Examiners’ reports 2015

Examiners’ reports 2015

LA3021 Company law – Zone A

Introduction
The examination paper followed the same format as in previous years. It produced
a wide spread of marks. You should refer to the Assessment Criteria to familiarise
yourself with the criteria that are applied to assessed work. The best answers
focused on the actual question being asked, and the specific issues it raised. Good
answers also demonstrated that the candidate had read around the subject, and
was able to apply this wider reading to the issues raised by the questions. The most
common weakness was a failure to focus on the questions asked, as the specific
comments below explain.
Note that errors in student extracts, below, were present in the original extract.

Comments on specific questions

PART A
Question 1
‘The limited liability company is an excellent legal vehicle for running a large
business that has many shareholders. However, it is poorly suited to the
smaller business with fewer shareholders.’
Discuss.
General remarks
This question raises an issue which has been continually debated about UK
company law: how well does it serve the needs of both large and small businesses?
The question puts forward a particular point of view – that it serves large
businesses well, and smaller ones poorly. Answers ought therefore to try to reach a
conclusion as to whether that is indeed the case. The question does, however, give
you the chance to be selective, picking out those areas of company law which most
obviously either serve well or serve badly, the large and the small business.
Law cases, reports and other references the examiners would expect you to
use
Companies Act 2006, explaining how it addresses the needs of large and small
businesses. Mention relevant areas of case law, such as those dealing with the
unfair prejudice regime, where courts have developed distinctive rules for the
‘quasi-partnership’. Consider also the Modern Company Law Review, and its
emphasis on ‘Think Small First’.

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Common errors
Failing to focus on the question and address both types of business referred to.
Some candidates probably had pre-prepared answers focusing only on whether the
company serves the needs of the small business well, and were unable to include in
their answer some analysis of the position in respect of the larger business. There
was also a tendency in many answers to focus on the reference to limited liability in
the question, and simply write all that was known about limited liability. Again, such
answers did not really address the specific claim being made.
A good answer to this question would…
begin by explaining the major differences between large and small businesses that
good ‘legal vehicles’ would address and respond to. So, it would explain how larger
businesses will indeed have more shareholders, but those shareholders will likely
have less involvement in running the business, and therefore perhaps be more
vulnerable to misbehavior by the company’s executives. The larger business may
need to raise more capital from the public, to enable its investors easily to sell their
shares, may need a more professional board, and better means of ensuring board
accountability, and so on. The smaller business will likely have fewer shareholders,
and be run more informally. It will more often encounter disputes between majority
and minority shareholders, and will therefore need better minority protection.
Insolvency will be a greater risk, requiring robust creditor protection and insolvency
procedures.
Having explained the different needs of larger and smaller businesses, a good
answer would then turn to consider how well company law in the UK meets these
needs. In respect of the larger business, you might address: the advantages of
limited liability in such a company, including the reduction in the need to monitor
management, or fellow shareholders; the benefit of perpetual succession; the
company’s ability to raise capital more easily, including through the granting of
floating charges; the comparative ease with which investors may be able to leave
the company and secure the return of their investment; and the ‘status’ which the
business will enjoy, especially as a ‘PLC’. For the smaller business, all the
foregoing advantages still apply, in theory, but some may not be so valuable to the
smaller business. A good answer will then consider whether some of the special
needs of smaller businesses are actually met. The law’s insistence on formal
division between shareholders and directors can create bureaucracy and
complexity. Other burdens imposed on the company, such as accounting/disclosure
rules, also weigh more heavily on the smaller company, and there are problems for
investors in recovering their investment, given there is no real market in the
company’s shares. A good answer would consider how far the relaxation of some of
these requirements for small/private companies have made the private company
better suited to the needs of smaller business.
Poor answers to this question…
often did not answer the question asked. There was often little real attempt to
explain how large and small businesses differ, and have different ‘needs’ from
whatever legal vehicle they use. Some weaker answers looked at this only in
respect of one type of business (usually the smaller one), whereas the question
required candidates to consider both. Some weaker answers simply wrote a long
explanation of the nature of, and the limitations on, limited liability, without really
focusing on the question actually asked. Some answers included very little
discussion or analysis of the law itself. The question clearly requires candidates to
show that they have a reasonable overview of the basic rules and principles of
company law, and can analyse these to work out how well these rules and
principles serve the needs of different types of business.

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Student extract
The limited company is increasing rapidly for several reasons. Firstly, a PLC
can register on the stock exchange after satisfying some rules and
regulations. Once the company gets approval to operate on the stock
exchange, the company can raise capital by issuing shares. Since the stock
exchange is regulated by the financial services authority it becomes easy to
sell shares as shareholders can rely on the information provided to them in
the market. . . .
In addition, in a public limited company it becomes easy to change the board
of directors if the company is not performing well. Shareholders have the right
to vote and take appropriate action for the benefit of the company. Hence, the
board of directors will always work in the interest of the shareholders since
they know that their jobs are at risk if there is no return on capital.
On the other hand, with small business it becomes more difficult to operate
under limited liability. Due to the complexity and requirement of the
Companies Act 2006, small business often have to close down when there is
disagreement amongst shareholders. Most private companies have few
shareholders and there is no right to vote. Hence, legally, it becomes difficult
to apply the law when the shareholders cannot come to a consensus. Very
often there are disagreements when there are two shareholders and it
becomes costly when the matter is referred to court. Private companies
cannot raise capital from the general public because they are not permitted
by law. . . Small business limited liability find it difficult to expand because of
the restriction they have on them due to the nature of the law. If they want to
change their structure, they have to change their articles and pay a small fee.
Therefore it is time consuming and costly.
Comment on extract
This was a very short answer, which made it difficult for the candidate to
demonstrate sufficient knowledge. The mark – a bare pass – reflected this. The
answer did touch on, or at least hint at, some relevant issues. However, it was
much too brief, and failed to develop or explain adequately these points. For
example, the issue of raising capital is clearly important, but the answer did not
really explain clearly how capital raising is different in big and small businesses, or
whether the private company form does anything, or does enough, to help the
smaller company raise the capital it will need. Likewise, the answer acknowledges
that there are likely to be greater problems of majority-minority conflicts in smaller
companies. But it does not really explain why this is so. More importantly, it does
not discuss properly how company law tries to address this problem in the smaller
company. This lack of detail about what the law actually does is a major weakness.
Elsewhere, there are significant inaccuracies in what the answer says. So, for
example, the answer suggests that shareholders have the right to vote in a larger
company, but not a smaller one. This is clearly very misleading. It is essential that
answers are concise and well-focused on the question, but that explanations of
what the law says are understandable and accurate.
Question 2
Compare the protection afforded to a minority shareholder by section 33
Companies Act 2006 with that provided by section 994 Companies Act 2006.
General remarks
This question requires a comparison of two different provisions, namely ss.33 and
994 Companies Act 2006. It is essential therefore to stick to these two provisions,
and not wander off onto other areas of law, even if they are similar to the two

