 The normal duration of a CVA is
Up to 12 months
3-5 years
5-10 years
5 What are the two most important grounds for compulsory liquidation?
(1) .................................................................................................................................................
(2) .................................................................................................................................................
C
6 A members' voluntary winding up is where the members decide to dissolve a solvent company. H
A
True P
T
False E
R
7 In what way are the powers of the members' nominee liquidator restricted pending the creditors'
meeting?
8 A creditor must satisfy one of three criteria in order to petition for a compulsory winding up. 8
Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.
180 Law
Answers to Interactive questions
1 A creditor with no minimum value of debt (if he is not also a qualifying floating charge holder)
2 A File notice of his appointment with the Registrar
B Submit a statement of his proposals to the Registrar and the company's members and
creditors
C Hold a creditors meeting
3 Company voluntary arrangement
4 3-5 years
5 (1) Company is unable to pay its debts
(2) It is just and equitable to wind up the company
6 True
7 He may only
Take control of the company's property
Dispose of goods which are perishable or which would otherwise diminish in value very
quickly
Do things necessary for the protection of the company's assets
(except with leave of the court).
8 He is owed more than 750 and the company has failed to satisfy his written demand for
payment within 21 days
His attempts to enforce a judgment order by execution have failed
The company is unable to pay its debts
9 The Official Receiver
10 Floating charge in favour of an unconnected person 1 year
Transaction at an undervalue 2 years
Preference in favour of an unconnected person 6 months
11 E, C, A, F, B, D
12 Official Receiver appointed as liquidator
Liquidation deemed to have commenced at time when petition first presented
Disposition of company property since commencement of liquidation deemed void
Legal proceedings against the company are halted
Employees are dismissed
Any floating charge crystallises
13 Yes
182 Law
CHAPTER 9
Partnership
Introduction
Examination context
Topic List
1 Ordinary partnerships
2 Comparison between ordinary partnerships and companies
3 Limited liability partnerships
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
183
Introduction
To define partnership
To know the procedure for the formation of a limited liability partnership and the
administrative consequences thereof
Specific syllabus references for this chapter are: 1e, 2a, b, c and i.
Syllabus links
The practical effects of partnership will be relevant when looking in detail at audit firms and their liability
in the Audit and Assurance paper.
Examination context
Partners' authority will be examined in the context of agency law, commonly in a scenario question. The
law on partnerships may also be examined by requiring a comparison with companies.
In the assessment, candidates may be required to:
Identify the differences between partnerships and companies
Recognise the authority a partner has to enter into contracts on behalf of the partnership
Identify the procedure required to form a limited liability partnership and the administrative
consequences
Identify the rights and duties which a member of a limited liability partnership possesses
184 Law
1 Ordinary partnerships
Section overview
A partnership is 'the relation which subsists between persons carrying on a business in common
with a view of profit'.
A partnership can be an informal arrangement or it can be formalised and regulated by a written
partnership agreement.
A partnership can be termed an 'ordinary' (or traditional) partnership in order to distinguish it
from a limited liability partnership (see section 3 below).
The Partnership Act 1890 governs ordinary partnerships.
Partnership is a common form of business association. It is flexible, because it can be either a formal or
informal arrangement, thus suiting both large organisations and small operations.
Some professions prohibit their members from carrying on practice through limited companies and
therefore operate as partnerships. However some permit their members to trade as 'limited liability
partnerships' which share many characteristics with companies (and which are described in section 3 of
this chapter). Businessmen are not so restricted and generally prefer to trade through a limited company
for the advantages this can bring.
1.1 Definition
A partnership is 'the relation which subsists between persons carrying on a business in common with a
view of profit' (s 1 Partnership Act 1890). This definition can be further explained as follows:
Relation which subsists A partnership does not have a separate legal personality, it is merely a
relationship between persons.
Between persons 'Person' includes companies. There must be at least two partners.
Carrying on a business Business includes 'every trade, occupation or profession'
It can be a single transaction (often referred to as a 'joint venture')
The business must involve some activity, so if two or more persons are C
merely the passive joint owners of revenue-producing property, such as H
investments or rented houses, that fact of itself does not make them A
partners. P
T
A partnership begins when the partners agree to conduct their business E
R
activity together which may well be before the business actually begins
to trade. Thus in Khan v Miah 2001 the parties to a proposed venture
(running a restaurant) were partners even before the restaurant opened
because, on the facts, they were clearly carrying on the business (by 9
leasing premises, hiring equipment and opening a bank account).
In common ie as joint proprietors (normally evidenced by the sharing of profits). For
example, where a shop owner employs a shop assistant, they are both
concerned with running a business at a profit but they cannot be said to be
partners.
With a view of profit The test is one of intention, so if partners plan to make a profit but actually
make a loss, that does not stop the arrangement being a partnership.
However if the purpose of the common endeavour is actually to gain business
experience, for example, there is no partnership (Davies v Newman 2000).
The word 'firm' is correctly used to denote a partnership. It is not correct to apply it to a registered
company (though newspapers often do so). The word 'company' may form part of the name of a
partnership (for example, 'Smith and Company') but the words 'limited company' and 'registered
company' can only be applied to a registered company.
Partnership 185
Interactive question 1: Partnerships [Difficulty level: Exam standard]
Interactive question text.
Identify whether the following three statements are true or false in relation to an ordinary partnership.
True False
A In England and Wales, an unlimited partnership has no existence
distinct from the partners
B Partners share equally in the venture's profits
Profits and losses These are shared equally in the absence of contrary agreement. If the
partnership agreement states that profits are to be shared in certain
proportions but is silent as to losses, then losses are to be shared in the same
proportions.
Management Every partner is entitled to take part in managing the firm's business; ordinary
management decisions can be made by a majority of partners.
Change in business Any decision on changing the nature of the partnership's business must be
unanimous.
Indemnity The firm must indemnify any partner against liabilities incurred in the ordinary
and proper conduct of the partnership business or in doing anything
necessarily done for the preservation of the partnership property or business.
Remuneration No partner is entitled to remuneration for acting in the partnership business.
Variation The partnership agreement may be varied with the consent of all the
partners.
Records and accounts These must be kept at the main place of business and must be open to
inspection by all partners.
Interest on capital None is paid on capital except by agreement. However, a partner is entitled
to 5% interest on advances beyond his original capital.
New partners New partners must only be introduced with the unanimous consent of
existing partners.
186 Law
Provisions of the Description
Partnership Act
Expulsion A partner may only be expelled by a majority of votes when the partnership
agreement allows; even then, the power must only be used in good faith and
for good reason.
Dissolution The authority of the partners after dissolution continues so far as is necessary
to wind up the partnership affairs and complete transactions already begun.
On dissolution, any partner can insist on realisation of the firm's assets,
payment of the firm's debts and distribution of the surplus.
Capital deficiency The remaining partners share a capital deficiency (what a partner owes but
cannot pay back) not as a loss but in ratio to the amounts of capital which they
originally contributed to the firm.
In addition to the rights and duties set out in the Partnership Act, partners also owe fiduciary duties to
the partnership by reason of being fiduciaries (in the same way that some directors' duties are fiduciary
in nature). These duties arise out of general principles of equity. For example, it is a breach of the duty
to act in good faith, to exercise a legal right (eg to expel a partner) for an improper motive. The
fiduciary nature of their relationship also prohibits partners from keeping profits derived from the
partnership without the consent of the other partners and requires them to avoid conflicts of interest
without full disclosure. Breach of these fiduciary duties may render the partner responsible liable to
account to the partnership for any monies received or to make good any other loss suffered.
True False
Partnership 187
The Act also provides that the firm and the partners will be bound by all partners' acts for carrying on in
the usual way business of the kind carried on by the firm unless
He has no authority to act for the firm in the particular matter and
The person with whom he is dealing either knows that he has no authority or does not know or
believe him to be a partner.
The courts have interpreted this provision to mean that the binding act should be done in the firms
name for the purpose of the firms business, and by a person who purports to act as a partner.
The Act specifically provides that where a partner pledges the credit of the firm for a purpose which has
no apparent connection with the firm's ordinary business, the firm will not be bound unless he has
actual express authority to do so.
If any restriction is placed on a partner's authority to bind the firm, no act done in contravention of
that restriction is binding on the firm where the third party has notice of the restriction.
Note that (except where a partner has actual authority) his authority often depends on the perception
of the third party. Generally speaking, if the third party genuinely believes that the partner has
authority, it is highly likely that the acts of the partner will bind the firm.
Note that a new partner admitted to an existing firm is liable for debts incurred only after he becomes
a partner. He is not liable for debts incurred before he was a partner unless he agrees otherwise.
