Company Law

LEARNING TEXT
COMPANY LAW
LEARNING TEXT
COMPANY LAW
Ryan Murray, LLB (Hons), PGCHE, Barrister

Lecturer in Law, Nottingham Law School
Materials are up to date to May 01 2007
CONTENTS
TABLE OF CASES ........................................................................................................................ v
TABLE OF STATUTES .............................................................................................................xiii
THE HISTORICAL DEVELOPMENT OF COMPANY LAW .............................................xix
CHAPTER ONE
CLASSIFICATION OF COMPANIES, LIMITED LIABILITY AND CORPORATE
PERSONALITY ............................................................................................................................. 1
1.1 Objectives .............................................................................................................................. 1
1.2 Types of Registered Companies ............................................................................................ 1
1.3 Advantages and Disadvantages of Incorporation................................................................... 8
1.4 The Process of Incorporation ............................................................................................... 12
1.5 Legal Personality and the Veil of Incorporation .................................................................. 15
1.6 The legal consequences of the Salomon principle ............................................................... 18
1.7 The Veil of Incorporation .................................................................................................... 22
1.8 Corporate Attribution........................................................................................................... 41
1.9 Conclusion ........................................................................................................................... 45
1.10 Questions............................................................................................................................. 46
CHAPTER TWO
FORMATION OF A REGISTERED COMPANY AND CORPORATE CONSTITUTION49
2.1 Objectives ............................................................................................................................ 49
2.2 The Formation of a Registered Company ............................................................................ 49
2.3 The Memorandum of Association ........................................................................................ 55
2.4 The Articles of Association.................................................................................................. 62
2.5 Questions.............................................................................................................................. 70
CHAPTER THREE
LAW OF PROMOTERS AND CORPORATE CONTRACTUAL CAPACITY................... 73
3.1 Objectives ............................................................................................................................ 73
3.2 Promoters ............................................................................................................................. 73
3.3 Company Contracts.............................................................................................................. 75
3.4 Post Incorporation Contracts................................................................................................ 78
3.5 Agency ................................................................................................................................. 78
3.6 Statutory Protection of Outsiders ......................................................................................... 83
3.7 The Rule in Turquand’s Case .............................................................................................. 86
3.8 Questions.............................................................................................................................. 90
CHAPTER FOUR
SHARE CAPITAL ....................................................................................................................... 93
4.1 Objectives ............................................................................................................................ 93
4.2 Share Capital and Capital Maintenance ............................................................................... 93
4.3 Capital Maintenance ............................................................................................................ 94
4.4 Shares................................................................................................................................... 95
4.5 Alteration of Share Capital ................................................................................................ 101
4.6 Transfer of Shares .............................................................................................................. 106
4.7 Redemption and Purchase by a Company of its Own Shares ............................................ 108
4.8 Financial Assistance for the Acquisition of Shares – See Cases & Materials 4.7 ............. 111
CONTENTS
4.9 Dividends........................................................................................................................... 114

4.10 Questions .......................................................................................................................... 118
CHAPTER FIVE
DEBT FINANCE AND COMPANY CHARGES ................................................................... 121
5.1 Objectives .......................................................................................................................... 121
5.2 Introduction ....................................................................................................................... 121
5.3 Corporate Security............................................................................................................. 122
5.4 The Priority of Charges ..................................................................................................... 125
5.5 Distinguishing Between Fixed and Floating Charges: Problems of Priority in the Peculiar
Context of Book Debt Security ......................................................................................... 125
5.6 Registration of Charges ..................................................................................................... 133
5.7 Receivership/Administrative receivership......................................................................... 137
5.8 Liquidators......................................................................................................................... 139
5.9 The advantages and disadvantages of Floating Charges ................................................... 144
5.10 Avoidance of charges ....................................................................................................... 146
5.11 Questions .......................................................................................................................... 156
CHAPTER SIX
COMPANY MANAGEMENT.................................................................................................. 159
6.1 Objectives .......................................................................................................................... 159
6.2 General Meetings............................................................................................................... 159
6.3 Proceedings at General Meetings ...................................................................................... 163
6.4 Types of Resolution........................................................................................................... 165
6.5 Additional Types of Resolution – De-Regulation ............................................................. 165
6.6 Duties of Shareholders ...................................................................................................... 169
6.7 Directors ............................................................................................................................ 170
6.8 Questions ........................................................................................................................... 177
CHAPTER SEVEN
THE DUTIES OF DIRECTORS .............................................................................................. 179
7.1 Objectives .......................................................................................................................... 179
7.2 Fiduciary Duties ................................................................................................................ 182
7.3 Duty of Care and Skill....................................................................................................... 195
7.4 Statutory Duties ................................................................................................................. 201
7.5 Remedies of the company against a director in breach of his duties................................. 208
7.6 Questions ........................................................................................................................... 209
CHAPTER EIGHT
RIGHTS OF THE MINORITY/SHAREHOLDER REMEDIES ......................................... 211
8.1 Objectives .......................................................................................................................... 211
8.2 The Rule in Foss v Harbottle ............................................................................................ 211
8.3 Minority Protection/Shareholder Remedies at Common Law........................................... 213
8.4 Statutory Minority Protection/Shareholder Remedies S. 459-461 .................................... 218
8.5 Section 461 ........................................................................................................................ 226
8.6 Valuation of Shares ........................................................................................................... 227
8.7 Public companies and s. 459 ............................................................................................. 229
8.8 The winding-up of the company on the ‘just and equitable’ ground. S. 122(1)(g) Insolvency
Act 1986 ............................................................................................................................ 231
8.9 The Link between S. 459 Companies Act and S. 122(1)(g) Insolvency Act 1986............ 233
8.10 Reform.............................................................................................................................. 233
8.11 Questions .......................................................................................................................... 234
iv
TABLE OF CASES
A & B C Chewing Gum Ltd, Re [1975] 1 WLR 579................................................................... 230
A & C Group Services, Re [1993] BCLC 1297 ........................................................................... 198
A L Underwood Ltd v Bank of Liverpool & Martins 1924 ........................................................... 81
Aberdeen Rail Co v Blaikie Bros (1854) 2 Eq Rep 1281, HL ..................................................... 187
Adams v Cape Industries Plc [1990] Ch 433 ..................................................................... 27, 28, 41
Aerators Ltd v Tollitt [1902] 2 Ch 319 .......................................................................................... 55
Agriplant Services Ltd, Re [1997] 2 BCLC 598, [1997] BCC 842.............................................. 149
Allen v Gold Reefs of West Africa Ltd 1900................................................................................. 65
Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd 1976 .......................................... 154
Arthur D Little Ltd v Ableco Finance (2002) The Times 22 April 2002 ..................................... 122
Ashbury Railway Carriage and Iron Company Ltd v Riche (1875) LR 7 HL 653,
[1874-80] All ER Rep 2219 ....................................................................................................... 55
ASRS Establishment Ltd, Re [2000] 1 B.C.L.C. 727 .................................................................. 128
Association of Certified Public Accountants of Britain v Secretary of State for Trade
and Industry [1997] BCC 736 .................................................................................................... 53
Astec (BSR) plc, Re [1999] BCC 59............................................................................................ 227
Atlas Wright (Europe) Ltd v Wright [1999] BCC 163......................................................... 166, 170
Attorney General's Reference (No 2 of 1982) [1984] QB 624................................................. 20, 44
Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34, CA............. 172
B. Liggett (Liverpool) Ltd v Barclays Bank Ltd 1928 ................................................................... 87

Badgerhill Properties Ltd v Cottrell 1991 ...................................................................................... 76
Bailey, Hay & Co Ltd, Re [1971] 1 WLR 1357, [1971] 3 All ER 693 ........................................ 165
Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, CA ............ 116
Ball v Eden Project Ltd [2002] 1 BCLC 313 ............................................................................... 190
Baltic Real Estate Ltd (No 2), Re [1993] BCLC 503................................................................... 219
Bamford v Bamford [1970] Ch 212 ............................................................................... 60, 173, 185
Barber & Nicholls Ltd v R & G Associates (London) Ltd (1981) 132 NLJ 1076 ......................... 26
Barings Plc (No 5), Re [1999] 1 BCLC 433................................................................................. 197
Barrett v Duckett [1995] 1 BCLC 243, CA.................................................................................. 216
Barron v Potter [1914] 1 Ch 895 .................................................................................................. 173
Barry Artist Ltd, Re [1985] 1 WLR 1305 .................................................................................... 166
Beacon Leisure Ltd, Re [1992] BCLC 565, [1991] BCC 213 ..................................................... 147
Beattie v B.F. Beattie Ltd 1938 ...................................................................................................... 63
Belmont Finance Corporation Ltd v Williams Furniture Ltd 1979.............................................. 114
Bhullar v Bhullar, Re Bhullar Bros Ltd [2003] All ER (D) 445 .................................................. 191
Birch v Cropper 1889 ..................................................................................................................... 95
Bird Precision Bellows Ltd, Re [1984] Ch 419............................................................................ 218
Bishopsgate Investment Management Ltd v Maxwell (No 2) [1994] 1 All ER 261 .................... 182
Bishopsgate Investment Management Ltd v Maxwell [1993] BCLC 1282 ................................. 198
Blue Arrow plc, Re [1987] BCLC 585......................................................................................... 227
Blum v OCP Reparations SA [1988] BCLC 170 ........................................................................... 26
Boardman & Anor v Phipps [1967] 2 AC 46 ............................................................................... 187
Borland's Trustee v Steel 1901 ....................................................................................................... 95
Bovey Hotel Ventures Ltd, Re 1981 ............................................................................................ 220
Bowman v Secular Society Ltd [1917] AC 406 ............................................................................. 13
Brady v Brady 1988 HL ............................................................................................................... 113
Bratton Seymour Service Co Ltd v Oxborough 1992 CA.............................................................. 64
Braymist Ltd. and others v Wise Finance Co Ltd [2002] All ER (D) 267 ..................................... 77
Brazilian Rubber Plantations & Estates Ltd, Re [1911] 1 Ch 425 ............................................... 193
Brenfield Squash Racquets Club Ltd, Re [1996] 2 BCLC 184 .................................................... 225
v
TABLE OF CASES
Brian D Pierson (Contractors) Ltd, Re [1999] BCC 26 ....................................................... 148, 194

Brightlife Ltd, Re [1987] Ch 200......................................................................................... 123, 126
British Bank of the Middle East v Sun Life Assurance of Canada (UK) Ltd 1983 ....................... 82
British Racing Drivers Club Ltd v Hextall Erskine, [1997] 1 BCLC 182 ................................... 203
Brown v British Abrasive Wheel Company 1919.......................................................................... 67
Burland v Earle [1902] AC 83 ..................................................................................................... 212
Bushell v Faith [1969] 2 Ch 438.................................................................................................. 171
C L Nye Ltd, Re [1971] Ch 442, CA ........................................................................................... 133

Canadian Aero Service Ltd v O'Malley (1974) 40 DLR (3d) 371............................................... 191
Cane v Jones [1980] 1 WLR 1451 ............................................................................................... 165
Cardiff Savings Bank, The Marquis of Bute's case, Re [1892] 2 Ch 100.................................... 194
Carney v Herbert 1985 PC........................................................................................................... 112
Carruth v ICI Ltd 1937 ................................................................................................................ 105
Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 ............................................... 181
Ciro Citterio Menswear plc v Thakrar [2002] 2 All ER 717 ....................................................... 202
City Equitable Fire Insurance Co, Re [1925] Ch 407 .......................................................... 193, 198
Clemens v Clemens Bros Ltd [1976] 2 All ER 268......................................................167, 186, 213
CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704 ...................................................................... 192
Cohen v Selby [2001] 1 BCLC 176 ............................................................................................. 198
Coleman v Myers [1977] 2 NZLR 225........................................................................................ 180
Commercial Solvents Corporation v EC Commission [1974] ECR 223 ....................................... 29
Company (No 001418 of 1988), Re 1991.................................................................................... 140
Company (No 004415 of 1996), Re [1997] 1 BCLC 479............................................................ 231
Company (No 004502) ex parte Johnson, Re 1992 ..................................................................... 224
Company ex parte Harries, Re [1989] BCLC 383 ....................................................................... 223
Company No 004377, Re [1987] BCLC 94................................................................................. 226
Company No.002567 of 1982, Re [1983] 1 WLR 927 ........................................................ 217, 231
Company No.00330 ex p Holden, Re [1991] BCLC 597 ............................................................ 226
Company No.003843 of 1986, Re [1987] BCLC 562 ................................................................. 218
Cook v Deeks [1916] 1 AC 554, PC.............................................................................192, 213, 215
Cotronic (UK) Ltd v Dezonie 1991 ............................................................................................... 76
Craven Textile Engineers Ltd v Batley Football Club Ltd [2001] BCC 679............................... 189
Creasey v Breachwood Motors Ltd [1993] BCLC 480, [1992] BCC 638..................................... 37
Criterion Properties plc v Stratford UK Properties LLC [2004] BCCC 570 (HL) ................ 82, 185
Crown Dilmun v Sutton [2004] 1 BCLC 468 .............................................................................. 191
Cumana Ltd, Re [1986] BCLC 430, CA...................................................................................... 223
Cumbrian Newspapers Group Ltd v Cumberland and Westmorland Herald Newspaper
and Printing Company Ltd 1986 .............................................................................................. 100
Currencies Direct Ltd v Ellis [2002] 1 BCLC 193 ...................................................................... 202
Dafen Tinplate Co Ltd v Llanelly Steel Company (1907) Ltd 1920 ............................................. 67
Daniels v Daniels [1978] Ch 406................................................................................................. 215
Destone Fabrics Ltd, Re [1941] Ch 319, CA ............................................................................... 151
DHN Food Distributors Ltd v Tower Hamlets London Borough Council
[1976] 1 WLR 852 ............................................................................................................... 27, 28
D'Jan of London Ltd, Re [1994] 1 BCLC 561............................................................................. 194
Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 .......................................................... 195
DPP v Kent and Sussex Contractors Ltd [1944] KB 146 ........................................................ 42, 43
Duckwari plc (No 1), Re [1997] 2 BCLC 713, ChD and CA ...................................................... 204
Duomatic Ltd, Re [1969] 2 Ch 365.............................................................................................. 165
Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 ................................................................ 217
vi
TABLE OF CASES
Edwards v Halliwell [1950] 2 All ER 1064 ......................................................................... 210, 212

Eley v Positive Government Security Life Assurance Company 1875.......................................... 63
Elgindata Ltd, Re [1991] BCLC 959.................................................................................... 223, 226
English and Colonial Produce Co Ltd, Re 1906............................................................................. 75
Eric Holmes (Property) Ltd, Re [1965] Ch 1052 ......................................................................... 133
Erlanger v New Sombrero Phosphate Co 1878 .............................................................................. 74
Erven Warnink BV v J Townend & Sons [1979] 2 All ER 927..................................................... 54
Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2 ................................ 213
Evans v Brunner Mond & Co [1921] 1 Ch 359............................................................................ 183
Ewing v Buttercup Margarine Company Ltd [1917] 2 Ch 1 .......................................................... 54
Exchange Travel (Holdings) Ltd (No 3), Re [1996] 2 BCLC 524, [1996] BCC 933................... 148
Extrasure Travel Insurances v Scattergood [2003] 1 BCLC 598 ................................................. 182
Fairline Shipping Corporation v Adamson [1975] QB 180 ........................................................... 39

Fairway Magazines Ltd, Re [1993] BCLC 643, [1992] BCC 924 ....................................... 147, 151
FG (Films) Ltd, Re [1953] 1 WLR 483.......................................................................................... 35
Firestone Tyre and Rubber Co Ltd v Lewellin [1957] 1 WLR 464 ......................................... 35, 36
Flitcroft's Case (1882) 21 ChD 518................................................................................ 94, 115, 116
Foss v Harbottle (1843) 2 Hare 461 ..................................................... 209, 210, 211, 212, 224, 232
Fowlers Vacola Mfg Company Ltd, Re 1966............................................................................... 105
Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd 1964 .................................... 81, 87
Full Cup International Ltd, Re [1995] BCC 682 .......................................................................... 231
G.E. Tunbridge Ltd, Re [1995] 1 BCLC 485 ............................................................................... 122

Gambotto v WCP Ltd 1995............................................................................................................ 67
Gardner v Parker [2004] All ER (D) 249 ..................................................................................... 211
General Accident v Midland Bank Ltd [1940] 2 KB 338 .............................................................. 19
German Date Coffee Co, Re 1882................................................................................................ 230
Giles v Rhind [2001] 2 BCLC 582............................................................................................... 211
Gilford Motor Co Ltd v Horne [1933] Ch 935......................................................................... 32, 33
Gluckstein v Barnes 1900............................................................................................................... 74
Greenhalgh v Arderne Cinemas Ltd 1950.......................................................................... 66, 67, 99
Gross v Rackind [2004] 4 All Er 735........................................................................................... 224
Grosvenor Press PLC, Re1985 ..................................................................................................... 104
Grove v Advantage Healthcare (T10) Ltd [2000] 1 B.C.L.C. 661............................................... 134
Guinness plc v Saunders [1990] 2 AC 663, HL ........................................................................... 200
Guinness v Land Corpn. of Ireland 1882 ....................................................................................... 62
H and others (restraint order: realisable property), Re [1996] 2 All ER 391 ................................. 33
Hackney Pavilion, Re 1924 .......................................................................................................... 106
Harman v BML Group Ltd [1994] 2 BCLC 674 CA ................................................................... 100
Harold Holdsworth & Co (Wakefield) Ltd v Caddies [1955] 1 WLR 352, HL ........................... 174
Haycraft v JRRT (Investments) Ltd 1993 .................................................................................... 106
Heald v O'Connor 1971................................................................................................................ 113
Hedley Byrne [1964] AC 465................................................................................................... 38, 39
Hely-Hutchinson v Brayhead Ltd 1968 CA ............................................................... 79, 80, 88, 188
Henderson v Merrett SyndicatesLtd.[1995] 2 AC 145................................................................... 38
Hendon v Adelman (1973) 117 SJ 63 ............................................................................................ 26
Hickman v Kent or Romney Marsh Sheep Breeders' Association 1915 ........................................ 63
HL Bolton (Engineering) Ltd v TJ Graham & Sons Ltd [1957] 1 QB 159.................................... 43
Hogg v Cramphorn Ltd [1967] Ch 254 ........................................................................................ 185
Holders Investment Trust Ltd, Re 1971 ......................................................................... 99, 106, 109
Holdsworth & Co v Caddies [1955] 1 WLR 352, HL.................................................................... 29
vii
TABLE OF CASES
Houghton & Co v Nothard, Lowe & Wills 1927 ........................................................................... 82

House of Fraser plc v ACGE Investments Ltd 1987.................................................................... 103
Howard Smith Ltd v Ampol Ltd [1974] AC 821, PC .......................................................... 184, 206
Howard v Patent Ivory Manufacturing Co 1888............................................................................ 87
Hydrodam (Corby) Ltd, Re [1994] 2 BCLC 180......................................................................... 168
Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443 ...................................... 190
International Sales & Agencies Ltd v Marcus 1982 ...................................................................... 83
Island Export Finance Ltd v Umunna [1986] BCLC 460 ............................................................ 191
Jaber v Science and Information Technology Ltd [1992] BCLC 764 ......................................... 217
Jenice Ltd v Dan [1993] BCLC 1349 ............................................................................................ 25
JH Rayner (Mincing Lane) Ltd v Department of Trade and Industry [1990] 2 AC 418,
(1989) 5 BCC 872 ...................................................................................................................... 19
JJ Harrison (Properties) Ltd v Harrison [2001] 1 BCLC 158 ...................................................... 187
JJ Harrison (Properties) Ltd v Harrison [2002] 1 BCLC 162 ........................................................ 20
John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 ........................................................ 172
Johnson v Gore Wood & Co (a firm) [2001] 2 WLR 72, HL...................................................... 210
Joint Receivers of Niltan Carson Ltd v Hawthorne [1988] BCLC 298 ....................................... 203
Jon Beauforte (London) Ltd, Re [1953] 1 Ch 131 ......................................................................... 57
Jones v Lipman [1962] 1 WLR 832........................................................................32, 33, 37, 39, 40
Jubilee Cotton Mills Ltd v Lewis [1924] AC 958 ................................................................... 13, 14
Jupiter House Investments (Cambridge) Ltd,Re 1985................................................................. 104
Knott v Cottee (1852) 16 Beav 77 ............................................................................................... 205

Kodak Ltd v Clark [1903] 1 KB 505 ............................................................................................. 36
Kredit-bank Cassel GmbH v Schenkers Ltd 1927 ......................................................................... 82
L Todd (Swanscombe) Ltd, Re 1990 ........................................................................................... 139

Lawlor v Gray 1980 CA .............................................................................................................. 112
Lee Behrens & Co Ltd, Re [1932] 2 Ch 46 ................................................................................. 183
Lee Panavision Ltd v Lee Lighting Ltd [1992] BCLC 22, CA.................................................... 200
Lee v Lee's Air Farming Ltd [1961] AC 12............................................................................. 21, 22
Legal Costs Negotiators Ltd, Morris v Hateley, Re, 18 February 1999 ...................................... 219
Loch v John Blackwood Ltd 1923 ............................................................................................... 230
London School of Electronics, Re [1986] Ch 211 ....................................................................... 223
Lonrho Ltd v Shell Petroleum Company Ltd [1981] 3 WLR 33, HL............................................ 29
Lyle and Scott Ltd v Scott's Trustees 1959.................................................................................. 107
M. C. Bacon Ltd, Re [1990] BCLC 324 .............................................................................. 146, 152

Macaura v Northern Assurance Co Ltd [1925] AC 619 .......................................................... 19, 23
MacDougall v Gardiner (1875) 1 Ch D 13 .......................................................................... 209, 212
Mackenzie and Company Ltd, Re 1916....................................................................................... 100
MacPherson v European Strategic Bureau [2000] 2 BCLC 683.................................................. 116
Macro (Ipswich) Ltd, Re [1994] 2 BCLC 354............................................................................. 223
Mahoney v East Holyford Mining Co 1875................................................................................... 87
Majestic Recording Studios Ltd, Re [1989] BCLC 1 .................................................................. 198
Manurewa Transport Ltd, Re [1971] NZLR 909 ......................................................................... 123
Matthew Ellis Ltd, Re [1933] 1 Ch 458....................................................................................... 151
Maxform SPA v B Mariani & Goodville Ltd [1981] 2 Lloyd's Rep 54 ........................................ 26
Mechanisations (Eaglescliffe) Ltd, Re [1966] Ch 20................................................................... 134
Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 3 WLR 413 ..... 43
viii
TABLE OF CASES
Milgate Developments Ltd, Re 1993............................................................................................ 225

Molineaux v London Birmingham and Manchester Insurance Co Ltd 1902 ................................. 64
Monolithic Building Co, Re [1915] 1 Ch 643 .............................................................................. 134
Morphites v Bernasconi [2003] EWCA Civ 289.......................................................................... 140
Morris v Kanssen 1946................................................................................................................... 87
Movitex Ltd v Bulfield [1988] BCLC 104, (1986) 2 BCC 99 ..................................................... 187
Multinational Gas and Petrochemical Company Ltd v Multinational Gas and
Petrochemical Services Ltd [1983] 1 Ch 258, CA ............................................................. 29, 186
Natal Land Co Ltd v Pauline Colliery Syndicate Ltd 1904............................................................ 75

National Dock Labour Board v Pinn & Wheeler Ltd [1989] BCLC 647....................................... 31
National Westminister Bank plc v Jones [2002] 1 BCLC 55....................................................... 123
Nelson v James Nelson and Sons Ltd 1914.................................................................................... 68
Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald [1995] 3 WLR 108............................. 200
New British Iron Company ex parte Beckwith, Re 1898 ............................................................... 63
New Cedos Engineering Co Ltd, Re [1994] 1 BCLC 797 ................................................... 106, 108
New York Taxicab Co, Re [1913] 1 Ch 1 .................................................................................... 138
Newborne v Sensolid (Great Britain) Ltd [1953] 1 All ER 708..................................................... 77
Newgate Stud Company v Penfold [2004] All Er (D) 372........................................................... 187
Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360........................................................... 224
Norman v Theodore Goddard [1991] BCLC 1028....................................................................... 194
North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589.......................................... 167
Nurcombe v Nurcombe [1985] 1 WLR 370................................................................................. 216
O’Neill v Phillips [1999] 2 All ER 961, HL ................................................................ 218, 226, 227

Old Silkstone Collieries Ltd, Re 1954.......................................................................................... 105
Ord v Belhaven Pubs Ltd [1998] BCC 607.............................................................................. 31, 36
Orleans Motor Co Ltd, Re [1911] 2 Ch 41................................................................................... 151
Oxted Motor Co Ltd, Re [1921] 3 KB 32 .................................................................................... 165
Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd 1971......................... 83

Parkes Garage (Swadlincote) Ltd, Re 1929.................................................................................. 151
Patrick and Lyon Ltd, Re 1933..................................................................................................... 140
Pavlides v Jensen [1956] Ch 565.................................................................................................. 215
Pearce, Duff & Co Ltd, Re [1960] 1 WLR 1014, [1960] 3 All ER 222....................................... 165
Pearl Maintenance Services Ltd, Re [1995] B.C.C. 657 .............................................................. 128
Pedley v Inland Waterways Association Ltd [1977] 1 All ER 209.............................................. 171
Pender v Lushington (1877) 6 Ch D 70................................................................................ 212, 214
Peppermint Park Ltd, Re [1998] BCC 23..................................................................................... 198
Percival v Wright [1902] 2 Ch 421 .............................................................................................. 180
Peskin v Anderson [2002] 1 B.C.L.C........................................................................................... 180
Peso-Silver Mines Ltd v Cropper (1965) 56 DLR (2d) 117......................................................... 192
Phonogram Ltd v Lane 1981 .............................................................................................. 75, 76, 90
Pinewood Joinery v Starelm Properties Ltd 1994 ........................................................................ 153
Planet Organic Ltd, Re [2000] 1 BCLC 366 ................................................................................ 225
Polly Peck International Plc, Re [1996] 2 All ER 433 ................................................................... 31
Popely v Planarrive Ltd [1997] 1 BCLC 8 ................................................................................... 108
Power v Sharp Investments Ltd [1994] 1 BCLC 111, [1993] BCC 609, CA............................... 150
Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447, CA............... 116, 166
Produce Marketing Consortium (No 2), Re 1989......................................................................... 141
Products (Holdings) Ltd v British Steel Corporation [1986] ....................................................... 183
Profinance Trust SA v Gladstone [2002] 1 BCLC 141 ................................................................ 225
Prudential Assurance Co Ltd v Chatterley - Whitfield Collieries Co Ltd 1949 ........................... 102
ix
TABLE OF CASES
Purpoint Ltd, Re 1991.................................................................................................................. 142
R A Noble & Sons (Clothing) Ltd, Re [1983] BCLC 273................................................... 218, 231
R v Grantham 1984 CA ............................................................................................................... 140
R v ICR Haulage Ltd [1944] KB 551 ...................................................................................... 42, 43
R v P & O European Ferries (Dover) Ltd (1991) 93 Cr App R 72 ................................................ 42
R v Philippou (1989) 89 Cr App R 290 ......................................................................................... 44
R v Registrar of Companies ex parte Central Bank of India [1986] QB 1114 ............................ 133
R v Registrar of Companies, ex parte Attorney General [1991] BCLC 476 ........................... 13, 52
R v Rozeik [1996] 1 BCLC 380..................................................................................................... 44
R W Peak (Kings Lynn) Ltd, Re [1998] 1 BCLC 193................................................................. 165
Racing UK Ltd v Doncaster Racecourse Ltd and Doncaster Council [2004] EWHC (QB).......... 83
Rayfield v Hands 1960................................................................................................................... 65
Re Brumark Investments Ltd [2001] UKPC 28................................................................... 126, 129
Re Chez Nico (Restaurants) Ltd [1992] B.C.L.C. 192 ................................................................ 180
Re Citybranch Group Ltd, Gross v Rackind [2004] 4 All Er 735................................................ 224
Re Cumana Ltd [1986] BCLC 430 .............................................................................................. 225
Re Elgindata Ltd [1991] BCLC 959 .....................................................................223, 224, 225, 231
Re Hill & Tyler Ltd, Harlow v Loveday [2004] B.C.C. 732 ....................................................... 112
Re Keenan Bros Ltd [1986] BCLC 242....................................................................................... 131
Re Keenan Brothers Ltd [1986] BCLC 242................................................................................. 132
Re Lands Allotment Co [1894] 1 Ch 316 .................................................................................... 205
Re London School of Electronics Ltd [1986] Ch 211.................................................................. 225
Re Northern Engineering Industries plc 1994 CA ....................................................................... 103
Re Phoenix Supplies Ltd, Phoenix Office Supplies Ltd v Larvin [2003] 1 BCLC 76................ 222
Re Saltdean Estate Co Ltd 1968 .................................................................................................. 100
Re Spectrum Plus Ltd, National Westminister Bank plc v Spectrum Plus Ltd and others
[2004] All ER (D) 76 ............................................................................................................... 125
Re Sticky Fingers Restaurant Ltd [1992] BCLC 84, [1991] BCC 754........................................ 161
Read v Astoria Garage (Streatham) Ltd 1952................................................................................ 68
Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378 ................................................................. 189
Regentcrest plc v Cohen [2001] 2 BCLC 80 ............................................................................... 181
Revlon Incorporation v Cripp & Lee Ltd [1980] FSR 85.............................................................. 29
Richards v Lundy [2000] 1 BCLC 376, [1999] BCC 786 ........................................................... 225
Rights and Issues Investment Trust Ltd v Stylo Shoes Ltd 1965 .................................................. 66
Ringtower Holdings plc [1989] BCLC 427 ................................................................................. 224
Roberta, The (1937) 58 Ll LR 159 ................................................................................................ 29
Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246, CA ........ 87, 183
Ross v Telford [1998] 1 BCLC 82, [1997] BCC 945 .......................................................... 161, 162
Rother Iron Works Ltd v Canterbury Precision Engineers Ltd 1973........................................... 124
Royal British Bank v Turquand 1856 ............................................................................................ 86
Ruben v Great Fingall Consolidated 1906..................................................................................... 88
Russell v Northern Bank Development Corp Ltd 1992 ................................................................. 65
Safeguard Industrial Investments Ltd v National Westminster Bank Ltd 1982 .......................... 107
Salmon v Quin & Axtens Ltd [1909] 1 Ch 311, CA.................................................................... 172
Salomon v Salomon & Co Ltd [1897] AC 22.......................1, 15, 17, 18, 21, 23, 27, 34, 39, 45, 74
Sam Weller & Sons Ltd, Re [1990] Ch 682 ........................................................................ 219, 220
Saul D Harrison and Sons plc, Re [1995] 1 BCLC 14................................................................. 220
Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324, HL......................... 29, 225
Scottish Insurance Corporation Ltd v Wilsons & Clyde Coal Co Ltd 1949 .................................. 96
Secretary of State for Trade and Industry v Bairstow [2004] All Er (D) 333 (Jul) ..................... 195
Secretary of State for Trade and Industry v Bottrill [1999] BCC 177 ........................................... 21
x
TABLE OF CASES
Secretary of State for Trade and Industry v Gray [1995] 1 BCLC 276,
[1995] BCC 554, CA........................................................................................................ 169, 197
Shaker v Al-Bedrawi [2003] 1 BCLC .......................................................................................... 211
Shuttleworth v Cox Bros and Company Ltd 1927 ......................................................................... 66
Sidebottom v Kershaw Leese and Co Ltd 1920 ............................................................................. 68
Smith and Fawcett Ltd, Re 1942 .................................................................................................. 108
Smith v Croft (No.2) [1988] Ch 114 .................................................................................... 211, 214
Smith v Henniker-Major and Co. [2002] BCC 544........................................................................ 84
Smith, Stone and Knight Ltd v Birmingham Corporation [1939] 4 All ER 116............................ 34
Southern Foundries (1926) Ltd v Shirlaw 1940 ............................................................................. 68
Standard Chartered Bank v Walker and another [1982] 1 WLR 1410......................................... 167
Steen v Law 1964 PC ................................................................................................................... 113
Stocznia Gdanska v Latvian Shipping Co [2002] 2 Lloyds Rep 436 (CA).................................... 40
Street v Mountford [1985] AC 809 .............................................................................................. 130
Swabey v Port Darwin Gold Mining Company 1889..................................................................... 64
Swaledale Cleaners Ltd, Re [1968] 3 All ER 619, CA ................................................................ 108
TCB Ltd v Gray 1986..................................................................................................................... 83

Telomatic Ltd, Re [1993] BCC 404 ............................................................................................. 135
Tesco Supermarkets Ltd v Nattrass [1972] AC 153................................................................. 43, 45
Tett v Phoenix Property and Investment Company Ltd 1985 ...................................................... 108
Trevor Ivory Ltd v Anderson [1992] 2 NZLR 517 ........................................................................ 39
Trevor v Whitworth 1887..................................................................................................... 108, 110
Trustor AB v Smallbone (No.2) 2 BCLC 436................................................................................ 31
Twycross v Grant 1877 .................................................................................................................. 73
Virdi v Abbey Leisure Ltd [1990] BCLC 32 ............................................................................... 226
W & M Roith Ltd, Re [1967] 1 WLR 432 ................................................................................... 182

Wallersteiner v Moir (No.2) [1975] QB 373................................................................................ 215
Watts v Midland Bank plc [1986] BCLC 15................................................................................ 216
Westmid Packing Services Ltd, Secretary of State for Trade and Industry v Griffiths,
Re [1998] 2 All ER 124, CA .................................................................................................... 197
White v Bristol Aeroplane Company Ltd 1953.............................................................................. 99
William C Leitch Bros Ltd, Re 1932............................................................................................ 140
Williams v Natural Life Health Foods Ltd [1998] 1 WLR 830 ..................................................... 38
Wills v Corfe Joinery Ltd [1997] BCC 511 ................................................................................. 148
Wilson v Kelland [1910] 2 Ch 306............................................................................................... 124
Woodroffes (Musical Instruments) Ltd, Re [1986] Ch 366 ................................................. 122, 123
Woolfson v Strathclyde Regional Council 1978 SLT 159 ................................................. 29, 37, 41
Yenidje Tobacco Co Ltd, Re 1916 ............................................................................................... 230

Yeovil Glove Co Ltd, Re [1965] Ch 148, CA .............................................................................. 150
Yorkshire Woolcombers’ Association Ltd, Re [1903] 2 Ch 284 ................................................. 121
Young v Ladies’ Imperial Club Ltd [1920] 2 KB 523 ................................................................. 160
Yukong Line Ltd of Korea v Rendsburg Investments Corp of Liberia [1998] 4 All ER 82 .......... 39
Zinotty Properties Ltd, Re [1984] 1 WLR 1249........................................................................... 230
xi
TABLE OF STATUTES
Bubble Act 1720, xix s. 26, 52

Business Names Act 1985, xxi, 55
s. 26(1)(b), 51
s. 26(1)(c), 51
Companies (Audit, Investigations and
Community Enterprise) Act 2004, xxii s. 26(1)(d)-(e), 51
Companies Act 1862, xx, 15, 16, 62
s. 26(2)(a), 52
Companies Act 1908, xx
s. 28, 5 s. 26(2)(b), 52
Companies Act 1929, xx s. 26(3), 51
Companies Act 1948, xx
s. 27(4), 50
Companies Act 1967, 5, 8
Companies Act 1985, xx, xxi, 1, 9, 10, 25, s. 28(1), 162, 165
26, 49, 58, 62, 83, 84, 86, 115, 116, 117,
s. 28(2), 53, 54
138, 141, 159, 160, 161, 162, 163, 164,
165, 166, 167, 168, 170, 180 s. 28(3), 53
s. 1(1), 6
s. 29, 52
s. 1(2)(a), 2, 3
s. 29 (2), 52
s. 1(2)(b), 4
s. 30, 51
s. 1(2)(c), 5
s. 32, 53
s. 1(3), 5
s. 32(1), 53
s. 1(3A), 6, 17
s. 32(3), 53
s. 2(4), 4
s. 35, 59, 78, 81, 90, 188
s. 2(5)(a), 2
s. 35(1), 61, 85, 89
s. 3A, 58, 61
s. 35(2), 59, 61, 89
s. 4, 61, 163, 165
s. 35(3), 61, 89
s. 5, 61
s. 35A, 59, 78, 81, 83, 84, 87, 90, 138,
s. 9, 65, 165
186
s. 10, 12
s. 35A(1), 83, 86, 89, 186
s. 11, 6
s. 35A(2), 83, 86, 186
s. 12, 12
s. 35A(4), 61, 85, 89
s. 13(3), 12
s. 35A(5), 89
s. 13(6), 13
s. 35B, 59, 61, 78, 81, 83, 85, 89
s. 13(7), 12, 13
s. 36, 78
s. 13(7)(a), 12
s. 36(4), 76
s. 13(7)(b), 12
s. 36C, 73, 77, 90
s. 14, 49, 62, 214, 219
s. 36C(1), 77
s. 25(1), 5, 50
s. 54(2), 7
xiii
TABLE OF STATUTES
s. 80, 101, 118, 186, 201, 207, 208, 209 s.164(1), 168
s. 80A, 101 s.164(2), 110, 168
s. 89, 101, 118, 208, 209, 225 s.164(5), 110
s. 91, 101 s.166, 110
s. 95, 101, 118, 208, 209 s.171(1), 111
s.101, 93 s.171(3), 111
s.101(1), 6 s.173(2), 111
s.103, 94 s.173(5), 111
s.117, 6, 7, 14 s.173(6), 111
s.117(1), 6 s.174(1), 111
s.117(2), 6 s.174(4), 111
s.118(1), 6 s.175(1) and (2), 111
s.121, 101 s.176(1), 111
s.123, 101 s.178(2), 109
s.125, 98, 100 s.178(3), 109
s.127, 98, 198 s.178(6), 109
s.135, 101, 102 s.185, 106
s.135(1), 165 s.221, 198
s.142, 103 s.222, 198
s.143, 110 s.226, 198
s.143(1), 109 s.227, 26, 198
s.143(3), 109 s.233, 198
s.151, 112, 113, 216 s.246, 8
s.151(2), 113 s.247, 8
s.152, 112 s.254, 5
s.153, 113 s.254(2)-(3), 5
s.153(2), 113 s.258, 26
s.159, 109 s.263, 115, 116
s.159(2), 109 s.277, 116
s.159(3), 109 s.282(1), 6
s.160, 109 s.282(3), 6
s.160(4), 110 s.283(1), 6
s.162, 110, 168 s.283(2), 6
s.162(3), 110 s.285, 87
s.163, 110, 168 s.288, 198
s.163(3), 110 s.293, 170
s.164, 168 s.303, 166, 173, 177, 208, 219, 224
xiv
TABLE OF STATUTES
s.303(1), 173 s.369(3)(a), 161
s.303(2), 173 s.369(3)(b), (4), 161
s.303(5), 173, 176 s.370(5), 164
s.304(1), 173 s.370A, 163
s.309, 182 s.371, 163
s.317, 191, 201, 203, 209 s.371(1), 164
s.317(3), 201 s.372, 164
s.319, 168 s.373, 164
s.320, 201, 206 s.376, 173
s.321, 205 s.378, 161, 162, 164, 165
s.322, 84, 207 s.378(1), 165
s.322(1), 206 s.378(2), 161
s.322(2)(a), 207 s.378(3), 161
s.322(3), 206, 207 s.378(4), 164
s.322A, 60 s.379, 173
s.330, 201, 202, 203, 204 s.379A, 166
s.337, 202 s.380, 167
s.346, 204 s.381A, 166, 168
s.348, 51, 54 s.381B, 166
s.349, 25, 51, 54 s.381C, 166
s.349(4), 25 s.391, 166
s.350, 54 s.395, 134, 136, 156
s.351(1)(d), 51 s.395(2), 135
s.352, 198 s.399(3), 136
s.353, 198 s.401(2), 134
s.363, 198 s.403, 135
s.366(1), (3), 160 s.404, 136
s.366(2), 160 s.425, 103
s.368, 160, 162, 173 s.459, iv, 99, 108, 163, 211, 213, 218,
s.368(2), 160 222, 223, 224, 226, 228, 229, 232, 233,
s.368(3), 160 234
s.368(4), 160, 162 s.459(1), 221, 229
s.368(4)-(6), 162 s.461, iv, 211, 213, 219, 221, 226, 234
s.368(8), 160, 162 s.461(2), 226
s.369, 161, 162, 163 s.461(2)(c), 226
s.369(1)(a), 161 s.707B, 167
s.369(1)(b), 161 s.714, 51
xv
TABLE OF STATUTES
s.719, 185 s.763, 13
s.727, 117 ss.642-644, 103
s.739(1), 206 Company Directors Disqualification Act
1986, xxi, xxii, 24, 170, 171, 172, 196,
s.741, 170
197, 199, 200
ss. 25-34, 50 s. 10, 171
ss. 43-48, 7 s. 11, 170
ss. 53-55, 7 s. 15, 24
ss.155, 114 s. 2, 24
ss.155-158, 113 s. 3, 24, 171
ss.395-399, 125, 155 s. 4, 171
ss.406 and 407, 133 s. 6, 24, 171, 197, 199, 200
Companies Act 1989, xxi, 49, 58, 59, 70, 83 s. 6(1), 197
Companies Act 2006, xxi, 12, 50, 55, 58, 60,
s. 6(4), 197
62, 112, 179, 181, 201, 202
s. 7, 6 s. 7(1), 197
s. 8, 50 s. 8, 171, 197
s. 17, 49 s.1A, 171, 197
s. 28, 50, 62
s. 31, 55, 58 Enterprise Act 2002, xxii, 126, 137, 145,
146
s.170(4), 179
s.251, 125, 146
s.171, 60, 180
s.172, 180
Insolvency Act 1986, xx, xxi, xxii, 13, 23,
s.173, 180 37, 41, 109, 121, 124, 127, 137, 138, 144,
180, 196, 222, 231, 233, 234
s.174, 180
s. 29(2), 137
s.175, 180
s. 37, 138
s.176, 181
s. 40, 127, 138, 144
s.177, 181
s. 42(3), 138
s.178, 181
s. 43, 138
s.182, 181, 201
s. 44, 138
s.188, 69
s. 47, 198
s.190, 204
s. 66, 198
s.190(5), 204
s. 84(1)(c), 165
s.191, 204
s. 98, 198
s.191(2), 204
s.112, 128
s.197, 202
s.122, 109
s.207, 202
s.122(g), iv, 211, 231, 232, 233, 234
s.270, 6
s.124A, 13
s.550, 208
xvi
TABLE OF STATUTES
s.125(2), 233 s.249, 148
s.131, 198 s.386, 145
s.175, 127, 144 s.423, 154
s.213, 23, 141, 142 s.435, 148
s.214, 23, 142, 143, 183, 188, 196 s.435(6), 148
s.214(4), 143, 196 Schedule B
s.234, 198 para 14, 137
s.235, 199 Insolvency Act 2000, xxii, 24
s.6(1)(2), 197
s.238, 41, 153, 198
s.239, 121, 144, 146, 147, 148, 150, 152,
Joint Stock Companies Act 1844, xx
153, 171, 198
Joint Stock Companies Act 1856, xx
s.239(4), 150
s.239(4)(b), 147, 150 Land Compensation Act 1961, 28
Limited Liability Act of 1855, xx
s.239(5), 150
Limited Partnerships Act 1907, 8
s.240, 153, 198
s.240(3), 148 Partnership Act 1890, 10
s.243, 41
Theft Act 1968, 44
s.245, 121, 144, 149, 150, 151, 152, 156
s. 15, 44
s.245(5), 150
xvii
INTRODUCTION TO THE MODULE
THE HISTORICAL DEVELOPMENT OF COMPANY

LAW
The study of Company Law is concerned with the study of Registered Companies. It is helpful to
look briefly at the history of the development of the company in order to understand exactly what
a company is. The earliest form of business organisation was that of the sole trader. However,
Guilds of Merchants were formed in the Middle Ages as an early form of trade protection, the
most famous being the Free Masons and the City Livery Companies. Each member of a guild
traded in accordance with the rules of the Guild. Thus, initially where people wished to trade
together they traded in an early form of partnership which even then was based on the concept of
agency. Each partner was an agent for the other partners and was liable to the whole extent of his
personal fortune for the debts of the partnership.
The modern form of company really developed when merchants began trading overseas. A
merchant from the guild traded on his own stock overseas but as a member of a company which
included similar merchants. Royal Charters began to confer privileges on these “companies” of
men in the 14th century but the charters did not become common until the 16th century. The
trading liability of each member was separate from other members, that is from the company, and
the charters were only obtained to gain a monopoly of trade in a particular territory.
Later the merchants started to operate on the principle of joint stock. The charter was given to a
group of individual merchants or a company who issued stock in the enterprise to investors
contributing varying amounts. The East India Company is the most famous of these early joint
stock companies. It is important to realise that many of these joint stock companies did not
receive a charter and therefore traded as an early form of partnership even though they described
themselves as “companies”. Only the chartered companies were incorporated and therefore were
incorporated chartered corporations. The only method of incorporation at common law initially
was by Royal Charter or by Statute. However because a form of stock market began to develop
Parliament began to regulate.
Parliament was forced to intervene fully as a result of the South Sea Bubble. Many people lost
their money as a result of wild trading in the stock of the South Sea Co. Shares increased and
increased in value as more and more people invested and eventually it was realised that people
had paid far more for the shares than they were worth. People started selling and of course in the
end the shares were worthless because no one wanted them. Other companies were also affected
by this wild speculation and as a result of this Parliament was forced to intervene. The Bubble Act
of 1720 was passed and seems to have had the effect of setting back the development of the joint
stock companies for three quarters of a century.
The Bubble Act allowed the carrying on of business in a partnership and since Royal Charters and
Acts of Parliament were difficult to obtain, people traded as partnerships but with a deed of
xix
THE HISTORICAL DEVELOPMENT OF COMPANY LAW
settlement. The assets of the company were held on trust by trustees but the business of the
company was managed by managers (the early form of director). Because these companies were
unincorporated there was no limited liability. Also there was always the fear that they were illegal
as a result of the Bubble Act. Thus it was difficult for the ordinary trader to find a satisfactory
business medium. Acts of Parliament were passed to allow the incorporation of companies for
banking, insurance (fire and marine), the running of canals and the bringing of water to cities but
not for other trades (and anyway the cost of a private Act of Parliament was prohibitive) and
Royal Charters were no longer used for trades. Hence traders began to turn to France and America
for a method of incorporation.
As a result, with the repeal of the Bubble Act in 1825, the Government began to involve itself
with the development of company law. By 1844 it was clear that there was a need for legislation
and as a result the first Companies Act, the Joint Stock Companies Act 1844, was passed. This
provided for the registration of the deed of settlement documents with a public official and stated
that a deed of settlement company, when registered, became an incorporated company. However
this Act did not cater for limited liability. Thus the companies formed under the 1844 legislation
were unlimited companies. As a result of public opinion, limited liability was introduced in the
Limited Liability Act of 1855.
Finally the Joint Stock Companies Act of 1856 repealed and incorporated the Act of 1855. This
Act introduced the modern form of registration of a memorandum and articles of association. All
that was required were seven subscribers who were willing to join together to form an
incorporated company with limited liability. This Act gave a tremendous freedom to those
forming registered companies. The only protection to the public was the use of the word
“Limited” after the name of company and the ability of the public to search the public register.
The development of company law since then has been based on a twenty year cyclical review of
the governing company law statute. As a result there has been since the Companies Act of 1862,
the Companies Acts of 1908, 1929 and 1948. There was no Act at the end of the 20 year cycle in
1973 in spite of the Jenkins Report. In 1972 came the first of the series of Acts required to
implement a series of European Union Directives on Company Law. As a result of these a new
consolidating Act was passed in 1985. Insolvency provisions are not contained in this Act. Instead
the Insolvency Act 1986 deals with both personal and company insolvency. In 1989 a further
Companies Act was passed to implement some of the European Union Company Directives. At
the same time it under took some reforms of the 1985 Act..
Reform of company law is now once again on the political agenda. In recent times the Law
Commission has published two substantial papers on shareholder remedies and directors’
duties (areas of law covered in Chapters 7 and 8). In 1998 the Department of Trade and
Industry launched a full-scale review of core company law which in November 2005
culminated in the Company Law Reform Bill which received Royal Assent on 8th November
2006 and became the Companies Act 2006. The full text of the 2006 Act with explanatory
notes can be found from the parliamentary website on
http://www.opsi.gov.uk/acts/acts2006a.htm.
Note that this historical information is included for background purposes only. It establishes the
context in which modern company law is studied and is not part of the examinable syllabus.
xx
Acts of Parliament
1. The Companies Act 2006
As mentioned above, the Act received Royal Assent on 8th November 2006. While a small
number of provisions came in force on that date ( See: Companies Act 2006 c 46, Pt 47 s 1300
(2)) the overwhelming majority are yet to come into force. This presents a particular problem for
Company Lawyers and Law Students alike. When fully implemented, the 2006 Act will
effectively repeal the 1985 Act (which, has stood for many years as the major source of modern
Company Law).
A consultation period is currently underway with the aim of addressing how the new provisions
under the 2006 Act will apply to exiting companies. It is expected that the 2006 Act will be fully
implemented by October 2008. For this reason, the provisions under both the 1985 Act and the
2006 Act (where appropriate) are presented in this text, with commentary on the effect that the
new provisions are likely to have.
• For an invalauable resource on the 2006 Act, please refer to the DTI Destinations Table.
This table identifies all the provisions of the 1985 Act and indicates their location in the
2006 Act.
The table can be found at:
http://www.opsi.gov.uk/acts/en2006/ukpgaen_20060046_Destinations_en.pdf
Consolidating all previous Acts, it is the principal Act in operation at the moment. However all
provisions relating to corporate insolvency have been removed from it. All reference to sections in
these materials relate to sections of this Act.
This sought to implement the seventh and eighth EU Directives. It has reduced the impact of the
ultra vires doctrine on company law (see further Chapter Two). It also introduced simplified
meeting procedures for private companies (see further Chapter Six).
4. The Insolvency Act 1986
A consolidating Act on bankruptcy and corporate insolvency; it introduced the new concept of
administration orders.
5. The Company Directors Disqualification Act 1986
This contains provisions relating to directors’ disqualification.
6. Business Names Act 1985
This contains rules relating to names under which persons may carry on a business.
Note also that the law of the European Union has an increasingly important impact on the
development of English company law. A number of company law directives have been adopted
many of which are now implemented in England and Wales.
xxi
7. The Enterprise Act 2002
Key provisions relate to competition law, insolvency, administration and administrative

receivership, and bankruptcy.
8. The Insolvency Act 2000
This has amended the Company Directors Disqualification Act 1986 and the Insolvency Act 1986
to allow “fast track” disqualification of directors, by requiring their undertaking not to be
involved in the management of a company for a specified time. The Act has also amended the
voluntary arrangement procedure for small companies.
9. Companies (Audit, Investigations and Community Enterprise) Act 2004
An act that seeks to ensure stronger regulation of the accounting and audit profession, to increase
investor confidence and strengthen investigatory powers, and came about largely as a result of the
Enron collapse as well as other high profile regulatory and auditory defaults.
xxii
The Classification of Companies
Business Organisations
Sole Traders Unincorporated Associations Corporations

e.g. Partnerships
Incorporated by Royal Charter Incorporated by

(Chartered Companies e.g. the Parliament
Hudson's Bay Company)
By Private Acts By Special Public Act By General Public Act

(Statutory Companies (Public Corporations) Now Companies Act 1985
e.g. Water and 1989 (Registered
Companies) Companies)
Companies Limited by Shares Companies Limited Unlimited Companies

by Guarantee
Since
1980
Public Private Private Private
xxiii
CHAPTER ONE
CLASSIFICATION OF COMPANIES, LIMITED

LIABILITY AND CORPORATE PERSONALITY
1.1 Objectives
By the end of this chapter you should be able to
1. Distinguish between the basic types of company which can be incorporated under the Companies
Act 1985.
2. Identify the key differences between public and private companies.
3. Understand the concept of limited liability.
4. Evaluate the advantages and disadvantages of incorporation.
5. Explain how a private company limited by shares is incorporated.
6. Appreciate the significance of the certificate of incorporation.
7. Understand the concept of separate corporate personality and appreciate the significance of the
House of Lords decision in Salomon v Salomon & Co Ltd.
8. Assess the legal consequences of the Salomon principle.
9. Define what is meant by the phrase, “the veil of incorporation”.
10. Recognise when the veil of incorporation can be lifted or pierced using a statutory provision.
11. Analyse the situations where the courts may be prepared to lift or pierce the veil of incorporation
at common law and extract the relevant principles from case law.
12. Explain the concept of corporate attribution and appreciate its links with the Salomon principle.
1.2 Types of Registered Companies
Companies are divided into three main types
1.1 Companies Limited by Shares
1.2 Companies Limited by Guarantee
1
PERSONALITY
1.3 Unlimited Companies
1.2.1 COMPANIES LIMITED BY SHARES
A company limited by shares is defined in s. 1(2)(a) as “a company having the liability of its
members limited by the memorandum to the amount, if any, unpaid on the shares respectively held
by them”. This clause is to be replaced by Clause 3 of the Company Law Reform Bill (the “Bill”)
when brought into force. By s. 2(5)(a), the memorandum of association of this type of company (see
further below) must contain a clause stating the amount of share capital with which it proposes to be
registered (the authorised or nominal share capital) and the division of that share capital into shares
of a fixed amount (often referred to as nominal or par value). When brought into force the Bill will
abolish the requirement of a company to have an authorised share capital.
SAQ 1
You are proposing to form a company limited by shares with an initial share capital of £1,000.
How would you express this in the memorandum of association so as to comply with s. 2(5)(a)?
First, you must state the amount of the initial share capital:
e.g. “The company’s share capital is £1,000. . .”.
Then, you must state how it is to be divided:
e.g. “The company’s share capital is £1,000 divided into 1,000 shares of £1 each”.
Here, the par value of each share is £1. It is perfectly possible to have a higher or lower par value as
long as the share capital is divided into shares of a fixed amount:
e.g. “The company’s share capital is £1,000 divided into 2,000 shares of 50 pence each”.
In a company limited by shares, the liability of the members is limited “to the amount, if any, unpaid
on [their] shares” (s. 1(2)(a)). This means that a member cannot generally be required to contribute
towards payment of the company’s debts once he has paid for his shares in full. Thus, if the company
becomes insolvent, a member whose shares were issued to him fully paid stands to lose only the
amount of his initial investment. This is the classic formulation of the concept of limited liability. As
we will see, a company is regarded as having a legal existence entirely distinct from that of its
members. As such, the liabilities of a company can be treated as its own, distinct from the general
liabilities of individual members. This idea of a legal distinction between a company and its members
underpins the concept of limited liability. What should by now be clear is that any notion of a
“limited liability company” is (put politely), a myth. Technically, one can pursue a company limited
by shares for the full amount of its own debts and liabilities. It is the liability of the company’s
members which is limited.
It follows logically from s. 1(2)(a) that a member is not, by statute, required to pay for shares in full
when they are issued by the company. Shares can be issued partly paid or even nil paid. Commonly,
however, the financial requirements of the company are such that it will require shares to be fully
paid from the outset.
2
PERSONALITY
SAQ 2
AJW Ltd has an authorised share capital of £1,000 divided into 1,000 shares of £1 each. The
company issues 500 £1 shares partly paid as to 50 pence per share (i.e. £250 in total) to B. AJW
Ltd goes into insolvent liquidation with substantial debts and liabilities. B still holds her shares.
What is the extent of B’s liability to AJW Ltd?
B’s liability to contribute to the assets of AJW Ltd is limited to the amount unpaid on her shares i.e.
50 pence per share, £250 in total. On general principles she would not have to contribute a penny
more than £250. If she had paid £500 when AJW Ltd issued the shares she would not now have any
liability to the company. Her shares would then have been fully paid.
A company limited by shares can also issue shares at a premium over and above their par value. For
example, AJW Ltd could have required B to pay £2 for her £1 shares. Of that £2, £1 would then
cover the par value of each share while the other £1 would be the share premium.
SAQ 3
What would your answer to the previous SAQ be if B had agreed to pay £2 for her £1 shares
but had deferred payment of the £1 premium on each share?
The House of Lords in the Ooregum Gold Mining case (in particular, Lord Watson) suggest that the
statutory words “amount, if any, unpaid” now in s. 1(2)(a) should be construed by reference to the
“fixed amount” i.e. par value of the shares into which the share capital is divided. If this is right then
B is not obliged under the statute to pay the premium to AJW Ltd. However, B would be liable to
pay the premium (i.e. £500 in total) as a matter of contract.
It should be clear that a shareholder does not have to pay the whole nominal amount of his share
to the company at once when acquiring the share from the company. However the directors may
call upon shareholders of partly paid shares to pay up the unpaid portion of the nominal amount of
their shares. These calls may be made during the life of the company or on winding up.
A company limited by shares obtains its working capital by the issue of shares. It may obtain
further funds later on by further issues of shares but it must have authority from the general
meeting to do this if it wants more than it original nominal or authorised capital.
Note that in a company limited by shares, the terms “member” and “shareholder” are effectively
interchangeable.
3
PERSONALITY
1.2.2 COMPANIES LIMITED BY GUARANTEE
A company limited by guarantee is defined in s. 1(2)(b) as “a company having the liability of its
members limited by the memorandum to such amount as the members may respectively thereby
undertake to contribute to the assets of the company in the event of its being wound up”. By s. 2(4),
the memorandum of association of this type of company must contain a clause stating that each
member undertakes to contribute a fixed amount to the assets of the company in the event of it being
wound up while he is a member (or within one year after he ceases to be a member). This is known as
a guarantee clause. A member cannot be required to contribute more than the sum specified in the
memorandum. Providing the guarantee is of a fixed amount, there is no specified minimum. Thus, in
practice, members of this type of company are rarely required to guarantee payment of anything more
than a nominal sum, e.g. £1.
ACTIVITY 1
Re-read the notes on companies limited by shares. What do you think are the similarities and
differences between a company limited by shares and a company limited by guarantee? Make a
list.
1.2.2.1 Similarities
A company limited by shares and a company limited by guarantee are similar in the following
respects:
(a) Both types of company are regarded as legal persons having a legal existence distinct from that
of their members.
(b) In both cases the liability of the members is limited.
1.2.2.2 Differences
There are also some notable differences:
(a) In a company limited by shares, a member who holds partly paid or nil paid shares can be
required to pay the outstanding amount at any time during the company’s life. This is often
referred to as a call. In a company limited by guarantee, a member can only be called upon to
contribute to the company at the end of its life, i.e. in the event of its winding up.
(b) Following on from (a), a company limited by guarantee cannot raise working capital from the
members during its lifetime by means of a share issue, unlike a company limited by shares.
Guarantee companies are therefore usually formed to pursue charitable or other non-
profitmaking objectives. They are not regarded as a suitable medium through which to carry on
a commercial enterprise with a view to profit.
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1.2.3 UNLIMITED COMPANIES
An unlimited company is defined in s. 1(2)(c) as “a company not having any limit on the liability of
its members”. This type of company is rarely formed and it is easy to see why. If an unlimited
company becomes insolvent then the members are potentially liable, without limit, to contribute to
the company from their personal assets in a winding up. Again, however, it is important to note that
an unlimited company is regarded as a legal person having a legal existence distinct from that of its
members. Its creditors must claim against the company. They cannot claim directly against the
members. It is open to the liquidator, on behalf of the company, to pursue the members for a personal
contribution without limit. These members’ contributions would then be used to discharge the
creditors’ claims on the company.
The major benefit to be derived from forming this type of company is that s. 254 exempts its directors
from the obligation to file accounts and directors’ and auditors’ reports at Companies House (though
this is not an unqualified exemption - see s. 254(2) and (3)). However, unlimited companies are very
rare and you can treat this as the last word on the subject.
1.2.4 PUBLIC OR PRIVATE?
As well as the basic classification discussed in above, companies can be sub-classified in a number of
ways. The main sub-classifications are public companies and private companies.
1.2.4.1 Public and private companies defined
A public company is defined in s. 1(3) as a company limited by shares or limited by guarantee and
having a share capital (a “hybrid company”), being a company the memorandum of which states
that it is to be a public company. Note that the hybrid company was abolished by the Companies Act
1980. However, a hybrid company which was incorporated before 22 December 1980 can continue
to exist as such providing it is now registered as a public company.
A private company is negatively defined in s. 1(3) as “a company that is not a public company”. The
private company was recognised as a form of incorporation by the Companies Act 1907 (this was
re-enacted by The Companies Act 1908 s. 28). It was a form of incorporation aimed at the small
trader but because, at that time, a balance sheet did not have to be filed by a private company with
the Registrar many large companies became private companies. Various attempts to rectify this
situation were made including dividing the private company into exempt and non-exempt
companies but none was successful. The Companies Act 1967 abolished the financial privileges
of the private company and adopted the principle that every limited company should publish its
accounts.
1.2.4.2 Differences between public and private companies
1. A public company can only now be incorporated as a company limited by shares. A private
company can also be incorporated as a company limited by guarantee or an unlimited company.
2. A public company’s name must end with the words “public limited company” or the
abbreviation “Plc” (or Welsh equivalent). This is the effect of s. 25(1).
3. The memorandum of association of a public company must state that it is a public company. The
memorandum of a private company does not need to state that it is a private company.
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4. A public company must be registered with an authorised share capital of not less than the
authorised minimum (s. 11). The current authorised minimum is £50,000 (s. 118(1)). There is no
prescribed minimum for a private company. Indeed, it is possible to incorporate a private company
limited by shares with an authorised share capital of as little as £1 or £2. As such, the benefits of
limited liability can, on the face of it, be obtained at a relatively low initial cost. The authorised
minimum capital requirement in public companies derives from the European Union Law (the
Second Company Law Directive).
5. The minimum number of persons required to form a public company is two (s. 1(1)). However,
following implementation of the Twelfth Company Law Directive by the Companies (Single
Member Private Limited Companies) Regulations 1992 (SI 1992 No 1699) which introduced a new
s. 1(3A) it is now possible for one person alone to form a private company limited by shares or
guarantee. (Once in force, Companies Act 2006, s.7 will allow a single person to form any type
of company)
6. The most significant difference of all is that a public company can offer its shares to the public.
Only a public company is permitted to publish an advertisement offering its shares for issue to the
public generally. In other words, if a company wishes to attract investment from anyone other than its
promoters or individual investors introduced to it without advertisement, it will need to be registered
as a public company. In return for this benefit, public companies are subject to far more stringent
statutory controls than private companies. Also, public companies whose shares are listed (e.g. on the
London Stock Exchange) are subject to additional regulatory controls imposed by the relevant stock
market.
7. We saw in 4. above that a public company must be registered with an authorised share capital of
no less than £50,000. In addition:
(a) A public company must have an issued (or allotted) share capital of no less than £50,000 (s.
117(2)).
(b) A public company may not issue shares unless they are paid up as to 25% of their par value
with any premium paid in full (s. 101(1)).
A newly-incorporated public company will not be allowed to commence business or borrow money
unless it meets these special share capital requirements. The effect is that a public company must
actually issue say 50,000 £1 shares to comply with s. 117(2). The shares could be issued partly paid.
However, applying s. 101(1) in this instance, they would need to be paid up at least as to 25 pence per
share. The company must therefore receive a minimum of £12,500.
There appears to be far less concern as to whether a private company limited by shares, the main
object of study on this course, has a share capital structure which is sufficient to support its
commercial objectives.
8. A company registered as a public company on its incorporation must obtain a s. 117 certificate
before it can commence trading or borrow money. The Registrar of Companies will not issue this
certificate unless the special share capital requirements are satisfied. A private company can start
business immediately without obtaining this certificate and without being required to establish that its
share capital is adequate for trading purposes.
9. A public company must have at least two directors (s. 282(1)) whereas a private company may
have a sole director (s. 282(3)). Both types of company must have a company secretary (s. 283(1)).
Where a private company has a sole director, the secretary must be someone different (s. 283(2)).
Note: Companies Act 2006, s.270 removes the requirement for a private company to appoint a
company secretary.
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It is hoped that the following summary of the main differences between public and private companies
will help you remember them:
Public Private
1. Must be limited by shares Not so
2. Must state in Memorandum it is public Not so
3. Minimum authorised share capital

£50,000 No minimum
4. Shares to be paid up 25% + any premium

before commence trading No payment requirements
5. May offer shares or debentures to the MUST NOT offer shares or debentures to the
public public
6. Name must end with public limited Name must end with limited or Ltd if limited.
company or PLC or plc or Plc . . . (Nothing if unlimited).
7. May not trade immediately after May trade immediately after incorporation
incorporation
8. Must have at least two directors May have a sole director
9. Must have at least two members May have one member
1.2.4.3 Re-registration
1.2.4.3.1 Re-registration of a private company as a public company

A company which was incorporated as a private company may re-register voluntarily as a public
company under ss. 43-48. A special resolution is required and the company must satisfy the Registrar
that it conforms with the requirements of the Act applicable to public companies (e.g. the share
capital requirements) before a certificate of re-registration can be issued. Note that the majority of
public companies are established by re-registration rather being incorporated as such from scratch.
There is no need to obtain a s. 117 certificate after re-registration and so the company can continue
trading throughout the process.
1.2.4.3.2 Re-registration of a public company as a private company

