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Company Law Question Paper

Company Law

Course:Accounting - Kasneb

Exam Year:2004

CJUNE 2004

QUESTION ONE
(a) The principle of corporate legal personality is an important and fundamental aspect of company law.

Discuss this statement citing relevant decided cases. (6 marks)

(b) Ropoff Company Ltd., a private limited company, has been under inquiry on alleged fraudulent financial transactions. The officers of the company under suspicion have denied any association with the company.

At the inquiry it was suggested that the corporate veil be lifted and the realities of the company in question be looked into.

Explain the instances when the veil of incorporation may be lifted. (14 marks)

QUESTION ONE
(a)
In the words of Lord MacNaghten in Salomon V. Salomon and Co. Ltd. (1897). “The company is at law a different person altogether from the subscribers to the memorandum…….”
This is the ratio decidendi in Salomon’s case and constitutes one of the fundamental principles of company law.
In simple legal parlance the principle of legal personality of the company is to the effect that when a company is incorporated it becomes a legal person, distinct and separate from its members and managers. It becomes a body corporate or a juristic person. It acquires an independent legal existence with rights and subject to duties with certain capacities and subject to incapacities.
The principle of corporate legal personality is now exemplified by the words that “From the date of incorporation mentioned in the certificate of incorporation, the subscribers to the memorandum together with such other persons as may from time to time become members of the company shall be a body corporate……”
The most fundamental attribute of incorporation from which all other consequences flow is that on incorporation a company becomes a body corporate – a different legal entity. This principle manifests itself through the principle of:
i) Limited liability: Sec 4 (2) (a) and (b) of the Companies Act.
ii) Perpetual succession: Sec 16(2) of the companies Act.
iii) Sue or be sued: Foss V. Harbottle (1843)
iv) Owning of property: section 16(2) of the Act Macaura V. Northern Assurance Co. (1925)
v) Capacity to contract: Lee V. Lee’s Air Farming Co. Ltd (1961)
vi) Common Seal: section 16 (2) of the Act.

A critical analysis of the Judicial and statutory authority demonstrates that the principle of corporate legal personality is incontrovertibly an important and fundamental aspect of company law.

(b)
This problem is based on the concept of piercing the corporate shell or simply put lifting the veil of incorporation or modifying the rule in Salomon’s case. Both parliament and courts of law have recognized circumstances in which the veil of incorporation may be lifted and regard had to the individual members of the company and its subsidiaries are treated as one of regard it had to the economic realities of the group. These circumstances are exceptions to the rule in Salomon’s case.

• Legislative or parliamentary or statutory exceptions
o Reduction in number of members: section 33 of the Companies Act.
o Non-publication or misdescription of the Companies name: section 109 (4) of the Act.
o Group accounts: section 150-152 of the Companies Act.
o Investigation of companies affairs: section 167 of the Act.
o Investigation of company membership: section 173 of the Act.
o Fraudulent trading: section 323 (1) (a) of the Act.
• Common law or judicial exceptions
o Agency trustee or nominee:
o Group enterprises:
o Determination of residence:
o Ratification Corporate acts
o Determination of Character:
o Fraud and Improper Conduct

QUESTION TWO
a) “The rule in the case of Ashbury Railway Carriage Vs. Riche (1875) stated that an act has not been authorized by the objects clause of a company’s Memorandum of Association in ultra vires to the company and the members cannot ratify it.”

Discuss. (8 marks)

b) Explain the various ways in which persons intending to form a company may avoid personal liability on contracts they make on behalf of the proposed company. (6 marks)

c) It has been held that the memorandum and Articles of Association of a company shall, when registered, bind the company and the members to the same extent as if the documents has been signed and sealed by each member and contained covenants an the part of each member to observe all the provisions of the memorandum and the articles.

Explain the effect of this provision on the relationship between shareholders and their company and between shareholders themselves. (6 marks)

QUESTION TWO
(a)
• This case is authorized for the proposition that a registered company’s capacity is restricted to the transactions set forth in the objects clause of the memorandum other transactions are ultra vires and therefore null and void.
• In this case the transaction in question i.e. purchase of concession and construction of railways was not authorized by the objects and was therefore declared ultra vires.
• This case interpreted the doctrine of ultra vires very restrictively thereby limiting corporate capacity.
• However, in Attorney General V. Great Eastern Railway Co. it was held that a transaction reasonably incidental to the attainment or pursuit of the objects of the company was Ultra Vires the company. In the words of Lord Selbourne “whatever may be regarded as fairly incidental to or consequential upon”
• The second aspect of ruling relates to ratification of an ultra vires transaction. In Ashburys case although members in general meeting purported to ratify the transaction it was held that the ratification had no legal effect since the transaction was void. This ruling is correct in that a void transaction is incapable of ratification. This principle was upheld in Rolled Steel Products (Holdings) Ltd V. British Steel Corporation and Others (1986) where Slade L. J. was emphatic that an ultra vires transaction cannot be rendered intra vires by ratification, delay acquiescence estoppel or lapse of time.