188 Law
Where a partner retires, he remains liable for any outstanding debts incurred while he was a partner,
unless the creditor has agreed to release him from liability. He is also liable for debts of the firm incurred
after his retirement if the creditor knew him to be a partner (before retirement) and has not had notice
of his retirement. Therefore, it is vital on retirement that a partner gives notice to all the creditors of the
firm. He may also consider entering into an agreement with the continuing partners that they will
indemnify him against any liability for post-retirement debts.
The liability of the partnership for a partner's acts before he retired is not affected by that partner's
retirement.
Partnership 189
2 Comparison between ordinary partnerships and
companies
Section overview
The key difference between a company and an ordinary partnership is that a company has a
separate legal personality, distinct from its members, whereas an ordinary partnership does not.
There are many other differences, some incidental to this key difference and some arising from
specific statutory provisions.
The principal differences between a registered company and an ordinary partnership are given in the
tables below, the first noting the differences which are commonly seen as advantages of incorporating a
business, the second noting those commonly seen as disadvantages, or conversely, advantages of
running a business as a partnership.
Legal entity Separate legal entity distinct from its Has no independent existence
members
Liability Company liable on its contracts Partners (personally) are jointly and
severally liable on partnership contracts
Limit on liability Members' liability can be limited by Partners' liability unlimited
shares or guarantee
Ownership Company owns assets and ownership Partners own assets jointly
not affected by change of members
Finance In addition to fixed charges, a company An ordinary partnership cannot do so
can raise finance by creating a floating
charge over its undertaking or assets,
allowing it to deal with them without the
lenders consent prior to any
crystallisation
Change of Company has perpetual succession (ie it The death, retirement or bankruptcy of a
membership is unaffected by a change in its partner dissolves the partnership (subject
members) to the terms of any partnership
agreement)
Transferability of Members' shares freely transferable A partner may assign his interest but the
ownership (subject to articles) assignee does not become a partner as a
result
Limit on No maximum, minimum one No maximum, minimum two
membership
Formation A company must be registered under the No particular formality is required for a
Companies Act partnership to exist
Administrative A company must file accounts and A partnership does not have to comply
consequences documents with the Registrar of with such formalities
Companies
190 Law
Factor Company Ordinary partnership
Cost A company faces the cost of compliance A partnership has no such cost
with administrative requirements and an
annual audit
Privacy A number of the company accounts and Only partners have a right of access to
documents must be open to public the partnership accounts
inspection
Management A company member cannot be directly Every partner has a right to participate in
involved in the management of the the management of the partnership
company unless he is also a director (subject to the terms of any partnership
agreement)
Withdrawal of A company is subject to strict rules It is more straightforward for a partner to
capital concerning repayment of capital withdraw capital
True False
C
H
3 Limited liability partnerships A
P
T
E
Section overview R
A limited liability partnership (LLP) is a corporate body, which combines the features of an
ordinary partnership with limited liability.
9
It is governed by the Limited Liability Partnerships Act 2000.
Its members are agents of the LLP.
An LLP is wound up like a company, rather than being dissolved on a change of membership.
Particular documents must be sent to the Registrar of Companies on and subsequent to
incorporation.
The limited liability partnership was introduced by the Limited Liability Partnerships Act 2000.
Essentially an LLP is an incorporated partnership that has a legal personality separate from that of its
members (whose liability is limited) and which is subject to regulation similar to that applicable to a
registered company. An LLP is not liable to tax in the same way as a company, rather the partners
('members') are taxed as individuals on partnership profits, just as in an ordinary partnership. It is often
an attractive way forward for firms of professionals because it preserves the partnership ethos in the
context of limited liability.
Partnership 191
An LLP should not be confused with a limited partnership registered under the Limited Partnership Act
1907. Such partnerships are extremely rare and they are only mentioned here to avoid potential
confusion with LLPs. Briefly, a limited partnership requires at least one general partner who has control
of the management of the business and whose liability must be unlimited. The other partners are not
entitled to participate in management and cannot bind the partnership and their liability is limited to
the amount of capital they invested in the business.
192 Law
Interactive question 5: Regulation of LLPs [Difficulty level: Easy]
Are the following statements true or false in relation to LLPs?
True False
B There must be at least one general partner who has unlimited liability
and control of the management of the LLP
C An LLP is normally subject to a requirement to have its accounts audited
annually just like a company
D The members of an LLP are required to prepare a report along the same
lines as a directors' report
Basically the law relating to companies' insolvency applies to LLPs, with two notable modifications:
Withdrawals made by members within two years prior to winding-up may be clawed back if it can
be shown that the member (at the time of the withdrawal) knew or had reasonable grounds to
believe that the LLP was or would become insolvent.
On a winding up, past and present members may be required to contribute to the assets of the LLP
to the extent that they have agreed to do so in any LLP agreement. Note that in the absence of
any relevant provision in an LLP agreement (which is not obligatory) the legal liability of members
on liquidation is not clear.
Partnership 193
Interactive question 6: Formation of LLP [Difficulty level: Easy]
Under the Limited Liability Partnerships Act 2000, certain requirements must be met in order for an LLP
to be legitimately formed. Indicate whether each of the following is a necessity of incorporation.
Yes No
B The name and address of at least one designated member must be given
194 Law
Summary and Self-test
Summary
Company Partnership
Yes Entity No
Partners: joint and
Company unlimited
several liability
Liability
Members: limited Unlimited
Company owns Partners own
Assets
Floating charge No
Minimum 1 Minimum 2
Publicity Privacy
9
Directors Management Partners
Partnership 195
Self-test
Answer the following questions.
1 What is the statutory definition of 'partnership'?
2 A partnership can exist when parties enter into a single transaction rather than a series of
transactions.
True
False
True
False
196 Law
9 Which of the following must be included on the incorporation form?
A Name of LLP
B Location of registered office
C Addresses of all branches
D Names of all members of the LLP
E Tax status of each member of the LLP
F Names of designated members
10 Members of LLPs are agents of the LLP and of each other.
True
False
Yes
No
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
C
H
A
P
T
E
R
Partnership 197
Answers to Interactive questions
198 Law
Answers to Self-test
1 Partnership is the relation which subsists between persons carrying on a business in common with
a view of profit.
2 True
3 To be involved in decision-making
To share in profits
To examine accounts
To insist on openness and honesty
To veto new partners
To be indemnified by fellow partners
4 Property
Owned
Equal
5 D
6 Separate entity
Members' liability can be limited
Company owns property and is liable on contracts
Company can create floating charge
Company has perpetual succession
7 No formality required on creation
Partnership need not register accounts and other documents
Partnership has greater freedom and privacy and less cost through not having to comply with
requirements of companies legislation
All partners can participate in management
Withdrawal of capital is generally easier
8 True C
H
9 A, B, D, F A
P
10 False. Members of an LLP are agents of the LLP but not of each other
T
11 B and C E
R
12 Yes
Partnership 199
200 Law
CHAPTER 10
Criminal law
Introduction
Examination context
Topic List
1 Whistleblowing
2 Fraud
3 Bribery
4 Money laundering
5 Law and ethics
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
201
Introduction
Syllabus links
There are links with directors' duties, which we have already considered, since directors can be in a
position to carry on fraudulent trading for example. Your Assurance and Audit and Assurance studies will
also address professional ethics generally and, in particular, the obligation and authority of an auditor or
assurance provider to make a protected disclosure.
Examination context
In the sample paper there were five questions on criminal law (out of 50).
In the assessment, candidates may be required to
Identify circumstances where an accountant is protected from dismissal and victimisation if he
raises concerns ('whistleblows') about malpractice in the workplace
Identify instances and consequences of fraud and money laundering
Advise on appropriate courses of action for an accountant faced with a money laundering scenario
Identify instances and consequences of bribery and corruption
Recognise the role of ethics and ethical codes and their interaction with law
202 Law
1 Whistleblowing
Section overview
UK law gives people at work protection when they raise genuine concerns about criminal or civil
offences, danger to health and safety or the environment, a miscarriage of justice or the cover up
of any of these.
A disclosure must be a qualifying disclosure, made in good faith to the appropriate person in the
appropriate manner, and the person making it must have a reasonable belief that the information
is valid.
'Whistleblowing' is the name commonly given to workers making a disclosure of wrongdoing (usually)
by their employer. That wrongdoing is often, though not necessarily, of a criminal nature. The relevant
legislation is the Public Interest Disclosure Act 1998, which inserts a number of new provisions in the
Employment Rights Act 1996. Note that the legislation does not impose an obligation to whistleblow,
rather it protects individuals who choose to do so, whether as a matter of conscience or ethics or
because they are following internal rules and procedures.
This protection is afforded to workers generally (and not just to employees) and there is no
requirement as to age or length of service. It therefore includes agency and home workers, but self-
employed people and volunteers are not included. The protection means that any worker who is
victimised or sacked in breach of the Act can present a complaint to an employment tribunal that he has
been subjected to a detriment in contravention of the statutory provisions. He may seek an interim
order to keep his job and/or compensation. Awards of compensation are uncapped and based on the
losses suffered.