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provisions mentioned; to cover both provisions in your answer; and to make the
answer comparative. So far as that last point is concerned, it is not enough simply
to write a good account of one provision, followed by a good account of the other.
The question requires greater analysis, in order to compare one against the other.
Law cases, reports and other references the examiners would expect you to
use
The two named provisions themselves, and relevant case law which has developed
to interpret them. For s.33, this includes, for example, cases such as Foss v
Harbottle, Hickman v Kent, Pender v Lushington, Rayfield v Hands, Eley v Positive
Government Security Life Assurance, Beattie v E and F Beattie, Salmon v Quin &
Axtens, Allen v Gold Reefs of West Africa and Greenhalgh v Arderne Cinemas. For
s.994, it includes cases such as Ebrahimi v Westbourne Galleries, O'Neill v Phillips,
Hawkes v Cuddy (No 2), Saul D Harrison, Re Elgindata Ltd, Re Blue Arrow, Grace
v Biagioli, Bird Precision Bellows Ltd, Irvine v Irvine (No 2) and Fulham FC v
Richards.
Some mention might also be made of relevant reports addressing these statutory
regimes, such as Law Commission Report No 246 (Shareholder remedies), and
relevant academic articles.
Common errors
Failing to do what the question asked. The question clearly required a comparison
between these two regimes, but many answers simply described each in turn,
without attempting to show what their differences and similarities were. Worse still,
some answers addressed only one of the two named regimes, producing an answer
that, inevitably, had no comparative element (for there was nothing to compare the
one chosen regime with), and which was in any case only half complete.
Finally, some answers, realising that the question was about two areas of minority
shareholder protection, chose to analyse other areas of such protection that were
not mentioned in the question. So, for example, a number of answers chose to
address derivative claims under Part 11 of the Companies Act 2006. Such material
was irrelevant to the question asked.
A good answer to this question would…
provide a concise but comprehensible and accurate description of the two named
regimes, and analyse the differences and similarities between them.
With regard to s.33, explain how protection is limited to rights under the constitution,
and even then, not all such rights may be enforceable under s.33. So, relief is subject
to a number of restrictions, including the ‘qua member’ requirement (show relevant
case law here to explain the controversy over this limitation), and the risk that the
breach will be characterised as a mere internal irregularity, which only the company
itself is entitled to enforce, under the rule in Foss v Harbottle. Note also how the
articles might be altered to avoid a breach in the first place, and the very modest
controls on alterations found in cases such as Allen v Gold Reefs. Note the limited
range of remedies that are available following a successful action under s.33 –
typically, injunction to prevent breach of constitution, and only very rarely damages.
By contrast, show how the grounds for relief under s.994 are much wider than those
under s.33 – conduct in affairs of the company that is unfairly prejudicial to the
interests of the members. Explain how this allows member to complain about far
more than a mere breach of the articles. Mention here relevant case law such as
Ebrahimi and O’Neill v Phillips to establish the scope of the misbehaviour that a
claimant can invoke.
Compare also how s.994 does not seem to be subject to the restrictions noted in
respect of s.33 (e.g. under s.994 one must complain of prejudice to one’s interests

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‘as a member’, but this seems much more liberally interpreted than the
corresponding ‘qua member’ requirement of s.33). Note also the very wide range of
remedies that can be awarded, and discuss the significance of the buy-out remedy,
including how shares are likely to be valued.
A short conclusion, drawing the above analysis together, would ensure the essay
provides a focused answer to the question set.
Poor answers to this question…
failed to compare the two regimes, simply providing two descriptions, one of s.33,
one of s.994, but saying nothing to analyse the differences and similarities between
the two regimes. Others addressed only one, or other, regime. Poor answers also
tended to lack sufficient detail in describing the content of each regime. So, for
example, there might be a direct copying of the sections, but then very little
explanation, based on relevant case law, of relevant aspects of the two provisions,
such as remedies which are available, or the scope of the misconduct in respect of
which an action under each provision might be brought.
Question 3
‘The UK corporate governance regime encourages those running large public
companies to maximise short-term profits instead of pursuing the company’s
long-term success.’
Do you agree, and what more could be done to encourage managers to
pursue the long-term success of the company?
General remarks
This question addresses the UK corporate governance regime for large companies.
It requires, however, a discussion of a specific issue with regard to that regime,
namely whether it encourages managers of large companies to focus on short-term
profits, rather than long-term success. This is a complaint about the UK regime that
has been made for many years, and has recently been the subject of a number of
different reviews and initiatives. The question requires you to explain what the issue
of short-termism is about, to say whether you think the UK regime really does
encourage such short-termism and to offer suggestions for what might be done to
encourage managers to take a more long-term approach to managing the company.
Law cases, reports and other references the examiners would expect you to
use
The various materials that make up the UK corporate governance regime. This
includes, of course, the UK Corporate Governance Code (2014). But there are other
materials that are also essential: the Stewardship Code (2012); relevant provisions
from the Companies Act 2006 (such as those dealing with the removal of directors,
or the setting of executives’ remuneration). You should also mention reports that
have addressed ‘short-termism’, especially the Kay Review.
Common errors
Preparing a ‘standard’ essay on corporate governance, which simply recites the
history of the UK Corporate Governance Code, and using that answer regardless of
what the question actually asks. Questions on the topic of corporate governance,
such as this one, tend to be much more focused, requiring discussion of a specific
aspect or issue.
This question is focused on ‘short-termism’. Many answers did not mention that at
all, or said nothing about how the various elements of the UK governance regime –
not simply the UK Corporate Governance, but other aspects too – try to address
this problem.

