STRATHMORE COLLEGE

SUBJECT 13. LAW II DISTANCE LEARNING PACK

COPYRIGHT
ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the copyright owner. This publication may not be lent, resold, hired or otherwise disposed of by any way of trade without the prior written consent of the copyright owner. THE REGISTERED TRUSTEES STRATHMORE EDUCATION TRUST 1992

INSTRUCTIONS FOR STUDENTS

This study guide is intended to assist distance learning students in their independent studies. The course has been broken down into eight lessons each of which should be considered as approximately one week of study for a full time student. Solve the reinforcement problems verifying your answer with the suggested solution contained at the back of the distance learning pack. When the lesson is completed, repeat the same procedure for each of the following lessons. At the end of lessons 2, 4, 6 and 8 there is a comprehensive assignment that you should complete and submit for marking to the distance learning administrator. SUBMISSION PROCEDURE 1. 2. After you have completed a comprehensive assignment clearly identify each question and number your pages. If you do not understand a portion of the course content or an assignment question indicate this in your answer so that your marker can respond to your problem areas. Be as specific as possible. Arrange the order of your pages by question number and fix them securely to the data sheet provided. Adequate postage must be affixed to the envelope. While waiting for your assignment to be marked and returned to you, continue to work through the next two lessons and the corresponding reinforcement problems and comprehensive assignment.

3.

4.

On the completion of the last comprehensive assignment a two week period of revision should be carried out of the whole course using the material in the revision section of the study pack. At the completion of this period the final Mock Examination paper should be completed under examination conditions. This should be sent to the distance learning administrator to arrive in Nairobi at least

five weeks before the date of your sitting the KASNEB Examinations. This paper will be marked and posted back to you within two weeks of receipt by the Distance Learning Administrator.

ACKNOWLEDGM ENT
We gratefully acknowledge permission to quote from the past examination papers of the Kenya Accountants and Secretaries Examination Board (KASNEB).

LAW II COURSE DESCRIPTION

The profile of the course is primarily concerned with the exposition of the legal principles within which companies function. A detailed review of the Companies Act is carried out, and in the Appendix of Cases supplied there are included those important rulings handed down by the courts, and which now comprise the significant case law on the subject. Students are guided to cases in the main text by the numbered reference given therein. The case law reference exemplifies the principles given in the text without disrupting the flow of information. It is essential that students use the copy of the Companies Act which accompanies their Study Pack to further their consolidate knowledge

LAW II
INDEX
CONTENTS
Lesson 1 Lesson 2 Incorporation and the company's constitution The raising of capital Comprehensive Assignment 1 Company membership and securities Company Management Comprehensive Assignment 2 Meetings and resolutions Debentures, Accounts and Audit Comprehensive Assignment 3 Legal protection of minorities Reconstructions, Merges and Winding up Comprehensive Assignment 4 KASNEB syllabus. Model answers to reinforcing questions. Selected past papers with model answers. Work through model answers ensuring they are understood. On completion submit final assignment to Strathmore.

Lesson 3 Lesson 4

Lesson 5 Lesson 6

Lesson 7 Lesson 8

Lesson 9

FINAL ASSIGNMENT Mock Examination Paper.

LESSON 1
CONTENTS
1 2 3 4. Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9 STUDY TEXT

COMPANY'S CONSTITUTION
CONTENTS
1 INCORPORATION Classification of companies Classification of registered companies Registration procedures Effect of registration Practical consequences of incorporation Lifting the veil of incorporation Unincorporated associations PROMOTION Promoters Pre-incorporation contracts THE COMPANY'S CONSTITUTION The memorandum of association The Name Clause Company names Names of foreign companies Business names

INCORPORATION AND THE

The Registered Office Clause The Objects Clause The doctrine of Ultra vires Rights under Ultra vires transactions Alteration of objects Limited liability clause Capital clause Association clause Alteration of the memorandum The articles of association Contents of articles The effect of the memorandum and articles Alteration of the Articles

INCORPORATION
1 CREATION OF LEGAL PERSONS
1.1 REASONS FOR CREATING LEGAL PERSONS Osborne's "Concise Law Dictionary" defines incorporation as a "merging together to form a single whole; conferring legal personality upon an association of individuals, or the holder of a certain office, pursuant to Royal Charter or Act of Parliament". For purposes of company law it denotes the legal process by which a group of people are enabled to carry on a business in such a way that the business is legally regarded as "a legal entity" that is altogether separate from the members of the group, individually and collectively. This mode of carrying on a business is resorted to because it has certain legal advantages, some of which are explained in paragraph 1.11.3. The business so incorporated is usually called "a company". 1.2 THE NATURE OF A COMPANY There is no precise legal definition of "a company". This is due to historical reasons which are too lengthy to be narrated in this text. Suffice it to say that the word "company" is a byproduct of mercantile rather than legal ingenuity and was in use in England long before what is now called "company Law" came into existence. Although the word was initially used by English merchants to denote associations which they had formed for trading overseas, such as British East India Company and the Hudson Bay Company, it was gradually extended with surprising latitude to diverse associations until it ceased to have a specific meaning. One major consequence of this extension is that the English Company Law which has been adopted in Kenya defines or classifies "companies" according to the mode of their formation rather than according to their intrinsic attributes. 1.3 CLASSIFICATION OF COMPANIES Section 389 of the Companies Act provides that "no company, association or partnership consisting of more than twenty persons shall be formed... unless it is registered as a company under this Act, or is formed in pursuance of some other Act, Act of the United Kingdom or of letters patent". Three types of company are provided for under this section. They are: (a) (b) (c) 1.4 Chartered companies. Statutory companies. Registered companies.

CHARTERED COMPANIES A chartered company is formed when the Queen or King of England issues a charter, or "letters patent", to a group of people who intend to carry on a business as a chartered company. No such company can be formed in Kenya after political independence and the words "letters patent" in s.389 only serve as a reminder of the English origin of our Companies Act which is the replica of the English Companies Act, 1948, with a few minor

modifications. 1.5 STATUTORY COMPANIES A statutory company is formed by a specific Act of Parliament, primarily as a means of conferring on it some powers which would not be available to it if it were formed by Royal Charter or registration under the Companies Act. A statutory company has no shareholders and its initial capital is provided by the Treasury. It is expected to operate according to commercial principles and to make profits. If it makes losses and becomes unable to pay its debts, its property can be attached by its creditors but it cannot be wound up on the application of any creditor. However, the government will usually come to its aid if it has no cash or other assets to pay its creditors. Examples of such companies are the water, gas, electric and railway companies formed in England during the last century. Most of these companies were nationalised by the British government after the second world war and their functions transferred to public boards and corporations set up by Acts of Parliament. The public boards and corporations resembled those that were later set up in Kenya by the colonial administration, such as the Agricultural Finance Corporation, and the Wheat Board. 1.6 REGISTERED COMPANIES A registered company is formed by registration under the Companies Act. It is this type of company that people usually have in mind when they talk of "a company". The notes that follow are concerned exclusively with "registered companies". It should be noted that s.2 of the Companies Act defines a company as "a company formed and registered under this Act." Classification of registered companies Registered companies are classified by s.4(1) of the Companies Act into: (a) A company formed by "any seven or more persons". Such a company is known in common parlance as a public company. A company formed by "any two or more persons". Such a company is referred to in the Act as "a private company".

(b)

A private company or a public company may be: (i) Limited by shares if the liability of its members is limited by its memorandum to the amount, if any, unpaid on the shares respectively held by them. Limited by guarantee if the liability of its members is limited by its memorandum to an amount which the members have undertaken to contribute to the assets of the company in the event of its being wound up. Unlimited if it does not have any limit on the liability of its members.

(ii)

(iii) 1.7

REGISTRATION PROCEDURES The procedures to be followed by persons who intend to form a registered company will depend on whether the proposed company is to be a public company or a private company. 1.7.1 Public Company The initial step that must be taken by promoters who are desirous of forming a public

company is the preparation of a document called the memorandum of association towhich at least seven of them will subscribe their names as prescribed by s.4 of the Act. The memorandum must contain a declaration by the promoters that they are desirous of being formed into a company pursuant thereto and must state: (a) the name of the company, with "limited" as the last word of the name of the company in the case of a company limited by shares or by guarantee; and that the registered office of the company is to be situate in Kenya; and the objects of the company; and the amount of capital with which the company is to be registered and the division of the capital into shares of a fixed amount.

(b) (c) (d)

The memorandum of a company limited by shares or by guarantee must state that the liability of the company's members is limited. The memorandum of a company limited by guarantee shall also state the amount"guaranteed" by each member of the company. The next step is the delivery of the memorandum to the registrar of companies together with some or all of the following documents: (i) Articles of association This document contains the regulations for management of a company. If the proposed company is to be limited by shares the promoters need not deliver it for registration. The provisions of Part I of Table A in the First Schedule to the Act will be automatically applicable to the company under Section II (2) of the Companies Act, if the promoters do not deliver it. (ii) Consent to act as director (Form No 209) If any person is appointed director of the company by the articles which are to be delivered for registration in lieu of Table A, Form No 209 must be delivered for registration after being duly completed and signed by him or by his agent authorized in writing to do so. The form is the statutory signification of the person's consent to act as director. (iii) List of persons who have consented to be directors (Form No 210) This form, when duly completed and signed, constitutes the statutory list of persons who have given their individual consents in Form no 209. It is to be delivered for registration only if the prospective directors have been appointed by the articles delivered for registration in lieu of Table A, or as complementary thereto. (iv) Statement of the Nominal Share Capital This statement is delivered for taxation purposes pursuant to Section 39 of the Stamp Duty Act. (v) Declaration of Compliance (Form No 208)

Form No 208, when duly completed and signed,constitutes the statutory declaration by the advocate engaged in the formation of the proposed company, or by the person named in the articles as a director or secretary of the company, that all the requirements of the Companies Act in respect of matters precedent to the registration of the company and incidental thereto have been complied with. 1.7.2 Registration If the aforesaid documents are correctly prepared in accordance with the provisions of the Companies Act they are registered, the registrar grants a certificate of incorporation and the company is formed from the date of incorporation written in the certificate. 1.7.3 Private Company In order to secure the registration of a private company the procedure described above is followed except that: (a) The memorandum of association will be signed by at least two of the company's promoters. Form Nos 209 and 210 are not delivered for registration because s.182(5) of the Act exempts promoters of a private company from the obligation to deliver them for registration. If articles of association are not delivered for registration the provisions of Part I of Table A will become the company's articles, as modified by Part II thereof.

(b)

(c)

1.7.4 Significance of Registration S.389 provides that "no company, association or partnership consisting of more than twenty persons shall be formed... unless it is registered as a company under this Act". The provision has been interpreted by the English and Kenyan courts to the effect that registration is the condition precedent to the formation of a registered company and failure to register a proposed company will mean that it does not legally exist: FortHall Bakery Supply Co v Wangoe(1) 1.8 EFFECT OF REGISTRATION S.16(2) of the Act provides that "from the date of incorporation mentioned in the certificate of incorporation the subscribers to the memorandum of association... shall be a body corporate by the name contained in the memorandum". This section has been judicially explained as follows: (a) The date mentioned (i.e. written) in the certificate of incorporation is the date from which the company's legal existence commences. Consequently, if an incorrect date is written in the certificate, that date would be regarded as the actual date on which the company was registered. This legal position was explained by the House of Lords, under the English Companies Act whose provisions in this regard are identical to s.16 (2) of the Kenya Companies Act, in the case of Jubilee Cotton Mills v Lewis (2) The company's registration constitutes it "a body corporate". It becomes "a legal person", or "corpora corporata", whose name is the name chosen for it by its

(b)

promoters and written in its memorandum of association. The certificate of incorporation may therefore be regarded as the company's birth certificate and the date written therein as the company's birthday. The concept of a registered company as "a person" was consummated in the celebrated case of Salomon v Salomon & Co Ltd (3). 1.9 PRACTICAL CONSEQUENCES OF INCORPORATION In the course of delivering his judgment in Salomon's case Lord Halsbury stated that "once the company is incorporated, it must be treated like any other independent person with rights and liabilities appropriate to itself". This means that the company, as an independent person, has rights and obligations which are not the same as the rights and obligations of the subscribers to its memorandum and the other persons who will join it later as its members. This is the fundamental attribute of corporate personality which is given practical effect in the following ways: 1.9.1 Limited liability The fact that a registered company is a different person altogether from the subscribers to its memorandum and its other members means that the company's debts are not the debts of its members. If the company has borrowed money,it and it alone is under an obligation to repay the loan. The members are under no such obligation and cannot be asked to repay the loan. This is illustrated by the case of Salomon v Salomon & Co Ltd (3) in which it was held that Salomon, as a member, was not under an obligation to repay the company's debts. In case a company is unable to pay its debts the creditors, or a creditor, may petition the High Court for an order to wind it up. During the winding up the members will be called upon to pay the amount which is unpaid on the shares they hold, if any, in the case of a company limited by shares, or the amount prescribed by the memorandum, in the case of a company limited by guarantee, as provided in s.4(2) of the Act. It should be noted that, in the case of a company limited by shares, what the members are paying are the amounts they owe to the company as its debtors in respect of shares that were sold to them on credit and have not been paid for in full. The company's liquidator will in turn use the money so paid to pay off, or reduce, the company's debts. The other point to be noted is that a company's creditor cannot institute legal proceedings against a company's member in order to recover from him what he owes the company. This is because the member does not, legally,become his debtor merely because the company is his debtor. 1.9.2 Perpetual Succession According to the Concise Oxford Dictionary, "perpetual" means, inter alia, "applicable, valid, for ever or for indefinite time" while "succession" means "a following in order". When used in relation to registered companies the phrase "perpetual succession" denotes a process whereby a company's membership changes in a definite order prescribed by the company's articles and goes on for an indefinite period of time until the company's liquidation. The "perpetual succession" occurs because a company and its members are separate persons and so the company's legal life is not terminated by a member's death.

1.9.3 Owning of Property Under s.16 (2) of the Act a registered company, as a person, has power to own movable and immovable property. It can actually do so if it can afford to buy them, or receives them as a gift. But it is important to note that, legally, the company's property does not belong to the members, either individually or as a group. It belongs to the company alone. This rule has been explained by the English courts in numerous cases among which Macaura v Northern Assurance Co (4) may be referred to as an example. It was also explained in A L Underwood Ltd v Bank of Liverpool (5) that a company's money is not members' money. Any member who uses the company's money to purchase personal items or discharge personal obligations will be liable to the company for conversion. This rule applies irrespective of whether the company is of a class popularly referred to as 'a one-man company'. 1.9.4 Suing and being Sued Because a company is at law a different person altogether from its members it follows that a wrong to, or by, the company does not legally constitute a wrong to, or by, the company's members. Consequently: (a) A member or members cannot institute legal proceedings to redress a wrong to the company. The company as the injured party is, generally speaking,the proper plaintiff. This is illustrated by the facts of, and the decision in, Foss v Harbottle (6). A member cannot be sued to redress a wrong by the company. This is illustrated by Salomon v Salomon& Co Ltd (3) in which it was held that Salomon was not liable for the company's debts and should not therefore have been sued to recover them.

(b)

1.10

LIFTING THE VEIL OF INCORPORATION The legal rule that a registered company is at law a different person altogether from the subscribers to the memorandum of association and other persons who join the company later on as its members has been modified in instances which have come to be known in company law as"lifting the veil of incorporation". Such instances may arise under statutory provisions or case law. 1.10.1 Statutory Provisions The following are the sections of the Kenya Companies Act which correspond to those sections of the English Companies Act 1948 which are usually listed in English Company law textbooks as the instances in which the veil of incorporation will be lifted under express statutory provisions: (a) Section 33: Membership fallen below statutory minimum This section provides that a company's member is personally liable for the company's debts incurred after the six months during which the company's membership had fallen below the statutory minimum, provided he was cognizant of the fact that the membership had so fallen. The section is regarded as an instance of "lifting the veil" because it modifies the principle established in Salomon v Salomon & Co Ltd that a member is not liable for the company's

debts, and permits the company's creditors to sue him directly in order to recover the debts. Liability under the section may arise on the death of a member if the death reduces the membership below the statutory minimum for the particular company and: (i) (ii) no transferee is registered as a new member, and the personal representative of the deceased member does not elect to be registered as a member, within the prescribed six months.

It should be noted that the section limits a member's liability to debts contracted after the six months. It does not make the member liable for any debts incurred during the six months which follow the reduction of membership. Neither does it make a member liable for any tort committed by the company during the relevant time. (b) s.109(4): Non-publication of a Company's Name Subsection (1) of Section 109 of the Act requires a company's officers and other agents to write its name on its seal, letters, business documents and negotiable instruments. This is to be done primarily for the benefit of third parties who might contract with a limited company without realising that it is a limited company. Subsection (4) of the section provides that any officer or agent of the company who does not comply with the aforesaid statutory requirements shall be liable to a fine not exceeding one thousand shillings, and shall further be personally liable to the holder of any bill of exchange, promissory note, cheque or order for goods which did not bear the company's correct name, unless the amount due thereon is duly paid by the company. The imposition of personal liability on the company's agent is what is regarded, in a somewhat loose sense, as "lifting the veil of incorporation". A probably better view would be to regard the section as a codification of the common law rule which makes an agent personally liable under a contract which he enters into with a third party without disclosing that he is acting for a principal. That, in effect, is what happens if a company's agent does not comply with the statutory requirement. Liability under this section is illustrated by Nasau Steam Press v Tyler & Others (7) and Penrose v Martyr (8). In the latter case the plaintiff told the court that she was NOT aware that the company was limited till after the bills were accepted. She had therefore been misled as to the legal status of the company. It should however be noted that the section does not require that the third party suing the company's officer should have been misled by the officer's failure to write the company's name correctly. (c) s.150: Group Accounts Section 150 requires a company which has subsidiaries to lay before the company in general meeting accounts or statements dealing with the state of affairs and profit or loss of the company and the subsidiaries at the time when the company's own balance sheet and profit and loss account are laid before the company's general meeting. The group accounts are to be prepared in accordance with the provisions of Sections 150 - 154 and paragraphs 17 - 18 of the Sixth Schedule to the Companies Act so as to appear "as the accounts of

an actual company". These provisions constitute what is regarded in a loose sense as an instance of "lifting the veil" because a member (the holding company) is obliged to incorporate into its balance sheet the assets and liabilities of the company of which it is a member (the subsidiary company) as if they were its own assets and liabilities. This is a modification of the general principle that a company's assets and liabilities are not a member's assets and liabilities and would not therefore be incorporated into the member's own balance sheet. (d) s.167: Investigation of Company's Affairs Section 167 gives an inspector appointed by the court powers to investigate the affairs of that company's subsidiary, or holding company, if the inspector thinks it necessary to do so for the purpose of his investigation. An investigation instituted pursuant to this power would be regarded, in a loose sense, as an instance of "lifting the veil" because the order to investigate a company sufficed to investigate the company's member, or vice versa, as if they were one entity. Generally speaking, a company and its member (in this case, the holding company) are altogether separate entities and a court order to investigate the affairs of a subsidiary company would not authorise an investigation of its holding company, and vice versa. (e) s.173(5): Investigation of Company's Membership Section 173(1) empowers the registrar to appoint one or more competent inspectors to investigate and report on the membership of any company for the purpose of determining the true persons who are or have been financially interested in the success or failure of the company or able to control or materially to influence the policy of the company. For the purpose of that investigation, subsection 5 of the section confers on the inspector, or inspectors, power to investigate the membership of the company's subsidiary or holding company for the same purpose. A company and its subsidiary, or subsidiaries, are thereby regarded as one entity for the purpose of the investigation, and the veil of incorporation thereby lifted. (f) s.210: Take-over bids Section 210 provides that where a scheme or contract involving the transfer of shares or any class of shares in a company to another company has been approved by the holders of not less than nine-tenths in value of the shares whose transfer is involved the transferee company may, at any time within two months after the expiration of four months after the making of the offer by the transferee company, give notice in the prescribed manner to any dissenting shareholder that it desires to acquire his shares. The dissenting shareholder must then apply to the court within one month from the date on which the notice was given for an order restraining the transferee company from compulsorily acquiring his shares. The court order may, in an appropriate situation, lift the veil of incorporation. This is illustrated by Re: Bugle Press Ltd (9) in which an offer made by a company was regarded as having been made, in substance, by the company's members. The court thereby lifted the

veil of incorporation by treating the company and its members as one entity for purposes of acceptance of the offer. (g) s.323: Fraudulent Trading Section 323 provides that if, in the course of the winding up of a 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, on the application of the official receiver or the liquidator or any creditor or contributory of the company may, if it thinks proper so to do, declare that any persons who were knowingly parties to the carrying on of the business in manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct. The personal liability of the person concerned for the company's debts is what constitutes, in an extremely loose sense, an instance of lifting the veil of incorporation. The corresponding section of the English Companies Act is invariably cited in English company law text-books as an instance of lifting the veil. The citation, though hallowed by English academic tradition, is logically untenable. No Kenya case appears to have been decided under the section. However, the relevant English cases do suggest that to be "knowingly parties" to fraudulent trading under the section some positive step must have been taken by those concerned: Re: Maidstone Building Provisions Ltd (10). It should be noted that, on its literal construction, s.323 appears to be wider than s.33 because it also covers liabilities other than debts, such as liability in tort, or damages for breach of contract. It can also be invoked against directors, members or anybody else who participated in the fraudulent trading. However, the obvious limitations of the section is that it can only be invoked on a winding up and the applicant must prove fraud. If the liquidator applies to the court any money received is distributed to creditors generally and forms part of the general assets of the company: Re William C Leitch Ltd (No 2) (II). However, if a creditor applies the court may award him his actual loss or, alternatively, order the defendants to pay his actual debt: Re: Cyona Distributors Ltd (12). 1.10.2 Lifting the veil under Case Law Numerous English cases have been variously classified by English writers as instances of "lifting the veil of incorporation". A few of these cases are summarised below. But it should be noted that the particular judges were merely ascertaining the facts of the case before them and making the appropriate decision rather than consciously or deliberately "lifting the veil of incorporation". It is the writers who have categorised the said cases as instances of lifting the veil because the decisions in those cases appeared to them to be a modification of the principle in Salomon's case. These cases may be explained under the following headings. (a) Agency

One of the ratio decidendi in Salomon's case was stated by Lord Macnaghten that "the company is not in law the agent of the subscribers". This proposition was affirmed by the English Court of Appeal and extended to associated companies in Ebbw Vale Urban District Council v South Wales Traffic Area Licensing Authority when Lord Cohen stated: "Under the ordinary rules of law, a parent company and a subsidiary company, even a 100% subsidiary company, are distinct legal entities, and in the absence of an agency contract between the two companies, one cannot be said to be the agent of the other. That seems to me to be clearly established by Salomon v Salomon & Co Ltd (3). From this statement, it can be inferred that, if a court held that a company acted in a particular instance as an agent of its holding company, the veil of incorporation would have been lifted. This is illustrated by the decision in Firestone Tyre & Rubber Co v Llewellin (12) in which it was held, on the basis of the trading arrangements between the holding company and its subsidiary, that the subsidiary was the agent of the holding company. (b) Fraud or improper conduct English courts have intervened on numerous occasions and lifted the veil of incorporation in order to circumvent a fraudulent or improper design by a bunch of scheming promoters or shareholders. This is illustrated by the decisions in Jones and Another v Lipman and Another (13) and Gilford Motor Co Ltd v Horne (14). The court's order in the latter case is usually cited as an instance of lifting the veil but it should be noted that the defendant (Horne) was not a member of the company and, in principle, no veil existed between him and the company which would have been lifted by the court. It is rather an instance of the court regarding the company as Mr Horne in another form ("alter ego"). (c) Enemy Character A company may be regarded as an enemy if, inter alia, all or substantially all of its shares are held by alien enemies. This is illustrated by Daimler Co Ltd v Continental Tyre & Rubber Co (Great Britain) Ltd (15). Since there appears to be no Kenya case on the point, the principles summarised by Lord Parker may be useful guidance to a Kenyan who might have to determine, in a given case, whether a particular company is to be regarded as a friend or enemy of Kenya. (d) Ratification of Corporate Acts A number of English cases which are regarded as instances of lifting the veil are those relating to informal ratification by the members of acts done on behalf of the company. In each of these cases the court regarded a decision of the members as the decision of the company itself and thereby lifted the veil of incorporation. This is illustrated by Re: Duomatic Ltd (16) and Re: Express Engineering Works Ltd (17). (e) Group Enterprises

Numerous cases have been decided by English courts the general tenor of which is to regard a subsidiary and its holding company as one entity. There is no basic principle governing the lifting of the veil in these instances and each decision was based on the facts of the particular case. Examples are Harold Holdsworth & Co Ltd vCaddies (18), Hellenic and General Trust Ltd (19) and DHN Food Distributors v London Borough of Tower Hamlets (20). 1.11 UNINCORPORATED ASSOCIATIONS A group of people may come together in order to pursue or promote a common purpose or activity but without going through the various legal procedures that ultimately result in the creation of a registered company. In such cases the association will not be a body corporate. The legal consequences of what those people do will depend on the provisions of the Act of Parliament and the general law governing the activities in question. If the provisions of the Act are violated the law will disregard the apparent association and, if necessary, make the individuals personally responsible for the things that they have done while using the name of the association. The common examples of unincorporated associations are trade unions, societies and partnerships. 1.11.1 Trade Unions Trade Unions are registered under s.11 of the Trade Unions Act 1952 with the primary object of regulating the relations between employees and employers. Section 27(1) of the Act provides that a registered trade union may sue or be sued under its registered name. However, s.23 provides that no suit or other legal proceedings shall be maintainable in any civil court against any registered trade union or an officer or member thereof in respect of any act done in contemplation or furtherance of a trade dispute. s.24 bars any such suits in respect of any tortious act alleged to have been committed by or on behalf of the trade union. Under section 25, a trade union is liable on any contract entered into by it or by an agent acting on its behalf. Under s.24 all property of a registered trade union are vested in its trustees for the use and benefit of the union and its members, and is under the control of the trustees. 1.11.2 Societies Societies are associations registered under the Societies Act 1968. Section 2(1) of the Act defines a society very broadly as including any club, company, partnership or other association of ten or more people, other than a registered company, corporation, trade union, co-operative society, registered school, bank or partnership of more than twenty persons. Examples of such societies are political parties such as K.A.N.U. and FORD, welfare societies and amateur football clubs. Although registration under the Act does not confer corporate personality on the association it provides a legal framework for proper management of what may be loosely called the association's affairs, and the machinery for the orderly termination of the affairs. 1.11.3 Partnerships A partnership is defined by s.3(1) of the Partnership Act as "the relation which subsists between persons carrying on a business in common with a view of profit". This is a definition of the relation that exists between the individual persons who are

trading as partners, rather than a definition of the apparent entity called a partnership. A partnership is not a body corporate and, being legally non-existent, cannot carry on a business. Section 6 of the Act states that persons who have entered into partnership with one another, are called collectively a firm, and the name under which their business is carried on is called the firm-name. The basic differences between registered companies and partnerships are as follows: (a) Formation Registration is the legal pre-requisite for the formation of a registered company: Fort Hall Bakery Supply Co v Wangoe (1). The Partnership Act does not prescribe registration as a condition precedent to partnership formation. A partnership may therefore be formed informally or, if the partners deem it prudent, in writing under a Partnership Deed or Articles. (b) Legal Status A registered company enjoys the legal status of a body corporate which is conferred on it by the Companies Act. A partnership is not a body corporate and is non-existent in the contemplation of the law. Such business as appears to be carried on by it is in fact carried on by the individual partners. (c) Number of Members A registered private company must have at least two members under s.4 of the Companies Act and a maximum of fifty members (excluding current and former employees of the company who are also its members), under s.30 of the Act. A public registered company must have at least seven members under s.4 of the Companies Act but without a prescribed upper limit. A partnership cannot consist of more than 20 partners. (d) Transfer of Shares Shares in a registered company are freely transferable unless the company's articles incorporate restrictive provisions. A partnership has no shares as such but a partner cannot transfer his interest in the firm to a third party unless all the partners have agreed to the proposed transfer. (e) Management A company's members have no right to participate in the company's day to day management. Such management is vested in the board of directors. Partners have the right to participate in the firm's day to day management since s.3 of the Partnership Act requires the business to be carried on "in common". The right of participation in the firm's management is however not given to a partner who has limited his liability for the firm's debts.

(f)

Agency A member is not, per se, an agent of the company: Salomon v Salomon & Co Ltd (3). A partner is an agent of the firm because the business is carried on "in common" by the partners themselves. The Partnership Act, s.7 also expressly provides that every partner is an agent of the firm and his other partners for the purpose of the business of the partnership.

(g)

Liability of Members A company's member is not personally liable for the company's debts because, legally, they are not his debts. A partner is personally liable for the firm's debts. This rule has been codified by s.11 of the Partnership Act which provides that "every partner in a firm is liable jointly with the other partners for all debts and obligations of the firm incurred while he is a partner", unless the partner is a limited partner.

(h)

Powers The ultra vires doctrine limits a company's powers to the attainment of the company's objects under its memorandum of association. Partnerships are not affected by the ultra vires doctrine and partners enjoy relative freedom to diversify the firm's operations.

(i)

Termination A member's death, bankruptcy or insanity does not terminate the Company's legal existence whereas a partner's death, bankruptcy or insanity terminates the partnership unless the partnership agreement provides otherwise.

(j)

Borrowing Money A company can borrow on the security of a "floating charge". A partnership cannot borrow on a "floating charge".

(k)

Ownership of Property A company's property does not belong to the shareholders, either individually or collectively. Consequently, a member cannot insure the property since he has no insurable interest therein: Macaura v Northern Assurance Co (4). A firm's property is the property of the partners who can therefore insure it and, in the case of cash, make drawings from it.

PROMOTION

A company comes into existence from the moment of its registration by the registrar of companies. However, the registration is preceded by what is called "promotion". The promotion consists in taking the necessary steps to incorporate the company and ensuring that it has sufficient capital to commence its operations. 2.1 Promoters

There is no general statutory or judicial definition of the word "promoter". This is so because the Lawmakers in England as well as the English judges were of the view that a comprehensive definition of the word would be limiting, and might prevent the court from catching "the next ingenious rogue" who might be brought to the court to account for his actions as promoter. Kenya has adopted the applicable English law. English judges have however described the word 'promoter' in varying terminology of which the following may be quoted: (a) A promoter is "one who undertakes to form a company with reference to a given project a and to set it going and who takes the necessary steps to accomplish that purpose" (per Cockburn, J): Twycross v Grant. "The term 'promoter' is a term not of law, but of business, usefully summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence",(per Bowen, J): Whaley Bridge Calico Printing Co v Green. It should be noted that s.45(5) of the Companies Act does not contain a general definition of 'promoter'. It merely defines the word for purposes of sub-section (1) of section 45 by excluding from the category of promoters persons who give professional services in connection with the formation of the company. The answer to the question "who is a 'promoter' must therefore depend on the facts of a particular case. 2.2 Legal Status A promoter is not an agent of the company he promotes. However, the English courts have held that he stands in a fiduciary relationship to the company he promotes, just as an agent stands in a fiduciary relationship to his principal: Re Leeds & Hanley Theatre of Variety (21). 2.3 Duties In Gluckstein v Barnes (22) it was stated that a promoter is under a legal duty to disclose to the company any profits or financial benefits, that he derives from the promotion. In other words, he cannot make a secret profit out of the promotion just as an agent is not allowed to make a secret profit from the agency. The disclosure to the company is made to: (a) an independent board of directors that is not composed of, or dominated by, the promoters' stooges or cronies, failing which, the company's members (usually those invited by a prospectus to purchase the company's shares). If a promoter fails to make the requisite disclosure the company may (i) (ii) repudiate any contract entered into between it, and the promoter, or recover the secret profit from the promoter, as illustrated by Gluckstein v Barnes.

(b)

(b)

2.4

Payment to Promoters A promoter has no legal right against the company he promotes. The main reason is that the company did not ask him to promote it, and because the company could not make a valid contract with him before its incorporation. In the case of companies which have adopted Table A, Article 80 empowers the directors to pay promoters their promotion expenses. It is however a power given to the directors and confers no legal rights on the promoter.

2.5

Pre-incorporation Contracts A pre-incorporated contract is an agreement which is entered into, usually by a promoter or promoters, on behalf of a company at a time when the company's formation has not been completed by its registration. A few cases have been contested in English courts regarding the effect of such agreements. The following rules were enunciated by the judges in the course of deciding the said cases: (a) If the agreement is a written one and it is apparent from the words used therein that the promoters were contracting as individuals, they will be held personally liable under the contract. This will be so because no oral testimony will be admissible in evidence to rebut the contents of the written document: Kelner v Baxter (23). In other words, they will not be allowed to say that they were contracting for the company. Regarding the case of Kelner v Baxter it should be noted that, according to the written document that the parties signed, the offer was made to, and was accepted by, the promoters personally. They were therefore made personally liable on the contract. This was clarified by Lord Goddard in the later case of Newborne v Sensolid Ltd (24) when he said that, in Kelner v Baxter, "the contract showed that it (i.e. the wine) was agreed to be sold to certain men who were the proposed directors of a company which was coming into existence. They agreed to buy". (b) If the agreement is a written one and it shows that the proposed company was the contracting party the promoters will not be allowed to enforce it in the event of its breach by the other party. This was explained in Newborne v Sensolid (Great Britain) Ltd (25) in which the judge, after observing the way in which the agreement was signed, stated: "It is a case in which the company is contracting and the company's contract is authenticated by the signature of one of the directors. The only person who had any contract here was the company and Mr Newborne's signature merely confirmed the company's signature". Mr Newborne, the promoter, could not be allowed to come forward and say, "Well, it is my contract". He could not therefore sue for its breach. As the company was not in existence when the contract was signed, the legal position is that there never was a contract and the signed document was legally a nullity. (c) A pre-incorporation contract cannot be ratified by the company after its registration. This is demonstrated by the facts of, and the decision in, Natal Land Co Ltd v Pauline Colliery Syndicate Ltd (25). Although the court's reasoning is not explicit the rule appears to be a consequence of the common law rule that ratification has retrospective effect. If the company were allowed to ratify the contract it would mean that it contracted on the date the contract was formed. This in effect would mean that the company contracted before it was formed.

This is impossible in practice and the aforesaid rule also renders it legally impossible. If the company wishes to revive the abortive contract it must make a fresh offer and, if the offer is accepted by the other party, a contract will come into existence from the moment of the acceptance. THE COMPANY'S CONSTITUTION The constitution of a registered company consists of two documents, namely, the memorandum of association and the articles of association. The contents of these documents will now be examined in detail. 3.1 The Memorandum of Association Definition In relation to companies registered under the Companies Act, a Memorandum of Association was judicially defined by Lord Cairns in Ashbury Railway Carriage Co Ltd v Riche as "the charter" which "defines the limitation of the powers of a company to be established under the Act". 3.1.3 Contents The contents of a Memorandum of Association are prescribed by Section 5 of the Companies Act and comprise the following 6 clauses: (a) (b) (c) (d) (e) (f) Name Clause; Registered Office Clause; Objects Clause; Limitation of liability Clause; Capital Clause; and Association Clause.

The "association clause" is not prescribed by Section 5 but is found as one of the clauses in Table B in the first Schedule to the Act. 3.1.4 Statutory Form Section 14 of the Act provides that the form of the Memorandum of Association of a company limited by shares shall be in accordance with the form set out in Table B, or as near there to as circumstances admit. Table B is reproduced on the next page.

TABLE B FORM OF MEMORANDUM OF ASSOCIATION OF A COMPANY LIMITED BY SHARES 1st 2nd 3rd The name of the company is "The Lake Victoria Steam Packet Company Limited". The registered office of the company will be situate in Kenya. The objects for which the company is established are, "the conveyance of passengers and goods in ships or boats between such places as the company may from time to time determine, and the doing all such other things as are incidental or conducive to the attainment of the above object". The liability of the members is limited. The share capital of the company is two hundred thousand shillings divided into one thousand shares of two hundred shillings each.

4th 5th

We, the several persons whose names and addresses are subscribed, are desirous of being formed into a company, in pursue of this memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names. Names, Postal Addresses, and Occupation of Subscribers. 1 2 3 4 5 6 7 Total Shares taken Number of shares taken by each Subscriber Signature of subscriber

Dated the ........................................ day of ........................................, 19..... Witness to the above signatures

Table B is taken from the English Companies Act 1862 and has been modified in practice, especially as regards the 3rd clause.

3.1.5 The Name Clause 3.1.5.1Choice of Name The promoters of a proposed company have freedom to choose its name but the freedom is limited by s.19(2) of the Act which provides that a proposed

name must not, in the opinion of the registrar, be undesirable. The registrar of companies has not issued a circular explaining the criteria he is likely to use when deciding, in a particular case, whether a proposed name is undesirable under the section. However, it might be relevant to note that the registrar of English companies, pursuant to his powers under the corresponding section of the English Companies Act 1948, issued Practice Note No C 186 in which he stated that he would normally regard a proposed name as undesirable if: i. ii. It is too like the name of an existing company. It is misleading, for example, if the name of a company likely to have small resources suggests that it is going to trade on a great scale over a wide field. It suggests some connection with the crown or members of the Royal Family or royal patronage, including names containing such words as "Royal", "King", "Queen", "Princess" and "Crown". It suggests connection with a government department or any Municipality or other local authority or any body incorporated by Royal Charter or by statute or with the government of any part of the Commonwealth or of any foreign country. It contains the words "British", unless the undertaking is Britishcontrolled and entirely or almost entirely British-owned and is also of substantial size and importance in its particular field of business. It includes "Imperial", "Commonwealth", "National", "International", "Corporation", "Co-operative", "Building Society", "Bank", "Bankers", "Banking", "Investment Trust", or "Trust", unless the circumstances justify the inclusion. It includes a surname which is not that of a proposed director, unless the circumstances justify the inclusion. It includes words which might be trade marks, unless a trade mark clearance has been obtained. It is probably that the registrar of Companies in Kenya is guided by the above rules, modified mutatis mutandis, when deciding on the desirability of any proposed name. 3.1.5.2 Reservation of Name To obviate the risk of choosing a name that ultimately turns out to be undesirable, the promoters should enquire from the registrar whether the name they intend to give the company is "too like" that of a company already in the register of companies. After obtaining confirmation that the name is a registerable one they should immediately make a written application for its reservation under s.19(1)(a) of the Act. Any such reservation shall remain in force for a period of thirty days or such longer period, not exceeding sixty days, as the registrar may, for special reasons, allow. No other company shall be entitled to be registered with the reserved name.

iii.

iv.

v.

vi.

vii.

viii.

These statutory provisions regarding the choice of a company's name are intended to confer on the company legal monopoly of its name. Because it lacks physical attributes which could assist its customers to differentiate it from another company with a similar name, a company can only rely on the legal monopoly of its name as its ultimate protection against what might constitute unfair instances of passing-off. They also avoid a situation in which two or more companies use one name with the resultant problem of identifying the company that is the contracting party in a commercial transaction. 3.1.5.3 Name to end with the word "Limited" S.5(1)(a) provides that the word "limited" must be the last word of the name of a company which is to be limited by shares or by guarantee. In Durham Fancy Goods Ltd v Michael Jackson (Fancy Goods) Ltd Donaldson, J, stated: "The word "Limited" is included in a company's name by way of description and not identification. Accordingly, a generally accepted abbreviation will serve this purpose as well as the word in full. The rest of the name, by contrast, serves as a means of identification". The use of the mystic word "limited' as the last word of a company's name is explicable only in the context of the historical evolution of English Company law. It was prescribed for the first time for English companies in 1856 by the Joint Stock Companies Act of that year and, in the words of Professor Gower, "was intended to act as a red flag warning the public of the dangers which they ran if they had dealings with the dangerous new invention". A member of the public dealing with a business organisation whose name ended with "ltd" was to be made aware that he was not dealing with a partnership and so could only blame himself if he burnt his fingers in the process. Its function may be likened to that of the ring on a married person's finger. 3.1.5.4 Power to dispense with the word "Limited" Although s.5 provides that the last word of the name of a limited company must be "limited" this would not be so if the Minister (probably the AttorneyGeneral) empowers the company to dispense with it. The Minister would do so "by licence" if he is satisfied that an association about to be formed as a limited company is to be formed for promoting commerce, art, science, religion, charity, or any other useful object, and it is intended that its profits, if any, or other income would be used in promoting its objects and the payment of any dividends to the association's members is prohibited. An existing registered company may obtain a licence to make, by special resolution, a change in its name so as to omit the word "Limited" from the end thereof. This can be done only after proving, inter alia, that the company is formed to promote charity and is prohibited from paying dividends to its members. A licence may be granted on such conditions as the Minister thinks fit and may, upon the recommendation of the registrar, be revoked by him subject to the company's right to be heard in opposition to the revocation. A company granted exemption under s.21 of the Act is also exempt from the requirements of s.109(1) which relate to the publication of the company's name.

3.1.5.5

Change of Name A company's name may be changed voluntarily or compulsorily (a) Voluntary Change A company's name may be changed voluntarily: i. Under s.20(1) if a special resolution is passed by the company for that purpose after obtaining the written approval of the registrar. The registrar's approval is required so as to ensure that he does not later on reject the proposed name on the ground that it is undesirable. Under section 20(2) if the name was inadvertently registered by a name which, in the opinion of the registrar, is too like the name by which a company in existence is previously registered. No particular type of resolution is prescribed by the section and the change may therefore be made by ordinary resolution. Although the section does not make it mandatory for the company to change its name it is advisable for the company to take immediate steps to effect the change as soon as it becomes aware of the situation. Any delay entails the risk of a passing-off action being instituted against the company. iii. Under section 21(2) if the Minister, by licence, authorises a company to make a change in its name. The change has to be made by special resolution so as to omit the word "limited" from the company's name.

ii.

(b)

Compulsory Change Section 20(2) of the Act provides that within six months of registration with a particular name the registrar may direct a change in name if in his opinion the name is "too like" that of a pre-existing company. In the event of such direction the change shall be made within a period of six weeks from the date of the direction or such longer period as he may think fit to allow. A change of name under this section may be made by ordinary resolution. Failure to comply with the registrar's directive is an offence punishable by a fine not exceeding one hundred shillings for every day during which the default continues. After a company changes its name under any of the above provisions it shall give to the registrar notice thereof within fourteen days. Upon receipt of the notice, the registrar shall i. ii. iii. enter the new name on the register in place of the former name; issue to the company a certificate of change of name; and publish the change of name in the Kenya Gazette.

Where a company changes its name either voluntarily or compulsorily the change will not affect any of its rights or obligations or render defective any legal proceedings by or against it, and any such proceedings may be continued or commenced against it by its new name. 3.1.5.6Publication of Name Section 109(1) requires every company (except one exempted under s.21): (a) To paint or affix its name in a conspicuous position on the outside of every office or place in which its business is carried on and to keep it so painted or affixed; To mention its name on all letters, notices, official publications, bills of exchange, promissory notes, endorsements, cheques, bills of parcels, orders, invoices, receipts and letters of credit of the company; and To engrave its name on its seal which shall be in the form of an embossed metal die.

(b)

(c)

If a company does not paint or affix its name as prescribed, the company and every officer in default are liable to a fine not exceeding one hundred shillings and if the company does not keep its name painted or affixed as prescribed, the company and the officer in default shall be liable to a default fine. In the event of failure to comply with (b) or (c) above, the company and the offiver responsible shall liable to a fine not exceeding one thousand shillings and the officer may be made personally liable to any creditor who has relied on the document, if the company fails to pay. This personal liability has been explained in paragraph 1.10.1(b) above, under "lifting the veil of incorporation". 3.1.5.7 Business Names If a company has a place of business in Kenya and carries on business under a business name which does not consist of its corporate name without any addition, the company must, within twenty-eight days after commencing business under the business name, submit to the registrar of business names a statement, called the Statement of Particulars, which contains the following particulars(a) (b) (c) the business name; the general nature of the business; the full address of the principal place of business and the postal address of the company;

(d) (e) (f)

the full address of every other place of business; the company's corporate name and registered and principal office, and the date of the commencement of business. Changes in the registered particulars (other than (e) and (f)) must be notified on the appropriate form within twenty-eight days after such change. If there is a default in registration, the persons in default are liable to a fine and, unless the court gives relief, the rights of the defaulter in relation to the business in question are unenforceable by the defaulter by action: Registration of Business Names Act, ss.10 - 11.

3.1.5.8

Restricted Names Section 17)1) of the Registration of Business Names Act provides that no company shall be registered under a business name: (a) which contains any word which, in the opinion of the registrar, is likely to mislead the public as to the nationality, race, or religion of the person by whom the business is wholly or mainly owned or controlled; which includes any of the words "Imperial", "Royal", "Crown", "Empire", "Government", "Municipal" or any other word which imports or suggests that the business enjoys the Queen's patronage or the patronage of any member of the Royal Family or of the government; which includes the word "Co-operative" or its equivalent in any other language or any abbreviation thereof, or which is identical with or is similar to that of a business or corporation existing, or is already registered under the Act or under the Companies Act, if in the opinion of the registrar, such registration would be likely to mislead the public.

(b)

(c)

(d)

3.1.5.9

Change of Business Name Section 17(4) of the Registration of Business Names Act provides that if (a) any company is, through inadvertence or otherwise, registered under a business name under which registration under the Act ought to have been refused; or any change of ownership of a business occurs as a result of which a company carrying on a business under a business name which, on an application for registration under the Act, ought to have been refused, the registrar shall, by notice in writing, require the company to change such business name within a time specified in the notice. The registrar is empowered to cancel the registered business name if the company fails to change it after he directed it to do so.

(b)

3.1.5.10 Prohibition Section 18 of the Registration of Business Names Act provides that the registration of a company's business name under the Act shall not be construed as authorising the use of a business name if, apart from such registration, the use thereof could be prohibited. 3.1.5.11 Publication of True Names Section 23(1) of the Registration of Business Names Act provides that a company using a business name distinct from its corporate name must disclose its corporate name in all trade circulars and business letters on or in which the business name appears and which are issued or sent by the company to any person. Failure to comply with this provision renders the company guilty of an offence punishable by a fine not exceeding one thousand shillings. 3.1.6 THE REGISTERED OFFICE CLAUSE 3.1.6.1 Section 5(1) (b) provides that the memorandum of association shall state that "the registered office of the company is to be situate in Kenya". The situation of the registered office in Kenya fixes the company's nationality as Kenyan and its domicile as Kenya, though not its residence. Residence is decided by ascertaining where the company's centre of management and control is. Thus a company may be resident in a number of countries where it has several centres of control in different countries. The residence of a company is important in connection with its liability to pay Kenya taxation.

3.1.6.2 Function of the Registered Office Section 107(1) provides that a company shall, as from the day on which it begins to carry on business or as from the fourteenth day after the date of its incorporation, whichever is the earlier, have a registered office and a registered postal address to which all communications and notices may be addressed. S.108(1) requires notice of the situation of the registered office and the registered postal address, and of any change therein, to be given within fourteen days after the date of incorporation of the company or of the change, as the case may be, to the registrar for registration. Failure to comply with the requirements of these sections renders the company, and every officer of the company who is in default, liable to a default fine. The primary function of the registered office is to act as the company's official address. It provides a convenient place where legal documents, notices, and other communications can be served. Section 391(1) provides that a document may be served on a company by, inter alia, leaving it at the registered office of the company. The following registers and documents are also kept at the company's registered office:i. The register of members, and if the company has one, the index of members, unless the register is made up elsewhere, in which case they can be kept where they are made up. Where the register and index (if any) are made up by an agent, they may be kept at the agent's office

(s.112 - 113). ii. iii. The register of directors and secretaries (s.201(1)). The company's register of charges (if the company is a limited company) (s.105(1)). A copy of any instrument creating any charge requiring registration under Part IV of the Act (s.104). The register of debenture holders (s.88(1). The register of directors' interests in shares in, or debentures of, the company or associated companies (s.196(1)). The minute books of general meetings (s.146(1)).

iv.

v. vi.

vii.

The above registers and documents are subject to the following rights of inspection: (a) The company's members are entitled to inspect them, free of charge, during business hours for at least two hours each day. Debenture holders of the company are entitled to inspect, free of charge, the register of debenture holders and, during the period beginning fourteen days before the date of the company's annual general meeting and ending three days after the date of its conclusion, the register of directors' shareholding. Any member of the public is entitled to inspect the register of directors and secretaries and the register of debenture holders on payment of a prescribed fee not exceeding two shillings for each inspection.

(b)

(c)

3.1.7 THE OBJECTS CLAUSE 3.1.7.1 Reasons for Stating Objects Section 5 (1) (c) requires the memorandum of association to state the objects of the company. The section does not however indicate why a company's objects have to be stated in the company's memorandum of association. In Cotman v Brougham (21) Lord Parker stated that the statement of a company's objects in its memorandum of association is intended to serve the following purposes: (a) To protect subscribers who learn from it the purpose to which their money can be applied. To protect persons who deal with the company and who can infer from it the extent of the company's powers.

(b)

These propositions will become clearer after a study of the doctrine of ultra vires. 3.1.7.2 The Doctrine of 'Ultra Vires'

The doctrine of ultra vires is a legal rule that was articulated by the House of Lords in the case of Ashbury Rail, Carriage and Iron Co Ltd v Riche (22) to the effect that, where a contract made by a company (usually by the directors on its behalf) is beyond the objects of the company as written in the company's memorandum of association, it is beyond the powers of the company to make the contract. The contract is void, illegal and unenforceable. Lord Cairns stated in an obiter dictum that such a contract cannot be ratified even by the unanimous consent of all the shareholders of the company. His Lordship observed that any purported ratification would mean that "the shareholders would thereby, by unanimous consent, have been attempting to do the very thing which, by Act of Parliament, they were prohibited from doing". A company's objects are stated pursuant to the provisions of an Act of Parliament. It must therefore be deduced, for example, that a company whose object has been stated to be "gold mining" cannot engage in "fried fish" business. This is because (a) Prospective investors who read the objects clause realised that the company was formed to mine gold. If they bought the company's shares they did so because they intended their money to be used in pursuance of the gold mining business. They did not give the money for any other business and the company does not have their consent to use it on any other business. If the company tries to use the money on a different venture, such as frying fish and chips, they can go to court for an injunction to restrain it from doing so. The statutory requirement that a company must state its objects in its memorandum would be rendered purposeless if, despite having stated the objects, the company was legally entitled to embark on any other activity. To prevent this happening, the courts concluded that the statement of objects would be taken to mean that what is not stated as an object cannot be pursued, or undertaken, by the company. In other words, the statutory requirement that the objects are to be stated implies that what has not been stated as an object cannot become a legitimate activity of the company.

(b)

3.1.7.3

Implied Powers The statement of Lord Cairns in 1875 in Ashbury Rail Co Ltd v Riche (22) to the effect that a contract beyond the objects of the company "in the memorandum of association" is "beyond the powers" of the company gives the impression that a company has no legal power to do anything which is not written in the memorandum of association. That would be a startling proposition because, in practice, companies have to do so many things in the course of their business that if all those things were to be written down in the memorandum of association, the memorandum would be such a gigantic document that nobody would print or read. It was therefore a welcome clarification of the legal position when, in 1880, Lord Selborne, L C, stated in Attorney-General v Great Eastern Railway Co that the doctrine of ultra vires, as explained in the Ashbury case, "ought to be reasonably, and not unreasonably, understood and applied". His Lordship then explained that it is not necessary for a company to write down in its memorandum everything that it would or could do in the course of its business because whatever may fairly

be regarded as incidental to, or consequential upon, those things which have been stated in the memorandum ought not, and would not, be held by the courts to be ultra vires. The courts would regard such things as impliedly within the company's powers unless they are "expressly prohibited" by the memorandum. The range of transactions that could be encompassed within the "implied powers rule" was illustrated by Lord Buckley in 1907 when, in Attorney - General v Mersey Railway Co, he stated: "To ascertain whether any particular act is ultra vires or not the (stated objects) must first be ascertained; then the special powers for effectuating those (objects) must be looked for, and then, if the act is not within either the (stated objects) as described in the memorandum, the inquiry remains whether the act is incidental to or consequential upon the (stated objects) and is a thing reasonably to be done for effectuating it ... By way of illustration, let me suppose that the (stated object) found in the memorandum of association of a (registered) company is to establish and carry on a hotel, and that express power is given to buy land at a particular place and to build and that as to anything further the... memorandum of association is silent. It is quite clear that all such acts as are reasonably necessary for effectuating that purpose are intra vires, such, for instance, as the purchase of furniture, and of linen, of provisions, and of wines and spirits, the hiring of servants, the payment of licences, the ownership probably of horses and carriages, the maintenance and working of an omnibus which shall attend at the railway station to take intending guests to the hotel and the like. In a large number of cases the maintenance of a garden and pleasure grounds would be intra vires... The maintenance of tennis lawns or of a bowling green would, in many circumstances, be legitimate. Under circumstances such as presently put, a golf links might be intra vires. All these and the like will without express mention be within the company's powers. Then I may instance other acts as to which it would be a question of fact in the case of the particular hotel whether it was such an act as was reasonably incidental or consequential. If, for instance, the hotel were at Bundoran or Rosapenna or elsewhere in the country it might be intra vires to lay out and maintain in good order a golf links or to acquire rights of fishing and to own boats and supply gillies for the purpose of fishing upon the lakes. It may be that in the particular locality customers could only be reasonably expected or obtained by offering these attractions, and they might be as necessary as a smoking-room or a bowling green elsewhere. If the hotel in question were the Savoy Hotel in the Strand or the Great Central Hotel in the Marylebone Road the proposition would cease to be true. So, again, if the hotel were situated in a place inaccessible unless special means of communication were providedsay, at a lovely spot at the end of a Scotch Loch to which there is no road, or at a place to which there is access by road but which is not served by any coach or mail cart serviceit might be intra vires for that hotel to run a steam launch or a motor-car to bring its guests to their destination. It would in such a case be analogous to the omnibus which the hotel in the country town sends to the railway station. The question is in each case a question of fact. Is the particular act as to which it is in question whether it is intra vires an act which in the circumstances of that particular case is incidental to or consequential upon or reasonably necessary for effectuating the object which the memorandum defines?..........." The gist of Lord Buckley's statement, above, may be summarised as follows: The judges will not regard a transaction undertaken by a company as ultra vires merely because it is not written in the company's memorandum of

association as one of the company's objects. They would in fact regard the transaction as intra vires by implication if i. it was reasonably incidental to any of the objects which have been written in the company's memorandum of association, and it was undertaken for the sole purpose of effectuating, or achieving, the written objects, or any of them.

ii.

Regarding the criteria to be used when deciding on whether a proposed transaction is "reasonably incidental" to the objects written in the memorandum, it was stated in Henderson v Bank of Australia (1888) that what other companies with similar objects do may be a good guide for a company regarding its implied powers. But it appears that, provided a transaction is decided on by the company (at a board or general meeting) in the bona fide belief that its pursuit would enable the company to get more customers or do more business, the court would not regard the transaction as ultra vires even though it may doubt its "reasonableness". It has also been clarified in numerous English cases that a trading company has implied power: i. ii. iii. iv. to borrow money and mortgage its property as security for the loan; to institute and defend legal proceedings; to sell the company's assets (but not the entire undertaking); to pay gratuities and pensions to employees and ex-employees and their dependants whilst the company is a going concern.

3.1.7.4 The Doctrine of "Constructive Notice" The doctrine of "constructive notice" is a rule of company law to the effect that a person transacting business with a company is taken to be aware of the contents of the company's public documents. "Public documents" in this context are those documents which a company is required by the Companies Act to deliver to the Registrar of Companies for registration at the Companies Registry. Examples of such documents are: (a) (b) (c) (d) the memorandum of association; the articles of association; the annual return; and special resolutions.

Because the Companies Registry is a "public office" the documents kept therein are generally referred to as "public documents" since members of the public are free to inspect them on payment of a prescribed fee. For purposes of the ultra vires doctrine, a person transacting business with a company will be taken to have read the objects clause in the company's memorandum of association. Consequently, if he concludes a contract with the company and it turns out that the contract was for a purpose which is neither expressly nor impliedly within the company's objects and hence ultra vires, he

is regarded as having entered into an ultra vires contract knowingly even though he was not actually aware of its being ultra vires. He cannot successfully sue the company for breach of the contract, as illustrated by the facts of, and the decision in, Ashbury Railway & Carriage Co v Riche (22). The legal justification for this rule is that since the company's public documents in its file at the Companies Registry are available there for inspection by any interested member of the public he should have gone to the Registry, asked for the Company's file, inspect the contents and, having found the memorandum of association, read the objects clause in order to ascertain whether the proposed contract is consistent with the company's objects. He would then have realised that the contract was not within the company's objects. If he fails to do so and it happens that the concluded contract was neither expressly nor impliedly within the company's objects, he will be regarded as having been aware that the contract was ultra vires. He cannot therefore be allowed to enforce it. The "constructive notice' rule may be likened to the old adage, "you can take a donkey to the river but you cannot force it to drink", but with the addition that, on your way back home, you would be entitled to tell the donkey: "Since you have simply refused to drink for no apparent reason, I will take it that you have drunk for today. I will therefore not take you to the river again today but will do so tomorrow when the drinking time comes". There appears to be no moral justification for allowing a person contracting with a company to rely on his own inaction as the basis for instituting legal proceedings against the company. It is rather tempting to say that the law, like God, protects only those who also protect themselves. The only plausible criticism that could be made against the constructive notice rule is its assumption that a potential contracting party who reads a company's objects will be able to make the correct legal conclusion regarding the vires of the proposed transaction, and its refusal to validate the transaction in cases where the party mistakenly believed the proposed contract to be intra vires the company. The fact that a perusal of the company's objects clause does not guarantee its correct interpretation is amply demonstrated by a number of English cases in which judges of the High Court, having read a disputed clause, concluded that the transaction was intra vires but the decision was later on reversed by the Court of Appeal or the House of Lords. If such senior judges can differ over the vires of a particular transaction, why should an ordinary businessman, or his legal advisor, be expected to decide the matter correctly? A close study of some of the relevant English cases pertaining to this issue, particularly the Ashbury case, seem to indicate that the decision of the higher court which finally disposed of the case was "correct" only in the sense that the higher court, being constitutionally mandated to make the final decision, also made the "correct" decision. There seems to be no legal justification for retention of the constructive notice rule. The fact that a person intending to contract with a company read the company's objects does not guarantee that he will interpret it correctly. And there appears to be no moral justification for blaming a person for not making a decision that was beyond his technical competence to make.

3.1.7.5

Effect of Ultra Vires Transaction An ultra vires transaction with a company may result in: (a) (b) a transfer of specific property to the company, or money being lent to the company.

The remedies available against the company will be as follows. 1. Property Transferred If specific property is transferred to a company pursuant to a transaction which, unknown to the transferor, is ultra vires the company, the ownership of the property is not transferred. The property remains the property of the transferor while the company only acquires possession of it. This is because an ultra vires transaction cannot constitute a "contract" which, pursuant to the Sale of Goods Act, s.3, is capable of vesting or transferring the ownership of the property in the transferee company. The transferor, on becoming aware of the legal position, would be entitled to trace his property and, on finding it, take possession of it. This remedy is known as "tracing". The company has no right to retain the property and its attempt to do so would constitute the tort of detinue. The other consequence of this rule is that, since there was no contract of sale, the transferor cannot sue the company for breach of contract, or the agreed price. The legal position in the converse situation is not clear. It is probable that the company cannot recover its property by tracing if the transferee is willing to pay the agreed price. However, the company might be able to recover it if the transferee has failed or refused to pay for it because to allow him to retain it after refusing to pay for it would constitute "unjust enrichment" which a court of equity is unlikely to condone. 2. Money Lent According to the decision in Re: David Payne & Co Ltd (23), a person lending money to a company is not bound to enquire as to why the company requires the money. He is entitled to assume that the money is being borrowed for the company's legitimate objects. His legal right to enforce the transaction will not be affected by the company's application of the borrowed funds to an ultra vires purpose. However, if the lender is told the purpose of the loan, he must read the company's memorandum of association to ascertain if the stated purpose is consistent with the company's objects, expressly or by implication. If he does not do so and the purpose turns out to be an ultra vires one, he will be deemed to have financed an ultra vires transaction knowingly: Re Introductions Ltd (25). He would not be entitled to sue the company for breach of contract.

3.1.7.6

Remedies of the Ultra Vires Lender In Sinclair v Brougham (26) the House of Lords explained that no action or suit lies at law or in equity to recover money lent to a company which has borrowed for an ultra vires purpose. This means that the ultra vires lender cannot sue, as lender, to recover the money he lent to the company. However, he might avail himself of one or other of the following remedies which were summarised by Buckley, J. in Re Birkbeck Permanent Benefit Building Society: i. If the result of the transaction is that the indebtedness of the company is not increased because the new loan was applied in discharging an old debt, the invalid lender can be treated as standing in the place of those whose debts have been paid off. In such a case the ultra vires loan "is not to be regarded as a borrowing transaction". The aforesaid remedy would also be available if the loan was applied in discharging a future debt (ie an indebtedness which was incurred after the money was borrowed). The basis of this remedy is that, since the company could legally become indebted in respect of the future debt, the lender whose money discharged it would be subrogated to the rights of the discharged creditor. However, he would be entitled to rank as a creditor of the company only to the extent to which his money was applied in discharging the intra vires debt and would not obtain the benefit of any security held by the intra vires creditor (although he would be entitled to enforce any security which was given to him). iii. If the lender can identify his money or the investment of his money in the hands of the borrowing company, he can call for its return. The basis of this remedy was explained by Lord Parker in Sinclair v Brougham (26) as follows: "A company or other statutory association cannot by itself or through an agent be party to an ultra vires act. If its directors or agents affecting to act on its behalf borrow money which it has no power to borrow, the money borrowed is in their hands the property of the lender." iv. If the lender cannot bring himself within any of the above propositions he would have no remedy except to participate in the division of the company's surplus assets, if any, which would be divisible among the ultra vires creditors rateably during the company's liquidation after all the company's members have received back their capital in full.

ii.

3.1.7.7

Alteration of Objects S.7 of the Act provides that a company shall not alter the "conditions" (ie contents) of its memorandum except in the cases, in the mode and to the extent for which express provision is made in the Act. This provision confers a special status on the memorandum as the basic document of the company whose contents are statutorily prescribed and protected.

Regarding alteration of objects, s.8 provides that a company may, by special resolution. alter the provisions of its memorandum with respect to its objects if the alteration would enable the company: i. To carry on its business more economically or more efficiently. In Re: Cyclists Touring Club (27) Warrington, J. stated that the alteration which is contemplated in this clause "seems ... to be an alteration which will leave the business of the company substantially what it was before, with only such changes in the mode of conducting it as will enable it to be carried on more economically or more efficiently". The clause does not permit alterations in the type of business which the company is conducting. ii. To attain its main purpose by new or improved means. This provision is not clear. It seems to be intended to facilitate the introduction of new powers which would assist in the achievement of the company's main "purpose" or object. If so, it would be a superfluous provision since a company has implied power to do anything which would enable it to achieve its main (ie stated) objects. iii. To enlarge or change the local area of its operations. If a proposed alteration under this clause was opposed by the prescribed number of the company's members the court could make it a condition of its confirmation that the company alters its name as well: Re: Egyptian Delta Land and Investment Co Ltd (28). iv. To carry on some business which under existing circumstances may conveniently or advantageously be combined with the business of the company. In Re: Cyclists Touring Club (27) it was held that, for a proposed alteration to fall under this clause, it must be "a proposal to combine a business of one kind with a business of another kind". The businesses must be of different kinds so that they may be "combined" and carried on by the company. If they were of the same kind the company would merely have enlarged or expanded the existing business. The key word in this clause is "combined". v. To restrict or abandon any of the objects specified in the memorandum: See Re: Hampstead Garden Suburb Trust Ltd (29). To sell or dispose of the whole or any part of the undertaking of the company. To amalgamate with any other company or body of persons.

vi.

vii.

In order to effect a proposed alteration the company's directors would have to convene an extraordinary general meeting of the company in order to consider and, if approved, pass a special resolution that the company's objects be altered as proposed. The general meeting may however change the text of the resolution so as to conform to its wishes provided that it falls within one or

other of the specified clauses. The resolution would be effective immediately it is passed if it was voted for by the holders of at least 86% in nominal value of the company's issued share capital or any class thereof or, if the company is not limited by shares, at least 86% of the members (assuming that the company does not have debenture holders who are entitled to object to alterations of its objects). This would be so even if the purpose of the alteration does not fall within the restrictions prescribed by the Act since no application could be made to the court to cancel the alteration. Such an application can only be made by or on behalf of (a) the holders of not less in the aggregate than 15% in nominal value of the company's issued share capital or any class thereof or, if the company is not limited by shares, not less than 15% of the company's members; or the holders of not less that 15% of the company's debentures entitling the holders to object to alterations of its objects. An application to the court cannot however be made by a person who consented to or voted in favour of the alteration. In the event of the application for cancellation being made the court is empowered to make an order: i. Cancelling the alteration. This is illustrated by Re: Cyclists Touring Club (27) in which the court refused to confirm the proposed alteration because it did not fall within any of the prescribed exceptions. Confirming the alteration either wholly or in part and on such terms and conditions as it thinks fit. The power to confirm in part was exercised in Re: Parent Tyre Co (30), while the power to confirm on conditions was exercised in Re: Egyptian Delta Land and Investment Co Ltd (28). Adjourning the proceedings in order that an arrangement may be made for the purchase of the interests of the dissenting members. In such a case the court may give such directions and make such orders as it may think expedient for facilitating or carrying the arrangement into effect. However, no part of the capital of the company can be expended in any such purchase. Where a company passes a resolution altering its objects and no application is made to the court for its cancellation it shall, within fourteen days from the end of the period allowed for making such an application, deliver to the registrar a printed copy of its altered memorandum. If an application is made the company shall (a) (b) forthwith give notice of that fact to the registrar, and within fourteen days from the date of the order cancelling or confirming the alteration wholly or in part, (or within such extended time as the court may allow) deliver to the registrar a certified copy of the order and, if the alteration is confirmed wholly or in part, a printed copy of the memorandum as altered.

(b)

ii.

iii.

3.1.8 LIMITED LIABILITY CLAUSE 3.1.8.1 Contents of the Clause Section 5(2) provides that the memorandum of a company limited by shares or by guarantee shall also state that "the liability of its members is limited". 3.1.8.2 Companies limited by shares Most registered companies, both public and private, are companies limited by shares. Such a company is defined by s.4(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". It should be noted that it is the liability of the company's members which is limited and not the company's own liability. To that extent the word "Ltd" at the end of the name of such a company is actually misleading. In such a company the capital is divided into shares of a specified amount, for example, capital of 100,000 shillings divided into 10,000 shares of 10/shillings each. Every member of the company is liable to pay 10/-for every share he holds and if, he has already paid the 10/-, he is not liable. If he has not paid the whole amount, he will be liable to pay the balance only. 3.1.8.3 Companies limited by guarantee S.4(2)(b) defines a company limited by guarantee 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". The memorandum of such a company would have a clause stating that "every member of the company undertakes to contribute to the assets of the company in the event of its being wound up while he is a member... such amount as may be required, not exceeding (so many) shillings". The member's liability is contingent and he can only be called upon to pay the amount "guaranteed" if the company is in liquidation. A company limited by guarantee may also have a share capital. The model memorandum and articles of association of such a company is Table D in the First Schedule to the Companies Act. The members of such a company have dual liability, that is, to pay the amount unpaid on their shares and the amount of the guarantee. The model memorandum and articles of association of a company limited by guarantee and not having a share capital is Table C in the First Schedule to the Companies Act. 3.1.8.4 Unlimited companies S.4(2)(c) defines an "unlimited company" as a company not having any limit on the liability of its members". In such a case, although the company is a separate legal entity, the members' liability resembles that of partners except that, technically, their liability is to the company itself and not to the creditors. An unlimited company may also have a share capital. The memorandum and articles of association of such a company would substantially correspond to Table E in the First Schedule to the Companies Act.

3.1.9 CAPITAL CLAUSE 3.1.9.1 Section 5(4)(a) provides that, in the case of a company having a share capital, the memorandum shall also (unless the company is an unlimited company) state "the amount of share capital with which the company proposes to be registered and the division thereof into shares of a fixed amount". Table B in the First Schedule to the Act, in pursuance of this provision, states that "The share capital of the company is two hundred thousand shillings divided into one thousand shares of two hundred shillings each". Reasons for stating capital The Act does not expressly state the reasons why the capital of a company should be stated. However, there is a clue in the qualifying words "unless the company is an unlimited company". This means that if a company has a share capital but is registered as an unlimited company the amount of the capital need not be stated in the memorandum. This is so because the company's creditors would NOT rely on that capital as their primary security. They need not therefore be informed about its quantum. The creditors of such a company would rely primarily on the members' private assets and their personal liability as their security for any money they lend to the company. It may therefore be said that the proposed capital of a limited company is stated in its memorandum of association so that the company's potential creditors may read the memorandum in order to ascertain the amount of the capital as stated therein. Having ascertained the amount they could then decide on the amount to lend to the company. This is so because, legally, the capital is their primary security for any money they lend to the company. In Ooregum Gold Mining Co of India Ltd v Roper Lord Halsbury stated that "the capital is fixed and certain and every creditor of the company is entitled to look to that capital as his security". 3.1.10 THE ASSOCIATION CLAUSE 3.1.10.1 What has generally come to be known as "the association clause" is not provided for in s.5 of the Companies Act which prescribes the contents of the memorandum of association. It is however the popular or academic designation of the last paragraph of Table B which contains a declaration that the subscribers to the memorandum of association "are desirous of being formed into a company, in pursuance of this memorandum of association and ... agree to take the number of shares in the company" set opposite their respective names. 3.1.10.2 The declarants then sign the memorandum and their signatures are then witnessed by at least one person who is not a subscriber. 3.1.11 OTHER CLAUSES 3.1.11.1 The clauses enumerated and explained above form part of the memorandum of association pursuant to the provisions of s.5 of the Companies Act. However, other clauses may be included in the memorandum, such as a clause providing special rights for different classes of shares. Such a clause is usually placed in the articles of association but is occasionally incorporated into the memorandum if it is the intention of the promoters that it should, as it were, be

3.1.9.2

"entrenched" (ie one which is more difficult to alter or is unalterable). 3.1.12 ALTERATION OF THE MEMORANDUM GENERALLY 3.1.12.1 Every clause of the memorandum may be altered except the registered office clause which constitutes Kenya the company's domicile. In addition to the methods of alteration of the name clause and the objects clause which have already been explained in paragraph 3.1.5.5 and paragraph 3.1.7.7, respectively, s.25 allows a company to alter clauses that are included in its memorandum but could lawfully have been contained in the articles. Such clauses can be altered by special resolution except where the memorandum itself provides for or prohibits the alteration of all or any of the said conditions. Holders of 15% of the issued shares have thirty days to apply to the court to challenge the alteration. In the event of such application the alteration shall not have effect except in so far as it is confirmed by the court. 3.2 THE ARTICLES OF ASSOCIATION 3.2.1 The articles of association are the regulations for the management of a company. The heading to Table A is "regulations for management of a company". 3.2.2 Form of Articles Table A, Part I is the model form of articles for a public company limited by shares. Part II thereof: (a) declares Part I to be applicable to a private company as well, with the exceptions of articles 24 and 53; incorporates the provisions which, under s.30 of the Act, must be incorporated in the articles of a company in order to constitute the company a private company, and modifies articles 24 and 53 of Part I in order to make them applicable to a private company.

(b)

(c)

Part I of Table A has 136 paragraphs which, pursuant to s.12, are divided into paragraphs which are numbered consecutively. Section 11(2) provides that if articles are not registered in the case of a company limited by shares, Table A shall be the regulations of the company in the same manner and to the same extent as if they were contained in duly registered articles. In practice advocates acting for company promoters usually copy nearly all the provisions of Table A and merely change a few clauses here and there to suit the requirements of the proposed company. 3.2.3 Statutory requirements S.12 provides that articles shall be (a) (b) (c) (d) in the English language; and printed; and divided into paragraphs numbered consecutively and dated; and

(e)

signed by each subscriber to the memorandum of association in the presence of at least one witness, who shall attest the signature and add his occupation and postal address.

3.2.4 Legal effect of articles S.22 provides that "the memorandum and articles shall, when registered, bind the company and the members thereof 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". The English courts have interpreted this section as follows: (a) The articles constitute a statutory contract which binds the members to the company, and also binds the company to the members. Consequently: i. A company may sue a member to restrain an imminent breach of the articles. This is illustrated by Hickman v Kent or Romney Marsh Sheepbreeders Association (31) in which the company obtained an injunction restraining a member (Hickman) from going to court in breach of the articles which provided for arbitration proceedings. A member may sue the company for any actual or `imminent' breach of the articles. This is illustrated by Wood v Odessa Waterworks Ltd (32) in which a member (Wood) successfully sued for an injunction restraining the company from paying dividends in the form that was not provided by the articles.

ii.

(b)

The members are bound to the company, and the company is bound to the members, only in their capacity as members. This is illustrated by the following cases: i. Eley v Positive Life Assurance Co (34) in which Eley failed in his contention that the company had committed a breach of the contract in the articles which appointed him as the company's lawyer for life because he was, in the court's view, suing qua lawyer and not qua member. Beattie v E F Beattie Ltd and Another (33) in which the company failed to restrain Mrs Beattie from suing in alleged breach of the articles which provided for arbitration. The court explained that Mrs Beattie was suing qua director and not qua member. She was therefore not bound by the arbitration clause which required members to refer disputes between them and the company to arbitration.

ii.

(c)

The articles also constitute a statutory contract which binds the members inter se (ie a member is bound to other members). In Hickman's case (31) Astbury J. stated, inter alia: "In my judgment, ... general articles dealing with the rights of members `as such' are treated as a statutory agreement between them and the company as well as between themselves inter se". This is illustrated by Rayfield v Hands (35) in which it was held that the defendants were bound, qua members, to buy the shares of the plaintiff (another member) as provided by the company's articles of association.

Members are also bound inter se by the pre-emption clauses in the company's articles of association which require members intending to sell their shares to offer them first to existing members who are given a right to buy the shares in preference to third parties. This is illustrated by Lyle & Scott Ltd v Scott's Trustees (36) 3.2.5 Alteration of Articles S.13(1) provides that a company may by special resolution alter or add to its articles. S.13(2) provides that any alteration or addition so made in the articles shall be as valid as if originally contained therein and subject to alteration in like manner by special resolution. 3.2.6 Limitations on power to alter articles The following are the legal restrictions on a company's power to alter its articles: (a) S.13(1) provides that the alteration is subject to the conditions contained in the company's memorandum of association. This means that an alteration to include a clause which contravenes a provision in the company memorandum is of no effect. Under s.13(1) a proposed alteration is subject to the provisions of the Act. An alteration that contains a clause which contravenes a provision in the Act is null and void. S.24 provides that no member of a company shall be bound by an alteration made in the articles after the date on which he became a member if and so far as the alteration requires him to take or subscribe for more shares than the number held by him at the date on which the alteration is made, or in any way increases his liability as at that date to contribute to the share capital of, or otherwise to pay money to, the company. It should be noted that the alteration is valid but does not bind members who have not agreed in writing to be bound by it. An alteration that varies the rights attached to any class of shares is invalid unless the variation of rights clause, if any, in the company's articles has been complied with. In addition, s.74 permits the holders of not less in the aggregate than fifteen per cent of the issued shares of that class who did not vote in favour of the resolution for the variation to apply to the court to have the variation cancelled. Once such an application has been made the variation will not have effect unless and until it is confirmed by the court. S.211 (3) provides that where an order made by the court under s.211(2) makes any alteration in or addition to a company's articles, the company concerned shall not have power without leave of the court to make any further alteration in or addition to the articles which is inconsistent with the provisions of the order. In Allen v Gold Reefs of West Africa (37) Lindley, M R stated: "Wide, however, as the language of s.13 is, the power conferred by it must, like all other powers, be exercised subject to the general principles of law and equity which are applicable to all powers exercised not only in the manner

(b)

(c)

(d)

(e)

(f)

required by law, but also bona fide for the benefit of the company as a whole". To be valid, therefore, a proposed alteration of articles must also be made bona fide and for the benefit of the company as a whole. Examples are: i. Sidebottom v Kershaw, Leese & Co Ltd (38) in which the alteration was held to be for the benefit of the company. Dafen Tinplate Co Ltd V Llanelly Steel Co Ltd (39) in which the alteration was declared to have been made "mala fides" and was not for the benefit of the company as a whole.

ii.

REINFORCING QUESTIONS

1 2

"Explain the procedure for forming a private company which is limited by shares" Otieno and his nine friends wish to have a company registered. They come to you for advice regarding the memorandum of association. Explain to them the major contents of a memorandum of association.

Check your answers with those given in Lesson 9 of the Study Pack

LESSON 2
CONTENTS
1 2 3 Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9

STUDY TEXT

RAISING AND MAINTENANCE OF CAPITAL

CONTENTS
1 RAISING OF CAPITAL Meaning of "capital" Classes of capital Method of public issue The prospectus issue Statutory provisions and cases relating to prospectus Allotment of shares Commencement of business 2 MAINTENANCE OF CAPITAL Issuing of shares at a discount Underwriting commission Brokerage Issuing of shares at a premium Purchase of own shares Financial assistance of acquisition of own shares Alteration of capital Reduction of capital Redemption of shares 3 DIVIDENDS

1.
1.1

RAISING OF CAPITAL
MEANING OF CAPITAL In commercial parlance, the word `capital' is generally used to denote the amount by which the assets of a business exceed its liabilities. However, in legal parlance the word "capital" is used to denote the amount of money which a company raises from a sale of its shares, or what represents that money.

1.2

TYPES OF CAPITAL A company's capital at any given moment may consist of: a) NOMINAL OR AUTHORISED CAPITAL This is the capital that is stated in the memorandum of association pursuant to S.5 (4) a) of the Act. It is called "nominal capital" because it is calculated on the basis of the "nominal" or book value of the shares into which it is divided. It is `authorised' in the sense that, once the memorandum of association is registered, the company can take immediate steps to raise the capital from the public without applying for a permit or license to collect the money. b) ISSUED CAPITAL The issued capital is that portion of the nominal capital which is constituted by the nominal value of the shares which have been issued by the company. It is also known as the "subscribed capital" or "allotted capital". It may be less than, or equal to, the nominal capital but cannot exceed it. c) PAID-UP CAPITAL The paid-up capital is constituted by the aggregate of the amount of money that is paid-up on each share issued by the company. It may be equal to or less than, the issued capital but cannot exceed it. d) CALLED-UP CAPITAL A company's called-up capital is constituted by the amount due is respect of calls made by the directors on issued shares. e) UNCALLED CAPITAL The uncalled capital is the amount not called up on shares which a company has issued. It is the nominal capital minus the called up and the paid-up capital. f) RESERVE CAPITAL The reserve capital is defined by S.62 of the Act as the portion of the issued but uncalled capital of a limited company which the company's members, by special resolution, have resolved that the company shall not call up unless and until it is in liquidation. It is to be called up only for purposes of the liquidation. As soon as the resolution is passed, the capital is, as it were, "put on reserve". The directors' power under the articles to make calls on shares will not be exercisable in respect of that capital, unless the company is being wound up. It is

referred to in the marginal note to S.62 as "the reserve liability" of a limited company. 1.3 METHODS OF PUBLIC ISSUE A company's authorised capital may be raised in one or the other of the following ways: a) PLACING A `placing' occurs if the company, instead of selling its shares directly to the public, arranges with a broker to sell them on its behalf.

Company.............................................Broker .......................sells the shares to..............Public (acts as the company's agent) The shares are said to be "placed" with the broker. A placing may be "a private placing" if the shares are to be offered for sale to selected customers of the broker (usually institutional investors) rather than made available to the general public. b) OFFER FOR SALE An "offer for sale" is an arrangement whereby a company sells some of its shares to a financial institution called "Issuing House". The issuing house will then re-sell the shares to the public. Company........sells shares to.......Issuing House............Resells the shares ..........to Public
(Issues a document called "Offer for sale")

The company normally issues renounceable allotment letters to the issuing house to facilitate the transfer of specific shares to designated purchasers. This obviates the necessity of having to register the name of the issuing house in the company's register of members when shares are allotted to it and having its name removed from the register shortly afterwards when the public buy the shares. c) PROSPECTUS ISSUE Under a prospectus issue the company sells the shares directly to the public rather than selling them through intermediaries. Company..........................................sells shares to ........................................Public (Issues a document called "prospectus") 1.4 THE PROSPECTUS ISSUE AND STATUTORY PROVISIONS 1.4.1 PURPOSE OF THE STATUTORY PROVISIONS A company's shares are legally regarded as goods. Consequently, the common law rule known as "caveat emptor" applied to their sale. In particular, the company as a seller was not bound to say anything to potential buyers which would enable them to assess the risks involved. Buyers were therefore left without a legal remedy if they bought shares which they would not have bought if the relevant material facts had been disclosed by the company's

agents. In an attempt to remedy this situation the Companies Act incorporated a number of statutory provisions which must be complied with. The provisions are as follows: 1.4.2 THE STATUTORY PROVISIONS i) Definition of "Prospectus" A prospectus is defined by S.2 as "any prospectus, notice, circular, advertisement or other invitation offering to the public for subscription or purchase any shares or debentures of a company" This particular definition was intended to prevent companies from evading the legal duties pertaining to the issue of a prospectus by issuing a prospectus under such name as "notice", "circular" or "advertisement". Whether a particular document is a prospectus will ultimately depend on the function it fulfills rather than the name given to it by its authors. Regarding the word "offering" in the definition it should be remembered that the issue of a prospectus by a company is not an offer as such but is a mere "invitation to treat". It is the application made in response to the prospectus that will constitute the "offer" ii) Dating of the prospectus s.39 provides that a prospectus shall be dated. The date shall, unless the contrary is proved, be taken as the date on which the prospectus was issued to the public. iii) Contents of the prospectus The authors of a prospectus are legally free to state therein whatever they deem appropriate to state but the contents must include, where applicable, the eighteen matters specified in Part I of the Third Schedule to the Act and the three reports specified in Part II of the said Schedule. Section 40(3) provides that, except as provided therein, it shall not be lawful for a company to issue any form of application for shares in or debentures of a company unless the form is issued with a prospectus which complies with the statutory requirements. However, a form of application for shares need not be issued with a prospectus if the form was issued either:i) in connection with a bona fide invitation to a person to enter into an underwriting agreement with respect to the shares or debentures; or in relation to shares or debentures which were not offered to the public; or to existing members or debenture holders of the company (irrespective of whether the applicant had the right to renounce in favour of other persons); or in relation to shares or debentures which are or are to be in all respects uniform with shares or debenture previously issued.

ii) iii)

iv)

1.4.3 THE MATTERS AND REPORTS The matters and reports to be stated in a prospectus may be summarised as follows: 1. The Matters The matters to be stated in a prospectus are: i) Directors' and Auditors of the company

a) b) c) d) ii)

Directors' names, addresses and occupations. Directors' qualification shares, if any, and their remuneration (if there is a provision in the articles). Directors' interest in the company's promotion. Auditors' names and postal addresses.

Formation expenses a) Preliminary expenses. b) Promoters' remuneration. c) Particulars of options on shares or debentures. Underwriting commission and brokerage. Investor information a) b) c) d) e) The minimum subscription. The time of the opening of the subscription lists. Amount payable on application and allotment. Voting and class rights Deferred shares.

d) iii)

iv)

Company's property and business a) b) c) d) e) Particulars of shares and debentures issued otherwise than for cash. Particulars of material contracts. Vendors of property to the company. Amount paid for property to be bought by the company, stating the amount paid for goodwill. Length of time the business has been carried on, if less than three years.

2.

The Reports i) An auditor's report showing: a) b) c) d) ii) Profits or losses in each of the last FIVE years. Rate of dividend during the last five years. Assets and liabilities at the date of the last accounts. Similar details with regard to subsidiary companies, if any.

Where the proceeds of the issue are to be used to buy a business, a report by named accountants on the profits or losses of the business for the last five years, and its assets and liabilities at the date of the last accounts. Where the proceeds of the issue are to be used to buy shares in a subsidiary, a similar report as in (ii) above.

iii)

1.4.4 MEANING OF "PUBLIC" For the purposes of the prospectus issue the word "public" is declared by S.57 (1) to include "any section of the public, whether selected as members or debenture holders of the company concerned or as clients of the person issuing the prospectus or in any other manner." In Re: South of England Natural Gas Co. Ltd (40) it was held that a document inviting

applications for shares in certain gas companies was an offer to the public even though it was marked "for private circulation only." However, a "circular" by which a company offered to acquire the shares of another company in exchange for its own shares was held not to be a "prospectus" within the statutory definition: Government Stock and other Securities Investment Co. Ltd v Christopher (41) 1.4.5 REGISTRATION OF PROSPECTUS S.43 (1) provides that no prospectus shall be issued by or on behalf of a company unless, on or before the date of its publication, there has been delivered to the registrar for registration a copy thereof signed by every person who is named therein as a director or proposed director of the company, or by his agent authorised in writing and having endorsed thereon or attached thereto a) b) an expert's consent to its issue (if the prospectus contains a statement by him), and a copy or memorandum of every "material contract" and a written statement signed by the named accountants or auditors indicating any adjustments to their report and the reasons for the adjustments (if the prospectus was issued generally.)

1.4.6 LIABILITIES IN RESPECT OF PROSPECTUSES 1. CRIMINAL LIABILITIES i) Issuing a form of application unaccompanied by a full prospectus: a fine not exceeding Shs.10,000/- (S.40 (4). Where a prospectus "includes any UNTRUE STATEMENTS":a) b) Fine not exceeding Shs. 10,000/- or Imprisonment for a term not exceeding two years, or Both such fine and imprisonment S.46 (1)

ii)

c) iii)

Knowingly issuing a prospectus containing a statement purporting to be made by an expert without the expert's consent to the issue thereof: fine not exceeding Shs. 10,000/- (S.42 (2). S.43 (5) imposes a fine not exceeding Shs.100/- per day for:a) Issuing a prospectus without delivering a signed copy thereof to the registrar for registration. Issuing a prospectus containing an expert's statement and delivering a signed copy thereof to the registrar for registration, but the copy so delivered does not have endorsed thereon (or attached thereto) the expert's consent to the issue of the prospectus, Issuing a prospectus and delivering a signed copy thereof to the registrar for registration, but the copy so delivered does not have endorsed thereon (or attached thereto)-

iv)

b)

c)

i) ii)

a copy of every material contract (or a memorandum thereof) or a written statement signed by the named accountants or auditors indicating any adjustments to their reports and the reasons for the adjustments.

2.

CIVIL LIABILITIES i) LIABILITY FOR FAILURE TO STATE ANY MATTER OR REPORT At Common Law, a contract of allotment is not a contract Uberrimae Fidei. The company is therefore not under a legal obligation to disclose or state in its prospectus any relevant matter or report. The allottee of shares has, therefore, no remedy against the company if he bought the shares which he would not have bought had the company made the relevant disclosure. This rule has not been changed by the disclosure requirements of the Companies Act. However, the allottee may have a remedy for an omission if the failure to state any relevant fact had the indirect effect of rendering a stated fact untrue, with S.48 (a) of the Act. For example, in COLES v WHITE CITY (MANCHESTER) GREYHOUND ASSOCIATION LTD the prospectus stated that the land to be acquired by the company was "eminently suitable" for greyhound racing. No mention was made of the fact that approval of the local council was required in order to build public stands and kennels. This was held by the Court of Appeal to be a ground for rescission by the plaintiff. ii) LIABILITY FOR MISSTATEMENT OR MISREPRESENTATION This will be governed by the general principles of the law of contract, depending on whether the misstatement was:a) A FRAUDULENT MISREPRESENTATION because the company made it i) ii) iii) b) knowingly, or recklessly, careless whether it be true or false, or without belief in its truth: DERRY v PEEK (42)

AN INNOCENT MISREPRESENTATION because the company made it honestly, believing what was stated to be true: DERRY v PEEK (42) 1 If the statement amounted to a fraudulent misrepresentation, the allottee may sue for damages; DERRY v PEEK. But the House of Lords held in HOULDSWORTH v CITY OF GLASGOW BANK that the allottee can only get damages if he is also in a position to rescind the contract of allotment. If the rescission is no longer possible, there will be no remedy. This is an exception to the general principle of the law of contract that a person who has been induced to enter in a contract by a fraudulent misrepresentation has the option of affirming the contract but suing for damages. If the statement amounted to an INNOCENT misrepresentation, the allottee CAN ONLY SUE FOR RESCISSION (i.e. asking

the court to order the company to remove his name from the members' register and refund the money he paid for the shares and he in turn returning the shares to the company). Damages cannot be awarded for an innocent misrepresentation. This was held by the House of Lords in DERRY v PEEK (42) However, the allottee's right of rescission (whether for innocent or fraudulent misrepresentation) will be lost if a) He did not institute rectification proceedings within a reasonable time after becoming aware of the misrepresentation: FIRST NATIONAL REINSURANCE CO. V. GREENFIELD (43). in seven months' delay was held to be unreasonable delay. He affirmed, or is deemed to have affirmed the contract after discovering the truth (e.g. by accepting dividends, attending and voting at meetings, selling or attempting to sell the shares). Third party rights acquired in the meantime would be interferred with, or The company has gone into liquidation and so the rights of creditors have crystallized and precede other claims: HOULDSWORTH Vs CITY OF GLASGOW BANK.

b)

c)

d)

EFFECT OF RESCISSION Where a contract of allotment is rescinded, the former shareholder will be entitled to his money back (normally with interest) and to a refund of any expenses to which he has ben put: RE: BRITISH GOLD FIELDS OF WEST AFRICA LTD. The plaintiff will also be entitled to have the company's registers RECTIFIED by deleting his name therefrom, and he can prove in the company's liquidation for the amount due to him: RE: BRITISH GOLD FIELDS OF W. AFRICA. iii) CIVIL LIABILITY OF DIRECTORS AND PROMOTERS Any person who subscribed for any shares or debentures on the faith of the prospectus may sue for compensation under S.45 of the Companies Act. The section is limited to prospectuses issued by or on behalf of the company and will afford no relief on an offer for sale or placing by existing holders (unless the company has made the allotment with that in view, so that S.47 applies). The section cannot be invoked by market purchasers of securities after the original allotment. The only persons who can be made liable under the section a) b) directors at the time of the issue of the prospectus; persons who consented to be named in the prospectus as directors or future directors; are:-

c) d)

promoters of the company, and every person who authorised the issue of the prospectus.

S.45 (2) states that "no person shall be liable... if he proves...". This means that the directors or promoters are prima facie liable thereunder unless they successfully avail themselves of the statutory defenses under the subsection, (i.e. they are presumed to be liable until they prove their innocence). In CLARK V URQUHART (44) the court explained that the amount of compensation payable under S.45 of the Act is calculated or measured in the same way as damages for fraudulent misrepresentation is measured. The court also explained that the word "compensation" was chosen in order to avoid the "invidious association" of damages with dishonesty in such a situation". The specified persons were to be made liable as a matter of policy, irrespective of their moral innocence. A person sued under S.45 can rebut the presumption of liability by proving that i) having consented to become a director he withdrew his consent before the issue of the prospectus and that it was issued without his authority or consent; or the prospectus was issued without his knowledge or consent, and that on becoming aware of its issue he forthwith gave reasonable public notice that it was issued without his knowledge or authority; or after the issue of the prospectus and before allotment thereunder he, on becoming aware of the untrue statement, withdrew his consent to the prospectus and gave reasonable public notice that he had done so and why; or as regards every untrue statement not purporting to be made on the authority of an expert or of a public official document or statement, he had reasonable ground to believe that the statement was true; or the statement was made by an expert and the expert consented to the inclusion of his statement in the prospectus and that he believed the expert to be competent to make the statement; or the statement was taken from a public official document or was made by an official, and was a correct and fair representation of the document or statement.

ii)

iii)

iv)

v)

vi)

If an expert consented to the inclusion of his report in the prospectus and the report is false he would not be liable if he proves i) that he withdrew his consent in writing before the prospectus was delivered for registration; or that after the prospectus was delivered for registration but before the allotment, he, on becoming aware of the untrue statement, withdrew his

ii)

consent in writing and gave reasonable public notice of the withdrawal, and the reason therefor; or iii) that he was competent to make the statement and up to the time of allotment believed on reasonable grounds that it was true.

1.5.

ALLOTMENT OF SHARES An allotment, legally, is the company's acceptance of an offer to buy its shares. It is governed by the following rules of the common law relating to contract. a) Where a company issues a prospectus, the issue is an invitation to treat but not an offer. It is not regarded as an offer because of practical reasons: if it was regarded as an offer, every application made pursuant thereto would constitute an acceptance and the company would be contractually bound to allot all the shares applied for. If the issue was oversubscribed, the company would be sued by the applicants who were not given the shares they had applied for. As this appears to be unjust the English courts have avoided the eventuality by regarding the issue of the prospectus merely as an invitation to treat. When applications are made, they will constitute offers. The company would then find out how many shares had been applied for and, if the issue is oversubscribed, accept applications which equal the shares available and reject the others. The company would not be sued by those to whom shares have not been allotted because there would be no contract between them and the company. They made offers which were not accepted by the company - and the company could not accept the various offers because it did not have shares to sell. The company's acceptance must be unconditional. If, therefore, the application was for 10 shares and only 5 were allotted, the allotment would be a counter-offer which the allottee could reject. But this might be the only reasonable or just thing for the company to do if the issue was over-subscribed. In order to overcome the legal problem, companies invariably prepare application forms which contain a clause to the effect that the applicant "agrees to accept" such number of shares as the company in its absolute discretion may allot to him. The acceptance must be communicated to the applicant. This means that the allottee must actually receive the letter of allotment so that he is aware of the allotment. If the letter of allotment is lost in transit there would be no binding contract. However, it was explained in Household Fire Insurance Co. Ltd v Grant (46) that, if the applicant expressly or impliedly authorised the company to communicate the acceptance by post, there would be a binding contract the moment the letter of acceptance is posted. It is irrelevant that the letter was delayed or, as in that case, was lost in transit. In such a case the Post Office would be regarded as the applicant's agent and delivery of the letter of allotment to the post office would legally be equivalent to its delivery to the applicant himselfin accordance with the principles of the law of agency. The allotment must be made within a reasonable time: Ramsgate Victoria Hotel Co v Montefiore (47).

b)

c)

d)

The above common law rules have been modified by the following statutory provisions: i) VOID ALLOTMENTS a) S.50 A renders an allotment void if it was made to a body corporate which is not a registered company without the prior written consent of the Treasury. This section was presumably "slotted in" in order to prevent public funds given by the Treasury to parastatal organisations from being invested in bogus companies "owned" by some of

the senior personnel in parastatals. b) S.53 (1) renders an allotment void if it was made before aplying for, or obtaining, stock exchange permission for the company's shares to be dealt in on the stock exchange. This is only applicable in cases where the prospectus had stated that the permission had been, or would be, applied for.

ii)

VOIDABLE ALLOTMENTS An allotment of shares is voidable if it is made in breach of a) Section 49 (1): by having been made before the minimum subscription was raised or subscribed, or before the sum payable on application for the shares applied for was paid to, and received by, the company. The "minimum subscription" is defined in paragraph 4 of the Third Schedule as the minimum amount which, in the opinion of the directors, must be raised by the issue in order to provide for the following matters 1. 2. 3. 4. The price of any property to be paid for out of the proceeds of the issue. The preliminary expenses and underwriting commission; Repayment of money borrowed by the company for (1) and/or (2); and Working capital.