In order to receive protection, the disclosure made by a worker must be
A qualifying disclosure of information
Made in good faith (except if made to a legal adviser)
Made to the appropriate person
1.4 Protection
A worker has the right not to be subjected to 'any detriment by any act, or any deliberate failure to act'
by his employer as a result of having made a protected disclosure. The right not to suffer a detriment
covers a number of issues, such as lack of promotion, lack of training or opportunity, unjustified
disciplinary action, pay issues or failure to renew contracts as a result of having made a protected
disclosure. In addition, an employee who is dismissed or selected for redundancy principally for having
made a protected disclosure shall be regarded as having been automatically unfairly dismissed. A worker
who is not an employee and is dismissed may rely on the general right not to suffer a detriment.
An employment tribunal may award compensation to any worker who has been victimised for making a
protected disclosure. The amount of such compensation will be whatever the tribunal considers to be
just and equitable, having regard to the loss suffered and the nature of the complaint.
204 Law
Compensation may include an amount for injury to feelings and it is not subject to a maximum limit. (In
January 2009, for example, a railworker was awarded 200,000 for whistleblowing after he was
pressurised to lie about an accident he witnessed.)
2 Fraud
Section overview
We shall address fraud as a basic criminal offence as well as in the context of fraudulent trading
and insider dealing.
Fraud can be committed by an abuse of position or failing to disclose information as much as by
deliberately making false representations.
Directors and others can be guilty of fraudulent trading where they carry on a business with an
intent to defraud creditors or for any fraudulent purpose.
Insider dealing is the criminal offence of dealing in securities while in possession of sensitive
information as an insider.
2.1 Fraud
Historically, prosecutions for fraud were made under various common law and statutory offences
relating to defrauding and deception. The Fraud Act 2006 has now established a single statutory offence C
of fraud, which offence can be committed in three ways: H
A
Fraud by false Dishonestly making a false representation of fact or law, intending thereby P
representation to make a gain for himself or another or to cause another party loss or expose T
E
that party to the risk of making loss. R
Fraud by failing to Dishonestly failing to disclose to another person information which he is
disclose information under a legal duty to disclose thereby intending to make a gain for himself
or another or to cause another party loss or expose that party to the risk of 10
making loss.
The maximum penalty for fraud under the Act is 10 years' imprisonment and an unlimited fine.
206 Law
2.3 Insider dealing
Insider dealing is governed by the Criminal Justice Act 1993.
The principal offence of insider dealing is dealing in securities while in possession of inside information
as an insider, the securities being price-affected by the information. It is also an offence to
Encourage another to deal in them, or to
Disclose the information other than in the proper performance of one's employment, office or
profession.
Some of these terms need explanation:
Defences
The individual has a defence regarding dealing and encouraging others to deal if he can show that:
C
He did not expect there to be a profit or avoidance of loss, or H
He had reasonable grounds to believe that the information had been disclosed widely, or A
He would have done what he did even if he did not have the information. P
T
Note that where information is disclosed in the course of one's employment or profession, no offence E
is committed. Thus where an auditor passes on information to the partner responsible for the audit he is R
not guilty of an offence. If the partner then deals, he may potentially be liable but the auditor will not
be.
10
Penalties
Maximum penalties given by the statute are seven years' imprisonment and/or an unlimited fine.
Contracts remain valid and enforceable in civil law.
Section overview
Bribery is an extremely serious offence which undermines public confidence in administrative,
professional and judicial affairs.
Bribery is involved primarily with the offering or receiving of gifts or payments.
The Bribery Act 2010 (the Act) came into force on 1 July 2011. The Act is intended to simplify the
previous law on bribery and corruption, which was to be found in common law and a number of
statutes.
208 Law
be kept under review. The guidance makes it clear that the extension of hospitality and gifts is permitted
where the purpose is to establish or encourage good business relations, but will fall foul of the Act
where the purpose is to persuade the other party improperly to award business or favours to the
organisation.
4 Money laundering
Section overview
Money laundering is the process by which the proceeds of crime (either cash or other property)
are converted into assets which appear to have a legitimate (rather than illegal) origin.
Relevant persons, including accountants in practice, are required by law to report any knowledge
or suspicion of money laundering to the authorities (currently the Serious Organised Crime
Agency (SOCA)
The primary legislation on money laundering is the Proceeds of Crime Act 2002 (POCA 2002),
supplemented by the Money Laundering Regulations 2007 (the Regulations).
C
H
The term money laundering covers any activity by which the apparent source and ownership of the A
proceeds of crime are changed, in such a way that the cash or other assets appear to have been P
obtained legitimately. T
E
Proceeds of crime, termed criminal property in POCA 2002, means any assets which have been R
procured by means of a criminal act. A criminal act is one which constitutes an offence against the
state, punishable by fines and/or imprisonment.
10
210 Law
Offence Description Defences Penalty
Failure to Failure to inform MLRO or SOCA There was a reasonable 5 years
report as soon as practicable, of any excuse for not making a imprisonment
knowledge or suspicion that report Unlimited fine
another person is engaged in The person does not know
money laundering or suspect money
Failure to inform MLRO/SOCA of laundering and his
any information which raises employer has not provided
reasonable grounds for suspicion him with appropriate
(ie an offence can be committed training
if a person should have been
suspicious in the circumstances)
Tipping off Disclosing to a third person that The person did not know or 2 years
a disclosure or report has been suspect that the disclosure imprisonment
made to the SOCA or other was likely to prejudice the Unlimited fine
appropriate person, where that investigation
disclosure is likely to prejudice The person had lawful
any investigation that might be authority or reasonable
carried out as a result of the excuse to make the
report disclosure
Disclosing that an investigation
is being contemplated or carried
out, where that disclosure is
likely to prejudice such an
investigation
Note that the reasonable excuse defences have been interpreted narrowly by the courts but fear of
physical violence or other menaces would almost certainly be sufficient.
212 Law
Suspicion is more difficult to define. The courts have interpreted it as being something less than
knowledge or belief but more than speculation. Although suspicion is by nature personal and
subjective, it should still be built on some objective foundation. There should be some degree of
consistency in the way that a firms MLRO treats possible causes of suspicion.
If there are reasonable grounds for suspicion, the activity concerned should be reported. But this should
not necessarily be taken to include higher-than-normal risk factors which may affect certain types of
business or certain areas of a businesss operation.
For example, the fact that a client, or a clients supplier, demands payment in cash is not in itself
suspicious, unless there are grounds for suspicion that the objective of this is tax evasion or some other
criminal activity. Some of the questions that should be asked might be as follows:
Is the transaction or activity normal for this customer?
Does the transaction or business make sense from a business/personal point of view?
Has the pattern of transactions changed?
Where the transaction is with an entity in another country is there a good business reason for this?
Firms must ensure that all staff are properly trained in, know and understand the procedure for dealing
with suspicions, including the identity of the MLRO.
It is also essential that firms follow the Regulations on awareness and training so that staff are able to
identify, and therefore report, suspicious transactions.
Note that suspicious activities include anything as described above which has come to a relevant
persons attention during the course of his or her business. This need not be the activity of a client
itself.
This exemption is a potentially difficult area for accountants as they may be involved in giving advice on
legal issues as part of a portfolio of services and therefore will need to exercise judgement as to when a
10
suspicion has been formed in privileged circumstances.
214 Law
C Make a report to the MLRO without delay and not query the transaction with the managing
director, as that might constitute the offence of tipping off
D Make a report to the MLRO without delay and let the company accountant know that such a
report has been made as a professional courtesy
See Answer at the end of this chapter.
Yes
No
Yes
No
Section overview
Chartered accountants accept the responsibility of acting in the public interest and also the role of
being at the forefront of the fight against domestic and international corruption in all its forms.
Accountants must have regard to ethical codes from the ICAEW and other relevant bodies in
addition to the legal requirements of statute and regulations already discussed in this chapter.
The commission of the criminal offences which you have just studied causes a major distortion of trade,
undermines the development of emerging markets and impacts upon a company's reputation and
ability to secure investment.
C
Of course, accountants should conduct themselves at all times with the utmost integrity in providing H
their services, but over and above this, they are encouraged to play a role proactively in upholding A
P
ethical standards for tackling corruption on a domestic and international level. It goes without saying T
that acts of bribery, fraud and insider dealing are unethical as well as criminal acts. E
R
You will be aware that many issues of corporate governance have arisen in response to high profile
corporate and accounting scandals and a significant influence in such matters is the profound effect that
allegations and investigations of criminal activity can have on companies and executives. It is the
10
criminal law, as well as the regulatory law, that is responsible for introducing and formulating
governance requirements and criminal sanctions provide an effective means of achieving sound
corporate governance.