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A good answer to this question would…

begin by explaining what is meant by ‘short-termism’ and ‘long-termism’. It would
examine the debate that these issues have generated, for example evidenced by
the work of the Kay Review, and including the extent to which short-termism is
problematic.
Then, it might turn to address those measures within the UK corporate governance
regime which might indeed encourage short-termism – such as remuneration
packages that reward executives for short-term success; hostile takeovers that
threaten removal of managers if share prices fall in the short term; more generally
whether investors – including institutional investors – demand short-term profit
maximisation. Connected to the latter, a good answer would then ask whether
shareholders are given the power, under the UK governance regime, to ensure that
managers must satisfy their desire for short-term profit maximisation; note for
example their control over the membership of the board of directors, the role of non-
executives under the UK Corporate Governance Code, increased shareholder
involvement in remuneration setting through the ‘Say on Pay’ rules, and so on.
Finally, a good answer would also look at the analysis of the Kay Review on those
aspects of the UK regime that encourage short-termism.
It might then look at some governance measures that aim to encourage greater
long-termism. Reference might be made to long-termism in s.172 Companies Act
2006, but including analysis of whether this makes any real difference to the
behaviour of directors. Reference might also be made to the remuneration setting
process, and especially the increased emphasis in the UK Corporate Governance
Code on long-term concerns, including in the remuneration process, and also in
terms of the long-term viability statement.
A good answer would look at the Stewardship Code (2012), asking whether, in
encouraging greater shareholder activism, it does anything to ensure that such
activism is directed towards long-term, rather than short-term, corporate
performance. Or does the Code exacerbate problems by increasing shareholder
power?
Finally, a good answer would address the final part of the question, which asks
what else might be done? There are clearly very many suggestions that might be
made, and even an excellent answer could not hope to cover all of them. Any
answer has to be selective, and include just some examples of steps that might be
taken. Possibilities here might include more radical restrictions on takeovers, doing
more to empower long term investors at expense of short-term investors, or doing
more to impose long-term executive compensation packages.
Poor answers to this question…
tended simply to set out a discussion of the history of the Combined Code/UK
Corporate Governance Code, with little attempt to examine the issues of long-
termism and short-termism, to show whether the UK regime does indeed encourage
the latter at the expense of the former, or to suggest how more long-termism might
be encouraged.
It is important to emphasise that questions on the examination paper are carefully
drafted to focus on particular issues. Answers must address those issues; pre-
prepared essays that give an answer to a different question from the one asked will
get little credit.
Student extract
The problem of short-termism occurs due to the fact that executives who
have stocks or shares are in the power to take actions which result in short-
term profits to increase dividends and make personal profit. Those running

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the company are in complete control of the final decisions and hence their
short term decisions have led to the failure of major companies. To curb this
issue, committees have been devised to address this fault. . . [There followed
a brief discussion of the early origins of the UK Corporate Governance Code,
and the essay then continued:]
NEDs were another device of these committees to keep executives in check.
NEDs are those appointed to the board to keep executives from making
selfish moves. NEDs have no stakes in the company and are to be
independent in character and judgement and without any ties that can
hamper that independence (Higgs). . ..
Then in 2002 Reports after Enron collapse decided to encourage the concept
of Enlightened Shareholder Value. This is to promote the care of
stakeholders by the company when making decisions. First they incorporated
section 172, in which directors must consider long term benefits of the
company by considering stakeholders. . .. [there was then some discussion of
the OFR, and of directors’ remuneration, and the essay then continued] The
idea of incorporating stakeholder interests promoted long-term goals as by
looking at long-term interests of the company short-termism would be curbed.
One of the most important committees formed to address the issue of short-
termism is the Kay Review 2013. This targeted the issue saying that
companies should make sure their executives do not take short-term
decisions to promote their interests over those of the company. They asked
NEDs to spend 30-36 days on the company, rather than their usual 20-25
days. Also, the idea of 5 year gap in bonuses and performance related pay,
and rolling contracts, were all recommendations that were given to ensure
that executives do not give themselves quick returns but result in company
collapsing in longer term.
Comment on extract
This answer gained a high 2.2. It was a solid answer, with the strength that it did
focus on the actual question asked. It avoided the tendency in many essays to give
a long, largely irrelevant, description of the history of the UK Corporate Governance
Code. Instead, it took the question as its focus, and attempted to explain what
short-termism involves, and what the UK governance system does to encourage or
control it.
Its main weakness was that it did not explain the points it was making as clearly as
it might, and some issues needed further detail. With regard to NEDs, for example,
more could be said about whether such directors can really be expected to pursue
long term goals, even if they are independent of managers. More detail could have
been given of the recommendations of the Kay Review. The Stewardship Code is
also important, but insufficiently addressed in this essay.
Question 4
Explain:
(a) what is meant by the following types of director: executive, non-
executive, de facto, de jure, shadow and nominee; and
(b) whether there are, and whether you think there ought to be, any
differences in the legal duties owed by each of these different types of
director.