A company which was incorporated as a public company may re-register voluntarily as a private
company under ss. 53-55. Again, a special resolution is required and all references to the company’s
status as a public company must be removed from its constitutional documents (e.g. the public
company clause in the memorandum of association). A certificate of re-registration is then issued.
This is a simpler process than the one outlined in 1.3.3.1 although it is open to minority shareholders
who meet the conditions in s. 54(2) to challenge the re-registration. This provision seeks to protect
minority shareholders who potentially stand to lose a ready market for their shares as a result.
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1.2.5 SMALL AND MEDIUM SIZED COMPANIES
It was seen earlier that the Companies Act 1967 imposed a requirement on all companies to
file/publish a set of accounts. This proved to be burdensome for small businesses and led to further
reform. Since 1981 private companies have been further sub-classified into small or medium-sized
companies. Neither type of company has to file a full set of accounts with the Registrar (s. 246),
although full information has to be prepared for shareholders. Small and medium-sized companies
qualify as such by meeting two or more of the following requirements in any year (s. 247):
SMALL MEDIUM
I Turnover Not more than £5.6 million Not more than £22.8 million
II Balance Sheet Total Not more than £2.8 million Not more than £11.4 million
III No. of Employees Not more than 50 Not more than 250
1.3 Advantages and Disadvantages of Incorporation
1.3.1 ADVANTAGES
Many of the advantages of incorporation stem from the recognition that a registered company is a
legal person having a legal existence distinct from that of its members. The legal consequences of this
idea of separate legal personality are explored more fully later in this Chapter.
1.3.1.1 Limited liability
The main advantage in forming a limited company is the availability of limited liability. As we have
seen, a registered limited company’s debts are its own. The company’s debts cannot be directly
attributed to the members of the company. In contrast, the member of an unincorporated partnership
is jointly and individually liable for all the firm’s debts incurred while he is a partner. Equally, an
individual trading on his own account as a sole trader is liable for all the debts of his business. A
partnership is treated in law as a commercial relationship between individuals. In England and Wales,
the partnership firm does not have a legal existence distinct from the individuals who participate in it.
The same is also true of a sole trader. Generally, it is only possible to acquire the benefit of limited
liability by incorporating a limited company. It is possible, by way of exception, to form a limited
partnership by registration under the Limited Partnerships Act 1907. However, a limited partnership
must have at least one general partner who is personally liable for all the debts of the firm. Also, it is
not possible for a limited partner to take part in the management of the firm without assuming full
liability for its debts. Given these drawbacks, the limited partnership, while not quite as dead as the
proverbial dodo, is a rare bird indeed. There is now separate legislation allowing members of certain
professions (such as lawyers or accountants) to form limited liability partnerships.
SAQ 4
What do you think is the major justification for limited liability as a matter of policy? Are
there any problems with limited liability and, if so, for whom?
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It is clear from the discussion in this chapter so far that it is not difficult to incorporate a limited
company. The actual process of incorporation is covered below. The logic of that process is that
limited liability is freely available as of right subject to compliance with a few straightforward
procedural requirements. The standard justification is that the free availability of limited liability is a
spur to enterprise. It encourages people to set up in business by reducing its risks. It encourages
investment in business as, theoretically, investors in a company limited by shares only stand to lose
the capital subscribed in return for their shares. Consequently, it enables businesses to raise capital
cheaply and easily. Commentators writing from a law and economics perspective often argue that
limited liability is therefore “efficient” in economic terms.
However, limited liability is not without its critics. We saw earlier how a private company limited by
shares can be incorporated with a very small authorised share capital. Anyone forming such a
company does not have to show that the company’s business is properly and adequately financed.
Easy access to limited liability may lead to the incorporation of companies whose businesses are
doomed from the outset to failure and insolvency. The costs of this failure must be absorbed by the
creditors of such companies (unless they can take security or protect themselves through the price
mechanism eg by charging higher prices) and in particular, unsecured creditors. The legal
ramifications of corporate insolvency are considered in detail in later chapters. For now, you should
note that one of the recurring questions in company law is how the balance between the benefits and
burdens of limited liability can best be struck.
For convenience the main differences between companies and partnerships are summarised below.
One of the most important differences is that limited liability is generally only available (at least in an
ordinary commercial context) through incorporation of a company:
Registered Companies Partnerships
1. Formation is by registration of certain Formation is by agreement, express or implied,

documents as required by the without any special formality.
Companies Act 1985.
2. Separate personality: A registered A partnership has no separate legal personality

company has a separate legal and is merely an association of several human
personality distinct from the human persons.
personalities of its members.
Salomon v Salomon Ltd 1897
3. Number of members: The minimum is A partnership cannot have more than 20

two members, one member for private members. (This may be increased in certain
companies. cases of professional partnerships). The
minimum is two.
4. Limited Liability: The liability of The liability of partners is always unlimited

every member may be limited (cf (except in the rare case of a limited
limited and unlimited companies). partnership).
5. Creditors: Creditors usually have no Creditors can sue partners jointly or

rights of action against members of a individually, in the firm’s name or in their own
registered company. names.
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6. Capacity: A company’s capacity is The capacity of a firm and its internal

fixed by its Memorandum of regulations are fixed by the Partnership
Association and its internal regulations Agreement (if any) or by the Partnership Act
by the Articles of Association (both of 1890 and can be altered at any time by
which can be altered only as permitted agreement among the partners.
by the Companies Act 1985).
7. Public documents: The Memorandum The Partnership Agreement and Accounts are
and Articles and copies of certain not open to public inspection.
resolutions and Accounts are Public
Documents and are open to inspection
by the public
8. Agency: No member of a company has Every partner has implied authority to act as
any implied agency to contract for the agent for the firm. (Unless a limited partner).
company (cf with directors).
9. Transfer of shares: Shares are freely Partners cannot transfer their “share” without
transferable without the consent of the agreement of the other partners.
other members or directors (unless the
articles of a company say otherwise).
10. Alteration of capital: This can only be The capital of a partnership can be altered
effected in accordance with procedure freely or in accordance with any procedure laid
laid down in the Companies Act. down in the partnership agreement.
11. Taxation: Registered companies are Taxation of partnerships is assessed on the

subject to special taxation procedures same principles as those of sole traders i.e.
and taxes. income tax etc.
12. Disputes: These are settled by votes Disputes between partners are settled by simple
among shareholders (with requisite majority (many partnership agreements contain
majorities laid down by the Companies an arbitration clause, laying down that
Act) or by directors. deadlocks shall be resolved by an arbitrator).
13. Liquidation: Companies are wound up Partnerships are dissolved in the manner
in the manner laid down by statute, provided by the Partnership Act usually by the
either by a liquidator appointed by partners themselves, subject to any provisions
members or creditors or by the court. contained in a partnership agreement.
14. Dissolution: A company remains in A partnership’s existence is terminated by

existence until the Registrar of agreement of the partners or by a court order.
Companies cancels its registration.
15. Death or Bankruptcy: A company The death or bankruptcy dissolves the

continues in being irrespective of the partnership unless there is an agreement to the
death or bankruptcy of its members. contrary.
16. Property: The company’s property The property of the partnership belongs to all
belongs to the company alone and not the members in common.
to the members.
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17. Companies may grant floating charges Partnerships may not grant floating charges
over assets. over assets.
18. Directors may be employees of the Partners may not be employees of the
company. partnership.
1.3.1.2 Security for borrowing
A company has wider scope for borrowing money and creating security in relation to borrowings
than an unincorporated business. In particular, only a registered company can create a floating
charge security over its assets (see Chapter 5 for a full discussion on floating charges and other
forms of corporate security interest).
1.3.2 DISADVANTAGES
1.3.2.1 Publicity and Companies Act compliance
In return for the privilege of limited liability conferred on their members, limited companies are made
subject to extensive formalities and disclosure obligations. As we will see later, various documents
must be filed with the Registrar of Companies on incorporation. There is also a continuous
requirement to file documents such as audited accounts and annual returns which apply to a company
throughout its active life. The costs of and formalities associated with incorporating and running a
limited company are therefore greater than those for an unincorporated business. Any member of the
public is entitled to search at Companies House in order to gain access to information filed by a
limited company in compliance with statutory obligations. Those who run an unincorporated business
can keep their affairs largely between themselves and the Inland Revenue. The accounts of a sole
trader or partnership are not open to general scrutiny by the public.
These disadvantages may well outweigh any benefit to be derived from limited liability. This is true
especially in the early years of a company’s business when any notion of limited liability is often
more apparent than real. After all, it is difficult to persuade even the friendliest of bank managers to
lend money to a newly-incorporated £2 company without its directors and members also being
required to give personal guarantees. Some of these difficulties have been reduced in recent times
through deregulation (eg reduced audit requirements for small companies and the concept of small
and medium sized companies discussed above).
1.3.2.2 Management structure
The management and formal decision-making structures of unincorporated businesses are somewhat
simpler than those of a limited company. Much of our companies legislation has been drafted with
the listed public company in mind. As we will see in later chapters company law often treats those
who manage a company’s business (the directors) as entirely separate from those who invest in and
own it (the shareholders). Consequently, the management and decision-making functions of a
company are, in law, split between a board of directors and the shareholders acting in general
meeting. This two-tier structure is artificial and cumbersome where, as is often the case, the
shareholders and directors are the same people, i.e. the company is owner-managed. Piecemeal
reforms have been introduced which aim to streamline formal decision-making in owner-managed
private companies. However, many now believe that small private companies should be subject to
their own separate and systematic company law regime.
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1.4 The Process of Incorporation
1.4.1 DOCUMENTS
To incorporate a private company limited by shares from scratch, those wishing to form the company
must deliver the documents referred to below to the Registrar. Note that companies may also be
registered electronically. The Registrar will then issue a certificate of incorporation if he is satisfied
that all the formal requirements have been met. The documents are:
(a) A memorandum of association (see further discussion in Chapter 2).
(b) Articles of association. These are the company’s internal rules and regulations (see further
Chapter 2).
Collectively, these documents are referred to as the company’s constitution. (Under the 2006 Act,
the structure of the company’s constitution will change quite dramatically. Again, see Chapter
2 for further details).
(c) A statement in prescribed form as to:
(i) who will be the first directors and secretary; and
(ii) the intended situation of the company’s registered office.
This is known as Form 10 because the requirement for it is contained in s. 10.
(d) A statutory declaration in prescribed form under s. 12 to the effect that all the statutory
requirements for incorporation have been met. The declaration must be made on Form 12 by
either the solicitor instructed to form the company or a person named in Form 10.
A registration fee (currently £20 if submitted in hard copy or £15 for electronic registration) must
also be paid. The White Paper “Company Law Reform” proposes, inter alia, that company formation
is made a simpler process. From the 1st January 2007 a web incorporation facility will be available.
1.4.2 THE CERTIFICATE OF INCORPORATION
Once the Registrar is satisfied that all the requirements of the Act are met he will issue a certificate
of incorporation. The company comes into existence as a legal person with effect from the date of
incorporation which is recorded on the certificate (s. 13(3)). The certificate of incorporation is thus
the corporate equivalent of a birth certificate.
On incorporation, the company is given a unique registered number. A company’s name may change
several times during its life. The registered number can never change.
Section 13(7)(a) provides that a certificate of incorporation is conclusive evidence that the
requirements of the Act in respect of registration have been complied with and that the association is
a company authorised to be registered as such. Section 13(7)(b) makes similar provision for public
companies. Generally, s. 13(7) makes it very difficult to challenge the validity of a company’s
incorporation.
While its certificate of incorporation is conclusive evidence that a company exists, it is not conclusive
evidence that its objects are legal. It is technically possible for the Crown (by the Attorney General)
to challenge a registration where a company’s objects are illegal or otherwise against public policy.
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This is illustrated by the following cases.
Bowman v Secular Society Ltd [1917] AC 406 concerned a company, the main object of which was
“to promote . . . the principle that human conduct should be based upon natural knowledge, and not
upon supernatural beliefs, and that human welfare in this world is the proper end of all thought and
action”. CB, by his will, left his residuary estate on trust for the company. CB’s next of kin
challenged the validity of this gift on the ground that the company’s objects were blasphemous.
Held: (construing an earlier statutory equivalent of s. 13(7)) that a certificate of incorporation is
conclusive evidence only of the fact of incorporation. It is not conclusive evidence as to the legality
of the company’s objects. Accordingly, it would be open to the Crown to institute proceedings by
way of certiorari to cancel a registration. Nevertheless, while the objects of the company clearly
involved a denial of Christianity, this did not constitute the offence of blasphemy and the gift was
therefore valid.
The only recorded case to date in which the court cancelled a registration is R v Registrar of
Companies, ex parte Attorney General [1991] BCLC 476, the Lindi St Claire case. There, a company
had been formed expressly to carry on the business of prostitution. The High Court quashed its
registration.
SAQ 5
The court in the Lindi St Claire case ordered that her company, Lindi St Claire (Personal
Services) Ltd, should be struck off the register. This amounted to a judicial dissolution of the
company. What legal effect do you think the cancellation of its registration might have on any
outstanding contracts entered into lawfully by a company during its existence.
The effect of cancellation on contracts validly entered into by the company is far from clear. Article
12, paragraph 3 of the first company law directive sought to introduce a requirement that the nullity
of a company should not affect the validity of any contracts entered into by it. This aspect of the
directive has not yet been introduced into English law. Given this uncertainty, it might be preferable
for the Secretary of State’s power to petition for the compulsory winding up of companies on public
interest grounds (Insolvency Act 1986, s. 124A) to be extended to cover this type of situation. This
would enable the company’s affairs to be properly wound up and its assets distributed to creditors
before formal dissolution.
Its certificate of incorporation is also conclusive as to the date on which a company was incorporated
and it must be taken to have been in existence during the whole of that day. Thus, even if there is
evidence that a certificate of incorporation was not actually signed and issued by the Registrar until
after the date recorded on it, the company will treated as having existed from the earlier date (see
Jubilee Cotton Mills Ltd v Lewis [1924] AC 958).
Where the Registrar registers an association’s memorandum which states that the association is to
be a public company, the certificate of incorporation must contain a statement that the company is
a public company. This is then conclusive evidence that the company is a public company
(s. 13(6)). A public company has a further certificate issued, a section 117 certificate (which
amounts to a certificate to commence business or a trading certificate) when the Registrar is
satisfied that the nominal value of the company’s allotted share capital is not less than the
authorised minimum (currently £50,000 – a figure unchanged by Companies Act 2006, s.763).
The amount paid up must be at least 25% of the nominal value of each share plus any premium. A
public company cannot do business or exercise any borrowing powers until the s. 117 trading
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certificate has been issued. If a public company does do business without a s. 117 trading
certificate, the company and any officer who is in default shall be liable to a fine. The transaction
is still valid but if the company breaks the contract, the directors of the company shall be liable
personally to indemnify the other party. This is an example of a situation where the veil of
incorporation can be lifted by statute (on which see generally below). Problems under s. 117
rarely arise because most companies begin life as private companies and are entitled to trade as
private companies when changing to public company status. Any contracts made before the
trading certificate is issued are made by the companies in their capacity as private companies.
1.4.3 “SAME DAY” REGISTRATION AND SHELF COMPANIES
In practice, those wishing to form a company will often be forced to move quickly in response to
commercial pressures. A company has no power to enter into contracts before the date of its
incorporation. Commercial pressures may be such that contracts need to be entered into urgently.
Unless a limited company can be incorporated quickly, those wishing to form it may be forced to
contract in their own names and without the benefit of limited liability. Incorporating from scratch by
following the steps outlined earlier can take time. However, two quicker alternatives are available as
follows.
1.4.3.1 “Same day” registration
It is possible, subject to filing the documents set out earlier, to obtain a certificate of incorporation
within a day. The documents must be filed by 3 pm at either Companies House in Cardiff or its
satellite registry in London.
It is now also possible to incorporate a company by electronic filing for those with the necessary
specialist software, and a reduced fee is applicable with effect from 1 February 2005.
SAQ 6
Given the principle derived from Jubilee Cotton Mills Ltd v Lewis (see above), do you think it
would be prudent to enter into contracts in a company’s name during the period after the
registration documents have been filed using the “same day” procedure but before issue of its
certificate of incorporation?
If a certificate of incorporation is issued on the same day, the company will be treated as having
existed for the whole of the day. Any contracts entered into in its name on that day will therefore be
the company’s contracts. However, problems may arise which delay issue of the certificate. For
example, the Registrar may reject the company’s proposed name. There is then a risk that any
contracts entered into will be pre-incorporation contracts (see Chapter 3). Thus, where time is very
short, it is advisable to acquire a company “off the shelf”.
1.4.3.2 Shelf companies
It is possible to acquire a company which has already been formed “off the shelf” or ready made from
a company formation agent. There is a healthy market with numerous operators competing to offer
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company formation and secretarial services to the legal and accountancy professions. The purchaser
of such a company will receive its certificate of incorporation and copies of the memorandum and
articles of association. The company formation agent or members of his staff will appear as
subscribers to the memorandum. Their names will also have been recorded on Form 10 as the first
directors and secretary. It will almost always be necessary to change the shelf company’s name. Also,
the subscriber shares will need to be transferred to the purchaser or his nominees. Equally, the first
directors and secretary will need to resign and be replaced by the purchaser’s appointees. It may also
be necessary to:
(a) change the company’s objects clause;
(b) adopt new articles of association; and/or
(c) alter the company’s authorised share capital (which for a shelf company will commonly be
£100).
The advantage of using a shelf company is that it already exists and contracts can, subject to the
terms of its memorandum, be entered into immediately on its behalf.
1.5 Legal Personality and the Veil of Incorporation
We saw above that a company comes into existence as a legal person when the Registrar issues its
certificate of incorporation. It is a basic principle of company law that a company has a legal
existence entirely distinct from that of its members. This idea underpins the concept of limited
liability because the liabilities of a company are treated as formally distinct from the personal
liabilities of its members. You cannot simply equate the company’s liabilities with those of its
members. It is this notion more than any other which distinguishes the corporate form from other
business media such as partnership.
The aim of this section is to explore more fully the development and consequences of this idea of
corporate legal personality. There will also be an attempt to subject the principle of corporate
personality to critical analysis. Is this principle absolute or is it subject to qualifications?
1.5.1 THE SALOMON PRINCIPLE
The House of Lords decision in Salomon v Salomon & Co Ltd [1897] AC 22 is a cornerstone of
modern company law. This decision finally resolved that a company which has complied with all the
formal requirements for registration under the Companies Act is a legal entity separate and distinct
from the individual members of the company. The facts are complex but please do not be deterred as
the Salomon litigation is worthy of detailed study. It is a fascinating story of a battle, so beloved of
English lawyers, between those old enemies “form” and “substance”. Salomon also arguably paved
the way for the widespread incorporation of small businesses and is therefore not without
considerable historical and cultural significance. The facts cannot be fully grasped without some
rudimentary understanding of corporate borrowing and security. You can find a basic introduction to
this subject in Chapter 5.
1.5.1.1 The facts of Salomon v Salomon & Co Ltd
For many years Aron Salomon ran an unincorporated business as a leather merchant and boot
manufacturer. Eventually, he decided to incorporate this business. He formed a private limited
company under the Companies Act 1862, the relevant statute at the time. The 1862 Act required a
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company to have at least seven members. Six family members joined Salomon as subscribers of the
memorandum. All seven subscribed initially for one share each in the company. Salomon then sold
all the assets of his unincorporated business to the company for just under £40,000. In exchange, the
company issued 20,000 £1 shares to Salomon. Payment of a further £10,000 of the consideration was
deferred and treated as a loan by Salomon to the company. The company issued debentures to
Salomon creating charges over its assets to secure repayment of the £10,000. Unfortunately, the
company’s business slumped due to recession in the boot and shoe trade. Salomon sought to raise
additional funds to support the business. He entered into a complex financing arrangement with a Mr
Broderip. Salomon caused the company to cancel his debentures and reissue them to Broderip as
security for a loan from him of £5,000. It appears that the debentures were, in fact, reissued to
Salomon who then transferred them by way of mortgage to Broderip. Consequently, Salomon
retained residual rights as a beneficial owner of the debentures. The company defaulted on Broderip’s
loan and he took steps to enforce his security. As a secured creditor, he was entitled to be paid first
out of the company’s assets before unsecured creditors (see further, Chapter 5). The company went
into insolvent liquidation. There were sufficient assets in the company to meet Broderip’s secured
claim with a small surplus of £1,000 left over. Salomon claimed the surplus under his residual rights
as beneficial owner of the debentures. This would leave nothing to meet the claims of unsecured
creditors which (apart from other unsecured sums owing to Salomon himself) amounted to some
£8,000. The liquidator brought proceedings against Salomon challenging his right to claim the £1,000
as a secured creditor and claiming further that Salomon was liable to indemnify the company against
all of its unsecured debts. In effect, the liquidator wanted to make Salomon personally liable for the
debts of the company.
1.5.1.2 The decision at first instance and in the Court of Appeal
At first instance, Vaughan Williams J held that Salomon was liable to indemnify the company against
all its debts. He was concerned by the fact that Salomon owned all but six of the 20,007 shares in
issue. The other members had only a very small interest. In substance, Salomon was running a one-
man business through the medium of a limited company. Thus, Salomon & Co Ltd was in Vaughan
Williams J’s eyes, nothing more than an alias for Salomon himself. The company had carried on
Salomon’s business as his nominee or agent. As such, the company had incurred liabilities at the
behest of Salomon as principal and was entitled to be indemnified against those liabilities. It is not
entirely clear on what grounds, other than loose allegations of fraud, the judge dismissed Salomon’s
claim under the debentures.
The Court of Appeal arrived at the same conclusion as Vaughan Williams J but by different means.
The full terms of the Court of Appeal’s order were as follows:
“This court, being of the opinion that the formation of the company, the agreement of August 1892
[transferring the unincorporated business to the limited company] and the issue of debentures to
Aron Salomon pursuant to such agreement, were a mere scheme to enable him to carry on business
in the name of the company, with limited liability, contrary to the intent and meaning of the
Companies Act 1862, and, further, to enable him to obtain a preference over other creditors of the
company by procuring a first charge on the assets of the company by means of such debentures.”
Like Vaughan Williams J, the Court of Appeal were troubled by the fact that, in substance, the
company was a one-man business trading with the benefit of limited liability. The other family
members had no real stake in the company. They were Salomon’s “dummies” or nominees. The
Court of Appeal considered that the formation of the company and transfer to it of the unincorporated
business amounted to a scheme to defraud creditors which was contrary to the spirit of the
Companies Act. Unlike Vaughan Williams J, the Court of Appeal concluded that the company was
the trustee of Salomon and the business rather than his agent. Nevertheless, the result was the same.
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Salomon was liable to indemnify the company. The Court of Appeal also rejected Salomon’s claim
under the debentures.
1.5.1.3 The House of Lords decision
The House of Lords unanimously allowed Salomon’s appeal and roundly criticised the reasoning of
the courts below. Their lordships first asked themselves whether Salomon & Co Ltd had been
lawfully incorporated for lawful purposes. The courts below suggested that the company had been
incorporated for purposes which were not within the contemplation of the Companies Act bearing in
mind that, in substance, it was a one-man company. Their lordships, however, were at a loss to
understand how the incorporation of Salomon & Co Ltd and the arrangements for the transfer of
Salomon’s unincorporated business could be contrary to the true meaning and intent of the
legislation. Salomon had filed a memorandum and articles of association as required by the Act.
There were seven subscribers of the memorandum as then required by the Act. They were seven real
people. The requirements of the Act had been met and the company was therefore properly
constituted. The courts below were clearly uncomfortable, as a matter of policy, with the idea that a
sole trader who owns and manages his business could incorporate the business and enjoy the benefits
of limited liability. This concern, however, did not justify reading a limitation into the Act.
Salomon’s motives for incorporating the company were irrelevant. The first part of the ratio is thus
that a company can be lawfully formed by complying with all the formal requirements as to
incorporation in the Act even if, in substance, it amounts to a one-man company. As such, the House
of Lords decision is a triumph of form over substance.
SAQ 7
Think back to the material on types of companies. If Salomon was alive today there would have
been no objection to his attempts to incorporate an owner-managed business. Why not? The
answer can be found in the next paragraph.
The wariness of the courts below needs to be put in context. The company limited by shares was
originally conceived as a vehicle for passive investment. It was contemplated that investors would put
their money into the company and sit back leaving a separate board of directors to manage its affairs
and, indirectly, their investment. The possibility of a financial return and the fact that their risk was
limited gave investors the necessary incentive to inject their funds in the first place. Our company law
is still dogged by this distinction between the respective roles of the investor and the company
director. When Salomon v Salomon & Co Ltd was decided the idea of an owner-managed company
in which investment and management functions were combined was entirely new. The courts below
thus resisted the notion that one man could invest in a company, enjoy the benefits of limited liability
and manage the company’s affairs at the same time. The House of Lords decision in Salomon
therefore marks a significant shift in corporate culture. It left the way open for the mass development
of the small, owner-managed private company limited by shares. The owner-managed company is
now fully recognised. So much so that it is now literally possible for one person alone to form a
private limited company (s. 1(3A)).
The courts below clearly accepted that the company was, in some sense, an entity distinct from
Salomon. How else could they say that the company was either Salomon’s agent or trustee.
Moreover, Vaughan Williams J and the Court of Appeal did not decide that Salomon was directly
liable to the creditors. It was held that he was liable to indemnify the company. Yet, on close
analysis, the true logic of the reasoning below was that by issuing the majority of its share capital to
one man, the company had somehow lost its legal personality and was nothing more or less than
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Salomon himself. Otherwise, how could Salomon be liable to indemnify the company given that his
personal liability was limited by statute to the amount unpaid on his shares. The second part of the
ratio is thus that a company lawfully incorporated under the Companies Act has a legal existence
entirely distinct from that of its members who are generally only liable to contribute personally to the
company’s assets to the extent provided by the legislation. As Lord Macnaghten put it:
“The company is at law a different person altogether from the subscribers to the memorandum,
and, though it may be that after incorporation the business is precisely the same as it was before,
the same persons are managers, and the same hands receive the profits, the company is not in law
the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any
shape or form, except to the extent and in the manner provided by the Act.”
On this basis, the House of Lords also appears to have allowed Salomon’s claim as a secured creditor.
It is thus generally possible for a shareholder or director to be a creditor of the company as well.
Much ink has been spilt and much court time spent in considering the ramifications of Salomon v
Salomon & Co Ltd. Even so, the basic premise that a company has a legal existence entirely distinct
from that of its members has never been seriously doubted since. As we will see below, attempts
have been made by both parliament and the courts to qualify the Salomon principle while retaining its
basic premise.
1.6 The legal consequences of the Salomon principle
1.6.1 COMPANY DEBTS
A company’s debts and liabilities are distinct from the debts and liabilities of its members. Thus
generally, creditors may only claim against the company for payment. They cannot proceed directly
against the members. As we saw earlier, this separate treatment of the debts of the company and the
personal debts of its members underpins the concept of limited liability.
SAQ 8
Red Ltd owns the entire issued share capital of Blue Ltd. Blue Ltd goes into insolvent
liquidation with debts of £50,000. Is Red Ltd liable for Blue Ltd’s debts? Give a reason for your
answer.
The SAQ above contains the simplest example of a corporate group.
Red Ltd is the parent or holding company and Blue Ltd is a subsidiary which is wholly owned by
Red Ltd. Generally, a parent company is not liable for debts incurred by its subsidiary and therefore
Red Ltd is not liable for Blue Ltd’s £50,000 debts. This follows logically from the Salomon principle.
Just as Salomon was a member of Salomon & Co Ltd, Red Ltd is a member of Blue Ltd. Blue Ltd
has a legal existence entirely distinct from Red Ltd. Red Ltd would generally only be liable to
contribute to the assets of Blue Ltd to the extent provided by the Act (i.e. if there are any amounts
unpaid on Red Ltd’s shares).
Claims by creditors may only be made against the company not against members individually.
Although the principle of limited liability is linked with a registered company, it does not always
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apply under the Companies Acts. It depends upon whether a company is registered as limited or
unlimited. However when obligations are incurred on behalf of any company limited or unlimited,
the company is primarily liable and not the members, though in the case of an unlimited company,
the company will ultimately be able to recover from its members whereas in the case of a limited
company, a member is only liable to contribute any amounts unpaid on their shares.
JH Rayner (Mincing Lane) Ltd v Department of Trade and Industry [1990] 2 AC 418, (1989) 5
BCC 872
The International Tin Council collapsed in 1985 owing millions of pounds in debts. The Council
had been formed by several states and creditors sought to sue the member states directly.
Held: that the Tin Council was a separate legal personality and therefore creditors could not sue
the members directly.
1.6.2 COMPANY PROPERTY AND TRANSFER OF MEMBERS’

INTERESTS
SAQ 9
In Macaura v Northern Assurance Co Ltd [1925] AC 619, M owned a timber estate. He
transferred ownership of all the timber on the estate to a limited company. M and his nominees
held all the company’s issued shares. M insured the timber against fire damage with several
insurance companies. The insurance was taken out in M’s name. The timber was destroyed by
fire and M sought to claim on the insurance. The insurers refused to pay so M issued
proceedings. What do you think was the outcome and why? See Cases & Materials 1.2 for a
more detailed overview of this case.
Macaura’s claim was unsuccessful. He had no insurable interest in the timber because it was not his
property. The timber belonged to the company. Macaura argued that his shareholding gave him a
proprietary interest in the company’s assets, i.e. the timber. This argument was emphatically rejected
by the House of Lords. Per Lord Buckmaster:
“. . . no shareholder has any right to any item of property owned by the company, for he has no
legal or equitable interest therein.”
Thus, while a shareholder has a proprietary interest in his shares, this does not give him any direct
proprietary rights in the company’s assets. Equally, a parent company does not enjoy any proprietary
rights in the assets of its subsidiary. The subsidiary’s property is distinct from that of its parent
(General Accident v Midland Bank Ltd [1940] 2 KB 338).
Shares in a company amount to a species of personal property in the hands of the shareholder. It
follows from Macaura that a shareholder’s interest in the company can be transferred without this
affecting ownership of the company’s assets.
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SAQ 10
Assume for a moment that Macaura’s argument had been accepted with the result that a
shareholder could be said to enjoy proprietary rights in the assets of the company. Then
imagine that Macaura wants to leave the company and sell all his shares to Mr X. What step
would need to be taken in relation to the company’s timber for Macaura to divest himself
entirely of his interest in the company and its assets?
Macaura argued that his shares in the company gave him a beneficial interest in the timber. The
logical corollary of this argument is that the company owned the bare legal title to the timber. If
Macaura had been right, it would arguably be impossible for a shareholder to transfer his entire
interest in the company simply by selling or giving away his shares. A shareholder would also need
to transfer his or her beneficial interest in the company’s assets to the buyer or donee.
Following Macaura it is technically easy for a shareholder to transfer his or her interest in the
company. The company’s property is distinct from the property of its shareholders. Shares
themselves are items of personal property which belong to the shareholder. As a matter of property
law, shares are freely transferable. A shareholder who transfers all of his shares ceases to have any
interest in the company.
A company is usually both the legal and beneficial owner of its property. There is no rule of law that
constitutes a company as trustee of its members property (JJ Harrison (Properties) Ltd v Harrison
[2002] 1 BCLC 162).
The position in an unincorporated business such as a partnership is somewhat different. An English

partnership firm does not have a separate legal personality. Put simply, the firm’s property is owned
by all the partners. Let’s say, for example, that A and B are in partnership and title to all the firm’s
assets is in their names. B decides to leave the partnership and X wants to join. To achieve this A and
B will have to transfer the firm’s assets into the names of A and X. Even then, B would not be
completely free of the firm. Under partnership law he would remain personally liable for the debts of
the firm incurred while he was a partner.
We will come across transfers of shares again in a later chapter. For now, note that a company’s
articles of association may impose restrictions on a shareholder’s ability to transfer shares.
Other consequences flow from the fact that a company’s property is legally distinguishable from that
of its members. Thus, an individual who owns all the shares in a company and serves as its sole
director, can be convicted for theft of the company’s property (see Attorney General’s Reference (No
2 of 1982) [1984] QB 624). Appropriation of a company’s property by its shareholders or directors
may also give rise to civil liability. This point is developed with particular reference to company
directors in chapter 7 of these course notes.
1.6.3 COMPANY CONTRACTS
A company can enter into contracts in its own name. We will consider the issue of corporate
contractual capacity in detail in chapter 3. For now, note that as a result of the Salomon principle, it
is possible for a company to enter into contractual relationships with its own shareholders and
directors.
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SAQ 11
Think back to Salomon v Salomon & Co Ltd. Can you recall what contracts Salomon made
with his own company? There is a reminder below.
Salomon made two contracts with the company. First, a contract for the sale of his unincorporated
business. Second, a contract in the form of debentures securing repayment of the £10,000 loan. As
well as being the major shareholder and a director, Salomon was also a secured creditor of the
company.
A company can enter into other types of contractual arrangement with its shareholders and directors.
This is illustrated by the Privy Council’s decision in Lee v Lee’s Air Farming Ltd [1961] AC 12, an
appeal from New Zealand. Here, L incorporated a company, Lee’s Air Farming Ltd. L held all but
one of the company’s issued shares. The company’s articles of association stated that (a) L was to be
governing director capable of exercising all the company’s powers and (b) L was to be employed as
the chief pilot of the company at a salary of £1,500 per annum. The company paid L his salary and
maintained a wages book. L piloted an aircraft owned by the company, using it to carry out the
company’s business which was the aerial top-dressing of farm lands. L was killed when the aircraft
crashed during the course of a top-dressing operation. His widow claimed workers’ compensation
from the company under a New Zealand statute. The crucial question was whether L was a “worker”
within the meaning of this legislation.
Held: that L was a worker within the meaning of the statute and, accordingly, his widow was entitled
to compensation. The company and L were separate and distinct legal entities which had entered into
a valid contract of employment. Although L was the controlling shareholder and governing director,
this did not prevent him from also being the company’s employee. Per Lord Morris of Borth-y-Gest:
“. . . it must be recognised that the appointment was made by the company, and that it was none the
less a valid appointment because it was the deceased himself who acted as the agent of the
company in arranging it. In their lordships’ view it is a logical consequence of Salomon’s case that
one person may function in dual capacities. There is no reason, therefore, to deny the possibility of
a contractual relationship being created as between the deceased and the company. If this stage is
reached then their lordships see no reason why the range of possible contractual relationships
should not include a contract for services. . . “
In the light of Lee v Lee’s Air Farming Ltd, it may be that we should reformulate the Salomon
principle. It appears that, in law, it is correct to say that a company has a legal existence distinct from
that of its members, directors and employees. Furthermore, a single individual can wear a number of
“hats” in a company. He or she can serve as a director and an employee while also holding shares.
This principle has been confirmed more recently in the case of Secretary of State for Trade and
Industry v Bottrill [1999] BCC 177, CA in which the court held that the controlling shareholder of a
company which had ceased trading was also an employee and so entitled to a redundancy payment
from the National Insurance Fund.
1.6.4 PERPETUAL SUCCESSION
We have seen that a company is born when its certificate of incorporation is issued. Similarly, a
company does not legally die until it is dissolved and struck off the register at Companies House. A
company’s continuing existence does not depend on the continuing existence of its members and
directors. Even if all of its members were to die, the company would be unaffected. Members may
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come and go; shares in the company may change hands. However, until a company’s name and
number is expunged from the register its legal existence continues perpetually.
1.6.5 CORPORATE TORT AND CRIME
A further implication of the Salomon principle is that a company can sue or be sued in its own name.
It is technically possible for a company to commit both torts and crimes. However, as the company’s
existence is artificial it can only commit torts and crimes through human agency. Corporate liability
therefore depends on whether the acts or omissions of human agents can be attributed to the
company. This concept of attribution is discussed further below.
1.6.6 COMPANY ACCOUNTS AND TAXATION
As a separate legal person, a company is required by statute to have its own accounts. Companies are
also subject to their own special form of tax known as corporation tax.
1.7 The Veil of Incorporation
Companies have a dual quality. We have seen that as a result of the Salomon principle, a company is
recognised as a legal entity having an independent existence. At the same time, a company’s
existence is artificial. It is simply a creature of statute which cannot act other than through human
agency. Thus, a company can also be described as an association of human beings. It is clear from
Lee v Lee’s Air Farming Ltd that the human beings who participate in the company’s affairs can wear
various “hats”, e.g. shareholders, directors and/or employees.
You will often find the Salomon principle clothed by the courts and academic commentators alike in
the language of metaphor. It is said that the formation of a company gives rise to a metaphorical veil
of incorporation which separates the company from its human participants. This is nothing more
than a restatement of the basic principle that generally the rights and obligations of the company are
distinct from the personal rights and obligations of its shareholders, directors and employees. To
extend the metaphor, it is not possible to “lift the veil” or “pierce the veil” as a matter of general
principle. All this seems to mean is that one cannot generally ignore a company’s separate legal
personality. The company’s rights cannot generally be treated as personal rights enforceable directly
by its shareholders, directors or employees. Equally, the company’s liabilities cannot be equated with
their personal liabilities. Thus, as we have seen, a company’s creditors cannot generally lift or pierce
the veil of incorporation and sue its shareholders directly for payment. All the last sentence does is to
restate the ratio of Salomon in the language of metaphor.
1.7.1 LIFTING THE VEIL OF INCORPORATION
It is now time to return to the question posed earlier. Is the Salomon principle absolute or is it subject
to qualifications? Can the veil of incorporation ever be lifted and a company’s separate legal
personality discarded?
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SAQ 12
Who might want to “lift the veil” and why? Write your ideas down.
The most obvious candidates are a company’s creditors. Creditors might want to lift the veil and
impose personal responsibility on the shareholders (or possibly other insiders, e.g. the directors) for
the company’s debts. This is particularly the case where the company is insolvent as in Salomon v
Salomon & Co Ltd and the fictional Red Ltd/Blue Ltd example given above.
Less obviously, company insiders might want to lift the veil and treat themselves and the company as
a collective entity. This is really what the plaintiff was trying to do in Macaura v Northern Assurance
Co Ltd. He wanted the court to disregard the company’s separate legal personality and treat the
company’s property as his personal property. If the court had allowed Macaura to lift the veil in this
way his claim would have succeeded.
Of course, both Salomon and Macaura are cases in which the courts declined to lift the veil.
Nevertheless, there are a number of express statutory provisions which allow the veil to be lifted.
There are also occasions on which the courts have lifted the veil of their own volition without
recourse to an express statutory provision. The Salomon principle cannot therefore be characterised
as one that is absolute and unqualified.
Note at this point that various commentators have sought to make a distinction between “lifting the
veil” and “piercing the veil”. The latter term is often used where personal liability is imposed on a
company insider (such as a director or shareholder). For the sake of simplicity, the terms are treated
as equivalent and interchangeable in this text.
1.7.2 LIFTING THE VEIL UNDER AN EXPRESS STATUTORY PROVISION
There are numerous examples of statutory provisions which allow the veil to be lifted and what
follows is not intended to be an exhaustive list.
1.7.2.1 Creditor protection
A number of statutory provisions have been enacted which seek to offer creditors some protection
against those who abuse the privileges of limited liability. Our insolvency legislation contains several
examples which enable criminal or civil liability to be imposed on company insiders.
Fraudulent and wrongful trading
Section 213 of the Insolvency Act 1986 (paraphrased) provides that if in the course of a company’s
winding up it appears that any of its business has been carried on with intent to defraud creditors, the
court, on the liquidator’s application, may declare that any persons knowingly party to the fraud, are
liable to make a personal contribution to the company’s assets.
This empowers the court to lift the veil and impose personal liability on “any persons” which could,
of course, include the company’s shareholders, directors or employees.
Section 214 of the Insolvency Act 1986 imposes personal liability on company directors for so-
called wrongful trading in the context of corporate insolvency. The provision has a similar shape to s.
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213 although there are also some notable differences. Under s. 214, the court may (again, exclusively
on the application of a liquidator) require the respondent to the application to make a personal
contribution to the company’s assets. The liquidator must establish that:
(a) the company is in insolvent liquidation; and
(b) at some time before the commencement of the liquidation, the respondent (who must be or
have been a director) knew or ought to have concluded that there was no reasonable prospect
that the company would avoid going into insolvent liquidation; and
(c) the respondent was a director of the company at that time.
The standard of proof is less exacting than that for fraudulent trading under s. 213 because of the
objective “knew or ought to have concluded” wording. At the same time, the ambit of s. 214 is
narrower because it only applies to directors. The provision seeks to deter directors from continuing
both to trade and obtain credit when the company is insolvent.
The fraudulent and wrongful trading provisions will be considered in greater depth in a later chapter.
For now, note that Professor Gower has described these provisions as, “. . . probably the most
extreme departure from the rule in Salomon’s case yet achieved in the United Kingdom” (Gower,
Principles of Modern Company Law, 5th ed., p. 111).
Disqualification of directors
A court may disqualify an individual from holding office as a company director for a minimum of
two years and a maximum of fifteen years under the Company Directors Disqualification Act 1986
(CDDA). The Act delineates the circumstances in which an order may be made. The circumstances
include:
(a) where a director is convicted of an indictable offence in relation to the company (s. 2);
(b) where a director has persistently breached provisions of companies legislation relating to the
filing of accounts and other returns at Companies House (s. 3); or
(c) where a director is shown unfit to be concerned in the management of a company by reason of
his conduct in relation to a company which has become insolvent (s. 6).
As we will see in chapter 7 of these course notes, 90% of all disqualification orders are made under
section 6, which is now an extremely important source of legal rules concerning the duties of
company directors and the standards of conduct expected from such persons.
If an individual becomes involved in the management of a company in contravention of a

disqualification order then the veil of incorporation can be lifted under s. 15. This makes the
disqualified individual personally responsible for all the debts of the company incurred during the
period of his involvement in the company’s management. The aim here is to protect the public and, in
particular, potential company creditors, from individuals regarded by the court as unfit to run
companies.
Prior to reforms implemented by the Insolvency Act 2000, an application for a disqualification order
had to be made to the court in most cases.
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1.7.2.2 Inadequate publicity given to company name
The Act has extensive publicity requirements. One example is the Companies Act 1985, s. 349
extracts from which appear below:
[s. 349(1)] . . . Every company shall have its name mentioned in legible characters
(a) in all business letters of the company,
(b) in all its notices and other official publications,
(c) in all bills of exchange, promissory notes, endorsements, cheques and orders for money or
goods purporting to be signed by or on behalf of the company, and
(d) in all its bills of parcels, invoices, receipts and letters of credit. . .
s. 349(4) . . . If an officer of a company or a person on its behalf signs or authorises to be signed on

behalf of the company any bill of exchange, promissory note, endorsement, cheque or order for
money or goods in which the company’s name is not mentioned as required by subsection (1), he is
liable to a fine; and he is further personally liable to the holder of the bill of exchange, promissory
note, cheque or order for money or goods for the amount of it (unless it is duly paid by the
company).
SAQ 13
Read the extracts from s. 349 carefully. Explain in your own words precisely how and in what
circumstances the veil of incorporation can be lifted under s. 349.
Section 349 imposes criminal and civil liability on a company officer (this term encompasses
company directors, managers and secretaries) who signs or authorises signature of any of the
documents listed in s. 349(4) if those documents do not contain the company’s name in legible
characters. The veil can be lifted in two ways. First, an officer can be subjected to a fine. Secondly, a
creditor can lift the veil and sue the officer for any amounts represented by the document which the
company has failed to pay. The provision can therefore assist creditors where the company is
insolvent.
SAQ 14
In Jenice Ltd v Dan [1993] BCLC 1349, a director of a company called Primekeen Ltd signed
cheques which showed the name of the company as “Primkeen Ltd”. A cheque signed by the
director was not honoured. The company went into liquidation. Do you think the director was
personally liable on the cheque under s. 349(4)?
The court refused to impose personal liability on the director in Jenice Ltd v Dan. The judge took the
view that this minor misspelling was not within the mischief of the section. The purpose of s. 349 is
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to ensure that those dealing with a limited company are fully aware of the implications of limited
liability. Clearly, if the word “limited” is missing personal liability will be imposed (Blum v OCP
Reparations SA [1988] BCLC 170). The same fate is likely to befall a director where the company’s
business name is used rather than its full corporate name (Maxform SPA v B Mariani & Goodville
Ltd [1981] 2 Lloyd’s Rep 54). However, Jenice Ltd v Dan is not without its critics. There is a line of
authority which suggests that any misdescription of the corporate name on cheques etc, could give
rise to personal liability. In Hendon v Adelman (1973) 117 SJ 63 the account title on a cheque drawn
on L & R Agencies Ltd missed out the “&”. Directors were held personally liable when the cheque
was not honoured. Further, in Barber & Nicholls Ltd v R & G Associates (London) Ltd (1981) 132
NLJ 1076, a director was liable on a cheque where “(London)” was missing from the account title.
The practical advice for directors is to make sure that company cheques supplied by the bank all
contain an overprinted account title which records the official corporate name fully and accurately.
Otherwise, a director held liable under s. 349(4) will be left to pursue the company’s bankers in
negligence, a course of action which is by no means guaranteed to succeed.
1.7.2.3 Corporate groups
We saw from the Red Ltd/Blue Ltd example earlier that, consistent with the Salomon principle, a
parent company is not generally liable for the debts of its subsidiary. In “veil of incorporation”
language, it is not generally possible to lift the subsidiary’s veil, ignore its corporate personality and
impose responsibility for its debts directly on the parent. Both parent and subsidiary have their own
separate legal personality.
However, the Companies Act 1985, s. 227, which provides for the preparation of group accounts,
requires the veil to be lifted and a parent and subsidiary treated as a collective entity for accounting
purposes. Section 227 states that:
If at the end of a financial year a company is a parent company the directors shall, as well as
preparing individual accounts for the year, prepare group accounts.
This differs somewhat from the statutory provisions considered so far which allow the veil to be
lifted and personal liability imposed on a company insider. Here, the purpose of lifting the veil is to
reveal the group commercial enterprise as a collective entity. After all, the shareholders of the parent
company want to know how well the overall enterprise is performing. They can derive this
information far more easily from a set of group or consolidated accounts than from the separate
accounts of the parent and subsidiary.
Parent and subsidiary undertakings are defined for accounting purposes only in s. 258. The definition
encompasses a narrow group relationship where one company holds a majority of the voting rights in
another company. The section also contains some broader definitions of “parent” and “subsidiary”.
Nonetheless, where those terms are used in this text, it is in the narrow sense unless there is an
indication to the contrary.
1.7.3 LIFTING THE VEIL OF INCORPORATION WITHOUT RECOURSE

TO AN EXPRESS STATUTORY PROVISION - THE ROLE OF THE
COURTS
We have seen that parliament has enacted several provisions which allow the veil to be lifted. Many
of these provisions reflect a formal attempt by parliament to ensure that the privileges of limited
liability are not abused. The next question is whether there are any circumstances in which the courts
will lift the veil without recourse to an express statutory provision. This is not an easy question to
answer. It is difficult to see any clear principles emerging from the reported cases. Judicial attitudes to
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the Salomon principle have fluctuated during the last quarter of a century. By the 1970s, the courts
(especially a Lord Denning inspired Court of Appeal) were showing an increased willingness to lift
the veil in the context of corporate groups. The courts became more liberal without ever challenging
the fundamentals of the decision in Salomon v Salomon & Co Ltd. The cause celebre of this judicial
trend remains the Court of Appeal decision in DHN Food Distributors Ltd v Tower Hamlets London
Borough Council [1976] 1 WLR 852, a decision which moved the respected academic company
lawyer, Clive Schmitthoff to conclude as follows:
“Thus, Salomon is in the shadow. It is still alive but no longer occupies the centre of the company
stage . . . Salomon is still law but it has been dethroned from the position of the most important case
in company law and now occupies the position of one of the ordinary cases on which the structure
of company law rests (Journal of Business Law for 1976 at pp 311-312).”
However, the Court of Appeal decision in Adams v Cape Industries Plc [1990] Ch 433 consolidated
a new era of judicial retrenchment. In recent times, the courts have demonstrated a marked reluctance
to question the Salomon orthodoxy and lift the veil unless compelled to do so by statute.
Adams v Cape Industries is perhaps the best starting point for an analysis of the various judicial
approaches to lifting the veil. In a lengthy judgment, Slade LJ reviewed the authorities and concluded
that there were broadly three categories of case where the courts had been prepared in the past to lift
the veil under the following headings:
(a) single economic unit;
(b) sham or facade;
(c) agency.
Case law in each of the three categories is analysed below in detail. For now, you need to become
familiar with the complex facts of Adams v Cape Industries and appreciate why “lifting the veil” was
a practical issue in this particular case.
1.7.3.1 The facts of Adams v Cape Industries Plc – More detailed extracts from the
judgment can be found at 1.4 in your Cases & Materials
Cape Industries Plc was a company incorporated in England and Wales. Cape was the ultimate parent
company of a worldwide group of companies. The group engaged in the business of mining asbestos
in South Africa. The asbestos was then marketed via subsidiaries around the world. An American
subsidiary, NAAC, marketed asbestos in the United States until it was put into liquidation in 1978. A
new American subsidiary called CPC was formed to continue Cape’s marketing activities in the
United States. Employees of a Cape customer which operated a factory in Texas, brought personal
injury actions in the American courts against Cape and its English subsidiary, Capasco. They claimed
to have suffered damage as a result of exposure to asbestos and alleged that Cape were responsible
for supplying asbestos to their employers without warning of the possible dangers. Judgments in
favour of the plaintiffs were entered against Cape in the American courts. The plaintiffs then sought
to export the American judgments and enforce them against Cape and its assets in England. The
crucial question for the Court of Appeal was whether the American judgments could be enforced
within this jurisdiction. In order to succeed, the plaintiffs were required to show, as a matter of
private international law, that Cape was resident or present in the United States. If we apply the
Salomon principle, Cape was a separate legal person clearly distinguishable from its foreign
subsidiaries. Cape was incorporated in England and Wales. Technically, it was clearly resident or
present in this jurisdiction.
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SAQ 15
Read the facts of Adams v Cape Industries Plc again. What arguments do you think the
plaintiffs put forward to support their contention that Cape was “present” in the United
States?
The plaintiffs advanced broadly three arguments with the same objective. All the arguments involved
lifting the veil. It was these arguments which prompted Slade LJ to adopt the categorisation referred
to above in his judgment:
Argument One: The court should ignore the separate corporate personalities of the American
subsidiaries, NAAC and CPC and that of Cape. The group should be treated as a single economic
unit having regard to the underlying commercial and economic realities of its operations. As such,
Cape must have been present in the United States because it was part of a collective entity which
included the American subsidiaries.
Argument Two: The court should treat the American subsidiary, CPC as a sham company. It was
merely a facade for Cape. Once the facade is removed, it becomes possible to say that Cape had
been present in the United States by or through CPC.
Argument Three: The court should treat the American subsidiaries, NAAC and CPC as the agents
of Cape. The American subsidiaries had carried on Cape’s business as agents on Cape’s behalf.
Cape had therefore been present in the United States on this basis.
We will now consider the authorities which were used to support Arguments One to Three and how
these arguments ultimately fared in Adams v Cape Industries Plc.
1.7.3.2 Argument One - Single Economic Unit
The plaintiffs in Adams v Cape Industries Plc submitted that it was open to the court to ignore the
corporate personalities of each company within a corporate group and treat them as a single entity. It
was also submitted that the court can lift the veil in this way whenever it considers that justice so
demands. We have seen already that a group is regarded by statute as a single economic unit for
certain narrow purposes such as the preparation of accounts. However, the plaintiffs in Adams v Cape
Industries sought to formulate a much more general proposition that the law should look to the
business enterprise as a whole rather than each individual company in isolation.
The plaintiffs relied on a number of authorities to develop this submission including DHN Food
Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852, a case which
excited considerable attention from academics at the time. DHN concerned a group of three
companies, DHN Food Distributors Ltd (“DHN”), Bronze Investments Ltd (“Bronze”) and DHN
Food Transport Ltd (“Transport”). Bronze and Transport were both wholly-owned subsidiaries of
DHN.
The core business of the group was carried on by DHN from premises owned by Bronze, its wholly
owned subsidiary. The vehicles used in DHN’s business were owned by Transport which was also a
wholly owned subsidiary. The defendant local authority compulsorily acquired the business premises
owned by Bronze. It paid compensation for the value of the land to Bronze under the Land
Compensation Act 1961. DHN claimed additional compensation for disturbance of its business. The
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local authority argued that DHN was not entitled to additional compensation for disturbance and the
Lands Tribunal agreed. The business disturbed was that of DHN. DHN had no property rights in the
premises owned by Bronze and was therefore not entitled to compensation for disturbance under the
Act. Conversely, Bronze owned the premises but had no business to disturb. DHN appealed.
The Court of Appeal held that this was a case in which, per Goff LJ, “. . . one is entitled to look at the
realities of the situation and to pierce the corporate veil”. The three companies could therefore be
treated as one and DHN was entitled to compensation for disturbance. As far as Lord Denning was
concerned, the group was closely analogous to a partnership in which the three companies were
partners. He did not believe that DHN should be deprived of compensation “on a technical point”.
The other members of the Court of Appeal agreed with Lord Denning but were keen to emphasise
that the court was not establishing a general principle. Per Goff LJ:
“I wish to safeguard myself by saying that so far as this ground [i.e. the veil of incorporation point]
is concerned, I am relying on the facts of this particular case. I would not at this juncture accept that
in every case where one has a group of companies one is entitled to pierce the veil, but in this case
the two subsidiaries were both wholly owned; further they had no separate business operations
whatsoever; thirdly . . . the nature of the question is highly relevant, namely whether the owners of
this business have been disturbed in their possession and enjoyment of it.”
Shaw LJ also appears to have regarded the facts in DHN as special.
The following cases where the veil of incorporation was apparently lifted and the group of
companies (i.e. holding and subsidiaries) regarded as one are dealt with in Gower’s Principles of
Modern Company Law.
• The Roberta (1937) 58 Ll LR 159
• Holdsworth & Co v Caddies [1955] 1 WLR 352, HL
• Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324, HL
• Revlon Incorporation v Cripp & Lee Ltd [1980] FSR 85
• Commercial Solvents Corporation v EC Commission [1974] ECR 223
However since 1980 the attitude of the courts to lifting the veil in this type of situation seems to
be hardening in favour of supporting the principle in Salomon v Salomon Ltd. i.e. each company
has its own separate legal personality.
In Lonrho Ltd v Shell Petroleum Company Ltd [1981] 3 WLR 33, HL, a case dealing with the
disclosure of documents in the context of litigation, subsidiaries were in control of the documents
but the veil was not lifted to treat the holding company (Shell) and the subsidiaries as one and
compel the subsidiaries to release the documents to the other side in the litigation.
Also in Multinational Gas and Petrochemical Company Ltd v Multinational Gas and
Petrochemical Services Ltd [1983] 1 Ch 258, CA the veil was not lifted. Here 3 oil companies set
up a subsidiary company. They were the only shareholders. The subsidiary went into liquidation.
Its liquidator wished to sue the oil companies.
Held, The veil would not be lifted to enable the liquidator to recover against them in respect of
the negligence of the subsidiary’s directors.
Goff LJ’s observations in DHN and the cases discussed posed a problem for the plaintiffs in Adams v
Cape Industries. Moreover, they were faced with a further obstacle, namely the House of Lords
decision in a Scottish case, Woolfson v Strathclyde Regional Council 1978 SLT 159. Unlike DHN,
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Woolfson attracted no academic interest at the time. Yet significantly, it casts doubt on the correctness
of the Court of Appeal’s reasoning in DHN on the veil of incorporation point.
The facts of Woolfson are superficially similar to the facts of DHN. The defendant local authority
compulsorily acquired some shop premises. The premises were divided into various units. Some of
the units were owned personally by W. The remaining units were owned by Solfred Holdings Ltd,
the issued shares of which were held by W and his wife. Another company, M & L Campbell
(Glasgow) Ltd occupied the entire premises for purposes of its retail business. W held all but one of
Campbell’s issued shares. W and Solfred jointly claimed statutory compensation for both the value of
the land and disturbance of Campbell’s business. The Lands Tribunal and the Court of Session
rejected the disturbance claim. Held, applying the Salomon principle, that there was no basis upon
which the veil of incorporation could be pierced to treat W and Solfred as occupiers as well as
owners of the premises. Nor was it possible, in principle, to hold that W, Solfred and Campbell were
a single entity thereby enabling W and Solfred to claim compensation for disturbance of Campbell’s
business. The crucial point of distinction for Lord Keith was that Bronze was a wholly owned
subsidiary of DHN. It was in total control of Bronze. The directors of both companies were the same.
Here, however, the company that carried on the business, namely Campbell, had no control over W
and Solfred, the owners of the land. Campbell and Solfred were associated companies because W
held shares in both of them. However, there was no parent and subsidiary relationship. It seems to
have made no difference to Lord Keith that W was in effective control of both Solfred and Campbell:
“In my opinion there is no basis consonant with principle upon which on the facts of this case the
corporate veil can be pierced to the effect of holding Woolfson to be the true owner of Campbell’s
business or the assets of Solfred.”
Goff LJ’s words in DHN thus proved to be something of a self-fulfilling prophecy. There is
apparently now no general principle which the courts can use to lift the veil and look to the
underlying commercial realities (see further the actual decision in Adams v Cape and Ord v Belhaven
both discussed below.
After Woolfson, it was just possible that the courts might have applied DHN to treat a parent
company and its wholly owned subsidiary as a single economic unit. However, with DHN already on
the ropes, it was left to the Court of Appeal in Adams v Cape Industries to deliver the knockout blow.
Slade LJ cited both Goff LJ’s observations and Woolfson in rejecting Argument One in Adams v
Cape Industries. He interpreted cases like DHN and others relied on by the plaintiffs (which included
the list above headed The Roberta) as decisions where, “the wording of a particular statute or contract
has been held to justify the treatment of parent and subsidiary as one unit, at least for some purposes”.
Thus, it appears that a single economic unit argument can only be used to lift the veil in two
circumstances:
(a) Where a statutory provision allows you to do so. A good example of this is the group accounts
provision which we came across earlier.
(b) Where a term in a contract allows you to do so.
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SAQ 16
Oak Ltd enters into a formal contract with X. Oak Ltd is named as a party to the contract. The
contract contains an express term which provides that, “all references to Oak Ltd wheresoever
they appear in this contract shall be construed to include a reference to Larch Ltd”. Larch Ltd
is a subsidiary of Oak Ltd. Could Larch Ltd enforce the contract against X?
As a matter of strict contract law, it appears that Larch Ltd could enforce the contract referred to in
the SAQ above. The contract itself provides, in effect, that Larch Ltd is also a party to it. It is clear
that Adams v Cape Industries does not affect this conclusion which is reached by construing a
contract.
Slade LJ went on to express the view that DHN should be regarded as a decision on the relevant
statutory provisions for compensation. Furthermore, there is no general principle which allows the
court to treat a group of companies as a single economic unit on the basis that it is just to do so. Per
Slade LJ:
“. . . save in cases which turn on the wording of particular statutes or contracts, the court is not free
to disregard the principle of Salomon v Salomon merely because it considers that justice so
requires. Our law, for better or worse, recognises the creation of subsidiary companies, which
though in one sense the creatures of their parent companies, will nevertheless under the general law
fall to be treated as separate legal entities with all the rights and liabilities which would normally
attach to separate legal entities.”
For a further case in which Woolfson was followed and the DHN approach flatly rejected see
National Dock Labour Board v Pinn & Wheeler Ltd [1989] BCLC 647. Three companies involved
in the unloading and processing of timber were regarded as separate companies. Macpherson J
said (following Woolfson) that there were no special circumstances enabling the court to lift the
corporate veil and treat the three companies as a single enterprise.
Note also that Adams v Cape Industries was followed in Re Polly Peck International Plc [1996] 2 All
ER 433. There, the court rejected a submission that a closely integrated group of companies should
be treated as a single economic unit where a rule of law founded in public policy would otherwise be
frustrated. A similar restrictive approach was taken by the Court of Appeal in Ord v Belhaven Pubs
Ltd [1998] BCC 607 which is discussed later, and Morritt V-C in Trustor AB v Smallbone (No.2)
2 BCLC 436
1.7.3.3 Argument Two - Sham or Facade
In Adams v Cape Industries, Slade LJ held that there is one well recognised qualification to the
Salomon principle. In so doing he drew upon the following passage from Woolfson in which Lord
Keith expresses doubts about DHN:
“I have some doubts whether in this respect the Court of Appeal properly applied the principle that
it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it
is a mere facade concealing the true facts.”
So, it was accepted in Adams v Cape Industries that the court may, by way of exception, lift the veil
and ignore the separate legal personality of a company which amounts to a mere “facade”. However,
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it is difficult to establish with any certainty from the authorities how this “well recognised exception”
works. This is not least because the courts, in applying the exception, have coined a bewildering array
of legal expletives. Examples include, “sham”, “mask”, “cloak”, “fraud” and “device”.
The plaintiffs in Adams v Cape Industries submitted that Cape’s American subsidiary, CPC, and a
Liechtenstein subsidiary, AMC, were, “a device or sham or cloak for grave impropriety on the part of
Cape . . . namely to ostensibly remove [its] assets from the USA to avoid liability for asbestos claims
whilst at the same time continuing to trade in asbestos there”. Slade LJ’s judgment makes it clear that
the court is obliged to examine the motive of the alleged perpetrator where a sham or facade
argument is put forward. This in itself enables the court to look behind the veil of incorporation and
consider the activities and motivations of a company’s human participants. The court can go even
further and actually lift the veil if the motive behind formation or use of a corporate structure can be
characterised as fraudulent, improper or unlawful. We then need to determine what constitutes a
fraudulent, improper or unlawful motive.
To answer this question, Slade LJ relied principally on Jones v Lipman [1962] 1 WLR 832. In that
case, the first defendant, L, agreed to sell some land to the plaintiffs and a date for completion of the
contract was fixed. Before completion, L sold and transferred ownership of the land to the second
defendant, a newly incorporated £100 company called Alamed Ltd. The evidence showed that L
effectively controlled the company. L indicated via his solicitors that he was prepared to pay damages
to the plaintiffs for breach of contract. The plaintiffs brought proceedings against L and Alamed Ltd
claiming specific performance of the contract. The first defendant admitted that the formation of the
company and transfer to it of the land was carried out solely for the purpose of defeating the
plaintiffs’ rights to specific performance.
Held: that an order for specific performance would be made against both L and the company.
Russell J reached this conclusion in two ways. First, he held that an order for specific performance
could not be resisted by L. L controlled the company and could therefore cause it to transfer the land
to the plaintiffs in accordance with the contract. However, the judge did not leave it there. He ordered
specific performance against the company as well on the grounds that it was a “sham”:
“The defendant company is the creature of the first defendant, a device and a sham, a mask which
he holds before his face in an attempt to avoid recognition by the eye of equity . . . an equitable
remedy is rightly to be granted against the creature in such circumstances.”
On this “sham” point Russell J followed the Court of Appeal decision in the next case:
Gilford Motor Co Ltd v Horne [1933] Ch 935

H was the former employee of the plaintiffs. H’s contract of employment with the plaintiffs contained
restrictive covenants which continued to apply after he left. He formed a company in which his wife
and one other held the shares. The company carried on a business which directly competed with the
plaintiffs’ business. The evidence showed that it was really H who controlled the company and ran its
business. H actively solicited the plaintiffs’ customers through and for the company. The company
therefore engaged in activities which H was prevented from doing by the restrictive covenants.
Held: that the company had been formed as a “cloak” or “sham” to enable H to evade his legal
obligations to the plaintiffs. An injunction was granted against both H and the company.
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SAQ 17
Reconsider Jones v Lipman and Gilford Motor Co Ltd v Horne. Can you formulate a single legal
proposition which summarises the effect of these decisions?
A possible proposition might be that where an individual forms a company solely to evade his or her
own existing legal obligations, the court can treat the company as a “sham” or “facade”. The essence
of this qualification to the Salomon principle is that it entitles the court to look behind the veil so that
the motives of company insiders come into view. Under normal circumstances, the motives of those
forming a company are considered irrelevant. All that matters is whether the statutory requirements
for incorporation have been met. However, it appears that the court can go behind the veil where
there is evidence that a company has been formed to evade the personal obligations of its promoters.
It is interesting to note that the court in both Jones v Lipman and Gilford Motor Co Ltd v Horne did
not deny the legal existence of the two sham companies. Indeed, as we have seen, the court made an
order against the company in each case.
Meanwhile, back in Adams v Cape Industries, Slade LJ was happy to approve Jones v Lipman and
endorse the “sham” qualification. However, he rejected the plaintiffs’ argument that Cape’s
American subsidiaries were sham companies.
There appear to be two main reasons for the rejection of Argument Two in Adams v Cape Industries:
(a) On the facts, all the shares in CPC were beneficially owned by a third party. It was an
independent business. This made it difficult to conclude that CPC was merely Cape’s facade.
(b) The setting up of the American marketing arrangements did not involve any actual or potential
illegality. Cape had not formed CPC to deprive anyone of their existing rights or as a means to
evade Cape’s own outstanding legal obligations. It was perfectly legal for Cape to use a
corporate structure to protect itself from possible tortious liabilities arising from the group’s
activities in the future. (On the use of corporate form to provide protection against contingent
liabilities see Ord v Belhaven below.
Thus, to summarise, it appears that the court can go behind the veil of incorporation where an
individual (or query, another company?) uses a corporate structure to evade either:
(a) limitations imposed on the individual’s conduct by law (see, for example, Re H and others
(restraint order: realisable property) [1996] 2 All ER 391 where companies had been used for
purposes of evading excise duty); or
(b) existing legal obligations (Jones v Lipman, Gilford Motor Co Ltd v Horne).
Moreover, where X, a director of Company A, misappropriates money or assets in breach of his

fiduciary duty owed to Company A and transfers such money or assets to Company B, a company
controlled by him, the court is entitled to pierce the veil of incorporation and treat receipt by
Company B as receipt by X, its controller. In this example, Company B would be regarded as a
sham company used as a device to receive money from Company A and an action in knowing
receipt would therefore lie against both Company B and X (Trustor AB v Smallbone 2 BCLC 436,
Ch D).
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1.7.3.4 Argument Three - Agency
Finally, the plaintiffs in Adams v Cape Industries argued that the American subsidiaries, NAAC and
CPC carried on Cape’s business in the United States. NAAC and CPC were nothing more than
Cape’s agents. They were formed simply to act at Cape’s bidding.
SAQ 18
Where have you come across an agency type argument before? Was it successful?
The answer is Salomon v Salomon & Co Ltd. Vaughan Williams J held at first instance in Salomon
that the company carried out Salomon’s business as his agent. Salomon, as principal, was therefore
liable to indemnify the company against all of its debts. This finding was rejected by the House of
Lords in Salomon. Nevertheless arguments asserting an agency relationship between a company and
its controlling shareholders appear to have been accepted in the following cases:
Smith, Stone and Knight Ltd v Birmingham Corporation [1939] 4 All ER 116
Here, SSK Ltd carried on business as paper manufacturers. SSK Ltd acquired the assets and trading
premises of a waste paper business from a partnership. Some time after the acquisition, SSK Ltd
formed a wholly owned subsidiary, BWC Ltd. The directors of the subsidiary were also directors of
the parent. BWC Ltd purported to carry on the waste paper business. The name “BWC Ltd” was
affixed to the premises and recorded on business notepaper and invoices. BWC Ltd thus nominally
occupied the premises and carried on the waste paper business. However, SSK Ltd never formally
transferred ownership of the assets and trading premises to BWC Ltd. Furthermore, SSK Ltd simply
treated the profits of the waste paper business as its own. As in DHN and Woolfson, the defendant
local authority compulsorily acquired the trading premises. The question was whether SSK Ltd could
recover both compensation for the value of the land and disturbance of the waste paper business.
Held: that it is perfectly possible for a company and its shareholders to make an arrangement
whereby the company carries on in business as agent for the shareholders. Whether there is such an
arrangement is a question of fact in each case. The key question to ask here was whether the
subsidiary carried on the business as the parent’s business or as its own. On the facts, BWC Ltd was
carrying on SSK Ltd’s business as agent and SSK Ltd was therefore entitled to compensation for
disturbance as the real occupier of the premises. BWC Ltd’s occupation of the premises was treated
as that of its principal, SSK Ltd.
Atkinson J used six tests to infer whether an agency relationship existed. Atkinson J’s six tests were:
Atkinson J used six tests to decide whether an agency existed:
• Were the profits treated as those of the parent company?
• Were the persons conducting the business appointed by the parent company?
• Was the parent company the head and brain of the trading venture?
• Did the parent company govern the venture and decide what should be done and what capital
should be embarked on it?
• Were the profits made by its (the parent company) skill and direction?
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• Was the parent company in effectual and constant control?
The answers to all the above in Smith Stone and Knight were yes.
Re FG (Films) Ltd [1953] 1 WLR 483

An English company with a £100 share capital sought to have a film registered as a British film. The
company had no place of business, no assets and no employees. The making of the film had been
financed by a large American company. Under the relevant legislation the applicant was required to
establish that the film was “made” by a British company.
Held: that the application failed. The English company was not the “maker” of the film within the
meaning of the legislation. Vaisey J remarked that the English company had acted merely as the
nominee and agent of the American company. It was an insignificant company with no real business
of its own which had been formed as part of an elaborate scheme designed to secure British
registration for the film.
Firestone Tyre and Rubber Co Ltd v Lewellin [1957] 1 WLR 464

In this case, an English company, Firestone was assessed for income tax on profits made from selling
tyres in Europe. The company sought to challenge this assessment. Firestone was the wholly owned
subsidiary of an American company. There were a series of formal agreements in place between the
American parent and Firestone. Under these agreements, Firestone acted effectively as the authorised
supplier of the parent company’s branded tyres to a network of European distributors. Firestone
received payment for the tyres in the UK from the distributors. Firestone retained the cost price plus
five per cent out of the payments received and remitted the balance to the American parent. The
relevant tax statute provided that any profits made by a non-UK resident arising from the operation of
a business within the UK were subject to UK tax. Moreover, the assessment could be raised against “.
. . any factor, agent, receiver, branch or manager” of the overseas concern. Firestone was assessed to
tax on the profits from sales to the European distributors. This was on the footing that the American
parent was operating its tyre trade in the UK through the agency of Firestone.
Held: (by the House of Lords) that the American parent had carried on a trade within the UK through
Firestone as its agent. UK tax was chargeable on the profits of this trade and Firestone had been
properly assessed for this tax as the UK agent.
Of these cases, Slade LJ cited only Firestone Tyre and Rubber Co Ltd v Lewellin in Adams. He held
that there is no presumption of agency. In other words, the court cannot infer an agency relationship
between a company and its shareholders simply from the fact of control:
“There is no presumption that the subsidiary is the parent company’s alter ego . . . If a company
chooses to arrange the affairs of its group in such a way that the business carried on in a particular
foreign country is the business of its subsidiary and not its own, it is . . . entitled to do so.”
On the facts, both NAAC and CPC had carried out a substantial amount of business on their own
account. There was no evidence that either of the American subsidiaries ever transacted business
formally as agent on Cape’s behalf and so as to subject Cape to binding contractual obligations.
Indeed, it was clear that the American subsidiaries had no general authority to enter into contracts
binding on Cape. This was inconsistent with a true agency relationship.
Clive Schmitthoff observed in the Journal of Business Law for 1976 (at p. 309) that, “the agency
construction has proved to be an important instrument for the adaptation of commercial law to
modern requirements”. After Adams v Cape Industries, one finds it difficult to be this sanguine as to
the future fate of agency arguments. The position can be summarised as follows:
(a) The court may look behind the veil of incorporation for evidence of an agency relationship and
is entitled to investigate the precise relationship between a company and its shareholders, or in
a group context, the subsidiary and its parent.
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(b) However, there is no presumption of agency. An agency relationship cannot be inferred from
control. The fact that an individual owns all the shares in a company and has the power to
appoint its board of directors does not give rise to an implied agency. The same applies in a
group context. Old cases such as Kodak Ltd v Clark are still good law.
Kodak Ltd v Clark [1903] 1 KB 505

The mere fact that all the shares except 2% were owned by the parent company was not sufficient
for the veil to be lifted and hence the parent company was not liable for corporation tax on the
profits earned by the subsidiary overseas.
(c) Nevertheless, where the evidence suggests (i) that the company is carrying on the business of
its shareholders as opposed to any business of its own and (ii) that the company has been given
general authority to contract on behalf of its shareholders, there may be a finding of agency.
Where does this leave the three authorities cited earlier to support the agency construction?
Smith, Stone and Knight is now of dubious value. Atkinson J’s six tests used to infer the existence of
agency all seem to turn on evidence of control. Was there a general authority to enter into contracts
in Smith Stone and Knight as seemingly now required in Adams? Sealy indicates that if the court
can infer an agency contract from the fact of control, the veil could be lifted at any time if the
court so wished “and the law would be unpredictable”. Gower says any prospect of establishing
that the subsidiary has general authority to carry on the parent company’s business is remote.
However, this is not to say that Atkinson J did not reach the correct decision on the facts. SSK Ltd
owned all the assets of the waste paper business including the premises. BWC Ltd appears to have
been an empty shell. On that basis it must be correct to say that BWC Ltd was simply carrying on
SSK Ltd’s business.
Similarly, in Re FG (Films) Ltd the applicant company was an empty shell which on the true
construction of the relevant statute could not possibly have “made” the film in question. Re FG
(Films) Ltd involved nothing more than a simple application of a statutory provision to the facts.
Finally, in Firestone Tyre and Rubber Co Ltd v Lewellin there were extensive contractual
arrangements in place between parent and subsidiary. The court was therefore entitled to hold that an
express agency relationship had arisen.
1.7.3.5 Cases after Adams v Cape
The cases decided after Adams v Cape continue to take a restrictive approach which appears to reflect
a view that the courts should not readily lift the veil in the absence of a statutory provision covering
the situation.
Ord v Belhaven Pubs Ltd [1998] BCC 607

The question in this case arose in the context of a corporate group. The plaintiffs had commenced
proceedings back in 1991 claiming damages in tort and contract from a company called Belhaven
Pubs Ltd. Belhaven ceased trading in 1995 while the proceedings were still pending. Appreciating
that a judgment against Belhaven would probably be worthless, the plaintiffs sought an
interlocutory order substituting Belhaven’s parent company, Ascot Holdings plc and/or another
group company, Ascot Estates Ltd for Belhaven as defendant(s) in the proceedings. The purpose
of the application was obvious. The plaintiffs wanted to be in a position to assert their claims
against viable targets. Needless to say, the application could only succeed if the court was
prepared to ignore the separate corporate personalities of Belhaven, Holdings and Estates and
allow a claim relating to one company within the group to be pursued against other group
companies.
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The application was granted at first instance but this decision was overturned on appeal.
Following the narrow approach taken in Woolfson v Strathclyde Regional Council and Adams v
Cape Industries plc, the Court of Appeal in Ord reiterated that corporate personality should only
be ignored where the corporate form is being used for some manifestly improper or fraudulent
purpose. The relevant question to ask was whether there had been any impropriety in this case.
There was evidence that major group restructuring had taken place between 1992 and 1995. As
part of this restructuring, assets had been moved out of Belhaven and into Holdings and Estates.
However, Belhaven had been credited with sums representing the book value of these assets by
way of consideration for the transfers. There was no evidence that the arrangements were in any
way intended directly to prejudice the plaintiffs. At first instance, the judge had decided that the
court was justified in lifting the veil because, in restructuring its affairs, the directors of the group
had treated group companies as though they were divisions of a single enterprise rather than as
separate legal entities. As such, the judge held that the group’s directors had acted in the group’s
interests and had failed to have regard to the interests of Belhaven’s creditors. The Court of
Appeal flatly rejected this approach and, on the authority of Adams v Cape Industries, held that a
bona fide group restructuring is perfectly lawful even where the result is that no assets are left in a
particular subsidiary to meet that subsidiary’s contingent liabilities. A number of other points can
be made which flow from the Court of Appeal’s decision:
(a) As far as the common law is concerned, the principles upon which the court will ignore
corporate personality and lift the veil of incorporation are almost completely inelastic.
(b) The common law has no concept of the business enterprise or the economic unit. As such,
there is still no concept of enterprise liability in English law and corporate form still
triumphs over business substance. The approach taken by an earlier Court of Appeal in
DHN Food Distributors v Tower Hamlets LBC (see above) continues to be treated with
disdain.
(c) Ord has overruled the earlier High Court decision in Creasey v Breachwood Motors Ltd
[1993] BCLC 480, [1992] BCC 638. In that case, the plaintiff brought a claim for wrongful
dismissal against his former employer, the defendant company. The company ceased
trading shortly after the writ was issued and its assets were transferred to another trading
company, BML, which had the same controllers. No consideration was paid for the
company’s assets although BML did pay off all of the company’s existing debts. No
provision was made for the contingent liability represented by the plaintiff’s claim and the
company was subsequently dissolved. The judge ruled that the claim could be brought
against BML. The court was justified in lifting the veil because the controllers had
deliberately shifted assets out of the company and into BML in full knowledge of the
plaintiff’s claim. Following the overruling of Creasey in Ord, the prospects of getting an
English court to lift the corporate veil appear increasingly remote. This is so even where
there is a strong inference that the company has been asset-stripped with a view to avoiding
foreseeable contingent liabilities. The only hope for a plaintiff at common law lies with the
narrow exception established in the cases of Gilford Motor Co v Horne and Jones v
Lipman. On these authorities, as we saw above, the court will disregard corporate
personality where the corporate form is used exclusively as a device to evade an existing,
fully crystallised contractual or other legal obligation. Furthermore, it is implicit in Ord that
the courts are unlikely to adopt a more flexible attitude without the sanction of parliament.
In this respect, a creditor in the same position as the plaintiffs in Ord and Creasey is left
with the (arguably forlorn) hope that a liquidator of the defendant company might
investigate his claim and any subsequent movement of assets out of the company with a
view to possible action under the statutory avoidance provisions in the Insolvency Act
1986.
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Williams v Natural Life Health Foods Ltd [1998] 1 WLR 830

