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Legal Rules and Application | Free Business Law Essay

Introduction and General Analysis

Sky-High Limited (The Company) was incorporated in 1990 with the share capital of 300,000 Ordinary Shares and 100,000 Preference Shares. The Company has three directors, Douglas, Orville and Enola. Each receives salaries. The company has adopted Table A with special provision for Enola to hold office for ten years on a salary of 60,000 and limiting their borrowing power to 175,000 without consent at the general meeting, by special resolution.

The company decided to enter into the service sector and opened a National Museum of Aviation by borrowing 600,000 from Big Bank Plc. Two subsidiaries were formed for this venture and the company held 100% shares in it.

The museum had to be closed and Douglas and Orville decided to cut costs and not to pay Digger plc, a creditor, of the subsidiary company for the building work. They told Enola that her services as legal adviser and director are not required. They passed a special resolution to reduce the share capital by paying off 50,000 preference shares consisting of Enola's 20,000 preference shares and 15,000 each of Douglas and Orville.

A company has a separate legal entity from its owner and has its own debts and liabilities and own property in its own name. As a consequence a subsidiary's debts and obligations are not generally be enforceable against its parent company. However, only in certain circumstances courts will be prepared to lift the veil of incorporation to establish who is hiding behind the legal personality of a company.

Legal Issues

1. Has the board exceeded its borrowing power bestowed upon it by Table A?
2. Does the object clause in the Company's constitutional document renders diversification ultra Vires?
3. Digger Plc is a creditor of a Subsidiary company who is in financial trouble does this makes the parent company liable?
4. Reduction of Capital, was the correct procedure followed? Application of provisions of Section 121 of Companies Act 1989.
5. Enola's termination: as an Employee, a Legal Adviser, and as a Director of the Company.
6. Enola's termination of employment, was the correct procedure followed?
7. Was the behaviour of other two directors prejudicial to her as a minority shareholder?

Application

The Companies Act 1985, Section 1 requires every company to have a memorandum which sets out its name, registered office object clause etc and regulates its dealings with the outsiders. The Articles of Association regulates its internal affairs such as director's powers, conduct of board meetings etc. The company has adopted Table A with some alteration and have inserted two extra clauses dealing with Enola's appointment as a Director for ten years at a salary of 60,000 per annum. The director's powers to borrow money have been restricted to 175,000 without having to seek approval at a general meeting. It is possible to change or amend the articles according to section 9 of the Companies Act 1985 provided strict procedures are complied with.

It is not clear what the object clause of the company states, however if it were specific to its business, then any act beyond those set out in its object clause would be ultra vires. However, generally object clauses are drafted so widely which covers every possible business and activity a company may wish to carry out. Therefore, the company's decision to diversify in to the service sector is unlikely to be ultra vires. In addition to this under the new proposals the doctrine of ultra vires do not exist.

It is not clear from the question whether any assets of the company have been used as a collateral for the loan of 600,000. The new structure of the company means Sky-High Limited has become a Parent company with 100% holding into its two subsidiaries.

Any business decision must be taken unanimously by all directors and should not exclude one of the directors. The reason being the aggrieved director could claim that he or she has been excluded from the management of the company and make a valid claim under section 459 of the Act for unfair prejudice to the minority shareholder. As is the case here, as management decisions have been made without consulting Enola regarding repaying preference shares to reduce company's financial burden. She has been excluded from the decision making process.

If it can be established that one party, the Sky-High Limited and its directors, are responsible for encouraging other party, its subsidiary, unlawfully to break its contract with the third party, Digger plc, then the Sky-High Limited would be held liable to the third party, Digger plc for its damages arising out of the breach. Clearly company has arranged its corporate structure in such a way as to limit its financial exposure. Under normal circumstances the parent company or the other subsidiary will not be liable for the debts of the other subsidiary with certain exceptions. The courts will only impose liability on parties involved in the contract other than the company itself, if it has a substantial proof of fraud. However, in Stoczina Gdanska SA V Latvian Shipping Co & Others there was no direct contractual relationship between the parent company and the third party therefore the claim was brought under tort.