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General remarks
This is again a very focused question. It is specific in terms of the knowledge and
the analysis it requires you to demonstrate. Part (a) requires you to show that you
understand the differences between a number of different types of director that are
recognised under UK company law.
Part (b) turns to the legal duties which different directors owe. Note that part (b) is
itself in two parts. The first part is ‘descriptive’. It requires you to explain how far the
current law on directors’ duties differentiates between different types of director.
The second part is ‘normative’. It requires you to say something about whether
different directors should be subject to different duties.
Law cases, reports and other references the examiners would expect you to
use
On the meaning of de jure, de facto and shadow directors, ss.250–51 Companies
Act 2006; relevant case law in interpreting these provisions, such as Secretary of
State for Trade and Industry v Hollier and Re Gemma Ltd (in liquidation). The
concept of a non-executive director under, for example, the UK Corporate
Governance Code (2014).
On the duties owed by different types of director, s.170(5) Companies Act 2006 and
case law arising thereunder, including Ultraframe v Fielding and Vivendi v Richards.
Mention reforms proposed by the Small Business, Enterprise and Employment Bill
2014 (which subsequently became the 2015 Act of that name). Consider inclusion
of shadow directors in some statutory provisions, such as under s.214 Insolvency
Act 1986. Other statutory definitions of directors’ duties in ss.171–77 Companies
Act 2006, and whether these differentiate between different types of director.
Common errors
The question tested a specific body of knowledge about the meaning of, and duties
owed by, different types of director. The most common mistakes were simply ones
of knowledge. Some candidates did not know the differences between these types
of director. There was a failure to identify the appropriate statutory rules, say in
ss.250–51 Companies Act 2006, or relevant case law.
In terms of the duties of directors, a common failing was simply to describe the
duties of directors generally, whereas the question was asking specifically whether
the content of these duties varies between different types of director. Also, many
answers failed to deal with the content of s.170(5) in discussing the nature of a
shadow director’s duties.
A good answer to this question would…
for part (a), work through the different types of director in turn, identifying relevant
definitions. Executive and non-executive directors are not defined in the Companies
Act 2006. Instead, this difference is less a legal one, but rather a more practical
one, based on their contractual relationship with the company and the role they are
appointed to perform. It would explain the meaning of a de jure director, and explain
how a person might be legally appointed to be a director. For the de facto director, it
would explain how s.250 acknowledges such a type of director. It would explain
how case law, such as Secretary of State for Trade and Industry v Hollier and Re
Gemma Ltd (in liquidation), has clarified what a person must do within a company to
count as a de facto director. For shadow director, it would explain the meaning of
s.251 Companies Act 2006, and emphasise some of the conditions within s.251,
such as the fact that the shadow director must give ‘directions’ to the board, must
give directions to a sufficient number of directors to determine board decisions and
that the board must be ‘accustomed’ to follow the shadow’s directions.

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For part (b), a good answer would explain that there are no statutory differences
prescribed between the duties of executives and NEDs, but that some duties (e.g.
s.174) may acknowledge differences in their roles in the company. It would explain
that the de facto director is treated as a ‘normal’ director under s.250, and therefore
liable for all the duties which apply to directors, plus liabilities for wrongful trading or
disqualification. For shadow directors it is less clear cut. Some statutory provisions
(e.g. wrongful trading) expressly apply to them. So far as the general duties are
concerned, s.170(5) needs to be considered, including its conflicting interpretation
in Ultraframe and Vivendi v Richards. A really good answer would note that the
SBEE Bill 2014 addressed this (although candidates were not required to know the
content of the 2015 Act based on that Bill). For nominee directors, a good answer
would explain the implications of ss.172 and 173 Companies Act 2006, and the
case of Hawkes v Cuddy.
Finally, candidates needed to offer some arguments whether the duties of all
different types of director should be the same (for example, the advantages of
consistency of treatment, simplification of law, etc.) or should differ (for example,
because they perform different roles within company; shadows may not always
realise they are shadows, may not be able to take advantage of some of the
mechanisms to avoid relief that de jure directors can, e.g. authorisation, etc.).
Poor answers to this question…
lacked the detailed and specific knowledge required, as set out above. There was
often a failure to address the statutory rules that provide some of the definitions
(say ss.250–51 Companies Act 2006) or relevant case law. The developing law
governing the duties of shadow directors was also often ignored. Weaker answers
tended to have little to say on the normative part of the question, in part (b).
PART B
Question 5
Megaholdings Plc is the parent company of a large corporate group. Its
various subsidiaries operate in a number of different industries, including
house-building. Arnold, a director of Megaholdings, learns that a large piece
of vacant land in London is about to be sold by auction. The land is suitable
for house-building, but houses can only be built if the Local Authority gives
its permission. The Local Authority says it will give permission, but only on
condition that the company building the houses carries out very expensive
landscaping works once the houses have been built. Arnold calculates that
carrying out these works will make building houses on the land unprofitable.
To get around this problem, Megaholdings incorporates a wholly-owned
subsidiary, Shellbuild Ltd, with a share capital of £1. Shellbuild Ltd purchases
the land and, in return for being given permission to build houses on the land,
enters into an agreement with the Local Authority to carry out the
landscaping works. Shellbuild quickly builds, and sells, the houses for a
substantial profit, which is immediately paid to Megaholdings as a dividend
and as ‘management charges’. Shellbuild has now informed the Local
Authority that it is insolvent, and does not intend to carry out the landscaping
works.
During the construction of the houses, Megaholdings told Shellbuild’s sole
director, Lorraine, that she must keep costs to an absolute minimum.
Megaholdings was aware that Shellbuild was using a number of very
dangerous work practices in order to cut costs, but Megaholdings did nothing
to stop this. Cecilia, a bricklayer employed by Shellbuild, was badly injured as
a result.