216 Law
Summary and Self-test
Summary
C
H
A
P
T
E
R
10
Unlimited fine
Money laundering
Knowledge
Suspicion
Report to SOCA/MLRO
Employers procedures
218 Law
Self-test
Answer the following questions.
1 Which Act governs the law on whistleblowing?
2 A person making a qualifying disclosure must be able to show, on the balance of probabilities, that
the matters alleged are true.
True
False
Yes
No
Yes
No
7 Dealing in securities while possessing inside information as an insider is an offence. What are the
other two principal offences of insider dealing?
8 Would the following statement constitute an offence under the Criminal Justice Act 1993? If so,
which offence?
'I can't tell you why, but now would be a good time to buy shares in Bloggs plc'.
9 What is the maximum penalty for insider dealing?
10 Complete the blanks:
Insider information is '........................................ ........................................
........................................ 'relating to a ........................................ ........................................ of
securities that are ........................................ ........................................ and not to securities
generally. It must, if ........................................ ........................................ , be likely to have a C
H
significant effect on ........................................ and it must be specific or ....................................... .
A
11 A person who accepts a bribe is guilty of an offence as well as the person who pays it. P
T
True E
R
False
14 Indicate which of the following statements are true and which are false.
15 Where an accountant gives advice on matters of revenue law, his advice is said to be protected by
legal professional privilege and need not be disclosed under any circumstances.
True
False
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
220 Law
Answers to Interactive questions
10
222 Law
CHAPTER 11
Introduction
Examination context
Topic List
1 'Employee' status and its significance
2 The employment contract
3 Unfair dismissal
4 Wrongful dismissal
5 Redundancy
6 The Data Protection Act 1998
Summary and Self-test
Answers to Interactive questions
Answers to Self-test
223
Introduction
To understand that an employment contract includes terms implied by law and to know
what they are
To identify the circumstances in which an employee is unfairly dismissed and appreciate
the consequences
To identify circumstances in which an employee is wrongfully dismissed and appreciate
the consequences
To understand the content and significance of the Data Protection Act 1998
Specific syllabus references for this chapter are: 4a, b, c, d and e.
Syllabus links
The practical effects of accounting for employees are looked at in Accounting and auditing payroll
systems are addressed in Assurance.
You dealt with information processing and security in Business and Finance. The Data Protection Act is
one of the reasons information must be kept secure.
Examination context
You may expect several questions on employee status and the contents of an employment contract.
Redundancy, wrongful dismissal and unfair dismissal are particularly important exam topics. Although
data protection is a relatively minor area of the syllabus, you should be prepared for questions on its
practical application.
In the assessment, candidates may be required to:
Identify who is an employee and the main legal consequences of employment status
Identify the key features of employment contracts
Recognise circumstances in which an employment contract may be terminated and the
consequences of termination
Identify when a dismissal constitutes a wrongful dismissal or an unfair dismissal
Identify the circumstances where an employee can claim a statutory redundancy payment
Identify the key requirements of the Data Protection Act 1998 on the use of personal information
and how the Act can affect the manner in which information systems are used by businesses
224 Law
1 'Employee' status and its significance C
H
A
Section overview P
T
An 'employee' can be distinguished from an 'independent contractor' or self-employed person. E
R
An employee is treated quite differently from an independent contractor in a number of respects,
including taxation, social security, health and safety, employment protection and liability in tort.
11
An employee is someone who is employed under a 'contract of service', ie a contract of employment,
which can be express or implied and oral or in writing. An independent contractor is someone who
works under a contract for services and is also described as 'self-employed'. A traditional equity partner
with a capital stake in the firm, involvement in management decisions and a share in profits and losses is
not an employee. Nor is a fixed share equity partner (Tiffin v Lester Aldridge LLP 2012). Whether so-
called partners are employees will depend on the facts of each case. A salaried partner, for example, is
likely to be an employee for employment law purposes.
The courts are often faced with determining whether someone is an employee or an independent
contractor. In doing so, the wording of any contract will not be conclusive (but may be relevant) and,
instead, the courts will apply a multiple test, taking into account a number of factors described below.
None of these factors is conclusive and the weight attached to each may vary. This multiple test looks at
the economic reality underpinning the employment relationship and asks whether, on balance, the
person can be said to be working 'on his own account' or is better described as an 'employee'.
There are three essential elements, or conditions, that must be present in order for the contract of
service (and thus the employer/ employee relationship) to exist, namely:
Condition Explanation
Personal service The employee must have agreed to provide his own work and skill in the
performance of a service for his employer. However, the fact that an employee is
able to delegate that performance in limited circumstances (for example when he is
sick or only with permission) will not mean that this condition is not met.
Control There must be some element of control exercisable by the employer over the
employee.
Mutuality of There must be an obligation on the employer to provide work and an obligation on
obligations the employee to do that work. Thus a 'casual worker' who works as and when
required, even if in preference to others, cannot be an employee because there is no
'mutuality of obligations'.
If these factors are not present there can be no contract of service. The fact that they are present,
however, does not mean that there will be a contract of service. The level of service and degree of
control will be taken into account along with the other factors listed below:
Personal Can he delegate or subcontract the task The greater the freedom to delegate, the
performance to another person if he so chooses and, if less likely someone will be considered to
so, to what extent? be an employee (and total freedom will
mean that the condition of personal
service is not satisfied).
Degree of ie if and to what extent the employer The greater the degree of control, the
control can tell the employee not only what to more likely someone will be considered
do but also how and when to do it. Are to be an employee.
there any restrictions on where he works
or for how long he works, for example?
It is fair to say that the nature of the claim brought before the court may influence its deliberations. For
example, if the claim relates to a breach of health and safety obligations, there will be a real public
interest in recognising an employer/employee relationship because of the statutory and common law
duties owed by an employer to an employee. Similarly, an employment tribunal might conclude that
someone is an employee, notwithstanding that the tax authorities treat him as a self-employed person.
226 Law
Interactive question 1: Employee or independent contractor?
[Difficulty level: Exam standard] C
H
Charles saw a sign advertising vacancies at a local building site. He contacted the foreman and was told A
that he would be required but that, because work depended on the weather conditions, he would work P
as and when required and would not be given an employment contract. He was also told that he would T
E
be accountable for his own income tax and national insurance. The foreman added that, like all of his
R
employees, he would be provided with tools and that at the beginning of each day he would be told
whether he would be needed and, if so, which site he would be working on that day. Lateness or theft
of materials would lead to his dismissal. Which of the following best describes his legal status?
11
A Charles is an employee because the provision of tools and control over his work, plus the fact that
he is told that he could be dismissed for lateness or theft indicate that he is an employee.
B Charles is not an employee due to the fact that he has to account for his own tax and national
insurance.
C Charles is an employee because he has responded to a job advertisement and the foreman referred
to the contractors as employees.
D Charles is not an employee because the fact that work is dependent on weather conditions means
that there is no mutuality of obligations.
See Answer at the end of this chapter.
However, there are several other practical reasons why the distinction between a contract of service
(employed) and a contract for services (self-employed) is important.
Employee Self-employed
Wrongful Can claim wrongful dismissal Cannot claim wrongful dismissal
dismissal
Employment There is legislation that confers protection Note that increasingly, employment
protection and benefits upon employees under a protection is given to 'workers' rather
contract of service, including than 'employees'. 'Workers' is more
Minimum periods of notice widely defined and will often include
those normally regarded as independent
Entitlement to statutory redundancy contractors as well as employees. It is
payment important that you know to which term
Remedies for unfair dismissal the legislation applies, for example,
statutory protection against unfair
Health and safety protection
dismissal applies to 'employees', but
(Sometimes the protection is subject to working time protection applies to
the employee having completed a certain 'workers'. Note too that statutory health
amount of continuous service.) and safety obligations on employers often
relate to both employees and
independent contractors.
Insolvency In liquidation, an employee has
preferential rights as a creditor for
payment of outstanding salary and
redundancy payments, up to certain
limits
Implied terms There are rights and duties implied in an These implied rights and duties do not
employment contract by common law generally apply to a contract for services
and statute, for example a mutual duty of
trust and confidence
Employee Self-employed
Tortious acts Employer is generally vicariously liable for Liability of person hiring an independent
tortious acts of employees, committed in contractor for contractor's acts severely
the course of employment limited unless there is strict liability
Taxation Deductions for income tax must be made The self-employed are taxed under
by an employer under PAYE (Schedule E) Schedule D and are directly responsible
from salary paid to employee to HM Revenue and Customs for tax due
VAT An independent contractor may have to
register for, and charge, VAT.