The Articles of a company does not create a contract between the company and the directors. The company was incorporated in 1990 that is over 15 years ago. This means her 10-year term set by the Articles has come to an end long time ago and does not seem to have been renewed for further 10 years. Therefore, the provisions of section 319(6) may apply which means either party (the company or herself) on giving reasonable notice may terminate her employment. The question is, whether reasonable amount of notice has been given to her.

Any director can be removed from their office by an ordinary resolution of the members. However, with a majority of votes, whether that majority is on a resolution for his own removal from the office a director may become virtually irremovable. If on the other hand, a director with a service contract with the company but does not have majority vote on a resolution to remove him from the office may be entitled to a substantial compensation for loss of office. If a director is removed in such a way he may be entitled to compensation for unfair dismissal. The procedure for removal of a director is set in section 303 of the Act, which provides for an ordinary resolution, that is, by majority of votes in the general meeting a director can be removed from his or her office. However, if the directors are the major shareholders then the minority shareholders have very limited rights to object the way the majority directors are running the affairs of the company. If the director is removed from the office it terminates any service contract it may have with the company. The amount of damages the director may be able to claim usually depends up on the remuneration package under his contract with the company.

The Memorandum of the company specifies the amount of the nominal capital it is allowed to issue to its members. If at a later stage, a company wishes to increase its share capital it may only do so by an ordinary resolution of the members in general meeting,

Provided the articles of the company allow this. Table A allows the company to increase its capital. The capital of the company is considered by the creditors as enough to satisfy their debts. The liability of the company is limited and therefore the capital of the company should not be reduced. However, in exceptional circumstances a company is allowed to reduce its share capital. The procedure is set out in section 135 to 137 of the Act. In order to do this the company must obtain an approval of its members by passing a special resolution. The company would need to make an application to the court to obtain its consent to do so. The application is heard in the Companies Court, which has a supervisory jurisdiction to exercise control, in order to ensure that the company's creditors are not prejudiced by reducing its capital. It ensures that the company has a power to do so.

Under the new proposals it is proposed that the procedure involved in reducing the share capital of the company should be simplified. A company can still apply to the court to reduce its share capital. An alternative procedure in which the directors of the company can make a statement confirming the solvency of the company after the share capital is reduced would be accepted. All companies whether private or public should be able to reduce their share capital, if needed, without having to follow the court procedure. The advantage of this new procedure would be the company's ability to release the funds by capital reductions, which is then available for distribution.

Advice: Douglas and Orville

Under the current legislation the directors of the company have statutory and common-law duties such as fiduciary duties. The White paper attempts to reform director's duties towards different interested parties. The directors should be concerned mainly with the best interest of the company's employees, customers and suppliers in addition to its own interest and that of its shareholders to help maintain and improve company's reputation in the business world and its impact on business community. Table A gives wide powers to the directors to manage the company. You must use your power in good faith, for examples you can use your powers to raise the capital by issue of new shares for the company but to use the power to reduce the capital so that less money is available for the creditors would be a breach of this duty.

The articles allow you to borrow up to 175,000 without consent by special resolution. You have exceeded this limit when you borrowed 600,000 from Big Bank Plc. You need to ensure that you have an authority to exceed the limit set in the article by obtaining the consent of the rest of the board members and shareholders.

Digger plc is a creditor of a subsidiary in which the company holds 100% shares.

Your decision not to pay Digger plc who completed the construction of the museum a year ago seems to have been made without consulting Enola who is a director as well.

The Company holds 100% shares in two subsidiary companies and you are the directors in both companies, it is possible that the courts may decide to lift the corporate veil and impose liabilities for subsidiaries debt on you.