(b)
• As a general rule a pre incorporation contract against the company did not exist and cannot ratify the transaction when incorporated, nor can directors of the company adopt or conform the contract (see Kelner V. Baxter) (Price V. Kelsal) (North Sydney Investments and General Tramways V. Higgins & Another) (Natal Land Company V. Pauline Colliery Syndicate)
• However a person can escape liability on per incorporation contracts by:
o The company entering into a new contract to the same effect as the previous one (Mawagolas case).
o Entering into a contract which expressly provides that the promoters liability shall cease when the company is formed.
o Entering into an agreement which expressly provides that it becomes legally binding upon the company when incorporated.

(c)
• This provision is to the effect that when the Articles are registered there comes into being a contract between the company on one hand and shareholders on the other to observe the provisions of the articles.
• Either party is free to sue the other for non compliance with the provisions of the articles. Welton V. Sattery.
• Hickman V. Kent or Romney Mash Sheep Breeders Association
• The company and its members have rights and subject to obligations.
• Rights conferred by the contract are only enforceable by members qua members Elley V. Positive Government Life Assurance Co., Beattie V. Beattie.
• The contract is unenforceable by an outsider.
• The contract is subject to the memorandum and provisions of the Companies Act.
• The terms of the contract keep on changing from time to time as and when the company alters the Articles.
• Courts have observes in Obiter that a second contract is created between each member and every other i.e. members inter se.
• The decision in Wood V. Odessa Water Works and Quin and Axtens Ltd. V. Salmon are cited for this argument.

QUESTION THREE
(a) Outline the qualified minority rights of a member which can only be enforced by the joint efforts of a membership group as defined under the Companies Act. (10 marks)

(b) The Articles of X Company Ltd provide that every member is entitled to one vote for each of the first ten shares and thereafter to one vote for each additional ten shares. Jane owns one hundred shares. She transfers ten of her shares to her nine nominees to increase her voting powering general meetings. Joseph, who is the chairman at the general meeting, refuses to accept the votes of Jane’s nominees.

Advise Jane on the validity of the Chairman’s action and her right as a member.
QUESTION THREE
(a)
Under the provisions of the Companies Act the following rights are only enforceable by joint effort:
I) Under section 8 (1) of the Companies Act, a company may by special resolution alter the objects clause of the memorandum. However the proposed alteration may be objected to by either.
Holders of not less than 15% in nominal value of the Company’s issued share capital.
Holders of not less than 15% of any class of shares of the Company.
Holders of not less than 15% of the Company’s debenture entitling them to object.
Not less than 15% of the Company’s members.
II) Under section 74 (1) of the Company’s Act, proposed variation of class rights may be objected to by holders of not less than 15% of that class of shares who did not consent or vote in favour, by an application to court within 30 days of the resolution or consent.
III) Under section 140 (1) of the Companies Act holders of not less than 1/20 of the total voting rights of all members or not less than 100 members of the Company may requisition notices of any resolution which may properly be moved at the next general meeting. They are also entitled to requisition the Company to circulate to members any statement of not more than 100 words with respect to the matter referred to any proposed resolution or business to be dealt with at a meeting.
IV) Under section 132 (1) of the Companies Act holders of not less than 1/10 of the paid up capital of the Company or the total voting rights of all members may requisition an extra ordinary general meeting by depositing a requisition with the Company at its registered office and if the directors do not within 21 days thereof convene a meeting, the requisionists or not less than ½ of them may convene a meeting. Such a meeting may be held within three months of the requisition.
V) Under section 137 (1) of the Companies Act, a poll can only be effectively demanded by:
o Not less than five members present in person or by proxy.
o A member or members representing not less than 1/10 of the total voting rights of all members having the right to vote.
o A member or members representing not less than 1/10 of the paid up capital.
VI) Under section 165 (1) of the Companies Act a Company’s affairs may be investigated by an inspector or inspectors appointed by the court at the instigation of either.
Not less than 200 members or members holding not less than 1/10 of the issued shares.
Not less than 1/5 of the number of persons in the company’s register of members.