Social security Employers must pay secondary Class 1 Independent contractors pay Class 2 and
contributions on behalf of employees 4 contributions
Employees make primary Class 1
contributions
There are also differences in statutory sick
pay and levies for industrial training
purposes
Yes No
A The company for which he works is required to declare and administer his
income tax under PAYE
B The company will not be vicariously liable for any tort committed by him
Section overview
An employment contract is usually made in writing although it can be created orally.
Where there is no written contract covering them, an employer must provide a written statement
of prescribed particulars within 2 months of the commencement of the employment.
Certain duties are implied into a contract of employment on the part of the employee and
employer, by common law and by statute.
An employment contract needs agreement between the parties, consideration and an intention to
create legal relations just like any other contract. It may be written or oral. A written contract is likely to
contain a number of express terms as to pay, hours, place of work and any special agreements between
employee and employer going beyond legally required employment rights (such as maternity pay
offered in excess of the statutory minimum).
228 Law
Generally speaking, a change in contract terms can only be made with the consent of both parties to
the contract. Also a new piece of legislation may result in a change to a term in an employment C
contract. Sometimes, an express term in the contract can give rights of variation, for example where a H
A
'mobility clause' allows an employer to require an employee to work at a different location. In such
P
cases, the employer must exercise the power reasonably since the courts will imply terms of trust and T
respect which have the effect of overriding a strict application of contractual obligations. E
R
United Bank Ltd v Akhtar 1989
The facts: An employee had a mobility clause in his employment contract under which he could be
required to work anywhere in Great Britain. His employer gave him notice on 5 June that he would 11
be transferred from Leeds to Birmingham as from 8 June. The employer refused the employee's
request for a three-month delay, based on his wife's ill-health and the need to sell his house. The
employee's subsequent request for 24 days' leave in order to sort out his affairs and to commence
work in Birmingham on 10 July was unanswered. When pay was stopped with effect from 5 June,
the employee resigned and claimed that he had been constructively dismissed.
Decision: The employee's claim succeeded. It was an implied term that the employer should
exercise his right under the express provision reasonably, including giving reasonable notice.
The last four particulars may be given by way of separate documents. The written particulars do not
constitute an employment contract, although they provide persuasive evidence of what the contract
contains. If the employee has a written contract of employment covering these points and has been
given a copy, it is not necessary to provide him with separate written particulars.
If the employer fails to comply with these requirements the employee may apply to an employment
tribunal for a declaration of what the terms should be. The tribunal may award compensation to an
employee claiming unfair dismissal if the particulars are incomplete.
Duty of faithful service The employee has a fundamental duty of faithful service or fidelity to his
(fidelity) employer. Thus an employee who works for an employer's competitor in
his spare time, or who frustrates the commercial objectives of his
employer, is in breach of this duty. Similarly, where an employee accepted
personal commissions from suppliers on orders that he placed with them
for goods supplied to his employer, he was justifiably dismissed and liable
to account to the employer for the commissions.
To obey lawful and The employee must show obedience to the employer's instructions unless
reasonable orders they require him
To do an unlawful act or
To expose himself to personal danger (not inherent in his work) or
To do something outside his contract.
Not to misuse This duty will not necessarily cease when the employment ceases. (Note
confidential information that when someone invents or writes something as part of his
employment, the right to the patent or copyright will normally belong to
his employer.)
To exercise reasonable The employee must demonstrate reasonable competence, care and skill
care and skill in the performance of his work, bearing in mind the degree of skill and
experience that the employee professes to have.
Personal service The contract of employment is a personal one and so the employee may
not delegate his duties without the employer's express or implied consent.
Trust and confidence This is a mutual obligation imposed on both parties and is based on
respect and consideration for each other. An employee should not, for
example, make unjustifiable complaints or false accusations about his
employer.
To pay reasonable This duty is subject to any express provision, for example to pay a rate
remuneration fixed by the parties, or to pay nothing during a lay-off.
To indemnify employees To indemnify the employee against expenses and losses incurred in the
course of employment.
Health and safety This is normally expressed as a duty to protect the employee against
reasonably foreseeable risks to his health, safety and welfare at work.
Health and safety obligations are also imposed by statute.
This common law duty is three-fold and incorporates the obligations to
provide
Safe plant and appliances
A safe system of work
Reasonably competent fellow-employees.
To provide work To provide work. Generally speaking, an employer will not be liable for
failing to provide work as long as he continues to pay wages (so liability is
more likely to arise where someone is paid on a commission basis).
230 Law
To provide accurate An employer does not have a duty to provide a reference (but if he does
C
reference (where one is provide one, he must exercise reasonable care and skill to ensure that the
H
provided) information contained in it is accurate and gives a fair impression of the A
employee. In particular, an employer cannot divulge information that is P
not known to the employee (for example customers' complaints against T
the employee). E
R
Not to disclose The employer must not divulge confidential information about the
confidential information employee to a third party without the employee's consent.
11
To maintain mutual trust The employer must treat the employee with due respect and
and confidence consideration. He must not, for example, conduct his business in a
disreputable fashion, thereby damaging the employee's reputation and
future employment prospects.
True False
A There is a duty of mutual trust and confidence between the employer and
the employee
B An employer has a duty to pay reasonable remuneration
C An employer does not owe a duty to provide a reference for his employee
Legislation also imposes a number of implied duties on employers, often implementing European
Directives on employment law issues. Many of these duties are concerned with 'family-friendly'
employment and the 'work-life balance', for example provisions regarding maternity and paternity rights,
flexible working arrangements and time off work. The principal duties implied by statute are as follows:
Subject Duty
Pay Under legislation protecting equal pay, contractual employment terms such as sick
pay, holiday pay and working hours should be as favourable as those given to an
employee of the opposite sex who is performing equal work or work of equal value,
unless a 'genuine material factor' exists that justifies the discrepancy (for example,
employees in London receiving a higher hourly rate than employees in
Aberystwyth).
Health and safety The Health and Safety at Work Act 1974 imposes general duties on employers,
including a duty to ensure the continuing good health, safety and welfare of his
employees, as far as is practicable. This general duty includes the following
obligations:
To provide and maintain plant and systems of work that are safe and without
risk
To make arrangements to ensure safe use, handling, storage and transport of
articles/substances
2 years but < 12 years Not less than 1 week per year of continuous employment
Either party may waive his entitlement to notice or accept a sum in lieu of notice.
During the period of notice an employee is entitled to pay at a rate not less than the average of his
earnings over the previous twelve weeks.
3 Unfair dismissal
Section overview
Employees covered by the statutory provisions for unfair dismissal have the right not to be unfairly
dismissed.
Breach of this right allows an employee to bring a claim for unfair dismissal to an employment
tribunal.
Reasons for dismissal are considered to be either automatically unfair or potentially fair.
Remedies include reinstatement, re-engagement and compensation.
232 Law
Legislation has widened the scope of protection to employees and increased the range of remedies
available in the event of dismissal. Unfair dismissal is governed by the Employment Rights Act 1996 as C
amended by the Employment Act 2008. H
A
P
T
3.1 The claim for unfair dismissal E
R
Certain categories of employee are excluded from the statutory unfair dismissal code, including
(generally speaking) persons employed to work outside Great Britain and employees dismissed while
taking unofficial strike or other industrial action.
11
Otherwise, in order to pursue a claim for unfair dismissal, the employee must have been continuously
employed for at least two years, whether full-time or part-time, with the same (or an associated)
employer. (Note that employees who began their employment before 6 April 2012 may bring an unfair
dismissal claim after only one year.)
In calculating continuous employment, it is possible for certain weeks to be excluded without them
breaking the continuity, for example time spent on strike or on service in the armed forces. Also, where
a business or undertaking is transferred and the employee then works for the transferee of the business,
that change will not constitute a break in the employee's length of continuous employment.
However, where the reason for dismissal is automatically unfair (see 3.3 below), for example where the
employee is pregnant, then there is no continuous employment requirement.
The employee must make a claim to an employment tribunal within three months of the effective date
of termination, that is to say:
Where there is termination by notice, the date on which the notice expires
Where there is termination without notice, the date on which the termination takes effect
Where an employee's fixed term contract is not renewed, the date on which that term expires
The employee must show:
That he is a qualifying employee and
That he has in fact been dismissed.
3.2 Dismissal
Dismissal for the purposes of an unfair dismissal claim may occur in one of three situations:
The non-renewal of a contract for a fixed term or specific task or
A termination by the employer, with or without notice or
A constructive dismissal
Constructive dismissal occurs where the employer repudiates some essential term of the contract, for
example by the imposition of a complete change in the employee's duties, and the employee resigns.
To establish constructive dismissal, an employee must show that:
His employer has committed a serious breach of contract
He left because of the breach
He has not 'waived' the breach, thereby affirming the contract.