If a company has not raised the minumum subscription it should not allot any shares but should wait and see if further applications would be made. S.49 (4) provides that if the minimum subscription has not been raised on the expiration of sixty days after the issue of the prospectus, all money received from applicants for shares shall be forthwith repaid to them without interest. The repayment should be made during the next 15 days. If however any application money is not repaid within seventy-five days after the issue of the prospectus, the directors of the company become personally liable for it and may be sued jointly or severally for the money, with interest thereon at the rate of 5% per annum from the expiration of the seventy-fifth day. A director would not be liable if he proves that the default in the repayment of the money was not due to any misconduct or negligence on his part. b) S.50: by having been made before the statement in lieu of prospectus, if any, was delivered to the registrar for registration.

iii)

VALID BUT IRREGULAR ALLOTMENTS An allotment of shares is valid but irregular under S.52 (3) if it was made before the time of the opening of the subscription lists. The section assumes that: a) the allotment was not made in contravention of S.50 A or S.53 so as to be void as a consequence, and the allotment was not made in breach of S.49 or S.51 so as to be voidable as a consequence.

b)

Although the allotment is valid, the company and every officer of the company who is in

default shall be liable to a fine not exceeding ten thousand shillings. 1.6 RETURN AS TO ALLOTMENTS Section 54 (1) provides that whenever a company limited by shares or a company limited by guarantee and having a share capital makes any allotment of its shares, the company shall, within sixty days thereafter, deliver to the registrar for registration i) A return of the allotments (on Form No.213), stating: a) the number and nominal amount of the shares allotted, b) the names, addresses and descriptions of the allottees, and c) the amount, if any, paid or due and payable on each share. In the case of shares allotted as fully or partly and paid up otherwise than in cash, a contract in writing constituting the title of the allottee to the allotment together with any contract of sale, or for services or other consideration in respect of which that allotment was made, such contracts being duly stamped, and a return (on Form No.213) stating the number and nominal amount of shares so allotted, the extent to which they are to be treated as paid up, and the consideration for the allotment.

ii)

If such a contract is not in writing, the prescribed particulars of the contract must be filed on Form No.221. The form must be stamped with the same stamp duty as would have been payable if the contract had been reduced to writing. 1.7 COMMENCEMENT OF BUSINESS Section III (1) provides that a public company which has issued a prospectus cannot commence business or exercise any borrowing powers unless:a) b) the minimum subscription has been raised; and every director of the company has paid to the company on each of the shares taken or contracted to be taken by him and for which he is liable to pay in cash, a proportion equal to the proportion payable on application and allotment on the shares offered for public subscription; and no money is or may become liable to be repaid to applicants for any shares or debentures which have been offered for public subscription by reason of any failure to apply for or to obtain permission for the shares or debentures to be dealt in on any stock exchange; and there has been delivered to the registrar of registration a statutory declaration by the secretary or one of the directors, in Form No.211, that the aforesaid conditions have been complied with.

c)

d)

If the minimum subscription was not raised the company can only commence business or exercise borrowing powers if:a) b) there has been delivered to the registrar for registration a statement in lieu of prospectus; Every director of the company has paid to the company, on each of shares taken or contracted to be taken by him and for which he is liable to pay in cash, a proportion equal to the proportion payable on application and allotment on the shares payable in cash; and there has been delivered to the registrar for registration a statutory declaration in Form

c)

No.212 by the secretary or one of the directors that condition b) above has been complied with. The registrar shall, on delivery to him of the relevant form, or statement in lieu of prospectus, certify that the company is entitled to commence business. The certificate is conclusive evidence that the company is entitled to commence business. Section III (4) provides that any contract made by a company before the date at which it is entitled to commence business shall be provisional only, and shall not be binding on the company until that date. This provision is somewhat ambiguous and it is not clear whether the "provisional" contract binds the other party. In Re "Otto" Electrical Manufacturing Co (Clinton's Claim) it was held that the company was not liable to pay for the goods which had been sold to it before it obtained the trading certificate. Since it was put into liquidation before obtaining the certificate, the contract did not "become binding" and the liquidator had therefore rightly rejected the claim. S.219 (c) provides that a company which does not commence its business within a year from its incorporation may be wound up by court. Section III does not apply to a private company which may therefore legally commence its business as soon as it is incorporated. 2.1. MAINTENANCE OF CAPITAL 2.1.1 The issued share capital of a company limited by shares is the primary security for the company's creditors. In Re: Exchange Banking Co (Flitcroft's Case) Jessel, M.R. stated: "A limited company by its memorandum of association declares that its capital is to be applied for the purpose of the business. It cannot reduce its capital except in the manner and with the safeguards provided by statute... One reason is thisthere is a statement that the capital shall be applied for the purposes of the business, and on the faith of that statement, which is sometimes said to be an implied contract with creditors, people dealing with the company give it credit. The creditor has no debtor but that impalpable thing the corporation, which has no property except the assets of the business. The creditor, therefore, I may say, gives credit to that capital, gives credit to the company on the faith of the representation that the capital shall be applied only for the purposes of the business..." The Companies Act therefore incorporated various provisions which are intended to ensure that a company's capital: i) ii) is not "watered down" as it comes into the company; and does not go out of the company once it has been received.

2.1.2 PROVISIONS WHICH PREVENT CAPITAL BEING "WATERED DOWN" The following are the provisions which are intended to prevent a company's capital being "watered down" as it comes into the company: 1 Issuing shares at a discount In Ooregum Gold Mining Co of India Ltd v Roper (45) the House of Lords held that it is illegal for a limited company to issue its shares at a discount. This decision was made on the basis of what is now S.5 (4) of the Act which provides that the memorandum shall state the amount with which the company will be registered and

"the division thereof into shares of a fixed amount". Since the nominal value of a share is fixed by the memorandum the company cannot issue the share at a discount. After the above case was decided, s.59 of the Act was incorporated so as to permit a company to issue its shares at a discount if a) The shares are of a class already issued. If the shares are of a class already issued, they will most likely have a market value. The market value would provide a basis upon which the company's directors would recommend, and the members resolve on, the amount of the discount. In the absence of such a market value any amount decided on as the new price for the shares would be as arbitrary as the original nominal value. b) The issue is authorised by a resolution passed in general meeting. This provision places upon the company's members ultimate responsibility for the issue at a discount. c) The resolution specifies the maximum rate of discount It is the members who determine, to a large extent, the market value of the shares. They can therefore jointly decide on the amount below which they would not be willing to sell their shares in the market . The amount so decided on would guide the directors on the maximum amount of discount at which they would be willing to issue the remaining shares, or some of them. d) Not less than one year has elapsed since the company was entitled to commence business. This provision obviates the risk of a hasty or premature issue at a discount. The statutory assumption appears to be that, having been in business for at least one year, the company would most likely have published its first balance sheet and declared a dividend which could induce a greater demand for its shares. e) The issue is sanctioned by the court. Although the grounds upon which the court is to excercise its discretion to sanction or reject the proposed issue are not spelt out, it appears that it would primarily be acting as the creditors' watchdog to protect their interests. This is so because creditors were not represented at the general meeting which passed the resolution authorizing the company to issue the shares at a discount and so the court steps in to protect their interests. If the issue of shares at a discount would adversely affect any creditor, the court would probably not sanction the issue. f) The issue is made within one month after the court's sanction. This provision acknowledges the fact that the stock exchange market is a highly fluid market. If a company's members pass a resolution authorizing an issue at a discount because of the prevailing market conditions the directors must act on the resolution before the market conditions change. The statutory assumption appears to be that the market conditions would have materially changed within one month after the court's confirmation. If the directors were

to issue the shares at a discount despite the changed conditions, the issue could not be justified. Another general meeting should be held to enable the members to reconsider their decision in the context of the changed conditions. However, the directors may ask the court to extend the time for issuing the shares at the prescribed discount if they are of the view, and the court concurs, that the market conditions have not materially changed. The flaw with this provision is that it does not provide a time limit for applying to the court for its sanction. 2 Payment of Underwriting Commission A "commission" is defined by Osborn's Concise Law Dictionary as, inter alia "an agent's remuneration". For purposes of company law, it denotes the amount of money paid by a company to a person "in consideration of his subscribing or agreeing to subscribe, whether absolutely or conditionally, for any shares in the company, or procuring or agreeing to procure subscriptions, whether absolute or conditional, for any shares in the company" Section 55 (1) of the Act allows a company to pay the commission if:a) b) the payment is authorized by the company's articles; and the commission paid or agreed to be paid does not exceed 10% of the price at which the shares are issued or the amount or rate authorized by the articles, whichever is the less; and the amount or rate per cent of the commission paid or agreed to be paid is i) in the case of shares offered to the public for subscribption, disclosed in the prospectus; or in the case of shares not offered to the public for subscription, disclosed in the statement in lieu of prospectus, or in Form No.225 signed by all the directors or their agents authorized in writing; and

c)

ii)

d)

the number of shares which it has been agreed to subscribe absolutely is disclosed in manner aforesaid. Section 55 (2) provides that, except as provided by subsection (1), no company shall apply any of its shares or capital money, either directly or indirectly, in payment of any commission, discount or allowance to any person in consideration of his subscribing or agreeing to subscribe, whether absolutely or conditionally, or procuring or agreeing to procure subscriptions, absolute or conditional, for any shares in the company, whether the shares or money be applied by being added to the purchase money of any property acquired by the company or to the contract price of any work to be executed for the company, or the money be paid out of the nominal purchase money or contract price, or otherwise. In Andreae V Zinc Mines of Great Britain Ltd (45) it was explained that any agreement to pay commission in contravention of S.55 is null and void. The effect of payment of underwriting commission is that the company's

shares will have been issued at a discount. S.55 is therefore intended to provide some measure of statutory control over a company's power to pay commission. 3 Brokerage Brokerage is a payment made by a company to a broker, or brokers, in consideration for "placing" the company's shares. It differs from underwriting commission in that it is a payment made to an agent who is selling the company's shares on its behalf without undertaking to buy the shares which he fails to sell. In Andreae V Zinc Mines of Great Britain Ltd (45) Bailhache, J. explained that a payment is brokerage only if it is made to "stockbrokers, bankers and the like, who exhibit prospectuses and send them to their customers, and by whose mediation the customers are induced to subscribe". Consequently, a payment which was made to a lady of a percentage on the amount of capital which she induced third parties to subscribe for shares in the defendant company was held not to be brokerage. The lady could not be regarded as a "broker" on the basis of such an isolated transaction. The person to whom the payment is made must be one who carries on the business of a broker, either exclusively or as part of his general business, as in the case of a banker. Subsection (3) provides that nothing in Section 55 "shall affect the power of any company to pay such brokerage as it has heretofore been lawful for a company to pay". It was previously held in Metropolitan Coal Consumers' Association V Scrimgeour (1895) that brokerage of a reasonable amount paid by a company in the ordinary course of its business was legal. In that case the brokerage was 2 1/2%. The usual brokerage varies between 1/4% - 1/2%. The reasonableness of the commission does not depend on mere percentages but on what it would cost the company to sell the shares by itself. If, by paying the brokerage, the company would spend less money in selling the shares then the payment would be regarded as a reasonable one. Although the payment of brokerage is a derivation from mercantile usage it is usual for companies to incorporate in their articles a clause which expressly authorises the company to pay brokerage. For example, Article 6 of Table A provides that "the company may also on any issue of shares pay such brokerage as may be lawful". Although payment of brokerage means that the company will ultimately receive less money for the shares it has issued the payment is not prohibited by the Act. It is essentially an expense which is incidental to the issue of the shares and a company cannot avoid incurring such an expense. 2.2.1 PROVISIONS WHICH PREVENT CAPITAL GOING OUT OF THE COMPANY In Trevor v Whitworth (1887) Lord Watson stated: "Paid-up capital may be diminished or lost in the course of the company's trading; that is a result which no legislation can prevent, but persons who deal with, and give credit to a limited company, naturally rely upon the fact that the company is trading with a certain amount of capital already paid, as well as upon the responsibility of its members for the capital remaining at a call; and they are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business". As Lord Watson acknowledged, no legislation can prevent a company's capital from being lost or diminished in the course of the company's business. However, various provisions of the Companies Act, and case law, are intended to ensure that no part of

the company's paid-up capital is paid out by the company except in the legitimate course of its business. They are: i) SHARES ISSUED AT A PREMIUM A company may at times issue its shares at a price above their nominal value, i.e at a premium. This may be necessitated by the fact that the company's shares which have already been issued are being sold in the open market at a price which is above their nominal value. Since such an issue does not jeopardize the position of the company's creditors there is no legal requirement that the issue be confirmed by the court. However, Section 58 (1) provides that where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account called "the share premium account". The section further provides that the share premium account shall be governed by the provisions of the Companies Act relating to the reduction of the share capital of a company as if the share premium account were paid share capital of the company. This means, in effect, that the funds credited to the share premium account are not paid out by the company except in the legitimate course of its business. Sub-section 2 provides that the share premium account may however be applied by the company: a) b) c) To pay up unissued shares of the company which are to be issued to members of the company as fully-paid bonus shares; To write off the preliminary expenses of the company; To write off the expenses of any issue of shares or debentures of the company, or the commission paid or discount allowed on such issue, or To provide for the premium payable on redemption of any redeemable preference shares or debentures of the company.

d)

MERGER ACCOUNTING It may happen that, during a "take-over" of one company (A) by another company (B), shares in the latter company are issued to shareholders of the former company in exchange. Company A would then be dissolved and Company B would acquire its shares. Should a share premium account be established by company B when the assets of Company A exceed the nominal value of Company A's shares? If a share premium account is opened the preacquisition profits of Company A would not be distributed by Company B. It may therefore be decided that no share premium account is to be opened. This method of accounting is known as "merger accounting". AQUISITION ACCOUNTING AND "MERGER RELIEF" In SHEARER V BERCAIN (1980) it was held that "merger accounting" is illegal and that a "true value" must be attributed to the non-cash assets acquired and the excess of the "true value" over the nominal value of the shares must be transferred to a share premium account. This method of accounting is known as "acquisition accounting" and means that the preacquisition profits of Company A cannot be distributed by Company B. It is

yet unclear as to whether Kenya courts will adopt the decision in Shearer v Bercain. The Kenya Companies Act does not provide "merger relief" that was introduced by the English Companies Act of 1981. ii) PURCHASE OF OWN SHARES Another possible way in which a company's paid-up capital may leave the company other than in the ordinary course of the company's business would be if the company purchased its own shares. It was therefore held in Trevor v Whitworth (48) that it is illegal for a limited company to purchase its own shares. Such a purchase, if permitted, would constitute an indirect reduction of the paid-up capital without compliance with the statutory provisions relating to reduction of capital. This is the general rule that is applicable in Kenya. This decision was said to be based on the implied provisions of the English Companies Act 1862. The said provisions were incorporated in the English Companies Act 1948 which in turn became our Companies Act (Cap. 486). It may however be criticized for its assumption that whenever a company buys its shares it would do so by utilizing its paid-up capital. It is in fact possible for a company to buy its shares without using its paid-up capital but using the money from a reserve fund which was constituted for that purpose. Such a purchase might in fact be beneficial to the company which could use it as a mechanism for propping up the market value of its shares at a time when there is panic selling by its shareholders which has been precipitated by adverse rumours about the company. The company would later resell the shares in such a way as to prevent high fluctuations in their market prices. Despite the rule in Trevor V Whitworth a company may purchase or acquire its own shares in the following cases: a) Where it acquires its own fully paid shares otherwise than for valuable consideration, as in Re: Castiglione's Will Trusts (49), Where it is a purchase of redeemable shares under S.60 of the Act. This is permitted because the redemption "shall not be taken as reducing the amount of the company's authorized share capital" if it is done in accordance with the provisions of the section. Where the shares are acquired pursuant to the resolution for reducing the company's capital under S.68 of the Act. Such acquisition is permitted because the interests of the company's creditors would have been protected by the court at the time of confirming the proposed reduction. Where the shares are purchased in pursuance of a court order under S.211 (2) on an application by the oppressed members. The shares purchased would be cancelled and the company's capital reduced accordingly.

b)

c)

d)

e)

Where the shares are forfeited for non-payment of a call, or where they are surrendered in lieu of a forfeiture.

iii)

FINANCIAL ASSISTANCE FOR PURCHASE OF OWN SHARES

S.56 (1) of the Act renders it unlawful for a company to give, whether directly or indirectly and whether by means of a loan, guarantee, the provision of security or otherwise, any financial assistance for the purpose of or in connection with a purchase or subscription made or to be made by any person of or for any shares in the company, or, where the company is a subsidiary company, in its holding company. The consequences of a contravention of the section are: a) The contract for the financial assistance is void and illegal, and cannot be enforced against a party thereto: Standard Bank v Mehotoro Farm (50); The company and every officer of the company who is in default shall be liable to a fine not exceeding twenty thousand shillings; Every director who is a party to the contravention is guilty of a breach of trust and is liable to recoup any losses which the company suffers as a result: Wallersteiner v Moir (51)

b)

c)

Exceptions S.56 (1) permits a company to give financial assistance for a purchase of, or subscription for, its shares in the following circumstances: a) Where the lending of money is part of the ordinary business of the company and the money is lent by the company in the ordinary course of its business. In Steen v Law (52) the Privy Council explained that this provision does not validate a loan given for the express purpose of enabling the loanee to purchase the lending company's shares. This is so because no company can be constituted for the sole purpose of lending money to persons who would be buying its shares so that a loan it gives for any other purpose would be regarded as an "unusual" or "extraordinary", loan. To be valid, therefore, the loan must have been given for one of the purpose for which the company ordinarily or usually lends money but was diverted (wholly or partly) to a purchase of the lending company's shares. Where the loan is to trustees to enable them to purchase fully paid shares in the company to be held under an employees' share scheme. Where the loan is to employees' (other than directors) to enable them to purchase or subscribe for fully-paid shares in the company or its holding company to be held by themselves by way of beneficial ownership. If a company gives a loan to an employee to purchase shares in the company the employee must have the shares registered in his own name and not the name of a spouse or child. This is intended to induce the employee to be more motivated and productive by ensuring that he personally and directly reaps the fruits of his increased productivity.

b)

c)

3.

ALTERATION OF CAPITAL

A company is empowered by S.63 to alter the provisions of its memorandum of association which relates

to its registered or authorised capital. However, the power is exercisable subject to the following conditions: a) The articles must confer the authority to alter the capital. If they do not, they may be altered by special resolution and the authority incorporated therein. The company must hold a general meeting for the purpose of altering the capital. The alteration must be authorised by an ordinary resolution (See Table A, Article 45). MODE OF ALTERATION The alteration of capital may be made by 1) Increasing the company's share capital by new shares of such amount as the resolution prescribes; or Consolidating and dividing all or any of the company's share capital into shares of larger amount than the existing shares; or Converting all or any of the company's paid-up shares into stock, or reconverting the stock into paid-up shares of any denomination; or Subdividing all or any of the shares into shares of smaller amount than is fixed by the memorandum; or Canceling shares which have not been taken or agreed to be taken by any person, and diminish the amount of the capital. This mode of alteration is also known as diminution of capital. Subsection (3) provides that it shall not be deemed to be a reduction of share capital within the meaning of the Act.

b) c) 3.1

2)

3)

4)

5)

3.2

The registrar must be notified of an alteration of capital within thirty days after the passing of the resolution authorizing the alteration. In the event of a failure to do so, the company and every officer of the company who is in default shall be liable to a default fine.

4.
4.1

REDUCTION OF CAPITAL
The general rule is that it is illegal for a company to reduce its capital. This is so because such a reduction would be tantamount to reducing the security available to the company's creditors: Trevor v Whitworth (48). However, S.68 (1) authorizes a company to reduce its capital if: a) The company's articles authorizes it to do so. If the articles do not confer the authority they can be amended by the inclusion therein of the requisite authority. The company passes a special resolution to that effect. The resolution is defined by S.68 (2) as "a resolution for reducing share capital". The court confirms the proposed reduction. The court's confirmation is required in order to protect the interests of the company's creditors, minority members and the general public, as explained below.

b)

c)

4.2

MODE OF REDUCTION

S.68 (1) expressly states that a company may reduce its capital "in any way". There is therefore no statutorily prescribed mode of reduction and the actual scheme adopted by the company will depend on the ingenuity of its directors or accountants. However, the Act gives the company an option of reducing its capital in one of the following ways: a. By extinguishing the liability on any of its shares in respect of Share Capital not paid up: S.68 (1) (a) Example: The company's memorandum reads: "... 1,000,000/- divided into 100,000 Ordinary Shares of 10/- each." amount already paid per share is shs.5/amount unpaid per share is shs.5/-

The company passes a special resolution to reduce the capital to shs.500,000/-. The resolution is confirmed by the court. The amended memorandum will read as follows: "... 500,000/- divided into 100,000/- Ordinary Shares of 5/- each." amount already paid per share is shs.5/the unpaid amount of 5/- per share ceases to be payable and the liability thereon is "extinguished."

b.

By reducing the liability on any of its shares in respect of share capital not paid up: S.68 (1) (a) Example: The company's memorandum reads: "... 1,000,000/- divided into 100,000/- Ordinary Shares of 10/- each." amount already paid per shares is shs.5/-. amount unpaid per share is shs.5/-. The company passes a special resolution to reduce the capital to shs.750,000/-. The resolution is confirmed by the court. The amended memorandum will read as follows: "... 750,000/- divided into 100,000 Ordinary Shares of shs.7/50 each." amount already paid per share is shs.5/-. amount unpaid per share becomes shs.2/50 (i.e. the liability on unpaid shares has been reduced from shs.5/- to shs.2/50).

c.

By canceling any paid-up share capital which is lost or unrepresented by available assets

without extinguishing or reducing liability on any shares: S.68 (1) (b): Example: The company's memorandum reads: "... 1,000,000/- divided into 100,000 Ordinary Shares of 10/- each.." amount already paid per share is shs.5/ amount unpaid on each share is shs.5/The Shs.500,000/- received from the shareholders was banked by the company. Shs.100,000/- was later withdrawn from the bank and used to buy goods for resale. After the goods were paid for and received, they were kept in the company's store pending delivery to customers the following day. The directors felt that it was unnecessary to insure the goods for one night only. A fire completely destroyed the good during the night. The shs.100,000/used to buy the goods represents the capital which, according to the Act, "is lost or unrepresented by available assets." The company passes a special to reduce its capital by shs.100,000/-. The resolution is confirmed by the court. The amended memorandum will read: "...900,000/- divided into 100,000 Ordinary Shares of 9/- each." amount unpaid on each share is shs.5/- (i.e. the liability on unpaid shares has not been reduced or extinguished). amount paid per share becomes 4/- (by consent of shareholders). This mode of reduction is legally possible but may be questioned from a practical point of view. The truth is that it is the shareholders who have in fact lost their capital. It should be noted that, despite the above reduction, the members will receive the same amount of dividend from the company as they would have received if, for psychological reasons, the directors did not ask them to reduce the capital so that the shares retained their 10/- nominal value. d. By canceling any paid up share capital which is lost or unrepresented by available assets and also reducing liability on any shares: S.68 (1) (b). Example: The company's memorandum reads: "...1,000,000/- divided into 100,000 Ordinary Shares of 10/- each." amount already paid per share is shs.5/amount unpaid per share is shs.5/-

Assume that the same type and quantity of goods are destroyed by fire in the same circumstances as in example (c) above.

The company passes a special resolution to reduce its capital by shs.200,000/-. The resolution is confirmed by the court. The amended memorandum will read: "...800,000/- divided into 100,000 Ordinary Shares of 8/- each." e. amount already paid per share is shs.5/amount unpaid per share becomes shs.3/-.

By cancelling any paid-up share capital which is lost or unrepresented by available assets and also extinguishing liablility on any shares: S.68 (1) (b) Example: The company's memorandum reads: "...1,000,000/- divided into 100,000/- Ordinary Shares of 10/- each." amount paid per share is 9/-. amount unpaid per share is 1/-. The shs.900,000/- received by the company from the shareholders is banked. Shs.100,000/is later withdrawn to buy goods for resale. The goods are destroyed by fire in circumstance identical with those in example (c) above. The company can reduce its capital by shs.200,000/- so that the amended memorandum will read as follows: "...800,000/- divided into 100,000/- Ordinary Shares of 8/- each." amount paid per share becomes 8/amount unpaid per share is NIL (i.e. the liablility of 1/- has been extinguished).

f.

By paying off paid-up share capital which is in excess of the wants of the company without extinguishing or reducing liability on any shares Examples: i) The company's memorandum reads:

"...10,000,000/- divided into 1,000,000 Ordinary Shares of Shs.10/- each." 5/- has been paid on each share 5/- is unpaid on each share The company can pass a special resolution to reduce the capital to 7,500,000/- by paying back to the shareholders shs.2,500,000/- out of the shs.5,000,000/- they have already paid to the company if the directors convince the members that the paid-up amount of shs.5,000,000/- is in excess of the company's current needs and it will take a long time before the company would require more capital.

The company's memorandum will be amended to read: "...Shs.7,500,000/- divided into 1,000,000 Ordinary Shares of 7/50 each." amount paid on each share becomes shs.2/50; amount unpaid on each share remains shs.5/-. ii) Study the scheme adopted by the British and American Trustee & Finance Corporation Ltd.

g.

By paying off paid-up capital which is in excess of the company's needs by extinguishing liability on any shares. Example: Read the scheme of reduction that was adopted by the British and American Trustee and Finance Corporation Ltd. and confirmed by the House of Lords.

h.

By paying off paid-up capital which is in excess of the company's needs and reducing liability on any shares Example: A company's authorised and issued capital is 10,000,000/- divided into 1,000,000 Ordinary Shares of 10/- each. Shs.5/- has been paid on each share. The company can pass a special resolution to reduce the capital to 5,000,000/- by paying to the shareholders shs.21/2m/- out of the 5m/- which they have already paid to the company if the directors tell the members that the paid up amount of shs.5m/- is in excess of the company's current needs. The company's amended memorandum will read as follows: "...5,000,000 divided into 1,000,000 Ordinary Shares of shs.5/- each." Amount paid on each share becomes 2/50 and the unpaid amount of 5/- is reduced to 2/50.

4.3

THE FUNCTION OF THE COURT In Scottish Insurance Corporation Ltd v. Wilsons & Clyde Coal Co. Lord Simmons stated: "But important though its task is to see that the procedure by which a reduction of capital is carried through is formally correct and that creditors are not prejudiced, it has the further duty of satisfying itself that the scheme is fair and equitable between the different classes of shareholders". The court would therefore, not confirm a scheme of reduction if it is of the view that it is not "fair and equitable" to any of shareholders. a) PROTECTION OF CREDITORS Where the reduction of capital involves diminution of unpaid capital or repayment to shareholders of paid-up capital, creditors have a statutory right under S.69(2) to object to the proposed reduction and, upon objection, a list of creditors must be given to the court. The court will then confirm the reduction if satisfied that the creditors:

i) ii)

have consented thereto; or, have been secured (i.e. given alternative security so that they will no longer rely on the reduced capital as their security), or have been discharged or paid off (S.70 (1).

iii) b)

PROTECTION OF MEMBERS 1. A majority of the company's members are protected by the requirement that a special resolution must be passed by the company's members in order to initiate the reduction process. It is most unlikely that a three-fourths majority of members could freely pass a resolution for reducing capital if the resolution is detrimental to their interests. A minority of the company's members are protected by their judicially acknowledged right to seek the court's protection where they are of the view that the resolution passed by the majority is not "fair and equitable": British and American Trustee and Finance Corporation Ltd, and Reduced V Couper (53) and Re: Thomas de la Rue and Co. Ltd and Reduced (55),

2.

c)

PROTECTION OF GENERAL PUBLIC It may happen that a resolution reducing a company's capital was passed in circumstances which indicate that the shareholders had not been properly and correctly informed about the real causes of the reduction. In such a case, it is desirable that the general public, as potential members of the company, should be told the truth about the reduction. Section 70 (2) (b) empowers the court where appropriate, to make an order requiring the company to publish, as the court directs, the reason for reduction or such other information in regard thereto as the court may think expedient with a view to giving proper information to the public, and, if the court thinks fit, the causes which led to the reduction. The court order confirming the reduction and the relevant minute as approved by the court, must be delivered to the registrar for registration. S71 (2) provides that, on the registration of the order and minute, and not before, the resolution for reducing share capital as confirmed by the order so registered shall take effect.

4.4

LIABILITY OF MEMBERS S.72 (1) provides that in the case of a reduction of share capital a member of the company, past or present, shall not be liable in respect of any share to any call or contribution exceeding in amount the difference, if any, between the amount of the share as fixed by the minute and the amount paid, or the reduced amount, if any, which is deemed to have been paid on the shares.

REDEMPTION OF SHARES
Section 60 (1) empowers a company limited by shares to issue preference shares which are, or at the option of the company are to be liable, to be redeemed, if the articles authorise such an issue. It however, provides that a) no such shares shall be redeemed except out of the profits of the company which would otherwise be available for dividend, or out of the proceeds of a fresh issue of shares made for the purposes of the redemption;

b) c)

no such shares shall be redeemed unless they are fully paid; the premium, if any, payable on redemption must have been provided for out of the profits of the company or out of the company's share premium account before the shares are redeemed; where any such shares are redeemed otherwise than out of the proceeds of a fresh issue, there shall out of profits which would otherwise have been available for dividend be trasferred to a reserved fund, to be called the capital redemption reserve fund, a sum equal to the nominal amount of the shares redeemed. The provisions of the Act relating to the reduction of the share capital of a company shall apply to the reserve fund as if it were paid-up share capital of the company, but subsection 5 provides that the capital redemption reserve fund may be applied by the company in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares. These provisions are intended to prevent a company's authorised capital from being reduced by any redemption of the redeemable preference shares of the company.

d)

DIVIDENDS

As a commercial term, the word "dividends" has a variable meaning which depends on the context in which it is used. For purposes of company law, it denotes the payments which a company makes out of its profits to the shareholders in the company. 6.1 BASIC RULE The basic rule is that "dividends must not be paid out of capital": Verner v General & Commercial Investment Trust (per Lindley, J). For purposes of this rule "Capital" means the money subscribed pursuant to the memorandum of association, or what represents that money: Verner v General & Commercial Investment Trust. 6.2 DECLARATION AND PAYMENT There is no provision in the Act dealing with payment of dividends. It is therefore governed by the provisions of the company's articles, failing which the provisions of Table A which are as follows: i) Article 114 The company in general meeting may declare dividends, but no dividend shall exceed the amount recommended by the directors. The use of the word "may" means that the company in general meeting is not bound to declare dividends even if the directors have recommend a particular amount. On the other hand, no dividend can be declared if the directors have recommended none. ii) Article 115 The directors may from time to time pay to the members such interim dividends as appear to the directors to be justified by the profits of the company. A resolution passed at a general meeting directing the directors to pay interim dividends is invalid. Scott v Scott (56) iii) Article 116 No dividend shall be paid otherwise than out of profits. In Verner v General & Commercial

Investment Trust Lindley, J expressed the view that, because the word "profits" is somewhat ambiguous, this provision should be understood to mean that "dividends must not be paid out of capital". Provided the dividend is not paid out of capital, it does not matter from whatever fund it is paid, whether called profits or otherwise. iv) Article 118 Subject to the rights of persons, if any, entitled to shares with special rights as to dividend, all dividends shall be declared and paid according to the amounts paid or credited as paid on the shares in respect whereof the dividend is paid. This provision modifies the common law rule that dividends are paid on the nominal value of the shares: Oak Bank Co. v Cram. v) Article 120 Any general meeting declaring a dividend may direct payment of such dividend wholly or partly by the distribution of specific assets and in particular of paid-up shares, debentures or any one or more of such ways. This article gives the company power to pay dividend in kind. In the absence of such a provision, dividend is payable in cash and the company may be restrained from paying it in any other form: Wood v Odessa Waterworks Co. (57) vi) Article 121 Any dividend, interest or other moneys payable in cash in respect of shares may be paid by cheque or warrant sent through the post directed to the registered address of the holder or, in the case of joint holders, to the registered address of that one of the joint holders who is first named on the register of members or to such person and to such address as the holder or joint holders may in writing direct. Every such cheque or warrant shall be made payable to the order of the person to whom it is sent. This provision gives the company express authority to remit the dividend cheque or warrant by post. If the dividend cheque or warrant is lost in transit the loss prima facie falls on the shareholder. In the absence of such a provision the company would have no authority to remit the dividends by post and, if it does and the dividend cheque is lost in transit, it must issue a fresh cheque to the shareholder: Thairlwall v Great Northern Rly. vii) Article 122 No dividend shall bear interest against the company. At common law the declaration of a dividend creates a simple contract debt due from the company to the shareholder which will be time-barred in six years form the date of declaration. 6.3 CASE LAW RELATING TO DIVIDENDS The above provisions of Table A supplement the following common law rules: 1) Losses in previous years need not be provided for. A dividend can be paid if there is a profit on the current year's trading: Re: National Bank of Wales (1899). Profits of previous years can be brought forward and distributed even if there is a revenue loss in the current trading year: Re: Hoare & Co (1904) Losses on fixed assets in the current year need not be made good by provision for depreciation before treating a revenue profit as available for dividend: Lee v Neuchatel Asphalte Co (1889)

2)

3)

4)

Unrealized capital profits on a revaluation of assets can be distributed by way of a dividend, or used to pay a bonus issue of fully paid shares: Dimbula Valley (Ceylon) Tea Co v Laurie (1961). Dividends must not be paid out of capital: Verner v General & Commercial Investment Trust.

5)

REINFORCING QUESTIONS
1. Your clients, a group of twenty farmers, wish to incorporate themselves as a company limited by shares. The company's main object will be growing and exporting of horticultural crops. They seek your advice on the following: a) What problems, if any, they will encounter if they should wish to bring further members into the company; (5 marks) Whether it will be possible to prevent a member from selling his shares to an outsider without the consent of the rest of the groups; (5 marks) The extent to which the company's finances and membership must become public knowledge; (5 marks) Whether it will be possible for an outsider to sue a member for recovery of money owed to him by the company; (5 marks)

b)

c)

d)

2.

"Mwangi has been induced to buy shares in the Makaa Co. Ltd on the faith of a statement in a prospectus that is untrue. What remedies are available to Mwangi against: (a) (b) Makaa Co. Ltd; the directors and promoters of the company?

COMPREHENSIVE ASSIGNMENT No.1

TO BE SUBMITTED AFTER LESSON 2
To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by the University. EXAMINATION PAPER. TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS 1. "The company is at law a different person altogether from the subscribers to the memorandum of association" (per Lord Macnaghten in Salomon v Salomon Co. Ltd.). Discuss this statement by reference to decided cases.

2.

What are the advantages, from a legal point of view, of converting a partnership business into a company limited by shares?

3.

Explain the provisions of the Companies Act which constitute "lifting the veil of incorporation".

4.

Explain the circumstances in which a company may: a. b. give financial assistance for a purchase of shares, and issue its shares at a discount.

5.

Explain the legal rules relating to payment of company dividends. To what extent may the legal rules be made to conform to accounting practice?

END OF COMPREHENSIVE ASSIGNMENT No.1 NOW SEND YOUR ASSIGNMENT TO STRATHMORE UNIVERSITY DISTANCE LEARNING CENTRE FOR MARKING

LESSON 3
COMPANY MEMBERSHIP AND SECURITIES
INSTRUCTIONS
1 2 3 Read the Study Text below. Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9.

CONTENTS
1. COMPANY MEMBERSHIP 1 Meaning of member 2 Methods of becoming a member 3 Cessation of membership 4 Who may become a member? 5 Register of members 6 Annual Return COMPANY SECURITIES 1 Shares 2 Transfer of shares 3 Mortgage of shares 4 Calls on shares 5 Lien on shares 6 Borrowing by companies DEBENTURES 1 Definition 2 Debentures and debenture stock 3 Issue of debentures 4 Debenture certificates 5 Debenture trust deed 6 Priority of charges

2.

3.

Registration of charges

1. COMPANY MEMBERSHIP
1.1 Definition of member
Although the marginal note to section 28 is "definition of member", the section does not define the word "member". Rather, it states the two basic ways in which a person may become a member of a company, namely (a) by subscribing the memorandum of the company, or (b) by agreeing to become a member and the entry of his name in the company's register of members.

1.2 Methods of becoming a member

A person may become a member of a company in one or other of the following ways: i. Subscribing to the Memorandum S.28 (1) provides that the subscribers to the Company's memorandum shall be deemed to have agreed to become members of the Company, and on the registration of the memorandum shall have their names entered in the company's register of members. The provision regarding entry in the register is an administrative directive for the company's implementation and non-compliance with it does not affect the preexisting membership. ii. Allotment A person to whom a company's shares have been allotted acquires his membership by virtue of sub-section 2 of s.28, being a person who has agreed to become a member. However, it was held in NICOL'S case that the membership commences from the moment the name is entered in the members' register. If the company wrongfully refuses to enter the name in the register, the allottee must take rectification proceedings for a court order directing the company to enter the name in its members' register.

iii. Transfer A transfer is a purchase of shares from a Company's shareholder, and not from the company itself. A transferee also acquires his membership by virtue of sub-section 2 of s.28, being a person who has agreed to become a member. The principle in NICOLs case applies to transferees as well, and a transferee becomes a member from the moment his name is entered in the register of members. iv. Transmission on death of a Member A transmission is a legal process by which ownership of shares in a company changes automatically on the death of a member to his personal representative. This is acknowledged by Table A, Article 29, which provides that "in case of the death of a member ... the personal representatives of the deceased where he was a sole holder shall be the only persons recognized by the law as having any title to his interest in the shares".

If the personal representative elects or decides to be registered himself as the holder of the shares, the election constitutes the agreement to be a member and the provisions of s.28(2) become applicable, namely, he will become a member from the moment his name is entered in the register of members. v. Transmission on bankruptcy of Member A bankrupt member's shares in a company will be transmitted to his trustee in bankruptcy according to the principles of bankruptcy law. The company's articles may give the trustee an option of being personally registered as a member, as is provided for by Table A, Article 30. If the trustee elects or decides to be registered as the holder of the shares the election constitutes the agreement to be a member and the provisions of sub-section 2 of s.28 become applicableie. the trustee in bankruptcy will become a member from the moment his name is entered in the register of members.

vi. Compliance with s.182 (2) A person who has consented to be a director, and has given the statutory undertaking to take and pay for his qualification shares, is declared by s.182(2) to be, "in the same position as if he had signed the memorandum." The provisions of s.28 (1) accordingly apply to him, and he becomes a member of the company at the moment the memorandum of association is registered. vii. Estoppel A person who, without having agreed to be a company's member, is aware that his name is wrongly entered in its register of members but takes no steps to have his name removed therefrom, may be estoppel from denying his apparent membership to somebody who relied on it and extended credit to the company.

1.3 Cessation of Membership

A person's membership of a company may cease or come to an end in many ways, some of which are: i. Transfer A "transfer" of shares occurs if an existing member sells them to a third party. If the third party is not yet a member, he will become a member from the moment his name is entered in the company's register of members. However, the transferee does not automatically cease to be a member as a consequence of the transfer. A member is not bound to sell all of his shares whenever he contemplates a sale. Table A, Article 23, permits members to transfer all or any of their shares. A member therefore ceases to be a member only if he transfers ALL of his shares. ii. Forfeiture Where a company's articles authorize the directors to forfeit a member's shares and the directors forfeit ALL of the shares held by a member, the member will cease to be a member from the date specified in the articles as the effective date for a forfeiture. Table A, Article 38 provides that "a statutory declaration in writing that the declarant is a director or the secretary of the company, and that a share in the company has been duly forfeited on a date stated in the declaration, shall be conclusive evidence of the facts therein stated."

Article 37 provides that a person whose shares have been forfeited shall cease to be a member in respect of the forfeited shares. He therefore ceases to be a member of the company only if all of the shares previously held by him are forfeited. iii. Surrender of Shares The precise nature of a surrender and the machinery by which it is effected are not clear since it is not provided for by the Companies Act or Table A. However, in Trevor v Whitworth the judge stated that a surrender "does not involve any payment out of the funds of the company," and that "if it were accepted in a case where the company were in a position to forfeit the shares the transaction would seem to me perfectly valid," presumably even if not expressly authorised by the articles. A person's membership will therefore come to an end if he surrenders all his shares to the company with the approval of the directors. iv. Death When a person dies, his membership of a company will come to an automatic end by virtue of the provisions of the Law of Succession. The shares previously held by him become, legally, the property of his personal representative. (see Table A, Article 29) v. Bankruptcy When a person becomes bankrupt, his membership of a company will come to an end under the provisions of the Bankruptcy Act which vest a bankrupt's property in his trustee in bankruptcy (see Table A, Article 32).

vi. Sale by a Company in exercise of lien A company, like an unpaid seller under the Sale of Goods Act, has a right of lien on its shares as security for the balance of their price. For example, Table A Article 11 gives the company "a first and paramount lien" on every unpaid share. If the Company sells ALL the shares held by a member, the membership will come to an end from the moment the buyer's name is entered in the register. Table A, Article 12 gives the company power to sell "any shares on which the company has a lien". vii. Redemption of redeemable preference shares If a member's entire holding consist exclusively of redeemable preference shares and all of these shares are redeemed by the company under the provisions of s.60 of the Companies Act, he will cease to be a member from the date on which his name is removed from the register of members. viii. Repudiation by an infant An infant member has a common law right to repudiate his membership of a company if there has been a total failure of consideration because the shares have become worthless: Steinberg v Scala (Leeds) Ltd (58). ix. Liquidation or winding up

A company's liquidation terminates membership of all former members, from the moment it becomes effective. x. Rescission of Contract: A shareholder who rescinds a contract of purchase of shares or allotment by reason of a vitiating element or otherwise ceases to be a member xi. Disclaimer by trustee in bankruptcy:

1.4 WHO MAY BECOME A MEMBER?

Capacity to be a member of a company is governed by the rules of the common law relating to contracts and anyone who has the capacity to make a contract may become a member of a company. The following are some of the special cases, which require some explanation. (a) Infants An infant is any person who has not attained the age of 18 years: the Age of Majority Act 1974. He has a common law right to enter into a contract to buy shares in a company, and thereby become a member of the company. The contract is however voidable at his option, and he may avoid it at any time during his infancy or within a reasonable time after attaining the age of 18 years. However, it was explained in Steinberg v Scala (Leeds) Ltd (59) that although the infant has a right to repudiate the contract he would only be entitled to get back the amount already paid if there has been a total failure of consideration because the shares have become valueless. A company's articles may however restrict membership of the company to adults only, in which case an infant would not become a member of the company. (b) Personal Representatives On a shareholder's death, ownership of the shares previously held by him is transmitted to his personal representative, who may be an executor or administrator. The personal representative would be entitled to be registered as a member of the company unless the company's articles provide otherwise. (c) Corporations A corporation, whether a registered company or not, may, if authorised by its memorandum (expressly or impliedly), take shares in a registered company and become a member of it. It would authorize "such person as it thinks fit to act as its representative at any meeting of the company". The authorization would be made by a resolution of its directors or other governing body under s.139(1)(a). Section 29(1) provides that a body corporate cannot be a member of a company, which is its holding company. Any allotment or transfer of shares in a company to its subsidiary shall be void except 1. Where the subsidiary is concerned as personal representative or trustee, unless the holding company or its subsidiary is beneficially interested under the trust and is not so interested only by way of security for the purposes of a transaction entered into by it is in the ordinary course of business which

includes the lending of money. This somewhat lengthy provision may be explained with the aid of some examples. i. M, who is a member of Z Bank Ltd, appoints its subsidiary, Z Bank (Executor & Trustee) Ltd, as his executor. On M's death, the subsidiary may be registered as a member of the holding company in respect of M shares. M transfers his shares to the subsidiary (in the above example) on trust for a beneficiary B, who borrows money from the holding company and secures repayment by mortgaging his interest in the shares to the company.

ii.

2. Where the subsidiary was a member of the holding company at the commencement of the Act on 1st January, 1962. Such a member would have no right to vote at meetings of the holding company or any class of members thereof except in respect of shares it holds as personal representative or trustee. (d) A person upon whom shares have devolved pursuant to the Provisions of Bankruptcy Act, may become a member of the company.

1.5 THE REGISTER OF MEMBERS

Section 112(1) requires every company to keep a register of its members and prescribes the contents of the register. 1.5.1 Contents The register of members must contain the following particulars i. the names and postal addresses of the members; ii. a statement of the shares held by each member, distinguished by its number if it has one;

iii. the amount paid or agreed to be considered as paid on the shares of each member; iv. the date at which each person was entered in the register as a member; and v. the date at which any person ceased to be a member.

Where the company has converted any of its shares into stock the register shall show the amount of stock held by each member instead of the amount of shares and the aforesaid particulars relating thereto. Failure to keep a register of members renders the company and every officer of the company who is in default liable to a default fine [s.112(4)]. Section 120 provides that the register of members shall be prima face evidence of the matters it contains. 1.5.2 Location

Section 112(2) requires the register of members to be kept at the registered office of the company. If it is made up at another office of the company, or at some other office, it may be kept at that other office provided the office is not at a place outside Kenya. The registrar must be informed of the place, other than the registered office, where the register is kept. Any change in that office must be notified to the registrar within fourteen days failing which the company and every officer of the company who is in default shall be liable to a default fine. 1.5.3 Index of Members Section 113(1) provides that a company with more than 50 members must, unless the register of members constitutes an index, keep an index (which may be in the form of a card index) of the names of the members of the company, and must alter the index within fourteen days after any alteration in the register. The index shall in respect of each member contain a sufficient indication to enable the account of that member in the register to be readily found and shall be at all times kept at the same place as the register of members.

1.5.4

Share Warrants Section 114(1) provides that on the issue of a share warrant the company shall strike out of its register of members the name of the member to whom the warrant has been issued and shall enter in the register (a) the fact of the issue of the warrant; (b) a statement of the shares included in the warrant, distinguishing each share by its number; and (c) the date of the issue of the warrant. The bearer of the warrant shall, subject to the articles of the company, be entitles, on surrendering it for cancellation, to have his name entered as a member in the register of members. If the articles so provide, the bearer of a share warrant shall be deemed to be a member of the company either to the full extent or for any purposes defined in the articles. Closure of Register: Under Section 117 of the Act a company may, on giving notice by advertisement in dome newspaper circulating in Kenya, or in that area of Kenya in which the registered office of the company is situate, close the register for any time or times not exceeding thirty days in each year.

1.5.5

Inspection of Register Section 115(1) provides that the register and index of members shall during business hours be open to the inspection of any member without charge, and of any other person on payment of a fee, not exceeding two shillings for each inspection, as the company may prescribe. Any person may require a copy of the register or any part thereof, on payment of one shilling or such less sum as the company may provide, for every hundred words or fractional part thereof

required to be copied. The copy must be supplied within a period of fourteen days commencing on the day next after the day on which the requirement is received by the company. If a company officer refuses an inspection or fails to provide a required copy, the company and every officer of the company who is in default shall be liable in respect of each offence to a fine not exceeding sh40 and further to a default fine of sh40. The court may by order (a) compel an immediate inspection of the register and index, or (b) direct that the copies required shall be sent to the person requiring them. The court order may also be made against the company's agent who keeps the company's register of members if the company's failure to provide a copy, or permit an inspection, is due to his default. S.117 permits a company, on giving notice by advertisement in some newspaper circulating in Kenya or in that area of Kenya in which the registered office of the company is situate, to close the register of members for any time or times not exceeding in the whole thirty days in each year. The purpose of this provision is to keep the register static so that members' holdings may be extracted as at a particular date for the purpose of computing dividends. 1.5.6 Rectification of the Register Section 118(1) empowers the High Court to rectify the register of members in two cases, namely i. ii. If the name of any person is, without sufficient cause, entered in or omitted from the company's register of members; or

Default is made or unnecessary delay takes place in entering on the register the fact of any person having ceased to be a member. The application to the court to rectify the register may be made by i. the aggrieved person; or ii. any member; or iii. the company. Where an application is made the court may i. refuse the application; ii. order rectification of the register and payment by the company of any damages sustained by any party aggrieved. An order rectifying the register can be made even when the company is being wound up: Re Sussex Brick Co (59). The case of Burns v Siemens Bros Dynamo Works Ltd (60) shows that the circumstances set out in Section 118(1), above, are not the only ones in which the court can order rectification. It may also do so where a name stands on the register without sufficient cause.

The court may also order rectification of the register by deleting a reference to some only of the registered shareholder's shares. It need not delete his name entirely. This is illustrated by Re Transatlantic Life Assurance Co Ltd (1979) in which the court deleted an additional number of shares, which had been issued to the applicant in breach of the prevailing Exchange Control Regulations but left the register intact as regards his previous shareholding. By s.118(4), if an order is made in the case of a company required to send a list of its members to the registrar, the court, when making an order for rectification of the register, shall by its order direct notice of the rectification to be given to the registrar. 1.5.7 Notice of Trusts Section 119 provides that no notice of any trust, expressed, implied or constructive, shall be entered on the register, or be receivable by the registrar. The consequences of this provision are as follows a. The company is entitled to treat every person whose name appears on the register as the beneficial owner of the shares even though he may in fact hold them in trust for another. In particular, if the company registers a transfer of shares held by a trustee, it is not liable to the beneficiaries under the trust even if the sale of the shares by the trustee was made in breach of the trust: Simpson v Molson's Bank (61)

b.

The company is not a trustee for persons claiming the shares under equitable titles: Societe Generale de Paris v Walker (62). The owner of an equitable interest in shares, such as an equitable mortgagee or the recipient of a bequest of shares, may protect his interest by serving on the company a stop notice (or what is sometimes called a notice in lieu of distringas), informing the company that he is interested in the shares and requiring the company to notify him of a receipt of a transfer of the said shares to a transferee other than himself. When the company eventually informs him of the proposed transfer he would then apply to the court for an injunction restraining the transfer.

1.5.8

Branch Register Section 121(1) empowers a company having a share capital, if authorised by its articles, to keep a branch register in any part of the Commonwealth outside Kenya of its members resident in that part of the Commonwealth. A branch register shall be deemed to be part of the company's register of members, which shall be known as the principal register, and must be kept in the same manner (s.122). The registrar of companies must be informed of the situation of the office where the branch register is kept within one month of its opening. A similar notice must also be given of its change or discontinuance [s.121(2)].

1.6 THE ANNUAL RETURN Section 125(1) provides that every company having a share capital shall, once at least in

every year, make a return (referred to in the marginal note as the "annual return") to the registrar of companies. No return need be made in the year of the company's incorporation or, if the company is not required by s.131 to hold an annual general meeting during the following year, in that year. The return must contain the matters, and be in the form specified in Part I of the Fifth Schedule. The Fifth Schedule matters are: 1. The situation of the registered office. 2. 3. The place where the register of members and the register of debenture holders are kept if they are not kept at the registered office. A summary, distinguishing between shares issued for cash and shares issued as fully or partly paid up otherwise than in cash, specifying (a) the amount of the share capital of the company and the number of shares into which it is divided; (b) the number of shares taken from the commencement of the company up to the date of the return; (c) the amount called up on each share; (d) the total amount of calls received; (e) the total amount of calls unpaid; (f) the total amount of the sums (if any) paid by way of commission in respect of any shares or debentures; (g) the discount allowed on the issue of any shares issued at a discount or so much of that discount as has not been written off at the date on which the return is made; (h) the total amount of the sums, if any, allowed by way of discount in respect of any debentures since the date of the last return; (i) (j) the total number of shares forfeited; the total amount of shares for which share warrants are outstanding at the date of the return and of share warrants issued and surrendered respectively since the date of the last return, and the number of shares comprised in each warrant.

4.

The total amount of the indebtedness of the company as at the date of the return in respect of all mortgages and charges which are required to be registered with the registrar. A list of present and past members (a) containing the names and postal addresses of all persons who, on the fourteenth day after the company's annual general meeting for the year, are members, and of persons who have ceased to be members since the date of the

5.

last return or, in the case of the first return, since the company's incorporation; (b) stating the number of shares held by each of the existing members at the date of the return, specifying shares transferred since the date of the last return (or, in the case of the first return, since incorporation) by persons who are still members and have ceased to be members respectively and the dates of registration of the transfers; (c) if the members' names are not arranged in alphabetical order, having an index annexed to enable the name of any person therein to be easily found. If any shares have been converted into stock, the amount of stock held by each of the existing members as required by proviso (ii) to section 125(1). 6. All particulars of the directors and the secretary as are contained in the register of directors and secretaries. The return made by a company not having a share capital shall contain the matters specified in (1), (2), (4) and (6) above. Time of completion of the Annual Return S.127(1) provides that the return must be completed within 42 days after the annual general meeting for the year and a copy signed by a director and the secretary shall be delivered to the registrar within the 42 days. If this provision is not complied with the company and every officer of the company who is in default shall be liable to a default fine. 1.6.1 ANNEXTURES S.128 (1) provides that there shall be annexed to the annual return (a) A copy of every balance sheet laid before the company in general meeting during the period to which the return relates. It shall be certified as a true copy by a director and the secretary. (b) A copy of the auditors' report on each balance sheet and a copy of the directors' report accompanying it. These provisions do not apply to a private company, unless at least one shareholder of the company is a public company. 1.6.2 Certificate to accompany Annual Return Section 129 provides that the annual return of a private company shall be endorsed with, or accompanied by, a certificate signed by a director and the secretary of the company to the effect that (a) The company has not since the date of its incorporation issued any invitation to the public to subscribe for its shares or debentures; (b) The excess of the number of members beyond 50 consists wholly of past or present employees of the company. This certificate is made only where the annual return discloses that the number of the company members exceeds 50.

2. COMPANY SECURITIES

The securities, which a company may legally issue, fall into two primary classes. The first of these classes is generally described as "shares" and the second as "debentures".

2.1 SHARES
i. Section 75 provides that "the shares or other interest of any member in a company shall be movable property". This provision creates more problems than it solves although it may be regarded as the statutory definition of a share. The definition of a share which is generally quoted in English text-books on Company Law is that of Farwell, J. in Borland's Trustee v Steel Brothers to the effect that "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 inter se in accordance with (Section 22 of the Companies Act). The contract contained in the articles of association is one of the original incidents of the share. 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". It should be noted from this definition that a share: (a) Is a yardstick of the holder's liability to the company (if the company is limited by shares); (b) Is the yardstick of the holder's right in the company, particularly the dividends payable by the company to the shareholders, voting rights and return of capital on a winding up; (c) Is the foundation, as it were, of the bundle of rights and liabilities arising from the statutory contract contained in the articles of association. It should also be noted that a share is a form of property which, being transferable, can be bought, sold, given as security for a loan or disposed of under a will. A person who owns one or more shares in a company is ipso facto, a member of the company (unless the company did not enter his name in its register of members as a consequence of which he is technically not regarded as a member of the company: Nicoll's case). Note: Companies limited by guarantee and not having a share capital have members who do not own shares in the company. ii. TYPES OF SHARES The classes or types of shares, which can be created and issued by a company, are not prescribed by the Companies Act. They depend on the provisions of the company's constitution, usually the articles of association, or the contract pursuant to which they are issued. Legally, therefore, a company can create any type or class of shares it pleases but in practice the following are the classes of shares generally issued by registered companies: 1. 2. Ordinary Shares Preference Shares

3. Participating Preference Shares 4. Redeemable Preference Shares 5. Deferred or founders or management shares 6. Employee Shares iii. RIGHTS OF SHAREHOLDERS Primary Rights The ownership of at least a share of one or other of the aforesaid classes constitutes the "holder" a member of the company which has issued the shares. As a member, the shareholder will enjoy certain rights in the company which, unless modified or excluded by the company's articles, will generally comprise the right to: i. attends general or class meetings of the company; ii. vote at the said meetings; and iii. receive a properly declared dividend. Secondary Rights Notices of general meetings Copies of balance sheet laid before the general meeting Copies of memorandum and articles Inspection of minutes of general meetings and registers Petition for the alternative remedy. iv. PREFERENCE SHARES The nature of "preference" shares and the rights attached to them have been explained by the English courts in various cases. The decisions may be summarised as follows: 1. The essential characteristic of a preference share is that it carries a prior right to receive an annual dividend of a fixed amount, eg 7 1/2% dividend. This is the only preferential right that it would have over the other shares, particularly the ordinary shares. If the share is to have any other preferential right, such a right must be expressly conferred by the contract under which it was issued or, exceptionally, the company's memorandum or articles of association.

2.

As regards the priority dividend entitlement, four points should be noted: (a) the right is merely to receive a dividend at the specified rate before any dividend may be paid on ordinary or other classes of shares. It is a priority right to whatever dividend may be declared. It is not a right to compel the company to pay the dividend if it declines to do so. This issue is likely to arise if the company decides to transfer profits to reserve or makes a provision in its accounts for a liability or loss instead of using the profits to pay the preference dividend. In BOND v BARROW HAEMATITE STEEL CO (1902) The company did not pay (ie "passed") its preference dividend. Bond and other preference shareholders contended that the company had available

reserves of 240,000 pounds from which it could have declared the dividend on their shares. The company replied that it had suffered realised losses of 200,000 pounds on the disposal or demolition of current assets and, in addition, its retained fixed assets had diminished in value generally by 50,000 pounds. It therefore decided to retain the funds in question to make good losses. HELD: The court could not overrule the directors in their decision that the "state of the accounts did not admit of any such payment" (of preference dividend). It was also held in Re Buenos Aires Great Southern Rly Co Ltd that if the company's articles entitle the preference shareholders to receive a fixed dividend for each year "out of the profits of the company", the words "profits of the company" means the profits available for dividend after setting aside such reserves as the directors think fit. If the whole of the profits are transferred to reserve the preference shareholders are NOT entitled to any dividends. (b) the right to receive a preference dividend is deemed to be cumulative unless the contrary is stated. If, therefore, a 7% dividend is not paid in year 1, the priority entitlement is normally carried forward to year 2, increasing the priority right for that year to 14%and so on. When arrears of cumulative dividend are paid, the holders of the shares at the time when the dividend is declared, are entitled to the whole of it even though they did not hold the shares in the year to which the arrears relate. An intention that preference shares could not carry forward an entitlement to arrears is usually expressed by the word "non-cumulative". But words such as "a dividend of X% payable out of the net profits of each year" sufficiently indicate that arrears may not be paid in a later year. If nothing is expressed (though cumulative preference shares are usually described as "cumulative" to remove all possible doubt) they are deemed to be cumulative: Webb v Earle (1875) (c) If the company which has arrears of unpaid cumulative preference dividends goes into liquidation, the preference shareholders cease to be entitled to the arrears unless: i. ii. a dividend has been declared though not yet paid when liquidation commences; or the articles (or other terms of issue) expressly provide that in a liquidation arrears are to be paid in priority to return of capital to members.

(d) Holders of preference shares have no entitlement to participate in any additional dividend over and above their specified rate. If, for example, a 7% dividend is paid on 7% preference shares, the entire balance of available profit may then be distributed to the holders of ordinary shares. But this rule also may be expressly overridden by the terms of issue. For example, the articles may provide that the preference shares are to

receive a priority 7% dividend and are also to participate equally in any dividends payable after the ordinary shares have received a 7% dividend. The company might then distribute, say, 9% to its ordinary shareholders and an extra 2% (making 9% in all) to its preference shareholders. These preference shares are called participative preference shares. Since there is no limit on the amount of dividend, which may be paid, on them they are a form of "equity share capital" even if their entitlement to capital is restricted. 3. In all other respects, preference shares carry the same rights as ordinary shares unless otherwise stated. If they do rank equally they carry the same rights, no more and no less, to return of capital and distribution of surplus assets and to vote. In practice, it is usual to issue preference shares on this basis. It is more usually expressly provided that: (a) the preference shares are to carry a priority right to return of capital; and (b) they are not to carry a right to vote except in specified circumstances, such as failure to pay the preference dividend, variation of their rights or on a resolution to wind up. 4. that: (a) the amount paid up on the preference shares, e.g. 1 pound on each 1 pound share, is to be paid in liquidation or reduction of capital before anything is repaid to ordinary shareholders; but (b) Unless otherwise stated, the holders of the preference shares are not entitled to share in surplus assets when the ordinary share capital has been repaid. 5. On a reduction of share capital (where the preference shares carry an entitlement to priority in repayment) it is in accordance with the rights of preference shareholders to pay them off first. They cannot object that to do this is a variation of their rights; it is strict observance of them (unless their rights are so expressed as to prevent it): Scottish Insurance Corporation Ltd v Wilsons & Clyde Coal Co Ltd. If preference shares carry no right to attend and vote at general meetings, the preference shareholders are still entitled to receive a copy of the annual accounts since these must be sent to "every member" and they are members. The advantages obtained by holders of preference shares are greater security of income and (if they carry priority in repayment of capital) greater security of capital. But in a period of persistent inflation, the entitlement to a fixed income and to capital fixed in money terms is an illusion. A number of drawbacks and pitfalls, e.g. loss of arrears in winding up and enforced repayment, have been indicated above. The type of investor to whom preference shares were attractive is better protected by investing in debentures since he then has a contractual right to his interest (whether or not the company makes profits) and as a creditor he is entitled to repayment of his capital before any class of shares is repaid. It is also advantageous to a company for tax reasons to issue debentures rather then preference shares. When preference shares carry a prior right to a return of capital the result is

6.

7.

v.

REDEEMABLE PREFERENCE SHARES A company with a share capital may, if authorised by its articles, issue preference shares, which are redeemable: C A, s. 60 (1).

2.2 TRANSFER OF SHARES

A share is, by its nature, transferable property. But to obtain transfer of the legal ownership of shares two conditions must be satisfied: (a) A "proper instrument of transfer" must be delivered to the company, which may not enter the transfer in its register until this is done: CA S. 77. (b) If, as is the general practice with private companies, the articles give to the directors power to refuse to register a transfer and the directors exercise their power in a proper way, the restriction imposed by the articles will prevent a transfer of legal ownership. Both principles, especially (b), require some explanation in detail. 2.2.1 TRANSFER PROCEDURE It was explained in Re Greene (63) that the rule which requires a "proper instrument" of transfer enforces the payment of stamp duty, normally at ad valorem rate on the consideration or (in the case of a gift) on the nominal value of the shares transferred. A company must reject an unstamped transfer under the provisions of Stamp Duty Act. This rule does not, however, apply to registration of shares in the names of personal representatives or trustees in bankruptcy since they are merely asserting powers of control and disposal of the shares of members whom they represent given to them by law under the rules of transmission. A member, however, cannot arrange for the direct transfer of his shares to a beneficiary after his death without a proper transfer (signed by his executors): Re Greene (63). The articles usually provide that: (a) The instrument of transfer must be "in any usual or common form" (i.e.. the forms used by stockbrokers); (b) the transferor's share certificate must accompany the transfer when presented for registration: Table A, Articles 23 and 25. The basic transfer procedure is that the transferor and transferee complete and sign the transfer form and have it stamped before delivering it to the company (with the transferor's share certificate) for registration. The transferee becomes a member and legal owner of the shares only when his name is entered in the register of members. The company issues to the transferee a new share certificate and cancels the old one. This is explained by the following diagram: 2.2.2 CERTIFICATION OF TRANSFERS

If the holder is not transferring his entire holding by a single transfer, it would be inappropriate for him to hand to the transferee a share certificate for a larger number of shares than are comprised in the transfer. In such a case the holder sends his signed transfer with his share certificate to the company for cancellation and the transfer form is returned to the transferor who then delivers it to the transferee for stamping and representation to the company. If the transferor is retaining some shares the company sends him a new share certificate for the reduced number of shares still registered in his name. This procedure is called "certification" of a transfer. It is explained by the following diagram: KEY (1) (2) (3) (4) (5) Certificate and signed transfer sent to company Signed transfer is endorsed and returned to transferor Transfer delivered to transferee Transfer stamped and sent to company New certificates sent to transferor and transferee

The transfer of registered debentures or of debenture stock is subject to the same rules as transfer of shares. Certification is a representation by the company to any person acting on the faith of the certification that documents have been produced to the company which on the face of them show a prima facie title of the transferor to the shares comprised in the transfer. It is not a representation that the transferor has any title to them but it does imply that the certificate will be retained: CA. S.81; Bishop v. Balkis Consolidated Ltd. Under s.81(2), any person who acts on a negligent certification can claim damages from the company for his loss if the company did not either receive or fails to retain the share certificate. But the company has no duty and no liability to anyone else. If, for example, the company returns the certified transfer form and the share certificate to the holder who sells the shares to A giving him the certified transfer form and also to B, giving B a second transfer form of the same shares with the transferor's certificate and A's transfer is then registered first, B has no claim against the company if it refuses to register the second transfer to him. B does not in this case rely on the certified transfer (of which he is unaware) and the share certificate was correct when first issued to the holder. In LONGMAN v BATH ELECTRIC TRAMWAYS A transfer of shares to B was registered and a certificate was prepared in his name. Before the certificate had been issued, B signed a transfer of the shares to H and this transfer was sent to the company for certification. The company certified the transfer (as it still had B's new share certificate) and returned the certified transfer to B. By mistake the company then sent to B the share certificate in his name. B deposited the share certificate with L as security for a loan. L later claimed that he was entitled to the shares. Held: L's claim must fail. He had never seen (and therefore did not rely on) the

certified transfer to H and mere possession of B's share certificate gave him no claim against the company since the certificate at the time of issue correctly described B as still the registered holder of the shares (ie the transfer to H had not at that point been delivered for registration). Ifto vary the facts of Longman's caseL had been able to secure registration as holder of the shares and the company had then rejected the transfer to H, H could claim compensation from the company since the certified transfer delivered to him would have been a representation by the company that it held B's certificate and that the transfer to H was valid. If identified shares are sold under a preliminary contract the rights and obligation incidental to ownership of the shares pass at once to the purchaser under the contract unless otherwise agreed. Thereafter, any dividend received by the vendor (pending registration of his transfer) must be paid over to the purchaser (unless the shares are sold "ex-div"). The purchaser must indemnify the vendor against any calls made on the shares before registration of the transfer. The vendor is, however, free to vote at meetings as he wishes until the purchase price has been paid to him. A vendor of shares has a duty (implied by the contract of sale) to deliver a transfer of the shares (in exchange for the price) which will give the purchaser good title to the shares. If he fails to deliver such a transfer, he is liable to pay damages. But the vendor does not (unless the contract expressly so provides) guarantee that the company will register the transfer. If the company rejects the transfer, the vendor as registered shareholder holds the shares in trust for the purchaser as his nominee. 2.2.3 RESTRICTIONS ON TRANSFER Section 30 of the Companies Act requires the articles of private companies to restrict the right to transfer the company's shares. The model articlesTable Acontains provisions which give the directors power to refuse to register a transfer of any share, whether fully or partly paid. The articles of a public company may also restrict the right to transfer the company's sharesusually if the shares are not fully paid or if the company has a lien on them. Unless the directors have a power under the articles to refuse a transfer and exercise that power properly, the transfer must be registered and the court may order rectification of the register for that purpose. The rules on the restriction of transfer are: (a) To exercise their power, the directors must consider the transfer and take a decision to refuse to register it. In RE HACKNEY PAVILION A transfer of shares was sent in by the executors of a deceased director and shareholder. The two surviving directors held a board meeting and disagreed as to whether the transfer should be registered. There was no casting vote. The secretary wrote to the executors to inform them that the directors had declined to register the transfer. Held:

This was incorrect since a positive act of refusal was necessary and there had been none. The register must be rectified by registering the transfer. (b) The directors in reaching their decision must act bona fide in what they consider to be the best interests of the company: RE: Smith & Fawcett (64) (c) Where the articles specify grounds of refusal, the directors may be required to identify the grounds of refusal. However, they are not obliged to disclose the detailed reasons for their decision (unless the articles so provide). If nonetheless the directors do disclose their reasons, the court will consider whether the directors acted bona fide or whether their reasons accord with the grounds specified in the articles (if that is the case). In RE BEDE SS CO LTD (1971) The directors were authorised to refuse transfers if in their opinion it was contrary to the interests of the company that the transferees should be members. The directors rejected transfers of small numbers of shares (and of single shares) on the ground that it was prejudicial to the company that its issued share capital should be fragmented. Held: The reason given could be challenged and was invalid. The power to refuse registration must (on the formula used in the articles) be confined to cases of objection to the transferees on personal grounds. In this case the directors were objecting to the small amount of shares transferred which was not an objection to the transferees personally. (d) The power of refusal must be exercised within a reasonable time from the receipt of the transfer. Under s. 80, a company is required to give notice of any refusal within sixty days. If the power is not exercised within a reasonable time it lapses and can no longer be used. The requirement of notice of refusal within sixty days effectually makes that the "reasonable" period. In RE SWALEDALE CLEANERS LTD (1968) On 3rd August 1967, transfers of shares were presented. There was only one director then in office and he purported to refuse to register the transfers in exercise of a power of refusal given by the articles. But a quorum for meetings of the directors was two and so the one director was not competent to exercise the powers of the board. On 11th December 1967 proceedings were begun for rectification of the register, i.e., a court order that the transfers should be entered in the register. On 18th December 1967 a second director was appointed and there was a board meeting at which the two directors refused to register the transfers (4 months, 14 days). Held: The attempt to exercise the power of refusal on 18th December 1967 was invalid since, in the interval of 4 1/2 months (since the transfers were

presented), the power had expired (as regards those transfers). Since the power of refusal had not been exercised the transfers must be entered in the register. The articles may also restrict the right to transfer shares by giving to members a right of first refusal of the shares, which other members may wish to transfer. Any such rights are strictly construed, i.e. a member who wishes to accept must observe the terms of the articles and a member will not be permitted to evade his obligation to make the offer. In LYLE & SCOTT v SCOTT'S TRUSTEES The articles required any member who might be "desirous of transferring" his shares to give notice to the company secretary so that the shares could be offered to other members. Certain members agreed to sell their shares to an outsider and, while remaining the registered holders, gave the purchaser their proxies so that he could secure control of the company. Held: These members were indeed "desirous of transferring" their shares and must give formal notice as the articles required. The cases cited above show that when there is a dispute over refusal to register the proper remedy is to apply to the court for rectification. A member who applied for an order for compulsory winding up of the company on the just and equitable ground was refused (Charles Forte {Investments} v Amanda) as "a winding up petition is not a proper remedy" in such a case because to liquidate the company would be unfair to other members not involved in the dispute. 2.2.4 SHARE CERTIFICATES (a) S.82 (1) provides that within sixty days of allotting shares or receiving a transfer, a company must have ready for delivery a certificate of the shares allotted or transferred (unless the transfer is rejected). This is a formal written declaration (usually issued under the seal of the company) that the person named is entered in the register as the holder of the shares specified. (b) A share certificate is a document on which is printed the name of the shareholder and the number of shares held (with any particulars such as "1 pound ordinary") is written (or typed). The seal of the company is affixed and witnessed by signatures (unless dispensed with). The standard printed wording on a share certificate reads: "This is to certify that (name of shareholder) is the holder of (number and any description) shares fully paid of (nominal value) each numbered ... to ... inclusive in the above named company subject to the memorandum and articles of association thereof." The distinguishing numbers may be omitted. The reference to the memorandum and articles is a reminder of the statutory rule that every

member is bound by these documents as a contract with the company, under s.22 of the Companies Act. Contents of the share certificate Name of the company Common seal of the company Registered holder of the shares Number of shares held Serial number Date of issue Signature of directors

A share certificate is not a document of title but is prima facie evidence of ownership. The company therefore requires the holder to surrender his certificate for cancellation when he transfers all or any of his shares. If the company issues a share certificate which is incorrect it is estoppel from denying that it is correct but only against a person who has relied upon it and thereby suffered loss. Estoppel by Share Certificate Although the share certificate is only prima facie evidence of title, its contents may lender the company liable under the equitable doctrine of estoppel. This is because the contents of the share certificate are a representation by the company to 3rd parties and a bona fide 3rd party who suffers loss or damage by reason of relying upon the representation will hold the company liable. The company cannot be heard to say that it never made the representation or that it was false. RE BAHIA & SAN FRANCISCO RAILWAY CO T was the registered holder of 5 shares. S and G forged a transfer of the shares to themselves and presented it for registration with T's share certificate which they held as her brokers. The transfer was registered and a new share certificate was issued to S and G as shareholders. S and G sold the shares to B and another person who were duly registered as holders. T had the shares re-registered in her name since the forged transfer was a nullity. B and the other purchaser claimed the value of the shares from the company as damages. Held: The claim was valid since the share certificate in the name of S and G was "a declaration by the company to all the world that the person in whose name the certificate is made out and to whom the certificate is given, is a shareholder of the company ... with the intention that it shall be acted upon in the sale and transfer of shares". (NB in this case the share certificate issued to S and G was genuine (although obtained by a forged transfer) and the claimants had not themselves presented a forged transfer since the transfer to them by S and G was genuine (although it related to shares to which S and G had no title). The principle of estoppel which applied in the case cited above is that if a person:

(a) makes a statement of fact with the intention that it shall be relied on; and

(b) the person to whom it is made does act in reliance on it and would suffer loss if the statement were subsequently denied as untrue, then the person who made the statement is estoppel, ie, is not permitted to deny his own statement by asserting the true facts. The position must remain or be resolved as if the statement made had been true. Apart from ownership, the company may be similarly estoppel from denying the correctness of the certificate in other respects. For example, if the certificate states that the shares are fully paid, the company cannot deny that this is so. In BLOOMENTHAL v FORD (1897) The company borrowed money from B and as security gave him share certificates for 10,000 shares of 1 pound each in his name in which the shares were described as fully paid. B believed that the amount due on shares had been paid by a previous holder. But this was not true. The company went into liquidation and the liquidator claimed from B the amount due on his shares. Held: The company was estopped by its own statement on the certificate that the shares were fully paid. The claim must fail. Read also the case of Burkinshaw v Nicolls. (65) (c) A person who is in possession of a share certificate in his name or the name of another person may have a valid claim (ie. the company may be estoppel from denying that the certificate is valid). But the claimant will fail in any of the following circumstances: i. If he has not relied on the share certificate in a transaction from which he will incur loss if the share certificate is repudiated by the company. In Tompkinson's case, below, the claim only succeeded because T had re-sold the shares in reliance on the certificate. In BALKIS CONSOLIDATED v TOMPKINSON P sold shares to T (but P had no title to the shares) and the company was induced by fraud on the part of P to issue a share certificate to T in the name of T. T later re-sold the shares. The company refused to register the transfers by T to the persons who had bought the shares from him on the ground that T had no title (like P before him). T purchased other shares to satisfy the claims of those to whom he had sold and claimed damages from the company. The company said that it was not estoppel from denying that T had any title to his shares. Held:

T could rely on the principle of estoppel since, in reliance on the share certificate issued to him, he had incurred liabilities by reselling the shares. (NB. T himself was not implicated, even indirectly, in procuring the issue of the certificate which was arranged by P.) ii. If he has obtained the certificate by presenting a forged transfer to himself for registration.

iii. If the certificate is a forgery or issued without authority. In RUBEN v GREAT FINGALL CONSOLIDATED The company secretary forged the necessary signature of a director on a share certificate and issued it. Held: The company was not estoppel from denying that the certificate was worthless. It was not a certificate issued by the company. 2.2.5 STOLEN CERTIFICATES AND FORGED TRANSFERS Most of the case-law is concerned with share certificates issued as a result of the delivery to the company of a forged transfer together with a stolen or misappropriated share certificate of the registered holder. The company accepts the transfer for registration and issues a new certificate to the transferee who then re-sells the shares to another person. The result is then as follows: (a) The original registered holder (A) can usually require the company to restore his name to the register since a forged transfer is a nullity which cannot deprive him of his title to the shares; (b) The person (B) who obtained registration of the forged transfer of shares to himself cannot rely on the share certificate issued to him since he obtained it by presenting a forged transfer. On the contrary, he is liable to compensate the company for its liability. This is so even if B is unaware of the forgery; (c) The second purchaser (C) has relied upon the share certificate issued to B. C is not disqualified from making the company liable on the certificate since C has not delivered a forged transfer to the company (Bahia case above). C is not the owner of the shares (since his claim is based on forged transfer by A to the person (B) who purported to transfer the shares to him. But as the company cannot deny that B's share certificate is correct it must compensate C either by paying C the amount which C paid to B for the shares or by buying other shares in order to be able to register those shares in the name of C. (Alternatively, the company may leave C's name on the register and buy other shares to register in the name of Aas in Barclay's case below). In SHEFFIELD CORPORATION v BARCLAY Stock was registered in the joint names of T and H. T forged H's

signature on a transfer and added his own. T delivered the transfer to B ( who was unaware of the forgery) and B obtained registration of the transfer to himself. B later transferred the shares to C to whom B delivered a transfer and the certificate issued to him. When the forgery was discovered, H claimed to be restored to the register as holder of the shares (T had died meanwhile) and the corporation, being estoppel against C, purchased shares in the market for registration as replacement in the name of H. The corporation claimed compensation from B. Held: B was liable to compensate the corporation since he had caused it to issue a false share certificate by delivering a forged transfer to himself for registration.

In the example given above it is assumed that the original registered holder has not contributed to the fraud. But if he does so, even innocently, he may be estoppel from asserting his ownership of the shares. He is not estoppel in this way merely because he leaves his share certificate in the possession of another person (see Bahia case above). But if he delivers a signed transfer to another person for a limited purpose he gives him apparent authority to use the transfer and so may be unable to repudiate an unauthorised use of the transfer. In FRY v SMELLIE The registered holder of shares gave to an agent a blank transfer (i.e. a transfer signed by transferor but without the name of a transferee inserted) with a view to the agent borrowing a specified sum of money using the shares as security. The agent exceeded his authority by mortgaging the shares for a larger sum. The shareholder denied that the transfer was valid since it had been used in a transaction, which exceeded the actual authority given to his agent. Held: The shareholder was estoppel from asserting that the agent had exceeded his authority. The private limitation of authority could not be pleaded against a third party who was not aware of it. Some companies in Kenya issue a "transfer notice" to the registered holder to the effect that a transfer of his shares had been presented for registration. However, if the registered holder ignores the notice (as happened in the Bahia case) he is not estoppel from later asserting that the transfer was not signed or authorised by him. Hence the issue of a transfer notice is of no value to the company and so in England the practice has been generally abandoned. It would however be advisable for public companies to insure against liability arising from accepting a forged transfer. 2.2.6 STOCK

A company may, if authorised by its articles, convert its issued shares into stock (or reconvert stock into shares). But shares must be allotted as shares ranking pari passu and be made fully paid before they can be converted into stock. The effect of conversion is that, for example, one hundred 1 pound shares become a single block of 100 pound stock owned and transferrable in units of defined value (usually the same amount as the value of the shares from which they are derived). It used to be common practice to convert fully paid shares to stock to dispense with use of identifying numbers for shares. But this result can now be achieved in other ways. It should be noted that reference to shares in the Companies Act includes stock unless otherwise indicated.(CA S.2).

2.3 MORTGAGE OF SHARES

This is a transaction whereby shares are used as collateral security for loans. The transaction is either legal or equitable. Under a legal mortgage the borrower transfers his shares to the mortgagee who becomes the registered holder subject to a separate agreement by which he undertakes to retransfer the shares to the mortgagor on repayment of the loan. The agreement also determines who is entitled to the dividends and gives the mortgagee the right to sell the shares if the mortgagor defaults on the loan. As registered holder, the mortgagee can transfer the shares to a purchaser who buys from him. The essential feature of an equitable or informal mortgage is that the borrower deposits his share certificate with the mortgagee but remains the registered holder of the shares. There is again an agreement containing the terms of the loan and the mortgage. The mortgagee may protect himself by serving a "stop notice" on the company but his possession of the share certificate is an effectual bar to dealings with the shares by the borrower. The equitable mortgagee's other potential difficulty is that since he is not a registered shareholder he has no direct means of transferring the shares to a purchaser if the borrower defaults and he decides to sell. He usually obtains from the mortgagor a "blank transfer", ie. a transfer signed by the mortgagor as registered holder but without the name of a transferee inserted. This usually gives the mortgagee an implied power to insert his own name as transferee in case of default. He can then dispose of the shares after transferring them into his name. Alternatively, the mortgagee may obtain from the mortgagor a power of attorney giving him power to insert the name of a purchaser on the transfer.

2.4 CALLS ON SHARES

Unless shares are already fully paid the registered holder is liable to pay the balance due when called on to do so. The power of the directors to make calls is defined by the articles. The procedure must be correctly applied. The rules or principles governing calls are embodied in Articles 15 21 of Table A. If a shareholder defaults in the payment of calls, the company may, if the articles so provide, forfeit his shares. Articles 3339 of Table A contain provisions which will apply if the company's articles do not provide for forfeiture.

2.5 LIEN ON SHARES

A lien is an equitable charge on the shares of a member to secure sums owing by the member to the company. The company has a lien only if its articles so provide and to the extent that the articles provide. Private companies however usually have a lien over fully paid as well as partly paid shares to secure sums owing by members whether in respect of their shares or other liabilities such as loans. The articles also give the company a power to enforce its lien (in case of the member's default) by sale of the shares. The company's lien gives it a first claim on the shares unless the company has notice of some existing claim to the shares before the holder becomes indebted to the company. BRADFORD BANKING COMPANY v BRIGGS & CO (1886) A member deposited his share certificate with the bank as an equitable mortgage of the shares to secure a loan to him by the bank. The bank gave notice to the company of its interest as mortgagee. Later, the member became indebted to the company. Held: As the company had prior notice of the bank's mortgage, its lien (although the right to a lien existed when the notice was received) was postponed to the mortgage since the company's claim under the lien arose after the bank's notice was received.

2.6 VALUATION OF SHARES

The articles of private companies often provide that a member who wants to sell his shares must first offer them to the existing members at a price to be fixed by the auditors. Similar provisions are often applicable in the case of a members death. In valuing the shares for this purpose, the auditor is not obliged to explain the basis of his valuation or to give his reasons for it, and he is not liable to an action by a party who is dissatisfied with it unless he is dishonest. If, however, he does give an explanation, the court can inquire into it and, if satisfied that the valuation has been made on the wrong basis, can declare that it is not binding, i.e. the valuation can be impeached for fraud, mistake or miscarriage, but on matters of opinion the court will not interfere. In Arenson v Casson Beckman Rutley & Co., it was held that for a valuer to establish immunity from suit, he must show that a dispute between at least two parties was sent to him to resolve in such a way that he had to exercise a judicial discretion. An auditor of a private company who, on request, values its shares in the knowledge that this valuation will determine the price to be paid under a contract owes a duty of care to both the vendor and the purchaser. Accordingly, on the facts of the case, the plaintiffs statement of claim disclosed a cause of action.

2.7 BORROWING BY COMPANIES

It has been observed that Most Companies like individuals require to borrow from time to time for the exigencies of their business. To entitle a company to borrow, it must have power to borrow given to it by its constitution. Whether a company has or has no power to borrow depend on its objects and powers specified in the objects and powers specified in the objects clause of the memorandum. Usually, the objects clause contains an express power to borrow. However, an implied power is sufficient. An

implied power arises whenever the objects are such that a power to borrow may fairly be regarded as incidental to the companys objects. This is the case with a non-trading company there must be something in the memorandum or articles to show expressly or inferentially that the company is to have a power to borrow. If a company has no power by its memorandum to borrow, it can remedy the defect by altering its objects pursuant to sec 8(1) of the companies Act. A newly registered public company must not exercise any borrowing powers unless the registrar of companies has issued it with a certificate of trading pursuant to sec 111 (3) of the Act. Sometimes the borrowing powers of a company are restricted by the memorandum or articles e.g. to a specific sum or to a sum not exceeding the paid up capital. However, in the vast majority of cases no limit is imposed. It therefore follows that if a company has an express or implied power to borrow, it may form time to time borrow as much as it wants subject to any restrictions in its articles. The power to borrow is generally exercised by directors. Article 79 of Table A is emphatic that The directors may exercise all the powers of the company to borrow money and to mortgage or charge its undertaking, property and uncalled capital, or any part thereof and to issue debentures, debenture stock and other securities whether outright or as security for any debt, liability or obligation of the company or of any third party. If a company has power to borrow, it has an incidental there to power to secure the repayment of borrowed money by mortgage or change of all or any of its property, real or personal present or future. Directors power to borrow may be general as above or special i.e. a clause empowering the directors to borrow or raise money. A company with a power to borrow may borrow in such manner as it thinks fit. It can therefore raise money on a legal mortgage of any specific portions of its property or by equitable charge by bonds, promissory notes or by debentures or debenture stocks. Where a company has no borrowing power or where the memorandum of association fixes a limit to the borrowing powers of the company a rare thing altogether any borrowing in the one case and any borrowing in excess of such limit in the other case is potentially ultra virus the company. If the company has unlimited powers of borrowing but the directors having only limited powers, exceed them the borrowing is irregular for want of authority. It is intra virus the company and may be ratified by shareholders. Additionally, the lender is protected by the rule in Turquands Case The lender of money borrowed ultra vires the company has in some cases a right against the directors personally for breach by them of their implied warranty of authority, if their acts amount to an implied representation of fact and it makes no difference as to the liability of the directors in such a case that they did not know that they were exceeding their powers.

3. DEBENTURES

3.1 S.2 of the Act defines "debenture" as including "debenture stock, bonds and any other
securities of a company whether constituting a charge on the assets of the company or not". There is no precise legal definition of a "debenture". In Levy v Abercorris Slate & Rubber Co Chitty, J stated that he could not find any precise legal definition of the term "debenture" and went on to observe that the word "is not, either in law or commerce, a strictly technical term, or what is called a term of art". He also stated that, etymologically, the word is a derivation from the Latin Debenture mihi which were the opening words of certain documents, which used to be issued by English companies in the 1860s as an acknowledgement of a loan the companies had received from the person to whom the document was issued. With the passage of time the word "debenture" acquired the meaning it generally has today, namely, a document issued by a registered company to acknowledge, or evidence, an indebtedness. Primarily, the word "debenture" is applied not to the indebtedness itself but to the document evidencing it.

3.2 Debentures and debenture stock

A debenture is usually a formal document in printed form. The main types, which a company can issue, are (a) A Single Debenture A single debenture is usually a formal document in printed form and sealed. It is usually issued when a company obtains a loan from a single lender, such as its bank. The bank would normally insist that the company signs and seals one of the bank's standard form of debenture which would not only create a charge in favour of the bank but would also give it certain powers in relation in the charged property. (b) Debentures Issued as a Series Debentures are issued as a series if the company decides to borrow money from different lenders on different dates but in such a way that the lenders would rank equally in their right to repayment and in any security given to them. Each lender receives a debenture in identical form in respect of his loan and the debentures are expressed to form a series ranking pari passu. (c) Debenture Stock "Debenture stock" is created when a public company issues "debenture stock certificates" to a class of debenture holders, evidencing the portion of the total to which each one of them is entitled. Each lender has a right to be repaid his capital at the due time and, before that time, to receive interest on it at the agreed rate. Each debenture will be for a specified sum, e.g. Sh 100 or Sh 1,000, as stipulated in the conditions of issue. Types of debentures Debentures may be issued as: i. Redeemable or irredeemable ii. Registered or bearer iii. Secured or unsecured (naked) Subordinated debentures Under American law, these are obligations often referred to as subordinated debts,

junior debts or inferior debts, upon which the right to receive payment is subordinated or deferred by a subordination agreement or clause, to the prior payment of certain other indebtedness, sometimes referred to as senior, superior or prior debts. The subordination may be incomplete or complete. If complete, the payment of principal and interest on the subordinated debt is deferred until the obligations on the senior debt is satisfied. The subordination is valid as between the parties.

3.3 Issue of Debentures

Debentures are usually issued by a resolution of the board of directors under powers conferred by the company's articles of association. Table A, Article 79 provides that "the directors may exercise all the powers of the company to borrow money ... and to issue debentures, debenture stock, and other securities". Such authority is however not required in the case of a trading company which has implied power to borrow money for the purposes of its business, and to give security for the loan by creating a mortgage or charge over its property. 3.3.1 Debentures and Shares Debentures and shares have the following similarities and differences. (a) Similarities i. A debenture is usually one of a series or class which is similar to a class of shares. ii. Debentures as well, as shares are long-term investments in the company and are transferable in the same manner.

iii. Debentures and shares may be issued in the same way through a prospectus issue. (b) Differences i. A shareholder is a member (i.e. an insider) whereas a debenture holder is a creditor (i.e. an outsider). ii. A shareholder has an interest in the company but not in the company's property. A debenture holder has no interest in the company but has an interest in the company's property, which constitutes his security. Consequently: 1. A shareholder can attend a meeting of the company and vote at the meeting whereas a debenture holder cannot do so. 2. A shareholder cannot insure the company's property whereas a debenture holder can do so (unless the debenture is a `naked' one). iii. Interest on debentures must be paid even if the company does not make a profit and can therefore be paid out of capital. Dividends on shares are payable only if profits are made and cannot be paid out of capital. iv. A company can purchase its own debentures but cannot, as a general rule, purchase its own shares.

v.

As a general rule, shares cannot be issued at a discount, whereas debentures may be issued at a discount.

3.4 Debenture Certificates

S.82(1) provides that debentures or debenture stock certificates must be completed and ready for delivery within sixty days after allotment or after the lodging of a transfer, unless the conditions of issue otherwise provide.

3.5 Debenture Trust Deed

When debentures are offered for public subscription, the company usually enters into a trust deed with trustees (usually a trust corporation). The trustees are appointed and paid by the company to act on behalf of the debenture holders. The charge securing the debentures is made in favour of the trustees who hold it on trust for the debenture stockholders. A debenture stockholder, unlike debenture holder, is not a creditor of the company. He cannot therefore present a petition to wind up the company: Re Dunderland Iron Co Ltd. The trustees are technically the creditors of the company for the whole debenture debt while the stockholder is an equitable beneficiary of the trust. 3.5.1 Contents of a Trust Deed The main terms of a trust deed are usually some or all of the following: i. A covenant (promise) by the company to pay to the debenture holders the agreed instalments of the loan and accrued interest. ii. A description of the property charged, whether specifically or by way of a floating charge.

iii. The events in which the security is to become enforceable, such as failure to pay the principal sum or interest as agreed. iv. A clause empowering the trustees to take possession of the property charged in the event of the security becoming enforceable, and to carry on the business and to sell the property charged. v. Appointment of a receiver vi. Meetings of debenture holders. vii. Covenants by the company to insure the property charged and to keep the property charged in good repair. Advantages of a Trust Deed A trust deed has several advantages some of which are (a) The circumstances in which the principal sum may become repayable are clearly spelt out. (b) The appointment of trustees facilitates the efficient administration of the trust since they are there to exercise continuous supervision of the debenture holders' rights and to take prompt action if the need arises.

3.5.2

(c) The trustees are empowered to appoint a receiver to carry on the business in case of urgency. (d) Covenants are entered into by the company for insurance, repair and other matters, which can be enforced by the trustees. (e) The trustees have a legal mortgage over the companys land. 3.5.3 Liability of Trustees Trustees for debenture holders owe the same duties to their beneficiaries as are owed by trustees in general. In particular, they cannot purchase the debentures without the consent of all the debenture-holders. S.90(1) provides that any provision in a trust deed, or in a contract with the holders of debentures secured by a trust deed, for exempting a trustee from, or indemnifying him against, liability for breach of trust where he fails to show the degree of care and diligence required of him as trustee (having regard to the provisions of the trust deed) shall be void. This provision does not however invalidate (a) any release given after the liability has arisen; or (b) a provision in a trust deed for the giving of such a release by a majority of not less than three-fourths in value of the debenture holders present and voting in person or by proxy at a meeting summoned for the purpose; or (c) a provision in a trust deed for the giving of such a release either with respect to specific acts or omissions or on the trustee dying or ceasing to act. 3.5.4 Remedies of debenture holders The remedies of debenture holders are generally conferred by the trust deed but will usually include the power i. property ii. To sue as creditors for arrears of interest or principal, or both To appoint a receiver to carry on the business or sell the charged

iii. To petition the High Court for a winding up order (on grounds of the company's inability to pay its debts), and iv. To apply to the court for the appointment of a receiver or for an order for sale if there is no power in the trust deed. 3.5.5 Register of Debenture Holders S.88(1) requires every company, which issues a series of debentures to keep at its registered office a register of holders of such debentures. If the work of

making up the register is done at some other office of the company, or of another person, it may be kept at that other office. The registrar shall be notified of such place and of any change thereof.

3.6 Charges Securing Debentures

3.6.1 Charges A charge on the assets of a company given by a debenture or a trust deed may be either a specific (fixed) charge or a floating charge. i. Fixed Charges A charge is a "fixed charge" if it is a mortgage of ascertained or specific property such as plant and machinery, freehold or leasehold land, or uncalled capital. It may also be legal or equitable. Floating Charges According to the decision of Romer, L J in Re: Yorkshire Woolcombers Association Ltd a charge is a "floating charge" if it has the following three characteristics: (a) it is a charge on a class of assets of a company, present and future; (b) the class is one which changes from time to time in the ordinary course of the company's business; and (c) it is contemplated by the charge that, until some event occurs which causes the charge to crystallise, the company may use the assets charged in the ordinary course of its business. Because the charge does not attach or fix at the time of its creation upon any particular asset, it is equitable by nature. Under the current Kenya and English law a floating charge cannot be issued by a partnership or sole trader. 3.6.2 Crystallization of Floating Charges A floating charge is a charge on a class of assets of a company. The actual assets in that class owned by the company change from time to time. The assets that the chargee is entitled to utilise for payment of the secured debt are the assets in the class that the company owns at the time when the charge crystallises. On crystallization a floating charge becomes a fixed or specific equitable charge. A floating charge crystallises: (i) When the chargee appoints an administrative receiver. The power to do so exists only by virtue of the charge contract, which must therefore specify the circumstances in which the power is exercisable. e.g. 1 liquidation or winding up 2 appointment of a receiver 3 levy of execution or distress

ii.

4 5

insolvency cessation of business

(ii) When the company goes into liquidation. (iii) When the company ceases to carry on business. (iv) If the charge contract so provides, when the chargee gives notice that the charge is converted into a fixed charge on whatever assets of the charged class are owned by the company at the time the notice is given. (v) When another floating charge on the companys assets crystallises it causes the company to cease business. (vi) Commencement of recovery proceedings against the company. (vii) Occurrence of an event, which under the terms of the debenture causes crystallization. 3.6.3 (a) Advantages of floating charges From the company's point of view, a floating charge may be regarded as conferring the following advantages: i. The company is free to deal with the assets charged as if they had not been charged. ii. Enables companies without fixed assets to borrow. iii. It enables the company to charge property which otherwise would not have been charged since such property cannot be subject to a fixed charge. iv. Enhances the borrowing capacity of a company of floating charges. (b) Disadvantages of floating charges From the lender's point of view, a floating charge has the following disadvantages: i. ii. iii. iv. v. The value of the assets charged is uncertain since no particular assets are charged. A floating charge created within 6 months before the commencement of winding up is deemed to be a fraudulent preference and is void. It is postponed to a later fixed charge. The charge may be avoided, during the company's liquidation, under s.314 of the Act, unless it is proved that the company immediately after the creation of the charge was solvent. Where a seller of goods reserves title until payment, a floating charge will not, on crystallisation, attach to these goods. This is illustrated by Aluminium Industries Vaassen v Romalpa Aluminium (647). Certain other interests e.g. landlords distress fortent, have priority over floating charges.

vi.

3.7 Priority of Charges

The priorities between charges are as follows: (a) Legal fixed charges rank according to their order of creation. (b) If an equitable fixed charge (ie an informal mortgage created by a deposit of title deeds to land or a share certificate with the lender) is created first and a legal charge over the same property is created later, the legal charge takes priority over the equitable charge. (c) A floating charge will be postponed to a later fixed charge over the same property. This is so because the fixed charge attaches to the charged property at the time of its creation whereas the floating charge attaches at the time of crystallization. The floating charge would however have priority over the later fixed charge if i. ii. the floating charge contained a "negative pledge" clause which prohibited the company from later on creating fixed charges with priority over it, and the holder of the fixed charge actually knew of the prohibition. In Re: Valletort Sanitary Co it was explained that registration of the floating charge would be constructive notice of the charge itself but not constructive notice of the contents of the charge, including the negative pledge clause.