(b)
• This problem is based on the right of a member to vote in Company general meetings. It is a trite principle of law that the right to vote is one of the proprietary rights of a member. It is one of the so-called individual membership rights of a member exercisable by a member irrespective of the wishes of the majority and if the right is violated the member has a personal action for redress.
• In this case the articles of X Company are very clear on voting and the Chairman has declined to accept the votes of Jane nominees in violation of Jane’s right to vote in a general meeting. Jane has a course of action to compel the Chairman to adept the votes of her nominees.
• My advise to Jane is to institute legal proceedings against the chairman to “compel him” to accept the votes, as was observed by Sir George Jessel MR in Pender V. Lushington.
• My advise is based on the decision in Pender V. Lushington whose facts were substantially similar to those of this case.

QUESTION FOUR
(a) Explain the category of persons to whom an auditor owes a duty of care in the preparation of his audit report.

(b) Enumerate the rights accorded to an auditor to enable him perform his duties as the auditor of a company.
(c) In Hedley Byrne V. Heller (1964) the court held that provided that it could be established that a special relationship existed between parties it was possible for a person to sue for having suffered a financial loss even though no contractual relationship existed between the parties.

Highlight the factors that should be established in order for a third party to successfully sue an auditor for professional negligence. (8 marks)

QUESTION FOUR
(a)
In preparing his audit report the auditor owes a duty of care to:
• The company: since an auditor is a professional engaged by the company to render certain services he owes the Company a legal duty of care in preparing his report.
• Third parties: an auditor owes a legal duty of care to third parties whom he knew or reasonably ought to have known would rely upon his audit report. To that effect such parties are his “neighbours” and the auditor may be
• Held liable for loss or liability arising by reason of reliance on his audit report.
• The auditor’s legal duty of care is founded on the premise that there is a special relationship between him and the company as well as such third parties.

(b)
• Right to examine the company’s books, vouchers and other relevant documents.
• Right to access to the Company’s books vouchers, accounts etc.
• Right to demand an explanation from officers of the company.
• Right to seek professional advise whenever necessary.
• Right to attend all general meetings of the Company.
• Right to be heard in general meeting on any matter concerning him as an auditor.
• Right to all notices and other communication to members.
• Right to rely on information provided by trusted servants of the company (in absence of suspicion)
• Right to remuneration for services rendered.
• Right to indemnity for any loss or liability arising in the course of discharging his obligations as auditor.

(c)
For a third party to successfully sue an auditor in damages for professional negligence it must be established that:
• The auditor was engaged on the premise that he professed to have certain skills.
• The auditor was at all material times aware that his report would be relied upon i.e. he knew or reasonably ought to have known.
• The third party suffered loss of financial nature

QUESTION FIVE
(a) Explain the circumstances when a dividend may become payable and enforceable as a debt against the company.

(b) Give reasons why a company may seek to control the funds from which dividends are paid.

(c) Explain the effect of the failure by the company to register a charge of a debenture.

QUESTION FIVE
(a)
• Under Article 114 of Table A directors recommend dividend and members declare the same in general meeting.
• Under Article 115 directors may form time-to-time pay member such intern dividend as is justified by profits of the Company.
• Under article 116, no dividend shall be paid otherwise than out of profits.
• Dividend is payable after payment of debts and other liabilities incurred during the year dividend is only enforceable after its formal declaration.

(b)
A company may seek to control the funds from which dividend is payable for various reasons:
• Facilitate maintenance of capital.
• Liability of members is generally limited.
• Maintain a certain level of reserves.

(c)
• The charge is void as against the liquidator.
• The amount secured becomes payable immediately.
• It is a criminal offence for which the company and every officer in default are liable to a fine no exceeding Kshs. 1,000.

QUESTION SIX
(a) Outline the provisions of the Companies Act, relating to civil and criminal liability in respect of non compliance with provisions relating to a prospectus on the Company and the directors.
(b) Makanga, Kamore and Gatweku are directors of Wakwetu Co. Ltd. The company is in dire need of capital to fund its expansion.

Advise them on the methods available for raising capital from the public.

(c) State the circumstances under which a Company can pay an underwriting commission.

QUESTION SIX
(a)
Civil Liability
Under section 45 (1) of the Companies Act a third party who suffers loss or damage by reason of subscribing for shares or debentures of a Company on the faith of prospectus containing any untrue statement is entitled to compensation for the loss or damage by any of the following persons:
• Every person who was a director of the Company at the time of issue.
• Every person who had authorized himself to be named as a director in the prospectus and was so named.
• Every person who had agreed to become a director of the Company either immediately or after an interval of time.
• Every person who was a promoter of the Company.
• Every person who authorized the issue of the prospectus.