This case explores the extent to which the courts can go behind the separate legal personality of a
company and impose liability in tort on its members and/or officers. In Williams, the second
defendant, M, was the principal shareholder and managing director of the first defendant
company. The company was formed originally to franchise the concept of a health food shop
based on one that M was running at the time. The plaintiffs wished to start up a similar shop and
entered into a franchise agreement with the company. They never came into direct contact with M
and never visited his pilot shop. They dealt only with intermediaries who had been engaged by the
company on a commission basis. After 18 months of trading the franchise was operating at a
substantial loss. The plaintiffs sold the business and sought to recover their resulting capital loss
from the defendants. They claimed that they had only decided to take on the franchise in reliance
on a set of detailed financial projections previously supplied to them by the company. M had
played a leading part in preparing these projections which turned out to be inaccurate. The
plaintiffs said that they had also been induced by statements in the company’s brochure referring
expressly to M’s status as a market leader in the retail health food trade. The problem for the
plaintiffs was that the company had been wound up and dissolved before the trial date and so any
claim against it in contract or misrepresentation was worthless. Thus the crucial question was
whether the court would impose liability on M for losses arising as a result of the negligent advice
given by the company in the form of the financial projections. To do so would relieve M of the
protection of the corporate veil.
M was held liable on Hedley Byrne principles at first instance, a decision upheld subsequently by
a majority of the Court of Appeal (see [1996] 1 BCLC 288, QBD; [1997] 1 BCLC 131, CA).
Despite the fact that no direct dealings had taken place between M and the plaintiffs, the view in
the lower courts was that M could reasonably be said to have assumed a personal duty to them.
Much of the basis for this finding lay in the terms of the brochure from which it was clear that the
company was in the business of selling M’s experience and expertise. The lone dissenting voice in
the Court of Appeal belonged to Sir Patrick Russell who considered that there were insufficient
grounds for imposing a personal duty of care. He said:
“I fully accept that the evidence disclosed that [M] must have had a hand in the preparation of
the figures, but in my judgment this is not sufficient to create on his part a duty of care owed
personally by [M] to the plaintiffs which lifts the shield of corporate protection. I cannot bring
myself to the view that the facts of this case can…create such special and exceptional
circumstances as to justify this court in holding [M] liable as well as [the company].”
This view received unequivocal support in the House of Lords, where M’s appeal was allowed. It
was accepted by their lordships that the applicable principles were those deriving from Hedley
Byrne [1964] AC 465 and Henderson v Merrett Syndicates Ltd.[1995] 2 AC 145. The relevant
question was whether there had been an assumption of responsibility by M such as to create a
direct relationship between him and the plaintiffs. The answer to this should be determined by
applying an objective test focusing on anything said or done by M, or on his behalf, in dealings
with the plaintiffs. Per Lord Steyn:
“The inquiry must be whether the director, or anybody on his behalf, conveyed directly or
indirectly to the prospective franchisees that the director assumed personal responsibility
towards the prospective franchisees.”
It must also be established that it was reasonable for the plaintiffs to rely on any personal
assumption of responsibility. In their lordships’ unanimous opinion there was simply no
assumption of responsibility by M. Again in the words of Lord Steyn:
“In the present case there were no personal dealings between [M] and the plaintiffs. There were
no exchanges or conduct crossing the line which could have conveyed to the plaintiffs that M
was willing to assume personal responsibility to them . . . I am also satisfied that there was not
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even evidence that the plaintiffs believed that [M] was undertaking personal responsibility to
them.”
Their lordships’ ruling suggests that where the plaintiff is under no illusion that he or she is
dealing with a corporate entity, there is little prospect that Hedley Byrne-style liability will be
imposed on its agents. As such, the House of Lords has brought English law back into line with
that of other common law jurisdictions such as New Zealand (see eg Trevor Ivory Ltd v Anderson
[1992] 2 NZLR 517). Clearly, the result would be different if there is confusion about whether the
agent is trading on his own account or through the medium of a limited company. For example, in
Fairline Shipping Corporation v Adamson [1975] QB 180, the plaintiffs successfully sued a
company director in tort for damages arising from the company’s negligent storage of their goods.
The distinguishing feature there was that it appeared from correspondence and invoices received
by the plaintiffs that the director was trading on his own behalf rather than as agent for the
company. It might be said of Fairline that the director had stepped out from behind the corporate
veil and, to use Lord Steyn’s language, conveyed the direct impression that he was assuming a
personal responsibility. There cannot be said to be the same degree of self-exposure in a case, like
Williams, where the plaintiffs are clear that they are contracting with a company.
Yukong Line Ltd of Korea v Rendsburg Investments Corp of Liberia [1998] 4 All ER 82
In a number of respects, the Yukong case is similar to Ord v Belhaven and Creasey v Breachwood
Motors (overruled in Ord). The plaintiff shipowner agreed to charter a vessel to the first
defendant, RIC. The charterparty was signed on behalf of RIC by Y in his capacity as director of
RIC’s shipping brokers. Subsequently, Y sent a fax on the broker’s letterhead informing the
plaintiff that RIC was unable to perform the charterparty and take delivery of the vessel. On the
same day, a sum of around US$250,000 was transferred from RIC’s bank account to another
company, LIC with the purpose of putting RIC’s assets beyond the reach of the plaintiff in the
event of litigation. Ultimate control of both RIC and LIC vested in Y. The plaintiff brought
proceedings against RIC, LIC and Y on a number of grounds. One claim was that Y should be
held liable to the plaintiff for breach of the charterparty on the basis that (a) in entering the
charterparty RIC had acted as Y’s agent (see Argument Three in Adams v Cape above) and/or (b)
Y’s conduct was such that the court was entitled to lift the veil of RIC and treat Y as if he was a
party to the contract. For (a) the plaintiff relied on Smith, Stone and Knight Ltd and for (b) on the
“sham/façade” cases.
Held: that RIC had not constituted itself as Y’s agent and there was no basis for lifting the veil.
The fact that a company acts at the direction of its controller and for his benefit does not mean
that the company thereby constitutes itself the agent of the controller. Applying Salomon v
Salomon & Co Ltd, something quite different would need to be established in order to show that
the company, in law an entity independent of its owner, was acting in some respect as agent for its
owner, the necessary requirement being to show that the relationship of agency was intended to be
created. The present case also differed from so-called “sham” cases such as Gilford v Horne and
Jones v Lipman. The basic difficulty was that the plaintiff could not identify any antecedent or
pre-existing obligation owed by RIC which Y had sought to evade. As in Ord there was a
contingent liability in contractual damages but no actual liability.
In reaching this conclusion, Toulson J. reappraised the “sham” cases and formed the clear view
that these cases are not strictly concerned with “lifting the veil” but involve the granting of a
wider form of equitable relief equally applicable outside the corporate context:
“If there is such a doctrine [i.e. that represented by the “sham” company cases], there is no
particular reason why it should be confined to cases involving limited companies. It not
infrequently happens…that a married man who owes substantial legal liabilities may transfer
assets to his wife in order to shelter them from his…creditors. The present case differs from
Jones v Lipman and Gilford v Horne where equitable relief was granted against the company
being used to perpetrate a continuing breach of contract by its controller, of which the company
had full knowledge. If either Mr Horne’s wife or Mr Lipman’s wife (assuming their existence)
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had agreed to act in a similar role to that of the company, no doubt similar equitable relief
would have been granted against the lady concerned. Salomon’s case would have been
irrelevant. In the same way, the fact that the company had separate legal personality was no bar
to the court granting relief against it as well as the contract breaker. That is quite different from
awarding damages against it for some antecedent breach of duty by the contracting party (for
example, some breach by Mr Horne of his employment contract prior to its termination or some
misrepresentation by Mr Lipman in answers to inquiries before contract) on the basis that the
company was to be put in the shoes of the contract breaker. [Counsel for the plaintiff] submitted
that this was the logical result of such cases and was sound in principle. I do not agree. I do not
see why in logic or in principle the company should have been liable for damages in such a
situation, any more than Mrs Lipman, if the land had been conveyed to her, should thereby have
become liable for any and every breach by Mr Lipman of his contract with Mr Jones. I do not
regard those cases as establishing a principle enabling [Y] to be treated as the charterer and so
liable to [the plaintiff] for damages for wrongful repudiation of the charterparty.”
In the discussion under Argument Two above, it was hinted that the “sham” basis of Gilford v
Horne and Jones v Lipman was questionable in that the courts in both cases were happy to
acknowledge the separate legal status of the companies and make orders against them. In the light
of Yukong, it is still clear that the courts will intervene if someone in Y’s position uses a company
as a means to evade a pre-existing (as opposed to contingent) liability. However, it appears that
the true basis of such intervention lies in equity rather than any notion of “lifting the veil”. In any
event, whatever interpretation is used, it remains the case that equitable relief will only be
available in narrow circumstances.
In summary, both Ord and Williams provide strong grounds for believing that the recent trend of
judicial conservatism in relation to the principle of corporate personality is set to continue, unless
contractual arrangements are used by a creditor in order to extend their reach to the assets of other
members of a corporate group. Creditors with strong negotiating power may insist upon cross-
guarantees from all companies within a group. A bank, for example, may insist that a company
guarantees to meet its own liabilities and that of all the other corporate group members, using
contractual agreements.
Stocznia Gdanska v Latvian Shipping Co [2002] 2 Lloyds Rep 436 (CA)

The defendant subsidiary (L) entered into a contract with the claimant (S) for six shipping vessels.
L was incorporated in Liberia with directors provided by a company (C). Larco, the parent
company of L, was not a party to the contract and gave no guarantees of L’s liabilities. Latco did,
however, enter into a contract with C that L would be kept in sufficient funds to honour its
liabilities as and when they became due. Due to a recession in the shipping market, Larco
informed L that it would not provide the necessary funds.
Held: The parent company was liable in tort for the indirect inducement to L to breach its contract
with the claimant.
1.7.3.6 Lifting the veil: Conclusions
The Salomon principle is not completely unqualified. There are a number of statutory provisions
which allow or require the veil of incorporation to be lifted. However, in the absence of a
contractual or a statutory provision, the courts are reluctant to lift the veil either:
(a) to impose liability on a company insider (eg a director or shareholder); or
(b) to allow a company insider to enforce a legal right which is vested in the company itself.
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After Woolfson v Strathclyde Regional Council, Adams v Cape Industries Plc and Ord v Belhaven, it
is clear that the court cannot, as a matter of general principle:
(a) lift the veil and treat a company and its shareholders or a corporate group as a single entity;
(b) lift the veil where it may be in the interests of justice to do so;
(c) raise a presumption of agency or infer an agency relationship from the fact of control.
Exceptionally, the courts can lift the veil where, in Lord Keith’s words, “. . . special circumstances
exist indicating that [the company] is a mere facade concealing the true facts”. The Court of Appeal’s
refusal in Adams v Cape Industries to establish clear principles for the operation of this “exception”
remains a source of lingering disappointment. It appears (following Yukong) that while its true basis
lies in equity, the courts will not use equity to defeat the operation of the Salomon principle. Where
does this leave those who find themselves in the position of the plaintiffs in Ord and Yukong? It
appears that the only course is for such persons to obtain a summary judgment on their claim as
quickly as possible and then use that as a means of forcing the defendant company into compulsory
liquidation (see Chapter 9). The hope then would be that the liquidator would seek to claw back into
the company the assets or monies originally transferred out in order to defeat the claim (relying on,
for example, sections 238 and/or 423 of the Insolvency Act 1986). The justification for the narrow
approach of the common law lies (a) in the need for certainty among those who use the corporate
form and (b) on the view that is for parliament to establish further “exceptions” by statute under
which the veil can be lifted.
For an excellent overview of this area please refer to Corporate Veil – Adrian Walters, Comp
Law 1998, 19(8), 226 – which can be found at P:35 of your Cases & Materials.
1.8 Corporate Attribution
A company has an independent legal existence. We saw earlier that a company can own property,
enter into contracts and even commit crime. However, at the same time, a company’s existence is
artificial. It can only act with the help of humans. To establish corporate criminal or civil liability, it
is often necessary to attribute the thoughts or actions of a company insider to the company itself. In
a sense, this process of attribution involves a departure from the Salomon principle that the
company’s legal existence is entirely distinct from that of its human participants. However, we must
be careful. The question in Salomon was whether a company insider was liable for the company’s
debts. The answer was no. In the cases which follow the question is usually whether legal liability
can be imposed on the company itself. Salomon established that a company insider cannot generally
be required to meet the company’s liabilities. Attributing the thoughts and actions of insiders to the
company for the purposes of imposing corporate liability does not necessarily offend against this
principle.
1.8.1 CORPORATE CRIME
1.8.1.1 Company as criminal
It used to be thought that a company could only be convicted of strict liability offences, i.e. offences
without a mens rea element. One technique deployed with strict liability offences was to borrow from
tort and say that a company can be made vicariously liable where an employee has completed the
actus reus in the course of his or her employment. However, it was assumed until the 1940s that a
company was incapable of committing an offence which required proof of a “guilty mind”. This
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seems perfectly logical. A company’s existence is artificial. It has no mind of its own. How then can
it have a “guilty mind”?
The courts answered this question by holding that the mens rea of a company insider could be
attributed to the company itself:
DPP v Kent and Sussex Contractors Ltd [1944] KB 146

The defendant company was charged with offences which required the prosecution to prove an intent
to deceive and “guilty knowledge”. The defendant argued that the charges should be dismissed
because a company could not form an intention or have knowledge.
Held: (by the divisional court) that the company was capable of committing the offences. For the
purposes of criminal liability, a company could be identified with its officers. If an officer had the
required intention or knowledge this could be attributed to the company. Per Viscount Caldecote CJ:
“. . . although the directors or general manager of a company are its agents, they are something
more. A company is incapable of acting or speaking or even of thinking except in so far as its
officers have acted, spoken or thought. . . The officers are the company for this purpose.”
DPP v Kent and Sussex Contractors Ltd was approved by the Court of Appeal in R v ICR Haulage
Ltd [1944] KB 551. There, a company’s conviction for common law conspiracy to defraud was
upheld by attributing the managing director’s state of mind to the company.
A company can even be convicted of manslaughter. This possibility was first admitted in R v P & O
European Ferries (Dover) Ltd (1991) 93 Cr App R 72, (which can be found at 1.5 in your Cases &
Materials) a case in which Turner J articulated the policy justification for extending criminal liability
to companies:
“Since the nineteenth century there has been a huge increase in the numbers and activities of
corporations. . . A clear case can be made for imputing to such corporations social duties including
the duty not to offend all relevant parts of the criminal law.”
ACTIVITY 2
Think of four offences which a company cannot commit. Why is it impossible for a company to
commit these offences?
You might have come up with the following:
(a) Bigamy (companies cannot get married).
(b) Sexual offences (companies are incapable of sexual relations).
(c) Treason (punishable by death; a company cannot be physically executed).
(d) Murder (punishable by mandatory life sentence; a company cannot be physically imprisoned).
Note that commentators also refer to attribution as the identification principle or the organic
theory.
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1.8.1.2 Directing mind
DPP v Kent and Sussex Contractors Ltd and R v ICR Haulage Ltd suggest that a company’s officers
can be identified with the company for the purposes of imposing corporate criminal liability. The
difficult question is whether any company insider from the managing director down to the tea lady
and the office junior can be identified with the company.
This question was answered restrictively by the Court of Appeal in a civil case, HL Bolton
(Engineering) Ltd v TJ Graham & Sons Ltd [1957] 1 QB 159. There, Lord Denning likened the
company to a human body and drew a distinction between “mere servants and agents” and what he
called the company’s “directing mind”:
“A company . . . has a brain and nerve centre which controls what it does. It also has hands which
hold the tools and act in accordance with directions from the centre. Some of the people in the
company are mere servants and agents who are nothing more than hands to do the work and cannot
be said to represent the mind and will. Others are directors and managers who represent the
directing mind and will of the company, and control what it does. The state of mind of these
managers is the state of mind of the company and is treated by the law as such.”
This dictum was applied by the House of Lords in the next case:
Tesco Supermarkets Ltd v Nattrass [1972] AC 153:

Tesco was charged with an offence of giving a misleading price indication contrary to consumer
protection legislation. The alleged offence was committed at one of the company’s branch stores. A
statutory defence was available if the defendant could prove that commission of the offence was due
to the act or default of another person, and that it (i.e. the defendant) had taken all reasonable
precautions to avoid commission of the offence by itself or any person under its control. The
prosecution argued that the branch manager should be identified with the company. He had failed to
take adequate precautions to avoid commission of the offence and this failure should be attributed to
the company. The defence would then be unavailable.
Held: (quashing Tesco’s conviction) that normally only the board of directors, the managing director
and perhaps other superior officers carry out management functions and speak and act as the
company. The failure of a subordinate manager to supervise the store properly was not attributable to
the company and he was therefore “another person” within the meaning of the statutory defence. On
the facts, Tesco were found to have devised and implemented a proper compliance system. Tesco had
therefore done all it could to avoid commission of the offence.
This restrictive view, limiting those who can be identified with the company to the board of directors
and other superior managers has been criticised. It takes no account of the fact that companies vary
considerably in size and organisational structure. It may serve well as a model for imposing criminal
liability upon a small owner-managed company. However, the “directing mind” hardly provides a
basis on which to develop a theory of corporate criminal liability appropriate to large companies or
multinationals. An alternative might be to impose general vicarious liability on companies for crimes
committed by their officers and employees during the course of employment. However, critics of this
approach regard it as too wide.
Nevertheless, the restrictive view has now been challenged by the Privy Council in Meridian Global
Funds Management Asia Ltd v Securities Commission [1995] 3 WLR 413. This case suggests that
the “directing mind” model is not always appropriate. Here, the question was whether the actions and
knowledge of an investment manager could be attributed to the company. If so, the company was
liable for a breach of the New Zealand securities legislation.
Held: that the investment manager’s knowledge could be attributed to the company which was
accordingly liable.
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It appears that corporate criminal liability can now be imposed by identifying the company with an
insider or employee who falls outside the narrow scope of the “directing mind”. Lord Hoffmann was
concerned in Meridian that if the company escaped liability simply because the board was unaware
of the activities of its investment managers, “. . . this would put a premium on the board paying as
little attention as possible to what its investment managers were doing”. In other words, the policy of
the legislation would be defeated. Much therefore turns on the policy of the particular legislation
under scrutiny.
After Meridian, if an individual has been put in charge of a particular corporate function, the chances
are that his state of mind will be attributed to the company even if the board and senior management
are unaware of his activities.
1.8.1.3 Company as victim of crime
The concept of attribution may also be relevant in determining whether an offence has been
perpetrated against the company. This is particularly true of offences under the Theft Act 1968 e.g.
theft and obtaining property by deception.
In Attorney General’s Reference (No 2 of 1982) [1984] QB 624 the question arose as to whether a
director and shareholder could steal from a company which he controlled. The defendants argued that
their knowledge of and consent to appropriations of company money could be attributed to the
company. It would then be possible to say that the company had consented to the defendants’ acts i.e.
no theft. This argument was rejected. Attorney General’s Reference (No 2 of 1982) has been followed
subsequently in R v Philippou (1989) 89 Cr App R 290.
The offence of obtaining property by deception (Theft Act 1968, s. 15) is not complete unless the
victim is genuinely deceived. Thus, to secure a conviction, the prosecution must establish that a
company insider whose state of mind can be attributed to the company has actually been deceived.
For an interesting example of a case in which the Court of Appeal quashed a conviction for obtaining
property by deception on precisely this point see R v Rozeik [1996] 1 BCLC 380.
1.8.2 CORPORATE CIVIL LIABILITY
Note that attribution can also be used to impose civil liability on a company in much the same way.
Indeed, Lord Denning’s “directing mind” derives from a civil case (see HL Bolton (Engineering) Ltd
referred to above).
SAQ 19
Can you think of any forms of civil wrong where it might be necessary to use attribution to
impose liability on a company?
Many forms of civil liability depend on the alleged wrongdoer’s state of knowledge. Two good
examples are the equitable wrongs of “knowing assistance” and “knowing receipt” whereby liability
can be imposed on a third party who participates in a breach of trust. To impose this type of liability
on a company it will be necessary to use attribution.
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A company is, of course, vicariously liable as an employer for torts committed by its employees in
the course of their employment. This, however, is a form of secondary liability. The company is
made liable for someone else’s torts by virtue of the employment relationship. Vicarious liability
does not involve any process of attribution.
1.9 Conclusion
For good or bad, the Salomon principle is still intact a century on from the House of Lords decision in
Salomon v Salomon & Co Ltd. To some extent, parliament has qualified the principle as the veil of
incorporation can be lifted under a range of statutory provisions. Statute aside, however, the courts
are now slow to lift the veil other than in very limited circumstances.
For certain purposes, notably the imposition of primary criminal and civil liability, the thoughts and
actions of insiders can be attributed to the company itself. Cases like Tesco Supermarkets Ltd v
Nattrass suggest that the courts are reluctant to develop a wide theory of attribution although there
are now signs (especially in Meridian) of a more flexible approach.
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1.10 Questions
These questions are to point you to things you need to know before you can begin to answer
examination questions. They are NOT examination questions.
1. What are the three main types of companies?
2. How do they differ from each other?
3. What are the differences between public and private companies?
4. When may a private company begin trading?
5. When may a public company begin trading?
6. What is the significance of (a) the certificate of incorporation and (b) the trading certificate?
7. What are the differences between companies and partnerships?
8. What does the “veil of incorporation” mean?
9. What are the consequences of having the principle of the veil of incorporation?
10. When may the veil of incorporation be lifted under statute?
11. When may the veil of incorporation be lifted at common law (ie under case law)?
The following question is an old examination question. An outline answer is given below it.
Please note that outline answers are just what they say they are: outlines. They give you guidance
on the general points that you might be expected to cover. They are not definitive and the
application of the law will always depend on the facts of the question set and the facts will not
necessarily be the same in courseworks and examinations!
Question
Trent Ltd is a private company which has two wholly-owned trading subsidiaries, Severn Ltd and
Ribble Ltd. The three companies have the same directors and rather than paying a dividend, the
two subsidiaries pay their profits to Trent Ltd by way of a management charge.
The board decided to expand the group’s business into the US market and to that end incorporated
an American subsidiary, Trent (Delaware) Inc for this purpose. A customer, Roach, issued a writ
claiming £1 million damages for breach of contract against Severn Ltd. The proceedings were
vigorously defended by Severn Ltd. Just before trial, most of Severn Ltd’s assets were transferred
to Ribble Ltd in what was described in the financial press as a “major group restructuring”. The
group’s auditors advised the board that Severn Ltd’s business was no longer viable without an
injection of fresh capital. Nevertheless, the subsidiary continued trading until Roach successfully
petitioned for its compulsory winding up having first obtained judgment on his contract claim at
trial. The American subsidiary is also now in insolvent liquidation.
Uncle Sam, a former employee of the American subsidiary brought a successful action in the US
courts for personal injuries sustained during the course of his employment. There are no assets in
the American subsidiary to meet this judgment.
46
PERSONALITY
Advise Roach and Sam who wish to enforce their judgments against Trent Ltd and/or Ribble Ltd.
N.B. You need only consider applicable principles of English company law.
Outline answer – See Cases & Materials 1.6.2 for a complete outline answer.
47
CHAPTER TWO
FORMATION OF A REGISTERED COMPANY AND

CORPORATE CONSTITUTION
2.1 Objectives
1. Recognise the difference between the memorandum of association and the articles of
association.
2. Recognise the main clauses in the memorandum of association of a private company limited by
shares.
3. Understand the purpose of the name clause and be able to apply the rules relating to the
choice of a company’s name.
4. Identify the purpose of the objects clause in a company’s memorandum of association.
5. Evaluate the effect of the ultra vires doctrine on contracts in the light of the Companies Act
1985 (as amended by the Companies Act 1989).
6. Understand the effect of s. 14 on members, directors etc.
7. Analyse when a company may alter its articles and in what circumstances majority power
may be the subject of equitable constraint.
8. Distinguish between the legal effect and validity of a contract based on a term in the articles
and a free standing service contract.
2.2 The Formation of a Registered Company
As has been previously stated, certain documents have to be sent to the Registrar of Companies to
enable the company to be registered as an incorporated company. From the 1st January 2007 a
web incorporation facility will be available.
Two of the documents require closer scrutiny than has previously been given:
1.1 The Memorandum of Association
1.2 The Articles of Association – These two documents combined are referred to as the
company’s constitution. However, once implemented, Companies Act 2006, s.17 will
49
FORMATION OF A REGISTERED COMPANY AND CORPORATE CONSTITUTION
have the effect of combining these two documents into a sinlge constitutional document;
the company’s articles. The content of the articles will thus form the company’s
constitution.
2.2.1 THE MEMORANDUM
There are seven clauses in the memorandum of a public company and six clauses in the
memorandum of a private company limited by shares.
Note: When in force, the provisions of the Companies Act 2006 will have a dramatic effect on the
content of a company’s memorandum. As mentioned above, the effect of the 2006 Act will be to
combine the memorandum and the articles into a single document. As a consequence, the
memorandum will be of little significance, only stating the wishes of the subscribers to form a
company and the names of those subscribers – Companies Act 2006, s.8.
For existing companies, the clauses below, which are currently required to be stated in the
memorandum, are to be treated as part of the company’s articles, Companies Act 2006, s.28
1. The Name Clause
2. The Registered Office Clause
2A. The Public Company Statement Clause (Public Company only)
3. The Objects Clause
4. The Limited Liability Clause (limited company only)
5. The Share Capital Clause (company limited by shares only)
6. The Association and Subscription Clause
The two clauses which require most study are the Name Clause and the Objects Clause.
2.2.2 THE NAME CLAUSE AND THE RULES REGULATING CHOICE OF

COMPANY NAME
Rules affecting the choice of a company name are contained in ss. 25-34. There are broadly three
types of restriction on the freedom of choice as follows:
(a) certain words must be included in the name;
(b) certain words cannot be used;
(c) the choice of name may be affected by the post-registration controls.
2.2.2.1 Words which must be included
The name of a public company must end with “public limited company” or Welsh equivalent (s.
25(1)). The name of a private limited company must end with “limited” or Welsh equivalent (s.
25(2)). Abbreviations (e.g. to “Plc” or “Ltd”) are permitted (s. 27(4)) but, again, these can only
50
appear at the end of the name (s. 26(1)(b)). The purpose of these provisions is simple. They ensure
that anyone dealing with a limited company can readily appreciate the limited liability of its
members.
Under s. 30 certain companies are exempt from the requirement to use Ltd as part of the name.
These are private companies limited by guarantee provided the objects of the company are the
promotion of commerce, art, science, education, religion, charity or any profession and the
company’s memorandum or articles require its profits to be applied in promoting its objects,
prohibit the payment of dividends to its members and require all the assets on a winding up to be
transferred to a body with similar objects.
To obtain the exemption, a statutory declaration must be delivered to the registrar stating that the
company complies with the above requirements.
The company is then also exempt from the requirement under s. 348 and s. 349 to publish its
name and from the requirement to send a list of its members to the registrar.
However, under s. 351(1)(d) an exempt company has to record the fact that it is a limited
company in all business letters and order forms. Also, if a company is a charity, if its name does
not include the word charity or charitable, then the company will have to state that it is a charity
on all business letters and order forms.
Companies using this exemption are for example, schools, charities, chambers of commerce,
professional bodies.
2.2.2.2 Restricted words and expressions
(a) A proposed name will not be accepted if it is the same as a name which already appears in the
index of company names which the Registrar is required to keep under s. 714 (s. 26(1)(c)). It is
therefore very risky for those forming the company to order stationery headed with the proposed
name before incorporation in case they are required to choose an alternative name. This risk does not
go away completely even after incorporation (see post-registration controls below)
ACTIVITY 1
Amelia, Jane and Wilfred wish to form a limited company. They file a memorandum of
association at Companies House inserting “AJW Limited” in the name clause. The Registrar
informs them that a company called AJW Ltd has already been incorporated and appears on
the index of names. How might they get around the problem and still end up with a company
name which contains the initial letter of their own names?
They might try other permutations of the letters A, J and W e.g., WJA Ltd (possibly JAW Ltd?!). The
introduction of punctuation marks (A.J.W. Ltd) or use of lower case letters (ajw ltd) will not work (s.
26(3)). Another common technique is to introduce a geographical qualification e.g. AJW
(Nottingham) Ltd or AJW (East Midlands) Ltd. While similar, these names are not exactly the same
as AJW Ltd and might prove acceptable.
(b) A proposed name will not be accepted if, in the opinion of the Secretary of State, its use would
constitute a criminal offence or the name is offensive (s. 26(1)(d)-(e)). R v Registrar of Companies,
51
ex parte Attorney General [1991] BCLC 476 concerned a company called Lindi St Claire (Personal
Services) Ltd which had been formed to carry on the business of prostitution. The ratio which is
considered in the material on the certificate of incorporation in Chapter One does not directly touch
upon the choice of name issue. However, it is clear from the facts that Miss St Claire had made
attempts to incorporate the company first as “Prostitute Ltd” and later as “Hookers Ltd”. Both names
were rejected by the Registrar presumably because they were considered offensive.
These prohibitions are absolute.
2.2.2.3 Words and expressions registrable with prior approval
(a) A company cannot be registered with a name which, in the Secretary of State’s opinion, would
be likely to give the impression that the company is in any way connected with Her Majesty’s
Government or with any local authority unless the Secretary of State gives prior approval (s.
26(2)(a)).
(b) Approval by the Secretary of State (or some other designated body) is required before a company
can be registered with a name including any word or expression specified in regulations (s. 26(2)(b)).
The Secretary of State is empowered by s. 29 to make such regulations. The current applicable
regulations are the Company and Business Names Regulations 1981 (SI No 1685, as subsequently
amended by SI 1982 No 1653, SI 1992 No 1196 and SI 1995 No 3022). These regulations contain a
list of sensitive words and expressions and an indication of the government department or body to
which an approach must be made under s. 29(2) for approval. Examples of listed words include,
British, Dental, English, European, Federation, Her Majesty, Prince, Queen, Royal and University. If
the proposed name has an “official” ring to it, it may well be a sensitive name and the regulations
should be checked.
ACTIVITY 2
You wish to incorporate a company with the name “International Dog Breeders Ltd”. The
company is to be based in the East Midlands. You intend to carry on in business as a breeder of
pedigree Yorkshire Terriers through the vehicle of the new company. What if any approvals
may be needed before this name can be used? Are any approvals that may be required likely to
be forthcoming?
Approval is needed from the Secretary of State before the word “international” can be used (see 1981
regulations). It is clear from Companies House guidance notes that approval will generally be given
to companies wishing to use this word if the company is involved in a trade which is international in
character. A dog breeding business in the East Midlands does not appear to have such a character and
approval is unlikely to be given. SI 1995 No 3022 amended the 1981 regulations to remove the word
“breeder” from the list with effect from 1 January 1996. Specific approval is thus not required for
“breeders”. In choosing an alternative name (suggest, for example, “East Midlands Dog Breeders
Ltd”), it is important to have in mind the general restrictions discussed above.
2.2.2.4 Post-registration controls
Before incorporation, the Registrar can only refuse to accept a proposed name on the grounds set out
in s. 26. Even if the Registrar accepts a proposed name, this is not necessarily the end of the story.
52
There are a series of statutory post-registration controls which empower the Secretary of State to
order a company to change its name:
(a) The Secretary of State may within 12 months after incorporation direct a company to change
its name where it is the same as, or in his opinion, too like a name already appearing on the
Registrar’s index of names when that company was incorporated (s. 28(2)). It is clear from
guidance notes issued by Companies House that the key issue here is whether there is any
danger of confusion between the two companies. Exercise of this discretion is usually triggered
by the complaint of the company whose name was on the register first.
(b) If it appears to the Secretary of State that misleading information was provided for the
purposes of incorporation with a particular name, then he may within 5 years of the date of
incorporation with that name direct the company to change it (s. 28(3)).
(c) Section 32 empowers the Secretary of State to direct a company to change its name if, in his
opinion, that name gives so misleading and indication of the nature of its activities as to be
likely to cause harm to the public. There is no time limit under this section. The company has
the right under s. 32(3) to apply to court to challenge the direction. The application must be
made within 3 weeks after the date of the direction.
As the Secretary of State’s powers are administrative in nature, any decision to exercise post-
registration control is susceptible to judicial review. There is only one reported case to date:
Association of Certified Public Accountants of Britain v Secretary of State for Trade and Industry
[1997] BCC 736
The Association appears to have been a company limited by guarantee. The Secretary of State
issued a direction under section 32(1) requiring the Association to change its name. The
Association applied to the court under section 32(3) to set aside the direction.
Held, (dismissing the application and affirming the direction) that:
(a) There was no statutory requirement on the Secretary of State to give reasons for why he had
formed the opinion that a direction was necessary; the case on a section 32(3) application
did not thus proceed by way of judicial review of an administrative discretion but as a
hearing de novo on evidence adduced by both sides;
(b) It followed that the court should form its own view as to whether or not the Association’s
name offended under section 32;
(c) The potentially damaging consequences of an enforced change of name should only be
visited on the company if real cause was shown and mere failure by the company to prove
that its name was not misleading was not a sound basis for confirming the direction;
(d) It is not enough to show that the name was misleading, a likelihood of harm must also be
shown;
(e) In the circumstances the order would be confirmed as use of the term “certified” connoted
that the Association maintained a system for ensuring a level of professional qualification,
standing and competence on the part of its members and that the organisation operated a
genuine system of monitoring and self-regulation. On the facts, the standards for
certification by the Association were so low as to make use of the word “certified”
misleading. As such, this term was also likely to harm the public who might be prepared to
pay more for someone they considered to be a “certified” accountant.
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2.2.2.5 Change of name
A company may voluntarily change its name at any time by special resolution. The new name must
comply with all the restrictions outlined above. If it does so comply, the Registrar will enter the new
name on the index in place of the former name and issue an altered certificate of incorporation
(known as a certificate of incorporation on change of name). The new name takes effect from the
date on the new certificate.
2.2.2.6 Publicising the company name
Once the company is incorporated it must:
(a) Paint or affix the full company name, and keep it painted or affixed in a conspicuous position
and in legible characters outside every office or place in which its business is carried on (s.
348).
(b) Include the full name in legible characters on all its business stationery including invoices and
cheques (s. 349). The company and every officer (e.g. directors and secretary) are liable to a
fine for non-compliance. Civil liability for breach of s. 349 is considered in the context of
statutory “lifting the veil” in Chapter One.
(c) If it adopts a company seal (now voluntary) have the full name engraved on the seal (s. 350).
2.2.2.7 Tort of passing off
A common law passing off action could be instigated by another company or business if a company
is incorporated with or trades under a name similar to the name of that company or business. Lord
Diplock identified five characteristics which must be present to found a passing off action in Erven
Warnink BV v J Townend & Sons [1979] 2 All ER 927 at 932:
“. . . (1) a misrepresentation (2) made by a trader in the course of a trade, (3) to prospective
customers of his or ultimate consumers of goods or services supplied by him, (4) which is
calculated to injure the business or goodwill of another trader (in the sense that this is a reasonably
foreseeable consequence) and (5) which causes actual damage to a business or goodwill of the
trader by whom the action is brought . . .”
To succeed, the plaintiff must establish that use of the defendant company’s name has confused the
public into believing that the defendant is, in fact, the plaintiff with resulting diversion of custom and
damage to the plaintiff’s goodwill. Damages may be recovered or an injunction obtained to restrain
the defendant’s use of the misleading name. Crucially, the Registrar’s acceptance of a name does not
make the company immune from a passing off action. As a first step, it is likely to be simpler and
cheaper for our potential plaintiff to complain to the Secretary of State in the hope that he might
exercise his discretion under s. 28(2) (see post-registration controls above). However, this option is
only open for 12 months after the date of incorporation of the “offending” company. Note also that
the Registrar’s acceptance of a name does not preclude possible action against the company for
infringement of a registered trademark..
Ewing v Buttercup Margarine Company Ltd [1917] 2 Ch 1

The plaintiff, trading under the name Buttercup Dairy Company, was able to restrain the
defendant company from using the name of Buttercup Margarine Company Ltd on the grounds
that confusion would be caused between the two names and this threatened the goodwill of the
plaintiff’s business.
54
Compare the Ewing case where the products were similar to Aerators Ltd v Tollitt [1902] 2 Ch
319 where the name in dispute was Automatic Aerator Patents Ltd. The product of the plaintiff
company was a patent for the instantaneous aeration of liquids for use in syphons ; the
defendant’s company was incorporated to deal with the large scale aeration of beer in pubs. No
injunction was granted since there would be no confusion between the products and no
corresponding threat to the goodwill of the plaintiff’s business.
2.2.2.8 Business names
It is possible for a company to trade under a name other than its official name on the Registrar’s
index. Thus, a company incorporated as “Wollaton Motor Transport Limited” could trade under the
rather less formal business name “Wollaton Motor Transport”. The use of such business names is
regulated by the Business Names Act 1985. As for company names, certain words and expressions
cannot be used without prior approval. The 1981 regulations discussed earlier apply equally to
business names. The Business Names Act 1985 also provides that full publicity must be given to the
official company name where the company trades under a business name. This is, of course, entirely
consistent with our companies legislation (see, for example, the publicity requirements in sections
348-350 discussed above).
2.3 The Memorandum of Association
2.3.1 THE OBJECTS CLAUSE
In this clause there is set out the purposes for which the company is formed or the kind of activity
or business in which it is to be involved.
Please note: Once the provisions of the Companies Act 2006 are in force, companies will, by
default, have unlimited objects unless they are specifically restricted by the articles, s.31
So, while the 2006 Act has not completely abolished the Ultra Vires Doctrine (see below) it
certainly narrows its application, with the company having to frame any restriction in the
articles.
2.3.1.1 The Ultra Vires Doctrine
1. A company incorporated under the Companies Act does not in fact have a full legal
personality (unlike individuals or chartered corporations) in that it can only act in accordance with
the purposes of its incorporation as defined in the objects clause.
2. Any other act which is outside the objects clause is beyond its powers and therefore at
common law it is ULTRA VIRES. Historically, any contract entered into by a company for a
purpose outside the objects specified in its memorandum was ultra vires (beyond its powers) and
void. The following case contains the classic application of the ultra vires doctrine in company
law:
Ashbury Railway Carriage and Iron Company Ltd v Riche (1875) LR 7 HL 653, [1874-80] All ER
Rep 2219
The defendant company’s objects were, “to make, sell, or lend on hire railway carriages and
waggons, and all kinds of railway plant . . . [and] to carry on the business of mechanical engineers
and general contractors. . . “. The company’s directors made contracts with the plaintiff on the
55
company’s behalf to finance a railway construction project. The company failed to perform the
contracts and plaintiff claimed damages for non-performance.
Held, (by the House of Lords) that the contract was ultra vires and void. The company had no power
to make the contracts. Even if the shareholders had unanimously approved the contracts afterwards
this would have made no difference. The shareholders could not retrospectively confer validity on a
contract which the company was not competent to make. Per Lord Chelmsford, “. . . ratification [i.e.,
by the shareholders] . . . could not have given life to a contract which had no existence in itself . . .”.
The plaintiff’s claim therefore failed because the contract was void or, put another way, a binding
contract never arose in the first place.
The plaintiff argued that the contracts were intra vires (that is, within the company’s powers) as the
company was empowered by its memorandum to carry on the business of “general contractors”. Lord
Cairns disposed of this argument by applying the ejusdem generis rule of construction. In other
words, he held that the wide term “general contractors” could only be interpreted with reference to
the specific type of business activities listed before it in the objects clause. The words “general
contractors” were thus to be construed with reference to the specific object which was “to carry on
the business of mechanical engineers”. The contracts in the case were in no way connected with the
business of mechanical engineers and were thus ultra vires.
3. The ultra vires rule was highly inconvenient. The position of the plaintiff in Ashbury Railway
Carriage v Riche is a case in point. There the company was able to escape its obligations to the
plaintiff by relying on the rule. The ultra vires rule created a disincentive to third parties against
contracting with companies. How could an outsider deal with a company safe in the knowledge that
any contract made would be legally enforceable? At the time Ashbury Railway Carriage v Riche was
decided, the difficulties for outsiders were compounded further by the doctrine of constructive
notice. By this doctrine an outsider was fixed with knowledge of the contents of any public document
filed with the Registrar of Companies whether he carried out a search at Companies House or not. A
memorandum of association is a public document. Thus, outsiders were deemed to know the contents
of a company’s objects clause and the extent of its contractual capacity. The combined effect of the
ultra vires rule and the doctrine of constructive notice was to put the onus firmly on outsiders to make
jolly sure that any proposed transaction fell within the company’s stated objects.
4. The ultra vires rule was no less inconvenient for a company when the boot happened to be on the
other foot. If the company had been the plaintiff in Ashbury Railway Carriage v Riche, the result
would have been exactly the same, i.e., the company would not have been able to enforce the
arrangement either. The position after Ashbury Railway Carriage v Riche can be summarised as
follows:
(a) Any transaction made for a purpose outside the objects clause was ultra vires and void.
(b) An ultra vires transaction could not be enforced by either party i.e., the outsider or the
company.
(c) An ultra vires transaction could not be ratified by the shareholders and then enforced. It was
impossible for the shareholders to confer legal validity on a transaction which the company had
no legal capacity to make.
5. If the ultra vires rule was potentially so inconvenient for company and outsider alike, what was
the justification for such a rule? In Ashbury v Riche Lord Cairns appeared to have two sets of people
in mind namely, a company’s shareholders and its creditors. Although it is not entirely clear from
the case report, the ultra vires rule operated primarily as a crude investor protection mechanism. The
theory was that investors in companies were entitled to know the nature of the enterprise to which
they entrusted their money. The ultra vires rule protected these investors against the misapplication
of their funds by the company’s directors or managers for purposes which they (i.e., the investors)
had not contemplated. Equally, the rule was said to protect creditors against the dissipation of a
56
company’s capital and assets for unauthorised purposes (an extension of the so-called capital
maintenance principle on which see further Chapter 4). In themselves, these policy objectives are
laudable. However, the combined effect of the ultra vires rule and the doctrine of constructive notice
often proved disastrous for outsiders. This is illustrated well by the next case:
Re Jon Beauforte (London) Ltd [1953] 1 Ch 131

A company was authorised by its objects clause to carry on the business of costumiers and gown
makers. The company engaged in the manufacture of veneered panels. This was clearly ultra vires.
The company went into liquidation. Three suppliers lodged claims for the payment of contract debts
by the company. The liquidator refused to allow these suppliers to claim as creditors in the
company’s liquidation. They had all supplied the factory at which the company manufactured
veneered panels. The liquidator argued that none of the claims were valid because they were based on
contracts which were ultra vires and void. One of the three had supplied coke to the factory in
response to orders received from the company on note paper headed “veneer panel manufacturers”.
Held: that all three claims had been rightfully rejected by the liquidator. It was not possible to claim
payment under an ultra vires contract.
The coke supplier argued that it was never aware of the purpose for which the coke would be used.
There was nothing to show that the coke was used for ultra vires purposes. The court dismissed this
argument in peremptory fashion. The coke supplier had actual notice (from the note paper) that the
business which the company was carrying on and for which the fuel was required was that of
veneered panel manufacturers. Simultaneously, it also had constructive notice of the contents of the
memorandum and was therefore deemed to know the nature of business which the company should
have been carrying on (i.e., that of costumiers and gown makers).
Re Jon Beauforte (London) Ltd demonstrates the operation of the ultra vires rule at its most absurd.
The utility of a rule which produced such manifestly unjust outcomes and created disincentives for
outsiders who might otherwise have been eager to contract with companies was increasingly called
into question. Before considering the recent statutory reform of the ultra vires rule (see below), we
now turn to consider various drafting devices which have been used to try and reduce its impact.
6. As a result of the above case, it became the practice for companies to increase the objects
clause by adding to the principal objects a large number of objects just in case they were needed.
Hence an objects clause of the type shown in the Table B memorandum [Companies (Tables A -
F) Regulations 1985] was no longer used.
7. Also companies began to add a large number of powers to their objects clauses. There is a
technical difference between objects of a company and the powers given to it to implement those
objects. These powers are implied and a company has an implied power to do whatever is
reasonably incidental to the carrying on of its objects. However because of the ultra vires doctrine,
and some confusion as to which powers were implied and which had to be expressly stated,
companies’ objects clauses contained a mixture of objects and powers.
8. Another problem that arose was that as a result of the number of sub-clauses in the objects
clause, the court developed a “main objects rule of construction”. The courts determined that only
one clause, usually the first, was the main or dominant purpose of the company. Companies
responded by drawing up the objects clause with an “independent objects” clause usually at the
end of the list of clauses. This clause stated that every clause must be considered to be a main
object and therefore independent of the other clauses.
9. The end result is that most companies now have exceedingly long objects clauses in attempt
to avoid the ultra vires doctrine. Attempts were made in 1972 in implementing the first company
law directive adopted by the European Community to avoid the consequences of a contract being
ultra vires. (Pre-1972 the contract was void and could not therefore be enforced by either the
company or the third party with which it had purported to contract). However the attempt was not
57
successful and a further attempt was not made until the enactment of the Companies Act 1989
(which amends the 1985 Act).
10. The basis of the problem is that outsiders should be protected from the ultra vires doctrine ;
no one has time to examine the documents at Companies House before he or she makes a contract
with the company and therefore it became clear that to make the contract void was both
unfortunate for the outsider and detrimental to the smooth operation of commerce. However
insiders, i.e. directors know what is happening and it is in the interests of shareholder protection to
be able to control them to some extent. The 1989 Act attempts to solve this outsider/insider
conflict by removing the problem for the outsider but retaining the doctrine as a limited internal
mechanism.
2.3.1.2 The Companies Act 1985 (as amended by the Companies Act 1989)
2.3.1.3 The New Objects Clause

1. S. 3A of the amended 1985 Act lays down a simplified objects clause. The idea is that all
companies registered since 1989 should use this new clause although it is not mandatory. The
section says that a company can carry on any trade or business whatsoever if the company’s
objects are stated to be “to carry on business as a general commercial company”.
Also the company has power to do all things which are incidental or conducive to the carrying on
of any trade or business by it.
SAQ 1
Will the simplified objects clause in s. 3A mean that no contracts will be ultra vires?
2. Unfortunately it seems that there may be problems with the simplified objects clause. The
provision limits the company’s incidental and ancillary powers in carrying on any trade or
business it chooses, to those which are in fact incidental or conducive to the business it is
carrying on. It is therefore not up to the directors or the company to decide whether the act or
contract is incidental to the business, it will be for the court to decide if the legality of the act is
challenged by a member of the company.
3. Also there may be activities which the company may wish to undertake which may not
constitute the carrying on of a trade or business or be incidental thereto e.g. the transfer of the
entire business to another company.
4. It is therefore quite likely that even if the new clause is adopted, the usual long list of standard
clauses and sub-clauses (including an independent objects clause) will continue to be used
alongside it.
5. Please note: Once the provisions of the Companies Act 2006 are in force companies will,
by default, have unlimited objects unless they are specifically restricted by the articles, s.31
58
2.3.1.4 Contractual Capacity

1. The purpose of the 1989 Act is to enable transactions entered into by the company to be valid
even if they are strictly ultra vires or beyond the company’s objects and powers.
2. S. 35 states:
“The validity of an act done by a company shall not be called into question on the ground of
lack of capacity by reason of anything in the company’s memorandum.”
This section does not abolish the ultra vires rule completely but it prevents the company and the
other parties to the contract from disputing the validity of the contract. Thus the effect as far as the
outsider is concerned is as if the ultra vires rule had been abolished.
3. However, this does not completely solve the outsider’s problem. The old common law
doctrine of constructive notice would apply if not addressed by statute. The memorandum, articles
and special resolutions are all public documents and available to anyone searching in Companies
House, Cardiff. The third party (outsider) could be deemed to have knowledge of the contents of
the memorandum and therefore be deemed to know that the contract was outside the objects
clause.
To protect the outsider even further s. 35A states:
“In favour of a person dealing with a company in good faith, the power of the board of directors
to bind the company, or authorise others to do so, shall be deemed free of any limitation under
the company’s constitution”.
4. The next question that arises is, should the third party (outsider) enquire whether a transaction
with a company is permitted by the objects clause in the memorandum? To prevent a massive
slow down in commerce while these enquiries are made, s. 35B states:
“a party to a transaction with a company is not bound to enquire as to whether it is permitted by

the company’s memorandum . . . to bind the company”.
This, in effect, solves the constructive notice problem referred to above.
5. Thus, a third party can enforce an ultra vires contract which means it is binding as far as the
company is concerned. What is the situation, however, if a third party wants to avoid the contract
which he entered into in good faith once he discovers the limitation on the company. It would
appear that he cannot complain on the grounds that the contract is ultra vires i.e. he also is bound
by the ultra vires contract.
6. It should therefore be seen that the ultra vires doctrine is not a problem for the outsider since
the 1989 Act save in the circumstances outlined in 5. above.
7. However the ultra vires rule still operates internally which is why it is not possible to say it
has been totally abolished. A shareholder can sue if the transaction is ultra vires.
S. 35(2) states:
“A member of a company may bring proceedings to restrain the doing of an act which would be
beyond the company’s capacity”.
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This right belongs to a shareholder whatever his shareholding. However, the proceedings must be
brought before any legal obligation is entered into by the company. This is to prevent completed
transactions from being reopened.
Please note that ss.35 (2) and (3) of the 1985 Act will be repealed by the 2006 Act.
8. If the shareholder is too late to restrain the company from entering into the ultra vires
contract, the directors may be sued by the company for breach of a duty to act within their powers
(see later notes on duties of directors - a position which will also be put on a statutory footing
when Companies Act 2006, s.171 is implemented). If the directors are in breach of duty their
action may however be ratified (i.e. validated) by special resolution. This first special resolution
authorises and enables the company to enforce the contract. If the directors have incurred liability
to the company (say, because the company has suffered loss as a result of being held bound by the
transaction) then they may be released from liability by a further special resolution. This “double”
resolution is very unusual.
The first special resolution effectively brings the contract within the company’s powers
retrospectively. The second special resolution says that the directors are not liable to the company
simply because they committed the company to a transaction which technically fell outside the
objects clause.
9. These special resolutions can only be passed when an ultra vires act has been done or the ultra
vires transaction entered into. Nothing can authorise the directors in advance to enter into an ultra
vires transaction. However, if a transaction which is contemplated appears to be potentially ultra
vies, the company could alter its objects to bring it within the company’s capacity (see below).
10. Acts by directors which are not ultra vires the company but are beyond their own powers as
directors require an ordinary resolution to ratify the breach.
See Bamford v Bamford (later notes).
There is an exception to the above and that is where the transaction is between the company and
one of its directors (or a connected person to the director). The transaction is then voidable at the
instance of the company s. 322A. It ceases to be voidable if it is ratified by the general meeting by
special resolution.
The director will be liable to account for any gain made by him and indemnify the company for
any loss or damage.
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Ultra vires
capacity - lack of
S. 35(1)
Act not called into question on

ground of lack of capacity by
reason of anything in Co’s
memo.
Binding on Co and 3rd party.
S. 35(2)
Sh/h sue before legal obligation
S. 35(3)
Directors
ratified act by spec res/n

relief from liability by spec
res/n
S. 35B
A party to a transaction with a
co (3rd party) not bound to
enquire whether permitted by
co’s memo.
2.3.1.5 Alterations of the Objects Clause
1. S. 4 says that a company may by special resolution alter its objects clause.
NB It is not expected that a company which has adopted the 1989 objects clause (s. 3A) “to carry
on business as a general commercial company” would ever wish to change its objects clause
irrespective of any future changes or extension of its business activities.
2. Note that under s. 5 an application may be made to the court, within 21 days after the
resolution is passed, to cancel the alteration and therefore it is probably sensible for the company
to wait 21 days before acting on the special resolution.
The application to cancel may be made by holders of not less than 15% of the issued share capital
or not less than 15% of the members. The court may either confirm the alteration on such
conditions as it thinks fit or cancel it.
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2.4 The Articles of Association
1. The articles of association dealing with internal regulations of a company are subordinate to
the memorandum. Thus if there is any inconsistency between them, the memorandum prevails and
the articles are void in so far as they conflict with the memorandum. It is unclear how the
Companies Act 2006 will tackle this issue. As noted above, following s.28 of the 2006 Act, the
provisions of the memorandum are to be treated as part of the articles. The relevant
procedure for dealing with conflict between these documents is not addressed by the 2006
Act.
Guinness v Land Corpn. of Ireland 1882

Company’s memo stated that its objects were the development of land in Ireland and activities
incidental thereto. Clause in articles stated that part of its capital was to be invested to generate
income which could be used as a guarantee fund for the payment of dividends on its preference
shares.
Held, that the intention of the memo was that the whole of the company’s capital be employed to
pursue its objects as per the objects clause. The establishment of the guarantee fund was
inconsistent with that. Therefore the provision was void.
2. If, however, there is any ambiguity or uncertainty in the memorandum, reference may be
made to the articles to resolve it.
3. Note that if the memorandum is perfectly clear, it must be read on its own.
4. There are three alternative forms which a company’s articles may take
(a) It may adopt Table A in full. See Companies (Tables A-F) Regulations 1985 in Statute
Book. Table A is a model form of articles.
(b) It may wholly exclude Table A and set out its own regulations in full.
(c) It may set out its own articles and adopt part of Table A. This means that the company’s
articles and Table A must therefore be read together and Table A is excluded only where
the articles are inconsistent with it. If no articles are registered, Table A becomes the
company’s articles automatically.
5. Although all the earlier Companies Acts were repealed by the Companies Act 1985, the
repeal does not affect the respective Tables A of the earlier Acts. Therefore a company formed
under e.g. the Companies Act 1862 is still governed by Table A of that Act. This is a matter of
some importance because the earlier Tables A differ from the 1985 Table A. This is the only area
which is not repealed. In all other aspects the 1985 Act prevails.
Please note: Under the Companies Act 2006, it is proposed that three sets of “Model
Articles” are to be made available. Public companies, private companies and companies
limited by guarantee will each have a specially tailored set of articles, which will replace the
current model prescribed by Table A.
2.4.1 BINDING FORCE OF ARTICLES
1. S. 14 provides that subject to the provisions of this Act, the memorandum and articles, when
registered, bind the company and the members to the same extent as if they respectively had been
signed and sealed by each member and contained covenants on the part of each member to
observe all the provisions of the memorandum and of the articles.
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2. The company is bound to its members in the same way as the members are bound to the
company.
Hickman v Kent or Romney Marsh Sheep Breeders’ Association 1915

Articles provided for reference of differences between company and any members to go to
arbitration rather than court. H brought court action against company in connection with a dispute
as to his expulsion from the company.
Held: Articles are a contract between company and members. Therefore the action was stayed. H
bound by articles and had to go to arbitration not court.
3. This so-called statutory contract can only be enforced by members acting in their capacity as
members. Thus, a member as a member may sue the company, for e.g. to restrain it from
excluding him from membership or to compel it to enter his name on the register of members or
to compel the company to allow him to vote at a meeting of members.
4. However according to Astbury J in Hickman’s case (above) “. . no right merely purporting to

be given by an article to a person . . . in a capacity other than that of member as for instance, as
solicitor, promoter, director, can be enforced against the company”.
Eley v Positive Government Security Life Assurance Company 1875

E was a shareholder. Articles said E should be solicitor to the company for life. Employed as such
for time then company ceased to employ him.
Held: E was not entitled to damages for breach of the statutory contract against the company.
Articles did not create a contract between E in his capacity as a solicitor and the company. In
other words, the right to continue as the company’s solicitor was an outsider right not a
membership right.
Beattie v B.F. Beattie Ltd 1938

Arbitration clause in contract. Director (who was also a member) wanted to use it when sued by
company for the return of money.
Held: He was being sued in his capacity as director, therefore he could not use the arbitration
clause and the court refused to stay the proceedings
For the difficulties caused by Hickman’s case see Gower and Sealy.
SAQ 2
If directors cannot use the articles as a contract and have not got a service contract, what
can be done for those who have already worked for the company on the basis of the articles
and not been paid?
5. Because the above rule can cause hardship, the courts have in some cases decided that a
clause in the articles, not dealing with the rights of a member as such, but apparently intended to
operate as a contract with him, in his capacity as e.g. a director can be regarded as the basis of a
separate contract taking effect outside the articles. Consequently the parties are treated as having
made a contract with the implied terms being that of the clause(s) in the articles and the parties are
bound by this. The contract can be inferred from past conduct.
Re New British Iron Company ex parte Beckwith 1898
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No express agreement for remuneration for directors but articles provided that they were to
receive annual remuneration of £1,000. Directors claimed arrears in the company’s liquidation.
Held: Could do so. Contract inferred from conduct of parties who acted in reliance on the clause
in the articles by working for the company as directors.
6. If a contract is implied in this way a person who has acted in accordance with it cannot be
deprived, by an alteration of the articles, of rights accrued under it. In other words, such an
alteration cannot take effect retrospectively.
Swabey v Port Darwin Gold Mining Company 1889

Articles provided for the payment to each director by way of remuneration a specified sum per
annum. By special resolution in July, company reduced this as from end of preceding year.
Plaintiff therefore resigned and sued company for 3 months remuneration for services prior to
resignation at pre-July rates.
Held: Entitled to recover because there was an implied contract in the terms of the clause.
Lord Esher “The articles do not themselves form a contract but from them you get the terms upon
which the director is serving”.
7. However, it is valid to alter the terms of the implied contract for the future at least after a
period of reasonable notice.
Molineaux v London Birmingham and Manchester Insurance Co Ltd 1902

Company altered articles to increase directors’ share qualifications.
Held:Directors impliedly agreed to take the further shares from the company when they
continued to act as directors and did not obtain the further shares elsewhere within a reasonable
time.
8. As far as contractual relationships between the members themselves are concerned (as
opposed to between the company and a member) it is settled that the members are contractually
bound to one another to obey the provisions of the memorandum and articles so far as they relate
to their rights and duties as members.
9. However in construing the articles, it is not possible to imply a term in the articles from
extrinsic circumstances.
Bratton Seymour Service Co Ltd v Oxborough 1992 CA

The issue before the court was whether it was possible to imply into the articles of association of
a company set up to manage a development of flats, a term that the shareholders, who were the
owners of the flats, should make contributions for the upkeep of the amenity areas of
development.
Held: The articles constitute a statutory contract with its own distinctive features. Whereas the
court might be able to infer a term purely by way of constructional implication, it was not
possible to go further and to imply a term from extrinsic circumstances. On the facts, it was not
possible to imply a term that the shareholders of a company should be under an obligation to
make an additional financial contribution since this went well beyond the language of the articles.
Steyn LJ. The question is whether it is ever permissible to imply into articles of association a
term, not on the basis of a construction or implication deriving purely from the consideration of
the language of the instrument, but on the basis of extrinsic evidence of surrounding
circumstances. If it contains provisions conferring rights and obligations on outsiders, then those
provisions do not act as part of the contract between the company and its members even if the
outsider is coincidentally a member. Similarly if the provisions are not truly referable to the rights
and obligations of members as such it does not operate as a contract.
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10. If the wrong affects the company as well as an individual member i.e. corporate rights are
infringed, normally that member can only enforce such agreement through the company because
of the rule in Foss v Harbottle which states when a wrong has been done to the company the
proper plaintiff is the company. (See later notes)
11. If personal rights are infringed, however, a clause in the articles may be seen as a personal
undertaking by a member to other members and in such a case the other members may sue him.
Rayfield v Hands 1960

Articles of private company said if member was intending to transfer his shares he should inform
the directors and the directors “will take the said shares equally between them at fair value”.
Held: Articles bound defendant directors, who were all members, to buy plaintiff shares and
related to the relationship between the plaintiff as a member and the defendants not as directors,
but as members of the company and it was not necessary for the company to be a party to the
action.
Gower points out “what he (Vaisey J) would have held if one of the directors had not been a
member is unclear”.
2.4.2 ALTERATION OF ARTICLES
1. A company may by special resolution alter or add to its articles (s. 9) although note that once
the CLR Bill is implemented it will be possible to entrench certain provisions in the articles.
2. Its power to do so cannot be taken away or limited by any provision in its memorandum or
articles or a contract to which the company is a party. But the altered articles must be consistent
with the company’s memorandum otherwise the alteration is void.
Russell v Northern Bank Development Corp Ltd 1992

In the 1970’s the company and four shareholders entered into a shareholders agreement. This
agreement was expressed to take precedence over the articles and further provided that no
additional share capital would be created or issued by the company without the written consent of
all the parties to the agreement. In 1988 the board decided to give notice to shareholders
proposing an increase in the company’s share capital.
Held: The company’s undertaking in the shareholders agreement not to increase its capital
without the consent of the four shareholders was unenforceable because it amounted to an
undertaking not to exercise its statutory powers.
NB. Since its undertaking was independent and severable from that of the shareholders, the
shareholders agreement was held to be enforceable as between the four shareholders.
3. The alteration must be in good faith and must benefit the company as a whole.
Allen v Gold Reefs of West Africa Ltd 1900

Articles gave the company a lien on partly paid shares to secure all debts and liabilities of a
member to the company. Zuccani on his death owed money to the company (arrears of calls on
partly paid shares) and was the only holder of fully paid shares. Articles altered so as to give the
company a lien on fully paid shares.
Held: Valid because exercised not only in manner required by law, but for the benefit of the
company as a whole.
4. The test of what is for the benefit of the company as a whole was seen in Shuttleworth v Cox
as merely being the majority voting in good faith for the change.
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Shuttleworth v Cox Bros and Company Ltd 1927

Company articles said directors should be permanent directors unless disqualified in 6 events.
None of 6 events occurred. Shuttleworth on 22 occasions within 12 months failed to account for
money he had received. Articles altered adding 7th event, i.e. request in writing signed by all
other directors that he should resign.
Held: Valid because exercised not only in manner required by law, but for the benefit of the
company as a whole.
Bankes LJ “the test is whether the alteration of the articles was in the opinion of the shareholders
for the benefit of the company”.
This seemed to get rid of the principle entirely since it is so difficult to prove otherwise.
5. However Evershed M.R. restated the test in
Greenhalgh v Arderne Cinemas Ltd 1950.

Articles of private company prohibited a transfer of shares to a non-member so long as another
existing member was willing to buy them at a fair value. Holder of majority of the shares wished
to transfer them to a non-member, so the articles were altered to permit a transfer to any person
with the sanction of an ordinary resolution.
Held: The alteration was bona fide and valid although thereby the minority lost their rights of pre-
emption.
Per Evershed M.R., “bona fide for the benefit of the company as a whole . . . means that the
shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a
whole . . . the phrase’ the company as a whole ‘does not . . . mean the company as a commercial
entity, distinct from the corporators: it means the corporators as a general body. That is to say the
case may be taken of an individual hypothetical member and it may be asked whether what is
proposed is, in the honest opinion of those who voted in its favour, for that person’s benefit.
“. . . a special resolution of this kind would be liable to impeached if the effect of it were to
discriminate between the majority shareholders and the minority shareholders, so as to give the
former an advantage of which the latter were deprived . . . it is therefore not necessary to
require that persons voting for a special resolution should, so to speak, dissociate themselves
altogether from their own prospects.”
One might add that to hold otherwise would do considerable violence to the principle of majority
rule.
6. Note that the state of mind of the member arises in the first part of the above statement hence
it is the second part which is the objective test of discrimination. Note the hypothetical member is
not only a present member but is someone who may be a member at any time, present or future
and who may have any number of shares i.e. a small or large shareholding.
7. The Greenhalgh v Arderne Cinemas Ltd objective test was followed in
Rights and Issues Investment Trust Ltd v Stylo Shoes Ltd 1965
Issued capital of Shoes Ltd comprised 400,000 management shares which carried 8 votes each
and 3,600,000 ordinary shares. S Ltd acquired shares in B Ltd in consideration of issue of
8,400,000 ordinary shares in S Ltd. Articles altered so as to double the votes carried by
management shares in order to ensure continuity of management. Special resolution carried by
large majority at an extraordinary general meeting of the company. Holders of management
shares, directors of S Ltd did not vote in respect of these share or their ordinary shares. Nor did
they vote at a separate class meeting of the ordinary shareholders which sanctioned the special
resolution.
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Held: Alteration valid.
Pennycuick J held that the resolutions were passed in good faith and that they did not discriminate
against the plaintiff in view of the fact that all the ordinary shareholders suffered the same dilution
of their voting power i.e. he used Evershed M.R.’s test of benefiting the company as a whole and
held that it did.
SAQ 3
Do you think it is for the benefit of the company to expropriate minority shares in certain
circumstances?
2.4.3 SITUATIONS WHERE ARTICLES ARE ALTERED
2.4.3.1 Expropriating Minority Shares
1. There have been certain cases whereby the articles have been altered giving power to the
majority to compel the minority to sell their shares. Although they were before Greenhalgh v
Arderne Cinemas Ltd, they seemed to be formulating the same objective test of oppression or
discrimination and in most cases the expropriation was held to be void.
Dafen Tinplate Co Ltd v Llanelly Steel Company (1907) Ltd 1920

The defendant company manufactured steel bars and members used steel bars and generally
purchased their supplies from the defendant company (although no obligation to do so). Plaintiff
company which held shares in the defendant began buying elsewhere. Defendant company altered
articles to enable it by ordinary resolution to require any member to sell its shares to other
members at a fair price but one member was expressly excluded from this (the majority).
Held: Alteration void.
Peterson J. “To say that such an unrestricted and unlimited power of expropriation is for the
benefit of the company appears to me to be confusing the interests of the majority with the benefit
of the company as a whole.”
See also Brown v British Abrasive Wheel Company 1919 where the company was in need of a
capital injection which the majority were prepared to provide if they could buy out the minority.
Articles changed so shareholder bound to transfer shares and exit the company if 9/10ths
requested in writing.
This was held to benefit the majority rather then the company and was therefore invalid.
A similar approach was taken by the High Court of Australia in Gambotto v WCP Ltd 1995 where
the articles of a company were again altered to provide that any shareholder controlling more than
90% of its shares could acquire compulsorily the remaining shares in the company.
Held: The onus of proof with respect to the validity of the alteration was on the majority (note not
the minority which is the position in England). Even though Mr Gambotto would arguably have
been better off financially as a result of the expropriation, the court struck down the alteration as it
eliminated his membership of the company and deprived him of valuable proprietary rights.
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2. A power of expropriation however will not always be void. It will be valid if it is calculated to
protect the company from an injury which it might otherwise suffer and is strictly limited to
serving that purpose.
Sidebottom v Kershaw Leese and Co Ltd 1920

A private company altered its articles to say that if any shareholder competed with the company’s
business he had to transfer his shares at their fair value to nominees of directors. S. was a
minority shareholder who had set up a competing business. He claimed that the alteration was
invalid.
Held: It was valid as, although the alteration affected S. directly, it nevertheless benefited the
company as a whole.
2.4.3.2 Service Contracts
1. A company cannot by altering its memorandum or articles, or by acting in accordance with its
articles alter the terms of a contract which it has already entered into and escape liability for
breach of such a contract.
Nelson v James Nelson and Sons Ltd 1914

The plaintiff by agreement in writing was appointed joint managing director “for so long as he
shall remain a director of the company and retain his due qualification and shall efficiently
perform the duties of the said office”. Article 85 of the company’s articles said that the board
might from time to time appoint one or more managing directors for such period as they should
deem fit and might revoke such appointment. The board revoked Nelson’s appointment and he
sued for damages.
Held: He was entitled to damages for breach of contract.
Thus a separate service contract appointing a person managing director for a prescribed term will
prevail over a provision in the articles empowering the company to revoke such an appointment.
2. If, however, a person appointed has no express service contract and the only source from
which the terms of a contract can be determined is the articles themselves, there is no breach of
contract when the company exercises a power to remove him which was expressly contained in
the articles.
Read v Astoria Garage (Streatham) Ltd 1952

Articles included term that directors might appoint a managing director for such term and at such
remuneration as they think fit but his appointment shall be subject to determination if he ceases
from any cause to be a director or if the company in general meeting resolve that his tenure as
managing director be determined. 17 years later managing director (Read) was sacked by general
meeting.
Held: No claim for breach of contract was possible.
3. It is important to note also that a person cannot obtain an injunction to prevent the
alteration of the memorandum or articles from taking effect.
4. The other party to a contract has however his ordinary remedies (that is damages) against the
company.
Southern Foundries (1926) Ltd v Shirlaw 1940
S was appointed under a separate service contract to be managing director of Southern for 10
years. Three years later Southern was taken over by another company and the articles altered in
such a way as to authorise that company to remove any director of Southern by notice in writing.
S was removed from office using this new procedure.
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Held: There had been an implied undertaking by Southern not to remove the managing director
and not to alter its articles so as to create a right to do so and the managing director was
accordingly entitled to damages for breach of contract.
Lord Porter “A company cannot be precluded from altering its articles, thereby giving itself
power to act upon the provisions of the altered articles - but so to act may nevertheless be a
breach of contract if it is contrary to a stipulation in a contract validly made before the alteration”.
5. However, by s.319 directors may not, without the sanction of a resolution in general meeting,
be given service contracts which are to continue for more than 5 years, on terms that the company
may not, within the duration of the contract, terminate the agreement by notice.
Any service contract for more than 5 years which is not so sanctioned shall be void to the extent
that it contravenes the section and shall be deemed to contain a term entitling the company to
terminate the agreement on reasonable notice.
Please note: When in force, Companies Act 2006, s.188 will have the effect that a director’s
long-term service contract under which the guranteed term of employment is, or may be,
longer than two years (as opposed to the current term of five years), will have to be
aproaved by resolution of members of the company.
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2.5 Questions
1. What are the documents which need to be sent to the Registrar when forming a company?
2. Which are the two major documents?
3. What are the rules relating to the choice of name for a company?
4. What problems could arise if the wrong name is chosen?
5. How may a company change its name?
6. What are the rules relating to use of name?
7. What is the ultra vires doctrine and what effect did it have on the drafting of objects clauses?
8. What effect has the 1989 Act had on the objects clause?
9. Why is an outsider not affected by the ultra vires doctrine?
10. What may a shareholder do if the company is about to make, or already has made, an ultra
vires contract?
11. What are the articles of association?
12. What is the legal effect of them?
13. Can a director enforce a clause in the articles as part of his/her contract with the company?
14. How may the articles be altered?
15. What attitude does the court take when articles are being altered?
16. Can minority shares be expropriated and if not, why not?
17. What effect do the articles have on directors’ service contracts?
The following question forms part of an old examination question. An outline answer is given
below it.
Question
Lynn is a director of a company in which she also has a small shareholding. There is a provision
in the articles of association stating that Lynn is to be a director for a fixed term of three years
from the date of incorporation at a salary of £20,000 per annum. The company was incorporated
in June 1999. It is now June 2000 but the company wishes to remove Lynn from office as a
director.
70
Advise Lynn as to whether the company can lawfully remove her from office and, if so, whether
she can rely on the provision in the articles.
71
CHAPTER THREE
LAW OF PROMOTERS AND CORPORATE

CONTRACTUAL CAPACITY
3.1 Objectives
1. Identify a promoter and his/her duties.
2. Recognise where a pre-incorporation contract under s. 36C has arisen.
3. Evaluate the common law rules of agency and how they apply in company law.
4. Explain how statute protects a third party’s contract.
5. Identify situations where the rule in Turquand’s case might be useful.
3.2 Promoters
(a) Definition
A definition of a promoter is “one who undertakes to form a company with reference to a given
project and to set it going and who takes the necessary steps to accomplish that purpose”
Cockburn CJ in Twycross v Grant 1877. As a result anyone can be a promoter and promoters vary
from those forming their own small private family companies to those forming a large public
company.
(b) The duties of a promoter
The two main fiduciary duties of promoters are
• not to make any secret profit out of the promotion of the company without the company’s
consent and
• to disclose to the company any interest which he/she has in a transaction entered into by the
company.
These are owed to the company.
1. If a promoter purchases property or a business and resells it to the company at an increased

price, this is a secret profit if the promoter does not disclose it to the company.
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LAW OF PROMOTERS AND CORPORATE CONTRACTUAL CAPACITY
Erlanger v New Sombrero Phosphate Co 1878.