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Advise:
(a) the Local Authority whether it can force Megaholdings to pay for the
costs of carrying out the landscaping works; and
(b) Cecilia, whether she can claim damages from Megaholdings for the
injuries she has suffered.
General remarks
This question is about the extent of the limited liability enjoyed by a company’s
shareholders, and the extent to which shareholders may face liability either as a
result of the doctrine of ‘veil lifting’, or through the imposition of a duty of care on a
shareholder to ensure their company does not commit a tort.
It is important to read carefully the facts of the question, and especially the
instructions which you must follow. Note that the question asks you to advise two
private parties – the local authority and Cecilia – whether they may take action
against the parent company. You are not asked whether, for example, a liquidator
can sue.
Law cases, reports and other references the examiners would expect you to
use
For part (a), relevant cases on the nature of a company’s separate legal personality
and the limited liability enjoyed by a company’s shareholders, including its parent
company; Salomon v Salomon, Lonrho v Shell; the doctrine of veil lifting/piercing,
and relevant case law exploring the limits of that doctrine, such as DHN Food
Distributors v Tower Hamlets LBC, Woolfson v Strathclyde Regional Council,
Adams v Cape Industries, Petrodel Resources Ltd v Prest and VTB Capital v
Nutritek International. For part (b), tortious actions under Chandler v Cape Plc,
Williams v Natural Life Health Foods Ltd, Thompson v Renwick Group Plc.
Common errors
For part (a), the most common errors were the failure to explain clearly the grounds
on which the veil might be lifted, and to apply these to the facts of the question.
Many answers noted the ‘façade’ ground, but failed to explain how, in Adams, and
again in Prest, this was linked to the evasion of an existing obligation. This
formulation then needed to be applied to the question, asking whether
Megaholdings forms its subsidiary in order to evade an existing obligation, or
merely to avoid incurring a future obligation. Other errors included a failure to
mention the most recent cases, such as Prest and VTB, and explain how these
Supreme Court decisions affect the grounds for veil lifting.
For part (b) there were two common errors. One was to treat this as another issue
of veil lifting. But the issue for (b) is about whether a parent company can owe a
direct duty, in tort, of care towards employees of the subsidiary company. Some
candidates failed to address this at all. The second error was a failure to mention
the most recent case law. Older cases such as Lubbe, form background, but the
current law is that established in, for example, Chandler v Cape Plc, and reinforced
by Thompson v Renwick.
A good answer to this question would…
for part (a), explain how a parent company is usually treated as a separate legal
entity, distinct from the subsidiary company it owns, and not liable for its
subsidiary’s debts. Cases such as Salomon, or Lonrho v Shell, confirm this position.
Apply this to the facts of the question – meaning the parent company will not be
liable to the local authority.
A good answer would then turn to examine the possibility of the local authority
seeking to lift the corporate veil, and impose on the parent company the contractual

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liability of its subsidiary. It would consider Adams v Cape, and the grounds for veil
lifting that the case established. It would also explain how more recent cases, such
as Prest, and VTB Capital, confirmed the effect of the Adams decision, and how
‘single economic entity’ is no longer sufficient to lift the veil.
The most relevant ground appears to be ‘façade’. This should be explained clearly,
especially the significance of avoiding an existing obligation, and applied to the
facts of the question. Note also the point made in VTB that even if the veil can be
lifted, this should not be done to transfer a contractual liability from the company
that incurred it to the company’s shareholder.
On (b), a good answer would identify how the issue here is the possibility that the
parent company might owe a duty of care to the employees of its subsidiary. The
most important case here is Chandler. The case should be explained clearly, and
the preconditions that the case established for the existence of a duty of care
should be clearly identified. Those conditions should then be applied to the facts of
this question. Particularly important here might be the requirement that the parent
and the subsidiary be involved in the same line of business. This condition was
emphasised in Thompson v Renwick Group Plc. Applied to the facts of this case, it
is not clear whether Mega is indeed in the same line of business as Shell, or
whether Mega merely acts as a holding company.
Note that the question talks only about the local authority, and Cecilia, taking action
against the parent company. It does not ask you to consider what action a liquidator
might take against the parent, say for wrongful trading.
Poor answers to this question…
failed to identify clearly the grounds for veil lifting or to apply them to the facts of the
question. It is essential to be as precise as possible. Poor answers also failed to
bring the discussion of the law up to date, either by ignoring more recent case law
on veil lifting (such as Prest) or ignoring more recent case law on tortious actions
against parent shareholders.
Student extract
[Begins by noting that an action against Shellbuild would be the normal route to
compensation, but this is impractical due to S’s insolvency. It then continues:]
Therefore, the authority may now try to sue Megaholding. The problem here
is that there is a general principle of separate legal entity and the shareholder
will have limited liability as it is separated from the subsidiary in the eyes of
the law, according to Salomon v Salomon. According to Lord McNaughten,
this will be the case even if there is full control by the shareholder or the
company is merely a technicality for limiting the shareholder’s liability.
What the court may wish to ask for the court is to lift the corporate veil and
allow them to sue Megaholding regardless of the separate legal entities.
However, the court in Adams v Cape has now seemingly restricted the lifting
to 3 situations. There may be lifting if there is a statutory document or
contract that can be interpreted to require lifting. However, there’s no such
document in our case.
Secondly, there may be a lifting in the agency situation. However, there is no
expressed agency in the case to suggest Shell is an agent of M. What the LA
will argue is that the there is an implied agency. It may depend on the old
case of Re FG Film where the court implied an agency as there is an under
capitalization of the company regards to the work that is done. As we can
see, Shell is a £1 company responsible for the whole development project
and should suffice. However, Adams v Cape has stated that there will be no
implied agency unless there is sign of day to day control of the subsidiary. . .

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LA3021 Company law

The third situation is a mere façade. The test is set out in Adams v Cape to
look at whether or not the corporate structure is used to avoid a previous
liability and that liability will have existed before the company is formed. This
is shown in Gilford v Horne. Lord Sumption also suggested in Prest v
Petrodel that the sham will require an abuse of the corporate structure to
evade a previous liability arising before incorporation. In our case, the liability
exists after incorporation of Shell.
[The essay then moved on to consider the significance of the transfer of assets,
noting cases such as Creasey and Ord, and then asked whether there was any
possibility of giving the façade test a wider reading than that suggested in Adams.
The essay then turned to part (b):]
What Cecilia will depend on is the test in Chandler v Cape. The court allowed
a claim as long as the parent company assumed liability over the working
environment of the subsidiary and a special relationship existed between the
parent and the worker. This will arise if the parent and subsidiary are in the
same line of business, parent has as much knowledge as the subsidiary
about the health and safety of the working environment and there is reliance
by the employee that will be presumed generally if there is knowledge or
control of the health and safety environment by the parent.
However, this is to be contrasted with Thompson v Renwick, where two
companies were in different lines of business, the parent was a mere holding
company with no knowledge over health and safety issues. . According to
Stephen Griffin, the test seems to look at whether there is control over
working policy …..
Comment on extract
This was an excellent essay. It was extremely clear in its explanations, and well
structured. It approached the grounds for veil lifting in a very accurate and logical
way, with a clear explanation of the available grounds, a full account of relevant
case law, some critical analysis of the law, and a reasonable use of academic
commentary. For each ground, the law is clearly stated before that law is applied to
the specific facts of the question.
On part (b), it identified the most important up to date case on shareholders’ duty of
care (Chandler), set out clearly the conditions for such a duty to arise, and then
applied that to the facts of the case.
Question 6
Rustic Timbers Ltd makes low-price furniture, which it sells through
supermarkets. The company has three directors, Archie, Bella and Charles.
Archie is a qualified accountant, and the company’s chairman. Bella, who has
a full-time job as a presenter of television programmes on furniture design,
has not attended any of Rustic Timbers’ board meetings for over a year.
Rustic Timbers has been running at a substantial loss for many months.
Archie calls a board meeting to discuss the company’s financial problems.
Bella does not attend the meeting. Charles argues the company should cease
trading immediately. Archie disagrees. He says the company might just
survive if it opens its own furniture store, selling its products directly to the
public. He admits the scheme is very risky, but argues the risk is worth taking
to protect the jobs of its current employees. He tells Charles he knows of a
suitable store to purchase for £105,000, which is currently owned by his
daughter, Paula. Charles objects to this, but Archie uses his casting vote as
Chairman to pass a resolution purchasing the store.

