Company Law Exam SAMPLE ANSWER

Question 1

This section explores the extent to which the DTI company reform 2005 white paper incorporated into the Company Act 2006. The Department of Trade and Industry (DTI) company law reform of 2005 proposed four aims (which will be discussed further in subsequent sections) for the future Company Act of 2006 to attempt and incorporate its future provisions.

First, the reform aimed to improve the engagement of shareholders and create a culture of long-term investment.[1] To achieve the above aim, the white paper proposes that ways of engaging shareholders and dialogue should be improved, indirect shareholders ought to participate in corporate governance, making sure that the duties of the directors were clearly established, and ensuring that minority shareholders also have the capacity to bring a charge to directors of they were in breach of their duty.[2]

In application, the Company Act[3] (2006) has codified the duties of the director, which stipulates that the director ought to act within powers accorded to them, promote company success, exert independent judgment, apply reasonable care, diligence, and skill, avoid conflict, refuse benefits by third parties, and declare interest in offers. [4] In addition, the Act has introduced a statutory statement of the duties of shareholders, which is directed towards encouraging the engagement of shareholders by offering strategic and enterprising information. Section 172 of the Company Act underlines that the company's directors should act in good faith for the wholesome benefits of all shareholders and stakeholders.[5] Promoting the interests of the company should consider shareholder benefits. From 2019, companies meeting the criteria set out in section 172 (1) of the Companies Act (2006) will be required to include a statement of the annual report

[1] The Department of Trade and Industry, Company Law Reform (White Paper, Cm 6456, 2010) ch 3-6
[1] Ibid 1,
[1] Company Act 2006 s 171-177
[1] Ibid 2
[1]  Company Act 2006, s 172(1)(a)(b)(c)(d)(e)

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regarding how they involved stakeholders and matters pertinent to the section.[6] This legal provision pushes the company's directors to assume a proactive role in engaging shareholders and other stakeholders to ensure decisions are made in consideration in critical review of the long-term implications and value creation for the future advantage and sustainability of the company.[7] Nonetheless, some scholars have argued that section 172 of the Company Act's wording is ambiguous and can have more than one legal interpretation. One is the interpretation that shareholder interests can only be pursued and other stakeholders' interests are followed. Also, Keay criticises that the term act in good faith is not practically specific as there is no way of holding directors accountable that they acted in good faith or not.[8] In addition, the Company Act evaluation underlines that engagement of shareholders is yet to be fully realised. Nonetheless, the assessment reflects that engaging shareholders is something that can be attained by legislation alone.[9]

The second aim of the company reformed white paper is improving the regulation of, particularly small businesses.[10] To realise this aim, the white paper recommends improving accessibility, application of a dynamically simplified model of article set for private companies, permitting companies to hold an electronic record of shareholders to minimise paper bulk that requires extra shelving in the organisation, withdrawing the requirement for a company secretary to be appointed, abolition of financial persistence regulation for private entities, and the abolition of authorised share capital.

In response, the "think small first approach" has been introduced by the companies act of 2006, which has simplified the company's requirements, which allows for greater flexibility, particularly for smaller businesses. The Company Act has removed the stipulation to hold an annual general meeting for private companies and has

[1] Ibid 2.
[1] Keay, Andrew. "Ascertaining the corporate objective: An entity maximisation and sustainability model." The Modern Law Review 71, no. 5 (2008): 663-698.
[1] Keay, Andrew. "Tackling the issue of the corporate objective: An analysis of the United Kingdom's enlightened shareholder value approach." Sydney L. Rev. 29 (2007): 577.
[1]  S Fettiplace and R Addis, Department for Business, Innovation, and Skills: Evaluation of the Companies Act 2006,(London, Volume One, Infogroup/ORC International 2010)
Pp. 13-14
[1] Ibid 1.

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accommodated procedures that permit written resolution. Companies have been privileged to abolish the role of Company Secretary. The Company Act 2006 has minimised restrictions when the private company offers assistance in the purchase of its own shares. Additionally, the company act has allowed private companies to reduce their capital without court sanctions. Nonetheless, the court has put in place is that to protect creditors. These aspects have significantly simplified and reduced the legal burden for small and medium-sized private companies.[11] The Act has significantly simplified the process of AGMs and has improved shareholders' democratic provisions, especially concerning indirect shareholders and written resolutions.