A syndicate purchased an island for £55,000. Island contained valuable phosphates. Syndicate
sold island to a company which they were promoting for £110,000.
Held: Since there was no disclosure to an independent board of directors, the company was
entitled to rescind the contract and recover the purchase money. Note that the remedy of
rescission would still have been available even if the syndicate had not profited from the re-sale.
In those circumstances there would still be a need for the promoters to disclose their interest.
2. It became fairly obvious, however, that it is often impossible to disclose to an independent

board of directors especially if a family company is involved. For example in Salomon v Salomon
the promoters were also the directors and nowadays this is often the position. A person or
partnership will form a company and sell their existing unincorporated business to the company of
which the person or partners are the first directors.
The solution to the problem is a full disclosure to existing and intended shareholders. This may be
done in a prospectus or in some other way such as the articles so that the incoming members have
full information. Partial disclosure is not enough.
Gluckstein v Barnes 1900

Promoters disclosed that they had purchased for £140,000 the property which the company was
now to purchase for £180,000. They did not disclose that they had bought debentures at a
substantial discount knowing they would be repaid at par once the company purchased the
property.
Held: These profits should also have been disclosed and the promoters were liable to account for
them to the company.
Contrast Salomon v Salomon where all the incoming shareholders knew the inflated price being
paid to Salomon for his business.
3. There should be a difference between the situation where a promoter acquires property for
himself and then later forms a company and sells the property to the company (the secret profit
situation) and the situation where a promoter forms a company first and then acquires property in
his own name and sells it to the company. In the latter situation he should properly be regarded as
a trustee and therefore should not in theory be able to make a profit out of the sale to the company
whether it is disclosed or otherwise. However, the courts seem willing to leave the profit with the
promoter provided there has been sufficient disclosure. The courts seem to accept that in the latter
situation, a promoter can purchase for resale to the company or he can purchase for the company.
In the former he can make a profit provided there is disclosure; in the latter he is regarded as a
trustee and cannot make a profit.
(c) Remedies for breach of duty
1. Since the duties are owed to the company, it is the company who is the proper plaintiff. (see
Foss v Harbottle - later notes) when the promoter is in breach of his/her duty. The company may
sue for rescission of the contract and/or recovery of the secret profit.
In Erlanger v New Sombrero Phosphate the company was entitled to rescind the contract. In
Gluckstein v Barnes the company could not rescind but elected to recover the secret profit.
The right of rescission is lost if the parties cannot be restored to their original position (restitutio
in integrum) or if third parties have acquired rights in good faith, for value and without notice.
Further situations arise whereby the promoter may be liable for deceit, or for damages for failure
to disclose or for negligence in allowing the company to purchase the property at such an
excessive price.
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3.3 Company Contracts
(a) Pre-Incorporation Contracts
1. A pre-incorporation contract is purported to be made on behalf of a company before its

incorporation and therefore the company is in fact non-existent. Before its incorporation a
company has no capacity to contract and therefore at common law no one can act as agent for it
because the principal does not exist. It is also not possible for the company to ratify this contract
after it is formed because for ratification to take place, the principal has to be in existence at the
time the contract was made.
Re English and Colonial Produce Co Ltd 1906

Solicitors could not recover their fees for setting up a company from the company after it was
formed.
Natal Land Co Ltd v Pauline Colliery Syndicate Ltd 1904

Before Pauline Colliery Ltd was incorporated, promoters contracted in its name for an option to
take a lease on land. The land was found to be rich in coal. Natal Company Ltd now owners of
the land refused to grant the lease when Pauline Colliery Ltd sought to exercise the option.
Held: Pauline Colliery Ltd could not force Natal Company Ltd to grant the lease because it had
not existed when the option contract was made.
2. The situation was resolved slightly by Kelner v Baxter 1866 whereby the person making the
contract on behalf of the non-existent principal was held to be personally liable on it.
Facts:
Three promoters made a contract “on behalf of” their unformed company for purchase of wine
from Kelner. The company was incorporated after this contract had been made but soon went into
liquidation.
Held: The promoters were personally liable on the contract.
Kelner v Baxter was distinguished in later cases and therefore at common law the situation was
highly unsatisfactory since no one seemed to be liable for pre-incorporation contracts and the risk
therefore lay with the other contracting party.
3. The situation changed in 1972 as a result of the 1st European Union Company Law Directive.
This is now implemented by s. 36C which states:
“A contract which purports to be made by or on behalf of a company at a time when the

company has not been formed has effect, subject to any agreement to the contrary, as one made
with the person purporting to act for the company or as agent for it, and he is personally liable
on the contract accordingly”.
Phonogram Ltd v Lane 1981

The parties contemplated the formation of a company to manage a newly formed pop group (to be
named Cheap Mean and Nasty) which would enter into a recording contract with the plaintiff.
Defendant signed an agreement “for and on behalf of” the proposed company and an advance
payment of £6,000 was given. Company was never formed and no recording contract was entered
into.
Held: Defendant liable to repay £6,000 as the person purporting to act for the company.
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Cotronic (UK) Ltd v Dezonie 1991

(Plaintiff Cotronic not involved in this appeal) The third party, Mrs Osborne entered into a
contract with Wendaland Builders Ltd in 1986 for building work on a residential home for the
elderly. Unfortunately, Wendaland Builders Ltd had been struck off the register in 1981 and
Dezonie, its controller, did not know. He found out and then formed another company with the
same name in 1988.
Held: This was not a s. 36(4) (statutory predecessor of s. 36C) situation. In 1986 no one had
thought about forming a new company at all therefore this was not a contract purporting to be
made on behalf of a non-existent company. The old company did not fit within s. 36(4) either.
Therefore the contract was a nullity and of no effect at all. However, a claim under quantum
meruit (plaintiff subcontractor claimed from Wendaland Builders Ltd who claimed from Mrs
Osborne) for work done was allowed.
Badgerhill Properties Ltd v Cottrell 1991

Mrs Cottrell employed firm which described the company incorrectly as Badgerhill Property Ltd.
Mrs Cottrell said she was entitled to claim under s. 36(4) (as it then was) against the company’s
director.
Held: s. 36(4) did not apply. The company had already been formed, even though it was using an
incorrect name, and had made the contract therefore the director could not be personally liable.
4. In both Cotronic and Badgerhill the words of Oliver LJ in Phonogram were used. Oliver LJ
said “The question I think in each case is what is the real intent as revealed by the contract? Does
the contract purport to be one which is directly between the supposed principal and the other
party, or does it purport to be one between the agent himself albeit acting for a supposed principal
and the other party? In other words, what we have to look at is whether the agent intended himself
to be a party to the contract”.
In Cotronic it was held that the contract was not with Dezonie himself and the third party since
that was not the real intent of the parties. In Badgerhill there was also no intention that Twigg, the
director should be a party to the contract. Twigg had merely appended his name to authenticate
the contract on behalf of the company.
5. To try and avoid liability under s. 36C (as it now is) promoters or agents use different
methods of contracting.
i. If it is essential that the contract should be made before incorporation the promoters may
contract with the third party personally and then assign the benefit of the contract to the
company after it is incorporated. A clause is put in the contract stating that the promoters
are released from their obligations if the company is willing to enter into an identical
contract with the third party after it has been incorporated. This is called novation.
ii. The promoters take an option to purchase then assign it to the company when it is
incorporated.
iii. The promoters prepare a draft agreement between intending company and third party and
the agreement is executed after incorporation.
iv. S. 36C says “subject to any agreement to the contrary”. Thus the parties may agree that the
promoter is not to be liable. However, in Phonogram Ltd v Lane, Lord Denning said the
words meant “unless otherwise agreed” and that s. 36(4) (as it then was) would apply
“unless there is a clear exclusion of personal liability”.
6. One issue that has only recently been resolved by the courts is whether s. 36C also entitles the
person purporting to act on behalf of the non-incorporated company to bring an action himself to
enforce the contract.
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Braymist Ltd. and others v Wise Finance Co Ltd [2002] All ER (D) 267
A contract was entered into by Braymist Ltd for the sale of a piece of land on 28th January 1993.
At the time the contract was made, Braymist had not yet been incorporated, and the title to the
property was held by another company, Plumtree Ltd. The latter company was a wholly owned
subsidiary of Pique Holdings plc. 75% of the shares in Pique were held by Mr Pool. Braymist Ltd
was finally incorporated on 5th March 1993. It was a wholly-owned subsidiary of Plumtree Ltd.
Mr Pool retained solicitors to act on the sale of the property. On his instructions the solicitors had
signed the contract “as Solicitors and Agents for Braymist Ltd”. The buyer subsequently failed to
complete the purchase and, accepting this as a repudiatory breach of contract, Braymist Ltd
rescinded the agreement. The question arose as to whether Braymist Ltd could maintain an action
in breach of contract against the buyer. The buyer claimed that Braymist Ltd had no contractual
rights because it was not in existence when the contract was made and so could not have been a
party to it. The main issue which the judge had to decide was whether s. 36C, a provision
designed to impose personal liability on a person purporting to act on behalf of a non-
incorporated company, also gave that person a positive right to enforce the contract in question.
Held: The contract was a complete nullity at common law following Newborne v Sensolid (Great
Britain) Ltd [1953] 1 All ER 708 had not been incorporated at the time the contract was made and
was therefore non-existent. None of the other parties had purported to enter into the contract as
principals, nor had they given any indication that they would assume personal liability under the
contract. Furthermore, it was not possible for Braymist Ltd to ratify the contract because at
common law, a company cannot ratify a contract, even where made expressly on its behalf, where
the contract was concluded before the company came into existence. However, on a proper
reading of s. 36C, the contract was valid and effective not only to hold those who purported to act
on behalf of the non-incorporated company (here, the solicitors) personally liable, but also to give
them the right to enforce the contract. Read literally, s. 36C(1) was clear and unambiguous: the
contract “has effect. . . as one made with the person purporting to act for the company or as its
agent” (emphasis added). This wording did not merely impose personal liability on the purported
agent. It gave the contract between the purported agent and the third party full effect. In the
judge’s view, the words, “. . . and he is personally liable on the contract accordingly”, were added
by Parliament to override the old common law position. The contract took effect as one between
the buyer and the solicitors.
SAQ 1
Does the holding that the purported agent has rights as well as liabilities under a pre-
incorporation contract make any practical difference?
One question that was not addressed at any length in the Braymist case is that of contractual
remedies. The solicitors had arguably suffered no loss as a result of the buyer’s breach. To the
extent that any quantifiable loss was suffered, it was suffered by Mr Pool and his group of
companies. It may well be that the rights of the purported agent under s. 36C will only be of
practical worth if it can be shown that he or she has suffered some quantifiable loss. This should
be possible in a case where the purported agent is the person who ends up controlling the
company once it has been incorporated. A further issue of academic interest is whether a
purported agent could enter into a contract intended to confer a benefit on a company as yet to be
incorporated which could then be relied upon by the company once it comes into existence. It
appears that this would now be possible under the Contracts (Rights of Third Parties) Act 1999
which abrogated the privity rule.
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3.4 Post Incorporation Contracts
Under s.36 a contract may be made:
i. by a company, by writing under its common seal or
ii. on behalf of a company, by any person acting under its authority, express or implied
1. If a contract is signed by a director and the company secretary or by two directors and is
expressed to be executed by the company, then it has the same effect as if executed under the
common seal of the company (whether or not a company has a common seal).
2. Where a person acts under authority of the company and makes a contract on behalf of the
company, then the company becomes contractually bound.
There are two problems regarding 2:
i. The contract may be beyond the company’s contractual capacity , i.e. ultra vires. However
this situation is covered by s. 35 (see earlier notes on the objects clause). Note also that the
CLR Bill when brought into force will effectively abolish all that remains of the ultra vires
doctrine as far as outsiders are concerned.
ii. The third party or outsider needs to know whether the person who has acted for the
company did so with the company’s authority, i.e. agency rules are involved here, or there
is statutory protection for the outsider. Alternatively, in a rare case the rule in Turquand’s
Case may help a third party.
3.5 Agency
Directors are agents of the company through whom the company acts. (Obviously a company -
the principal - cannot act by itself). English company law places great emphasis on the status of
the board of directors collectively and it treats the board as a collective agent of the company.
Directors are also bound individually by the ordinary rules relating to agency and third parties are
also bound by these rules.
We have seen that many difficulties of corporate contracting can be resolved (from the third
party’s point of view) by sections 35, 35A and 35B. What if, an individual director acts in a way
which purports to bind the company. It is in that situation where the rules of agency at common
law are likely to have residual application. The basic rule is that an agent can only act within his
authority.
Authority is actual, usual or apparent (ostensible). If an agent acts with actual, usual or apparent
authority then the company is bound by the act. If the agent does not have the required authority,
the company is not bound and all the outsider can do is sue the agent for breach of warranty of
authority.
The company may however ratify an unauthorised act (by ordinary resolution if intra vires, by
special resolution if ultra vires).
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3.5.1 ACTUAL AUTHORITY
Actual authority is the authority conferred on the agent by the contract governing his agency
which has been agreed between him and the company.
The agency contract may be express or implied.
a. Express authority
This may take the form of a deed or may be written or oral.
The normal rules of interpretation of contracts will be used to measure the extent of the agent’s
authority and also the surrounding circumstances will be taken into consideration; for example,
the usual trade practices of that type of agent.
The articles usually confer authority on directors and the authority is usually conferred on the
board of directors as a whole. The articles usually contain powers of delegation by the board. Also
the articles allow the board to appoint one or more of its numbers to be a managing director. The
articles may however reserve certain matters for the approval of the general (shareholders)
meeting.
b. Implied authority
In certain circumstances the principal (the company) will be bound by any act done by the agent if
that act is necessary for or reasonably incidental to the carrying out of the express authority given
to the agent.
Implied authority is based on the idea of giving business efficacy to a transaction. It can
sometimes be inferred from previous dealings between the principal and agent.
Hely-Hutchinson v Brayhead Ltd 1968 CA

R was the chairman and acted as managing director of the defendant company. He often made
contracts which the board later approved. Plaintiff was chairman and managing director of
another company. Plaintiff became a director of defendant company and R signed an agreement
whereby the defendant company agreed to guarantee the repayment of money owed to the
plaintiff, and to indemnify him against certain losses. Defendant company said R had no authority
to make the contract on its behalf.
Held: By Court of Appeal, R had actual authority. It was implied from the conduct of the board
acquiescing in the past to his making contracts without the prior sanction of the board.
NB. Hely-Hutchinson has not been followed in later cases. In this case the judge at first instance
held that R had apparent authority to bind the company. This would seem to be the preferable
decision.
3.5.2 USUAL AUTHORITY
This can go outside the limits of express authority. The question is not what powers have been
given to the agent expressly or impliedly by the principal but rather what powers does this agent
in this particular trade usually have?
i.e. is it usual for someone in the agent’s trade or profession to have these particular powers?
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The principal may have limited the agent’s usual powers by forbidding him to carry out certain
acts but this does not affect third parties if they are unaware of the limitation. The principal will
be bound by all such acts of the agent.
3.5.3 APPARENT OR OSTENSIBLE AUTHORITY OR AGENCY BY

ESTOPPEL
The ability of a company to repudiate an act of an agent outside the agent’s actual authority is
severely limited by the common law doctrine of apparent authority.
a. Apparent authority is authority which appears to exist as a result of the principal’s conduct. It
arises where the principal in some way represents that authority has been given to the agent
although no authority has in fact been given.
b. If a third party contracts with the agent in reliance on this representation then the principal
will be bound by the agent’s acts.
Another way of expressing this is to say that the principal is estopped from denying that the
agency relationship exists.
c. Managing Directors
i. A person’s job title or official position is the most important area where apparent authority
arises and the principal gives the job title. A managing director is expected to have a wide range
of authority to make contracts on the company’s behalf by the nature of his job title.
Therefore when a person deals with a managing director unaware of any restrictions placed on his
authority, the third party can assume that he has the powers a managing director usually has and
the company is estopped from denying this.
Hely-Hutchinson v Brayhead Ltd 1968 CA – See Cases & Materials 3.3 for more detail.
In this case, because R was de facto managing director, Roskill J at first instance said he had
apparent authority because the board had allowed him in the past to enter into commitments of
the kind he entered into in this particular case. This amounted to a representation by the principal.
Pennington says this case shows that a managing director’s apparent authority includes the ability
to bind the company to indemnify persons who have given guarantees.
SAQ 2
When might the actual authority of a managing director be different from his apparent
authority?
ii. Often, an agent’s actual authority is the same as his apparent authority. Sometimes, however,
there may be a limitation on the agent’s actual authority which makes it less than his apparent
authority.
This situation occurs when his authority has been expressly limited by the principal.
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If the third party is aware of any express limitation or if something came to his attention and a
reasonable man would have been suspicious and would have made enquiries, then the third party
is not entitled to rely on apparent authority.
A L Underwood Ltd v Bank of Liverpool & Martins 1924

MD owned all shares in a company except one. He paid company cheques into his personal
account and drew cheques for his own purposes on the company’s bank account.
Held: The bank was put on enquiry. Since it had not enquired whether the endorsements were
authorised it was liable to the company for conversion of the cheques and could not rely on the
MD’s apparent authority.
iii. The other situation which arises in which actual authority is less than apparent authority is
where the person has never been appointed to the position he appears to hold. The company will
be bound by the person’s acts only if it is estopped from denying that it gave him the authority he
appeared to have.
This arises if the company has represented or held out the person as having authority and the third
party relied on this representation.
The usual situation that arises is where a person is held out as being a managing director and yet
he has never been properly appointed as such.
Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd 1964

Defendant company was formed to purchase and resell an estate. Articles gave full powers of
management to directors, (four of them) and also power to appoint an MD though none was ever
formally appointed. Kapoor, a director, acted as de facto MD and the board permitted him to do
so. K instructed architects to do certain work in connection with the estate.
Held: Company bound by the contract and liable for architect’s fees.
See Cases & Materials 3.3.2 for Lord Diplock’s complete judgment.
Diplock LJ said: “. . . the relevant law . . . can be summarised by stating four conditions which
must be fulfilled to entitle a contractor to enforce against a company a contract purportedly
entered into on its behalf by an agent who had no actual authority to do so.
It must be shown -
• that a representation that the agent had authority to enter on behalf of the company into a
contract of the kind sought to be enforced was made to the contractor;
• that such representation was made by a person or persons who had ‘actual’ authority to
manage the business of the company either generally or in respect of those matters to which the
contract relates;
• that the contractor was induced by such representation to enter into the contract, that is, that
he in fact relied upon it.”
Diplock LJ’s fourth condition is no longer relevant because of s. 35 and s. 35A and s. 35B if the
contractor dealt with the company in good faith.
Under (2) the representation will usually be inferred from the board’s conduct namely its
acquiescence in the agent’s activities.
In Freeman & Lockyer, K had apparent authority because he had been held out by the board as de
facto MD by conduct and therefore as having the wide authority of an MD. This contract was
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within the usual authority of an MD. Therefore, the plaintiffs in relying on the representation
could assume that he had been properly appointed.
If the representation is made by someone without actual authority (see Diplock LJ’s second
condition), e.g. the agent himself, the outsider cannot rely on it.
British Bank of the Middle East v Sun Life Assurance of Canada (UK) Ltd 1983
A sales representative whose job title was ‘unit manager’ of an insurance company purported to
bind his company to repay sums to a bank which had been lent to another company. He had no
actual authority. The bank received confirmation of the unit manager’s authority from a branch
manager of the company
Held: Neither manager had the requisite authority. The unit manager had no authority to give
such an undertaking to the bank. The branch manager had no authority to represent that the unit
manager had such authority. The bank knew of the usual limitations on the authority of these
managers and accordingly the company was not bound.
Criterion Properties plc v Stratford UK Properties LLC [2004] UKHL 28.

Criterion’s managing director had no actual authority to agree the terms of a ‘poison pill’
agreement. The issue before the House of Lords concerned whether the MD had apparent
authority to agree the terms, even though these terms could be detrimental to Criterion. If the
board of Criterion had power to sign the agreement, the company would be bound.
Held: The H of L confirmed that a third party can rely on apparent authority only in the absence
of knowledge that the agent lacks actual authority.
d. Persons not Managing Director
i. Where the outsider (third party) is dealing with someone other than a managing director, his
position may be difficult. This applies, e.g. if the person is simply a director who is not or has not
been held out as a managing director, because a single director acing alone usually has no
authority to bind the company, i.e. no usual or apparent authority.
ii. Also if the outsider is dealing with a manager, secretary, etc., he will be protected only if he
can establish that, regarding the transaction in question, the person had actual authority (i.e.
express or implied) or usual authority for that job, or that he had apparent authority, i.e. the
company was estopped from denying that it was bound
Kredit-bank Cassel GmbH v Schenkers Ltd 1927

Articles empowered directors to decide who should have authority to draw bills of exchange on
company’s behalf. Clarke, the company’s Manchester branch manager, drew bills on the
company’s behalf in favour of Kredit-bank. Kredit-bank accepted them believing Clarke to have
authority to draw them.
Held: C had no such authority and it was unusual for a branch manager to have such authority.
The company was not bound
Houghton & Co v Nothard, Lowe & Wills 1927

Lowe, a director, purported to make on behalf of the defendant company an agreement whereby
the plaintiff company was to sell on commission goods imported by the defendant company and
retain the proceeds as security for a debt owed to the plaintiff company by another company of
which L was also a director. There was a power of delegation in the articles but L had no actual
authority to make the agreement.
Held: Defendant company was not bound by agreement. The House of Lords regarded as
significant the fact that L acted merely as one of the company’s ordinary directors rather than as a
managing director.
Cases like Kredit-bank Cassel, and Houghton involved transactions which were outside the scope
of the usual authority of persons in the position of those acting for the company and in each of
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them the plaintiffs were forced to rely on the fact that under the articles, the necessary authority
might have been delegated. This was not sufficient to protect the plaintiffs. In Freeman Lockyer
Willmer J said - “if the articles merely empower the directors to delegate to an officer, authority
to do an act, and the officer purports to do the act, then if the act is one which would ordinarily be
beyond the powers of such an officer, the plaintiff cannot assume that the directors have delegated
to the officer power to do the act; and if they have not done so, the plaintiff cannot recover.”
iii. A company secretary’s usual authority which hardly existed before 1971, has been extended
to include authority to enter into contracts relating to the administrative side of a company’s
affairs.
Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd 1971

Company secretary purported to hire cars on behalf of the company for the purposes of meeting
customers and fraudulently used the cars for his own private purposes.
Held: Secretary had apparent authority to enter into contracts for the hire of cars on behalf of the
company and the company was liable to pay the hire charges.
In the above situation usual authority has overlapped with apparent authority. The case was
decided on the ground that the company secretary had apparent authority but it can also be seen as
an illustration of how a particular class of agent has certain powers and duties which are regarded
as usual for agents in that class or position.
For another recent application see Racing UK Ltd v Doncaster Racecourse Ltd and Doncaster
Council [2004] EWHC (QB).
3.6 Statutory Protection of Outsiders
3.6.1 SECTION 35A COMPANIES ACT 1985
Again, the ability of a company to repudiate an act of one of its agents as outside the agent’s
authority is limited by the Companies Act 1985, sections 35A and 35B (introduced by the 1989
Act). S. 35A covers situations where the transaction entered into is intra vires the company but a
limitation has been imposed on the directors (usually in the company’s constitution).
S. 35A(l) In favour of a person dealing with a company in good faith, the power of the board of
directors to bind the company, or authorise others to do so, shall be deemed to be free of any
limitation under the company’s constitution.
S. 35A(2) goes on to say that for this purpose -
a. A person “deals with” a company if he is a party to any transaction or other act to which the
company is a party.
This means that the transaction must be entered into with the board of directors collectively or by
a person authorised by them, i.e. the transaction must be entered into by an agent (with actual,
usual or apparent authority)
NB International Sales & Agencies Ltd v Marcus 1982 was effectively overruled by the above
statutory definition of ‘deals with’
TCB Ltd v Gray 1986

The defendant gave a guarantee to the plaintiff for a company called Link of which he was a
director. A debenture evidencing Link’s debt had been signed by Gray’s attorney. Link’s articles
83
required a director to sign personally. The defendant argued that the debenture did not bind Link
and, accordingly, he could not be sued under the guarantee.
Held: The plaintiff had acted in good faith and was protected by the statutory predecessor of s.
35A.
b. A person shall not be regarded as acting in bad faith by reason only of his knowing that an act
is beyond the powers of the directors under the company’s constitution. s. 35A(l) refers to good
faith. Knowing that an act is beyond the powers of its directors is not regarded as acting in bad
faith. There has to be some further element such as fraud, misrepresentation, disregard of a
fiduciary duty owed to the company by the person dealing with it or concurrence in breaches of
fiduciary duties by directors. It is only then that the company can repudiate the contract.
c. “A person shall be presumed to have acted in good faith unless the contrary is proved.” This
is self-explanatory.
d. Problems arise if the transaction was authorized by an inquorate board.
Smith v Henniker-Major 2002

S was a director of Saxon Petroleum Developments Limited. He claimed that the company had
suffered loss as a result of the defendant’s negligence. The company purported to assign its cause
of action against the defendant to S and, in the light of this, S brought proceedings in his own
name. The defendant contested S’s right to sue by challenging the validity of the assignment. At
the date of the assignment there had only been two directors, S himself and M. The company’s
articles were in the form of Table A, regulation 89 which requires a quorum of two:
The directors had not amended the quorum requirement. The assignment was approved by the
board at a meeting which, although properly convened, M was unable to attend. S therefore
purported to act with the board’s authority and minuted that the board had authorised him to
execute the assignment on the company’s behalf. In the light of reg 89, the board was inquorate. S
claimed that the assignment was valid by virtue of section 35A. He argued that the quorum
requirement was a “limitation” on the power of the board and that, in his favour, the company was
deemed to have transacted free of that limitation.
Held: At first instance ([2002] BCC 544), Rimer J concluded that the assignment was invalid and
therefore S had no cause of action. Section 35A only applies to powers exercisable by the
directors when they act together as a properly constituted board. To ascertain whether they have
acted as a board one needed to look at the articles. Per Rimer J: “If the articles provide that a
quorum for their meeting is three, then a meeting of only two of them will not be a meeting of
‘the board’ at all, or at any rate it will not be a meeting at which the board can transact
businesses.” If an inquorate board does attempt to transact business, the transactions will be a
nullity. The board has not reached the point at which it can exercise any power at all.
The majority of the Court of Appeal affirmed the decision of Rimer J, but on a different ground.
Carnworth LJ and Schieman LJ agreed that S could not rely on s. 35A to validate the assignment,
although there was disagreement as to whether a director could benefit from the section when his
appointment required him to act according to the company’s constitution. Carnworth LJ
considered that whilst a ‘person dealing with a company’ could include a director, S could not
rely on this because as chairman of the company he was not oblivious to the situation and had
been personally responsible for the error. Schieman LJ agreed that s. 35A did not extend to
enabling a director in S’s position to rely on his own error vis a vis a third party. Walker LJ
provided a dissenting judgement in that whilst S could rely on s. 35A, s. 322 CA 1985 provided a
restraint in that the transaction would be voidable at the instance of the company.
The different reasoning applied has done little to resolve the ambiguities of the scope of s.35A.
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3.6.2 SECTION 35B COMPANIES ACT 1985
S. 35B “A party to a transaction with the company is not bound to enquire as to whether it is
permitted by the company’s memorandum or as to any limitation on the powers of the board of
directors to bind the company or authorise others to do so.”
i. Where the board acts, e.g. by itself or authorises another
If the board authorises someone to act and it is within the power of the board to authorise that
person to act, then that power is deemed, as far as the outsider is concerned, to be free of any
limitations in the company’s memorandum or articles. This means that the other party is not
required to examine the documents of the company to see if there are any restrictions on the
power of the board to delegate.
The documents include any resolution passed by the company in general meeting as well as the
memorandum and articles. The company is bound by the delegation. If the board acts itself, e.g.
by a board resolution, then equally the board’s powers are deemed free of any limitation and the
company is bound by the act.
ii. Where a person who is authorised by the board acts
As stated above, the power of delegation itself is regarded as being free of any limitation.
However, a problem may arise if the authorised person acts outside his or her authority.
The authorised person may be a director or an officer of the company and the actual terms of his
authority may have been restricted when it was given to him.
The outsider may only disregard the restrictions if he could have done so under agency law, i.e.
by arguing that the authorised person has usual or apparent authority.
3.6.3 RIGHTS OF SHAREHOLDERS
Shareholders may bring proceedings to restrain the doing of an act which is beyond the powers of
directors. However, once a legal obligation to an outsider is incurred, the shareholder may not
bring such proceedings. S. 35A(4).
The directors themselves may be sued for exceeding their powers unless their acts have been
ratified in general meeting by ordinary resolution.
3.6.4 RIGHTS OF THE OUTSIDER
Normally one presumes the outsider wishes the company to be bound by the contract and all the
above law is dealt with from this premise.
However, what happens if the outsider who has acted in good faith finds out about limitations etc.
later on and does not wish to be bound by the act, e.g. the contract.
If the act done was ultra vires the company, then the outsider is bound by the contract. S. 35(1)
says the validity of an ultra vires act shall not be called into question (see earlier notes in Chapter
Two). This is an objective statement and applies to both the company and the other party.
85
However, what if the contract was intra vires and yet in excess of the powers of the directors? The
Companies Act 1985 does not deal with this situation and therefore it may be that the outsider
could repudiate the transaction.
3.7 The Rule in Turquand’s Case
a. The rule in Turquand’s case derives from the case of Royal British Bank v Turquand 1856
and is called the “Indoor Management” rule – See Cases & Materials 3.3
b. There are certain transactions which may be defective, not because they conflict with the
memorandum or articles or e.g. a special resolution, but because some condition or procedure laid
down, in e.g. the articles, has not been complied with. Looking at the memorandum or articles or
e.g. copies of special resolutions (which all have to be filed at Companies House in Cardiff) will
only reveal the existence of the procedure but cannot reveal whether it has been complied with.
c. The question that arose was whether a third party should make further enquiries and ascertain
whether the company has complied with its own procedures.
d. Royal British Bank v Turquand held that a third party could generally assume compliance
with the procedure.
Facts: Under a registered deed of settlement (equivalent to modern memo and articles) the board
of directors were authorised to borrow such sums as were authorised by the company in general
meeting (i.e. the shareholders). The board borrowed sums from the bank on the company’s behalf
but no resolution had been passed in general meeting.
Held: Company bound by the borrowing. The bank was entitled to assume that there had been
compliance with procedures laid down by statute or the company’s constitution.
e. The rule played a large part in mitigating the severity of the old constructive notice doctrine
which stated that everyone was presumed to have knowledge of public documents.
f. Also, as a result of s. 35(A)(1) the power of the board is deemed free of any limitation under
the company’s constitution. Therefore if the facts of Turquand’s case happened now, the bank
would claim that they could deem the board free of the limitation on its borrowing powers.
Therefore, if the board of directors makes a contract, on the company’s behalf, it is unlikely that
Turquand’s case would be used.
g. Also, if a third party deals with an agent who has authority then again s. 35(A)(1) covers the
situation. The company has to be a party to the transaction under s. 35(A)(2) and if an agent is
given authority then the company is a party.
SAQ 3
Can you think of a situation where statute or agency won’t help an outsider but the rule in
Turquand’s case will?
h. So the question arises as to when will the rule in Turquand’s case be of use?
86
It seems that the main areas of application are in the non-appointment of directors and where the
outsider has dealt with someone other than the board The defective appointment of a director is
dealt with in s. 285 which states that the acts of a director are valid not withstanding any defect
that may afterwards be discovered in his appointment. Turquand’s case would apply to defective
appointments also. However, s. 285 does not apply to non-appointment of directors.
i. Agency rules cover a situation involving non-appointment of directors (see Freeman &
Lockyer v Buckhurst Park Properties (Mangal) Ltd). In Freeman & Lockyer however, those with
actual authority to manage the business (i.e. the board) represented that the agent had authority. A
situation could arise where no one has actual authority even to make such a representation
because no one has been formally appointed as a director. In that case, Turquand’s case only
would apply.
Mahoney v East Holyford Mining Co 1875

A bank was instructed to honour cheques signed by 2 of 3 named directors and the company
secretary. The instruction purported to be by board resolution in accordance with the
memorandum and articles. However, none of the named directors had been appointed. Those
acting as directors had merely assumed the role. The company’s liquidator sued the bank to
recover the money paid out of the account arguing that there had been no authorisation to pay out.
Held: Bank not liable. Rule in Turquand’s case applied. If all the public documents were
inspected, everything seemed to be in accordance with the memorandum and articles. As such,
the Bank could assume internal compliance with the procedure for appointing the directors.
j. Where the outsider has dealt with someone other than the board, however, he is entitled to
rely on the fact that the board has unlimited powers of delegation but he cannot assume that the
board has actually exercised its powers. He can only do that through the agency rules or through
Turquand’s case.
k. It would therefore seem that apart from the Mahoney situation, the rule in Turquand’s case
has little independent application. Most of the situations covered by Turquand’s case are also
covered by agency rules or statute. Sealy suggests it may be available where someone is not
“dealing with” a company under s. 35A or is not “a party to a transaction” under s. 35B.
l. There are situations where a person could not rely on Turquand’s case even if the situation
seems to warrant it.
These situations are:
i. Where the outsider is not acting in good faith.

Rolled Steel Products (Holdings Ltd) v British Steel Corporation 1986 – See
Cases & Materials P;77
ii. Where the third party has notice of the irregularity or is put on enquiry.
B. Liggett (Liverpool) Ltd v Barclays Bank Ltd 1928 - See Cases & Materials
P:78
iii. Where the third party is in reality an ‘insider’.

Howard v Patent Ivory Manufacturing Co 1888 - See Cases & Materials P:81
In this case the third parties were all directors of the company. Directors are taken to know
whether the internal requirements of the company have been observed. Directors are
normally considered to be insiders not outsiders.
This was reinforced in Morris v Kanssen 1946.
However, it is not always clear who is an insider and who an outsider.
87
Hely-Hutchinson v Brayhead Ltd 1968

The plaintiff director sought to enforce a contract he had made in his private capacity with the
company which had acted for this purpose through another director who was alleged not to have
actual authority. The defendant company argued that the plaintiff was an insider who could not
use Turquand’s case.
Held: Even a director will not necessarily for all purposes be an insider. The plaintiff was treated
as an outsider and his claim against the company allowed.
iv. Where the third party (or outsider) relies on a forgery.

Ruben v Great Fingall Consolidated 1906 - See Cases & Materials P:82
However, note that a company may be estopped from relying on the fact of forgery.
All the cases outlined above in which the outsider has not been allowed to rely on Turquand are
covered in greater depth in the Cases & Materials.
88
Ultra vires Limitation on Board by Limitation by Board

Co’s constitution on agent
capacity - lack of
(memo, arts, sp res/n, ord
res/n, agreements)
S. 35(1)
Nothing in Act. therefore
S. 35A(1) existing agency rules apply
Act not called into question on
ground of lack of capacity by
reason of anything in In favour of person dealing in Has agent got authority?
company’s memo. good faith, power of board 1. Actual authority
deemed free of limitation 2. Usual authority or apparent
under co’s constitution authority
Binding on company and 3rd

party. Binding on co. Only 3rd party from
sue (i) status (MD)
or
S. 35(2) (ii) estoppel (co held out)
Sh/h sue before legal S. 35A(2)
obligation (a) Deals - co has to be 3. Ratification if no
a party authority
i.e. has agent got authority?
Actual, ostensible etc. or does If agent has authority then 3rd
S. 35(3) Turquand’s case apply. party can bind company
(b) Knowing beyond powers
under co’s constitution - not
Directors bad faith OR
(c) Presumed to have acted in
ratified act by spec res/n good faith The Rule in Turquand’s case.
relief from liability by spec Can assume internal
res/n management and procedure
S. 35B has been complied with.
S. 35B
A party to a transaction with a 3rd party not bound to enquire
co (3rd party) not bound to whether permitted by co’s
enquire whether permitted by memo or by any limitations on
co’s memo. powers of board to bind co or
authorise others
S. 35A(4)
Sh/h sue before legal

obligation
S. 35A(5)
Directors liable for exceeding

powers. Common law deals
with situation.
89
3.8 Questions
examination questions. They are NOT examination type questions.
1. What is a promoter and what are the duties of a promoter?
2. What is a pre-incorporation contract?
3. What effect does s. 36C have on pre-incorporation contracts?
4. What did Oliver LJ say in Phonogram Ltd v Lane 1981 and what effect has it had?
5. What is the actual authority of an agent?
6. What is apparent authority?
7. How does apparent authority arise for managing directors?
8. What are Diplock L.J.’s tests?
9. What is the effect of an outsider dealing with a person who is not a managing director?
10. What is the effect of s. 35(A)?
11. What is the effect of s. 35?
12. What is the rule in Turquand’s case?
13. When does the rule apply?
14. What are the exceptions to the rule?
Question
The articles of association of Fishcake Ltd are in the form of Table A except there is a provision
which requires the board of directors to obtain the consent of the general meeting before selling
any of its chain of fish and chip restaurants. Mr Skate was appointed by the board as managing
director pursuant to a service contract which required him to obtain the board’s consent before
borrowing any sum on the company’s behalf in excess of £50,000.
In March 1998 Mr Skate entered into a contract to sell two of the company’s restaurants to Batter
Ltd without seeking shareholder approval. Batter Ltd’s advisers were aware of the provision in
Fishcake Ltd’s articles. In April 1998 Mr Skate completed a refinancing of Fishcake Ltd which
involved borrowing £100,000 from West Bank. The board have only just discovered this. Earlier
this month Mr Skate acquired a wholesale fish supplier based in Grimsby with a view to cutting
the company’s overheads. However, the company’s objects clause provides that its sole business
is “to operate a chain of fish and chip restaurants”. The board are now trying to get out of the
acquisition contract because it turns out that the fish supplier has a number of sizeable contingent
liabilities and is threatened with insolvency.
90
Advise the board of Fishcake Ltd whether the company is bound by the various contracts and as
to its rights of action, if any, against Mr Skate.
Outline answer – See Cases and Materials 3.5.2 for a complete outline answer.
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CHAPTER FOUR
SHARE CAPITAL
4.1 Objectives
• recognise the difference between an ordinary share and a preference share;
• analyse class rights relating to dividends and capital;
• evaluate the variation of class rights;
• explain how share capital may be increased and how a reduction of capital takes place;
• understand how shares are transferred;
• identify the redemption and purchase by a company of its own shares whether out of profits or
capital;
• understand how a company can give financial assistance for the purchase of its own shares
and the consequences;
• evaluate the rules relating to dividends.
4.2 Share Capital and Capital Maintenance
4.2.1 CONSIDERATION FOR ALLOTMENT
1. The general rule is that an allottee must pay for his shares in full unless the company does not
require it i.e. if the shares are allotted in consideration of payment of part of the nominal amount
and of a promise of payment of the remainder as and when required by the company. In this
situation the shares are partly paid shares. The allottee’s liability to the company is limited to the
part unpaid on his shares. If the company is one limited by shares that is the extent of the
allottee’s liability (see notes in Chapter One).
2. Under s. 101 a public company must not allot shares unless at least one quarter of its nominal
value has been paid up together with the whole of any premium.
3. Payment for the shares in a public company must be in cash if the consideration includes an
undertaking which is to be performed more than 5 years after the date of the allotment.
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SHARE CAPITAL
A private company is not bound by s. 101 but where payment is non-cash in a private company,
the contract or particulars of the contract must be lodged with the Registrar of Companies.
4. A public company must not allot shares otherwise than in cash unless the consideration for
the allotment has been independently valued (s. 103) usually by the auditor of the company. This
requirement reflects article 10 of the Second Company Law Directive, the theory being that the
minimum capital rules for public companies would be undermined if non-cash consideration was
not the subject of an objective monitoring process. As far as a private company is concerned, the
Court will not enquire into the adequacy of any non-cash consideration.
a. The Issue of Shares at a Discount
Section 100 states the basic rule that shares must not be allotted at a discount. This means that
they must not be allotted as fully paid for a consideration less than the nominal amount recorded
in the memorandum.
Note there is nothing to prevent the issue of debentures at a discount.
b. The Issue of Shares at a Premium
The nominal value of a share is fixed by the memorandum e.g. £1. However the share may sell for
more than its nominal value i.e. its market value (reflecting the asset worth of the company)
maybe greater than its nominal value. The difference between the nominal value and the market
value is called the premium.
A company may issue shares at a premium. If a company issues shares at a premium, a sum equal
to the value of the premium must be transferred to an account called “the share premium account”
(s. 130). The provisions of the Act relating to the reduction of share capital treat the share
premium account as part of the company’s paid up capital.
4.3 Capital Maintenance
The rules relating to share allotments and the rules discussed below concerning the return of
capital to shareholders are all part of the principle that companies should maintain their capital.
The capital maintenance doctrine, now enshrined in the Companies Act, was developed by the
courts in the nineteenth century to protect creditors from the risk (a) that capital apparently
subscribed might turn out to be illusory (see non-cash consideration for allotments above) and (b)
that shareholders would subsequently withdraw their investment. The principle therefore seeks to
prevent shareholders from subverting the basic rule that the company’s assets on winding up are
distributed to creditors first. Lord Jessel MR explained the principle thus in Flitcroft’s Case
(1882) 21 ChD 518:
“The creditor … gives credit to the company on the faith of the representation that [the
company’s share] capital shall be applied only for the purposes of the business, and he therefore
has a right to say that the corporation shall keep its capital and not return it to the shareholders.”
Many of the rules discussed in this chapter reflect this idea of capital maintenance or (as is the
case with the reduction of capital and company own-purchase procedures discussed below)
amount to legislative exceptions to the basic principle.
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4.4 Shares
a. Introduction
1. “Shareholders are not, in the eye of the law, part owners of the undertaking”. Evershed LJ.
Therefore the word ‘share’ does not give quite the right impression because shareholders no
longer share any property in common : what they do share are certain rights in respect of
dividends, return of capital on a winding up, voting and so forth.
2. The following definition of a share was offered by Farwell J (Borland’s Trustee v Steel 1901).
“A share is the interest of a shareholder in the company measured by a sum of money, for the
purpose of liability in the first place, and of interest in the second, but also consisting of a series
of mutual covenants entered into by all the shareholders . . . A share is not a sum of money . . .
but is an interest measured by a sum of money and made up of various rights contained in the
contract, including the right to a sum of money of a more or less amount.”
3. The membership rights a shareholder has in the company, as well as against it, distinguish a
shareholder from a debenture holder. A debenture holder has rights as a creditor of the company
but does not have membership rights.
4. Shares can be issued in a number of different classes with different rights attached to each
class. Public companies usually issue preference shares and perhaps two types of ordinary shares
and private companies usually issue one class of share.
5. The initial presumption is that all shares rank equally (see Birch v Cropper 1889).
b. Preference Shares
1. These confer on the holder some preference over other classes either in respect of dividend or
of repayment of capital or voting or a mixture of the three. They may, in some cases participate
with the other shareholders after their preferential rights have been satisfied. Preferential rights
can simply be seen as examples of enhanced rights bargained for by investors in order to protect
their investment or reflect the amount of commercial risk that they are prepared to take. Thus,
preference share rights are not cast in stone and may come in a variety of combinations. There is
no single defined parcel of rights that can be pointed to as the definitive preference share. Most of
the rules developed by the courts for construing “bargained for” preference rights are “gap filling”
rules of the sort commonly encountered in classical nineteenth century contract law. In other
words, if the draftsperson has made no provision on a particular point, the court sets a default rule
to determine what should happen. The rule in Birch v Cropper that all shares rank equally in the
absence of express provision to the contrary is an example of such a rule.
2. The preference shares may be cumulative. This means that if dividends are declared and not
paid in any one year or are not declared and are therefore not paid, they are made up in
subsequent years when profits are available and arrears together with the current year’s dividend
must be paid before the payment of any dividend on ordinary shares. If nothing is said in the
articles or the terms on which the preference shares are issued, the presumption is that preference
shares are cumulative (this presumption is another example of a default rule set by the court).
3. If any rights are expressly stated in the articles then that statement is presumed to be
exhaustive as far as that matter is concerned. Therefore if preference shares have preference as
to dividend, they are presumed to be non-participating in surplus profits. Take the example of a
company that issues 5% £1 preference shares. The 5% per cent means that the holders of these
shares are entitled to receive a dividend of 5% of £1 (5 pence in the pound), in other words 5
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SHARE CAPITAL
pence per share, before ordinary shareholders are entitled to receive anything. This means that if
the company can only afford to pay a dividend to cover the preference dividend, the ordinary
shareholders would get nothing. What if in a given year the company has sufficient distributable
profits to pay 5 pence per share to the preference shareholders, 5 pence per share to the ordinary
shareholders and there is still a surplus of available profit to distribute. In the example, the
ordinary shareholders alone would be entitled to the surplus as the 5% dividend preference would
be presumed to be exhaustive - these preference shares would only be entitled to participate in the
surplus profits alongside ordinary shareholders if they were expressly “fully participating in
surplus profits” (in which case the basic presumption would be displaced).
4. Similarly if they are given a preferential right to return of capital on a winding up they are
presumed to be non-participating in surplus assets.
Scottish Insurance Corporation Ltd v Wilsons & Clyde Coal Co Ltd 1949
The company’s business was nationalised and its assets transferred to the National Coal Board. In
anticipation of voluntary liquidation, the company proposed to reduce its capital by returning
their capital to the holders of the preference shares. The articles said that preference stock ranked
before ordinary shares in winding up. In other words the preference shareholders were entitled to
receive back the capital which they had subscribed in priority to ordinary shareholders. Given that
the company was solvent and there would be a surplus of assets available after having returned
initial subscribed capital to all shareholders, the question arose as to whether the preference
shareholders were entitled to more than simply their initial capital back.
Held: The proposed reduction was not unfair or inequitable. Preference shareholders were not
entitled in a winding up to share in surplus assets or to receive more than a return of their initial
capital. The right as stated in the articles were exhaustive.
5. The same applies to attendance and voting. If, for example, they are given a vote in certain
circumstances (e.g. if dividends are in arrears) it is implied that they have no vote in other
circumstances. You cannot imply additional preferential rights from a stated preference.
6. It is presumed that preferential dividends are payable only if declared and hence arrears of
cumulative dividend are not payable in a winding up unless previously declared.
7. The return of capital in a company’s lifetime is treated as a partial winding-up therefore the
winding up rules apply to such a distribution of capital. Note how this issue of capital rights
attaching to shares is crucial in applying the rules relating to capital reduction and variation of
rights (see below).
Priority in a Winding Up
Order of Priority
1. Prima Facie i.e. articles say nothing apart 1. Debts and liabilities.
from calling the share a preference share 2. Arrears of preference dividends (if
for dividend purposes. Therefore dividend declared).
rights are different to those of the ordinary 3. Return of capital: preference and ordinary
shareholders. shares rateably. (Birch v Cropper)
4. Surplus assets: preference and ordinary
shares rateably. (Birch v Cropper)
P.T.O
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SHARE CAPITAL
2. Usual Situation i.e. articles state that the 1. Debts and liabilities.
preference share has priority as to both 2. Arrears of preference dividend if declared.
return of capital and dividend. 3. Return of capital :
a. preference shares in full
b. then ordinary shares in full
4. Surplus assets, ordinary shares only (since
the statement is presumed to be exhaustive
as far as that matter is concerned).
3. Unusual Situation i.e. articles state that 1. Debts and liabilities.
the preference share has priority as to the 2. Arrears of preference dividend if declared.
return of capital and a right to surplus 3. Return of capital :
assets on a winding up. a. preference shares in full
b. then ordinary shares in full
4. Surplus assets, preference and ordinary
shares rateably.
Summary
1. All shares rank equally if nothing is said i.e. they have the same dividend, capital and voting
rights.
2. If however something is said (usually in the articles) and that something relates only to the
dividend, then capital and voting rights are unaffected. The same goes for voting - it does not
affect capital and dividend rights.
NB. By calling a share a preference share, special rights are automatically being attached to
dividends or capital or both i.e. a preferential right to payment of dividends first or to capital first.
3. If something is said then what is said defines the rights exhaustively i.e. there are no further
rights within the e.g. dividend right. However, the capital and voting rights still rank equally.
4. Usually, preference shares by their name are changing the dividend right from ranking equally
with ordinary shares to having preferential rights. e.g. 6% preference share. If preferential shares
also have priority as to the return of capital on a winding up then they no longer rank equally with
the ordinary shares in respect of capital rights.
5. Because what is said defines their rights exhaustively, then if they have capital rights they
only have the right to priority as to the return of capital on a winding up and no rights to anything
else. e.g. a share in surplus assets.
c. Ordinary Shares
1. Ordinary shares are the class of shares which do not fit into any other types of class e.g.
preferential, deferred etc.
2. If a company’s shares are all of one class then these are ordinary shares and if a company has
a share capital it must have at least one ordinary share.
3. However distinctions among ordinary shares may be drawn, by dividing them into separate
classes with different voting rights e.g. ‘A’, ‘B’ and ‘C’ ordinary shares.
4. Provided that the company’s regulations are complied with, the company has complete
freedom as to the creation of classes and as to the names it gives them.
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SHARE CAPITAL
5. The ordinary shares usually carry the main financial risk if the company is unsuccessful but
they carry the greatest prospects of financial reward if the company is successful.
6. In a winding up the ordinary shares are usually entitled to the entire surplus of assets
remaining after payment of liabilities of the company and after the return of the capital of all
classes of shares unless preference shares have the right to participate in the distribution of these
assets.
d. Variation of Special Rights of Classes of Shareholders
1. When preferential or other special rights are attached to a class of shares, it is important to
know whether these rights can be varied and if so, by what procedure.
2. Special rights refer to rights especially given to shares of that class by the memorandum or the
articles. They usually relate to dividend, voting or the distribution of assets in the winding up of
the company.
3. It is more usual to define special rights in the articles, but if they are defined in the
memorandum the shareholders of that class of share may be better protected in that the company
may find it more difficult to vary their rights.
i. Special Class Rights in the Memorandum
1. If the memorandum provides a variation procedure than that procedure must be followed. The
minority right under s. 127 comes into operation (holders of at least 15% of the class can apply to
the court within 21 days to have variation cancelled).
2. If the memorandum prohibits a variation, then the rights may not be varied (unless under a
scheme of arrangement or reconstruction).
3. If the memorandum does not contain provisions relating to variation, those rights may only be
varied if all the members of the company agree to the variation. s. 125(5).
ii. Special Class Rights in the Articles – See Cases & Materials 4.4
1. The articles may contain a clause, known as the “modification or variation of rights” clause
which provides for the alteration of special class rights.
2. A typical example would be as follows:
“If at any time the share capital is divided into different classes of shares, the rights attached to
any class .. may .. be varied with the consent in writing of the holders of three fourths of the
issued shares of that class, or with the sanction of any extraordinary resolution passed at a
separate general meeting of the holders of the shares of the class.”
3. If the articles do not contain a provision for the variation of class rights then s. 125 applies.
This provides that a 3/4 majority in writing or an extraordinary resolution must be obtained from
the relevant class.
4. Whenever the articles contain a clause similar to one above s. 127 may be used by a
dissenting minority.
5. Section 127 provides that the holders of 15% of the issued shares of the class who did not
consent to the variation may apply to the court within 21 days to have the variation cancelled and
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SHARE CAPITAL
it will not then become effective unless sanctioned by the court. (Note that a minority, not
restricted to 15%, could use s.459 - see later notes).
6. The sole ground on which the court can disallow the variation is where it is satisfied, having
regard to all the circumstances of the case, that the variation would unfairly prejudice the
shareholders of the class represented by the application. Section 127(4). If it is not so satisfied the
court must allow the variation.
7. A variation of class rights is unobjectionable where those holding the requisite majority of the
shares of the class vote in favour of the variation in the bona fide belief that they are acting in the
interests of the class as a whole. The majority of the class must though consider what is best for
the shareholders as a class and not prefer their own interests.
Re Holders Investment Trust Ltd 1971

A reduction of capital was to be effected by cancelling 5% £1 redeemable preference shares and
allotting the holders an equivalent amount of 6% unsecured loan stock. The majority of
preference shareholders who supported the reduction were also holders of 52% of the company’s
ordinary shares and non-voting ordinary shares.
Held: Court refused to sanction the reduction. The majority had considered its own interests as
ordinary shareholders without considering what was best for preference shareholders as a class.
SAQ 1
What effect does a variation of rights attached to one class of shares have on shares of a
different class?
8. The variation of the rights of one class of shares is bound to affect the enjoyment of other
shares in the company but no separate consents are required from the other classes in this
situation.
Greenhalgh v Arderne Cinemas Ltd (No 1) 1946

2/- ordinary shares ranked equally for voting purposes with a separate class of 10/- ordinary
shares. A subdivision of the 10/- ordinary shares was proposed whereby each share was to be
divided into 5 shares of 2/- each. This altered the voting control of the company.
Held: This did not amount to a variation of voting rights attached to the original 2/- shares. The
only voting right attached to that share was one vote per share and that right remained intact.
9. The proposed issue of new capital ranking equally with the old has been held not to affect the
rights of existing shareholders.
White v Bristol Aeroplane Company Ltd 1953

A company issued 660,000 £1 preference shares ranking equally with existing 600,000 £1
preference shares and 2,640,000 ordinary shares ranking equally with existing £3,300,000
ordinary shares. The new shares were to be issued to existing ordinary shareholders and paid for
out of the reserve fund.
Held: The proposed issue did not ‘affect’ the right of the existing preference shareholders and
thus did not amount to a variation.
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SHARE CAPITAL
Only the enjoyment of the rights was affected; the rights themselves were not. Gower says
“it is strange to protect a class from having its votes halved while refusing to protect it when the
votes of the other class are doubled; the practical effect is the same in both cases.”
Re Saltdean Estate Co Ltd 1968

The company proposed to pay back the preference shareholders’ capital paid-up on each share of
10/- plus a premium of 5/- per share.
Held: The preference shareholders had priority in respect of return of capital but no right to
share in surplus assets. The proposal did not amount to a variation of their class rights.
No separate class meetings are necessary to approve a reduction of capital if priority is given to
the different classes of shares in accordance with the terms on which they were issued.
10. Other rights, not mentioned above, may also be attached to a share or the rights may be in
another document, for example, a shareholders’ agreement.
Harman v BML Group Ltd [1994] 2 BCLC 674 CA

The company’s shares were divided into A and B shares. The B shares were held by Blumenthal,
the A shares held by others, the majority of whom were Harman and Mills. There was a
shareholders agreement between all the shareholders which dealt with many matters including the
fact that a meeting could not be quorate unless a B shareholder or proxy was present.
Held: This was a class right and had the same effect as if the rights had been set out in the articles.
11. Rights may also be attached to a shareholder, in his capacity as a shareholder, not to a
particular share.
Cumbrian Newspapers Group Ltd v Cumberland and Westmorland Herald Newspaper and
Printing Company Ltd 1986
The plaintiff company B held over 10% of the ordinary shares in the defendant company.
Company B enjoyed 1. rights of pre-emption over other shareholders 2. rights in respect of
unissued shares and 3. rights to appoint a director of the defendant company. The defendant
company proposed to alter the articles and cancel these special rights. The plaintiff said these
were class rights and could not be varied without its consent. The rights were conferred on
company B and not on particular shares.
Held: The rights were class rights. A company which by its articles confers special rights on one
or more of its members thereby constitutes the holders of those rights a class for the purposes of
s. 125. The special rights could not therefore be altered without following the variation of rights
procedure under s. 125 i.e. consent of company B was required.
12. Dividend rights are not taken into account when reducing capital; capital rights only are
relevant.
Re Mackenzie and Company Ltd 1916

If preference shareholders have no priority as to return of capital and no voting power but are
merely entitled to a preferential dividend, a rateable reduction on all shares, preference and
ordinary, cancelling lost paid-up capital, though diminishing the preference dividend, is not a
variation of the rights of the preference shareholder so as to require their sanction under an
ordinary variation of rights clause.
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4.5 Alteration of Share Capital
The two main ways of altering the capital of a company are
a. The increase of share capital (s. 121)

and
b. The reduction of share capital (s. 135)
Note that when brought into force Clauses 550-554 of the CLR Bill will deal with alteration of
share capital by a limited company.
a. The Increase of Share Capital
1. Section 121 provides that a company limited by shares if so authorised by its articles, may
alter the conditions of its memorandum so as to increase its share capital by new shares of such
amount as it thinks expedient.
Table A article 32 gives the necessary authority:
“The company may by ordinary resolution increase its share capital by new shares of such
amount as the resolution prescribes”.
When the capital has been increased, notice must be given to the Registrar within 15 days after
the passing of the ordinary resolution authorising the increase (s. 123).
2. Note that the power to increase the capital, i.e. the nominal or authorised capital, must be
exercised by the company in general meeting and the directors have no power to exercise it. Also,
note that the directors may allot unissued shares. This is not an increase in capital under s. 121
because the company already has power to issue up to the amount of the nominal capital.
3. However, s. 80 restricts the power of directors to allot new shares. The directors need the
authority from the general meeting or the articles to allot shares. The authority, once given is
limited to no more than 5 years (unless there is an elective resolution in operation under s. 80A
giving longer than 5 years). The authority must specify the maximum number of shares which
may be allotted (or issued) and impose conditions. The authority may later be revoked or varied
by ordinary resolution even if it is given by the articles. The elective resolution may also be
revoked by ordinary resolution.
4. Once the directors have authority to allot (or issue) the new shares, which exist in this case
because of the increase in capital, they have to comply with s. 89. This section gives proportional
pre-emption rights to existing shareholders. Thus, existing shareholders have a right to be offered
the new shares first and the amount they are offered should reflect the proportion of shares they
already hold.
Example : A owns 35% of the share capital in X Ltd.
X Ltd increases its share capital.
A has a right to be offered 35% of the new issue.
5. S. 89 may be inconvenient for a company, especially where the company wishes to bring in
new shareholders. Therefore s. 95 gives the shareholders power to exclude pre-emption rights by
the passing of a special resolution. Also by s. 91 a private company only may exclude s. 89 by
provision in the articles. Note that once implemented Clauses 543-547 of the CLR Bill will deal
with disapplication of the statutory pre-emption provisions.
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b. The Reduction of Capital
Section 135 provides that, subject to confirmation by the court, a company limited by shares may,
if so authorised by its articles, by special resolution reduce its share capital in any way. Table A
Article 34 gives the necessary authority. It says that a company may by special resolution reduce
its share capital. Once the special resolution has been passed, the company must apply to the court
for an order confirming the reduction.
The usual situations in which capital is reduced are as follows.
i. by extinguishing or reducing the liability of its shareholders for unpaid capital in respect of
their shares or
ii. by returning to its shareholders any paid-up capital which is in excess of its wants or
iii. by cancelling any paid up capital which is lost or unrepresented by available assets.
i. Reduction of Liability for Unpaid Capital
This is usually done by reducing the nominal value of the shares.
Example : The company has issued £1 nominal value shares and the shareholders have paid 75p
for each share. The liability of the shareholders for unpaid capital is 25p on each share. The
liability of the shareholders for the unpaid capital (25p on each share) may be reduced to nothing
by reducing the nominal value of each share to 75p.
ii. Return of Paid-Up Capital in Excess of the Company’s Needs – See Cases & Materials 4.5
This may occur when a company has sold part of its undertaking or assets. The company will
distribute the cash among the shareholders and cancel an appropriate number of their shares.
It may also occur when a company wishes to obtain capital more cheaply e.g. if it has issued 10%
preference shares, it may wish to pay the preference shareholders back and issue 6% preference
shares.
The court will normally sanction a reduction where the rights of different classes are correctly
adhered to and it will do this even if for e.g. a class of shareholders will not be able to obtain such
a good investment when they re-invest.
Prudential Assurance Co Ltd v Chatterley - Whitfield Collieries Co Ltd 1949

The issued capital of a coal company was one-half ordinary shares and one half 6% preference
shares. It enjoyed a surplus of capital as a result of nationalisation of the coal industry. Special
resolution was passed to pay off preference shareholders. Preference shareholders had hopes of
additional advantages as a result of regulations to be made under the Coal Industry
Nationalisation Act 1946.
Held: Additional advantages were immaterial. Preference shareholders were being treated
according to their rights and the reduction was confirmed.
Preference shares which have priority as regards repayment of capital in a winding up will be paid
off first and this will not be regarded as unfair even though if dividend rights are also attached to
the shares, the preference shareholders will be denied a share of future profits. In other words, if
the proposal to return capital adheres to class capital rights and exhausts them (see above), the
court will sanction the reduction even if it is opposed by the class in question.
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The reason the order of distribution of assets should follow the order of distribution on a winding
up is because a reduction is in effect a partial winding up.
If the proposed distribution does not follow the order on a winding up then there is variation of
class rights and the variation of class rights procedure must be followed otherwise the courts will
not sanction the reduction.
House of Fraser plc v ACGE Investments Ltd 1987

A petition was presented to the court to sanction the House of Fraser’s wish to pay off the whole
of the preference share capital in excess of the company’s needs. A special resolution was passed
at an EGM but there were no class meetings. Preference shareholders said it was a variation of
their rights.
Held: No variation of rights. The reduction accorded to the rights of the preference shareholders.
Re Northern Engineering Industries plc 1994 CA

The articles stated expressly that the rights attached to shares would be deemed to be varied by
“the reduction of the capital paid upon such shares”. The company proposed to reduce its capital
by paying off the preference shares and cancelling them. No class consents were obtained.
Held: The reduction could not be confirmed by the court because of the express term in the
articles.
iii. Cancellation of Capital which is Lost or Unrepresented by Assets
In this situation the company may decide to reduce its capital by the amount of the deficiency.
As above, the order in which different classes of shares are reduced (to account for the loss of
assets) should follow the order of distribution of capital in a winding up. This means that the loss
is borne by those shareholders who come last in the list of priority in a winding up. Therefore, if a
company has allotted preference shares which carry the right (or priority) to repayment of capital
in a winding up before the ordinary share capital is repaid, the reduction (i.e. the loss) must be
borne first by the ordinary shares and only after their paid-up value has been extinguished will the
preference shares be reduced.
If, however, the preference shareholders do not have priority in the repayment of capital, a
reduction of capital should be borne rateably by the preference and ordinary shareholders i.e. the
same percentage should be cancelled or reduced in respect of each share.
Note that under s. 142 if a public company loses capital so that its assets are half or less of its
called-up share capital, the directors of the company must publicise the fact by calling an
extraordinary general meeting for the purpose of considering whether any, and if so, what,
measures should be taken to deal with the situation.
c. Sanction by the Court of the Reduction of Capital
The reduction of capital is not limited to the above three methods. Any scheme of reduction may
be sanctioned by the court. However if there is any objection to the reduction by a member or
creditor the court may hold that the reduction should take place through a scheme of arrangement
under s. 425.
Please note: ss.642-644 Companies Act 2006 will have the effect that private companies will
be able to reduce their share capital without having to obtain the sanction of the court. Only
a special resolution will be required – supported by a solvency statement by the directors.
The requirement that a capital reduction be sanctioned by the court will still remain in
relation to public companies.
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The court should sanction a reduction of capital unless what is proposed to be done is unfair or
inequitable in the interests of
i. The creditors
and/or
ii. The shareholders
i. The Creditors
1. If a reduction of capital involves reducing the unpaid liability on a share or returning paid up
capital to the shareholders any creditor may object to the reduction.
2. To ensure that creditors have either been paid off or have been give a chance to object, a list
of the company’s creditors must be filed in court, notices must be sent to those creditors and
notices of the proposed reduction must be published in the London Gazette and one other daily
London newspaper. The court will only proceed with the action if it is satisfied that all known
creditors have been paid or have consented to the reduction. The court may dispense with the
above provisions if a sufficient sum of money to satisfy all claims is deposited with the court.
3. If a creditor does not know of the above, is not on the list of creditors and the reduction is
sanctioned and the company cannot then pay his debt, the creditor may require each shareholder
at the date the reduction takes effect to contribute towards payment of his claim. The amount must
not exceed the difference between the nominal and paid up values of the shares immediately
before the reduction.
4. Where paid up capital is reduced because it has been lost, the provisions for the protection of
creditors do not apply unless the court so directs. This is because their position is the same before
the reduction as afterwards.
5. The danger of reduction in the case of untrue losses is realised, and the courts require proof of
the alleged loss.
In Re Jupiter House Investments (Cambridge) Ltd 1985

Company petitioned court to reduce capital after substantial loss. Said capital was lost or was
unrepresented by available assets. There was a possibility that the loss might be recovered by
litigation. Court said it could not sanction reduction because the loss was not permanent. After
adjournment, company then gave an undertaking to safeguard the interests of any creditors. These
creditors, both present and future, might be prejudiced if any of the lost money (which
represented capital) was recovered and was made available for distribution as dividends. The
company agreed that any capital that was recovered by litigation would be paid into a permanent
capital reserve and would not be available for dividends.
The court said the loss must be permanent but the court exercised its discretion and allowed the
reduction because of the undertaking.
In Re Grosvenor Press PLC 1985

Applied to court to reduce capital - again a loss which might not be permanent. Therefore did not
claim it was lost because could not show it was permanent (Jupiter House case already taken
place and considered). Instead the company offered an undertaking that any lost capital would be
paid into a special capital reserve. The fund would provide protection for existing creditors.
Held: Capital is not lost unless it is permanently lost otherwise a cancellation would prejudice
existing shareholders ; there are safeguards for future creditors so in the absence of special
circumstances, the court should not require a company to establish a permanent capital reserve.
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6. The safeguards for future creditors are the documents in Companies House showing the new
capital structure.
Summary of Both Cases
A company cannot pay dividends while it has a deficit on its profit and loss account. It may
decide to eliminate this deficit by a reduction of capital. There has been an increase in these
reduction of capital cases. Where such companies are not able to establish a permanent loss of
capital a reduction would prejudice existing creditors. In such circumstances the court can require
an undertaking from the company to protect these creditors by a requirement that any lost capital
it recovers it pays into a special reserve which cannot be used for the payment of dividends. The
capital reserve need only remain while the company has outstanding liabilities which existed at
the time the reduction took place. A permanent reserve to protect existing and future creditors
should only be required in special circumstances.
ii. The Shareholders
1. As stated previously, the order of reduction should follow the order of distribution on a
winding up. This relates to shareholders of different classes of shares. The normal order of
reduction of capital as between different classes of shares can be varied with the consent of the
shareholders who are adversely affected, providing the proper variation of rights procedure is
adhered to.
Re Fowlers Vacola Mfg Company Ltd 1966

The articles gave preference shareholders priority as to the return of capital on a winding up.
Capital was to be reduced by the return of excess capital to the ordinary shareholders.
Held: Reduction of capital by return of capital to shareholders is prima facie unfair if made
otherwise than according to priorities on a winding up. In the circumstances, the reduction was
not fair or equitable and the confirmation by the court was refused.
If a reduction of capital involves a variation of class rights and the variation of rights clause in the
articles is not complied with the court will refuse to confirm the reduction.
Re Old Silkstone Collieries Ltd 1954

This was another case which followed the nationalisation of the coal industry. The first reduction
of capital gave a class of preference shareholders special rights to share in the proceeds of
government compensation. The second reduction of capital was not sanctioned by the preference
shareholders in a class meeting and effectively removed the special rights. Therefore, the
necessary variation of rights sanction had not been obtained and the court refused to sanction the
second reduction.
2. The burden of proving that the reduction is unfair lies on those who oppose it.
Carruth v ICI Ltd 1937

There was a proposal to cancel half the amount of the company’s deferred shares and then
convert and consolidate every four deferred shares into a £1 ordinary share. A class meeting of
the deferred shareholders was held. They agreed. However, an ordinary shareholder was present
at the class meeting but no objection was made at the time.
Held: The objection to the ordinary shareholder’s presence had been waived by the conduct of the
deferred shareholders. The plaintiff could not complain it was unfair since he had agreed to it.
The deferred shareholders were not unfairly treated and the reduction was confirmed.
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SAQ 2
When do you think the courts will refuse a reduction of capital?
3. Once the court is satisfied that the rights of different classes of shareholders are adhered to, it
has to ensure that the reduction is fair and equitable and that it will not unfairly prejudice any
present or future shareholder. However, Gower states that it is difficult to find a case where the
courts have refused confirmation on the sole ground that it was unfair.
The only case which gets near is Re Holders Investment Trust Ltd 1971 where the majority of
preference shareholders voted in the interests of their ordinary shareholding and therefore did not
act in good faith in the interests of members of the preference share class generally.
4.6 Transfer of Shares
1. The basic principle is that shares are freely transferable. However, restrictions on the transfers
may be placed. These restrictions are most unlikely in a public company. It is therefore necessary
to look at the articles to discover whether or not there are restrictions on the ability to transfer. A
transferee under a valid transfer has an absolute right to be registered as a member unless the
articles take away that right. If the articles take away the right, the directors must exercise their
right to decline to register the transfer otherwise the transferee becomes entitled to be registered.
Re Hackney Pavilion 1924

Under the articles, the board had power “to decline” to register a transfer and owing to deadlock
on the board they were unable either to pass a resolution to agree to the transfer or decline it.
Held: The power to decline had not been positively exercised and therefore the transferee was
entitled to be registered.
Also, unreasonable delay on the part of the board to consider registration of transfers, will mean
that the right to refuse is lost. In practice, the board can delay 2 months because s. 185 says the
company must within 2 months have complete and ready for delivery the new share certificate or
reject the transfer.
Re New Cedos Engineering Co Ltd [1994] 1 BCLC 797

Directors did not refuse to register within two months because there were no validly appointed
directors. The transferee was therefore entitled to be registered as a member of the company.
2. Once the contract by which the shareholder undertakes to transfer his or her shares is made,
the transferee has an equitable title to the shares and the transferor holds them until registration, as
trustee for the transferee. However, until the purchase price is fully paid the seller remaining on
the register of members is entitled, as against the purchaser, to vote as he wishes in respect of the
shares. The unpaid vendor does not have to vote in accordance with the purchaser’s directions.
(Haycraft v JRRT (Investments) Ltd 1993).
Since the transferee only acquires an equitable title until registration, delay in entering his name
on the register may cause him difficulties. An existing prior equitable right may emerge or a
second transfer may be entered into and registered thus defeating the first transfer.
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The basic rule is that priority of title prevails where all things are equal. Legal title (i.e. name on
company’s register) has priority but if neither is on the register i.e. there are successive and
competing equitable titles, the first in time prevails.
Delay in registration also affects the transferor in that if the shares are partly paid, he is still liable
for calls on the shares until registration of the transferee.
a. Restrictions on the Transfer of Shares
1. Article 24 Table A provides that the directors may decline to register any transfer of a share
(not being a fully paid share) to a person of whom they do not approve. This means they may only
decline to register a partly paid share. Articles in private companies often go beyond this. For
example, they may prohibit the transfer of a share to any person who is not a member of a
specified class e.g. the family and/or provide that before transferring to an outsider, the transferor
must first offer the shares to other members on a proportional basis and give them a right of pre-
emption (i.e. right to first refusal).
It is usual to supplement these pre-emption clauses with a general restriction clause providing e.g.
that after the failure of those entitled to pre-emptive rights to acquire the shares and after their
subsequent offer to other shareholders with pre-emption rights, and their refusal, the directors
may decline the transfer. This keeps outsiders out of small family companies.
2. The provisions of a pre-emption clause cannot be evaded by a shareholder selling his

beneficial interest in the share to an outsider, without the consent of the directors, and constituting
himself a nominee for the purchaser and being prepared to vote on the instruction of the outsider.
Lyle and Scott Ltd v Scott’s Trustees 1959

The articles said that no transfer of shares could take place as long as any existing shareholder
was willing to buy. Those “desirous of transferring” should tell the company secretary of the
number of shares they wished to transfer. Shareholders, on a take-over bid, accepted an outside
offer to buy their shares but did not transfer the shares immediately. However, they were to
transfer them when requested to do so by the purchasers.
Held: They were “desirous of transferring” and therefore had to comply with the pre-emption
clause.
However, where there is no transfer contemplated, the vendors do not have to comply with the
pre-emption clause.
Safeguard Industrial Investments Ltd v National Westminster Bank Ltd 1982

Articles required “proposing transferor” to give notice to the company to set in motion the pre-
emption procedure. The bank was the executor of a deceased member who had bequeathed his
shares to two other members of the company. It was registered as holder of the shares and it was
to hold them for the beneficiaries under the will on completion of the administration of the estate.
However, at their request, it did not propose to transfer legal title in the shares to them.
Held: The Bank did not fall within the articles. It had no intention of transferring the shares and
the word ‘transfer’ was apt to cover only the transfer of the legal title to the shares not the transfer
of beneficial interests.
3. Most pre-emption clauses contain provisions for the ascertainment of the “fair value” of the
shares. They often provide that, in the absence of agreement between the transferor and the
transferee, that the value has to be ascertained by the company’s auditor. The auditor need not
state reasons for his valuation and the burden of proving that it was an improper valuation is on
the person objecting to it.
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4. Where a discretion as to registering transfers is given by the articles to the directors, the court
will not control the exercise of this discretion, unless it is proved that the directors are not
exercising it bona fide.
Re Smith and Fawcett Ltd 1942

On the death of a member who held one-half of the issued shares, the surviving director who held
the other half refused to register the executors except in respect of part of the deceased
shareholding and imposed a condition that the balance was to be transferred to him at a fixed
price. There were 8002 shares in total. This would give the director 6001 shares.
Held: No evidence of lack of bona fides therefore rectification of register was refused. NB. The
minority shareholders could use s. 459 (since 1981).
The directors may be given the power to refuse to register a transfer of shares without having to
give any reasons and the court will accept this.
If, however, they do give their reasons, the court will consider if the reasons are acceptable.
The power of refusal must be exercised within a reasonable time which must not normally exceed
2 months (see above). The power is lost if not exercised with in that time. (See Re Swaledale
Cleaners Ltd [1968] 3 All ER 619, CA and Popely v Planarrive Ltd [1997] 1 BCLC 8).
5. If the transfer of shares is made in breach of pre-emption provisions in the articles, the
transfer is not valid. The directors have no power to register a transfer which, to their knowledge,
has been effected in breach of the articles.
Tett v Phoenix Property and Investment Company Ltd 1985

The articles prohibited the transfer of shares outside the company if an existing member was
“willing” to buy them. The board registered a transfer to an outsider which was made without the
members’ knowledge.
Held: A term was to be implied into the provision that shares should not be transferred to an
outsider without reasonable steps first having been taken to give members an opportunity to take
them up. This transfer was invalid because such ‘reasonable’ steps had not been taken.
6. An application may be made for the rectification of the register of members if a person has a
right to the transfer of shares and the directors refuse to register the transfer.
Re New Cedos Engineering Co Ltd [1994] 1 BCLC 797

The directors had power to refuse to register a transfer but they were required to notify the
personal representative within three months of receiving notice of the death of a member that the
company had found a member willing to purchase the shares at fair value. This the company did
not do.
Held: On the true construction of the pre-emption provision, the applicant was entitled to
rectification of the register.
4.7 Redemption and Purchase by a Company of its Own Shares
1. The basic rule was laid down in
Trevor v Whitworth 1887.