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 Examiners’ reports 2015

Charles storms out of the board meeting, and has since refused to speak to
Archie. After six months it is clear Archie’s strategy has failed, the company’s
losses have increased, and the company is now being wound up. Joan has
been appointed as the company’s liquidator. She has discovered that,
although the price paid for the store at the time was quite reasonable, it has
since fallen in value.
Advise Joan what action might be taken in respect of the foregoing events.
General remarks
This question looks at the duties and liabilities of directors. It requires identification
of the possible breaches of duty, or potential liabilities, of each character mentioned
in the question, a careful explanation of the relevant duty or liability, and then its
application to the facts to see if Joan, the liquidator, could indeed take action
against the named person.
Law cases, reports and other references the examiners would expect you to
use
Companies Act 2006, ss.170–78; the case law relevant to interpreting those
statutory duties, including Re Barings Plc (No 5) [1999] 1 BCLC 433 and Lexi
Holdings (in liquidation) v Luqman [2008] 2 BCLC 725 on s.174 Companies Act
2006; Regentcrest plc v Cohen (2001) 2 BCLC 319 and Charterbridge Corporation
v Lloyds Bank Ltd [1970] Ch 62 on s.172; s.190 Companies Act 2006; Re Produce
Marketing [1989] BCLC 513.
Common errors
The two main errors/omissions were as follows:
(a) The purchase of the store from Archie’s daughter, Paula, involves a conflict of
interest. Most candidates spotted this. However, note that this conflict arises ‘in
relation to a transaction or arrangement with the company’ (in other words, arises
out of the transaction between Paula and the company). Thus, although s.175
Companies Act 2006 generally deals with conflicts of interest, this section does not
apply where the conflict arises out of a transaction with the company (see s.175(3)).
Instead, this conflict of interest is covered only by s.177. Too many candidates
spent too long trying to apply s.175 to the purchase of the store, instead of s.177.
(b) Many candidates also failed to spot that the purchase of the store is also a
substantial property transaction, within s.190 Companies Act 2006.
A good answer to this question would…
take each director in turn, consider their possible breaches of duty or potential
liabilities, describe accurately and concisely the content of the relevant duty or
potential liability, and then apply it to the facts of the question to determine the
director’s likely legal position.
Archie may be in breach of s.172 – duty to promote success of company – by his
expansion scheme. If the company is on the verge of insolvency, then his duty is
primarily to protect the interests of creditors: s.172(3) and West Mercia Safetywear
v Dodd. If insolvency is not likely, then his duty is to protect the interests of
shareholders. Either way, his concern for employees’ interests may breach s.172.
However, note the duty is ‘subjective’ – Regentcrest.
He may argue that he honestly believed that his expansion scheme would best
promote the success of the company and best protect creditor interests. If he simply
failed even to consider whether his actions would indeed best serve creditors or
shareholders’ interests, then the court might ask whether no reasonable director
could think what he did would best promote their interests (Charterbridge). In any
case, he may be liable under s.174 – as a chartered accountant, he will be judged

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against the higher subjective standard reflecting his expertise. His decision to
expand, rather than terminate, the business suggests he has not demonstrated the
care and skill reasonably expected of someone with his expertise and qualifications.
He may also be liable under s.214 Insolvency Act 1986 – wrongful trading. If so, he
would be liable to contribute towards the shortfall of the company’s assets. Note Re
Produce Marketing – the amount of the contribution will be calculated on a
compensatory basis.
Regarding the purchase of the store, the relevant provision here is, first, s.177 (not
s.175). Archie has an interest in this proposed purchase, since it is from his
daughter. According to s.177, he should declare his interest to the board. If he fails
to do so, the transaction becomes voidable at the instance of the company, or
Archie becomes accountable for any profit he derives from the purchase. Disclosure
is not required if the board already knew, or should have known, of his interest:
s.177(6)(b). However, given that the price exceeds £100,000, and the purchase is
from someone connected to a director (within s.252), the purchase is a ‘substantial
property transaction’ and, under s.190, requires shareholder approval. A good
answer would spot this additional requirement, and explain the consequences of
Archie’s failure to secure shareholder approval: the transaction is voidable
(s.195(2)), and recovery of gains (unlikely) or damages for loss against Paula and
Archie (s.195(3)–(4)).
Turning to Bella, she may be liable under s.174 Companies Act 2006, or for
wrongful trading under s.214 Insolvency Act 1986, for her absence from meetings,
and her failure to stop A’s expansion plans. Courts are now more ready to find a
breach of duty in a failure to act and play a minimal governance role (e.g. Lexi
Holdings; Re Barings, etc.).
Charles, on the other hand, may not be in breach of any duty, since he has taken
some steps to prevent Archie’s plans. A good answer would therefore ask whether
he has done enough to avoid liability under s.174 Companies Act 2006 and s.214
Insolvency Act 1986.
Poor answers to this question…
dealt badly with the purchase of the store, missing the relevance of ss.177 and 190
Companies Act 2006. Failed to address the possibility of liability under s.214
Insolvency Act 1986. Failed to explain clearly the duties to which the directors were
subject, and failed to identify relevant case law in explaining the content of these
duties.
Question 7
Bookworms Ltd was incorporated in 1902, and runs a chain of bookshops.
The objects clause in Bookworms’ constitution states that it shall operate a
chain of bookshops. Sarah owns 26% of the company’s shares, but is not a
director of the company. In recent years the company’s sales have fallen, and
the board has decided the company should stop selling books and convert all
its shops to cafes. Sarah strongly objects to this.
Bookworms’ board has been trying, for some weeks, to negotiate a building
contract with Quickbuild Plc, to convert Bookworms’ London bookshop into a
café. James, who has been working as an intern for Bookworms, is keen to
prove himself. He visits Quickbuild’s offices, finalises negotiations with
Quickbuild’s managing director, Alice, and signs the contract on Bookworms’
behalf. Alice is concerned whether James is exceeding his authority. She
speaks to James’ secretary at Bookworms, who tells her James has full
authority to sign any contract for Bookworms.