The third aim of the reform is to make it easier to establish and operate a company.[12] To attain this, the white paper recommends enabling a single individual to form any type of company; it should be sufficient for the primary rules on the company's internal workings to be placed in one document referred to as 'the articles,' which should be different for public and private companies. The DTI also proposes that companies should be able to operate freely within different parts of Great Britain. The white paper also recommends that access to the director's home address be restricted due to safety concerns and reduce the reluctance of individuals to be directors due to the lack of privacy.[13]  

In response, the company act has made it easier for one to start a company by consolidating the memorandum of association and the article of association. The 2006 company act has withdrawn the requirement for the directors to render their personal address and has permitted the addresses of shareholders removed in the annual return.[14]

The fourth aim recommended by the proposal only formed is that the future company act should have legislative powers to make it easier for future provisions to be readily updated and adopted into law.[15] The above recommendation intends to do the company Act into a statutory instrument that can amend its own sections. This provision has already begun being implemented. For example, in 2015, there was the introduction of the 'small

[1] Ibid 4.
[1] Ibid 1
[1] Ibid 1.
[1] Ibid 4.
[1] Ibid 1.

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business Enterprise and employment Act 2015,' which introduced an extra section in the companies act of 2006. Further, in 2018, the company's miscellaneous reporting regulations were added, including section 172, as explained earlier.

In summary, the Company Act of 2006 has met the aims stipulated in the DTI white paper to a great extent. Notably, the Act has removed most unnecessary provisions that create bureaucracy in starting and maintaining public and private companies. However, there are ambiguous aspects of the law, like directors showing evidence to stakeholders on measures they have taken to comply with the law. It is also commendable that Company Act 2006 has a flexible statutory instrument that amends its own sections, which allows it to be in response to Britain's economic and political environment that enables and fosters national and international inverters.

 Question 2

Shareholder Primacy is a Myth

Usually, the managerial role of a company is accorded to governors and directors who are in charge of managing the company's daily operations. Initially, in the UK, shareholders' contribution to a company was primarily financial. Shareholders did not participate in control or governance issues. However, in response to the corporate failures, the Cadbury committee report in 1992 [16] made recommendations that would make shareholders more involved in the organization's operations, which is a governance type referred to as shareholder primacy. This approach to corporate governance gives eminence to shareholders. Therefore, directors and managers are responsible for providing prominence primarily to shareholders, and other responsibilities are to be considered derivative or secondary.[17]

[1] Committee on the Financial Aspects of Corporate Governance (1992) Report with Code of Best Practice, [Cadbury Report], London: Gee Publishing.
[1] Keay, Andrew. "Shareholder primacy in corporate law: can it survive? Should it survive?." (2010): 369-413.

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As such, it is critical to recognise the idea of shareholder primacy had its basis in responding to poor governance of public companies where directors allegedly mismanage shareholders' financial input for their personal financial gain. In response, the government has issued several non-binding corporate governance codes as means to ensure that shareholders' interests are held when an organisation makes its decisions. Nonetheless, the practical applicability of shareholder primacy is essentially a myth.[18]

The most recent current corporate governance code came into effect in (2019) even though it has several versions previously that are similar.[19] According to the UK corporate governance code, shareholders have the role of appointing auditors and directors as well as ensuring that the company has proper governance structures in place. While the corporate governance code sets commendable guidelines, their realistic, practical application is a myth in theory.

 For one, companies have a chance to "comply or explain" to the code. The comply and explain approach has been commended. It accommodates the company's flexibility due to differences in maturity pedigree and size; however, its voluntary nature creates misunderstanding on its implementation.[20]The comply or explain approach has been considerably criticised due to its ambiguity in underlining whether the code should be implemented or not. On the occasion that a company does not comply with the governance code, it may explain this in a ‘compliance statement.’ However, following this, there is no other option the shareholders can take in reviewing the statement for its authenticity or even applicability to the business needs. [21]This is a loophole in that the governance code does not offer guidance for the rules for explaining to shareholders the reason for non-compliance to the governance code. Moreover, their shareholders are not

[1] Stout, Lynn A. "New Thinking on" Shareholder Primacy." Accounting, Economics, and Law 2, no. 2 (2012).
[1] Financial Reporting Council. "The UK corporate governance code." ( Great Britain 2018).
[1] Ibid.
[1] Arcot, Sridhar, Valentina Bruno, and Antoine Faure-Grimaud. "Corporate governance in the UK: Is the comply or explain approach working?." International Review of Law and Economics 30, no. 2 (2010): 193-201.