The company went into liquidation. A former shareholder claimed the unpaid balance of the
purchase price for his shares which he had sold back to the company before the liquidation.
Held: A company cannot be a member of itself and therefore cannot generally purchase its own
shares.
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This basic prohibition is repeated in s. 143(1) which states that a limited company shall not
acquire its own shares. Breach renders the acquisition void and the company and any defaulting
officer criminally liable.
2. However, there are several exceptions to s. 143(1).
The major exception is s. 143(3). Subsection (l) does not apply in relation to the redemption or
purchase of shares in accordance with Part V Chapter VII 1985 Act.
a. Power to Issue Redeemable Shares
“Redeem - to buy back, recover by stipulated payment.” Oxford Dictionary.
Usually redeemable shares are made redeemable between certain dates. The contract will say
whether the shares are to be redeemed in any event or at the option of the company (“call
option”), or at the option of the shareholder (“put option”), and whether any premium (and if so,
what) is payable on redemption.
S. 178(2) If the company fails to redeem its shares it cannot be liable in damages. S. 178(3) A
shareholder may obtain an order for specific performance, however, unless the company can show
that it cannot meet the cost of redemption out of distributable profits.
In Re Holders Investment Trust 1971 Megarry J indicated that a shareholder whose shares are not
redeemed on the agreed date may be able to obtain an injunction to prevent the company from
paying dividends until his shares are redeemed. This case is also authority for saying that a
shareholder may petition for a winding up under s. 122 Insolvency Act 1986 on the just and
equitable ground.
S. 178(6) If the company goes into liquidation, any money owed in respect of redeemable shares
is deferred to creditors and shareholders with priority as to the return of capital but ranks in front
of claims of other shareholders.
The 1985 Act gives both private and public companies the right to redeem their redeemable
shares. S. 159 gives this right but says, ‘if authorised to do so by its articles’. Table A, Article 3
gives the authority. There are certain safeguards in the interests of capital maintenance and other
matters. The safeguards applying to public companies are more stringent than those which apply
to private companies.
1. S. 159(2) No redeemable shares may be issued at a time when there are no issued shares
which are not redeemable i.e. these must be at least one ordinary (unredeemable) share. This is in
order to prevent a situation arising whereby a company has no members left because all its shares
have been redeemed.
2. Redeemable Shares may not be redeemed unless they are fully paid s. 159(3) and the terms of
redemption must provide for payment on redemption.
3. S. 160 Redeemable shares may only be redeemed out of distributable profits of the company
or out of the proceeds of a fresh issue of shares made for the purpose of redemption. Any
premium payable on redemption must be paid out of the distributable profits of the company.
4. Private Companies may also redeem shares out of capital (see later).
5. Shares redeemed under s. 159 are treated as cancelled on redemption and the company’s
issued share capital is diminished accordingly. However, the amount of the company’s nominal or
authorised capital as recorded in the memorandum remains the same.
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i. Purpose of having redeemable shares
The aim is to introduce greater flexibility and also to encourage investment in small companies. In
particular, redeemable shares reduce the difficulty encountered in some small companies where
members can often find themselves ‘locked in’ because no one is willing to buy their shares under
the terms of a pre-emption clause in the articles. Also, from a family viewpoint, one attraction of
redeemable shares is that capital can be raised for the company without the family having to part
with control on a permanent basis. It is common for providers of venture capital finance to invest
in the form of redeemable shares for precisely this reason.
b. Company Own Purchase of Shares
1. As stated previously, although the basic rule is that a company cannot purchase its own shares
(s. 143) s. 162 allows a company to purchase its own shares provided it is authorised to do so by
its articles.
2. Table A, article 35 gives such authority.
3. S. 162(3) says, however, that a company may not purchase any of its shares if as a result of
the purchase there would be no member left holding shares other than redeemable shares.
4. By S. 160(4) the shares are treated as cancelled when purchased by the company. The
company does not therefore become a member of itself. This is still illegal as in Trevor v
Whitworth. However, since 1 December 2003 certain companies have an alternative option of
holding such shares ‘in treasury’.
5. Own purchases are labelled as follows -
a. “Market” - own purchased by a listed public company
b. “Off-market” - own purchased by a private company

(or an unquoted public company)
a. Market
i. S. 163(3) It is a market purchase if the purchase is made on a recognised investment exchange

(save where the shares are not subject to a marketing arrangement on that investment exchange
see b.i. below).
ii. S. 166 Approval by ordinary resolution must be given in advance by the company in general
meeting.
b. Off-Market
i. S. 163 A purchase is off-market if the shares are bought otherwise than on a recognised
investment exchange or in circumstances where the purchase is not subject to a marketing
arrangement.
ii. S. 164(2) Approval by special resolution must be given in advance.
iii. S. 164(5) The special resolution is not effective if the vote of any member holding the shares
would be required to pass the resolution.
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iv. Also, the resolution is not effective unless a copy of the contract or a written memorandum of
its terms is available for inspection by members of the company both at the registered office of the
company for a period of not less than 15 days ending with the date of the meeting at which the
resolution is to be proposed and at the meeting itself.
Market and Off-Market
1. Both public and private companies may purchase their shares out of distributable profits or a
fresh issue of shares.
2. However, private companies may also purchase out of capital if the profits are not sufficient
for the purpose, provided certain conditions are complied with.
c. The Redemption or Purchase of Shares out of Capital
1. S. 171(1) states that a private company may, if authorised by its articles, purchase or redeem
its shares out of capital.
2. Table A, Article 35, gives this authority.
3. S. 171(3) Distributable profits must be used before capital.
4. S. 173(5) The directors must sign a statutory declaration which declares that, in the opinion
of the directors, the company can pay its debts for the following year. This is a declaration of
solvency which is designed to protect creditors.
5. S. 173(6)It is an offence for a director to make such a declaration without having reasonable
grounds for the opinion expressed in the declaration.
6. S. 173(5) An auditors report must be annexed to the statutory declaration of solvency, stating
that the auditors have enquired into the company’s state of affairs and they are not aware of
anything to indicate that the opinion of the directors is unreasonable.
7. S. 173(2) The payment must be approved by a further special resolution.
8. S. 174(1) This must be passed within a week of the statutory declaration of solvency being
made.
9. S. 174(4) The statutory declaration and the auditors report must be available for inspection at
the meeting called to pass the special resolution. This is known as the resolution for payment out
of capital.
10. S. 175(1) & (2) Publicity must be given in the Gazette and either in a national newspaper or
by notice to each of its creditors.
11. S. 176(1) Objections may be made by any member of the company other than one who
consented to or voted in favour of the resolution or any creditor.
4.8 Financial Assistance for the Acquisition of Shares – See Cases &
Materials 4.7
1. The 1985 Act maintains a basic prohibition against financial assistance in respect of public
companies but provides for a substantial relaxation of the prohibition in the case of private
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companies. In fact, when in force, the Companies Act 2006 will abolish the restrictions in
relation to private companies.
2. S. 151 contains the basic prohibition. It is not lawful for a company or any of its subsidiaries
to give financial assistance for the acquisition of its shares before or at the time such acquisition
took place. This is subject to certain exempted cases in relation to public companies and to
provisions in favour of private companies (known as the “whitewash” procedure (ss. 155-158).
For a recent discussion of the issues raised, see Re Hill & Tyler Ltd, Harlow v Loveday [2004]
B.C.C. 732.
SAQ 3
When do you think a company would give financial assistance for the purchase of its own
shares?
3. Financial assistance is defined in s. 152 to include (i) gifts; (ii) a guarantee, security or
indemnity; (iii) a release or waiver; (iv) a loan or other agreement where the obligations of one
party arise before the obligations of another; and (v) in any other form where the net assets of the
company are reduced as a result.
4. Example - as stated in 3. a loan by a public company for the purchase of its own shares which
is in breach of s. 151, is illegal and void. In general money and property passed under the illegal
contract cannot be recovered.
The issue arises as to the effect on the actual contract for the purchase of the shares where there is
illegal financial assistance.
In Lawlor v Gray 1980 CA it was held that a vendor of shares owed a statutory duty to the
company and a contractual duty to the purchaser to perform the agreement without any breach of
the section. On the facts of the case it was possible for the sale of the shares to have been carried
out lawfully.
In Carney v Herbert 1985 PC the transaction for the purchase of shares involved a sale
agreement, a guarantee and mortgages. It was held that the mortgages were illegal since they
amounted to provision by a subsidiary company of financial assistance in connection with the
purchase of shares in its holding company. Nevertheless, the remainder of the transaction could
be enforced as the mortgages were severable from it. The mortgages were severable in that they
did not go to the heart of the transaction.
Generally, however, the contract may not be severable and then the contract itself is illegal and
void.
5. If a company gives security (in the form of a guarantee or debenture) for a sum lent by one
person to another to enable the latter to purchase shares in the company, the security is illegal and
void and no liability can arise under a personal guarantee given by the purchaser and endorsed on
the debenture.
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Heald v O’Connor 1971

The seller of controlling shareholding in a company lent part of the price to the buyer, the loan
being secured by a debenture granted by the company and endorsed by a guarantee of the
purchaser.
Held: The debenture was void for illegality and the seller could not recover on the guarantee
which was also tainted by illegality.
6. An exception to s. 151 states that financial assistance may be given (s. 153(2)) if it is given in
good faith and in the interests of the company and the company’s principal purpose in giving
assistance is merely part of a larger purpose. For example, where the principal purpose is to buy
assets then the fact that a small part of the purchase price is to be used to purchase shares may be
merely incidental.
Brady v Brady 1988 HL – If you are feeling brave, refer to the Cases & Materials for more
detailed facts contained in the speech of Lord Oliver.
Two brothers ran the company T Brady & Sons Ltd (‘Brady’). Relations broke down. A scheme
was proposed whereby they separated each taking a different part of the business while the
company itself was kept alive and trading. As part of the scheme a company called Motoreal Ltd
purchased shares in Brady and in doing so incurred a liability. At a later stage of the scheme
Motoreal Ltd caused Brady to transfer half its assets to another company (Actavista Ltd) to
discharge the liability that Motoreal Ltd had incurred in the purchase of shares. All parties
accepted this was a breach of s. 151 but the question was, did it come within section 153(2)?
Held: The scheme contravened s. 151(2) and was not saved by s. 153(2). (However, since the
exceptions in ss. 155-158 could be utilised, the parties were required to use that method and
therefore subject to compliance with ss. 155-158 the scheme was not illegal under s. 151).
Lord Oliver felt that the difficulty in applying s. 153(2) lay in part (a). What has to be sought is
some larger overall purpose of the company in which the resultant reduction or discharge of
indebtedness is merely incidental. He said that it is important to distinguish between a purpose
and the reason why a purpose is formed. Reason is not the same as purpose. In Brady the only
purpose of the scheme was said to be the acquisition of the shares and the wider benefits such as
freedom from management deadlock (which the Court of Appeal had felt were principal or larger
purposes) were merely the ‘reasons’ for doing it.
Thus the word ‘purpose’ is very narrowly construed and distinguished from ‘reasons’.
The Court of Appeal judgment is helpful in that it clarifies what is the meaning of “in good faith
in the interests of the company” in s. 153(2)(b). There, the majority held that although the
transaction was in good faith, it was not ‘in the interests of the company’ because the company
had received no consideration for the transfer of half its assets. A subjective approach was
adopted, i.e. had the directors considered it to be in the interests of the company which according
to Nourse LJ, included creditors as well as shareholders. This is similar to the directors’ fiduciary
duty to act in good faith (see Chapter Seven).
7. Further exceptions are (s. 153):
(i) Where the lending of money is part of the ordinary business of the company, the lending of
money by the company in the ordinary course of business.
Steen v Law 1964 PC

For taxation reasons International Vending Machines Ltd, of which the two appellants were the
only directors (and one other shareholder) decided to become the wholly owned subsidiary of a
public company, A M Holdings Ltd. The three holders of the IVM shares sold them to AMH for
£200,000. IVM lent AMH £200,000 to pay for the shares. IVM was placed in liquidation and the
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liquidators sued the two defendants for damages. IVM normally lent money to a guarantee fund
set up for purchasers of their vending machines, i.e. they guaranteed purchasers an income of
20% on their original outlay.
Held: The loan to AMH was not lending in the ordinary course of IVM’s business and therefore
the defendants were liable. Indeed, the Privy Council added that it is “virtually impossible to see
how loans, big or small, deliberately made by a company for the direct purpose of financing a
purchase of its shares could ever be described as made in the ordinary course of its business”.
(ii) The provision by a company in accordance with an employees’ share scheme, of money for
the acquisition of fully paid shares.
(iii) The making of loans to persons other than directors who are employed in good faith by the
company.
8. The main exception to the basic prohibition is s. 155 which relaxes the above restrictions in
favour of private companies. A special procedure is laid down which must be followed to validate
transactions. Also the assistance may only be given if the company’s net assets are not reduced, or
if the assets are reduced, it may only be given out of distributable profits.
The procedure is as follows:
(i) The directors of the company must make a statutory declaration that the company can pay
its debts.
(ii) An auditor’s report must be annexed to the statutory declaration.
(iii) A special resolution must be passed by the company in general meeting within a week of
the statutory declaration.
Any dissenters must hold not less than 10% in nominal value of the company’s issued share
capital and may apply to the court for the cancellation of the resolution.
9. If the contract is illegal and void the directors of the company may be liable for breach of
fiduciary duty.
Belmont Finance Corporation Ltd v Williams Furniture Ltd 1979.

The defendants, two of whom were directors of the plaintiff company sold property worth
£60,000 to the plaintiff company for £500,000 and then used the proceeds to purchase shares in
plaintiff company.
Held: The company was a victim of the conspiracy not a party to the conspiracy. The directors’
knowledge was not attributed to the company, therefore the company had a valid claim against its
directors.
The Company Law Review has criticized the provisions on financial assistance as being overly
technical and complex. It recommended the removal of the prohibition in favour of concentrating
on those transactions that might prejudice the interests of creditors. The provisions that relate to
financial assistance are found in clauses 565-566 and will operate to effectively remove the need
for private companies to have to resort to the ‘whitewash procedure’.
4.9 Dividends
a. A dividend is a portion of the company’s profits which are legally available for distribution to
the members. It is payable in proportion to the nominal amount of the share unless the articles say
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otherwise. Table A art 104 said it is paid according to the amounts paid up on shares. Thus, under
Table A a larger dividend should be paid in respect of fully-paid shares compared with partly-paid
shares.
b. The fundamental rule is that dividends must not be paid out of capital.
Flitcroft’s Case 1882

The directors for many years laid before the shareholders balance sheets which contained false
information. They included as good debts, debts they knew to be bad. Therefore, the business
appeared to be profitable when, in fact, it was not. The shareholders meetings therefore habitually
declared dividends which the company paid.
Held: These were payments out of capital and the directors who had recommended the dividends
were liable to repay them.
c. This leads to the rule stated in s. 263 that “a company shall not make a distribution except out
of profits available for the purpose”. The reason for this is that the share capital must be
maintained in the interests of creditors and should not generally be returned to shareholders.
d. The courts and the Companies Act 1985 have laid down a number of rules for ascertaining the
profits available for payment of the dividend.
Rules for ascertaining distributable profits
a. S. 263(3) states that a company’s profits available for distribution are its accumulated,
realised profits, so far as not previously utilised by distribution or capitalisation, less its
accumulated, realised losses, so far as not previously written off in a reduction or re-organisation
of capital duly made.
b. The wide definition of ‘distribution’ under s. 263 catches every transfer of a company’s
assets, in cash or otherwise, to members, except in the following situations.
i. the issue of fully or partly paid bonus shares.
ii. the redemption or purchase of any of the company’s own shares out of capital (including
the proceeds of any fresh issue of shares) or out of unrealised profits in accordance with
Chapter VII of Part V of the Act (see earlier notes).
iii. the authorised reduction of capital (see earlier notes).
iv. the distribution of assets to members on a winding up.
Effect of paying dividends out of capital
a. All directors who are knowingly parties to the payment of dividends out of capital are jointly
and severally liable to replace the amount of dividends so paid with interest as in Flitcroft’s Case.
b. The directors are entitled at common law to an indemnity from any shareholder who received
dividends and knew they were paid out of capital.
Moxham v Grant 1900

Directors distributed a portion of capital to shareholders who knew they were being paid out of
capital. The company was subsequently wound up. The liquidator obtained an order that the
payment had been ultra vires.
Held: The directors were entitled to an indemnity from shareholders.
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c. Alternatively, the recipient of an unlawful dividend could possibly be treated as a constructive

trustee.
Precision Dippings Ltd v Precision Dippings Marketing Ltd & Others 1985 CA
The company’s accounts had been qualified by the auditors. A cash dividend of £60,000 was paid
by the plaintiff to its parent company (Marketing). No written statement (in accordance with what
is now s. 271(4)) had been made by the auditors at the time of the distribution indicating that in
their opinion their reasons for qualifying the accounts were not material in determining whether
the distribution was lawful. The dividend payment used up all the company’s available funds and
it went into liquidation during the following year. The liquidator claimed repayment of the
£60,000.
Held: The parent company while unaware that the dividend was unlawful was aware of the facts
giving rise to its unlawfulness. The parent was therefore liable to repay the dividend as a
constructive trustee.
d. The Act does not impose any specific liability civil or criminal on directors or on those
responsible for preparing accounts. Neither does it make an unlawful distribution void or voidable
except where any member knows, or has reasonable grounds for believing that he is the recipient
of an unlawful distribution. He will then be liable to repay to the company the amount received. s.
277
Where directors have authorised an unlawful distribution, they will be treated as having acted
beyond their powers and in breach of fiduciary duty. This has two consequences: (a) the
distribution may be set aside as having not been in the best interests of the company: MacPherson
v European Strategic Bureau [2000] 2 BCLC 683 and (b) the directors may be liable to repay
such dividends if they knew the facts that gave rise to the illegality even though they did not
actually know that the distribution was unlawful.
Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, CA
The directors authorised payment of dividends on the company’s ordinary and preference shares
based on its accounts for 1990 and 1991. The company suffered a financial crisis and trading in its
shares on the Stock Exchange was suspended in 1993. The company subsequently claimed that
the dividends had been paid unlawfully because (a) there were insufficient distributable profits for
the purposes of CA 1985, s 263 (see above) and (b) that the accounts for 1990 and 1991 upon
which the dividend calculations were based did not give a true and fair view of the company’s
financial position at the time. The directors argued that the breach of section 263 was purely
technical because the company’s subsidiaries had sufficient distributable reserves that could have
been distributed to the company to enable it to meet the dividends. They also argued that the
principle in Flitcroft’s Case (see above) only applied in the case of an insolvent company as
otherwise the company’s shareholders would receive an unmerited windfall when the amount of
the unlawful dividends repaid by the directors were distributed to them by way of lawful dividend
(ie the shareholders would get to keep the unlawful dividends that they had received and be
entitled to participate in any future distribution made by the company out of the proceeds of the
unlawful dividend recouped from the directors). Finally, they argued that their liability (if any)
should be limited to the difference between the amount of the unlawful dividends (some £78
million) and the dividends that could lawfully have been paid at the time.
Held: The company was entitled to recover the full amount of the dividend from the directors. The
directors could not go behind the 1990 and 1991 accounts bearing in mind the strict and
mandatory nature of the provisions in the Act regulating the preparation and authorisation of the
accounts and requiring dividends to be paid out of distributable profits as disclosed by those
accounts. Flitcroft’s Case applied regardless of whether the company was solvent or insolvent
and, as a separate legal person, the company was entitled to reclaim dividends unlawfully paid for
the protection of both creditors and shareholders. The directors owed fiduciary duties to the
company (on which see further Chapter 7) and these placed them in a position analogous to
trustees. Accordingly, they were liable for deliberately and dishonestly paying unlawful dividends
out of company funds under their stewardship even though there might have been no loss because
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lawful dividends of the same amount could have been paid had the accounts reflected the true
position. The directors had not acted “honestly and reasonable” and so, contrary to the finding at
first instance, they were not entitled to relief under CA 1985, s 727.
Further rules
a. Articles usually give power to a company in general meeting to declare a dividend not
exceeding that recommended by the directors. The shareholders have no right to receive the
dividend until it has been declared.
b. Further articles usually give the directors power to pay an interim dividend (on a date between
annual general meetings). Since it is not declared, the shareholders have no absolute legal right to
receive an interim dividend.
c. If the articles so provide a dividend may be paid by the issue to members of bonus shares
credited as fully paid. The appropriate sum will have to be transferred from the profit and loss
account or reserve account to the share capital account. This is also known as a capitalisation
issue.
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4.10 Questions
examination questions.
1. What does the issuing of shares at a discount and the issuing of shares at a premium mean?
2. What is a preference share? How does it differ from an ordinary share?
3. What does ‘all shares rank equally’ mean and what does ‘construing the rights attached to a
class of shares exhaustively’ mean?
4. What does ‘priority as to the return of capital’ mean?
5. What special rights are attached to a share stated to be a “10% preference share”?
6. How may rights attached to shares be varied?
7. What must the class meeting take into account when voting to vary rights of that class?
8. What is ‘the enjoyment of rights’ and how does it affect the variation of rights?
9. How may share capital be increased?
10. Why are s. 80, s. 89 and s. 95 relevant in an increase of share capital?
11. What does a reduction of capital involve? What are the three main situations in which capital
may be reduced?
12. What factors must the court take into consideration when asked to sanction a reduction of
capital as far as creditors are concerned?
13. What factors must the court take into consideration when asked to sanction a reduction of
capital as far as the shareholders are concerned?
14. What is the basic rule regarding the transfer of shares and where would you expect to find any
variation of that rule?
15. What restrictions would you commonly expect to see on the transfer of shares in a private
company?
16. How might a shareholder attempt to evade any restrictions on the transfer of shares?
17. What is a redeemable share and how may a company redeem its shares?
18. What is the basic rule regarding the acquisition by a company of its own shares?
19. What are the statutory provisions allowing a company to purchase its own shares?
20. When and how may a company use its capital to purchase shares?
21. How may a company give financial assistance to someone else to purchase shares?
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22. What is the effect on the contract if the financial assistance is illegal?
23. Who may the company sue where illegal financial assistance has been given to enable a third
party to purchase its shares resulting in loss to the company?
24. What is a dividend?
25. What are the rules for ascertaining distributable profits?
26. What are the possible legal consequences of paying dividends out of capital?
Question
The articles of association of Massive Ltd show that its share capital is divided into ordinary
shares and a separate class of “A” preference shares bearing a 12% cumulative preferential
dividend. There are 25,000 £1 ordinary shares in issue held by Zorba and Frank. Frank also holds
15,000 of the 20,000 issued £1 “A” preference shares. The remaining 5,000 “A” shares are held
by Rachel.
At a recent Extraordinary General Meeting of Massive Ltd an ordinary resolution was passed
which sub-divided the 25,000 £1 ordinary shares into 50,000 ordinary shares of 50 pence thereby
doubling the votes attaching to the ordinary shares. At the same meeting a special resolution was
passed to authorise the paying off of the “A” shares. As a result of this re-organisation of share
capital, Rachel is to receive her initial subscribed £5,000 back but is also to be given an option to
subscribe for 5,000 new “C” preference shares carrying a reduced 6% non-cumulative preferential
dividend.
Advise Rachel who is not happy about the proposal but would be prepared to sell her “A” shares
to Massive Ltd for £10,000 without the option to subscribe for “C” shares.
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CHAPTER FIVE
DEBT FINANCE AND COMPANY CHARGES
5.1 Objectives
• Recognise the difference between a fixed and floating charge.
• Understand the significance of registration of charges.
• Evaluate the disadvantages and advantages of floating charge security.
• Understand and apply the transaction avoidance provisions in sections 239 and 245 of the
Insolvency Act 1986.
5.2 Introduction
A company may obtain finance by issuing shares (see Chapter Four) but it may also obtain
finance by borrowing i.e. loan capital. The usual lenders of money to companies are the banks;
but often directors of a company or shareholders are also prepared to lend it money. Lenders and
borrowers are free to negotiate such contractual terms according to their circumstances and
assessment of risk.
The lender usually prefers to have some security for the loan in case it is not repaid on time or at
all. The document which acknowledges a debt due from a company is called a debenture. Legally
that is the meaning of a debenture i.e. a debenture is not strictly a security instrument. However,
most people, including the banks, regard a debenture as the principal means by which a company
gives security for the repayment of a loan. The security itself usually takes the form of charges on
the company’s assets. The debenture will contain a clause that the amount lent is repayable by a
certain date and in the meantime interest is payable at, for example, quarterly intervals.
A debenture differs from a share in several ways.
1. The debenture holder is a creditor whereas the shareholder is a member of the company.
2. Under a debenture, the interest payable is a debt and therefore must be paid regardless of
whether there are profits or not, whereas dividends on shares may only be paid out of profits
available for distribution.
3. Debentures may be issued at a discount whereas shares may not.
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5.3 Corporate Security
A debenture usually creates charges on the assets of the company. These charges may be either
2.1 fixed charges or
2.2 floating charges.
For reasons which will hopefully become clear a lender will often take security comprising both
types of charge.
5.3.1 A FIXED CHARGE
This is a legal or equitable mortgage on specified assets which are identified when the charge is
created e.g. land, buildings or immovable plant.
The advantages of taking a fixed charge are that
• the company cannot sell or otherwise dispose of the property without the consent of the
debenture holder.
• the security ranks high on the list of order of payment on a winding up or receivership.
• the fixed charge generally has priority over earlier floating charges created over the same
assets or class of assets unless there is a prohibition on this.
The important point to note is that it is not the nature or type of the secured asset which is
determinative - what matters in determining whether a charge is fixed or floating is whether and
to what extent the company is restricted from dealing with the secured asset in the ordinary course
of its business.
For an interesting commentary on chacterisation of fixed charges see: Atherton and Mokal,
‘Charges over Chattels: Issues in the fixed/floating jurisprudence’, The Company Lawyer (2005)
Vol 26:1, pp 10-18 – Which can be found at 5.1 in your Cases & Materials.
5.3.2 A FLOATING CHARGE
In determining whether a charge is floating charge, the courts have usually taken Romer LJ’s
three propositions as their starting point (Re Yorkshire Woolcombers’ Association Ltd [1903] 2 Ch
284).
A charge is a floating charge if:
• It is a charge upon all of a certain class of assets, present and future (e.g. stock in trade or the
whole assets and undertaking for the time being of a company, or a book or trading debt owed
to the company by its customers);
• which class is, in the ordinary course of the company’s business, changing from time to time
• and until steps are taken to enforce the charge, the company can carry on business in the
ordinary way as regards the assets charged.
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A floating charge is an equitable charge on some or all of the company’s present or future
property. It is a present charge not a future charge. The company is free to sell or dispose of the
property subject to a floating charge as it pleases. Once the property is realised (disposed of) the
floating charge no longer attaches to it. If new property is acquired in the future, then the floating
charge attaches to it while it belongs to the company and while the debt is outstanding.
It is not necessary to call a charge a floating charge (Re G.E. Tunbridge Ltd [1995] 1 BCLC 485).
If the above three characteristics attach to the charge, it is recognised as a floating charge. If any
of Romer LJ’s three characteristics are not present, the charge may be a fixed charge. Gower
defines a floating charge as “a charge which floats like a cloud over the whole assets”.
Arthur D Little Ltd v Ableco Finance (2002) The Times 22 April 2002.
A company which was not in the business of trading in shares purported to create a floating
charge over its shares in a wholly owned subsidiary.
Held: The charge was a fixed charge. The charge was over assets which did not change from time
to time in the ordinary course of business even though the company was free to deal with the
assets without the chargee’s permission.
Another distinguishing factor of a floating charge, apart from the company’s ability to deal with
the secured assets during the company’s lifetime, is the fact that it may crystallise.
On crystallisation a floating charge is converted into a fixed equitable charge on the assets
actually within the class at the moment of crystallisation. This means that the company is no
longer free to deal with those assets. The characteristic of a fixed charge, which is that the
company cannot realise the security without the consent of the debenture holder, attaches at the
moment of crystallisation to assets previously subject to the floating charge. From the moment of
crystallisation the company cannot deal with floating charge assets in the ordinary course of
business. Equally, however, for the purpose of priority issues in insolvency, the charge will still
rank as a floating charge.
SAQ 1
When do you think a floating charge will crystallise?
The following events cause a floating charge to crystallise (express provision usually being made
for such events in the debenture itself).
1. The appointment of a receiver or administrative receiver over some or all of the company’s
assets. This generally occurs under the terms of the debenture, where for example, the company
defaults on the loan repayments.
2. The making of a compulsory winding up order.
3. The cessation of the company’s business. This has not been universally accepted as a
crystallising event. Pennington says that only two out of ten decisions generally cited in support
of it, actually do support it. However, Re Woodroffes (Musical Instruments) Ltd [1986] Ch 366 is
generally regarded as an authority supporting it.
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Re Woodroffes (Musical Instruments) Ltd

The company created a floating charge over all its assets in favour of a bank. Subsequently,
without the bank’s consent, the company created a second floating charge in favour of Mrs
Woodroffe. Mrs W’s debenture further provided that she could convert the floating charge into a
specific (ie fixed) charge by notice to the company. She gave such notice to the company on 27th
August. Five days later the bank appointed receivers under the first floating charge. The court was
faced with two questions: (1) Did crystallisation of Mrs W’s floating charge on 27th August have
the effect of automatically crystallising the bank’s floating charge (2) If not, could the cessation of
a company’s business in law cause automatic crystallisation of a floating charge. In relation to (2)
the bank argued that the company’s business had ceased on 27th August.
Held: Question (1) was answered in the negative. As for question (2), it was held that in law any
floating charge will automatically crystallise upon cessation of the company’s business. However,
on the facts there was insufficient evidence to show that the company ceased business prior to 1st
September and it followed that the bank’s floating charge did not crystallise until it appointed
receivers.
Nourse J made a distinction between ceasing to carry on business and ceasing to be a going
concern. He said that the material event is a cessation of business. “A cessation of business
necessarily puts an end to the company’s dealings with its assets.”
See also the more recent case of National Westminister Bank plc v Jones [2002] 1 BCLC 55.
4. Events of automatic crystallisation can also be expressly provided for in the debenture, e.g.
breach of a term of the debenture by the company or where the assets fall below or debts exceed
certain prescribed thresholds. An automatic crystallisation clause states that on the happening of
the event, the floating charge will crystallise or is thereupon converted into a fixed charge. Often,
the lender will not know the event has occurred.
Re Manurewa Transport Ltd [1971] NZLR 909

A company created a floating charge containing an express automatic crystallisation clause which
said that the floating charge would become fixed on the happening of certain events. One such
event was breach of a clause forbidding creation of further charges without consent of the
chargee. The company created a further charge without consent.
Held: Crystallisation can take place without the chargee’s intervention on the happening of an
event which is expressed in the debenture to be an event of automatic crystallisation.
Re Brightlife Ltd [1987] Ch 200

A company created a floating charge which gave its holder a right at any time to convert the
floating charge into a specific charge by notice to the company as regards any assets specified in
such notice. On 10th December the chargee served a notice to convert. On 20th December the
company went into liquidation.
Held: Service of a notice as provided for in the debenture was effective to convert the floating
charge into a fixed charge i.e. crystallisation took place on 10th December.
NB The actual decision that the debt secured by the debenture ranked in priority to the
preferential creditors has now effectively been overruled by the Insolvency Act 1986.
From the facts it can be seen that Hoffmann J’s view that Re Manurewa Transport Ltd was
authority supporting the general validity of a provision for automatic crystallisation is obiter.
Nevertheless it is strong authority which is worthy of consideration.
Finally, the main criticism of automatic crystallisation is that it can occur without anyone
knowing. This poses particular difficulties for third parties about to lend money to a company.
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5.4 The Priority of Charges
As stated previously a fixed charge ranks in priority over any floating charge created earlier over
the same assets. This is one of the disadvantages of a floating charge (discussed further below).
Also, if the assets are subject to any lien or set off created before crystallisation then the floating
charge is subject to the holder of such a right.
Rother Iron Works Ltd v Canterbury Precision Engineers Ltd 1973

Rother created a floating charge in favour of a bank. Rother owed the defendants £124 under
previous contracts. The defendant contracted on 18th October 1971 to purchase goods worth £159
from Rother. The goods were delivered on 3 November. The bank’s floating charge crystallised
on 21st October. The defendants claimed that they could set off Rother’s debt owing to them
when sued by receiver for £159.
Held: As the right of set off arose before crystallisation only £35 was payable by the defendants.
To strengthen the position of holders of floating charges, the use of the ‘negative pledge’ clause
has become quite common. This clause restricts the right of the company to create charges that
rank in priority over the floating charge. Thus, the company agrees that later fixed charges will
not take priority over this floating charge and also that later floating charges over specific assets
(which normally rank in priority to a general floating charge over all the company’s assets) will
not take priority. (NB As between two floating charges over the same property, the first in time of
creation has priority).
However, negative pledge clauses cause difficulty. Even if the later fixed chargee has notice of
the existence of the earlier floating charge, it is generally believed that the clause will not work
unless he/she also has notice of its terms. Registration of the charge at Companies House does not
fix the later fixed chargee with constructive notice. The view from practice is that where the later
fixed chargee has actual notice of the restriction then the earlier floating chargee is protected (a
view supported by Wilson v Kelland [1910] 2 Ch 306). Practitioners therefore commonly set out
the full terms of any negative pledge clause in the prescribed particulars which have to be filed
with the Registrar of Companies when registering the charge. The theory is that anyone carrying
out a company search (in particular, a subsequent lender) cannot then fail to be fixed with actual
notice. This is the prevailing view. However, it is not universally accepted. The main objection to
it is that strictly under ss. 395-399 there is no requirement to include details of any negative
pledge in the prescribed particulars.
5.5 Distinguishing Between Fixed and Floating Charges: Problems

of Priority in the Peculiar Context of Book Debt Security
Recent case law has made the task of differentiating between fixed and floating charge security
more difficult. In particular, the question of whether a charge over book debts should be
characterised as fixed or floating is one of considerable legal and economic significance for
broadly two reasons:
(1) On the insolvency of the corporate borrower, the answer to the question determines who, as
between the secured creditor and the preferential creditors, has first entitlement to be paid out
of the proceeds realised from the charged assets. This is because in administrative
receivership and liquidation preferential creditors are entitled to be paid ahead of the secured
creditor out of floating charge assets but not out of fixed charge assets (Note that this has been
the subject of extensive change as a result of s. 251 of the Enterprise Act 2002, which came
into force 15 September 2003 – see para 5.8.2.2 below). The upshot is that questions over the
nature of the security would often descend into a “winner takes all” contest between a lender
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and the preferential creditors: the lender arguing that the charge should be construed as fixed
enabling it to “scoop the pool”; the preferential creditors arguing that the charge should be
construed as floating triggering their prior entitlement under the Insolvency Act (precisely this
situation arose in the New Bullas decision discussed below). Whether this situation will
change following the enactment of the Enterprise Act 2002 remains to be seen.
(2) Book debts (ie sums of money owing to the company eg in respect of goods and services
supplied by the company on credit terms) are an important and potentially valuable source of
security (assuming they are not bad debts!). In theory, it may be problematic if the courts
routinely treat a charge over book debts expressed to be fixed as merely floating. Lenders may
theoretically be discouraged from advancing money to corporate businesses on the security of
book debts without the guaranteed protection of a fixed charge.
The requirement of lenders for the best possible security in the form of a fixed charge has given
rise to considerable legal difficulty. In orthodox legal theory, the distinction between a fixed and
floating charge turns largely on the question of whether the company is free to deal with the
charged assets in the ordinary course of its business. The classic “definition” of the floating
charge remains that of Romer L.J. in Re Yorkshire Woolcombers Association Ltd (see 2.2 above).
While it is clear that Romer L.J. never intended his statement to be an exact or exhaustive
definition, it has, broadly speaking, become an article of faith that the company’s freedom to deal
with the charged assets during its active trading life is the “badge” of a floating charge. In the
context of book debt security, this deceptively simple analysis gives rise to a difficult conundrum.
For the lender to achieve best security in the form of a fixed charge, the company must not be free
to deal with the charged assets without the lender’s consent. However, book debts are by nature a
relatively liquid asset and, once realised, the proceeds are an important source of working capital
for the company. It makes little commercial sense for the company to relinquish control of its
cash flow as this may, of course, be crucial to its trading prospects and future growth (including
its prospects for servicing and repaying the secured loan). Subsequent cases bear witness to the
struggle of lenders to find the “holy grail”: a form of security giving them a level of control
consistent with a fixed charge while still allowing book debt proceeds to be ploughed back into
the company’s business.
For the main clearing bank lenders the conundrum was until recently largely resolved by the
seminal decision in Siebe Gorman & Co. Ltd v Barclays Bank Ltd [1979] 2 Lloyd’s Rep. 142. In
that case the debenture (a) prohibited the company from charging or assigning uncollected debts
without the lender’s consent (b) required the company to pay book debt proceeds into an account
with the lender and (c) required the company to execute a legal assignment of uncollected debts if
asked by the lender to do so. Slade J. held that it was implicit in these arrangements that the
company was not free to draw on the proceeds in the account without the lender’s consent. On
their true construction, the relevant terms of the debenture did therefore take effect as a fixed
charge over book debts. The decision has not been without its critics and courts in other
jurisdictions have declined to follow it broadly on the ground that the absence of any express
restriction on the company’s ability to withdraw funds from its account is inconsistent with a
fixed charge. It seems to rest on the (arguably fictional) premise that a clearing bank lender is
always in a position to prevent the company from making a withdrawal from an account held with
that lender and, as such, can be said to be giving its active consent each time a withdrawal is
made. Nevertheless, until very recently Siebe Gorman acquired, at least in the context of bilateral
clearing bank lending and security arrangements, the status of orthodoxy and the level of lender
control over back debt proceeds remained, in this context, the principal means of determining
whether a charge is fixed or floating. This form of debenture has since become the standard form
for many bank lenders.
This section ends with a discussion of the recent case of Re Spectrum Plus Ltd, National
Westminister Bank plc v Spectrum Plus Ltd and others [2004] All ER (D) 76, in which Sir
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Andrew Morritt VC concluded that the construction of the debenture in Siebe Gorman was
wrong.
The position in relation to non-clearing bank lenders has been more complex. In Re Brightlife Ltd
[1987] Ch. 200, [1986] B.C.L.C., (1986) 2 B.C.C. 99,359 a debenture in favour of a private lender
purported to create a “first specific charge” over book debts. The company was expressly
restricted from selling, factoring or discounting its uncollected debts. However, it was free to pay
book debt proceeds into its ordinary business account and draw on those proceeds as it pleased.
Hoffmann J., accepting the correctness of the approach in Siebe Gorman, held that the freedom of
the company to deal with the proceeds was the “. . . badge of a floating charge and inconsistent
with a fixed charge.” The problem for the non-clearing bank lender, at least in Siebe Gorman
terms, is that it is not in a position to assert direct control over the bank account in which the
proceeds are held. Moreover, any express controls in the debenture may be regarded as
commercially improbable and not a true reflection of the parties’ intentions.
The Court of Appeal decision in Re New Bullas Trading Ltd [1994] 1 B.C.L.C. 485, [1994]
B.C.C. 36 and the security instrument considered in that case represent a possible solution to the
“control” problem. Indeed, it is arguable that New Bullas aimed to do for the non-clearer what
Siebe Gorman does for the clearing bank. The lender in New Bullas was the venture capital
provider, 3i plc. 3i’s debenture purported to create a fixed charge over uncollected book debts. As
in Brightlife, the company was expressly prohibited from assigning, factoring or discounting its
uncollected debts. However, the provisions in relation to proceeds were novel. The company was
required to pay the proceeds into a bank account designated by 3i and deal with them in
accordance with any written directions which might be given in writing by 3i from time to time.
In the absence of any directions from 3i, the proceeds were expressly released from the fixed
charge and became subject to the general floating charge over the other property and assets of the
company. At first instance, Knox J. held that the company’s freedom to deal with the proceeds in
the absence of a direction from 3i was inconsistent with the existence of a fixed charge. Reversing
Knox J., the Court of Appeal held (a) that the company was not free to deal with the proceeds of
its own volition: the parties had clearly agreed that the proceeds would only be released if 3i gave
no direction and (b) that it was open to the parties to agree that book debts are subject to a fixed
charge while they are uncollected and to a floating charge on realisation. 3i’s contractual right to
restrict dealings with the proceeds combined with the express release were seen as being
compatible with a fixed charge. The decision has been the subject of much discussion and
criticism (See eg M. Bridge, “Fixed Charges and Freedom of Contract” (1994) 110 Law Quarterly
Review 340; R. Goode, “Charges Over Book Debts: A Missed Opportunity” (1994) 110 Law
Quarterly Review 592; - which can be found in your Cases & Materials at 5.4 after the
judgment of the Court of Appeal in Re New Bullas; A. Berg, “Charges Over Book Debts: A
Reply” [1995] Journal of Business Law 433; S. Worthington, “Fixed Charges Over Book Debts
and Other Receivables” (1997) 113 Law Quarterly Review 562). One question to emerge is
whether it is correct to regard uncollected debts and their proceeds as a single, indivisible asset or
as two separate assets capable of being charged separately. The point is that if debts and proceeds
are best regarded as a single asset then it follows that the freedom of the company to deal with any
part of the “asset” will, on the orthodox view, be inconsistent with a fixed charge. A further
principled objection to New Bullas is that it effectively allows the parties to contract around the
statutory protection afforded to preferential creditors by the Insolvency Act 1986, ss. 40 and 175,
the charge “as created” being fixed rather than floating. However, the policy issues are far from
cut and dried. As indicated above, the decision in New Bullas is perhaps best seen as an attempt to
put the non-clearing bank lender on a level playing field with the clearing bank. In the meantime,
as draftspersons and courts try to adapt to new patterns of financing, it is inevitable that some
uncertainty will prevail. The courts have continued to wrestle with the implications of the New
Bullas decision. The trend of the cases discussed below is against New Bullas and in favour of a
modified version of the orthodox view that “control” over the charged asset is the crucial
determinant of the status of the charge. The landmark decision of the Privy Council in Re
Brumark Investments Ltd [2001] UKPC 28 emphatically rejected New Bullas.
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Re Double S Printers
In Re Double S Printers Ltd [1999] B.C.C. 303, the company granted a debenture to S, a director
and 50% shareholder, to secure a number of loans made by him with a view to keeping the
company afloat. The debenture purported to create a first fixed charge over present and future
book debts. However, it did not expressly prohibit the company from assigning, factoring or
discounting its uncollected debts and made no provision with regard to proceeds. The company
went into liquidation and the liquidator asked the court to direct (on an application under the
Insolvency Act, s. 112) whether and to what extent the debenture created an enforceable fixed
charge. The obvious implication of the arrangements (despite the description of the charge) was
that S was to have no control over book debts or proceeds (a point conceded by S’s counsel). S’s
own evidence confirmed that his purpose in making the loans was to keep the company afloat and
this was inconsistent with the idea that he would want to starve the company of cash flow, for
example, by requiring book debt proceeds to be retained in a separate account. Nevertheless, it
was submitted that the necessary element of control was present in that, as a director of the
company and one of two signatories under the bank mandate, S exercised actual control over the
book debts through his control of the company’s business account. The court rejected the
submission. Per Jonathan Parker J:
“In order for the debenture to take effect as a fixed charge over present and future book debts,
there must, it seems to me, be some right of control over the debts, or their proceeds,
exercisable by [S] in his capacity as chargee, and not in some other capacity, e.g. as a director
of the company. The opportunity for [S] to exercise de facto control of the company’s bank
account in his capacity as a director of the company is, in my view, nihil ad rem.”
The judge was reinforced in this conclusion by two points:
(1) S might relinquish control during the continuance of the security either (a) by ceasing to be a
director or (b) by assigning the debenture to a third party.
(2) In his capacity as a director, S was under a fiduciary duty to act bona fide in the company’s
interests, and not for a collateral purpose such as the maintenance of his rights as chargee.
Re Westmaze Ltd
In Re Westmaze Ltd [1999] B.C.C. 441, the company granted a debenture to Excelsior, a non-
clearing bank lender, to secure a sum advanced to fund the purchase from Excelsior of some
business premises. The debenture purported to create a fixed charge over “all book and other
debts revenues and claims both present and future . . .” and the company expressly covenanted
that it would not, without Excelsior’s prior written consent (a) “create or attempt to create or
permit or subsist any mortgage charge debenture or pledge or permit any lien or other
encumbrance . . . to arise to affect the goodwill undertaking property assets revenues and rights
hereby charged (‘the Charged Assets’) and/or (b) “part with possession transfer sell lease or
otherwise dispose of the Charged Assets or any part thereof or attempt or agree to do so. . .”.
Thus, there was a clear prohibition on the company dealing with uncollected debts. As well as a
series of fixed charges over other specified assets, the debenture also contained a general floating
charge over all the other assets of the company. Like Brightlife however, there was no restriction
on the company paying book debt proceeds into its ordinary business account and drawing on
those proceeds as it pleased. The company went into administrative receivership and Excelsior
applied for a declaration that the debenture created an enforceable fixed charge over book debts.
The main thrust of Excelsior’s case was that the fixed charge was confined in its operation to
uncollected debts, and that once debts were realised, the proceeds became subject to the general
floating charge. In support of the view that debts and proceeds could be treated separately,
Excelsior relied on New Bullas. Sitting as a deputy judge of the High Court, Mr David Oliver
Q.C. held that the charge floated. Excelsior’s submission could not be sustained as the charge
expressly encompassed “book debts and other revenues”, which the judge took to include book
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debt proceeds. The lack of any restriction on the company’s ability to deal with the proceeds was
therefore fatal (applying Brightlife and Re Pearl Maintenance Services Ltd [1995] B.C.C. 657).
The question of whether it is ever permissible (as per New Bullas) to differentiate between debts
and proceeds was left open.
Re ASRS Establishment Ltd

In Re ASRS Establishment Ltd [2000] 1 B.C.L.C. 727 the company granted a debenture to DQH, a
non-bank financier, as security for the provision of trade finance facilities. One of the sub-
paragraphs of the debenture’s charging clause purported to create a fixed charge over “all book
debts, bank account credit balances and other debts and claims now or at any time during the
continuance of this security due or owing to the company”. The company was expressly restricted
from dealing with the uncollected book debts (other than for the purpose of collecting them)
without DQH’s written consent and required to pay book debt proceeds into a bank account
designated by DQH. However, DQH had not enforced the latter requirement and so, in reality, the
company was free to recycle the proceeds of book debts for use in its business. The company
became insolvent and DQH appointed an administrative receiver. Shortly afterwards, the
company went into liquidation.
The main dispute concerned a sum of $1.1m held in an escrow account. The origins of this
account lay in a corporate transaction between the company and a third party, Swedish Match.
The company had been required under the terms of the transaction to deposit the sum with a well-
known clearing bank. Ultimate entitlement to the proceeds was also a matter regulated by the
parties’ agreement. The sum would be released to the company if certain defined events occurred.
If not, it would be released to Swedish Match. The receiver argued that the debenture created a
fixed charge over the company’s interest in the escrow monies and that DHQ was therefore
entitled to them. The liquidator argued that the escrow monies were subject only to a floating
charge.
Park J. held that the charge floated. At first sight the decision is surprising because the company
was clearly not free to deal with the escrow monies in the course of its business and this lack of
freedom might arguably indicate a fixed charge. The main steps in the judge’s reasoning were as
follows:
(1) The escrow monies were not the proceeds of book debts but could be treated as falling within
“other debts and claims…owing to the company” under the debenture.
(2) The relevant sub-paragraph could not be read so as to create a fixed charge over some of the
assets within the specified class and a floating charge over others. In other words, it could
only be construed as creating a fixed charge if it was capable of subsisting as a fixed charge
over all the categories of assets specified i.e. book debts, credit balances and other debts and
claims.
(3) Conversely, if the company was free to deal with any of the property within the class then the
charge could only take effect as a floating charge. Taking “book debts, bank account credit
balances and other debts and claims. . .” as a composite class, the judge held that, in
substance, the company was free to deal with such property in the course of its business
without reference to DQH. For example, in relation to book debts, it was clear that the
company was free to recycle collected proceeds into its business as DQH had not required it
to pay them into a designated bank account despite being entitled to do so under the
debenture.
The decision has clear implications for the drafting of standard form debentures. In effect, it
would only have been possible to create a fixed charge in this case if the debenture had contained
a self-contained sub-paragraph referring exclusively to the company’s interest in the escrow
monies. This suggests that it may be unwise to use broad, generic descriptions of asset classes
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when drafting the charging clause and may call for careful sub-division. The justification for the
decision probably lies in the fact that the company was restricted from dealing with the escrow
monies by its arrangement with Swedish Match rather than by DQH. There would presumably
have been nothing to stop the company dealing with the escrow monies had they been released
before it went into receivership. Thus, Re ASRS Establishment Ltd turns ultimately on DQH’s
failure to assert its own independent control over the company’s interest in the account.
Re Brumark Investments Ltd; Agnew v Commissioner of Inland Revenue [2001] UKPC 28

Brumark Investments is, without doubt, the most significant decision on fixed and floating
charges for a decade. The case came on appeal to the Privy Council from the Court of Appeal of
New Zealand. While the Privy Council’s advice does not have the status of a House of Lords
decision, there is no doubt that in commercial circles the view it expresses amounts to a highly
authoritative and definitive statement of English, as well as New Zealand law. You would be well
advised to read the Privy Council’s advice which was delivered by Lord Millett. As a lesson in the
history and evolution of the floating charge it far surpasses what any textbook can offer.
Facts and decision in the New Zealand courts

The only assets in the hands of the receiver available for distribution were the realised proceeds of
book debts that had been uncollected at the date the company went into receivership. The question
of who, as between the charge-holder (“Westpac”) and the preferential creditors, was entitled to
the proceeds depended on whether the charge over book debts was fixed or floating. The
debenture, which appears to have been drafted with New Bullas in mind, drew a clear distinction
between book debts and proceeds. It purported to confer a fixed charge over present and future
book debts and a further fixed charge over the proceeds of debts “. . . received before the first to
occur of Westpac requiring such proceeds to be paid into an account or deposit . . . [held with
Westpac] . . . and the charge . . . crystallising or being enforced”. The overall intention was to
subject the uncollected debts to a fixed charge while giving the company freedom to recycle the
proceeds. In theory, unless Westpac insisted that the proceeds were paid into a designated account
(it never did), the debts would cease to be subject to the fixed charge on collection and Westpac’s
floating charge would catch the proceeds.
At first instance, Fisher J. held that it is possible to create separate security interests in book debts
and their proceeds. In his view, the critical difference between fixed and floating charges was that,
under the former, the company is prohibited from disposing of the charged assets to others.
However, a power of disposition was not to be confused with a power to consume the charged
asset or to convert it into a form where it no longer attracts the application of the charge. On this
analysis, the company’s freedom to collect book debts and convert them into proceeds falling
outside the ambit of the charge over uncollected debts does not of itself mean that the charge can
only ever float. As long as the company was restricted from dealing with the uncollected debts
(i.e. by a prohibition on factoring or assignment), he thought it was possible for the charge over
uncollected debts to be fixed (note how this contrasts starkly with the decision of Hoffmann J. in
Brightlife discussed above).
The New Zealand Court of Appeal reversed Fisher J., preferring a floating charge
characterisation. The main points from the judgment were as follows:
(1) On general principle, if the company is free to deal with the charged assets, the charge
cannot be a fixed charge.
(2) The characterisation of the charge over uncollected debts does not turn (as Fisher J.
thought) on whether the company is free to deal with the proceeds once they are collected
(i.e. after the original asset is extinguished and has ceased to be subject to the charge). It
involves determining whether or not the charged book debts are under the control of the
company.
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(3) There is no distinction between dealing in the uncollected debts by disposal to third parties
and dealing by collection of the debts on the company’s own account. Thus, the company’s
freedom to extinguish or release the charge by collecting the debts on its own account was
fatal to a fixed charge characterisation.
The receiver appealed to the Privy Council.
The Privy Council’s advice in Brumark

The Privy Council upheld the decision of the New Zealand Court of Appeal. The charge over the
uncollected debts was a floating charge and the proceeds were therefore payable to the
preferential creditors in priority to the charge-holder. Lord Millett started out by saying that the
central question was whether the company’s right to collect the book debts and deal with the
proceeds free from the security meant that the charge on the uncollected debts, though described
as “fixed” was nevertheless a floating charge until its crystallisation. In approaching this question,
he reviewed the historical development of the floating charge with reference to all the leading
Victorian and Edwardian case law (including Romer L.J.’s description of the floating charge in Re
Yorkshire Woolcombers Association Ltd). He then went onto review the cases specifically dealing
with book debt security (including Siebe Gorman, Brightlife and New Bullas). The principal
theme of Nourse L.J.’s judgment in New Bullas was that the parties were free to make whatever
agreement they liked. The question, on that view, was therefore simply one of construction:
unless unlawful, the intention of the parties, as discerned from the terms of the debenture, should
prevail. The Privy Council in Brumark considered this approach to be “fundamentally mistaken”
and held that New Bullas was wrongly decided on the following grounds:
(1) The question is not merely one of construction. In deciding whether a charge is a fixed or
floating charge, the court is engaged in a two-stage process. First, it must construe the
charge and seek to ascertain the parties’ intention from the language used. This stage will
not determine definitively whether the charge is fixed or floating. Secondly, the court must
categorise the charge as a matter of law. This does not depend solely on the intention of the
parties. As Lord Millett put it:
“If their intention, properly gathered from the language of the instrument, is to grant the
company rights in respect of the charged assets which are inconsistent with the nature of a
fixed charge, then the charge cannot be a fixed charge however they may have chosen to
describe it (emphasis added). A similar process is involved in construing a document to see
whether it creates a licence or tenancy. The court must construe the grant to ascertain the
intention of the parties: but the only intention which is relevant is the intention to grant
exclusive possession: see Street v Mountford [1985] AC 809 at p 826 per Lord Templeman.
So here: in construing a debenture to see whether it creates a fixed or a floating charge, the
only intention which is relevant is the intention that the company should be free to deal
with the charged assets and withdraw them from the security without the consent of the
holder of the charge; or to put the question another way, whether the charged assets were
intended to be under the control of the company or of the charge holder (emphasis added).”
(2) There are two methods by which uncollected book debts can be realised – i.e. converted
into money. Either (a) an uncollected debt (which is a chose in action) can be sold to a third
party who effectively buys the right to collect it (note: this is the basis of any factoring
arrangement) or (b) the debt can be collected. Thus, a restriction on sale or assignment
which nevertheless allows collection and free use of the proceeds is inconsistent with the
concept of a fixed charge: it allows the debt and its proceeds to be withdrawn from the
security by the act of the company in collecting it.
(3) Property and proceeds are clearly different assets. When an uncollected debt is sold, the
seller exchanges a property right in the debt (a chose in action) for a property right in the
sale proceeds. When a debt is collected, it is wholly extinguished and is replaced in the
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hands of the company by a different asset, namely its proceeds. While a debt and its
proceeds are therefore separate assets, the latter are merely the traceable proceeds of the
former and represent its entire value. Any attempt in the present context to separate the
treatment of debts and proceeds for security purposes makes no commercial sense as the
creditor will still wish to have security over the proceeds.
(4) It is possible to constitute a charge on book debts a fixed charge by prohibiting the
company from realising the debts, whether by assignment or collection. The effect would
be that the company would not be able to sell or collect a debt without first obtaining the
consent of the charge holder. However, in line with Siebe Gorman, it is not necessary to go
that far. It will be sufficient for the holder of the charge to appoint the company its agent to
collect the debts for its account and on its behalf. The Privy Council thus approved of Slade
J.’s decision in Siebe Gorman but added that it would not be enough to provide in the
debenture simply that debts should be paid into a designated or blocked account if, in
practice, the proceeds were freely at the disposal of the company.
(5) On the facts in Brumark, the company was left in control of the process by which the
charged assets were extinguished and replaced by different assets which were not the
subject of a fixed charge and were at the free disposal of the company. That was
inconsistent with the nature of a fixed charge.
The conundrum discussed at the outset of this section remains. Unless the charge-holder is in a
position to control both the assignment and the collection of the debts, the charge over book debts
will float and lose priority to the preferential creditors. However, the degree of control required
for the charge to be fixed (e.g. use of a designated account) is not easily reconcilable with the
parties’ commercial objectives (see Re Keenan Bros Ltd [1986] BCLC 242).
Note that this case has attracted considerable comment, see in particular Berg, ‘Recharacterisation
after Enron’ [2003] JBL 205, and Pennington, ‘The Inter-Changeability of Fixed and Floating
Charges’ [2003] Company Lawyer 60 – which can be found at P:171 of your Cases &
Materials. Arguably, this outcome was inevitable as a result of the Privy Council guidance in
Brumark.
Subsequent to this decision in Brumark (5 June 2001) the Crown Departments have issued a
statement that where an insolvency practitioner has made a distribution of book debt proceeds
subject to a purported fixed charge the Crown Departments reserve a right to challenge that
payment if they consider that charge to be a floating charge. However, the ability to challenge will
not have retrospective effect to the decision.
Whilst the guidance given by the Privy Council in Brumark arguably clarified the situation, it did
raise specific doubts over the landmark decision in Siebe Gorman.
Re Spectrum Plus Ltd, National Westminister Bank plc v Spectrum Plus Ltd and others [2004].
A company obtained an overdraft facility with the bank and granted a debenture to secure all
monies due. Until certain steps were taken by the bank the company was free to draw cheques in
the ordinary course of its business. As a means of creating both a fixed and floating charge over
book debts, the bank relied on wording in the debenture that was indistinguishable from that used
in Siebe Gorman. The company was liquidated in 2001. The bank sought a declaration that the
debenture created a fixed charge over the company’s book debts.
Held: At first instance Andrew Merritt VC concluded that Siebe Gorman was wrongly decided,
and that the debenture document (in the form that had been relied upon for the past 25 years) was
insufficient to create a fixed charge. Applying Brumark, the starting point was to construe the
document to ascertain the nature of the rights and obligations the parties intended to create. The
essential issue was whether it was intended that the company should be free to deal with the book
debts and withdraw them from the security without the bank’s consent. On the true construction,
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the collection and the unimpeded use of the proceeds was both permitted and envisaged, and
consequently was inconsistent with the nature of a fixed charge. Sir Andrew Merritt distinguished
the decision in Re Keenan Brothers Ltd [1986] BCLC 242, since that debenture specifically
provided that withdrawals from the account to which the proceeds of the book debts had to be
created could only take place with the prior written consent of the bank. This restriction meant
that the charge created was fixed and not floating.
The Court of Appeal subsequently reversed this decision, and confirmed Siebe Gorman by
allowing the bank’s appeal. The fact that the debenture required the proceeds of book debts to be
paid into an account held by the chargee bank was seen as the critical factor. As perhaps expected,
the appeal to the House of Lords has confirmed that Siebe Gorman was wrongly decided and that
the charge was in fact insufficient to create a fixed charge. The House referred to the possible
mechanism for a ‘blocked’ account in order to ensure that a lender had sufficient control, but did
not elaborate on how this could be achieved.
5.6 Registration of Charges
Charges created by a company are required to be registered
• In the company’s own register of debentures
• With the Registrar of Companies
• With HM Land Registry or at the Land Charges Department.
5.6.1 REGISTRATION IN THE COMPANY’S OWN REGISTER
Sections 406 and 407 of the 1985 Act states that every company shall keep at its registered office:
• a copy of every instrument creating a charge over the company’s property. (i.e. a copy of the
original debenture) and
• a register of all such charges.
The register is called the register of debentures and entries must contain:
• a short description of the property charged,
• the amount of the charge and
• the names of the persons entitled to it.
The register is open to inspection. It is free to a creditor or a member but a fee can be required
from anyone else. The register is usually kept together with all the company’s other statutory
books and registers such as the register of members, the register of directors etc.
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5.6.2 REGISTRATION WITH REGISTRAR OF COMPANIES
1. Section 395 provides that prescribed particulars of certain specified charges created by
companies registered in England, together with the instrument, if any, creating them, must be
delivered to the Registrar within 21 days after their creation.
2. The specified charges include fixed and floating charges.

3. Among the particulars that are required are:
• the date of creation of charges
• the amount secured
• short particulars of the property charged
• the persons entitled to the charge.
4. It is the duty of the company to register the particulars required by s. 395 (see s. 399).
Registration, however, may be effected by any person interested in the charge.
5. On registration of a charge, the Registrar gives a certificate of registration, which is

conclusive evidence that the requirements of the Act as to registration have been complied with
(s. 401(2)).
R v Registrar of Companies ex parte Central Bank of India [1986] QB 1114

A charge registered over Esal Commodities in favour of the bank was incomplete. There was no
original instrument either. The Registrar returned it to be amended outside the 21 day period and
only then issued a certificate. Esal applied for judicial review arguing that the Registrar had been
wrong in recording the later date on the certificate.
Held: The actions of any person or body performing public functions were subject to judicial
review. However, as the Companies Act states that the certificate is conclusive evidence of
registration, this precluded the court from quashing the certificate.
6. The particulars delivered to the Registrar may incorrectly state the property charged or the
amount or date of the charge, but if a certificate is given, the grantee of the charge is protected.
Re Eric Holmes (Property) Ltd [1965] Ch 1052

In 1960 the company purchased some properties. R, a shareholder, advanced money for this
purpose and the company granted a charge in his favour. The charge was created on 5 June 1961
but not dated. The charge was registered on 11 July and the date recorded by the Registrar for
creation was 23 June. On 4 August the company went into liquidation.
Held: The charges were valid under the Companies Act. The certificate of Registrar was
conclusive evidence even though the particulars submitted were incorrect. (NB The charge was,
however, set aside as a fraudulent preference ie on other grounds).
Re C L Nye Ltd [1971] Ch 442, CA

Solicitor inserted the wrong date for the creation of the charge with the result that it was accepted
for registration more than 21 days after its creation.
Held: Even though the date of creation was wrongly stated, once the certificate was granted, s.
401(2) applied and it was conclusive evidence that the requirements as to registration had been
complied with.
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Re Mechanisations (Eaglescliffe) Ltd [1966] Ch 20

Two charges registered mentioned sums of £16,000 and £2,000 but did not mention other sums
lent by NBC to the company. The Registrar issued certificates. On liquidation NBC claimed that
an extra £5,000 was secured on top of the £18,000.
Held: The charges were a valid security for the full amount due under them (i.e. £23,000). The
certificate of the Registrar was conclusive that the necessary particulars for registration had been
complied with. It is not conclusive evidence that the amount stated to be secured by the charge is
in fact the amount secured by the charge. Thus, evidence of the parties’ true intentions was
admissible in the Mechanisations (Eaglescliffe) case.
It seems that the creditor will still be protected if the particulars filed with the Registrar
mistakenly contain the wrong company number (see Grove v Advantage Healthcare (T10) Ltd
[2000] 1 B.C.L.C. 661).
7. To discover the exact terms of the charge, one has to look at the document creating it and not
at the register.
8. When the debt for which the registered charge was given is discharged, the Registrar enters a
memorandum of satisfaction or release on the register (s. 403).
9. The Register maintained by the Registrar of Companies is open to the public.
SAQ 2
What do you think is the effect of failure to register a charge at Companies House?
5.6.3 NON-REGISTRATION
If the prescribed particulars are not delivered to the Registrar within 21 days after the date of its
creation the charge is void against the administrator or liquidator of the company and any creditor
of the company.
Also, even if a subsequent chargee knew of the creation of the unregistered charge, the charge is
still void against the second chargee.
Re Monolithic Building Co [1915] 1 Ch 643

A charge was created in favour of T to secure £500. It was not registered. Subsequently, another
charge was created in favour of J for a further £500. This was registered. J knew of the charge
created in favour of T.
Held: Even though J knew of T’s charge, his charge retained priority.
Note that the loan itself is unaffected. Therefore, if the charge is void for non-registration, the loan
becomes immediately repayable with interest (s. 395(2)).
Where a charge is void for failure to register its holder is treated in the company’s liquidation or
administration as an unsecured creditor. This should therefore encourage the chargee to register
the charge. However, the creditor’s charge is not void against the company or anyone else not
mentioned in s. 395. Consequently, the creditor may enforce the charge prior to the company
going into liquidation or administration.
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Failure to register also gives rise to criminal liability punishable by fine both for the company and
every officer of it who is in default (s. 399(3)).
5.6.4 RECTIFICATION OF THE REGISTER
1. Application may be made by the company or any person interested to the court under s. 404 to
extend the time to register or rectify the register (meaning in simple terms, register late) if:-
(a) the omission is:
• accidental or
• due to inadvertence or
• some other significant cause or
• not of a nature to prejudice the creditors or shareholders or;
(b) on the ground that it is just and equitable to grant relief.
2. Relief will usually only be granted “without prejudice to the rights of parties acquired during
the period between the date of creation of the said charge and the date of its actual registration”.
This is known as a Joplin proviso
Re Telomatic Ltd [1993] BCC 404

A charge was created over the company’s land in favour of Barclays Bank in 1989 but not
registered. Barclays received a fax on 4th October 1990 from Cyprus Popular Bank plc (“CB”)
saying that CB was going to take a second charge over the land. CB took the charge on 5th
October and it was registered on 19th October 1990. Telomatic was dissolved on 18th February
1992. Barclays wished to have the company restored to the register to enable them to register their
charge out of time.
Held:
1. The late application to register the Barclays charge was refused. The court was not satisfied
that any of the five grounds set out in the section were made out. The court’s discretion to extend
the time had not therefore arisen. Even assuming that the jurisdiction had arisen, the court would
have refused to exercise its discretion to allow late registration because the company had already
gone into liquidation and there had been a considerable delay before the making of the
application.
2. If leave for registration had been given, it would have been made subject to a Joplin proviso.
CB’s knowledge of Barclay’s charge, as evidenced by their fax, was irrelevant. The statutory
scheme was based on registration not actual notice apart from the register.
3. A Joplin proviso protects rights acquired against the company’s property so that a secured
creditor whose charge is created and properly registered after the creation of an unregistered
charge will not lose priority. The unregistered charge is, of course, void under s. 395 and remains
so unless and until registered under s. 404.
4. Unsecured creditors with no charge on the company’s property are not protected by a Joplin
proviso.
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5.6.5 REGISTRATION OF CHARGES OVER LAND
Where the security includes a charge over land there are additional considerations. In the case of
registered land, the charge must be registered at the Land Registry. In the case of unregistered
land, the charge must be registered as a land charge.
5.7 Receivership/Administrative receivership
Following several Law Commissions the government came to the view that the one-sided nature
of administrative receivership operated to prejudice companies in financial difficulties. One of the
aims of the Enterprise Act 2002 serves to abolish the right of a floating charge holder to appoint
an administrative receiver to realise their security (subject to specified exceptions, as below). The
overriding intention of this provision is to encourage corporate rescue, if possible, or alternatively
to secure a better realization of assets for the collective benefit of all creditors.
Section 250 of the Enterprise Act 2002 (which came into force 15 September 2003) inserts a new
ss. 72 H (2), (3), (4) and (5) into the Insolvency Act 1986 and provides that the ‘holder of a
qualifying floating charge’ is prohibited from appointing an administrative receiver. A holder of a
qualifying floating charge is defined in Sch B, para. 14, and essentially is someone entitled to
appoint an administrator or administrative receiver under debentures’ secured by a floating
charge, which relates to the whole, or substantially the whole, of the company’s property. This
prohibition will apply to a floating charge created on or after a date to be specified by statutory
instrument.
However, the right to appoint an administrative receiver will be retained for securities taken
before the legislation comes into force. Given the vast amount of security presently in existence it
is likely to be some time before administration receivers cease to be appointed. The ability to
appoint administrative receivers is also retained for certain specialist markets, private finance
initiative and utility project financing and companies that are registered social landlords. For this
reason the material below has been retained.
There are two types of receiver
• An administrative receiver
• A receiver
Both are appointed by a debenture holder to protect and realise his/her security under a fixed or
floating charge.
• The administrative receiver is a receiver of the whole (or substantially the whole) of a
company’s property appointed by the holders of any debentures secured by a charge which
when created was a floating charge (Insolvency Act 1986, s. 29(2)).
• A receiver may take possession of only part of the company’s property (for example a
specific asset secured by a floating charge or a Law of Property Act receiver appointed under
a legal mortgage over real property).
Most receivers used to be administrative receivers because it was standard practice for secured
lenders to take a general floating charge over all the assets and business of a corporate borrower.
However, since 15 September 2003 the holder of a ‘qualifying floating charge’ may not appoint
an administrative receiver of the company, although this prohibition only applies to securities
created after this date. For this reason the material on administrative receivers is still relevant.
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Note that if the debenture is an ordinary mortgage of property, i.e. a fixed charge over specific
land, the debenture holder may exercise his power of sale without appointing a receiver.
1. An administrative receiver is usually appointed under an express or implied power in the

debenture. An administrative receiver must be a licensed insolvency practitioner. The crucial
point is that the administrative receiver is therefore appointed by the debenture holder to enforce
and realise the debenture holder’s security. The administrative receiver’s first duty is to the
appointing creditor. While he/she has other duties (in particular, to pay the preferential creditors
out of floating charge assets before accounting to the debenture holder for floating charge
proceeds - Insolvency Act 1986, s. 40), the administrative receiver is a creature of contract,
fortified by statute whose responsibilities to other creditors of the company is limited.
SAQ 3
What powers do you think an administrative receiver would need?
2. An administrative receiver not only has powers laid down as a matter of contract in the
debenture but also has statutory powers laid down in the Insolvency Act 1986 (“IA”) s. 42 and
Schedule 1. These powers include:
• Power to take possession of, collect and get in the property of the company.
• Power to sell or otherwise dispose of the property.
• Power to borrow money.
• Power to bring or defend any legal proceedings.
• Power to make any payment which is necessary or incidental to the performance of his
functions.
• Power to carry on the business of the company.
• Power to present or defend a petition for the winding up of the company.
3. The administrative receiver is treated as an agent of the company (s. 44 IA 1986). He is

personally liable on all contracts made by him but may be indemnified by the company if he acts
within his authority. A person dealing with an administrative receiver in good faith and for value
is not concerned to inquire whether the receiver is acting within his powers (s. 42(3)IA) (This is
similar to s. 35A Companies Act 1985). As far as existing contracts are concerned, i.e. ones made
before the administrative receiver was appointed, his appointment does not terminate them.
Finally under s. 43 IA 1986, the administrative receiver can sell property which is subject to a
security which has priority over his appointor’s security providing the court authorises the
disposal. The money received from the sale must be paid to the person who had the prior security,
to the extent that it satisfies that security.
4. A receiver (as opposed to an administrative receiver) is also appointed under a power in the
debenture (or in rare circumstances by the court) and he too is usually treated as an agent of the
company. Under s. 37 IA 1986 he is personally liable on contracts made by him within his
authority but is entitled to be indemnified out of the assets of the company. His powers are laid
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down in the debenture not in the Insolvency Act (unlike an administrative receiver) but the
powers in the debenture will probably include many of the statutory powers given to an
administrative receiver. He can be given power in the debenture to manage the company, if this is
required, and he will then be known as a receiver and manager. Finally, he does not have the
power to sell property which is subject to a security having priority over that of his appointor
(unlike an administrative receiver).
5. Administrative receivers and receivers may also be appointed by the court. This is unusual.
The debenture should be clear as to when they may be appointed and in that situation an
application to the court is unnecessary. However, a situation may arise upon which the debenture
is silent and yet the debenture holder wishes an administrative receiver or receiver to be
appointed. The court may appoint a receiver:
• when the principal or interest is an arrears; or
• the company is being wound up; or
• the security is in jeopardy.
The first two should be covered by the debenture but because there may be a dispute as to when
the security is in jeopardy, an application to the court may be necessary to cover this.
The security is in jeopardy in the following situations:
• where there is a risk of the property being seized to pay claims of creditors not ranking in
priority to this debenture holder.
• where there is only one asset and it is going to be distributed to members
• where execution is about to be levied against the secured assets by a judgment creditor
• where a creditors’ winding up petition is pending.
The security is not in jeopardy if the company is a going concern and yet the assets are not
sufficient to repay the debentures in full. In Re New York Taxicab Co [1913] 1 Ch 1 this situation
arose. However, creditors were not pressing and there was no risk of the assets being seized and
sold by creditors. Therefore the security was held not to be in jeopardy.
5.8 Liquidators
5.8.1 COMPULSORY LIQUIDATION
1. When a winding up order is made by the court, the official receiver, by virtue of his office,
becomes the interim liquidator of the company and continues in office until another person
becomes liquidator.
2. At any time when he is liquidator of the company, the official receiver may summon a
meeting of the company’s creditors for the purpose of choosing a person to be liquidator in his
place. (Note that such a liquidator has to be an insolvency practitioner).
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5.8.2 VOLUNTARY LIQUIDATION
1. In a creditors’ voluntary liquidation, the liquidator shall be the person nominated by the
creditors. Where no person has been nominated by the creditors, the liquidator will be the person
nominated by the shareholders in a company meeting.
2. In a members’ voluntary winding up, the shareholders in general meeting will appoint a
liquidator.
3. Again, note that the liquidator has to be an insolvency practitioner.
THINK POINT
What do you think is the job of a liquidator?
5.8.3 POWERS OF THE LIQUIDATOR
The job of the liquidator is to collect in all the assets of the company and then pay the creditors
according to their rights (see the list referring to preferential creditors and ordinary creditors
below). If there is any surplus after the creditors have been paid (which is unlikely except in a
members’ voluntary winding up) the shareholders are entitled to get their capital back and divide
any surplus amongst themselves according to their rights.
5.8.4 “SELLING THE ASSETS”
Apart from taking over all the existing property of the company, and disclaiming onerous
property, examples of which are unprofitable contracts or property which is unsaleable or is such
that it may give rise to a liability to pay more money, the liquidator may swell the assets in other
ways.
5.8.4.1 Fraudulent trading s.213
1. If in the course of the winding up of the company it appears that any business of the company
has been carried on with intent to defraud creditors of the company or creditors of any other
person or for any fraudulent purpose, the court may declare that any persons who were knowingly
parties to the fraudulent trading are to be liable to make such contributions (if any) to the
company’s assets as the court thinks proper.
Re L Todd (Swanscombe) Ltd 1990

Liquidator sought a declaration that Morez a director of the company had knowingly been a party
to the carrying on of the business of the company with intent to defraud creditors. M admitted that
he had intended to defraud HM Customs and Excise but not other creditors. Debts of company
£70,000.
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5.8.4.2 Wrongful trading s. 214
1. If in the course of the winding up of an insolvent company it appears that at sometime before
the commencement of the winding up of the company, a director of the company knew or ought
to have concluded that there was no reasonable prospect that the company would avoid going into
insolvent liquidation, the court on the application of the liquidator, may declare that the director is
to make such contribution (if any) to the company’s assets as the court thinks proper.
2. The standard is an objective standard because the director ought to have concluded that there
was no reasonable prospect.
3. Shadow directors are included.
4. If the court is satisfied that the director knew or ought to have concluded that there was no
reasonable prospect that the company would avoid going into insolvent liquidation, it will NOT
make a declaration if it satisfied that the director took every step to minimise the loss to the
company’s creditors, he ought to have taken.
5. Note that the above refers to EVERY STEP, not every reasonable step. Therefore the burden
is quite heavy and this is the section which may catch many directors.
6. We have a major case which discusses the effect of s. 214.
Re Produce Marketing Consortium (No 2) 1989