However, sections 45 (2) and (3) of the Companies Act prescribe specific defences to directors and experts sued under section 45 (1).

Criminal liability
• Under section 40(3) of the Act it is a criminal offence to issue any form of application for shares or debentures of a company without a prospectus which complies the provisions of the Companies Act. A person guilt of contravening such provision is liable to a fine not exceeding Kshs. 10,000.
• Under section 42 (2) of the Act it is a criminal offence to issue a prospectus containing a statement purporting to have been made by an expert without such expert’s written consent. The company and every person knowingly a party to the issue liable to a fine not exceeding Kshs. 10,000.
• Under section 43 (5) of the Act it is a criminal offence to issue a prospectus before a copy thereof has been delivered to the registrar for registration. The company and every person who is knowingly a party to the issue are liable to a fine not exceeding Kshs. 100 for every day until a copy thereof is delivered.
• Under section 43(5) of the Act is a criminal offence to deliver to the registrar for registration a copy of a prospectus without the necessary annextures. The company and every person who is knowingly a party to the issue are liable to a fine not exceeding Kshs. 100 for every day until a copy with the necessary annextures is delivered.
• Under section 46 (1) of the Act, it is a criminal offence to authorize the issue of a prospectus containing any untrue statement. A person guilty of contravening this section is liable to a fine not exceeding Kshs. 10,000 or imprisonment for a term not exceeding 2 years or both. However the accused escapes responsibility by providing either that:
o The false statement was immaterial.
o He has reasonable grounds to believe and did believe up to the time of issue that the statement was untrue.

(b)
A company may raise capital from the public in three ways. This process is often referred to as “floatation” or “flotation” and securities are availed to the public for subscription. These approaches are:
• Direct invitation to the public (public or prospectus issue)
• Offer for sale
• Placing

Direct invitation
By this method, the company prepares and issues a prospectus inviting the public to subscribe for its securities. The prospectus must comply with the requirements of the Companies Act and application forms must be enclosed. The company is responsible for the administrative tasks of the issue and bears the risk if the issue is unsuccessful. To spread such risk the company may arrange for the issue to be underwritten by an underwriter who undertakes to take up all or a specified number of securities if not taken up by the public in return for a commission. The prospectus ordinarily identifies the underwriter, if any. Members of the public and corporations make offers for the securities by completing and submitting to the Company an application form.

Offer for sale
By this method the company desirous of raising capital allots all the securities to an issuing house which in turn prepares and issues a prospectus inviting the public to subscribe for the securities. The securities are offered at a premium and the issuing house may arrange for the issue to be underwritten so as to spread risk. Once an application for securities is made the issuing house renounces its allotment in favour of the applicant. This approach has two advantages:
• It relieves the company the administrative tasks of the issue.
• The company receives the entire consideration on the issue.

Placing
By this method the company arranges with an issuing house to purchase all the securities on offer or take them up and then “place” them with its clients privately.
There is no direct or indirect invitation to the public. This approach ensures that the securities are taken up by selected persons or institutions.
If the issuing house does not purchase the securities it acts as an agent for the company and is paid brokerage for the services rendered.

(c)
Underwriting commission is a payment made by a company to a broker issuing house or a bank in consideration for its undertaking to take up all or specified number of shares not taken up by the public. The commission is payable whether or not the shares are taken up by the public and may be in the form of shares and money.
• The payment is an integral part of an underwriting agreement.
• The provisions of the Companies Act enable Companies to pay a commission to any person in a consideration of his
o Subscribing for its shares.
o Agreeing to subscribe
o Procuring a subscription
o Agreeing to procure subscription
The payment of such commission may be absolute or conditional provided:
o It is authorized by the articles
o It does not exceed 10% of the price at which the shares are issued or the amount or rate authorized by the articles whichever is less.
o It is disclosed in the prospectus in the case of shares offered to the public.

QUESTION SEVEN
The Board of Borrowers Company Ltd. has applied for a loan from Uchumi Commercial Bank. The Bank has advised that any loan will be conditional upon the bank being granted security in the form of a combination of fixed and floating charges on the companies assets. The bank has also advised Borrowers Company Ltd. that the charges will be contained in the bank’s standard form debenture document. This contains a “negative pledge clause” and a term which enables the bank to place the company in administrative receivership in the event of default by the company.