If he fails to show that he is treating the contract as repudiated (for example by walking out) he cannot
claim that he has been constructively dismissed. Examples of breaches of contract which have led to
claims of constructive dismissal include the following:
A reduction in pay
A complete change in the nature of the job
A failure to provide a suitable working environment
The breach must be a serious one. Thus, in one case, an employer's refusal to give an advance against
holiday pay was not sufficient.
Whether or not a dismissal has occurred is a question of fact and will depend on all the circumstances.
Where an employee is dismissed, with or without notice, or where a fixed term contract is not renewed,
Reason
Capability or If the employer dismisses for want of capability on the part of the employee, the
qualifications employer has to establish that the lack of capability at the time of dismissal was of
such a nature and degree as to justify a dismissal, taking into account:
What the contract requires
The general standard of performance of his employees in this trade
The previous standard of performance of the dismissed employee himself
'Capability' is to be assessed by reference to skills, aptitude, health or any other
physical or mental quality. 'Qualification' means any academic or technical
qualifications relevant to the position that the employee holds. There must be a
contractual obligation (express or implied) to hold the relevant qualification in
order that a dismissal for lack of it can be considered fair.
The lack of capability or qualification must be sufficiently serious and it may arise
from one particular incident or a series of incidents. Thus, for example, a shop
manageress who left her shop dirty and untidy, who failed to maintain cash
registers and who did not put stock away was fairly dismissed.
234 Law
Reason
C
In another case, an airline pilot who landed his plane negligently on one occasion H
was held to have been fairly dismissed. It was recognised that the degree of A
professional skill was so high in his case that even small departures from that P
T
standard could be sufficiently serious as to justify dismissal. E
Employee's It is not necessary to prove that the employee is guilty of the alleged misconduct, R
misconduct only that the employer genuinely and reasonably believes him to be. Various types
of misconduct have been held to justify dismissal, including abusive language,
drink and drug abuse, theft and dishonesty, violence, downloading pornography, 11
racial and sexual harassment and persistent lateness or absenteeism.
Redundancy If an employee is dismissed mainly or only on the ground of redundancy (see
section 5.1), he may claim remedies for unfair dismissal if he can show one of the
following.
There were one or more other employees in similar positions who might have
been made redundant and that he was selected for redundancy in breach of a
customary arrangement or agreed procedure.
He was selected for a reason connected with trade union membership.
A redundancy selection procedure should be in conformity with good industrial
relations practice, ie
The employer should give as much warning as possible of impending
redundancies.
The employer should consult with the trade union as to the best means of
achieving the desired management result.
It should be possible to check criteria for selection against such things as
attendance records, efficiency at the job and length of service.
The employer should ensure that the selection is made fairly.
The employer should consider whether an offer of alternative employment can
be made.
Statutory This applies where there is a legal prohibition or restriction on either the employer
restriction or the employee which prevents the employment from being continued lawfully
(for example, if a doctor or a solicitor employed as such is struck off the relevant
professional register, or an employee loses his driving licence, which he needs to
be able to do his job).
Some other ie some other substantial reason that could justify the dismissal of an employee
substantial holding the position that the employee held. Thus dismissal has been considered
reason fair where, for example:
The employee was married to one of his employer's competitors
The employee refused to accept a change of shift working, made in the
interests of the business and with the agreement of a large majority of other
employees
The employees alleged paedophile activity substantially risked the reputation of
his public sector employer (even though the employee was not convicted of
any offence)
Following the abolition of the default retirement age, an employer who wishes
to dismiss an employee on retirement grounds will need to satisfy this ground
of some other substantial reason. He will need to show that the retirement
age is proportionate and objectively justified and also that a fair procedure has
been followed.
Yes No
Asif has been employed for twelve months, having commenced employment
in March 2012, and has been given three months' notice of dismissal.
Beatrice commenced employment in May 2012 and had been employed for
four months when she was dismissed without notice because her employer
discovered that she was pregnant.
3.5 Reasonableness
Once the employment tribunal is of the view that the dismissal occurred for a potentially fair reason, it is
then required to review the circumstances and to decide whether 'on the basis of equity and the
substantial merits of the case', the employer acted reasonably in dismissing the employee. Whether the
employer has acted reasonably or unreasonably is a question of fact depending on all the circumstances,
including the size and resources of the business. The tribunal will consider:
Have relevant procedures been followed? These may include internal procedures, contractual
provisions or a code of practice relevant to the employment. In particular, the tribunal will have
regard to the Acas code of practice in this area (see 3.6 below) in deciding whether the employer
behaved reasonably.
Did the employer take all circumstances into consideration? For example if an inexperienced
employee is struggling to do his work, the employer is expected to help by advice or supervision in
the hope that he may improve.
What would any reasonable employer have done?
Except in the most flagrant cases it is not reasonable for an employer to dismiss an employee without
first warning him that if he continues or repeats what has happened at least once he is likely to be
dismissed. The tribunal might conclude that demotion (or some other step short of dismissal) might
have been fair where dismissal was not.
In the case of a dismissal for want of capability or qualifications, reasonableness by the employer can be
demonstrated by, for example
Consultation with the employee to determine areas of difficulty
Allowing a reasonable time for improvement
Providing training if necessary
Considering all alternatives to dismissal.
If the employer relies on ill health as the grounds of incapability there must be proper medical
evidence. The employer is entitled to consider his own business needs.
In Coulson v Felixstowe Dock & Rly Co Ltd, an employee was off work for considerable periods of time due
to ill health. He was given six months to prove his fitness and warned that he would be regraded if he
could not do so. He became ill again and was dismissed. It was held that the employer had acted
reasonably and could not be expected to keep a job open indefinitely. The tribunal had to consider the
fairness to the business as well as to the employee.
236 Law
Interactive question 5: Unfair dismissal 2 [Difficulty level: Exam standard]
C
Indicate whether or not each of the following statements is correct. H
A
The dismissal of an employee will constitute an unfair dismissal if it: P
T
Yes No Maybe E
R
A Is on the grounds of pregnancy
Remedy Description
Reinstatement An order that the employee may return to the same job without any break of
continuity.
In deciding whether to exercise these powers, the tribunal must take into account
whether the complainant wishes to be reinstated and whether it is reasonably
practicable and just for the employer to comply. Such orders are in fact very
infrequent.
Re-engagement An order that the employee is given new employment with the employer (or his
successor or associate) on terms that are comparable with the old job or otherwise
suitable.
The Employment Appeal Tribunal has ruled that an order for re-engagement should
not be made if there has been a breakdown in confidence between the parties. This
was in a case where the employee was dismissed following allegations of drug
dealing on company premises and time-keeping offences.
Compensation may be ordered in three categories (in each case subject to statutory
maximums that are updated from time to time):
A basic award, calculated by reference to the employee's length of service and
age and which is subject to a prescribed maximum amount. It is liable to be
reduced where the employee unreasonably refuses an offer of reinstatement or
otherwise behaves unreasonably. The basic award is also reduced by the amount
of any redundancy payment made. However, the basic award is made for unfair
dismissal regardless of the loss suffered by the employee and there is no duty on
the employee to mitigate any loss.
A compensatory award, being such amount as the tribunal considers to be 'just
and equitable in all the circumstances, having regard to the loss sustained by the
complainant in consequence of the dismissal in so far as that loss is attributable
to action taken by the employer' (and taking account of the basic award). This
will be in respect of any additional loss of earnings, expenses and benefits and
will be assessed on common law principles of damages for breach of contract,
including a duty on the employee to take reasonable steps to mitigate any loss.
An additional award, which can only be awarded if the employer does not
comply with an order for reinstatement or re-engagement and does not show
that it was impracticable to do so. It comprises between 26 and 52 weeks' pay
(subject to a prescribed maximum, as with the basic award).
In addition, a tribunal may order the employer to pay consequential losses to the employee to reflect
any financial loss suffered as a result of the employer making unauthorised deductions or failing to make
redundancy payments (s 7 Employment Act 2008).
4 Wrongful dismissal
Section overview
Wrongful dismissal is a common law action that applies where an employer dismisses an
employee in breach of contract.
Summary dismissal may be justified in exceptional circumstances.
The usual remedy for wrongful dismissal is damages but an injunction or declaration may be
awarded.
238 Law
4.1 Unfair dismissal or wrongful dismissal?
C
Although claims are most commonly brought for unfair dismissal nowadays, an action for wrongful H
dismissal can be brought instead or at the same time (although this is very rare). It might even be more A
advisable in certain circumstances, for example: P
T
Where an award of damages would exceed the statutory maximum for compensation in an unfair E
R
dismissal case
Where a claim for unfair dismissal has not been brought within three months of the effective date
of termination (an action for wrongful dismissal can be brought within six years of the breach) 11
A dismissal might be 'fair' but nonetheless wrongful, if insufficient notice is given
An employee might not qualify to bring a claim for unfair dismissal, for example if he lacks the
necessary period of continuous employment.