(d) If two floating charges are created over the general assets of the company they rank in order of creation. (e) If a company creates a floating charge over a particular kind of assets, e.g. book debts, the charge will rank before an existing floating charge over the general assets: Re Automatic Bottle makers. 3.8 Registration of Charges 3.8.1 Section 96(1) requires the prescribed particulars of specified charges on a company's property or undertaking to be delivered to the registrar for registration within 42 days after the date on which the charge was created. The specified charges are: (a) A charge to secure an issue of debentures; (b) A charge on uncalled share capital; (c) A charge created by an instrument, which, if executed by an individual, would require registration as an instrument under the Chattels Transfer Act (e.g. a Letter of hypothecation); (d) A charge on land; (e) A charge on book debts of the company; (f) A floating charge; (g) A charge on calls made but not paid; (h) A charge on a ship or any share in a ship;

(i)

A charge on goodwill, a patent, a copyright or a trademark.

3.8.2

The prescribed particulars The "prescribed particulars" of registered charges are enumerated in Form No 214 and are: i. The date and description of the instrument creating or evidencing the mortgage or charge; ii. The amount secured by the mortgage or charge; iii. Short particulars of the property charged; iv. Names, postal addresses and descriptions of the persons entitled to the charge; and v. Amount of rate per cent of commission, allowance or discount (if any) paid.

3.8.3

General Aim The purpose of registering the aforesaid particulars is to enable a would-be creditor to know the company's existing indebtedness and the assets available for their settlement.

3.8.4

Certificate of Registration S.99 requires the registrar to give a certificate, under his hand, of the registration of any of the specified charges. The certificate shall be conclusive evidence that the statutory requirements as to registration have been complied with. Consequently, the charge would not be rendered void on the grounds that one of the prescribed particulars, such as the date of the creation of the charge, is later found to be incorrect: Re C.L. NYE LTD (66).

3.8.5

Effect of Non-Registration Registration of charge cures all defects characterising the charge. The charge is deemed to have been made in due compliance with the provisions of the companies Act. As was the case in National Provincial and Union Bank of England V. Charnley. Section 96(1) provides that if the prescribed particulars if any of the specified charges is not registered within the prescribed period of 42 days the charge will be "void against the liquidator and any creditor of the company". Although the charge becomes void: i. The money secured becomes immediately repayable. This means that the lender is not bound by the terms of the charge and can take immediate steps to recover his money; and The court is empowered by s.102 to extend the time for registration of

ii.

the charge on being satisfied that the omission to register the charge within the prescribed time was accidental or was due to inadvertence or other sufficient cause, provided that neither creditors nor shareholders would be prejudiced by the extension.

Although it is the company's duty to effect the registration s.97 (1) permits the registration to be effected on the application of any person interested in the charge. The person shall be entitled to recover from the company the amount of any fees properly paid by him to the registrar on registration. 3.8.6 Register Of Charges S.105 (1) provides that every limited company shall keep at its registered office a register of charges and enter therein (a) a short description of the property charged; (b) the amount of the charge; and (c) the names of the persons entitled to the charge. Failure to comply with s.105 (1) does not invalidate the charge but the officers of the company responsible for the omission shall be liable to a fine not exceeding one thousand shillings.

INSIDER TRADING OR DEALING

Insider dealing occurs where an individual or organisation buys or sells securities while knowingly in possession of some piece of confidential information which is not generally available and which is not likely, if made available to the general public, to materially affect the price of the securities. For example, where a company director who is aware that the company is in a bad financial state sells his shares knowing that this information will be made public with an announcement of a cut in dividend payment. It is argued that the use of insider information is unfair to those who deal with the insider, though it is difficult to identify the looser since the transaction takes place on the stock exchange. However, a person who buys something which turns out to be worthless than the price paid for it may feel aggrieved. In principle, dealings in a market generally reflect the value of the security if all the information used in valuation is available to both buyers and sellers. Information generally used by those involved in company securities relate to: (i) World trade in the particular market in which the company is trading (ii) Economy of the country (iii) How the company is handling its affairs. With the expansion of dealings in stock exchange, it has become evident that taking advantage of inside information is fraudulent on other investors and could lower public confidence in the stock exchange, and for officers of the company, this amounts to a breach of trust since the information is obtained in the course of their employment. 4.1 Case for Regulation In the realm of company law, it may be necessary to regulate insider trading or dealing since the insider with access to confidential information is in potential conflict of interest situation, in particular where his position in the company enables him to dictate

or influence when the public disclosure of price-sensitive information is to be made. In such a case, the officers decision and his won desire to trade advantageously in the companys shares may conflict and such conduct is likely to bring the company into disrepute. It is thereof recognised that it is wrong for a director or another to deal in a companys securities knowing of some development which is likely to affect the price of the securities which other members of the public are generally privy to.

4.2 Liability Under the United States Law, persons involved in insider dealings are bound to account to the company or to the individual dealt with. In Britain, the problem is dealt with by the provisions of the Companies Act, Company Securities (Insider Dealing) Act, 1985 and the Criminal Justice Act, 1993. At common law, officers of the company are free to hold and deal in the shares of the company. However, use of confidential information is actionable. This legal position is traceable to the decision in Percival v Wright where joint holders of some shares of an unlisted colliery company offered them for sale to the chairman of the company and two other directors at a price determined by an independent value at 12 10s but after conclusion of the sale, it was discovered that while negotiating the purchase, the chairman was involved in discussions of the possible sale of the whole colliery at a price that would have made each share in the company worth more than 12 10s. However, the colliery was never sold. In an action by Percival and his co-shareholders to have the sale set aside on the ground of non-disclosure by the chairman, it was held that since the directors owed their duties to the company, there was no duty to disclose. In the words of Swinfen Eady J. The contrary view would place directors in a most invidious position, as they could not buy or sell shares without disclosing negotiations, a premature disclosure of which might well be against the best interest of the company. I am of the opinion that directors are not in that position. The decision in Percival v Wright was upheld in Tent v Phoenix Property & Invest Co. Ltd. (1984. In Multinational gas & Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. (1983), Dillon L. J. observed: The directors stand in a fiduciary relationship to the company and they owe fiduciary duties to the company though not to individual shareholders. However, in Allen v Hyatt 1914 where shareholders had engaged directors to investigate on their behalf and the directors benefited, it was held that since the directors were agents of the shareholders, they were liable to account to the shareholders. In Kenya, the problem of insider trading is addressed by Section 33 of the Capital Markets Authority Act, Cap 485 A under Section 33 (1) of the Act, insider trading is a criminal offence. Under the section, (1) A person who is, or at any time in the preceding six months has been connected with a body corporate shall not deal in any securities of that body corporate he is

in possession of information that is not generally available but, if it were, would be likely to materially affect the price of those securities. (2) A person who is, or at any time in the preceding six months has been, connected with a body corporate shall not deal in any securities of any body corporate if by reason of his so being, or having been, connected with the first mentioned body corporate he is in possession of information that is not generally available but, if it were, would be likely materially to affect the price of those securities; and relate to any transaction (actual or expected) involving both bodies corporate or involving one of them and securities of the other. Where a person is in possession of any such information as is mentioned in subsection (1) and (2) that if generally available would be likely materially to affect the price of securities but is not precluded by either of those subsections from dealing in those securities, he shall not deal in those securities if (a) he has obtained the information, directly or indirectly, from another person and is aware, or ought reasonably to be aware, of facts or circumstances by virtue of which that other person is himself precluded by subsection (1) or (2) from dealing in those securities; and (b) when the information was so obtained, he was associated with that other person or had with him an arrangement for the communication of information of a kind to which those subsections apply with a view to dealing in securities by himself and that other person or either of them. (4) A person shall not, at any time when he is precluded by subsections (1), (2) or (3) from dealing in any securities, cause or procure any other person to deal in those securities. A person shall not, at nay time when he is precluded by subsections (1), (2) or (3) from dealing in any securities by reason of his being in possession of any information, communicate that information to any other person if (a) trading in those securities is permitted on any securities exchange; and (b) he knows, or has reason to believe, that the other person will make use of the information for the purpose of dealing or causing or procuring another person to deal in those securities. (6) Without prejudice to subsection (3) but subject to subsections (7) and (8), a body corporate shall not deal in any securities at a time when any officer of that body corporate is precluded by subsections (1), (2) or (3) from dealing in those securities. A body corporate is not precluded by subsection (6) from entering into a transaction at any time by reason only of information in the possession of an officer of that body corporate if

(a)

(b) (3)

(5)

(7)

(a) the decision to enter into the transaction was taken on its behalf by a person other than the officer (b) it had in operation at that time arrangements to ensure that the information was not communicated to that person and that no advice with respect to the transaction was given to him by a person in possession of the information; and (c) the information was not so communicated and such advice was not so given. (8) A body corporate is not precluded by subsection (6) from dealing in securities of another body corporate at any time by reason of only of information in the possession of an officer of that first-mentioned body corporate, being information that was obtained by officer is the course of the performance of his duties as an officer of that first mentioned body corporate and that relates to proposed dealings by that first-mentioned body corporate in securities of that other body corporate. For the purpose of this section, a person is connected with a body corporate if, being a natural person (a) he is an officer of that body corporate or of a related body corporate; (b) he is a substantial shareholder in that body corporate or in a related body corporate; or (c) he occupies a position that may reasonably by expected to give him access to information of a kind to which subsection (1) and (2) apply by virtue of (i) any professional or business relationship existing between himself (or his employer or a body corporate of which he is an officer) and that body corporate or a related body corporate; or (ii) his being an officer of a substantial shareholder in that body corporate or in a related body corporate. (10) This section does not preclude the holder of a brokers or dealers licence from dealing in securities, or rights or interests in securities, of a body corporate, being securities or rights or interests that are permitted by a securities exchange to be traded on the stock market of that securities exchange, if (a) the holder of the licence enters into the transaction concerned as agent for another person pursuant to a specific instruction by that other person to effect that transaction; (b) the holder of the licence has not given any advice to the other person in relation to dealing in securities, or rights or interests in securities, of that body corporate that are included in the same class as the first-mentioned securities; and (c) the other person is not associated with the holder of the licence. (11) For the purpose of subsection (8), officer, in relation to a body corporate,

(9)

includes (a) (b) (c) (d) (e) a director, secretary, executive officer of employee of the body corporate; a receiver, or receiver and manager, of property of the body corporate; an official manager or a deputy official manager of the body corporate; a liquidator of the body corporate; and a trustee or other person administering a compromise or arrangement made between the body corporate and another person or other persons.

(12) A person who contravenes this section shall be guilty of an offence and shall be liable (a) on a first conviction (i) in the case of a person being a body corporate, to a fine not exceeding one million and five hundred thousand shillings; (ii) in the case of any other person, including a director or officer of a body corporate, to a fine not exceeding five hundred thousand shillings or to imprisonment for a term not exceeding five years or to both;

(b) on any subsequent conviction (i) in the case of a person being a body corporate, to a fine not exceeding three million shillings; or (ii) in the case of any other person, including a director or officer of a body corporate, to a fine not exceeding one million shillings or to imprisonment for a term not exceeding seven years or to both. (13) An action under this section for the recovery of a loss shall not be commenced after the expiration of six years after the date of completion of the transaction in which the loss occurred. (14) Nothing in subsection (12) affects any liability that a person may incur under any other section of this Act or any other law.

CENTRAL DEPOSITORY SYSTEM

A central depository system (CDS) is for securities what a bank is for cash. In its simplest form, a CDS is a computerised ledger system that enables the holding and transfer of securities without the need for physical movement. Hence, ownership of a security would be via book entry, rather than by physical exchange. A simple example best demonstrates how a CDS operates. Company X issues some shares, which are subscribed by party A and party B. Rather than the shares being delivered to A and B, Company X delivers the shares to the CDS, who holds those shares in safe custody for A and B. If A decides to sell to B, then in non-CDS environment, A would deliver the shares to B in exchange for payments via a broker. A manual registration process would then follow this. However, with the CDS, the shares would remain in safe custody with a book entry debit to As account and a credit to Bs account. Simultaneously, B will pay A. Thus the CDS plays an important role in bringing together issuers (e.g. corporates), investors (e.g. institutions), intermediaries (e.g. brokers) and interested third parties (e.g. regulators).

In order to understand the CDS infrastructure, three areas need to be distinguished. (i) Corporate Framework The CDS will be a separate legal entity to be incorporated and licensed in Kenya to provide central clearing, settlement and depository services for securities held in electronic form. It will be licensed under a law defining all the powers, duties and responsibilities of the company.

(ii) Management The importance of the CDS to the broader objective of capital market development and the fact that the CDS is a start-up Project implies that the quality of the management team will be a critical element of success for the Project. (iii) Functional Structure The CDS will replace many of the manual paper based procedures that currently exist. For example, it will replace the manual trade settlement process currently in place at the NSE and will replace some of the existing manual corporate actions (e.g. dividend distribution, distribution of rights etc.)

5.1 FUNCTIONS OF A CENTRAL DEPOSITORY SYSTEM The typical functions of a CDS are: i) Immobilization of securities: This means the storage of securities certificates in a vault in order to eliminate physical movement. The objective is to minimize physical movement of securities where complete elimination of physical movements is not achievable. Dematerialised Securities which means the elimination of physical certificates or documents of title, so that those securities exist only as computer records. ii) Providing book entry accounts: this means an accounting system for securities and cash, which electronically facilitates the exchange of ownership of securities and the movement of cash. Thus, the securities move between parties without the need for movement of physical documents. The cash moves with aid of cash clearing mechanisms. iii) Delivery Versus Payment (DVP) or Effective DVP: this means that the exchange of securities and cash payment between counter parties in a transaction occurs simultaneously. In an environment where DVP is possible, cash settlement and beneficial ownership can be transferred intra-day. This requires an electronic link between the CDS and the national central payment system. In Kenya, it is likely that settlement will be on an effective DVP basis. This is whereby the cash settlement element is transferred into the Kenyan banking system. iv) Distribution of dividend, interest and redemption monies, handling of corporate actions, notably rights and bonus issues. 5.2 WHY IS CDS A GOOD IDEA? The introduction of the CDS service will serve several goals. When implementing the

goals, many new business standards will be introduced to the Kenyan capital markets, all of which will have a significant benefit to the domestic and international attractiveness of the markets. These business development goals and associated benefits are described below. 1. Achieve electronic straight through processing and eliminate outdated certificate processes The immediate goal of CDS is to implement a complete end-to-end electronic clearing, settlement and central depository service for immobilized (and ultimately dematerialised) securities. This means all back office securities processing transaction will be undertaken through electronic means. The only exception being company secretarial matters. The ability to achieve straight through processing (STP) for pre-settlement, settlement and post-settlement transactions means all transactions will be captured electronically and wherever possible will be automated. Thus achieving electronic processing of the pre-settlement, settlement and post-settlement ranges of transactions means lower transaction, settlement and market risk. Electronic STP avoids many of the problems and risks associated with the legacy process as encapsulated in the current certificated environment (which are from the bygone era of the old UK style 1948 Companies Act). For example, currently settlement problems can prevent an investor re-selling securities due to settlement and re-registration delays. If a stock goes down in price in the meantime, then the manual processes that are in existence today can prove to create a significant opportunity cost for the investor. An inability to liquidate a position due to re-certification problems is potentially very costly. The CDS should lower transaction costs by lowering both risk and opportunity costs. 2. Immobilize all traded securities Initially, the majority of securities handled by the CDS will be equities already listed on the NSE. However, the proposed CDS legislation has been carefully prepared to allow the sponsors and users of the CDS to provide CDS services for other types of securities. There are three benefits arising from this flexibility: i) An opportunity exists to immobilize securities traded on another exchange especially regionally by capturing cross-border immobilization of securities, improve liquidity of the local market. An opportunity exists to immobilize impeding privatisation securities this will result in cost efficiencies for issuers and investors. CDS has the opportunity to immobilize and provide book entry transfer settlement services for government bonds and treasury bills simplifies the settlement process in the market. It should be noted that the Central Bank of Kenya (CBK) has recently established its own CDS for the immobilisation of government bonds and treasury bills. Once the CDS has been established, CBK may use this for settling and clearing.

ii) iii)

3. Implementing a CDS will assist national economic development and progress At the heart of the CDS service will be a high performance central messageprocessing engine for NSE securities. The engine is the central CDS system. All back office transactions will be processed across this engine in the form of messages and no longer by moving paper/certificates and transfer forms. Access to the CDS settlement engine will be across a secure network with relevant levels of cryptographic protection between central system and its users. Cryptographic security means the digital security of electronic messages. This means that every time a participant decides to transmit a message on an immobilized security, the cryptography will ensure that the messages meet certain security standards for example non-repudiation. The benefit of this will be that no user will be able to deny that the message was sent from their gateway and similarly any attempts to interfere in the process of message transmission will be prevented and detected. This electronic packaging or enveloping of messages will significantly improve the quality of security transfers, transaction movements and in practice is infinitely more secure than the certificate equivalents that exist in Kenya today. A potentially wide range of products can be built on the CDS solution and assuming these are factored into the solution that is ultimately selected. The CDS infrastructure can be used in subsequent phases to implement other message driven services. Examples of such services would include credit cards and loan approval information. 4. Ensure CDS operates within modern, fair, transparent and secure rules Surrounding the CDS technology and procedures will be a comprehensive of CDS rules within which participants will operate. These rules will provide for improved depositor and user protection suitable for a range of electronic commerce transactions. These laws and rules will introduce a range of new standards to Kenya migrating the Kenyan capital markets from a legal infrastructure that was previously developed in the late 1940s. Once Kenya passes the laws and rules for the CDS, it will embrace a set of concepts that are more relevant to the next millennium. At the simplest level, the electronic message has a greater business benefit in law when compared to the certificate under the current law, a holder of a certificate has only prima facie evidence of ownership. An investor who has an electronic record within a secure CDS account (and is therefore recorded on the list of depositors) is however deemed to be a member/shareholder of the company. The benefit of this deeming principle is that the investor will receive dividends more quickly, settlement will be real time and therefore portfolio turnover and therefore liquidity can improve. In addition, the deeming provision will remove the huge wasted effort in broker back officers, at the NSE and at registrars, chasing overdue settlements, claims on corporate actions, record cut off problems and the like. Therefore, in the immediate term, as soon as CDS is implemented and the law

enacted, it will reduce the evidence of ownership risk associated with certificate holdings. Over the longer term, the presence of the CDS will add significant and much needed infrastructure developments to the Kenyan banking and commercial community which will expedite the time to market for future electronic settlement developments. The infrastructure will not only improve the efficiency of local commercial transactions, but they will curtail the threats of settlement dis-intermediation whilst attracting additional business to Kenya. The benefits associated with the business development goals and other benefits to Kenya of the CDS can be summarised in the context of the benefits accruing to the key market participants, as summarised in the table below: Interested Party Benefits

1. Economy/Government

1 Improvements of the infrastructure supporting the capital markets will attract more foreign portfolio investment, as this will mean, at a minimum reduced settlement time and counterpart/settlement risk 2 Potentially greater mobilized domestic savings. Significantly improve liquidity of the capital markets 3 Lower the cost of capital as a result of improved liquidity 4 Reduces the systemic risk arising from current clearing and settlement processes 5 Improves the transparency of the market 6 Reduction in the instance of fraud as a result of immobilized securities 7 Establishment of the infrastructure, ensures that any types of securities that may be introduced such as option, can be cleared safely 8 Greater market turnover due to improved liquidity. Lowers transaction costs 9 Reduction of settlement risk with introduction of DVP or effective DVP 10 Improves transparency of the markets 11 Faster settlement with associated reduction in funding costs 12 Lower cost of clearing/transfers through reduced paper work and labour intensive activities 13 Improved liquidity as cash flows will be more accurately known and as a result of greater stock turnover 14 Elimination of financial loss due to misplacement, forgery or loss of scrip and reduces the evidence of ownership risk 15 Improves back office efficiency through standardized procedures and controls (with CDs, brokers, registrars and investors) 16 Improved and timely communication from the issuer to the investor, includes reduced delay in receiving benefits and rights and improved information dissemination of company meeting 17 Transparency ensures improved investment decisions

2. CMA and NSE

3. Investors (Institutions, market professionals and private investors

It may be necessary to consult the provisions of the Act to see how it facilitates its operation.

REINFORCING QUESTIONS
1. 2. "A company must take great care when issuing share certificates". Discuss this statement. G. presents to H. Ltd a valid document transferring 250 shares into his name. By mistake H. Ltd issues him with a certificate for 2,500 shares. What are the consequences for H. Ltd?

Check your answers with those given in Lesson 9 of the Study Pack.

LESSON 3
COMPANY MEMBERSHIP AND SECURITIES
INSTRUCTIONS
1 2 3 Read the Study Text below. Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9.

CONTENTS
1. COMPANY MEMBERSHIP 1 Meaning of member 2 Methods of becoming a member 3 Cessation of membership 4 Who may become a member? 5 Register of members 6 Annual Return COMPANY SECURITIES 1 Shares 2 Transfer of shares 3 Mortgage of shares 4 Calls on shares 5 Lien on shares 6 Borrowing by companies DEBENTURES 1 Definition 2 Debentures and debenture stock 3 Issue of debentures 4 Debenture certificates 5 Debenture trust deed 6 Priority of charges

2.

3.

Registration of charges

1. COMPANY MEMBERSHIP
1.1 Definition of member
Although the marginal note to section 28 is "definition of member", the section does not define the word "member". Rather, it states the two basic ways in which a person may become a member of a company, namely (a) by subscribing the memorandum of the company, or (b) by agreeing to become a member and the entry of his name in the company's register of members.

1.2 Methods of becoming a member

A person may become a member of a company in one or other of the following ways: i. Subscribing to the Memorandum S.28 (1) provides that the subscribers to the Company's memorandum shall be deemed to have agreed to become members of the Company, and on the registration of the memorandum shall have their names entered in the company's register of members. The provision regarding entry in the register is an administrative directive for the company's implementation and non-compliance with it does not affect the preexisting membership. ii. Allotment A person to whom a company's shares have been allotted acquires his membership by virtue of sub-section 2 of s.28, being a person who has agreed to become a member. However, it was held in NICOL'S case that the membership commences from the moment the name is entered in the members' register. If the company wrongfully refuses to enter the name in the register, the allottee must take rectification proceedings for a court order directing the company to enter the name in its members' register.

iii. Transfer A transfer is a purchase of shares from a Company's shareholder, and not from the company itself. A transferee also acquires his membership by virtue of sub-section 2 of s.28, being a person who has agreed to become a member. The principle in NICOLs case applies to transferees as well, and a transferee becomes a member from the moment his name is entered in the register of members. iv. Transmission on death of a Member A transmission is a legal process by which ownership of shares in a company changes automatically on the death of a member to his personal representative. This is acknowledged by Table A, Article 29, which provides that "in case of the death of a member ... the personal representatives of the deceased where he was a sole holder shall be the only persons recognized by the law as having any title to his interest in the shares".

If the personal representative elects or decides to be registered himself as the holder of the shares, the election constitutes the agreement to be a member and the provisions of s.28(2) become applicable, namely, he will become a member from the moment his name is entered in the register of members. v. Transmission on bankruptcy of Member A bankrupt member's shares in a company will be transmitted to his trustee in bankruptcy according to the principles of bankruptcy law. The company's articles may give the trustee an option of being personally registered as a member, as is provided for by Table A, Article 30. If the trustee elects or decides to be registered as the holder of the shares the election constitutes the agreement to be a member and the provisions of sub-section 2 of s.28 become applicableie. the trustee in bankruptcy will become a member from the moment his name is entered in the register of members.

vi. Compliance with s.182 (2) A person who has consented to be a director, and has given the statutory undertaking to take and pay for his qualification shares, is declared by s.182(2) to be, "in the same position as if he had signed the memorandum." The provisions of s.28 (1) accordingly apply to him, and he becomes a member of the company at the moment the memorandum of association is registered. vii. Estoppel A person who, without having agreed to be a company's member, is aware that his name is wrongly entered in its register of members but takes no steps to have his name removed therefrom, may be estoppel from denying his apparent membership to somebody who relied on it and extended credit to the company.

1.3 Cessation of Membership

A person's membership of a company may cease or come to an end in many ways, some of which are: i. Transfer A "transfer" of shares occurs if an existing member sells them to a third party. If the third party is not yet a member, he will become a member from the moment his name is entered in the company's register of members. However, the transferee does not automatically cease to be a member as a consequence of the transfer. A member is not bound to sell all of his shares whenever he contemplates a sale. Table A, Article 23, permits members to transfer all or any of their shares. A member therefore ceases to be a member only if he transfers ALL of his shares. ii. Forfeiture Where a company's articles authorize the directors to forfeit a member's shares and the directors forfeit ALL of the shares held by a member, the member will cease to be a member from the date specified in the articles as the effective date for a forfeiture. Table A, Article 38 provides that "a statutory declaration in writing that the declarant is a director or the secretary of the company, and that a share in the company has been duly forfeited on a date stated in the declaration, shall be conclusive evidence of the facts therein stated."

Article 37 provides that a person whose shares have been forfeited shall cease to be a member in respect of the forfeited shares. He therefore ceases to be a member of the company only if all of the shares previously held by him are forfeited. iii. Surrender of Shares The precise nature of a surrender and the machinery by which it is effected are not clear since it is not provided for by the Companies Act or Table A. However, in Trevor v Whitworth the judge stated that a surrender "does not involve any payment out of the funds of the company," and that "if it were accepted in a case where the company were in a position to forfeit the shares the transaction would seem to me perfectly valid," presumably even if not expressly authorised by the articles. A person's membership will therefore come to an end if he surrenders all his shares to the company with the approval of the directors. iv. Death When a person dies, his membership of a company will come to an automatic end by virtue of the provisions of the Law of Succession. The shares previously held by him become, legally, the property of his personal representative. (see Table A, Article 29) v. Bankruptcy When a person becomes bankrupt, his membership of a company will come to an end under the provisions of the Bankruptcy Act which vest a bankrupt's property in his trustee in bankruptcy (see Table A, Article 32).

vi. Sale by a Company in exercise of lien A company, like an unpaid seller under the Sale of Goods Act, has a right of lien on its shares as security for the balance of their price. For example, Table A Article 11 gives the company "a first and paramount lien" on every unpaid share. If the Company sells ALL the shares held by a member, the membership will come to an end from the moment the buyer's name is entered in the register. Table A, Article 12 gives the company power to sell "any shares on which the company has a lien". vii. Redemption of redeemable preference shares If a member's entire holding consist exclusively of redeemable preference shares and all of these shares are redeemed by the company under the provisions of s.60 of the Companies Act, he will cease to be a member from the date on which his name is removed from the register of members. viii. Repudiation by an infant An infant member has a common law right to repudiate his membership of a company if there has been a total failure of consideration because the shares have become worthless: Steinberg v Scala (Leeds) Ltd (58). ix. Liquidation or winding up

A company's liquidation terminates membership of all former members, from the moment it becomes effective. x. Rescission of Contract: A shareholder who rescinds a contract of purchase of shares or allotment by reason of a vitiating element or otherwise ceases to be a member xi. Disclaimer by trustee in bankruptcy:

1.4 WHO MAY BECOME A MEMBER?

Capacity to be a member of a company is governed by the rules of the common law relating to contracts and anyone who has the capacity to make a contract may become a member of a company. The following are some of the special cases, which require some explanation. (a) Infants An infant is any person who has not attained the age of 18 years: the Age of Majority Act 1974. He has a common law right to enter into a contract to buy shares in a company, and thereby become a member of the company. The contract is however voidable at his option, and he may avoid it at any time during his infancy or within a reasonable time after attaining the age of 18 years. However, it was explained in Steinberg v Scala (Leeds) Ltd (59) that although the infant has a right to repudiate the contract he would only be entitled to get back the amount already paid if there has been a total failure of consideration because the shares have become valueless. A company's articles may however restrict membership of the company to adults only, in which case an infant would not become a member of the company. (b) Personal Representatives On a shareholder's death, ownership of the shares previously held by him is transmitted to his personal representative, who may be an executor or administrator. The personal representative would be entitled to be registered as a member of the company unless the company's articles provide otherwise. (c) Corporations A corporation, whether a registered company or not, may, if authorised by its memorandum (expressly or impliedly), take shares in a registered company and become a member of it. It would authorize "such person as it thinks fit to act as its representative at any meeting of the company". The authorization would be made by a resolution of its directors or other governing body under s.139(1)(a). Section 29(1) provides that a body corporate cannot be a member of a company, which is its holding company. Any allotment or transfer of shares in a company to its subsidiary shall be void except 1. Where the subsidiary is concerned as personal representative or trustee, unless the holding company or its subsidiary is beneficially interested under the trust and is not so interested only by way of security for the purposes of a transaction entered into by it is in the ordinary course of business which

includes the lending of money. This somewhat lengthy provision may be explained with the aid of some examples. i. M, who is a member of Z Bank Ltd, appoints its subsidiary, Z Bank (Executor & Trustee) Ltd, as his executor. On M's death, the subsidiary may be registered as a member of the holding company in respect of M shares. M transfers his shares to the subsidiary (in the above example) on trust for a beneficiary B, who borrows money from the holding company and secures repayment by mortgaging his interest in the shares to the company.

ii.

2. Where the subsidiary was a member of the holding company at the commencement of the Act on 1st January, 1962. Such a member would have no right to vote at meetings of the holding company or any class of members thereof except in respect of shares it holds as personal representative or trustee. (d) A person upon whom shares have devolved pursuant to the Provisions of Bankruptcy Act, may become a member of the company.

1.5 THE REGISTER OF MEMBERS

Section 112(1) requires every company to keep a register of its members and prescribes the contents of the register. 1.5.1 Contents The register of members must contain the following particulars i. the names and postal addresses of the members; ii. a statement of the shares held by each member, distinguished by its number if it has one;

iii. the amount paid or agreed to be considered as paid on the shares of each member; iv. the date at which each person was entered in the register as a member; and v. the date at which any person ceased to be a member.

Where the company has converted any of its shares into stock the register shall show the amount of stock held by each member instead of the amount of shares and the aforesaid particulars relating thereto. Failure to keep a register of members renders the company and every officer of the company who is in default liable to a default fine [s.112(4)]. Section 120 provides that the register of members shall be prima face evidence of the matters it contains. 1.5.2 Location

Section 112(2) requires the register of members to be kept at the registered office of the company. If it is made up at another office of the company, or at some other office, it may be kept at that other office provided the office is not at a place outside Kenya. The registrar must be informed of the place, other than the registered office, where the register is kept. Any change in that office must be notified to the registrar within fourteen days failing which the company and every officer of the company who is in default shall be liable to a default fine. 1.5.3 Index of Members Section 113(1) provides that a company with more than 50 members must, unless the register of members constitutes an index, keep an index (which may be in the form of a card index) of the names of the members of the company, and must alter the index within fourteen days after any alteration in the register. The index shall in respect of each member contain a sufficient indication to enable the account of that member in the register to be readily found and shall be at all times kept at the same place as the register of members.

1.5.4

Share Warrants Section 114(1) provides that on the issue of a share warrant the company shall strike out of its register of members the name of the member to whom the warrant has been issued and shall enter in the register (a) the fact of the issue of the warrant; (b) a statement of the shares included in the warrant, distinguishing each share by its number; and (c) the date of the issue of the warrant. The bearer of the warrant shall, subject to the articles of the company, be entitles, on surrendering it for cancellation, to have his name entered as a member in the register of members. If the articles so provide, the bearer of a share warrant shall be deemed to be a member of the company either to the full extent or for any purposes defined in the articles. Closure of Register: Under Section 117 of the Act a company may, on giving notice by advertisement in dome newspaper circulating in Kenya, or in that area of Kenya in which the registered office of the company is situate, close the register for any time or times not exceeding thirty days in each year.

1.5.5

Inspection of Register Section 115(1) provides that the register and index of members shall during business hours be open to the inspection of any member without charge, and of any other person on payment of a fee, not exceeding two shillings for each inspection, as the company may prescribe. Any person may require a copy of the register or any part thereof, on payment of one shilling or such less sum as the company may provide, for every hundred words or fractional part thereof

required to be copied. The copy must be supplied within a period of fourteen days commencing on the day next after the day on which the requirement is received by the company. If a company officer refuses an inspection or fails to provide a required copy, the company and every officer of the company who is in default shall be liable in respect of each offence to a fine not exceeding sh40 and further to a default fine of sh40. The court may by order (a) compel an immediate inspection of the register and index, or (b) direct that the copies required shall be sent to the person requiring them. The court order may also be made against the company's agent who keeps the company's register of members if the company's failure to provide a copy, or permit an inspection, is due to his default. S.117 permits a company, on giving notice by advertisement in some newspaper circulating in Kenya or in that area of Kenya in which the registered office of the company is situate, to close the register of members for any time or times not exceeding in the whole thirty days in each year. The purpose of this provision is to keep the register static so that members' holdings may be extracted as at a particular date for the purpose of computing dividends. 1.5.6 Rectification of the Register Section 118(1) empowers the High Court to rectify the register of members in two cases, namely i. ii. If the name of any person is, without sufficient cause, entered in or omitted from the company's register of members; or

Default is made or unnecessary delay takes place in entering on the register the fact of any person having ceased to be a member. The application to the court to rectify the register may be made by i. the aggrieved person; or ii. any member; or iii. the company. Where an application is made the court may i. refuse the application; ii. order rectification of the register and payment by the company of any damages sustained by any party aggrieved. An order rectifying the register can be made even when the company is being wound up: Re Sussex Brick Co (59). The case of Burns v Siemens Bros Dynamo Works Ltd (60) shows that the circumstances set out in Section 118(1), above, are not the only ones in which the court can order rectification. It may also do so where a name stands on the register without sufficient cause.

The court may also order rectification of the register by deleting a reference to some only of the registered shareholder's shares. It need not delete his name entirely. This is illustrated by Re Transatlantic Life Assurance Co Ltd (1979) in which the court deleted an additional number of shares, which had been issued to the applicant in breach of the prevailing Exchange Control Regulations but left the register intact as regards his previous shareholding. By s.118(4), if an order is made in the case of a company required to send a list of its members to the registrar, the court, when making an order for rectification of the register, shall by its order direct notice of the rectification to be given to the registrar. 1.5.7 Notice of Trusts Section 119 provides that no notice of any trust, expressed, implied or constructive, shall be entered on the register, or be receivable by the registrar. The consequences of this provision are as follows a. The company is entitled to treat every person whose name appears on the register as the beneficial owner of the shares even though he may in fact hold them in trust for another. In particular, if the company registers a transfer of shares held by a trustee, it is not liable to the beneficiaries under the trust even if the sale of the shares by the trustee was made in breach of the trust: Simpson v Molson's Bank (61)

b.

The company is not a trustee for persons claiming the shares under equitable titles: Societe Generale de Paris v Walker (62). The owner of an equitable interest in shares, such as an equitable mortgagee or the recipient of a bequest of shares, may protect his interest by serving on the company a stop notice (or what is sometimes called a notice in lieu of distringas), informing the company that he is interested in the shares and requiring the company to notify him of a receipt of a transfer of the said shares to a transferee other than himself. When the company eventually informs him of the proposed transfer he would then apply to the court for an injunction restraining the transfer.

1.5.8

Branch Register Section 121(1) empowers a company having a share capital, if authorised by its articles, to keep a branch register in any part of the Commonwealth outside Kenya of its members resident in that part of the Commonwealth. A branch register shall be deemed to be part of the company's register of members, which shall be known as the principal register, and must be kept in the same manner (s.122). The registrar of companies must be informed of the situation of the office where the branch register is kept within one month of its opening. A similar notice must also be given of its change or discontinuance [s.121(2)].

1.6 THE ANNUAL RETURN Section 125(1) provides that every company having a share capital shall, once at least in

every year, make a return (referred to in the marginal note as the "annual return") to the registrar of companies. No return need be made in the year of the company's incorporation or, if the company is not required by s.131 to hold an annual general meeting during the following year, in that year. The return must contain the matters, and be in the form specified in Part I of the Fifth Schedule. The Fifth Schedule matters are: 1. The situation of the registered office. 2. 3. The place where the register of members and the register of debenture holders are kept if they are not kept at the registered office. A summary, distinguishing between shares issued for cash and shares issued as fully or partly paid up otherwise than in cash, specifying (a) the amount of the share capital of the company and the number of shares into which it is divided; (b) the number of shares taken from the commencement of the company up to the date of the return; (c) the amount called up on each share; (d) the total amount of calls received; (e) the total amount of calls unpaid; (f) the total amount of the sums (if any) paid by way of commission in respect of any shares or debentures; (g) the discount allowed on the issue of any shares issued at a discount or so much of that discount as has not been written off at the date on which the return is made; (h) the total amount of the sums, if any, allowed by way of discount in respect of any debentures since the date of the last return; (i) (j) the total number of shares forfeited; the total amount of shares for which share warrants are outstanding at the date of the return and of share warrants issued and surrendered respectively since the date of the last return, and the number of shares comprised in each warrant.

4.

The total amount of the indebtedness of the company as at the date of the return in respect of all mortgages and charges which are required to be registered with the registrar. A list of present and past members (a) containing the names and postal addresses of all persons who, on the fourteenth day after the company's annual general meeting for the year, are members, and of persons who have ceased to be members since the date of the

5.

last return or, in the case of the first return, since the company's incorporation; (b) stating the number of shares held by each of the existing members at the date of the return, specifying shares transferred since the date of the last return (or, in the case of the first return, since incorporation) by persons who are still members and have ceased to be members respectively and the dates of registration of the transfers; (c) if the members' names are not arranged in alphabetical order, having an index annexed to enable the name of any person therein to be easily found. If any shares have been converted into stock, the amount of stock held by each of the existing members as required by proviso (ii) to section 125(1). 6. All particulars of the directors and the secretary as are contained in the register of directors and secretaries. The return made by a company not having a share capital shall contain the matters specified in (1), (2), (4) and (6) above. Time of completion of the Annual Return S.127(1) provides that the return must be completed within 42 days after the annual general meeting for the year and a copy signed by a director and the secretary shall be delivered to the registrar within the 42 days. If this provision is not complied with the company and every officer of the company who is in default shall be liable to a default fine. 1.6.1 ANNEXTURES S.128 (1) provides that there shall be annexed to the annual return (a) A copy of every balance sheet laid before the company in general meeting during the period to which the return relates. It shall be certified as a true copy by a director and the secretary. (b) A copy of the auditors' report on each balance sheet and a copy of the directors' report accompanying it. These provisions do not apply to a private company, unless at least one shareholder of the company is a public company. 1.6.2 Certificate to accompany Annual Return Section 129 provides that the annual return of a private company shall be endorsed with, or accompanied by, a certificate signed by a director and the secretary of the company to the effect that (a) The company has not since the date of its incorporation issued any invitation to the public to subscribe for its shares or debentures; (b) The excess of the number of members beyond 50 consists wholly of past or present employees of the company. This certificate is made only where the annual return discloses that the number of the company members exceeds 50.

2. COMPANY SECURITIES

The securities, which a company may legally issue, fall into two primary classes. The first of these classes is generally described as "shares" and the second as "debentures".

2.1 SHARES
i. Section 75 provides that "the shares or other interest of any member in a company shall be movable property". This provision creates more problems than it solves although it may be regarded as the statutory definition of a share. The definition of a share which is generally quoted in English text-books on Company Law is that of Farwell, J. in Borland's Trustee v Steel Brothers to the effect that "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 inter se in accordance with (Section 22 of the Companies Act). The contract contained in the articles of association is one of the original incidents of the share. 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". It should be noted from this definition that a share: (a) Is a yardstick of the holder's liability to the company (if the company is limited by shares); (b) Is the yardstick of the holder's right in the company, particularly the dividends payable by the company to the shareholders, voting rights and return of capital on a winding up; (c) Is the foundation, as it were, of the bundle of rights and liabilities arising from the statutory contract contained in the articles of association. It should also be noted that a share is a form of property which, being transferable, can be bought, sold, given as security for a loan or disposed of under a will. A person who owns one or more shares in a company is ipso facto, a member of the company (unless the company did not enter his name in its register of members as a consequence of which he is technically not regarded as a member of the company: Nicoll's case). Note: Companies limited by guarantee and not having a share capital have members who do not own shares in the company. ii. TYPES OF SHARES The classes or types of shares, which can be created and issued by a company, are not prescribed by the Companies Act. They depend on the provisions of the company's constitution, usually the articles of association, or the contract pursuant to which they are issued. Legally, therefore, a company can create any type or class of shares it pleases but in practice the following are the classes of shares generally issued by registered companies: 1. 2. Ordinary Shares Preference Shares

3. Participating Preference Shares 4. Redeemable Preference Shares 5. Deferred or founders or management shares 6. Employee Shares iii. RIGHTS OF SHAREHOLDERS Primary Rights The ownership of at least a share of one or other of the aforesaid classes constitutes the "holder" a member of the company which has issued the shares. As a member, the shareholder will enjoy certain rights in the company which, unless modified or excluded by the company's articles, will generally comprise the right to: i. attends general or class meetings of the company; ii. vote at the said meetings; and iii. receive a properly declared dividend. Secondary Rights Notices of general meetings Copies of balance sheet laid before the general meeting Copies of memorandum and articles Inspection of minutes of general meetings and registers Petition for the alternative remedy. iv. PREFERENCE SHARES The nature of "preference" shares and the rights attached to them have been explained by the English courts in various cases. The decisions may be summarised as follows: 1. The essential characteristic of a preference share is that it carries a prior right to receive an annual dividend of a fixed amount, eg 7 1/2% dividend. This is the only preferential right that it would have over the other shares, particularly the ordinary shares. If the share is to have any other preferential right, such a right must be expressly conferred by the contract under which it was issued or, exceptionally, the company's memorandum or articles of association.

2.

As regards the priority dividend entitlement, four points should be noted: (a) the right is merely to receive a dividend at the specified rate before any dividend may be paid on ordinary or other classes of shares. It is a priority right to whatever dividend may be declared. It is not a right to compel the company to pay the dividend if it declines to do so. This issue is likely to arise if the company decides to transfer profits to reserve or makes a provision in its accounts for a liability or loss instead of using the profits to pay the preference dividend. In BOND v BARROW HAEMATITE STEEL CO (1902) The company did not pay (ie "passed") its preference dividend. Bond and other preference shareholders contended that the company had available

reserves of 240,000 pounds from which it could have declared the dividend on their shares. The company replied that it had suffered realised losses of 200,000 pounds on the disposal or demolition of current assets and, in addition, its retained fixed assets had diminished in value generally by 50,000 pounds. It therefore decided to retain the funds in question to make good losses. HELD: The court could not overrule the directors in their decision that the "state of the accounts did not admit of any such payment" (of preference dividend). It was also held in Re Buenos Aires Great Southern Rly Co Ltd that if the company's articles entitle the preference shareholders to receive a fixed dividend for each year "out of the profits of the company", the words "profits of the company" means the profits available for dividend after setting aside such reserves as the directors think fit. If the whole of the profits are transferred to reserve the preference shareholders are NOT entitled to any dividends. (b) the right to receive a preference dividend is deemed to be cumulative unless the contrary is stated. If, therefore, a 7% dividend is not paid in year 1, the priority entitlement is normally carried forward to year 2, increasing the priority right for that year to 14%and so on. When arrears of cumulative dividend are paid, the holders of the shares at the time when the dividend is declared, are entitled to the whole of it even though they did not hold the shares in the year to which the arrears relate. An intention that preference shares could not carry forward an entitlement to arrears is usually expressed by the word "non-cumulative". But words such as "a dividend of X% payable out of the net profits of each year" sufficiently indicate that arrears may not be paid in a later year. If nothing is expressed (though cumulative preference shares are usually described as "cumulative" to remove all possible doubt) they are deemed to be cumulative: Webb v Earle (1875) (c) If the company which has arrears of unpaid cumulative preference dividends goes into liquidation, the preference shareholders cease to be entitled to the arrears unless: i. ii. a dividend has been declared though not yet paid when liquidation commences; or the articles (or other terms of issue) expressly provide that in a liquidation arrears are to be paid in priority to return of capital to members.

(d) Holders of preference shares have no entitlement to participate in any additional dividend over and above their specified rate. If, for example, a 7% dividend is paid on 7% preference shares, the entire balance of available profit may then be distributed to the holders of ordinary shares. But this rule also may be expressly overridden by the terms of issue. For example, the articles may provide that the preference shares are to

receive a priority 7% dividend and are also to participate equally in any dividends payable after the ordinary shares have received a 7% dividend. The company might then distribute, say, 9% to its ordinary shareholders and an extra 2% (making 9% in all) to its preference shareholders. These preference shares are called participative preference shares. Since there is no limit on the amount of dividend, which may be paid, on them they are a form of "equity share capital" even if their entitlement to capital is restricted. 3. In all other respects, preference shares carry the same rights as ordinary shares unless otherwise stated. If they do rank equally they carry the same rights, no more and no less, to return of capital and distribution of surplus assets and to vote. In practice, it is usual to issue preference shares on this basis. It is more usually expressly provided that: (a) the preference shares are to carry a priority right to return of capital; and (b) they are not to carry a right to vote except in specified circumstances, such as failure to pay the preference dividend, variation of their rights or on a resolution to wind up. 4. that: (a) the amount paid up on the preference shares, e.g. 1 pound on each 1 pound share, is to be paid in liquidation or reduction of capital before anything is repaid to ordinary shareholders; but (b) Unless otherwise stated, the holders of the preference shares are not entitled to share in surplus assets when the ordinary share capital has been repaid. 5. On a reduction of share capital (where the preference shares carry an entitlement to priority in repayment) it is in accordance with the rights of preference shareholders to pay them off first. They cannot object that to do this is a variation of their rights; it is strict observance of them (unless their rights are so expressed as to prevent it): Scottish Insurance Corporation Ltd v Wilsons & Clyde Coal Co Ltd. If preference shares carry no right to attend and vote at general meetings, the preference shareholders are still entitled to receive a copy of the annual accounts since these must be sent to "every member" and they are members. The advantages obtained by holders of preference shares are greater security of income and (if they carry priority in repayment of capital) greater security of capital. But in a period of persistent inflation, the entitlement to a fixed income and to capital fixed in money terms is an illusion. A number of drawbacks and pitfalls, e.g. loss of arrears in winding up and enforced repayment, have been indicated above. The type of investor to whom preference shares were attractive is better protected by investing in debentures since he then has a contractual right to his interest (whether or not the company makes profits) and as a creditor he is entitled to repayment of his capital before any class of shares is repaid. It is also advantageous to a company for tax reasons to issue debentures rather then preference shares. When preference shares carry a prior right to a return of capital the result is

6.

7.

v.

REDEEMABLE PREFERENCE SHARES A company with a share capital may, if authorised by its articles, issue preference shares, which are redeemable: C A, s. 60 (1).

2.2 TRANSFER OF SHARES

A share is, by its nature, transferable property. But to obtain transfer of the legal ownership of shares two conditions must be satisfied: (a) A "proper instrument of transfer" must be delivered to the company, which may not enter the transfer in its register until this is done: CA S. 77. (b) If, as is the general practice with private companies, the articles give to the directors power to refuse to register a transfer and the directors exercise their power in a proper way, the restriction imposed by the articles will prevent a transfer of legal ownership. Both principles, especially (b), require some explanation in detail. 2.2.1 TRANSFER PROCEDURE It was explained in Re Greene (63) that the rule which requires a "proper instrument" of transfer enforces the payment of stamp duty, normally at ad valorem rate on the consideration or (in the case of a gift) on the nominal value of the shares transferred. A company must reject an unstamped transfer under the provisions of Stamp Duty Act. This rule does not, however, apply to registration of shares in the names of personal representatives or trustees in bankruptcy since they are merely asserting powers of control and disposal of the shares of members whom they represent given to them by law under the rules of transmission. A member, however, cannot arrange for the direct transfer of his shares to a beneficiary after his death without a proper transfer (signed by his executors): Re Greene (63). The articles usually provide that: (a) The instrument of transfer must be "in any usual or common form" (i.e.. the forms used by stockbrokers); (b) the transferor's share certificate must accompany the transfer when presented for registration: Table A, Articles 23 and 25. The basic transfer procedure is that the transferor and transferee complete and sign the transfer form and have it stamped before delivering it to the company (with the transferor's share certificate) for registration. The transferee becomes a member and legal owner of the shares only when his name is entered in the register of members. The company issues to the transferee a new share certificate and cancels the old one. This is explained by the following diagram: 2.2.2 CERTIFICATION OF TRANSFERS

If the holder is not transferring his entire holding by a single transfer, it would be inappropriate for him to hand to the transferee a share certificate for a larger number of shares than are comprised in the transfer. In such a case the holder sends his signed transfer with his share certificate to the company for cancellation and the transfer form is returned to the transferor who then delivers it to the transferee for stamping and representation to the company. If the transferor is retaining some shares the company sends him a new share certificate for the reduced number of shares still registered in his name. This procedure is called "certification" of a transfer. It is explained by the following diagram: KEY (1) (2) (3) (4) (5) Certificate and signed transfer sent to company Signed transfer is endorsed and returned to transferor Transfer delivered to transferee Transfer stamped and sent to company New certificates sent to transferor and transferee

The transfer of registered debentures or of debenture stock is subject to the same rules as transfer of shares. Certification is a representation by the company to any person acting on the faith of the certification that documents have been produced to the company which on the face of them show a prima facie title of the transferor to the shares comprised in the transfer. It is not a representation that the transferor has any title to them but it does imply that the certificate will be retained: CA. S.81; Bishop v. Balkis Consolidated Ltd. Under s.81(2), any person who acts on a negligent certification can claim damages from the company for his loss if the company did not either receive or fails to retain the share certificate. But the company has no duty and no liability to anyone else. If, for example, the company returns the certified transfer form and the share certificate to the holder who sells the shares to A giving him the certified transfer form and also to B, giving B a second transfer form of the same shares with the transferor's certificate and A's transfer is then registered first, B has no claim against the company if it refuses to register the second transfer to him. B does not in this case rely on the certified transfer (of which he is unaware) and the share certificate was correct when first issued to the holder. In LONGMAN v BATH ELECTRIC TRAMWAYS A transfer of shares to B was registered and a certificate was prepared in his name. Before the certificate had been issued, B signed a transfer of the shares to H and this transfer was sent to the company for certification. The company certified the transfer (as it still had B's new share certificate) and returned the certified transfer to B. By mistake the company then sent to B the share certificate in his name. B deposited the share certificate with L as security for a loan. L later claimed that he was entitled to the shares. Held: L's claim must fail. He had never seen (and therefore did not rely on) the

certified transfer to H and mere possession of B's share certificate gave him no claim against the company since the certificate at the time of issue correctly described B as still the registered holder of the shares (ie the transfer to H had not at that point been delivered for registration). Ifto vary the facts of Longman's caseL had been able to secure registration as holder of the shares and the company had then rejected the transfer to H, H could claim compensation from the company since the certified transfer delivered to him would have been a representation by the company that it held B's certificate and that the transfer to H was valid. If identified shares are sold under a preliminary contract the rights and obligation incidental to ownership of the shares pass at once to the purchaser under the contract unless otherwise agreed. Thereafter, any dividend received by the vendor (pending registration of his transfer) must be paid over to the purchaser (unless the shares are sold "ex-div"). The purchaser must indemnify the vendor against any calls made on the shares before registration of the transfer. The vendor is, however, free to vote at meetings as he wishes until the purchase price has been paid to him. A vendor of shares has a duty (implied by the contract of sale) to deliver a transfer of the shares (in exchange for the price) which will give the purchaser good title to the shares. If he fails to deliver such a transfer, he is liable to pay damages. But the vendor does not (unless the contract expressly so provides) guarantee that the company will register the transfer. If the company rejects the transfer, the vendor as registered shareholder holds the shares in trust for the purchaser as his nominee. 2.2.3 RESTRICTIONS ON TRANSFER Section 30 of the Companies Act requires the articles of private companies to restrict the right to transfer the company's shares. The model articlesTable Acontains provisions which give the directors power to refuse to register a transfer of any share, whether fully or partly paid. The articles of a public company may also restrict the right to transfer the company's sharesusually if the shares are not fully paid or if the company has a lien on them. Unless the directors have a power under the articles to refuse a transfer and exercise that power properly, the transfer must be registered and the court may order rectification of the register for that purpose. The rules on the restriction of transfer are: (a) To exercise their power, the directors must consider the transfer and take a decision to refuse to register it. In RE HACKNEY PAVILION A transfer of shares was sent in by the executors of a deceased director and shareholder. The two surviving directors held a board meeting and disagreed as to whether the transfer should be registered. There was no casting vote. The secretary wrote to the executors to inform them that the directors had declined to register the transfer. Held:

This was incorrect since a positive act of refusal was necessary and there had been none. The register must be rectified by registering the transfer. (b) The directors in reaching their decision must act bona fide in what they consider to be the best interests of the company: RE: Smith & Fawcett (64) (c) Where the articles specify grounds of refusal, the directors may be required to identify the grounds of refusal. However, they are not obliged to disclose the detailed reasons for their decision (unless the articles so provide). If nonetheless the directors do disclose their reasons, the court will consider whether the directors acted bona fide or whether their reasons accord with the grounds specified in the articles (if that is the case). In RE BEDE SS CO LTD (1971) The directors were authorised to refuse transfers if in their opinion it was contrary to the interests of the company that the transferees should be members. The directors rejected transfers of small numbers of shares (and of single shares) on the ground that it was prejudicial to the company that its issued share capital should be fragmented. Held: The reason given could be challenged and was invalid. The power to refuse registration must (on the formula used in the articles) be confined to cases of objection to the transferees on personal grounds. In this case the directors were objecting to the small amount of shares transferred which was not an objection to the transferees personally. (d) The power of refusal must be exercised within a reasonable time from the receipt of the transfer. Under s. 80, a company is required to give notice of any refusal within sixty days. If the power is not exercised within a reasonable time it lapses and can no longer be used. The requirement of notice of refusal within sixty days effectually makes that the "reasonable" period. In RE SWALEDALE CLEANERS LTD (1968) On 3rd August 1967, transfers of shares were presented. There was only one director then in office and he purported to refuse to register the transfers in exercise of a power of refusal given by the articles. But a quorum for meetings of the directors was two and so the one director was not competent to exercise the powers of the board. On 11th December 1967 proceedings were begun for rectification of the register, i.e., a court order that the transfers should be entered in the register. On 18th December 1967 a second director was appointed and there was a board meeting at which the two directors refused to register the transfers (4 months, 14 days). Held: The attempt to exercise the power of refusal on 18th December 1967 was invalid since, in the interval of 4 1/2 months (since the transfers were

presented), the power had expired (as regards those transfers). Since the power of refusal had not been exercised the transfers must be entered in the register. The articles may also restrict the right to transfer shares by giving to members a right of first refusal of the shares, which other members may wish to transfer. Any such rights are strictly construed, i.e. a member who wishes to accept must observe the terms of the articles and a member will not be permitted to evade his obligation to make the offer. In LYLE & SCOTT v SCOTT'S TRUSTEES The articles required any member who might be "desirous of transferring" his shares to give notice to the company secretary so that the shares could be offered to other members. Certain members agreed to sell their shares to an outsider and, while remaining the registered holders, gave the purchaser their proxies so that he could secure control of the company. Held: These members were indeed "desirous of transferring" their shares and must give formal notice as the articles required. The cases cited above show that when there is a dispute over refusal to register the proper remedy is to apply to the court for rectification. A member who applied for an order for compulsory winding up of the company on the just and equitable ground was refused (Charles Forte {Investments} v Amanda) as "a winding up petition is not a proper remedy" in such a case because to liquidate the company would be unfair to other members not involved in the dispute. 2.2.4 SHARE CERTIFICATES (a) S.82 (1) provides that within sixty days of allotting shares or receiving a transfer, a company must have ready for delivery a certificate of the shares allotted or transferred (unless the transfer is rejected). This is a formal written declaration (usually issued under the seal of the company) that the person named is entered in the register as the holder of the shares specified. (b) A share certificate is a document on which is printed the name of the shareholder and the number of shares held (with any particulars such as "1 pound ordinary") is written (or typed). The seal of the company is affixed and witnessed by signatures (unless dispensed with). The standard printed wording on a share certificate reads: "This is to certify that (name of shareholder) is the holder of (number and any description) shares fully paid of (nominal value) each numbered ... to ... inclusive in the above named company subject to the memorandum and articles of association thereof." The distinguishing numbers may be omitted. The reference to the memorandum and articles is a reminder of the statutory rule that every

member is bound by these documents as a contract with the company, under s.22 of the Companies Act. Contents of the share certificate Name of the company Common seal of the company Registered holder of the shares Number of shares held Serial number Date of issue Signature of directors

A share certificate is not a document of title but is prima facie evidence of ownership. The company therefore requires the holder to surrender his certificate for cancellation when he transfers all or any of his shares. If the company issues a share certificate which is incorrect it is estoppel from denying that it is correct but only against a person who has relied upon it and thereby suffered loss. Estoppel by Share Certificate Although the share certificate is only prima facie evidence of title, its contents may lender the company liable under the equitable doctrine of estoppel. This is because the contents of the share certificate are a representation by the company to 3rd parties and a bona fide 3rd party who suffers loss or damage by reason of relying upon the representation will hold the company liable. The company cannot be heard to say that it never made the representation or that it was false. RE BAHIA & SAN FRANCISCO RAILWAY CO T was the registered holder of 5 shares. S and G forged a transfer of the shares to themselves and presented it for registration with T's share certificate which they held as her brokers. The transfer was registered and a new share certificate was issued to S and G as shareholders. S and G sold the shares to B and another person who were duly registered as holders. T had the shares re-registered in her name since the forged transfer was a nullity. B and the other purchaser claimed the value of the shares from the company as damages. Held: The claim was valid since the share certificate in the name of S and G was "a declaration by the company to all the world that the person in whose name the certificate is made out and to whom the certificate is given, is a shareholder of the company ... with the intention that it shall be acted upon in the sale and transfer of shares". (NB in this case the share certificate issued to S and G was genuine (although obtained by a forged transfer) and the claimants had not themselves presented a forged transfer since the transfer to them by S and G was genuine (although it related to shares to which S and G had no title). The principle of estoppel which applied in the case cited above is that if a person:

(a) makes a statement of fact with the intention that it shall be relied on; and

(b) the person to whom it is made does act in reliance on it and would suffer loss if the statement were subsequently denied as untrue, then the person who made the statement is estoppel, ie, is not permitted to deny his own statement by asserting the true facts. The position must remain or be resolved as if the statement made had been true. Apart from ownership, the company may be similarly estoppel from denying the correctness of the certificate in other respects. For example, if the certificate states that the shares are fully paid, the company cannot deny that this is so. In BLOOMENTHAL v FORD (1897) The company borrowed money from B and as security gave him share certificates for 10,000 shares of 1 pound each in his name in which the shares were described as fully paid. B believed that the amount due on shares had been paid by a previous holder. But this was not true. The company went into liquidation and the liquidator claimed from B the amount due on his shares. Held: The company was estopped by its own statement on the certificate that the shares were fully paid. The claim must fail. Read also the case of Burkinshaw v Nicolls. (65) (c) A person who is in possession of a share certificate in his name or the name of another person may have a valid claim (ie. the company may be estoppel from denying that the certificate is valid). But the claimant will fail in any of the following circumstances: i. If he has not relied on the share certificate in a transaction from which he will incur loss if the share certificate is repudiated by the company. In Tompkinson's case, below, the claim only succeeded because T had re-sold the shares in reliance on the certificate. In BALKIS CONSOLIDATED v TOMPKINSON P sold shares to T (but P had no title to the shares) and the company was induced by fraud on the part of P to issue a share certificate to T in the name of T. T later re-sold the shares. The company refused to register the transfers by T to the persons who had bought the shares from him on the ground that T had no title (like P before him). T purchased other shares to satisfy the claims of those to whom he had sold and claimed damages from the company. The company said that it was not estoppel from denying that T had any title to his shares. Held:

T could rely on the principle of estoppel since, in reliance on the share certificate issued to him, he had incurred liabilities by reselling the shares. (NB. T himself was not implicated, even indirectly, in procuring the issue of the certificate which was arranged by P.) ii. If he has obtained the certificate by presenting a forged transfer to himself for registration.

iii. If the certificate is a forgery or issued without authority. In RUBEN v GREAT FINGALL CONSOLIDATED The company secretary forged the necessary signature of a director on a share certificate and issued it. Held: The company was not estoppel from denying that the certificate was worthless. It was not a certificate issued by the company. 2.2.5 STOLEN CERTIFICATES AND FORGED TRANSFERS Most of the case-law is concerned with share certificates issued as a result of the delivery to the company of a forged transfer together with a stolen or misappropriated share certificate of the registered holder. The company accepts the transfer for registration and issues a new certificate to the transferee who then re-sells the shares to another person. The result is then as follows: (a) The original registered holder (A) can usually require the company to restore his name to the register since a forged transfer is a nullity which cannot deprive him of his title to the shares; (b) The person (B) who obtained registration of the forged transfer of shares to himself cannot rely on the share certificate issued to him since he obtained it by presenting a forged transfer. On the contrary, he is liable to compensate the company for its liability. This is so even if B is unaware of the forgery; (c) The second purchaser (C) has relied upon the share certificate issued to B. C is not disqualified from making the company liable on the certificate since C has not delivered a forged transfer to the company (Bahia case above). C is not the owner of the shares (since his claim is based on forged transfer by A to the person (B) who purported to transfer the shares to him. But as the company cannot deny that B's share certificate is correct it must compensate C either by paying C the amount which C paid to B for the shares or by buying other shares in order to be able to register those shares in the name of C. (Alternatively, the company may leave C's name on the register and buy other shares to register in the name of Aas in Barclay's case below). In SHEFFIELD CORPORATION v BARCLAY Stock was registered in the joint names of T and H. T forged H's

signature on a transfer and added his own. T delivered the transfer to B ( who was unaware of the forgery) and B obtained registration of the transfer to himself. B later transferred the shares to C to whom B delivered a transfer and the certificate issued to him. When the forgery was discovered, H claimed to be restored to the register as holder of the shares (T had died meanwhile) and the corporation, being estoppel against C, purchased shares in the market for registration as replacement in the name of H. The corporation claimed compensation from B. Held: B was liable to compensate the corporation since he had caused it to issue a false share certificate by delivering a forged transfer to himself for registration.

In the example given above it is assumed that the original registered holder has not contributed to the fraud. But if he does so, even innocently, he may be estoppel from asserting his ownership of the shares. He is not estoppel in this way merely because he leaves his share certificate in the possession of another person (see Bahia case above). But if he delivers a signed transfer to another person for a limited purpose he gives him apparent authority to use the transfer and so may be unable to repudiate an unauthorised use of the transfer. In FRY v SMELLIE The registered holder of shares gave to an agent a blank transfer (i.e. a transfer signed by transferor but without the name of a transferee inserted) with a view to the agent borrowing a specified sum of money using the shares as security. The agent exceeded his authority by mortgaging the shares for a larger sum. The shareholder denied that the transfer was valid since it had been used in a transaction, which exceeded the actual authority given to his agent. Held: The shareholder was estoppel from asserting that the agent had exceeded his authority. The private limitation of authority could not be pleaded against a third party who was not aware of it. Some companies in Kenya issue a "transfer notice" to the registered holder to the effect that a transfer of his shares had been presented for registration. However, if the registered holder ignores the notice (as happened in the Bahia case) he is not estoppel from later asserting that the transfer was not signed or authorised by him. Hence the issue of a transfer notice is of no value to the company and so in England the practice has been generally abandoned. It would however be advisable for public companies to insure against liability arising from accepting a forged transfer. 2.2.6 STOCK

A company may, if authorised by its articles, convert its issued shares into stock (or reconvert stock into shares). But shares must be allotted as shares ranking pari passu and be made fully paid before they can be converted into stock. The effect of conversion is that, for example, one hundred 1 pound shares become a single block of 100 pound stock owned and transferrable in units of defined value (usually the same amount as the value of the shares from which they are derived). It used to be common practice to convert fully paid shares to stock to dispense with use of identifying numbers for shares. But this result can now be achieved in other ways. It should be noted that reference to shares in the Companies Act includes stock unless otherwise indicated.(CA S.2).

2.3 MORTGAGE OF SHARES

This is a transaction whereby shares are used as collateral security for loans. The transaction is either legal or equitable. Under a legal mortgage the borrower transfers his shares to the mortgagee who becomes the registered holder subject to a separate agreement by which he undertakes to retransfer the shares to the mortgagor on repayment of the loan. The agreement also determines who is entitled to the dividends and gives the mortgagee the right to sell the shares if the mortgagor defaults on the loan. As registered holder, the mortgagee can transfer the shares to a purchaser who buys from him. The essential feature of an equitable or informal mortgage is that the borrower deposits his share certificate with the mortgagee but remains the registered holder of the shares. There is again an agreement containing the terms of the loan and the mortgage. The mortgagee may protect himself by serving a "stop notice" on the company but his possession of the share certificate is an effectual bar to dealings with the shares by the borrower. The equitable mortgagee's other potential difficulty is that since he is not a registered shareholder he has no direct means of transferring the shares to a purchaser if the borrower defaults and he decides to sell. He usually obtains from the mortgagor a "blank transfer", ie. a transfer signed by the mortgagor as registered holder but without the name of a transferee inserted. This usually gives the mortgagee an implied power to insert his own name as transferee in case of default. He can then dispose of the shares after transferring them into his name. Alternatively, the mortgagee may obtain from the mortgagor a power of attorney giving him power to insert the name of a purchaser on the transfer.

2.4 CALLS ON SHARES

Unless shares are already fully paid the registered holder is liable to pay the balance due when called on to do so. The power of the directors to make calls is defined by the articles. The procedure must be correctly applied. The rules or principles governing calls are embodied in Articles 15 21 of Table A. If a shareholder defaults in the payment of calls, the company may, if the articles so provide, forfeit his shares. Articles 3339 of Table A contain provisions which will apply if the company's articles do not provide for forfeiture.

2.5 LIEN ON SHARES

A lien is an equitable charge on the shares of a member to secure sums owing by the member to the company. The company has a lien only if its articles so provide and to the extent that the articles provide. Private companies however usually have a lien over fully paid as well as partly paid shares to secure sums owing by members whether in respect of their shares or other liabilities such as loans. The articles also give the company a power to enforce its lien (in case of the member's default) by sale of the shares. The company's lien gives it a first claim on the shares unless the company has notice of some existing claim to the shares before the holder becomes indebted to the company. BRADFORD BANKING COMPANY v BRIGGS & CO (1886) A member deposited his share certificate with the bank as an equitable mortgage of the shares to secure a loan to him by the bank. The bank gave notice to the company of its interest as mortgagee. Later, the member became indebted to the company. Held: As the company had prior notice of the bank's mortgage, its lien (although the right to a lien existed when the notice was received) was postponed to the mortgage since the company's claim under the lien arose after the bank's notice was received.

2.6 VALUATION OF SHARES

The articles of private companies often provide that a member who wants to sell his shares must first offer them to the existing members at a price to be fixed by the auditors. Similar provisions are often applicable in the case of a members death. In valuing the shares for this purpose, the auditor is not obliged to explain the basis of his valuation or to give his reasons for it, and he is not liable to an action by a party who is dissatisfied with it unless he is dishonest. If, however, he does give an explanation, the court can inquire into it and, if satisfied that the valuation has been made on the wrong basis, can declare that it is not binding, i.e. the valuation can be impeached for fraud, mistake or miscarriage, but on matters of opinion the court will not interfere. In Arenson v Casson Beckman Rutley & Co., it was held that for a valuer to establish immunity from suit, he must show that a dispute between at least two parties was sent to him to resolve in such a way that he had to exercise a judicial discretion. An auditor of a private company who, on request, values its shares in the knowledge that this valuation will determine the price to be paid under a contract owes a duty of care to both the vendor and the purchaser. Accordingly, on the facts of the case, the plaintiffs statement of claim disclosed a cause of action.

2.7 BORROWING BY COMPANIES

It has been observed that Most Companies like individuals require to borrow from time to time for the exigencies of their business. To entitle a company to borrow, it must have power to borrow given to it by its constitution. Whether a company has or has no power to borrow depend on its objects and powers specified in the objects and powers specified in the objects clause of the memorandum. Usually, the objects clause contains an express power to borrow. However, an implied power is sufficient. An

implied power arises whenever the objects are such that a power to borrow may fairly be regarded as incidental to the companys objects. This is the case with a non-trading company there must be something in the memorandum or articles to show expressly or inferentially that the company is to have a power to borrow. If a company has no power by its memorandum to borrow, it can remedy the defect by altering its objects pursuant to sec 8(1) of the companies Act. A newly registered public company must not exercise any borrowing powers unless the registrar of companies has issued it with a certificate of trading pursuant to sec 111 (3) of the Act. Sometimes the borrowing powers of a company are restricted by the memorandum or articles e.g. to a specific sum or to a sum not exceeding the paid up capital. However, in the vast majority of cases no limit is imposed. It therefore follows that if a company has an express or implied power to borrow, it may form time to time borrow as much as it wants subject to any restrictions in its articles. The power to borrow is generally exercised by directors. Article 79 of Table A is emphatic that The directors may exercise all the powers of the company to borrow money and to mortgage or charge its undertaking, property and uncalled capital, or any part thereof and to issue debentures, debenture stock and other securities whether outright or as security for any debt, liability or obligation of the company or of any third party. If a company has power to borrow, it has an incidental there to power to secure the repayment of borrowed money by mortgage or change of all or any of its property, real or personal present or future. Directors power to borrow may be general as above or special i.e. a clause empowering the directors to borrow or raise money. A company with a power to borrow may borrow in such manner as it thinks fit. It can therefore raise money on a legal mortgage of any specific portions of its property or by equitable charge by bonds, promissory notes or by debentures or debenture stocks. Where a company has no borrowing power or where the memorandum of association fixes a limit to the borrowing powers of the company a rare thing altogether any borrowing in the one case and any borrowing in excess of such limit in the other case is potentially ultra virus the company. If the company has unlimited powers of borrowing but the directors having only limited powers, exceed them the borrowing is irregular for want of authority. It is intra virus the company and may be ratified by shareholders. Additionally, the lender is protected by the rule in Turquands Case The lender of money borrowed ultra vires the company has in some cases a right against the directors personally for breach by them of their implied warranty of authority, if their acts amount to an implied representation of fact and it makes no difference as to the liability of the directors in such a case that they did not know that they were exceeding their powers.

3. DEBENTURES

3.1 S.2 of the Act defines "debenture" as including "debenture stock, bonds and any other
securities of a company whether constituting a charge on the assets of the company or not". There is no precise legal definition of a "debenture". In Levy v Abercorris Slate & Rubber Co Chitty, J stated that he could not find any precise legal definition of the term "debenture" and went on to observe that the word "is not, either in law or commerce, a strictly technical term, or what is called a term of art". He also stated that, etymologically, the word is a derivation from the Latin Debenture mihi which were the opening words of certain documents, which used to be issued by English companies in the 1860s as an acknowledgement of a loan the companies had received from the person to whom the document was issued. With the passage of time the word "debenture" acquired the meaning it generally has today, namely, a document issued by a registered company to acknowledge, or evidence, an indebtedness. Primarily, the word "debenture" is applied not to the indebtedness itself but to the document evidencing it.

3.2 Debentures and debenture stock

A debenture is usually a formal document in printed form. The main types, which a company can issue, are (a) A Single Debenture A single debenture is usually a formal document in printed form and sealed. It is usually issued when a company obtains a loan from a single lender, such as its bank. The bank would normally insist that the company signs and seals one of the bank's standard form of debenture which would not only create a charge in favour of the bank but would also give it certain powers in relation in the charged property. (b) Debentures Issued as a Series Debentures are issued as a series if the company decides to borrow money from different lenders on different dates but in such a way that the lenders would rank equally in their right to repayment and in any security given to them. Each lender receives a debenture in identical form in respect of his loan and the debentures are expressed to form a series ranking pari passu. (c) Debenture Stock "Debenture stock" is created when a public company issues "debenture stock certificates" to a class of debenture holders, evidencing the portion of the total to which each one of them is entitled. Each lender has a right to be repaid his capital at the due time and, before that time, to receive interest on it at the agreed rate. Each debenture will be for a specified sum, e.g. Sh 100 or Sh 1,000, as stipulated in the conditions of issue. Types of debentures Debentures may be issued as: i. Redeemable or irredeemable ii. Registered or bearer iii. Secured or unsecured (naked) Subordinated debentures Under American law, these are obligations often referred to as subordinated debts,

junior debts or inferior debts, upon which the right to receive payment is subordinated or deferred by a subordination agreement or clause, to the prior payment of certain other indebtedness, sometimes referred to as senior, superior or prior debts. The subordination may be incomplete or complete. If complete, the payment of principal and interest on the subordinated debt is deferred until the obligations on the senior debt is satisfied. The subordination is valid as between the parties.

3.3 Issue of Debentures

Debentures are usually issued by a resolution of the board of directors under powers conferred by the company's articles of association. Table A, Article 79 provides that "the directors may exercise all the powers of the company to borrow money ... and to issue debentures, debenture stock, and other securities". Such authority is however not required in the case of a trading company which has implied power to borrow money for the purposes of its business, and to give security for the loan by creating a mortgage or charge over its property. 3.3.1 Debentures and Shares Debentures and shares have the following similarities and differences. (a) Similarities i. A debenture is usually one of a series or class which is similar to a class of shares. ii. Debentures as well, as shares are long-term investments in the company and are transferable in the same manner.

iii. Debentures and shares may be issued in the same way through a prospectus issue. (b) Differences i. A shareholder is a member (i.e. an insider) whereas a debenture holder is a creditor (i.e. an outsider). ii. A shareholder has an interest in the company but not in the company's property. A debenture holder has no interest in the company but has an interest in the company's property, which constitutes his security. Consequently: 1. A shareholder can attend a meeting of the company and vote at the meeting whereas a debenture holder cannot do so. 2. A shareholder cannot insure the company's property whereas a debenture holder can do so (unless the debenture is a `naked' one). iii. Interest on debentures must be paid even if the company does not make a profit and can therefore be paid out of capital. Dividends on shares are payable only if profits are made and cannot be paid out of capital. iv. A company can purchase its own debentures but cannot, as a general rule, purchase its own shares.

v.

As a general rule, shares cannot be issued at a discount, whereas debentures may be issued at a discount.

3.4 Debenture Certificates

S.82(1) provides that debentures or debenture stock certificates must be completed and ready for delivery within sixty days after allotment or after the lodging of a transfer, unless the conditions of issue otherwise provide.

3.5 Debenture Trust Deed

When debentures are offered for public subscription, the company usually enters into a trust deed with trustees (usually a trust corporation). The trustees are appointed and paid by the company to act on behalf of the debenture holders. The charge securing the debentures is made in favour of the trustees who hold it on trust for the debenture stockholders. A debenture stockholder, unlike debenture holder, is not a creditor of the company. He cannot therefore present a petition to wind up the company: Re Dunderland Iron Co Ltd. The trustees are technically the creditors of the company for the whole debenture debt while the stockholder is an equitable beneficiary of the trust. 3.5.1 Contents of a Trust Deed The main terms of a trust deed are usually some or all of the following: i. A covenant (promise) by the company to pay to the debenture holders the agreed instalments of the loan and accrued interest. ii. A description of the property charged, whether specifically or by way of a floating charge.

iii. The events in which the security is to become enforceable, such as failure to pay the principal sum or interest as agreed. iv. A clause empowering the trustees to take possession of the property charged in the event of the security becoming enforceable, and to carry on the business and to sell the property charged. v. Appointment of a receiver vi. Meetings of debenture holders. vii. Covenants by the company to insure the property charged and to keep the property charged in good repair. Advantages of a Trust Deed A trust deed has several advantages some of which are (a) The circumstances in which the principal sum may become repayable are clearly spelt out. (b) The appointment of trustees facilitates the efficient administration of the trust since they are there to exercise continuous supervision of the debenture holders' rights and to take prompt action if the need arises.

3.5.2

(c) The trustees are empowered to appoint a receiver to carry on the business in case of urgency. (d) Covenants are entered into by the company for insurance, repair and other matters, which can be enforced by the trustees. (e) The trustees have a legal mortgage over the companys land. 3.5.3 Liability of Trustees Trustees for debenture holders owe the same duties to their beneficiaries as are owed by trustees in general. In particular, they cannot purchase the debentures without the consent of all the debenture-holders. S.90(1) provides that any provision in a trust deed, or in a contract with the holders of debentures secured by a trust deed, for exempting a trustee from, or indemnifying him against, liability for breach of trust where he fails to show the degree of care and diligence required of him as trustee (having regard to the provisions of the trust deed) shall be void. This provision does not however invalidate (a) any release given after the liability has arisen; or (b) a provision in a trust deed for the giving of such a release by a majority of not less than three-fourths in value of the debenture holders present and voting in person or by proxy at a meeting summoned for the purpose; or (c) a provision in a trust deed for the giving of such a release either with respect to specific acts or omissions or on the trustee dying or ceasing to act. 3.5.4 Remedies of debenture holders The remedies of debenture holders are generally conferred by the trust deed but will usually include the power i. property ii. To sue as creditors for arrears of interest or principal, or both To appoint a receiver to carry on the business or sell the charged

iii. To petition the High Court for a winding up order (on grounds of the company's inability to pay its debts), and iv. To apply to the court for the appointment of a receiver or for an order for sale if there is no power in the trust deed. 3.5.5 Register of Debenture Holders S.88(1) requires every company, which issues a series of debentures to keep at its registered office a register of holders of such debentures. If the work of

making up the register is done at some other office of the company, or of another person, it may be kept at that other office. The registrar shall be notified of such place and of any change thereof.

3.6 Charges Securing Debentures

3.6.1 Charges A charge on the assets of a company given by a debenture or a trust deed may be either a specific (fixed) charge or a floating charge. i. Fixed Charges A charge is a "fixed charge" if it is a mortgage of ascertained or specific property such as plant and machinery, freehold or leasehold land, or uncalled capital. It may also be legal or equitable. Floating Charges According to the decision of Romer, L J in Re: Yorkshire Woolcombers Association Ltd a charge is a "floating charge" if it has the following three characteristics: (a) it is a charge on a class of assets of a company, present and future; (b) the class is one which changes from time to time in the ordinary course of the company's business; and (c) it is contemplated by the charge that, until some event occurs which causes the charge to crystallise, the company may use the assets charged in the ordinary course of its business. Because the charge does not attach or fix at the time of its creation upon any particular asset, it is equitable by nature. Under the current Kenya and English law a floating charge cannot be issued by a partnership or sole trader. 3.6.2 Crystallization of Floating Charges A floating charge is a charge on a class of assets of a company. The actual assets in that class owned by the company change from time to time. The assets that the chargee is entitled to utilise for payment of the secured debt are the assets in the class that the company owns at the time when the charge crystallises. On crystallization a floating charge becomes a fixed or specific equitable charge. A floating charge crystallises: (i) When the chargee appoints an administrative receiver. The power to do so exists only by virtue of the charge contract, which must therefore specify the circumstances in which the power is exercisable. e.g. 1 liquidation or winding up 2 appointment of a receiver 3 levy of execution or distress

ii.

4 5

insolvency cessation of business

(ii) When the company goes into liquidation. (iii) When the company ceases to carry on business. (iv) If the charge contract so provides, when the chargee gives notice that the charge is converted into a fixed charge on whatever assets of the charged class are owned by the company at the time the notice is given. (v) When another floating charge on the companys assets crystallises it causes the company to cease business. (vi) Commencement of recovery proceedings against the company. (vii) Occurrence of an event, which under the terms of the debenture causes crystallization. 3.6.3 (a) Advantages of floating charges From the company's point of view, a floating charge may be regarded as conferring the following advantages: i. The company is free to deal with the assets charged as if they had not been charged. ii. Enables companies without fixed assets to borrow. iii. It enables the company to charge property which otherwise would not have been charged since such property cannot be subject to a fixed charge. iv. Enhances the borrowing capacity of a company of floating charges. (b) Disadvantages of floating charges From the lender's point of view, a floating charge has the following disadvantages: i. ii. iii. iv. v. The value of the assets charged is uncertain since no particular assets are charged. A floating charge created within 6 months before the commencement of winding up is deemed to be a fraudulent preference and is void. It is postponed to a later fixed charge. The charge may be avoided, during the company's liquidation, under s.314 of the Act, unless it is proved that the company immediately after the creation of the charge was solvent. Where a seller of goods reserves title until payment, a floating charge will not, on crystallisation, attach to these goods. This is illustrated by Aluminium Industries Vaassen v Romalpa Aluminium (647). Certain other interests e.g. landlords distress fortent, have priority over floating charges.

vi.

3.7 Priority of Charges

The priorities between charges are as follows: (a) Legal fixed charges rank according to their order of creation. (b) If an equitable fixed charge (ie an informal mortgage created by a deposit of title deeds to land or a share certificate with the lender) is created first and a legal charge over the same property is created later, the legal charge takes priority over the equitable charge. (c) A floating charge will be postponed to a later fixed charge over the same property. This is so because the fixed charge attaches to the charged property at the time of its creation whereas the floating charge attaches at the time of crystallization. The floating charge would however have priority over the later fixed charge if i. ii. the floating charge contained a "negative pledge" clause which prohibited the company from later on creating fixed charges with priority over it, and the holder of the fixed charge actually knew of the prohibition. In Re: Valletort Sanitary Co it was explained that registration of the floating charge would be constructive notice of the charge itself but not constructive notice of the contents of the charge, including the negative pledge clause.

(d) If two floating charges are created over the general assets of the company they rank in order of creation. (e) If a company creates a floating charge over a particular kind of assets, e.g. book debts, the charge will rank before an existing floating charge over the general assets: Re Automatic Bottle makers. 3.8 Registration of Charges 3.8.1 Section 96(1) requires the prescribed particulars of specified charges on a company's property or undertaking to be delivered to the registrar for registration within 42 days after the date on which the charge was created. The specified charges are: (a) A charge to secure an issue of debentures; (b) A charge on uncalled share capital; (c) A charge created by an instrument, which, if executed by an individual, would require registration as an instrument under the Chattels Transfer Act (e.g. a Letter of hypothecation); (d) A charge on land; (e) A charge on book debts of the company; (f) A floating charge; (g) A charge on calls made but not paid; (h) A charge on a ship or any share in a ship;

(i)

A charge on goodwill, a patent, a copyright or a trademark.

3.8.2

The prescribed particulars The "prescribed particulars" of registered charges are enumerated in Form No 214 and are: i. The date and description of the instrument creating or evidencing the mortgage or charge; ii. The amount secured by the mortgage or charge; iii. Short particulars of the property charged; iv. Names, postal addresses and descriptions of the persons entitled to the charge; and v. Amount of rate per cent of commission, allowance or discount (if any) paid.

3.8.3

General Aim The purpose of registering the aforesaid particulars is to enable a would-be creditor to know the company's existing indebtedness and the assets available for their settlement.

3.8.4

Certificate of Registration S.99 requires the registrar to give a certificate, under his hand, of the registration of any of the specified charges. The certificate shall be conclusive evidence that the statutory requirements as to registration have been complied with. Consequently, the charge would not be rendered void on the grounds that one of the prescribed particulars, such as the date of the creation of the charge, is later found to be incorrect: Re C.L. NYE LTD (66).

3.8.5

Effect of Non-Registration Registration of charge cures all defects characterising the charge. The charge is deemed to have been made in due compliance with the provisions of the companies Act. As was the case in National Provincial and Union Bank of England V. Charnley. Section 96(1) provides that if the prescribed particulars if any of the specified charges is not registered within the prescribed period of 42 days the charge will be "void against the liquidator and any creditor of the company". Although the charge becomes void: i. The money secured becomes immediately repayable. This means that the lender is not bound by the terms of the charge and can take immediate steps to recover his money; and The court is empowered by s.102 to extend the time for registration of

ii.

the charge on being satisfied that the omission to register the charge within the prescribed time was accidental or was due to inadvertence or other sufficient cause, provided that neither creditors nor shareholders would be prejudiced by the extension.

Although it is the company's duty to effect the registration s.97 (1) permits the registration to be effected on the application of any person interested in the charge. The person shall be entitled to recover from the company the amount of any fees properly paid by him to the registrar on registration. 3.8.6 Register Of Charges S.105 (1) provides that every limited company shall keep at its registered office a register of charges and enter therein (a) a short description of the property charged; (b) the amount of the charge; and (c) the names of the persons entitled to the charge. Failure to comply with s.105 (1) does not invalidate the charge but the officers of the company responsible for the omission shall be liable to a fine not exceeding one thousand shillings.

INSIDER TRADING OR DEALING

Insider dealing occurs where an individual or organisation buys or sells securities while knowingly in possession of some piece of confidential information which is not generally available and which is not likely, if made available to the general public, to materially affect the price of the securities. For example, where a company director who is aware that the company is in a bad financial state sells his shares knowing that this information will be made public with an announcement of a cut in dividend payment. It is argued that the use of insider information is unfair to those who deal with the insider, though it is difficult to identify the looser since the transaction takes place on the stock exchange. However, a person who buys something which turns out to be worthless than the price paid for it may feel aggrieved. In principle, dealings in a market generally reflect the value of the security if all the information used in valuation is available to both buyers and sellers. Information generally used by those involved in company securities relate to: (i) World trade in the particular market in which the company is trading (ii) Economy of the country (iii) How the company is handling its affairs. With the expansion of dealings in stock exchange, it has become evident that taking advantage of inside information is fraudulent on other investors and could lower public confidence in the stock exchange, and for officers of the company, this amounts to a breach of trust since the information is obtained in the course of their employment. 4.1 Case for Regulation In the realm of company law, it may be necessary to regulate insider trading or dealing since the insider with access to confidential information is in potential conflict of interest situation, in particular where his position in the company enables him to dictate

or influence when the public disclosure of price-sensitive information is to be made. In such a case, the officers decision and his won desire to trade advantageously in the companys shares may conflict and such conduct is likely to bring the company into disrepute. It is thereof recognised that it is wrong for a director or another to deal in a companys securities knowing of some development which is likely to affect the price of the securities which other members of the public are generally privy to.

4.2 Liability Under the United States Law, persons involved in insider dealings are bound to account to the company or to the individual dealt with. In Britain, the problem is dealt with by the provisions of the Companies Act, Company Securities (Insider Dealing) Act, 1985 and the Criminal Justice Act, 1993. At common law, officers of the company are free to hold and deal in the shares of the company. However, use of confidential information is actionable. This legal position is traceable to the decision in Percival v Wright where joint holders of some shares of an unlisted colliery company offered them for sale to the chairman of the company and two other directors at a price determined by an independent value at 12 10s but after conclusion of the sale, it was discovered that while negotiating the purchase, the chairman was involved in discussions of the possible sale of the whole colliery at a price that would have made each share in the company worth more than 12 10s. However, the colliery was never sold. In an action by Percival and his co-shareholders to have the sale set aside on the ground of non-disclosure by the chairman, it was held that since the directors owed their duties to the company, there was no duty to disclose. In the words of Swinfen Eady J. The contrary view would place directors in a most invidious position, as they could not buy or sell shares without disclosing negotiations, a premature disclosure of which might well be against the best interest of the company. I am of the opinion that directors are not in that position. The decision in Percival v Wright was upheld in Tent v Phoenix Property & Invest Co. Ltd. (1984. In Multinational gas & Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. (1983), Dillon L. J. observed: The directors stand in a fiduciary relationship to the company and they owe fiduciary duties to the company though not to individual shareholders. However, in Allen v Hyatt 1914 where shareholders had engaged directors to investigate on their behalf and the directors benefited, it was held that since the directors were agents of the shareholders, they were liable to account to the shareholders. In Kenya, the problem of insider trading is addressed by Section 33 of the Capital Markets Authority Act, Cap 485 A under Section 33 (1) of the Act, insider trading is a criminal offence. Under the section, (1) A person who is, or at any time in the preceding six months has been connected with a body corporate shall not deal in any securities of that body corporate he is

in possession of information that is not generally available but, if it were, would be likely to materially affect the price of those securities. (2) A person who is, or at any time in the preceding six months has been, connected with a body corporate shall not deal in any securities of any body corporate if by reason of his so being, or having been, connected with the first mentioned body corporate he is in possession of information that is not generally available but, if it were, would be likely materially to affect the price of those securities; and relate to any transaction (actual or expected) involving both bodies corporate or involving one of them and securities of the other. Where a person is in possession of any such information as is mentioned in subsection (1) and (2) that if generally available would be likely materially to affect the price of securities but is not precluded by either of those subsections from dealing in those securities, he shall not deal in those securities if (a) he has obtained the information, directly or indirectly, from another person and is aware, or ought reasonably to be aware, of facts or circumstances by virtue of which that other person is himself precluded by subsection (1) or (2) from dealing in those securities; and (b) when the information was so obtained, he was associated with that other person or had with him an arrangement for the communication of information of a kind to which those subsections apply with a view to dealing in securities by himself and that other person or either of them. (4) A person shall not, at any time when he is precluded by subsections (1), (2) or (3) from dealing in any securities, cause or procure any other person to deal in those securities. A person shall not, at nay time when he is precluded by subsections (1), (2) or (3) from dealing in any securities by reason of his being in possession of any information, communicate that information to any other person if (a) trading in those securities is permitted on any securities exchange; and (b) he knows, or has reason to believe, that the other person will make use of the information for the purpose of dealing or causing or procuring another person to deal in those securities. (6) Without prejudice to subsection (3) but subject to subsections (7) and (8), a body corporate shall not deal in any securities at a time when any officer of that body corporate is precluded by subsections (1), (2) or (3) from dealing in those securities. A body corporate is not precluded by subsection (6) from entering into a transaction at any time by reason only of information in the possession of an officer of that body corporate if

(a)

(b) (3)

(5)

(7)

(a) the decision to enter into the transaction was taken on its behalf by a person other than the officer (b) it had in operation at that time arrangements to ensure that the information was not communicated to that person and that no advice with respect to the transaction was given to him by a person in possession of the information; and (c) the information was not so communicated and such advice was not so given. (8) A body corporate is not precluded by subsection (6) from dealing in securities of another body corporate at any time by reason of only of information in the possession of an officer of that first-mentioned body corporate, being information that was obtained by officer is the course of the performance of his duties as an officer of that first mentioned body corporate and that relates to proposed dealings by that first-mentioned body corporate in securities of that other body corporate. For the purpose of this section, a person is connected with a body corporate if, being a natural person (a) he is an officer of that body corporate or of a related body corporate; (b) he is a substantial shareholder in that body corporate or in a related body corporate; or (c) he occupies a position that may reasonably by expected to give him access to information of a kind to which subsection (1) and (2) apply by virtue of (i) any professional or business relationship existing between himself (or his employer or a body corporate of which he is an officer) and that body corporate or a related body corporate; or (ii) his being an officer of a substantial shareholder in that body corporate or in a related body corporate. (10) This section does not preclude the holder of a brokers or dealers licence from dealing in securities, or rights or interests in securities, of a body corporate, being securities or rights or interests that are permitted by a securities exchange to be traded on the stock market of that securities exchange, if (a) the holder of the licence enters into the transaction concerned as agent for another person pursuant to a specific instruction by that other person to effect that transaction; (b) the holder of the licence has not given any advice to the other person in relation to dealing in securities, or rights or interests in securities, of that body corporate that are included in the same class as the first-mentioned securities; and (c) the other person is not associated with the holder of the licence. (11) For the purpose of subsection (8), officer, in relation to a body corporate,

(9)

includes (a) (b) (c) (d) (e) a director, secretary, executive officer of employee of the body corporate; a receiver, or receiver and manager, of property of the body corporate; an official manager or a deputy official manager of the body corporate; a liquidator of the body corporate; and a trustee or other person administering a compromise or arrangement made between the body corporate and another person or other persons.

(12) A person who contravenes this section shall be guilty of an offence and shall be liable (a) on a first conviction (i) in the case of a person being a body corporate, to a fine not exceeding one million and five hundred thousand shillings; (ii) in the case of any other person, including a director or officer of a body corporate, to a fine not exceeding five hundred thousand shillings or to imprisonment for a term not exceeding five years or to both;

(b) on any subsequent conviction (i) in the case of a person being a body corporate, to a fine not exceeding three million shillings; or (ii) in the case of any other person, including a director or officer of a body corporate, to a fine not exceeding one million shillings or to imprisonment for a term not exceeding seven years or to both. (13) An action under this section for the recovery of a loss shall not be commenced after the expiration of six years after the date of completion of the transaction in which the loss occurred. (14) Nothing in subsection (12) affects any liability that a person may incur under any other section of this Act or any other law.

CENTRAL DEPOSITORY SYSTEM

A central depository system (CDS) is for securities what a bank is for cash. In its simplest form, a CDS is a computerised ledger system that enables the holding and transfer of securities without the need for physical movement. Hence, ownership of a security would be via book entry, rather than by physical exchange. A simple example best demonstrates how a CDS operates. Company X issues some shares, which are subscribed by party A and party B. Rather than the shares being delivered to A and B, Company X delivers the shares to the CDS, who holds those shares in safe custody for A and B. If A decides to sell to B, then in non-CDS environment, A would deliver the shares to B in exchange for payments via a broker. A manual registration process would then follow this. However, with the CDS, the shares would remain in safe custody with a book entry debit to As account and a credit to Bs account. Simultaneously, B will pay A. Thus the CDS plays an important role in bringing together issuers (e.g. corporates), investors (e.g. institutions), intermediaries (e.g. brokers) and interested third parties (e.g. regulators).

In order to understand the CDS infrastructure, three areas need to be distinguished. (i) Corporate Framework The CDS will be a separate legal entity to be incorporated and licensed in Kenya to provide central clearing, settlement and depository services for securities held in electronic form. It will be licensed under a law defining all the powers, duties and responsibilities of the company.

(ii) Management The importance of the CDS to the broader objective of capital market development and the fact that the CDS is a start-up Project implies that the quality of the management team will be a critical element of success for the Project. (iii) Functional Structure The CDS will replace many of the manual paper based procedures that currently exist. For example, it will replace the manual trade settlement process currently in place at the NSE and will replace some of the existing manual corporate actions (e.g. dividend distribution, distribution of rights etc.)