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even given an opportunity to justify or satisfy the explanation issued by the directors as acceptable.[22]

This can be derived in the manner in which Jones and Pollitt[23] criticise the government deals with the issue of corporate governance. The government sets up committees with 'stakeholders' such as Cadbury, the owner of the public corporation Cadbury chocolate who may have divergent interests with the 'shareholders,' which may present a potential conflict in interest in the issued guidelines and prospect for applicability.[24]

In addition, the rules of the governance code are not rigid, but the guidance office gives a company the flexibility to adapt the code to its companies needs. This means a company can claim that it adjusted the governance code to its business needs. Also, the recommendations issued by the shareholders are not enforceable.[25]

Also, theoretically conceptualisation of what shareholder primacy is taking into account the interest of shareholders. However, gaining an understanding of the shareholders' interests is elusive. To explain this, it is critical to understand that directors and stakeholders are a united front, while shareholders are diverse and their interests can rarely be consolidated. The only joint interest that stakeholders have is making profits. Thus, explaining why shareholder activism primarily occurs when the company has experienced significant losses. Subsequently, when shareholders do not have a united front, stakeholders and directors can easily claim their actions are towards the benefit of the shareholders regardless of whether they will benefit or not. This means the stakeholder's interests will always override shareholders' interests. [26]

[1] Keay, A. (2014). Comply or explain in corporate governance codes: in need of greater regulatory oversight?. Legal Studies, 34(2), 279-304.
[1] Jones, Ian, and Michael Pollitt. "Understanding how issues in corporate governance develop: Cadbury report to Higgs review." Corporate Governance: An International Review 12, no. 2 (2004): 162-171.
[1] MacNeil, Iain, and Xiao Li. "Comply or Explain": market discipline and non‐compliance with the Combined Code." Corporate Governance: An International Review 14, no. 5 (2006): 486-496.
[1] Ibid 21.
[1] Rose, Caspar. "Firm performance and comply or explain disclosure in corporate governance." European Management Journal 34, no. 3 (2016): 202-222.

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Into the bargain, shareholders take on a largely passive role just as before the institutionalization of the corporate governance code. Additionally, despite proactive measures by the government to involve shareholders more in the governance of a company, our shareholders remain largely disinterested in the governance of the business.[27] Additionally, they should also make it hard for them to make a meaningful impact on a company's governance. Their role involves just giving advice, which may not be necessarily regarded. Just like before the Cadbury report, company directors can not be held accountable to the shareholders. The only time shareholders expressed interest in the organisation is when the company is underperforming.  Thus, just like before, corporations are only accountable more to the media and its scrutiny as opposed to its shareholders.[28]

In summary, shareholder primacy is essentially a myth as it is challenging to bring together meaningfully the interests of shareholders. Moreover, the shareholders are usually not interested in engaging the company's affairs. Additionally, the legal instruments supporting corporate governance in the UK are non-binding, which makes shareholders rely primarily on the good faith and will of the directors in safeguarding their interest in a primal manner.

[1] Keay, Andrew. "Comply or explain in corporate governance codes: in need of greater regulatory oversight?." Legal Studies 34, no. 2 (2014): 279-304.
[1] Jones, Ian, and Michael Pollitt. "Understanding how issues in corporate governance develop: Cadbury report to Higgs review." Corporate Governance: An International Review 12, no. 2 (2004): 162-171.

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QUESTION 3: PART A

Advice to BWL

The case of BWL has five primary legal issues that need to be addressed by directors Joe and Cramer; otherwise, they may result in serious ramifications.

The first issue is that shareholders have not received any dividends paid out for eight years, which is an indicator of mismanagement as the bottled water business is considered profitable. Further, and the previous biggest shareholder of the company (Lincoln), who held a 36% stake, sold his share after he was convinced that the company's operation had resulted in no profits.

The law requires directors to act "in good faith" towards the promotion of a company's success to the benefit of all members.[29] Directors should take into account the long-term impact and consequences of their actions,[30] the interest of employees,[31] relationship with customers and suppliers,[32] and acting in a manner that is fair to shareholders.[33]

In analysing the facts of the case, BWL has not had a long-term increase in value, which is the government definition of "success,"[34] evidenced by the fact that dividends have not been paid for the last eight years, and the company is losing shareholders. In addition, they allotted shares to Olive at a discount of 33% percent. They have also paid extravagant dividends, which reveals disregard of how such actions may affect the company in the long term.[35]