PMC, which had two directors, carried on business as an importer of fruit from Spain. Trade
began to decline in 1981. The drift towards insolvency was clear from the accounts from 1981
onwards. By 1984 large losses had been incurred and there was a large bank overdraft guaranteed
by one of the directors. There was a history of accounts being prepared well out of time. In
January 1987 accounts for 1984/85 and 85/86 were submitted to PMC for approval. The issue
was whether after April 1986 and before October 1987, when the company went into insolvent
liquidation, the directors were liable for wrongful trading under s. 214 IA 1986.
Held: They were liable under the section.
Knox J said that the requirements for fraudulent trading (under s. 213) including an intent to
defraud and fraudulent purpose with “the need for actual dishonesty and real moral blame” were
not requirements for liability for wrongful trading (under s. 214). The director is to be judged by
the standards of what can reasonably be expected of a person fulfilling his functions who shows
reasonable diligence in doing so. Knox J accepted that one has took at the particular company and
the particular business. “It follows that the general knowledge, skill and experience postulated
will be much less extensive in a small company in a modest way of business with simple
accounting procedures and equipment, than it will be in a large company with sophisticated
procedures.”
However, he went on to say that there were minimum standards. He emphasised the obligation
under the Companies Act to keep up to date accounting records. In PMC the preparation of
accounts was “woefully late”. He said that the knowledge to be imputed in testing whether or not
directors knew or ought to have concluded that there was no reasonable prospect of the company
avoiding insolvent liquidation “is not limited to the documentary material actually available at the
given time . . . there is to be included by way of factual information not only what was actually
there but what, given reasonable diligence and an appropriate level of general knowledge, skill
and experience, was ascertainable.” Knox J said that not only did the directors actually know
things were very bad in 1986 but they were to be treated as having known or ascertained the
actual deficit of assets over liabilities at that time. They ought to have concluded at the end of July
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1986 (not February 1987 when they actually signed the preceding two years’ accounts) that there
was no reasonable prospect that PMC would avoid going into insolvent liquidation.
Knox J then looked at whether after July 1986, the respondents (the directors) took every step
with a view to minimising the potential loss to the creditors of PMC, as they ought to have taken.
He said that the fact that they continued to trade for another year meant they did not take every
step.
Finally, in looking at the exercise of the court’s discretion to declare that a director is liable to
make such contribution (if any) to the company’s assets as the court thinks proper, Knox J said
that the jurisdiction was primarily compensatory rather than penal.
“Prima facie the appropriate amount that a director is declared to be liable to contribute is the
amount by which the company’s assets can be discerned to have been depleted by the director’s
conduct . . . But Parliament has indeed chosen very wide words of discretion and it would be
undesirable to seek to spell out limits on that discretion . . . the fact there was no fraudulent
intent is not of itself a reason for fixing the amount at a nominal or low figure for that would
amount to frustrating what I discern as Parliament’s intention in adding s. 214 to s. 213 in the
1986 Act, but I am not persuaded that it is right to ignore that fact totally.”
Knox J took into consideration various factors such as failure to appreciate a clear situation rather
than deliberate wrong doing, some untruths, a solemn warning from the auditor which was
ignored and the conducting of trade so that the bank indebtedness was reduced (reducing the
director’s exposure under the guarantee) at the expense of ordinary creditors. He finally fixed on a
sum of £75,000. Interest had to be paid on this contribution which ran from the date of the
commencement of the winding up. As far as costs were concerned Knox J said “costs follow the
event in this type of application” and therefore the directors had to pay the costs.
7. In Re Purpoint Ltd 1991

A similar situation of trading while insolvent arose and also the company maintained no proper
books of accounts. The director was liable for wrongful trading. It was also stated that the purpose
of an order under s. 214 is to recoup the loss to the company arising from wrongful trading so as
to benefit all the company’s creditors and the court has no jurisdiction to direct payment to a
particular class of creditor.
8. In Norman v Theodore Goddard 1991 the interpretation of s. 214(4) was raised and it was
held that a director was entitled to trust person in positions of responsibility and until there was a
reason to distrust them he would not be in breach of s. 214(4). In this case one director, Bingham
persuaded another director, Quirk to deposit large sums of money with a company he said was
owned by Theodore Goddard Trust Company and which in fact was not. It was owed by Bingham
and he stole all the money. There was no reason for Q to distrust B and therefore he was not
liable. This case is also relevant to a discussion of the common law duty of care and still owed by
a director to the company (see Chapter Seven).
For a recent case in which wrongful trading proceedings were successful see Re Brian D Pierson
(Contractors) Ltd [1999] BCC 26.
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5.9 The advantages and disadvantages of Floating Charges
5.9.1 THE ADVANTAGES OF A FLOATING CHARGE
1. A floating charge is advantageous to a company in that it enables the company to charge

property which changes in the course of business and over which it is impracticable to create a
fixed charge. Until crystallisation, the company can, in the ordinary course of business, realise
assets within the class of charged property without the consent of the debenture holder.
2. A floating charge has advantages to the debenture holder in that, on crystallisation, he secures
priority to repayment over unsecured creditors.
5.9.2 THE DISADVANTAGES OF A FLOATING CHARGE
• Priority of a later fixed charge over a floating charge
• Priority in a receivership or winding up
• S. 239 Insolvency Act 1986
• S. 245 Insolvency Act 1986
• Retention of title clauses.
5.9.2.1 Priority of Charges
This has been dealt with previously. A later fixed charge ranks in priority over an earlier floating
charge in respect of the same assets. Also, a floating charge over specific assets ranks in priority
to an earlier general floating charge over all the assets and undertaking of the company.
This disadvantage may be resolved by a negative pledge clause in the earlier floating charge.
5.9.2.2 Priority of creditors in a receivership or winding up
When an administrative receiver or receiver is appointed by the holders of a charge which, as

created, was a floating charge, s. 40 IA 1986 states that if the company is not at the time in the
course of being wound up, its preferential debts shall be paid first before any claims for principal
or interest by the floating chargee. It is important to note that s.40 refers to “a charge which, as
created, was a floating charge”. This means that, although the technical effect of crystallisation is
to convert a floating charge into a fixed charge, it does not take on all the characteristics of a fixed
charge. In particular it does not take priority over preferential creditors. S. 175 IA 1986 makes
similar provision for company liquidations.
Note that the fixed chargee may well have already exercised a power of sale over, for example,
land and therefore realised his security before the receivership. In any event the position of a fixed
chargee is unaffected by the statutory provisions relating to preferential creditors. This is because
the holder of a first fixed charge has an unquestioned proprietary claim to the proceeds of sale of
the asset or assets the subject of the fixed charge. It is for this reason that there is often a dispute
over whether a charge is fixed or floating. If the holder of the charge can successfully claim that it
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is fixed, he/she will have a proprietary claim to any proceeds of sale. Such proceeds will go to pay
that charge holder first and only if there is any surplus will the proceeds be applied to meet other
claims. If the charge is floating it ranks beneath other claims (see below) which are accorded
priority by statute.
S. 386 and Schedule 6 IA 1986 deal with the statutory order of priority in corporate insolvency.
Costs and expenses of the receivership or liquidation retain priority over preferential creditors.
Preferential creditors rank ahead of the holder of any floating charge. (See para 5.9.2.2.1 below).
The order of distribution on a winding up is:
1. Costs and expenses of the receivership. (These must be paid in full before any payment is
made to those under 2 below).
2. Preferential creditors. S. 386 and Schedule 6 IA 1986 (as amended by s251 Enterprise Act
2002). These include:
2.1 Remuneration of employees (wages or salary etc.) due in the previous 4 months. The
maximum amount recoverable by employees as a preferential claim is prescribed by the
Secretary of State. It is currently £800.
2.2 Contributions to occupational pension schemes
2.3 Accrued holiday pay.
These all rank equally and therefore if the assets are not sufficient to pay all categories, then
each category abates equally. Preferential creditors must be paid in full before moving to
category 3.
3. Debts secured by a floating charge which as created was a floating charge. These must be
paid in full before moving to the next category.
4. Ordinary unsecured creditors.
It can therefore be seen that floating charges come fairly low in the order of priority and by
the time the creditors in categories 1 and 2 have been paid, there may be no money left. If,
(unusually), any assets remain, these must be used to pay the unsecured creditors in
accordance with the principle of pari passu.
Creditors with fixed charges over security are not involved in the above table. They exercise their
power of sale and, as indicated above, are paid out of the proceeds of sale of the security as they
have priority over the floating charge. If the sale does not generate enough money to pay the
whole debt, they rank with ordinary creditors for the balance. This has led major lenders such as
banks and other financial institutions to take fixed charges over all the specific assets such as
land, buildings, fixed plant and machinery and floating charges over the remainder of all the
company’s assets (including a general/overlapping floating charge over the entirety of the
company’s assets and undertaking). In this way if insufficient money is generated from the sale of
the security subject to a fixed charge, the creditor can then use a floating charge as a back up. This
gives the secured creditor an added advantage over ordinary unsecured creditors. Whether this
situation will change as a result of the Enterprise Act 2002 abolishing the preferential status of
Crown debts remains to be seen (see 5.9.2.2.1)
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5.9.2.2.1 Preferential creditors

Section 251 of the Enterprise Act 2002 will abolish the Crown’s preferential status as a creditor in
insolvency. This means that the Inland Revenue and HM Customs and Excise will no longer be
able to claim their rights to twelve months PAYE and National Insurance contributions or six
months unpaid VAT ahead of floating charge holders and unsecured creditors. However, the £800
capped claim by employees for wage arrears, holiday contributions and outstanding employers’
contributions to pension schemes will not be affected. One implication of the abolition of Crown
preference will be that more assets are available to the holders of floating charge securities then
previously, thereby leaving the unsecured creditors in much the same position as they were
before. However, under s. 176A of the IA 1986 a proportion of the recoveries obtained upon the
enforcement of a floating charge will be ring-fenced for the benefit of unsecured creditors. This
proportion, or ‘prescribed part’ (s.176A(2)) is calculated as follows:
a) where the company’s net property does not exceed £10,000, 50% of that property;
b) for property over £10,000, the sum of;
(i) 50% of the first £10,000, the sum of;

(ii) 20% of the remainder, up to a maximum of £600,000.
Note that these changes will not have retrospective effect on existing floating charge holders.
5.10 Avoidance of charges
An overriding objective of the liquidator in the winding up of a company is to ensure the equal
treatment of creditors. In certain circumstances charges may be avoided for reasons other than
non-registration.
5.10.1 Avoidance of a preference s. 239 1A 1986
This provision allows either a fixed or a floating charge to be set aside in which case the creditor
becomes an unsecured creditor.
1. An administrator (appointed under an administration order - see later notes) or a liquidator

may apply to the court where the company has at a relevant time given a preference to any person
(the provision does not apply in favour of an administrative receiver).
A company gives a preference if:
(a) that person is one of the company’s creditors (or a surety or a guarantor for any of the
company’s debts) AND
(b) the company does anything which puts that person in a better position than he would have
been if that thing had not been done.
Examples of a “preference” as defined include the paying off a creditor or for our purposes here,
the creation of a fixed or floating charge in favour of an existing creditor.
2. The company must be “influenced” in giving the preference by a desire to put the creditor into
a better position than he would have been in if the thing had not been done.
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SAQ 4
Under what circumstances do you think a company could be influenced by a desire to put
the creditor in a better position than they would have been in?
Re M. C. Bacon Ltd [1990]BCLC 324

A company was trading near to the limit of its unsecured overdraft facility when it lost its major
customer and its two experienced directors retired. The bank indicated that it would require
security for the existing sums outstanding on the overdraft as well as any fresh lending and, in
response, the company created fixed and floating charges over its assets. Subsequently the
company’s liquidator applied to set the security aside under s. 239 IA 1986.
Held: The fixed and floating charges were not void as a preference.
Millett J (as he then was) said this was the first case under s. 239, and as a result he decided to
give some guidance as to the meaning of the words under the section. He rejected old pre-1986
Act case law because the words in the section had been changed. He said the test was “whether
the company’s decision was influenced by a desire to produce the effect mentioned” in sub-
section (4)(b). He said: “Desire is subjective. A man can choose the lesser of two evils without
desiring either.” He went on to say that there must have been a desire to improve the creditor’s
position in the event of an insolvent liquidation: “A man is not to be taken as desiring all the
necessary consequences of his actions . . . [u]nder the new regime a transaction will not be set
aside unless the company positively wished to improve the creditor’s position in the event of its
own insolvent liquidation.”
He then dealt with the evidence required. He said direct evidence of the desire was not required.
“Its existence can be inferred from the circumstances of the case.”
He also said, however, that the mere presence of the desire was not enough. “It must have
influenced the decision to enter into the transaction . . . [i]t need not be the only factor or even the
decisive one.”
Finally, he said: “it is not necessary to prove that, if the requisite desire had not been present, the
company would not have entered into the transaction. That would be too high a test.”
Millet J found no evidence that two of the directors had wished to improve the bank’s position in
the event of an insolvent liquidation. “Either we gave the bank a debenture or they called in the
overdraft” i.e. the directors had a genuine belief that the company could be pulled round and
granting the security was the only means of ensuring the bank’s continuing support. This did not
amount to a “desire” to improve the position of the bank in the event of insolvency.
Another point made was that s. 239 would have applied if the third director, Mr Glover, had been
influenced by a desire to improve the bank’s position in the event of liquidation for “if he was,
then, the company’s decision was similarly influenced even though Mr Glover did not
communicate any such desire to the others.” “They [the other two] were greatly influenced by Mr
Glover’s recommendation that the debenture should be granted.” In the event, Millett J held that
he (Mr Glover) was also not influenced by a desire to improve the bank’s position in the event of
the company’s liquidation.
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3. The relevant time is:
(a) two years before the onset of insolvency if the creditor is connected with the company
(except employees) or
(b) six months before the onset of insolvency for any other person.
The onset of insolvency is defined in s. 240(3) IA 1986 as the date of the commencement of the
winding up.
4. In both cases the company must be unable to pay its debts (i.e. be insolvent) at the time the
preference was given or become insolvent as a result of the transaction. It is unlikely that the
granting of a fixed or floating charge will make a company become insolvent as a result of the
transaction. (However, the payment of money may do so.)
5. It is presumed that if the company gives a preference to a connected person, it was influenced
in so giving it by a “desire” as discussed in 2. above. The onus is then on the connected person to
rebut the presumption and show that the company was not influenced by a desire to put him or her
in a better position. Connected persons are defined in s. 249 IA as:
(a) a director or shadow director of the company or an associate of such a director or shadow
director or
(b) an associate of the company.
The term “associate” is further defined in s. 435 IA. An associate of an individual (ie of a director
or shadow director) would include the individual’s husband or wife, or relative, or the husband or
wife of a relative or any individual with whom he/she was in partnership or a company controlled
by the individual. An associate of the company would include any other company broadly
speaking controlled by the same person (see s. 435(6) for the applicable criteria).
Re Beacon Leisure Ltd [1992] BCLC 565, [1991] BCC 213

The company ran a billiard saloon. The sole directors and shareholders were Raja, Norris and
Bines. N and B leased the premises from R and the company occupied them for its business. The
company paid rent to R, due on 1st January 1988, in December 1987 before it fell due. The
company went into an insolvent liquidation on 28th January. The liquidator claimed that the
payment of rent was a preference under s. 239. He said that since all three were connected with
the company (as directors) there was a presumption that the rental payment was influenced by a
desire to put R N and B (as creditors) in a better position.
Held: R was not a creditor of the company for rent. N and B were owed money by the company
because there was an intention that a sum for rent should be paid to them out of the business so
that they could then make payments under the lease. They remained liable at all times to R as
lessees. Payment of the rent directly to R by the company relieved them of their own liability to R
as lessees. However, it did not mean that the company was strictly under any obligation to pay R
directly. In other words, R’s creditors were N and B not the company.
The court went on to consider whether the company, in deciding to pay the rent, was influenced
by a desire to put the three directors in a better position than they would have been if the rent had
not been paid? This is a presumption that has to be rebutted in a case involving connected
persons. It was rebutted here. Mr R.A.K. Wright QC held that the necessary desire did not exist
and should not be inferred. It was a commercial decision to pay the rent.
Re Fairway Magazines Ltd [1993] BCLC 643, [1992] BCC 924

The applicant, F, was a director of the company and had guaranteed the overdraft of the company.
He claimed that in reliance on a promise that the company would execute a debenture in his
favour, he had advanced £15,000 to reduce the bank overdraft on 28 August 1990. The debenture
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was executed on 27 September. Further money (£20,000) was advanced by F between 8 October
and 22 January 1991. By granting the debenture the company put F in a better position than he
would have been in. This was because the effect of the transaction was (a) to transform him into a
secured creditor and (b) to reduce his exposure under his personal guarantee. Because F was a
director, the presumption that the company was “influenced by a desire” arose. Had F discharged
the burden of showing the contrary?
Held: F had successfully rebutted the presumption The company was solely influenced by
commercial considerations, namely the need to raise money to reduce its overdraft. Granting the
debenture did not amount to a preference.
Mummery J: “First the test is whether the decision was influenced by a desire to produce the
effect identified in the statute, that effect being to improve the creditor’s position in the event of
an insolvent liquidation. Second, a desire to produce that effect is a subjective state of mind . . .
there may often be no direct evidence of that state of mind. It may be inferred from all relevant
circumstances. Finally the relevant time to consider is the time when the decision was made to
grant the debenture (21 August) not the date of the execution of the debenture.”
6. The court may make any order it thinks fit for restoring the position to what it would have
been if the company had not given the preference. Therefore any fixed or floating charges can be
set a side and the creditor returned to the position of being an unsecured creditor. Alternatively,
where appropriate the court can order money paid to a creditor to be returned.
7. Note that, in contrast with section 245 below, section 239 is not exclusively concerned with
situations where the company creates security (e.g. in the form of a floating charge) in favour of
an existing unsecured creditor to secure the existing indebtedness. It has a wider objective and
should not be regarded merely as a problem for a floating charge holder. A good example of
another type of preference case which, on the facts, fell within section 239 is Re Exchange Travel
(Holdings) Ltd (No 3) [1996] 2 BCLC 524, [1996] BCC 933 affirmed CA sub nom Katz v
McNally [1999] BCC 291.
Re Exchange Travel (Holdings) Ltd (No 3)

The three directors of the company had made unsecured loans to the company. These sums stood
to their credit in loan accounts set up by the company. In July 1990, the company made payments
to the directors which had the effect of discharging in full the amounts owing to two of them and
reducing by 50% the amount owing to the third. These transactions were challenged by the
company’s liquidator and held to be preferences.
SAQ 5
How can you say that the payments had put the directors in a better position?
The point here is that the directors were put in a better position. The amounts owing were
unsecured. Under normal circumstances, the directors would have been required to prove in the
liquidation for these amounts in competition with other unsecured creditors. The prospects of
them recovering anything more than a fraction of what they were owed in the liquidation were
almost nil. Their position was thus improved by the payments and the fact that the company’s
general assets had been diminished in making the payments was prejudicial to the company’s
other creditors. For two similar decisions on very similar facts (cases also involving the
discharging of directors’ loan accounts) see Wills v Corfe Joinery Ltd [1997] BCC 511 and Re
Brian D Pierson (Contractors) Ltd [1999] BCC 26. Equally, where an unconnected creditor is
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paid in circumstances where a connected person’s position as guarantor is improved, the court
may apply section 239:
Re Agriplant Services Ltd [1997] 2 BCLC 598, [1997] BCC 842

The company leased certain assets from a leasing company, CAF. Payments under the leases were
guaranteed by one of the directors, S. The question was whether sums paid to the leasing
company two weeks before the company went into voluntary liquidation amounted to an unlawful
preference.
Held: (1) Section 239(4) referred to a preference being made to “a person” who was a creditor of
the company or guarantor for its debts. Section 239(5) referred to an order against “any person”
where the company was influenced by the desire to put “that person” in a better position as
described in s. 239(4)(b). The next question was whether there was the necessary desire to prefer
both S and CAF. (2) In procuring the company to make the payment to CAF, S had his own
liability under his guarantee directly in mind and in so doing was influenced by a desire to reduce
the company’s indebtedness to CAF with the consequence that his own position on an insolvent
liquidation of the company would also be improved. (3) In making the payment to CAF the
company, that is to say S, was influenced by a desire to improve the position of S and of CAF on
an insolvent liquidation of the company. It was only by improving CAF’s position on the
insolvent liquidation of the company that S’s own position under his guarantee could itself be
improved. S wanted (desired) to reduce the company’s debt to CAF, i.e. to produce in relation to
CAF the effect described in s. 239(4)(b) for just that reason. The court ordered CAF to repay the
company and further ordered S to reimburse CAF under his guarantee.
The cases discussed illustrate the potential width of section 239 so please do not assume that it is
confined in application to floating charges created at a relevant time.
5.10.2 Avoidance of floating charges s. 245 1A 1986
1. This section gives the ordinary creditor more of a chance to recover some money because the
floating charge security is avoided and the creditor accordingly loses priority over unsecured
creditors. Section 245 can only apply to a floating charge.
The section states that where a company is being wound up or where fresh consideration, such as
an administration order is made, a floating charge created at the “relevant time”is invalid unless
money paid or goods or services supplied, or any debt of the company discharged at the same
time as, or after, the creation of the charge. This means that if consideration for the charge was
given at the same time as, or after, its creation, the charge is a valid charge.
2. This section was enacted to prevent, in particular, directors who have lent money to their
company in the past on an unsecured basis from taking a floating charge as the company
approaches insolvency.
3. The relevant time is
(a) in the case of a person who is connected with the company, at a time in the period of two
years ending with the onset of insolvency. (NB The company may be solvent immediately
after granting the charge) or
(b) in the case of any other person, within 12 months of the onset of insolvency. Here it must
also be shown that the company was at that time unable to pay its debts or became unable to
pay its debts in consequence of the transaction under which the charge was created.
4. The onset of insolvency is defined in section 245(5) and is similar to the position under
section 239.
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5. Connected persons for the purposes of section 245 are the same as for section 239.
6. Note that under this section it is the security which becomes invalid. The debt remains and
therefore the chargee is treated as an ordinary unsecured creditor.
7. What does “at the same time as” mean?
Power v Sharp Investments Ltd [1994] 1 BCLC 111, [1993] BCC 609, CA
Shoe Lace Ltd was in financial difficulties. On 20 March 1990 it decided to grant a debenture to
Sharp Ltd, its parent company, to secure past and future advances in consideration of being given
further short term finance. Sharp Ltd then advanced £300,000 to the company on 3rd April,
£50,000 in May, £75,000 in June and £11,500 on 16th July. The debenture was executed on 24th
July. A petition for the compulsory winding up of Shoe Lace Ltd was presented on 4th September
and the company was wound up on 20th November.
Held: The floating charge would be set aside under s. 245.
The floating charge was created at the relevant time because it was created within two years of the
onset of insolvency. It had been created in favour of a connected person, Sharp Ltd which
controlled Shoe Lace Ltd (and was therefore an “associate”). The charge was therefore void
except to the extent that Sharp had paid money to the company “at the same time as, or after, the
creation of the charge.”
Slade LJ:
“. . . no moneys paid before the execution of the debenture will qualify for the exemption . . .
unless the interval between payment and execution (of the charge) is so short that it can be
regarded as minimal and payment and execution can be regarded as contemporaneous.”
“It is always open to the lender not to lend unless the charge has actually been executed; this
must be the prudent course.”
8. What amounts to “money paid” for the purposes of s. 245? Banks often allow companies to
operate on an unsecured overdraft and then at some point take security for the overdraft.
Re Yeovil Glove Co Ltd [1965] Ch 148, CA

The company had an unsecured overdraft with the bank. It then created a floating charge in the
bank’s favour 12 months before going into liquidation. Since the charge had been created, the
bank had honoured £110,000 worth of cheques and credited £111,000 worth of payments to the
company’s account.
Held: The £110,000 paid on the cheques by the bank was new money advanced to the company
and was paid in consideration of the charge. Every payment out was a provision of new money.
Therefore, the charge did not fall foul of a statutory predecessor of s. 245 and the charge was
valid.
9. The rule in Clayton’s Case was applied in Re Yeovil Glove. This rule states that the earliest
payments into an account are set off against the earliest payments out and vice versa. Therefore,
payments in by the company must satisfy debts in order of creation. This had the effect that
payments in after the charge was created (the £111,000 in Re Yeovil Glove) had to be used to pay
off the debts which already existed before the charge was created. This meant that the whole of
the pre-charge indebtedness was treated as paid off by the post-charge payments in. The bank then
advanced new money which was secured by the charge. As a result there was nothing left for
unsecured creditors.
10. The money which is paid must be intended to benefit the company. The company must
receive genuine new value.
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Re Matthew Ellis Ltd [1933] 1 Ch 458

The company owed money to a partnership in which one of its directors was a partner. The
partnership refused to supply any more goods to the company unless the debt was paid. The
director lent money, secured by a floating charge, to the company on condition that the
partnership debt was paid out of the money lent. The company went into liquidation 4 months
later.
Held: The charge was valid. The consideration paid for it was intended to benefit the company.
If, however, the money is intended to benefit creditors instead of the company, i.e. the company
does not genuinely receive new value, the charge will be invalid.
Re Destone Fabrics Ltd [1941] Ch 319, CA

An insolvent company owed money to three of its directors. A third party lent the company
money secured by a floating charge. The money had been provided by one of the directors. The
third party was his nominee. The money was used to pay off the three directors. The company
went into liquidation within 12 months.
Held: The charge was invalid. The money was intended to benefit the creditors not the company
and therefore, in effect, no genuine new value was received by the company.
If the payment is to substitute a secured debt for an unsecured debt then the payment is not in
substance “money paid . . . to the company” within section 245 (2)(a):
Re Orleans Motor Co Ltd [1911] 2 Ch 41
The directors were guarantors of the company’s bank overdraft. Payments were made by the
directors to the company by cheque with the company as drawee. This had the effect of reducing
the overdraft. Debentures were granted to secure those payments by the directors.
Held: The sums were not secured by the debentures because they never became part of the
company’s assets to do with as it liked. The company was under an obligation to hand those sums
to the bank in discharge of the overdraft. That operated for the benefit of the directors by reducing
their exposure as guarantors.
Re Fairway Magazines Ltd

See the notes on s. 239 for facts. A claim was also made in this case under s. 245 and the question
arose as to whether the payments between October and January were made for the benefit of the
company.
Held: The case was analogous to Re Orleans Motor Co Ltd. The effect of the payments of
£20,000 was to reduce the applicant’s liability under his guarantee and such payments were not
new money within the meaning of s. 245 and the floating charge to the extent of £20,000 was set
aside under this section.
11. This section does not provide for the refund of any money actually paid to the chargee and
therefore if payment is made the section does not apply.
Re Parkes Garage (Swadlincote) Ltd 1929.

An insolvent company already owed money to creditors. It later executed a floating charge to
secure repayment. These creditors were paid off on 27th July. On 14th September a compulsory
winding up order was made.
Held: The then statutory equivalent of s. 245 could not be used to compel repayment of the
money.
However, it was recognised in the above case, that this could be a preference and therefore in the
kind of situation where payment has been made, the liquidator should apply under s. 239 not s.
245 for repayment.
12. Note that s. 245 only applies to floating charges not fixed charges. However s. 239
(preferences) could be used to set aside a fixed charge in appropriate circumstances.
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5.10.3 Transactions at an undervalue s. 238
1. An administrator or liquidator may apply to the court if the company has at a relevant time
entered into a transaction at an undervalue with any person.
2. A transaction is at an undervalue if
a. it is a gift (i.e. no consideration) or
b. the value given to the company is significantly less than the value of the consideration
provided by the company.
3. It is a defence if the company entered into the transaction in good faith and for the purpose of
carrying on its business and, that at the time it did so, there were reasonable grounds for believing
that the transaction would benefit the company.
4. The relevant time is two years before the onset of insolvency.
5. The company must be insolvent at the time (as with preferences). However, it is presumed
that the company is insolvent in the case of a connected person. The connected person must
therefore rebut the presumption: i.e. prove the contrary i.e. that the company was solvent.
6. Again the court may make any order it thinks fit so money is repayable or property returnable.
Again bona fide purchasers for value are protected.
Re M C Bacon Ltd 1990

(see Preferences s. 239 - debenture notes for facts)
Liquidator said the granting of the fixed and floating charge was a transaction at an undervalue
under s. 238. the court held that it was not a gift, nor was it without consideration. The
consideration consisted of the bank’s forbearance from calling in the overdraft and honouring
cheques and making fresh advances to the company. Also the mere creation of a security over
assets does not deplete them and does not come within the section.
SAQ 6
To what extent are preferences and transactions at an undervalue similar?
5.10.4 Similarities between s. 239 (preferences) and s. 238 (transactions at an

undervalue).
1. Both require an administrator or liquidator to bring the action.
2. The relevant time is the same (see s. 240 IA 1986) for connected persons - two years ending
with the onset of insolvency. If persons are not connected it is still 2 years for transactions at an
undervalue but 6 months for a preference.
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3. The company must be insolvent when the transaction at an undervalue is made or a preference
is given or become unable to pay its debts as a result of the transaction or preference.
4. The court can make any order it thinks fit for restoring the position to what it would have
been.
5. For connected persons there are presumptions
i. transaction at an undervalue, a presumed insolvency.
ii. Preferences, presumption that the company was influenced by a desire to put the connected
person into a better position than he/she would have been had the thing not been done.
5.10.5 Transactions defrauding creditors s. 423
1. This section is also concerned with transactions at an undervalue.
A company enters into a transaction at an undervalue if
a. the company makes a gift (or there is no consideration)
or
b. the company enters into a transaction with the other where the consideration s significantly
less than the consideration provided by the company.
2. If the court is satisfied that the transaction was entered into for the purposes of putting assets
beyond the reach of a person who is making or may make a claim, it may restore the position to
that it would have been or require payment to be made.
3. The liquidator, administrator or victim of the transaction may apply to the court. The victim
of the transaction must have the leave of the court to apply.
Pinewood Joinery v Starelm Properties Ltd 1994

A hostel was worth £750,000 but was encumbered with a mortgage in favour of the Bank for
£2.6m. There was no planning permission to change the hostel to a hotel, but the company
intended to apply. The applicants carried out work on the hostel. They were owed £100,000. The
hostel was transferred to an associate company for £1 for tax reasons.
Held: This was not a transaction at an undervalue. The hostel was not worth even £1 because of
the mortgage and lack of planning permission.
5.10.6 Retention of title clauses
A floating chargee may assume that the company owns a great deal of stock whereas in fact the
company’s suppliers may retain title to the stock by means of a provision in the supply contract.
1. Another name for this type of provision is a Romalpa clause after the case in which this type
of clause was first recognised. Sellers of goods to companies are aware of the fact that if a
company goes into liquidation before they have been paid, they are unlikely to recover anything.
As unsecured creditors they will rank behind creditors holding fixed and floating charges over the
assets of the company. They therefore endeavour to protect themselves by a retention of title
clause. This clause states that title to the goods remains with the seller until payment.
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Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd 1976

Aluminium foil was supplied to the company by the plaintiff. A retention of title clause said that
ownership of the foil would not pass until the price was paid in full. Products made with the foil
by the company could be sold but on terms that the company was the plaintiff’s agent.
Held: The plaintiff could trace the price due to them into the proceeds of sale of the manufactured
goods ahead of secured and unsecured creditors.
The basis of the decision is that the property in the foil never passed to the buyers and therefore
the proceeds of subsales belonged to the plaintiff suppliers.
2. Since the Romalpa case the situation has become much more complex. There appears to be no
problem about retention of title clauses where the goods are not mixed by the company with other
goods and therefore remain identifiable. However, where the goods have been mixed in a
manufacturing process with other goods belonging to the company or third parties, the courts
have generally found that the parties must have intended title to pass to the company with the
effect that the retention of title clause will operate as a “charge back” over the company’s assets
void for lack of registration under sections 395-399 of the Companies Act.
3. The situation above, whereby the mixed goods are treated as the property of the seller, is
unlikely to occur except where the clause imposes a duty on the buyer to keep the proceeds of any
subsale separate from other company money. However, even this may not work because usually
the price of the mixed goods is greater than the sum owing to the original supplier. In this
situation, it is likely that the courts will say a charge has been created in favour of the seller which
is void for non-registration.
4. Therefore, as far as a prior floating chargee is concerned, he need not worry too much about
retention of title clauses except where goods are unmixed. In that situation, the goods remain the
property of the seller, not the company, and cannot be used to satisfy his security. But if the goods
are mixed, the seller is regarded as taking a floating charge over them and this (assuming proper
registration) would rank in priority after the prior floating charge since it was created later.
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5.11 Questions
examination questions. They re NOT examination type questions.
1. What is a fixed charge?
2. What is a floating charge?
3. What is crystallisation?
4. What is the priority of charges? How does the “negative pledge” clause affect priority?
5. When registering a charge in the company’s own register of charges, what is involved?
6. What does section 395 say?
7. What happens if charges are not registered with the Registrar of Companies?
8. What is rectification of the register and what is its effect?
9. What is an administrative receiver and what are his powers?
10. What are the advantages and disadvantages of a floating charge?
11. What is the statutory order of distribution in a receivership or winding up?
12. What is a preference and how may it be avoided? What is the meaning of “influenced by a
desire”?
13. What is the effect of s. 245?
14. In s. 245 what does “at the same time as” mean?
15. In s. 245 what does “money paid” mean?
16. What is a retention of title clause?
Question
Charles and Doreen set up Toffs Ltd on 16th January 1995 in order to run an up-market clothing
hire business. Funds for the new company came from issuing shares to Charles, and £100,000 was
provided by Doreen who took a debenture creating fixed and floating charges. The debenture was
created on 16th January 1995 and registered on 7th February 1995. Both Charles and Doreen were
appointed to the board.
The initial funds quickly ran out in paying for stock and a sophisticated computerised order
system. Charles and Doreen therefore approached Toffs Ltd’s bankers, Drakes, who agreed to
advance £300,000 to the company in return for a debenture with fixed charges over stock and the
computer system and a floating charge over the company’s business and undertaking. The
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debenture, which contained a negative pledge clause, was executed and registered on 14th
February 1995.
£100,000 of Drake’s loan was used to pay off Doreen’s debenture and £50,000 was paid to
Sandringham Ltd, a company which supplied morning coats to Toffs Ltd. Sandringham Ltd had
refused to continue to supply Toffs Ltd unless their unpaid invoices were met in full and were
threatening to present a winding up petition against Toffs Ltd. Doreen persuaded Sandringham
Ltd to accept a floating charge in addition to the £50,000 to secure Sandringham’s remaining
debt. The debenture was created and registered on 1st March 1995.
The new funds failed to alleviate Toffs Ltd’s difficulties and on 27th July 1995 Sun Systems, one
of Toffs Ltd’s creditors, presented a winding up petition in the High Court. The High Court made
the winding up order against Toffs Ltd on 24th August 1995.
The liquidator seeks your advice as to the collection and distribution of assets.
Outline answer – see Cases & Materials 5.7.2 for a complete outline answer.
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CHAPTER SIX
COMPANY MANAGEMENT
6.1 Objectives
• Understand the differences between the AGM, the EGM and other types of meetings.
• Be familiar with the procedure in meetings.
• Recognise the different kinds of resolutions and their significance.
• Appreciate the duties of shareholders.
• Know who may be appointed as a director.
• Understand how a director may be removed from office.
• Evaluate the powers of directors.
“The members of the Company normally express their will at general meetings by passing
resolutions. . . The meetings have to be properly convened and due notice of them has to be
given. The procedure at the meetings must not be irregular; the resolutions have to be carried by
the majorities required by statute or the articles and in some cases have to be confirmed by the
court or the Department of Trade. Further, some resolutions have to be notified to the Registrar
of Companies in the time and manner laid down by the Act; and all have to be duly recorded in
the minutes of the meetings.” (Palmer’s Company Law)
6.2 General Meetings
We will see that in the Table A company considerable power is vested in the board of directors. In
company law theory, the role of the shareholders is residual but directorial power is
counterbalanced by general meeting control over the composition of the board and the legal duties
imposed on directors. Certain matters are reserved to the general meeting by CA 1985 or Table A.
If the Act or articles of association provide in given circumstances that a resolution must be
passed by the shareholders then usually (subject to what is said below about deregulation) there
will need to be a general meeting.
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There are two types of general meeting:
• Annual General Meetings; and
• Extraordinary General Meetings.
6.2.1 ANNUAL GENERAL MEETING (“AGM”)
(a) An AGM must be held each calendar year and it must not be held later than 15 months from
the date of the previous AGM (CA 1985 s. 366(1), (3)).
(b) The first AGM of a company must be held within 18 months of incorporation. An AGM
need not be held in the year of incorporation (CA 1985 s. 366(2)).
(c) The AGM provides shareholders with an opportunity to question the board on the
company’s performance. The AGM will be asked to approve the annual accounts and the
directors’ annual report (see generally the requirements of Pt VII of CA 1985).and may be
called upon to reappoint any directors required to retire by rotation (see Table A arts 73-76).
6.2.2 EXTRAORDINARY GENERAL MEETING (“EGM”)
(a) General meetings other than AGMs are called EGMs. EGMs can be called in 2 ways (see
(b) and (c) below).
(b) Board call
Company articles usually provide that the directors may call an EGM any time they wish by
passing a resolution at a properly convened and constituted board meeting - see eg. Table A
art 37.
(c) Members’ requisition
Alternatively CA 1985 s. 368(1) states that the directors must call an EGM on the
requisition of the holders of not less than one-tenth of such of the company’s paid-up
capital as carries the right to vote at general meetings (CA 1985 s. 368(2)). Where this
procedure is used:
• The requisition must state the objects of the meeting and must be signed by the
requisitionists and deposited at the company’s registered office (CA 1985 s. 368(3)).
• CA 1985 s. 368(4) enables the requisitionists themselves to convene the meeting if the
directors fail to issue notices of EGM to the shareholders within 21 days following receipt
of the requisition by the company.
• The meeting is not properly convened if the date fixed for the meeting by the directors is
more than 28 days after the notice calling it: CA 1985 s. 368(8). However, to comply
with the ordinary notice rules (see further 1.4 below) shareholders must receive not less
than 14 clear days notice of the meeting (21 clear days notice if a special resolution is to
be moved).
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6.2.3 CLASS MEETINGS
If the shares of the company are divided into various classes, class meetings have to be held when
CA, the articles or terms of issue so require. The most frequent case in which class meetings are
required is where it is proposed to vary the rights attaching to a particular class or shares.
6.2.4 CALLING GENERAL MEETINGS
(a) The length of notice for an AGM is not less than 21 clear days: CA 1985 s. 369(1)(a).
(b) The length of notice for an EGM is not less than 14 clear days: CA 1985 s. 369(1)(b).
(c) If a special resolution is proposed at any meeting 21 clear days notice must always be
given: CA 1985 s. 378(2).
(d) Meaning of “clear days”: in computing the period of notice the day on which notice of
EGM is sent out and the day of the meeting itself must be discounted.
(e) A meeting may be called at shorter notice in the following circumstances
• AGMs - if all shareholders agree: CA 1985 s. 369(3)(a).
• EGMs - if a majority in number of shareholders together holding not less than 95% in
nominal value of the shares giving a right to attend and vote at the meeting agree: CA 1985
s. 369(3)(b), (4).
It is possible to call an EGM to consider a special resolution on short notice: CA 1985 s. 378(3).
EXAMPLE (SHORT NOTICE PROCEDURE)
Eg 1 Adrian, Barry, Cherie and Doris are the only shareholders and directors of ABCD Ltd. Each
of them holds 25% of the company’s issued share capital. They wish to move a shareholders’
resolution proposing a change of the company’s rather boring name. All four are in favour of the
change.
Under the general rules, the four (constituted as the board) could call an EGM (under Table A art
37) but would be required to give themselves (as shareholders) 21 days’ notice of EGM (special
resolution) under s. 378(2). They would like to change the name more quickly than that.
Adrian, Barry, Cherie and Doris all agree to use short notice procedure and call an EGM of
ABCD Ltd for the next day. This can be done. They are a majority in number (4-0) together
holding more than 95% in nominal value of the shares (CA 1985 s. 378(3)). [NB They could
avoid the need for a formal EGM altogether by using written resolution procedure: see 4.2
below].
Eg 2 Take another company, AB Ltd. Alice and Brian are the sole shareholders and directors.
Alice owns 95% of the issued shares, Brian the other 5%. Alice wants an EGM to be convened on
short notice. Brian objects.
Unless Brian agrees, the short notice procedure cannot be used. Alice has 95% but she is not a
majority in number (1-1). Both elements must be satisfied.
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(f) Notice of the meeting must be given to all shareholders entitled under the articles to notice:
Young v Ladies’ Imperial Club Ltd [1920] 2 KB 523. The notice must specify the date,
place and time of the meeting.
(g) An omission to give notice to any person entitled to it invalidates the meeting although the
articles usually contain a clause relaxing this rule in the case of accidental omissions see eg.
Table A art 39. Moreover, even if the procedure adopted is flawed the court will often not
intervene in favour of the shareholder affected if the result of the meeting, following correct
procedure, would have been the same in any event - the court will not act in vain. For an
example in the specific context of short notice procedure see Re Ransomes plc [1999] 1
BCLC 775.
EXAMPLE (REQUISITION PROCEDURE)
A member of Eastmid Ltd who holds 10% of the paid up voting capital lodges a requisition under
CA 1985 s. 368 at Eastmid Ltd’s registered office on 1st March. The requisition states that the
object of the meeting is to move a special resolution under CA 1985 s. 28(1) to change the
company’s name from Eastmid Ltd to Westmid Ltd.
Under s. 368 procedure the board of Eastmid Ltd is required to act by convening an EGM within
21 days of the requisition being deposited. [This means that the board must send out notice to all
shareholders calling the EGM. It does not mean that the EGM must be held within 21 days]. If the
board of Eastmid Ltd has not sent out Notice of EGM by 22nd March the requisitioning member
could convene the EGM and recover any reasonable expenses incurred in so doing from the
company (CA 1985 s. 368(4)-(6)).
The board of Eastmid Ltd chooses to comply with s. 368(4) and send out notice of EGM within
21 days. How much notice are the shareholders entitled to? Under general rules, shareholders are
generally entitled to 14 days’ notice (CA 1985 s. 369) and 21 days’ notice if a special resolution is
to be considered (CA 1985 s. 378). “Notice” here means the period the company is required to
leave between the date of the notice of EGM and the date on which the meeting is scheduled to
take place. Here a special resolution is to be considered so at least 21 days’ notice must be given.
Thus, for example, on the general rules, if the board decides to send out Notice of EGM on 2nd
March the earliest date the meeting could take place would be 24th March being 21 clear days
after 2nd March.
The board is not deemed to have duly convened a requisitioned EGM if it calls the meeting for a
date more than 28 days after the date of the notice convening the meeting ie the period of notice
should not exceed 28 days (CA 1985 s. 368(8)). The board of Eastmid Ltd must therefore avoid
giving too much notice. If the date of the meeting was set for say 2nd April this would be more
than 28 days after 2nd March and the meeting would not be duly convened under s. 368(8). In this
example, the meeting could be called for 24th March at the earliest but no later than 30th March.
Requisition procedure thus forces the board to act quickly and gives the directors no scope to put
matters off indefinitely.
6.2.5 ELECTRONIC COMMUNICATIONS
The effect of the Companies Act 1985 (Electronic Communications) Order 2000 SI 2000 No 3373
(“the Order”) on the foregoing should be noted. The Order makes provision in line with the
Electronic Communications Act 2000 allowing for documents to be submitted to Companies
House in electronic form and notices of meetings to be communicated to members by electronic
means. It makes a number of amendments to the Act and to Table A. Any company incorporated
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without filing a set of articles after 22nd December 2000 will be subject to the amended version
of Table A by default. For present purposes the relevant provisions of the Order are to be found in
regs 12 and 18-19. Reg 18 is particularly important. This inserts a new subsection (4A) in s. 369.
The effect of the amended section is that notice of a general meeting is treated as having been
given to a member if it was sent using electronic communications to an address notified by the
member to the company for that purpose. Furthermore, a member will also be treated as having
received notice of general meeting where (a) the company and that member have agreed that
notices of meetings may instead be accessed via a website; (b) the meeting is a meeting to which
that agreement applies; (c) that person is notified of (i) the publication of the notice on a website,
(ii) the address of that website, (iii) the place on the website that the notice may be accessed and
how it may be accessed and (d) the notice continues to be published on that website throughout
the period beginning with the giving of the notification and ending with the conclusion of the
meeting. For the purposes of this second provision, notice is treated as having been given to the
member at the time he or she was notified of the matters in (c) above. Table A has been amended
to reflect these changes (see, in particular, articles 111-112 of Table A which are amended by
Schedule 1 of the Order. NB these changes have no application to the short notice procedure
outlined in 1.4(e) above.
6.3 Proceedings at General Meetings
6.3.1 QUORUM
For proceedings at a general meeting to be valid a quorum must be present. The articles usually
fix the quorum: see eg. Table A art 40 which provides that a quorum is two members present in
person or by proxy. In the case of a single member private company a quorum of one suffices: CA
1985 s. 370A.
6.3.2 FRUSTRATED QUORUM
Could a minority shareholder use the quorum rules to frustrate the wishes of a majority
shareholder simply by not attending? The court may order a meeting to be called, held and
conducted in any manner the court thinks fit under CA 1985 s. 371. Section 371 is a “last resort”
remedy available in certain circumstances where, for practical reasons, it is not possible to call
and hold a meeting in full compliance with the Act and the company’s articles.
Re Sticky Fingers Restaurant Ltd [1992] BCLC 84, [1991] BCC 754
The company had two directors who were also the only shareholders. The quorum for both board
and general meetings was two. A dispute arose between the two. One, who was the minority
shareholder, refused to attend meetings. The majority shareholder applied to court for an order
under s. 371 that a meeting could be held at which he alone would constitute a quorum. The
object of the meeting was to appoint two more directors. Held Order made on condition that the
applicant undertook not to take steps to have the other director removed from office pending the
outcome of the latter’s petition under CA 1985 s. 459 (which will be covered later).
It is clear therefore that s. 371 can be used to prevent a minority shareholder from abusing the
quorum requirements by refusing to attend meetings, thereby preventing a majority shareholder
from exercising the voting rights attaching to his shares.
Note, however, that it is apparently possible to contract out of s. 371. The effect of Ross v Telford
[1998] 1 BCLC 82, [1997] BCC 945 is that s. 371 cannot be used to affect substantive voting
rights or to shift the balance of power in a case where the members have agreed to share power
equally and where any deadlock can be taken to have been agreed by them for mutual protection.
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Ross v Telford
A company had two shareholders each holding 50% of the issued share capital. A deadlock arose.
One shareholder applied to the court for an order under s. 371 convening a meeting at which he
and his solicitor would be treated as constituting a quorum.
Held: It was not appropriate for the court to exercise its discretion to make the order. To do so
would enable one 50% shareholder to outvote the other. This contravened the fundamental basis
on which the company had been incorporated and Sticky Fingers was accordingly distinguishable.
6.3.3 CHAIR
Articles commonly provide that the board’s chair shall also take the chair at general meetings -
see Table A art 42. In the absence of such provision, any member elected by the members present
may act as chair: CA 1985 s. 370(5).
6.3.4 VOTING
(a) Unless the articles state otherwise, questions at a general meeting fall to be decided in the
first instance by a show of hands. Every member present in person has one vote on a show
of hands regardless of the size of his/her shareholding.
A declaration from the chair that an extraordinary or special resolution has been passed by a
show of hands is “conclusive evidence of the fact without proof of the number or proportion
of the votes recorded in favour of or against the resolution” - see CA 1985 s. 378(4) and
Table A art 47.
(b) However, the articles usually provide that a poll vote may be taken. At common law any
one member of an association whether incorporated or otherwise may demand a poll. The
articles usually specify the conditions subject to which a poll may be requested - see eg.
Table A art 46. Note that CA 1985 s. 373 prevents a company from excluding the right to
demand a poll. On a poll, it is usual for every member to have one vote per share held -
see Table A art 54.
(c) Table A art 50 gives the chair of general meeting a casting vote on a show of hands or a poll.
This is often excluded in practice (especially in private companies) and, in any event, is
only relevant where the proposed resolution is capable of being passed by simple majority.
6.3.5 PROXIES
CA 1985 s. 372(1) states that any member entitled to attend and vote at a meeting is entitled to
appoint another person as his/her proxy. The proxy need not be another member. The proxy
cannot vote on a show of hands, only a poll. In a private company a proxy appointed to attend and
vote has the same right as his/her appointor to speak at the meeting and demand a poll. Note that
s. 372 and the relevant provisions in Table A applicable to proxies (arts 60-62) have been
amended by the Companies Act 1985 (Electronic Communications) Order 2000 (see reg 19 and
Schedule 1). The Order is discussed generally in 1.5 above. Here its main effect is to allow
members to use electronic means of communication to appoint proxies and notify the company of
such appointments.
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6.4 Types of Resolution
6.4.1 ORDINARY RESOLUTIONS
(a) These are resolutions which require a simple majority.
(b) It is not necessary for the resolution to be carried by a majority of those present at the
meeting. If several abstain this is irrelevant - the majority is taken of those who actually
vote for or against the resolution.
(c) It is also not necessary to set out the precise words of the proposed ordinary resolution in
the notice convening the meeting.
6.4.2 EXTRAORDINARY RESOLUTIONS
(a) These require a 75% majority of the shareholders voting in person or by proxy at a general
meeting: CA 1985 s. 378(1).
(b) The resolution in the form in which it is to be passed should be set out precisely in the
notice convening the meeting.
(c) This type of resolution is used primarily to commence a creditors’ voluntary winding up:
see IA 1986 s. 84(1)(c).
6.4.3 SPECIAL RESOLUTIONS
(a) Like an extraordinary resolution, these require a 75% majority. Unless short notice
procedure is used (see 1.4 above) 21 clear days notice of the resolution is required.
(b) The resolution in the form in which it is to be passed should be set out in the notice
convening the meeting.
(c) This type of resolution is required where the company wishes to make fundamental changes
to its constitution eg.
• to alter its objects (CA 1985 s. 4)
• to alter its articles (CA 1985 s. 9)
• to change its name (CA 1985 s. 28(1))
• to reduce its capital (CA 1985 s. 135(1).
6.5 Additional Types of Resolution – De-Regulation
There are two ways in which the formal and time consuming corporate meeting procedures
discussed above can be relaxed for private companies:
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6.5.1 THE ELECTIVE REGIME
A private limited company can dispense with 5 statutory requirements specified in CA 1985 s.
379A by elective resolution. Agreement in person or by proxy of all members entitled to attend
and vote at a general meeting is required to pass an elective resolution. Unlike other types of
resolution, if someone does not attend or fails to vote the resolution will not be passed.
An elective resolution requires at least 21 days notice and it is not possible to convene a meeting
to consider an elective resolution on short notice. Notice of a meeting to pass an elective
resolution can now be communicated to members by electronic means: see the Companies Act
1985 (Electronic Communications) Order 2000, reg 21 which amends s. 379A. The rules are the
same as those that apply in general to notices of meetings (see 1.5 above).
An elective resolution can be revoked by ordinary resolution.

Note that once the CLR Bill is brought into force the ‘elective’ regime will represent the default
position for private companies and will mean, amongst other things, that private limited
companies will not be required to hold an AGM unless they specifically choose to do so.
6.5.2 WRITTEN RESOLUTIONS
(a) CA 1985 s. 381A: anything which can be done by a resolution of the company in general
meeting or by resolution of a class meeting may be done without a meeting and without
any previous notice, by a resolution in writing.
(b) A written resolution must be signed by or on behalf of all members who would be entitled
to attend and vote at such a meeting.
(c) The signatures need not be on a single document. The date of the resolution is the date of
the last signature to be obtained.
(d) An ordinary, special or extraordinary resolution may be passed as a written resolution. The
only exceptions are a resolution to remove a director under CA 1985 s. 303 and a resolution
to remove an auditor under CA 1985 s. 391: see s. 381A(7).
(e) A copy of the proposed written resolution must be sent to the company’s auditors at or
before the time that the resolution is sent to the members for signature: CA 1985 s. 381B.
NB1. Table A art 53 allows a company to dispense with the requirement to hold a meeting.
There is no need to notify the auditors. CA 1985 s. 381C provides that the statutory written
resolution procedure in no way prejudices the ability of the company to use the article 53
procedure.
NB2 The Companies Act 1985 (Electronic Communications) Order 2000 does not apply to
written resolution procedure (whether under section 381A or Table A art 53).
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6.5.3 NOTIFICATION TO THE REGISTRAR OF COMPANIES
Notice must be given to the registrar of special and extraordinary resolutions. The same is true
where written resolution procedure is used to pass a special or extraordinary resolution.
Resolutions may be filed by electronic means provided the delivery is in a form or manner
acceptable to the registrar: see CA 1985, s. 707B (as inserted by the Companies Act 1985
(Electronic Communications) Order 2000, reg 27).
Ordinary resolutions need not generally be filed. For exceptions see CA 1985 s. 380.
6.5.4 INFORMAL RESOLUTIONS: THE PRINCIPLE OF UNANIMOUS

CONSENT AT COMMON LAW
It is well established at common law that a unanimous decision of the members on a matter or act
falling within the company’s capacity will generally bind the company in relation to that matter or
act. The courts often have recourse to this principle where there has been a failure to comply with
the formal requirements for passing resolutions laid down in the Act but the evidence shows that
all the members had reached informal agreement. The principle has been applied in broadly two
sets of circumstances:
To validate decisions made at general meetings which, by reason of some procedural irregularity,
were not properly convened. The case of Re Oxted Motor Co Ltd [1921] 3 KB 32 is a good
example of this. There, the shareholders passed an extraordinary resolution to put the company
into voluntary winding up. However, the notice convening the meeting was irregular because it
failed to specify that the resolution was to be proposed as an extraordinary resolution. Even so,
the judge held that the resolution was valid because all the shareholders had been present at the
meeting and, on the principle of unanimous consent, could be treated as having waived the formal
notice requirements. For other examples, see Re Pearce, Duff & Co Ltd [1960] 1 WLR 1014,
[1960] 3 All ER 222 and Re Bailey, Hay & Co Ltd [1971] 1 WLR 1357, [1971] 3 All ER 693.
1. To treat the company as having passed a formal resolution in circumstances where none was
formally proposed and no meeting formally convened. Thus, in Re Duomatic Ltd [1969] 2 Ch
365 it was held that the informal approval of all the shareholders in relation to the payment of
director’s remuneration was sufficient to bind the company even though the articles required
such questions to be determined by formal resolution in general meeting. Similarly, in Cane v
Jones [1980] 1 WLR 1451 the court ruled that an informal agreement of all the shareholders
was effective to alter a companyís articles of association despite the requirement in the Act
for a special resolution – see Cases & Materials 6.2
2. To treat the company as having passed a formal resolution in circumstances where none was
formally proposed and no meeting formally convened. Thus, in Re Duomatic Ltd [1969] 2 Ch
365 it was held that the informal approval of all the shareholders in relation to the payment of
directors’ remuneration was sufficient to bind the company even though the articles required
such questions to be determined by formal resolution in general meeting. Similarly, in Cane v
Jones [1980] 1 WLR 1451 the court ruled that an informal agreement of all the shareholders
was effective to alter a companyís articles of association despite the requirement in the Act
for a special resolution.
In the recent case of Re R W Peak (Kings Lynn) Ltd [1998] 1 BCLC 193 the High Court addressed
the question of whether there are any limits to this common law pragmatism.
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RW Peak (Kings Lynn) Ltd

The case concerned a small private company that originally had two shareholders, R and N. A
written agreement was entered into providing for the company to purchase R’s majority
shareholding. R signed the agreement in his personal capacity and N signed it on behalf of the
company. The company was not authorised by its articles to purchase its own shares and no
special resolution was proposed or passed before the agreement was entered into as required by
the Companies Act 1985, s. 164. After N’s death, R applied for his name to be restored to the
company’s registered members, arguing that the agreement was void for want of compliance with
the Act. Against this, the company argued that the transaction was saved by the principle of
unanimous consent because it had clearly been approved by the two shareholders at the time.
Held: Lindsay J rejected the company’s argument on two grounds:
(1) His main point was that even if R and N’s signatures could be treated as a written resolution
under section 381A of the Act, this would not have been an effective approval for the
purposes of section 164. As we saw above, section 381A allows private companies to pass
resolutions without the need for a formal meeting provided that all members who are entitled
to attend and vote at the general meeting have approved the resolution in writing. Lindsay J
noted that if the company had decided to use the written resolution procedure to approve the
company-own purchase, it would still have been necessary, on the wording of section 164(1)
and (2), for the written resolution to have been passed before the agreement was entered into.
Here, of course, the only evidence of shareholder approval was provided by the agreement
itself. The judge, perhaps not surprisingly, was unable to see how the two signatures on the
agreement could possibly be treated as the equivalent of a resolution predating the agreement.
He reasoned that if a written resolution under section 381A was ineffective to approve a
company-own purchase unless passed in advance of the purchase agreement, the same must
be true of a purported shareholder approval that was even less formal than a written
resolution.
(2) The second ground for the decision was more general and lay in the judge’s conviction that
the statutory procedure governing company-own purchases serves to protect creditors as well
as members. Lindsay J recognised that the own purchase procedure is a statutory exception to
the established common law principle that a company must not return share capital to its
members during the companyís lifetime as to do so potentially diminishes the assets available
to cover creditor’s claims (see Chapter Four). This line has been taken before (see e.g.
Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447, CA – which can
be found in your Cases & Materials (statutory procedures prohibiting payment of dividends
out of capital could not be waived by members alone) and Re Barry Artist Ltd [1985] 1 WLR
1305 (obiter to the effect that reduction of capital is not exclusively a matter for the company
and its members. It followed that the members alone were not able to dispense with statutory
formalities that had been enacted for the benefit of creditors as well as members. On this
reasoning, the Duomatic principle can only apply to override formalities that exclusively
benefit the members.
The most important practical point arising from Peak is that neither the Duomatic principle nor
even a section 381A written resolution can be used retrospectively to validate a company-own
purchase given that the Act requires the purchase agreement to be approved by resolution in
advance. The procedures in sections 162-164 must be followed to the letter. Nevertheless, if the
relevant provision is construed as being for the protection of the members only (and not other
constituencies such as creditors) there is no reason why a Duomatic approval cannot be effective
(for a recent successful application of the principle to a resolution under section 319 of the
Companies Act see the Court of Appeal decision in Atlas Wright (Europe) Ltd v Wright [1999]
BCC 163). Needless to say, used properly, section 381A written resolutions are greatly to be
preferred to informal consents as they are not subject to the constraints described in (2) above and
can be used as a means to pass most resolutions regardless of whose interests the resolution serves
to protect.
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6.6 Duties of Shareholders
1. The duties of shareholders in their capacity as shareholders are very limited and do not equate
by any means with their rights of which there are many, (e.g. right to vote, right to dividends
when declared, right to a return of capital on a winding-up, etc.).
2. The main area of concern in relation to duties applies when they cast their votes. May they
vote as they wish, having regard to their own interests or do they have to consider other
shareholders’ interests or the company’s interest?
3. It has already been shown that when directors vote in their capacity as directors, i.e. at board
meetings, they have to vote bona fide and for the benefit of the company. (NB. When directors
vote in the general meeting they are voting not as directors but as shareholders.)
4. The leading case in this matter states that every shareholder, and this includes a shareholder
who is also a director, generally has a right to vote in his own interests.
North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589

Plaintiff, Henry Beatty, was a shareholder in the company. Director and shareholder, James
Beatty, sold his steamer to the company. The company, in general meeting, voted on sale and
adopted it. JB had one/third of the votes and used these to vote in favour. HB sought to have the
contract set aside. He sued the company and five directors.
Held: JB was entitled to vote in his own interests. The contract had been validly approved (or to
use the technical jargon “ratified”).
5. Thus, the basic rule is that a shareholder may vote as he pleases and does not have to consider
interests other than his own.
6. However, there are some exceptions to this basic rule. These are:
6.1 The freedom of a shareholder to vote is limited in that his actions must not amount to a fraud
on the minority. We will cover this in more detail in Chapter Eight.
6.2 When directors do not act bona fide for the benefit of the company it seems it is impossible
for them to ratify their actions where they are the majority shareholders because the action comes
within the meaning of fraud on the minority. See further Chapter Eight.
6.3 Where there are equitable considerations which make it unjust to vote in a certain way. (See
Clemens v Clemens Bros Ltd [1976] 2 All ER 268).
6.4 When the articles are to be altered, in voting for the special resolution, the shareholder must
vote bona fide for the benefit of the company. See Allen v Gold Reefs of West Africa, Greenhalgh
v Arderne Cinemas etc. in Chapter Two.
6.5 In a class meeting called to propose a resolution to vary the rights of that class, the
shareholder must vote for the benefit of the class. See Re Holders Investment Trusts Ltd in
Chapter Four.
6.6 Where the conduct of the shareholder is manifestly injurious to the interests of the company.
Standard Chartered Bank v Walker and another [1982] 1 WLR 1410

Brent Walker Ltd was in acute financial difficulties. A restructuring agreement was proposed; if it
was not approved the company would collapse. W held between 5% and 10% of the votes. W was
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going to be sacked as a director. The bank asked for an order requiring W to vote in favour of the
proposed restructuring.
Held: order granted. It is only in the most extreme cases that this should be done but where the
conduct of the shareholder would be manifestly injurious to the interests of the company
(including its creditors) then an injunction would be granted to prevent a shareholder from voting
his shares as he wished.
6.7 Directors
6.7.1 APPOINTMENT OF DIRECTORS
1. The board of directors of a company manages the business of the company subject to control
or supervision by the general meeting and any provisions of the memorandum and articles of
association or the Companies Acts.
2. Every company must have a board of directors. With a public company the minimum number
required is two and with a private company the minimum is one.
3. The power to appoint directors may be given to the shareholders in general meeting or to the
directors themselves or even to an outsider.
4. In the Companies Act “director” includes any person occupying the position of director
regardless of the name given. A “shadow director” is a person in accordance with whose
directions or instructions, the directors of the company are accustomed to act, s. 741.
Where a body corporate is a director of a company whether de jure, shadow or de facto, it does
not follow that its own directors must be shadow directors of that company. See Re Hydrodam
(Corby) Ltd [1994] 2 BCLC 180. A de facto director is one who claims to act and purports to act
as a director although not validly appointed as such. A shadow director claims not to be a director.
S/he is not held out as a director of a company. “He lurks in the shadows, sheltering behind others
who, he claims, are the only directors of the company to the exclusion of himself.” However
giving advice in a professional capacity upon which the board acts (e.g. as a solicitor) does not
necessarily make a person a shadow director.
5. Directors may, if authorised by the articles, appoint a managing director. Table A Art 84 gives
such authorisation. Under article 72 the managing director is merely a delegate of the board and
his/her powers may be withdrawn by the board if it chooses.
6. There are certain persons who are not allowed to act as directors:
• Undischarged bankrupts (s. 11 Company Directors Disqualification Act)
• The aged (s. 293 CA 1985)
• Those required to have a share qualification who do not hold the required number of shares
• Those disqualified under the Company Directors Disqualification Act 1986 (“CDDA”).
7. Under the CDDA the court may make an order disqualifying a person from acting as a
director. A court order can be made in the following circumstances:
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• where a director is convicted of an indictable offence in connection with the promotion,

formation, management, liquidation or receivership of a company or management of the
company’s property, s. 2
• where he has been persistently in default regarding the filing of returns, s. 3
• where it appears he has been guilty of fraudulent trading or any other fraud in relation to the
company, s. 4
• where he is or has been a director of a company which has become insolvent and his conduct
as a director makes him unfit to be concerned in the management of a company, s. 6
• where he has been a director of a company and his conduct (as revealed in the course of the
exercise of certain specified powers of investigation) makes him unfit to be concerned in the
management of a company, s. 8
• where the director is liable for wrongful trading s. 10
Alternatively, under s.1A CDDA, a disqualified director may give a ‘disqualification undertaking’
to the Secretary of State for Trade and Industry, thereby avoiding the need to involve the courts
(see Chapter Seven). The period of disqualification varies between two to fifteen years
depending on the gravity of the director’s misdemeanours. The majority of orders are made on the
application of the Secretary of State for Trade and Industry under sections 6 and 8.
Disqualification has become an important means of enforcing directors’ duties and (as we will see
further in Chapter Seven) is now the source of much of the modern law of directors’ duties. The
following case is a leading example of the kind of case which is brought under section 6 of the
CDDA:
Secretary of State for Trade and Industry v Gray [1995] 1 BCLC 276, [1995] BCC 554, CA
It was alleged that the two respondents (1) caused the company to trade while insolvent (2) failed
to keep proper accounting records (3) failed to file audited accounts on time and (4) made
preferential payments contrary to S.239 IA 1986. While the first allegation was not made out, all
the others were. Nevertheless, the judge held that the directors were not “unfit” within the
meaning of section 6. The Secretary of State appealed.
Held: Section 6 imposed a duty on the court to disqualify a person whose conduct had shown him
to be unfit. The purpose of disqualification was to protect the public from those whose past
conduct showed them to have fallen short of proper standards. Even in a case where it was
apparent at the time of trial that the respondents posed no present risk to the public, there was still
a duty to disqualify if the evidence of their past conduct was such as to make them unfit. The
reason why parliament had imposed a duty to disqualify on the court was that disqualification
under section 6 does not just serve to keep miscreant directors “off the road” but is also concerned
with deterrence and raising the standards of all company directors. Although a judge’s assessment
of a director’s conduct was a mixed question of fact and law and one with which an appellate
court would be slow to interfere, the appellate court could substitute its own evaluation if satisfied
that the judge had erred. Appeal allowed. Both directors were disqualified the statutory minimum
period applicable under section 6 which is 2 years.
8. Directors’ share qualification
• The articles of association of a company may require each of its directors to hold a certain
minimum number of shares in the company. This is known as a directors’ share
qualification.
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• A director need not obtain his qualification shares before he is appointed nor need he
obtain them by allotment from the company, but unless he obtains them within two
months after his appointment (unless the court otherwise provides he must immediately
vacate office and is guilty of an offence if he continues to act as a director. He cannot be
reappointed until he has obtained his share qualification.
6.7.2 VACATION OF OFFICE OF DIRECTOR
SAQ 1
When might a director have to leave office?
1. The above provisions invalidating appointments arise here, e.g. bankruptcy, disqualification
under the CDDA, age limit and loss of share qualification.
2. Also , the articles may state additional grounds for vacating office, e.g. if he becomes of
unsound mined or is absent for more than six months from meetings of directors held during that
period without the permission of the board of directors. See Table A article 81.
3. Companies often have a term in their articles that a number of directors should automatically
retire each year by rotation and the vacancy is filled at the AGM. Retiring directors are eligible
for re-election. See Table A, article 73.
4.1 The articles of a company may lay down the period for which a person is to be director and
when that period expires, the office is automatically vacated.
4.2 If the terms of the director’s contract are implied from the terms of the articles, then the
articles may be altered and the director forced to vacate his office. He will then have no redress
against the company.
4.3 However, if the director has an express service contract and he is forced to vacate his office
by a change in the articles, the director may sue the company for damages for breach of his
express service contract. See Southern Foundries v Shirlaw in Chapter Two.
4.4 NB Section 319 Directors may not, without the sanction of a resolution in general meeting, be
given service contracts for more than 5 years.
4.5 Any fixed term in a director’s service contract exceeding five years and where the contract
cannot be terminated by notice or can be terminated only in specified circumstances needs prior
approval by ordinary resolution of the company in general meeting. The terms of the proposed
contract must be available for inspection by shareholders both at the company’s registered office
for 15 days before the meeting and at the meeting itself. While it is not sensible to rely on
informal approvals, the case of Atlas Wright (Europe) Ltd v Wright [1999] BCC 163 suggests that
the general meeting may waive these formal requirements and that the unanimous consent of the
shareholders without further formality would be sufficient to approve a section 319 resolution.
If prior approval is not obtained then the term, to the extent that it contravenes the section, is void
and instead the service contract is deemed to contain a term which entitles the company to
terminate it at any time by the giving of reasonable notice.
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5.1 By Section 303(1) every company has power to remove any director by ordinary resolution
before the expiration of his period of office, notwithstanding anything in its articles or in any
agreement between the company and the director.
5.2 Section 303(2) states that special notice must be given of the resolution to remove the
director. Special notice is defined in section 379. Its effect is that the person who moves the
resolution must give notice of it to the company at least 28 days before the meeting is held and the
company must give at least 14 days notice of it to its members. It must be given at the same time
and manner as it gives notice of the meeting or, if that is not possible, the resolution must either
be advertised in a newspaper or be notified to members in a way permitted by the articles at least
21 days before the meeting.
5.3 To prevent directors avoiding the provision by claiming that the notice had not been given in
time, section 379 states that if the directors call a meeting for a date 28 days or less after the
notice has been given to the company, the notice is deemed to have been properly given.
5.4 Section 304(1) provides that where notice is given of an intended resolution to remove a
director, on receipt of the notice, the company must send a copy to the director concerned. He
may require the company to circulate to members a statement by him in his defence when notice
of the meeting is sent to them. If the defence is not circulated the director may have it read out at
the general meeting.
5.5 The director is also entitled to address the meeting at which the resolution is to be considered.
5.6 The director will lose these rights if the court considers that the director is trying to secure
publicity for defamatory matter.
5.7 The shares held by a director may carry additional voting rights when his removal is being
sought. These additional rights may make it possible to defeat the wishes of the general meeting
by blocking a resolution under s. 303.
Bushell v Faith [1969] 2 Ch 438

Director’s shares carried special voting rights - 3 votes per share on a resolution to remove him.
These rights were contained in the articles. Held: The special voting rights were upheld by the
House of Lords and the ordinary resolution to remove the director was defeated. The decision has
been the subject of much criticism because it seems to override the express wording of section
303(1) which states that a company can remove a director from office by ordinary resolution
“notwithstanding anything in its articles”.
N.B. Table A does not contain or create any special voting rights.
5.8 A director who is removed under s. 303 may sue for damages only if he has a binding contract
entitling him either to hold his position for a fixed term or to be dismissed only after a prescribed
time or on reasonable notice. Nevertheless, removal under s.303 is without prejudice to such
rights to compensation (s. 303(5)).
5.9 For a shareholder to propose a resolution to sack a director it is necessary for the directors to
agree or for that shareholder to have the necessary s. 368 powers (10% paid up capital) to
requisition an EGM (see earlier). Failing that it is necessary under s. 376 for the shareholders (or a
group of shareholders) to have one/twentieth of the total voting rights and thus have the power to
compel the directors to include a s. 303 the resolution on the agenda of the AGM.
Pedley v Inland Waterways Association Ltd [1977] 1 All ER 209

A member circulated a resolution for consideration at an AGM. It proposed that all directors
should be removed. The company refused to include the item on the agenda for the AGM.
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Held: The then equivalent of section 376 did not confer on an individual member the right to
compel the inclusion of a resolution on the agenda of a company meeting.
6.7.3 THE POWERS OF DIRECTORS
1. The board of directors and the members in general meeting can between them exercise all the
company’s powers. The division of power between the two groups is usually determined by the
articles, subject to certain provisions in the Companies Act.
2. Table A article 70 states that “The business of the company shall be managed by the directors
who may exercise all the powers of the company”. This power is subject to the provisions of the
Act, the memorandum and the articles and any direction given by special resolution.
3. This means that the directors and no one else, are responsible for the management of the
company. The members cannot by an ordinary resolution supercede the directors powers or
instruct them how they shall exercise their powers unless the articles say otherwise, or an Act of
Parliament says otherwise.
Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34, CA – See Cases
& Materials 6.3
The articles of a company contained an article like Table A, article 70 except that it was stated to
be “subject to such regulations as might be made by the company by extraordinary resolution”. A
majority of the shareholders arranged a sale of company assets and requisitioned a meeting at
which an ordinary resolution requiring the directors to execute the contract on behalf of the
company was passed.
Held: The directors were not bound to obey the resolution. Only an ordinary resolution had been
passed when the articles stated that an extraordinary resolution was required.
4. The general meeting cannot interfere with a decision of the directors unless the directors are
acting contrary to the provisions of the Act or articles.
Salmon v Quin & Axtens Ltd [1909] 1 Ch 311, CA

In this case, under the articles, the general management of the company was vested in the board of
directors. The articles also said that no resolution of the directors was valid if either of two joint
managing directors dissented from the resolution. The plaintiff, one of the managing directors,
objected to the company acquiring certain premises. General meeting by simple majority
“ratified” directors resolution, approving the acquisition. Plaintiff sued on behalf of himself and
all other shareholders in the company.
Held: Injunction granted. Ordinary resolution passed was inconsistent with the power of veto in
the articles. Affirmed by House of Lords on appeal - see [1909] AC 442.
5. The doctrine of division of powers was also discussed by Greer LJ in the following case:
John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113

General power of management of the company was delegated by the articles to the board of
directors. The company in general meeting resolved that proceedings which had been instituted by
the directors in the company’s name be discontinued.
Held: Resolution of general meeting invalid.
Greer LJ “A company is an entity distinct alike from its shareholders and its directors. Some of its
powers may, according to its articles, be exercised by directors, certain other powers may be
reserved for the shareholders in general meeting. If powers of management are vested in the
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directors, they and they alone can exercise these powers. The only way in which the general body
of the shareholders can control the exercise of the powers vested by the articles in the directors, is
by altering their articles, or, if opportunity arises, by refusing to re-elect the directors of whose
actions they disapprove. They cannot themselves usurp the powers which by the articles are
vested in the directors any more than the directors can usurp the powers vested by the articles in
the general body of shareholders.”
The power to institute and conduct proceedings in the company’s name was therefore properly
exercisable by the board.
6. The rule that the general meeting cannot direct how the company’s affairs are to be managed
or overrule any decision made by the directors in the conduct of the company’s business, applies
even to matters not specifically delegated to the directors provided they are not expressly reserved
to the general meeting by the Companies Act and the articles; i.e. the directors have residual
power.
SAQ 2
What can shareholders do if they do not like what the directors are doing?
7. The only thing the members in general meeting can do is to alter the articles directing how the
affairs of the company are to be managed or sack the directors as indicated by Greer LJ in the
passage cited above.
8. However, if for some reason the board cannot or will not exercise the powers vested in it, i.e.
it is in default, the general meeting may do so. Action by the general meeting has been held to be
effective in this situation.
Barron v Potter [1914] 1 Ch 895

The articles gave the board of directors power to appoint additional directors. The company had
only two directors but one would not act with the other and the board was deadlocked. Company,
in general meeting, purported by ordinary resolution to appoint an additional director.
Held: The general meeting had not overriden the powers of directors. Here, for practical purposes,
there was no board of directors at all. If directors having certain powers are unwilling or unable to
exercise them, there must be some power in the company to do it and this default power vests in
general meeting.
9. It is also quite valid for the board of directors to refer any matter to the general meeting either
to ratify what they have done or to decide on action to be taken. If what they have done is outside
their powers or an abuse of their powers they will be well advised to do this:
Bamford v Bamford [1970] Ch 212

In order to ward off a takeover bid the directors allotted 500,000 shares in the company to another
company. The articles provided that the unissued shares were to be at the directors’ disposal. Two
shareholders brought an action against the directors claiming that the allotment was invalid in that
it was not made bona fide in the interests of the company. The directors then convened an
extraordinary general meeting which ratified the allotment. Could the general meeting cure the
irregularity?
Held: The general meeting could generally ratify a breach of duty by the directors, by passing an
ordinary resolution. See further Chapter Seven on the concept of ratification.
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10. If the directors have attempted to exercise powers reserved to the company in general
meeting, the company, in general meeting, can ratify their action by the appropriate resolution.
6.7.4 POWER TO APPOINT A MANAGING DIRECTOR
Directors may, if authorised by the articles, appoint a managing director.
1. Table A Article 84: “The directors may appoint one or more of their number to the office of
managing director.”
2. Under article 72, the managing director is merely a delegate of the board and his powers may
be withdrawn by the board as it chooses. A managing director is only independent from the board
if his powers are conferred by the articles. If so he may prevent the board from interfering in the
exercise of his powers.
Harold Holdsworth & Co (Wakefield) Ltd v Caddies [1955] 1 WLR 352, HL – See Cases &
Materials 6.4
C was appointed MD of the company. His service agreement stated that he should perform such
duties and exercise such powers in relation to the business of the company and the businesses of
its existing subsidiary companies which might from time to time be assigned to or vested in him
by the directors. Later, the directors resolved that C should confine his attention to a subsidiary
company.
Held: This was not a breach of contract. C could be demoted. The directors had a discretion as to
the extent of his managing the company or its subsidiaries on the true construction of his service
contract.
3. A managing director automatically vacates his office when he ceases to be a director.