5.1 FUNCTIONS OF A CENTRAL DEPOSITORY SYSTEM The typical functions of a CDS are: i) Immobilization of securities: This means the storage of securities certificates in a vault in order to eliminate physical movement. The objective is to minimize physical movement of securities where complete elimination of physical movements is not achievable. Dematerialised Securities which means the elimination of physical certificates or documents of title, so that those securities exist only as computer records. ii) Providing book entry accounts: this means an accounting system for securities and cash, which electronically facilitates the exchange of ownership of securities and the movement of cash. Thus, the securities move between parties without the need for movement of physical documents. The cash moves with aid of cash clearing mechanisms. iii) Delivery Versus Payment (DVP) or Effective DVP: this means that the exchange of securities and cash payment between counter parties in a transaction occurs simultaneously. In an environment where DVP is possible, cash settlement and beneficial ownership can be transferred intra-day. This requires an electronic link between the CDS and the national central payment system. In Kenya, it is likely that settlement will be on an effective DVP basis. This is whereby the cash settlement element is transferred into the Kenyan banking system. iv) Distribution of dividend, interest and redemption monies, handling of corporate actions, notably rights and bonus issues. 5.2 WHY IS CDS A GOOD IDEA? The introduction of the CDS service will serve several goals. When implementing the

goals, many new business standards will be introduced to the Kenyan capital markets, all of which will have a significant benefit to the domestic and international attractiveness of the markets. These business development goals and associated benefits are described below. 1. Achieve electronic straight through processing and eliminate outdated certificate processes The immediate goal of CDS is to implement a complete end-to-end electronic clearing, settlement and central depository service for immobilized (and ultimately dematerialised) securities. This means all back office securities processing transaction will be undertaken through electronic means. The only exception being company secretarial matters. The ability to achieve straight through processing (STP) for pre-settlement, settlement and post-settlement transactions means all transactions will be captured electronically and wherever possible will be automated. Thus achieving electronic processing of the pre-settlement, settlement and post-settlement ranges of transactions means lower transaction, settlement and market risk. Electronic STP avoids many of the problems and risks associated with the legacy process as encapsulated in the current certificated environment (which are from the bygone era of the old UK style 1948 Companies Act). For example, currently settlement problems can prevent an investor re-selling securities due to settlement and re-registration delays. If a stock goes down in price in the meantime, then the manual processes that are in existence today can prove to create a significant opportunity cost for the investor. An inability to liquidate a position due to re-certification problems is potentially very costly. The CDS should lower transaction costs by lowering both risk and opportunity costs. 2. Immobilize all traded securities Initially, the majority of securities handled by the CDS will be equities already listed on the NSE. However, the proposed CDS legislation has been carefully prepared to allow the sponsors and users of the CDS to provide CDS services for other types of securities. There are three benefits arising from this flexibility: i) An opportunity exists to immobilize securities traded on another exchange especially regionally by capturing cross-border immobilization of securities, improve liquidity of the local market. An opportunity exists to immobilize impeding privatisation securities this will result in cost efficiencies for issuers and investors. CDS has the opportunity to immobilize and provide book entry transfer settlement services for government bonds and treasury bills simplifies the settlement process in the market. It should be noted that the Central Bank of Kenya (CBK) has recently established its own CDS for the immobilisation of government bonds and treasury bills. Once the CDS has been established, CBK may use this for settling and clearing.

ii) iii)

3. Implementing a CDS will assist national economic development and progress At the heart of the CDS service will be a high performance central messageprocessing engine for NSE securities. The engine is the central CDS system. All back office transactions will be processed across this engine in the form of messages and no longer by moving paper/certificates and transfer forms. Access to the CDS settlement engine will be across a secure network with relevant levels of cryptographic protection between central system and its users. Cryptographic security means the digital security of electronic messages. This means that every time a participant decides to transmit a message on an immobilized security, the cryptography will ensure that the messages meet certain security standards for example non-repudiation. The benefit of this will be that no user will be able to deny that the message was sent from their gateway and similarly any attempts to interfere in the process of message transmission will be prevented and detected. This electronic packaging or enveloping of messages will significantly improve the quality of security transfers, transaction movements and in practice is infinitely more secure than the certificate equivalents that exist in Kenya today. A potentially wide range of products can be built on the CDS solution and assuming these are factored into the solution that is ultimately selected. The CDS infrastructure can be used in subsequent phases to implement other message driven services. Examples of such services would include credit cards and loan approval information. 4. Ensure CDS operates within modern, fair, transparent and secure rules Surrounding the CDS technology and procedures will be a comprehensive of CDS rules within which participants will operate. These rules will provide for improved depositor and user protection suitable for a range of electronic commerce transactions. These laws and rules will introduce a range of new standards to Kenya migrating the Kenyan capital markets from a legal infrastructure that was previously developed in the late 1940s. Once Kenya passes the laws and rules for the CDS, it will embrace a set of concepts that are more relevant to the next millennium. At the simplest level, the electronic message has a greater business benefit in law when compared to the certificate under the current law, a holder of a certificate has only prima facie evidence of ownership. An investor who has an electronic record within a secure CDS account (and is therefore recorded on the list of depositors) is however deemed to be a member/shareholder of the company. The benefit of this deeming principle is that the investor will receive dividends more quickly, settlement will be real time and therefore portfolio turnover and therefore liquidity can improve. In addition, the deeming provision will remove the huge wasted effort in broker back officers, at the NSE and at registrars, chasing overdue settlements, claims on corporate actions, record cut off problems and the like. Therefore, in the immediate term, as soon as CDS is implemented and the law

enacted, it will reduce the evidence of ownership risk associated with certificate holdings. Over the longer term, the presence of the CDS will add significant and much needed infrastructure developments to the Kenyan banking and commercial community which will expedite the time to market for future electronic settlement developments. The infrastructure will not only improve the efficiency of local commercial transactions, but they will curtail the threats of settlement dis-intermediation whilst attracting additional business to Kenya. The benefits associated with the business development goals and other benefits to Kenya of the CDS can be summarised in the context of the benefits accruing to the key market participants, as summarised in the table below: Interested Party Benefits

1. Economy/Government

1 Improvements of the infrastructure supporting the capital markets will attract more foreign portfolio investment, as this will mean, at a minimum reduced settlement time and counterpart/settlement risk 2 Potentially greater mobilized domestic savings. Significantly improve liquidity of the capital markets 3 Lower the cost of capital as a result of improved liquidity 4 Reduces the systemic risk arising from current clearing and settlement processes 5 Improves the transparency of the market 6 Reduction in the instance of fraud as a result of immobilized securities 7 Establishment of the infrastructure, ensures that any types of securities that may be introduced such as option, can be cleared safely 8 Greater market turnover due to improved liquidity. Lowers transaction costs 9 Reduction of settlement risk with introduction of DVP or effective DVP 10 Improves transparency of the markets 11 Faster settlement with associated reduction in funding costs 12 Lower cost of clearing/transfers through reduced paper work and labour intensive activities 13 Improved liquidity as cash flows will be more accurately known and as a result of greater stock turnover 14 Elimination of financial loss due to misplacement, forgery or loss of scrip and reduces the evidence of ownership risk 15 Improves back office efficiency through standardized procedures and controls (with CDs, brokers, registrars and investors) 16 Improved and timely communication from the issuer to the investor, includes reduced delay in receiving benefits and rights and improved information dissemination of company meeting 17 Transparency ensures improved investment decisions

2. CMA and NSE

3. Investors (Institutions, market professionals and private investors

It may be necessary to consult the provisions of the Act to see how it facilitates its operation.

REINFORCING QUESTIONS
1. 2. "A company must take great care when issuing share certificates". Discuss this statement. G. presents to H. Ltd a valid document transferring 250 shares into his name. By mistake H. Ltd issues him with a certificate for 2,500 shares. What are the consequences for H. Ltd?

Check your answers with those given in Lesson 9 of the Study Pack.

LESSON 9
REVISION AID
INDEX
1. 2. KASNEB SYLLABUS MODEL ANSWERS TO REINFORCEMENT QUESTIONS
Lesson 1 Lesson 2 Lesson 3 Lesson 4 Lesson 5 Lesson 6 Lesson 7 Lesson 8

3. 4. 5.

SELECTED CPA PAST PAPERS ANSWERS TO PAST PAPERS MOCK EXAMINATION PAPER

NOTE: ALL MODEL ANSWERS HAVE BEEN PROVIDED BY THE STAFF OF THE DISTANCE LEARNING CENTRE.

KASNEB SYLLABUS
OBJECTIVE
To examine candidates understanding of the legal principles relating to the nature and registration of companies. The ability to describe the various classes of companies and define the nature and contents of the Memorandum and Articles of Association. To appreciate the legal principles that govern the raising of capital for companies and to understand the principles relating to accounts, auditors and payment of dividends.

CONTENT
Nature and Classification of Registered Companies
1 2 3 4 5 6 7 8 9 10 Definition of a company Procedure for registration of a company Certificate of Incorporation Effect of Registration Registered companies and partnerships contrasted Companies limited by shares Companies Limited by guarantee Unlimited companies Public and Private companies Holding and subsidiary companies

Memorandum and Articles of Association and Promoters of Companies

1 2 3 4 5 6 7 Clauses in the memorandum of association (name, registered office, objects, liability, share capital and other clauses) Alteration of the memorandum of association Form of articles Adoption and application of Table A Effect of the registration of the articles Alteration of articles Promoters: meaning of the term Promoter; position and duties of promoters; payment for promotion services; pre-incorporation contracts

Share Capital
1 2 3 4 5 6 7 8 9 10 11 12 13 14 Meaning of capital Types of capital Raising of share capital Public offer of shares (Direct invitation, offers for sale, placings) Misrepresentation and omissions in listing particulars or prospectus Commissions and discounts Underwriting and brokerage Allotments of shares Commencement of business Issue of shares at Discount and at Premium Share Premium Account and issue other than for cash Alteration of share capital Maintenance and reduction of capital The acquisition and redemption by a company of its own shares; general rules relating to

acquisitions; redemption and purchases of shares; redemption or purchase of shares out of capital 15 Financial assistance by a company for purchase of its own shares: liability of the company; exceptions to the rule; legal significance to the lender

Membership Shares and Majority Rule

Ways of becoming a member Who has become a member Register of members Disclosure of substantial holdings Classes of shares Share certificate Transfer and transmission of shares Mortgage of shares Calls and liens on shares Forfeiture and surrender of shares Share warrant Valuation of shares Majority Rule and Minority Protection: The Rule of Foss vs Harbottle; Protection of minority; Winding up by the court on the just and equitable ground; Investigations and powers to obtain information Investor protection; Insider dealing (Capital Markets Authority Act Cap. 485A) Central Depository System

Meetings
Kinds of general meetings Notices of meetings Proceedings at meetings Proxies Resolutions

Directors, Secretaries and Auditors

Number and appointment of directors Persons who cannot become directors Share qualification of directors Register of directors and secretaries Particulars of directors and secretaries Disclosure of directors shareholdings Directors service contracts Powers and duties of directors Vacation of office by directors Remuneration of directors Loans to directors Compensation to directors for loss of office Directors and insolvency Transaction involving directors; the rule in Turquands case Directors powers and shareholders control Qualification: Certified Public Secretaries Act (Cap. 534) Appointment: Companies Act

Powers and duties Accounts, Audit and Auditors: Books of account; Laying the Accounts before the company in general meeting and filing them with the Registrar; The annual accounts; Group accounts; Directors report; Auditors report; Appointment of Auditors; Qualification of Auditors; Vacation of office by Auditors; Remuneration of Auditors; Powers and duties of Auditors

MODEL ANSWERS TO REINFORCEMENT QUESTIONS

LESSON 1
ANSWER ONE
The initial steps that must be taken by promoters who are desirous of forming a private company limited by shares is the preparation of a document called the Memorandum of Association to which at least two of them will subscribe their names pursuant to Section 4 of the Companies Act. The Memorandum of Association must state: (i) The name of the proposed company, with "Limited" as the last word thereof since the proposed company is to be limited by shares.

(ii) That the registered office of the company is to be situate in Kenya. (iii) That the liability of the company's members is limited. (iv) The objects of the company. (v) The amount of capital with which the proposed company will be registered and the division thereof into shares of a fixed amount. The Memorandum of Association must also contain a declaration by the promoters that they are desirous of being formed into a company pursuant thereto. The second step that the promoters must take is the preparation of the following documents: 1. ARTICLES OF ASSOCIATION This document will contain the regulations for the company's management. In the instant case it is not mandatory for the promoters to prepare it since their proposed company is to be limited by shares and can therefore adopt the provisions of Table A, Part I as modified by Part II thereof. THE STATUTORY DECLARATION OF COMPLIANCE (FORM NO. 208) This document is obtainable from the companies registry and having been obtained, must have the prescribed information filled or inserted therein so as to constitute it a declaration by an advocate engaged in the formation of the company (or a person named in the articles as a director or secretary of the company) that all the requirements of the Companies Act for the companys registration have been complied with. STATEMENT OF NOMINAL SHARE CAPITAL The promoters must obtain from the Companies registry a document called Statement of Nominal Share Capital and insert therein the prescribed information about the proposed share capital of the company. This is done for purposes of computing the stamp duty payable on the companys formation. The final step that the promoters must take is the delivery of the above documents to the registrar of companies. If the documents are prepared in accordance with the provisions of the Companies Act they

2.

3.

will be registered and the Registrar will issue the companys certificate of incorporation. The company will come into existence from the date written in the Certificate of Incorporation.

ANSWER TWO
I would explain to Otieno and his friends that the major contents of a Memorandum of Association are prescribed in Section 5 of the Companies Act which requires the memorandum to state: 1. The name of the company, with "LIMITED" as the last word thereof if the proposed company is to be registered with limited liability on the part of its members. This requirement anticipates the eventual birth of the proposed company as a distinct legal entity which must have a name of its own. Professor Cower has stated that the mystic word "LIMITED" at the end of the company's name is intended to act as a red flag warning the public of the dangers which they ran if they have dealings with a limited company. 2. That the registered office of the proposed company will be situate in Kenya. The purpose of this statement is to facilitate the identification of the company's domicile, primarily for taxation purposes. The objects of the proposed company. I will tell Otieno and his friends that in the case of COTMAN v. BROUGHAM, the court explained that the statement of the objects is intended to serve the following purposes: (i) To enable a company's members know the purpose to which their money invested in the company could be applied; and

3.

(ii) To protect company's potential creditors whom the law assumes will read the registered memorandum and be able to infer from the stated objects the extent of the company's powers. I would also explain to Otieno and his friends that their proposed company shall not have power to transact any business that is neither expressly nor impliedly within the stated objects. Any attempt to enter into such contracts would be ultra vires and illegal: ASHBURY RAIL CO. v. RICHE. 4. If the proposed company is to be registered with limited liability on the part of its members, the memorandum shall contain: (i) A statement that the liability of the members is limited and, if limited by guarantee, the maximum amount of money which each member can be expected to pay during the company's liquidation; and

(ii) A statement of the amount of share capital which the proposed company will be expected to raise after its incorporation, and the division thereof into shares of a fixed amount. I will explain to Otieno and his friends that, in the case of OOREGUM GOLD MINING CO.

LTD. v. ROPER, the judge stated that a companys capital "is fixed and certain, and every creditor of the company is entitled to look to that capital as his security". The statement of the company's authorised share capital is, therefore, an indication to the company's potential creditors of the potential maximum assets of the company which would constitute the security for any credit to the company.

LESSON 2
ANSWER 1
(a) The advice that I would give my clients regarding the problems they are likely to encounter if they wish to bring further members into the company would be as follows: Availability of further shares They would not be in a position to bring further members into the company if no further shares are available for issue to the proposed members. The proposed company, being limited by shares, would have its capita divided into a number of shares of a fixed amount. Once those shares are issued there would be no more shares to be issued, unless the company in general meeting passed an ordinary resolution altering its capita pursuant to s.63 of the Act by increasing its share capita by new shares of such nominal value as is thought to be expedient. (b) Transfer of shares As a general rule, a member's shares in the company are items of property which he is legally entitled to dispose of at any time and to whoever he pleases. Consequently, he cannot be stopped from doing so unless the company's articles are suitably worded in order to confer on the director's power to refuse to register a proposed transfer of shares unless the consent of the rest of the members to the proposed transfer has been obtained. The restrictions would be within the principle enunciated by the court in Re: Smith & Fawcett Ltd that a shareholder's right to transfer his shares is not an absolute right, and that it can be restricted by articles which are clearly drafted to confer the restrictions on transfer. The shareholder would then be bound by the provisions of the articles, as illustrated by Lyle & Scott Ltd v Scott's Trustees. (c) Finance and membership (i) Finances

The Companies Act requires every company having a share capital to annex to its annual return to the registrar of companies a statement of its share capita and debentures, a copy of every balance sheet and profit and loss account laid before the company in general meeting during the accounting period to which the return relates, as well as the director's report and a copy of the auditor's report. These documents are available at the company's registry for public inspection, and the company's finances will become public knowledge to the extent that the documents reveal them. (ii) Membership S.112 of the Act requires every company to keep a register of its members. S.115(1) of the

Act provides that the register shall be open to the inspection of any members without charge and of any other person on payment of two shillings, or such less sum as the company may prescribe for each inspection. (d) It will not be possible for an outsider to sue a member for recovery of money owed to him by the company. This was explained in Salomon v Salomon & Co. Ltd and is the general rule. However, it would be possible for the outsider to sue a member under s.33 of the Act if the company's membership had fallen below the statutory minimum and the company continued to trade thereafter for a period exceeding six months. A member who was cognizant of the membership having so fallen would be personally liable for the debts of the company contracted after the six months and could be sued personally to recover the said debts

ANSWER 2
The remedies available to Mwangi will depend on whether the untrue statement was an innocent or fraudulent misrepresentation, as was defined by the House of Lords in the case of Derry v. Peek. A. A. If it was an innocent misrepresentation, i.e. it was made without any desire to mislead Mwangi and the maker believed it to be true, as explained in Derry v. Peek, then:1. AGAINST THE MAKAA CO. LTD (a) No damages can be awarded: DERRY v. PEEK. (b) Mwangi may be able to rescind the contract of allotment and recover his money. However, he will not be able to rescind if:(i) He has affirmed the contract after discovering the truth, e.g. by accepting dividends, attending or voting at any of the company's meetings or attempting to sell the shares.

(ii) Third parties have acquired rights to the shares in the meantime. (iii) The company has gone into liquidation: HOULDSWORTH v. CITY of GLASGOW BANK (iv) He has delayed in taking rectification proceedings after discovering the truth: RE: FIRST NATIONAL RE-INSURANCE CO. GREENFIELD 2. AGAINST THE DIRECTORS AND PROMOTERS OF MAKAA CO. LTD. Mwangi may institute an action for compensation under s.45(1) of the Companies Act. The directors and promoters are prima facie liable to him unless they can avail themselves of the defenses listed in Section 45(2) of the Companies Act. They will be liable though the statement was innocently made if it is proved that they had no reasonable grounds to believe that the untrue statement was true. B. If the untrue statement was a fraudulent misrepresentation, that is, it was made knowingly, recklessly or without belief in its truth (DERRY v PEEK) then Mwangi may have the following remedies:-

1.

AGAINST THE MAKAA CO. LTD. He may institute an action for damages against the company provided that he is in a position to rescind the contract of allotment: HOULDSWORTH v CITY OF GLASGOW BANK.

2.

AGAINST THE DIRECTORS AND PROMOTERS OF MAI(AA CO. LTD He may institute an action for compensation as indicated in A(2) above. The defendants are prima facie liable to him unless they successfully plead the defenses under Section 45(2) of the Companies Act.

LESSON 3
ANSWER 1
A share certificate is a document issued by a company and which states the name of a shareholder in the company, the number and description of the shares held by him and the amount paid on the shares. It has been judicially described as "a declaration by the company to al the world that the person in whose name the certificate is made out and to whom it is given is a shareholder of the company ..... with the intention that it shall be acted upon in the sale and transfer of shares". Re: Bahia & San Francisco Railway Co. A company must therefore take great care when issuing share certificates so as to avoid stating therein what is incorrect. If a company negligently issues a certificate that is incorrect in some material particulars it may be estopped from denying the correctness of the stated facts if a third party bought the shares in reliance thereon. This may be illustrated by:(i) Re: Bahia & San Francisco Railway Co. in which the company was estopped from denying the title of the person who had been named in the certificate as the registered holder of the specified shares. (ii) Burkinshaw v. Nicolls in which the company was estopped from denying that the specified shares had been fully paid as stated in the certificate.

ANSWER 2
The legal consequences for H. Ltd. will depend on whether G. has transferred the shares to a bona fide purchaser who had no notice of the company's mistake. (i) If G. has not transferred the shares, the company would be entitled to ask him to surrender the certificate for cancellation in order that a new certificate for 250 shares may be issued to him. This is because s.83 of the Companies Act provides that, between the company and G., the certificate is merely a prima facie evidence of his title. This means that G may be called upon to prove that he holds 2,500 shares in the company as stated in the certificate and if he fails to do so the company can cancel the certificate and issue a new one for 250 shares. G cannot plead estoppel against the company because he knew the true facts and was not prejudiced by the misstatement.

(ii) If G. has transferred the shares, H. Ltd. will be estopped from denying that he held 2,500

shares. The company will therefore be compelled to compensate the purchaser by paying him the amount which he paid to G. for the 2,250 non-existent shares or buying other 2,250 shares in the market in order to register them in his name: Re: Bahia & San Fransisco Railway Co.; Sheffield Corporation v. Barclay.

LESSON 4
ANSWER 1
The remedies which are available to an ultra.vires lender were explained by Buckley, J in Re: Birkbeck Permanent Benefit Building Society as follows: i. If the result of the transaction is that the indebtedness of the borrowing company is not increased because the new loan was used to discharge an old debt, the ultra vires lender would be treated as standing in the place of those intra vires creditors whose debts have been paid off. In such a case the ultra vires loan is not regarded as a loan. If the result of the transaction is that the indebtedness of the borrowing company is not increased because the new loan was used to discharge a future debt (i.e. an indebtedness which was incurred after the money was borrowed), the ultra vires lenders would again be treated as standing in the place of those intra vires creditors whose debts have been paid off. The basis of this remedy is that, since the company could legally become indebted in respect of the future debt, the lender whose money discharged it would be subrogated to the rights of the discharged creditor. However, he would be entitled to rank as a creditor of the company only to the extent to which his money was applied in discharging the intra vires debt(s). He would also not obtain the benefit of any security which had been given to the intra vires creditor. He would however be entitled to enforce any security which was given to him. iii. If the ultra vires lender can identify his money or the investment of his money in the hands of the borrowing company, he can call for its return. This is because "a company or other statutory association cannot by itself or through an agent be party to an ultra vires act. If its directors or agents affecting to act on its behaf borrow money which it has no power to borrow, the money is in their hands the propersy of the lender": Sinclair v Brougham (per Lord Parks). An ultra vires lender who cannot avail himself of one of the aforesaid remedies would be entitled to participate in the division of the company's surplus assets, if any, which would be divisible among the ultra vires creditors rateably during the company's liquidation after all the company's members have received back their capita in full.

ii.

ANSWER 2
1. APPOINTMENT OF DIRECTORS The appointment of a company's directors is governed by the provisions of the company's articles of association. In the absence of such provisions the provisions of Table A be as follows: Table A, Articles 75 provides that the number of the directors and the names of the first directors shal be determined in writing by the subscribers of the memorandum of association, or a majority of them. The signatories to the memorandum of association shall be the first directors unless and until they appoint the first directors. Article 89 provides that at the first annual general meeting of the company al the first

directors shall retire from office. This is to enable the members of the company to elect directors of their choice. At the annual general meeting in every subsequent years one-third of the directors for the time being, or, if their number is not three or a multiple of three, then the numbers nearest one-third, shall retire from office. The directors to retire in every year shall be those who have been longest in office since their last election, but as between persons who became directors on the same day those to retire shall (unless they otherwise agree among themselves) be determined by lot. Article 91 provides that a retiring director shall be eligible for re-election. By Article 92, the company at the meeting at which a director retires may fill the vacated office by electing a person thereto. In default of such election the retiring director shall if offering himself for re-election be deemed to have been re-elected, unless at such meeting it is expressly resolved not to fill such vacated office or unless a resolution for the re-election of such director shall have been put to the meeting and lost. Article 93 provides that no person other than a director retiring at the meeting shall, unless recommended by the directors, be eligible for election to the office of director at any general meeting unless not less than three nor more than twenty-one days before the date appointed for the meeting there shall have been left at the registered office of the company notice in writing signed by a member duly qualified to attend and vote at the meeting for which such notice is given, of his intention to propose such person for election, and also notice in writing signed by that person of his willingness to be elected. Article 94 empowers the company from time to time by ordinary resolution to increase or reduce the number of directors and to determine in what rotation the increased or reduced number is to go out of office. Article 95 empowers the directors at any time, and from time to time, to appoint any person to be a director either to fill a casual vacancy or as an addition to the existing directors provided that the total numbers of directors does not at any time exceed the total number of directors fixed by the general meeting. 2. DISQUALIFICATION OF DIRECTORS The circumstances in which a director may be disqualified from holding office of director are, in the absence of other provisions in the company's articles, governed by Table A, Article 88 and are as follows: i. The director fails to obtain the share qualification (if any) within two months, or within two months, or within the shorter period prescribed by the company's articles of association. This provision incorporates Section 183(3) of the Companies Act. The director attained the age of seventy. This provision incorporates the provisions of Section 186(2). This provision only applies to directors of a public company.

ii.

iii. The director becomes bankrupt or makes any arrangement or composition with his creditors generally. iv. The director becomes of unsound mind.

3.

REMOVAL OF DIRECTORS Section 185(1) of the Companies Act provides that a company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in its articles or in any agreement between it and him.

ANSWER 3
(a) Since there was no clause in the memorandum of association regarding the paper manufacturing business, the company had no expressed power to undertake the business: ASHBURY RAIL CO. v. RICHE - where it was stated that a transaction which is beyond a company's objects in the memorandum is beyond the company's powers and illegal. Although the company had no express power to undertake the paper manufacturing business it does not necessarily mean that the business was ultra vires the company. It could be impliedly authorised by the memorandum within the principles enunciated by the House of Lords in A.G v. G.E. Rly Co. and other relevant cases. If it was incidental to, or consequential upon the company's objects and was done to effectuate them. If so, the legal position would be as follows:(i) If the manufacture of the paper was reasonable incidental to the stated objects and was undertaken to effectuate them, the company had implied power to undertake it. The borrowing would be valid and security enforceable: A.G. v. G.E. Rly Co.

(ii) If the manufacture of the paper was NOT reasonably incidental to the stated objects, the company had no implied power to undertake the business and, since it also had no express power to carry on the business, the transaction would be illegal and void. The security given would also be void and unenforceable: RE INTRODUCTIONS LTD. (b) If the ordinary resolution was not passed by the members, the transaction would be intra vires, the company and its borrowing valid and binding on the company notwithstanding the director's lack of authority to undertake it. The passing of an ordinary resolution was, according to ROYAL BRITISH BANK v. TURQUAND, an "indoor management" condition which the lender was entitled to assume that the directors had complied with. The security given is valid and enforceable against the company. (c) The passing of a special resolution is not an "indoor management" requirement but an essential condition which "A" Ltd. was bound to check whether it had been complied with. If the resolution had been passed it would have been delivered for registration under S.143 of the Companies Act and a copy thereof would have been available for "A" Ltd. to verify. A Ltd. is therefore presumed, under the constructive notice rule, to have been aware that the resolution had not been passed. B Ltd. is therefore only liable to the extent of Shs.100,000 which is the amount which the directors were authorised to borrow without a special resolution: IRVINE v. UNION BANK OF AUSTRALIA.

LESSON 5
ANSWER 1
In Sharp v. Dawes the judge stated that prima facie, the word "meeting" means "a coming together of more than one person". There is therefore, legally, no meeting if only one person attends a proposed meeting, or if all persons who attended the meeting leave and only one person is left. The above rule will not apply if: (a) The meeting is an annual general meeting which is held pursuant to s.131(2) of the Act. The said section provides that if default is made in holding the annual general meeting of a company in accordance with s.131(1) the registrar may, on the application of any member of the company, call or direct the calling of a general meeting of the company and give such ancillary or consequential directions as the registrar thinks expedient. The directions which the registrar may give include "a direction that one member of the company present in person or by proxy shall be deemed to constitute a meeting". (b) The meeting is held pursuant to s.135(1) of the Act. The section provides that if for any reason it is impracticable to call a meeting of a company in any manner in which meetings of that company may be called, or to conduct the meeting of the company in manner prescribed by the article or the Act, the court may, either of its own motion or on the application of any director of the company or of any member of the company who would be entitled to vote at the meeting, order a meeting of the company to be called, held and conducted in such manner as the court thinks fit. Where any such order is made the court may give such ancillary or consequential directions as it thinks expedient, including a direction that "one member of the company present in person or proxy shall be deemed to constitute a meeting". The power of the court in this regard was exercised in the leading case of Re: El Sombrero Ltd. (c) If the meeting is a class meeting which is held to authorize a variation of some right(s) attached to a class of shares and it happens that all the shares of that class are held by one person. Such a person would constitute a meeting for purposes of giving the requisite authority to vary the relevant rights. This was explained in East v Bennett Brothers Ltd. (d) The meeting is an adjourned meeting and the articles provide that "a member or members present shall be deemed to constitute a quorum".

ANSWER 2
a. The legal principle in the case of Salomon v Salomon & Co. Ltd. is that: " the company is at law a different person altogether from the subscriber to the Memorandum" (per Lord Macnaghten). It has rights and liabilities or obligations of its own which are distinct or separate from those of its members. The exception to the principle in Salomon v Salomon & Co. Ltd. are the instances in which "the veil of incorporation is said to be lifted and this may occur under the provisions of the Companies Act or judicial interpretation".

1.

Lifting of the veil under the Companies Act. This will occur in the following instances: i. When a member or members are made personally liable for the company's debts incurred after six months of a company's trading with less than the statutory minimum membership. The debts are paid by the members as if they were his/their debts, contrary to the decision in Salomon v Salomon, in which Salomon, a member, was held not liable for the company's debts. When a company's officer or agent is made personally liable for the company's debts incurred at a time when the identity of the company was not made known to the other party by the failure to publicise the company's name as required by the Act.

ii.

iii. When the accounts of a holding company are combined with those of its subsidiaries to form group accounts, as if the holding company and its subsidiary were one entity. iv. When an inspector is appointed to investigate a company's affairs also investigates of any other related company as if the two companies were one entity. v. When an inspector appointed to investigate a company's membership also investigates the membership of any other related company as if the two companies were one entity.

vi. When the courts regard a take over bid made by a company as being in substance made by the company's members, as is illustrated by the case of RE: BUGLE PRESS LTD. vii. When misfeance proceedings are instituted during a company's winding up against persons who were responsible for conducting the company's trading affairs fraudulently. 2. Lifting the veil under judicial interpretation The veil of incorporation have been lifted but he courts in the following instances: i. When an wholly owned subsidiary company carrying on the holding company's business was held in Smith, Stones & Knight v Birmingham Corporation to be the agent of the latter. This decision was an exception to the principle stated in Salomon's case that a company is not the agent of the subscribers. When the residence of the majority shareholder(s) who is controlling the company's affairs is held for purposes of taxation to be the residence of the company also, as if the company and the shareholder(s) were one person. This may also govern enemy status or subjection to the jurisdiction of Kenya Courts (Daimler v. Continental Tyre Co. Ltd.).

ii.

iii. When an informal decision of a company's members is also regarded as the decision of the company authorising payment of director's remuneration: RE: DUOMATIC LTD iv. When a breach of contract by a member was regarded in Jones v. Lipman as a breach of contract by the company and specific performance decreed against both the company and member. v. When a company was held to be an enemy on the ground of PUBLIC POLICY because its members were Germans and legally enemies of England during the Second World War: Daimler Ltd v Continental Tyre Co. Ltd.

vi. When a vehicle belonging to a Mutual Benefit Society Incorporated as a company was said to belong to its members to whom the coal was being delivered in the vehicle: Trebanog Working Men's Club v Macdonald. The Society was therefore NOT liable for presentation for a quasi-coime of contravening the terms of the vehicle's license. viii. When an employee of a holding company (Mr. Caddies) was also declared to be an employee of a subsidiary company to which his services had been transferred against his will: Houdsworth Co. v Caddies. b. i. ADVICE TO CLIPSE LTD.: The material facts of the case are substantially the same as the material facts of Gildford Motors Co. v Horne in which the veil was lifted and the defendant Horne and the company he had formed were restrained from soliciting the plaintiff's customers in breach of a clause in this contract of employment. I would advise Clipse Ltd. to sue Walter and Desks Ltd. The company would be regarded as Walter's "alter ego" and restrained from committing a breach of the contract between Walter and Clipse Ltd. ii. ADVICE TO WILF: I would advice Wilf to sue Walter for breach of contract and ask the court to decree specific performance against Walter and Desks Ltd. My advice would be based on Lipman v Jones case whose material facts are substantially the same as the given facts. The court would regard Walter and Desks Ltd. as one person and order the company to transfer the house to Wilf. The court would not allow Walter to evade a contractual obligation by incorporating a company for that purpose.

LESSON 6
ANSWER 1
(a) The Companies Act requires every company to appoint an auditor, who must normally be a member of a recognized professional accountancy body. The auditor must report to the members on the accounts examined by him, on every balance sheet and profit and loss account, and, where applicable, on group accounts. He should exercise reasonable care in discharging them: RE CROWN BANK. The primary duty of the auditor is to carry out such investigations as will enable him to form an opinion that the accounts have been properly prepared, and to state whether the accounts give a true and fair view. According to case law, the auditor is not expected to be suspicious but reasonably careful. However, if his suspicion is aroused then he must investigate the matter exhaustively, i.e. he must "go to the bottom". The auditor, in the course of his work, must comply with the auditing procedures which have been recommended by the Institute of Certified and Public Accountants of Kenya. His failure to do so would be prima facie evidence of negligence and, hence, a breach of his duty to the company. (b) Duties to prospective investors The duties of the auditor to prospective investors have not been fully explained by the courts, either in Kenya or England. However, it is generally believed that an auditor owes a wider duty of care whenever there is a `special relationship' between him and other persons who rely on the accuracy of his work. This belief is based on inferences from the House of Lords decision in Hedley Byrne & Co. Ltd v Heller & Partners Ltd. The auditor might also be liable in negligence to third parties whom he was aware would rely on his report in making a decision on whether to invest money in the company. It is submitted that such liability would be in negligence under the "neighbour principle" in Donoghue v Stevenson.

ANSWER 2
a. The advantages and disadvantages that a company enjoys in securing its debentures by way of a floating charge are: i. It enables the company to create a charge over assets over which the company would find it impracticable to create a fixed charge, i.e. assets which are constantly changing in the course of business. The company is allowed to deal with the assets charged in the course of its business as if they had not been charged. Accordingly, the company can dispose of the assets and in doing so free them from the charge; and incoming after-acquired assets will equally be subject to it.

ii.

b.

The general rule as to priorities between fixed and floating charges is that a later fixed charge will take priority over an earlier floating charge, because of floating charge does not attach to specific property until it crystallizes. As between themselves, floating charges rank in order of creation except that a general

c.

floating charge on the whole undertaking may be deferred to a subsequent specific floating charge on a particular class of assets: RE AUTOMATIC BOTTLE MAKERS A floating charge crystallizes when some default occurs and the debenture holder takes steps to enforce his security-usually by appointing a receiver or by seeking an appointment by the court. Default occursi. In the circumstances specified in the debentures or the debenture trust deed for example, when the company fails to pay the principal or interest as they fall due, or when the company ceases trading. On winding-up. This event will normally be specified in the debenture or trust-deed as one which allows the lenders to appoint a receiver. It differs from (i) above in that the charge automatically crystallises on winding-up, even if the debenture holders have taken no steps to enforce their security.

ii.

d.

The provisions which ought to be included in a debenture trust deed for the benefit of a creditor that is to lend money to a company, on the security of a floating charge is a clause to the effect that the company shall not create a subsequent fixed charge over the same class of assets within the floating charge. If the holder of a later fixed charge takes within notice of such restriction he would probably be deferred to the floating charge but it is uncertain whether the mere registration of the debenture securing a floating charge under s.96 of the Companies Act, without specific mention of the above restriction, is constructive notice to the world at large, not only of the existence of the debenture but of all its clauses including the restriction: RE: VALLETORT SANITARY CO. LTD.-in which it was held that registration of the charge constituted constructive notice of its existence but not of its contents.

LESSON 7
ANSWER 1
Section 211(1) of the Companies Act provides that any member of a company who complains that the affairs of the company are being conducted in a manner oppressive to some part of the members (including himself), may make an application to the court by petition for an order under the section. S.211(1) further provides that if on any such petition the court is of opinion (a) that the company's affairs are being conducted as aforesaid; and (b) that to wind up the company would unfairly prejudice that part of the members, but otherwise the facts would justify the making of a winding-up order on the ground that it was just and equitable that the company should be wound, the court may, with a view to bringing to an end the matters complained of, make such order as it thinks fit. The order which the court makes may be for regulating the conduct of the company's affairs in future, or for the purchase of the shares of any members of the company by other members of the company or by the company. No Kenya cases appear to have been contested under the section. However, numerous cases that were instituted by minorities in English courts were all dismissed except two cases only, namely (i) Scottish Wholesale Co-operative Society Ltd v Meyer, and Another (ii) Re: H.R. Harmer. (c) (d) that the petitioner and others were being oppressed as members qua member. that the oppressive conduct was continuous.

The English courts dismissed the other cases on highly technical grounds such as (a) there was no "oppression" established: Re: Five Minute Car Wash Ltd-the oppression envisaged by the section being some "visible departure from the standards of fair play"; (b) the petitioner had not been "oppressed" as a member but in some other capacity: Elder v Elder & Watson (c) what was complained of was an isolated act of impropriety rather than a continuing process of wrongdoing or oppression; and (d) the petitioner had failed to establish that the facts complained of justified a winding up of the company on the grounds that it was "justified and equitable" to do so. This judicial interpretation of the section rendered it ineffective as a minority protection section in English. The same would be the case in Kenya if Kenyan courts were to adopt the same restrictive and literal interpretation of the English Courts. However, the existence of the section may act as a deterrent by restraining majorities in companies from acting unfairly towards the minority. For the section gives some hope of going to court to obtain relief from oppression-although the success of the petition is not guaranteed. To that extent, Professor Gower's statement that the section "will probably always prove more

potent when brandished in terrorem than when actually used to strike" seems to be justified.

ANSWER 2
The veil of incorporation has been disregarded, or lifted, by the courts in numerous instances. The following are some of the instances: 1. Agency or trustee or nominee In Salomon v Salomon and Co. Ltd. Lord Cairns stated that ..."the company is not at law the agent of its members." This statement constitutes the other aspect of the basic legal principle known as "the veil of incorporation". In this context, the principle would be disregarded -and 'the veil lifted'-if a company were to be regarded as an agent of its members. For example, in Firestone Tyre & Rubber Co. Ltd v Lewellin a wholly - owned subsidiary company was regarded, on the basis of the trading arrangements between the two companies, as the agent of an American holding company which had incorporated it in England to manufacture and sell in Europe the holding company's brand of tyres. 2. Determination of Character In Salomon v Salomon & Co. Ltd Lord Macnaghten stated that "the company is at law a different person altogether from the subscribers to the memorandum". This means, inter alia, that the subscribers residence will not be the company's residence. In Daimler Co. Ltd v Continental Tyre and Rubber Co. Ltd the House of Lords held that the plaintiff company was resident in Germany because: (i) all except one of its shares were held by persons resident in Germany, and

(ii) all the directors resided in Germany. By regarding the subscribers' residence as the company's residence the court "lifted the veil" and treated the subscribers to the memorandum and the company as one entity. 3. Ratification of Corporate Acts Because of the legal separation between a company and its members, a decision made by the company's members as individuals is not generally regarded as the company's decision. In Re Express Engineering Works Ltd. the court held that a transaction which had been unanimously assented to by all the shareholders of the company was binding on the company although the assent had not been given at a members' general meeting. The court thereby "lifted the veil" of incorporation by equating an informal assent of the members with an assent of the company itself. 4. Fraud and Improper Conduct The courts have intervened on numerous occasions and 'lifted the veil' of incorporation in order to prevent something fraudulent or improper from taking place. In Jones v Lipman the defendant had attempted to avoid having to complete a sale of his

house to the plaintiff by transferring it to a company formed for the purpose. Both the defendant and the company were ordered to specifically perform the contract with the plaintiff. The court thereby "lifted the veil" by regarding a breach of contract by the subscriber as a breach of contract by the company itself. 5. Group Enterprises Numerous instances of lifting the veil have occurred in transactions or arrangements involving a number of companies within a group. In Holdsworth & Co Ltd. v Caddies the court held that there had been no breach of Mr Caddies' contract as managing director when the directors of the appellant company resolved that he should confine his attention to one of the subsidiary companies within the group and cease to act as the group's managing director. This decision constitutes an instance of lifting the veil because the court regarded a company (i.e. the subsidiary company) as being the same entity as the subscribers (i.e. the holding company). In effect, Mr Caddies would be working for the holding company at the time he was working in the subsidiary company. Another instance of lifting the veil in the case of group enterprises is The Roberta where a holding company was held liable on a bill of exchange signed on behalf of its wholly owned subsidiary. The court stated that the subsidiary was "a separate entity ... in name alone, and probably for the purposes of taxation." 6. Determination of residence Judicial authority has it that a company resides in the country in which its affairs are controlled and managed from since companies are managed by human beings, to ascertain a companys residence therefore, it is necessary to pierce the shell. As was the case in De Beers Consolidated mines Ltd V. Howe (1906)

LESSON 8
ANSWER 1
Voluntary winding up: It is voluntary because the company in general meeting, usually by a three quarters majority of votes to pass a special resolution, decides to go into liquidation: Companies Act s.271 (there is also a little used procedure for winding up by passing an ordinary resolution). The winding up is deemed to commence at the passing of the resolution. A voluntary winding up is a creditors' voluntary winding up unless the directors make and file at the Companies Registry a statutory declaration of solvency: s.276. The declaration is made by all the directors, or if there are more than two directors, by a majority of them. It states that after proper enquiry the directors are satisfied that the company will be able to pay its debts in full within a specified period of not more than 12 months. It has a statement of assets and liabilities attached. The declaration should be made not more than 30 days before the meeting at which the resolution to wind up is passed and not later than just before the meeting. It must be delivered to the Companies Registry before the meeting: s.276(2)(a). If it later appears that the company is unable to pay its debts in full the directors may be punished by fine or imprisonment unless they can show that they had reasonable grounds for making their declaration. The liquidator calls a meeting of creditors to report that the company is insolvent. When a declaration of solvency is duly made the liquidator proceeds as a members' voluntary winding up. The members in general meeting resolve by special resolution to wind up and to appoint a liquidator. When the liquidator needs approval for the exercise of statutory powers he convenes a general meeting for the purpose. The liquidator assumes many of the functions of the directors but they retain some powers and continue in office. In a creditors' voluntary liquidation the directors convene a general meeting to pass an extraordinary resolution to wind up on the grounds that the company cannot pay its debts. The meeting also nominates a liquidator. It is the duty of the directors to convene a meeting of creditors to be held after the general meeting of members and in any event not later than the following day. Although members may ordinarily waive the period of notice for a general meeting, there is a minimum period of seven days notice in this case. The creditors' meeting is presided over by a director who lays before it a financial statement. The meeting nominates a liquidator. If the two meetings nominate different liquidators, the liquidator chosen by the creditors is appointed unless the members appeal to the court and the court upholds their objections. The meetings of members and creditors may each appoint up to five of their number to be members of a committee of inspection to work with the liquidator. In a creditors' voluntary winding up whenever the liquidator calls a meeting of contributories (past or present members) he also calls a meeting of creditors. Compulsory winding up: It is compulsory because the court makes an order that the company shall be wound up. The winding up is deemed to commence on the date when the petition to the court is first presented,

i.e. the order is retrospective when made. The petition to the court should specify one of the various grounds contained in s.219. There are seven grounds in all but almost all petitions are based on either (1) the company's inability to pay its debts, or (2) the `just and equitable' ground. In case (1) the petitioner is a creditor claiming a debt of more than Shs.1,000. In case (2) the petitioner is a contributory. He must have been a registered shareholder for at least six of the previous 18 months, unless he acquired his shares direct from the company as an allottee or by inheritance from a deceased shareholder. s.221. When the petition is presented to the court a copy is delivered to the company. The petition is also advertised so that any creditors or other interested parties may be aware of it. After an interval of say three months the court hears the petitioner and any other interested persons and either makes an order or refuses to do so. The order is retrospective to the presentation of the petition so that any disposition of the company's assets in the interval of any transfer of its shares is open to review. Such transactions are invalid unless approved by the court. As soon as an order for compulsory liquidation is made the Official Receiver, who is an official of the High Court, becomes provisional liquidator (unless the court has already appointed a provisional liquidator at an earlier stage). The Official Receiver convenes separate meetings of contributories and of creditors to obtain nominations of a permanent liquidator and members of a joint committee of inspection. He reports the nomination to the court which usually makes the appointments proposed. The Official Receiver continues as liquidator if no other liquidator is appointed. The Official Receiver also receives a financial report, usually by the directors, in the form of a statement of affairs. He in turn reports to the court. An order for compulsory liquidation terminates the appointment of the directors and any contracts of employments which they have with the company. Comparison The main difference is that in voluntary liquidation the court is not involved. The liquidator may however apply to the court for any order which it would make in a compulsory liquidation. In a compulsory liquidation the liquidator (if not the Official Receiver) is an officer of the court (although he is usually an accountant in private practice who specialises in insolvency work). A compulsory liquidation order is retrospective to the date of the petition. A resolution to wind up voluntarily takes effect only when passed and is not retrospective.

ANSWER 2
(a) I would advise the supplier of oil that he may not sue Threads Ltd for the price of the oil. My advise would be based on the decision of Re Jon Beauforte Ltd in which the material facts were substantially the same as those of the case before us. In the case of Re Jon Beauforte Ltd the judge stated that since the company had ordered the coke on a letter which also described it as "manufacturers of veneered panels", the supplier of the coke had actual notice that the company was manufacturing veneered panels and was ordering the coke for that purpose. As he had constructive notice of the company's objects, he had actual notice that the coke was being bought for an ultra vires purpose since the manufacture of veneered panels was not one of the company's objects. He had therefore entered into an ultra vires contract of sale knowingly and could not sue to enforce it. Applying the above reasoning to the case before us, it can be said that since the notepaper describe Threads Ltd. as "paper manufacturers" the supplier of oil had actual notice that the oil was being ordered for use in the manufacture of paper. As he had constructive notice of the objects of threads and they knew that they did not include paper manufacturing, he had actual notice that the oil was being ordered for an ultra vires purpose. He had knowingly entered into an ultra vires contract and cannot sue to enforce it. The alternative for the supplier of oil is to recover back oil itself as it still exists. The Sale of Goods Act defines a sale as a contract whereby the seller transfers the ownership of the goods to the buyer. If there is no contract, no sale can take place. If goods have been delivered on the mistaken belief that a contract exists the apparent seller retains the ownership of his goods while the apparent buyer merely acquires their possession. The seller is entitled to recover possession of the goods from the buyer as soon as he becomes aware of the actual position. In this case Threads Ltd. merely acquired possession of the oil. The contract of sale, being ultra vires and void, did not vest ownership of the oil in them. The oil remained the property of the supplier who is entitled to recover it. This is the remedy of restitution and is available to a party to an ultra vires transaction: Re Birkbeck Permanent Benefit Building Society Ltd. (b) The general rule is that a minority shareholder cannot sue in respect of wrongs done by the company's directors; Foss v Harbottle. However, this rule is subject to certain exceptions. One of the exceptions is where the act complained of is ultra vires and illegal. In such a case a minority shareholder is entitled to institute proceedings in respect thereof since there is no chance of the wrong complained of being ratified by the company's general meeting. Atieno may therefore sue to restrain the company from carrying on the business of paper manufacturers which is ultra vires.

PAST CPA EXAMINATION PAPERS

KENYA ACCOUNTANTS AND SECRETARIES NATIONAL EXAMINATION BOARD

CPA PART III LAW II

THURSDAY: 7 JUNE 2001 Time Allowed: 3 hours. Answer any FIVE questions. ALL questions carry equal marks QUESTION ONE (a) To what extent does the doctrine of constructive notice operate negatively? (4 marks) (b) Y Ltd. whose articles are similar to Table A, publish a weekly magazine. In one issue an article is critical of the policies of the city commission. A number of Commissioners who are also members of the company requisition a general meeting and secure the passing of an ordinary resolution ordering the company to publish in the next issue a withdrawal of the criticism. The directors of the company are adamant. The angry commissioners approach you for the purpose of filing an action to compel the directors to publish a withdrawal. Advise them. (12 marks)

(c) In what circumstances may a company accept shares surrendered by a member? (4 marks) (Total: 20 marks) QUESTION TWO (a) Explain the remedies that are available to an investor who has been induced to take shares by false statements made in a prospectus. (4 marks) (b) Explain how the capital of a company may be: (i) altered; (4 marks) (ii) reduced (4 marks) (iii) increased (8 marks) (Total: 20 marks) QUESTION THREE (a) What are the salient duties ad powers of the Chairman of a general meeting of a company? Illustrate your answer with reference to decided cases. (10 marks) (b) Outline the classes of persons who may effectively demand for a poll during a general meeting. (5 marks) (c) Section 143 (1) of the Companies Act Cap 486 provides that A printed copy of every resolution or agreement to which this Section applies shall, within 30 days after the passing or making thereof, be delivered to the registrar for registration. Identify five resolutions or agreements registrable under this section. (5 marks)

(Total: 20 marks)

QUESTION FOUR (a) What books of account is a company required to keep and what provisions regulate group accounts? (8 marks) (b) Analyse the circumstances under which the group accounts of a company need not deal with a subsidiary of the company. (6 marks) (c) In what circumstances may a public company register a statement in lieu of prospectus with the registrar? (6 marks) (Total: 20 marks) QUESTION FIVE (a) What are the advantages and disadvantages of a floating charge to a debenture holder? (8 marks) (b) Outline the exceptions to the general prohibition on financial assistance by a company for the purchase of its own shares. (6 marks) (c) Outline the circumstances under which a floating charge will crystallise (Total: 20 marks) (6 marks)

QUESTION SIX (a) Explain five circumstances under which the veil of incorporated may be lifted by the court. (10 marks) (b) Name and briefly explain four classes of persons who may incur civil liability in respect of a false statement in a prospectus. (4 marks) (c) (i) Explain the doctrine of ultra vires with regard to the objects of a company. (2 marks) (ii) State the effects of ultra vires transactions. (2 marks) (iii) What are the purpose of the rule? (2 marks) (Total: 20 marks) QUESTION SEVEN In the context of voluntary winding up, explain the statutory provisions regarding the powers of the liquidator which may be exercisable: (i) with the court sanction (10 marks)

(ii) without the court sanction. (10 marks) (Total: 20 marks) QUESTION EIGHT (a) Detail the conditions that have to be satisfied before an applicant can bring an action successfully under the exception to the Rule in Foss v Harbottle. (10 marks) (b) Naliaka owns 10% of the issued shares in Pendo Limited. There are two directors Wanyonyi and Wafula who have an eccentric style of management. They own 45% of the issued shares. Naliaka understands that Wanyonyi and Wafula want to merge Pendo Ltd. with another more profitable company that the two directors wholly own.

If this plan goes ahead, Naliakas shareholding will be reduced to 3% of the merged business. Naliaka is financially dependent on the dividends she gets from Pendo Limited and that future dividends may be much less. Advise Naliaka of her legal position and protection under the law if any. (Total: 20 marks) (10 marks)

KENYA ACCOUNTANTS AND SECRETARIES NATIONAL EXAMINATION BOARD

CPA PART III LAW II

THURSDAY: 6 December 1996 Time Allowed: 3 hours.

Answer any FIVE questions. ALL questions carry equal marks QUESTION ONE Maneno and three of his friends recently retired from the Civil Service under the voluntary retirement scheme. They intend taking advantage of the on-going Structural Adjustment Programmes (SAPs) by going into business. (a) Advise them on the procedures they have to follow in order to register a public company limited by shares. (16 marks) (b) Explain to them how the procedure would differ from that for forming a private company limited by shares. (4 marks) (Total: 20 marks) QUESTION TWO (a) Define a foreign company and describe the documentary information which it must display at its place of business. (14 marks) (b) A and B is a German company that established an office in Eldoret way back on 3 February 1962. Briefly discuss the validity of the following acts: (i) a certified copy of its memorandum and articles of association was in both German and English. (ii) the companys official documents were ledged with the registrar on the 28th day after establishment. (iii) the principal place of business was switched from Eldoret to Mombasa and notice thereof given after 30 days. (6 marks) (Total: 20 marks) QUESTION THREE Write short notes on the following: (a) Issued share capital; (5 marks) (b) The difference between shares and debentures; (8 marks) (c) Capitalisation of profits; (4 marks) (d) A holding company. (3 marks) (Total: 20 marks) QUESTION FOUR (a) In what circumstances, if any, will a director be treated as an agent of the company? (14 marks)

(b) The directors of Ujenzi Ltd. diverted some funds meant for the extension of the commercial wing of the companys business premises to fund the expensive wedding of a son of one of the directors. At that particular time, Tony Lemata was the Secretary. He eventually became a director. At Lematas very first board meeting, the earlier breach was ratified. To what extent, if any, would Lemata be liable for the earlier breach? (6 marks) (Total: 20 marks) QUESTION FIVE Discuss in detail the rule and exceptions in Royal British Bank v Turquard (20 marks)

QUESTION SIX (a) Do the majority of directors have a right to exclude an unpopular shareholder from attending the meetings of a company? (8 marks) (b) For three consecutive years, Kichwa Ngumu has been a member of Wazalendo Company Ltd., a company incorporated in Kenya in 1980 under the Companies act, Cap. 486. During this time, he has not received any notice of the companys meetings. Other members of the company have always excluded him from such meetings because he is normally controversial. Kichwa Ngumu is now contemplating petitioning the High Court of Kenya for the compulsory winding up of Wazalendo Company Ltd. because of the treatment to which he has been subjected by the company. As his lawyer, he seeks your advise on the following matters: (i) Does he have a locus standi to petition for winding up under Cap. 486?(2 marks) (ii) On what grounds can he advance under the provisions of the companies Act, Cap. 486? (10 marks) (Total: 20 marks) QUESTION SEVEN (a) Discuss the powers and limitations of raising loans by directors of public limited liability companies. (12 marks) (b) What remedies are available to the lender in circumstances where directors borrow loans outside the powers of the company with or without the knowledge of the lender? (8 marks) (Total: 20 marks) QUESTION EIGHT Explain the grounds by which a company may be wound up by the court.

(20 marks)

MODEL ANSWERS TO PAST CPA PAPERS

MODEL ANSWERS TO CPA IV LAW II EXAMINATION SET JUNE 2001. Question 1
(a) This doctrine is to the effect that persons who deal with the company are deemed to know the contents of its public documents, namely memorandum, articles special resolutions etc. They are deemed to know the companys contractual capacity i.e. whether a transaction is intra or ultra vires the company. This is because these documents are registrable with the registrar and are open for inspection by any person who cares to inspect them. This doctrine protects the company from persons who do not inquire. It is a modification to the doctrine of indoor management. This doctrine operates negatively in that although parties are deemed to know the contents of the public documents, a party can only rely on those contents it has actual knowledge of their existence in the documents. It was so held in Rama Corporation v Proved Tins and General Investments where it was held that the plaintiff could not rely on the article permitting delegation since it had no notice of its existence. The company could not be held liable on the contract. (b) This problem is based on the division of powers between the general meeting and the board. Under this principle, each organ has its own sphere of influence as dictated by the articles. An organ must as a general rule not interfere with the exercise of a power vested in the other. In this case, since the articles of Y Ltd are similar to Table A, then under Article 80, the management of the company affairs is vested in the board except in those matters specifically allotted to the company at general meeting. The directors are in charge of the publication hence the general meeting must not interfere. By passing the resolution, the general meeting is in fact interfering with the exercise of a power vested by the articles in the board.

My advice to the commissioners is that they have no actionable claim against the directors. They cannot sue since the directors are not abusing, exceeding or exercising their powers in contravention of the articles. My advise is based on the decision in Scott v Scott where the general meeting purported to compel the directors of the company to pay an interim dividend, which was a power vested in the board. It was held that the resolution could not be given effect. A similar holding was made in Shaw v Shaw where the general meeting purported to interfere with the exercise of a power vested in the board of directors. (c) As a general rule, surrender of shares is not authorised by law. This is a situation whereby a member gives up his shares to the company. It is generally not provided for by the articles. However, a company may accept such shares in two circumstances: (i) to avoid the formalities of forfeiture (ii) fully paid up shares may be accepted in return for shares of the same nominal value.

Question 2 (a) The remedies available to a subscriber include: (i) Compensation for any loss or damage occasioned by the untrue statements i.e. Sec 45 of the Act. (ii) (iii) Damages for loss or liability arising. This remedy is available to the investor in the false statements were negligently or fraudulently misrepresented. Rescission of contract: The innocent party has the right to resciud the contract if the false statements were innocently, fraudulently or negligently made. The right is exercisable at the earliest possible instance. Indemnity: This remedy which entails monetary compensation is available if the false statements were innocently made. However, it is only available where the innocent misrepresentation occasion direct financial loss.

(iv)

(b) (i) Under Section 63 (1) of the Companies Act, the capital of accompany can be altered in various ways namely: 1 increase of capital 2 sub-division of shares 2 conversion of shares to stock 3 re-conversion of stock to shares 4 consolidation of shares 5 diminution of capital To alter the companys capital in the afore-mentioned ways, the following conditions are necessary: 6 the articles of the company must authorise the alteration 7 the alteration must be authorised by an ordinary resolution of members in general meeting 8 the registrar must be notified of the alteration within 30 days of the resolution. (ii) The Companies Act prescribes the circumstances in which a company may reduce its capital. The circumstances are prescribed in sections 68 to 71 of the Act. For a company to reduce its capital the following conditions/steps are necessary. 9 Authority of the articles: Under Section 68 (1) of the Companies Act, the power to reduce a companys capital must be embodied in the articles.

10 Special resolution: Under Section 68 (1) of the Act, a reduction of capital must be authorised by a special resolution of members in the general meeting. This resolution is referred to as resolution for reducing capital. A reduction of capital may take the form of: 1) extinguishing or reducing liability of unpaid capital 2) cancellation of any paid up capital which is lost or unrepresented by available assets 3) paying of any paid up capital which is in excess of the wants of the company. 11 Application to court for confirmation: Under Section 69 (1) of the Act, an application must be made to the court for confirmation of the reduction. The court must generally satisfy itself that the reduction is not unfairly prejudicial to any class of members or creditors. In particular, it must satisfy itself that creditors entitled to object have objected or consented to the alteration. In the case of and objection, the courts must satisfy itself that the creditors claim has been discharged, determined or secured. If satisfied that creditors interests have been given the requisite attention, the court may confirm the reduction. 12 Confirmation of the reduction: Under Section 70 (1) of the Act, if the court is satisfied that all creditors have consented and/or their claims have been discharged, determined r secured, it may make an order confirming the reduction on such terms and conditions as it deems fit. The court may for any special reason and for a specified duration order the company to add the words and reduced to its name and for the duration of the order, the words and reduced form part of the companys name. 13 Registration of the reduction: Under Section 71 (1) of the Act, upon production of a certified copy of the court order and the mincite approving the reduction of capital, the registrar of companies registers the same and publishes the same in accordance with the direction of the court. 14 Under Section 71 (2) of the Act, a reduction of capital take effect when registered by the registrar. (iii) Under Section 63 (1) of the Companies Act, a company limited by shares may, if authorised by its articles, increase its capital by new shares of any amount. e increase must be authorised by an ordinary resolution of members in general meeting. Under Section 65 (1) of the Act, the registrar must be notified of the increase within 30 days of the resolution whereupon he registers the same. Question 3 (a) Duties 15 Satisfy himself that the meeting is duly constituted 16 Inform himself the business of the meeting 17 Satisfy himself that a quorum of members is present 18 Call the meeting to order 19 Frame issues for debate or discussion 20 Make decisions on points of order 21 Ensure that the sense of the meeting is kept and/or maintained by putting relevant questions 22 Maintain order in the conduct of those present at the meeting 23 Ensure that minutes of the meeting are taken 24 Conduct voting and declare results. Relevant Case Law Powers: 25 to adjourn the meeting at any time with consent of the members 26 to stop discussion of any matter after reasonable debate

27 28 29 30 31 (b)

to demand voting by poll close the meeting after its business is accomplished determine who to speak and for how long to declare results of any voting to cast a vote or a second vote in the event of a tie.

32 The chairman of the meeting 33 At least three members. 34 A member or members representing not less than 1/10th of the issued shares, present in person or by proxy. 35 A member or members representing not less than 1/10 of the total voting rights present in person or by proxy 36 Specific resolutions (c) 37 Resolutions which have been agreed to by all members of the company which if not so agreed, would not be effective for their purpose unless passed as special resolutions. 38 Resolutions which agreed to by holders of a particular class of shares, which if not so agreed, would not be effective for their purpose unless supported by a specified majority or passed in a particular manner. 39 Resolutions which effectively binds all the holders of a particular class or shares whether or not agreed to by all. 40 A resolution to wind up a company voluntarily on the ground of either lapse of time or occurrence of an event contemplated by the articles. Question 4 (a) Under Section 147 (1) of the Act, every company must keep certain books in the English language, namely: 41 Assets and liabilities of the company 42 Sales and purchases of goods by the company 43 Receipts and expenses by the company Under Section 150 (1) of the Act, if a company has subsidiaries, it must lay group accounts before a general meeting of the holding company. Under Section 151 (1) of the Act, the group accounts laid before the general meeting must comprise: 44 a consolidated balance sheet of the company and the subsidiaries dealt with 45 a consolidated profit and loss account of the company and the subsidiaries. These accounts must give a true and fair view of the state of affairs and profit or loss of the company and its subsidiaries dealt with as a whole. However, in certain circumstances the accounts of a subsidiary need not be incorporated into the group accounts. (b) 46 If the subsidiary is wholly owned by a company incorporated in Kenya. 47 If the directors of the holding company are of the opinion that doing so would: i) be impracticable ii) occasion delay or expense iii) be misleading iv) be harmful to the business of the company or any subsidiary v) be of no real value to members

48 If directors are of the opinion that the business of the company and that of the subsidiary are so different that the enterprise cannot be treated as one. (c) 49 When a private company goes public in accordance with the provisions of Section 32 (1) of the Companies Act, a copy of a statement in lieu, if any, must be delivered within 14 days of the resolution effecting the change. 50 Under Section 50 (1) of the Act, if a public company having a share capital has not issued a prospectus with reference to its formation or has issued one but has not proceeded to allot any of the shares offered, no share should be allotted until at least after 3 days, after delivery to the registrar for registration, a statement in lieu of prospectus, signed by all persons who are named or proposed directors and containing the particulars of Part I and II of the 4th Schedule. 51 Under Section 111 (2) of the act, if a public company has failed to raise the minimum subscription to facilitate the issue of a certificate of trading, these must be delivered to the registrar for registration inter alia a statement in lieu of prospectus Question 5 (a) Advantages 52 It enables companies without fixed assets to borrow. 53 It enhances the borrowing capacity of companies with fixed assts. 54 It does not prevent the company from disposing off and acquiring new stock 55 It charges both existing and future assets of the company 56 Upon crystallisation, the chargee becomes entitled to sell the security. Disadvantages 57 The value of the security provided by the company remains uncertain until crystallisation 58 A fixed charge created subsequent to the floating charge has priority in the satisfaction of claims. 59 Other interests e.g. landlords distress for rent have priority in the satisfaction of claims 60 A floating charge created within 6 months before the commencement of winding up is deemed to be a fraudulent preference and is void. 61 A floating charge created within 12 months before the commencement of winding up is invalid unless it is proved, that the company was solvent immediately after its creation. (b) The rule in Trevor v Whitworth prohibits the company from purchasing its shares. This rule is now embodied in Section 56 (1) of the Companies Act. However, there are several exception to this rule: 62 If the lending of money is the ordinary business of the company and the same is lent in the ordinary course of such business 63 If the company has in force a scheme to advance loans to trustees to enable them purchase its fully paid up shares for the benefit of all employees including salaried directors. 64 If the company has in force a scheme to advance loans to all its bona fide employees other than directors to enable them purchase its fully paid up shares by way of beneficial ownership. (c) 65 Default in payment of the principal or interest when due and payable provided the chargee takes some step to enforce the security 66 Commencement of recovery proceedings against the company. 67 Appointment of a receiver by a chargee or the court upon application. 68 Commencement of winding up 69 Occurrence of an event contemplated by the debenture 70 If the company ceases to carry on business Question 6 (a) In the Words of Lord Denning in Littlewood Stores Ltd v Inland Revenue Commissioner

The courts can and often do draw aside the veil. They can and often do pull off the mask. They look to see what really lies behind. The legislature has shown the way with group accounts and the rest. And the courts should follow suit (i) Agency or trustee or nominee In Re: F. G. Films Ltd Firestone Tyre and Rubber Co. v Llewellin Smith Stone an Knight v Burmingham Corporation

(ii) Determination o ascertainment of residence Deebers Consolidated Mines Ltd. v Howe (iii) Ratification of corporate acts In Re: Duomatic Ltd In Re: Express Engineering Co. Ltd. (iv) Group Enterprises Harold Holdsworth v Caddies (v) Fraud or improper conduct In Re: Buggle Press Ltd. Jones v Lipman and Another Gilford Motor Co. Ltd v Horne and Another (vi) Determination of character Daimler Ltd. v Continental Tyre and Rubber Co. (b) 71 72 73 74 75 (c) (i) Ultra vires literally means beyond the powers. It is a rule of capacity which delimits the contractual capacity of a company. Under Section 5 (1) of the Acts, a companys memorandum must set out the objects of the company. This delimits the doctrine of ultra vires the company. At common law, a companys capacity is restricted to the objects in the memorandum and those other transactions that are reasonably incidental to the pursuit or attainment of those objects. Other transactions are ultra vires the company The doctrine of ultra vires in relation to the companys objects was formulated in Ashbury Railway Carriage and Iron Co. v Riche and Attorney General v Great Eastern Railway co. (ii) An ultra vires transaction is void since the company had no capacity to enter into it. Such a transaction is generally unenforceable. It cannot be rendered intra vires by estoppel acquiescence, lapse of time, delay or ratification. It was so held in the Rolled Steel Products (Holdings) Ltd. v British Steel Corporation and Others (1986) every person who was a promoter of the company every person who was a director of the company at the time. every person who authorised himself to be named by the prospectus as director and was so named. every person who authorised the issue of the prospectus every person who had agreed to become a director of the company either immediately or after an interval of time.

Once intra vires, always ultra vires. It was so held in Brady v Brady (1987) (iii) In the words of Lord Parker of Waddington in Cotman v Broughman the doctrine of ultra vires serves a double purpose. 76 It protects subscribers who learn from it in what spheres their investment can be applied by the company. 77 It protects persons who deal with the companys contractual capacity. Question 7 (i) In a compulsory winding up, the liquidator including a provisional liquidator exercises the following powers with the sanction of the court or committee of inspection. 78 79 80 81 82 83 To bring or defend actions and legal proceedings in the name and on behalf of the company To carry on the business of the company so far as may be necessary for beneficial winding up. To appoint an advocate to assist him in the performance of his duties To pay any classes of creditors in full To make any compromise or arrangement with creditors To compromise all calls and liabilities to calls, debts and other liabilities.

(ii) On his own responsibility and without obtaining any sanction the liquidator can: 84 Sell the property of the company by public auction or private contract. 85 Do all act as and execute, in the name and on behalf of the company all deeds and documents and use the companys seal therefore 86 Prove, rank and claim in the bankruptcy or insolvency or any contributory 87 Draw, accept, make and endorse any bill of exchange or promissory note in the name and on behalf of the company. 88 Raise money on the security of the companys assets 89 Take out letters of administration to any deceased contributory and to do any other act necessary for obtaining payment of money from a contributory or his estate. 90 Appoint an agent to do any business which the liquidator cannot do himself. 91 Do all such other things as are necessary for winding up the affairs of the company and distributing its assets. Question 8 (a) 92 the conduct complained of most of the lowest involve some fraud 93 the fraudsters or wrong doers must be in control of the company 94 the company must be made one of the dependants in the action 95 the plaintiff shareholder must sue in a representative capacity on behalf of himself and other members other than the real defendants. 96 the right to bring a derivative action is afforded to the individual member as a matter of grace. 97 the plaintiff remains dominus litis until judgement and can discontinue or settle the action at his pleasure. (b) As a shareholder, Naliaka is protected by law in that at Common Law, though a majority shareholder is free to vote selfishly, he must always do so in the best interest of the company otherwise the decision is questionable in a court of law. As was the case in Menier v Hooper Telegraph Wires In this case, since the proposed merger purports to benefit the majority shareholders at the expense of the minority, i.e. Naliaka, the decision to merge is challengeable in a court of law. My advise to Naliaka is therefore to sue the majority shareholders and the company for disallowance of the merger. My advise is based on the decision in Menier v Hooper Telegraph Wires where the majority shareholders purported to benefit at the expense of the minority.

MODEL ANSWERS TO CPA IV LAW II EXAMINATION SET DECEMBER 1996.

Question 1 (c) Procedure vi) Choice of suitable name which should be reserved vii) Prepare the constitutive documents i.e. 98 Memorandum of Association, 99 Articles of Association, 100 Statements of Nominal Capital, 101 Declaration of Compliance, 102 List of Directors, 103 Written consent of directors, 104 Notice of Location of registered office viii) The Memorandum of Association must indicate that the company is limited by shares. ix) The Memorandum of Association must be signed by at least seven promoters x) The Articles of Association must also be signed by at least seven people. xi) After preparation of documents, they must be stamped (stamp duty) xii) Presentation to the registrar of companies xiii) If the registrar is satisfied that all the documents are in order, he shall issue a certificate of incorporation (d) 105 They are not required to write a list of directors on their consent. 106 The minimum number of signatures is two not seven

Question 2 (a) A foreign company is one incorporated outside Kenya but having a place of business in Kenya Documentary information displayed 107 Certificate of incorporation: Exhibit on the outside of every office or place of business its name and country of its incorporation in English and in the original language. 108 State in every prospectus and on all publications and exhibit outside every office or place of business whether the liability of the members is limited. (b) (i) (ii) (iii) This is proper and valid. A foreign company is required to file a certified copy of its documents translated in English. This was complied with. Such documents is required to be filed within 30 days. This was in order. Any change of place of business must be done within 60 days. This was done. The act is valid.

Question 3 (a) Issued Share Capital 109 This is also known as the subscribed share capital 110 It is the portion of the share capital which has been issued and taken up. 111 It must be maintained at all times 112 It need not be necessarily paid for 113 It is the capital on which the company may make calls 114 It can never exceed the nominal capital (b) SharesDebentures -115 Constitutes membership to the company -116 Shares are irredeemable generally -117 Attach voting rights -118 Entitled to dividends -119 Generally not secured -120 May not be issued on a discount -121 A company cannot purchase its own shares.

-122 -123 -124 -125 -126 -127 -128

Constitutes creditors to the company Are generally redeemable Attaches no voting rights Entitled to interest on debentures Generally secured May not be issued at a discount A company can purchase its own shares

(c) Capitalisation of profits is the converting profits available for distribution as dividends into capital by issuing bonus shares. It requires an ordinary resolution. When returns are made, they must be accompanied by a contract constituting the title of allottee in case the profits were issued as shares (d) A holding company 129 It is a company which is a subsidiary of another. 130 It controls the directorship/management. 131 It must hold of the shares 132 Holding and subsidiaries are treated as one for purposes of accounts. Question 4 (a) A director may sometimes be regarded as an agent of the company. In Farquson v Wilson, it was held that directors are merely agents. 133 the company cannot act on its own 134 it acts through directors 135 it is a case of principal and agent 136 where the agent is liable, the directors would be liable 137 this is only so if he acts within the powers/authority (b) A director is only an agent of the company and not of the other directors. Nothing done by the board can impose liability on a director who did not know of their action and did not participate in it even if he attended subsequent board meetings at which such wrongful acts are ratified. To be liable, he must

have taken part of acquiesced in it. Reference: Re: Forest of Dean Coal Ltd. Where it was held that a director is not liable for any breach of trust that occurred before he became a director Question 5 The rule states that every person associating with a company is deemed to have notice of its public documents but not having notice of the minute book of the Board of Directors and thus a party dealing with a company would not be bound by internal rules which might be adopted by the Board of Directors itself. People dealing with registered companies are deemed to know the limits of the companys power and directors and other officers. A member of the public is thus expected to inspect such public documents i.e. the Memorandum of Association and Articles of Association. Any person who enters into contracts with the company, which are ultra vires the company or the powers of the directors will not be entitled to any remedy. The harshness of the rule was mitigated in the rule of Royal British Bank v Turquand. Facts Directors had powers to issue bonds provided they were authorised to do so by a general resolution of the company itself The directors issued a bond to Turquand but no resolution had been passed authorising its issue. It was held that Turquand was entitled to assume that a resolution had been duly passed and was not bound to inquire in to the regularity of the internal proceedings. Exceptions 138 Where the person dealing with the company knows the internal regulations have not been complied with. 139 Where the person purports to act as a director on behalf of the company in the transaction, it is his duty to see that the Articles are complied with 140 Where the articles show that a liable resolution is required, he cannot ignore the irregularity. 141 Where there are suspicious circumstances putting the outsider upon enquiry 142 Where the document apparently issued by the company is a forgery. Question 6 (a) Majority directors dont have a right to exclude a minority shareholder. Right to attend a meeting is inalieanable right of a shareholder. It is a primary right which cannot be taken away. (b) (i) He does not have capacity to petition for winding up if he is not a contributory. If he is a contributory, he has the locus standi to petition (ii) He can petition for under just and equitable grounds. Because he has been disqualified from attending. Lock v John Blackwood Question 7 (a) 143 If it is a trading company, directors have powers to raise loans. 144 They should not borrow in excess of what has been resolved by the Board (Articles of Association) 145 They go hand in hand with powers to give securities for the loans. 146 They can create a charge or mortgage on the companys property. 147 There are some properties which cannot be given out as securities of reserve capital

148 They can only borrow from sanctified creditors. (b) Remedies 149 Directors can be held personally liable 150 Training 151 Subrogation if it was used for legitimate debt 152 Injunction to stop company from utilising the funds 153 These are equitable remedies 154 Otherwise, ultra vires borrowing has no remedy in law. Reference: Sinclair v Broudhem Question 8 This is done under Section 219 of the Companies Act if by special resolution the company has: 155 Failure to submit statutory report to Registrar 156 Default in holding the statutory meeting 157 Failure to commence business within one or suspend business for one year 158 Failure to pay debt/insolvency 159 Where number of members fall below statutory minimum 160 In case of foreign company, if winding up proceedings commence in that country

MOCK EXAMINATION
STRATHMORE COLLEGE LAW II Answer ANY FIVE questions All questions carry equal marks

1. (a)

"A promoter is not an agent for the company which he is forming because a company cannot have an agent before it comes into existence". Elucidate this statement showing very clearly who promoters are and what their duties are towards the company. Are there any remedies available to a company in case of breach of duties by a promoter towards the company?

(b)

2. What are the effects of the Articles of Association and Memorandum of Association to: (a) The Company and the members; (b) The members in relation to one another; (c) The company and third parties? 3. Write short notes on the following in relation to a company: (a) A share and the different types of shares. (b) A debenture. (c) A charge. 4. Who are members of a company according to the Companies Act (Cap.486)? 5. Outline the provisions of the Companies Act providing for Civil and Criminal liability in respect of non-compliance with provisions relating to prospectus. 6. Company X was unable to pursue its object of coal mining as a consequence of the nationalization of the coal industry. Consequent thereto, the company intended to go into voluntary liquidation on receipt of compensation due to it for its collieries. Pending the receipt of this compensation the company resolved to reduce its capital by returning the whole paid up capital to its 7% preference shareholders. (a) What is the requirement for reduction of capital? (b) What would be your opinion if the preference shareholders went to court to object to the reduction of the capital for inter alia that the reduction was unfair because as they would no longer be shareholders they would be unable to participate in the surplus assets remaining after the return of capital in the eventual liquidation? 7. (a) What are the fiduciary duties of directors to the company?

(b) What are the duties of the Company Secretary under the Companies Act (Cap.486)?

8. (a) What is the distinction between voluntary winding up and compulsory winding up of a company? (b) What are the consequences of a resolution for voluntary winding up of a company? END OF MOCK EXAMINATION NOW SEND YOUR ANSWERS TO THE DISTANCE LEARNING CENTRE FOR MARKING

LESSON 4
CONTENTS
1 2 3 Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9

STUDY TEXT

MANAGEMENT
4.1 Introduction

COMPANY

A company, being an artificial person, cannot manage its own affairs. It is therefore not surprising to find that the articles of every registered company have provisions regarding the delegation of powers pertaining to the company's management. For example, Table A, Article 80 provides that "the business of the company shall be managed by the directors". 4.2 Numbers of Directors S.177 provides that every company (other than a private company) shall have at least two directors, and every private company shall have at least one director. Under Table A, Article 75 the actual number of the directors would initially be decided upon by the subscribers of the memorandum, or a majority of them, and until so determined the signatories to the memorandum of association shall be the first directors. Table A, Article 94 empowers the company from time to time by ordinary resolution to increase or reduce the number of its directors. 4.3 Appointment of Directors In the absence of other provisions in a company's articles, the directors of the company would be appointed in accordance with the following provisions of Table A.

4.3.1 First Directors The names of the first directors shall be decided in writing by the subscribers of the memorandum of association or a majority of them. If there is a deadlock, all the signatories to the memorandum of association shall be the company's first directors. 4.3.2 Subsequent Directors The subsequent directors are appointed by the members in general meeting beginning from the first annual general meeting at which all the first directors retire from office and the members are given the first opportunity to elect directors of their own choice. The retiring directors are however eligible for election under Article 89. At the second annual general meeting one-third of the directors are to retire from office, the ones to retire being the ones who have been longest in office since their last election. As between persons who became directors on the same day those to retire shall (unless they otherwise agree among themselves) be determined by lot. One-third of the board shall thereafter retire annually. 4.3.3 Casual Appointments Article 95 permits the board of directors to fill a vacancy in the board or to get an additional director to join the board for practical reasons provided that the appointment does not cause the number of directors to exceed the limit imposed by the articles. The person appointed director in this way shall hold office until the next annual general meeting. He will then be eligible for re-election, but his appointment will not be taken into account when deciding on the directors who shall retire from office. 4.4 Restrictions on Appointment The following are the restrictions which the Act imposes on appointment of directors: 1. S.182(1): Appointment by the Articles S.182(1) provides that a person shall not be capable of being appointed director of a company by the articles unless, before the registration of the articles, he has by himself or by his agent authorized in writing i. signed and delivered to the registrar for registration a consent in writing to act as such director; and either a) signed the memorandum for a number of shares not less than his qualification, if any; or taken and paid or agreed to pay for his qualification shares, if any; or signed or made and delivered to the registrar for registration an undertaking to take and pay for his qualification shares, if any, or the statutory declaration that a number of shares not less than his qualification, if any, are registered in his name.

ii.

b) c)

2.

S.183: Qualification Shares S.183(1) provides that it shall be the duty of every director who is by the articles of the

company required to hold a specified qualification, and who is not already qualified, to obtain his qualification within two months after his appointment, or within the shorter time (if any) fixed by the articles. Subsection (3) further provides that if the director fails to obtain his share qualification, or ceases to hold the required number of shares, he shall vacate his office. If he does not actually do so but continues to act as director he becomes a de facto director : Rv Ivan Arthur Camps (67). 3. S.186 : Age Limit S.186 provides that no person shall be capable of being appointed a director of a public company or a private company which is a subsidiary of a public company if at the time of his appointment (a) (b) he has not attained the age of twenty-one; or he has attained the age of seventy.

This provision does not apply if: (a) (b) The company's articles provide otherwise; or "Special notice" of the resolution to appoint the director was given to the company.

The company must also have given notice of it (i.e. the special notice) to its members and stated the age of the proposed director. S.142 defines "special notice" as a notice given to the company not less than twenty eight days, before the meeting at which the relevant resolution is to be moved. 4. S.188 : Undischarged Bankrupts S.188 provides that if an undischarged bankrupt acts as director of any company without leave of the court he shall be liable to imprisonment for a term not exceeding two years or to a fine not exceeding Shs.10,000/=, or both. 5. S.189 : Fraudulent Persons S.189(1) empowers the court to make an order restraining a person from being appointed, or acting, as a company's director for a period not exceeding five years if i. The person is convicted of any offence in connection with the promotion, formation or management of a company; or In the course of a winding up, it appears that the person has been guilty of fraudulent trading (under s.323) or has otherwise been guilty, while an officer of the company, of any fraud or breach of duty to the company.

ii.

6.

S.184 : Individual Voting S.184(1) provides that appointment of directors is to be voted on individually unless a motion for the appointment of two or more persons as directors by a single resolution was agreed upon by the meeting without any vote being given against it.

A resolution moved in contravention of this provision is void {s.184(2)}. 4.5 Defects in Appointment S.181 provides that a director's acts shall be valid despite any defect that may afterwards be discovered in his appointment or qualification. This provision applies to technical defects in appointment or qualification, such as a failure to obtain the director's share qualification within the prescribed time. An example is Rv Camps (67). 4.6 Disqualification of Directors Table A, Article 88 provides, under the heading "disqualification of directors", that the office of director shall be vacated if the director (a) ceases to be a director by virtue of s.183 (ie. failure to obtain a share qualification) or s.186 (ie. age limit); or becomes bankrupt or makes any arrangement or composition with his creditors generally; or becomes prohibited from being a director by reason of any order made under s.189 of the Act; or becomes of unsound mind; or resigns his office by notice in writing to the company; or shall for more than six months have been absent without permission of the directors from meetings of the directors held during that period.

(b) (c)

(d) (e) (f)

Regarding clause (e) above, it was held in Latchford Premier Cinema Co. V Ennion that a verbal notice of resignation which is given to, and is accepted by, the general meeting is effective and cannot be withdrawn. This is so because the general meeting would be deemed to have amended the company's articles by deleting the words "in writing". By implication, a purported oral notice of resignation which is given to, and purportedly accepted by, the board of directors would be invalid since the directors cannot legally alter the company's articles of association. Regarding clause (f) , it should be noted that it does not say that the director in question shall vacate office if he "absents himself". Such a provision would have disqualified the director only if the absence in question was voluntary, as in cases where he was ill and could not attend the board meetings. On the other hand, the office would be vacated if the director was absent because his doctor had advised him to go abroad on medical grounds: McConnel's Claim. 4.7 Vacation of Office In addition to vacating office under the aforesaid provisions of Article 88 a person may cease to be a director for various reasons, such as (a) (b) (c) (d) 4.8 death; or retirement by rotation under the articles; or court order restraining him from acting as director; or dissolution of the company.

Removal of Directors

By s.185(1) a company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in the articles or in any agreement between him and the company. Special notice must be given of any resolution to remove the director, or to appoint another director in his place. On receipt of the special notice the company must send a copy to the director concerned who is entitled, if he so wishes, to make written representations (not exceeding a reasonable length) to the company. If the director so requests, the company must send the representations to the members with notice of the meeting unless the representations are received by it too late for it to do so. In such a case the representations would be read out at the meeting at which the director would also be entitled to be heard. The representations need not be sent out by the company or read out at the general meeting if, on the application, either of the company or of any other person who claims to be aggrieved, the court is satisfied that they have been made in order to secure needless publicity for defamatory matter. The removal will be effective if it is decided on by an ordinary resolution. In Bushell v Faith and Another (67) Harman, L J defined "an ordinary resolution" as "a resolution depending for its passing on a simple majority of votes validly cast in conformity with the articles". 4.9 Compensation for Removal Subsection (6) provides that nothing in s.185 shall be taken as depriving a removed director of compensation or damages payable to him in respect of the termination of his appointment as director or of any appointment terminating with that as director. This provision which restates the common law rule, would enable a managing director to sue the company for damages for wrongful dismissal if the effect of his removal as director was to prematurely terminate his appointment as managing director, and was inconsistent with the contract. The director might also, if he is a member of the company, be entitled to an order for the winding up of the company by the court on the "just and equitable" ground: Ebrahimi v Westbourne Galleries Ltd. 4.10 Directors' Remuneration For technical reasons the directors are not regarded as servants or employees of the company of which they are directors. They therefore have no right to be paid for their services unless there is a provision for payment in the articles. In the case of companies which have adopted Table A, Article 76 provides that "the remuneration of the directors shall from time to time be determined by the company in general meeting." In Re: Duomatic Ltd it was explained that a provision in the articles authorizing payment of directors' remuneration does not, per se, give the right to be paid any specific amount. There must also be a resolution passed by the company in general meeting authorizing the payment. Provided the resolution has been passed, the remuneration is payable whether profits are earned or not: Re: Lundy Granite Co. Article 76 provides that "the remuneration shall be deemed to accrue from day to day". This means that a director who vacates office before completing a year or a month in office is entitled to a proportionate part of his yearly, or monthly salary: Moriarty v Regent's Garage Co. S.190(1) provides that "it shall not be lawful for a company to pay a director remuneration (whether as a director or otherwise) free of income tax or surtax", except under a contract which was in force two years before the commencement of the Act on 1st January 1962 which provides expressly (and not by reference to the articles) for payment of tax-free payments. Any provision in the articles regarding tax-free payments "shall have effect as if it provided for payment, as a gross sum subject

to income tax and surtax, of the net sum for which it actually provides". 4.11 Compensation for Loss of Office (a) Section 192 makes it unlawful for a company to make a director any payment by way of compensation for loss of office, or as consideration for or in connection with his retirement, unless particulars of the proposed payment, including the amount, are disclosed to the members of the company and the proposal is approved by the company in general meeting. If the payment is not disclosed and approved, the director to whom it is paid shall be deemed to have received it in trust for the company. The directors who paid the money are liable to repay the money to the company : Re: Duomatic. Section 193 makes it unlawful, in connection with the transfer of the whole or any part of the undertaking or property of a company, for any payment to be made to any director of the company by way of compensation for loss of office or on retirement unless particulars are disclosed and approved. If such a payment is not disclosed the director holds it upon trust for the company. Section 194 deals with the situation where the shares of the company are being transferred. It applies where the transfer results from i. ii. an offer made to the general body of shareholders; an offer made by another company with a view to the company becoming its subsidiary or a subsidiary of its holding company; an offer made by an individual with a view to his acquiring at least one-third of the voting power at any general meeting of the company; or any other offer which is conditional on acceptance to a given extent.

(b)

(c)

iii.

iv.

If a payment is made to a director as compensation for loss of office or on his retirement in any of the aforesaid circumstances, he must take reasonable steps to ensure that the particulars of the proposed payments are disclosed in the offer. If this is not done, the director holds the payment on trust for the persons who have sold their shares as a result of the offer. Section 195(3) provides that references under sections 192, 193 and 194 to payments made to any director by way of compensation for loss of office do not include any bona fide payment by way of damages for breach of contract or by way of pension in respect of past services. 4.12 Loans to Directors Section 191(1) renders unlawful any loan made by a company to a director of the company or its holding company. It is also unlawful for the company to guarantee a loan given to its director by any other person. These restrictions do not apply to (a) (b) (c) a private company; or a subsidiary whose director is its holding company; or payments made to a director to meet expenses incurred or to be incurred by him for purposes of the company, or to enable him properly to perform his duties as an officer of the company; or

(d)

a loan given by a money lending company, such as a bank, in the ordinary course of its business.

4.13

Duties of Directors The duties of directors are usually considered under two broad headings, namely i. ii. 1. Duties of care and skill at common law, and Fiduciary duties as enunciated by courts of equity. Duties of Care and Skill The directors' duties of care and skill have been formulated in a series of cases brought against directors in order to make them liable in negligence for the manner in which they conducted the company's affairs. These duties were summarised by Romer, J. in RE CITY EQUITABLE FIRE INSURANCE CO LTD as follows: i. 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 rule prescribes a duty which is partly objective ( the standard of the reasonable man) and partly subjective (the reasonably man is deemed to have the knowledge and experience of the particular director). It may also be expressed by saying that, if a foolish director makes foolish decisions resulting in loss to the company, he cannot be liable for negligence. It would be unreasonable to expect a foolish director to make wise decisions. However, if the director made very foolish decisions resulting in loss to the company, he will be liable in negligence since it is not reasonable to expect a foolish director to make very foolish decisions. On the other hand, a wise director will be liable if he makes unwise decisions, since it is unreasonable to expect him, a wise man, to make unwise or foolish decisions. A directorship is not a professional job with a legally prescribed qualification. In the circumstances, anybody (even a six-months-old baby) can become a director. All that the law can expect him to do is to serve the company honestly and to the best of his ability. In RE: MARQUIS OF BUTE'S CASE the director became the director at the age of six months by inheriting the office from his father who had died. ii. 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. In RE MARQUIS OF BUTE'S CASE a director who had attended only one board meeting in thirty eight years was exonerated from liability for alleged negligence on the ground that "neglect or omission to attend meetings is not, in my opinion, the same thing as neglect or omission of a duty which ought to be performed at those meetings" (per Stirling, J.) A company is, however, free to impose a duty on its directors to attend board meetings within a certain period of time and to prescribe the consequences of a breach of the duty. See, for example, Table A, Article 88(f).

iii.

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. If a director is to be made liable, it can only be on the basis of his personal negligence, and it is not negligence to delegate some responsibilities to officials or employees of the company whose previous conduct has given no grounds for distrust or suspicion. In DOVEY v CORY a director was held not liable for negligence merely because he had failed to verify false information regarding the company's accounts which he had been given by the company's manager and managing director. The court stated: "Business cannot be carried on upon principles of distrust. Men in responsible positions must be trusted by those above them, as well as by those below them, until there is reason to distrust them. We agree that care and prudence do not involve distrust."

2.

Fiduciary Duties The fiduciary duties of directors arising from their fiduciary relation to the company have been the subject of consideration in an enormous body of case law but the ratio decidendi of the cases can be reduced to two fundamental propositions: (a) A director is not allowed to put himself in a position where his interest and duty conflict.

The application of this rule is illustrated by the following cases: 1. Aberdeen Rly Co v Blaikie Brothers (68). S.200(5) adopts this rule by providing that nothing in section 200(5) shall be taken to prejudice the operation of "any rule of law" restricting directors of a company from having any interest in contracts with the company". S.200 requires a director who is in any way interested in a contract with the company to declare the nature of his interest at a board meeting. He must disclose the interest at the first board meeting at which the contract is to be discussed or, if he did not have an interest at that time, at the first board meeting after his interest arose. This provision is supplemented by Article 84 of Table A which provides that i. The director shall not vote in respect of the contract. If he does vote, his vote shall not be counted; and The director shall not be counted in the quorum present at the meeting.

ii. 2.

Industrial Development Consultants Ltd v Cooley (69) in which the director became personally interested in a contract he had been assigned to negotiate for the company. Cook v Deeks (70) in which some of the company's directors diverted to themselves a contract that was intended to be for the company. It was held that they had to surrender the benefit of the contract to the company. In law the benefit of the contract belonged to the company which the directors had formed for the purpose of obtaining the contract but in equity the contract belonged to the company for which it was

3.

intended. In Bray v Ford Lord Herschell stated that the aforesaid rule is not "founded upon principles of morality" but is based on the consideration that human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty and thus prejudicing those whom he was bound to protect". (b) A director is not, unless otherwise expressly provided, entitled to make a profit: Boston Deep Sea Fishing Co v Ansell (71). This rule is essentially a restatement of the fundamental rule of the law of agency that an agent must not make a secret profit. The cases in company law are just examples of how a particular agent (the company director) committed a breach of his duties to a particular principal (the company). In Percival v Wright (72) it was held that the directors owe their fiduciary duties to the company alone and not to the members. The decision raises a problem that has become known as "insider dealing". 4.14 Relief from Liability Under s.402(1) the court has power in an action against an officer for breach of duty to grant relief where, although the officer is in breach, it appears that he has acted honestly and reasonably and, having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused for the negligence, default, breach of duty or breach of trust. 4.15 Directors Powers Equity regards directors as holding their powers on trust for the company. They can only exercise those powers for the benefit of the company, otherwise the purported exercise will be regarded as "ultra vires" and invalid. In such cases the court would regard the transaction as having been entered into for an "extraneous purpose". This is illustrated by i. Re Roith Ltd (73). The extraneous purpose was consideration of the widow's welfare rather than the company's benefit. Hutton v West Cork Railway Co. (74). The resolutions had not given adequate consideration to the question whether the company would benefit from the proposed payments. Hogg v Cramphorn (75). The extraneous purpose was the desire to pre-empt the take-over bid. The directors had not exercised their power for the benefit of the company.

ii.

iii.

4.16

Register of Directors' Shareholdings Section 196(1) requires every company to keep a register showing the number, description and amount of any shares or debentures which are held by or in trust for the director, or of which he has any right to become the holder (whether on payment or not) in (a) (b) (c) the company; or the company's subsidiary or holding company; or a subsidiary of the company's holding company.

The register shall be kept at the company's registered office and shall be open to the inspection of

any member or debenture holder during business hours during the period beginning 14 days before the date of the company's annual general meeting and ending three days after the conclusion of the meeting (a day which is a Saturday, Sunday or public holiday being disregarded in computing the fourteen days). 4.17 Division of company's Powers Article 80 of Table A states: "The business of the company shall be managed by the directors who may... exercise all such powers of the company as are not, by the Act or by these regulations, required to be exercised by the company in general meeting, subject, nevertheless, to any of these regulations, to the provisions of the Act and to such regulations, being not inconsistent with the aforesaid regulations or provisions, as may be prescribed by the Company in general meeting; but no regulation made by the company in general meeting shall invalidate any prior act of the directors which would have been valid if that regulation had not been made." What this article means as far as the division of powers between a company's Board of Directors and the Members in general meeting has been a controversial topic. It may be discussed with the aid of the following chart:

CHART OF COMPANY'S POWERS POWERS 1 2 3 4 5 6 7 ORGAN RESPONSIBLE DIRECTORS DIRECTORS GENERAL MEETING GENERAL MEETING GENERAL MEETING ? (Articles Silent) ? (Articles Silent)

LEGAL QUESTIONS Can the General Meeting: a) b) c) d) e) Direct the directors regarding the exercise of Power 1 or 2? Overrule the directors regarding a decision made in exercise of Power 1 or 2? Direct the directors regarding the exercises of Power 6 or 7? Overrule the directors regarding a decision made pursuant to Power 6 or 7? Exercise Power 1 or 2?

ANSWERS: The answers to questions (a) to (d) above are not clear and are controversial. According to Professor Gower, the answer to each of the above questions is NO. However, according to Goldberg, the answer to the above questions is YES. It is hoped that the controversy will be ended by further litigation which will give conclusive judicial interpretation of Article 80. In England, however, the controversy was recently ended by a complete overhaul of Table A, Article 80 under the Company's Act of 1989. Regarding question (e) above, the cases of BARRON V POTTER and FORSTER V FORSTER, in particular, establish the rule that, if the Board is unable to function because it is paralysed by personal feuds, between the directors, the powers normally reserved to it by the articles will revert to the members in general meeting who may exercise them so that the company's operations may continue rather than grind to a halt. There is no academic controversy over this proposition. 4.18 The Managing Director 4.18.1 Appointment In Ellis v Bailey and Company (East Africa) Limited (76) it was stated that "without specific authority in the articles directors may not appoint one of their number to the position of managing director or other salaried office ... such an appointment would entail delegation of authority ... not authorised for directors". This formulation of the law is a derivation from the general maxim of agency law, "delegatus non potest delegare". 4.18.2 In the case of companies which have adopted Table A, Article 107 empowers directors to appoint a managing director "for such period and on such terms as they think fit". In Craven-Ellis v Cannons Ltd it was explained that the words "the directors" at the beginning of Article 107 means "the de jure directors". Consequently, a purported appointment by de facto directors would be null and void. A managing director occupies a crucial position in the management of a company and as such it would be improper to allow people who are in fact illegally in office (the de facto directors) to appoint him. This decision is not inconsistent with s.2 of the Act which defines "director" as including a de facto director because the section provides that the definition will apply "except where the context otherwise requires". 4.18.3 Powers of Managing Director Article 109 provides that "the directors may entrust to and confer upon a managing director any of the powers exercisable by them upon such terms and conditions and with such restrictions as they may think fit, and either collaterally with or to the exclusion of their own powers and may from time to time revoke, withdraw, alter or vary all or any of such powers". The purport of this lengthy provision is not clear. However the phrase "either collaterally with or to the to the exclusion of their own powers" would have startling consequences if they were given their literal interpretation. That seems to be one of the reasons why they no longer appear in the current Table A of the English Companies Act 1989.

4.18.4

Remuneration Article 108 provides that "a managing director shall receive such remuneration (whether by way of salary, commission or participation in profits, or partly in one way and partly in another) as the directors may determine". It was explained in Craven-Ellis v Cannons Ltd that, unless the articles provide otherwise, a managing director would be entitled to remuneration payable on a quantum meruit basis in respect of services rendered to the company, in those cases where the directors had not fixed his remuneration at the time of his appointment. No such payment would however be made if the articles, like Article 108, contain specific provisions pertaining to the payment of remuneration. This is illustrated by Re Richmond Gate Property Co Ltd in which it was held that the phrase "as the directors may determine" meant that the managing director would be entitled to no remuneration unless and until the directors actually decided it. A payment on a quantum meruit would be inconsistent with the express provisions of the articles regarding payment of remuneration.

4.18.5

Removal Article 107 provides that the managing director's "appointment shall be automatically determined if he cease from any cause to be a director". It was explained in Southern Foundries Ltd v Shirlaw (77) that if the appointment constituted a service agreement with the company the managing director would be entitled to sue the company for damages if the removal from directorship derogated from the terms of the agreement and constituted a breach of it, such as being removed before the period fixed in the service agreement expired. If on the other hand the appointment does not constitute a service contract the managing director would have no remedy for premature removal, as illustrated by Read v Astoria Garage Ltd (78).