[1] Company Act s 172(1)
[1] Ibid s172 (1)(a)
[1] Ibid s172 (1)(b)
[1] Ibid s172 (1)(c)
[1] Ibid s172 (1)(f)
[1] Definition by Lord Goldsmith, Lords Grand Committee, February 6, 2006, column 255, quoted in the recently published guidance Companies Act 2006, Duties of company directors, Ministerial Statements, DTI June 2007, at p. 7
[1] Company Act s172 (1)(a)

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The directors have only acted towards their own interests, and other stakeholders continue to benefit, while shareholders' interests have not been reasonably considered. The actions of the directors do not have a long-term perspective on the success of the business. When the shareholders do not benefit from their investments in the company, they will likely withdraw from the company, just like BWL has lost Lincoln with a 36% stake. If the current trend continues, the company will lose even more shareholders. Subsequently,  the company will find it challenging to attract new investors. In a manner, the directors will be considered not to have exercised diligence, care, and due skill to ensure that the company's long-term success is safeguarded.

In conclusion, if the directors are found in breach of section 172, The consequences would be the same as those of the common law rule or the equitable principle applied.[36] This would be equivalent to the common law breach of fiduciary duty. If it is proved that the directors breached their fiduciary duties, they can be charged fines for damages, including legal costs and indirect damages. [37]

The second issue is the directors have private dealings, which conflict with the companies interests. The company’s directors allotted Olive extraordinary shares so that she is able to block Lincoln's decision to remove Jon and Cramer from office. The law requires the directors to avoid conflict of interests with the interests of the company.[38] This involves utilising the company opportunities and information towards personal gains.[39] The directors are required to declare personal conflicts of interest they have been involved in through the business transactions through writing to the board or during a board meeting. The only way such dealing with Olive may be permitted is if it is contained in the company's articles of association and the directors have disclosed the matter to the board of the organisation.[40] The above authorisation can only be valid if the directors involved in the conflict of interest are not involved

[1] Company Act s 178(1)
[1] Devonshire, Peter. "Account of profits for breach of fiduciary duty." Sydney L. Rev. 32 (2010): 389.
[1] Company Act s 175(1)
[1] Ibid s 175(2)
[1] Ibid s 175(5)(a)(b)

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in making the decisions and directors in question are not allowed to vote.[41]

In analysis, there is a transactional and situational conflict of interest. The directors at BWL are engaging in a transactional conflict of interest by using the information that Lincoln wants to remove them as directors of the company. As such, they bring Olive in and allot extraordinary shares to, which is illegal. At this point, BWL has not entered into an agreement with BWL, but they have created a conflict of interest for personal gain. The transaction purely enables Olive to block Lincoln's power to vote them out of the board. 

In conclusion, failure to declare a conflict of interest and to have it approved is considered a breach of the Company Act, and the concerned directors may be liable for a fine. [42]

The third issue is the allotment of shares. The law prohibits directors from alloting shares from private companies.[43]  Additionally, loaning money to Olive to buy company shares requires shareholder approval if one sells shares of 100 000 GBP or 10% of the company's shares (whichever is lower).[44]

In analysis, the company directors have decided to allot 12,000 GBP extraordinary shares to Olive in order to give her enough power to veto Lincoln's decision to remove them as company directors.  Even worse, the shares are sold to her at a discount of 33% of their original value. Additionally, the company has issued Olive a loan of 3000 GBP to purchase the shares. These decisions are made without involving shareholders. The decision is also not made in consideration of the long-term benefits of the company but a personal interest to continue operating as directors. In conclusion, directors that knowingly allot shares are liable for a fine upon conviction or indictment. [45]

[1] Ibid s 175(6)(a)(b)
[1] Ibid 178 (1).
[1] Ibid s 549(1)(a)
[1] Ibid s 550(1)(a)
[1] Ibid s 549(5)(a)(b)

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The fourth issue is the creation of extraordinary shares. The law requires shareholder approval in the creation of a new class of shares. The company needs Form SHO2 that describes the different rights between the stakeholders to be filed at Companies House. The directors should act within the company's powers, which gives authorisation for their actions. In analysis, the directors have created a new class of shares (extraordinary shares) without shareholders' approval.  The class of shares allows Olive more powers, as she can veto Lincoln's decision, who has 20,000 shares with only 12 000 shares. In conclusion, the company directors breached the stipulations of the Company Act (2006) and breached their fiduciary duty, which makes the directors liable for a fine as a remedy.[46]