If you wanted to remove Enola as a director then you should have done that by ordinary resolution of the shareholders with special notice as per section 303 of the Act. A copy of the resolution should have been sent to her before distribution to the shareholders so that she could have attached a written statement. Under section 304 the Act she is entitled to address the meeting. You have to give the notice at least 21 days before the resolution as per s 379(2).

In Enola's case what is fair needs to be decided by taking into consideration both facts and law. The law almost always relates to general principles, which have been established over the years. Therefore, it is important to take into account the general principles, for removing Enola from her job, which have been established by the tribunals.

The Employment Rights Act 1996, Section 98 (4) states that whether the dismissal is fair or unfair will depend on what reasons the employer has put forward, the circumstances surrounding the employer's decision, that is the size and resources available to the employer. This will decide whether the employer has acted reasonably or unreasonably by dismissing the employee by reason of employee's behaviour.

You, as Enola's employer followed fair procedure while dismissing her and your response was that of a reasonable response expected from a reasonable employer? It should be noted at this stage that the burden of proof with regard to fairness is neutral which really means that you do not have to prove it if the fact are doubtful or in dispute. Generally, though, if Enola does complain to the tribunal then the tribunal will expect you to show why you made that decision and how that decision to dismiss her was reasonable. The reason being, you as an employer have made that decision and therefore, have greater access to information and responsibility to prove that your decision was correct.

In practice tribunals take into account the Advisory, Conciliation and Arbitration Service Code of Practice on Disciplinary Practice and Procedures in Employment. If you fail to follow the code, this does not automatically mean that the dismissal was unfair but it becomes much more difficult to prove your case. She is likely to claim discrimination under the Sex Discrimination Act. You need to:

• Apply to the court to reduce the share capital ensuring creditor's interest are not adversely affected
• Give special notice of special resolution to remove Enola from her office as a Director
• Consider putting the subsidiaries in insolvent or Creditors' Voluntary Liquidation

Advice to Enola

As a director and legal adviser appointed by the Articles of the company you are an employee. As an employee you have a right not to be dismissed unfairly. No disciplinary action or a verbal warning been given to you. Instead you have been dismissed on the spot without warning or notice because of the disagreement over the future of the business. This is a Summary Dismissal, which is only used in certain circumstances such as Gross Misconduct. The company cannot justify a disagreement in the board meeting as gross misconduct. The company has to give you reasons in writing as to why they have dismissed you within a reasonable time or within certain time limit set by you. The company must draw your attention to the Appeal procedure, if any and invite you to appeal if you wish to do that.

If you appeal against the company's decision you have to apply to the Employment Tribunal using ET1 form, for Unfair Dismissal. You may claim Sex Discrimination on the grounds that you are the only female director on the Board. There do not seem to be any obvious reasons for your dismissal without following proper procedure. You have more than 50% chance of successfully claiming compensation for loss of office and unfair dismissal.

From the information available you have been working in the company for over fourteen years and the articles only provide you with ten years as a legal adviser and director of the company unless a new service contract was issued to you at the end of that period in year 2000. You could also claim Fraud on Minority by virtue of section 459 of the Companies Act 1985. It is a two-tier litigation and costs are prohibitive. Your chances of success are 70%.

Advice to Digger Plc

You can issue a winding up petition against the company, a Creditor's Voluntary Liquidation. You must carry out a full company search to find out the company's financial position to prove that company is unable to pay its debts as they fall due. The Big Bank Plc may have a first charge over the museum building. If the building is worth more than what company owes to the bank and there are no other creditors, then it would be worth pursuing this route. Otherwise generally in liquidation there is no guarantee of full recovery of the debt and you will have to wait for a long time to recover anything. It is expensive and time consuming to follow this route. You may simply issue a claim against the company to recover the debt.

Bibliography and References

1. Business Law and Practice by Scott Slorach & Jason Ellis published by Blackstone press.

2. Business Law by Stephen Judge, second edition published by Macmillan law masters.

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