4.19

The Company Secretary 4.19.1 Appointment of the Secretary By section 179, every company must have a secretary but a sole director cannot be a secretary as well. Table A, Article 110, provides that the secretary shall be appointed by the directors on such terms and conditions as they think fit and may be dismissed by them. Section 179 provides that a corporation cannot be a secretary if its sole director is also the sole director of the company. 4.19.2 Powers and Duties The powers and duties of the secretary depend on the size and nature of the company and the personal contractual arrangements that it makes with him. However, a company usually has the following powers and duties: (a) To be present at all meetings, including board meetings, and take the minutes of such proceedings. On the instructions of the board, to issue notices of meetings to members and others. To countersign instruments to which the company seal has been affixed (see

(b)

(c)

Article 113 of Table A). (d) (e) To conduct and record transfer of shares. To keep the books of the company, particularly those relating to the internal administration of the company, eg. the share register, and register of charges. To make all the returns of the company, eg. the annual returns, notice of special resolutions, etc.

(f)

Section 180 provides that a provision requiring or authorizing a thing to be done by or to a director and the secretary, is not satisfied by it being done by or to the same person acting as secretary and director. 4.19.3 Position in Relation to the Company In 1882 Lord Esher in Barnett, Hoares & Co v South London Tramsways Co stated that: "A secretary is a mere servant; his position is that he is to do what he is told, and no person can assume that statements made by him are necessarily to be accepted as trustworthy without further inquiry." Thus it was held in various cases that the secretary had no independent authority to bind the company by contract. However, in 1971 in Panorama Developments Ltd v Fidelis Furnishing Fabrics Ltd the Court of Appeal stated that in modern times the secretary is no longer a mere clerk; he is a chief administrative officer of the company and thus can make representations on behalf of the company and enter into contracts on its behalf as long as they concern the administrative side of the business such as contracts for the employment of staff, the acquisition of office equipment or the hiring of transport for visiting the company's factory, as the secretary had done in that case. However, apart from such exceptions, the secretary still has no power and so he acts outside his authority if, for example, he borrows money in the company's behalf, or negotiates contracts other than those necessary for administrative purposes, or calls a general meeting on his own authority; of course the Articles empower the directors to delegate any of their powers to any agent they choose, they may delegate to the secretary and this is not uncommon, especially when the secretary is also a director. 4.19.4 Liability The secretary is an officer of the company and thus he owes fiduciary duties to the company which are similar to those of a director, eg. he must act in good faith and must not make a secret profit. Moreover, in the event of a liquidation, the secretary as an officer of the company will be liable under section 323 if he has been guilty of a misfeasance. The secretary will also be liable to specific criminal penalties if he details or omits a wrongful act in respect of his statutory duties. Thus, for example, he can be made to pay a default fine if he fails to sign the annual return and accompanying documents and as the officer most clearly in default will be liable in the event of failure to keep and make available registers such as the registers of directors and secretaries. 4.19.5 Indemnity Section 206 applies to the secretary and thus a provision in the Articles or any contract exempting him from liability is void. However, again the Court can relieve him from

liability in certain cases (see section 402). 4.20 Unauthorized Contracts It may sometimes happen that a company's agent, while entering into a contract on behalf of the company, exceeds his powers under the articles of association. To what extent is the company bound by the contract? 4.20.1 The Rule in Royal British Bank v Turquand In Royal British Bank v Turquand (80) a company was ordered to repay a loan which its directors had borrowed on its behalf without the authority of an ordinary resolution prescribed by the articles of association. In the course of delivering his judgement Jervis, C J stated: "The dealings with these companies are not like dealings with other partnerships, and the parties dealing with them are bound to read the statute and the deed of settlement. But they are not bound to do more. And the party here, on reading the deed of settlement, would find, not a prohibition from borrowing, but a permission to do so on certain conditions. Finding that the authority might be made complete by a resolution, he would have a right to infer the fact of a resolution authorizing that which on the face of the document appeared to be legitimately done". This statement can be reduced to two propositions which constitute what is compositely known as "the rule in Turquand's case", namely: i. A person dealing with a company is bound to read the relevant restrictive provisions of the Companies Act, the company's memorandum of association and the company's articles of association. If he does not do so, he will be deemed to have read them and, as a consequence, to have been aware of their provisions. In so far as the articles provide that a transaction may be effected by some internal procedure, the person dealing with the company (called "outsider") may assume that the procedure has been duly complied with.

ii.

The effect of these propositions is that the company will be bound by the transaction even if the prescribed procedure was in fact not followed or complied with. An "internal procedure" for this purpose would usually be a decision of the company which is made by an ordinary resolution passed by the company in general meeting, or a resolution of the directors passed at a board meeting. Such a resolution is not registerable at the Companies Registry pursuant to s.143 or any other section of the Companies Act and the outsider who goes to the Registry would not be in a position to ascertain whether it had in fact been passed. Rather than compel him to go to the relevant office of the company to make enquiries, the courts decided to, as it were, "give him the benefit of the doubt" by holding that the resolution will be deemed to have been passed even if it had not actually been passed. 4.20.2 Examples The following cases are some of the leading examples of the application of "the rule in Turquand's case:"

(a)

Mahoney v East Holyford Mining Co The company "secretary" sent the company's bank what purported to be a final copy of a resolution of the board authorizing the payment of cheques signed by two of three named "directors" and by the named "secretary". The bank, relying on the "resolution", honoured cheques signed in accordance with its provisions. The company later went into liquidation and it was then realized that neither the "directors" nor the "secretary" had been properly appointed and no general or board meetings had ever been held. The liquidator's contention that the cheques which had been signed by the "directors" and the "secretary" had been wrongly paid and the bank must refund the money was rejected. The bank was not bound to enquire whether the "directors" and the "secretary" had been properly appointed and could rely on the rule in Turquand's case.

(b)

Freeman & Lockyer v Buckhurst Park Properties Ltd The articles of a company formed to purchase and resell an estate empowered the directors to appoint one of their body managing director. Kapoor, a director, was never appointed managing director but, to the knowledge of the board, he acted as such. On behalf of the company he instructed the plaintiffs, a firm of architects and surveyors, to apply for planning permission with a view to developing the estate. The company later refused to pay the plaintiffs' fees on the ground that Kapoor had no authority to engage them. Held, the company was bound by the contract and liable for the plaintiffs' fees. The act of engaging architects was within the apparent authority of a managing director of a property company and the plaintiffs were not obliged to enquire whether the person they were dealing with (Kapoor) was properly appointed. It was sufficient that under the articles there was a power to appoint a managing director, and that the board of directors had allowed one of them (Kapoor) to act as such. In any case, a resolution of the board appointing a managing director is not registerable under s.143 and so its passing cannot be ascertained by a visit to the companies registry.

(c) 4.20.3

HelyHutchinson v Brayhead Ltd (81)

Exceptions The rule in Turquand's case will not apply if: i. The person suing the company is in fact an insider, such as a director of the company: Howard v Patent Ivory Co (82). Such a person has access to the company's documents from which he may discover the lack of authority. Exceptionally, he may succeed against the company if he proves that he was a recently-appointed director and had not fully acquainted himself with the internal procedures of the company. ii. The company's articles prescribed a special resolution which had not been passed, as illustrated by Irvine v Union Bank of Australia (83). A special resolution is registerable under s.143 of the Companies Act and if it had been passed a copy thereof would have been delivered for registration and

would have been found among the company's documents at the companies registry. Its absence shall have warned the outsider that it had not been passed. iii. There were special circumstances which should have put the outsider on inquiry: Underwood Ltd v Bank of Liverpool (case No 5); Liggett v Barclays Bank (84). The transaction is ultra vires the company, since a company's agent cannot have authority to transact a business which the company itself lacks capacity to transact. The transaction relates to the issue of a forged document, such as a forged share certificate issued by the secretary without the authority of the board, as illustrated by Ruben v Great Finggall Consolidated Ltd.

iv.

v.

vi. Knowledge of irregularity: Liggett v Barclays Bank vii As insider.

REINFORCING QUESTIONS
1. 2. Explain the remedies which are available to an ultra vires lender. Explain the regulations governing the appointment, disqualification and removal of directors.

3.

"A" Ltd loans Shs 200,000/= to "B" Ltd on security to enable that company to purchase paper making machinery. What would the legal situation be in each of the following cases? (a) B Ltd was not empowered by its memorandum to act as paper manufacturers.

(b)

B Ltd's articles permitted the directors to borrow amounts in excess of Shs 100,000/= only with the consent of an ordinary resolution of the company's members. No such resolution had in fact been passed. B Ltd's articles permitted the directors to borrow amounts in excess of 100,000/= only with the consent of a special resolution of the company's members. No such resolution had been passed.

(c)

Check your answers with those given in Lesson 9 of the Study Pack

COMPREHENSIVE ASSIGNMENT No.2

TO BE SUBMITTED AFTER LESSON 4
To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by the College. EXAMINATION PAPER. TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS 1. a. Section 22 of the Company's Act provides that "the memorandum and articles shall, when registered, find the company and the members thereof ..." Explain this provision by reference to decided cases. b. What are the legal restrictions on a company's power to alter its articles of association?

2.

a. b.

What are the legal restrictions on a company's power to reduce its capital? How are the interests of the following safeguarded when a reduction of capital is proposed: i. ii. iii. creditors; shareholders; and future investors?

3.

Explain the different ways in which a person may become a member of a company.

4.

a. b.

What are the advantages and disadvantages of a floating charge as a form of security? What are the rules regarding the priorities between charges?

5.

Explain the legal rules relating to the appointment of company's directors

6.

Explain the legal status and duties of the company secretary.

END OF COMPREHENSIVE ASSIGNMENT No.2 NOW SEND TO THE DISTANCE LEARNING CENTRE FOR MARKING

LESSON 5
MEETINGS AND RESOLUTIONS
CONTENTS
1 2 3 Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9

STUDY TEXT 5.1 Company General Meetings These are held from time to time in order: (a) to comply with statutory provisions which require certain general meeting to be held in order to transact specified business, such as the statutory meeting, the annual general meeting and class meetings. to transact business which may only be transacted at a general meeting of the members or shareholders, such as alteration or reduction of the company's capital. to enable the directors and members to exchange views regarding the running of the company's affairs or resolve some existing dispute.

(b)

(c)

5.2

Types of General Meeting

5.2.1 The Statutory Meeting By section 130 every public company limited by shares and every public company limited by guarantee and having a share capital shall, within a period of not less than one month nor more than three months from the date at which the company is entitled to commence business, hold a general meeting of the members of the company, which shall be called the statutory meeting. The statutory

meeting is held for the specific purpose of enabling the members of the company to consider the statutory report. However, s.130(7) provides that "the members of the company present at the meeting shall be at liberty to discuss any matter relating to the formation of the company, or arising out of the statutory report, whether previous notice has been given or not." But no resolution of which notice has not been given in accordance with the articles may be passed at the meeting. Contents of the statutory report. Section 130(3) provides that the statutory report shall be certified by not less than two directors of the company and shall state (a) the total number of shares allotted, distinguishing shares allotted as fully or partially paid up otherwise than in cash, the consideration for which the shares have been allotted and, in the case of shares partly paid up, the extent to which they are so paid up; the total amount of cash received by the company in respect of all the shares allotted, distinguished as aforesaid; an abstract of the receipts of the company and of the payments made therein, up to a date within seven days of the report, exhibiting under distinctive headings the receipts of the company from shares and debentures and other sources, the payments made and particulars concerning the balance remaining in hand, and an account or estimate of the preliminary expenses of the company; the names, postal addresses and descriptions of the directors, auditors, if any, managers if any, and the secretary of the company; and the particulars of any contract the modification of which is to be submitted to the meeting for its approval, together with particulars of the modification or proposed modification.

(b)

(c)

(d)

(e)

By s.130(4) the statutory report shall, so far as it relates to the shares allotted by the company, the cash received in respect of such shares and the receipts any payments of the company on capital account, be certified as correct by the auditors, if any, of the company. By s.130(2) a copy of the statutory report is to be forwarded by the directors to every member of the company at least fourteen days before the day on which the statutory meeting is to be held. However, there is a proviso that if the report is forwarded later than prescribed, it shall be deemed to have been duly forwarded if it is so agreed by all the members entitled to attend and vote at the meeting. The directors shall cause a certified copy of the statutory report to be delivered to the registrar for registration forthwith after the sending thereof to the members of the company(s.130(5). List of Members S.130(6) provides that the directors shall cause a list showing the names and postal addresses of the members of the company, and the number of shares held by them respectively, to be produced at the commencement of the meeting and to remain open and accessible to any member of the company during the continuance of the meeting. By s.130(9) if there is any default in complying with the provisions of s.130, every director of the company who is knowingly and wilfully guilty of the default shall be liable to a fine not exceeding one thousand shillings. It should be noted that the statutory meeting is not held by a private company, and that it is held only once in the lifetime of a public company. It is the first official coming-together of the

company's members and is held within a very short time after the company is entitled to commence business. Its timing is important because the members are in fact being given a chance to ascertain, before it is too late, whether the minimum subscription was raised and, in the event of the minimum subscription not having been raised, to decide on whether to avoid the contract of allotment. These are matters in respect of which any procrastination could be financially disastrous for the members since the company could be put into liquidation before the members had come together to ascertain what had happened since the time the prospectus was issued. 5.2.2 The Annual General Meeting Section 131(1) provides that "every company shall in each year hold a general meeting as its annual general meeting in addition to any other meetings in that year, and shall specify the meeting as such in the notices calling it". Not more than fifteen months must elapse between the date of one annual general meeting and the next. The word "year" was defined in Gibson v Barton as "calendar year", ie. the period January 1 to December 31. S.131(1) has a proviso to the effect that, so long as a company holds its first annual general meeting within eighteen months of its incorporation, it need not hold it in the following year. Thus a company incorporated on October 1, 1992, need not hold its first annual general meeting until March 1994. Subsection (2) provides that if default is made in holding an annual general meeting in accordance with the aforesaid provisions, the registrar may, on the application of any member of the company, call or direct the calling of a general meeting of the company and give such ancillary or consequential directions as he thinks expedient, including a direction that one member of the company present in person or by proxy shall be deemed to constitute a meeting. The registrar is not bound to call or direct the calling of the meeting but, in the event of his refusing to do so, the aggrieved member may apply to the court for an order : Re: El Sombrero Ltd (88), in which the court made an order after the registrar had declined to do so. Section 131 does not provide for the business which may be transacted at the annual general meeting but Table A, Article 52 mentions the following as the "ordinary" or usual business at an annual general meeting: i. ii. iii. iv. declaring a dividend; the consideration of the accounts, balance sheets and the reports of the directors and auditors; the election of directors in the place of those retiring, and the appointment of, and the fixing of the remuneration of, the auditors.

Subsection 5 makes it a criminal offence punishable with a fine not exceeding two thousand shillings for the company and every officer of the company to fail to hold the annual general meeting or comply with any directions of the registrar regarding the calling and conduct of the meeting. 5.2.3 Extraordinary General Meetings S.132(1) provides for the convening of "extraordinary" general meeting but does not define it. Neither is the word "extraordinary" defined in any other section of the Act. However, Table A, Article 48 provides that all general meetings other than annual general meetings shall be called extraordinary general meetings.

Table A, Article 49 further provides that the directors may, whenever they think fit, convene an extraordinary general meeting. Further, by s.132(1), despite anything in the articles of a company, the directors are bound to convene an extraordinary general meeting of the company on the requisition of the holders of not less than one-tenth of the paid-up capital of the company carrying the right of voting at general meetings of the company, or, if the company has no share capital, of members representing not less than one-tenth of the total voting rights. S.132(2) provides that the requisition must state the objects of the meeting, and must be signed by the requisitionists and deposited at the registered office of the company. S.132(3) provides that if the directors do not within 21 days from the date of the deposit of the requisition proceed to convene a meeting, the requisitionists, or any of them representing more than one-half of the total voting rights of all of them, may themselves convene a meeting, so long as they do so within three months of the requisition. S.132(5) entitles the requisitionists to recover any reasonable expenses incurred in convening the meeting from the company, and the company may in turn recover these from the fees or other remuneration of the defaulting directors. The company's articles cannot deprive the members of the right to requisition a meeting under S.132 because the section requires the directors to proceed to convene a meeting on requisition "notwithstanding anything" in the company's articles. However, the section is defective in the sense that, although the directors are required to convene the meeting, they need not hold it within any particular limit of time. They may therefore defeat the purposes of the section by calling the meeting for a date, say, six months ahead, provided they do so within the 21 day period. In the event of their doing so the requisitionists cannot convene another meeting, as illustrated by Re: Windward Islands Enterprises (U.K) Ltd (1982). The Jenkins Committee recommended that the requisitionists should be empowered to call the meeting themselves if the directors call the meeting to be held later than 28 days after the notice convening it was sent out. The company's articles may also contain such a provision although the current Table A lacks one. Section 135(1) provides that, if for any reason it is impracticable to call or conduct a meeting of a company in accordance with the articles or the Act, the court may, either of its own motion or on application by any director or any member entitled to voted at the meeting, order a meeting to be called, held and conducted in such manner as the court thinks fit. Where the court makes an order, it may give such ancillary or consequential directions as it thinks expedient including a direction that one member of the company present in person or by proxy shall be deemed to constitute a meeting. The power of the court in this regard is illustrated by Re: El Sombrero Ltd (88). 5.2.4 Class Meetings "Class meetings" are not provided for by the Act. however, a class meeting may be held pursuant to the provisions of the company articles of association, if any. Table A, Article 4 allows a company to vary the rights attached to any class of shares if the variation is consented to in writing by the holders of three-fourths of the issued shares of that class or is sanctioned by a special resolution passed at "a separate general meeting of the holders of the shares of the class". The provisions of Table A in relation to general meetings shall apply to every such separate general meeting, except that the necessary quorum shall be two persons at least holding or representing by proxy one-third of the issued shares of the class. It should be noted that, although holders of other classes of shares may attend the meeting as happened in Carruth v I.C.I. Ltd, infra, they cannot vote thereat.

5.3

Convening of General Meetings General meetings are normally convened by the Board of Directors pursuant, to the relevant provision of the company's articles, such as Table A, Article 49. a) Table A, Article 49 empowers any director or any two members of the company to convene an extraordinary general meeting if at any time there are not within Kenya sufficient directors capable of acting to form a quorum. Such a meeting is to be convened in the same manner as nearly as possible as that in which meetings may be convened by the directors. S.132(3) empowers members holding not less than one-tenth of the paid-up capital of a company, or representing not less than one-tenth of the total voting rights of all the members, to convene an extra-ordinary general meeting of the company if the directors have failed to do so despite their requisition . S.134(b) empowers two or more members holding not less than one-tenth of the issued share capital, not less than five per cent in number of the members of the company, to call a meeting of the company if the articles do not provide otherwise.

b)

c)

The company secretary or other officer of the company has no power to call a general meeting: Re: State of Wyoming Syndicate (89). However, the directors may ratify the unauthorized act. Good Faith The directors must act in good faith when calling a meeting,. Thus, in Cannon v Tasks, the directors called the annual general meeting at an earlier date than was usual for the company to hold it. Their intention in doing so was to ensure that transfers of shares to certain persons who were likely to oppose some of their proposals would not be registered in time so that they would be unable to vote. An injunction stopping the meeting from being held was granted. However, once the directors have called the meeting they cannot postpone or cancel it. For example, in Smith v Paringa Mines Ltd, a notice was issued purporting to postpone the holding of a general meeting of shareholders which had previously been duly convened. One of the directors of the company who was in disagreement with the remainder of the board attended the meeting together with several shareholders. It was held that resolutions passed at the meeting were valid and effective. The purported postponement of the meeting was inoperative since the articles pursuant to which the meeting had ben convened did not give specific power to postpone a convened meeting. The proper course is for the meeting to be held and, with the consent of the majority of those present and voting, adjourned. 5.3.1 Length of Notice S.133(1) provides that any provision of a company's articles shall be void in so far as it provides for the calling of a meeting of the company (other than an adjourned meeting) by a shorter notice than 21 days. The notice must be in writing. S.133(2) provides that, except in so far as the articles of a company make other provision in that behalf (not being a provision avoided by S.133(1), a meeting of the company (other than an adjourned meeting) may be called giving twenty-one days notice in writing. This in effect means that a company's articles may provide for a longer period of notice than twenty-one days but cannot provide for a shorter period. By S.133(3) a meeting of a company, if called by a shorter period of notice than that prescribed in S.133(1) or by the company's articles, shall be deemed to have been duly called if it is so agreed -

a)

in the case of the annual general meeting, by all the members entitled to attend and vote at the meeting; and in the case of any other meeting, by a majority in number of the members having a right to attend and vote at the meeting, being a majority together holding not less than 95% in nominal value of the shares giving a right to attend and vote at the meeting; or in the case of a company not having a share capital, a majority together representing no less than 95% of the total voting rights at that meeting of all the members.

b)

It was explained in Re: Pearce Duff & Co. Ltd that the mere fact all the members are present at the meeting and pass a particular resolution, either unanimously or by a majority holding 95% of the voting rights, does not imply consent to short notice. Anyone who voted for the resolution can therefore change his mind afterwards and challenge it. S.133 does not indicate whether the days of notice must be "clear days". However, Table A, Article 50 provides that the notice "shall be exclusive of the day on which it is served or deemed to be served and of the day for which it is given". 5.3.2 Service of Notice Section 134 (a) provides that, unless the articles of the company make other provision in that behalf, notice of the meeting of a company shall be served on every member of the company in the manner in which notices are required to be served by Table A. Where the company's articles provides, as S.134(a) does, that notice of the meeting shall be served on every member, a failure to give notice to a single member would render the meeting a nullity at common law: Re: West Canadian Collieries Ltd (90) in which Plowman, J. stated: "It is well settled that as regards a general meeting failure to give notice to a single person entitlted to receive notice renders the meeting a nullity". The primary purpose of the common law rule appears to be to impose on the company's officers who are entrusted with the power of convening its meetings the obligation of acting fairly towards every member of company. They must invite all the members to the meeting and not just those whom they believe are likely to support private property to be run according to their personal whims. Although it might at first sight appear unfair to invalidate a meeting at which a majority of the company's members passed relevant resolutions, it should be borne in mind that those who attended the meeting and voted might not, after all, have voted the way they did if the aggrieved member had been present and drawn their attention to some aspect of the matter which they did not advert to during their deliberations. Needless to say, a single member can influence the entire general meeting without necessarily having to be a Mark Anthony. And it is vital for the proper management of the company's affairs that no decision of its members should be adopted as its own, and implemented, unless there is some reasonable assurance that, as it were, `no stone was left unturned' during the process of arriving at the particular decision. The common law rule applies irrespective of whether the failure to give notice of the meeting was deliberate or unintentional. However, it is competent for the company's members to reflect on the matter and, if they deem it appropriate, amend the company's articles by incorporation, therein of a suitable provision. For example, Table A, Article 51 provides that "the accidental omission to give notice of a meeting to.... any person entitled to receive notice shall not invalidate the proceedings at that meeting". In such a case, notice of the meeting would be deemed to have been given despite an "accidental omission " to give the notice: Re: West Canadian Caollieries Ltd(90) commenting on the apparent attempt of the article to validate "the proceedings at" the meeting rather than the meeting itself, Plowman, J. stated:

"It must, I think, be implicit.. that a meeting, the proceedings of which are to be taken to be valid notwithstanding the omission to be deemed to have been duly convened for the purposes of the articles... in the absence of such an implication, there would be no meeting the proceedings of which would be validated by the articles". In Musselwhite v C. H. Musselwhite & Son Ltd (91) it was explained that a deliberate failure to give notice of a meeting to a member on the mistaken grounds that the member was not entitled to the notice would not be regarded as an "accidental omission" within the relevant article, since it was a mistake of the law. The meeting was therefore declared null and void. Table A, Article 134 provides that notice of every general meeting shall be given to a) every member of the company except those members who (having no registered address within Kenya have not supplied to the company an address within Kenya for the giving of notices to them; the personal representation or trustee in bankruptcy of a member who, but for his death or bankruptcy, would be entitled to receive notice of the meeting, and the auditor for the time being of the company.

b)

c)

METHOD OF SERVICE Article 131 provides that a notice may be given by the company to any member either personally or by sending it by post to him at his registered address or at the address, if any, for the giving of notice to him. Where a notice is sent by post, service of the notice shall be deemed to be effected within 72 hours of properly addressing, prepaying and posting a letter containing the notice. Article 132 provides that a notice may be given by the company to the joint holders of a share by giving the notice to the joint holder first named in the register of members in respect of the share. Under Article 133, a notice may be given to the personal representative or trustee in bankruptcy by sending it through the post in a prepaid letter addressed to them by name, or by any official description, at the address, if any, within Kenya-supplied by them for the purpose, if no address has been supplied, the notice shall be given in any manner in which it might have been given if the death or bankruptcy of the registered holder had not occurred. CONTENTS OF THE NOTICE The notice convening a meeting must be clear and explicit so that the person receiving it may be in a position to decide whether or not he ought in his own interest to attend the meeting: Tiessen v Henderson (92). This is the fundamental legal requirement. In practice, however, the articles generally mention some of the items that have to be stated in the notice. For example, Table A, Article 50 states that the notice "shall specify the place, the day and the hour of of meeting and, in case of special business, the general nature of that business". If the meeting is the annual general meeting, the notice must "specify the meeting as such" as prescribed by s.131(1). If the meeting is convened to pass a special resolution the notice must specify "the intention to propose the resolution as a special resolution" (5.141(1)). 5.4 QUORUM

A quorum is the minimum number of persons who must be present at a meeting in order that the meeting may validly transact the business for which it was convened. Under Table A, article 53, no business is to be transacted at a general meeting unless a quorum of members is present "at the time when the meeting proceeds to business". In Re: Hartly Baird Ltd it was held that the words "of the time when the meeting proceeds to business" mean that the quorum is required only at the time when the meeting begins. There need therefore be no quorm after the meeting has began and it may be legally continued - provided there are at least two persons present who would constitute a valid meeting at common law. S.134(c) provides that, unless the articles otherwise provide (a) The quorum for a private company shall be two members present in person. This provision is modified by Table A, part II, Article 4 which states that the members may be present in person or by proxy. The quorum for a public company shall be three members personally present. Table A, Article 53, adopts this provision.

(b)

Where the articles prescribe a quorum of at least two members, and there is no quorum, there would also be no valid meeting. This is so because as was explained in Sharp v Dawes (93), "the word `meeting' prima facie means a coming together of more than one person". EXCEPTIONS A valid meeting may be constituted by the presence of one person in the following cases: (i) If the meeting is an annual general meeting which was called by, or on the direction of, the registrar pursuant to S.131(2). In such a case, the section empowers the registrar to direct "that one member of the company present in person or by proxy shall be deemed to constitute a meeting". If the meeting is one which has been called pursuant to a court order under S.135(1). The section empowers the court to direct that "one member of the company present in person or by proxy shall be deemed to constitute a meeting". This is illustrated by Re: El Sombren Ltd (88) If the meeting is a class meeting held pursuant to the provisions of the articles for the purpose of authorizing a variation of a right to those shares and all the shares are held by one member, as in East v Bennett Brothers Ltd(94). If the meeting is an adjourned meeting and the articles provide that "the member or members present shall be a quorum".

(ii)

(iii)

(iv)

5.41

ADJOURNMENT Table A, Article 54 provides that if within half an hour from the time appointed for the meeting a quorum is not present, the meeting, if convened upon the requisition of members, shall be dissolved, in any other case it shall stand adjourned to the same day in the next week, at the same time and place or to such other day and at such other time and place as the director may determine.

5.5

PROXIES By S.136(1), any member of a company entitled to attend and vote at a meeting of the company

shall be entitled to appoint another person (whether a member or not) as his proxy to attend and vote instead of him. A proxy appointed to attend and vote instead of a member of a private company shall also have the same right as the member to speak at the meeting. However, unless the articles otherwise provide (i) (ii) No proxy shall be appointed by a member of a company not having a share capital; and a member of a private company shall not be entitled to appoint more than one proxy to attend on the same occasion; and a proxy shall not be entitled to vote except on a poll.

(iii)

By S.136(2), every notice of a meeting must state the member`s right to appoint a proxy or proxies and that they need not be members. If default is made in complying with this subsection as respects any meeting every officer of the company who is in default shall be liable to a fine not exceeding Shs.1,000. S.136(3) renders void any provision contained in a company`s article requiring the instrument appointing a proxy to be received by the company or any other person more than 48 hours before a meeting or adjourned meeting in order that the appointment may be effective thereat. 5.6 THE CHAIRMAN The person legally endowed with authority to control and superintend the conduct of a meeting is generally styled "the chairman". He derives his authority from his appointment, and the mode of his appointment will depend upon the type of meeting over which he is called upon to preside. 5.6.1 ELECTION OF CHAIRMAN S.134(d) provides that, unless the articles of a company contain a contrary provision, any member elected by the members present at a meeting may be chairman thereof. In such a case, either those responsible for the convening of the meeting or some other member of it will nominate a proposed chairman. There is no general rule which requires such a proposal to be supported by a seconder, but it is customary that it be formally seconded. The proposal is then put to the meeting, and upon its being carried the nominee becomes the chairman of the meeting, deriving his authority from the consensus of those present. Table A,Article 55 provides that the chairman, if any, of the board of directors shall preside as chairman at every general meeting of the company, or if there is no such chairman, fifteen minutes after the time appointed for the holding of the meeting or he is unwilling to act, the directors present shall elect one of their number to be chairman of the meeting. Article 56 further provides that if at any meeting no director is willing to act as chairman or if no director is present within fifteen minutes after the time appointed for holding the meeting, the members present shall choose one of their number to be chairman of the meeting.

5.6.2 FUNCTION AND POWERS OF CHAIRMAN In the case of National Dwellings Society v Sykes Chitty, J. stated: "It is the duty of the chairman, and his function, to preserve order, and to take care that the

proceedings are conducted in a proper manner, and that the sense of the meeting is properly ascertained with regard to any question which is properly before the meeting". From this dictum and other judicial decisions the principal powers and duties of a chairman emerge as the following:(i) (ii) (iii) (iv) (v) (vi) Determining that the meeting is properly constituted and that a quorum is present. Informing himself as to the business and objects thereof Preserving order in the conduct of those present. Containing discussion within the scope of the meeting and reasonable limits of time. Deciding whether proposed motions and amendments are in order. Formulating for discussion and decision questions which have been moved for the consideration of the meeting. Deciding points of order and other incidental matters which require decision at the time.

(vii)

(viii) Ascertaining the sense of the meeting by(a) (b) (c) putting relevant questions to the meeting and taking a vote on them (and, where authorised, giving a casting vote.) declaring the result, and causing a poll to be taken if duly demanded

(ix)

In the case of a meeting which is recurrent or is one of a series, to deal with the record or minutes of the proceedings.

(xi) Declaring the meeting closed when business has been completed. Regarding this point, it should be noted that the chairman has no power to adjourn a meeting merely because the proceedings have taken a turn which he himself does not like: National Dwellings Society v Sykes (95). However, he may adjourn the meeting if it becomes disorderly or if the members present agree.

5.7

PROCEEDINGS AT MEETINGS

(a)

Each item of business comprised in the notice should be taken separately, discussed and put to the vote. Members may propose ammendments to the resolutions. The chairman should reject any amendment which is outside the limits set by the notice convening the meeting. With ordinary business this rule may present no difficulty with special business, which has necessarily been described in details in the notice, there are only limited possibilities of amendment. If the special business is an ordinary resolution it may be possible to amend it so as to reduce its effect to something less (provided that the change does not entirely alter its character) eg. an ordinary resolution authorising the directors to borrow 100,000 pounds might be amended to substitute a limit of 50,000 pounds (but not to increase it to 150,000 pounds as 100,000 pounds would have been stated in the notice). It is not possible to pass a special resolution which differs in substance from the text set out in the notice.

Case: RE MOORGATE MERCANTILE HOLDINGS (1980) A special resolution set out in the notice provided for the total cancellation of a share premium account balance of 1,356,900.48 pounds since the assets which it represented had been lost ( form of reduction of share capital). At the meeting the resolution was amended, for technical reasons, to reduce the balance to 321.17 pounds and it was passed in that form. Held: The resolution as passed was invalid since it was not the special resolution of which notice had been given. Even the retention of 321 pounds out of 1.4m pounds is a change of substance. (b) If the chairman wrongly rejects an amendment and the resolution is carried in its original form it is invalid. If he allows the amendment to be discussed it should be put to the vote before the original resolution. If the amendment is carried the resolution as amended is then put to the vote. The rights of members to vote and the number of votes to which they are entitled in respect of their shares are fixed by the articles. One vote per share is normal but some shares, eg. preference shares, may carry no voting rights in normal circumstances. To shorten the proceedings at meetings the procedure is: i. on putting a resolution to the vote the chairman calls for a show of hands, ie. one vote may be given by each member present in person: proxies do not vote. The chairman declares the result. Unless a poll is then demanded, the chairman's declaration (duly recorded in the minutes) is conclusive. No one can re-count hands after the meeting (but see para 35 below). If a real test of voting strength is required a poll may be demanded. The result of the previous show of hands is then disregarded. On a poll every member and also proxies representing absent members may cast the full number of votes to which they are entitled. A poll need not be held forthwith but may be postponed so that arrangements to hold it can be made.

(c)

ii.

Although the chairman's declaration of the result of a vote on a show of hands is made "conclusive" (by the articles {Table A Art 58} and by CA s.141(2) as regards special resolutions) unless a poll is demanded, this is not as absolute and final a decision as the word "conclusive" suggests. It prevents subsequent argument about the count of hands raised on a show of hands. But it is still possible to challenge the chairman's declaration on the ground that it was fraudulent or manifestly wrong. Case: RE CARATAL (NEW) MINES LTD (1902) A special resolution was put to the vote on show of hands. The chairman counted the hands raised "for" and "against" and said "6 for and 23 against but there were 200 voting by proxy and I declare the resolution carried". This declaration was later challenged in court. Held: The declaration invalid since on the chairman's own figures there was no majority on a show of hands. Proxies may vote on a poll (which had not been held) but not on show of hands and should have been disregarded. (d) Any provision in the articles is void insofar as its effect is: (a) to exclude the right to demand a poll on any question other than the election of a chairman by the meeting or an adjournment;

(b)

to make ineffective a demand for a poll: i. ii. iii. by not less than five members by member(s) representing not less than one-tenth of the total voting rights: by member(s) holding shares which represent not less than one-tenth of the paid-up capital;

ie. the articles may well say that three people may demand a poll but cannot validly say that at least six people are required - such a rule would be void and five people could demand a poll. (s.137) (e) When a poll is held it is usual to appoint "scrutineers" and to ask members and proxies to sign voting cards or lists. The votes cast are checked against the register of members and the chairman declares the result. In voting either by show of hands or on a poll it is the number of votes cast which determines the result. Votes which are not cast, whether the member who does not use them is present or absent are simply disregarded. Hence the majority vote may be much less than half or three quarters) of the total votes which could be cast.

(f)

5.8

Resolutions A meeting reaches a decision by passing a resolution. There are two kinds of resolution, ie. (a) an ordinary resolution which is carried by a simple majority of votes cast. Where no other kind of resolution is specified "resolution" means an ordinary resolution; and a special resolution which requires both a three-quarters majority of votes cast and 21 days notice: (s.142).

(b)

5.8.1 Apart from the required size of the majority and period of notice the main differences between the types of resolution are: (a) the text of special resolutions must be set out in full in the notice convening the meeting (and it must be described as special resolution): CA s.142. This is not necessary for an ordinary resolution if it is ordinary business; and a signed copy of every special resolution (and equivalent decisions by unanimous consent of members) must be delivered to the registrar for filing. Some ordinary resolutions, particularly those relating to share capital, have to be delivered for filing but many do not.

(b)

5.8.2 The prescribed 21 days notice for a special resolution may be waived with the consent of a majority of members holding not less than 95% of issued shares carrying voting rights (unless of course it is to be proposed at an AGM when 100% consent is required). 5.8.3 A special resolution is required for major changes in the company such as a change of name, alteration of objects or of the articles, reduction of share capital, and winding up the company voluntarily (except on grounds of insolvency or under the provisions of the articles) or presenting a petition by the company for an order for compulsory winding up. 5.9 Minutes Separate minutes or proceedings of directors and general meetings must be kept; the latter are open

to inspection by members. The minutes when signed by the chairman of the meeting or next succeeding meeting, are prima facie evidence of the proceedings (ss.145 - 146). 5.10 When a Meeting is Unnecessary

5.10.1 The purpose of holding general meetings with all the formality which this entails is to give to each member the opportunity of voting (in person or by proxy) on the resolutions before the meeting. If the meeting is not properly convened and held its purported decisions are not binding on any member who disagrees with and challenges them. His right to do so exists whether he was absent from the meeting or attended it but was in the minority. But this is a protection given to a dissenting member. If every member in fact agrees it would be pointless and wrong to allow any non-member to dispute the validity of the unanimous decision because unanimity was achieved in some informal way. 5.10.2 Accordingly a unanimous decision of the members is treated as a substitute for a formal decision in general meeting properly convened and held and is equally binding. Case: RE EXPRESS ENGINEERING WORKS (1920) The five individuals who were both the directors and all the members of the company held a directors' meeting and resolved unanimously to issue debentures. For technical reasons their decision as directors was invalid but could be ratified by a general meeting. Held: The decision was valid since it had been agreed to by everyone who could have voted on it at a general meeting. In the above case there was a meeting. But the principle was later extended to cases where, without holding any meeting at all the members had all, even if informally, agreed to the relevant decision. Case: RE DUOMATIC (1969) The company was in liquidation and the liquidator sought to recover three payments which he asserted had not been properly approved in general meeting as was required. These were: (a) compensation paid to a director for loss of office. The payment had been approved by three directors who were also the only ordinary shareholders entitled to attend and vote but it had not been disclosed (as is required by CA s.192) to the holders of non-voting preference shares; remuneration paid to directors and later sanctioned by all shareholders through approval of the accounts in which these payments were disclosed; the remuneration paid in advance of approval by shareholders was made in accordance with previous practice. It was irregular but the directors would be excused (under CA s.402).

(b)

(c)

5.10.3 Finally the assent principle of unanimity of the members has been extended to cover cases where every member had the opportunity to object and either voted in favour or merely abstained. Case: RE BAILEY HAY & CO LTD (1971) All five members of the company attended a general meeting which had not been validly convened owing to a defective notice. At the meeting two members voted in favour of a resolution to wind up the company and the other three abstained.

Held: There was sufficient "unanimity" to validate the resolution since all members had been present and none had dissented. By this means informal decisions which would otherwise be invalid are valid. The same principle may be given formal recognition by articles which provide that a written resolution signed by all the members should have the same effect as a resolution duly passed at a general meeting. Articles in this form substitute one formality (a resolution signed by all members) for another (a resolution passed in general meeting). The assent principle is more flexible since it recognises as valid a unanimous agreement of the members reached without any meeting or other formality at all. 5.11 REGISTRATION OF RESOLUTIONS By S.143(1) a printed copy of the following resolutions shall, within 30 days after the passing thereof, be delivered to the registrar for registration: (a) Special resolutions; (b) resolutions agreed to by all the members which would otherwise not have been effective unless passed as special resolutions; resolutions agreed to by all the members of a class of shareholders; and resolutions requiring a company to be wound up voluntarily.

(c) (d)

By S.144 where a resolution is passed at an adjourned meeting of (a) a company (b) (c) the holders of any class of shares in a company; the directors of a company, the resolution is treated as having been passed on the date on which it was in fact passed on the date of the original meeting.

REINFORCING QUESTIONS
1. "What exceptions are there to the rule in Sharp v Dawes (1876) 2 Q.B.D. that one person cannot constitute a meeting?" a. The general legal principle is that a company has a separate legal existence from that of its members. In what circumstances does that principle apply? Give examples of such situations. Walter is employed as managing director by Clipse Ltd, whose main object is to retail office equipment. His contract of employment contains a clause that, in the event of his leaving the employment of Clipse Ltd, he will not solicit their customers for a period of two years. He later resigned from his employment and advised his wife Jean and a friend of his to form a new company, Desks Ltd, whose main object is also to retail office equipment. Bill is a salesman employed by Desks Ltd. He was given customer lists by Walter and immediately started soliciting Clipse Ltd's customers. In order to raise cash for his new business, Walter enters into a contract to sell his house to Wilf for one million shillings. Bill, who has always admired the house, approached Walter and made an offer to buy the house for Shs 1,200,000. Walter then transferred the ownership of the house to Desks Ltd, and on behalf of the company entered into negotiations to sell the house to Bill. Advise Clipse Ltd and Wilf on any action they can take.

2.

b.

Check your answers with those given in Lesson 9 of the Study Pack

LESSON 6
ACCOUNTS AND AUDIT
CONTENTS
1 2 3 Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9

STUDY TEXT

6.1

Books of Account By s.147(1) every company shall cause to be kept in the English language "proper books of account" with respect to (a) all sums of money received and expended by the company and the matters in respect of which the receipt and expenditure takes place; all sales and purchases of goods by the company; the assets and liabilities of the company.

(b) (c)

S.147(2) provides that "proper books of account" shall be deemed not to have been kept with respect to the matters aforesaid if there are not kept such books as are necessary to give a true and fair view of the state of the company's affairs and to explain its transactions. By s.147(3) (a) the books of account are to be kept at the registered office of the company or, with the consent of the registrar and subject to such conditions as he may impose, at such other place as the directors think fit, and shall at all times be open to inspection by the directors.

6.2

Profit and Loss Account By s.148(1) the directors of every company shall, at some date not later than eighteen months after the incorporation of the company and subsequently once at least in every calendar year, lay before the company in general meeting a profit and loss account for the period, in the case of the first account, since the incorporation of the company, and, in any other case, since the preceding account. The account shall be made up to a date not earlier than the date of the meeting by more than nine months or, in the case of a company carrying on business or having interests abroad, by more than twelve months. A company which does not trade for profit is required to lay an income and expenditure account instead of a profit and loss account. The period during which the accounts are to be laid before the general meeting may be extended by the registrar for any special reasons.

6.3

Contents and Form of Accounts By s.149(1), every balance sheet shall give a true and fair view of the state of affairs of the company as at the end of its financial year, and every profit and loss account shall give a true and fair view of the profit or loss of the company for the financial year. By s.149(2), a company's balance sheet and profit and loss account shall comply with the requirements of the Sixth Schedule to the Act, (subject to such modifications as the registrar may, on the application or with the consent of the company's directors, allow).

6.4

Group Accounts S.150(1) provides that if, at the end of its financial year, a company has subsidiaries, then it must include in its annual accounts "group accounts" dealing with the affairs of the subsidiaries as well. By s.150(2)(b) group accounts need not deal with a subsidiary of the company if the company's directors are of opinion that i. it is impracticable, or would be of no real value to the members of the company, in view of the insignificant amounts involved, or would involve expense or delay out of proportion to the value to members of the company; or the result would be misleading; or the result would be harmful to the business of the company or any of its subsidiaries; or the business of the holding company and that of the subsidiary are so different that they cannot reasonably be treated as a single undertaking.

ii. iii. iv.

The approval of the registrar shall be required for not dealing in group accounts with a subsidiary on grounds (iii) or (iv). By s.150(2)(a), a company is exempt from the obligation to prepare group accounts if it is a wholly owned subsidiary of another body corporate incorporated in Kenya. 6.5 Form of Group Accounts S.151(1) provides that the group accounts laid before a holding company shall be consolidated accounts comprising

(a)

a consolidated balance sheet dealing with the state of affairs of the company and all the subsidiaries to be dealt with in group accounts; a consolidated profit and loss account dealing with the profit or loss of the company and those subsidiaries.

(b)

However, the group accounts need not be prepared in this form if the directors are of the view that they could be prepared in another form which would be readily appreciated by the company's members (s.15(1)). 6.6 Contents of Group Accounts By s.152(1), the group accounts laid before a company shall give a true and fair view of the state of affairs and profit or loss of the company and the subsidiaries dealt with thereby as a whole, so far as concerns members of the company. S.153(1) further provides that the group accounts, if prepared as consolidated accounts, shall comply with the requirements of the Sixth Schedule to the Act, so far as applicable thereto, and if not so prepared, shall give the same or equivalent information. 6.7 Financial Year of Holding Company and Subsidiary S.153(1) provides that a holding company's directors shall ensure that, except where in their opinion there are good reasons against it, the financial year of each of its subsidiaries shall coincide with the company's own financial year. By s.153(2) the registrar is empowered to postpone the submission of a company's accounts to a general meeting from one calendar year to the next for purposes of enabling the company's financial year to end with that of the holding company. 6.8 Balance sheet S.148(2) requires the directors to prepare and lay before the company in general meeting a balance sheet as at the date to which the profit and loss account, or the income and expenditure account, is made up. By s.155(1) the balance sheet shall be signed on behalf of the board by two of the directors of the company, or if there is only one director, by that director. By s.155(4) if any balance sheet is not signed as required but a copy is issued, circulated or published, the company and every officer who is in default shall be liable to a fine not exceeding one thousand shillings. 6.9 Accounts to be Annexed to Balance Sheet By S.156 (1) the profit and loss account, and, so far as not incorporated in the balance sheet or profit and loss account, any group accounts laid before the company in general meeting, shall be annexed to the balance sheet. however, S.156 (2) requires the accounts so annexed to be approved by the board of directors before the balance sheet is signed on their behalf. By S.156 (3), if any copy of the balance sheet is issued, circulated or published without having annexed thereto a copy of the profit and loss to be annexed, the company and every officer of the company who is in default shall be liable to a fine not exceeding one thousand shillings.

6.10

Directors Report By S.157 (1) the balance sheet must have attached to it a directors' report on the company's affairs, including the amount, if any, which they recommend should be paid by way of dividend, and the amount, if any, which they propose to carry to reserves within the meaning of the Sixth Schedule to the Act.

6.11

AUDITORS

6.11.1 APPOINTMENT: S.159 (1) provides that "every company shall at each annual general meeting appoint an auditor or auditors to hold office from the conclusion of that, until the conclusion of the next, annual general meeting". 6.11.2 REAPPOINTMENT: By S.159 (2) a retiring auditor shall be deemed to be reappointed without any resolution being passed unless:a) b) he is not qualified for reappointment; or a resolution has been passed at that meeting (i.e. annual general meeting) appointing somebody instead of him or providing expressly that he shall not be appointed; or he has given the company notice in writing of his unwillingness to be reappointed.

c)

6.11.3 APPOINTMENT BY REGISTRAR: "Where at an annual general meeting no auditors are appointed or are deemed to be reappointed, the Registrar may appoint a person to fill the vacancy" (S.159 (3). 6.11.4 APPOINTMENT BY DIRECTORS: The first auditors of a company may be appointed by the directors at any time before the first annual general meeting, and auditors so appointed shall hold office until the conclusion of that meeting. In default of appointment of the first auditors by directors the company may do so. Where the directors have appointed the first auditors, the company may "at a general meeting remove such auditors and appoint in their place any other persons who have been nominated for appointment by any member of the company. Notice of nomination to be given to the members at least FOURTEEN DAYS before the date of the meeting. 6.11.5 CASUAL VACANCIES: By S.159 (6) "The directors may fill any casual vacancy in th office of auditor, but while any such vacancy continues the surviving or continuing auditor or auditors, if any, may act". 6.11.6 QUALIFICATIONS: By S.161 (1) "A person or firm shall not be qualified for appointment as auditor of a company unless he or, in the case of a firm, every partner in the firm is the holder of a practising certificate issued pursuant to s.21 of the Accountants Act

6.11.7 PERSONS WHO CANNOT BE APPOINTED: Under S.161 (2) none of the following persons shall be qualified for appointment as auditor of a company a) b) c) d) an officer or servant of the company; a person who is a partner of or in the employment of an officer or servant of the company (unless the company is a private company); a body corporate, and persons who are disqualified for appointment as auditor of the company's subsidiary or holding company or subsidiary of the company's holding company.

6.11.8 PENALTY FOR IMPROPER APPOINTMENT: S.161 (4) provides that if any unqualified person is appointed as auditor, the person appointed, the company and every officer in default, shall be liable to a fine not exceeding Shs.4,000/-. 6.11.9 DUTIES OF AUDITORS The duties of auditors are explained in the following cases. 1. RE: KINGSTON COTTON MILL CO. (1896)(CHANCERY) For some years before a company was wound up, balance sheets signed by the auditors were published by the directors to the shareholders in which the value of the company's stock-intrade at the end of each year was grossly overstated. The auditors relied on certificates, willfully false, given by J., one of the directors who was also manager, as to the value of the stock-in-trade. Dividends were paid for some years on the footing that the balance sheets were correct but if the stock-in-trade had been stated at its true value it would have appeared that there were no profits out of which a dividend could be paid. NOTE: i) In each case the amount of stock-in-trade at the end of the year was entered in the balance sheet "as per manager's certificate". The manager was a man of great business ability and of high repute , and up to the stoppage of the company was trusted by everyone; but he had designedly exaggerated the value of the stock-in-trade in order to make the company appear prosperous.

ii)

QUESTION: Was it the duty of the auditors to test the accuracy of the manager's certificate by a comparison of the figures in the books, and were they liable for the dividends which had been paid in consequence of the erroneous balance sheets? HELD: It being not part of the duty of the auditors to take stock, they were justified in relying on the certificates of the manager, a person of acknowledged competence and high reputation, and they were not bound to check his certificates in the absence of anything to raise suspicion. They were not liable for the dividends wrongfully paid. NOTE:

i)

An auditor is not bound to be suspicious where there are no circumstances to arouse suspicion; he is only bound to exercise a reasonable amount of care and skill. Where an officer of a company has committed a breach of his duty to the company, the direct consequence of which has been a misapplication of its assets, for which he could be made responsible in an action, such breach of duty is a "misfeasance' for which he may be summarily proceeded against under the Companies Act, and it is not necessary that an action should be brought. The object of the section is to facilitate the recovery by the liquidator of assets of a company improperly dealt with by its promoters, directors and other officers. The section applies to breaches of trust and to misfeasances by such persons, but is inapplicable to cases of breach of contract, trespass, negligence, etc.

ii)

LINDLEY, LJ stated:

...To decide this question, it is necessary to consider 1) 2) what their duty was; how they performed it, and in what respects (if any) they failed to perform it. The duty of an auditor generally was very carefully considered by this court in RE: LONDON AND GENERAL BANK (1895) and I cannot usefully add anything to what will be found there. It was there pointed out that an auditor`s duty is to examine the books, ascertain that they are right, and to prepare a balance sheet showing the true financial position of the company at the time to which the balance sheet refers. But it was also pointed out that an auditor is not an insurer, and that in the discharge of his duty he is only bound to exercise a reasonable amount of care and skill. It was further pointed out that what in any particular case is a reasonable amount of care and skill depends on the circumstances of the case; that if there is nothing which ought to excite suspicion, less care may or ought to have been aroused. These are the general principles which have to be applied to cases of this description. I protest, however, against the notion that an auditor is bound to be suspicious as distinguished from reasonably careful. To substitute the one expression for the other may easily lead to serious error...... Auditors are, however, in my opinion bound to see what exceptional duties, if any, are cast upon them by the articles of the company whose accounts they are called upon to audit. Ignorance of the articles and of exceptional duties imposed by them would not afford any legal justification for not observing them....... (such as taking stock). The complaints made against the auditors in this particular case... is that they failed to detect certain frauds. There is no charge of dishonesty on the part of the auditors. They did not certify or pass anything which they did not honestly believe to be true. It is said, however, that they were culpably careless...... frauds were committed by the manager, who in order to bolster up the company and to make it appear flourishing when it was the reverse, deliberately exaggerated both the quantities and values of the cotton and yarn in the company`s mills.... I confess I cannot see that their omission to check his (i.e. manager`s) returns was a breach of their duty to the company. It is no part of an auditor`s duty to take stock..... He must rely on other people for details of the stock in trade on hand. In the case of a cotton mill he must rely on some skilled person for the materials necessary to enable him to enter the stock-in-trade at its proper value in the balance sheet. In this case the auditors relied on the manager. He was a man of high character and of unquestionable competence. He was trusted by every one who knew him.... the directors are not to be

blamed for trusting him. The auditors had no suspicion that he was not to be trusted to give accurate information as to the stock-in-trade in hand, and they trusted him accordingly in that matter. But it is said that they ought not to have done so, and for this reason. The stock journal showed the quantities that is, the weight in pounds of the cotton and yarn at the end of each year. Other books showed the quantities of cotton bought during the year and the quantities of yarn sold during the year. If these books had been compared by the auditors they would have found that the quantity of cotton and yarn in hand at the end of the year ought to be much less than the quantity shown in the stock journal, and so much less that the value of the cotton and yarn entered in the stock journal could not be right, or at all events was so abnormally large as to excite suspicion and demand further inquiry....... But although it is no doubt true that such a process might have been gone through, and that, if gone through, the fraud would have been discovered, can it be truly said that the auditors were wanting in reasonable care not thinking it necessary to test the managing director`s return? I cannot bring myself to think they were, nor do I think that any jury of businessmen would take a different view. It is not sufficient to say that the frauds must have been detected if the entries in the books had been put together in a way which never occurred to any one before suspicion was aroused. The question is whether, no suspicion of anything wrong being entertained, there was a want of reasonable care on the part of the auditors in relying on the returns made by a competent and trusted expert relating to matters on which information from such a person was essential. I cannot think there was. The manager had no apparent conflict between his interest and his duty. His position was not similar to that of a cashier who was to account for the cash which he receives, and whose own account of his receipts and payments could not reasonably be taken by an auditor without further inquiry. LOPES,LJ.:" ... (1) What is a misfeasance within the meaning of S.324(1)? Have the auditors in the circumstances of this case committed a misfeasance? It has been held that an auditor is an officer within the meaning of the Section:- In RE LONDON AND GENERAL BANK. But has there been any misfeasance by the auditors? This depends upon what meaning is to be assigned to the word "misfeasance" as used in this section. The learned judge in the court below held that misfeasance covered any misconduct by an officer of the company as such for which such officer might have been sued apart from the section. In my judgement this is too wide. It would cover any act of negligence - any actionable wrong by an officer of a company which did not involve any misapplication of the assets of the company. The object of this section of the Act is to enable the liquidator to recover any assets of the company improperly dealt with by any officer of the company, and must be interpreted bearing that object in mind. It doubtless covers any breach of duty by an officer of the company in his capacity of officer resulting in any improper misapplication of the assets or property of the company........ It is the duty of an auditor to bring to bear on the work he has to perform that skill, care, and caution which a reasonably competent, careful, and cautious auditor would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case. An auditor is not bound to be a detective, or, as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watchdog, but not a blood bound. He is justified in believing, tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest, and so rely upon their representations, provided, he takes reasonable care. If there is anything calculated to excite suspicion he should probe it to the bottom; but in the absence of anything of that kind he is only bound to be reasonably cautious and careful. It is not the duty of an auditor to take stock; he is not a stock expert; there are many matters in respect of which he must rely on the honesty and accuracy of others. He does not guarantee the discovery of all frauds..... The duties of auditors must not be rendered too onerous. Their work is responsible and laborious, and the remuneration moderate. I should be sorry to see the liability of auditors extended any further than in RE LONDON AND GENERAL BANK........

Auditors must not be made liable for not tracking out ingenious and carefully laid schemes of fraud when there is nothing to arouse their suspicion, and when those frauds are perpetrated by tried servants of the company and are undetected for years by the directors. So to hold would make the position of an auditor intolerable..... KAY, LJ.: ".... The words of the section are "any misfeasance or breach of trust in relation to the company.... misfeasance means something other than a breach of trust...... it does not mean mere non-feasance: RE WEDGWOOD COAL AND IRON CO...... I think the only safe interpretation to adopt is that it includes all cases other than breaches of trust in which an officer of the company has been guilty of a breach of his duty as such officer which has caused pecuniary loss to the company by misapplication of its assets, and for which he might have been made liable in a action......" 2. RE LONDON AND GENERAL BANK An auditor represented a confidential report to the directors calling their attention to the insufficiency of the securities in which the capital of the company was invested, and the difficulty of realizing them, but in his report to the shareholders merely stated that the value of the assets was dependent on realization, and in the result the shareholders were deceived as to the condition of the company, and a dividend was declared out of capital and not out of income. HELD: The auditors had been guilty of misfeasance under S.10 of the Companies (winding-up) Act, 1890, and was liable to make good the amount of dividend paid (amounting to $14,433.3s). LINDLEY, LJ.: "....... it is the duty of the directors, and not of the auditors, to recommend to the shareholders the amounts to be appropriated for dividends and it is the duty of the directors to have proper accounts kept, so as to show the true state and condition of the company........ it is for the shareholders, but only on the recommendation of the directors, to declare a dividend. It is impossible to read the section of the Companies Act without being struck with the importance of the enactment that the auditors are to be appointed by the shareholders, and are to report to them directly, and not to or through the directors. The object of this enactment is obvious. It evidently is to secure to the shareholders independent and reliable information respecting the true financial position of the company at the time of the audit..... It is no part of an auditor's duty to give advice, either to directors or shareholders, as to what they ought to do. An auditor has nothing to do with the prudence or imprudence of making loans with or without security. It is nothing to him whether the business of a company is being conducted prudently or imprudently, profitably or unprofitably. It is nothing to him whether dividends are properly or improperly declared, provided he discharges his own duty to the shareholders. His business is to ascertain and state the true financial position of the company at the time of the audit, and his duty is confined to that. But then comes the question, how is he to ascertain that position? The answer is, by examining the books of the company. But he does not discharge his duty by doing this without inquiry and without taking any trouble to see that the books themselves show the company's true position. He must take reasonable care to ascertain that they do so. Unless he does this his audit would be worse than idle farce. Assuming the books to be so kept as to show the company's true financial position, the auditor has to frame a balance showing that position according to the books and to certify that the balance sheet represented is correct in that sense. But his first duty is to examine the books, not merely for the purposes of ascertaining what they do show, but also for the purposes of satisfying himself that they show the true financial position of the company....... An auditor, however,

is not bound to do more than exercise reasonable care and skill in making inquiries, and investigations. He is not an insurer; he does not guarantee that the books do correctly show the true position of the company's affairs; he does not even guarantee that his balance sheet is accurate according to the books of the company. If he did, he would be responsible for error on his part, even if he were himself deceived without any want of reasonable care on his part, say, by the fraudulent concealment of a book from him. His obligation is not so onerous as this. Such I take to be the duty of the auditor; he must be honest.... i.e.he must not certify what he does not believe to be true, and he must take reasonable care and skill before he believes that what he certifies is true. What is reasonable care in any particular case depend upon the circumstances of that case. Where there is nothing to excite suspicion very little inquiry will be reasonably sufficient, and in practice I believe businessmen select a few cases at haphazard, see that they are right, and assume that others like them are correct also. Where suspicion is aroused more care is obviously necessary; but, still, an auditor is not bound to exercise more than reasonable care and skill, even in a case of suspicion, and he is perfectly justified in acting on the opinion of an expert where special knowledge is required....... It is satisfactory to find that the legal standard of duty is not too high for business purposes, and is recognized as correct by businessmen..... A person whose duty it is to convey information to others does not discharge that duty by simply giving them so much information as is calculated to induce them,or some of them, to ask for more. Information and means of information are by no means equivalent terms.... The auditor is to make a report to the shareholders, but the mode of doing so and the form of the report are not prescribed..... an auditor who gives shareholders means of information instead of information respecting a company's financial position does so at his peril and runs the very serious risk of being held judicially to have failed to discharge his duty . In this case I have no hesitation in saying that Mr. Theobald did fail to discharge his duty to the shareholders in certifying and laying before them the balance sheet...... without any reference to the report which he laid before the directors and with no other warning than is conveyed by the words, "The value of the assets as shown on the balance sheet is dependent upon realization". It is a mere truism to say that the value of loans and securities depends on their realization. We were told that a statement to that effect, is so unusual in an auditor's certificate that the mere presence of those words was enough to excite suspicion. But, as already stated, the duty of an auditor might infer from an unusual statement that something was seriously wrong, it by no means follows that ordinary people would have their suspicion aroused by a similar statement, if, as in this case, its language expresses no more than any ordinary person would infer without.....the balance sheet and profit and loss account being true and correct in the sense that they were in accordance with the books. But they were, nevertheless, entirely misleading, and misrepresented the real position of the company. Under these circumstances I am compelled to hold that Mr. Theobald failed to discharge his duty to the shareholders... Possibly he did not realize the extent of his duty to the shareholders as distinguished from the directors, and he unfortunately consented to leave the Chairman to explain the true state of the company to the shareholders instead of doing so himself. The fact, however, remains, and cannot be got over, that the balance sheet and certificate of February 1892 did not show the true position of the company at the end of 1891, and that this was owing to the omission by the auditor to lay before the shareholders the material information which he had obtained in the course of his employment as auditor of the company, and to which he called the attention of the directors.... Where did the money come from with which the dividends were paid? The money came from cash at the bankers or in hand; but this cash could not be properly treated as profit, and the directors and auditors knew this perfectly well...." RIGBY, LJ. "....The articles of association cannot absolve the auditors from any obligation

imposed upon them by the statute.... Under the statute the members of the company are entitled to have the safeguard of an expression of opinion of the auditors to the effect, first, that the balance sheet, is properly drawn up so as to exhibit a true and correct view of the state of the company's affairs. The words "as shown by the books of the company" seem to me to be introduced to relieve the auditors from any responsibility as to affairs of the company kept out of the books and concealed from them, but not to confine it to a mere statement of the correspondence of the balance sheet with entries in the books. A full and fair balance sheet must be such a balance sheet as to convey any known causes of weakness in the financial position, or suggest anything which cannot be supported as fairly correct in a business point of view." 3. RE ALLEN CRAIG & CO. (LONDON) LTD. (1934) Chapter.483 The reports and balance sheets for the years ending June 30, 1925, and, June 30, 1926, were signed by two directors. The reports annexed to these balance sheets were signed by the auditors. The question was: What was the duty of auditors in respect of these two balance sheets? The auditors merely sent the reports and balance sheets to the secretary of the company, and they never got beyond the secretary. The directors never called a general meeting to consider theses balance sheets and reports. By S.162 (1) of the Companies Act "The auditors shall make a report to the members on the accounts examined by them, and on every balance sheet laid before the company in general meeting during their tenure of office......" BENNET, J: "....Does the statute impose on the auditors the duty of making their report to every member of the company? Now if you give the words their plain meaning it would seem that that obligation is imposed on them. But when you begin to reflect on the question it cannot, I think, have been the intention of the legislators to impose that duty on the auditors and it certainly has never been the practice, since the obligation has been imposed, for auditors themselves to send their reports to every member of the company... I do not think it possible to hold that the words "the members".... mean "all the members". It cannot be that the auditors are to be at the expense and trouble not merely of sending their report through the post but of delivering a copy to every member. It seems that one is forced by circumstances to limit the meaning of the words "the members" and I hold that they mean "the members assembled in the general meeting".... if the report is to be made to the members in general meeting, then it would not be right, I think, to hold that the duty of the auditors is to make that report themselves to the members in general meeting unless they can themselves call a general meeting or can compel someone else to call a general meeting. There are no means by which they can call a general meeting or compel other persons to convene a general meeting. The only persons who can call a general meeting are the directors or the meeting who have called upon the directors to do so and they have failed to do so. The audience themselves are powerless. In my judgement the duty of the auditors, after having affixed their signatures to the reports annexed to a balance sheet, is confined to forwarding, that report to the secretary of the company, leaving the secretary of the company or the directors to perform the duties which the statute imposes of convening a general meeting to consider the report....The statute

compels directors to convene a meeting once a year and compels directors to present reports to the general meeting and it is for the shareholders to see that the directors do their duty...the duty of the auditors is discharged by sending the report to the secretary of the company....."

REINFORCEMENT QUESTIONS 1. "Compare the auditor's duties to the company which has appointed him with his duties to prospective investors in that company". a. What advantages does a company enjoy in securing its debentures by way of a floating charge? (4 marks) What are the rules relating to priority of charges? (6 marks) (4 marks)

2.

b. c. d.

In what circumstances will a floating charge "crystallise?"

What provisions ought to be included in a debenture trust deed for the benefit of a creditor that is to lend money to a company on the security of a floating charge? (6 marks)

Check your answers with those given in Lesson 9 of the Study Pack

COMPREHENSIVE ASSIGNMENT No.3

TO BE SUBMITTED AFTER LESSON 6
To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by the College. EXAMINATION PAPER. TIME ALLOWED: THREE HOURS. ANSWER ANY FIVE QUESTIONS

1.

Kaiuki and Munene trade in partnership as garage mechanics. They are considering changing their form of business association and trading as a private registered company limited by shares. Explain to them the legal procedures that they must follow in order to form such a company, and advise them on the advantages and disadvantages of trading as a private compay as opposed to a partnership.

2.

Give an account of the procedures a company must follow when it wishes: a. b. to reduce its capital; and to issue shares at a premium.

3.

a. b.

"A company must take great care when issuing share certificates". Explain this statement. G presents to H Ltd a valid document transferring 250 shares into his name. By mistake, HLtd issues him with a certificate for 2,500 shares. What are the possible consequences for H Ltd.?

4.

The articles of Happy Days Ltd. include the following provisions: i. All disputes between the company and its members shall be referred to arbitration in the first instance. Greg, Paul and Brian shall be the directors of the company for life. Michael shall be employed as the company accountant. The direcors shall have the power to declare dividend to paid to the shareholders Every member who intends to transfer his shares inform the directors who will take the shares between them at a fair value. Greg, Paul and Brian are members of the company. Michael is not. a. Philip, a shareholder, wishes to sell his shares in the company and offers to sell them to Greg, Paul and Brian. They refuse to buy them. Philip intends to bring action against Greg, Paul and Brian for breach of contract.

ii. iii. iv. v.

Advise Philip. b. At a properly convened and conducted extraordinary general meeting the second article referred to above is altered to read as follows: Greg, Paul and Brian shall be directors of the company until they attain the age of 65 years. Brian will be 65 years of age next month and wishes to challenge the alteration. Brian holds 15% of the issued share capital of the company. Advise Brian. c. Michael's work has been unsatisfactory and for the last 2 years the directors have employed Frank as a company accountant. Michael wishes to challenge the failure to employ him in accordance with the article. Advise Michael. d. The company has made substantial profits and a dividend has been declared. The directors resolve to distribute this in a form of debentures stock carrying interest at 10% and redeemable at par in 1995. John, a shareholder, wishes to have his dividend in cash and to challenge the directors resolution. Advise John.

5.

a.

What are the provisions of the Companyies Act relating to quorum at general meetings of a registered company and calling of such meetings? The article of association of Pole Ltd. provide that "no business shall be transacted at any general meeting unless a quorum of members is present at the time when the meeting proceeds to business". Matata, a hot-tempered member of the company, attended the annual general meeting of the company which was held last week. He argued at length against an ordinary resolution which had been proposed. In the end, he lost his temper and left the meeting. His absence reduced the quorum below requisite minimum but the resolution was passed by the remainder of those present. He has come to enquire from you as to whether the resolution is valid. What advise would you give him?

b.

6.

a.

What is the rule in Royal British Bank V. Turguand (1856), and what defence against its application are available to a company? Beetlecrush Ltd. was a company involved in pest control. In 1991 Pellet was appointed as a Managing Director of the company by a board resolution, which gave him exclusive power to manage the company, subject only to a requirement to get the approval of the board for all the contracts in excess of 50,000. On behalf of the company, Pellet began negotiation for the purchase of the insecticides from Toxin, who had supplied the company with similar products for a number of years. Before these negotiations were concluded, Toxin accepted an invitation to become a member of the board of Beetlecrush Ltd. and henceforth duly attended its board meetings. Some months after this, Pellet, without getting the approval of the board, signed a contract with Toxin for

b.

the supply of 80,000 worth of insecticides. Preliminary trials with these insecticides have revealed that they are not as effective as the company has been hoping. The board, with exception of Pellet and Toxin, is now seeking a way in which the company can claim that it is not bound by its obligations under the contract. Advise the board.

7.

What are the characteristics of a floating charge? What is the effect of crystallisation? State two advantages and two disadvantages of a floating charge.

8.

Under what circumstances may a company be wound up on the ground that "it is just and equitable" to do so?

END OF COMPREHENSIVE ASSIGNMENT No.3 NOW SEND TO THE DISTANCE LEARNING CENTRE FOR MARKING

LESSON 7

MINORITIES
CONTENTS
1 2 3

LEGAL PROTECTION OF

Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9

STUDY TEXT

7.1

INTRODUCTION According to decisions of English courts, companies are democratic organisations whose affairs are to be managed by the directors according to the provisions of the Companies Act, the company's memorandum and articles of association and, where a decision of the members is required, according to the decision of the majority of the company's members expressed as an ordinary or special resolution. The minority of members who have been outvoted during the passing of the relevant resolution must be prepared to abide by the decision of the majority of the company's members. There are however a few but significant instances in which the Companies Act and the general law prescribe certain legal limits on the power of the majority to bind the minority of the company's members. In particular, a resolution passed by the majority would not be allowed to prevail in certain circumstances if it is unfair or prejudicial to the minority, such as a resolution which (i) requires a member to take or subscribe for more shares than the number held by him at the date on which the resolution was passed

(ii) (iii)

alters the company's objects; reduces the company's capital in a way which is not "fair and equitable" between the different classes of shareholders; empowers the company to embark on or continue with, a course of trading which was not contemplated by the minority at the time the company was being formed (in which case the court would be prepared to make an order for the winding up of the company on the ground that it is "just and equitable" to do so); or constitutes "a fraud on the minority".

(iv)

(v)

A few of these instances will be examined in detail. 7.2 STATUTORY PROVISIONS

7.2.1 VARIATION OF CLASS RIGHTS Article 4 of Table A permits a company to vary the rights attached to any class of shares if the proposed variation is consented to in writing by the holders of three-fourths of the issued shares of that class or is sanctioned by a special resolution passed at a separate general meeting of the holders of the shares of the class. 7.2.2 The purpose of this article is to protect the minority members in a company against the majority members in the company by ensuring that they do not hold a joint meeting in which the majority class could pass a resolution for variation of the minority's rights despite their opposition. Such a resolution would not be a fair one as it would effectively enable the majority forcibly to modify or appropriate to themselves some rights of the minority. However, the fundamental flaw in the article is its failure to make provision for the protection of the minority members in the minority class. This omission has been compensated for by Section 74 of the Act which entitles the holders of not less in the aggregate than fifteen per cent of the issued shares of the class being varied to apply to the court to have the variation cancelled, provided that they did not consent to or vote in favour of the resolution for the variation. 7.2.3 Where any application is made pursuant to this provision, the variation shall not have effect unless and until it is confirmed by the court. An application under the section must be made by petition within thirty days after the date on which the consent was given or the resolution was passed. It may be made on behalf of the applicants by such one or more of their number as they may appoint in writing for the purpose. S. 74(3) provides that on any such application the court, after hearing the applicant and any other persons who apply to the court to be heard and appear to the court to be interested in the application, may disallow the variation if 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 applicant. 7.2.4 The following are some of the relevant English cases. (a) Re Holders Investment Trust Ltd (1979) The company proposed to reduce its share capital by repayment of the 5% 1 pound Cumulative Preference Shares (which were entitled to repayment of capital in priority to ordinary shares) and to effect repayment by the allotment to the holders an equivalent

amount of 6% unsecured loan stock, repayable 1985/90. The trustees of trusts which held 90% of the issued preference shares voted at a class meeting in favour of the scheme because they had been advised that as holders of 52% of the company's ordinary stock and nonvoting ordinary shares they would derive overall benefit from the change. It was held that the resolution passed at the class meeting was invalid since the trustees who provided the majority of votes cast were not concerned with benefit to holders of the preference shares as a class. They had instead considered what was best in their own interests, based on their large holding of stock and ordinary shares. Although this case came to the court for approval of the reduction of share capital and not as an objection to variation of class rights, it is in fact the leading case on the principles which the court will apply in dealing with the objection to a variation of class rights approved by a majority of the class. (b) CARRUTH v. I.C.I. Ltd (1973) There was a sequence of general and class meetings to approve the successive stages of a capital re-organisation. Out of 1,600 members present only 565 were holders of deferred shares. But only the holders of shares of each class were invited to vote (as a class) at their class meeting. The others present took no part. It was held that there was no irregularity of procedure in conducting a class meeting in the presence of non-members of the class. A class meeting is one at which only members of a particular class vote. It does not matter that others who are not members of the class are present. 7.2.5 It is only necessary to follow the variation of class rights procedure (and a dissenting minority can only apply to the court for cancellation) if what is proposed amounts to a variation of the class, right of itself. It is not a variation of class rights: (a) to issue shares of the same class to allottees who are not already members of the class (unless the defined class rights prohibit this); WHITE v. BRISTOL AEROPLANE CO. The company made a bonus issue of new ordinary and preference shares to the existing ordinary shareholders who alone were entitled under the article to participate in bonus issues. The existing preference shareholders objected that by reducing their proportion of the class of preference shares the bonus issue was a variation of class rights to which they had not consented. Held: This was not variation of class rights since the existing preference shareholders had the same number of shares (and votes at a class meeting) as before. (b) to subdivide shares of another class with the incidental effect of increasing the voting strength of that other class: GREENHALGH v. ARDERNE CINEMAS The company had two classes of ordinary shares, i.e. 50p shares and 10p shares. Every share carried one vote. A resolution was passed to subdivide each 50p share into five 10p shares, thus multiplying the votes of that class by five.

Held: The rights of the original 10p shares had not been varied since they still had one vote per share as before. (c) to return capital to the holders of preference shares which carry no right on a winding up to share in surplus assets but merely a right to prior repayment; RE SALTDEAN ESTATE CO. LTD. The company had ordinary shares and preference shares. The preference shareholders were entitled to the prior return of capital on a winding up but nothing more. The company proposed to repay the preference shareholders with the court sanction and return their capital to them so that the class of preference shareholders would be eliminated. Held: This was not a variation of class rights of the preference shareholders. The company could resolve to go into liquidation at any time and the preference shareholders would then only receive a return of capital and this they had been given. (d) to create and issue a new class of preference shares with priority over an existing class of preference shares: UNDERWOOD v. LONDON MUSIC HALL. By analogy an improvement in the rights of existing preference shares, e.g. by raising the rate of preference dividend from, say, 6% to 8%, is not a variation of the rights of ordinary shareholders although it diminishes the residual profits available for distribution to the latter as ordinary dividends. 7.2.6 The cases cited in (a) to (d) illustrate the principle that without a "literal variation" of a class right (as defined by the memorandum or articles) there is no alteration of rights to which the safeguards of the variation of rights clause (e.g. Table A, Article 4) apply. Dr. Rice contends that the instances constitute a variation of the enjoyment of the class rights rather than a variation of class right itself. In the Bristol Aeroplane Case it was said of the issue of additional preference shares that: "the existing preference shareholders will be in a less advantageous position on such occasions as entitle them to register their votes whether at a general meeting of the company or at separate meetings of their own class. But there is to my mind a distinction, and a sensible distinction, between an affecting of the rights and an affecting of ... the capacity to turn them to account". It is a sensible or practical distinction because many decisions taken in the course of the company's business might affect the value of the shareholders' rights. For example, suppose that a company has two businesses: one is a dependable source of profits sufficient to provide for the preference dividend but those profits are a poor return on capital employed. The directors then decide to sell that business at a high price in order to reinvest the proceeds in expanding the company's other business which offers prospects of long-term capital growth but very little immediate profit. The position of preference shareholders would be affected since there may no longer be sufficient profits to cover their dividend. But it would not be appropriate that they should have a veto (under variation of rights procedure) or an opportunity to apply to the court for a veto on what is essentially a question of commercial strategy. It would probably be better to limit the constraint of variation

of rights procedure to clear-cut and direct alteration of class rights, e.g. a reduction in the rate of preference dividend from, say, 8% to 6%. 7.2.7 In making this approach the courts have nonetheless kept the door open for action to deal with discrimination against a class by indirect means. In the Bristol Aeroplane Case it was said (as an obiter dictum) that if the ordinary shareholders had passed a resolution simply to double the votes attached to the ordinary shares this would have been a variation of the voting rights of preference shares (to which the safeguards described above would apply). A class of shares may carry different rights in one respect (e.g. a preference dividend) but the same rights as other classes in other respects. Because of the difference it ranks as a class to which the safeguards apply. This is so even when the class right to be varied is shared with the other class. Suppose, for example, the articles give one vote per share to both ordinary and preference shares. A proposal to reduce the votes of preference shares to, say, 1 vote for 10 preference shares is a variation of a class right since it is enjoyed by that class (and also by the ordinary shareholders). S.74(4) provides that the decision of the court on any application shall be final. the company must deliver a certified copy of the court order to the registrar within thirty days after the making of the order. 7.3 OPPRESSION OF MINORITIES

7.3.1 Section 211 of the Act provides that any member of a company who complains that the affairs of the company are being conducted in a manner oppressive to some part of the members, including himself, may make an order under the section. The court is empowered to make such order as it thinks fit with a view to bringing to an end the matters complained of if, on any such petition, it is of the opinion that: (a) (b) the company's affairs are being conducted as alleged by the applicant, and to wind up the company would unfairly prejudice the applicants but the proved facts would have justified the company's winding up on the "just and equitable" grounds.

7.3.2 An order made by the court may(a) regulate the conduct of the company's affairs in future, as in Re: H.R. Harmer Ltd;- in which the father (Harmer) was restrained from managing the company in future. Order the purchase of some members shares by other members, as in Scottish Wholesale Co-operative Society v Meyer, or order the purchase of some members' shares by the company itself and a consequent reduction of the company's capital.

(b)

(c)

7.3.3 MEANING OF "OPPRESSION". The Section does not define the word "oppression" or what constitutes "oppressive conduct". However, the Cohen Committee's Report (1947) gave the following as examples of oppressive conduct envisaged by the Section. (a) Where controlling directors unreasonably refuse to register transfers of the minority holdings so as to force a sale to themselves at a low price. Where the controlling directors take excessive remuneration so as to leave virtually nothing

(b)

for distribution by way of dividend. To these, the Jenkins Committee added the following: (a) (b) The issue of shares to directors and others on advantageous terms. The passing of non-cumulative preference dividends on shares held by the minority.

In Scottish Co-operative Wholesale Society Ltd v Meyer (1958) Lord Denning observed that "the section gives a large discretion to the court" which would be "well exercised in making an oppressor make compensation to those who have suffered at his hands. In Re H.R. Harmer Ltd (1959) Jenkins, L.J. stated: "Prima facie, therefore, the word `oppressive' must be given its ordinary sense" 7.3.4 CONDITIONS FOR RELIEF In H.R. Harmer Ltd (1959) Jenkins L.J. summarised the conditions which must be met before relief under the section can be granted by the court when he stated that: (1) The oppression complained of must be complained of by a member of the company and must be oppression to some part of the members (including himself) in their or his capacity as a member or members of the company as such. The facts of the case must not only be those that would justify the making of a winding-up order under the `just and equitable' rule but must also be of a character which have in them the requisite element of oppression The phrase "the affairs of the company are being conducted" suggests prima facie a continuing process and is wide enough to cover oppression by anyone who is taking part in the conduct of the affairs of the company whether de facto or de jare. The word "oppressive" must be given its ordinary sense and the question must be whether in that sense the conduct complained of is oppressive to a member or members as such. The strict application of these conditions by the English courts rendered the section largely ineffective as a minority protection section and culminated in its repeal by the English Companies Art 1980. Only the following cases had been successfully brought under the section(i) (ii) Re. H.R. Harmer Ltd (98), and Scottish Wholesale Co-operative Society Ltd v Meyer and Another (97).

(2)

(3)

(4)

The other applications had been dismissed on the grounds of non-compliance with one or other of the prescribed conditions. No Kenya case appears to have been contested under the section and it is therefore not possible to evaluate the effectiveness of the section as, in Professor Gower's words, "a weapon in the (minority) shareholder's armoury". The section would however be equally ineffective in Kenya if Kenya courts were to adopt the same restrictive conditions that have been postulated by the English courts.

7.4

CASE LAW

7.4.1 The aforesaid statutory provisions for the protection of minorities have been supplemented by judicial intervention in a variety of cases which are generally explained under the following major headings: 7.4.2 Fraud on the Minority Professor Gower, writing on fraud on the minority, has stated: ".......the exact meaning of the expression `fraud on the minority' is not easy to determine. But at least it is clear that both `fraud' and "minority" are used somewhat loosely. There need not be any actual deceit; if there were, those on whom it was practiced would have a common law remedy against those who had wilfully deceived them. "Fraud" here connotes an abuse of power analogous to its meaning in a court of equity to describe a misuse of a fiduciary position. Nor is it necessary that those who are injured should be a minority; indeed, the injured party will normally be the company itself, though sometimes those who have really suffered will be a class or section of members, not necessarily a numerical minority, who are outvoted by the controllers. It covers certain "acts of a fraudulent character"- in the wider sense just described - of which "familiar examples are when the majority are endeavoring 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". (Gower's Modern Company Law,3rd Edition, pg. 564) Most of the cases in which the principle has actually been applied appear to fall within one of the following two classes:1. Where the company is defrauded (i) Misappropriation of corporate property Examples: Menier v Hooper's Telegraph Works Cook v Deeks (ii) Breach of duty by directors Examples: Alexander v Automatic Telephone Co. 2. Where the minority as individuals are defrauded (i) Expulsion of minority A purported expulsion of a member from the company will amount to fraud unless it is done bona fide and for the benefit of the company. The following cases are relevant: Dafen Tinplate Co. Ltd. v Llanelli Steel Co. Ltd. Brown v British Abrasive Wheel Co. Sidebotton v Kershaw Leese & Co. (ii) Inequitable use of majority power

Examples: Clemens v Clemens Bros Ltd. (99) The exception of "fraud on the minority" depends, where the company is defrauded, on "wrongdoer control," i.e. the individual shareholder must show that the wrongdoers control the company, as where they control the board and general meetings and will not permit an action to be brought in the company's name. Furthermore, wrongdoer control is essential because cases of misappropriation of property and breach of duty can be ratified by a 51 per cent majority of the members which is not controlled by the wrongdoers. The wrongdoers will obviously be in the above position if they have voting control as they had, for example, in Menier and Cook. However, in Prudential Assurance Co. Ltd. v Newman Industries Vinelott, J. held that de facto control was enough, i.e. the company does what the wrongdoers want even though the wrongdoers do not have voting control. They are able to persuade the majority to follow them. NEGLIGENCE It is still uncertain whether damage caused by negligence can be brought under the heading of "fraud" for the purpose of the exception of "fraud on the minority." In Daniels v Daniels the judge said that a minority shareholder who had no other remedy should be able to sue whenever directors use their powers intentionally or unintentionally, fraudulently or negligently, in a manner which benefits them at the expense of the company.

7.4.3 THE RULE IN FOSS v HARBOTTLE What has come to be known in company law as "the rule in Foss v Harbottle" is the decision of Vice-Chancellor Wigram in the case of Foss v Harbottle in which the facts, briefly, were as follows. The plaintiffs, Foss and Turton, were shareholders in a company called The Victoria Park Co. which was formed by statute to buy land for use as a pleasure park. The defendants were the company's five directors and others. The plaintiffs alleged that the defendants had defrauded the company in various ways, and in particular that certain of the defendants had sold land belonging to them to the company at an exorbitant price. They asked the court to order the defendants to make good the losses to the company and also sought the appointment of a receiver. It was held that it was incompetent for the plaintiffs to bring such proceedings, the sole right to do so being that of the company in its corporate character. The judge stated: "In law the corporation and the aggregate members of the corporation are not the same thing for purposes like this; and the only question can be whether the facts alleged in this case justify a departure from the rule which, prima facie, would require that the corporation should sue in its own name and in its corporate character or in the name of someone whom the law has appointed to be its representative." The judge eventually concluded that no departure from the rule was justified in the case before him. The same rule was restated with more clarity by Lord Davey in Burland v Earle when he stated; "In order to redress a wrong done to the company or to recover moneys or damages alleged to be due to the company, the action should prima facie be brought by the company itself."

7.4.4 Purpose of the rule It has been stated by various English judges that without the rule in Foss v Harbottle (i) There would be futile actions. A court order made on an application by an aggrieved minority of members (such as the two members of the Victoria Park Co.) would be made redundant by a resolution passed later on at the company's meeting confirming or ratifying what the minority had complained of in court. (ii) There is a likelihood of multiplicity of suits if each and every shareholder were to institute proceedings without any co-ordination with the others. The principle of corporate personality enunciated in Salomon v Salomon and Co. Ltd would be undermined. Since a company is a separate legal person it is the company that has suffered a wrong but not its members. The principle of majority rule would be violated. The law views companies as democracies of the majority shareholders. Consequently,"if the thing complained of is a thing which in substance the majority of the company are entitled to do, or if something has been done irregularly which the majority of the company are entitled to do regularly, or if something has been done illegally which the majority of the company are entitled to do legally, there can be no use in having litigation about it, the ultimate end of which is only that a meeting has to be called, and then ultimately the majority gets its wishes" (per Mellish, L.J. in MacDougall v Gardiner) 7.4.5 Exceptions to the rule in Foss v Harbottle According to Professor Wedderburn, the so-called exceptions are essentially no exceptions at all. They appear to be situations in which there is no chance of confirmation by the majority and to which the rule is, therefore, inapplicable. However, the exceptions were summarised by Jenkins, L.J. in Edwards v Halliwell (100) as follows1. Ultra vires and illegality "Where the act complained of is wholly ultra vires the company or association the rule has no application because there is no question of the transaction being confirmed by any majority," (per Jenkins, L.J.) 2. Special majorities The rule in Foss v Harbottle does not prevent an individual member from suing if the matter in respect of which he was suing was one which could be done or sanctioned, not by a simple majority of the members of the company or association (i.e. an ordinary resolution), but only by some special majority (i.e. a special resolution) which has not been obtained. 3. Personal rights invaded A shareholder may sue to protect from invasion their own individual rights as members.

(iii)

(iv)

This is illustrated by Pender v Lushington (101) 4. Fraud on a minority and the wrongdoers are in control of the company "It has been further pointed out that where what has been done amounts to what is generally called in these cases a fraud on the minority and wrongdoers are themselves in control of the company, the rule is relaxed in favour of the aggrieved minority who are allowed to bring what is known as a minority shareholders' action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievances could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue," (per Jenkins, L.J.) 7.4.6 Forms of action A minority of shareholders or an individual shareholder suing under one of the above exceptions may institute one of the following actions i) A personal action Where an individual member sues not in right of the company but in his own right to protect his individual rights as member, he can bring an action in his own name and may sue on behalf of himself and other members. An example is Pender v Lushington in which a shareholder was able to enforce the article giving him a right to vote at meetings and compel the directors to record his vote. Other instances in which an individual member can sue in his own name include:(a) (b) When the company is acting illegally or ultra vires; Where a special majority is required and has not been obtained (eg. Edwards v Halliwell); Where the company is acting contrary to its articles (eg. Wood v Odessa Waterworks Co Ltd)

(c)

ii)

A representative action Where individual shareholders have suffered personal loss in addition to the injury to the company one shareholder may bring a representative action on behalf of himself and all the other shareholders who have suffered similar injury. If the action is successful the plaintiff will obtain a declaration that the improper conduct has been proved. Each injured party may then claim damages without further need to prove improper conduct. An example is Hogg v Cramphorn (1966)

iii)

A derivative action In Nurcombe v Nurcombe Lawton L J stated that a derivative action is a procedural device for enabling the court to do justice to a company controlled by miscreant directors or shareholders. It is called "derivative" because the right to sue derives from that of the company. In such a case the minority shareholders sue on behalf of themselves and all other shareholders except those who are defendants and may join the company as a defendant.The directors are usually the defendants. Where the action is successful, the damages awarded belong to the company.

A derivative action is usually appropriate where the wrongdoers have voting control and therefore prevent the company from suing, as in Cork v Deeks or Alexander v Automatic Telephone Co (103). Although the rule in Foss V Harbottle indicates the right of the majority of the company's members to pass resolutions on the company's behalf, it hedges that right with rules or exceptions which are also intended to protect the interests of minority members in appropriate situations. But it should be noted that, in the process of protecting their perceived interests, the minority are also in fact, protecting the interests of the company itself since the company cannot protect itself in such situations.

REINFORCING QUESTION
1. "As a weapon in the shareholders armoury it will probably always prove more potent when brandished in terrorem than when actually used to strike" (Gower). To what extent is this a justifiable commentary on Section 211 of the Companies Act?

2.

Explain the instances in which the "veil of incorporation" may be lifted by the courts (under judicial interpretation or case law).

Check your answers with those given in Lesson 9 of the Study Pack

LESSON 8
RECONSTRUCTIONS, MERGERS AND WINDING UP
CONTENTS
1 2 3 Read the Study Text below Attempt Reinforcing Questions at the end of the Study Text. Check your answers with those given in Lesson 9

STUDY TEXT

8.1

INTRODUCTION (a) Reconstructions, mergers and takeovers are not defined terms. A reconstruction may be an alternative of the structure of a group of companies or an alteration of the capital structure of a single company. A merger (also called an amalgamation) is a transaction whereby two or more companies are combined in some way in united ownership. The simplest method is a takeover bid whereby Company A acquires the issued share capital of Company B so that they form a single group in which A is the holding company and B is the subsidiary. A more complex type of merger entails the transfer of a business (and the assets employed in it) from one company to another. If the acquiring company (in either a take-over bid for shares or a purchase of assets) allots its own shares as consideration for the acquisition the members of the company whose business or share capital is acquired will become additional members of the acquiring company. A company may absorb a minority shareholding in its partly-owned subsidiary in exchange for cash or shares.

(b)

(c)

(d)

Finally a company may seek to alter the rights of its creditors, eg. by variation of the rights of debenture holders, by mutual agreement. In these transactions it is first necessary to select the only available (or if more than one) the most convenient method to effect the proposed change. The advantages and disadvantages of each method are explained below in connection with the method itself. The essential elements of every method are that if a decisive majority of members or creditors can be obtained by the correct procedure the minority (if any) who dissent will be bound by the majority decision. But in each case the minority is given safeguards or rights of objection to the court to balance the element of compulsion. Although a minority cannot frustrate the change by their opposition they are entitled to a fair deal.

(e)

8.2

CHOICE OF METHOD

8.2.1 There are three statutory methods to be considered: (a) Where one company offers to acquire the shares of another company and its offer is accepted by holders of 90 per cent or more of the shares for which the offer is made the acquiring company may compel the non-accepting minority to transfer their shares on the same terms. This is the standard procedure for "mopping up a minority" and achieving complete success in a take-over bid. It is no objection that the acquiring company already owns (directly or through subsidiaries) some shares of the other company. Accordingly this method is also available to acquire the outstanding minority shareholding of a partly-owned subsidiary (s.210). Where one company transfers its undertaking (and assets) to another company in exchange for shares to be alloted direct or distributed to the members of the company, the company which makes the transfer must go into voluntary liquidation and the transfer must be approved by special resolution passed in general meeting. The acquiring company may be a new company formed for the purpose. There is then a change of company but the same shareholders as a group own the same business (through a company). It is a form of reconstruction. If however the acquiring company already has a business and a different group of members this method effects an amalgamation so that the two groups of shareholders join together in holding the shares of a single company which owns both businesses (s.280). A scheme of arrangement may be used in many different situations. Essentially it is suitable for making a change in the rights of shareholders or creditors of an existing and continuing company. But it can also be used to effect a take-over (as described in (a) above) or to carry out a reconstruction involving changes of company structure (s.207).

(b)

(c)

8.2.2 It will be seen that methods (a) and (b) relate to specific types of transaction. They can only be used in those transactions. The flexibility of a scheme of arrangement has led to its extended use though (see para 8.3.3 below) there is some doubt whether it is correct to use it in a situation where company law affords some other and more specific procedures. 8.2.3 Where there is a choice of method the choice is usually between a scheme of arrangement and some more specific alternative method. The considerations affecting the choice are explained below. 8.3 SCHEME OF ARRANGEMENT

8.3.1 The following sequence of action is necessary: (a) application is made to the court (usually by the company itself) for an order that one or more

meetings of members and/or of creditors (if the scheme will affect the rights of creditors (if the scheme will affect the rights of creditors) shall be held. With the application the company submits a document setting out in detail the terms of the scheme of arrangement and also an explanatory statement to be issued with the notice(s) convening the meeting(s). If the court is satisfied that the scheme is generally suitable for consideration as a "scheme of arrangement" under s.207 it will order that a meeting of meetings be held to consider it. The court is not at this stage concerned with the details of the scheme nor with the issue (which may arise later) as to whether there are conflicts of interest which require that separate meetings should be held. The court merely looks at the outline of the scheme and if it seems suitable orders that meeting(s) be held; (b) a meeting or several meetings is or are held as the court has ordered. A substantial quorum, say members (present in person or by proxy) holding one-third of the shares, is required and the scheme must be approved by members (or, as the case may be, creditors) voting at each meeting who (i) (ii) are a majority in number, and represent three-quarters in value of the shares (or at a creditors' meeting, of the amounts owing).

Requirement (ii) is imposed to safeguard a minority in numbers who have a larger financial stake than the numerical majority: Re NFU Development Trust. (c) following approval of the scheme at meeting(s) application is made to the court for an order to approve and implement the scheme. At this stage any minority which opposes the scheme may state its objections for consideration by the court: a copy of the court order approving the scheme is delivered to the registrar and the scheme then takes effect, ie, the changes are made automatically as soon as this is done.

(d)

8.3.2 A scheme of arrangement is very flexible since it may be used to effect any "compromise or arrangement" with members or a class of members with creditors or a class of creditors. It has been used to vary the rights attached to debentures or preference shares (when there are obstacles to a straightforward reduction of capital or variation of class rights) or to reorganize the capital structure of a company or to acquire shares of a company (instead of a take-over bid to which s.210 will apply). But if there is a specific procedure, such as a reduction of capital or a variation of class rights which can be used the court would not permit the use of a scheme of arrangement to avoid some safeguard of minority interests available under that specific procedure. 8.3.3 S.207 refers to a "class" of members or of creditors. Obviously if two or more companies are involved or if one company has two classes of shares, eg. preference and ordinary, or is proposing a compromise with different classes of creditors, eg. debenture holders and unsecured trade creditors, it must ask the court to order that separate meetings be held of each group and it must obtain the required majority approval at each meeting. But the principle is carried even further. If within say one class of shareholders there are groups whose interests in the proposed scheme are clearly different the court must be asked to order that separate meetings be called of each group. It has been said that each meeting "must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest" (Sovereign Life Assurance Co v Dodd). If those who propose the scheme do not in their application to the court distinguish each such group (to be consulted separately) the court will at the final decision stage withhold its approval on the ground that there has not been fair and proper consultation.