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 Examiners’ reports 2015

Bookworms’ board also recently decided to award a one-year-service contract

to Petra, one of Bookworms’ directors. Bookworms’ articles say that any
employment contract awarded to a director must be approved unanimously by
all of its shareholders. However, the board deliberately chose not to get
shareholder approval, believing that Sarah was bound to refuse her consent.
Advise Sarah whether:
(a) Bookworms is bound by the contract with Quickbuild;
(b) she, Sarah, could prevent Bookworms converting any other stores
into cafes;
(c) Bookworms is bound by the contract with Petra;
(d) the directors of Bookworms have breached their duties to the
company.
General remarks
This question raises a number of different issues that concern company contracts
that are in breach of provisions of the company’s constitution. The question is
structured so as to divide up very clearly these issues. It is intended to test whether
you can clearly differentiate between them.
Law cases, reports and other references the examiners would expect you to
use
Sections 31, 39, 40 and 41 Companies Act 2006; the rules on directors’ authority,
including ostensible authority (Freeman v Lockyer [1964] 2 QB 480); s.33
Companies Act 2006; s.171 Companies Act 2006.
Common errors
As noted, the question was divided into the four subparts, with each addressing a
very different aspect of this area of law. The most common error was a failure to
deal with the specific issues that were being asked in those sub-parts. See below to
understand what each subpart was separately addressing. A further recurrent error
was failure to spot the relevance of s.41 Companies Act 2006 in respect of part (c)
of the question. Again, see below.
A good answer to this question would…
Deal with the following points for each subpart of the question:
(a) This part deals with a contract that has already been entered into, but which is
arguably both ultra vires, and unauthorised. Although arguably ultra vires, it is
rendered valid by s.39. However, James probably lacks authority, as an intern. It
seems unlikely that he was given express authority to sign such a contract, and
would not have implied authority. Ostensible authority looks unlikely – since the
secretary who represents that James was authorised was, herself, unlikely to have
authority to enter into this contract; Freeman v Lockyer. The end result is that the
contract is void. However, the board of Bookworms could choose to ratify it, making
the contract binding on Bookworms.
(b) This part deals with a potential, future, transaction. Such a transaction by
Bookworms would be ultra vires. And since this is not an existing obligation, s.39
does not apply to validate it. Instead, Sarah would be able to take proceedings
under s.33 to enforce the restriction on the company’s objects in its constitution.
Sarah would obtain an injunction requiring the company to stick to its objects
clause. The company could not change its objects clause, since by s.21 such a
change would require a special resolution, which Sarah could block.
(c) In respect of the award of the employment contract to Petra, the power of the
board to award such a contract is subject to a contractual limitation in the articles. If

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the board lacked authority, then the contract is void. However, Petra would be able
to rely on s.40, assuming that she could demonstrate good faith, which is probably
likely, given s.40(2)(b). But in this case, the contract is with a director, so s.41 also
applies. This renders the contract voidable by the company.
(d) The directors have likely breached their duties, and specifically the duty in
s.171(a) Companies Act 2006 – the duty to observe the company’s constitution. But
the duty is owed to the company; the decision whether the company will sue for
breach of duty is to be taken by the board. If the board refuses to make the
company sue, then Sarah might possibly bring a derivative claim, but she is
probably unlikely to get permission to continue such a claim.
Poor answers to this question…
failed to separate out the different issues identified above. The greatest weakness
was probably on part (b), where too many answers failed to note that future
contracts to convert further shops to cafes had, of course, not yet been entered into,
so that Sarah would be able to enjoin such contracts, and s.39 would not prevent
her doing so. Also, poor answers failed to note the relevance of s.41 to the award of
the employment contract to Petra.
Question 8
Buildit Ltd has three directors, Ai, Chao and Ju. The company engages in
property development. Ai and Chao each own 45% of the company’s shares,
and Ju owns the remainder. In 2013, the company borrowed £100,000 from
Feng, who is Ai’s brother. The loan is interest free, but its repayment can be
demanded at any time by Feng.
In November 2014, the company was offered a very profitable opportunity. Ai
and Chao decided to take the opportunity for themselves. Immediately before
doing so, Ai and Chao circulated a ‘written resolution’ between themselves
(but not Ju), as shareholders of Buildit, authorising themselves to take the
opportunity for their own personal benefit. They have since made a personal
profit of £1million each from this opportunity.
At a subsequent board meeting of Buildit, Ju demands that the company sue
Ai and Chao ‘for their flagrant breach of duty’. Ai and Chao refuse Ju’s
request. They argue that their conduct was authorised by the shareholders.
They also point out that if proceedings were taken, Ai’s brother would
immediately demand repayment of his loan, causing the company to collapse.
Advise Ju whether, if she started a derivative claim against Ai and Chao, she
would be likely to be given permission by the court to continue that claim.
Would your answer be any different if the company’s articles provided that
‘Ju shall not be entitled to bring a derivative claim on behalf of the company’.
General remarks
This question concerns derivative claims. However, it is again very specific in what
it asks you to write about. You must advise Ju ‘whether she is likely to be given
permission to continue . . . that (derivative) claim’. This is not an opportunity to write
all you know about derivative claims, directors’ duties, or so on. It is limited to the
giving of permission to continue a derivative claim. It requires you to demonstrate
that you know what the criteria are that the court must follow when deciding whether
to give such permission, and that you can apply those criteria to the facts of this
case. There are many such criteria (in s.263(2) and (3)), and there is a lot to say to
explain what each one means, how those criteria ‘fit together’, and how they would
be applied to the facts of this case. There is no time to waste considering other
matters that the question does not ask about.