The fifth issue is the BWL purchases the shares back from Lincoln, and the shares are then cancelled. From 2013, the law allows the company to buy back its shares even when it does not have enough distributable profits.[47] Buying back can only be limited if the company's articles of association explicitly prohibit the company from buying back the shares. Additionally, the agreements with shareholders must not contain pre-emption rights. These rights require that a company initially offers the shares to the existing shareholders prior to transferring to another entity, including itself.[48] Shares bought back are paid by the company after the tractions.[49] Upon purchase of off-market shares, the company must cancel them or hold them in treasury.[50]

In analysis, BWL directors have acted in accordance with the Company Act (2005), which allows buybacks and subsequently cancelled them. However, the BWL articles of association must be reviewed to ensure they do not expressly prohibit share buybacks. In conclusion, there is no legal conflict with regard to the above decision.

[1] Ibid s 549(5)(a)(b)
[1] The Companies Act 2006 (Amendment of Part 18) Regulations 2013 (Statutory Instrument 2013/999)
[1]   Companies Act 2006 s 649(1)
[1]  Companies Act 2006 (Amendment of Part 18) Regulations 2015 (Statutory Instrument 2015/532)
[1] Company Act 2005 s 724.

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In summary, the actions of directors’ conflict with interest and undermine the statutory provisions of the Company Act with regard to illegal allotment of shares, illegal creation of a different class of shares, illegal issuance of loans for the share purchase, and acting in a manner that would jeopardise long-term perpetuity of the company. As such, the directors are to face the same consequences "as would apply if the corresponding common law rule or equitable principle applied."[51]

[1] Company Act 2005 s178

 

QUESTION 3: PART B

 

Dear Mr.,

SUBJECT: LEGAL ADVICE ON STARTING THE WATER BOTTLING BUSINESS AS COMPANY OR SOLE TRADER

The purpose of this email is to offer you legal advice with regards to whether to start a sole trader business or a company by explaining to you the strengths and weaknesses of each option.

Concerning, starting the bottled water business as a sole trader means that you will own and operate the business alone. These will involve keeping accounting records for business expenses and sales, paying annual income tax returns on profits, filing a self-assessment tax, and paying insurance  (class 2 and 4) costs for the business. Moreover,  if your turnover for the business is over 85,000 GBP, you are required to apply for VAT.  Additionally, you have unlimited liability, which denotes there will be no legal distinction between you and the business. As such, your personal property is applied to pay for any debts the company may incur. On the subject of business naming, you may operate under your name or choose a different name for the company as a sole trader. Still, you do not need to register it unless you want to prevent other businesses from using your trade name. It is also critical to recognise that the startup cost of a bottled water company may be considerably high due to the expensive equipment required to run the business. As a sole trader, you have limited options for raising capital for your business: personal savings, personal loans, borrowing,  and borrowing from friends and family.  As a sole trader, the business dies when you leave the company.[52]

There are also the options of starting a company. The owners have a limited liability company, which denotes that the owners are legally separate from the business.[53] You will be required to register the company through Companies House, which is the national companies registrar. You will be required to solicit a lawyer to draft an Article of associations, essentially contracts between shareholders and directors. Lawyers will also help develop employee contracts, intellectual property agreements, and company policies, which are critical in helping resolve problems within the company and business conflicts. Starting a company is expensive in terms of the legal fees incurred and takes considerably a longer time to be set up.[54]

Additionally, a company is required to submit numerous reports regularly to the Companies House and HMRC to ensure companies continue to be registered in accordance with the company law. This includes maintaining statutory registers of income, expenditure, and accounting; her report of the company's financial activities filed annually at Companies House and HMRC; filing a confirmation statement annually to verify the company's details, submission of an annual tax return; submitting regular payroll reports; self-assessment registration; and filing personal tax returns.

The advantage of starting a company is that you get a professional image, and your company will be considered more reliable, established, and trustworthy. The company also has a perpetual existence, meaning it can continue to run even after you leave the company. Also, as a company, you have the option of selling shares to get additional funding to support, particularly the initial startup.

In offering advice on which option you should take, starting a company would be a better option. Even though startup and legal requirements for a sole trader are considerably more accessible, it would be less suitable for a bottled water company that requires considerable initial capital. Since there are limited options for raising capital, a company is better. Moreover, it will be challenging to run the bottled water business alone, especially because the nature of business is labour intensive with high turnover and low profits, which requires high efficiency; otherwise, the company will suffer significant losses. There are NO conflict issues.

Regards Lawyer,

 Arden LLP Solicitors

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