(a) (i) In numbered paragraphs distinguish between a fixed and a floating charge. (6 marks)
(ii) What are the disadvantages of a floating charge to the bank? (4 marks)

(b) Explain the meaning of a “negative pledge” clause. (4 marks)
(c) Explain how administrative receivership differs from liquidation. (6 marks)

QUESTION SEVEN
(a) (i)
The locus classicus distinction between the fixed and floating charge was enunciated by the Lord MacNaghten in Illingworth V. Holdsworth.
Fixed charge:
• This is a legal or specific charge.
• It is a charge securing a debenture on a specific asset or an asset capable of being ascertained or defined.
• The security is identifiable and its value is ascertainable.

Floating charge:
• This is an equitable charge
• In the words of the Learned Judge it is “ambulatory and shifting in its nature.”
• It is a charge securing a debenture on the assets of a going concern but which remain dormant until crystallization.
• It secures a debenture on a class of assets of the company both present and future the assets must belong to class which keep on changing from time to time in the ordinary course of business of the Company.
• The value of the security remain uncertain as the Company is free to dispose off and acquire new stock.

(ii)
• A fixed charge created after a floating charge has priority in the satisfaction of claims.
• Other interests for example landlords distress for rent have priority over floating charges.
• Under section 312 of the Companies Act, a floating charge created within 6 months before the commencement of winding up is deemed to be fraudulent preference and is void.
• Under section 314 of the Companies Act, a floating charge created within 12 months before the commencement of winding up is invalid unless it provided that the Company was solvent immediately after its creation.

(b)
This is a clause or paragraph in a debenture to the effect that the Company shall not create a charge in priority to the current one. It ensures that the charge retains priority in the satisfaction of claims.

(c)
Although administrative receivership and winding up are similar in certain many respects, they differ in that:
• Whereas a receiver takes possession of the property of the company over which he is appointed and realizes is for the benefit of the holder(s) a liquidator is appointed to wind up the Company and terminate its existence.
• An administrative receiver may be appointed to enforce a charge given by a debenture or trust deed under a power contained in the debenture or the trust deed or by the court. A liquidator may be appointed by the court, members or creditors or both.
• A receiver may be appointed when the Company is being wound up.
• Administrative receivership permits the appointment of a receiver and manager to carry on the business of the Company for the purposes of selling it as a going concern.
• A receiver appointed under a power in a debenture or a trust deed, the debenture usually provides that he is the agent of the Company.
• A receiver appointed by the Court is personally liable on the contracts made by him in the course of receivership while a liquidator is not.
• The terms of appointment may require a receiver to render accounts to debenture holders.

QUESTION EIGHT
Section 40 (1) of the Companies Act requires a prospectus to contain the matters and reports specified in Part I and II of the Third Schedule.

Explain these matters as outlined in the Third Schedule.

QUESTION EIGHT
Section 40 (1) of the Companies Act provides that
“Every prospectus issued by or on behalf of a Company or by or on behalf of any person who is or has been engaged or interested in the formation of the Company, shall state the matters specified in Part I of the Third Schedule and set out the reports specified in Part II of that Schedule…..”

Part I of the schedule contains the following matters
• Number of founders, management or deferred shares if any.
• Share qualification of directors if any
• Names, postal addresses and occupation of directors and proposed directors
• Minimum subscription.
• Time of opening of the subscription lists.
• Amount payable on application and allotment.
• Particulars of options on shares and debentures
• Particulars of shares and debentures payable otherwise than for cash.
• Particulars of persons who have sold assets to the company
• Amount paid to such persons for assets including any amount payable for purposes of goodwill
• Commission paid by the company.
• Preliminary expenses or an estimate thereof.
• Amount if any paid to promoters
• Particulars of material contracts entered into by the company in the ordinary course of business
• Names and postal address of auditors if any
• Directors interest, if any in the promotion of the company or its property.
• Voting and class rights
• Length of time the company has carried on the business if less than 3 years.

Part II of the schedule sets out the following reports
• An auditors report with respect to
• Profit or losses in each of the last 5 years.
• Rate of dividend in each of the last 5 years.
• Assets and liabilities as at the last date of accounts
• And similar information on the Company’s subsidiaries if any
• In the proceeds of the issue or any part thereof is to be applied directly or indirectly in the purchase of any business, a report by named accountants on the profit or losses of the business in each of the last 5 years.
• Assets and liabilities of the business as at the last date of accounts.
• If the proceeds of the issue or any part thereof is to be applied directly or indirectly in the acquisition of share in a subsidiary, a report by named accountants on the profit or loss of the Company in each of the last 5 years.
• Assets and liabilities as at the last date of accounts.
And similar information on the subsidiaries of the Company if any

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