Case: RE HELLENIC AND GENERAL TRUST (1976) A scheme of arrangement was agreed between Hambros and Hellenic whereby the shareholders of Hellenic were to have their shares in the company cancelled in return for cash compensation. Hambros was to pay the compensation and then receive the same number of shares in Hellenic. The scheme was approved at a meeting of Hellenic by a majority in number of the shareholders holding three quarters in value of the shares involved. But a wholly-owned subsidiary of Hambros (MIT) held 53% of the shares in Hellenic and voted for the scheme. Hellenic applied for approval of the scheme and was opposed by a Greek Bank, a 14% shareholder in Hellenic. Its objections were that it wished to retain its membership and also that the cash received for its shares would be subject to heavy capital gains tax liability in Greece. The Greek bank opposed the approval of the scheme before the court on two grounds. First, MIT as a subsidiary of Hambros had a different interest in the scheme from the other shareholders of Hellenic. MIT was Hambros indirectly; it was seeking to acquire the 47% of Hellenic which it did not (through MIT) already own. There should therefore have been a separate meeting of the holders of the 47% of Hellenic shares not already under the Hambros' control through MIT. At such a meeting the Greek bank (with 14% out of 47%) could have prevented approval by the required three quarters majority. Secondly, the purpose of the scheme was to enable Hambros to acquire 47% of the shares of Hellenic. (The device of cancelling the shares for cash and issuing new ones to Hambros was to save the stamp duty payable on a straightforward transfer of the shares - an example of the advantages of a scheme of arrangement). It was argued that a scheme of arrangement should not be used in a situation for which the take-over bid procedure was appropriate. Under take-over bid rules the required 90% acceptance (from the independent shareholders) would not have been obtained since the Greek bank held more than onetenth of the outstanding 47% minority shareholdings. Held: The first ground of objection was valid, ie. if within a single class of shareholders there are groups whose interests in the scheme are clearly different and opposed, approval must be obtained from separate meetings of each group. The second objection was also upheld (though it was not necessary to decide this point as the scheme was disapproved on the first ground). In an earlier case, however, Re National Bank (1966), the court rejected this argument as there is nothing in the statutory rules to prohibit the use of a scheme of arrangement to effect a take-over bid. A second requirement is that the company concerned shall show its support for the scheme since s.207 relates to schemes of arrangement "between" a company and its members or creditors. Hence a member cannot obtain a court order for calling meetings if the company itself is opposed to the scheme: Re Savoy Hotel (1981). 8.3.4 It is also necessary that the members or creditors who are to vote on the scheme should be able to understand its full effects. Accordingly when notices are issued to convene the meetings ordered by the court an explanatory statement must also be issued: CA, s.208. The statement: (a) explain the effect of the scheme ie. puts the proposal forward in terms which a non-expert can understand;

(b)

disclose any material interests in the scheme of the directors, whether as directors, members, creditors or otherwise and the effect of the scheme on the directors' interests if different from like interests of other persons; if the scheme affects the rights of debenture holders the statement discloses any interest of a trustee for debenture holders in the scheme. As an example a statement has been held to be deficient under (a) because it stated that assets had been valued but did not disclose the amount of the revaluation. If the statement is defective on technical points the court cannot approve the scheme. The whole operation must be repeated using a satisfactory explanatory statement.

(c)

8.3.5 When the scheme is before the court for final approval a minority may object on any of the various grounds indicated above ie. that a s.207 procedure is inappropriate or has not been correctly observed, or that approval has not been obtained in a proper way or that the court in its discretion should reject the scheme since it would be unfair. 8.3.6 If the court approves the scheme and makes an order providing for any of the following under s.209 (1):(a) the transfer of the whole or part of the undertaking and property or liabilities to the "new" company; the allotment of shares and debentures etc. in that company without winding up; the continuation of any legal proceedings; the dissolution of the old company without winding up; provision for dissentients; such incidental and consequential matters necessary to secure the scheme to be effective;

(b) (c) (d) (e) (f)

An official copy of the order must be delivered to the registrar. 8.3.7 A scheme of arrangement under s.207 offers three main advantages: (a) it can be used in circumstances to which s.210 and s.280 do not apply. As explained above it has only to be an "arrangement or compromise" of some sort with members or creditors; in circumstances where s.207 is an alternative procedure a scheme of arrangement only requires approval by three quarters of the votes cast at each meeting. This is a less stringent requirement than s.210 imposes since s,210 operates only if holders of 90 per cent of all the shares for which the offer is made accept the offer. If there is doubt whether 90 per cent acceptance is obtainable a s.207 scheme is to be preferred. But if (as in the Hellenic & General Trust Case - para 11 above) the court concludes that an identified minority has been denied the veto which s.210 would have given it is unlikely to give its approval under s.207. Apart from technical points it would be unfair to do so; the court order to implement the approved scheme under s.209(1) often saves substantial expense which could otherwise be incurred if the arrangement were effected in some other way.

(b)

(c)

8.3.8 The disadvantage of a scheme of arrangement is that it requires the preparation of elaborate

documents and the observance of a strict procedure, including an initial and final application to the court and the holding of meetings. All this is expensive. Hence a scheme of arrangement is only suitable for large companies where substantial values or assets are affected. Otherwise it is uneconomical. 8.3.9 If a company which is or is about to be in voluntary liquidation proposes to make a composition with its creditors it has a choice between the following alternatives: (a) a scheme of arrangement under s.207; (b) an arrangement sanctioned by three quarters (in number and in value) of the creditors under CA: s.300. This liquidation procedure is binding on a minority unless the court on the application of a creditor or contributory (member) orders otherwise; a compromise made by the liquidator in exercise of statutory powers under CA, s.241 or s.297(1)(a). For this purpose he must obtain approval of members, creditors, committee of inspection or the court according to the circumstances of the case.

(c)

It is usual to proceed under s.207 as there are technical difficulties over s.300 procedure. The liquidator's powers to reach a compromise with creditors are restricted to cases where all creditors (of the same class) are treated alike, e.g. a uniform payment of Shs.15 in 1 pound to be accepted in full settlement. But if their rights are to be varied a scheme of arrangement is required, i.e. s.207 is the correct procedure. CASE: RE TRIX (1970) A liquidator proposed to distribute assets to creditors otherwise than in accordance with their rights. He applied to the court under s.241 for its approval of the exercise of his statutory power of compromise. He explained that a scheme of arrangement under s.207 would entail heavy expense which would deprive creditors of any advantage which that method might confer. Non-ascending creditors objected. Held: S.207 gives to creditors a right to state their objections to the court and the court may then in its discretion decide whether to approve the scheme. They would be unfair deprived of that opportunity under the more summary procedure of s.241. The liquidator's application for approval was rejected. 8.4 TAKE-OVER BID:

8.4.1 If Company A ("the transferee company") offers to acquire shares of Company B ("the transferor") and the scheme or contract to which the offer relates is accepted by holders of nine-tenths of the shares for which the offer is made Company A may then compulsorily acquire the remaining 10 per cent (or less) of the shares so as to achieve a complete 100 per cent acquisition of the shares: CA, s.210. 8.4.2 It is standard procedure in making a take-over bit to state that if 90 per cent acceptance is attained compulsory acquisition under s.210 will follow. Company A may resort to s.210 whether it offers its own shares or cash for shares of Company B. The procedure is available if Company A already owns shares of Company B and offers to acquire those which it does not already own (but see para 22 below.) The non-accepting minority may however apply to the court to prevent Company A

from acquiring their shares. The rules of procedure are explained below. 8.4.3 The offer must be made by a company to acquire shares of another. S.210 is not available to an individual who makes a take-over bid (but he can always form a company for the purpose: provided no fraud or imoproper conduct is involved: Re Bugle Press Ltd. (see paragraph 8.4.11) 8.4.4 If Company B has two or more classes of shares and Company A makes an offer for shares of both classes this is treated as two separate offers. S.210 applies separately to shares of each class for which 90 per cent acceptance is obtained. In such cases it is usual (but not legally necessary) for Company A to reserve the right to withdraw its offer for either class if acceptance from the other class does not reach the 90 per cent level which makes s.210 applicable. 8.4.5 If Company A directly or through subsidiaries owns more than one-tenth of the shares of Company B then (in order to be able to use s.210) Company A must: (a) (b) offer the same terms for all the shares which it does not already own; obtain acceptances from holders who are three-quarters in number as well as holders of 90 per cent of the shares.

8.4.6 The wording of s.210 is ambiguous but it is generally taken that Company A must offer to acquire all of the shares of Company B which it does not already own if it is then to use s.210 to acquire the remaining shares in Company B (or all the shares of the class) for which the offer is made. 8.4.7 Acceptance on the required scale must be obtained within a maximum of four months from the date of the offer. The position then is that: (a) at the end of the four month period (not earlier than that even if 90 per cent acceptance is attained before the period expires) Company A may (but it need not do so if it does not wishhowever see paragraph 25 below) serve notice on the non-accepting shareholders of its intention to acquire their shares on the same terms as have been accepted by the majority. This notice may be given at any time within a two month period following the four month period; on receiving the notice from Company A each non-accepting shareholder of Company B has one month in which he may apply to the court to order that Company A shall not acquire his shares (see paragraphs 27-28 below); one month after serving notice on non-accepting shareholders (or if they apply to the court but fail then as the court has disposed of their application) Company A may require Company B (i) (ii) to transfer the shares of its non-accepting shareholders to Company A, and to receive the purchase consideration to hold in trust for the non-accepting shareholders.

(b)

(c)

By this means the outstanding shares are transferred without any further action on the part of the non-accepting shareholders. 8.4.8 The non-accepting shareholders have a further statutory safeguard. Company A is not obliged to serve notice of intention to acquire their shares. But as soon as Company A's total ownership of shares in Company B reaches 90 per cent (or 90 per cent of a class) it must within one month give notice of that fact to the holders of the outstanding shares. Those shareholders may then within the

ensuing three months require Company A to acquire their shares on the same terms as have been accepted by the approving shareholders. By this means the shareholders who at first did not accept the offer for their shares may accept it in order to escape from the unsatisfactory position or remaining as a very small minority of members in a company (B) dominated by a single shareholder (A): CA, s.210(2). 8.4.9 The minority whose shares are acquired compulsory under s.210 are entitled to all the benefits included in the original offer and accepted by the holders of 90 per cent or more of the shares. Company A must not only pay the same price (or other consideration); it must repeat all other inducements such as a cash alternative. When Company A offers its own shares in exchange for shares of Company B it is a common practice to make the offer more attractive by arranging with a third party that the latter will make a simultaneous offer (for a limited period only) to purchase from shareholders of Company B their consideration shares (allotted by Company A) if they do not wish to retain them. A holder of shares of Company B then has the choice of (i) retaining his new shares in Company A or (ii) selling them (the "cash alternative") immediately at a stated price to a third party. When s.210 is used to acquire the outstanding shares of Company B the bidder (Company A) must arrange for a cash alternative to be provided since that was part of the terms (although it came from a third party) which induced a high level of acceptance: Re Carlton Holdings (1971) 8.4.10 A non-accepting shareholder who applies to the court to set aside the proposed compulsory acquisition of his shares under s.210 will fail unless he can make out a very strong case. Acceptance by holders of 90 per cent or more of the shares indicates that the terms offered are fair. This is so even if the objector contends that he had need of more information in order to reach a decision or that Company A in acquiring control of Company B will obtain special advantages (e.g. elimination of a competitor) which are not reflected in the price offered for his shares. Objection on those grounds only are likely to fail. 8.4.11 But the court will not permit s.210 to be used in an artificial and oppressive manner. Case: RE BUGLE PRESS (1900) X, Y and Z held 4,500, 4,500 and 1,000 one pound shares respectively, of Company B. They were the only shareholders and X and Y were the directors. X and Y wished to eliminate Z. S.210 however is not available to individuals. So X and Y formed a new company (Company A) in which they were the only two shareholders. Company A then offered to acquire all the shares of Company B. X and Y accepted the offer but Z did not. Company A served notice on Z that it has secured 90 per cent acceptance (the shares of X and Y) and intended to acquire Z's 1,000 shares under s.210. Z applied to court. Held: Company A was a sham since (lifting the veil of incorporation) it was merely the majority shareholders (X and Y) in Company B seeking to expropriate the shares of the minority (Z). S.210 could not be used in these circumstances. Z's objections were upheld. 8.4.12 The alternative to acquisition under s.210 (in a take-over bid) is a scheme of arrangement under s.207. The choice may be determined by comparative costs (see paragraphs 8.3.7(c) and 8.3.8). Stamp duty is payable (at the two per cent ad valorem rate) on transfers of shares of Company B in a transaction to which s.210 applies. It can be avoided under s.207. But under s.210 procedure there is usually no expense of court proceeds as few minority shareholders persist in their objections to the point of making application to the court (at some expense to themselves). 8.4.13 On the other hand if there is uncertainty about obtaining 90 per cent acceptance and a scheme of arrangement is not excessive in costs it is an easier route to the intended result. It is particularly

useful when Company A is seeking to acquire those shares of a partly-owned subsidiary (Company B) which it does not own. In such cases some minority shareholders of B may be indifferent or passively opposed; Company A cannot count on their acceptances (to achieve 90 per cent) but reckons that they cannot or will not deny it a three quarters majority at a meeting. There is often a delicate balance of conflicting risks and considerations in choosing between s.207 and s.210 in such situations. 8.5 RECONSTRUCTION UNDER S.280

8.5.1 The essential features of this type of reconstruction have been described at 8.2.1(b). It is subject to several disadvantages and is little used. But when a reconstruction takes this form s.280 procedure must be followed so that a dissenting minority does have the appropriate safeguard.

8.5.2 This procedure applies to a company which is proposed to be or is in course of being wound up voluntarily. A company in liquidation must dispose of its assets (other than cash) by sale in order to pay its debts and distribute any surplus to its members. The special feature of a s.280 reconstruction is that the business or property of Company P is transferred to Company Q in exchange for shares of the latter company which are allotted direct or distributed by the liquidator to members of Company P. Obviously the creditors of Company P will have to be paid in cash. A dissenting minority of members of Company P can also require to be paid in cash. Hence substantial sums may have to be found in cash. This is one of the drawbacks. 8.5.3 A company in (or about to go into) members' voluntary liquidation may by special resolution authorize the liquidator to sell the business or property for shares (of some other company) to be distributed to members. But any member who did not vote in favour of the special resolution may in the ensuing seven days deliver to the registered office a notice addressed to the liquidator requiring him either to pay that member the value of his interest in cash or to abandon the proposed sale: CA s.280. 8.5.4 If the company is in a creditors voluntary liquidation a special resolution to approve the sale must be passed and it is also necessary for the sale to be approved by the court or by the committee of inspection: CA s.292. Moreover a creditor can at any time within a year of the passing of the special resolution (in a members voluntary winding up) render it invalid by obtaining a court order for compulsory liquidation: s.280(5). It is therefore prudent to dispose of possible objections by creditors before the company enters into the transaction. 8.5.5 Hence the usual procedure is: (a) first to dispose of possible objections by creditors by paying their debts or providing security for their due payment of their debts. Alternatively the company may seek to obtain the consent of the creditors to the transfer of liability for their debts to the transferee company (as part of the terms on which the business is sold); then to convene a general meeting and propose a special resolution to approve the sale of the business in exchange for shares of the purchasing company. It thus becomes evident how many members may demand to be bought out for cash since only members who did not vote in favour of the resolution can opt for the cash payment. If it is clear that the cash expenditure will be prohibitive the scheme can be abandoned before the company goes into liquidation; finally (as the second step at the same general meeting) to move a resolution to go into liquidation. If it is to be a creditors voluntary liquidation then a committee of inspection must be appointed and asked to approve the sale under s.292.

(b)

(c)

8.5.6 If a member claims to be paid the value of his interest in cash the amount (if it cannot be agreed) is to be determined by an arbitrator. The member must make out his own case before the arbitrator in support of his claim; the company is not under a duty to answer his questions. If a member fails to give notice within the seven days period to the liquidator of his demand for cash he is entitled to his proportion of the transferee company's shares or if he refuses to accept them they may be sold and the proceeds paid over in settlement since (by failing to observe s.280 procedure) he has forfeited his entitlement under s.280. 8.5.7 The disadvantages of s.280 are that cash may have to be provided to pay off creditors and dissenting members or alternatively the sale may have to be abandoned. Secondly, the company must go into liquidation which is an irreversible process. But s.280 procedure is obligatory in the situation to which it relates. It may be preferable to make the desired reconstruction in some other way. For example the company to which the business is to be transferred might make a take-over bid (using s.210 to achieve 100 per cent success) for the share capital of the company whose business it wishes to acquire. When the latter company is a wholly owned subsidiary there is no procedural difficulty in transferring its business to the holding company. There is no obligatory cash alternative in a s.210 transaction though it is sometimes provided as an extra inducement (paragraph 26 above). 8.5.8 The advantage of transferring a business from one company to another (with the same shareholders in the end) is that by this means the business may be moved away from a company with a tangled history to a new company which makes a fresh start. As explained (paragraph 6(b) above) this procedure can also be used to effect a merger of two companies each with an existing business. CONTRACT OF SALE 8.5.9 This method is used in the case of very small companies. All members and creditors enter into a contract by which the new company takes over the assets of the other. Note: It requires 100 per cent approval by everyone concerned. No one can be compelled to enter into a contract of which he disapproves. 8.6 WINDING-UP

8.6.1 METHOD OF DISSOLUTION: (a) A company is dissolved, i.e. ceases to exist, when its name is removed from the register. It is usually necessary, before it can be dissolved, to liquidate or wind up the company ("liquidation" and "winding up" have the same meaning ); i.e. the assets are realized, the debts are paid, the surplus (if any) is returned to members, and the company is then dissolved. But the registrar has power, if it appears to him that the company is defunct to strike it off the register summarily without a previous liquidation: CA s.339. There is also an obsolete procedure for voluntary winding up under the supervision of the court: CA s.304. Liquidation begins with a formal decision to liquidate. If the members in general meeting resolve to wind up the company that is a voluntary winding up, which may be either a members' or creditors' voluntary winding up depending on the creditors' expectation that the company will or will not be able to pay its debts in full. Creditors have a decisive part in the liquidation of an insolvent company since the remaining assets belong to them. Although voluntary liquidation is simpler, quicker and less expensive, it is possible only if a majority of votes is cast in general meeting on a resolution to liquidate. A company may, however, be obliged to wind up by a compulsory liquidation ordered by the court on a petition usually presented by a creditor or a member.

(b)

(c)

(d)

Whether liquidation is voluntary or compulsory it is in the hands of the liquidator (or joint liquidators) who take over control of the company from its directors. Although liquidation may begin in different ways and there are differences of procedure the working method is much the same in every type of liquidation and the same legal problems can arise. The sequence of topics below is the procedure by which compulsory, members' voluntary and creditors' voluntary liquidation begin. The legal problems, with which the liquidator may be concerned are considered in the next following session.

(e)

8.6.2 COMPULSORY LIQUIDATION: A petition is presented to the High Court under s.218 of the Companies Act. The petition will specify one of the seven grounds for compulsory winding up and be presented (usually) either by a creditor or by a member (called a "contributory" in the context of liquidation). The seven standard grounds for compulsory winding up are listed in s.219 as follows(a) (b) the company has by special resolution resolved that it should be wound up by the court; the company does not deliver the statutory report to the registrar or defaults in holding the statutory meeting; the company has not commenced its business within a year from its incorporation or has suspended its business for a whole year; the company is unable to pay its debts; (see s.220). the number of members of the company has reduced, in the case of a private company, below two, or, in the case of a public company, below seven; the court considers that it is just and equitable to wind up the company. (see p.12). in the case of a company incorporated outside Kenya and carrying on business in Kenya, liquidation proceedings have been commenced in respect of it in the country of its incorporation or territory in which it has established a place of business.

(c)

(d) (e)

(f) (g)

COMPANY UNABLE TO PAY ITS DEBTS: By section 220, a creditor who petitions on grounds of the company's insolvency may rely on any of the following situations to show (as he is required to do) that the company is unable to pay its debts: (a) a creditor (or creditors) to whom the company owes more than one thousand shillings serves on the company at its registered office a written demand for payment and the company neglects, within the ensuing 21 clear days, either to pay the debt or to offer reasonable security for it. If, however, the company denies on apparently reasonable grounds that it owes the money the court will dismiss the petition and leave the creditor to establish his claim by taking legal proceedings for debt; a creditor obtains judgement against the company for debt, attempts to enforce the judgement but is unable to obtain payment, i.e. no assets of the company have been found and seized; a creditor satisfies the court that taking account of the contingent and prospective liabilities of the company it is unable to pay its debts. The petition may be based on a statement of

(b)

(c)

estimated assets and liabilities or the creditor may show that the company is no longer paying its trade debts as they fall due. But this is the residual category and any suitable evidence of actual or prospective insolvency may be adduced. Although no minimum amount is specified for (b) or (c) a one thousand shillings minimum is in practice applied (it need not all be owed to one creditor if others support his petition and together they claim Shs.1,000 or more). The debt claimed must be a specified amount, i.e. a claim for general damages or for a specific sum less a deduction of uncertain amount will not do. The petitioner need not be the original creditor but may have acquired the debt, e.g. a debt collection agency may petition if the debt is then owing to it. 8.6.3 At the hearing other creditors of the company may oppose the petition. If so, the court is likely to decide in favour of those to whom the larger amount is owing. But the court may also consider the reasons for the differences between the creditors: Case: RE SOUTHARD & CO. (1979) A holding company arranged for its subsidiary, of which it was the largest creditor, to go into voluntary liquidation. The holding company, as a creditor, later petitioned for the compulsory winding up of the subsidiary in order to oust the original liquidator. The trade creditors, to whom the subsidiary owned smaller sums, wished the voluntary liquidation to continue. Held: The court might consider the reasons for the petition and the opposition to it and was not bound to accede to the wishes of the larger creditor. The petition was dismissed. 8.6.4 WINDING UP ON "THE JUST AND EQUITABLE GROUND": Unlike the other five grounds this one is widely interpreted and it is no objection that the petition is based on facts unlike the other grounds, (i.e. the ejusdem generis rule does not apply) or facts without precedent (as regards the just and equitable ground itself. The just and equitable ground is usually relied on by a member (contributory) who is dissatisfied with or is at loggerheads with the directors or controlling shareholders over the management of the company. But something more than dissatisfaction is needed to make it just and equitable that the company should be wound up. Although the court has a wide discretionary power, winding up orders have been made in the following situations: (a) The substratum of the company has gone, i.e. the only main object(s) of the company (its underlying basis or substratum) cannot be or can no longer be achieved: Case: RE GERMAN DATE COFFEE CO. (1882) The objects clause specified with much particularity that the sole object was to manufacture coffee from dates under a German patent. The German government refused to grant a patent. The company manufactured coffee under a Swedish patent for sale in German. A contributory petition for compulsory winding up. Held: The company existed only to "work a particular patent" and as it could not do so it should be

wound up. But if there are two or more alternative objects (in the proper sense objects rather than ancilliary powers) inability to achieve one of them does not justify winding up: (Re Kitson & Co. (1946) two businesses - one was sold - petition dismissed): (b) There is a complete deadlock in the management of the company's affairs. Cases: (i) RE YENIDJE TOBACCO CO. (1946) Two sole traders merged their businesses in a company of which they were the only directors and shareholders. They quarrelled bitterly and one sued the other for fraud. Meanwhile they refused to speak to each other and conducted board meetings by passing notes through the hands of the secretary. The defendant in the fraud action petitioned for compulsory winding up, which was opposed by the other member. Held: "In substance these two people are really partners" and by analogy with the law of partnership (which permits dissolution if the partners are really unable to work together) it was just and equitable to order liquidation. (c) The members or directors are associated in the company on the basis of certain understandings but one (or more) exercises his legal rights against another in breach of those understandings with results which are unfair. Such situations are sometimes referred to as a "fraud on the minority" Case: EBRAHIM v. WESTBOURNE GALLERIES (1973) E and N carried on business together for 25 years, originally as partners and for the last 10 years through a company in which each originally had 500 shares. E and N were the first directors and shared the profits as directors' remuneration; no dividends were paid. When N's son joined the business he became a third director and E and N each transferred 100 shares to N's son. Eventually there were disputes: N and his son used their voting control in general meeting (600 votes against 400) to remove E from his directorship under the power of removal given by Companies Act 1948 s.184 (Kenya, s.185). E sued to have the company wound up. Held: The company should be wound up. N and his son were within their legal rights in removing E from his directorship but the past relationship made it "unjust or inequitable" to insist on legal rights and the court could intervene on equitable principles to order liquidation. E's petition for relief on grounds of oppression of minority failed since he failed to make out a strong enough case for such relief. 8.7 PROCEEDINGS FOR COMPULSORY LIQUIDATION:

8.7.1 When the petition is presented to the court a copy is delivered to the company in case it objects, and it is advertised so that other creditors may intervene if they wish. At the hearing, a creditor whose debt is unpaid is likely to secure an order for compulsory liquidation (as his remedy of last resort) unless the company (paragraph 8) or opposing creditors (paragraph 9) persuade the court to

dismiss the petition. 8.7.2 If the petition is presented by a member (contributory) he must show (in addition to suitable grounds for compulsory liquidation) that: (a) the company is solvent or alternatively refuses to supply information of its financial position. The court will not order compulsory liquidation on a member's petition if he has nothing to gain from it. If the company is insolvent he would receive nothing since the creditors then take all the assets; he has been a registered shareholder for at least six of the 18 months up to the date of his petition. But this rule is not applied if the petitioner acquired his shares by allotment direct from the company or by inheritance from a deceased member or if the petition is based on the number of members having fallen below two: CA s.221.

(b)

A personal representative of a deceased shareholder may petition but he must first obtain a grant of probate etc. to establish his authority to represent the estate: CA, s.216. The trustee in bankruptcy of a bankrupt contributory may also petition on his behalf: CA, s.217. 8.7.3 EFFECTS OF AN ORDER FOR COMPULSORY LIQUIDATION: The effects of the order are as follows: (a) the Official Receiver (an Official of the High Court whose duties relate mainly to bankruptcy of individuals) becomes provisional liquidator; s.236 the liquidation is deemed to have begun at the time (possibly several months earlier) when the petition was first presented. If the compulsory liquidation follows voluntary liquidation already in progress (see Southard Case above) liquidation runs from the commencement of the voluntary liquidation: s.226. any disposition of the company's property and transfer of its shares subsequent to the commencement of liquidation is void unless the court orders otherwise: s.224. any legal proceedings in progress against the company are halted (and none may thereafter begin) unless the court gives leave. Any seizure of the company's assets after commencement of liquidation is void: ss.225 and 228. the employees of the company are automatically dismissed. The provisional liquidator assumes the powers of management previously held by the directors.

(b)

(c)

(d)

(e)

The assets of the company remain the company's legal property but under the liquidator's control unless the court by order vests the assets in the liquidator. The business of the company may continue but it is the liquidator's duty to continue it with a view only to realisation, e.g. by sale as a going concern. Any floating charge crystallizes. Liquidation may invalidate charges and other previous transactions. 8.7.4 Within 14 days of the making of the order for winding up a statement of affairs must be delivered to the liquidator (Official Receiver) verified by one or more directors and by the secretary (and possibly by other persons). The statement shows the assets and liabilities of the company and includes a list of creditors with particulars of any security which creditors may hold: CA, s.232. 8.7.5 The Official Receiver may require that others concerned in the recent management of the company shall join in submitting the statement of affairs. These may be (at the Official Receiver's discretion

unless the court has given directions): (a) (b) present or past officers of the company, i.e. its management; employees who are or who have been in the service of the company within the previous year if it is considered that they can provide the information required; persons who have taken part in the formation of the company within the previous year.

(c)

8.7.6 The Official Receiver makes a preliminary report to the court on the causes of the company's failure and states whether in his opinion he should make further investigation and report on suspected fraud; s.233. If he does so this may lead on to the public examination in open court of those believed to be implicated (a much-feared sanction). 8.7.7 The Official Receiver also calls separate meetings of creditors and of contributories within one month of the order for liquidation: s.236. Each meeting may nominate a permanent liquidator to replace the Official Receiver and also representatives to serve as members of a committee of inspection (to work with the liquidator). The Official Receiver reports to the court which may appoint a permanent liquidator and a committee of inspection. If no other liquidator is appointed (or if the post falls vacant) the Official Receiver continues to act as liquidator. A liquidator must be an individual and may not be an undischarged bankrupt.

8.7.8 Notice of the order for compulsory liquidation and of the appointment of a liquidator is given to the registrar and in the Kenya Gazette. When the liquidator completes his task he reports to the court, which examines his accounts, and makes an order for dissolution of the company. The order is sent to the registrar who gives notice of it in the Kenya Gazette and dissolves the company: ss.247 and 269. If while the liquidation is in progress the liquidator decides to call meetings of contributories or creditors he may arrange to do so under powers vested in the court: s.336. 8.8 RESOLUTION TO WIND UP VOLUNTARILY:

8.8.1 The type of resolution to be passed varies with the circumstances of the case, as provided in s.271 (1): (a) If the articles provide for liquidation at the end of a specified period or on the happening of an event, e.g. the completion of the transaction for which the company was formed, an ordinary resolution (referring to the articles) suffices; or A company may, by special resolution (giving no reason), resolve to wind up voluntarily

(b)

The winding up commences on the passing of the resolution. The company must within 14 days after the passing of the resolution give notice of it by advertisement in the Kenya Gazette, and also in some newspapers circulating in Kenya: s.272(1). 8.8.2 DECLARATION OF SOLVENCY: A voluntary winding up is a members' voluntary winding up only if the directors make and deliver to the registrar a declaration of solvency: s.276(4). This is a statutory declaration that the directors have made a full inquiry into the affairs of the company and are of the opinion that it will be able to pay its debts in full within a specified period,

not exceeding 12 months. The declaration is made by all the directors or, if there are more than two directors, by a majority of them. The declaration includes a statement of the company's assets and liabilities as at the latest practicable date before the declaration is made. The declaration must be: (a) made within the thirty days immediately preceding the date of the passing of the resolution for winding up, and delivered to the registrar for registration before that date: s.276(2)

(b)

If the liquidator later concludes that the company will be unable to pay its debts he shall further notify the registrar accordingly and call a meeting of creditors and lay before them a statement of assets and liabilities: s.281(1) It is a criminal offence punishable by fine or imprisonment for a director to make a declaration of solvency without having reasonable grounds for it, i.e. if the company proves to be insolvent he will have to justify his previous declaration or be punished. 8.8.3 In a members' voluntary winding up the creditors play no part since the assumption is that their debts will be paid in full. There is no committee of inspection (on which creditors would be represented). The liquidator calls special and annual meetings of members to whom he reports: (a) within three months after each anniversary of the commencement of the winding up the liquidator must call a meeting and lay before it an account of his transactions during the year: s.282. when the liquidation is complete the liquidator calls a meeting to lay before it his final accounts.

(b)

After holding the final meeting the liquidator sends a copy of his accounts to the registrar who dissolves the company three months later by removing its name from the register: s.283(4). 8.9 CREDITORS' VOLUNTARY WINDING UP:

8.9.1 If no declaration of solvency is made and delivered to the registrar, the liquidation process is a creditors' voluntary winding up even if in the end the company pays its debts in full. To commence a creditors' voluntary winding up the directors convene a general meeting of member to pass a special resolution. They also convene a meeting of creditors, sending notices to creditors individually and advertising the meeting once in the Kenya Gazette and once at least in a newspaper circulating in Kenya: s.286(2). The meeting of members is held first and its business is: (a) (b) (c) to resolve to wind up; to appoint a liquidator; and to nominate representatives to be members of the committee of inspection.

8.9.2 The creditors' meeting is convened for the same day at a later time than the members' meeting or it

is held the following day. One of the directors presides at the creditors' meeting and lays before it a full statement of the company's affairs and a list of creditors with the amounts owing to them. The creditors' meeting nominates a liquidator and up to five representatives of creditors to be members of the committee of inspection. If the creditors nominate a different person to be liquidator their choice prevails over the nomination by the members (subject to a right of appeal to the court). It is no longer possible to prevent the creditors from appointing the first liquidator by failing to call a creditors' meeting after holding a members' meeting (to appoint a liquidator of their choice) on short notice. (This device was first developed in Re Centrebind (1966) and is colloquially called "centrebinding"). Any meeting of members called to initiate a winding up must be convened with not less than 7 days notice. 8.9.3 The main differences between a members' and a creditors' voluntary winding up are that: (a) in a creditors' voluntary winding up the liquidator, although responsible to members as well as creditors, is selected by the creditors. In a members' voluntary winding up he is appointed by the members; in a creditors' voluntary winding up the liquidator must obtain the approval (usually) of the committee of inspection for the exercise of certain statutory powers. In a members' voluntary winding up he obtains approval from the members in general meeting; there is a committee of inspection in a creditors' voluntary winding up with up to five members, a majority of whom being appointed by the creditors: s.288(1). There is no committee in a members' voluntary winding up.

(b)

(c)

The effect is that the creditors have a decisive influence on the conduct of the liquidation. This is reasonable since it is assumed (in the absence of a statutory declaration of solvency) that the company is unable to pay its debts in full. The remaining assets will therefore be realized for the benefit of the creditors and the members get nothing (unless the company proves to be solvent after all). Meetings are held in the same sequence as in a members' voluntary winding up but the meetings of creditors are called at the same intervals as the meetings of members and for similar purposes. 8.9.4 THE EFFECT OF VOLUNTARY WINDING UP: The main difference in legal consequences between a compulsory and voluntary winding up are: (a) A voluntary winding up commences on the day when the resolution to wind up is passed. It is not retrospective; The Official Receiver does not become provisional liquidator. The members or creditors select and appoint the liquidator and he is not an officer of the court; There is no automatic stay of legal proceedings against the company nor are previous dispositions or seizure of its assets void. But the liquidator in a voluntary winding up has a general right to apply to the court to make any order which the court can make in a compulsory liquidation. He would do so to prevent any creditor obtaining an unfair advantage over other creditors; The liquidator replaces the directors in the management of the company (unless he decides to retain them). The employees are not automatically dismissed by commencement of voluntary liquidation. But insolvent liquidation may amount to repudiation of their contracts

(b)

(c)

(d)

of employment (and provisions of the statutory employment protection code apply). 8.9.5 LIQUIDATORS' POWERS: The liquidator (in any type of liquidation) has numerous statutory powers but in the exercise of some of them he must obtain the approval of the court, or of the committee of inspection or of meetings of members or creditors. He may always apply to the court for an order to resolve any unusual difficulty. The more important statutory powers of the liquidator are: (a) (b) to conduct legal proceedings in the name and on behalf of the company; to carry on the business of the company so far as may be necessary for the beneficial winding up thereof. to appoint an advocate and to assist him in the performance of his duties; to pay any classes of creditors in full; to make any compromise with creditors; to compromise calls: s.241(1).

(c) (d) (e) (f)

8.9.6 COMMITTEE OF INSPECTION: A committee of inspection is appointed in a compulsory liquidation and in a creditors' voluntary liquidation. It usually comprises such number of representatives of members and of creditors as may be agreed on by the meeting of creditors and contributors. If they disagree, the court decides the number (in a creditors' voluntary liquidation limited to a maximum of five). The committee meets once a month unless otherwise agreed and may be summoned at any time by the liquidator or by a member of the committee: s.249. The general function of the committee is to work with the liquidator, to supervise his accounts, to approve the exercise of certain of his statutory powers and to fix his remuneration. Like the liquidator himself members of the committee are in a fiduciary position and may not secure unauthorized personal advantages, e.g. by purchase of the company's assets. 8.9.7 CALLS ON CONTRIBUTORIES: Every person who is a member of the company at the commencement of winding up and every past member is in principle liable to contribute to the company's assets whatever may be required to enable it to pay its debts in full. Present and past members are therefore called "contributories". This serves to give present and past members the status of contributories with, for example, the right to petition for compulsory winding up. But if the company is limited by shares and its issued shares are fully paid the contributories have not liability to contribute anything in normal circumstances. A contributory may be liable to contribute in the following circumstances: (a) if the shares which he holds or previously held are partly paid or if it is found that the rules on consideration have been breached in the allotment of shares as fully paid' if the company is limited by guarantee;

(b)

(c)

if the company is unlimited.

As explained below the persons who are members at the time when liquidation commences are primarily liable (when there is any liability). The liability of past members is very restricted. If it is necessary to make calls on contributories the liquidator draws up a list "A" of contributories who were members at the commencement of the winding up and a list "B" of contributories who were members within the year preceding the commencement of winding up. A list B contributory has liability limited by the following principles: (a) he is only liable to pay what is due on the shares which he previously held and only so much of the amount due on those shares as the present holder (a list A contributory) is unable to pay; he can only be required to contribute (within the limits stated in (a) above) in order to pay those debts of the company incurred before he ceased to be a member which are still owing.

(b)

As stated above a past member ceases to be liable altogether (on partly paid shares) if the company continues (without going into liquidation) for a year. 8.10 TRANSACTIONS ARISING IN A LIQUIDATION

8.10.1 In collection in and realisation of assets in order to pay the company's debts and then to distribute any surplus to members the liquidator will have dealings with creditors, secured and unsecured, with members and others. He may have to enforce claims on behalf of the company against those who previously managed its business. He has also to consider whether the charges on the company's assets on which secured creditors rely are still valid. This topic is concerned with the legal aspects of these problems and transactions of the liquidator. 8.10.2 ASSETS IN THE POSSESSION OF CREDITORS: If the creditor has seized assets in the course of executing a judgement for debt against the company and at the commencement of the winding up or on receiving notice that it is about to begin the creditor has not completed the process of recovering what is owed to him, the liquidator may compel him to return the asset to the company. 8.10.3 DISCLAIMER OF ASSETS: The liquidator has a statutory right of disclaimer of assets: s.135. The rules are: (a) (b) he must obtain leave of the court; the right of disclaimer is limited to property of the following kinds:(i) (ii) (iii) (iv) (c) land burdened with onerous covenants; shares; unprofitable contracts; other property which is difficult to sell because of the burdens attached to it;

the liquidator must disclaim within a period of 12 months (unless the court extends the period). The period is reckoned from commencement of winding up or the data when the liquidator became aware of the property if this was more than one month after that commencement. Moreover, the other party may serve on the liquidator a notice requiring him within 28 days to state whether he intends to disclaim. If the liquidator does not within

that period declare an intention of disclaimer he losses the right to do so; (d) any person who suffers loss by the disclaimer becomes a creditor of the company for the amount of his loss. If the property disclaimed is a lease which has been mortgaged or sub-let the court may vest the property disclaimed in the mortgagee or sub-lessee.

8.10.4 PROOF OF DEBTS: Many of the rules of bankruptcy apply to the discharge of the company's debts: s.310. The liquidator must obviously require satisfactory evidence that a creditor's claim is properly admissible as a liability. This is done (where necessary) by a procedure for "proof of debts". If the company is solvent every kind of debt which is legally enforceable may be admitted. If it is insolvent unliquidated claims in tort are not admissible. But the injured party may be permitted to bring an action against the company in tort so that his claim may be converted by the award of damage into a liquidated sum so long as it is liquidated when the claimant comes into prove. A statute-barred debt should be rejected since it is not legally enforceable. But in a members' voluntary winding up the liquidator may with the consent of all contributories pay such a debt. The general rules on statute-barred debts are: (a) in a normal case a debt becomes statute-barred (i.e. the creditor may no longer take legal proceedings to enforce payment) if it remains unpaid for six years and the creditor does not within that time commence legal proceedings to recover it. the company becomes liable again to pay a statute-barred debt (after six years) if it issues to the creditor a written acknowledgement of its indebtedness.

(b)

The liquidator must also consider whether any debts of the company arise from contracts which are ultra vires or ultra vires the company but made by the directors without authority. The liquidator must according to his judgement of the legal position either. (a) (b) reject the creditor's claim as invalid if that is possible, or consider claiming compensation from the directors who made the unauthorized contract on the grounds of their misfeasance under s.323.

8.11

SECURED CREDITORS:

8.11.1 A secured creditor may: (a) realize his security and prove as an unsecured creditor for the balance (if any) of his debt; value the security and prove for any balance. In this case the liquidator may either redeem the security at the creditor's value or require it to be sold; rely on his security and not prove at all; the liquidator may then redeem by payment in full; surrender his security and prove for the whole debt.

(b)

(c)

(d)

A secured creditor who proves his debt must disclose his security and prove only for the

balance as an unsecured creditor. The liquidator may find that the security given by a floating charge over the undertaking and assets of the company has been enforced (before liquidation began) by the appointment of a receiver and manager who is in charge of the entire business and property of the company. The liquidator should consider whether the charge has become invalid by reason of the commencement of liquidation (paragraph 10 below). If however it is valid the liquidator must wait to see whether there will be any surplus from the company's assets which the receiver will pay over to him when the secured creditors who appointed the receiver have been paid in full. The sequence of events may be reversed i.e. the liquidator causes a floating charge to crystallize and a receiver is appointed after the liquidator has taken control. In that case the liquidator must hand over the business to the receiver since he represents creditors who have a prior claim. 8.11.2 The liquidation itself may render a charge over the company's assets void in any of the following circumstances: (a) (b) the charge was not registered within 42 days of creation as required by s.96; the charge is a floating charge created within the period of 12 months before commencement of liquidation (paragraph 24 below), or the charge is void as a fraudulent preference (paragraph 28 below).

(c)

If the charge is void the receiver's powers and appointment lapse and he must account to the liquidator for his transactions and the assets of the company still under his control. If there are not sufficient other assets to pay preferential debts those debts are paid out of property subject to a floating charge in priority to that charge. It is the duty of the liquidator to ensure that debts are paid in their due order of priority. 8.12 UNSECURED ORDINARY DEBTS:

8.12.1 A secured creditor obtains payment (to the extent that his security is adequate i.e. if it exceeds in value the amount owing to him) because he has a valid prior claim to that security. Unsecured creditors are paid out of the remaining assets, i.e. the aggregate of: (a) any surplus value obtained by secured creditors in realising the assets which are their security and paid over to the liquidator, and any assets which are not subject to charges given to secured creditors.

(b)

But two special claims have to be given their due priority, i.e. (a) (b) costs of winding up including the legal expemses and liquidator's remineration, and preferential unsecured debts.

8.12.2 The order of application of assets is therefore as follows: (a) secured creditors who have fixed charges are entitled to be paid out of their security so far as it suffices. If the security is insufficient in value to pay the debt in full the creditor rank as an unsecured creditor for the balance;

(b) (c)

the costs of winding up are paid next, i.e. they rank before floating charges; preferential unsecured debts (paragraph 15 below) are paid next, i.e. they rank before floating charges in so far as there are no other assets available to pay preferential debts. If the floating charge covers the entire undertaking and property of the company (as is normal in modern practice) there will be no uncharged assets; debts secured by floating charges come next in order; unsecured non-preferential debts come next; deferred debts come last in order.

(d) (e) (f) 8.13

PREFERENTIAL DEBTS:

8.13.1 These unsecured debts which rank ahead of a floating charge and non-preferential debts are: (a) one year's taxes, i.e. corporation tax, PAYE income tax deducted, rates, VAT unpaid at the "relevant date". The relevant date is defined as: (i) the date of the order for compulsory liquidation (or any earlier order for appointment of a provisional liquidator); or the date of passing the resolution to wind up voluntarily.

(ii)

If more than one year's tax is outstanding the Income Tax Department may select whichever year yields the largest amount of corporation tax; in other cases it is the latest year's tax which is a preferential debt; (b) wages and salary of an employee, i.e. clerk, servant, workman or labourer (including commission or piece work payments) of the four months up to the relevant date limited to a maximum of four thousand shillings owed to each individual employee, accrued holiday pay and employer's National Social Security Fund (NSSF) contributions. A director is not an employee in respect of a claim for unpaid fees but he may be in respect of salary if he has a contract of service.

8.13.2 Loan creditors and landlords are subject to special rules in certain circumstances: (a) if a person (usually a bank) lends money to the company to enable it to pay wages which, if unpaid, would be preferential debts, he himself becomes a preferential creditor in respect of that part of his loan which is used to pay preferential wage debts; a landlord's remedy if rent is unpaid is to seize and sell the tenant's goods on the premises (called "levying distress"). If he does not within six months before compulsory liquidation commences he must give up the proceeds if the liquidator requires them for payment of preferential debts. The rule does not apply in a voluntary liquidation: CA, s.311(7).

(b)

8.14

DEFERRED DEBTS: A debt owed to a member as member, i.e. an unpaid dividend, is a deferred debt paid only when ordinary debts have been paid in full.

8.15

RIGHTS OF EMPLOYEES: The effect of liquidation is often to terminate the contracts of service of employees of the company. The company may owe them arrears of wages or salaries which can be preferential debts wholly or in part.

8.16

DISTRIBUTION OF SURPLUS ASSETS: If the debts are paid in full the liquidator should apply what remains in repayment of capital paid on shares and then distribute any residue to those entitled to the surplus. Unless otherwise stated all shares rank equally. But the articles often provide that preference share capital is to be repaid in priority (with the implication that preference shares do not carry a right to participate in any surplus left after all paid up share capital has been paid).

8.17

A company may (by its memorandum or articles or by a resolution passed in general meeting) authorize distribution of assets (after payment of debts which must have priority) not to members but to, for example, a charity or to employees of the company. Payments to employees made after the company has ceased to carry on or has sold its business are not within its powers: Parke v. Daily News Ltd. AVOIDANCE OF FLOATING CHARGES:

8.18

8.18.1 Under s.314 liquidation automatically renders void any floating charge created within the period of 12 months before commencement of liquidation subject to the following exceptions: (a) valid if the company was solvent at the time when the charge was created. A company is not solvent unless it can pay its debts in full as they fall due; if the company was not solvent the floating charge is still valid as security for cash paid to the company (with interest at six per cent per annum) after the charge was created and in consideration of the loan. The general purpose of the rule is to prevent an unsecured creditor of an insolvent company from getting advantage over other creditors by obtaining a floating charge to secure an existing debt at a time when the company is heading towards insolvent liquidation. It is only the charge (as security) not the debt itself which becomes void. 8.18.2 If the charge is created to secure a loan of new money the rule is generously interpreted. Case: RE F AND E STANTON (1929) A lender agreed to lend money to a company on the security of a floating charge. The money was lent but the charge was not created until afterwards. A few days after the creation of the charge the company went into liquidation. Held: The charge was valid since the loan was made in consideration of the promise of security. It was not material that the money was lent before the charge was created. On the other hand if money is lent after a floating charge is created but is used (as was intended) to pay off an unsecured debt (of the same creditor) existing when the charge was created, this will not be treated as a new loan and the charge will be void (as security for the later loan).

(b)

In determining the date when money is lent through transactions on running account the rule in Clayton's Case is applied, ie. any repayment is applied to pay off the earliest advance. Case: RE YEOVIL GLOVE CO (1965) At the time when the floating charge was created the company had a bank overdraft of about 68,000 pounds. Over the next few months it paid in cheques totalling 111,000 pounds and drew cheques totalling 110,000 pounds. At the commencement of liquidation (within 12 months of creating the charge) the debt balance on the account was 67,000 pounds, ie. almost the same as when the charge was created. Held: The loan of 68,000 pounds at the date when the charge was created had been repaid by the subsequent credits of 111,000 pounds to the account. The balance of 67,000 pounds owing at the commencement of liquidation was "new money" lent after the charge was created (ie. part of the 110,000 pounds drawn out) and so the charge was a valid security for that loan. 8.19 Fraudulent Preference Under s.312, any disposition of the company's property and any creation of a charge, fixed or floating, effected during the period of six months before commencement of liquidations void as a fraudulent preference if: (a) (b) (c) done voluntarily; and done with the intention of preferring one creditor (or surety) over another; at a time when the company was insolvent, ie. unable to pay its debts in full.

A "disposition" includes the payment of a debt. Payment of one creditor with the intention of preferring him to others is a common example of fraudulent preference (if the other conditions are met). Case: RE M KUSHLER LTD (1943) The directors had given personal guarantees of the company's bank overdraft. They arranged that the company should pay its trade receipts into the account but should not pay its trade debts as they fell due with the result that the bank overdraft was paid off. Shortly afterwards the company went into insolvent liquidation. Held: This was fraudulent preference and the bank must repay the sums received. The directors' liability under their guarantee to the bank then revived. A payment made or charge created under threat of legal proceedings is not voluntary and so it cannot be treated as fraudulent preference even though its purpose and effect is to treat one creditor more favorable than the rest. An ordinary commercial payment of debts made without intention of giving an advance may not amount to fraudulent preference: Re Paraguassu Steam Tramway Co (1974). However, it has recently been held that a payment will constitute a fraudulent preference if the debtor, at the time of

making it, knew that he could not pay his debts as they arose and intended to pay one of his creditors in full ahead of the others. Case: RE MATHEWS (1982) The proprietors of an insolvent small company (who were aware of the insolvency) paid cheques into the company's bank account. Two days later the company ceased trading and two days after that the proprietors notified the bank of the termination of their personal guarantees of the company's borrowing. Held: Banking cheques after a decision to stop trading was a fraudulent preference in favour of the bank since at that time the proprietors knew that the other creditors would not be paid (even though they honestly believed that they would eventually be paid). When a transaction is void as a fraudulent preference any charge created is void and any cash paid or property transferred by the company must be returned to the liquidator. There can be complications when a third party, usually a creditor, has given security (eg. deposit with the lender of the title deeds of the director's house) as security for the company's debt. The purpose of the fraudulent preference (as in the Kushler Case above) is often to release a third party from his involvement in the company's debt. When the debt is paid (as a fraudulent preference) the lender returns to the guarantor whatever security the latter has given. When the lender has to return to the liquidator the payment received he cannot require the guarantor to reinstate his security but the latter continues to be (or if there is no previous personal guarantee by him becomes) personally liable to the lender as a guarantor of the debt: CA, s.313. 8.20 Fraudulent Trading Under s.323, if the court finds that the business of a company in liquidation has been carried on with intent to defraud creditors or for any fraudulent purpose it may declare that any persons who were knowingly parties to carrying on the business in this fashion shall be liable for debts of the company as the court may decide. It has been said that "if a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors receiving payment of those debts, it is, in general, a proper inference that the company is carrying on business with intent to "defraud" (per Maugham J. in William C Leitch Bros (No 1)(1932). But in another case the same judge said that there must be evidence of "real dishonesty". No Kenyan case has been decided on the section. 8.20.2 Various rules have been established to determine what is fraudulent trading: (a) Only persons who take the decision to carry on the company's business in this way or play some active part are liable. An employee who is aware that the debts incurred may not be paid and who merely fails to inform the directors of the situation is not a "party" to carrying on business since it is not a decision or action on his part. Case: RE MAIDSTONE BUILDING PROVISIONS (1971) The secretary of the company also acted as financial adviser to the directors. The secretary was aware but did not tell the directors that in carrying on its business the company was incurring debts which it was not likely to pay. Proceedings were brought against the secretary for fraudulent trading.

Held: As the secretary did not take the decision to continue trading he was not a "party" to fraudulent trading. In so far as he had failed to provide information and advice which it was his duty to give he might have been negligent but that was not an issue in these proceedings. (b) "Carrying on business" can include a single transaction and also the mere payment of debts as distinct from making trading contracts. Case: RE SARFLAX (1979) The company owed money to trade creditors and also had outstanding against it a large claim for breach of contract which it disputed (though the claimant had obtained judgement in his favour in the Italian courts). The directors used the remaining assets to discharge the trade debts. When the company went into liquidation the liquidator sought a declaration that the directors had carried on business with intent to defraud the Italian creditor. Held: In paying the other debts the directors had "carried on business" but this was not a case of "intent to defraud" the Italian claimant, whose claim they did not accept. (The issue of possible fraudulent preference of the trade creditors was not raised). 8.20.3 If the liquidator considers that there has been fraudulent trading he should apply to the court for an order that those responsible (usually the directors) are liable to make good to the company all or some specified part of the company's debts. If the liquidator does not do this a creditor might be able to obtain an order that those at fault must pay the creditor direct: Re Cyone Distributors (1967). The liquidator should also report the facts to the Attorney General so that he may institute criminal proceedings. 8.21 Misfeasance Under s.324, misfeasance proceedings may be instituted against a director, promoter, manager, liquidator or "officer" (including an auditor) of a company in liquidation either to recover the company's property from him or to claim compensation for the loss to the company caused by his misfeasance. The most obvious case of misfeasance is where a director or other officer of the company is found to have misappropriated property of the company. He can be compelled by misfeasance proceedings to return it. His conduct may also be criminal misappropriation of property for which he can be prosecuted. The other type of misfeasance case is where the company has suffered loss owing to the incompetence or neglect of a director or other officer. It is not however easy to establish that there has been breach of a fiduciary duty such that an order should be made (on grounds of misfeasance) for payment of compensation. For some lesser default the liquidator could bring an action for negligence. In the context of misfeasance proceedings an auditor is exceptionally an "officer" who can be liable: he is not an "officer" in any other situation since he has no management functions. A receiver is not an "officer" who can be held liable (if the company later goes into liquidation) for misfeasance.

Case. RE B JOHNSON & JOHNSON CO (BUILDERS) (1955) Misfeasance proceeds were brought against a receiver on the ground that he had in his management of the company's business taken decisions which were "detrimental from the company's point of view", eg. closing down parts of its business. Held: A receiver is a representative of the secured creditors by or for whom he is appointed. He is not an officer of the company who can be liable for misfeasance. If however a receiver does not act bona fide (ie. honestly) the company might have a claim against him but not misfeasance. 8.22 Other Legal Procedures The court may order the examination in private or public (ie. open court) of an officer of a company in liquidation or of any person known or suspected to have its property or information about it in his possession. Public examination is ordered only in cases of suspected fraud. Concealment of information from a liquidator, falsification of company records and wrongful disposal of property of a company in liquidation may give rise to criminal proceedings against the person at fault. 8.23 Revival of a Dissolved Company Liquidation leads on to dissolution of the company. The court may, however, within the ensuing two years order that dissolution be rescinded and the company restored to the register -usually because some asset or liability previously overlooked has come to light: CA, s.338. 8.24 Liquidators and Receivers The distinction between liquidators and receivers must be kept clear: (a) a receiver is a representative of secured creditors appointed by them (or by the court on their behalf) to enforce their security, ie. to take control of the company's assets subject to a charge and to raise money from those assets to pay the secured debt. If the debt is paid the receiver vacates office and the directors resume full control; a liquidator is appointed by the court (compulsory liquidation) or by members and creditors (creditors' voluntary liquidation). His task is to take control of all the company's assets with a view of their realisation and the payment of all debts of the company and distribution of any surplus to members. At the end of a liquidation the company is dissolved. There are a number of points of similarity: (a) in a compulsory (but not a voluntary) liquidation the directors have to submit a statement of affairs to the Official Receiver as provisional liquidator. If a receiver is appointed under a floating charge covering the company's undertaking as a whole he too is entitled to be given a statement of affairs. accountants who specialize in insolvency may be appointed as liquidators or as receivers (sometimes they combine these positions in the same company but professional opinion in the U.K. has hardened against this position since there can be difficult conflicts of interest to resolve between unsecured creditors and members on

(b)

(b)

one side and secured creditors on the other); (c) a receiver appointed under a floating charge is also manager of the business (or a manager is appointed to assist him). His function is to continue to carry on the business on a going concern basis. The liquidator's function is to sell the company's assets on the best terms he can get. As closure costs (redundancy payments to employees etc.) can be heavy a liquidator may decide to carry on the business with a view to selling it as a going concern. But this is only one of the alternatives open to him; neither liquidator nor receiver usually has the assets of the business vested in his legal ownership (though a liquidator may obtain a court order for assets to be vested in him under CA, s.240 - but this is not common). Both liquidator and receiver have control of the company's assets.

(d)

There are also significant differences: (a) a liquidator has numerous statutory powers. A receiver must rely on the powers given by the debenture under which he is appointed (or by the court); a receiver is personally liable on the contracts which he makes for the company. A liquidator has no such liability. But either, if he fails to perform his duties properly, may be called to account in various ways.

(b)

REINFORCEMENT QUESTIONS
1. "Explain the difference between a voluntary winding up and a compulsory winding up, outlining the procedures to be followed in each type of winding up".

2.

Concerned at the recession on the textile business, Onyango, a director of Threads Ltd., decided that the company should cease manufacturing textiles but should instead manufacture paper. Writing on note paper which described the company as paper manufactures, Onyango ordered a quantity of oil for use in the new paper factory which he had built. The oil was delivered but Threads refused to pay for it on the ground that the contract was ultra vires. Atieno, a minority shareholder in Threads Ltd, is now anxious that the company should close down its paper manufacturing business as soon as possible. (a) Advise the supplier of oil whether he may sue Threads Ltd for the price of the oil, or alternatively, recover back the oil itself which has not been used by Threads Ltd. Advise Atieno whether she may restrain the company from carrying on the business of paper manufacturers.

(b)

Check your answers with those given in Lesson 9 of the Study Pack

COMPREHENSIVE ASSIGNMENT No.4

TO BE SUBMITTED AFTER LESSON 8
To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by the College. EXAMINATION PAPER. TIME ALLOWED: THREE HOURS. ANY FIVE QUESTIONS

1.

a.

The general legal principle is that a company has a separate legal existence from that of its members. In what circumstance does that principle not apply? Give examples of such situations. (10 marks) Walter is employed as a Managing Director by Clispe Ltd. whose main object is to retail office equipment. His contract of employment contains a clause which states that in the event of his leaving the employment of Clipse Ltd. he will not solicit their customers for a period of two years. He resigns his employment and together with his wife Jean form a new company, Desks Ltd., whose main object is also retailing office equipment. Bill is a salesman employed by Desks Ltd. He is given customer lists by Walter and immediately starts soliciting Clipse Ltd.'s customers. In order to raise cash for his new business Walter enters into a contract to sell his house to Wilf for 50,000. Bill who has always admired the house approaches Walter and makes him an offer of 60,000. Walter transfers the ownership of the house to Desks Ltd., and on behalf of the company enters into negotiations to sell the house to Bill. Advise Clipse Ltd. and Wilf on any action they can make. (10 marks)

b.

2.

a.

What are the permitted statutory reasons for altering the objects clause of the Memorandum of Association? What procedures must be followed by the company for such an alteration to be effected? (10 marks)

b.

Baktobasiks plc is a company whose main object is to promote hill walking and camping outdoors. The company has only issued ordinary shares. There has been a declining interest in these activities and the directors decide to call an extraordinary general meeting to alter the main object of the company so that it now becomes "to promote the interest of all lovers of the countryside and provide camping sites for the drivers of motorised vans". At the extraordinary general meeting of which proper notice was given, 80% of the present voted in favour of the resolution and 20% against. After the meeting a group of dissatisfied shareholders who between them own 17% of the ordinary shares in the company approach you. They ask what further action, if any, they can take. i. ii. What advice would you give them? Tom is a shareholder who owns 4% of the ordinary shares in the company. Tom voted

in favour of the resolution but, after the meeting, the dissatisfied shareholders persuaded him to object. If you had learned this, would you still give the same advice as before or not? What would be your reasons? (10 marks)

3.

Concerned at the recession in the textile business David, a director of Threadbare Ltd., decided that the company should cease manufacturing textiles but should instead manufacture computers. Writing on notepaper which described the company as computer manufacturers David ordered a quantity of oil for heating the new computer factory which he had built. The oil was delivered but Treadbare Ltd. refused to pay for it on the ground that the contract was ultra vires. Meany, a minority shareholder in Threadbare Ltd., is now anxious that the company should close down its computer manufacturing business as soon as possible. a. Advise the supplier of oil whether he may sue Threadbare Ltd. for price of the oil or alternatively recover back the oil itself assuming that it still exists. Advise Meany whether he may restrain the company from carrying on the business of computer manufacturers.

b.

4.

The articles of Biashara Ltd include the following provisions: i. ii. iii. iv. v. All disputes between the company and its members shall be referred to arbitration. Kariuki Munene and Karanja shall be the directors of the company for life. Onyango shall be employed as the company's lawyer. The directors shall have the powers to declare a dividend to be paid to the shareholders. Every member of the company who intends to transfer his shares shall inform the directors who will take the shares between them at a fair value. Kariuki, Munene and Karanja are members of the company. Onyango is not. a. Mutiso, shareholder, wishes to sell his 1,000 shares in the company and offers to sell them to Kariuki, Munene and Karanja. They refuse to buy the shares. Mutiso intends to bring an action against the directors for breach of contract. Advise Mutiso. b. At a properly convened and conducted extraordinary general meeting, the second article referred to above is altered to read as follow: "Kariuki, Munene and Karanja shall be directors of the company until they attain the age of 65 years". Karanja will be 60 years of age next month and wishes to challenge the alteration. Advise Karanja. c. Onyango's work has been unsatisfactory and for the last six months the company has employed Patel as the company accountant. Onyango wishes to challenge the company's failure to employ him in accordance with the articles. Advise him.

d.

The company has made substantial profits and a dividend has been declared. The directors resolve to distribute this in form of debentures stock carrying interest at 10% and redeemable at par in 1998. Wamalwa, a shareholder, wishes to have his dividend in cash and challenges the directors' resolution. Advise Him.

5.

a.

What are the characteristics of a floating charge? What is the effect of crystallisation? State two advantages and disadvantages of a floating charge. What are the statutory requirements imposed on limited companies by the Companies Act in respect of registration and inspection of the details of a floating charge? What are the sanctions for non-compliance. What is meant by "the minimum subscription"? Biashara Ltd. has an authorised share capital of Shs 1,000,000 which is divided into 100,000 ordinary shares of Shs 10 each. The company issues a prospectus inviting the public to apply for all the 100,000 shares. The prospectus states that the minimum subscription in relation to the issue is Shs 500,000. i. Under what conditions may the directors make an initial allotment of the shares that the public have applied for? What would be the legal position if the directors allotted the shares applied for in breach of the said conditions?

b.

6.

a. b.

ii.

7.

Makanyanga, the managing director of Makanyanga Enterprises Ltd., borrowed from Maendeleo Bank Ltd., 50,000. This loan was made expressly for the purpose of makanyanga Enterprises Ltd.'s business of selling corrugated iron sheets. Unknown to the bank this business has never been within the scope of the company's memorandum of association. Makanyanga used this loan to pay off a mortgage of the company's premises. Advise the bank who have now discovered the true position. Would your answer be different if the bank manager who dealt with Makanyaga did not know that the loan was required for the corrugated iron sheets business?

8.

a.

What legal effect is given to a contract purporting to be made on behalf of a company which had not been formed at the time of contracting? (4 marks) Can a company, upon incorporation, ratify such a contract? (2 marks) What legal effect is given to a contract purporting to be made on behalf of a company which had been dissolved (i.e. had ceased to exist) at the time of contracting? (2 marks) What are the rules governing the power of a company incorporated under the Companies Act to ratify a contract, made on its behalf, which is clearly beyond the objects of the company as defined in the memorandum? (7 marks)

b.

c.

d.

END OF COMPREHENSIVE ASSIGNMENT No.4

NOW SEND TO THE DISTANCE LEARNING CENTRE FOR MARKING

STRATHMORE COLLEGE
LAW II APPENDIX OF CASES DISTANCE LEARNING For reference to the cases in the LAW II Study Pack

LAW II
APPENDIX OF CASES

1.

FORT-HALL BAKERY SUPPLY CO v WANGOE A plaint bearing the name "The Fort-Hall Bakery supply Co." as the plaintiff was filed against the defendant for recovery of a certain amount of money from him. During the hearing it was established that the business called "The Fort-Hall Bakery Supply Co." was being carried on by a group of forty-five people and had not been registered under the Companies Act. The defendant's advocate thereupon submitted that the action was not properly before the court since the business was illegal under s.338 of the then Companies Act (Cap 288) which was identical to s.389 of the current Companies Act. It was held that the plaintiffs could not be recognized as having any legal existence and were incapable of maintaining the action. The court thereupon terminated the proceedings without making any order as to costs because a non-existent plaintiff can neither pay nor receive costs. Templeton, J. stated: "The Act was intended, as it appears to me, to prevent the mischief arising from large trading undertakings being carried on by large fluctuating bodies, so that persons dealing with them did not know with whom they were contracting, and so might be put to great difficulty and expense, which was a public mischief to be repressed".

2.

JUBILEE COTTON MILLS v LEWIS Lewis was a promoter of a company formed to purchase a cotton mill and to carry on the business of cotton spinning. The memorandum and articles of the proposed company were delivered to the Registrar of Companies on 6th January 1920. The Registrar registered the company on 8th January 1920 but, by an oversight, dated the certificate 6th January, 1920. On 6th January a large number of fully paid shares were alloted to the vendors of the mill, and they were later transferred to Lewis. The question that the courts were asked to consider was whether the allotment was valid since it was done before the company was actually registered. The House of Lords held that the allotment was valid since it was made the day which, according to the certificate of incorporation, the company was registered. It also explained that a company is deemed to be incorporated from the day of the date on its certificate of incorporation, and from the first moment of the day, and that the phrase "from the date of incorporation" does not mean "from some part of" that date but means the whole of that day. The Act does not in this connection divide a day into hours and minutes.

3.

SALOMON v SALOMON & CO. LTD. Salomon for many years carried on business as a leather merchant. In 1892 he registered a limited liability company known as Salomon & Co. Ltd. to take over the business. The share capital of the company was 40,000, divided into 40,000 shares of 1 each. The company duly took over the business of Salomon at the agreed purchase price of 38,782 19s 7d. after it was agreed that part of the purchase price should be paid by the issue of debentures by the company to Salomon. In pursuance of the said agreement as to the mode of payment of the purchase price, debentures for 10,000 were issued by the company to Salomon in part payment thereof. Later, at the request of Salomon, these debentures were cancelled and fresh debentures to the same amount were issued to X as security for 5,000 lent by X to Salomon, and Salomon lent this sum of 5,000 to the company. Shortly after the registration of the company, 20,000 shares of 1 were issued by the company to

Salomon. For these he paid 1 per share out of the balance of the purchase money deemed to have been received by him for the business. From that date until an order was made for the compulsory liquidation of the company, in 1893, the share register of the company remained unaltered, 20,000 shares being held by Salomon while his wife, daughter and four sons held one share each. The company became insolvent and defaulted in paying interest on the debentures, and in 1893 x instituted an action to enforce his security against the assets of the company. Thereafter, at the instance of unsecured creditors of the company, a liquidation order was made, and a liquidator appointed. The debts of the unsecured creditors of the company amounted to 7,733 8s 3d. The assets of the company amounted to approximately 6,000 and after allowing for x's debt and interest under the debentures, it would leave a balance of 1,005, which Salomon claimed as a beneficial owner of the debentures for 10,000. In x's action to enforce his security, the liquidator made a counterclaim against x and Salomon, and contended that the company was the mere nominee and agent of Salomon, that Salomon was liable to indemnify the liquidator against the whole of the unsecured debts of the company, and that he was entitled to a lien for that sum on all moneys payable by the company to Salomon. The Court of Appeal agreed with the liquidator's contentions and Salomon appealed to the House of Lords. It was held by the House of Lords that the company was a distinct person from Salomon and not his agent and that the debentures were perfectly valid. Lord Macnagheten said: "The company attains maturity on its birth. There is no period of minority - no interval of incapacity ... 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, and 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".

4.

MACAURA v NORTHERN ASSURANCE CO. Macaura who owned an estate sold the whole of the timber on the estate to a company in consideration of the allotment to him of 42,000 fully paid 1 shares. All the company's shares were held by him and his nominees, and he was also an unsecured creditor for the company for an amount of 19,000. Subsequently to the sale he effected insurance policies in his own name with the Northern Assurance Company and other insurance companies, covering the timber against fire. Two weeks after the policies were effected, almost all the timber was destroyed in a fire. A claim brought by him on the policies was dismissed by the House of Lords on the ground that he had no insurable interest on the timber. In the course of his judgement Lord Sumner said: "It is clear that the appellant had no insurable interest in the timber described. It was not his. It belonged to Irish Canadian Sawmills Ltd. He had no lien or security over it and, though it lay on his land by his permission, he had no responsibility to its owner for its safety, nor was it there under any contract that enabled him to hold it for his debt. He owned almost all the shares in the company, and the company owed him a good deal of money, but neither as creditor nor as shareholder, could he insure the company's assets. The debt was not exposed to fire nor were the shares ...... His relation was to the company, not to its goods.

5.

A.L. UNDERWOOD LTD v BANK OF LIVERPOOL Mr Underwood had carried on business as an engineering and machinery merchant. In 1919 he

converted the business into a limited company with 10,001 of the 10,002 shares into which the capital of the company was divided being alloted to himself, his wife owning the remaining one share. Underwood as the sole director became possessed of forty five cheques of the aggregated value of the 8,502 4s, drawn in favour of the company. He indorsed them "A.L.U Ltd. A.L.U Sole Director" and paid them into his own personal account with the Bank of Liverpool, instead of paying them into the company's account with another bank. The Bank of Liverpool, the defendants, without inquiring whether the company had a separate banking account, collected the cheques and credited Underwood with the proceeds and honoured cheques drawn by him against them to pay his private debts. The court was of the opinion that when doing what they had done, the Bank of Liverpool had treated Mr Underwood as being identical with the company by virtue of his peculiar position as the beneficial owner of all the company's shares and its sole director. Consequently, the bank had overlooked the materiality of the cheques being drawn in the company's favour and not in Underwood's favour. In action for conversion of brought by the company on behalf of a creditor to whom debentures had been issued by the company it was held that the Bank of Liverpool was liable and that it was precluded upon the following grounds from arguing that Underwood, when paying the cheques into his own account, was acting within the scope of his apparent authority as agent of the company: (i) The act of an agent paying his principal's cheque into his own account was so unusual as to put them on inquiry, and they ought to have inquired whether the company had a separate banking account, and, if it had, why the cheques were not paid into that account. The bank's failure to make the inquiry amounted to negligence. Underwood, when paying in the cheques, did not purport to act as the company's agent but as being himself the company and that the bank so treated him.

(ii)

In the course of his judgement Atkin, L.J. said:"The directors whether collectively or singly have no actual authority to steal the company's goods".

6.

FOSS v HARBOTTLE The plaintiffs, Foss and Turton were shareholders in a company called `The Victoria Park Company' which was formed to buy land for use as a pleasure park. The defendants were the other directors and shareholders of the company. The plaintiffs alleged that the defendants had defrauded the company in various ways, and in particular that certain of the defendants had sold land belonging to them to the company at an exorbitant price. The plaintiffs now asked the court to order that the defendants make good the losses to the company. It was held by Vice Chancellor Wigram that since the company's board of directors was still in existence, and since it was possible to call a general meeting of the company, there was nothing to prevent the company from obtaining redress in its corporate character, and the action by plaintiffs could not be sustained.

7.

NASAU STEAM PRESS v TYLER AND OTHERS The defendants were two directors and the secretary of a company whose registered name was

"The Bastille Syndicate Limited". The action was brought upon two dishonored bills of exchange which had been accepted by the defendants on behalf of the company. The acceptance was stated on the bills to be on behalf of "Old Paris and Bastille Syndicate Limited". It was held that the name of the company was not mentioned in the acceptance in accordance with the statutory requirements and the defendants were personally liable on the bills. Mathew J. stated: "The sole question in this case is, whether the name of the company as inserted in the bills of exchange was the correct name of the company. I have come to the conclusion that it was not. For some reason or other it was deemed advisable to add to the real name of the company the words "Old Paris", and the acceptance adopts that misdescription........ the statute has not been complied with, and that the defendants are liable".

8.

PENROSE v MARTYR A bill of exchange was drawn on "The S.W Steam Packet Company" although the company's full name was "The S.W Steam Packet Company Limited". The defendant, who was the company secretary, wrote across the bill "Accepted, payable at Messrs B & Co., J.M., Secretary to the said company". The bill was dishonored and the holder sued the secretary as acceptor. It was held that he was personally liable on the bill. Lord Campbell, C.J. stated: "I think the case too clear for serious argument. The draft is directed to the company and it is accepted by their officer, and though he does not say in terms that he accepts it for them, he says, "Accepted". "John Martyr" Secretary to the said company "which is saying he signed it on their behalf so he signed a bill on their behalf without their name on it".

9.

RE BUGLE PRESS LTD. Bugle Press Ltd. had an issued capital of 10,000 1 shares, of which Jackson held 4,500, Shaw held 4,500 and Treby held 1,000. Jackson and Shaw then incorporated a new company, called Jackson and Shaw (Holdings) Ltd., with an issued capital of 100 shares, of which each of them held 50 shares. This company them made an offer to the shareholders of Bugle Press Ltd. which was accepted by Jackson and Shaw but rejected by Treby. The company then served a notice on Treby stating that it wished to purchase his shares. Treby applied to the court for an order restraining the intended purchase on the ground that it amounted to an expropriation of his interest in that the shareholders of Jackson and Treby (Holdings) Ltd. were the same persons who held 90% of the shares in Bugle Press Ltd. and who had purported to accept the offer. The application succeeded. The court regarded the offer made by Jackson and Shaw (Holdings) Ltd. as having, in substance, been made by Jackson and Shaw as individuals and thereby lifting the veil of incorporation by treating the company and its members as one entity for purposes of acceptance of the offer.

10.

RE MAIDSTONE BUILDING PROVISIONS LTD. A partner in a firm of accountants which acted as auditors to Maidstone was appointed secretary of the company. He attended board meetings and pointed out that the company was making large losses.

Nevertheless, trading continued and debts were incurred which the company had no reasonable prospect for being able to pay. Eventually, the company went into liquidation owing 99,000. The liquidator sought to make the secretary personally liable, contending that he had been a party to fraudulent trading by the company because he had not advised the directors to stop trading. The contention was rejected. Pennycuka J. stated: "The steps he (the secretary) omitted to take were to give certain advice to the directors. It seems to me impossible to say mere inertia ... could represent being a party to the carrying on of the business of the company".

11.

RE WILLIAM C. LEITCH BROTHERS, LTD (NO.2) A declaration having been made by the court in the course of the windingup of a company, that W.C.L., a governing director of the company, had been knowingly a party to carrying on the company's business with intent to defraud creditors between certain dates, fixing the liability of the director at 6,000, and charging a debenture for 4,000 issued to the director with that liability, the liquidator recovered the sum of 3,356 from the director in respect of the declaration, and asked for directions as to the application of that sum and any further sum he might recover under the judgment, among the creditors of the company. Held, that the moneys so recovered and to be recovered were not to be exclusively applied for the benefit of creditors whose debts were contracted during the period when the business of the company was carried on with intent to defraud creditors, but formed part of the general assets of the company available for all creditors, on the same principle as that applicable to moneys recovered from "B" contributories. Eve, J: " ... the company was incorporated in December, 1926, and in June 1930, was ordered to be wound up compulsorily on the petition presented on May 21 1930. The respondent was a director of the company throughout and, after a trial which lasted the greater part of four days, my brother Maugham found as fact that during the months from March 1, 1930, the company was carrying on business with intent to defraud creditors, and that it was so carrying on business to the knowledge and, indeed, under the direction of the respondent. He accordingly made the order I have stated, and the liquidator, having recovered some 3,356 on account of the 6,000, now requires directions as to how he ought to deal with the moneys in hand and anything further he may recover. The substantial question is whether they form part of the general assets of the company available for all the creditors, or whether they ought to be exclusively applied for any restricted class of creditors, and in particluar for creditors with whom debts were contracted during the period when the business was being carried on with intent to defraud. ... The section, no doubt, presents difficulties, but in approaching its construction it is to be noted that it is one of a group of sections271 to 277 (of the Companies Act 1929) dealing with offences antecedent to or in the course of the winding up. It can only be brought into operation in the course of a winding up, and in cases where is prima facie evidence of the company's business having been carried on for fraudulent purposes. It is not a section which regulates the procedure of an ordinary winding up or controls the administration of the assets of the company. It is directed solely to the particular offence of fraudulent trading and to (attaching personal liability therefore) to directors who knowingly have been parties thereto. it imposes a liability, but it does not purport to create any new rights for the creditors. It cannot, in my opinion, be regarded as a section involving any departure from the general scheme of all modes of winding up (s156), that is to say, a pari passu distribution of the assets. It may well be that the debts of the defrauded creditors. But this is not of itself a ground for holding that the ordinary rules of equality are to be disregarded and a preference created in favour of the defrauded creditors. The position is, in my opinion, in all

respects analogous to that of "B" contributories. Their liability to contribute is fixed by the amount of indebtness existing at the time when they respectivly ceased to be members, but their contributions are not applicable exclusively to the discharge of that indebtedness, but form part of the general assets of the company for the payment of all the creditors ...".

12.

FIRESTONE TYRE & RUBBER CO. v LLEWELLIN An American company formed a wholly-owned subsidiary in England to manufacture and sell its brand of tyres in Europe. The American company negotiated agreements with European distributors under which the latter would place orders with the American company which the English subsidiary would carry out. In fact the distributors sent their orders to the subsidiary direct and the orders were met without any consultation with the American company. The subsidiary received the money for the tyres sold to the distributors and, after deducting its manufacturing expenses plus 5 per cent, it forwarded the balance of the money to the American company. All the directors of the subsidiary resided in England (except one who was the president of the American company) and they managed the subsidiary's affairs free from day-today control by the American company. It was held by the House of Lords that the American company was carrying on business in England through its English subsidiary "acting as its agent" and it was consequently liable to pay United Kingdom tax.

13.

JONES AND ANOTHER v LIPMAN AND ANOTHER Lipman agreed to sell freehold land with registered title to the plaintiffs for 5,250. Pending completion he sold and transferred the land to the defendant company (having a capital of 100), which he acquired and of which he and a clerk of his solicitors were sole shareholders and directors, for 3,000, of which 1,564 was borrowed by the defendant company from a bank and the rest remained owing to him. In an action by the plaintiffs for specific performance, it was held that, in the circumstances of the case, the defendant company was a cloak for Lipman (the first defendant), who could compel a transfer of the land to the plaintiffs, and the court would accordingly decree specific performance against both defendants. Lawrence L.J. stated: "The defendant company is the creature of the first defendant, a device and a shame, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity.... The proper order to make is an order on both the defendants specifically to perform the agreement between the plaintiffs and the first defendant." The court's order to Lipman and the company to specifically perform Lipman's contract with the plaintiffs lifted the veil of incorporation by regarding a breach of contract by the company itself and thereby treating them as one entity.

14.

GILFORD MOTOR COMPANY LTD v HORNE AND ANOTHER (1933) The plaintiff company bought the various parts of motor vehicles from manufactures, assembled the parts on the company's premises and sold the products under the name of Gilford Motor Vehicles. They also sold separate parts which were handed over to the buyers for cash. By an agreement dated May 30, 1929, the defendant was appointed managing director of the plaintiff company for a term of six years from September 1, 1928. Clause 9 of the agreement provided that "the managing director shall not at any time while he shall hod the office of a

managing director or afterwards solicit, interfere with or endeavour to entice away from the company any person, firm or company who at any time during or at the date of the determination of the employment of the managing director were customers of or in the habit of dealing with the company". The employment of the defendant as managing director was terminated in November, 1931, by an agreement between the parties under which the defendant was to receive a fixed sum payable in instalments. Shortly afterwards the defendant opened a business for the sale of spare parts of Gilford Vehicles but on April 8, 1932 he incorporates a private company called "J.M. Horne & Co" the second defendant, and transferred the business to it. "J.M" were the initials of the defendant's wife. The company had a capital of 500 shares of 1 each, of which 202 were issued. 101 being issued to the defendant's wife and 101 to a Mr Howard, who was previously an employee of the plaintiff company but later became an employee of the defendant company. The defendant's wife and Mr Howard were the only directors of the defendant company whose registered office was private house of the defendant. Shortly after its incorporation, the defendant company sent out circulars and other documents inviting some persons to deal with it as a company which could supply Gilford Motor spare parts. The persons to whom the circulars were sent had been customers of the plaintiff company during the period when the defendant was managing director of that company. The evidence adduced in court established that the defendant's wife, as one of the directors, was not taking any part in the business or the management of the defendant company and the other director, Mr Howard, who in fact was an employer of the company. One of the witnesses said in the witness box that, from all dealings which he had with the defendant company, he had formed the opinion that the "boss" was the defendant Horne. On the basis of the aforesaid facts the Court of Appeal granted an injunction restraining the defendant Horne and the defendant company from committing breaches of the covenants between the defendant and the plaintiff company. Farwell J. stated: "...... the defendant company was the channel through which the defendant Horne was carrying on his business. Of course, in the law the defendant company is a separate entity from the defendant Horne, but I cannot help feeling quite convinced that at any rate one of the reasons for the creation of that company was the fear of Mr Horne that he might commit breaches of the covenant in carrying on the business and in sending out circulars as he was doing, and that he might possibly avoid that liability if he did it through the defendant company ......." Lord Hanwort, M.R. stated in the Court of Appeal: "I do hold that the company was "a mere cloak of sham"; I do hold that it was a mere device for enabling Mr E.B Horne to continue to commit breaches of clause 9 and under those circumstances the injunction must go against both defendants".

15.

DAIMLER CO. LTD v CONTINENTAL TYRE & RUBBER CO. A company was incorporated in England with a capital of 25,000 in 1 shares for the purpose of selling in England tyres made in Germany by a German company, who held the bulk of shares in the English company. The holders of the remaining shares (except one) and all the directors were Germans resident in German. The one share was registered in the name of the secretary, who was born in German, but resided i England and had become a naturalised British subject.

After the outbreak of the war between England and Germany, an action was commenced in the name of the English company by specially indorsed writ issued by the company's solicitors on the instructions of the secretary, for payment of a trade debt. One of the defences was that the company was an alien enemy company and that payment of the debt would be trading with the enemy. This defense was rejected by the trial judge and the Court of Appeal but was upheld by the House of Lords where Lord Parker stated: "My Lords, the truth is that considerations which govern civil liability and rights of property in time of peace differ radically from those which govern enemy character in time of war....... I think the law on the subject may be summarised in the following propositions: 1. A company incorporated in the United Kingdom is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience ...... it can be neither loyal nor disloyal. It can be neither friend nor enemy. Such a company can only act through agents properly authorised, and so long as it is carrying on business in this country through agents so authorised and residing in this or a friendly country it is a prima facie to be regarded as a friend....... Such a company may, however, assume an enemy character. This will be the case if its agents or the persons in de facto control of its affairs, whether authorised or not, are resident in an enemy country, or, wherever resident, are adhering to the enemy or taking instructions from or acting under the control of enemies. A person knowingly dealing with the company is such a case is dealing with the enemy. The character of individual shareholders cannot of itself affect the character of the company. This is admittedly so in times of peace, during which each shareholder is at liberty to exercise and enjoy such rights as are by law incident to his status as shareholder..... The enemy character of individual shareholders and their conduct may, however, be very material on the question whether the company's agents, or the persons in de facto control of its affairs, are in fact adhering to, taking instructions from, or acting under the control of enemies. This materially will vary with the number of shareholders who are enemies and the value of their holdings. The fact, if it be the fact, that after eliminating the enemy shareholders the number of shareholders is insufficient for the purposes of holding meetings of the company or appointing directors or other officers in the present case...... the fact that he (the secretary) held one share only out of 25,000 shares, and was the only shareholder who was not an enemy, might well throw on the company the onus of proving that he was not acting under the control of, taking his instructions from, or adhering to the King's enemies in such manner as to impose an enemy character on the company itself...... In a similar way a company registered in the United Kingdom, but carrying on business in neutral country through agents properly authorised and resident here or in neutral country, is prima facie to be regarded as a friend, but may, through its agents or persons in de facto control of its affairs, assume an enemy character. A company registered in United Kingdom but carrying on business in an enemy country is be regarded as an enemy. My Lords, the foregoing propositions.... have, I think, the advantage of affording convenient and intelligible guidance to the public on questions of trading with the enemy.

2.

3.

4.

5.

6.

16.

RE DUOMATIC LTD (1969) A company incorporated in 1960, with a share capital of 100 1 ordinary shares and 80,000 1 non-voting redeemable preference shares, had originally three directors E.H. and T. who held all the ordinary shares. E. and T. became critical of the way in which H. performed his duties and could have voted him off the board, but since he threatened, if dismissed, to sue the company, they paid him 4,000 to leave the company. He ceased to be a director on April 1, 1963, and later transferred his shares to E. on April 17, 1964, W. a representative of a finance company, B Ltd, who were financing the company's hire-purchase business, became a director. In July, 1964, E. transferred some of his shares to W. and some to C. and K., two other officers of B Ltd. On August 13, 1964 the capital of the company was increased by the creation of 25,000 additional ordinary shares and thereafter the ordinary shareholders consisted of E., T., W., C., K., B Ltd and another company. The company's articles of association incorporated article 76 of Table A in the Schedule to the Companies Act, 1948, but no resolution authorising directors to receive remuneration was ever passed. None of the directors had contracts of service. They drew sums according to their personal needs, and at the end of each financial year the sums so drawn were totalled, grossed up for tax and entered in the accounts as "directors' salaries". In the year ending April 30, 1964, when E. was in control of the company, E. drew 9,000 but no final accounts were aged. When W. had become a director in April, 1964, E. had agreed with the shareholders to draw a lower rate of remuneration of 60 a week, although no meeting was held or resolution passed, but the period May 1, 1964, to October 23, 1964 when the company went into voluntary liquidation, he drew a sum in excess of that rate. On summons by the liquidators seeking inter alia, repayment of the sums paid to E. and H. respectively as salaries on the ground that such sums had never been voted in general meeting, it was held that since E. and H. had, at the time when they are only ordinary shareholders, approved the accounts showing the payments to them of 10,151 0s 8d and 5,510 1s 0d, respectively. The liquidators could not recover the payments. Buckley, J stated: "Where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is binding as a resolution in a general meeting would be. The preference shareholder, having shares which conferred upon him no right to recieve notice of or attend and vote at a general meeting of the company could in no worse position if the matter were dealt with informally by agreement between all the shareholders having voting rights than he would be if the shareholders met together in a duly constituted general meeting.

17.

RE: EXPRESS ENGINEERING WORKS LTD. (1920) A syndicate of five persons formed a private company, in which they were the sole shareholders, and sold it for 15,000 in debentures of the company, property which they had a few days before acquired for 7,000 The contract for the sale and the issue of the debentures was carried out at a meeting of the five who, there and then appointed themselves directors. This meeting was described in the minutes as a board meeting. At a subsequent meeting, the seal of the company was affixed to the debentures. The articles of

the company privided that no director should vote in respect of any contract agreement in which he might interested. In the winding up of the company the liquidator claimed a declaration that the issue of the debentures was invalid and should be set aside. The claim failed. Warrington L.J. stated: "As directors they could not but as shareholders acting together they could have made the agreement in question. It was competent to them to waive all formalities as regards notice of meetings, etc., and to resolve themselves into a meeting of shareholders and unanimously pass the resolution in question. In as much as they could not in one capacity effectively do what was required but could do it in another, it is to be assumed that as businessmen they would act in the capacity in which they had power to act".

18.

HAROLD HOLDSWORTH & CO LTD v CADDIES By an agreement made in 1949 between the appellant company and the respondent it was provided that, for a term of five years, he was appointed "a managing director of the company and as such managing director he shall perform the duties and exercise the powers in relation to the business of the company and the business........ of its existing subsidiary companies...... which may be from time to time assigned to or vested in him by the board of directors of the company". In 1950 the board resolved that he should confine his attentions to one of these subsidiaries only. He refused to do so and brought an action for damages for breach of contract. It was held by the House of Lords that Lord Reid stated: "It was argued that the subsidiary companies were separate legal entities each under the control of its own board of directors, that in law the board of the appellant company could not assign any duties to anyone in relation to the management of the subsidiary companies and that therefore he agreement cannot be construed as entitling them to assign any such duties to the respondent. My Lords, in my judgement this is too technical an argument. This is an agreement re mercatoria and it must be construed in light of the facts and realities of the situation". This decision constitutes an instance of lifting the veil because the court regarded a company (the subsidiary company) as being the same entity as the subscribers (the holding company). In effect, Mr Caddies would be working for the holding company at the time he was working in the subsidiary company.

19.

HELLENIC AND GENERAL TRUST LTD. (1975) A company called MIT was a wholly owned subsidiary of Hambros Ltd. and held 53 per cent of the ordinary shares of Hellenic. A scheme of arrangement was put forward under which Hambros was to acquire all the ordinary shares of Hellenic for a cash consideration of 48p per share. The ordinary shareholders met and over 80 per cent approved the scheme, MIT voting in support. However, the National Bank of Greece, which was a minority shareholder, opposed the scheme because it would be liable to meet a heavy tax burden under Greek law as a result of receipt of cash for its shares. Templeman J. refused to approve the scheme after he ruled that there should have been a separate class meeting of ordinary shareholders who were not a wholly-owned subsidiary of Hambros, thus in effect regarding the holding company, Hambros, and the subsidiary MIT as one economic unit in the class meeting.

20.

DHN FOOD DISTRIBUTORS v LONDON BOROUGH OF TOWER HAMLETS (1976)

DHN food distributors was a holding company which ran its business through two wholly-owned subsidiaries, Bronze Investments Ltd. and DHN Food Transport Ltd. The group collected food from the docks and distributed it to retail outlets. Bronze Investments Ltd. owned the premises in Bow from which the business was conducted and DHN Food Transport Ltd ran the distribution side of the business. Tower Hamlets compulsory acquired the premises in Bow for the purpose of building houses. This power of compulsory acquisition arose under the Housing Act 1957 and compensation was payable under the Land Compensation Act of 1961 under two headings: (a) the value of the land, and (b) disturbance of business. Tower Hamlets was prepared to pay 360,000 for the value of the land but refused to pay the second heading because DHN Food Distributors and DHN Transport Ltd had no interest in the land. This was disadvantageous to the group as a whole since the loss of the premises had caused all three companies to go into liquidation, it being impossible to find other suitable premises. However, Lord Denning in the Court of Appeal drew aside the corporate veil and treated DHN Food Distributors as owner of the property whereupon Tower Hamlets became liable to pay for disturbance of business. The basis of Lord Denning's judgement was that company legislation required group accounts and to that extent recognized a group entity which he felt the judiciary should do also.

21.

COTMAN v BROUGHAM The Memorandum of an oil company mentioned a vast variety of objects, and among them the underwriting of shares in another company. The objects clause was wound up by words which Lord FINLAY in his speech in the House of Lords later declared "extraordinary". By the closing words all the various objects mentioned were declared principal ones and in no way subsidiary to the first mentioned object. The company underwrote shares in a rubber company, and the validity of that fact was disputed. Decision The House of Lords held that the underwriting agreement was not ultra vires the company. Lord PARKER said:"My Lords, Mr Whinney in his able argument that, in considering whether a particular transaction was or was not ultra vires a company, regard ought to be had to the question whether at the date of the transaction the company could have been wound up on the ground that its substratum had failed. Upon consideration I cannot accept this suggestion. The question whether or not a company can be wound up for failure of substratum is a question of equity between a company and its shareholders. The question whether or not a transaction is ultra vires is a question of law between the company and a third party. The truth is that the statement of a company's objects in its memorandum is intended to serve a double purpose. In the first place it gives protection to subscribers who learn from it the purpose to which their money can be applied. In the second place it gives protection to persons who deal with the company, and who can infer from it the extent of the company's powers. The narrower the objects the greater is the security of those who transact business with the company. Moreover, experience soon shows that persons who transact business with companies do not like having to depend on inference when the validity of a proposed transaction is in question. Even a power to borrow money could not always be safely inferred, much loess such a power of underwriting shares in another company. Thus arose the practice of specifying powers as objects, a practice rendered possible by the fact that there is no statutory limit on the number of objects which may be specified. But even thus, a person proposing to deal with a company could not be absolutely safe, for powers specified as objects might be read as ancillary to and exercisable only for the purpose of attaining what might be held to be the company's main or paramount object, and on this construction no one could be quite certain whether the Court would not hold any proposed transaction to be ultra vires. At any rate,

all the surrounding circumstances would require investigation. Fresh clauses were framed to meet this difficulty, and the result is the modern memorandum of association with its multifarious list of objects and powers specified as objects and its clauses designed to prevent any specified object being read as ancillary to some other object. A person who deals with a company can do everything which it is expressly authorised to do by its memorandum of association, and need not investigate the equities between the company and its shareholders."

22.

ASHBURY RAIL, CARRIAGE AND IRON CO. LTD. v RICHE A company was registered under the Companies Act 1862, and by the third clause of the memorandum of association the objects of the company were defined as follows:"The objects for which the company is established are to make and sell, or lend on hire, railway carriages and wagons, and all kinds of rail plant, fittings, machinery, and rolling-stock; to carry on the business of mechanical engineering and general contractors; to purchase and sell, as merchants, timber, coal, metals, or other materials; and to buy and sell any such materials on commission, or as agents." The directors agreed to purchase a concession for making a railway in Belgium, and to form a company in Belgium (called Societe Anonyme) to work the concession, and it was further agreed that Messrs. Riche commenced the work, and for some time the Ashbury Company paid money to the Societe Anonyme to be paid by them to the contractor, Messrs. Riche. Later, difficulties arose, and the shareholders of the Ashbury Company disapproved of what had been done in the matter of the railway, and required the directors to take over the company's interests therein, and to indemnify the shareholders. The directors, however, on behalf of the company, repudiated the contract for the construction of the railway, as being ultra vires the company, and Messrs. Riche now send the company for damages for breach of contract. Decision: On appeal to the House of Lords, it was held that the contract was ultra vires (beyond the powers of) the company, and that accordingly the company was not liable to Messrs. Riche. In the course of his judgement in the House of Lords, Lord CAIRNS, L.C. said:"Your Lordships are well aware that this is the Act" (that is, the Companies Act, 1862) "which put upon its present permanent footing the regulation of joint stock companies which were to be authorised to trade with a limit to their liability .......... and I will ask your Lordships to observe ....... the marked and entire difference there is between the two documents which form the title deeds of companies of this description - I mean the Memorandum of Association on the hand, and the Articles of Association on the other hand. with regard to Memorandum of Association, your Lordships will find that, that is, as it were, the charter and defines the limitation of the powers of a company to be established under the Act. With regard to the Articles of Association, those articles play a par subsidiary to the Memorandum of Association." And later, Lord CAIRNS said:Now I am clearly of opinion that this contract was entirely, as I have said, `beyond the objects' in the memorandum of association. If so, it was thereby placed `beyond the powers of' the company to make the contract. If so, my Lords, it is not a question whether the contract ever was ratified or was not ratified. If it was a contract void at its beginning, it was void because the company could not make the contract. If every shareholder of the company had been in the room and every

shareholder of the company had said: "That is a contract which we desire to make, which we authorise the directors to make, to which we sanction the placing of the seal of the company" the case would not have stood in any different position from that in which it stands now. The shareholders would thereby, by unanimous consent, have been attempting to do the very thing which, by Act of Parliament, they were prohibited from doing."

23.

RE DAVID PAYNE & CO. LTD. X, who was a director of A company, and who also had some interest in B company, happened to learn in his private capacity that B company, which had general borrowing powers, proposed to raise a loan for purposes outside its business. He induced A company to make the loan to B company, which applied it as proposed. The loan was made on the security of a debenture. The court held that the debenture was a valid security. The private knowledge of X was not to be imputed to A company. ROMER L.J........ Where you have a limited company with a memorandum of association authorising the company to embark on a series of transactions, if among those purposes you find a power to borrow generally for the purposes of the company, I take it to be clear beyond controversy at the present day that, when money is being borrowed within the limits of the power of borrowing as to amount, the person who lends the money is not bound to inquire to what purpose the borrowing company is about to apply the money so borrowed .......

24.

RE JON BEAUFORTE (LONDON) LTD. A company, which was authorised by its memorandum of association to carry on the business of costumiers and gown-makers, embarked on the business of making veneered panels and erected a factory for this purpose. The company later went into liquidation. Among the proofs of debts was one for coke supplied to the factory. The suppliers argued that the fuel might have been used for legitimate purposes. The court affirmed the decision of the liquidator to reject the claim on the ground that the contract to which it related was ultra vires. ROXBURGH J. ........... The argument is that the company needed fuel for its legitimate business, and that the fuel merchant cannot be prejudiced by its misapplication. I need not consider what the position might have been if the fuel merchant had not had clear notice that the business, which the company was carrying on and for which the fuel was required, was that of veneered panel manufacturers. The correspondence shows that they had actual notice of that, and,h as they had constructive notice of the contents of the memorandum of association, they had notice that the transaction was ultra vires the company. Their proof was rightly rejected, although they and the other claimants may have other rights arising out of these ultra vires transactions. (Dealing with two other claims in respect of which judgements had been obtained against the company, Roxburgh J. said): "It seems to me that any compromise made upon the footing that the contract is ultra vires, and any judgement suffered in an action in which the defence of ultra vires is not raised, can be set aside because (applying the principle stated) it is ultra vires the company to proceed upon the footing that the contract is intra vires, whether by negotiating a compromise on that footing or by submitting to judgement without delivering an appropriate defence .......... In this case of an ultra vires contract no judgement founded upon it is inviolable, unless it embodies a decision of a court upon the issue of ultra vires or a compromise of that issue ......"

25.