Cases are commonly brought in the county court or High Court although employment tribunals have a
concurrent jurisdiction.
Yes No
5 Redundancy
Section overview
Redundancy is a form of dismissal (and may be fair or unfair depending on the circumstances).
Redundancy gives rise to a right to a statutory redundancy payment provided certain criteria are
met.
240 Law
5.1 What is redundancy?
C
A dismissal is treated as caused by redundancy if the only or main reason is that: H
A
The employer has ceased, or intends to cease, to carry on the business for the purposes for which P
the employee has been employed, or T
E
The employer has ceased, or intends to cease to carry on the business in the place where the R
employee was employed, or
The requirements of that business for employees to carry out work of a particular kind, or for them
11
to carry out the work in the place where they were so employed, have ceased or diminished.
If the employee's contract contains a mobility clause, enabling the employer to require him to work at
other places than his present place of employment, then any such requirement (because there is no
longer work at his present place of employment) will not constitute redundancy. However, the tribunal
has held that the fact that there is a mobility clause does not mean that 'the place where the employee
was employed' is extended to include every place where he could be employed.
The proper test for determining whether or not an employee is redundant is to see whether there has
been a reduction of the employer's requirements for employees to work at the place where the person
concerned is employed. This is a question of fact.
In British Broadcasting Corporation v Farnworth 1998 a radio producer's fixed term contract was not
renewed and the employer advertised for a radio producer with more experience. It was held by the EAT
that the less experienced radio producer was indeed redundant as the requirement for her level of
services had diminished.
Solution
Amy is entitled to a statutory redundancy payment. She is an employee with more than 2 years'
continuous employment and has been dismissed for reasons of redundancy, namely that Sparkle
Windows Ltd no longer has need of employees at the place where Amy was employed. The fact that she
could be required to work elsewhere in Bournemouth and Winchester did not mean that she was to be
regarded as being employed in those places.
Wrongful dismissal
Unfair dismissal
Constructive dismissal
Redundancy pay claim
Section overview
The Act is concerned with personal data (subject to some exemptions) held on computer-based
information systems and manual files.
The purpose of the Act is to protect individuals from misuse of information about them.
The Act requires all those who hold or process personal data to comply with eight data protection
principles in relation to that data.
Individuals are given rights in relation to their personal data, such as rights of access and the right
to prevent processing which is likely to cause damage or distress.
Data controllers are individuals, partnerships or companies who hold data that is processed or intended
to be processed for their own use.
Data subjects are individuals (not companies) to whom personal data relate.
You should be aware that a proposed European data protection regulation is likely to make significant
changes to data protection law in member states, although changes are not expected before 2014.
242 Law
controller in relation to the data subject. The Act is also concerned with any 'processing' of the data,
including the collection, use, disclosure and destruction of it. C
H
The purpose of the Act is to protect individuals from use of incorrect information or misuse of correct, A
but confidential, information. P
T
E
6.2 Penalties for non-compliance R
The principle
The right
Access Right of subjects to access data held about them (which must not be kept in
an encoded form). Principally, a subject can obtain a copy of information
held, including any in pictorial form
Avoidance of damage Prevention of processing likely to cause damage or distress
Junk mail Prevention of processing for direct-marketing (junk mail)
Automatic decisions To request that no decision that materially affects you should be based solely
on automatic processes (for example, automatic credit scoring)
Compensation Right to compensation if damage is caused by contravention of the Act
Action against Right to take action to rectify or destroy inaccurate data
inaccurate data
Information Right to ask the Information Commissioner to assess whether the Act has
Commissioner been contravened
Interactive question 8: Data Protection Act 1998 [Difficulty level: Exam standard]
Kylie is a data subject of Compliance Ltd. She has asked to see the information held about her by the
company on its personnel files. In doing so, she has discovered that the data was inaccurate, as it had
not been updated to reflect the fact that Kylie has remarried and changed her name. She is also cross
that the company has refused to show her its payroll records, as she is convinced that she is being paid
less than a colleague of hers.
Answer the following questions:
Yes No
244 Law
C
Summary and Self-test H
A
P
T
E
R
Summary
(Sections 1-2 of this chapter)
11
246 Law
A
C
P
H
T
A
E
P
R
T
E
R
11
11
True
False
True
False
5 Name five matters in respect of which the distinction between employed and self-employed
workers is important.
6 Within what period must an employer provide a written statement of employment particulars
where no contract has been provided?
7 Which of the following are duties owed by the employer by health and safety legislation?
A To ensure adequate access to places of work
B To make provision for medical personnel at the place of work
C To ensure the safe-keeping of an employee's personal effects while he is engaged in his work
duties
D To provide a healthy working environment
248 Law
8 What is the statutory minimum period of notice to which an employee with 5 years' continuous
service is entitled? C
H
9 What is the necessary period of continuous employment for an unfair dismissal claim where A
dismissal is for the following reasons? P
T
A Lack of qualification E
B Making a protected disclosure R
C Pregnancy
10 List the five potentially fair reasons for dismissal.
11
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
11 Name three automatically unfair reasons for dismissal.
.................................................................................................................................................
.................................................................................................................................................
.................................................................................................................................................
12 By how much may an award be adjusted in order to take account of an unreasonable failure to
comply with the Acas code of practice in a dismissal?
13 Which is the most frequent remedy awarded for unfair dismissal?
A Compensation
B Re-engagement
C Reinstatement
True
False
18 Which of the following is not one of the eight data protection principles?
A Personal data shall be accurate and, where necessary, kept up to date
B Personal data shall not be kept for longer than six years
C Personal data shall be adequate, relevant and not excessive
19 Is data relating to an employee's medical health including drug testing exempt from the Data
Protection Act?
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved
these objectives, please tick them off.
250 Law
Answer to Interactive question 7
C
Unfair dismissal or a claim for redundancy pay, provided he can prove the requisite facts. However, non- H
renewal cannot give rise to a claim for wrongful dismissal (although termination before the expiry of a A
fixed term contract would). Constructive dismissal is not relevant in this scenario. P
T
E
Answer to Interactive question 8 R
A Yes
B No, only if Kylie could show loss 11
252 Law
Index
253
254 Law
Bonus issue, 138
A
Bonus shares, 139
Breach of a disqualification order, 111
Acceptance, 8
Breach of contract, 231
express, 8
Breach of directors duties, 109
inferred, 8
Breach of warranty of authority, 53
Accountants, 193, 213
Bribe, 48, 108
Accounting records, 92
Bribery and corruption, 208
Accounts, 66
Business names, 89
Accounts and reports, 84, 91
Actual express authority, 50
Actual implied authority, 50
C
Administration, 161
Called-up share capital, 142
Administrators, 112, 150, 161
Capital redemption reserve, 146
Advantages and disadvantages of an IVA, 173
Case
Advantages of administration, 164
Caparo Industries plc v Dickman and Others
Advantages of incorporation, 190
1990, 66
Agency, 45, 104
Donoghue v Stevenson 1932, 62
liability of the parties, 52
Hedley Byrne v Heller and Partners 1964, 65
Agency by consent, 46
Re A Company 1983, 117
Agency by estoppel, 46
The Wagon Mound 1961, 70
Agency by ratification, 47
Certificate of incorporation, 86, 91
Agency of necessity, 46
Certificates of registration of charges, 91, 150
Agents, 45
Charges, 147, 170
authority
Chartered accountant, 175
actual express authority, 50
Class rights, 136
actual implied authority, 50
Communication of acceptance, 9