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Law cases, reports and other references the examiners would expect you to
use
Part 11 Companies Act 2006; the need to gain the court’s permission to continue
the claim under s.261; the criteria for granting permission under s.263(2) and (3);
the case law interpreting those statutory criteria (e.g. Iesini v Westrip Holdings Ltd
[2009] EWHC 2526 (Ch); Franbar Holdings v Patel [2008] BCC 885; Kleanthous v
Paphitis [2011] EWHC 2287; Mission Capital Plc v Sinclair [2008] BCC 866; Wishart
v Castlecroft Securities Ltd [2010] BCC 161. Section 291 Companies Act 2006 on
the procedure for written resolutions.
Common errors
A failure to confine answers to what the question asked. Too many answers dealt
very superficially with the statutory criteria, and failed to mention any case law
relevant to the interpretation of those criteria. There were also often
misunderstandings about what the criteria mean, especially, for example, that which
asks the court to consider whether a ‘hypothetical director’ acting in accordance
with the duty in s.172 would continue the claim. Also, a failure to understand the
process of shareholder authorisation.
A good answer to this question would…
focus on what the question asks, in terms of the granting of permission to continue
the derivative claim. Permission is dealt with in s.263 Companies Act 2006. That
section lays out three mandatory bars to the court granting permission to continue,
and a number of discretionary factors which the court must follow if none of the
mandatory bars applies.
Starting with the mandatory bars, there appears here to have been no ratification.
There does appear to be a purported authorisation, but we need to ask whether the
authorisation is valid, since it is purportedly passed as a written resolution, but
seems not to fulfil requirements for a valid resolution – it is not clear that it is
circulated by the company, and contrary to s.291, it has not apparently been
circulated to all eligible members. So it is unlikely to be a valid authorisation. A
really good answer would ask whether this breach was capable of being authorised
in any event – did it constitute fraud?
Would a hypothetical director not continue this claim? Note the Iesini factors to
consider – here the claim looks potentially strong (it seems a fairly clear breach of
s.175), it is for a lot of money, we are not told that the company cannot afford to
fund it, presumably the directors have the means to satisfy any judgment against
them. But Ai’s brother’s threat to withdraw the loan looks like a relevant
consideration; Kleanthous v Paphitis. Note the Iesini test: only if no reasonable
director would proceed should action be stopped on this mandatory bar.
Assuming no mandatory bar applies, a good answer would then proceed to the
discretionary factors. The courts have tended to assume that the claimant is acting
in good faith, and the hypothetical director test has been discussed already.
Ratification is unlikely (given the s.239 requirement that wrongdoers do not vote).
There is no evidence of the company (i.e. the board) having decided not to sue. The
court might, however, feel that Ju ought to use s.994 instead of pursuing a
derivative claim: Franbar.
Finally, would it make any difference if the constitution included the mentioned
provision? Would such a clause be enforceable against Ju? In general the articles
are enforceable (s.33). However, the articles cannot exclude mandatory provisions
from the Companies Act. The right to bring derivative claims is probably a
mandatory right. Against this, one might draw parallels with s.994 and Fulham v
Richards which did uphold a provision requiring a shareholder to use arbitration
instead of petitioning under s.994.

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LA3021 Company law

Poor answers to this question…

spent too long addressing general issues regarding the nature of derivative claims,
rather than focusing specifically on the permission issue, as the question required.
When the permission issue was discussed, poor answers said too little about the
criteria for granting permission. Poor answers mentioned only some of the relevant
criteria, or failed to provide any real analysis of what the criteria actually mean
(including case law relevant to their interpretation), or applied the criteria poorly to
the facts of the question. Poor answers also often simply ignored the final point in
the question (the effect of the suggested provision in the articles).
Student extract
As per the general rule, a director owes fiduciary duty to the company only,
not to its shareholders unless under certain circumstances. According to
section 170 of the Companies Act 2006, the directors owe a fiduciary duty to
the company only and in s171 the director of a company must act in
accordance with the company’s constitution and only exercise powers for the
purpose they are conferred.
[There then followed a fairly long discussion of whether there was in fact a breach
of duty here at all, and then a similarly long discussion about who is entitled to take
proceedings when a director is in breach. The essay then continued:]
With the prevailing exceptions to he rule in Foss, Lord Wedderburn held that
in case of fraud on minority the minority shareholder can bring a claim
against the majority shareholders of the company . A minority can take action
for a representative action, personal rights being infringed, or reflective loss.
[The essay then turned, finally, to look at the grounds for giving permission to
continue a claim:]
According to s263(3) there are certain things that are ‘good faith’ of the
member who is seeking the claim, the importance that a person acting in
accordance with s172 decides to pursue the claim. . as per section 263(2) the
court will refuse permission to grant a derivative claim if the court is satisfied
that if Ju who in accordance with section 172 will not seek to continue the
claim. Secondly where the cause of action arises from an act or omission has
been authorized. As per Ai and Chao held that Buildit had authorized them to
do the act, hence it was authorized after it occurred.
Comment on extract
This was a rather poor answer. The candidate spent far too long introducing the
background to derivative claims, the general exceptions to the rule in Foss, and so
on. The question asked only about the granting of permission to continue a claim
already begun. The answer should have started with that.
Because so long was spent on this general introduction, the candidate had too little
time to examine the ‘permission’ issue in sufficient detail. In consequence, it covered
only a few of the criteria relevant to the permission issue. The criteria that were
covered were explained very poorly, with little reference to case law to illuminate the
statutory rules. And the rules were not really applied to the facts of the question.

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