Whether he may sue for damages or not depends upon whether or not he has a service contract. If
he does not have a service contract and serves on the terms of the articles the members can alter
those terms and he cannot claim compensation (unless e.g. rights to remuneration have already
accrued).
4. A managing director is not affected by the retirement by rotation provisions in

Table A.
6.7.5 REMOVAL OF MANAGING DIRECTOR
If he ceases to be a director then under article 84 an MD’s office automatically terminates. If he is

sacked from being a director then the company may be liable in damages if there is a breach of his
service contract (see s. 303(5)).
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6.8 Questions
These questions are points you need to know before you can begin to answer examination
questions. They are NOT examination questions.
1. What are the two main types of company meeting?
2. How do they differ from each other?
3. What are the rules relating to notice of general meetings?
4. Summarise the procedure at general meetings reflecting the importance of quorums,

chairmen, polls and proxies.
5. What resolutions can be passed and how do they differ from each other?
6. What are the duties of shareholders?
7. How are directors appointed?
8. Who are not allowed to act as directors?
9. How may a director be removed from office under s. 303?
10. What are the powers of directors? Answer with reference to article 70 Table A and the
doctrine of the division of powers.
11. What are the rules relating to managing directors?
NB
You are unlikely to get a whole examination question on this chapter; it will form part of a whole
question, the other parts coming from other chapters. A working knowledge of meeting procedure
is likely to prove useful.
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CHAPTER SEVEN
THE DUTIES OF DIRECTORS
7.1 Objectives
By the end of this chapter you should be able to:
• Understand the concept of directors’ fiduciary duties
• Analyse the different types of fiduciary duties and understand how they are applied
• Be aware of the duty of care and skill
• Distinguish between statutory duties and duties imposed by the common law
• Recognise the likely consequences of a breach of duty
• Outline the reforms proposed.
INTRODUCTION
There are three categories of duty which a director owes to the company. These are:
1. Fiduciary duties;
2. Duty of care and skill; and
3. Statutory duties.
Please note: The Companies Act 2006 will place these duties in statutory form, which is
perhaps the most wide ranging aspect of the 2006 Act. To this effect, the 2006 Act will
effectively abolish the above distinction between common law and equity. That said, s.170
(4) provides that “regard shall be had to corresponding common law and equitable
principles in interpreting and applying the general duties.” So while it will no longer be
appropriate to distinguish between common law and equity in terms of the duties owed,
strangely the 2006 Act makes allowance for these distinctions when interpreting the new
duties under statute.
As you will see, there are familiar aspects to many of these “new” statutory duties and given
the lack of any case law on how these duties are to operate, the pre-2006 Act position is
presented below in addition to the new provisions of the 2006 Act.
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Duty to Act within Powers
s.171 Companies Act 2006 provides that a director must “act in accordance with the company’s
constitution and only exercise powers for the purposes for which they were conferred. With that
in mind, it is likely that regard will be had to the relevant case law on the fiduciary duty requiring
directors to exercise their powers for the proper purpose for which they were conferred (See: 7.2.2
below).
Duty to Promote the Success of the Company
s.172 Companies Act 2006 creates a new duty for the director to “act in the way he considers, in
good faith, would be most likely to promote the success of the company and its members. To this
extent, it replaces the requirement to act in the “best interests of the company” (See 7.2.1 below)
with that of “promoting the success of the company and its members.” However, it is not entirely
clear whether the phrase “success” of the company will be interpreted in the same way as “best
interests of the company.”
However, far from being a mere codification of the exiting fiduciary duty to act bona fide in the
best interests of the company, the new duty introduces factors to which the directors should have
to regard.
Among other things, the directors should have regard to:
(a) The likely consequences of any decision long term,
(b) The interests of the company’s employees (which restates s.309 Companies Act 1985).
(c) The need to foster the company’s business relationships with suppliers, customers and others,
(d) The impact of the company’s operations on the community and the environment,
(e) The desirability of the company maintaining a reputation for high standards of business
conduct,
(f) The need to act fairly as between members of the company.
Duty to Exercise Independent Judgment
s.173 Companies Act 2006 provides that a director must exercise independent judgment. A
director will not infringe this duty if he acts in accordance with an agreement duly entered into by
the company that restricts the future exercise of discretion by its directors, or in a way authroised
by the company’s constitution.
Duty to Exercise Reasonable Care and Skill
s.174 Companies Act 2006 provides a restatement of the existing common law duty to act with
reasonable care and skill (see 7.3 below). In particular the standard of care owed reflects the
developments at common law in adopting the test of the “reasonably diligent person” from s.214
Insolvency Act 1986.
The director must therefore display the skill care and diligence of a reasonably diligent person
with:
(a) The general knowledge, skill and experience that may reasonably be expected of a person
carrying out the functions carried out by the director in relation to the company (an objective test);
and,
(b) The general knowledge, skill and experience that the director has (a subjective test).
Duty to Avoid Conflicts of Interest
s.175 Companies Act 2006 requires that a director must avoid a situation in which he has, or
could have, a direct interest that conflicts, or possibly may conflict, with the interests of the
company. This includes the exploitation of any property, information or opportunity (and it is
immaterial whether the company could take advantage of the property, information or
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7.2 Fiduciary Duties
1. The fiduciary duties of directors are similar to those of trustees and duties of good faith and
honesty are owed by each director individually. However, the duties are owed to the company as
an entity or any other body corporate to which the company is associated and not to individual
members of it. This principle stems from Percival v Wright [1902].
Percival v Wright [1902] 2 Ch 421

The claimants approached directors of the company and asked if anyone would buy their shares.
The directors agreed to do so at £12.10s. per share. Later the claimants
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the shareholders as a whole (provided that this does not involve a breach of duty of any other of
his duties). The “material factors” to be taken into consideration when deciding what is most
likely to promote the success of the company include the short and long term consequences of the
possible actions, including the company’s need to foster good business relationships with
employees, suppliers and customers. (See Company Law Review (1999) para. 5.1.11 and
Modernising Company Law Cm 5553, para. 3.3).
In ideological terms, it is fair to say that with the exception of statutory provisions such as
section 309, section 214 of the Insolvency Act and the Company Directors’ Disqualification
Act 1986, the present law of directors’ obligations is concerned primarily with protecting the
company’s shareholders (rather than wider constituencies) given the extent of the power
usually vested in the directors within the corporate structure (see eg Table A article 70 and the
division of powers doctrine discussed in Chapter 6).
The fiduciary duties are “the duties of being honest and trustworthy”.
7.2.1 THE DIRECTORS MUST ACT BONA FIDE IN THE BEST INTERESTS
OF THE COMPANY
1. Directors must act bona fide in what they consider is in the company’s interests and not for
any collateral purpose. The test is broadly subjective.
“The proper test, I think . . . must be whether an intelligent and honest man in the position of a
director in the company concerned, could, in the whole of the existing circumstances have
reasonably believed that . . . [his actions] . . . were for the benefit of the company.”
Per Pennycuick J in Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62.
The approach taken by the courts is illustrated by the two cases that follow:
Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62

C Ltd was part of a group of companies. C Ltd gave guarantees that it would meet the debts owed
by other group companies to the bank in the event that those companies defaulted. The guarantee
was supported by a legal charge. C Ltd later sought to set aside the guarantee and charge as not
being in the interests of C Ltd.
Held: The transactions would not be set aside. It was clear that an “intelligent and honest man”
might reasonably have concluded that, as an integral part of the group, C Ltd would benefit from
a transaction that benefited the group. In other words, it could not be said that C Ltd’s directors
had failed to act in C Ltd’s interests even though, technically speaking, it was other legal entities
within the group that received the direct benefit.
Regentcrest plc v Cohen [2001] 2 BCLC 80

The claimant company (R Ltd) was in the business of property development. The defendant and
his brother owned all the issued shares in R Ltd. Both were also directors. R Ltd acquired the
entire issued share capital of G Ltd, a company that owned a single plot of development land
valued at £4.2 million. The value of G Ltd therefore depended wholly on the value of the land. In
the event that the net asset value of G Ltd decreased by the date of completion of the proposed
development, the share purchase agreement provided that the sellers would be liable to repay R
Ltd the amount of the decrease in cash (the clawback provision). The development was never
completed but under the terms of the clawback provision, R Ltd was entitled to recover £1.5
million from the sellers. The property market collapsed and R Ltd got into considerable financial
difficulties. At a board meeting, the defendant and his brother voted in favour of a resolution to
waive the clawback claim in consideration of the sellers giving their services to R Ltd free of
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charge for a specified period. The company went into liquidation, and by its liquidators, brought
an action against the defendant claiming equitable compensation for breach of fiduciary duty on
the basis that he had failed to act in the company’s interests by voting not to pursue the
company’s claim.
Held: The duty imposed on directors to act bona fide in the interests of the company is a
subjective one. The question is not whether, viewed objectively by the court, the particular act or
omission was in fact in the interests of the company; still less is the question whether the court,
had it been in the position of the director at the relevant time, might have acted differently. Rather
the question is whether the director honestly believed that his act or omission was in the interests
of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the
act or omission under challenge resulted in substantial detriment to the company, the director will
have a harder task persuading the court that he honestly believed it to be in the company’s
interest; but that does not detract from the subjective nature of the test. The evidence showed that
the defendant and his brother had honestly believed that they were acting in the interests of R Ltd.
The liquidator’s case, that they had been motivated solely by a desire to protect the sellers against
the risk of the clawback claim being pursued was rejected. Moreover, they had good commercial
reasons for waiving the claim as it enabled them to secure the valuable services of the sellers at a
time when the company was in difficulty and in need of support. In any event, there were
considerable doubts as to whether the sellers would have had the financial means to meet the
claim.
2. The courts will not consider that the directors have acted in good faith if they have
considered their own or a third party’s interest without considering whether their act was also in
the interests of the company.
Re W & M Roith Ltd [1967] 1 WLR 432

The company agreed to pay a pension for life to the wife of its controlling shareholder and
director at a time when he was in failing health. No thought had been given to whether this was
for the benefit of the company and the sole object was to make provision for the widow.
Held: The agreement did not bind the company and was set aside.
Bishopsgate Investment Management Ltd v Maxwell (No 2) [1994] 1 All ER 261

The company was a trustee of the Maxwell group pension schemes. The defendant director, a son
of the late tycoon Robert Maxwell, was asked to execute a number of stock transfer forms on the
company’s behalf, with the effect that substantial amounts of the pension scheme’s assets were
transferred for no consideration to another company which controlled Robert Maxwell’s private
interests. The company (in liquidation) took proceedings against the defendant seeking
compensation in equity for the lost assets.
Held: The defendant was liable. He had not asked himself what purpose the documents served. He
had simply signed them without addressing his mind as to whether the relevant transactions were
in the company’s interests.
For a recent example of a director not acting in the interests of the company see Extrasure Travel
Insurances v Scattergood [2003] 1 BCLC 598, where the court found that the two defendant
directors had caused the company to transfer money to another company in the group to allow that
company to pay a creditor without the honest belief that this transfer was in the interests of the
transferor. The approach in Regentcrest plc v Cohen was applied.
3. As regards “the interests of the company”, the words refer (in ideological terms) primarily to
the interests of the members as a whole, but may also extend, as we saw above, to creditors
present and future, and employees. Also the interests of the company may be considered to
include the wider public interest, eg charitable donations and political contributions.
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Evans v Brunner Mond & Co [1921] 1 Ch 359

A donation for the purpose of scientific education by a chemical manufacturing company was
challenged by dissentient shareholders.
Held: That such donations were reasonably incidental to the objects of the company and therefore
for the benefit of the company.
However, because “interests” of the company means the interest of the company as a commercial
entity, it is the interests of the shareholders which are generally regarded as paramount. Thus, as a
result, express provision usually needs to be made to protect other constituencies. For example,
section 719 gives the company power to make provision for employees when the company is
wound up or on the transfer to any person of the whole or part of its undertaking. Section 719
allows this provision to be made even if it is not in the best interests of the company.
4. In Re Lee Behrens & Co Ltd [1932] 2 Ch 46, Eve J laid down three tests to decide whether
an act of the director was bona fide in the best interests of the company:
• Is the transaction reasonably incidental to the carrying on of the company’s business?
• Is it a bona fide transaction?
• Is it done for the benefit and to promote the prosperity of the company?
There has been much criticism of the tests but in Rolled Steel Products (Holdings) Ltd v British
Steel Corporation [1986] Ch 246, CA it was suggested that they might still have a role to play in
deciding whether a director was acting bona fide in the best interests of the company.
Slade LJ said the tests should be finally laid to rest when dealing with legal issues arising from a
gratuitous payment sanctioned by the directors “though they will be helpful in considering
whether or not in any given case directors have abused the powers vested in them by the
company.”
Rolled Steel: Products (Holdings) Ltd v British Steel Corporation [1986]

A clause in its memorandum entitled the plaintiff company to give guarantees to Shenkman, a
director and majority shareholder of the plaintiff company. Shenkman also controlled another
company, Scottish Steel, which owed money to Colvilles Ltd (which later became British Steel).
The plaintiff company guaranteed Scottish Steel’s liabilities to British Steel. Sums due from
Scottish Steel were demanded and eventually paid by the plaintiff company. The payment to
British Steel benefited Shenkman personally because it reduced his exposure as guarantor of
Scottish Steel’s debts. Colvilles Ltd and the shareholders of Scottish Steel knew all the details of
these transactions. The plaintiff company went into liquidation and the liquidator contested the
validity of the guarantee.
Held: The clause created a power and the exercise of it was intra vires the company. However, the
directors lacked authority to exercise the power and since Colvilles Ltd knew of this, ie the
unauthorised nature of the transaction, no rights could be conferred on Colvilles Ltd (now British
Steel) and the sums paid were held by British Steel as constructive trustee for the plaintiff
company.
The points that arise here are:
1. This was an abuse of a power. The company (acting by its liquidator) could set the transaction
aside on the grounds that it was an abuse of power, ie the contract was voidable at the
instance of the company.
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2. A third party who has notice that a transaction was entered into in excess or abuse of the
powers of the directors cannot enforce such a transaction against the company.
3. Such a third party will be accountable as constructive trustee for any money or property of the
company which it receives.
It is unlikely that if the case arose now that section 35A of the Companies Act (see Chapter 3)
would protect Colvilles Ltd. The argument would be that, notwithstanding the presumption of
good faith in section 35A(2), Colvilles Ltd had not dealt with the plaintiff company in good faith
for the purposes of section 35A(1).
6. The duty to act bona fide in the interests of the company would appear from the cases
above to have emerged as a separate head of duty, distinct from the other heads discussed below.
All of the cases discussed involved companies which were engaged in gratuitous transactions (be
it the provision of a widow’s pension, the making of a corporate donation or the giving of a
guarantee) and the natural approach was to explore whether these transactions should be set aside
as not being in the company’s interests. However, some commentators (especially those with
expertise in the field of equity and trusts) have argued that, strictly speaking, there is only one
fiduciary duty, namely this duty to act bona fide (also referred to as a general duty of loyalty to
the company or an overriding duty of good faith). On this analysis, the specific heads of duty
referred to below (eg the “no conflict” and “no profit” rules) are simply outworkings of the
general duty rather than separate duties. To some extent this is simply a matter of semantics.
However, it is useful to think of the fiduciary duties as being part of a seamless web of obligations
aimed at protecting the company from directorial abuse and encouraging directors, in situations of
conflict, to prefer the interests of the company.
7.2.2 THE DUTY TO EXERCISE POWERS FOR THE PROPER PURPOSE

FOR WHICH THEY WERE CONFERRED
1. Powers may be delegated by the company in its articles to directors but they may abuse these
powers by exercising them for an improper purpose; eg to preserve their own control. In this case
they will probably also be in breach of the general duty to act bona fide in the interests of the
company.
2. However, certain situations arise whereby directors do act in good faith (at least, subjectively)
but still exercise their powers for a purpose which is objectively different from that for which the
powers were conferred upon them. If powers have been conferred on the directors, the courts may
look at their exercise objectively.
3. Common situations in which the courts have considered an improper exercise of powers is the
issuing of new shares, particularly in the contexts of deterring a takeover bid. In a Table A
company, this power is vested in the directors (effectively as part of the board’s article 70 powers)
although it is also subject to control by the general meeting under section 80 (see Chapter 4).
That was not always so and the courts have used the basic fiduciary standard to fashion rights and
obligations in this area.
Howard Smith Ltd v Ampol Ltd [1974] AC 821, PC

The plaintiff company (Ampol) were majority shareholders in another company (R W Miller
Holdings Ltd). They launched a bid to take over the remaining shares in the company. The bid
was rejected as being too low. A third company, Howard Smith Ltd bid at a higher price. Ampol
objected to this bid. The board of Miller therefore allotted unissued shares to Howard Smith
putting Ampol in the minority and increasing the likelihood that Howard Smith’s bid (which the
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board favoured) would succeed. Ampol sought to have the allotment to Howard Smith set aside.
Held: The allotment would be set aside and the parties restored to their original positions.
In this case the Privy Council said that the correct test was to ask “what was the primary purpose
of issuing new shares”. If it was to raise capital then it was valid even though as a secondary
consequence it deprived a majority shareholder of his control. In Howard Smith’s case the
primary purpose was to dilute the majority voting power and allow their offer to proceed without
Ampol’s opposition (which given their majority position at the outset, would otherwise have been
effective). Therefore, although the directors were not trying to obtain a personal advantage, and
were acting bona fide in a subjective sense (they believed the Howard Smith bid to be the better
one for the company’s business), it was an improper use of a power and therefore invalid. Lord
Wilberforce used a four part test to assess whether the directors could satisfy the objective
substantial purposes test:
(i) Identify the nature and extent of the power in question;

(ii) Identify the range of purposes for which the power might properly be exercised;
(iii) Identify the substantial purpose for which it was actually exercised in the particular
case;
(iv) Measure that purpose in (iii) against the range of permissible purposes to reach a
conclusion.
Criterion Properties plc v Stratford UK Properties LLC [2004] BCC 570 (HL)
The MD entered into an agreement with a substantial shareholder with the intention of deterring
any potential would-be bidder for a takeover of the company. The effect of this ‘poison-pill’
agreement was to require the company to buy out the shareholder at a substantial sum on the
occurrence of any change in control of the company, including the removal of the MD. The MD’s
employment was terminated and the company sought to avoid the contract on the grounds that it
had been entered into for an improper purpose.
Held: Entering into the contract could not be justified as being in the best interests of the
company nor as a proper exercise of director’s powers.
SAQ 1
What do you think is the role of the general meeting in a situation like this?
4. If the directors do exercise their power in an improper way and the power is intra vires the
company, the general meeting may, at common law, ratify the improper use.
Hogg v Cramphorn Ltd [1967] Ch 254

To forestall a takeover bid (thought not to be for the benefit of the company) and to gain effective
control, the directors issued unissued shares in the company to trustees to be held for the benefit
of employees. The shares were paid for by the trustees using an interest-free loan from the
company. This effectively prevented the takeover bid. A shareholder challenged the validity of the
issue.
Held: The share issue and loan transaction had been entered into to secure a controlling interest
for the directors. Nevertheless, the judge held proceedings over so that a general meeting could be
held (the trustees not to vote) to consider the position. The general meeting was held and all
actions of the directors ratified.
See also Bamford v Bamford [1970] Ch 212 in Chapter Six.
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5. However, the general meeting cannot ratify any act falling within the exceptions to the rule in
Foss v Harbottle (see later notes). Ratification here means ratification by ordinary resolution.
6. Also, the general meeting cannot ratify where there are equitable considerations which make
it unjust to vote in a certain way.
Clemens v Clemens Bros Ltd [1976] 2 All ER 268

45% of the shares in the company were held by the plaintiff, 55% by the plaintiff’s aunt. The aunt
was also one of five directors. Resolutions in general meeting were passed to ratify an issue of
further shares to the directors and to trustees of an employee share scheme. As a result, the
plaintiff’s holding had now been reduced to 25% and she therefore lost power to block special
resolutions.
Held: On the plaintiff’s application, the resolutions and share issue would be set aside. The
motive of the aunt was primarily to injure the plaintiff, not to consider what was for the benefit of
the company.
7. If all the members informally consent to a breach of duty by a director, it may be possible to
argue that this unanimous consent can relieve a director from breach of duty. The distinction may
be that ordinary ratification is required if there is an abuse of powers given in the articles whereas
unanimous ratification is required if there is an abuse of powers given in the memorandum.
In Rolled Steel Products Ltd v British Steel discussed above, the abuse related to powers in the
memorandum.
There is a debate over whether a unanimous shareholder ratification would avail the directors in
circumstances where other constituencies such as creditors are affected by the breach of duty. The
next case represents the orthodox position.
Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services [1983]
Ch 258, CA
The liquidator sought to serve a writ out of the jurisdiction on three international oil companies
who were shareholders of a subsidiary set up by them. The liquidator claimed that the directors of
the subsidiary had been negligent in their conduct. This conduct had been unanimously informally
approved by the shareholders.
Held: The shareholders could ratify the acts of the directors who owed no duties to third parties
such as creditors (represented by the liquidator).
However, there was an argument that the position would be different if the company was
insolvent at the time of the ratification. May LJ thought that the ratification would not bind the
liquidator and dissented. For fuller coverage see Sealy. The converse of the principle in this case
is that directors owe no duties to creditors. However, this orthodox position is under strain in the
light of more recent statutory developments - especially section 214 of the Insolvency Act and the
Company Directors’ Disqualification Act 1986 which have arguably moved the common law
away from the strict position enunciated above (see discussion in Farrar’s Company Law, 4th ed.
1998 at pages 382-385).
Finally, note that unanimous approval is not necessary to relieve from liability a breach that is
ultra vires the company. Under section 35 of the Companies Act the shareholders can ratify the
breach by special resolution and by a further special resolution may relieve directors from any
liability incurred as a result of the breach (see further Chapter Two).
Also, the shareholders probably cannot ratify a fraud on the creditors. This type of fraud is only
going to occur when the company is insolvent.
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8. If a power has been exercised by the directors without the necessary bona fide, the action may
be declared void. Any agreement is voidable against a third party who was aware of the lack of
bona fides. Any loss to the company may be made good by the directors responsible (see
Criterion Properties plc v Stratford UK Properties LLC [2003]).
7.2.3 AVOIDANCE OF CONFLICT OF INTEREST AND DUTY
This duty is of particular significance for contracts between a director and the company.
1. The basic rule (which may be referred to as the “no conflict” rule) is that a director must not
enter into a contract with the company either directly (ie on his own account) or indirectly (eg
through a relation or another company or business in his control), ie a director must not have an
interest in any contract entered into by the company unless that interest is fully disclosed and
approved by the company.
The basic position of whether a conflict exists or not is “whether a reasonable man would think
there was a real possibility of conflict” (Boardman & Anor v Phipps [1967] 2 AC 46 at 124).
The “no conflict” duty is not so much a duty to avoid all situations of conflict absolutely but a
duty to disclose and seek ratification if such situations arise (see the characterisation of the duty
(or prohibition) in Movitex Ltd v Bulfield [1988] BCLC 104, (1986) 2 BCC 99,403). The leading
case, which is set out below, illustrates the strictness of the rule.
Aberdeen Rail Co v Blaikie Bros (1854) 2 Eq Rep 1281, HL.

The defendant company entered into a contract to purchase a quantity of chairs from the plaintiff
partnership. At the time the contract was concluded, a director of the company was also a member
of the partnership.
Held: The defendant company was entitled to rescind the contract.
Lord Cranworth LC - “No one having . . . duties to discharge shall be allowed to enter into
engagements in which he has or can have a personal interest conflicting, or which possibly may
conflict with, the interests of those whom he is bound to protect.” Lord Cranworth went on to say
that the principle was adhered to so strictly that the question whether or not the contract was fair
(ie in the sense that no fairer deal was available elsewhere in the market place) was not relevant.
It follows from this that a director should not enter into a contract with the company whether
directly or indirectly. Thus, as a general rule, a director must not have an interest in any contract
entered into by the company unless that interest is disclosed to and ratified by general meeting. At
common law, the general meeting may sanction the director’s interest by ordinary resolution. This
reflects the point that the duty is as much concerned with the disclosure of the conflict as with
avoidance of conflict. The essence of the rule was neatly captured by the deputy judge at first
instance JJ Harrison (Properties) Ltd v Harrison [2001] 1 BCLC 158 at 171. There it was said
that a director who puts himself in a position where his personal interests conflict with those of
the company is subject to the equitable self-dealing rule whereby he is not entitled to enter into
the transaction unless the shareholders give their informed consent to it. An even more recent
application was given by Richards J in Newgate Stud Company v Penfold [2004] All Er (D) 372.
If the rule is broken (as where a director enters a contract with the company without disclosure
and ratification), the company is entitled, subject to equitable defences (such as bars on the
remedy of rescission) to set the transaction aside or to other appropriate relief without any inquiry
as to whether the transaction was on proper or fair terms. In addition, any profit made by the
director may also be recoverable under the “no profit” rule.
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The company’s consent must be fully informed. The rule still bites if the conflicted director
makes some disclosure but it later turns out that the disclosure made was less than full and frank.
JJ Harrison (Properties) Ltd v Harrison

A company had four directors, one of whom, PH was responsible for its day to day running. In
1986 PH acquired some land from the company. A few years earlier an application for planning
permission in relation to the land had been turned down. At the time of the acquisition the land
was valued at £8,400 but its development potential was expressly excluded by the valuer in
preparing his written valuation. PH disclosed to the company (a) that he was acquiring the land,
(b) the terms of the acquisition and (c) the written valuation. However, he did not disclose that a
further application for planning permission had been made. Moreover, he did not disclose that he
had received firm assurances that planning permission would be granted. Two months after the
acquisition planning permission was granted. PH eventually sold the land for a total in excess of
£230,000. The company brought an action against PH.
Held: PH had breached the “no conflict” rule because he had not made full disclosure of material
information affecting the potential value of the land. At first instance (see report at [2001] 1
BCLC 158), the deputy judge held that the company was entitled to an account of profits and/or
equitable compensation. However, the Court of Appeal held that directors who dispose of
company property in breach of their fiduciary duties must be treated as having committed a
breach of trust and that, accordingly, PH had held the land on constructive trust for the company.
This ruling has the following important implications as far as remedies that may be available:
(a) Where a director acquires and deals with company property in breach of fiduciary duty, he or
she holds the property as constructive trustee meaning that the company is entitled to a
proprietary rather than a merely personal remedy (such as equitable compensation or an
account of profits).
(b) It follows that, if at the date of judgment, the director still holds the property, he will be liable
to return it and if it has appreciated in value the company will be entitled to the benefit of that
increase.
(c) Moreover, any third party who dealt with or received the property with knowledge of the
breach of duty could also be fixed with secondary liability under trusts law principles
(“knowing assistance” and “knowing receipt”).
(d) Where the director no longer holds the property ie because he or she has sold it on to a bona
fide purchaser for value (as was the case on the facts of JJ Harrison), the finding of a
constructive trust means that he or she will be treated in the same way as a defaulting trustee.
This means that the company would be entitled to claim the value of the property at its highest
point during the existence of the trust.
2. If such a contract is entered into, the contract is voidable at the option of the company (Hely-
Hutchinson v Brayhead Ltd [1968] 1 QB 549) and any profits made by the director personally are
recoverable by the company in equity under the “no profit” rule (see below).
The general meeting may sanction the director’s interest by ordinary resolution. This reflects the
point that the duty is as much concerned with disclosure of the conflict as it is with the avoidance
of conflict in the first place.
3. If the parties cannot be restored either wholly or substantially to their pre-contractual

positions, the court will not set aside the transaction even though it is tainted by conflict of
interest. In equity, the remedy of rescission is subject to a number of qualifications or bars, one of
which is that the remedy will only be granted if restitutio in integrum (restoration of parties to
original position) remains possible.
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Craven Textile Engineers Ltd v Batley Football Club Ltd [2001] BCC 679
H and N were two directors of the defendant company, B Ltd. Both were vying for control of B
Ltd. H was also a director and the majority shareholder of the claimant company, C Ltd. H lost his
power struggle with N and was removed from office as a director of B Ltd. He caused C Ltd to
bring an action against B Ltd claiming payment of five unpaid invoices for labour and materials
supplied by C Ltd and used to make improvements to B Ltd’s football ground at a time when H
had still been a director of B Ltd. B Ltd defended the action by claiming that the contracts were
tainted by conflict of interest on the grounds that H had failed to disclose his involvement in C
Ltd to the board of B Ltd when the contracts were made.
Held: B Ltd was ordered to pay the invoices in full. Although it was accepted that H had not made
the required disclosure and that the affected contracts were technically voidable, the court would
only set aside the contract if it could do what was practically just to restore the parties to their
original positions. The work had been done and the materials had been incorporated into the
fabric of the football ground. It was therefore not possible to return these things to C Ltd.
Moreover, it was clear that B Ltd had enjoyed the benefit of the work and materials and, in equity,
the court would not set aside the contract if, as a result, one party would be entitled to retain a
valuable benefit for which they had not paid.
4. To overcome these rules articles of companies usually contain a waiver clause that if the
director discloses his interest to the board then the contract is fully effective and the director is
not liable to account for any profit made. Table A article 85 contains such a waiver clause. The
point is that it avoids the need for the shareholders to be consulted each time a problem arises
which may be cumbersome and costly. The shareholders are protected in that the director cannot
generally self-ratify under article 85. This is because under articles 94-95 a director who is
interested in any matter which conflicts or may conflict with the interests of the company is
(generally speaking) disqualified from voting or counting in the quorum of a board meeting at
which the matter is raised.
5. The “no conflict” rule in equity overlaps with section 317 of the Companies Act which is
considered further below.
7.2.4 DUTY OF DIRECTORS NOT TO MAKE A SECRET PROFIT
1. The directors must not use company assets to make a personal, undisclosed, profit. For
example, they must not sell company property to themselves at an undervalue or sell their own
property to the company at an over-value. This can be referred to as the “no profit” rule and it is a
logical extension of the “no conflict” rule discussed above.
2. If they do use company property to make a profit they must disclose this to the shareholders,
ie to the company in general meeting and the shareholders must ratify their action. The profit is no
longer secret once disclosure has been made. Again, this reflects the point that the duty is not
absolute. The problem arises if disclosure is not made and ratification obtained. The rule is strict
and bites even in circumstances where the company has suffered no loss. Equity concentrates on
the fiduciary position of the director and if the director exploits that fiduciary position to make a
gain or profit, equity will intervene in the absence of disclosure and ratification. Regal Hastings
is considered to be the high-water mark of the “no-profit” rule.
Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378

The company owned one cinema and wished to acquire the leases of two more and sell all three as
going concern. A subsidiary was formed to acquire the other two. The owner of the cinemas
insisted that the directors personally guarantee rental payments under the leases unless the paid up
capital of the subsidiary was at least £5,000. The company was unable to subscribe in cash for
more than 2,000 shares therefore the directors and their friends took up the remaining 3,000. Later
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instead of selling the cinemas, the shares in both companies were sold and, in the cases of the
subsidiary, the directors made a profit of £2.16s.1d. per share. The new controllers of the
company then caused it to bring an action against the former directors to recover the profit they
had made on the sale of their shares in the subsidiary.
Held: The directors stood in a fiduciary relationship to the plaintiff company. They had acquired
the shares in the subsidiary by reason of the fact that they were directors of the plaintiff company.
They were accordingly liable in equity to account for profits made in the course of the execution
of that office.
3. Several points arise from this case. The first point is that if the directors had obtained
ratification from the general meeting then they would have been protected. Secondly, although the
directors had apparently acted in good faith this did not assist them. Thirdly, the directors claimed
they had not deprived the company of anything in that the 3,000 shares in the subsidiary had
never been the company’s property and the company had insufficient funds to subscribe for them.
However, in equity, it is strictly not necessary to establish that the company suffered any loss. The
important point is that the directors made a gain while in a fiduciary position which was not
disclosed. In spite of (or because of) all these points, the directors were held to be in breach of
fiduciary duty. The case demonstrates how strictly equitable rules are applied. Equity concentrates
far more on the nature of the fiduciary relationship than on the precise consequences of breach.
The fact that a fiduciary has been enriched is of great significance even if it is doubtful whether
the company has suffered a genuine loss. For a recent case involving a breach of a director’s
fiduciary duty see Ball v Eden Project Ltd [2002] 1 BCLC 313.
SAQ 2
What would the situation be if the company could not benefit itself from the transaction?
As we saw in Regal (Hastings), it appears to be irrelevant that a company is unable to benefit

itself. This view is confirmed and extended by the following case:
Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443

The defendant, while managing director of the plaintiff, obtained information that a certain project
was to be undertaken. An approach was made to him by the other party and his services sought as
an individual consultant free from his association with the company. It was extremely unlikely
that the company would have got the work; it was the director’s expertise that interested the third
party. The director resigned as managing director, ostensibly on grounds of ill health. He then
took up a consultancy position at the invitation of the third party.
Held: He was liable to account for the profits he made from his arrangement with the third party.
Roskill J: “Information which came to him while he was managing director and which was of
concern to the plaintiffs and relevant for the plaintiffs to know, was information which it was his
duty to pass on to the plaintiffs”. He had one capacity at that time and it was as managing
director. The fact that the plaintiffs would not have got the benefit of the contract for themselves
was not an issue; the rule that the director must not put himself in a position whereby his duty and
interest conflict is paramount. Also, the director is still in breach even if he leaves the company
and then uses the information.
The Court of Appeal has recently confirmed this strict approach.
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Bhullar v Bhullar, Re Bhullar Bros Ltd [2003] All ER (D) 445

Two directors of a family company acquired property adjacent to the company premises without
disclosing this opportunity to the company. They argued that since the company was in the
process of being sold, it would have no interest in the matter, even though the land would have
been commercially attractive.
Held: The defendant was liable even though there was no evidence that the company would have
pursued the opportunity. The directors held the property on trust for the company.
Parker LJ:
“ Whether the company could or would have taken that opportunity, had it been made aware of it,
is not to the point: the existence of the opportunity was information which it was relevant for the
company to know, and it follows that the appellants were under a duty to communicate it to the
company.”
See also the recent decision of Crown Dilmun v Sutton [2004] 1 BCLC 468, where the defendant
was found liable, having failed to disclose an opportunity to the company. It was held that the
company (of which the defendant was a director, was liable to account for its profit after taking
the opportunity). This decision contrasts with the more relaxed approach taken by other
jurisdictions towards the taking of opportunities by directors in these circumstances.
5. The director should bear in mind that as long as there is full disclosure of information, the
director’s use of such information can be regarded as authorised and ratified. This disclosure and
authorisation will have to be given to and by the company in general meeting at common law (or
the board under Table A article 85 - see above) . However, note that the general meeting cannot
ratify a fraud on the minority (see Chapter Eight).
6. The courts have shown signs of moving away from the emphasis on the fiduciary’s conduct
and position towards a closer analysis of the business opportunity which that fiduciary has
appropriated. This trend has been particularly notable in Commonwealth authority though the
next case is an English High Court decision.
Island Export Finance Ltd v Umunna [1986] BCLC 460

While Umunna was managing director of the company, it supplied the Cameroons with an order
for postal boxes. Orders for the postal boxes dried up and the company did nothing to secure
further orders. Later, Umunna resigned as managing director because of the way he had been
treated by company. Two and a half months later Umunna obtained contracts for products
including postal boxes from the Cameroons for his own company. IEF said he was in breach of
his fiduciary duty which continued after his resignation.
Held: While fiduciary duties do not cease upon resignation, Umunna was not in breach. The
knowledge he had acquired was knowledge which he was free to exploit for his own benefit after
his employment with IEF ceased. To argue otherwise would be to operate a restraint of trade.
Also, IEF was not actively pursuing further orders from the Cameroons and so this was not a
“maturing business opportunity” (see next case). As a result, Umunna was free to take the
business opportunity himself.
Canadian Aero Service Ltd v O’Malley (1974) 40 DLR (3d) 371, Canadian Supreme Court
The president and vice president of the company tried to obtain a contract on behalf of the
company. They then resigned, formed a new company and acquired the contract for the new
company.
Held: The court found:
• A diversion of a maturing business opportunity that the company was actively pursuing;
• Directors were participants in the negotiations;
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• Resignation had been prompted by a desire to obtain the contract for themselves;
• Position with the new company, rather than a fresh initiative, led to obtaining the contract.
They were therefore liable to account to their former company for the profits made.
Laskin J “This ethic disqualifies a director or senior officer from usurping for himself or diverting
to another person or company with whom or with which he is associated a maturing business
opportunity which his company is actively pursuing; he is also precluded from so acting even
after his resignation where the resignation may fairly be said to have been prompted or influenced
by a wish to acquire for himself the opportunity sought by the company, or where it was his
position with the company rather than a fresh initiative that led him to the opportunity which he
later acquired.”
Cf Peso-Silver Mines Ltd v Cropper (1965) 56 DLR (2d) 117, Canadian Supreme Court
An opportunity to acquire mineral prospecting claims was rejected by the board. The company
was in difficult financial circumstances and did not wish to take up the opportunity. Three of the
directors formed a new company and acquired the claims at the same price which had been
offered originally. They were subsequently sued by the company to account for their gains. Held:
The three directors were not liable. The plaintiff company’s board had rejected the offer for sound
business reasons and had acted bona fide. The opportunity was therefore no longer available to
the company and the three directors as individuals could take up the opportunity for their own
personal benefit.
This decision has been criticised on the grounds that it requires the court to evaluate the good
faith of the directors in making the decision on the company’s behalf not to pursue the
opportunity. However, Island Export Finance seems to be following this approach and it is an
approach which has attracted some support from academic commentators (see J Lowry & R
Edmunds, “The Corporate Opportunity Doctrine” (1998) 61 MLR 515; J. Lowry, “Regal
(Hastings) Fifty Years On: Breaking the Bonds of the Ancien Regime?” (1994) 45 NILQ 1). And
more recently, see Grantham (2003) 66 MLR 109 and Goddard (2004) 25 Co Law 23.
7. Some authorities suggest that a director who in breach of fiduciary duty exploits a maturing
business opportunity for his own benefit after his resignation holds the opportunity on
constructive trust for the company and is liable accordingly. This involves treating the
“opportunity” as “property” capable of forming the subject matter of a trust: see eg Cook v Deeks
[1916] 1 AC 554, PC and the following recent case.
CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704

A director of an advertising agency company resigned and set up his own competing business.
The staff and principal clients of the company subsequently joined him. The company brought an
action against him alleging that he had exploited maturing business opportunities in breach of his
fiduciary duty to the company.
Held: The underlying basis of the liability of a director who exploits after his resignation a
maturing business opportunity of the company is that the opportunity is to be treated as if it were
property of the company in relation to which the director had fiduciary duties. By seeking to
exploit the opportunity after resignation he is appropriating that property for himself.
Accordingly, he becomes a trustee of the fruits of his abuse of the company’s property which he
has acquired in circumstances where he knowingly had a conflict of interest, and exploited it by
resigning from the company. On the facts it was found that S’s resignation had been prompted by
a desire to acquire the business or business opportunities that he had previously been actively
pursuing on behalf of CMSD for his new company and that he had deliberately diverted that
business and those opportunities to the new company. S was therefore liable to account in equity
for the profits made by him from exploiting CMSD’s business and opportunities via the new
company.
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The decision can be criticised because it appears to confuse (or insufficiently differentiate) two
separate heads of liability namely (a) the liability of a fiduciary to account for profits made
personally by exploiting his or her fiduciary position and (b) the liability of a trustee to restore
misappropriated trust property to the fund. Despite the reference to trust, the outcome (ie that S
was liable to account for profits made) seems consistent with (a). The difficulty arises because, in
contrast to Regal Hastings and Cooley, the company in CMS Dolphin v Simonet did lose
something, ie the value of the contracts diverted to the new company. With that in mind, it is
perhaps understandable that the court regarded that lost value as “property” capable of giving rise
to trust remedies.
7.3 Duty of Care and Skill
1. In the case of Re City Equitable Fire Insurance Co [1925] Ch 407 Romer J laid down three
propositions which he took to encapsulate the common law duty of care and skill:
• The standard of care expected

• Attendance
• Delegation
City Equitable
The directors of an insurance company left the management of the company to B, its managing
director. Owing to B’s fraud a large amount of the company’s assets disappeared. Items appeared
on balance sheet under the headings of “loans at call or at short notice” and “cash at bank or in
hand”, but the directors never enquired as to how these figures were reached. The “loans” were to
B and the cash was in the hands of a firm of stockbrokers in which B was a partner.
Held: The other directors had been prima facie negligent and were in breach of the duty of care
and skill. (They escaped liability because of an exclusion clause in the articles). Romer J’s three
propositions were as follows:
1.1 A director need not exhibit in the performance of his duties a greater degree of skill than may
reasonably be expected from a person of his knowledge and experience. This largely subjective
approach was drawn from the following case:
Re Brazilian Rubber Plantations & Estates Ltd [1911] 1 Ch 425

The non-executive directors of a company were sued on grounds of negligence in respect of losses
sustained by the company in a ruinous speculation in rubber plantations in North Brazil.
Held: The directors were not in breach of the duty of care and skill.
Neville J: a director “may undertake the management of a rubber company in complete ignorance
of everything connected with rubber without incurring responsibility for the mistakes which may
result from such ignorance.”
The standard of care traditionally expected of directors, especially those we would now term
“non-executive” directors, was, on this authority, notably lax.
1.2 “A director is not bound to give continuous attention to the affairs of his company. His duties
are of an intermittent nature to be performed at periodical board meetings, and at meetings of any
committee of the board upon which he happens to be placed. He is not, however, bound to attend
all such meetings, though he ought to attend whenever, in the circumstances, he is reasonably able
to do so.”
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Re Cardiff Savings Bank, The Marquis of Bute’s case [1892] 2 Ch 100

The Marquis became president of Cardiff Savings Bank at age 6 months. He attended one board
meeting in 38 years.
Held: Despite his manifest lack of participation in the company’s affairs, the Marquis was not
liable for irregularities which occurred in the lending operations of the bank.
Stirling J: “Neglect or omission to attend meetings is not . . . the same thing as neglect or
omission of a duty which ought to be performed at those meetings.”
However, we will see below that such lack of participation is not now likely to be as readily
condoned.
1.3 “In respect of all duties that, having regard to the exigencies of business and the articles of
association may properly be left to some other official, a director is, in the absence of grounds for
suspicion, justified in trusting that official to perform such duties honestly.”
Such officials are the agents and servants of the company, not of the directors.
It can be seen from the cases discussed so far that most of the problems which arise in this context
involve a failure on the part of some directors to monitor the activities of other directors (often
executive or managing directors) or senior employees. This problem of delegation, monitoring
and supervision is a core issue in the duty of care and skill (see Re Barings Plc (No. 5) discussed
further below).
2. While the common law duty of care and skill has not been traditionally onerous, there have
been signs more recently that the standard is tightening. A director needs to be aware of the
impact of section 214 Insolvency Act 1986 and the possibility of being disqualified as a director
for being unfit under the Company Directors Disqualification Act 1986.
Re D’Jan of London Ltd [1994] 1 BCLC 561

D’Jan a director of the company signed an insurance proposal without reading it. The proposal
contained inaccurate information. The liquidator brought an action against D’Jan alleging
negligence after a refusal by the insurer to indemnify the company under the insurance policy.
Held: D’Jan was negligent and the appropriate test to apply was that used to assess liability for
wrongful trading under the wrongful trading provision in section 214 of the Insolvency Act 1986.
Hoffmann J (as he then was) said that the duty of care owed by a director at common law is
accurately stated in IA 1986 s. 214(4). Under that test it is necessary to judge the director’s
conduct against the conduct that might be expected of a reasonably diligent person having (a) the
general knowledge, skill and experience that may reasonably be expected of a person carrying out
the same functions as are carried out by that director in relation to the company and, (b) the
general knowledge, skill and experience that that director has. The effect of (a) is that the
director’s conduct is evaluated against the benchmark of the reasonable director carrying out his
function in a comparable company. This means there is scope, depending on his position for the
court to apply a “reasonable managing director”, “reasonable executive director”, “reasonable
finance director” etc approach. Under (b) subjective factors can be taken into account but such
factors cannot be used to reduce the standard in (a) below the minimum standard of “the
reasonable director carrying out that director’s function”. Subjective factors (eg particular
expertise, level of experience etc) can only be used to raise the standard (see Re Brian D Pierson
(Contractors) Ltd [1999] BCC 26).
It is therefore probable that the three tests in Re City Equitable Fire Insurance Co have to be read
in the light of cases since 1986. For another case decided by Hoffmann J in which a similar
approach was adopted see Norman v Theodore Goddard [1991] BCLC 1028 and for discussion of
both D’Jan and Norman see A Hicks, “Directors’ Liability for Management Errors” (1994) 110
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LQR 390. This trend towards “minimum standards” is reflected in jurisprudence under the
Company Directors’ Disqualification Act 1986 (see below).
3. In Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 two directors were found liable
for signing blank cheques for a third director to fill in at a later date. He had used the monies to
make unsecured loans which subsequently turned out to be irrecoverable. No distinction was
drawn between executive and non-executive directors in this case.
4. In keeping with these developments, it is strongly arguable that cases decided under the
Company Directors’ Disqualification Act 1986 (“CDDA”) are now driving the common law
standard higher. It will be recalled from Chapter 6 that section 6 of the CDDA, in particular, has
become one of the principal mechanisms by which directors’ duties are enforced. There are other
provisions in the CDDA but it is intended here to confine analysis to the particular impact of
section 6 which is the most commonly-used provision.
Section 6(1) of the CDDA provides:
“The court shall make a disqualification order against a person in any case where, on an
application under this section, it is satisfied (a) that he is or has been a director of a company
which has at any time become insolvent (whether while he was a director or subsequently), and
(b) that his conduct as a director of that company (either taken alone or taken together with his
conduct as a director of any other company or companies) makes him unfit to be concerned in
the management of a company.”
For these purposes a company “becomes insolvent” if (a) it goes into liquidation at a time when
its assets are insufficient for the payment of its debts and other liabilities and the expenses of the
winding up” or (b) the company enters administration or (c) an administrative receiver of the
company is appointed (section 6(2)).
The minimum period of disqualification under section 6 is 2 years and the maximum period is 15
years (section 6(4)). If the court finds that the director’s conduct makes him unfit it must
disqualify him for at least 2 years. For a recent example where a disqualification order was
granted see Secretary of State for Trade and Industry v Bairstow [2004] All Er (D) 333 (Jul),
were Mr Bairstow (now aged 73) was disqualified for a period of 6 years for failing to supervise
delegated functions.
An application for a section 6 order can be made by the Secretary of State for Trade and Industry,
or if the Secretary of State so directs in the case of a person who is or has been a director of a
company which is being wound up by the court in England and Wales, by the official receiver
(section 7(1)). Since 2 April 2001, s.1A CDDA (inserted by s.6(1)(2) of the IA 2000) allows a
disqualified director to give an out of court undertaking to the Secretary of State for Trade and
Industry, not to be involved in the management of a company for a specified time. This “fast
track” disqualification avoids the need for court proceedings and is designed to increase efficiency
in dealing with errant directors.
Section 9 of the CDDA provides that in determining whether a director’s conduct makes him unfit
for the purposes of section 6, the court must have regard in particular to matters mentioned in
Schedule 1. In a section 6 case, the Schedule 1 factors are as follows:
• Any misfeasance or breach of any fiduciary or other duty by the director in relation to the
company.
• Any misapplication or retention by the director of, or any conduct by the director giving rise
to an obligation to account for, any money or other property of the company.
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• The extent of the director’s responsibility for any failure to comply with any of the following
provisions of the Companies Act, namely
• Section 221 (companies to keep accounting records)
• Section 222 (where and for how long records to be kept)
• Section 288 (register of directors and secretaries)
• Section 352 (obligation to keep and enter up register of members)
• Section 353 (location of register of members)
• Section 363 (duty of company to make annual returns)
• Sections 399 and 415 (company’s duty to register charges it creates).
• The extent of the director’s responsibility for any failure by the directors of the company to
comply with
• Section 226 or 227 of the Companies Act (duty to prepare annual accounts), or
• Section 233 of that Act (approval and signature of accounts).
• The extent of the director’s responsibility for the causes of the company becoming insolvent.
• The extent of the director’s responsibility for any failure by the company to supply any goods
or services which have been paid for (in whole or in part).
• The extent of the director’s responsibility for the company entering into any transaction or
giving any preference, being a transaction or preference liable to be set aside under section
127 or sections 238-240 of the Insolvency Act.
• The extent of the director’s responsibility for any failure by the directors of the company to
comply with section 98 of the Insolvency Act (duty to call creditors’ meeting in creditors’
voluntary winding up).
• Any failure by the director to comply with any obligation imposed on him by or under any of
the following provisions of the Insolvency Act
• Section 22 (company’s statement of affairs in administration)
• Section 47 (statement of affairs to administrative receiver)
• Section 66 (statement of affairs in Scottish receivership)
• Section 99 (directors’ duty to attend meeting; statement of affairs in creditors’ voluntary

winding up)
• Section 131 (statement of affairs in winding up by the court)
• Section 234 (duty of any one with company property to deliver it up)
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• Section 235 (duty to co-operate with liquidator)
These factors are not exhaustive, ie the court can consider other conduct. However, it will be
noted that the range of possible misconduct capable of giving rise to a finding of unfitness is, on
the Schedule alone, very wide.
The consensus in the jurisprudence is that the purpose of the disqualification is to protect the
public in broadly three ways: (a) by keeping unfit directors “off the road”, (b) by deterring the
unfit director for the future (individual deterrence) and (c) by deterring all other company
directors and raising standards of conduct generally (general deterrence). On this general point,
see Secretary of State for Trade and Industry v Gray [1995] 1 BCLC 276, CA (discussed earlier
in Chapter Six) and Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry
v Griffiths [1998] 2 All ER 124, CA. One possible effect of these cases is that we should see
section 6 not simply as a narrow provision concerned with the directors of insolvent companies,
but rather as one which is now being used to fashion standards of general application to company
directors. The leading section 6 case is now Re Barings Plc (No 5) [1999] 1 BCLC 433, a case in
which the court had to determine whether the conduct of three former executives of the collapsed
Barings Bank made them unfit. One notable aspect of Jonathan Parker J’s judgment in the case is
his explicit reformulation of the duty of care and skill.
Re Barings Plc (No 5)

The background facts are, of course, well known but bear brief repetition. Barings collapsed in
February 1995 as a direct result of the unauthorised trading activities of a group subsidiary,
Baring Futures (Singapore) Pte Ltd on the Singapore International Monetary Exchange. The
individual directly responsible was Nick Leeson, the senior floor trader and general manager of
Baring Futures. Leeson incurred losses amounting to some £827 million which he concealed in an
unnamed client account. The report of the Board of Banking Supervision in Singapore attributed
the collapse of Barings to the unauthorised and ultimately catastrophic activities of, it appears,
one individual (Leeson) that went undetected as a consequence of a failure of management and
other internal controls of the most basic kind. The Secretary of State for Trade and Industry
therefore sought orders under s. 6 of the CDDA against several senior executives of Barings on
the ground that their conduct as directors made them unfit to be concerned in the management of a
company. The crux of the case against the executives was that each was guilty of serious failures
of management in relation to Leeson’s activities thereby demonstrating incompetence of such a
high degree as to justify a disqualification order. The honesty and integrity of the executives was
not questioned, only their competence.
Held: It was accepted by the judge that the board of directors may delegate specific tasks and
functions within the company or group to managers and/or employees. However, this does not
mean that directors (either individually or collectively) cease to bear any responsibility for the
discharge of the delegated function. The judge’s exposition of the law can be summarised in the
following series of propositions:
(a) Directors have, both collectively and individually, a continuing duty to acquire and
maintain a sufficient knowledge and understanding of the company’s business to enable
them properly to discharge their duties as directors.
(b) While directors are entitled (subject to the company’s articles of association) to delegate
particular functions to those below them in the management chain and to trust their
competence and integrity to a reasonable extent, the exercise of a power of delegation does
not absolve a director from the duty to supervise the discharge of the delegated functions.
(c) No rule of universal application can be formulated as to the residual duty of monitoring and
supervision referred to in (2) above. The extent of the duty, and the question whether it has
been discharged, must depend on the facts of each particular case, including the director’s
role in the management of the company.
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On the facts, it was found that there had been a wholesale failure on the part of the three
executives to keep themselves properly informed concerning Leeson’s activities within Baring
Futures and to discharge their management responsibilities in relation to the supervision of those
activities. Furthermore, it was stated that the level of reward which a director received from the
company could be taken into account as the higher the level of reward, the greater the
responsibilities which might reasonably be expected to go with it.
The decision in Re Barings Plc can be seen as a further refinement of the director’s duty of
diligence. Anyone taking up a directorship cannot simply regard it as an honorific position. All
directors, whatever their status, have a basic duty to keep themselves regularly informed of
company affairs (especially financial matters) and to participate at least in some degree in the
supervision and monitoring of their co-directors and other delegates. Directors who abdicate their
responsibilities, fail to keep themselves properly informed and/or seek to disassociate themselves
completely from the supervision of the company’s activities risk disqualification and possible
liability for misfeasance should it become insolvent. (Contrast the Re Cardiff Savings Bank case
discussed above). This view is supported by several other disqualification cases (see eg Re A & C
Group Services [1993] BCLC 1297; Re Majestic Recording Studios Ltd [1989] BCLC 1; Re
Peppermint Park Ltd [1998] BCC 23). The precise extent of this basic obligation will depend on
how the particular business is organised and on what part in the management of that business each
director could reasonably be expected to play (see Bishopsgate Investment Management Ltd v
Maxwell [1993] BCLC 1282 at 1285). One implication of this is that more will be expected of
executive directors than of non-executive directors although it would be wrong to assume that
non-executive directors have no responsibility. The level of an individual director’s remuneration
is, after Barings, also relevant in determining the extent of his duty. The higher the level of his
remuneration, the greater the responsibility that the director may reasonably be expected to
exercise. Similarly, the standard of the basic duty may be scaled upwards to reflect the level of
each director’s skills and experience (see earlier). Given that one acknowledged purpose of s. 6 of
the CDDA is to improve standards of conduct among directors, it is likely that the courts will
regard the law as stated in Barings as being of general application. The time for a substantial
reformulation by the higher courts of the well-known principles enunciated in Re City Equitable
Fire Insurance [1925] Ch 407 in an ordinary civil dispute between a company and its directors is
surely not far off.
5. It is clear from the foregoing that the standard of the duty is now much more onerous.
However, as with any duty of care, the onus remains on the company to establish that breach of
the duty caused the company loss. The requirement of causation should not be overlooked and can
pose considerable difficulties to a claimant company where the substance of what is alleged is that
a director failed to take a sufficiently active part in the company’s affairs: i.e. a claim based on an
omission.
Cohen v Selby [2001] 1 BCLC 176

G was the director of a company which carried on business as a trader in diamonds. In 1991 he
resigned as director and his 19-year old son, A, was appointed in his place. G continued to run the
company’s business and make all the salient decisions. A was content to leave everything to his
father and took no active part in the running of the company. G purchased a large amount of
diamonds at auction but while he was en route to the continent to deliver them to customers, the
diamonds were stolen. No insurance had been put in place. Consequently, the company lost over
half a million pounds (being the value of the diamonds). The company went into liquidation and
its liquidators brought an action on the company’s behalf against G and A.
Held by CA: There was no doubt that G had been grossly negligent and that his failure to effect
insurance had caused the company’s loss. However, on the pleaded case, A was not liable. It was
alleged against A that he had been negligent and in breach of duty in delegating to G the power to
decide whether to effect insurance against loss or theft. For that allegation to be made out, it
would need to be shown that G was an unsuitable delegate and this was not the case. The trial
judge had concluded that A was liable on the basis that he had abdicated all responsibility for the
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company and abjectly surrendered his duties. However, this was not the pleaded case. If the case
had been pleaded in this way it would have been incumbent on the company to set out in detail
what it was A ought to have done that he had failed to do and to establish that there was a
causative link between what he had failed to do and the loss which the company had suffered. As
the question of causation had not been addressed by the trial judge, A was entitled to succeed on
appeal.
7.4 Statutory Duties
1. Interests in contracts s. 317
2. Loans to directors s. 330
3. Substantial Property Transactions s. 320
4. Authority to allot shares s. 80
5. Loans to directors s. 330
Again, these duties must now be read in light of Companies Act 2006
7.4.1 INTERESTS IN CONTRACTS S. 317
This statutory duty will be replaced by the duty to declare an interest in an exisitng
transaction under s.182 Companies Act 2006.
1. Section 317 contains a criminal sanction and gives statutory force to the waiver rules in that
disclosure of the director’s interest in a contract whether direct or indirect must be made to the
board. Directors are liable to a fine for breach of s. 317. By Table A articles 94-95 the director
may not vote or count in the quorum at a board meeting which considers a contract in which he
has an interest.
2. The nature of the interest must be disclosed, eg how much profit the director is making, but
unfortunately this rule is limited by s. 317(3) which provides that a general notice may be
sufficient. Under s. 317(3) a director need only notify the board once that he is a member of a
specified company or firm or connected with a person connected with such businesses. The effect
of this disclosure is that he is to be regarded as interested in any contract made with such a
business.
SAQ 3
What are the consequences of a breach of s. 317?
3. If a director is in default of s. 317, he is liable to a fine as stated above. But also the director
may not use the protection of the waiver clause (Art. 85) in the articles in relation to liability
under s. 317. In addition, the basic rule (that a director must not enter into a contract either
201
directly or indirectly) applies and the contract is voidable at the option of the company under the
civil law (see earlier notes). Also any profits made by the director are recoverable.
Guinness plc v Saunders [1990] 2 AC 663, HL

A committee of the board of directors (Saunders, Ward and Roux) agreed to pay Ward
remuneration of £5.2m for legal advice. This was not authorised by the full board. The plaintiff
sought repayment on grounds that the payment was unauthorised. The committee had been
established to settle the terms of a bid for Distillers Co Plc. By the articles remuneration could
only be authorised by the board. There was a breach of s.317 but the company could not claim
repayment under s.317. Ward did have to repay on the civil ground that there was no
authorisation and therefore the contract could be avoided. The court nevertheless expressed the
view that s.317 shows the importance which the legislature attaches to the principle that a
company should be protected against a director who has a conflict of interest and duty.
4. Disclosure at board meetings is required even if all the directors are informally aware of the
conflict of interest. However, “The court would hesitate to find that the failure to declare at a
board meeting an interest common to all members and, ex hypothesi, already known to all of the
board, is a breach of s. 317”. Per curiam Lee Panavision Ltd v Lee Lighting Ltd [1992] BCLC 22,
CA.
5. There is an important question as to whether there can be compliance with the section if there
is a sole director and if so how.
In Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald [1995] 3 WLR 108 it was held that
there could be a directors’ meeting in the case of a sole directorship. The director should therefore
make a declaration at the meeting which should be recorded if there is no one else present. If, for
example, the company secretary is present, the declaration does not have to be recorded to be
valid. In this case it was left to the trial judge to determine whether, on the facts, the declaration
had been made. (The company secretary was allegedly present but no record was made). This
leads to the odd result that in company law, it is possible to have a meeting with yourself!
7.4.2 LOANS TO DIRECTORS S.330
Please note: This area must also be read in light of Companies Act 2006 ss. 197 – 214.
1. S.330 states that a company shall not make a loan to a director of the company or its holding
company, or enter into any guarantee or provide any security in connection with a loan made by
any person to such director. This provision only applies to loans which exceed £5,000 in
aggregate. A loan of £5,000 or less made by a company to its director is therefore legal.
Under s.197 Companies Act 2006, the shareholders can now authorise such a loan providing
that full disclouse of its extent and nature has been given.
Further, s.207 provides that authorisation is not required if the value of the transaction does
not exceed £10,000 (the current limit being £5,000).
2. The majority of the rules concerned with loans to directors relate to public companies, and
there are some exceptions to s. 330 as far as private companies are concerned.
3. The major exception is that for private companies, a company may provide any of its directors
with funds to meet expenditure incurred or to be incurred for the purposes of the company or to
enable the directors to perform their duties (s. 337).
4. The provision is made subject to the prior approval of the company in general meeting by
ordinary resolution following disclosure of the amount and purpose of the payment.
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However, if the company in general meeting does not approve the payment for the above purpose
at or before the next AGM the expenditure incurred must be repaid within six months of that
meeting.
5. Public companies have further restrictions on them.
They may not make:

(a) A quasi-loan to a director (a quasi-loan is where company meets a financial obligation of
director and is to be reimbursed later). An example of a quasi-loan is a credit card
transaction where the company is the cardholder and the director uses the card for personal
purposes.
(b) A loan or quasi-loan to any person connected with a director (connected person means
spouse, child under 18, company where he is interested in more than 20% of the equity
share capital, partner).
Exceptions are:
(a) A quasi-loan which is to be reimbursed within two months providing the total amount
outstanding of all quasi-loans by the company does not exceed £5,000.
(b) Credit transactions, eg where it supplies goods or sells land under a hire purchase or
conditional sale agreement (ie periodic payments) to the director or connected person,
providing the total amount outstanding does not exceed £5,000.
(c) A credit transaction entered into in the ordinary course of business, the value of which is no
greater and the terms no more favourable than would be offered to an unconnected person
of the same financial standing.
(d) The same exception as to expenditure incurred for the purposes of the company as in
private companies except that the maximum amount allowed is £10,000 for a public
company (no maximum amount for a private company).
(e) A money-lending company may make a loan in the ordinary course of business providing
others are offered the same terms. Favourable terms may however be offered to a director to
enable him to purchase or improve his main residence provided such loans are normally
available to the company’s employees for this purpose and the total amount of the loan does
not exceed £100,000.
The director of a public company is also liable to a fine and/or imprisonment for breach.
6. An arrangement or transaction contravening these provisions is voidable by the company

unless:
(a) Restitution is no longer possible;
(b) Third party rights (for value and without notice) would be affected (s. 341(1)).
A loan is therefore valid unless, and until, it is avoided by the company.
7. Those involved must indemnify the company for any loss and must account for any gain.
8. No criminal sanctions exist in the case of private companies.
9. Transactions under s. 330 shall be treated as giving the director an interest in a contract which
should be disclosed under s. 317.
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10. Transactions under s. 330 must be disclosed in the accounts.
11. A prohibited loan to a director does not make the director a constructive trustee. Therefore, no
form of tracing claim is available. (Ciro Citterio Menswear plc v Thakrar [2002] 2 All ER 717).
12. A company may enforce repayment of an illegal loan made under s. 330 (Currencies Direct
Ltd v Ellis [2002] 1 BCLC 193).
13. Clauses 180-181 of the CLR Bill will amend s330 to raise the de minimis exception from
£5,000 to £10,000
7.4.3 SUBSTANTIAL PROPERTY TRANSACTIONS s. 320
1. Section 320 states that a company shall not enter into an arrangement whereby a director of
the company or its holding company or a person connected with such a director, acquires or is to
acquire one or more non-cash assets of the requisite value from the company, or alternatively,
whereby the company acquires, or is to acquire, one or more non-cash assets of the requisite value
from such a director or connected person, unless the arrangement is first approved by a resolution
of the company in general meeting.
Please note: s.190 (5) Companies Act 2006 provides that the above restriction will not apply
so far as it relates to anything which the director of a company is entitled to do under his
service contract.
2. Connected person means (see section 346):
(a) spouse, legitimate or illegitimate children and step-children under 18;
(b) companies in which the director or connected persons have a 20% interest;
(c) a trustee of a trust in which a person in (a) and (b) could benefit;
(d) his business partner or a business partner of any person in (a), (b) or (c).
3. A non-cash asset is any property or interest in property other than cash and will be of requisite
value if its value at the time of the arrangement is not less than £2,000 but exceeds £100,000. If
the value is less than £100,000 but is more than ten per cent of the company’s net assets as
disclosed in the latest filed accounts it is also of the requisite value. Where no accounts have been
prepared, the amount of its called up share capital should be used rather than net assets.
Please note: s.191(2) Companies Act 2006 will raise the threshold below which no
authorisation is required from £2000 to £5000.
4. Note - if such an arrangement is to be entered into it must first be approved by an ordinary

resolution of the company in general meeting.
5. If the consent of the general meeting is not given, the contract is voidable by the company
unless:
(a) third party rights (for value and without notice) would be affected, or
(b) restoration of the parties to their pre-contractual position is no longer possible, or
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(c) the contract has been affirmed afterwards by the members in general meeting within a
reasonable period.
6. The directors who authorised the arrangement (not just the one who entered into the
arrangement or any connected person) are liable to indemnify the company against any loss, and
are liable to account for any profit made. However, a connected person or authorising director is
excused liability if they did not know the circumstances. Also a director is not liable if he can
show that he took all reasonable steps to ensure the company’s compliance with s. 320.
7. An example of a substantial property transaction is where a director sells business premises to

the company in return for shares. Approval of the members in general meeting must first be
obtained subject to the “requisite value” provisions.
8. Section 321 waives the approval requirement if the director concerned acquires the assets
from the company of which he is a member, solely by virtue of being a shareholder of the
company; eg bonus shares or shares obtained under pre-emption rights.
9. S. 320 transactions must be disclosed in the accounts.
10. The burden of proof is on the person alleging breach of s. 320.
Joint Receivers of Niltan Carson Ltd v Hawthorne [1988] BCLC 298

N, the receiver and manager of a company’s assets appointed by debenture holders, was claiming
entitlement to money also claimed by H the borough of Lambeth. The company ran an
unsuccessful hotel business. H decided to run it as a community home. There was an agreement
that she should lease the hotel from the company. N claimed the value of the lease was greater
than 10% of its net assets and that the transaction was in breach of section 320. N produced no
evidence of the value of the lease or of how the value was calculated, nor did he produce any
accounts.
Held: Anyone who alleges that a non-cash asset exceeds the requisite value has to prove the fact.
In the absence of any evidence there was no breach of s. 320 (s.48 at the time the case was
decided).
11. In the case of British Racing Drivers Club Ltd v Hextall Erskine, [1997] 1 BCLC 182
Carnwarth J. offered the following observations:
The thinking behind [section 320] is that if directors enter into a substantial commercial
transaction with one of their number, there is a danger that their judgment may be distorted by
conflicts of interest and loyalties, even in cases where there is no actual dishonesty. The section
is designed to protect a company against such distortions. It enables the members to provide a
check.
The facts of the case are something of a salutary lesson as to the importance of watching the inter-
relationship between the various statutory provisions applying to directors, the common law and
equitable rules on directors’ duties and the articles of association. W was a director of B Ltd and T
Ltd. The two companies entered a joint venture agreement whereby B Ltd acquired a half interest
in T Ltd for £5.3 million. B Ltd’s solicitors advised that for company law purposes the transaction
would not be open to challenge as long as W declared his interest at a board of meeting of B Ltd
and did not vote on a board resolution of B Ltd to approve the transaction. Of course, W was
required to declare his interest at common law, under the articles and by section 317. However, B
Ltd was acquiring a non-cash asset (shares in T Ltd) of a requisite value (substantially in excess
of £100,000!) from one of its directors. The transaction should therefore have been approved by
the shareholders under section 320. They refused to ratify it retrospectively and so it had to be
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completely unravelled, W repurchasing the shares in T Ltd at a much reduced price. A £2.1
million negligence action against the solicitors was successful.
12. The question of the extent to which a director who acts in breach of section 320 might be
required to indemnify the company against loss resulting from his actions has been considered in
the Duckwari litigation:
Non-cash asset: Re Duckwari plc (No 1) [1997] 2 BCLC 713, ChD and CA
It is only transactions between companies and their directors involving the transfer of a non-cash
asset that are caught by section 320. The scope of the term non-cash asset was explored in Re
Duckwari plc (No 1). In this case, C was a director of the plaintiff company, D plc. He was also
the director and controller of O Ltd with the result that C and O Ltd were connected persons for
the purposes of section 320. O Ltd agreed to purchase a freehold property for £495,000 and, on
exchange of contracts, paid a 10% deposit to the sellers. Before the completion date, it was agreed
that O Ltd would pass the property on to D plc on the basis that D plc would pay the balance of
the purchase price and reimburse O Ltd for the 10% deposit. D plc then completed the purchase.
After the collapse of the property market, D plc brought proceedings against C and O Ltd alleging
that the transaction between O Ltd and D plc was caught by section 320 and should have been
approved in advance by D plc’s shareholders. The critical question was whether D plc had
acquired a non-cash asset. This term is defined in section 739(1) of the 1985 Act as meaning any
property or interest in property other than cash. The Court of Appeal held that this clearly
embraced the arrangement between D plc and O Ltd. Millett LJ stated that the arrangement could
be analysed in two ways that are effectively identical. It could be said that D plc had acquired the
benefit of O Ltd’s contract with the seller. Equally, it could be said that D plc had acquired an
equitable interest in the property. Either way, the subject matter of the transaction was a non-cash
asset falling within section 320. The Court of Appeal arrived at a valuation of £49,500 (ie the
value of the deposit) and this fell within the “requisite value” for the purposes of section 320(2).
Remedies for breach of s 320: Re Duckwari plc (No 2) 1998, CA