ostensible or apparent authority, 50
postal rule, 9, 10
duties and rights, 48
prescribed method, 9
Agreement, 3, 228
waiver, 9
Allotment of shares, 137
Company, 79
Alteration of share capital, 143
alteration of status, 83
Alternate director, 101
members, 112
An intention to create legal relations, 3
private, 83
Annual accounts, 92, 113
public, 83
Annual general meetings, 120
public and private
Annual return, 92, 192
differences, 83
Anticipatory breach, 29
Company Directors Disqualification Act 1986,
Appointment of an administrator, 161
103
Approval of directors' actions, 113
Company formation
Articles, 137
application form, 85
Articles of Association, 112
Company is a sham, 81
alteration, 90
Company meetings, 115
entrenchment, 90
class meetings, 123
model articles, 89
notice and special notice, 122
Audit exemption, 192
poll, 122
Audit requirements, 93
proceedings at meetings, 122
Auditors, 67, 84, 213
proxies, 122
Auditor's report, 69, 92
records, 123
Authority, 104
written resolutions, 121
Authority and liability of LLP members, 193
Company names
Authority of the agent, 50
change of name, 88
Automatically unfair reasons for dismissal, 234
prohibited names, 88
Avoidance of charges, 170
Company records, 90
Company secretary, 84, 93, 206
B
Compulsory liquidation, 168
Consequences of administration, 163
Bankruptcy, 174
Consideration, 228
Bankruptcy order, 111
adequacy, 12
Bankruptcy proceedings, 189
debt cases, 14
Index 255
executed, 12 Directors' statement and auditor's report, 91
executory, 12 Disadvantages of incorporation, 190
existing contractual duty owed to the a third Discharge of contract, 27
party, 13 breach, 29
existing contractual duty owed to the fraustration, 28
promisor, 13 performance, 27
existing statutory duty, 13 Disclosure of wrongdoing, 203
forbearance or waiver of existing rights, 13 Disqualification, 101, 193
past, 12 Disqualification of directors, 110
sufficiency, 12 Disqualify, 103
Constructive dismissal, 233 Dissolution and insolvency of a partnership,
Continuously employed, 241 189
Contract, 3, 27 Distribution to creditors, 176
unenforceable, 4 Dividends, 146
Contract for services, 225, 227 Duress, 3
Contract of employment, 225 Duties of the administrator, 162
Contract of service, 225, 227 Duty of care, 63, 65, 67, 193
Contracts (Rights of Third Parties) Act 1999, 18
Contractual remedies, 30 E
damages, 30
injunction, 33 Economic or financial loss, 65
specific performance, 33 Effect of bankruptcy, 175
Contributory negligence, 70 Employee, 71, 164, 224, 241
Course of his employment, 71 Employee's implied duties, 230
Creditors, 150, 164 Employer/ employee relationship, 225
Creditors' interests, 105 Employer's implied duties, 230
Creditors' voluntary liquidation, 161 Employment tribunal, 203
Crystallisation, 148 Encouraging another to deal, 207
Crystallised, 150 Equity securities, 138
Equity share capital, 142
D Exclusion clauses, 34, 68, 70
incorporation, 34
Damages, 61 UCTA, 35
Data controllers, 242, 243 Executive director, 101
Data Protection Act 1998, 224, 242 Exemptions from the Data Protection Act, 244
Data protection principles, 243 Expectation interest, 31
Data subjects, 242, 243 Express terms, 15, 228
De facto director, 101
Dealing, 207 F
Debenture, 146
Debenture holders, 192 Fiduciary duties, 187
Declaration of solvency, 167 Fiduciary relationship, 48
Derivative action, 113 Firm, 185
Derivative action on behalf of the company, Fixed charge, 147, 149
115 Floating charge, 148, 150
Derivative claim, 115 Form, 4
Director, 101, 175 Formation and regulation of a partnership, 186
Directors, 84, 101, 164 Formation of an LLP, 192
restriction on powers, 103 Foss v Harbottle, 114
vacation of office Fraud, 110
death of the director, 102 Fraudulent and wrongful trading, 82
disqualification, 102 Fraudulent or wrongful trading, 193
removal, 102 Fraudulent trading, 110, 206
Directors and their appointment, 101 'Freedom of contract', 3
Directors' authority, 104
Directors' duties, 105 G
Director's powers, 103
Directors' Remuneration Report, 92 Gagging clauses, 205
Directors' Report, 92 General duties, 105
Directors' service contracts, 91 General meeting, 113, 115, 120
256 Law
Good faith, 204 Meetings and resolutions, 119
Gross negligence, 111 Members, 164, 172
Groups of companies, 81 Members' rights and communication, 112
Guarantee, 4 Members voluntary winding up, 167
Memorandum of association, 85
I Misrepresentation, 4
Mistake, 4
Illegality, 3 Mitigation, 32
Implied terms, 3, 17, 227 Mobility clause, 229, 241
court, 16 Money or money's worth, 139
business efficiency, 16
implicitly required, 17 N
custom, 16
statute, 16 Name, 84
Incidental authority, 50 Negative pledge clause, 150
Independent contractor, 45, 71, 224 Negligence, 62, 109
Information Commissioner, 243 breach of duty, 63
Information rights, 113 breach of duty of care, 63
Injunction, 61 defences and damages, 69
Insider, 207 duty of care, 62
Insider dealing, 207 loss caused by breach, 64
Insolvency practitioner, 169, 175 Negligent misstatement, 62, 65
Intention to create legal relations, 10, 228 Net assets, 146
commercial, 11 New partner, 188
social, domestic and family, 11 Nominal value, 139
Invitation to treat, 5 'Non-cash' consideration, 139
Issued or allotted share capital, 142 Non-executive director, 102
Not to accept benefits from third parties, 108
J Notice provisions, 232
Index 257
Penalties for non-compliance with the Data Res ipsa loquitur, 63
Protection Act, 243 Resolutions at general meeting, 121
Penalty clauses, 32 Rights issue, 138
Penalty for fraud, 206 Rights of pre-emption, 138
Personal data, 242 Rights of the agent, 49
Personal liability, 193 Romalpa clause, 149
'Phoenix' companies, 110
Poll, 122 S
Potentially fair reasons for dismissal, 234
Pre-emption rights, 84 Separate legal person, 115
Preference, 135, 147 Separate legal personality, 79
Preference shares, 147 Serious Organised Crime Agency, 212
Preferences, 164, 171 Service contracts, 113
Preferential creditors, 161 Shadow director, 101, 103, 105, 109
Preferential debts, 172, 176 Share premium account, 139, 146
Pre-incorporation contracts, 87 Shareholders' agreement, 102, 112
Premium, 139 Shares, 135
Priorities on liquidation, 171 class rights
Priority of charges, 149 variation, 136
Private company, 83, 121 Small and medium-sized companies, 93
Privity, 17 Sole traders, 173
exceptions, 17 Special, 121
Privity of contract, 45 Special notice, 102
Promoter, 87 Special relationship, 62, 66
Proper claimant, 115 Special resolution, 83, 88, 167
Provisions of the Partnership Act, 186 Specific statutory duties, 105
Proxies, 122 Standard form contract, 3
Public company, 83, 120, 121, 146 Statement of capital, 135
Pure economic loss, 62 Statement of capital and initial shareholdings,
Purpose of administration, 161 86
Statement of guarantee, 86
Q Statement of intention, 5
Statutory code of most directors' duties, 105
Qualifying disclosure, 203 Statutory demand, 175
Quantum meruit, 27 Statutory dismissal procedure, 237
Statutory rights of minorities, 115
R Subject to contract, 11
Substantial property transactions, 113
Ratification, 109 Summary dismissal, 239
Reasonably foreseeable, 68 Supervisor, 173
Receivers, 112, 150
Records of resolutions and minutes, 91 T
Redeemable shares, 135
Redundancy, 224, 235, 241 Termination and insolvency of an LLP, 193
Register, 91 Terms, 15
Register of charges and copies of charges, 91 The Law Reform (Frustrated Contracts) Act
Register of directors, 91 1943, 28
Register of directors' residential addresses, 91 The role of the liquidator, 170
Register of members, 91 To act within powers, 105
Registered office, 192 To avoid conflict of interest, 107
Registration documents, 85 To declare interest in proposed transaction or
Registration of charges, 150 arrangement, 108
Regulation and administration of an LLP, 192 To exercise independent judgement, 106
Reliance interest, 31 To exercise reasonable care, skill and diligence,
Remedies for unfair dismissal, 238 107
Remedies for wrongful dismissal, 240 To promote the success of the company, 106
Remoteness of damage, 30 Tort, 61
Repayment of capital, 135 Tort of deceit, 53
Repudiatory breach, 29 Trading certificate, 86, 91, 169
Request for information, 7 Trading without a trading certificate, 82
258 Law
Transactions at an undervalue, 164, 170 Usual authority, 50
Transfer of shares, 140
Type of company, 80 V
Type of resolution, 121
Types of capital, 142 Variation of class rights, 115
Types of company, 83 Veil of incorporation, 80
limited, 83 Vicarious liability
unlimited, 83 to establish, 71
Types of shares, 135 Vicarious liability and agency, 72
Void, 3, 4, 35, 113, 175
U Voidable, 3, 4, 113
Volenti non fit injuria, 70
Undischarged bankrupt, 175
Undue influence, 3 W
Unfair dismissal, 224, 231
Unfairly prejudicial, 136 Weighted voting rights, 102
Unfairly prejudicial conduct, 115, 116 Winding up, 86, 110
Unissued share capital, 142 just and equitable, 115
Unlimited, 83 Written particulars, 229
Unlimited company, 80 Written resolutions, 84
Unlisted shares, 140 Wrongful and fraudulent trading, 109
Unsecured creditor, 161, 174 Wrongful dismissal, 224, 227, 231
Unsecured loan, 146 Wrongful trading, 109
Index 259
260 Law
Notes
Notes
Notes
Notes
Notes
Notes
Notes
Notes
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