RE INTRODUCTIONS LTD. The memorandum of association of a company included among the objects of the company "To borrow or raise money in such manner as the company shall think fit and in particular by the issue of debentures." The objects clause of the memorandum concluded with a declaration "that each of the preceding sub-clauses shall be construed independently of and shall be in no way limited by reference to any other sub-clause and that the objects set out in each sub-clause are independent objects of the company." At a time when the sole activity being carried on by the company was pig-breeding, which was ultra vires the company, i.e. not included in the object clause, the company gave debentures to its bank as security for its overdraft. Before it took this security the bank had been given a copy of the memorandum and articles of association of the company, and knew that the company's sole business was pig-breeding. HELD: Borrowing money was a power of a company, and could not be an object, the powers of the company could be exercised only for purposes intra vires the company, and so the company was not entitled, despite the clause and the declaration,h to borrow money for pig-breeding; accordingly, as the bank knew that the borrowing was for an ultra vires purpose, the debentures were void. (Note: company in liquidation). HARMAN L.J.: "It was argued that the only obligation of the defendant bank was to satisfy itself that there was an express power to borrow money and that this power was converted into an object by the concluding words ..... It was said that if this was so not only need the bank enquire no further but they were unaffected by knowledge that they had that the activity on which the money was to be spent was one beyond the company's powers. The judge rejected this view and I agree with him. He based his judgement I think, on the view that a power or an object conferred on a company to borrow cannot mean something in the air: borrowing is not an end in itself and must be for some purpose of the company, and as this borrowing was for an ultra vires purpose that is an end of the matter....... you cannot convert a power into an object merely by saying so ........... I would agree that if the defendant bank did not know what the purpose of the borrowing was it need not enquire, but it did know, and I can find nothing in Cotman v Brougham to protect it not withstanding that knowledge. An earlier case, Re David Payne & Co Ltd..... shows the limit to which this particular doctrine can go. The first words of the head note are as follows: "Where a company has a general power to borrow money for the purposes of its business, a lender is not bound to enquire into the purpose for which the money is intended to be applied and the misapplication of the money by the company does not avoid the loan in the absence of knowledge or the part of the lender that the money was intended to be misapplied"............. I agree with the judge that it is a necessarily implied addition to a power to borrow, whether express or implied, that one should l add "for the purposes of the company". his borrowing was not for a legitimate purpose of the company; the bank knew it and therefore cannot rely on its debentures. I would dismiss the appeal. RUSSEL, L.J.:"If the borrowing clause had expressly stated hat it did not include borrowing for use in n undertaking ultra vires the company it would have been plainly unarguable that the defendant bank's security was valid, the bank being fully aware that the borrowing was only for us in the pig-breeding business and being at last deemed to be aware that such business was wholly

ultra vires the company. But in very borrowing clause that which I have stated as having been expressly stated is implicit, whether or not the objects clause contains the provision that is contained here. Putting the matter round the other way, supposing the borrowing clause had purported expressly to include borrowing for use in a business ultra vires the company, no lender could conceivably rely upon such a provision, which would have to be ignored as mere nonsense"

26.

SINCLAIR v BROUGHAM In the winding up of a building society which had embarked upon ultra vires banking activities, questions of priority arose between the outside creditors, the shareholders and the bank depositors. By consent, the outside creditors were paid out in full, leaving the question of how the remaining assets,which were insufficient to meet the claims of shareholders and depositors in full, should be distributed. The House of Lords held that the assets should be distributed pari passus between the shareholders and depositors in proportion to the amount credited to them in the books of the company. LORD PARKER OF WADDINGTON:........" Accepting the principle that no action or suit lies at law or in equity to recover money lent to a company or association which has no power to borrow the question remains whether the lender has any other remedies. On this point the result of the authorities may be stated as follows:First, it appeals to be well settled that if the borrowed money be applied in paying off legitimate indebtedness of the company or association (whether the indebtedness be incurred before or after the money was borrowed), the lenders are entitled to rank as creditors of the company or association "to the extent to which the money has been so applied." There appears to be some doubts as to whether this result is arrived at by treating the contract of loan as validated to the extent there is no increase in the indebtedness of the company or association, in which case, if the contract of loan involves a security for the money borrowed, the security would be validated to a like extent; or whether the better view is that the lenders are subrogated to the rights of the legitimate creditors who have been paid off......... Secondly, it appears to be also well settled that the lender in an ultra vires loan transaction has a right to what is known as a tracing order. A company or other statutory association cannot by itself or through an agent be party to an ultra vires act. It its directors or agents affecting to act on its behalf borrow money which it has no power to borrow, the money borrowed is in their hands the property of the lender. At law, therefore, the lender can recover the money, so long as he can identify it, and even if it has been employed in purchasing property, there may be cases in which, by ratifying the action of those who have so employed it, he may recover the property purchased ........... The case therefore, presents itself in this way. Here is a mass of assets arising in the course of an ultra vires business carried on by the directors and agents of the society. There are, on the other hand, liabilities, how or for what purpose incurred is not in evidence. No one claims any interest in the assets except the ultra vires lenders, the members of the society and the creditors, in respect of the liabilities to which I have referred. The ultra vires lenders and the members are willing that these liabilities and the cost of the liquidation, which are in effect costs of administering the fund, shall be first paid. If this is done, what is left may be taken to represent in part the moneys of the ultra vires lenders and in part the moneys of the society wrongfully employed in the business. The equities of the ultra vires lenders and of the society are equal, and it follows that the remainder of the assets ought to be divided between the ultra vires lenders and the society rateably, according to the capital amount contributed by such lenders and the society

respectively......."

27.

RE: CYCLISTS' TOURING CLUB The club was incorporated as a limited liability company having as its objects the promotion of the use of cycles for touring and other purposes. The court refused to sanction an alteration of the memorandum making all tourists, including motorists, eligible for membership. WARRINGTON J........... It has been said by Mr. Eve that the alteration comes within either clause (a) or clause (d) enlarging the membership of the club in the way proposed, it will be possible to carry on the business of the club as altered more economically or more efficiently. But with all respect to that argument, I do not think that it is sound. The alteration which is contemplated in that clause seems to me to be an alteration which will leave the business of the company substantially what it was before, with only such changes in the mode of conducting it as will enable it to be carried on more economically or more efficiently. But in the present case the proposed alteration would alter the business of the club completely. The business of the club at present is - reading again from the memorandum - promote, assist and protect the use of bicycles and other similar vehicles, on the public roads, and to provide certain privileges for those who tour on bicycles, tricycles and other similar vehicles. That is the business which it seems to me is contemplated by clause (a), and it is impossible to say that that business will be conducted more efficiently is a business of catering for the privileges, and protecting the interests, not of the riders of bicycles and tricycles, but of tourists generally, and only incidentally, as part of that body, of the riders of bicycles and tricycles. It seems to me it cannot come under clause (a). Does it come under clause (d): "To carry on some business which under existing circumstances may conveniently or advantageously be combined with the business of the company? Of course it may be said that you can separate touring on bicycles and touring in other ways, and that what it is proposed to do is to combine, with the business of a club formed to promote the sport of bicycling, the business of a club formed to promote the sport of touring in motors. But that, as it seems to me, is not the true result of what is proposed. Having regard to the business of the club as at present, which is to cater for a particular class of tourists. It seems to me that you cannot regard this as a proposal to combine a business of one kind with a business of another kind. It is really intended to enlarge the business which is now carried on by giving the privileges and the advantages of the carrying on of that business to a larger class of people. But even assuming that that is wrong, and supposing that it is sought to combine the business of catering for tourists, other than those who tour on bicycles and tricycles, with the business of catering for those who tour on bicycles and tricycles, it made out that the new business can conveniently or advantageously be combined with the business of the company? In my opinion that is not only not made out, but it seems to me that it is impossible to maintain that view in face of the affidavits which have been filed in support of the petition. The statement in the affidavit of the chairman of the council of the club in support of the petition is that touring on bicycles has gone out of favour chiefly on account of the introduction of motor cars, which, besides being more attractive in themselves, have to a great extent destroyed the pleasure of cycling, and have increased the risk of accident in the use of bicycles. It seems to me that one of the present objects of the club, namely, to project bicyclists in their touring, would be to protect them against that very danger which the chairman has emphasised in the affidavit which he has filed. If the business of catering for motorists is combined with this, the club could only protect bicyclists against the dangers arising from motors by taking measures against another class of its own members; and it seems to me that the result would be that it would be impossible to combine (I am relying on the evidence filed in support of the petition) the business of catering for and protecting the rights and interests of motorists with the business of catering for and protecting the rights and interests on the roads of those who ride bicycles and tricycles.

On those grounds it seems to me that I must refuse the petition, and I must refuse it with costs.

28.

RE: EGYPTIAN DELTA LAND AND INVESTMENT CO. LTD The "Egyptian Delta Land and Investment Co. Ltd" was formed to acquire land in Egypt. It proposed altering its objects in order to be able to acquire land in the Sudan. Held: The additional power would be granted on condition that the company changed its name to "Egyptian Delta and Sudan Land and Investment Co. Ltd."

29.

RE: HAMPSTEAD GARDEN SUBURB TRUST LTD A clause in the company's memorandum provided that surplus assets on the company's winding up should be given to any institution with objects which were similar to those of the company and, in default, to any charitable institution. The clause was altered so as to provide that any balance on a winding up should go to a named charity. Held: That the alteration was not one that would enable the company "to restrict or abandon" any of its objects and was ineffective.

30.

RE: PARENT TYRE CO. The company petitioned the court to confirm a special resolution altering its object pursuant to s.8 of the Companies Act 1908 under which it was necessary to seek the court's confirmation before the resolution could become effective. The company had been incorporated to manufacture rubber tyres and vehicle spare parts, and to invest in companies which manufactured such goods. It wished to change to the business of finance, banking and underwriting "and to deal in any kind of property, either real or personal". It had not carried on any business since 1912 but had made certain investments which were permitted by its memorandum. It was held that the proposed alteration of objects pertaining to a finance, banking and underwriting business was valid because it would enable he company to carry on a business which could be conveniently or advantageously combined with its existing business. However, the alteration pertaining to dealing "in any kind of property either real or personal".

31.

HICKMAN v. KENT OR ROMNEY MARSH SHEEP-BREEDERS' ASSOCIATION. The defendant association was incorporated as a non-profit-making company. Article 49 of its articles of association provided that disputes between the association and any of its members should be referred to arbitration. Hickman, a member, brought this action complaining of various irregularities in the affairs of the association, including the refusal to register his sheep in its published flock book, and a threat to expel him from membership. The association was granted a stay of proceedings on the ground that the statutory provision corresponding to the present s.22 made article 49 an agreement to arbitrate, enforceable as between the association and a member. ASTBURY J. This is a summons by the defendants to stay proceedings in the action pursuant to section 4 of the Arbitration Act 1889. The action is against the defendant association and their

secretary Chapman, and the plaintiff, who became a member in 1905, claims certain injunctions and a declaration and other relief in respect of matters arising out of and relating solely to the affairs of the association. In substance he claims to enforce his rights under the association's articles ......... (After stating the objects of the association and reading article 49 as to arbitration, his Lordship continued:) This is a common from of article in private companies, and the objects of this association being what they are, it and its members might be seriously prejudiced by a public trial of their disputes, and if this summons fails, as the plaintiff contends that it should, these arbitration clauses in articles are of very little, if any, value. It is clear on the authorities that if there is a sub-mission to arbitration within the meaning of the Arbitration Act 1889, there is a prima facie duty cast upon the court to act upon such an agreement ........ In the present case the defendants contend, first, that article 49, dealing as it does with the members of the association, in their capacity of members only, constitutes a submission within the meaning of the Arbitration Act, or, secondly, that the contract contained in the plaintiff's application for membership and the association's acceptance of it amounts to such a submission. The plaintiff contests both these propositions, and independently of the particular....... Now in these four cases the article relied upon purported to give specific contractual rights to persons in some capacity other than that of shareholder, and in none of them were members seeking to enforce or protect rights given to them as members, in common with the other corporators. The actual decisions amount to this. An outsider to whom rights purport to be given by the articles in his capacity as such outsider, whether he is or subsequently becomes a member, cannot sue on those articles treating them as contracts between himself and the company to enforce those rights. Those rights are not part of the general regulations of the company applicable alike to all shareholders and can only exist by virtue of some contract between such person and the company, and the subsequent allotment of shares to an outsider in whose favour such an article is inserted does not enable him to sue the company on such an article to enforce rights which are res inter alios acta and not part of the general rights of the corporators as such.......... The wording of section 14, sub-section 1, of the (1908) Act, which is in the same terms as section 16 of the Companies Act 1862, is difficult to construe or understand. A company cannot in the ordinary course be bound otherwise than by statute or contract and it is in this section that its obligation must be found. As far as the members are concerned, the section does not say with whom they are to be deemed to have covenanted, but the section cannot mean that the company is not to be bound when it says it is to be bound, as if, etc., nor can the section mean that the members are to be under no obligation to the company under the articles in which their rights and duties as corporators are to be found. Much of the difficulty is removed if the company be regarded, as the framers of the section may very well have so regarded it as being treated in law as a party to its own memorandum and articles....... It seems clear from other authorities that a company is entitled as against its members to enforce and restrain breaches of its regulations. It is also clear from many authorities that shareholders as against their company can enforce and restrain breaches of its regulations, and in many of these cases judicial expressions of opinion appear, which, in my judgement, it is impossible to disregard. In Welton v. Saffery Lord Herschell, who dissented on the main question from the rest of the House, made the following general observation: `Section 16 of the Act of 1862 provides that the articles of association, when registered, shall bind the company and the members thereof to the same extent as if each member had signed his name and affixed his seal thereto, and there were in such articles contained a covenant on the part of himself, his heirs, executors and administrators to conform to all the regulations contained in such articles, subject to the provisions of this Act. The

articles thus become in effect a contract under seal by each member of the company, and regulate his rights. They cannot, of course, diminish or affect any liability created by the express terms of the statute; but, as i have said, the statute does not purport to settle the rights of the members inter se, it leaves these to be determined by the articles (or the articles and memorandum together), which are the social contract regulating those rights. I think it was intended to permit perfect freedom in this respect. It is quite true that the articles constitute a contract between each member and the company, and that there is no contract in terms between the individual members of the company; but the articles do not any the less, in my opinion, regulate their rights inter se. Such rights can only be enforced by or against a member through the company, or through the liquidator representing the company, but I think that no member has, as between himself and another member, any right beyond that which the contract with the company gives. In all these last mentioned cases the respective articles sought to be enforced related to the rights and obligations of the members generally as such and not to rights of the character dealt with in the four authorities first above referred to. It is difficult to reconcile these two classes of decisions and the judicial opinions therein expressed, but I think this much is clear, first, that no article can constitute a contract between the company and a third person; secondly that no right merely purporting to be given by an article to a person, whether a member or not, in a capacity other than that of a member, as, for instance, as solicitor, promoter, director, can be enforced against the company; and, thirdly, that articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the company respectively............. In the present case, the plaintiff's action is, in substance, to enforce his rights as a member under the articles against the association. Article 49 is a general article applying to all the members as such, and, apart from technicalities, it would seem reasonable that the plaintiff ought not to be allowed in the absence of any evidence filled by him to proceed with an action to enforce his rights under the articles, seeing that the action is a breach of his obligation under article 49 to submit his disputes with the association to arbitration, and if the case fails within the Act 1 see no reason for exercising my discretion under section 4 in his favour. In my judgement, article 49, for the reasons above referred to, creates rights and obligations enforceable as between the plaintiff and the association respectively and those rights and obligations are contained in a written document, but whether that document is a contract or agreement between the plaintiff and the association within section 27 of the Arbitration Act depends upon whether the decisions in Eley v. Positive Life Assurance Co., and the other three cases of a similar character above referred to, ought to be regarded as only dealing with and applying to articles purporting, first, to contain an agreement with the company and a third person, or, secondly, to define the rights of a shareholder in some capacity other than that of a member of the company. To reconcile those decisions with the other expressions of judicial opinion above mentioned, some such view should, I think, be adopted and general articles dealing with the rights of members `as such' are treated as a statutory agreement between them and the company as well as between themselves inter se, and, in my judgement, article 49 in the present case does constitute a submission to arbitration within the true meaning and intent of the Arbitration Act...........

32.

WOOD v. ODESSA WATER WORKS CO. (1889) 42 Ch.D. 636 Chancery Division The articles empowered the directors to declare a dividend `to be paid' to the shareholders. The company passed an ordinary resolution proposing to pay no dividend but instead to give the

shareholders debenture bonds redeemable at par, by an annual drawing extending over thirty years. Wood, a shareholder, sought an injunction to restrain the company from acting on the resolution. It was held that the proposal was inconsistent with the articles, and the injunction was accordingly granted. STIRLING J...... It was not disputed that profits available for the payment of a dividend by the company had been actually to create a charge on the assets of the company, or to raise money by means of such charge, or to apply the money so raised in payment of a dividend. The question, simply, is whether it is within the power of a majority of the shareholders to insist against the will of a minority that the profits which have been actually earned shall be divided, not by the payment of cash, but by the issue of debenture-bonds of the company bearing interest at 5 per cent and repayable at par by an annual drawing extending over thirty years. It is to be inferred from the terms in which the bonds are offered for subscription that the company cannot issue them in the open market except at a discount of at least 10 per cent. Now the rights of the shareholders in respect of a division of the profits of the company are governed by the provisions in the articles of association. By section 16 of the Companies Act 1862, the articles of association `bind the company and the members thereof to the same extent as if each member had subscribed his name and affixed his seal thereto,h and there were in such articles contained a covenant on the part of himself, his heirs, executors, and administrators, to conform to all the regulations contained in such articles, subject to the provisions of this Act'. Section 50 of the Act provides the means for altering the regulations of the company contained in the articles of association by passing a special resolution, but no such resolution has in this case been passed or attempted to be passed; and the question is, whether this is a matter as to which the majority of the shareholders can bind those shareholders who dissent. The articles of association constitute a contract not merely between the shareholders and the company, but between each individual shareholder and every other; and the question which I have just stated must,h in my opinion, be answered in the negative if there be in the articles a contract between the shareholders as to a division of profits, and the provisions of that contract have not been followed........ That then brings me to consider whether that which is proposed to be done in the present case is in accordance with the articles of association of the company. Those articles provide (101) that the directors may, with the sanction of a general meeting, declare a dividend to be paid to the shareholders. Prima facie that means to be paid in cash. The debenture-bonds proposed to be issued are not payments in cash; they are merely agreements or promises to pay: and if the contention of the company prevails a shareholder will be compelled to accept in lieu of cash a debt of the company payable at some uncertain future period. In my opinion that contention ought not to prevail.........

33.

BEATTIE v. E. & F. BEATTIE LT (1938) Ch.708 Court of Appeal The plaintiff brought a representative action on behalf of herself and the other shareholders, alleging (inter alia) that certain sums had been improperly paid by the defendant company to Ernest Beattie, the second defendant, as remuneration for his services as managing director and chairman of directors. Ernest Beattie moved for a stay of proceedings, relying on article 133 of the company's articles of association, which provided that disputes between members or between the company and any member should be referred to arbitration. A stay was refused, on the ground that the article affected Ernest Beattie only in his capacity as a member, and not when, as here, he was sued as a director. GREEN M.R. ........ To bring himself within section 4 of the Arbitration Act (1889) the appellant must point to a written agreement for submission. For that reason it will not be sufficient for him to rely on an agreement appointing him director which is merely to be inferred from conduct, even if in such an agreement a term corresponding to article 133 ought to be imported. An agreement

so extracted from the general relationship of the parties would not be a sufficient submission within section 4. The appellant, accordingly, seeks to find in the articles themselves a contract to which he is a party giving him the right to demand an arbitration in the present circumstances. I cannot find that contract. The appellant must rely on section 20 of the Companies Act 1929, which gives to articles of association a contractual force...... Mr Cleveland-Stevens says: Here is a member - namely, Mr. Ernest Beattie. Here is an article which provides that a dispute between the company and a member shall be referred to arbitration. It covers, among other things, a dispute relating to an act or default of a director. And he says that what he is seeking in the present case to do is to enforce that right as a member under that article and not any right as a director; that he has a right, and all other members have a right, when they find the company disputing with a director, to insist on that dispute being referred to arbitration. Mr Cleveland-Stevens says that the case must be treated as though the circumstances that the appellant happens to be a director is immaterial. He says that it is quite immaterial that the member who is demanding arbitration is himself the member attacked. In my judgment, that argument is based on an incorrect view both as to the effect of the article and as to the effect of section 22 of the Companies Act. The question as to the precise effect of section 22 has been the subject of considerable controversy in the past, and it may very well be that there will be considerable controversy about it in the future. But it appears to me that this much, at any rate, is good law: that the contractual force given to the articles of association by the section is limited to such provisions for the articles as apply to the relationship for the members in their capacity as members.......... It is to be observed that the real matter which is here being litigated is a dispute between the company and the appellant in his capacity as a director, and when the appellant, relying on this clause, seeks to have that dispute referred to arbitration, it is that dispute and none other which he is seeking to have referred, and by seeking to have it referred he is not, in my judgment, seeking to enforce a right which is common to himself and all other members. He is seeking to enforce a quite different right. I will explain what I mean. Let me assume that this article on its true construction entitles any member of the company to say to the company, when it is in dispute with a director; `You, the company, are bound by your contract with me in the articles to refer this dispute to arbitration, and I call upon you so to do'. That is the right, and the only right in this respect, which is common to all the members, under this article. If that were the right which the appellant was seeking to exercise, there might be something to be said for that argument, but, with all respect to the able argument of Mr Cleveland-Stevens, it appears to me that that is not at all the right which the appellant is seeking to enforce. He is not seeking to enforce a right to call on the company to arbitrate a dispute which is only accidentally a dispute with himself. He is asking, as a disputant, to have dispute to which he is a party referred. That is sufficient to differentiate it from the right which is common to all the other members of the company under this article, which I have tried to define. That right is one which a member might find very great difficulty in enforcing in the courts, because it concerns a matter relating to the internal management of the company, with which the courts will not, in general, interfere. But quite apart form that consideration, the two rights are, in my judgement, perfectly distinct and quite different - the general right of a member as a member and the right which the appellant as a party to the dispute is seeking to enforce ........... In the result, the appeal must be dismissed.

34.

ELEY v. POSITIVE GOVERNMENT LIFE ASSURANCE CO.

(Court of Appeal) Article 118 of the company's articles provided: `Mr.William Eley, of No.27, New Broad Street, in the City of London, "shall be" the solicitor to the company, and shall transact all the legal business of the company, including parliamentary business, for the usual and accustomed fees and charges, and shall not be removed from his office except for misconduct.' Eley, the plaintiff, who had himself drafted the company's documents for registration, and who became a shareholder several months after its incorporation, sued the company for breach of contract in not employing him as its solicitor. In the Exchequer Division, it was held that the articles did not create any contract between Eley and the company. Eley appealed, but the Court of Appeal affirmed the decision. LORD CAIRNS L.C. ......... This case was first rested on the 118th article. Articles of association, as is well-known, follow the memorandum, which states the objects of the company, while the articles state the arrangement between the members. They are an agreement inter socios, and in that view, if the introductory words are applied to article 118, it becomes a covenant between the parties to it that they will employ the plaintiff. Now, so far as that is concerned, it is res inter alios acta, the plaintiff is no party to it. No doubt he thought that by inserting it he was making his employment safe as against the company; but his relying on that view of the law does not alter the legal effect of the articles. This article is either a stipulation which would bind the members, or else a mandate to the directors. In either case it is a matter between the directors and shareholders, and not between them and the plaintiff. The matter has been put in another way, it is said, this, though not an agreement in itself, is at all events a statement of what had been agreed upon; it must have been intended to be brought to the plaintiff's knowledge, he has accepted and acted upon it, and therefore it is evidence of another agreement on which he can rely. Now it may be considered that article 118 would have warranted the directors in entering into an agreement with the plaintiff by which they should contract to employ the plaintiff; but I ask, was such a contract ever made? A joint stock company may act under their seal, or by the signature of their directors, which may have equal effect as their seal, or possible by a resolution of the board. Nothing of the kind exists here; and if the article is not an agreement on which the plaintiff can rely, there is nothing in the case before us but the fact of his employment, and that would entitle him to remuneration only for work he has done. This seems to us to dispose of the whole case.

35.

RAYFIELD v. HANDS Article 11 of the articles of association of Field-Davis Ltd. provided: `Every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at a fair value ...' Rayfield, a member, sought to compel the defendants, the three directors of the company, to purchase his shares in accordance with this provision. The court declared that they were bound to do so. VAISEY J. It is article 11 with which I am mainly concerned in the present case, in the following circumstances. On or about 4 April 1955 the plaintiff, by a notice in writing bearing that date, informed the defendants as the directors of the company of his intention to transfer his shares to them as provided by article 11. The defendants were and are, however, unwilling and contend that they are not liable to take and pay for the plaintiff's shares. They say that article 11 imposes no enforceable liability upon them, and they base their contention first on the wording of article 11 itself, arguing that on its true construction it does not purport to impose any liability on the company's directors. (His Lordship considered the wording of article 11 and rejected this argument.) The next and most difficult point taken by the defendants, as to which it would appear that there is

no very clear judicial authority, is that article 11, as part of the company's articles of association, does not do what it looks like doing, that is, to create a contractual relationship between the plaintiff as shareholder and vendor and the defendants as directors and purchasers. This depends on section 20(1) of the Companies Act 1948. (His Lordship read the section and passages from various text-books. He continued:) Now the question arises at the outset whether the terms of article 11 relate to the rights of members inter se (that being the expression found in so many of the cases), or whether the relationship is between a member as such and directors as such. I may dispose of this point very briefly by saying that, in my judgement, the relationship here is between the plaintiff as a member and the defendants not as directors but as members. In re Leicester Club and County Racecourse Co., Pearson J., referring to the directors of a company, said that they `continue to be members of the company, and I prefer to call them working members of the company,' and on the same page he also said: `directors cannot divest themselves of their character of members of the company. From first to last.......... they are doing their work in the capacity of members, and working members of the company...........' I am of opinion, therefore, that this is in words a contract or quasi-contract between members, and not between members and directors. On the whole, if the proper way to construe the articles of association of a company is as a commercial or business document to which the maxim `validate if possible' applies, I think that the plaintiff in this action ought to succeed. Not one of the judges in the case to which I have already referred, Dean v. Prince, showed any signs of shock or surprise in the assumption there made of a contract between directors being formed by the terms of company's articles. I am encouraged, not I hope unreasonably, to find in this case a contract similarly formed between a member and member-directors in relation to their holdings of the company's shares in its articles. The conclusion to which I have come may not be of so general an application as to extend to the articles of association of every company, for it is, I think, material to remember that this private company is one of that class of companies which bears a close analogy to a partnership; Nobody, I suppose, would doubt that a partnership deed might validly and properly provide for the acquisition of the share of one partner by another partner on terms identical with those of article 11 in the present case. I do not intend to decide more in the present case than is necessary to support my conclusion, though it may be that the principles upon which my conclusion is founded are of more general application than might be supposed from some of the authorities on the point. I will make an appropriate declaration of the plaintiff's rights, or will order the defendants to give effect to them, and if necessary there must be an inquiry to ascertain the fair value of the shares ..........

36.

LYLE & SCOTT LTD v. SCOTT'S TRUSTEES The articles of Lyle & Scott Ltd, a private company, prohibited a registered holder of more than one per cent of the company's shares from selling them if any other ordinary shareholder was willing to buy them, and required the would-be seller to inform the secretary in writing of the number of shares he wished to transfer, so that notice could be sent to the holders of ordinary shares for offers. Scott's Trustee held more than one per cent of the shares, and, in common with the other shareholders, were approached on behalf of Hugh Fraser, who had no shares in the company, with an offer to buy shares. The respondents agreed that, if the offer became unconditional, which it did, Fraser's nominees would be authorized to use general proxies, and that they would deliver their share certificates and execute transfer deeds when called upon to do

so. Fraser paid for the shares. The company sought a declaration that the respondents were bound to implement the articles. Held - (House of Lords) - They were. Having agreed to sell their shares to Fraser, they could not deny that they were "desirous of transferring their shares within the meaning of Article 9 merely because it suited the purchaser to delay the registration for the time being. There was an unequivocal desire to sell, and the secretary must be notified, and the machinery of the articles set in motion.

37.

ALLEN v. GOLD REEFS OF WEST AFRICA LTD. The defendant company was incorporated on July 2, 1895, and clause 5 of the memorandum of association was as follows:- "The capital of the company is 90,000, divided into 360,000 shares of (S.5/= each). The said shares or any shares issued upon an increase of capital or any proportion thereof respectively may be issued fully paid up, at a premium, or at par, and with such preference, privileges or priority over or postponement to the remaining or any other shares of the company in respect of dividends or otherwise as may be determined." The memorandum was accompanied by articles of association, which provided (article 2) that the word "member" should mean a registered holder of any share or stock of the company; (article 29) "that the obligations, and liabilities of any member to or towards the company upon all shares (not being fully paid) held by such member..........; (article 42) that any person becoming entitled to a share in consequence of the death of any member might elect either to be registered himself as a holder, or to have some person nominated by him registered as a transferee thereof; (article 45) that a person so becoming entitled should, subject to any lien of the company, be entitled to receive dividends, bonuses, or other monies payable in respect of the share, but should not be entitled to notices of, or to attend or vote at meetings of the company, or save as aforesaid, to any of the rights or privileges of the members, unless and until he should have become a member in respect of the shares." Shares, both fully paid up and not fully paid up, were issued by the company. One Zuccani, as the nominee of the vendor to the company, had a number of fully paid-up shares alloted to him by way of purchase money for the property acquired by the company under their memorandum of association, and he held 27,885 of these shares at the time of his death, these shares being his own property. In addition to these fully paid-up shares, Zuccani applied for and had allotted to him 60,000 ordinary 5s. shares, not paid-up. These were applied for and allotted on the terms of the company's prospectus and articles of association. At the time of his death (4th February, 1897) Zuccani was the registered holder of the 27,885 fully paid-up vendor's shares, and also of 36,435 other shares partly paid-up, and he owed the company 6,072. 10s. for calls in respect of these, besides interest to a considerable amount. The plaintiffs, as Zuccani's executors, did not get themselves registered as members of the company in respect of any of Zucanni's shares, and they had not sufficient assets to answer his liabilities. Steps were taken to have his estate administered in the Chancery Division, but the company, instead of electing to carry in a proof for its debts, proceeded to take more summary measures for recovering it. In the first place, on February 9, 1897, a notice was sent out of an extraordinary general meeting of the company to be held on February, 18, for the purpose of passing a special resolution to alter article 29 of the articles of association by omitting the words "not being fully paid." This notice was posted to Zuccani at his registered address, although the directors were then aware of his

death. The meeting was held on February 18, and the special resolution was then passed. Thereupon notice of a confirmatory meeting to be held on March 8, was as before, sent to Zuccani's registered address. Both notices, addressed to Zuccani personally, came to the knowledge of the plaintiffs, his executors. On March 8, the confirmatory meeting was held and the resolution confirmed. Thus the company claimed to extend their lien to all fully paid-up shares. These were in fact no fully paid-up shares except those belonging to Zuccani. The next step the company took was this. The directors, purporting to act, under articles 22, 23 and 24, on June 4, 1897 posted to Zucanni at his registered address a notice requiring him to pay by June 21st the sum of 6,072 10s. due for calls on the 36,435 shares, a sum of 804-6-11 for interest on arrears of calls, and further interest form the date of the notice; the notice also stating that in the event of non-payment by the time appointed those shares would be liable to be forfeited. This notice was also sent to the plaintiffs, Zuccani's execution, who had not then lodged the probate of his will with the company for registration. The amounts demanded were not paid, and on June 23, the directors passed a resolution purporting to forfeit the 36,435 partly paid-up shares. On January, 29, 1897 the directors had declined to register a transfer of some of Zuccani's fully paid-up shares but ultimately, finding that the articles gave no power to the company or its directors to refuse to register a transfer of fully paid-up shares, they passed the transfer. The plaintiffs brought an action seeking a declaration that the defendant company had no lien upon the fully paid-up shares, and an injunction to restrain the forfeiture of the partly paid-up shares. Held: (Court of Appeal) The alteration of the articles was valid and the company had a lien on all Zuccani's shares. LINDLEY MR.: "........... I cannot agree ......... that the resolution is invalid by reason of any defect in the notice. Notices of meetings have only to be given to members, and the executors were not members. If no notice at all had been sent to the executors or to Zuccani's registered address, the omission would not, in my opinion, have affected the propriety of holding the meeting or the validity of the resolutions passed at them. Article 45 expressly provided that notice of meetings need not be sent to executors who had not become members. To hold that notice of meetings were to be given to the unregistered legal personal representatives of all deceased members would be to paralyse the transaction of business, and would be contrary to the ordinary principles applicable to corporate bodies and, indeed, to other associations as well ....................................... The facts above stated raise the following very important questions, namely, (1) whether a limited company, registered with articles conferring no lien on its fully paid-up shares, can by special resolution alter those articles by imposing a lien on such shares? (2) whether, if it can, the lien so imposed can be made to apply to debts owing by fully paid-up shareholders to the company at the time of the alteration of the articles? (3) whether, if it can, fully paid-up shares allotted to vendors of property to the company are in any different position from other fully paid-up shares issued by the company? The articles of company are the regulations binding on its members: Companies Act s.22. They have the effect of a contract...... but the exact nature of this contract is even now very difficult to define. Be its nature what it may, the company is empowered by the statute to alter the regulations contained in its articles from time to time by special resolutions; and any regulation or article purporting to deprive the company of this power is invalid on the ground that it is contrary

to the statute.......... The power thus conferred on companies to alter the regulations contained in their articles is limited only by the provisions contained in the statute and the conditions contained in the company's memorandum of association. Wide, however, as the language of S.13 is, the power conferred by it must, like all other powers, be exercised subject to the general principles of law and equity which are applicable to all powers exercised not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded. These conditions are always implied, and are seldom, if ever, expressed. But if they are complied with I can discover no ground for judicially putting any other restrictions on the power conferred by the section that those contained in it. How shares shall be transferred, and whether the company shall have any lien on them are clearly matters of regulation properly........ prescribed by a company's articles of association............. But then comes the question whether this (i.e. alteration of articles) can be done so as to impose a lien or restriction in respect of a debt contracted before and existing at the time when the articles are altered. Again, speaking generally, I am of opinion that the articles can be so altered, and that if they are altered bona fide for the benefit of the company, they will be valid and binding as altered on the existing holders of paid-up shares, whether such holders are indebted or not indebted to the company when the alteration is made............. But, although the regulations contained in a company's articles of association are revocable by special resolution, a special contract may be made with the company in the terms of or embodying one or more of the articles and the question will then arise whether an alteration of the articles so embodied is consistent or inconsistent with the real bargain between the parties. A company cannot break its contracts by altering its articles, but, when dealing with contracts between a member of the company and the company respecting his shares, care must be taken not to assume that the contract involves as one of its terms an article which is not to be altered. It is easy to imagine cases in which even a member of a company may acquire by contract or otherwise special rights against the company which exclude him from the operation of a subsequently altered article. Such a case arose in Swabey v. Port Darwin Gold Mining Co., where it was held that directors, who had earned fees payable under a company's articles, could not be deprived of them by a subsequent alteration of the articles, which reduced the fees payable to directors. I take it to be clear that an application for an allotment of shares on the terms of the company's articles does not exclude the power to alter them nor the application of them, when altered, to the shares so applied for and allotted. To exclude that power or the application of an altered article to particular shares, some clear and distinct agreement for that exclusion must be shown, or some circumstances must be proved conferring a legal or equitable right on the shareholder to be treated by the company differently from the other shareholders. Zuccani bargained for fully paid-up shares and he got them. The imposition of a lien on them did not render them less fully paid-up than they were before. They remained what they were. Zuccani did not bargain that the regulations relating to paid-up shares should never be altered, or that, if altered, his shares should be treated differently from other fully paid-up shares. I cannot see that the company broke its bargain with him in any way by altering its regulations or by enforcing the altered regulations as it did......... The fact that Zuccani's executors were the only persons practically affected at the time by the alterations made in the articles excites suspicions as to the bona fide of the company. But, although the executors were the only persons who were actually affected at the time, that was because Zuccani was the only holder of paid-up shares who at the time was in arrear of calls. The altered articles applied to "all holders of fully paid shares", and made no distinction between them. The directors cannot be charged with bad faith............"

ROMER, L.J.: "....... That the reason for the alteration was very existence of the large debt due from Mr.Zuccani and that the company had principally in mind this large debt due when it made the alteration in the articles, is no ground for impeaching the action of the company. It appears to me that the shareholders were acting in the trust and best interest of the company in exercising the legal right to alter the articles so that the company might as one result obtain payment of the debt due from Mr.Zuccani. The shareholders were only bound to look to the interests of the company. They were not bound to consult or consider Mr.Zuccani's separate or private interests......"

38.

SIDEBOTTOM v. KERSHAW, LEESE & CO. LTD The defendant company had altered its articles by introducing a provision which gave the directors power to buy out at fair price the shareholding of any member who competed with the company's business. The plaintiffs, who were minority shareholders and who carried on a competing business, unsuccessfully challenged the validity of the alteration. LORD STERNDALE M.R......... There are two objections to this alteration: One is a very broad one indeed, it is that whatever alterations a company may be empowered to make in its articles varying the terms upon which its members may hold their shares, it cannot alter its articles so as to provide a means of what was called `expelling', as in this case, by buying out a particular member and making him lease to be a member. I cannot find that such an exception as that is anywhere stated in any of the authorities existing......... but there is not doubt - in fact I think it is established by Phillips v. Manufacturers' Securities Ltd that a power such as this is a perfectly valid power in the case of original articles, and it seems to me that prima facie if it could be in the original articles, it could be introduced into the altered articles provided only it is done bona fide for the benefit of the company as a whole. The introduction into an altered article of a power of buying a person out or expelling him can only be held invalid if the alteration is not made bona fide for the benefit of the company....... .......In my opinion, the whole of this case comes down to rather a narrow question of fact, which is this: When the directors of this company introduced this alteration giving power to buy up the shares of members who were in competing businesses did they do it bona fide for the benefit of the company or not? It seems to me quite clear that it may be very much to the benefit of the company to get rid of members who are in competing businesses........ I think there can be no doubt that a member of a competing business or an owner of a competing business who is a member of the company has a much better chance of knowing what is going on in the business of the company, and of thereby helping his own competition with it, than if he were a non-member; and looking at it broadly, I cannot have any doubt that in a small private company like this the exclusion of members who are carrying on competing business may very well be of great benefit to the company. That seems to me to be precisely a point which ought to be decided by the voices of the business men who understand the business and understand the nature of competition, and whether such a position is or is not for the benefit of the company. I think, looking at the alteration broadly, that it is for the benefit of the company that they should not be obliged to have amongst them as members persons who are competing with them in business, and who may get knowledge from their membership which would enable them to compete better. That brings me to the last point. It is said that that might be so were it not for the fact that the directors and the secretary have said, "This is directed against Mr.Bodden", and therefore it is not done bonafide for the benefit of the company but that it is done to get rid of Mr.Bodden. If it were directed against Mr.Bodden from any malicious motive I should agree with that - the thing would cease to be bona fide at once; but these alterations are not as a rule made without some circumstances having arisen to bring the necessity of the alteration to the minds of the directors. I do not mind this as meaning anything more than this: `It was the position of Mr.Bodden that made us appreciate the detriment that there might be to the company in having members competing with

them in their business, and we passed this, and our intention was, if it became necessary, to use it in the case of Mr.Bodden; that is what we had in our minds at the time; but we also had in our minds that Mr.Bodden is not the only person who might compete, and therefore we passed this general article in order to enable us to apply it in any case where it was for the good of the company that it should be applied'. `It is a question of fact. I come to the conclusion of fact to which I think the Vice-Chancellor came, that the directors were acting perfectly bona fide, that they were passing the resolution for the benefit of the company; but that no doubt the occasion of their passing it was because they realized in the person of Mr.Bodden that it was a bad thing to have members who were competing with them........ For these reasons I think this is a valid article. I think the alteration was within the competence of the company, and therefore this appeal must be allowed with casts here and below. WARRINGTON L.J. and EVE J. delivered concurring judgements.

39.

DAFEN TINPLATE CO. LTD V. LLANELLY STEEL CO. (1907) LTD The defendant company altered its articles so as to introduce a power enabling the majority of the shareholders to require any member (with one named exception) to transfer his shares at a fair value to an approved transferee. The plaintiff company, which held shares in the defendant company, and had transferred their custom as purchasers of steel from the defendants to a rival company, opposed the alteration. Peterson J. upheld their objection, because in his own view the alteration was wider than necessary. PETERSON J......." In Sidebotton's case the Court of Appeal sanctioned an alteration of the articles of association which enabled the directors to require a shareholder who carried on a competing business, or was a director of a company carrying on a competing business, to transfer his shares, and it did so on the ground that the alteration was for the benefit of the company as a whole. It has been suggested that the only question in such a case as this is whether the shareholders bona fide or honestly believed that the alteration was for the benefit of the company. But this is not, in my view, the true meaning of the words of Lindley M. R. or of the judgement in Sidebotton's case. (*Refer to p.31) The question is whether in fact the alteration is genuinely for the benefit of the company. The Lord Sterndale accepted and approved of the view expressed by Lord Wrenbury in his book on the Companies Act, 9th ed., p.25, that: possibly the limitation on the power of altering the articles may turn out to be that the alteration must not be such as to sacrifice the interests of the minority to those of a majority without any reasonable prospect of advantage to the company as a whole, and stated that it agreed with the principle enunciated by Lindley M. R. Warrington L. J. protested against the idea that `bona fide' and `for the benefit of the company' were two separate things in Lindley M. R.'s exposition of the law; and Eve J. in stating the principle to be applied said: `Was the resolution adopted, or was the alteration made for the benefit of the company or for the benefit of some section of the company, without reference to the benefit of the company as a whole? The question of fact then which I have to consider is whether the alteration of the articles which enables the majority of the shareholders to compel any shareholders to transfer his shares, can properly be said to be for the benefit of the company. It may be for the benefit of majority of the shareholders to acquire the shares of the minority, but how can it be said to be for the benefit of the company that any shareholder, against whom no charge of acting to the detriment of the company can be urged, and who is in every respect a desirable member of the company, and for whose expropriation there is no reason except the will of the majority, should be forced to transfer his shares to the majority or to anyone else? Such a provision might in some circumstances be very prejudicial to the company's interest. For instance, on an issue of new capital, the knowledge that he might be expropriated as soon as his capital was on the point of producing profitable

results might well exercise a deterrent influence on a man who was invited to take shares in the company....... In my view it cannot be said that a power on the part of the majority to expropriate any shareholder they may think proper at their will and pleasure is for the benefit of the company as a whole. 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. In my opinion, the power which, in this case, has been conferred upon the majority of the shareholders by the alteration of the articles of association in this case is too wide and is not such a power as can be assumed by the majority. The power of compulsory acquisition by the majority of shares which the owner does not desire to sell is not lightly to be assumed whenever it pleases the majority to do so. The shareholder is entitled to say non hace in foodera veni; and while on the authorities as they stand at present it is possible to alter the articles in such a way as to confer this power, if it can be shown that the power is for the benefit of the company as a whole. I am of opinion that such a power cannot be supported if it is not established that the power is bona fide or genuinely for the company's benefit.............."

40.

RE: SOUTH OF ENGLAND NATURAL GAS & PETROLEUM CO. LTD. The South of England Natural Gas and Petroleum Company was incorporated on 30th January 1909 with a capital of 20,000 divided into 10,000 preference shares of 1 each and 10,000 ordinary shares of 1 each. On 21st February, 1910, a prospectus was issued marked "For private circulation only", but also containing a statement "This prospectus has been filed with the Registrar of Joint Stock Companies". It offered for subscription 7,000 preference shares, 9,000 ordinary shares, and 5,000 debentures and stated that the minimum subscription upon which the directors might proceed to allotment was fifty shares. The prospectus was sent, it was stated, only to shareholders in certain gas companies in which Eaton, the promoter of the company who undertook the distribution of the prospectus, was interested. The issue was not publicly advertised and only 3,000 copies were sent out. Only 200 shares were applied for, and of these 180 were applied for by the directors of the company. In March 1910, the company applied for and obtained a certificate from the Registrar of Joint Stock Companies that they were entitled to commence business. Upon this application the managing director made a statutory declaration that the prospectus fixing 50 as the minimum subscription had been issued to the public. On 3rd April, 1910, a prospectus was issued offering 8,000 preference and 8,000 ordinary shares and some debentures. This prospectus was publicly advertised and issued in the ordinary way. It did not contain a statement of the amount offered for subscription or the amount allotted on the previous allotment as required by s.81(d), Companies Act (Consolidated), 1908, (see now para.6, 4th Schedule, Companies Act 1948). On this issue 1,150 ordinary and 943 preference shares were applied for and allotted C.P. Byrne applied for and was allotted 200 preference shares; he paid 50 allotment money but died on 28th June without having paid 150 which had by that time become due. His executors moved to rectify the register of shareholders by removing his name on the ground of the omission in the prospectus. In answer to this application the managing director filed an affidavit that the earlier issue was private only, and not an offer to the public, and therefore did not need to be mentioned in the second prospectus.

SWINFEW EADY, J.:.........."I am satisfied that the first prospectus did offer shares to the public, and none the less because copies were sent only to shareholders in gas companies who were the most likely subscribers. It follows that the second prospectus contained a subsequent offer and did not comply with s.81(d). Then the question is what is the remedy of the shareholder? Is he entitled to rescind his contract and have his money back? There is no provision of that kind in s.81, nor in any other section relating to the omissions relied on in this case. But the section does contemplate a liability in damages on the part of the "directors and other persons responsible for the prospectus", for sub.s. (6) exonerates such persons form liability if they can prove certain matters (see now s.38(4) Companies Act, 1948). That is equivalent to saying that they are liable if they cannot prove them. In my opinion the allottee is not entitled to rescind his contract because of any breach of the statutory requirements, which extend to such comparatively unimportant matters as the names and addresses of the company's auditors. His remedy is against the directors...... The motion therefore fails".

41.

GOVERNMENT STOCK & OTHER SECURITIES INVESTMENT COMPANY LTD. v. CHRISTOPHER AND OTHERS:(1956) By a circular dated 12th November, 1955 and issued by the British and Commonwealth Shipping Co. Ltd. (hereinafter called "The New Company'), the new company offered to acquire the whole of each class of preference and ordinary shares and stock in the issued capitals of the UnionCastle Mail Steamship Co. Ltd. and the Clan Line Steamers Ltd. and to issue its own shares in exchange therefor. The circular was sent to all members of Union-Castle and Clan Line Steamers Ltd. together with a form headed "Form of Acceptance and Transfer". The offer was expressed to be conditional on acceptance on or before 30th December 1955, or such later date not after 29th February 1956 as the new company might allow, by the holders of not less than 90 per cent of every class of issued capital of Clan Line and Union-Castle, or such less percentage as the new company might elect to accept, and on permission to deal and to quote being granted by the council of the Stock Exchange before the dispatch of letters of allotment. The plaintiff company contended, inter alia, that the circular was a "prospectus" to which s.38 of the Companies Act 1948, applied, and that as such it did not comply with the requirement of the Act. On behalf of itself and other shareholders of Union-Castle, it moved for an injunction against seven directors of Union-Castle and against Union-Castle to restrain the.......... WYNN-PARRY, J.: ...... I think that in order to understand and consider the attacks which the plaintiff company makes on the circular, I should first consider its nature. It is alleged by the plaintiff company that it is a prospectus to which s.38 of the Companies Act 1948 has a wider meaning than in s.455, the reason put forward being that in section (3) reference is made to the issue of "A form of application", and that there being nothing in the subsection to limit the issue of the form of application to an allotment and issue for cash, it must apply where the consideration is a consideration other than cash. This, it is said, constitutes a context requiring the word "prospectus" to cover documents not included in the definition in s.455. I do not accept this view. S.38 follows s.37, which appears under the heading "prospectus". There is no ground whatsoever for giving the word "prospectus" in s.37 any more extended meaning than it has in s.455, and it would be strange if in the very next section "prospectus" were to be found to have a wider meaning. I can see no need to attribute any other meaning to "prospectus" in s.38 than that given in s.455. The reference in subsection (3) to a form of application means only a form of application in connection with a prospectus offering shares for subscription of purchase.

It is clear that the circular does not involve an offer for the purchase of any shares. The shares in question are unissued shares of the new company, so they cannot be the subject of an offer for purchase. It becomes necessary, therefore, to consider the word "subscription" in the definition of "prospectus". In my view the word means: taking or agreeing to take shares for cash. It imports that the person agreeing to take the shares puts himself under a liability to pay the nominal amount thereof in cash........ paras.4,5,6 and 7 of Part 1 of Schedule 4 to the Act clearly require that "subscription" and "subscribe" involve the notion of payment in cash. The circular in this case does not invite subscription for shares in cash. For these reasons I am of opinion that the circular is not a prospectus within the meaning of that word as used in the Companies Act, 1948...... I am further of opinion that the circular was not distributed to the public. I accept the proposition..... that the test is not who receives the circular, but who can accept the offer put forward. In this case it can only be persons legally or equitably interested as shareholders in the shares of Union-Castle or Clan. In the case of those who accept non-renounceable letters of allotment will be issued. In these circumstances the case appears to me to fall within s.55(2) of the Companies Act, 1948. The circular is not a prospectus, but what it purports to be, namely, the communication of an offer to exchange shares in the new company for shares in Union-Castle or Clan as the case may be. .....In the result, in my judgement, the plaintiff company is not entitled to any of the injunctions for which it asks, and consequently the motion must be dismissed.

42.

DERRY v. PEEK (House of Lords) The Plymouth, Davenport & District Tramways Co. was, by its special incorporating Act, authorised to construct and run certain tramways. The Act authorised it to use horse trams and, with the consent of the Board of Trade, steam-driven trams. The directors (including Derry) put out a prospectus which stated that `one great feature' of the understanding as that, `by the special Act of Parliament obtained, the company has the right to use steam or mechanical motive power'. Sir Henry Peek, the plaintiff, subscribed for shares on the faith of the prospectus, but brought this action claiming damages in deceit against the directors when the Board of Trade refused to consent to the use of steam on most of the company's tramways. The House of Lords, on the basis that the statement was made bona fide (though without any foundation) reversed the decision of the Court of Appeal which had held this sufficient to constitute deceit. LORD HERSCHELL.......... In the court below Cotton, L.J., said:"What in my opinion is a correct statement of the law is this, that where a man makes a statement to be acted upon by others which is false, and which is known by him to be false, that is, without any reasonable ground for believing it to be true, he is liable in an action of deceit at the suit of anyone to whom it was addressed or anyone of the class to whom it was addressed and who was materially induced by the misstatement to do an act to his prejudice". About much that is here stated there cannot, I think, be two opinions. But when the learned Lord justice speaks of a statement made recklessly or without care whether it is true or false, that is without any reasonable ground for believing it to be true, I find myself, with all respect, unable to agree that these are convertible expressions. To make a statement careless whatever it be true or false, and therefore without any real belief in its truth, appears to me to be an essentially different thing from making, through want of care, a false statement, which is nevertheless honestly believed to be true. And it is surely conceivable that a man believes that what he states is the fact, though he has been so wanting in care that the court may think that there were no sufficient grounds to warrant his belief.

I shall have to consider hereafter whether the want of reasonable ground for believing the statement made is sufficient to support of deceit. I am only concerned for the moment to point out that it does not follow that it is so, because there is authority for saying that a statement made recklessly, without caring whether it be true or false, affords sufficient foundation for such an action..... I think that the authorities establish the following propositions: First, in order to sustain an action of deceit, there must be proof of fraud, and nothing short of that will suffice. Secondly, fraud is proved when it is shown that a false representation has been made (i) knowingly, or (2) without belief in its truth, or (3) recklessly, carelessly whether it be true or false. Although I have treated the second and third as distinct cases, I think the third is but an instance of the second, for one who makes a statement under such circumstances can have no real belief in the truth of what he states. To prevent a false statement being fraudulent, there must, I think, always be an honest belief in its truth, and this probably covers the whole ground, for one who knowingly alleges that which is false, has obviously no such honest belief. Thirdly, if fraud be proved, the motive of the person guilty of it is immaterial. It matters not that there was no intention to cheat or to injure the person to whom the statement was made....... In my opinion, making a false statement through want of care falls far short of, and is a very different thing from, fraud, and the same may be said of a false representation honestly believed though on insufficient grounds......... At the same time, I desire to say distinctly that when a false statement has been made the questions whether there were reasonable grounds for believing it, and what were the means of knowledge in the possession of the person making it, are most weighty matters for consideration. The ground upon which an alleged belief was founded is a most important test of its reality. I can conceive many cases where the fact that an alleged belief was destitute of all reasonable foundation would suffice of itself to convince the court that it was not really entertained, and that the representation was a fraudulent one. So, too, although means of knowledge are, as was pointed out by Lord Blackburn in Brownie v. Campbell, a very different thing from knowledge, if I thought that a person making a false statement had shut his eyes to the facts, or purposely abstained from inquiring into them, I should hold that honest belief was absent, and that he was just as fraudulent as if he had knowingly stated that which was false......."

43.

FIRST NATIONAL REINSURANCE CO. LTD. v. GREENFIELD (King's Bench Divisional Court) Greenfield applied for 150 shares in the plaintiff company relying on a prospectus which wrongly named one F. as underwriter. On learning of the error he asked to have the allotment to him canceled, but took no other steps until sued by the company seven months later for a call. The court affirming the decision of the City of London Court, held that without rectification of the share register the defence was not good, and that the defendant had lost the right to rescind by laches. (i.e unreasonable delay). LUSH, J.,... There are three classes of cases in which the question of repudiation has to be considered. The first is where there is an executory contract and the defendant pleads that he has been induced to enter into it by fraud. No difficulty occurs in that case. All the defendant has to make out is that he has not affirmed the contract, but that on the contrary when he had notice of the fraud he disclaimed or repudiated it. If he established that, he succeeds in resisting the claim founded upon the executory contract. The second class of cases is where the contract has been executed - where the chattel or the chose in action, whatever it may be, has been transferred, or where, if it be a contract for the sale of land, the land has been conveyed. There the defendant

must do more than merely prove the fraud and the repudiation: he must prove that there has been a restitutio in integrum as far as possible. The contract having been completed and the subjectmatter of it having been transferred he must, in order to rescind the contract or to resist an action, show that there has been restitutio. At first sight it might appear that that includes a case like the present where there was a contract to take shares and the shares have been duly allotted. Shares stand, in my opinion, upon an entirely different footing; they represent what I may call a third class of cases. If a person agrees to accept shares, and shares have been allotted to him, and his name is on the register, he is liable by statute to pay the calls. I do not mean that there is an express section in the Companies Act which says that he shall pay the calls, but the statutory right which a company has to enforce payment of what is due as a debt in effect amounts to a statutory obligation upon the shareholder to pay the calls. What is a proper defence to an action for calls brought against a shareholder? The member being liable qua shareholder to pay the calls, the only plea one would have thought that could be effective would be a plea that he is not a shareholder. The plaintiff alleges that the defendant has a certain status, that of a shareholder. The statute says a shareholder must pay the calls. One would expect the plea would be: `I am not a shareholder'. In substance that the proper plea. I do not mean that a person must plead and prove that his name has actually been taken off the register, but he must plead that, so far as he is concerned, he had taken steps, and taken them within a reasonable time after discovery of the fraud, to have his name removed from the register, that is all he can do. He cannot take his own name off the register and thereby cease to be a shareholder. He can only invoke the jurisdiction of the court and ask it to do so. If he has done that, and if it turns out ultimately that his name will be removed from the register, the judgement of course dates back to his application, and it will in substance turn out to be true that he has ceased to be a shareholder and therefore not liable to pay calls. That, in my view, is the position in law of a defendant in an action of this kind; it is not enough merely to treat the claim as if it were a claim on a contract and say: `I have been deceived, and I have repudiated my contract'.

44.

CLARK v. URQUHART (House of Lords) The question was whether the plaintiff, having accepted a payment into court in satisfaction of a claim in deceit, could nevertheless pursue a claim for compensation under s.84 of the Companies Act of 1908 (s.45 of the present Act) and endeavor to establish additional loss. The House of Lords, reversing the Court of Appeal in Northern Ireland, held that he could not, as the measure of damages was the same in both cases. VISCOUNT SUMMER..... So much for the evidence of liability. That liability gives rise under the section to a right to `compensation'. With great respect to the Lords Justices, who held otherwise, I cannot hold that compensation here is, either as to the amount recoverable or the mode of measuring it, something different from and even greater than damages. Very shortly after the Directors Liability Act of 1890 was passed, which is reproduced in s.84 of the Act of 1908, it was stated on high authority that the object of it was to give, as against persons who came within its terms, the remedy which the final decision in DERRY v. PEEK in this House had limited to those who could prove a case of deceit, and this has since been generally adopted, and in my opinion is correct. I can understand that the legislature deemed it necessary, as a matter of policy, to make certain persons liable for false statements in a prospectus, even though they did not know them to be false. I can understand that the word `compensation', which has no technical significance to the contrary, was selected because it represented the difference between the actual value of the debentures taken and the sum paid for them on the face of the prospectus, and at the same time avoided the invidious association of damages with dishonesty in such a connection. What I cannot understand is how the legislature should have thought fit to impose on a director, who has authorised a misstatement innocently, a larger liability than falls on one who has done it in order to cheat, or to put it in the power of the plaintiff to get more money by omitting a charge of fraud than he could get by proving it. Again, if for some inscrutable reason such was the policy

adopted, I cannot see why this gross difference was made to lurk in the use of a colourless and inoffensive word like `compensation'. Great as is the difference between the elements which constitute the two causes of action, the injury to be made good to the plaintiff is the same, and I see no reason for measuring it in one way in the one case and in a different way in the other........... LORD ATKIN.......... I desire for myself to disclaim any intention in this case to decide what is the true measure of damages in an action for deceit of this kind. Both parties have accepted the measure of damages laid down in McConnel v. Wright. I find it difficult to suppose that there is any difference in the measure of damages in an action of deceit depending upon the nature of the transaction into which the plaintiff is fraudulently induced to enter. Whether he buys shares or buys sugar, whether he subscribes for shares or agrees to enter into partnership, or in any other way alters his position to his detriment, in principle, the measure of damages should be the same, and whether estimated by a jury or a judge. I should have thought it would be based on the actual damage directly flowing from the fraudulent inducement. The formula in McConnel v. Wright may be correct or it may be expressed in too rigid terms. I reserve the right to consider it if it should ever be in issue in this House. LORDS BLANESBURGH and TOMLIN delivered concurring opinions. LORD THANKERTON concurred. (The suggestion of Lord Atkin that the formula in McConnel v. Wright may be too rigidly expressed is usually thought to refer to the possibility of consequential losses - not, of course, damages for loss of bargain of loss of profits, for these are heads of contract damages; but out-of-pocket expenses incurred in relation to investment would no doubt be recoverable)

45.

ANDREAE v. ZINC MINES OF GREAT BRITAIN LTD The company agreed to pay Andreae a commission of 10% on every sum that was accepted by it on his introduction. No statement in the prescribed form (i.e Form No.225) was registered with the registrar of companies. On one ocassion, Andreae introduced 4,600 to the company, and was paid 200, and with it was agreed that the balance of 200 would be paid later. However, the company defaulted and was sued for the money. The cort held that Andreae was not entitled to the money since the payment was unlawful under what is now s.55 of the Kenya Act. The company could not however recover the 200 already paid.

46.

HOUSEHOLD FIRE INSURANCE CO. LTD v. GRANT Grant had applied for 100 shares in the plaintiff company by handing to an agent of the company on 30th September 1874 a written application for the shares. On 20th October, 1874, the company secretary made out the letter of allotment in favour of Grant and posted it to him after entering his name on the register of shareholders. The letter never reached Grant who contented, as a consequence, that he was not a member of the company. It was held that there was a binding contract between Grant and the company because, although he had not expressly told the company to post the letter of allotment, the court was of the view that the post is the ordinary mode of transmission of an allotment letter. Baggalay, L.J. stated: "Now a letter of application for shares in a public company expressed in the usual form, must, I think, having regard to the usage in such matters, be considered as authorizing the acceptance of the offer by a letter through the post".

47.

RAMSGATE VICTORIA HOTEL CO. v. MONTEFIORE On 8th June, 1864 the defendant applied for fifty shares in the plaintiff company but no allotment was made till 23rd November. On 8th November, the defendant, leaving received no communication from the company, withdrew the shares, and the company sued to enforce the allotment. It was held that the interval from June to November was unreasonable and judgement was given for the defendant.

48.

TREVOR v. WHITEWORTH (1887) James Schofield & Sons Ltd was incorporated in 1865 under the Companies Act 1862. Its articles authorized it to purchase its own shares. During the company's liquidation a former shareholder made a claim against the company for the balance of the prive of his shares which he had sold to the company before the liquidation but had not been wholly paid for. The liquidation rejected the claim and the shareholder sued for breach of contract. Held - (by the House of Lords) that the company had no power under the Companies Act to purchase its own shares, that the purported purchase was therefore ultra vires the company and void. Lord Herschell stated: "It cannot be question since the case of Ashbury Railway Carriage and Iron Co. v. Riche that a company cannot employ its funds for the purpose of any transactions which do not come within the objects speicfied in the memorandum and that a company cannot by its articles of association extend its power in this respect.......... What is the meaning of the distinction thus draun between a company without limit on the liability of its members and a company where the liability is limited, but in the latter case, to assure to those dealing with the company that the whole of the subscribed capital, unless diminished by expenditure upon the objects defined by the memorandum, shall remain available for the discharge of its liabilities? The capital may, no doubt, be diminished by expenditure upon and reasonably incidental to all the objects specified. A part of it may be lost in carrying on the business operations authorized. Of this all persons trusting the company are aware, and take the risk. But I think they have a right to rely, and were intended by the legislature to have a right to rely, on the capital remaining undiminished by any expenditure outside these limits, or by the return of any part of it to the shareholders." Lord Macnaghten, in the course of his judgement, stated: "It appears to me that the notion of a limited company taking power to buy up its own shares is contrary to the plain intention of the Act of 1862, and inconsistent with the conditions upon which, and upon which alone, Parliament has granted to individuals who are desirous of trading in partnership the priviledge of limiting their liability......... When Parliament santions the doing of a thing under certain conditions and with certain restrictions, it must be taken that the thing is prohibited unless the prescribed conditions and restrictions are observed." Lord Watson stated: "One of the main objects contemplated by the Legislature in restricting the power of limited companies to reduce the amount of their capital as set forth in the memoradum is to protect the interests of the outside public who may become their creditors. In my opinion the effect of these statutory restrictions is to prohibit every transaction between a company and a shareholder by means of which the money already paid to the company in respect of his shares is returned to him, unless the court has sanctioned the transction."

49.

RE: CASTIGLIONE'S WILL TRUSTS

A testor, Edwin James castiglione, by his will directed that 1,000 fully-paid shares in a private company called Castiglione, Erskine & Co. Ltd be held in trust for his son for life, and after his death without leaving any child, the shares should be transferred to the company. The son died without children and the validity of the bequest was questioned. Held By Danckwerts, J. - the shares could not be transferred to the company itself, but could be transferred to nominees to hold on trust for the company.

50.

THE STANDARD BANK v. MEHOTORO FARM LTD AND ANOTHER (High Court Civil Case No.353/70) The first defendant as the customer of the plaintiff executed two memoranda of charge in favour of the plaintiff over its two farms as security for overdraft facilities up to a maximum of Shs.320,000/=. The second defendant negotiated for the purchase of the first defendant's assets; the plaintiff advanced Shs.66,000/= to the second defendant towards purchase of the assets. Thereafter the second defendant and his wife (the third defendant) successfully negotiated the purchase of all the shares in the first defendant for Shs.660,000/=. The advance of Shs.66,000/= made by plaintiff to second defendant was used as a deposit for the purchase of shares. This was done by the plaintiff closing the second defendant's account and transferring the debit balance of Shs.66,000/= to the first defendant's account. The plaintiff advanced the total price of the shares to the FIRST defendant and this was secured by unstamping the existing memoranda of charge by two INSTRUMENTS OF VARIATION under which the first defendant agreed that the amount secured be increased to Shs.660,000/= and also by the guarantees of the second and third defendants. At the time of these transactions the first defendant owed the plaintiff Shs.203,309/95 under the pre-existing overdraft arrangements. The plaintiff in this suit claimed:(1) (2) (3) repayment of the loan from the first defendant, payment of Shs.660,000/= from the second and third defendants as guarantors; and an order that in default of payment by the defendants as claimed above, the first defendant's shares be SOLD and the proceeds of the sale be utilised in the discharge of the debt.

HELD: (1) Since the plaintiff advanced the money to the first defendant for the KNOWN PURPOSE of this money being lent to the second and third defendants to purchase shares in the first defendant's company (sic.) the advance as rendered illegal, void and irrecoverable by s.56 of the Companies Act (Cap.486). Likewise the securities, charges and guarantees given or executed in connection therewith are also illegal and void and no money advanced directly or indirectly thereunder is recoverable.

(2)

51.

WALLERSTEINER v. MOIR

The relevant facts in this case were as follows:(a) On 30th March 1962 Camp Bird Ltd, a public company, made an agreement with a Dr.Wallersteiner to sell to the Rothschild Trust its shares (an 80% holding) in Hartley Baird Ltd. for 518,787. The Rothschild Trust was registered in Liechtenstein and was controlled by Dr.Wallersteiner. The money for the Camp Bird shares was not found by the Rotchschild Trust (in effect Dr.Wallersteiner). It was found (i) by loans which Hartley Baird Ltd made to Dr.Wallersteiner (in the name of his company Investment Finance Trust Ltd of Nassav); by regarding as canceled certain sales commissions which Camp Bird owed to Dr.Wallersteiner's various Liechtenstein companies. It was alleged that these commissions were not really owed but fabricated.

(b)

(c)

(ii)

All this was achieved because Dr.Wallersteiner has a controlling interest in the various companies involved who could in consequence be made to do what he wanted. These transactions came to the notice of Mr.Moir, a minority shareholder in Hartley Baird Ltd and he made statements to the press and applied to the Department of Trade for an investigation into Hartley Baird's affairs. This resulted in an action by Dr.Wallersteiner for libel. The libel action was struck out and on other matters relevant to company law the Court of Appeal decided:(i) the loan by Hartley Baird Ltd to the Rothschild Trust assisted the acquisition of Hartley Baird shares by the Rothschild Trust and was a plain breach of what is now s.151. Dr.Wallersteiner was liable to repay the loan to Hartley Baird Ltd. Since Dr.Wallersteiner was a director of Hartley Baird Ltd there was also an infringement of the provisions relating to loans to directors. (see nw ss.330-334) The corporate veil. In the course of his judgement Lord Denning MR said: `It is plain that Dr.Wallersteiner used many companies, trusts or other legal entities as if they belonged to him. He was in control of them as much as any "one man company" is under the control of the one man who owns all the shares and is the chairman and the Managing Director. He made contracts of enormous magnitude on their behalf on a sheet of notepaper without reference to anyone else....... Counsel for Dr.Wallersteiner repudiated this suggestion. It was quite wrong he said, to pierce the corporate veil. The principle enunciated Salomon v. Salomon & Co. Ltd (1897) was sacrosanct. If we were to treat each of these concerns as belonging to Dr.Wallersteiner himself under another hat, we should not, he said, be lifting a corner of the corporate veil. We should be sending it up in flames. After accepting that the various concerns were distinct legal entities Lord Denning went on to say: `Even so, I am quite clear that they were just the puppets of Dr.Wallersteiner. He controlled their every movement. Each danced to his bidding. He pulled the strings. No one else got within reach of them. Transformed into legal language they were his agents to do as he commanded. He was the principal behind them. I am of the opinion that the court should pull aside the corporate veil and treat these concerns as being his creatures for whose doings he should be, and is, responsible. At any rate, it was up to him to show that anyone else had a say in their affairs and he never did so.

(ii)

(iii)

52.

STEENVLAW (Liquidator of International Vending Machines Properties Ltd) (Privy Council, on appeal from the Supreme Court of New South Wales). By s.148 of the Companies Act, 1936 of New South Wales: "(1)... It shall not be lawful for a company to give...... by means of a loan..... any financial assistance for the purpose of ....... a purchase made or to be made by any person of any shares in the company: Provided that nothing in this section shall be taken to prohibit (a) where the lending of money is part of the ordinary business of a company, the lending by a company of money in the ordinary course of its business......."

In this appeal, the Privy Council was called upon to decide whether certain transactions by which a company (I.V.M.) gave financial assistance for the purchase of its shares by another company (A.M.H.) contravened the provisions of the Act. The appellants were the directors of I.V.M. at the time of the transactions and had been found guilty of misfeasance or breach of duty in causing the loan to A.M.H. to be made. The judgement of the Privy Council was delivered by Viscount Radcliffe. VISCOUNT RADCLIFFE: "............ The section in question first appeared in the law of New South Wales in the year 1936. As it had been introduced into the United Kingdom a few years earlier as section 45 of the Companies Act of 1929, it is safe to assume that the later piece of legislation took its inspiration from the earlier. There is no difficulty in describing the notorious objections to a company's money being used to assist the purchase of its own shares (see, for instance, the practice described by Lord Greene M.R. in re: V.G.M. Holdings Ltd) but the question that now calls for consideration is what is the scope and nature of the various exemptions allowed by the section from its general prohibition of money being provided for such purposes. When provisos (b) and (c) are contrasted with proviso (a), it seems clear that the second and third are intended to take care of situations different in kind from that envisaged by the first. What they exempt are loans or other transactions which are explicitly designed by the lender to make possible what would otherwise be directly prohibited by the general words of the section - the purchase of employees' shares by trustees under an established company scheme or the purchase by employees, not being directors, of shareholdings in the company for their own beneficial purposes. Purchases of these two kinds fall within limited and defined categories: the section envisages (see subsection (2)) that each loan made for either of these reasons will admit of identification as such and that the aggregate amount of such loans outstanding at the date of any balance-sheet will be capable of precise computation and statement. Proviso (a), on the other hand, is expressed in different terms. Whatever exemption it confers is not described in relation to the purposes for or in connection with which the money is made available, nor, it seems, are moneys loaned in reliance on this proviso envisaged as admitting of identification according to the purpose of the loan. If it were otherwise, what could be the reason of requiring the aggregate of outstanding loans made under (b) and (c) to be shown in the balance sheet, but not of making any similar requirement with regard to loans protected under proviso (a)? This proviso, then, must be read not as exempting particular loan transactions made for identifiable purposes but as protecting a company engaged in money-lending as part of its ordinary business from an infraction of the law, even though moneys borrowed from it are used and, perhaps, used to its knowledge, in the purchase of its own shares. Even so, the qualification is imposed that, to escape liability, the loan transaction must be made in the ordinary course of its business. Nothing, therefore, is protected except what is consistent with the normal course of its

business and is lending of a kind which the company ordinarily practices. In their Lordships' opinion, such an approach to the interpretation of proviso (a) necessarily requires that the "lending of money", to be part of the ordinary business of a company must be what may be called a lending of money in general, in the sense, for example, that moneylending is part of the ordinary business of a registered moneylender or a bank. Such lenders are not obliged to accept their borrowers, but it is characteristic of their business that, if they do lend, the money made available is at the borrower's free disposition and is not, except in special circumstances, confined to special uses or restricted to particular and defined purposes. Unless the lending of money as part of the ordinary business of a company is understood in this sense, the absurd result would be reached that any lending operations of which it made a practice, however restricted their purpose or remote from general money-lending, would qualify the comapny to ignore the prohibition of the section and finance purchases of its shares, provided that it could describe such advances as made in the ordinary course of its business. Thus a company which, for instance, lent money from time to time to trade suppliers or purchasers claim that the lending of money was part of its ordinary business and that it was accordingly one of the companies intended to be protected by proviso (a), if it chose to make loans in connection with the purchase of its shares. Yet it is not possible to suppose that the section could have been intended to provide any exemption or relief for such cases, for there could be no good reason for allowing a company to use previous lendings for quite different purposes as the justification for share purchase loans, which the legislation is in general intended to forbid. This interpretation is supported by the fact that in the proviso the "ordinary business of the company" is associated with "lending.... of money in the ordinary course of its business". The latter words are not intended, their Lordships think, to be synonymous with "the ordinary course of business" itself and seem to refer more particularly to advances of a scale and for a purpose similar to those regularly made by the company in carrying out its business. Such a constitution accords naturally with the idea of general moneylending, provided that the advances do not amount to a departure from the usual order of business: but it, is on the other hand, 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..........." Appeal dismissed.

53.

BRITISH AND AMERICAN TRUSTEE AND FINANCE CORPORATION, LTD. AND REDUCED v. COUPER (House of Lords, 1894). The appellant company, as a company limited by shares, had power under its articles to reduce its capital by paying off capital. The shares were divided into ordinary shares partly paid up, and founders' shares fully paid up. The company had carried on business both in England and the United States but it being found impossible to do so in both countries with advantage it was determined that the company should cease to carry on business in the United States, that the American investments should be made over to the American shareholders, their shares being canceled, and that the English shareholders should take the English assets, receiving an agreed sum by way of adjustment. This arrangement was carried out by special resolution providing that the capital should be reduced by paying off the shares (both ordinary and founder's) held by the American shareholders (the capital represented thereby being in excess of the wants of the company,) and that such shares and all liability thereon be wholly extinguished. The company presented a petition praying the court to confirm the resolution. All the creditors were either paid or assented to the arrangement. The confirmation by the court was opposed by one shareholder. HELD:

Reversing the decision of the Court of Appeal, that the reduction of capital was within the powers conferred by the Companies Act and that the arrangement being a fair and equitable one there was no reason why it should not be confirmed. LORD HERSCHELL: "..........When the case of TREVOR v. WHITWORTH was before this House, my noble and learned friend Lord Macnaghten said: "I may say that the Act of 1867, as explained by the Act of 1877, seems to prohibit a company from purchasing its own shares, except under certain stringent conditions............ There can be no doubt that the ratio decided in that case was in part, at least, this that a company which paid away its assets for the purchase of its own shares did thereby reduce its capital, and that not in a manner authorized by the Legislature".

54.

IN RE MEUX'S BREWERY COMPANY LTD. (1918) The company was incorporated with a fully paid share capital of 1,000,000, in addition to which it had issued 1,000,000 perpetual debentures stock secured by certain trust deeds constituting a floating security. In 1904 the company had incurred losses amounting to upwards of 800,000, since which year no dividend had been declared, the profits in each year being applied in reduction of the deficiency, which now amounted to 640,000 or upwards. In 1917, by special resolution, the company resolved to reduce its capital to 360,000 by writing off the lost capital. (Article 46 of the Articles of association empowered the company from time to time, by special resolution, to reduce its capital by paying off capital or canceling capital which had been lost or was unrepresented by available assets). The reduction did not involve the diminution of any liability in respect of any unpaid capital or the payment to any shareholder of any paid-up capital. This petition by the company to confirm the special resolution was opposed by certain holders of debenture stock on the ground that the proposed reduction would be prejudiced to their security by enabling the company to pay dividends out of profits instead of such profits being applied in making good the lost capital. The assets according to the latest balance sheet exceeded the amount of the debenture debt by 500,000 and upwards. No evidence was adduced to show what part of the lost capital was attributable to circulating capital. Held: That the holders of the debentures stock were not entitled to object to the reduction. ASTBURY J.: "I think that I am at least right in saying that prima facie creditors are not supposed to be concerned in these questions of reduction of capital where no diminution of unpaid capital or repayment to shareholders of paid-up capital is involved, in other words, if the court is to allow a secured creditor in particular to object to a reduction which does not involve such a diminution of assets as is referred to in s.69(2), it is at least incumbent on him to make out a strong case before such a direction would be given."

55.

RE THOMAS DE LA RUE & CO. LIMITED & REDUCED (A scheme for the reduction of the share capital of a company comes within s.68 of the Companies Act, although it differentiates between the holders of the same class of shares to the extent of paying off some and not others and imposes upon the shareholders whose shares are to be extinguished the obligation to accept debenture stock in lieu of cash, and also involves the advance to the company of the money's to be utilized in redemption of the share capital by the very persons whose shares are to be redeemed.)

In confirmation the scheme as on the whole fair and equitable the court made it a term of its confirmation that the costs of a dissentient shareholder, who had assisted the court by his criticism of the scheme, should be provided by the petitioning company.) EVE,J: "This petition has given rise to an interesting discussion. The company thereby seek the confirmation by the court of a scheme for the reduction of their share capital. The capital is large - 1,200,000 divided in 10 shares, whereof 30,000 are "A" 5 per cent (Cumulative preference shares, 40,000 are "B" 5 per cent cumulative preference shares and 50,000 are ordinary shares. The company desires to reduce the capital by the sum of 560,000, and they propose to bring that reduction about by paying off the whole of the 30,000 "A" shares and 26,000 out of the 40,000 "B" shares. They have not sufficient moneys in hand wherewith to provide for these payments in full, but they have an accumulated reserve of undistributed profits amounting to 266,000 and upwards, and 34,000 which the individuals mainly interested in the company's welfare are prepared to advance to the company by ways of loan without security, in paying off the 300,000 representing the capital paid up on the "A" preference shares. They further propose to raise the money required for paying off the 260,000 represented by 26,000 "B" preference shares by the issue of perpetual debenture stock charged upon the assets of the company and carrying interest at the rate of 4 per cent per annum; but they do not contemplate raising this money from any outside quarter, but from those who under the scheme will be entitled to receive it on payment off of their shares. In other words, the scheme imposes upon each holder of the 26,000 "B" shares the obligation to accept in exchange for and in satisfaction of his holding as a shareholder an aliquot proportion of the debenture stock equivalent in nominal amount to the amount paid upon his "B" shares. Such is the scheme of reduction, and the first question which arises is whether such a scheme comes within "(s.68 of the Companies Act); if it does not, it is a scheme which the court has no jurisdiction to confirm. The section is in very wide terms. It enacts that, "subject to confirmation by the court, a company limited by shares ....... may, if so authorized by its articles, by special resolution reduce its share capital in any way", and then goes on to deal with some particular modes of reducing capital; but it is obvious from the wording of the section itself and from what has been laid down by the House of Lords in the two cases which deal with this matter very fully, namely COUPER'S case and Poole v National Bank of China, that full effect is to be given to the earlier part of the section without reference to the particular modes indicated in the latter part and that this latter part is not to be treated in any way as limiting or controlling the wide power conferred by the earlier part." It cannot be denied that the scheme under consideration is one for reducing the share capital of the company, but it involves in the case of the "B" shareholders the payment off of some only of the shares - 26,000 out of 40,000 - and further it imposes on those of the shareholders whose shares are to be extinguished the obligation to accept debenture stock in lieu of cash. Do these elements put the scheme outside S.68? Guided by the authorities to which I have just referred and by the case of In Re nixon's Navigation Co. I do not think they do. It is thereby established that in a scheme for the reduction of share capital a company mat differentiate between the holders of the same class of shares at least to the extent of paying off some and not paying off others, and that it is open to a company desiring to reduce its share capital to borrow a sufficient fund to pay off the capital represented by the shares by which the capital is to be reduced. It is true that the scheme here proposed involves something further - the advance to the company of the moneys to be utilized in redemption of the share capital by the very persons whose shares are to be redeemed but this addition does not in my opinion, put the scheme outside the section. It is an element to be taken into consideration by the court in exercising the discretion with which it is charged............... The dissenting shareholder regards the reduction in the rate of interest as not being compensated for by the additional security afforded by the debenture stock, and therefore he dissents. That he is entitled to do, but in determining whether the scheme is so inequitable as to compel me at his invitation to withhold my confirmation of it, I am bound - all other things being equal - to pay regard to the fact that the view which he takes is the view of a very small minority ........... I

therefore, propose to confirm the reduction ........ and I propose, therefore, to confirm the reduction on the condition that the debenture stock which is to be issued to the "B" shareholders is to be made repayable at the expiration of forty years from the date of issue, and is not to be what is called "perpetual debenture stock"

56.

SCOTT v SCOTT The plaintiffs were two members and the defendants the remaining members of a private limited company, Frank F. Scott (Liverpool) Ltd, which had adopted the provisions of Table A. Resolutions were passed in general meeting to the effect, inter alia, that certain payments in respect of interim dividend be paid to preference shareholders. The plaintiffs contended that the resolution was invalid. It was held by the Court of Appeal that the resolution was invalid as an attempt by the general meeting to usurp the directors' powers of financial control derived from the articles.

57.

WOOD v ODESSA WATERWORKS CO. A company declared a dividend and passed a resolution to pay it by giving to the shareholders debenture bonds bearing interest and redeemable at par, by an annual drawing, over thirty years. The articles empowered the company to declare a dividend "to be paid" to the shareholders. It was held that the words "to be paid" meant paid in cash, and a shareholder suing on behalf of himself and the other shareholders could restrain the company from acting on the resolution on the ground that it contravened the articles.

58.

STEINBERG v SCALA (LEEDS) LTD Miss Steinberg, an infant, purchase 500 1 shares from the defendant company. She paid 10 shillings on each share and, being unable to meet some calls, repudiated the contract while she was still a minor and claimed (a) (b) Held rectification of the register of members to remove her name therefrom, and thereby relieve her from liability on future calls; and recovery of the money already paid. (a) (b) She was entitled to rescind and so was not liable for future calls, but She was not entitled to recover the money already paid because there had not been a total failure of consideration. She had got the thing for which the money was paid, namely, the shares. Although she had not yet received any dividends on the shares, the shares had some value.

59.

RE: SUSSEX BRICK CO. On 16 January 1901, W. Belcher transferred shares in the company to G.B. Browne and D.G.H. Pollock. The transfers were deposited with the company for registration but, owing to unnecessary delay on the part of the company, they were not registered. In April, 1903, the company passed a special resolution to wind up voluntarily for the purpose of reconstruction. No notice of the meeting was rent to Browne or Pollock, but they did give notice of dissent to the liquidator, requiring him to abstain from carrying the resolution into effects or to buy them out.

The liquidator would not accept the notice as valid because neither Browne nor Pollock was on the register of members. Browne and Pollock applied to the court for rectification of the register. They asked the court aid make the order retrospective so that their notice of dissent to the liquidator would thereby be validated. Held that the court had jurisdiction to rectify the register even when the company was in liquidation. The order was granted as prayed.

60.

BURNS v SIEMENS BROS DYNAMO WORKS LTD The plaintiffs, Burns and Hambro, were the joint owners of shares in the defendant company. The shares were entered in the company's register in the joint names of Burns and Hambro. The company's articles provided that, where there were joint holders, the person whose name appeared first in the register of members, and no other, should be entitled to vote in respect of the shares. This meant that Hambro had no voting rights. Burns and Hambro sued for a rectification of the register so that it may show that the plaintiffs owned roughly half of the joint shareholding. Held the court had jurisdiction to make such an order and the company was required to rectify the register, showing shares numbered 1 to 1,000 in the names of Burns and Hambro, and shares numbered 10,0001 to 19993 in the names of Hambro and Burns.

61.

SIMPSON v MOLSON'S BANK X's shares were, on his death, registered in the name of his executors. They subsequently transferred the shares to Y in breach of the terms of X's will, and the transfer was registered by the company. The company had a copy of the will in its possession, and its president was one of X's executors. Held the company did not act wrongful, as it was only bound to satisfy itself from the will that the executors were executors, and was not concerned with the disposition by X of his property.

62.

SOCIETE GENERALE DE PARIS v WALKER. James Walker was the registered holder of 100 shares in X Ltd, and he created two charges over the shares, one on 9 March 1881, in favour of James Scott Walker, who took the certificates and a blank transfer, and one on 1 December 1882, in favour of the appellants, the latter charge being created by means of a blank transfer, duly executed but without the deposit of the share certificate. The appellants tried to obtain registration first, but X Ltd. would not register the transfer without the certificates, and later the executors of James Scott Walker informed X Ltd. that they had the certificates. This action was brought to decide who had the title to the share. The articles of X Ltd. provided that the company should not be bound to recognize any equitable interest in its shares. The appellants claimed that because they notified first the fact of their equitable interest in the shares, they were entitled as against the executors of James Scott Walker. Held by the House of Lords - they were not, because neither the company nor its officers could be treated as trustees for the purpose of notifying equitable interests over the shares. The title to the shares was in the person eventually registered by the company, and the company was right in refusing to register a

person who could not produce the share certificates. The respondents were entitled to the shares.

63.

RE: GREENE The directors of Faulkner Greene & Co. Ltd, a private company, wishing to ensure that their shares in the company should pass on their deaths directly to their respective wives, altered the company's articles to provide that this should happen automatically on a director's death, notwithstanding any provision or direction made in the director's life-time for their disposition upon his death. Greene, a director, died intestate on 20 January 1945. Pursuant to the article, his widow was registered as the holder of his shares. The administrator of his estate took out a summons to determine whether the article was valid, and whether any beneficial interest in the shares had passed to the widow. The court answered both questions in the negative. HARMAN J. The first question which arises is as to the validity of the article introduced by the special resolution of 20 August 1942. Is it competent to a company by an article in this form to by-pass, so to speak, the personal representatives of a deceased holder of shares and to put them direct into the name of his widow? In my judgement, it is not. Such an article is contrary to section 63 of the Companies Act 1929 (now section 77 of the Companies Act). I believe that the primary object of a section in this form, which first appeared in the Companies Act 1928, was scotch the then prevalent practice of providing for the oral transfer of shares to the great detriment of the Revenue, but in my judgement of transfer has been delivered, nor has the right to the shares been transmitted to the widow by operation of law. In my judgement, therefore, the registration of the widow was wrong and the register ought to be rectified accordingly by registering the shares in the joint names of the personal representatives, who are the plaintiff and the first defendant. So far as the company is concerned there is an end of the matter, for it is not bound to recognize any equitable interest. The first defendant nevertheless claims that as between herself and the other beneficiaries under the intestacy she is beneficially entitled to the shares, and to this claim I must now turn. The widow puts her claim in three ways. Firstly she says that there was an imperfect gift to her of the shares which was perfected when she obtained a grant of administration.

64.

RE: SMITH & FAWCETT LTD. Article 10 of the company's articles provided that the directors might in their absolute and uncontrolled discretion refuse to register any transfer of shares. There were only two directors and shareholders. Smith and Fawcett, who held 4,001 shares each. After Fawcett's death, Smith and a co-opted director refused to register a transfer of his shares into the names of his executors, or one of them, but Smith offered instead to register 20,001 shares and to buy the remaining 2,000 shares at a price fixed by himself. The court refused to intervene in the exercise of this discreet evidence of mala fides. LORD GREENE M.R. The principles to be applied in cases where the articles of a company confer a discretion on directors with regard to the acceptance of transfers of shares are, for the present purposes, free from doubt. They must exercise their discretion bona fide in what they consider - not what a court may consider - is in the interests of the company, and not for any collateral purpose. They must have regard to those considerations, and those considerations only, which the articles on their true construction permit them to take into consideration, and in construing the relevant provisions in the articles it is to be borne in mind that one of the normal

rights of a shareholder is the right to deal freely with his property and to transfer it to whomsoever he pleases. When it is said, as it has been said more than once, that regard must be had to this last consideration, it means, I apprehend, nothing more than that the shareholder has such a prima facie right, and that right is not to be cut down by uncertain language or doubtful implications. The right, if it is to be cut down, must be cut down with satisfactory clarity. It certainly does not mean that articles, if appropriately framed, cannot be allowed to cut down the right of transfer to any extent which the articles on their true construction permit. Another consideration which must be borne in mind is that this type of article is one which is for the post part confined to private companies. Private companies are in law separate entities just as much as are public companies, but from the business and personal point of view they are much more analogous to partnerships than to public corporations. Accordingly, it is to be expected that in the articles of such a company the control of the directors over the membership may be very strict indeed. There are, or may be, very good business reasons why those who bring such companies into existence should give them a constitution which confers on the directors powers of the widest description. The language of the article in the present case does not point out any particular matter as being the only matter to which the directors are to pay attention in deciding whether or not they will allow the transfer to be registered. The article does not, for instance, say, as is to be found in some articles, that they may refuse to register any transfer of shares to a person not already a member of the company or to a transferee of whom they do not approve. Where articles are framed with some such limitation on the discretionary power of refusal as I have mentioned in those two examples, it follows on plain principle that if the directors go outside the matters which the articles say are to be the matters and the only matters which they are to have regard, the directors will have exceeded their powers. Shares in the British Farmers pure Linseed Cake Co. Ltd. which were not in fact paid up, were issued to Goulton, together with a share certificate under the seal of the company which described the shares as `fully paid up'. These shares were later bought in good faith by Nicolls (as trustee for a third party) and Nicolls was registered as the holder. In the winding-up of the company, the liquidator sought to make Nicolls pay up the full amount of the shares as a contributory. The company was held estopped by the certificate from denying that the shares were fully paid up. LORD BLACKBURN ........ When a person makes to another the representation, `I take upon myself to say such and such things do exist, and you may act upon the basis that they do exist', and the other man does really act upon that basis, it seems to me it is of the very essence of justice that, between those two parties, their right should be regulated, not by the real state of the facts, but by that conventional state of facts which the two parties agree to make the basis of their action; and that is what I apprehend is meant by estoppel in pass or homologation .......... Now in the present case the company has issued under the seal of the company a certificate in the form which is set out in the case, in which the company has asserted that these shares have been fully paid up. These certificates are issued under the directions of the Act of Parliament, and are made "prima facie evidence of all that they state;" only prima facie evidence. "The certificates are given and issued for the very purpose of enabling the person who holds them to go to others for the purpose, amongst others, of selling the shares, and to say: "Here is the certificate; you see I am a shareholder, as the company has so certified it. Act upon that, and bargain with me upon the supposition that I am." That is the very object with which they are issued under the company's seal. Now when the company has so issued the certificate under the company's seal to enable a person to induce others to buy the shares, and more especially when the company has registered the transfer solely in consequence of that, it would be in the highest degree an injustice to say that the company shall, as against that person, be permitted to say, "There was a mistake or inaccuracy in the representations that the shares have been fully paid up." You would be fully entitled to say as against everybody else who had acted upon it that it worked an estoppel. I think the liquidators would be exactly in the same position..........

65.

ALUMINIUM INDUSTRIES VAASSEN BV v ROMALPA ALUMINIUM The plaintiffs (AIV) sold aluminium foil to the defendants under a contract of sale which provided, inter alia:(i) that the ownership of the goods to be delivered by the plaintiffs would only be transferred to the purchasers (the defendants) when they had met all that was owing to the plaintiffs, no matter on what grounds; that the defendants should store the foil separately; that if the foil was used to make new "objects", those "objects" should be stored separately and be owned by the plaintiff as security for payment; that the defendants could sell the new "objects" but as agents of the plaintiffs.

(ii) (iii)

(iv)

The defendant company got into financial difficulties and was in debt to its bankers in the sum of 200,000. The bank had a debenture secured over the company's assets and appointed a receiver under that debenture. At the time of the receiver's appointment the company owed the plaintiffs 122,000 and, in order to recover some of that money at the expense of the bank, the plaintiffs sought, under the conditions of sale, to recover from the company (the defendants) foil valued in round terms at 50,000 and the cash proceeds of resold foil of some 35,000. The proceeds had been received from third party purchasers from the company after the receiver was appointed and he had kept the fund of 35,000 separate so that it was not mixed with the company's other funds. Held by the Court of Appeal (in England) - that the foil was recoverable and so were the proceeds of sale since there were two fiduciary relationships between the plaintiffs and the defendant company as follows (a) The defendant company (Romalpa) was a bailee of the plaintiff's (AIV) goods because ownership had not passed to Romalpa. Romalpa was AIV's agent for the purpose of the sale of "objects" made with the foil. Therefore Romalpa was accountable to AIV for the foil and the proceeds of its sale and AIV could trace the proceeds into the hands of the receiver.

(b)

66.

RE: C.L. NYE LTD The company completed a charge in favour of a bank on 28th February 1964. Due to an oversight by the bank's solicitor the charge was not registered. On the 18th June 1964 the oversight was noticed and on the 3rd July 1964 registration was applied for. The 18th June was inserted as the date of creation of the charge and the charge was duly registered. On the 16th July the company went into liquidation and the liquidator sought a declaration that the charge was void because if was registered too late. It was held that since a certificate of registration is conclusive evidence of the date of creation of the charge it must be regarded as created on 18th June 1964. Since it was registered within 21 days of this date (Note: the time allowed for registration in England is 21 days) it was valid and could be enforced by the bank.

67.

R.V. IVAN ARTHUR CAMPS (Court of Appeal for East Africa) (1962) The respondent, in his capacity as a director of a company, had been charged with several

offences under the Companies Act. Although the directors of the company had under article 96 of the Company's Articles of Association duly appointed him to be director and he had acted as such, he never acquired the required share qualification but in a statutory return, subsequent to his appointment, he was shown as a director which, by article 84, was fixed at ONE FULLY PAIDUP share in his own right. Article 87(c) which was substantially in the same terms of S.183(1) and S.183(3) of the Act provided that the office of the director shall be vacated if a director ceased to hold the number of shares required to qualify him for office or fails to acquire the same within TWO MONTHS after his election or appointment. The magistrate held that as the respondent had never possessed or acquired his qualifying share, his appointment was invalid and that there was no case for him to answer. He also held that the respondent was never even a de facto director and that in any event a de facto director was not criminally liable as a director for offences under the Companies Act. Against that decision the Attorney-General appealed to the High Court by way of case stated, but the appeal was dismissed, the Court holding that a de facto director was not liable qua director for criminal offences under the Companies Act. On a further appeal it was submitted (for the crown) that the respondent was validly appointed a de jure director, that thereafter he was a de facto director and that a de facto director was criminally liable for offences under the Companies Act. HELD: (i) The word "director" in the Companies Act includes a de facto director unless the context otherwise requires, and looking at the mischief at which the sections in question aimed a de facto director is as much a person whose conduct should be the subject of the sections as a person who has been duly appointed a director. The respondent was duly and validly appointed a de jure director but he ceased to be a de jure director two months later as he failed to acquire his share qualification within that time. If the respondent acted as a director after the expiration of two months from his appointment he was then a de facto director and he was a director for the purpose of those sections of the Companies Act which it was alleged he had contravened. Appeal allowed. Acquittal set aside. SIR RONALD SINCLAIR, P. "......... Where the acquisition of a share qualification is not a condition precedent to the appointment of a director, he may be appointed and act before he qualifies and his act as a director are valid if done before he is bound by law to acquire his qualification................... In this present case the acquisition of a qualifying share by the respondent was clearly a condition subsequent, and not a condition presedent, to his appointment. In our view he was validly appointed as a director on February 10, 1959, and he continued to be a de jure director until the expiration of two months from the date of his appointment when under article 87 his office of director was vacated. If he then continued to act as a director he was a de facto director only............ We return now to the meaning of the definition of "director" in S.2 of the Companies Act which, as we have said, is stated to include "Any person occupying the position of a director by whatever name called".......... We are therefore of opinion that the word "director" in the Companies Act includes a de facto director

(ii)

(iii)

unless the context otherwise requires............. We do not think the penalties to which an unqualified person acting as a director is liable under S.183(5) of the Companies Act indicate a contrary intention. To hold otherwise would, in our view, defeat the object of the penal sections relating to the liability of directors. Looking to the mischiefs intended to be aimed at by the sections in question, it seems to us that a de facto director is as much a person who has been duly appointed as director. If a de facto manager can be liable, so should a de facto director.............................."

68.