Following the Court of Appeal’s declaration in Duckwari (No 1) (see above), the courts then had
to determine the extent of D plc’s remedies for breach of section 320 given that the transaction
had not been approved by its shareholders. The primary remedy under section 322(1) is rescission
(see above) but it was accepted that rescission had ceased to be available once D plc had
completed the purchase. Even so, a secondary remedy is available under section 322(3). This
renders, among others, a director and any person connected with him liable to account to the
company for any gains which they have made from the offending transaction and to indemnify the
company for any loss or damage resulting from the arrangement or transaction. The difficult
question facing the courts concerned the ambit of the indemnity for loss and damage. D plc had
completed the transaction while the property market was still buoyant. However, by the time it
came to the sell, the market had collapsed and the property only fetched around £180,000. The
question of practical importance was whether D plc could claim indemnity for the difference
between the purchase price of £495,000 and the sale price of £180,000, a difference representing
the fall in market value which had occurred after D plc had completed the purchase. In Re
Duckwari (No 2), the High Court ruled that D plc had suffered no recoverable loss. On the judge’s
view, the purpose of sections 320-322 was to regulate self-dealing transactions involving either
the acquisition of assets by the company at an inflated price or the disposal of assets at an
undervalue. The indemnity therefore covered any difference between the market value of the asset
at the date of the transaction and the price paid or received by the company. The original
valuation of £495,000 had never been questioned. O Ltd had therefore passed the property on to D
plc at its true value at that time and there was no loss. On this reasoning, D plc was only entitled
to recover if the £495,000 originally paid represented an inflated price for the property.
The Court of Appeal disagreed with the High Court and held that D plc was entitled to recover the
full loss attributable to the asset’s decline in value after completion. The Court of Appeal appear
to have reached this decision on the following grounds:
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(a) The transaction was analogous to the purchase of an unauthorised investment by a trustee.
The assets of a company vest in the company and so the directors can not accurately be
regarded as trustees of those assets. Nevertheless, on the authority of Re Lands Allotment
Co [1894] 1 Ch 316 directors have always been treated as trustees of assets or money
coming under their control and are liable to make good any sums which they misapply on
the same basis as a trustee. Citing Knott v Cottee (1852) 16 Beav 77 in support, the court
continued by reiterating the well settled principle that a trustee who misapplies trust funds
in the acquisition of an unauthorised investment is liable to restore to the trust the amount of
the loss incurred when that investment is eventually sold. Per Nourse LJ:
It is well recognised that the basis on which a trustee is liable to make good a
misapplication of trust moneys is strict and sometimes harsh, especially where there has
been a huge depreciation in the value of the asset acquired. I can understand the
reluctance of the judge to visit [C] (with whom I include [O Ltd]) with the consequences
of the loss. But the loss has to fall somewhere and, if a proposal to purchase the property
had been put to and rejected by the shareholders, it would have lain with [C].
This trusts analysis was not inconsistent with the specific statutory guidance on remedies given
in section 322. Furthermore, it was fair to say that the loss resulted from the transaction on the
ground that no loss would have been incurred but for the purchase.
(b) On the wording of section 322(2)(a) it is clear that the company is barred from seeking the
primary remedy of rescission where it has already been indemnified against any loss or
damage suffered under section 322(3). Nourse LJ said that this provision was only
explicable if the indemnity against loss or damage placed the company in a position
equivalent to that in which it would have been had rescission been ordered. Clearly, if the
transaction had been capable of rescission at the time, D plc would have been entitled to
recover all the purchase money. The court felt compelled, reading section 322(3) alongside
section 322(2)(a), to reach the conclusion that D plc should recover its full loss.
Thus, it must be noted that the statutory remedies in section 322 are essentially equitable in
character and have more in common with the remedies which apply when trustees use trust funds
for unauthorised purposes than with traditional damages at common law (eg in tort or contract).
REFORMS: Clauses 173-174 of the CLR Bill will replace s320 in that a company may enter into
a contract to buy or sell an asset if it first obtains approval of the company in general meeting.
Clause 174(2) raises the minimum value of a substantial property transaction to £5,000.
Exceptions to the rule are found in Clauses 175-178.
7.4.4 AUTHORITY TO ALLOT SHARES S.80
Section 80 restricts the power of directors to allot new shares. They need authority to allot either
from -
(a) the company in general meeting, or
(b) the articles of the company.
The authority may be given for a particular exercise of the power or it may be for the exercise of
that power generally.
The consent from (a) or (b) is limited to no more than 5 years in duration unless there is an
elective resolution which makes the time more than 5 years.
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The authority to allot shares may be revoked or varied by ordinary resolution.
Please note: s.550 Companies Act 2006 will provide that where a private company has only
one class of shares, the directors may allot shares of that class providing that the company’s
articles do not prohibit such an allotment.
Section 80 does not apply to subscriber shares (from subscriber clause in memorandum) or shares
allotted pursuant to an employees’ share scheme.
Once directors have power to allot shares under s. 80 the question arises as to whom must the
shares be allotted. Section 89 gives pre-emption rights to existing shareholders in that shares must
first be offered to each shareholder on a proportional basis.
However, s. 89 may be excluded by a s. 95 special resolution or by a provision in the

memorandum or articles (see earlier notes). A common practice would be for the company in
general meeting by special resolution to authorise the directors to allot shares as they think fit.
Section 89 does not apply to a non-cash allotment or shares allotted pursuant to an employee
share scheme.
In summary:
The directors must first obtain authority to allot shares (s. 80). Then, having the authority, they
must allot to existing shareholders (s. 89 unless non-cash or employee share scheme) on a
proportional basis. If s. 89 is excluded or does not apply, they will have authority to allot to
people other than the existing shareholders. Finally, in allotting the shares, they must be allotted
for the proper purpose, eg to raise capital. (See Howard Smith Ltd v Ampol Ltd earlier).
If the directors are in breach of duty and issue shares for an improper purpose, the breach may be
ratified by the general meeting providing it is neither a fraud on the minority (see Chapter Eight)
nor are there equitable considerations making it unjust to vote in a certain way (see earlier notes).
7.5 Remedies of the company against a director in breach of his

duties
1. Injunction (in the case of fiduciary duties)
2. Payment of damages or compensation to the company (in the case of the duty of care and
skill)
3. Restoration of the company’s property if traceable (fiduciary duties)
4. Rescission of any contract entered into in breach of duty (fiduciary duties)
5. Account of profits
In an appropriate case the director might also find himself subject to a s. 303 resolution seeking
his removal from office.
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7.6 Questions
1. To whom are the fiduciary duties owed?
2. How does a director act bona fide in the best interests of the company?
3. What happens when a director exercises his/her power for an improper purpose?
4. Can the shareholders in general meeting involve themselves in a director’s abuse of power?
5. Regarding the duty not to make a secret profit, what is the case Regal (Hastings) about and
what effect has it had on this duty?
6. What is the difference between the director’s duty not to make a secret profit and not to
appropriate a “maturing business opportunity.”?
7. What is the basic rule when directors make a contract with the company directly or indirectly?
8. What is the duty of care and skill and how effective is it?
9. What is the effect of s. 317
10. May companies make loans to directors, and if so, to what extent?
11. What is the effect of a director purchasing or selling his/her own property to the company?
12. Summarise the effect of s. 80, s. 89 and s. 95.
Question
Graham and Sue, a married couple, for many years ran a successful company, Compserve Ltd
which designs and sells software for use in browsing the Internet. In their late fifties, Graham and
Sue decided to reduce their daily involvement in the business and invited Jon and Imran to join
the company. Jon and Imran both invested in the company but Graham and Sue retain 51% of its
issued shares. Imran became managing director.
Last year, Imran invested £30,000 of Compserve Ltd’s reserves in a Japanese investment trust. He
had seen the scheme advertised in a reputable financial journal as a “modest capital risk promising
good yields” when compared with prevailing bank base interest rates. Instability in Far Eastern
stock markets has wiped all the value off this investment.
Graham and Sue have now come across an advertisement placed in Imran’s name in a computer
magazine. In the advert, Imran is offering to sell the rights to one of the company’s products and
is asking for potential customers to make advance payments to an address which turns out to be
his own flat. Imran has also arranged for the sale of the company’s Alfa Romeo to Jon. The car,
which is brand new, is worth £15,000. Jon has agreed to pay for it in a year’s time.
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Advise Graham and Sue.
Outline answer – see Cases & Materials 7.3.2 for a complete outline answer.
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CHAPTER EIGHT
RIGHTS OF THE MINORITY/SHAREHOLDER

REMEDIES
8.1 Objectives
At the end of this chapter you should be able to
• Apply the rule in Foss v Harbottle
• Recognise the exceptions to the rule in Foss v Harbottle
• Analyse s. 459 and s. 461 and their application
• Distinguish between s. 459 and s. 122(g) IA 1986
8.2 The Rule in Foss v Harbottle
1. In any action in which a wrong is alleged to have been done to a company, the proper
claimant is the company itself. This is known as the rule in Foss v Harbottle (1843) 2 Hare 461.
Foss v Harbottle
Directors sold land belonging to them to the company at a price above market value. Two
minority shareholders took proceedings on behalf of themselves and other members against the
directors to compel them to account for their gains.
Held: As the acts of the directors were capable of ratification by a majority of the members, it was
for the majority to decide whether or not the company should sue the directors ie the proper
claimant where the company as an entity has suffered wrongdoing is the company itself.
The rule effectively recognises the legal personality of the company and the fact that the company
therefore has its own separate rights and obligations. The second aspect of the rule is that it
illustrates a reluctance on the part of the courts to intervene in circumstances where the matter is
capable of being resolved within the internal mechanisms of the company.
2. The rule was later extended to cover cases where what is complained of is some internal
irregularity in the operation of the company. However, the internal irregularity must be capable of
being confirmed/sanctioned by the majority.
MacDougall v Gardiner (1875) 1 Ch D 13

On a motion for the adjournment of a general meeting, the chairman had ruled that no poll vote
could be demanded. The articles said that the chairman could adjourn but also that there was to be
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RIGHTS OF THE MINORITY/SHAREHOLDER REMEDIES
W Ltd’s action was settled and it received nearly £2 million in damages and costs. Subsequently,
J commenced fresh proceedings against the solicitors. He claimed that the solicitors owed him a
separate duty of care in contract and tort in relation to the exercise of the option and that the
breach of this separate duty had caused him substantial personal losses over and above those
suffered by the company (principally the costs of personal borrowings that he was obliged to
make to finance his other business interests while W Ltd’s business was effectively frozen
pending the resolution of the original litigation against the seller). The solicitors applied to strike
out J’s claim.
Held: Where a company suffers loss caused by a breach of duty owed to it, only the company may
sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity to make
good a diminution in the value of his shares that merely reflects the loss suffered by the company.
However, where a company suffers loss caused by a breach of duty to it, and a shareholder suffers
a loss separate and distinct from that suffered by the company caused by breach of a duty
independently owed to the shareholder each may sue to recover the loss caused to it by breach of
the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to
that other. On the facts, it was at least arguable that J had suffered loss that was separate and
distinct and so the action was allowed to proceed to trial.
The rule barring recovery of reflective loss seeks to protect the defendant against the possibility
that two different parties will recover for the same loss (ie it is in part a rule against double
recovery). Moreover, in barring the shareholder’s recovery, the rule also seeks to protect the
company, its members and creditors collectively by ensuring that the company enjoys the primary
right of recovery. However, it may be thought to operate unfairly in cases where the company
resolves not to bring an action or is unable to do so: see discussion in Giles v Rhind [2001] 2
BCLC 582, where the wrongdoer, by his wrongdoing, had disabled the company from pursuing
any claim for damages. The claimant was therefore allowed to proceed with his claim which
included a claim for diminution in the value of his shareholding. A further application of the no
reflective loss principle can be found in Shaker v Al-Bedwari [2003] 1 BCLC and Gardner v
Parker [2004] All ER (D) 249.
6. Because Foss v Harbottle leaves the minority in an unprotected position, exceptions have
arisen and statutory provisions have come into being which provide some protection for the
minority. By far and away the most important protections are to be found in sections 459-461 of
the Companies Act. However, the usefulness of section 459 can only be fully understood against
the background of common law shareholder remedies. Moreover, despite their acknowledged
ineffectiveness, remedies at common law remain available and so we discuss them first.
8.3 Minority Protection/Shareholder Remedies at Common Law
8.3.1 EXCEPTIONS TO THE RULE IN FOSS v HARBOTTLE
An individual shareholder may sue in the following circumstances:
1. When the complaint is that the company is acting or proposing to act ultra vires. No ordinary
majority can sanction such an act. See Ashbury Railway Carriage Company v Riche (Chapter
Two). The same applies where the act in question is illegal. However, this exception is strictly
controlled as the following case illustrates:
Smith v Croft (No.2) [1988] Ch 114

The claimants were minority shareholders who claimed to recover on behalf of the company sums
which had been expended in ultra vires transactions.
Held: The claimants had locus standi to bring an action on behalf of the company in relation to
ultra vires transactions BUT claimants had no right to sue if a majority of the shareholders
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independent of the defendants did not want the action to continue, i.e. they would have to pursue
the matter in a derivative action.
2. When the act complained of requires the sanction of a special or extraordinary resolution and
the requisite majority to approve such a resolution has not been obtained. See Edwards v
Halliwell (above).
3. Where it is alleged that the personal rights of the claimant shareholder have been infringed or
are about to be infringed. Strictly, this is not a true exception to the general rule. It is a situation in
which Foss v Harbottle does not apply because infringement of personal rights does not involve
wrongdoing to the company.
Pender v Lushington (1877) 6 Ch D 70

The chairman of the general meeting of a company, in breach of the company’s articles, rejected
as invalid certain votes which were cast. A shareholder whose votes were rejected brought a
personal action against the chairman.
Held: The right to have votes recorded was an individual membership right which a member has a
personal right to enforce. N.B. this is effectively an action to enforce the statutory contract under
s. 14 (see Chapter Two).
Contrast MacDougall v Gardiner (above) where the court refused to allow a minority shareholder
to complain where the chairman refused to call a poll vote on the basis that the majority could
ratify the chairman’s action. As such, there are problems at common law in determining precisely
where to draw the line between a wrong actionable by a shareholder (based on personal rights
infringement) and a wrong/irregularity falling four square within the rule in Foss v Harbottle. A
further point is that where there is any overlap eg a wrong which might equally be characterised
as a wrong to the company or a wrong to the shareholder, it is safer to assume that the rule in Foss
will apply.
4. Where those who control the company (ie the majority), are perpetrating a fraud on the
minority. No resolution can ratify a fraud on the minority.
SAQ 1
What do you think fraud on the minority means?
4.1 “Fraud” here means not actual deceit but an abuse of power as for eg a breach of a fiduciary
duty. It occurs when “the majority are endeavouring directly or indirectly to appropriate to
themselves money, property or advantages which belong to the company or in which the other
shareholders are entitled to participate.” Lord Davey in Burland v Earle [1902] AC 83.
Fraud on the minority has a wider meaning than the usual meaning of the word “fraud” and could
encompass:
(a) Expropriation of the property of the company or in some circumstances, that of the
minority, or
(b) Breach of the directors’ duties of good faith, or
(c) Voting for company resolutions which require good faith, without the necessary bona fides.
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See further Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2 where
Megarry VC refused to accept that because the majority acted in good faith there was no fraud on
the minority.
4.2 A resolution of a general meeting cannot authorise the directors to act where to do so would
constitute a fraud on the minority. If the directors have acted in their own interests or those of
third party in a way that constitutes fraud, rather than in the interests of the company, a resolution
of the general meeting will not protect them or relieve them from liability.
Cook v Deeks [1916] 1 AC 554

The directors of a construction company obtained a contract in their own names to construct a
railway. The contract was obtained under circumstances which amounted to breach of trust by the
directors who then used their voting powers to pass a resolution of the company declaring that the
company had no interest in the contract and ratifying their actions.
Held: The benefit of the contract belonged to the company. The appropriation of the contract by
the directors amounted to a fraud on the minority and the resolution purporting to ratify the
directors’ actions was invalid.
Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2

The claimant company was formed by the defendant council for the purpose of managing a block
of 60 flats. The company’s 60 shares were initially owned by the defendant council. The flats
were let on long leases. Each purchaser was given 1 share in the company. Voting rights were
retained by the defendant council until all flats had been disposed of. After 12 flats were sold the
defendants decided (after a change in political control of the council) to let the remainder to
council tenants. The defendant used its voting power to compel the company’s directors to
discontinue an action brought in the company’s name against the defendant to enforce
performance of its agreement to use best endeavours to sell all the flats. One of 12 shareholders
applied to be substituted as claimant in the action so she could continue it as a derivative action.
Held: Her application was allowed. There had been a fraud on the minority by those in control.
The action of the majority injured one category of shareholder (the lessees) to the benefit of
another (the council). Fraud, Megarry VC said, included an abuse of power.
4.3 A minority shareholders action for fraud on the minority can only be admitted if the
wrongdoers are in control of the company. This probably includes control through nominees.
5. Where there are equitable considerations which make it unjust to vote in a certain way. The
general meeting cannot ratify in these circumstances.
Clemens v Clemens Bros Ltd [1976] 2 All ER 268

The claimant owned 45% of the shares and her aunt owned 55%. The aunt was also one of five
directors. The directors issued shares to trustees of an employee share scheme and as a result the
claimant’s shareholding was diluted and she lost her power to block special resolutions. The
general meeting ratified the share issue.
Held: Resolution and share issue set aside. It was held that there were equitable considerations
which made it unjust for the aunt to vote in favour of the resolution.
The motive of the aunt was primarily to injure the claimant, not to consider what was for the
benefit of the company, and although normally shareholders may vote as they wish, it seems that
when equitable considerations can be superimposed they lose their right to vote freely.
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8.3.2 ENFORCING THE DUTIES OWED TO OR BY THE COMPANY:

SHAREHOLDER ACTIONS
Where an individual member brings an action to remedy a wrong done to the company, or to
compel the company to conduct its affairs in accordance with its constitution and the rule of law
governing it, the action will take one of the following forms:
(a) Derivative: Here the individual member brings a claim against third parties for the
company’s benefit, ie he is trying to enforce a claim in the company’s right and his right to
sue is derived from that of the company; or
(b) Personal: This occurs where the member sues the company directly as when he is
attempting to prevent or remedy the infringement of personal rights (a Pender v Lushington
type action) or
(c) Representative: Where a number of people have the same interests (for example, the same
personal right has been infringed) one may be able to sue as a representative of all those
affected to prevent multiplicity of action.
8.3.2.1 The derivative action
1. The defendants must be in control of the company. They are often the directors also. It was
always thought that this meant voting control but in Prudential Assurance Co Ltd v Newman
Industries Ltd Vinelott J said, that control could be de facto control. “Control embraces a broad
spectrum extending from an overall absolute majority of votes cast at one end, to a majority of
votes at the other end made up of those likely to be cast by the delinquent himself, plus those
voting with him as a result of influence or apathy.” The Court of Appeal did not express an
opinion on this.
A further obstacle to derivative proceedings arose in Smith v Croft (No.2) [1988] Ch 114.
Smith v Croft (No.2)

The claimants were minority shareholders who claimed to recover on behalf of the company
money paid under ultra vires transactions and in breach of s.151 of the Companies Act. The
claimants had 14% of the votes, the defendants 63%. Others who did not wish the litigation to
proceed held 23%.
Held: Although the claimants had standing to bring a derivative action, they had no right to sue
because a majority of the shareholders who were independent of the defendants did not want the
action to continue.
Knox J. The question to ask is “whether the majority within the minority, can prevent the
minority within the minority from prosecuting the action for redress.” Knox J thought it proper to
have regard to the views of independent minority shareholders.
Sealy states:
“It is generally felt that it is an over-simplification to run together all the questions of
authorisation, ratification, affirmation of a transaction otherwise voidable, release and
condonation of wrongdoers and wrongdoing etc and try to match them up with the issue of a
claimants right to sue”.
2. Not every wrong to the company will justify a derivative action to remedy it. Normally
the wrong complained off must be such as to constitute a fraud on the minority which
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could not therefore be validly waived or ratified by the company in general meeting as per
Cook v Deeks (see above).
For an interesting discussion of the issues see, ‘Ratification of breaches of directors duties: the
implications of the reform proposals regarding the availability of derivative actions’. The
Company Lawyer (2004) 25:7, p.197-212.
Pavlides v Jensen [1956] Ch 565

A minority shareholder complained that the directors had negligently sold an asset (a mine) of the
company at a gross under valuation.
Held: A derivative action could not be brought since the general meeting could properly have
ratified the directors’ action and resolved not to sue in respect of it. In other words, there was no
“wrongdoer control”.
Per Danckwerts J:
“There is no allegation of fraud on the part of the directors or appropriation of assets of the
company by the majority shareholders in fraud of the minority . . . it was open to the company
by a vote of the majority to decide that, if the directors by their negligence or error of judgment
had sold the company’s mine at an undervalue, proceedings should not be taken by the
company against the directors.”
3. If the sale at a gross undervalue had been to a director or controlling shareholder then this
could apparently be an expropriation of the company’s property falling within the definition of
“fraud”. This is so even if the act complained of was “merely negligent” in the Pavlides v Jensen
sense. The point is that those in control of the company must in some sense benefit from the
wrongdoing for it to be “fraud”.
Daniels v Daniels [1978] Ch 406

Three minority shareholders brought an action against majority shareholders on grounds that the
company had sold land to Mrs Daniels in 1970 for £4,250. In 1974 Mrs D sold the land for
£120,000.
Held: The minority were entitled to bring a derivative action on the company’s behalf against the
directors on grounds of negligence.
Templeman J widened the definition of fraud. “A minority shareholder who has no other remedy
may sue where directors use their powers, intentionally or unintentionally, fraudulently or
negligently in a manner which benefits themselves at the expense of the company.”
4. The company must be made a party to the action so that judgment can be given in its favour.
A minority shareholder will not therefore gain anything directly from the action he brings. He
may, of course, gain indirectly if the status quo ante in the company is restored.
5. The problem of costs was a major deterrent to bringing an action of this kind until
Wallersteiner v Moir (No.2) [1975] QB 373. Lord Denning held there that it is open to the court
to order that the company, since it is the true claimant, should indemnify the claimant shareholder
against the costs incurred in the action, whether or not the action succeeds.
6. The claimant shareholder should also bring derivative proceedings in a representative

capacity on behalf of himself and all the other members apart from the defendants. This ensures
that all members are bound by the result.
7. The court can examine the behaviour of the shareholder bringing the derivative action and
may refuse leave to proceed on equitable grounds - “He who comes to equity must come with
clean hands.”
217
Nurcombe v Nurcombe [1985] 1 WLR 370

The husband was the majority shareholder of a company in which his wife was the minority
shareholder. He appropriated money of the company for his own use. His wife sued in
matrimonial proceedings and was awarded an amount covering that money and reflecting the
resultant loss in value of her shares. She now sought to bring a derivative action on behalf of the
company as well.
Held: She was refused leave. She had with knowledge of the facts elected to bring a claim in
matrimonial proceedings and it would be inequitable to allow a double claim through the
mechanism of derivative proceedings.
8. If the company has no right to bring an action in the first place then no derivative action can
be allowed. This is perfectly logical. See Watts v Midland Bank plc [1986] BCLC 15
9. A shareholder may be allowed to bring a derivative action on behalf of a company where the
action is brought bona fide for the benefit of the company and not for an ulterior purpose.
Conversely, if the action is brought for an ulterior purpose or if another adequate remedy is
available, the court may not allow the derivative action to proceed.
Barrett v Duckett [1995] 1 BCLC 243, CA

The company could be put into voluntary liquidation as an alternative remedy. Also, a bitter
matrimonial dispute lay behind the action. The claimant’s daughter and the defendant were
divorced. The claimant could, in the circumstances, have sought to bring derivative proceedings
against the daughter but chose to proceed against her former son-in-law. Her decision to litigate
against one and not the other was motivated by personal feelings and family loyalties. These were
ulterior purposes which were a bar to the grant of leave to pursue the company’s action, even
though this was the only route open to her.
10. Note that Clauses 239 of the CLR Bill will effectively put the common law right to a
derivative action onto a statutory footing.
8.3.2.2 The personal action and representative action
1. Where a wrong is being done or threatened by a company the company becomes the real
defendant.
2. The proper claimant is anyone who has a personal right as against the company which is
being infringed.
3. The claimant could proceed in a representative capacity if other shareholders are suffering in
the same way, and in fact this is the usual practice. It is desirable because all are bound by the
decision and it prevents multiplicity of suits.
4. The directors must be joined as defendants if some personal relief is sought against them.
8.4 Statutory Minority Protection/Shareholder Remedies S. 459-461
Section 459 vests a substantive right of action in individual members or shareholders. Provided
that the member’s complaint falls within the court’s jurisdiction under s. 459, a remedy may be
available.
Under s. 459, a member of a company may apply to the court by petition for an order on the
ground that the company’s affairs are being or have been conducted in a manner which is unfairly
218
prejudicial to the interests of its members generally or some part of the members (including at
least himself).
The majority of the cases are concerned with exclusion and removal of minority shareholders
from the board, improper allotment of shares and self-dealing by the directors. However, this is
not to say that other forms of misconduct could not fall within the scope of the provision.
8.4.1 A “MEMBER” OF A COMPANY
This includes those who are not registered members but to whom shares in a company have been
transmitted by operation of law, eg personal representatives of a deceased member or a trustee in
bankruptcy of a bankrupt member. They are allowed to petition under the section without being
registered as members. (This is to prevent directors from forcing personal representatives or a
trustee in bankruptcy to sell shares to them at a price below fair value by refusing to register a
transfer).
For the purpose of s. 459, “member” has to be given the meaning assigned to it by s. 22 of the
Companies Act. So for example, in Jaber v Science and Information Technology Ltd [1992]
BCLC 764 no claim could be made under s. 459 by employees of a company who were not
members.
The courts have said that the member must be affected in his or her capacity as a member.
However, this has not been construed as being as narrow as the qua member limitation under
section 14 (see Chapter 2)
The ability to participate in management forms an integral part of membership rights in a small
private company. Therefore, exclusion from management may prejudice members in their
capacity as a member in a quasi-partnership situation where there is a fundamental right to
participate in management and where a relationship of mutual trust and confidence has broken
down.
Re a Company No.002567 of 1982 [1983] 1 WLR 927

T and C who had previously been in partnership, formed a company of which they were
shareholders and directors. R later joined them as shareholder and director. Relationships broke
down and T was excluded from management. The question was, did the exclusion affect him in
his capacity as a member? Vinelott J said it seemed unlikely that Parliament could have intended
to exclude from the scope of the section a shareholder in this position.
Thus the word “interests” appears to extend the rights of members beyond those contemplated by
the statutory contract under s. 14. In other words, in certain contexts, while on the face of it the
conduct complained of may affect a member in his capacity as a director, there may still be
grounds for a petition under section 459. The reasoning in Re a Company draws heavily on the
reasoning of Lord Wilberforce in an important case on just and equitable winding up, namely
Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 - A full account of which can be found at
8.4 in your Cases & Materials. The facts of that case were similar. However, as the unfair
prejudice remedy was not available in Ebrahimi (s. 459 was not introduced until 1980), the only
avenue open to the petitioner in that case was to petition for just and equitable winding up (see
further below). One important feature of section 459 jurisprudence is that equitable notions of
fairness have been transplanted from winding up cases like Ebrahimi and used to fashion
shareholder remedies under ss. 459-461. The effect is that, in certain circumstances the exercise
of majority power may be made the subject of equitable constraints. In those circumstances, the
majority may be acting perfectly lawfully (eg by passing a resolution to remove a member from
office as a director under section 303 following the procedures laid down in the Act and the
219
company’s articles to the letter). Nevertheless, if there are considerations of a personal character
arising between the parties or informal understandings which make it inequitable for the majority
to insist on their or the company’s strict legal rights, it may be that an otherwise lawful act could
amount to unfairly prejudicial conduct giving rise to a remedy under section 459. Equitable
considerations will not arise simply because the company is small. In Ebrahimi Lord Wilberforce
identified the following factors and said that one or more of them would need to be present:
• An association formed or continued on the basis of a personal relationship involving mutual

confidence
• An agreement or understanding that all or some of the shareholders shall participate in the
conduct of the business, and
• Restrictions in the articles on the transfer of members’ interests in the company
In a listed public company, none of these factors will usually be present and if shareholders are
unhappy with the conduct of the company’s affairs, their “remedy” is to sell their shares on the
stock market and exit the company. There is no ready market for shares in private companies,
hence the importance of s. 459 for “locked in” members of such companies. Another important
factor which surfaced in Ebrahimi was that the company distributed profits by way of directors’
remuneration. In other words, rather than declaring dividends, the company provided the owner-
managers with a return linked to their directorships. As such, once the petitioner was excluded
from management he was essentially deprived of the return on his investment. In the
circumstances envisaged by Lord Wilberforce, it will often be said that, as a result of equitable
considerations, a member of an owner-managed company has a “legitimate interest” to remain
actively involved in the management of the company and/or the monitoring of his/her investment.
For further background on these ideas of equitable constraint and legitimate interest see the
extended discussion of the House of Lords in O’Neill v Phillips [1999] 2 All ER 961.
Re Bird Precision Bellows Ltd [1984] Ch 419

A and N, minority shareholders and directors, were excluded from management. They petitioned
for their shares to be purchased under ss. 459 - 461.
Held: There was unfairly prejudicial conduct and an order was made for B to purchase their
shares.
However, not all exclusions from management affect or prejudice the interests of members.
Re R A Noble & Sons (Clothing) Ltd [1983] BCLC 273

The petitioner was excluded from management but he had only been half-hearted in objecting to
his exclusion and had not actively participated in management when he had the chance to do so.
Nourse J said he had brought the exclusion on himself and to the extent that he had a “legitimate
interest” to participate in management he had not actively relied on it.
Where small owner-managed private companies or quasi-partnerships are involved the concept of
unfair prejudice enables the court to take into account not only the rights of the members under
the company’s constitution but also the legitimate expectations arising from any agreements or
understandings which the members may have between themselves.
On the same theme, in Re a Company No.003843 of 1986 [1987] BCLC 562 Millett J said that the
courts take a fairly flexible approach to s. 459. Mr and Mrs D were minority shareholders but
played no active role in management. The company agreed to buy out their shareholding for
£24,000. The company later repudiated this. Mr and Mrs D petitioned the court asking to be
appointed as directors so that they could participate in management and receive remuneration.
220
Held: Their real purpose was to obtain proper financial recompense from the company. They
should therefore sue on the agreement or seek buy-out relief (see later) under s.461. It would be
wholly unrealistic and inappropriate for the court to impose new directors on an already active
and competent board.
Also, in Re Sam Weller & Sons Ltd [1990] Ch 682 Peter Gibson J said “Parliament recognised
that members may have different interests, even if their rights as members are the same . . . it is
possible that even if all the members are prejudiced by the conduct complained of, the interests of
only some may be unfairly prejudiced.”
Whether a majority shareholder is a “member” who could properly petition is a moot point.
In Re Baltic Real Estate Ltd (No 2) [1993] BCLC 503 a petition presented by a majority
shareholder to purchase the respondents’ shares was not struck out as being vexatious. This left
the point open. However, in Re Legal Costs Negotiators Ltd, Morris v Hateley, 18 February 1999,
unreported, the Court of Appeal had to consider whether a petition brought by a company’s
controlling shareholders should be allowed to proceed to trial. The three petitioners and the
respondent, H, were originally in partnership. The business was subsequently transferred to and
carried on by the company. Each of the four partners became a director and employee of the
company and held 25% of its issued share capital. H was dismissed from his employment and
resigned as a director. However, he retained his 25% shareholding. Following his dismissal, the
company prospered through the efforts of the three petitioners with the effect that the value of the
company’s shares increased. The object of the petition was an order under s. 461 compelling H to
sell his shares to the petitioners. It was pleaded that the company’s affairs had been or were being
conducted in a manner unfairly prejudicial to the petitioners’ interests as members of the
company. This claim was based on the ground that the petitioners had a legitimate expectation
that H would contribute to the company and be engaged full time in its business which had been
frustrated by his actions. The Court of Appeal upheld the judge’s decision to strike out the
petition as disclosing no reasonable cause of action. The following points were made:
(1) It was accepted that H’s conduct prior to his dismissal (which had given rise to a number of
serious allegations of breach of duty in relation to the company’s accounting function) was
capable of amounting to conduct in the affairs of the company for the purposes of s. 459(1). It
was also accepted that the petitioners’ interests as members were prejudiced by H’s conduct.
However, the conduct was not unfairly prejudicial because the petitioners, given their
majority positions, were able to bring the prejudicial state of affairs to an end by terminating
H’s contract of employment and removing him from office as a director. Thus, if the
prejudice can be remedied in such a way that the objectionable conduct could not recur, there
is no scope for giving relief under ss. 459-461.
(2) H’s retention of his shares following his dismissal did not amount to conduct in the affairs of
the company and so fell outside the scope of s. 459(1).
(3) Sections 459-461 were enacted to remedy abuses of power which cause prejudice to
shareholders who lack the power to stop that abuse.
The decision accords with the traditional refusal of the courts to intervene where the matter
complained of can be remedied through the internal mechanisms of the company. It has two
immediate practical consequences. First, there is very little scope for majority shareholder
petitions under section 459 as the majority will generally have sufficient power to deal with most
matters internally. Secondly, parties like those in this case who are contemplating a quasi-
partnership type of corporate set-up would be well-advised to include some form of exit
mechanism in either the articles of association or a shareholders’ agreement to enable those who
remain to purchase a departing director’s shares.
221
In Gross v Rackind [2004] EWCA Civ 815 the petitioners were two families, the Gross family
and the Rackind family. Each held 50% of the shares in Citybranch Group Ltd. Mr Gross and Mr
Rackind were the directors of the company. The company owned two wholly owned subsidiaries,
both under the directorships of Mr Gross and Rackind. Following a family dispute proceedings
were brought by the Rackinds to wind up the company under s122(1)(g) Insolvency Act 1986. In
response the Gross family brought a petition under s459. The main issue on appeal concerned
whether the court had jurisdiction to order relief on a parent company in circumstances where it
had had been the affairs of a wholly owned subsidiary that had given rise to the allegation of
unfairly prejudicial conduct. In effect the court ignored the Salomon principle and held that the
group functioned as one economic entity.
8.4.2 THE CONDUCT MUST BE UNFAIRLY PREJUDICIAL
SAQ 2
What do you think is unfairly prejudicial conduct?
1. The test is that of the reasonable bystander and was first laid down by Slade J in Re Bovey
Hotel Ventures Ltd 1981 (unreported). In that case, a husband and wife were members of a family
company. After the break up of their marriage, the wife was excluded from management. She
petitioned successfully for an order that she be permitted to buy out her husband’s shares.
Test: If a reasonable bystander, observing the consequences of the working partners conduct and
judging it to have been prejudicial to the interests of the petitioner, would have regarded it as
having been unfair then there is unfairly prejudicial conduct.
This is an objective test.
Re Sam Weller & Son Ltd [1990] Ch 682

Petitioners said that their interests had been unfairly prejudiced by payment of the same derisory
dividend for many years (37 years) and by proposed capital expenditure of which there was no
evidence that it would be profitable. The company applied to have the petition struck out as
disclosing no cause of action.
Held: The petition was allowed to proceed. “Interest” was wider than rights and Parliament had
recognised in the terms of s. 459 that members could have different interests even though they
shared the same rights.
The test of unfairly prejudicial conduct was an objective one and it was not necessary to show that
those responsible were acting in bad faith or in the conscious knowledge that what they were
doing was unfair. Section 459 is not concerned with the consequences of the allegedly unfairly
prejudicial conduct or the interests of those responsible for it, but rather with its effect on the
interests of the petitioner. On the facts there might be unfairly prejudicial conduct. Application to
strike out petition dismissed.
2. This test has recently been modified and the approach now likely to be favoured by the higher
courts is to judge fairness objectively in the light of the overall commercial context. Hoffman LJ
(as he then was) said in Re Saul D Harrison and Sons plc [1995] 1 BCLC 14 that the starting
point is to consider whether there has been an infringement of the articles or an abuse of the
powers of the board. Even if the conduct complained of is not in accordance with the articles it
222
will not necessarily be unfair. Equally, it would be quite possible for conduct to be technically
lawful yet still unfair. This would be so where the strict letter of the articles does not fully reflect
the real understanding between members which formed the basis of their association. The last
point reflects the recognition of equitable constraints and legitimate expectations in the context of
owner-managed companies especially in cases involving exclusion from management (see earlier
discussion of Ebrahimi etc above).
Saul D Harrison
The petitioner was the holder of a separate class of shares in the company. She did not hold
ordinary shares. Her shares carried a right to dividends and return of capital but no entitlement to
vote. The company had substantial assets but in recent years had been trading at a loss. The
petitioner argued that the company should have ceased trading and distributed its assets to
shareholders (including herself) rather than it continuing to be run at a loss at risk to the assets.
She argued that the decision of the company to continue trading was unfairly prejudicial to her
interests and that she had a legitimate expectation that the company would be wound up and its
assets distributed once the company started to make losses. She also argued that the only reason
the company was continuing to trade was to enable the controllers to draw large sums in directors’
remuneration effectively at her expense.
Held: by CA (upholding the judge), on Ebrahimi principles, there are cases where the personal
relationship between a shareholder and those who control the company may entitle the
shareholder to say that it would be unfairly prejudicial for the controllers to exercise board powers
conferred by the articles on the board of the general meeting. Such an entitlement often arises out
of a fundamental understanding between the shareholders which formed the basis of their
association but was not put into contractual form, such as an assumption that each of the parties
who has ventured his capital will also participate in the management of the company and receive
the return on his investment in the form of salary rather than dividend. This, however, was not one
of those cases. The starting point was to consider the commercial relationship between the parties
and that was governed by the contractual terms set out in the articles of association. There was no
ground for saying that the petitioner’s rights were not adequately and exhaustively laid down in
the articles. To the extent that she had any “legitimate expectations” these amounted to no more
than an expectation that the board would manage the company in accordance with their fiduciary
obligations, the terms of the articles and the Act.
So generally conduct is not unfairly prejudicial where it is in accordance with the company’s
constitution. In Saul D Harrison the exercise of the company’s legal and constitutional rights was
not constrained by equitable considerations. This result is not surprising given that the petitioner
had accepted shares which carried no right to vote and therefore no right whatsoever to participate
in decision-making or to intervene in the deliberations of the board.
The Court of Appeal has thus tightened the way in which a “legitimate expectations” argument
can be deployed under s. 459. If the conduct complained of accords with the company’s
constitution it cannot, as a general rule, be challenged. Only if the petitioner can demonstrate
either (a) that a personal relationship exists with the majority giving rise to a legitimate
expectation which has been flouted or (b) that a constitutional power has been exercised for an
improper purpose will proceedings under s. 459 succeed.
3. In the first ever House of Lords case on section 459, O’Neill v Phillips [1999] 2 All ER 961,
Lord Hoffmann continued this careful approach. In this case, the petitioner was originally an
employee of the company. He was later elevated to the board and allotted a minority
shareholding. The majority shareholder discussed increasing the petitioner’s stake in the company
to 50% if certain business targets were met and draft documentation was drawn up with this in
mind but never executed. It was the practice during this period for the majority shareholder to
share the company’s profits with the petitioner 50:50. The petitioner, at this stage, put some of his
own money into the company and entered into a guarantee of the company’s bank facilities. The
company suffered a down turn in business and the majority shareholder sought to resume the
position of managing director which, in effect, the petitioner had been occupying. The petitioner’s
223
role in management was reduced and the majority shareholder said that he would no longer
receive 50 % of the profits, only his salary and dividends on his shares. The petition alleged that
the majority shareholder’s conduct was unfairly prejudicial conduct in the affairs of the company.
Held: (overturning the Court of Appeal and restoring the order of the trial judge) the petition
would be dismissed. The difficulty for the petitioner was that he was not completely excluded
from management. He remained a director and continued to earn a salary. On the question of
increasing the petitioner’s shareholding, he never had any right in equity to additional shares.
There was simply never a concluded agreement on the point and the majority shareholder could
not be said to have behaved unfairly in withdrawing from negotiations. Where, as here, parties
enter into negotiations with a view to a transfer of shares on professional advice and subject to a
condition that they are not to be bound until a formal document has been executed, it was not
possible to say that an obligation has arisen in fairness or equity at an earlier stage. The same
reasoning applied to the sharing of profits. The trial judge found as a fact that there was no
unconditional promise about the sharing of profits. The majority shareholder had said informally
that he would share profits equally while the petitioner managed the company and he himself did
not have to be involved in its day to day running. However, he deliberately retained control of the
company and with it the right to redraw the petitioner’s responsibilities.
This point was recently confirmed by the Court of Appeal.
Re Phoenix Supplies Ltd, Phoenix Office Supplies Ltd v Larvin [2003] 1 BCLC 76
The petitioner was a director with a one third shareholding. He resigned as an employee for
reasons unrelated to the company, but retained his directorship and membership subsequent to
being bought out. Following his resignation, the remaining two directors excluded him from
management. The company’s articles failed to provide for the purchase of shares. The director
petitioned under s. 459.
Held: At first instance, the court found unfair prejudice and ordered a pro-rata valuation to be
applied. Reversing the decision, the Court of Appeal noted that a quasi-partnership arrangement
does not provide for a ‘no-fault divorce’ entitling one partner to have his shares purchased at fair
value when he had no contractual right to do so.
In O’Neill v Phillips, Lord Hoffmann drew heavily on concepts from partnership law. He said that
if, in substance, the relationship between the members is akin to partnership, as will often be the
case in small owner-managed (or quasi-partnership) companies where the owner-managers are all
directors and equal shareholders, then equity may constrain the exercise of strict legal rights by
the company if the exercise of those rights would be contrary to good faith. So a case such as Re a
company no 002567 (see above) can be analysed along the lines that there is an equity in s. 459
which enables the court, in an appropriate case, to restrain two equal shareholders from exercising
the company’s legal power to deprive a third equal shareholder of his director’s remuneration
and/or to remove him from office by ordinary resolution under s. 303. In other words, Lord
Hoffmann is saying that the logic of the Ebrahimi approach to just and equitable winding up
applies equally to s. 459 given its broad concern for questions of fairness.
It is clear in the light of these authorities that s. 459 is capable of being broadly construed
especially in the context of the small, owner-managed or “quasi-partnership” private company.
However, the courts now lay great stress on the overall commercial context and, as O’Neill v
Phillips suggests, they may well be reluctant to widen the category of “equitable considerations”
much beyond the Ebrahimi-type situation.
4. Does mismanagement of a company constitute unfairly prejudicial conduct? Peter Gibson J in

Re Sam Weller & Son Ltd said the court would ordinarily be very reluctant to accept that
managerial decisions could amount to unfairly prejudicial conduct.
224
Re Elgindata Ltd [1991] BCLC 959

R was an inventor who held (through his company) a patent relating to a calculator used by
persons carrying on business in the bond market. E Ltd which was to manufacture the calculator,
was controlled by P. R and R’s wife were minority shareholders in E Ltd. Relations between P
and R broke down and R resigned from the board. R alleged under s. 459 that P had mismanaged
the affairs of the company.
Held: Serious mismanagement could constitute unfairly prejudicial conduct but normally the
courts would be reluctant to find that mismanagement of itself would amount to unfairly
prejudicial conduct. The petition failed as there was insufficient evidence of serious
mismanagement.
However, in Re Macro (Ipswich) Ltd [1994] 2 BCLC 354 it was held that the mismanagement had
been so serious that the court should order the majority to buy-out the petitioner at a price which
took account of the company’s losses incurred through mismanagement.
5. The conduct of the petitioner may be relevant.
Re London School of Electronics [1986] Ch 211

A company provided courses for students. It was a small owner-managed, quasi-partnership
company. The petitioner was sacked as a director and teacher. He set up on his own and poached
the company’s students.
Held: Despite his somewhat inequitable behaviour his removal was still unfairly prejudicial
conduct and the petition succeeded.
However, the court may take the petitioner’s conduct into account in valuing his interest when
determining the extent of any remedy. In an appropriate case the court might regard the
petitioner’s conduct as having contributed significantly to the difficulties which have arisen. In
that case, it may be that the conduct of the respondent will be considered fair (see R A Noble &
Sons (Clothing) Ltd earlier).
6. Improper share allotments have also been treated as unfairly prejudicial conduct.
Re Cumana Ltd [1986] BCLC 430, CA

The petitioner was involved in litigation with controlling shareholders. They proposed to make a
rights issue which, if he did not take it up would have reduced his shareholding. The company
knew that he could not take it up because his available funds were locked up in the litigation.
Held: The rights issue was unfairly prejudicial to the petitioner’s interests as a member because
the majority knew that the petitioner was in dire financial straits and took advantage of this.
See also Re a Company ex parte Harries [1989] BCLC 383

Rees set up a company with his wife. Harries joined later and held 40% of the shares. In 1982 H
ceased to play a part in the business or receive remuneration. In 1983 shares were allotted to R
increasing his shareholding from 60% to 96% and reducing H’s from 40% to 4%. H petitioned for
an order that R purchase his shares.
Held: The allotment was unfairly prejudicial conduct as the allotment was made by R secretly. H
was not given an opportunity to take up shares proportionate to his existing shareholding, ie there
was a breach of s. 89. The money raised from the allotment was commercially irrelevant to the
needs of the company and R had deliberately calculated that its effect would be to increase his and
reduce H’s holding.
225
8.4.3 AFFAIRS OF THE COMPANY
The conduct complained of must relate to the affairs of the company in respect of acts done by the
company or those with power to act on its behalf. As per Gibson J said in Ringtower Holdings plc
[1989] BCLC 427, ‘the relevant conduct must relate to the affairs of the company of which the
petititioners are members’.
1. The affairs of the parent company can be considered as the affairs of the subsidiary where the
parent exists.
Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360
The parent company withheld money due to its subsidiary company.
Held: The parent could be regarded as the affairs of its subsidiary, for the purposes of s. 45.
2. Equally, the affairs of the subsidiary, can be regarded as the affairs of the parent.
Re Citybranch Group Ltd, Gross v Rackind [2004] 4 All Er 735

The Gross family and the Rackind family owned 50% each of the holding company which had
two subsidies. The business of the group was conducted through the subsidiaries. Mr Rackind and
Mr Gross were the only directors of the subsidiary, and together with one other family member of
the Gross family, were the directors of the other family. The relationship between the families
brokedown and the Gross family prevented a s. 459 petition in respect of the holding company.
The question before the court was whether it had power to make an order under s. 459 in relation
to a holding company where the affairs of its subsidiary were being conducted in an unfairly
prejudicial manner and where the directors were in common.
Held: The affairs of the subsidiaries could be regarded as the affairs of the parent company where
there are directors in common. Note that this decision has implications for the corporate veil
principle.
8.5 Section 461
The court under s. 461(1), if satisfied that a petition is well founded, may make such order as it
thinks fit; in particular it may (s. 461 (2)):
(a) regulate the company’s affairs in the future;
(b) require the company to refrain from doing or continuing an act complained of by the
petitioner;
(c) authorise civil proceedings to be brought in the name and on behalf of the company;
(d) provide for the purchase of the shares of any members of the company by other members or
by the company itself (“buy out relief”).
Section 461(2)(c) was brought in so that actions under the exception of fraud on the minority to
Foss v Harbottle would not be used and section 459 would be used instead. However, a petitioner
cannot claim an indemnity for costs from the company under s. 459 unlike the claimant in a
derivative action brought under the fraud on the minority exception to Foss v Harbottle. Re
Elgindata Ltd 1991 Per Curiam “the costs of an action under s. 459 which is essentially a dispute
between the shareholders should not be borne by the company”. In Re a company (No 004502) ex
parte Johnson 1992 Harman J said it would be a misfeasance on the part of the directors to use
the company’s money to pay legal expenses incurred in connection with such proceedings
226
(because essentially s. 459 proceedings amount to a dispute between shareholders). In Re Milgate

Developments Ltd 1993 it was held that there was no justification for companies incurring any
expenditure in connection with s. 459 proceedings. Therefore derivative actions are still being
used and section 461(2)(c) is something of a dead letter.
The usual order applied for under ss. 459 - 461 is for the majority and/or the company to buy the
petitioner’s shares, although on occasions, the court has ordered the majority to “sell out” to the
minority (see Re Brenfield Squash Racquets Club Ltd [1996] 2 BCLC 184). The problem then
arises as to how the court should value the shares.
8.6 Valuation of Shares
Nourse J in Re Bird Precision Bellows Ltd said that in valuing the shares there was no guidance
under the Act. In the cases arising under the section the petitioner is usually a minority
shareholder. Normally, when valuing minority shares a discount is made because such a
shareholding does not confer control.
Nourse J said regarding the valuation of shares there was no rule of universal application and the
facts of each case should be taken into consideration. But where there is a quasi-partnership and
there has been unfairly prejudicial conduct, the shares should be valued on a pro rata basis and not
discounted. (This was confirmed by the Court of Appeal in 1985). The minority shareholder is
being forced to sell and it is not fair or equitable to put him in the same position as someone
selling freely (for further application of this approach see Re Planet Organic Ltd [2000] 1 BCLC
366 and Richards v Lundy [2000] 1 BCLC 376, [1999] BCC 786.
Regarding the date of the valuation, it could be earlier than the date of the petition (Re a Company
No.002567) but in Re London School of Electronics the date of the petition was taken. In Re
Elgindata Ltd it was the date of the order i.e. the date varies according to the facts. Recently, in
Profinance Trust SA v Gladstone [2002] 1 BCLC 141 the Court of Appeal held that as a general
rule, the date for valuing shares from a minority shareholder should be the date when the order
was made. Notwithstanding this general rule Walker LJ offered guidance as to when an earlier
valuation date would be appropriate:
• Where a company has been deprived of its business, an early valuation date (and
compensating adjustments) may be required in fairness to the claimant. This would apply
where the business of the company had been deliberately run down or diverted to businesses
connected with the respondents (see Scottish Co-operative Wholesale Society v Meyer [1959]
AC 324).
• Where a company has been reconstructed or its business has changed significantly, so that it
has a new economic identity, an early valuation date may be required in fairness to one or
both parties. An early valuation would provide protection for respondents who had build up
the company after the departure of the petitioner who should therefore not be entitled to share
in this additional value (see Re London School of Electronics Ltd [1986] Ch 211.
• Where a minority shareholder had issued a petition and there was a general fall in share
prices, in fairness to the claimant the court might have the shares valued at an early date,
especially if the court strongly disapproved of the majority shareholder’s prejudicial conduct.
In Re Cumana Ltd [1986] BCLC 430 the fall in value of the petitioner’s shares was partly due
to a general fall in the shares of high technology companies, but also because of the
respondent’s unscrupulous behaviour.
227
• However, the court should not direct an early valuation date simply to provide the most
advantageous exit from the company for the claimant (particularly where severe prejudice has
not been proved). In Re Elgindata an early valuation date would have been unduly
advantageous to the petitioner given that, for reasons not connected with the unfairly
prejudicial conduct, the company’s profits had peaked three years prior to the hearing of the
petition and had then declined rapidly. To fix a valuation at a time when the company’s
fortunes were near their peak would have been highly unfair to the respondents.
Finally, the Court of Appeal emphasised that the date of valuation may be heavily influenced by
the parties’ conduct either before or during the course of the proceedings, in keeping with the
House of Lords decision in O’Neill v Phillips.
The judges are aware that the flexibility of s. 459 may become an instrument of oppression by a
petitioner, ie he may threaten to sue under the section if he does not get the price he wants for his
shares.
SAQ 3
How should shares be valued?
The initial approach to valuation was to look at the machinery provided by the articles (see Re a
Company No 004377 [1987] BCLC 94 Hoffmann J). However the Court of Appeal rejected that
approach and it would seem that even if a price fixing formula is generally fair in the articles, if it
depreciates the value of the member’s interest, then the articles will not be used to ascertain the
price and the court will value the shares on a pro rata (not discounted) basis.
Virdi v Abbey Leisure Ltd [1990] BCLC 32.

Two of the three shareholders (60%) offered to purchase the third shareholder’s (Virdi) shares
(40%) in accordance with the articles. He refused to accept a valuation under the articles. The
Company had run a night club called “The Pavilion” for some years. It had then been sold. Virdi
wanted 40% of the proceeds of sale on the transfer of his shares to the other two.
Held: There was a risk that an accountant in carrying out a valuation under the articles, might
value V’s shares at a discount because he was a minority shareholder and there was nothing
unreasonable in V refusing to accept this risk. His shares should therefore be valued to take full
account of his notional 40% share of the asset worth of the company.
Virdi was followed in Re a Company No.00330 ex p Holden [1991] BCLC 597 where again the
company’s articles provided for expert valuation by the auditor of shares on a share transfer.
H held five of the 99 shares, B and F held the other 94. All three were directors. Relationships
broke down. H was sacked as a director. Then B and F sold the company’s principal asset. The
company then had no business. H, under the articles, was compelled to transfer his shares to B
and F. As an employee who had left he was deemed to have served a notice on the company
requiring it to purchase his shares. H wanted the majority to be restrained from relying on the
valuation provision in the articles. Held: that where the articles provided an adequate price-fixing
formula for the compulsory purchase of the shares of the minority, the court would not intervene.
But Virdi had to be considered and Harman thought that here there was a risk that the method of
valuation would depreciate the value of the petitioner’s interest as in Virdi. The auditor/valuer was
not required to explain how he reached his valuation, leaving H no basis to attack it and also there
was no machinery for H to put relevant matters to the valuer.
228
Thus it would seem that even if a price fixing formula is generally fair in the articles, if there is a
risk that the value of a member’s interest may be depreciated, then the articles will not be used to
ascertain the price. Section 459 will apply and the courts will value the shares on a pro-rata (not
discounted) basis.
On a related point, a petition seeking buy-out relief will not generally succeed if a reasonable
offer has been made for the purchase of the petitioner’s shares. The basic point is that if the
petitioner will do no better by proceeding to trial than he/she would be accepting the offer, the
conduct complained of will not be regarded as unfairly prejudicial. What would count as a
reasonable offer in this context was described in some detail by Lord Hoffmann in the recent case
of O’ Neill v Phillips [1999] 2 All ER 961, HL which you are strongly advised to read.
8.7 Public companies and s. 459
Actions in relation to public companies have generally been unsuccessful.
Re Blue Arrow plc [1987] BCLC 585

The petitioner failed to establish any legitimate expectation that the company’s articles would not
be altered so as to enable her to stay in office. Vinelott J indicated that one should look to the
formal constitution of a public company for expectations. It is unlikely there are any informal
agreements or understandings outside the constitution which are capable of enforcement.
In Re Astec (BSR) plc [1999] BCC 59, the Companies Court struck out a petition brought by
institutional shareholders of a listed company. The material facts were that an American company,
Emerson, acquired a 45% stake in Astec in consideration for the sale to Astec of a number of its
businesses. As a result of stakebuilding, Emerson’s shareholding in Astec subsequently increased
to over 50%. At this stage three of Astec’s ten directors were Emerson nominees. Emerson
approached Astec’s independent directors (ie those not nominated by Emerson) with a view to
obtaining their support for a recommended bid for the rest of the company’s shares. This approach
was rejected, the independent directors making it clear that if an offer was put to the shareholders
at the price proposed they would advise the shareholders to reject it as inadequate. Emerson’s
response was to requisition an extraordinary general meeting with the aim of reconstituting
Astec’s board so that Emerson nominees were in the majority. This meeting took place and the
resolutions were duly passed albeit in the face of strong opposition from minority shareholders.
Several points were raised by the petitioners and dealt with as follows:
(1) It was alleged that even before the EGM that Emerson’s nominees (at this stage a minority of
the board) had sought to prevent Astec from paying a dividend or, alternatively from
increasing the dividend. The judge concluded that the mere voicing of dissentient views by a
minority on the board cannot found a petition under s. 459. Had Emerson used its voting
power to cause the company to cease to pay future dividends, such an act might or might not
have amounted to unfairly prejudicial conduct depending on the circumstances at the time.
However, Emerson had not acted in this way.
(2) It was further alleged that Emerson and its nominees had engaged in a course of conduct
(which included the making of public announcements) designed to diminish the Astec share
price and pressure the petitioners into accepting a low offer for their shares. This allegation
was rejected. The fact that Emerson took a more pessimistic view of the company’s financial
circumstances and prospects than the independent directors did not raise any inference that
they had deliberately sought to engineer the share price. There was no evidence that a public
announcement concerning Astec’s financial affairs had depressed the share price and as such
announcement was made by Emerson on its own behalf as majority shareholder, it did not
constitute conduct in the company’s affairs for the purposes of s. 459(1).
229
(3) It was further alleged that the reconstitution of the board following the EGM was unfairly
prejudicial to the petitioners. Even assuming that the passing of a shareholders’ resolution
was capable of amounting to an act by the company in the conduct of its affairs, it was found
that there was no basis for a petition under s. 459. As the judge put it (at p. 76):
“The fact that a majority of the shareholders (in the shape of Emerson) chose to exercise its
voting rights contrary to the recommendation of the board, or of a number of individual
directors, is no more than a demonstration of the fact that the board does not control the
shareholders.”
Any complaint that the reconstitution of the board gave rise to a serious risk that minority
shareholders would be unfairly prejudiced in the future was speculative and was not based on
an “act or proposed act or omission of the company” sufficient to bring it within the scope of
s. 459(1).
(4) It was further alleged that Emerson’s actions breached certain aspects of the Listing Rules, the
City Code and the Cadbury Code. These were rejected either because of a lack of any specific
prejudice or (in the case of the City Code) because non-compliance did not amount to conduct
in Astec’s affairs.
(5) The final set of allegations were that the petitioners’ legitimate expectations in relation to the
running of Astec had been breached. The judge reiterated the basic principle of ‘majority rule’
and went on to reject (pp. 86-87) the notion that legitimate expectations could arise in the
context of a listed company:
“. . . [O]nly in exceptional circumstances will the exercise of legal rights conferred by the
articles of association be held to be subject to equitable constraints. In most companies,
whether large or small, and in most contexts, no such constraints will exist. The contractual
and statutory structure created by the articles of association and the Act will be complete in
itself unaffected by extraneous equitable considerations. . . Thus, as I read [the authorities],
in order to give rise to an equitable constraint based on legitimate expectation what is
required is a personal relationship or personal dealings of some kind between the party
seeking to exercise the legal right and the party seeking to restrain such exercise, such as
will affect the conscience of the former. In my judgment, in the absence of a personal
relationship or personal dealings of that kind a shareholder can reasonably and legitimately
expect no more than that the board . . . will act in accordance with its fiduciary duties and
that the affairs of the company will be conducted in accordance with its articles of
association and with the Act . . . [T]he concept of legitimate expectation . . . can have no
place in the context of public listed companies. Moreover, its introduction in that context
would . . . in all probability prove to be a recipe for chaos. If the market in a company’s
shares is to have any credibility, members of the public dealing in that market must it seems
to me to be entitled to proceed on the footing that the constitution of the company is as it
appears in the company’s public documents, unaffected by any extraneous equitable
considerations and constraints.”
Delivering a final blow, the judge also held that the petition constituted an abuse of process given
that its real purpose was to pressure Emerson into launching a full takeover bid. The decision in
Astec adds further weight to the view that a petition seeking buy-out relief in the public company
context is very likely to be dead in the water. Equitable constraints on the exercise of majority
power are only likely to be found in private “quasi-partnership” type companies where it is easier
to show that the company is underpinned by a set of close, informal personal relationships.
Moreover, it appears from Astec that the courts will not allow s. 459 to be used in contexts which
are the subject of detailed self-regulation.
230
8.8 The winding-up of the company on the ‘just and equitable’

ground. S. 122(1)(g) Insolvency Act 1986
1. S. 122(1)(g) “A company may be wound up by the court if the court is of the opinion that it is
just and equitable that the company should be wound up.”
2. The petition under s. 122(1)(g) may be presented by others, apart from a minority
shareholder, including the company, a creditor or a controlling shareholder.
3. Also, the conduct of which a member complains need not affect him in his capacity as a
member.
4. The leading case on s. 122(1)(g) is the Ebrahimi case discussed already in the context of
s.459. This widened the scope of the remedy under the section quite considerably.
Facts: Petition brought by Mr Ebrahimi. E and Nazar had been in partnership. In 1958 they
incorporated their business each holding 500 shares. Then Nazar’s son joined the company and
was given 100 shares from each. Therefore the Nazars were in control. Relationships deteriorated
during 1965. Dividends were not paid, only directors’ remuneration. The profitability of the
business was reduced by the behaviour of the Nazars. E protested. In 1969 he was removed from
his directorship and consequently was no longer entitled to receive directors’ remuneration. E
petitioned for just and equitable winding up.
Held: Indisputable inference that when E and N turned their partnership into a company this was
on the basis that the character of the association would, as a matter of personal relations and good
faith, remain the same. The petition was granted because that personal relationship had broken
down.
Lord Wilberforce, “It would be impossible and wholly undesirable to define the circumstances in
which these (just and equitable) considerations may arise.” However, he went on to say, “the
super imposition of equitable considerations requires something which typically may include one
and probably more of the following elements:
(i) an association formed or continued on the basis of a personal relationship, involving mutual
confidence - this element will often be found where a pre-existing partnership has been
converted into a limited company;
(ii) an agreement, or understanding, that all, or some (for there may be ‘sleeping’ members), of
the shareholders shall participate in the conduct of the business;
(iii) restriction upon the transfer of the members’ interest in the company - so that if confidence
is lost, or one member removed from management, he cannot take out his stake and go
elsewhere.”
5. With reference to E’s removal under the Companies Act Lord Wilberforce went on to say,
“The just and equitable provision nevertheless comes to his assistance if he can point to, and
prove, some special underlying obligation of his fellow member(s) in good faith, or confidence,
that so long as the business continues he shall be entitled to management participation, an
obligation so basic that, if broken, the conclusion must be that the association must be dissolved.
And the principles on which he may do so are those worked out by the courts in partnership cases
where there has been exclusion from management even when under the partnership agreement
there is a power of expulsion.
231
Applied in Re A & B C Chewing Gum Ltd [1975] 1 WLR 579 and Re Zinotty Properties Ltd
[1984] 1 WLR 1249.
6. Note that s. 459 did not exist in 1973. S. 459 was brought in to cover the Ebrahimi type of
situation and E would use s. 459 now (see notes on the link between s. 459 and s. 122(g)). Indeed,
much of the s. 459 jurisprudence which develops the idea of equitable “legitimate expectations”
derives originally from Lord Wilberforce’s opinion in Ebrahimi.
7. The main kinds of situation in which the just and equitable principle may be invoked are as
follows:
(a) Expulsion from office. This requires a special underlying obligation as detailed in Re
Westbourne Galleries (see above).
(b) Justifiable loss of confidence. A petitioner who can show that he has justifiably lost
confidence in the ability or determination of the existing management to conduct the
company’s affairs in a proper manner may be entitled to an order.
Loch v John Blackwood Ltd 1923

Family company formed to carry on testator’s business and to divide the profits among his family
entitled under his will to share them. MD held majority voting power. He did not hold general
meetings, submit accounts or recommend dividends and laid himself open to the suspicion that
his object in so doing was to acquire the minority’s shares at an undervalue.
Held: The company should be wound up. Confidence in management was, on the facts,
justifiably at an end.
Mere assertions of loss of confidence or vague allegations of impropriety are not sufficient; nor
will the petitioner succeed if the breakdown in confidence between himself and the other parties is
essentially due to his own conduct.
(c) Quasi-partnerships (see Westbourne Galleries). This arises where the shares are divided
equally between two members (or groups) who have become irreconcilable with the result
that the business can no longer be effectively carried on.
Re Yenidje Tobacco Co Ltd 1916

Two members in a deadlock company (each held 50% of the shares) became bitterly hostile. The
company was profitable.
Held: Mutual confidence lost and company should be wound up.
(d) Failure of substratum. Where a company is no longer able, or never has been able, to
carry on the business for the purpose for which it was formed.
Re German Date Coffee Co 1882

Often this is an application of the ultra vires principle but it may also occur when a company has
sold its business or divested itself of its major assets, then even though the majority may wish to
keep the company in existence and invest the proceeds, a minority may claim that the company
should be wound up.
8. As with s. 459, costs are not borne by the company.
232
8.9 The Link between S. 459 Companies Act and S. 122(1)(g)

Insolvency Act 1986
1. Most petitioners petition under s. 459 and also petition in the alternative under s. 122(1)(g).
Thus, they want their shares purchased for unfairly prejudicial conduct but if that fails they want
the company wound up on the just and equitable ground.
2. S. 125(2) Insolvency Act 1986 says that if the court is of the opinion that some other remedy
is available to the petitioners and they are acting unreasonably in seeking to have the company
wound up instead of pursuing that other remedy, then no winding up order will be granted. A
1990 court practice direction also states that it is undesirable for a petition to be presented under
both provisions.
In Re a Company No.002567 1983

Vinelott J said, “the jurisdiction of the court under s. 125(2) IA 1986 is discretionary”. The court
could refuse to make an order if satisfied that . . . it would be unfair to the other shareholders to
make that order, having regard to any offer they have made to the petitioner to meet his grievance
in another way (ie an offer to purchase his shares at a fair price).
3. Re R A Noble & Sons (Clothing) Ltd 1983

The petitioner failed under s. 459 (s. 75 as it then was) because he brought the exclusion on
himself but he succeeded under s. 122(g) because the mutual trust and confidence in a quasi-
partnership company had been destroyed and the breakdown was irreparable.
4. Note, however, the recent case of Re a Company (No 004415 of 1996) [1997] 1 BCLC 479 in
which Sir Richard Scott V-C struck out the just and equitable winding up part of a petition
brought under both provisions. He held that the making of an order on the just and equitable
ground was a remedy of last resort and by far the most likely form of relief in the case was a buy-
out order under section 461.
It is possible that the court might allow a petition under both heads to proceed if there was
evidence that either the company or the wrongdoing majority would be unable to fund a section
461 buyout through lack of resources. This follows from Ferris J’s decision in Re Full Cup
International Ltd [1995] BCC 682. Here, despite a finding of unfair prejudice the judge refused
an order that the respondents buy out the petitioner’s shares and made a winding up order instead.
In exercising his discretion, he held that as the company was no longer a going concern and there
were practical difficulties in arriving at a valuation a winding up was more sensible. He also took
the view that the petitioner would receive no more on a buy-out than on a liquidation. Ferris J’s
decision was upheld by the Court of Appeal in March 1997.
8.10 Reform
The Law Commission has reviewed this area and has commented that the technical obscurity and
complexity of the rule in Foss v Harbottle may thwart many well-justified minority shareholder
complaints. Unfair prejudice proceedings often involve ‘complex factual investigation’ and costly
and time consuming litigation (see Re Elgindata Ltd [1991] BCLC 959). Their Report,
“Shareholders Remedies” (1997) Cm 3769, proposed the replacement of the derivative action
with a statutory procedure to be available where there has been a breach of directors’ duties.
These recommendations have been supported by the DTI (See: Modernising Company Law Cm
553-1 July (2002) para 3.18), and has now been translated into the CLR Bill. Once brought into
force a statutory derivative action will be able to be brought by a member “for any act or omission
involving negligence, default, breach of duty or breach of trust…”. Despite earlier suggestions,
however, it appears that the statutory provisions will not reverse the effects of O’Neil v Philips.
233
8.11 Questions
1. What is the rule in Foss v Harbottle?
2. List the exceptions to the rule in Foss v Harbottle when an individual shareholder may sue.
3. What is fraud on the minority?
4. What effect does fraud on the minority have on the rule in Foss v Harbottle?
5. What types of court proceeding may shareholders bring if they are relying on an exception to
the rule in Foss v Harbottle?
6. What does s. 459 say?
7. How is a person affected as a member of a company when suing under s. 459?
8. Discuss the reasonable bystander test.
9. What effect has s. 459 had on improper allotments of shares?
10. What does s. 461 say?
11. How are shares valued and what is the effect of the valuation under s. 461 on the normal
discounting rules?
12. Evaluate the effect of a price fixing mechanism under the articles and recent judgments on s.
461.
13. What are the basic rules for the winding up of a company on the “just and equitable” ground?
14. What was the effect of the Ebrahimi case?
15. What are the main situations in which the just and equitable principle may be invoked under
s. 122(1)(g) Insolvency Act 1986?
The following is a question from an old examination paper. An outline answer is given
underneath it.
Question
Eric ran his own unincorporated business selling computers. He decided to incorporate the
business, setting up a company called Sunshine Ltd (“SL”) in which he was originally the only
shareholder and director. Between 1990 and 1997 SL’s business flourished and expanded.
Wishing to reduce his active involvement in the company and to spend more time with his
grandchildren, Eric caused SL to appoint his most trusted employee, Des, as a director and allot
him a 25% shareholding in the company. At the same time, Eric said to Des, “. . . if everything
goes well with the company in the next year or so, I might be persuaded to increase your stake to
40%.”
234
Under Des’s management, the company continued to do well during 1998 but suffered losses
during the last quarter of 1999 and first half of this year. Eric blamed Des for this reversal in
fortunes and took the following steps:
• He convened an EGM and used his shareholding to push through a resolution removing Des
from office as a director.
• He caused SL to issue some new shares in the company to his wife with the effect that
Des’s stake was reduced to 15%.
• He caused SL to transfer its assets to a partnership business run by him and his wife.
• He offered to buy Des’s remaining 15% stake at a pro rata valuation.
Advise Des as to his possible rights of action and the company law remedies (if any) available to
him. Note that for the purposes of this question you can assume (without discussion) that the
transfer of assets in (c) above is a breach of directors’ fiduciary duties.
Outline answer – see 8.6.2 Cases & Materials for a complete outline answer.
235

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LEARNING TEXT

Ryan Murray, LLB (Hons), PGCHE, Barrister

TABLE OF STATUTES .............................................................................................................xiii

THE HISTORICAL DEVELOPMENT OF COMPANY LAW .............................................xix

4.9 Dividends........................................................................................................................... 114

B. Liggett (Liverpool) Ltd v Barclays Bank Ltd 1928 ................................................................... 87

Brian D Pierson (Contractors) Ltd, Re [1999] BCC 26 ....................................................... 148, 194

C L Nye Ltd, Re [1971] Ch 442, CA ........................................................................................... 133

Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 ................................................................ 217

Edwards v Halliwell [1950] 2 All ER 1064 ......................................................................... 210, 212

Fairline Shipping Corporation v Adamson [1975] QB 180 ........................................................... 39

G.E. Tunbridge Ltd, Re [1995] 1 BCLC 485 ............................................................................... 122

Houghton & Co v Nothard, Lowe & Wills 1927 ........................................................................... 82

Knott v Cottee (1852) 16 Beav 77 ............................................................................................... 205

L Todd (Swanscombe) Ltd, Re 1990 ........................................................................................... 139

M. C. Bacon Ltd, Re [1990] BCLC 324 .............................................................................. 146, 152

Milgate Developments Ltd, Re 1993............................................................................................ 225

Natal Land Co Ltd v Pauline Colliery Syndicate Ltd 1904............................................................ 75

O’Neill v Phillips [1999] 2 All ER 961, HL ................................................................ 218, 226, 227

Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd 1971......................... 83

Purpoint Ltd, Re 1991.................................................................................................................. 142

TCB Ltd v Gray 1986..................................................................................................................... 83

Virdi v Abbey Leisure Ltd [1990] BCLC 32 ............................................................................... 226

W & M Roith Ltd, Re [1967] 1 WLR 432 ................................................................................... 182

Yenidje Tobacco Co Ltd, Re 1916 ............................................................................................... 230

Zinotty Properties Ltd, Re [1984] 1 WLR 1249........................................................................... 230

Bubble Act 1720, xix s. 26, 52

THE HISTORICAL DEVELOPMENT OF COMPANY

1. The Companies Act 2006

2. The Companies Act 1985

3. The Companies Act 1989

4. The Insolvency Act 1986

5. The Company Directors Disqualification Act 1986

This contains provisions relating to directors’ disqualification.

6. Business Names Act 1985

7. The Enterprise Act 2002

Key provisions relate to competition law, insolvency, administration and administrative

8. The Insolvency Act 2000

9. Companies (Audit, Investigations and Community Enterprise) Act 2004

The Classification of Companies

Sole Traders Unincorporated Associations Corporations

Incorporated by Royal Charter Incorporated by

By Private Acts By Special Public Act By General Public Act

Companies Limited by Shares Companies Limited Unlimited Companies

Public Private Private Private

CLASSIFICATION OF COMPANIES, LIMITED

By the end of this chapter you should be able to

2. Identify the key differences between public and private companies.

3. Understand the concept of limited liability.

4. Evaluate the advantages and disadvantages of incorporation.

5. Explain how a private company limited by shares is incorporated.

6. Appreciate the significance of the certificate of incorporation.

8. Assess the legal consequences of the Salomon principle.

9. Define what is meant by the phrase, “the veil of incorporation”.

1.2 Types of Registered Companies

Companies are divided into three main types

1.1 Companies Limited by Shares

1.2 Companies Limited by Guarantee

1.3 Unlimited Companies