BUSHELL v FAITH AND ANOTHER (1969) A general meeting was requisitioned with a view to passing a resolution to remove the defendant from his directorship. The meeting was held on 22nd November 1968, when on a poll the votes of the plaintiff and her sister were recorded for the resolution removing the defendant, whereas his votes were recorded, against it. It is the contention of the plaintiff that the resolution was passed by 200 votes to 100 and the defendant therefore ceased to be a director. It is the defendant's contention that, having regard to Article 9 of the articles of association, the resolution was lost by 200 votes to 300 and that he remains a director. The motion was directed or restraining the defendant pending trial from acting as a director, and the judge granted the relief asked. HARMAN, L.J.: "The question turns on a single section of the Companies Act, 1948, S.184(1) (which in Kenya is S.185) whereby it is enacted that: "A company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in its articles................ The articles here adopt Table A with modifications. One of the adopted articles is Article 62, which provides that, subject to any rights or restrictions for the time being attached to any class or classes of shares, on a show of hands every member present in person shall have one vote and on a poll every member shall have one vote for each share of which he is the holder. Special article 9 provides:"In the event of a resolution being proposed at any general meeting of the company for removal from office of any director any shares held by that director shall on a poll in respect of such resolution carry the right to THREE VOTES PER SHARE and reg.62 of Part 1 of A Table A shall be construed accordingly" This special article exactly fits the circumstances of this case........ He (the defendant) was thus able to record 300 votes and outvote his sisters, who only recorded 200 votes between them. The plaintiff however argues, and the judge held, that article 9 is a contravention of S.184 of the Act and therefore invalid, and that is the subject of this appeal. The judge held that a resolution passed (as he put it) "under article 9" is not an "ordinary resolution" within the meaning of S.184 of the Act and therefore it is ineffective to remove a director. I do not myself accede to this reasoning. "It seems to me that the words "ordinary resolution", which are found nowhere in the Act except in S.184, merely connote "a resolution depending for its passing on a simple majority of votes validly cast in conformity with the articles............" The defendant's argument goes on to urge that there is nothing in the section or in the Act of 1948 to prevent the attachment of special voting rights to special shares or classes of shares, and that is what has happened here, an ordinary resolution for the removal of the .....defendant director being

lost because his shares counted THREE TO ONE for this purpose. The plaintiff on the other hand argues that an article in this form is invalid as being a mere device for circumventing the section. The judge held that it made a mockery of it, and counsel for the plaintiff advanced the proposition that any provision in the articles having as its object to make more difficult the removal of a director is void, whether operating directly or indirectly. This article 9 operated indirectly. It certainly does in effect make the removal of a director more difficult. It follows, says counsel, that it is invalid. I cannot accept this view because I do not find it in the Act, which merely says that a simple majority of votes will unseat a director. The Act does not as I see it, prevent certain shares or classes of shares having special voting rights attached to them and on certain occasions. The obvious example is that of preference shares, which usually carry no vote unless their dividend be in arrear or the resolution proposed affects their interest. There are many other instances of shares with special voting rights and I do not see anything in the Act which prohibits the giving of special voting rights to the shares of a director who finds his position attacked. RUSSEL L.J. "Section 184(1) of the Companies Act 1948 enacts that a company may by ordinary resolution remove a director. This spelt out, means that a director may be removed by a resolution of the company in general meeting passed by a majority of votes cast at the meeting. The section continues, "notwithstanding anything in its articles": these words though convenient in the drafting of the section add nothing: without them a provision in the articles requiring a greater majority than a simple majority for the effectiveness of such a resolution would contradict the statute and be of no effect. The question is whether art.9, which on the occasion of such a resolution being proposed attaches to any share registered in the name of the director named in the resolution three votes in place of one vote, is provision purporting, contrary to the section, to require for his removal a greater majority than simple votes cast at the meeting, and therefore of no effect. It seems to me that it is manifestly not such a provision. Section 184 says nothing about voting rights attached to shares. It does not seek to restrict the powers of a company by its articles to attach to different shares or classes of shares different voting rights, either generally or on particular types of resolution, including the particular type in question........... It is argued, and the judge accepted the argument, that an article such as article 9 if effective made nonsense of the section, was contrary to its gist and purpose, and for that reason must be considered contrary to the section. This approach I think begs the question whether the purpose of the section included the purpose of fettering a company's rights to say what voting rights attached to its shares ............... In my view it would ........ not conflict with the section if the article provided that on a resolution for the removal of the director either, (a) (b) shares other than the class should have no vote; or that the shares of that class should have attached to them enough votes to pass or defeat a resolution for that removal.............

69.

ABERDEEN RAILWAY CO. v BLAIKIE BROS (1854)

The respondents, Blaikie Bros, had agreed to manufacture iron chairs for the railway company at 8 10s per ton, and sued to enforce the contract. The railway company pleaded that it was not bound by the contract because, at the time when it was made, the chairman, of its board of directors was managing partner of the respondents. This plea was upheld by the House of Lords. LORD CHANWORTH L.C. ...... This, therefore, brings us to the general question whether a director of a railway company is or is not precluded form dealing on behalf of the compoany with himself, or with a firm in which he is a partner. The directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is of course the duty of those agents so to act as best to prmote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principle. And it is a rule of universal application that no one having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting with the interests of those whom he is bound to protect. So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into. It obviously is, or may be, impossible to demonstrate how far in any particular case the terms of such a contract have been the best for the interest of the beneficiary, which it was possible to obtain. It may sometimes happen that the terms on which a trustee has dealt or attempted to deal with the estate or interests of those for whom he is a trustee, have been so good as could have been obtained from any other person, - they may even at the time have been better. But still so inflexible is the rule that no inquiry on that subject is permitted. The English authorities on this head are numerous and uniform. The principle was acted on by Lord King in Keech v. Sandford, and by Lord Hardwicke in Whelpdale v. Cookson and the whole subject was considered by Lord Eldon on a great variety of occasions......... It is true that the questions have generally arisen on agreements for purchases or leases of land, and not, as here, on a contract of a mercantile character. But this can make no difference in principle. The inability to contract depends not on the subject-matter of the agreement, but on the fiduciary character of the contracting party, and I cannot entertain a doubt of its being applicable to the case of a party who is acting as manager of a mercantile or trading business for the benefit or others, no less than to that of an agent or trustee employed in selling or letting land. Was then Mr. Blaikie so acting in the case now before us? - if he was, did he while so acting contract on behalf of those for whom he was acting with himself? Both these questions must obviously be answered in the affirmative. Mr. Blaikie was not only a director, but (if that was necessary) the chairman of the directors. In that character it was his bounden duty to make the best bargains he could for the benefit of the company. While he filled that character, namely, on 6 February 1846, he entered into a contract on behalf of the company with his own firm, for the purchase of a large quantity of iron chairs at a certain stipulated price. His duty to the company imposed on him the obligation of obtaining these chairs

at the lowest possible price. His personal interest would lead him in an entirely opposite direction, would induce him to fix the price as high as possible. This is the very evil against which the rule in question is directed, and I here see nothing whatever to prevent its application. I observe that Lord Fullerton seemed to doubt whether the rule would apply where the party whose act or contract is called in question is only one of a body of directors, not a sole trustee or manager. But, with all deference, this appears to me to make no difference. It was Mr. Blaikie's duty to give to his co-directors, and through them to the company, the full benefit of all the knowledge and skill which he could bring to bear on the subject. He was bound to assist them in getting the articles contracted for at the cheapest possible rate. As far as related to the advice he should give them, he put his interest in conflict with his duty, and whether he was the sole director or only one of many, can make no difference in principle. The same observation applies to the fact that he was not the sole person contracting with the company; he was one of the firm of Blaikie Brothers, with whom the contract was made, and so interested in driving as hard a bargain with the company as he could induce them to make........"

70.

INDUSTRIAL DEVELOPMENT CONSULTANTS LTD v. COOLEY (1972) Facts of the Case: The plaintiffs were one of the group of companies which offered to large industrial enterprises, both in the public and private sector, comprehensive construction services which included the services of architects, engineers, project managers, construction analysts and others involved in such work. The defendant was an architect of considerable distinction and attainment in his own sphere; he had worked in the gas industry for some 17 years, and prior to his appointment as Managing Director of the plaintiffs had been the chief architect for the West Midlands Gas Board. The success which the plaintiffs had attained was largely in the private sector and they were anxious to enter the public sector. Because of the defendant's connections and contacts in the gas industry the chairman of the group offered the defendant the post of Managing Director of the plaintiffs at a salary of 6,000 a year with considerable fringe benefits. The defendant accepted and the appointment took effect from 5th February, 1968. No service agreement was signed however with the result that whilst the defendant was with the plaintiffs there was no press provision as to notice and no covenants of any kind restrictive or otherwise. Within days of joining the plaintiffs the defendant embarked on negotiations with the Eastern Gas Board in an effort to discharge his duty to the plaintiffs. In 1968 the Eastern Gas Board were contemplating building four depots and had not decided whether to farm out the work to other architects or do it themselves. The plaintiffs were interested in this work and with the aid of the defendant they attempted to get at least one of the depots. That attempt failed. It became evident that the Eastern Gas Board disliked the set up of the plaintiffs' organisation and were not prepared to deal with the plaintiffs in any capacity. In May 1969 the Eastern Gas Board finally decided on the location of their four depots. In addition they decided to build a central store to support the four depots. At that time a new deputy chairman of the Eastern Gas Board was appointed and during discussion with his colleagues at the board about the project the defendant's name was mentioned. The deputy chairman was of the opinion that the defendant was the right man for the job and so he telephoned him at his home and arranged a meeting. At the meeting on 13th June the defendant

soon realized that he had a good chance of getting the work from the Eastern Gas Board for himself, the board made it clear that they were only interested in employing the defendant privately and that they were also in a hurry to proceed with the projects. The defendant realized that if he was to get this work he had to free himself from the plaintiffs as soon as possible. He therefore made an appointment to see the group chairman and at the interview told him that he wanted to resign on account of his health. Because the defendant's representations as to the state of his health the group chairman got the impression that the defendant was on the verge of a breakdown and so agreed to release him quickly. The representations made by the defendant about his health were to his knowledge untrue. The defendant ceased to be managing director of the plaintiffs from 1st August. On 6th August the Eastern Gas Board wrote to the defendant offering him employment as project manager for four projects, the defendant to be totally responsible for the design and supervision of the four projects. This work was in substance the same work which the plaintiffs had unsuccessfully attempted to obtain in 1968. In an action by the plaintiffs for an account of the whole of Mr. Cooley's earnings for breach of fiduciary duty, the defendant denied that there was any fiduciary duty or any breach of such duty, contending that if there were a remedy lay in damages but that the plaintiffs had suffered no damages since they would not have obtained the work for themselves in any case. HELD: (i) While the defendant was managing director of the plaintiffs a fiduciary relationship existed between him and the plaintiffs; accordingly information which came to him while he was managing director and was of concern to the plaintiffs, a duty therefore to disclose all information which he received in the course of his dealings with the Gas Board. Instead he had embarked on a deliberate course with the Gas Board in direct conflict with his pre-existing and continuing duty as managing director of the plaintiffs. He was therefore breach of his fiduciary duty to the plaintiffs in failing to pass on to them all the relevant information received in the course of his dealings with the Gas Board and in guarding it for his own personal purposes and profit. Because of his breach of duty the defendant was liable to ACCOUNT to the plaintiffs for ALL THE BENEFIT HE HAD RECEIVED OR WOULD RECEIVE UNDER THE CONTRACT WITH THE GAS BOARD.

(ii)

The question whether the benefit of the contract would have been obtained for the plaintiffs but for the defendant's breach of fiduciary duty was irrelevant. It was therefore irrelevant that, as a result of the order to account, the plaintiffs would receive a benefit which they would not otherwise have receive. Keech v. Sandford, and dicta of Lord Granworth L.C. in Aberdeen Railway Co. v. Blaike Brothers, and Lord Upjojn in Boardman v. Phipps. ROSKILL J: "....... I think the right approach to the present case is first to consider the duty which a director (including a managing director) owed to the company of which he is a director. This has been the subject of repeat statements in cases of the highest authority over the years. The law is summarised in BUCKLEY ON THE COMPANIES ACTS (13th Ed. pp.876, 877). "Upon general rules of equity a person holding a fiduciary position as director cannot obtain for himself a benefit derived from the employment of the company's funds, unless the company knows and assents. No director can, in the absence of a stipulation to the contrary, partake in any benefit from a contract which requires the sanction of a board of which he is a member. He stands in a fiduciary position towards the company, and if he makes any profit when he is acting for the

company, he must account to the company. It makes no difference that the profit is one which the company itself could not have obtained, the question being not whether the company would have acquired it, but whether the director acquired it while working for the company, nor that the interest of the director is as a trustee for a third party. The reason for this is, that the company has a right to the services of its paid directors as an entire board; that it has a right to the advise of every director upon matters which are brought before the board for consideration; and that the general rule that no trustee can derive any benefit from dealing with the trust funds applied with still greater force to that state of things in which the interest of the trustee deprives the company of the benefit of his advice and assistance."

71.

COOK v. DEEKS (1916) (Privy Council) The defendants, three of the four directors of the Toronto Construction Company, who were named Deeks, Deeks and Hinds, resolved to break their business relations with the fourth director, the plaintiff Cook. The company had built up considerable good-will with the Canadian Pacific Railway Company as a result of the satisfactory performance of a series of construction contracts, each of which had been negotiated with the railway company's representative by one of the defendants. The last of these contracts, the Shore Line contract, was negotiated in the same way, but when the arrangements were completed, the defendants took it in their own names and not that of the company. Cook claimed that the company was entitled to the benefit of the contract, and that a shareholders' resolution (which the defendants had carried by their own votes) purporting to confirm that the company claimed no interest in the contract was ineffective. The Privy Council upheld both contentions, reversing the decisions of the courts in Ontario in favour of the defendants. The opinion of their Lordships was delivered by LORD BUCKMASTER......... The management of Messrs Deeks and Hinds of the affairs of the construction company was eminently satisfactory; but so far as railway construction was concerned the whole of their reputation for the efficient conduct of their business had been gained by them while acting as directors of the Toronto Construction Company. In 1911, and probably at an earlier date, the three defendants had settled that they would no longer continue business relationships with the plaintiff. It is unnecessary to seek the cause of the quarrel, or to determine whether they had good reason for the opinion that they had formed. There was nothing to compel them to work with or for the plaintiff, and it is impossible to see that they were bound to continue their relationship with him by any legal or moral consideration. They were however, involved with him in different reciprocal duties, by reason of their relationship in connection with the Toronto Construction Company, and if they desired freedom to act, without regard to the restrictions that those relationships imposed, it was necessary that they should terminate their position as directors and shareholders in the company and place it in dissolution. This they could easily have accomplished owing to the fact that they held three-fourths of the share capital. It is suggested that they might also have resolved at a general meeting of the company that the company should no longer continue the work. This would have been all b equivalent to a resolution of voluntary liquidation; but even this step was not taken. While still retaining their position as directors, while still actually acting as managers of the company, and with their duties to the company of which the plaintiff was a shareholder entirely unchanged, they proceeded to negotiate with Mr, Leonard for the New Shore Line contract, in reality on their own behalf, but in exactly the same manner as they had always acted for the company,h and doubtless with their claims enforced by the expeditious manner in which they, while acting for the company, had caused the last contract to be carried through.......... During the whole of this discussion, up till the time when these prices were fixed, it does not appear that at any moment the representatives of the Canadian Pacific Railway Company were told that this contract was in any way different from the others that had been negotiated in the same manner on behalf of the Toronto Construction Company, although it was plain that Mr.

Deeks, when he was engaged on the Georgian Hay and Seaboard line, that when it was finished Messrs Deeks and Hinds intended to go on their own account and leave Mr. Cook. But after all the necessary preliminaries of the contract had been concluded Mr. Hinds made to Mr. Leonard this statement: `Remember, if we get this contract it is to be Deeks's and I, and not the Toronto Construction Company.' On 12 March 1912 the Canadian Pacific Railway Company made the necessary appropriation for the contract, and this was communicated to Mr. Deeks by Mr. Ramsay, that company's engineer of construction, who said that they might proceed with the contract at once. As from this moment, although the formal contract was not signed until 1 April 1912, the defendants became certain of their position, and knew that they had obtained the contract for themselves. They then for the first time informed the plaintiff of what had happened. He protested without ret, and the defendants G.S. Deeks, G.M. Deeks and T.R. Hinds to carry out the work. The contract was accordingly taken over by this company, by whom the work was carried out and the profits made. On 20 March 1912 there was a meeting of directors of the Toronto Construction Company, at which the three defendants were present,h and they resolved that a fresh meeting of the shareholders be held to consider the question of the voluntary liquidation of the company. Ultimately, after sundry meetings which are really not material, on 26 April 1913 resolutions were passed owing to the voting power of the defendants G.S. Deeks, G.M. Deeks and T.R. Hinds, approving the sale of part of the plant of the company to the Dominion Construction Company, and a declaration was made that the company had no interest in the Shore Line Contract, and that the directors were authorised to defend this action, which had in the meantime been instituted. Two questions of law arise out of this long history of fact. The first is whether, apart altogether from the subsequent resolutions, the company would have been at liberty to claim from the three defendants the benefit of the contract which they had obtained from the Canadian Pacific Railway Company; and the second, which only arises if the first be answered in the affirmative, whether in such event the majority of the shareholders of the company constituted by the three defendants could ratify and approve of what was done and thereby release all claim against the director. It is the latter question to which the Appellate Division of the Supreme Court of Ontario have given most consideration, but the former needs to be carefully examined in order to ascertain the circumstances upon which the latter question depends. It cannot be properly answered by considering the abstract relationship of directors and companies; the real matter for determination is what, in the spec circumstances of this case, was the relationship that existed between Messrs Deeks and Hinds and the company that they controlled. Now it appears plain that the entire management of the company, so far as obtaining and executing contracts in the east was concerned, was in their hands, and, indeed, it was in part this fact which was one of the causes of their disagreement with the plaintiff. The way they used this position is perfectly plain. They accelerated the work on the expiring contract of the company in order to stand well with the Canadian Pacific Railway when the next contract should be offered, and although Mr. Mclean was told that the acceleration was to enable the company chances whatever of acquiring the benefit, and avoided letting their co-director have any knowledge of the matter. Their Lordships think that the statement of the trial judge upon this point is well founded when he said that it is hard to resist the inference that Mr. Hinds was careful to avoid anything which would waken Mr. Cook from his fancied security, and again, that `the sole and only object on the part of the defendants was to get rid of a business associate whom they deemed, and I think rightly deemed, unsatisfactory from a business standpoint.' In other words, they intentionally concealed all circumstances relating to their negotiations until a point had been reached when the whole arrangement had been concluded in their own favour and there was no longer any real chance that there could be any interference with their plans. This means that while entrusted with the conduct of the affairs of the company they deliberately designed to exclude, and used their influence and position to exclude, the company whose interest it was their first duty to protect........

It is quite right to point out the importance of avoiding the establishment of rules as to the directors' duties which would impose upon them burdens so heavy and responsibilities so great that man of good position would hesitate to accept the office. But, on the other hand, men who assume the complete control of a company's business must remember that they are not at liberty to sacrifice the interests which they are bound to protect, and while ostensibly acting for the company, divert in their own favour business which should properly belong to the company they represent. Their Lordships think that, in the circumstances, the defendants T.R. Hinds and G.S. and G.M. Deeks were guilty of a distinct breach of duty in the course they took to secure the contract, and that they cannot retain the benefit of such contract for themselves, but must be regarded as holding it on behalf of the company. There remains the more difficult consideration of whether this position can be made regular by resolutions of the company controlled by the votes of these three defendants. The Supreme Court have given this matter the most careful consideration, but their Lordships are unable to agree with the conclusion which they reached. In their Lordships' opinion the Supreme Court has insufficiently recognised the distinction between two classes of case and has applied the principles applicable to the case of a director selling to his company property which was in equity as well as at law his own, and which he could dispose of as he thought fit, to the case of a director dealing with property which, though his own at law, in equity belonged to his company. The cases of North-West Transportation Co. v. Beatty and Burland v. Earle both belonged to the former class. In each, directors had sold to the company property in which the company had no interest at law or in equity. If the company claimed any interest by reason of the transactions, it could only be by affirming the sale, in which case such sale, though initially voidable, would be validated by subsequent ratification. If the company refused to affirm the sale the transaction would be set aside and the parties restored to their former position, the directors getting the property and the company receiving back the purchase price. There would be no middle course. The company could not insist on retaining the property while paying less than the price agreed. This would be for the court to make a new contract between the parties. It would be quite another thing if the director had originally acquired the property which he sold to his company under circumstances which made it in equity the property of the company. The distinction to which their Lordships have drawn attention is expressly recognised by LORD Davey in Burland v. Earle and is the foundation of the judgement in North-West Transportation Co. v. Beatty, and is clearly explained in the case of Jacobus Marler Estates v. Marler............. If, as their Lordships find on the facts, the contract in question was entered into under such circumstances that the directors could not retain the benefit of it for themselves, then it belonged in equity to the company and ought to have been dealt with as an asset of the company. Even supposing it be not ultra vires of a company to make a present to its directors, it appears quite certain that directors holding a majority of votes would not be permitted to make a present to themselves. This would be to allow a majority to oppress the minority. To such circumstances the cases of North-West Transportation Co. v. Beatty and Burland v. Earle have no application. In the same way, if directors have acquired for themselves property or rights which they must be regarded as holding on behalf of the company, a resolution that the rights of the company should be disregarded in the matter would amount to forfeiting the interest and property of the minority of shareholders in favour of the majority, and that by the votes of those who are interested in securing the property for themselves. Such use of voting power has never been sanctioned by the courts, and, indeed, was expressly disapproved in the case of Menier v. Hooper's Telegraph Works.

If their Lordships took the view that, in the circumstances of this case, the directors had exercised a discretion or decided on a matter of policy (the view which appears to have been entertained by the Supreme Court) different results would ensue, but this is not a conclusion which their Lordships are able to accept. It follows that the defendants must account to the Toronto Company for the profits which they have made out of the transaction..........."

72.

BOSTON DEEP SEA FISHING CO. v ANSELL (1888) Ansell was a director of thd plaintiff company and, on the company's behalf, contracted for the building of fishing smacks. Unknown to the company, he was paid a commission on the contract by the shipbuilders. He was also a shareholder in an ice company which, in addition to dividends, paid bonuses to shareholders who were owners of fishing smacks and who employed the ice company in supplying ice to the fishing smacks. Ansell employed the ice company in respect of the plaintiff company's fishing smacks and received the bonus. Held Ansell must account to the company for both the commission and the bonus, although the bonus could never have been received by the plaintiff company as it was not a shareholder in the ice company.

73.

PERCIVAL v. WRIGHT The plaintiff wished to sell shares in the company and wrote to the secretary asking if he knew of anyone willing to buy. After negotiations, the Chairman of the board of directors arranged the purchase of 253 shares, 85 for himself and 84 for each of his fellow directors at a price based on the plaintiff's valuation of 12 10s per share. The transfers were approved by the board and the transactions completed. The plaintiff subsequently discovered that prior to and during the negotiations for the sale, a Mr. Holden was also negotiating with the board for the purchase of the company for resale to a new company, and was offering various prices for shares, all of which exceeded 15612 10s per share. No firm offer was ever made, and the negotiations ultimately proved abortive, and the court was not satisfied that the board ever intended to sell. The plaintiff brought this action against the directors asking for the sale of his shares to be set aside for nondisclosure. Held The directors are not trustees for the individual shareholders and may purchase their shares without disclosing pending negotiations for the sale of the company. A contrary view would mean that they could not buy or sell shares without disclosing negotiations, a premature disclosure of which might well be against the best interests of the company. There was no unfair dealing since the shareholder in fact approached the directors and named his own price.

74.

RE: W&M ROITH LTD. The controlling shareholder and director of two companies wished to provide for his widow but did not want to leave her his shares. Accordingly he entered into a service agreement with one of the companies under which his widow was entitled to a pension for life on his death. Held On the application of the liquidator - that the agreement was not binding on the company.

75.

HUTTON v. WEST CORK RAILWAY CO. The West Cork Railway Company had entered into an agreement to sell its undertaking to the

Cork and Bandon Railway Company and remained in existence purely for the purpose of winding up. After the sale had been completed, the shareholders resolved at a meeting to spend 1,050 of the purchase money in compensating the salaried employees of the company for their loss of employment and 1,500 to the directors, who were not servants, as remuneration for their past services. It appeared that the directors had always understood that they were going to serve the company for nothing and there was in fact no power in the company's constitution to pay them. Hutton, a dissentient shareholder, challenged the validity of the resolution. Held By the Court of Appeal - that although these payment might be made whilst the company was a going concern, a gratuitous payment could not be justified once the company had ceased to be a going concern. Therefore the payments could not be made. `A railway company, or the directors of the company, might send down all the porters at a railway station to have tea in the country at the expense of the company. Why should they not? It is reasonably incidental to the carrying on of the business of the company; and a company which always treated its employees with draconian severity, and never allowed them a single inch more than the strict letter of the bond, would soon find itself deserted at all events, unless labour was very much more easy to obtain in the market than it often is. The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company......... I think the resolution as to compensation is clearly wrong. The directors have no right to give it. It might in some instances be worth the while of the company to compensate a meritorious, but dismissed officer, but that kind of justification cannot exist in the case of a dying company. I think that makes the resolution bad....' per Bowen L.J.

76.

HOGG v. CRAMPHORN In order to prevent a take-over bid, which they honestly thought would be bad for the company as a whole, the directors used certain money belonging to the company which was standing in an account headed ""employees" benevolent and pension fund" to set up a pension scheme by issuing preference shares bearing 10 votes each. This had the effect of giving the trustees of the fund and the directors together control of the company. The directors had power to issue shares but not attach more than one vote to each. This action was brought by a minority shareholder on behalf of all the others except the directors against the company and the directors. Held Since the proper purpose of issuing shares is to raise capital for the company, an issue made to forestall a take-over bid was a breach of the directors' fiduciary duties. The allotment could not stand unless confirmed in general meeting and a meeting should be convened to consider whether to approve what had been done. However, the increased votes should not be exercised by the directors at the meeting though they could exercise their original votes.

77.

ELLIS v. BAILEY & CO. (EAST AFRICA) ETC. The appellant, who resided in Kenya, and three other persons who resided in England, one of whom was a Mr. P., were named in the articles of association of the respondent company as the FIRST DIRECTORS. Mr. P. was also managing director of a company in England which was the parent of the respondent company (The respondent company was formed with an issued share capital of 6,000 1 shares; of which 5999 shares were held by the parent company and one was held by the appellant as trustee for the parent company) At the first meeting of directors of the respondent company held in 1958, the appellant was by resolution appointed managing director but he was given no service agreement. The appellant

was paid at the rate of 2,500 p.a., the payment being entered in the respondent company's accounts as salary. The appellant was summarily dismissed on December 9, 1959, by an authorised representative of Mr. P., who had discovered that the appellant had been personally concerned in transactions with the respondent company of which the other directors were unaware. These transactions had resulted in the respondent company financing the appellant to the extent of about 1,000. At a meeting of directors held in England on December 11, 1959 the dismissal of the appellant was confirmed but notice of this meeting was not given to the appellant. On January 10, 1960, the appellant started his own business. The respondent company then sued the appellant for the amount owed by him in answer to which the appellant filed a defence and counter-claim admitting the amount owing, but claiming Shs.16,666/68 salary accrued to the date of filing the defence. The ground for the counterclaim was that his directorship had never been lawfully terminated. The judge gave judgement in favour of the respondent company on its claim, and on the counterclaim the judge held that the appellant had not been effectively dismissed because the resolution of the directors confirming the dismissal was of no effect as it had NOT been passed in general meeting as required by cl.68 of Table "A" of the Companies Act, which was incorporated in the respondent company's articles. On appeal it was held:(i) the directors had power to dismiss or confirm the dismissal of the appellant as managing director and the judge had erred in holding that as managing director the appellant could only be dismissed by the respondent company in general meeting. even though the respondent company had power under cl.68 of Table "A" to determine the appellant's appointment in general meeting, this did NOT derogate from the directors' full powers of management. the appellant's appointment as managing director had been effectively terminated on December 9, 1959.

(ii)

(iii)

NEWBOLD, J.A. "............ Power was given in the articles to confer on a managing director all orany of the powers of the directors and at any time to revoke such powers........ On December 9, 1959, a Mr. Flowitt, who was not a director of the company but who had arrived from England a few days before to investigate the unsatisfactory position of the company (learnt of these dealings) informed the appellant that he had laid himself open to criminal proceedings and told the appellant to leave the office at once and without any salary. Mr. Flowitt was armed with a letter of authority signed by Mr. Pethed to close down the company and dispense with the appellant's services, which letter had been shown to the appellant on December 7. The appellant had then expressed surprise at the authority and stated that he was unaware of any meeting of the company or of the directors at which decisions of such gravity could have been made. On December 11, 1959, a meeting of the directors was held at Iikley, Yorkshire, which endorsed the action of Mr. Flotwitt in the "dismissal of Mr. P.G. Ellis.......... consequent upon his findings on his arrival in Nairobi." No notice of the meeting was given to the appellant......... The two main issues on appeal are as follows: first, was the appellant's appointment as managing director effectively terminated on December 9, 1959, whether or not such termination was wrongful; secondly, if the appellant's appointment as managing director was not effectively terminated, did the appellant by his action in opening his own business repudicate his contract and

in effect resign his appointment............ The undisputed evidence ....... was that the appellant's entitlement to any remuneration arose from his position as managing director and not from his position as director. There is, in my view, a basic and not merely a technical difference between a claim for remuneration as a director and a claim for salary as a managing director, and a claim in one capacity cannot be supported by evidence of the other capacity. As was said ........... in SOUTHERN FOUNDARIES (1926) LTD v SHIRLAW ......., when referring to the position of a managing director: "........... the two positions, that of director and that of manager, involve different qualifications, duties and responsibilities." In FOWLER v COMMERCIAL TIMBER CO. LTD, Scrufton, L.J., referred "the two positions of the plaintiff 1. as managing director........ and 2. as a director....." and this passage was quoted with approval by the Council in LEE v. LEE'S AIR FARMING LTD............. Turning now to the first of the main issues argued on the appeal, I understand the learned judge to have held that under reg.68 of Table "A" the appointment of a managing director may only be terminated against his will if he ceases from any cause to be a director or if the company in general meeting determines the appointment. The learned judge, having examined the facts, held that the appellant had not ceased to be a director by reason of disqualification and that the resolution of the board of directors confirming the dismissal of the appellant was of no effect as it was not passed in general meeting. Regulation 68 of Table "A", so far as it is relevant to this point, reads as follows:"The directors may from time to time appoint one.............. of their body to the office of managing director......... for such time and at such remuneration..... as they may think fit, and a director so appointed shall not............ be subject to retirement by rotation ....... but his appointment shall be subject to determination ipso facto if he ceases from any cause to be a director, or if the company in general meeting resolve that his tenure of the office of managing director ............ be determined". Does this mean that though the appointment is made by the directors they have no power to determine it or does it mean that the directors may determine the appointment and in addition the company in general meeting has an overriding power of determination. Though there are obita dicta to the contrary in NELSON v JAMES NELSON AND SONS LTD., in my view on first principles the directors who make the appointment have power to terminate it, and the matter is placed beyond doubt by s.47 of the Interpretation and General Provisions Act, 1956, which provides that, unless the contrary intention appears, a person having a power to appoint under any written law (and reg.68 of Table "A" is a written law) shall also have the power to dismiss. A number of cases have been decided on the basis that the directors have effectively dismissed a managing director (see FOSTER v FOSTER.........., READ v ASTORIA GARAGE (STREATHAN) LTD.............) In my view reg.68 of Table "A" gives to the directors a power to appoint a managing director on such terms as may be agreed. Such terms could include a provision that the managing director was to continue as such for a specified period or a provision that he was not to be dismissed without reasonable notice. In either of such cases the directors could not, unless there was justification for a summary dismissal, dismiss the managing director contrary to the agreed terms without laying the company open to an action for wrongful dismissal, but there remains the overriding power of the company in general meeting to terminate the appointment. But, subject to the dismissal not being contrary to any terms, express or implied, of the appointment, the directors, by having the power to appoint, inherently also have the power to dismiss. This being so, with respect to the learned judge, I consider that he erred in holding that the appellant could only be dismissed from his appointment as managing director by the company in general meeting;

in my view the board of directors had power to dismiss or confirm the dismissal of the appellant as managing director.......... It is urged, however, that the meeting of the directors on December 11, 1959, was not properly convened in that NO NOTICE OF THE MEETING was given to the appellant and as a consequence............. the resolution confirming the dismissal of the appellant was ineffective (see also YOUNG v LADIES IMPERIAL CLUB)................ Accepting for the purposes of this case that notice of the meeting should have been given to the appellant, even though the meeting took place in England and the appellant was in Kenya and could not under the articles have voted on the question of his dismissal, and that resolutions at a directors' meeting of which due notice has not been given may in a number of cases be ineffective, was the resolution dismissing the appellant for reasons which the directors regarded, with some justification, as misconduct such that the courts would say that the dismissal is ineffective. The appellant is claiming under an implied service agreement the terms of which have not been set out in writing but which must I think consist of the terms referred to in the letter from Mr.Pethed to the appellant offering him the appointment and a term that the agreement is subject to the articles. The cases dealing with the service agreement of a managing clearly assume that the ordinary law of master and servant would apply to the appointment of the appellant as managing director (see for example LEE's case, and ANDERSON v SUTHERLAND (PETERHEAD LTD) and with respect to the learned judge I see no reason, nor has he given any, for holding the contrary. As I understand the law of master and servant it is that unless the servant has a certain statutory status, a de facto dismissal is effective even though the dismissal may be wrongful and give rise to a claim for damages. This, perhaps, is merely another aspect of the principle that the courts will not normally grant specific performance of a contract of service. I consider that the case of BARBER v MANCHESTER REGIONAL HOSPITAL BOARD makes it clear that the post of managing director (whatever may be the position of a director) cannot be said to be an appointment having a statutory status so that any dismissal therefrom to be effective must comply with all the requirements in accordance with the principle set out in VINE v NATIONAL DOCK LABOUR BOARD (1957) A.C 488). As Lord Wright said in the SOUTHERN FOUNDRIES case. "In the same way art.105 which empowers the company by extraordinary resolution to remove any director is equally excluded in the case of a managing director by article 91. If the company under article 105 has passed an extraordinary resolution to remove the respondent during his term of ten years, he would not (sic) doubt have ceased to hod office because a claim by him for specific performance or kindred relief would, I assume, fail, but the removal would have been a breach, of the agreement, unless for good cause....... The case would have been simply a case of wrongful dismissal of a servant or employee. The servant or employee is in such a case effectively dismisses" In this case the appellant is not claiming damages for wrongful dismissal but he is claiming salary on the ground that he is still the managing director in effect therefore he is asking for specific performance of at least one aspect of a contract of service. In this case there has undoubtedly been a de facto dismissal of the appellant on December, 9, 1959, which, however irregularly, was confirmed by the board of directors on December 11, 1959, and which the company two and a half years later is claiming to have been an effective dismissal. For the courts to say that the appellant was not effectively dismissed and is thus still the managing director of the company would, in my view, be quite wrong and would offend against the principles that a master can effectively even though wrongful dismiss a servant, that a contract of personal service will not be specifically enforced and that equity will not interfere where an irregularity has been committed if it lies within the power of the person committing the irregularity to correct it at any time. It could, in my view, be all the more extraordinary to force on to an unwilling company a managing director who was considered by his fellow directors, with some justification, to have been guilty

of misconduct justifying summary dismissal and to do so in the case of a private company where all the shares are held by the parent company who would thus have had full power at any time either to reinstate the appellant or to confirm his dismissal. My attention has not been drawn to any case in which the dismissal of a managing director, however wrongful or irregular, has been held to be ineffective and any claim arising out of any such dismissal has almost invariably been for damages for wrongful dismissal and not for "salary owing" by reason of an ineffective dismissal".............. In any opinion, therefore, the appellant was effectively dismissed on December 9, 1959..........." SIR TREVOR GOULD, Ag. V-P:"............s.3 of the Interpretation and General Provisions Ordinance, 1959, "written law" is so defined as to include "all Ordinances" and by s.17 every schedule to or table in any written law shall be construed and have effect as part of such written law. Table "A" is therefore a written law, and as the sole purpose which the regulations in Table "A" may serve is to take effect as articles of limited companies, those who adopt or do not exclude them must be deemed to know and accept the legal implications which follow........... Regulation 67 of Table "A", which is also one of the articles of the respondent company, is in the usual terms giving the directors power to manage the business and to exercise all such powers of the company as are not by the ordinance or the articles required to be exercised by the company in general meeting. That, in the ordinary course of business, would include power to engage and dismiss employees, and in the circumstances of the present case, there being nothing in the articles of the respondent company which indicates the contrary, I would accept that the current of authorities shows that the position of the appellant qua managing director was that of employee. Apart from authority, I would not think that because a power is given by reg.68 to the company IN GENERAL MEETING to determine the appellant's tenure of office as managing director, it follows that there is any derogation from the full powers of management of the directors. ......... It is true that without specific authority in the articles directors may not appoint on e of their number to the position of managing director or other salaried office ...... Such an appointment would entail delegation of authority or payment of remuneration not authorised for directors. But where there is, as here, specific authority to appoint for such term and at such remuneration as may be decided by the directors, is there any reason to suppose that reg.68 is to be regarded as a complete code so far as appointment and dismissal is concerned? It contains no specific denial of the directors' power to dismiss, if one is implied if the company in general meeting resolve", in reg.68, are to be of managing director be exercised only in general meeting, would they detract from the powers conferred by reg.67. As a matter of drafting of course it would have been easy to reserve a power of revocation to the directors in reg.68, but it would have been equally easy to make it clear that only the occurrence of one or two circumstances stated in the concluding words of that regulation could determine the appointment, otherwise than by the expiry of his term. It would be in my reading of reg.68 that the power given to the company in general meeting is an overriding one, enabling the company to take that particular matter out of the hands of the directors if it wishes; that it is a recognition of the rule that a company cannot give nor overrule their decisions unless the articles so provide JOHN SHAW & SONS LTD V SHAW As I see it, the power of the company in general meeting under reg.68 and the power of the directors to manage in all which is not "required" to be done in general meeting can co-exist without conflict, and the existence of the power in the general meeting does not import a requirement that the tenure of office of a managing director may be determined in that way only. I should perhaps repeat that I am referring to power of effective determination, irrespective of whether it amounts to breach of contract. ......... If powers of management in the terms of reg.67 do not include power to dismiss for good cause there seems to be no good reason to say they include power to suspend a managing director from his duties even for the protection of the company. .......... As Newbold, J A has observed in his judgement, a court will not give specific performance of a contract of

service and that is in effect what the appellant seeks. In my judgement the respondent company has effectively excluded the appellant from his position as managing director and his remedy (if he has good ground on the merits) is in an action for wrongful dismissal or wrongful repudiation". NOTES 1. 2. Reg.67 referred to in this case is now Article 80 of Table "A". "Reg.68" is now Article 107, but it should be observed that the words, "or if the company in general meeting resolve that his tenure of the office of managing director ........... be determined" in Reg.68 have been omitted from Article 107 of the current Table A.

78.

SOUTHERN FOUNDRIES (1926) LTD V SHIRLAW (194) (HOUSE OF LORDS): In 1933, the respondent was by a written agreement appointed managing Director of the appellant company (Southern) for ten years. In 1936, after Souther had been taken over by Federated Foundries Ltd. (Federated), Southern altered its articles so as to include, inter alia; a new article 8 which empowered Federated by a written instrument to remove any director of Southern. In 1937 Federated exercised this power and removed the respondent from his directorship. He sued Southern for breach of contract and Federated for wrongly procuring the breach of contract. He was awarded 12,000 pounds damages against both defendants, and the award was upheld by the Court of Appeal (Greene M R dissenting) and by the House of Lords (Viscount Maugham and Lord Romer dissenting). LORD ATKIN My Lords, the question in this case is whether the appellant company have broken their contract with the respondent made in December 1933 that he should hold articles adopted by the company, after the agreement, the respondent was removed from the position of director of the company by the Federated Foundries Ltd. There can be no doubt that the office of managing director could only be held by a director, and that upon the holder of the office of managing director ceasing for any cause to be a director the office would be ipso fact vacated. Under the articles in existence at the date of agreement, by article 89 the office of a director could be vacated on the happening of six various events, bankruptcy, lunacy, etc., including the giving by the director of one month's notice to resign; while by article 105 the company by extraordinary resolution could remove him from his office. I feel no doubt that the true construction of the agreement is that the company agreed to employ the respondent and the respondent agreed to serve the company as managing director for the period of ten years. It was by the constitution of the company a condition of holding such office that the holder should continue to be director and such continuance depend upon the terms of the articles regulating the office of director. It was not disputed, and I take it to be clear law, that the company's articles so regulating the office of director could be altered from time to time: and therefore the continuance in office of managing director under the agreement depended upon the provisions of the articles from time to time; and therefore the continuance in articles from time to time. Thus the contract of employment for the term of ten years was dependent upon the managing director continuing to be a director. This continuance of the directorship was a concurrent condition. The arrangement between the parties appears to me to be exactly described by the words of Cockburn C J in Stirling v Maitland: `If the party enters into an agreement which can only take effect by the continuance of an existing state of circumstance': and in such a state of things the Lord Chief Justice said: `I look on the law to be that.... there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that sate of circumstances, under which alone the arrangement can be operative.' That proposition in my opinion is well established by law. Personally I should not so much base the law on an implied term, as on a positive rule of the law of contract that conduct of either promisor or promisee which can be said to amount to himself `of his own motion' bringing about the impossibility of performance is in itself a breach. If A promises to marry B and before

performance of the contract marries C, A is not sued for breach of an implied contract not to marry any one else, but of his own contract to marry B. I think it follows that if either the company of its own motion removed the respondent from the office of director to be vacated by giving one month's notice of resignation under article 89, either of them would have committed a breach of the agreement in question. As Kennedy L J said in Measures Bros Ltd v Measures in discussing this very question of the effect upon a contract of employment as managing director: `It is elementary justice that one of the parties to a contract shall not get rid of his responsibilities thereunder by disabling the other contractor from fulfilling his part of the bargain. I cannot agree with the view of the contract taken by the Master of the Rolls that the parties must be taken to have agreed that the term, though expressed to be for ten years, was subject to be determined by any cause including the will of either party expressed in accordance with the articles; and that such determination therefore could not constitute a breach. I should have construed the agreement as I do on the first two clauses alone, but the remaining clauses and particularly those dealing with the mutual obligations between the respondent and Sir Berkeley Sheffield in this tripartite agreement in my view strongly reinforce that construction. I agree, therefore, with the trial judge, with the majority of the Court of Appeal, and with I believe all your Lordships in thinking that if during the term the respondent had given a notice of resignation, or if the company had exercised its power of removal under article 105, either would have committed a breach of the contract. The question that remains is whether if the removal by the company would have been a breach by the company, the removal under the altered articles by the Federated Foundries Ltd. was a breach by the company. In this matter the Master of Rolls agreed with the other members of the Court of Appeal; but all the members of this House are not agreed. My Lords, it is obvious that the question is not as simple as in the case just considered of the removal being by the Southern Foundries Ltd; but I venture respectively to think that the result must be the same. The office of director involves contractual arrangements between the director and the company. If the company removes the director it puts an end to the contract: for in the contract, by operation of law, or by the will of the two parties. The altered article 8 which gives power to the Federated Foundries Ltd to remove from office any director of the company is, when analysed, a power to the Federated to terminate a contract between the Southern and its directors. It is an act which binds the Southern as against its promises; and if a wrong to the respondent if done by the Southern it surely must be a wrong to the respondent if done by the Federated who derive their power to dot the act from the Southern only. If a landlord gives power to a tenant to discharge the landlord's servants, gardener or gamekeeper, it is the master, the landlord, who is bound by the consequences of that discharge whether rightful, or whether wrongful, and so involving the payment of damages. If a man buys goods and contracts with a sub-purchaser to take delivery direct from his vendor, and contracts with his vendor to give delivery to the sub-purchaser, the latter's recourse for breach of contract to deliver is against his own intermediate seller and not against the head vendor. If then the Federated of their own motion determine the concurrent condition it appears to me that necessarily they cause the Southern to break the contract. The action of the Federated was, I think I may say avowedly, taken for the sole purpose of bringing the managing director's agreement to an end. I do not think that it could be said that the Southern committed any breach by adopting the new articles. But when the Federated acted upon the power conferred upon them in the new articles they bound the Southern if they acted in such a way that action by the Southern on the same articles would be a breach. It is not a question of agency but of acting under powers conferred by contract to interfere with a contract between the party granting the power and third person.......... LORD PORTER........ The general principle therefore may, I think, be thus stated. A company cannot be precluded form 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 validly made before the alteration. Nor can an injunction be granted to prevent the adoption of the new articles and in that sense they are binding on all and sundry, but for the company to act upon them

will none the less render it liable in damages if such action is contrary th the previous engagements of the company. If, therefore, the altered articles had provided for the dismissal without notice of a managing director previously appointed, the dismissal would be intra vires the company but would nevertheless expose the company to an action for damages if the appointment had been for a term, of say ten years and he were dismissed in less......... LORD WRIGHT delivered a concurring opinion. VISCOUNT MAUGHAM and LORD ROMER dissented.

79.

READ v. ASTORIA GARAGE (STREATHAM) LTD. - (1952) The defendant company's articles included article 68 of Table A of the 1929 Act, which provided that the directors might appoint a managing director for such term and at such remuneration as they might think fit; `.......but this appointment shall be subject to determination ipso facto if he ceases from any cause to be a director, or if the company in general meeting resolve that his tenure of the office of managing director be determined'. Read was appointed managing director at a salary of 7 per week by a resolution of the board. JENKINS L.J......... There is no record anywhere of any terms on which the plaintiff was appointed managing director beyond the minute of resolution No.4 which was passed at the first meeting of the directors by which the plaintiff was appointed managing director at a salary of 7 per week from 1 February 1932, and the articles of association of the company. The company's articles adopted Table A, with certain modifications. Amongst the articles of Table A adopted was article No. 68. (His Lordship read the article). It is argued by Mr. Harold Brown for the plaintiff that, notwithstanding the provisions of article 68, there was a contract between the plaintiff and the defendant company in the nature of a contract of general hiring - a plain contract of employment, one of the terms of which was that the plaintiff's employment should not be determined by the defendant company except by reasonable notice. The judge came to the conclusion that the terms of the plaintiff's appointment were not such as to entitle him to any notice in the event of the company choosing under article 68 to resolve in general meeting that his tenure of office as managing director be determined, and, in my judgement, the judge was clearly right.

80.

ROYAL BRITISH BANK v. TURQUAND (1856) 6 E.&B. 327 Exchequer Chamber Turquand was sued, as the official manager of a coal mining and railway company incorporated under the Act of 1844, on a bond for 2,000 which had been given by the company to the plaintiff bank to secure its drawings on current account. The bond was given under the seal of the company and signed by two directors and the secretary, but the company alleged that under the terms of its registered "deed of settlement" the directors had power to borrow only such sums as had been authorised by a general resolution. No such resolution had been passed. The Court of Exchequer Chamber, affirming the judgement of the Court of Queen's Bench, held that even so the company was bound by the bond. JERVIS C.J. I am of opinion that the judgement of the Court of Queen's Bench ought to be affirmed. I incline to think that the question which has been principally argued both here and in that court does not necessarily arise, and need not be determined. My impression is (though I will not state it as a fixed opinion) that the resolution set forth in the replication goes far enough to satisfy the requisites of the deed of settlement. The deed allows the directors to borrow on bond such sum or sums of money as shall from time to time, by a resolution passed at a general meeting

of the company, be authorised to be borrowed: and the replication shows a resolution, passed at a general meeting, authorizing the directors to borrow on bond such sums for such periods and at such rates of interest as they might deem expedient, in accordance with the deed of settlement and the Act of Parliament; but the resolution does not otherwise define the amount to be borrowed. That seems to me enough. If that be so, the other question does not arise. But whether it be so or not we need not decide; for it seems to us that the plea, whether we consider it as a confession and avoidance or a special non est factum, does not raise any objection to this advance as against the company. We may now take for granted that the dealings with these companies are not like dealings with other partnerships, and that the parties dealing with them are bound to read the statute and the deed of settlement. But they are not bound to do more. And a prohibition from borrowing, but a permission to do so on certain conditions. "Finding that the authority might be made complete by a resolution, he would have a right to infer the fact of a resolution authorizing that which on the face of the document appeared to be legitimately done. (i.e he would be entitled to assume that the resolution had been passed) the party here, on reading the deed of settlement, would find, not POLLOCK C.B., ALDERSON and BRAMWELL BB., and CRESSWELL and CROWDER JJ. concurred.

81.

HELY-HUTCHINSON v. BRAYHEAD LTD (1968) 1 Q.B. 549 (Chancery Division and Court of Appeal) Richards was chairman of directors of the defendant company and its chief executive or `de facto managing director', who often committed the company to contracts on his own initiative and only disclosed the matter to the board subsequently. The board acquiesced in this practice. The plaintiff (referred to in the judgement as Lord Suirdale) was chairman and managing director of another company, `Perdio', which it was planned should eventually be merged with or acquired by the defendant. As part of an agreement to put more money into Perdio, the plaintiff (who had been made a director of the defendant company) was given certain letters (referred to as C.23 and C.26) signed by Richards, by which the defendant agreed to guarantee the repayment of money owed to the plaintiff and to indemnify him against certain losses. When sued on these undertakings, the defendant alleged that Richards had no authority to make the contract in question. Roskill J. held that Richards had apparent authority to bind his company; the Court of Appeal affirmed his decision, but on the ground that he had actual authority. ROSKILL J...... The question to what extent there may be implied authority in a chairman or managing director acting as such as distinct form express authority, so as to bind a company to acts done by him in the course of his duties as chairman or managing director or chief executive, is one of considerable difficulty and one upon which there appears to be little or no relevant authority. The conception of implied authority in such a person as distinct from express authority is not easy having regard to the cases on this branch of the law on ostensible or apparent authority. I was urged by Mr MacCrindle that as Mr Richards was both chairman and de facto managing director there was for that reason alone implied authority in him to do what he did. I have some difficulty in accepting that. I would not be prepared to hold that there is implied authority in a chairman of a company, merely by reason of his office, to do what Mr Richards did in this particular case in signing C.23 and C.26. I do not think that mere status, derived from the holding of a particular office such as chairman or managing director or chief executive, of itself implies an authority which would not otherwise exist. There may be cases where such an implication can be made, but I do not propose to decide this issue on this point because I am quite satisfies, for the large number of reasons I shall endeavor to give, that there was ostensible or apparent authority in Mr Richards to do what he did.

The set-up in Brayhead is easy to envisage. It was an industrial holding company with a large number of subsidiaries. Its directors were in the main working directors, each in charge of a section of the holding company's subsidiaries. One would look after electronics, another engineering, and so on. They would all come back to Mr Richards for advice and - which is more important - decision from time to time on matters concerning their own particular group. The final decision - and the final decision most especially on any matter concerning finance - was Mr Richards' and nobody else's. Sometimes, I dare say, the directors persuaded him to take or to refrain from taking a particular step; no doubt, like any wise chief executive, he sought and obtained advice before he made up his mind; but in all these cases the final decision, I am quite satisfied, rested with him and with nobody else. If one goes through the minutes and documents which have been put before me, one can see repeated examples of Mr Richards acting in this way. Sometimes, of course, the matter would come back to the board for formal ratification after he had committed Brayhead, perhaps technically without express authority. On other occasions, of which there are a number of examples in the minutes, he plainly committed Brayhead and then, as it were, reported the matter afterwards........ I have no doubt that the board knew that he was doing this sort of thing all the time, and that whenever he thought it was necessary he assumed, or purported to assume, authority to bind Brayhead, and that the board allowed him to do it and acquiesced in his doing it. That is not to say, to use Mr Finer's phrase yesterday, that all the directors were `Yes men'; I am sure they were nothing of the kind. Mr Richards was a forceful personality; he knew his own mind. I think he quite clearly was allowed by Brayhead to hod himself out as having ostensible or apparent authority to enter into commitments of the kind which he entered into or purported to enter into, when he signed C.23 and C.26.......... (The Court of Appeal affirmed the decision of Roskill J., but on the grounds that Richards had actual authority.) LORD DENNING M.R.... I need not consider at length the law on the authority of an agent, actual, apparent or ostensible. That has been done in the judgements of this court in FREEMAN & LOCKYER v. BUCKHURST PARK PROPERTIES (MANGAL) LTD. It is there shown that actual authority may be express or implied. It is express when it is given by express words, such as when a board of directors pass a resolution which authorizes two of their number to sign cheques. It is implied when it is inferred from the conduct of the parties and the circumstances of the case, such as when the board of directors appoint one of their number to be managing director. They thereby impliedly authorize him to do all such things as fall within the usual scope of that office. Actual authority, express or implied, is binding as between the company and the agent, and also as between the company and others, whether they are within the company or outside it. Ostensible or apparent authority is the authority of an agent as it appears to others. It often coincides with actual authority. Thus, when the board appoint one of their number to be managing director, they invest him not only with implied authority, but also with ostensible authority to do all such things as fall within the usual scope of that office. Other people who see him acting as managing director are entitled to assume that he has the usual authority of a managing director. But sometimes ostensible authority exceeds actual authority. For instance, when the board appoint the managing director, they may expressly limit his authority by saying he is not to order goods worth more than 500 without the sanction of the board. In that case his actual authority is subject to the 500 limitation, but his ostensible authority includes all the usual authority of a managing director. The company is bound by his ostensible authority in his dealings with those who do not know of the limitation ... Apply these principles here. It is plain that Mr Richards had no express authority to enter into these two contracts on behalf of the company: nor had he any such authority implied from the nature of his office. He had been duly appointed chairman of the company but that office in itself

did not carry with it authority to enter into contracts without the sanction of the board..... The judge held that Mr Richards had ostensible or apparent authority to make the contract, but I think his findings carry with it the necessary inference that he had also actual authority, such authority being implied from the circumstance that the board by their conduct over many months had acquiesced in his acting as their chief executive and committing Brayhead Ltd to contracts without the necessity of sanction from the board. LORDS WILBERFORCE and PEARSON delivered concurring judgements.

82.

HOWARD v. PATENT IVORY MANUFACTURING CO. (1888) 38 Ch.D. 156 Chancery Division (The facts appear from the judgement.) KAY J..... But then a very much more serious question has been raised, and that is this. The debentures were issued by the directors, and it is said that the power of the directors to issue debentures is limited, and the limit is very plain when you look at article 95, which is as follows. The directors are empowered `to borrow from time to time on behalf of the company such sums of money, not exceeding in the whole at any one time 1,000, as the directors think necessary or advisable, also to raise such further moneys as may be authorised from time to time by resolution of any general meeting of shareholders summoned for the purpose'. So that when the directors have borrowed up to 1,000, and there are existing loans unpaid to that amount, the borrowing power of the directors is exhausted, and no more can be borrowed without the authority of a general meeting of shareholders. Then the next clause is: `To secure the repayment of any moneys so borrowed, together with the interest, by debentures'. Therefore the directors could only issue valid debentures for moneys borrowed by themselves without the assent of a general meeting to the extent of the borrowing power to authorize themselves to borrow and beyond that, in order to issue debentures, there must be the assent of the general meeting. Now in this case, unfortunately for the holders of these debentures, they are all directors, and therefore the well-known authorities which make it unnecessary to see whether the internal regulations of a company have been observed or not do not apply: because, of course, the directors must be taken to know that the internal requirements of the company had not been observed in the case of these debentures. Accordingly, I am very sorry to say that I cannot treat the debentures as valid to the extent of more than 1,000. How that sum is to be allotted between the different parties I do not know. I have heard nothing on that point. I must treat the issue of the debentures as being invalid within the knowledge of the directors beyond the amount of 1,000. There must be a declaration that the first ten only of the thirty-five debentures, taking them according to their numbers, are valid."

83.

IRVINE v. UNION BANK OF AUSTRALIA (1877) 2 App. Case 366 Privy Council The bank sought to enforce a security given to it by the Oriental Rice Co. Ltd over a rice mill situated in Rangoon. The directors of the company had exceeded the limit of an amount equal to half the paid-up capital imposed on their power to borrow by the articles of association, but the bank argued that the company in general meeting might by a special resolution have enlarged the directors' powers, and that the bank was entitled to assume that this had been done. The contention was rejected: if any such vote had been passed, the fact would have been apparent from the company's registered document.

SIR BARNES PEACOCK delivered the opinion of Privy Council....... The case of Royal British Bank v. Turquand, and the same case in error, were cited in the course of argument to show that the excess of authority was a matter only between the shareholders and the directors, and that it does not affect the rights of the bank. In that case it was said by Chief Justice Jervis: We may now take it for granted that the dealings with these companies are not like dealings with other partnerships, and that parties dealing with them are bound to read the statute and the deed of settlement; but they are not bound to do more. The party here (that is in Turquand's case) on reading the deed of settlement would find not a prohibition from borrowing, but a permission to do so on certain conditions.' In the present case, if the bank had referred to case 50 of the articles of association they would have found that the directors were expressly prohibited from borrowing beyond a certain amount. (Note: In Turquand's case, there was no such limit) The case of Royal British Bank v. Turquand was decided with reference to a company registered under (the Act of 1844), and Chief Justice Jervis remarked that the lender finding that the authority might have been made complete by a resolution would have a right to infer the fact of a resolution authorizing that which on the face of the document appeared to be legitimately done. In the present case, however, the bank would have found that, by the articles of association, the directors were expressly restricted from borrowing beyond a certain amount, and they must have known that if the general powers vested in the directors by article 50 had been extended or enlarged by a resolution of a general meeting of the shareholders under the provisions of section 51, a copy of that resolution ought, in regular course, to have been forwarded to the Registrar of Joint Stock Companies, in pursuance of section 53 of the Companies Act, and would have been found amongst its records. (Note: S.51 is now S.143 of the Kenya Act) Their Lordships are of opinion that the learned Recorder was correct in holding that this case is different from that of Royal British Bank v. Turquand..... For the above reasons their Lordships are of opinion that the plaintiffs are not entitled as against the defendant to a charge on the property beyond the amount of one-half of 17,100, the paid-up capital of the company. The amount therefore allowed to the plaintiffs by the decree of the lower court must be reduced, and their Lordships will humbly advise Her Majesty that the decree be reversed, and that it be declared that the plaintiffs had a valid equitable mortgage on the property mentioned in the plaint of the principle sum of 8,550 only..........."

84.

B. LIGGET (LIVERPOOL) LTD v. BARCLAYS BANK (1928) I.K.B. 48 (King's Bench Division) The original directors of the plaintiff company were Ligget and Melia, and the articles empowered the directors at any time to appoint an additional director. The bank was instructed to honour cheques signed by the two directors, but Ligget was in the habit of issuing cheques signed only by himself which Melia would subsequently countersign at the bank, sometimes after they had been paid. In July 1925 Melia instructed the bank that cheques were not to be paid without his signature, but the former practice was at times still followed. In September 1925 Ligget as chairman of the board wrote informing the bank that his wife had been appointed an additional director. Melia was unaware of this letter and of the alleged `appointment' of Mrs Ligget. The bank thereafter honoured cheques signed by Mr and Mrs Ligget. The bank was sued by the company for paying these cheques without authority, and it was held liable, on the ground that it had been put on inquiry.

WRIGHT J.......... The primary defence set up by the defendant bank is one based upon an application of the well-known rule which is often referred to as the rule in the Royal British Bank v. Turquand, a rule which has been applied in a great many cases to which I have been referred..... The rule as relied on by the defendant bank is that the defendant bank having had the articles of association were entitled to assume that the notice of 1 September 1925 sent to them by the chairman was a valid and proper notice, because according to the articles of association it was possible if the proper steps in the matter of internal management had been taken by the directors of the company that Mrs Ligget should have been duly appointed an additional director, as the notice stated. I am relieved from any examination of the exact definition of this very respectable but perhaps somewhat ambiguous rule of law, because the plaintiff company in answer to that contention have alleged that the defendant bank in any case is not entitled to the benefit of hat rule by reason of circumstances of the case and were negligent in not investigating the position before they accepted and acted upon the notice of the appointment of a new director. On that issue I put two questions to the jury, and the questions were these: `Was the bank put on inquiry whether the appointment of Mrs Ligget was in order?' The jury answered: `Yes.' `Secondly, whether the bank was guilty of negligence in paying the bills and cheques complained of?' and again the jury answered `Yes'. Whatever may be the exact scope of the rule in Turquand's case I think it is quite clear on principle and on the authorities I have already referred to that it can never be relied upon by a person who is put on inquiry. The rule proceeds on a presumption that certain acts have been regularly done, and if the circumstances are such that the person claiming the benefit of the rule is really put on inquiry, if there are circumstances which debar that person from relying of the prima facie presumption, then it is clear, I think, that he cannot claim the benefit of the rule; and if, therefore, the answers of the jury to the questions which I put to them stand, it is clear, I think, that his defence will not avail the defendants here......"

85.

BURKINSHAW v. NICOLLS Shares in the British Farmers Pure Linseed Cake Co. Ltd. which were not in fact paid up, were issued to Goulton, together with a share certificate under the seal of the company which described the shares as `fully paid up'. These shares were later bought in good faith by Nicolls (as trustee for a third party) and Nicolls was registered as the holder. In the winding-up of the company, the liquidator sought to make Nicolls pay up the full amount of the shares as a contributory. The company was held estopped by the certificate from denying that the shares were fully paid up. LORD BLACKBURN........When a person makes to another the representation, `I take upon myself to say such and such things do exist, and you may act upon the basis that they do exist', and the other man does really act upon that basis, it seems to me it is of the very essence of justice that, between those two parties, their right should be regulated, not by the real state of the facts, but by that conventional state of facts which the two parties agree to make the basis of their action; and that is what I apprehend is meant by estoppel in pass or homologation............. Now in the present case the company has issued under the seal of the company a certificate in the form which is set out in the case, in which the company has asserted that these shares have been fully paid up. These certificates are issued under the directions of the Act of Parliament, and are made "prima facie evidence of all that they state;" only prima facie evidence. "The certificates are given and issued for the very purpose of enabling the person who holds them to go to others for the purpose, amongst others, of selling the shares, and to say: `Here is the certificate; you see I am a shareholder, as the company has so certified it." Act upon that, and bargain with me upon the supposition that I am." That is the very object with which they are issued under the company's seal. Now when the company has so issued the certificate under the company's seal to enable a person to induce others to buy the shares, and more especially when the company has registered the transfer solely in consequence of that, it would be in the highest degree an injustice to say that the company shall, as against that person, be permitted to say, "There was a mistake or inaccuracy

in the representations that the shares have been fully paid up." You would be fully entitled to say as against everybody else who had acted upon it that it worked an estoppel. I think the liquidators would be exactly in the same position ... ".

86.

BARRON v. POTTER (1914) 1 Ch. 895 Chancery Division The two directors of the company were not on speaking terms, so that effective board meetings could not be held. (This aspect of the case is dealt with above, at p. 287). The plaintiff, Canon Barron, had requisitioned a shareholders' meeting at which additional directors had purportedly been appointed, but the defendant objected that the power to make such appointments was vested by the company's articles in the directors. It was held that, in view of the deadlock, the power in question reverted to the general meeting, and so the appointments were valid. WARRINGTON J. (having held that no proper board meeting had been held: see above, p.287). The question then arises, was the resolution passed at the general meeting of the company a valid appointment? The argument against the validity of the appointment is that the articles of association of the company gave to the board of directors the power of appointing additional directors, that the company has accordingly surrendered the power, and that the directors alone can exercise it. It is true that the general point was so decided by Eve J. in Blair Open Hearth Furnace Co. v. Reigart and I am not concerned to say that in ordinary cases where there is a board ready and willing to act it would be competent for the company to override the power conferred on the directors by the articles except by way of special resolution for the purposes of altering the articles. But the case which I have to deal with is a different one. For practical purposes there is no board of directors at all. The only directors are two persons, one of whom refuses to act with the other, and the question is; What is to be done under these circumstances? On this point I think that I can usefully refer to the judgement of the Court of Appeal in Isle of Wight Ry. Co. v. Tahourdin, not for the sake of the decision, which depended on the fact that it was a case under the Companies Clauses Consolidation Act 1845, but for the sake of the observations of Cotton and Fry L.JJ. upon the effect of a deadlock such as arose in the present case. Cotton L.J. says: "Then it is said that there is no power in the meeting of shareholders to elect new directors, for that under the 89th section the power would be in the remaining directors. The remaining directors would no doubt have that power if there was a quorum left. But suppose the meeting were to remove so many directors that a quorum was not left, what then follows? It has been argued that in that case, there being no board which could act, there would be no power of filling up the board so as to enable it to work. In my opinion that is utterly wrong. A power is given by the 89th section to the remaining directors if they think proper so to do to elect persons to fill up the vacancies. I do not see how it is possible for a non-existent body to think proper to fill up vacancies. In such a case a general meeting duly summoned for the purpose must have power to elect a new board so as not to let the business of the company be at a deadlock'........... Those observations express a principle which seems to me to be as applicable to the case of a limited company incorporated under the Companies (Consolidation) Act 1908 as to a case falling under the Companies Clauses Consolidation Act 1845, and moreover to be a principle founded on plain common sense. If directors having certain powers are unable or unwilling to exercise them - are in fact a non-existent body for the purpose - there must be some power in the company to do itself that which under other circumstances would be otherwise done. The directors in the present case being unwilling to appoint additional directors under the power conferred on them by the articles, in my opinion, the company in general meeting has power to make the appointment........

87.

FOSTER v. FOSTER

(1916) 1 Ch. 532 Chancery Division The shareholders in the company were split into two factions; that controlled by the defendant, Mrs. M.Foster, could narrowly outvote the plaintiff and his supporters. The plaintiff had been removed from the office of chairman and had had his salary as a director cut from 300 to 25 per annum; and, instead of being sole managing director, he was made a joint managing director with Mrs. Foster. (He complained of all these moves, but the court held that the resolutions were in each case regular). Later, at a board meeting of three directors held in January 1915, resolutions were carried by Mrs. Foster and the third director, against the opposition of the plaintiff, removing him from the post of managing director and appointing Mrs. Foster sole managing director at a substantial remuneration. These resolutions were irregular, since Article 93 of the articles forbade a director (in this case Mrs Foster) from voting in respect of any contract in which he or she was interested. But the court held that his was an irregularity which the shareholders could ratify, or alternatively a matter in which, because of deadlock, competence had reverted from the board to the general meeting. In either case it was for the shareholders to put it right, and the court had no jurisdiction.

88.

RE: EL SOMBRERO LTD. (1958) (CHANCERY DIVISION) The applicant held 900 of the 1,000 shares in the company, while the remaining shares were held as to 50 each by the two respondents, who were its only directors. The applicant had twice requisitioned a meeting of the company for the purpose of exercising the power given by s.184 of the Companies Act 1948 to remove the directors by ordinary resolution, but on each occasion the respondents had absented themselves in order to ensure that the quorum of two members (as fixed by the articles) was not present. He sought an order under s.135 and a direction that one person should be deemed to constitute a quorum at such meeting. The court, overruling the decision of the registrar, made an order accordingly WYNN - PARRY J:........."The first point of law which arises involves the construction of section 135(1) of the Companies Act 1948, the examination being directed to consider the scope of the phrase `If for any reason it is impracticable to call a meeting of a company in any manner in which meetings of that company may be called, or to conduct the meeting of the company in manner prescribed by the articles or this Act.........' It is to be observed that the section opens with the words `If for any reason', and therefore it follows that the section is intended to have, and, indeed, has by reason of its language, a necessarily wide scope. The next words are `......it is impracticable to call a meeting of a company.........' The question then arises, what is the scope of the word `impracticable'? It is conceded that the word `impracticable' is not synonymous with the word `impossible'; and it appears to me that the question necessarily raised by the introduction of that word `impracticable' is merely this: examine the circumstances of the particular case and answer the question whether, as a practical matter, the desired meeting of the company can be conducted, there being no doubt, of course, that it can be convened and held. Upon the face of the section there is no express limitation which would operate to give those words `is impracticable' any less meaning than that which I have stated, and I can find no good reason in the arguments which have been addressed to me on behalf of the respondent for qualifying in any way the force of that word `impracticable' or the interpretation which I have placed upon it, and therefore upon that point I am in favour of the applicant. (His Lordship then discussed various passages from the decision of the registrar and continued;) Later, referring to an argument which had been put before him by Mr, Cohen on behalf of the applicant, namely, that the applicant, as a majority shareholder, is entitled to remove the personal respondents form the board under section 184, and that the court would be stultifying the applicant's statutory powers if he refused to make the order which was asked for, the registrar said this: `I cannot accept that proposition as correct. His power of removing a director under section

184 is limited to doing so by ordinary resolution and under the terms of his contract with the respondents they have power to prevent him from passing such a resolution if they wish to do so. I do not consider that the court ought to exercise its powers under section 135 in such a way as to deprive the respondents against their will of the power.' With all respect to the registrar, I think those passages proceed upon misconception. It was conceded by Mr. Lindner, and, in my view, very properly conceded, that it was not possible to say that the respondents, by virtue of the articles, had such right as is implicit in the use of the word `entitled' by the registrar, to prevent the applicant from holding and conducting the meeting. They have, it is true, a power to prevent him from doing so, but that power is not derived from the articles; it is derived from the accidental distribution of the shareholding in this company, and that, to my mind, explains the whole difficulty which has arisen. I therefore arrive at the stage where I hold that I have jurisdiction in this case, and there is nothing to prevent me exercising the discretion which is given under the section if I choose to exercise it. It is true that I am sitting as an appellate court, but I am entitled to consider the question of discretion, because, in my view, as I have held, the registrar has misdirected himself on a question of law. In my judgement, this is eminently a case in which the court ought to exercise its discretion; first, because if the court were to refuse the application it would be depriving the applicant of a statutory right, which, through the company, he is entitled to exercise under section 184(1), to remove the respondents as directors; secondly (and I think this is a proper matter to take into account as part of the reasons for deciding to exercise my discretion), the evidence disclosed that the respondents are failing to perform their statutory duty to call an annual general meeting. The period within which they should have held an annual general meeting expired at some date in October 1957. Their excuse in the evidence is that there would be no use in convening and holding an annual general meeting, because the accounts for the first period of the company's history are not yet available. I have read the evidence with care, and I do not accept it as bona fide evidence. There is a clear statutory duty on the directors to call the meeting whether or not the accounts, the consideration of which is only one of the matters to be dealt with at an annual general meeting are ready or not. It cannot possibly serve as an excuse for failing to perform that statutory duty. It is quite obvious that the only reason why the respondents refuse to call an annual general meeting is because the inevitable result of convening and holding that meeting would be that they would find that they had ceased to be directors...... For these reasons, therefore, I propose to accede to this application and to direct a meeting of the company to be held under the power given me by section 135 of the Companies Act 1948. (After a discussion it was agreed that the order should direct that one member of the company present in person or by proxy should be deemed to constitute a quorum and that the meeting should be held at the offices of the applicant's solicitors.)

89.

RE: STATE OF WYOMING SYNDICATE LTD (1901) 2 Ch.431 A company was governed, so far as the calling of meetings was concerned, by Table A (in Schedule 1 to the Act of 1862), clause 32 of which provided that "the directors may, whenever they think fit.... convene an extraordinary general meeting." By the articles of association two directors constituted a quorum. A requisition was sent to the directors in accordance with s.13 of the Companies Act, 1900, requesting them to convene a meeting to pass an extraordinary resolution for voluntary winding-up. Within the twenty-one days allowed to the directors, by s.13, for convening the meeting, the secretary of the company, without the authority of the directors, summoned the meeting. At the meeting two directors, the requisitionists, and many shareholders were present, and the resolution was passed by the required

majority. At the hearing of a petition by a creditor for the compulsory winding-up of the company, the defence was set up that a voluntary winding-up was pending, and that the petitioner did not show that he was thereby prejudiced. Held:that the secretary had no power to issue the notices, that there was no ratification of his act, that the so-called ratification of the company was invalid, and that a compulsory winding-up order must be made.

WRIGHT, J:"........... In my judgement it is clear in law that the meeting could not have been properly summoned on the day on which it was summoned except by the directors. It could not be summoned by the requisitionists because the twenty-one days limited by s.13 of the Act of 1900 had not expired. I need not decide whether requisitionists can, after the expiration of the twenty-one days mentioned in the section, call a meeting by notices signed by the secretary. But before that period had expired only the directors could call the meeting, and the secretary could not, without their authority, summon a meeting...... Nothing can be more important than the question whether a company should proceed to voluntary liquidation, especially when a petition for a compulsory winding-up order is pending against the company, and it seems to me that proceedings of this kind ought to be conducted with substantial propriety......... If he (i.e the secretary) does summon a meeting without authority I do not think I ought to hold that a resolution passed at the meeting is valid. If it had been a mere question of informality with reference to the constitution of the board which summoned the meeting, for instance, some question as to whether there was a proper quorum present, I might have applied the principle of BROWNE v. LA TRINIDAD.... but I think I should be going too far if I held that it applied to the present case. No doubt two directors, the requisitionists, and many shareholders were present at the meeting, and there would have been great reason for argument if there had been full knowledge of the irregularity and the directors had done anything to recognize the act of the secretary as their act. Then a different question would have arisen, but there is here no question here of ratification, and I must hold that the meeting was improperly convened, and that no valid resolution for the voluntary winding-up was passed. There will therefore be the usual compulsory order for winding-up."

90.

RE: WEST CANADIAN COLLIERIES LTD. (1962) Ch. 370 The registrar of a company, West Canadian Collieries Ltd., in sending out to members notices of a special resolution for the reduction of capital to be proposed at the annual general meeting, inadvertently omitted to send notices to nine of the members. The omission was due to the fact that the addressograph plates of these nine members were kept in a separate place to ensure that dividend warrants were not sent out to them, since in the past such warrants had wither been returned to the company or not been cashed. Article 75 of the company's articles of association was identical in terms with article 51 of Table A. The special resolution was passed at the meeting, and the company petitioned the court for confirmation of the reduction of capital. The petition was unopposed. PLOWMAN J.: The question which I have to decide is whether the allegation that the special resolution for the reduction of capital was duly passed has been proved, having regard to the events which happened concerning the notices convening the annual general meeting and the

omission to send the notices to those nine members......... There appears to be no authority as to the effect of that article (article 75) in the circumstances that I am considering although it is a common form article in identically the same terms as article 51 of the current Table A. The fact that it is a Table A article means that its validity as an article cannot be impugned.............. In the first place, I am satisfied that the omission to give notice of the meeting to the nine members in question was "accidental" within article 75. It follows from that that the omission to give notice to the nine members did not - and I quote the article - "invalidate the proceedings at that meeting." But the question arises whether the result of this is (a) that though the proceedings of the meeting were valid, the notice of the meeting is nevertheless still not deemed to have been duly given for the purposes of s.141, or (b) that the notice of the meeting is to be deemed to have been duly given for the purposes of that section. The latter, in my judgement, is the true view. It must, I think, be implicit in article 75 that a meeting, the proceedings of which are to be taken to be valid notwithstanding the omission to give notice to members, is to be deemed to have been duly convened for the purposes of the articles, including in those purposes the manner of convening the meeting. It seems to me that, in the absence of such an implication, there would be no meeting the proceedings of which could be validated by the articles. I say that there would be no meeting, because "it is well settled that as regards a general meeting failure to give notice to a single person entitled to receive notice renders the meeting a nullity." I therefore hold that the notice of the meeting was duly given, and that the resolution in question was duly passed for the purposes of S.141, and therefore....... I propose to confirm the reduction."

91.

MUSSELWHITE v. C.H. MUSSELWHITE & SON LTD (1962) Ch.964 The company failed to give notice of an annual general meeting to the two plaintiffs who had sold their shares to the two defendants but had not been paid and remained on the register of members. The directors believed that the plaintiffs were not entitled to the notice. The plaintiffs claimed successfully that the meeting was a nullity and that they had the right to decide how their shares should be voted until full payment had been received. RUSSEL, J:"......... On 30th December 1958 the annual general meeting of the company was held. I am not concerned with what business was before the meeting or what passed. No notice of the meeting was served on the plaintiffs. Prima facie the meeting was a nullity for that reason. The defendants, however, rely on the relevant article 403 of Table A, which is in this form: "The accidental omission to give notice of a meeting......... to any member shall not invalidate the proceedings at any meeting." (His Lordship referred to the evidence, and continued:) On those facts I fail to understand how the omission to give notice to the plaintiffs was accidental....... Prima facie, therefore, the plaintiffs are entitled to their declaration that the annual general meeting was a nullity. On that basis, they ask for an order that the annual general meeting for the year 1957-8, now long overdue, be held...........

92.

TIESSEN v. HENDERSON (1889) 1 Ch.861. The Violet Consolidated Gold Mining Co. Ltd was in difficulty, and meetings were summoned to put before the shareholders alternative schemes for reconstruction. The scheme which was approved was one in which certain of the directors had a strong financial interest, but this fact was not disclosed in the notice convening the meeting. The notice merely stated that the "guarantors" of the new scheme were to have a "right of call" or share option on 50,000 of new shares of the company without telling the shareholders that three of the directors were interested as such

"guarantors". Kekewich, J. held the resolution invalid. Kekewich J: "........... The question is merely whether each shareholder as and when he received the notice of the meeting, in which I include the circular of the same date, had fair warning of what was to be submitted to the meeting. A shareholder may properly and prudently leave matters in which he takes no personal interest to the decision of the majority. But in that case he is content to be bound by the vote of the majority; because he knows the matter about which the majority are to vote at the meeting. If he does not know that, he has not a fair chance of determining in his own interest whether he ought to attend the meeting, make further enquiries, or leave others to determine the matter for him. The shareholder must be regarded as a man of ordinary prudence. Treating it as a commercial matter, he has invested his money in this company; the company is in difficulties, and reconstruction is necessary and what he has to consider when the notice and the circular come to him is whether, on the whole, this is the best thing that can be done. He is either to vote himself in person or by proxy, or he is to leave it to the majority to decide. It seems to me impossible to exclude from the matters which he ought, as a prudent man, to consider, the question whether some of his directors should be remunerated by means of this call on shares........ Why should any shareholder reading this circular think for a moment that two of his directors....... were to have a large proportion of the 50,000 shares on which there was to be a call in favour of the guarantors? He is told that the guarantors were the Henderson company. He is not told that they were to derive a personal benefit. Of course I am told, and with perfect honesty no doubt, that these gentlemen only wished to do the best for the company, that they were largely interested in it, and they thought it the best thing to do. True; but they did so for a commission, or for remuneration; and they were not prepared to do the best they could without being paid for it............ and those facts were not stated in the circular. If a meeting properly convened, and properly instructed as to the purpose for which it is convened, chooses to do so I think it ought to have the opportunity of considering the point. The man I am protecting is not the dissentient, but the absent shareholder the man who is absent because, having received and with more or less care looked at this circular, he comes to the conclusion that on the whole he will not oppose the scheme, but leave it to the majority. I cannot tell whether he would have left it to the majority of the meeting to decide if he had known the real facts. He did not know the real facts; and, therefore, I think the resolution is not binding upon him."

93.

SHARP v. DAWES (1876) 2 Q.B.D. 26 (COURT OF APPEAL) A meeting of a cost-book mining company governed by the Stannaries Acts was summoned for the purpose, inter alia, of making a call. It was attended by only one member, Silversides, and the secretary (who was not a member); and the following proceedings took place, as recounted in a notice sent to all members: At a general meeting of the shareholders, held at 2, Gresham Buildings, Basinghall Street, London, E.C., on Wednesday, the 30th day of December, 1874, pursuant to notice, R.H. Silversides, Esq., in the chair, the notice convening the meeting having been read, the minutes of the last meeting were confirmed. The financial statement, ending the 28th of November, showing a balance of 83 11s. 5d. against the shareholders, having been read, it was Resolved - `That the same be received and passed.' Captain William Taylor's report having been read, it was Resolved - `That the same be received and passed, and, together with the financial statement, be printed and circulated among the shareholders.'

Resolved - `That a call of 4s. 6d. per share be now and is hereby made payable to the secretary, and that a discount of 5 per cent be allowed if paid by the 20th of January, 1875.' Resolved - `In consequence of the death of Lieut-Col. W.T. Nicolls, and until the appointment of a shareholder to act in his stead, that all cheques be signed by Mr.R.H. Silversides and Mr.Granville Sharp jointly.' 1. (These tin-mining companies are unincorporated and governed by special statutes: see Gower, Modern Company Law, 3rd edition (London, 1969), p.7).

(Signed) R.H. Silversides, Chairman. Resolved - `That a vote of thanks be given to the chairman.' (Signed) Granville Sharp, Secretary. The call was in due course made on a shareholder, Dawes, who refused to pay it. It was held that the meeting was a nullity and that therefore the call was invalid. LORD COLERIDGE C.J. "This is an attempt to enforce against the defendant a call purporting to have been made under section 10 of the Stannaries Act 1869. Of course it cannot be enforced unless it was duly made within the Act. Now, the Act says that a call may be made at a meeting of a company with special notice, and we must ascertain what within the meaning of the Act is a meeting, and whether one person alone can constitute such a meeting. It is said that the requirements of the Act are satisfied by a single shareholder going to the place appointed and professing to pass resolutions. The sixth and seventh sections of the Act show conclusively that there must be more than one person present; and the word `meeting' prima facie means a coming together of more than one person. It is, of course, possible to show that the word `meeting' has a meaning different from the ordinary meaning, but there is nothing here to show this to be the case. It appears therefore to me that this call was not made at a meeting of the company within the meaning of the Act. The order of the court below must be reversed. MELLISH L.J. "In this case no doubt, a meeting was duly summoned, but only one shareholder attended. It is clear that, according to the ordinary use of the English language, a meeting could no more be constituted by one person than a meeting could have been constituted if no shareholder at all had attended. No business could be done at such a meeting, and the call is invalid."

94.

EAST v. BENNET BROTHERS LTD (1911) 1 Ch.163 (Chancery Division) The memorandum of association authorised the company to increase its capital by the creation (inter alia) of new shares to rank pari passu with existing classes of shares, provided that the issue was sanctioned by an extraordinary resolution of the existing holders of shares of the class in question at a separate meeting of such holders. A fresh issue of preference shares was made at a time when all the existing preference shares were held by Joseph Bennett, who gave his approval at a `meeting' attended, according to the minute-book only by himself. This action was held to be equivalent to the resolution required by the memorandum. WARRINGTON J. referred to Sharp v. Dawes (above) and continued: But now what I have to consider is whether this is not one of the cases referred to by Lord Coleridge C.J. as one in which it may be possible to show that the word `meeting' has a meaning different from the ordinary meaning. For that I think I am entitled to see what is the object of the provision in the

memorandum of association. Plainly, as I have already said, that object is that before affecting the rights of the preference shareholders it shall be necessary to obtain and record in a formal manner the assent of the preference shareholders to that course. I think I may take it also that the persons who framed this document may have had, and must be taken to have had, in their minds the possibility at all events that this particular class of shares might fall into the hands of one person. There is nothing to prevent it in the constitution of the company. One must regard the memorandum as far as possible as proving for circumstances which in the ordinary course may arise. That being so, I think I may very fairly say that where one person only is the holder of all the shares of a particular class, and as that person cannot meet himself, or form a meeting with himself in the ordinary sense, the person who framed this memorandum having such a position in contemplation must be taken to have used the word `meeting', not in the strict sense in which it is usually used, but as including the case of one single shareholder. There is, of course, no difficulty in treating the formally expressed assent of Bennet as a resolution. The only question is the purely technical difficulty arising from the use of the word `meeting' in the memorandum. I think on the whole that I may give effect to obvious common sense by holding that in this particular case, where there is only one shareholder of the class, on the true construction of the memorandum, the expression `meeting' may be held to include that case. It seems to me, therefore, that the shares were validly issues, and that there is therefore no necessity for the rectification of the register........"

95.

NATIONAL DWELLINGS SOCIETY v. SYKES (1894) 3 Ch.159 Chancery Division After a resolution proposed by the chairman, Sykes, had been lost, he declared the meeting dissolved and left the room together with his supporters, although the remainder of the agenda had not been dealt with. The shareholders who were left elected another chairman and proceeded with the business, but Sykes and his supporters refused to recognize the validity of the decisions so reached. It was held that the chairman had no power to declare the meeting dissolved in this way. CHITTY J. A question of some importance has been mooted in this case, with regard to the powers of the chairman over a meeting. Unquestionably it is the duty of the chairman, and his function, to preserve order, and to take care that the proceedings are conducted in a proper manner, and that the sense of the meeting is properly ascertained with regard to any question which is properly before the meeting. But, in my opinion, the power which has been contended for is not within the scope of the authority of the chairman - namely, to stop the meeting at his own will and pleasure. The meeting is called for the particular purposes of the company. According to the constitution of the company, a certain officer has to preside. He presides with reference to the business which is there to be transacted. In my opinion, he cannot say, after that business has been opened, `I will have no more to do with it; I will not let this meeting proceed; I will stop it; I declare the meeting dissolved, and I leave the chair.' In my opinion, that is not within his power. The meeting by itself (and these articles certainly apply to what I have said) can resolve to go on with the business for which it has been convened, and appoint a chairman to conduct the business which the other chairman, forgetful of his duty or violating his duty, has tried to stop because the proceedings have taken a turn which he himself does not like........ (The decisions which had been taken in the absence of the chairman were accordingly ruled to have been valid, including a resolution appointing a committee of investigation. Other matters still in issue were then referred to another meeting for determination.)

96.

SECOND CONSOLIDATED TRUST LTD. v. CEYLON AMALGAMATED TEA &

RUBBER ESTATES LTD. (1943) 2 AII E.R. 567 Chancery Division (The power of the chairman to demand a poll must be exercised not in accordance with his own wishes or judgement but in such a way as to give effect to "the real sense of the meeting") A meeting of debenture stockholders was attended by fourteen people in person, but this number was insufficient to form a quorum. The chairman, Fidler, whose bona fides was not questioned, declined to exercise his power to demand a poll (in which case the proxies which he held would have been lost.) Instead he declared the resolution carried by the unanimous vote of the fourteen persons present. These proceedings were brought to challenge the validity of the resolution. UTHWATT J......... The duty of a chairman of a meeting is to ascertain the sense of the meeting upon any resolution properly coming before the meeting. Then comes the question as to his position in regard to his right to demand a poll. Upon a fair construction of this (debenture stock trust) deed, I do not regard that as a personal right to be exercised according to the fancy of the chairman; in other words, I do not think he has an unlimited discretion as to the manner in which he may exercise that power. It appears to me that the power to demand a poll is a power possessed by the chairman which is to be exercised or not to be exercised according to his decision whether it is necessary to exercise the power in order to ascertain the sense of the meeting upon the matter before them; in other words, it is a power directed towards enabling him to carry on the meeting for the purpose for which it is convened. In this particular case, the first thing the chairman knew was this, that in order to have a quorum at the meeting at all he must count in at any rate some of the proxies which he held. The second thing he knew and which is not denied is that, if a poll were demanded and he used his proxies, the resolution could not be carried. In those circumstances, it seems to me that the chairman in this particular case is deciding not to demand a poll never had his mind directed to the real point which he should have considered before coming to a decision. That point was how best to ascertain the sense of the meeting. The position was: `I have these proxies in my possession; they have been sent to everybody. Everybody has had a chance of expressing their views. Some are present; others are not. Unless I count in some at least of the proxies, I have not got a quorum. How then shall I get the sense of this meeting?' I do not think he ever directed his mind to that point, and, not having directed his mind to that point, which is a matter which he ought to have taken into consideration, it seems to me that he failed in this particular case in his duty as chairman, and, having so failed in his duty as chairman, the resolution was not properly carried. I would just like to add this, that, in addition to having this duty to demand a poll or exercise his power to demand a poll, I think - and I think Fidler as a business man must take the same point of view - he would be under a duty in law to exercise all the proxies which he held as chairman in accordance with the instructions which they contained."

97.

SCOTTISH CO-OPERATIVE WHOLESALE SOCIETY LTD. v. MEYER AND ANOTHER (1958) 3 W.L.R. 404 The affairs of a company must not be conducted in a manner oppressive to some of it's members. FACTS OF THE CASE The society formed a subsidiary company for the manufacture and sale of rayon materials, and

Meyer and Lucas, because of their expert knowledge and trade connections, were appointed joint managing directors. Three nominees of the society, who also served on the board of the society, were appointed to the board of the company as directors. The company issued 7,900 shares, Meyer holding 3,450, Lucas 450 and the society 4,000. For several years the company prospered. Because of changed circumstances the society offered to buy the shares of Meyer and Lucas, but they declined the offer on the ground that it was below the true value of the shares. Thereupon the society, with the knowledge of its three nominee directors, diverted business from the company to a department within its own organisation, and this in time brought the business of the company virtually to a standstill and greatly reduced the value of its shares. Faced with this situation Meyer and Lucas petitioned the Court under section 210 of the Companies Act, 1948, for an order that the society should purchase their shares at a price based on their value before business was diverted from the company or at a price which the Court regarded as fair. DECISION It was held by the House of Lords that the society must buy the shares at a fair price, as determined by the Court below. Viscount Simonds said, at p. 407:"It was a plan which demanded utmost good faith on both sides and ... it was the lack of it on the part of the society which led to this discreditable tale ... It is common ground that at the date of the presentation of the petition ... it was just and equitable that the (p. 407) company should be wound up. It could hardly be denied that to wind up the company would unfairly prejudice the respondents. The only question is whether, its affairs were being conducted in a manner oppressive to the respondents. (After accepting the findings in the Court below that the conduct of affairs was oppressive to the respondents:) It is, however, necessary, if section 210 is to be successfully invoked, to show not only that there has been oppression of the minority shareholders of a company but also that it has been the affairs of the company which have been conducted in an oppressive manner ...(page 409). "At any rate by the end of 1952 it was the policy of the society by one means or another to destroy the company it had created, knowing that the minority shareholders alone would suffer in that process ... (p.410). The three nominee directors were aware ... of the policy of the society ... I have not been able to find the least trace that they regarded themselves as owing any duty to the company of which they were directors. They were the nominees of the society and, if the society doomed the company to destruction, it was not for them to put out a saving hand... Nominees of a parent company upon the board of a subsidiary company may be placed in a difficult and delicate position. It is, then, the more incumbent on the parent company to behave with scrupulous fairness to the minority shareholders and to avoid imposing upon their nominees the alternative of disregarding their instructions or betraying the interests of the minority. In the present case the society pursued a different course. It was ruthless and unscrupulous in design and it was effective in operation, and ... it was promoted by the action of inaction of the nominee.... "But, it is said, let it be assumed that the society acted in an oppressive manner; yet they did not conduct the affairs of the company in an oppressive manner. My Lords,. it may be that the acts of the society of which complaint is made could not be regarded as conduct of the affairs of the company, if the society and the company were bodies wholly independent of each other, competitors in the rayon market, and (p.411) using against each other such methods of trade warfare as custom permitted. But this is to pursue a false analogy. It is not possible to separate the transactions of the society from those of the company. Every step taken by the latter was determined by the policy of the former ... It is just because the society could not only use the ordinary and legitimate weapons of commercial warfare but could also control from within the operations of the company that it is illegitimate to regard the conduct of the company's affairs as a matter for which they had no responsibility. It appears to me to be a glaring example of precisely

... the evil Parliament intended to remedy. "Some criticism was made of the relief given by the order of the court. It was said that only that relief could be given which had as its object and presumable its effect the bringing to an end the matters complained of and that an order upon the society to purchase the respondents' shares in the company did not satisfy that condition. This argument is without substance. The matter complained of was the oppression of the minority shareholders by the society. They will no longer be oppressed and will cease to complain if the society purchase their shares...." Lord Keith of Avonholm said, at p.429:"It was said that appeal could not be made to section 210 unless the company had a continuing life ahead of it (because section 210 (2) (b) provides that an order may be made if the court is of opinion ... that to wind up the company would unfairly prejudice' the oppressed minority) and here it was clear that the company would have to be wound up. But that means that if oppression is carried to the extent of destruction of the business of the company no recourse can be had to remedies of the section. This would be to defeat the whole purpose of the section. The present position is due to the oppression and but for the oppression it must be assumed that the company would be an active and presumably flourishing concern...." Lord Denning said, at p.434:"It is, no doubt, true that an order of this kind gives to the oppressed shareholders what is in effect money compensation for the injury done to them: but I see no objection to this. The section gives a large discretion to the Court and it is well exercised in making an oppressor make compensation to those who have suffered at his hands".

98.

RE H R HARMER LTD (1959) (Court of Appeal) In 1947 Harmer senior ('the father') formed a private company to take over the stamp-dealing business which he had founded many years earlier; and although as a result of a succession of gifts and purchases the majority of shares in the company were now owned by his sons, the father retained his voting control. The father and sons were appointed life directors by the articles of association, which also constituted the father 'governing director'- an office not defined as carrying any distinctive powers. The sons petitioned for relief under s.210, alleging that the father (by now aged upwards of 88) ran the business as if it were entirely his own, ignoring the wishes of his co-directors, the resolutions of the board, and the interests of the shareholders. (He had, inter alia, founded a branch of the business in Australia, against the wishes of the other directors, which proved unprofitable; purportedly dismissed an old servant and fellow director on his own initiative; procured the appointment of his own 'yes-men' to the board; drawn unauthorised expenses for himself and his wife; engaged a detective to watch the staff; countermanded resolutions of the board; and endeavoured to sell off the company's American business, severely damaging its goodwill.) Roxburgh J. granted the sons relief under s.210, ordering inter alia, 'that the company should contract for the services of the father as a philatelic consultant at a named salary that the father should not interfere in the affairs of the company otherwise than in accordance with the valid decisions of the board of directors, and that he should be appointed president of the company for life, but that this office should not impose any duties or rights or powers'. The order was upheld by the Court of Appeal.

JENKINS L.J. referred to the evidence and continued: I should next say a word or two as to the scope and effect of section 210 of the Act....it is to be observed, first, that the person permitted to apply to the court under section 210 is `any member of the company', and he must show 'that the affairs of the company are being conducted in a manner oppressive to some part of the members (including himself)'. this indicates that the oppression complained of must be complained of by a member of the company and must be of oppression to some part of the members (including himself) in their or his capacity as a member or members of the company as such. Secondly it is to be noted that the section does not purport to apply to every case in which the facts would justify the making of a winding-up order under the `just and equitable' rule, but only to those cases of that character which have in them the requisite element of oppression.Thirdly, the phrase `the company are being conducted' suggests prima facia a continuing process by anyone who is taking part in the conduct of the affairs of the company whether defacto or dejure. Fourthly, the section gives no guidance as to the meaning of the word `oppressive', although it does,as already mentioned, indicate that the victim or victims of the oppressive conduct must be a member or members of the company as such. Prima facie, therefore the word `oppressive' must be given its ordinary sense and the question must be whether in that sense the conduct complained of is oppressive to a member or members as such. inasmuch as in the present case it is not in dispute that the facts would justify a winding-up order the `just equitable' rule and it is recognised that such an order would unfairly prejudice the complaining members, this would appear to be in effect the only question in issue... (His Lordship referred to the evidence and continued:) The question remains whether,on these facts, the petitioners were rightly granted the relief which Roxburg J. thought fair to grant under section 210. upon this issue Mr. Harold Brown, for the father, made in effect these submissions.....First, he said that the dons should not be heard to complain since they acquired their shares through the generosity of their father,who having built up the business, proceeded to turn it into a company and to hand over a major part of the beneficial interest in the form of shares to his sons virtually by way of gift. As to this, the sons did at all events pay for their preference shares, and if they had not paid anything, two of them at all events had long been working in the business, while the third gave up his career in the Colonial Office in order to take up employment in the business. moreover, the question of consideration appears to me irrelevant, a mere matter of prejudice. Suppose the transaction was a mere matter of gift, the gift, if valid (and there is no suggestion that it was not ) must surely have conferred the same rights as if the transaction had been for full consideration. Mr Harold Brown's second point was that the sons knew full well when the company was formed that the father was to retain control by means of his predominant holding of `B' shares so long as he lived. I agree, but cannot concur with Mr Brown in adducing from this that the sons must be taken to have assumed that the father would exercise control irregularly by doing what he thought fit without reference to the board or in defiance of the board's decisions. Then the third submissions of Mr Harold Brown was that what was done by the father was not oppressive of the rights of the sons as members, but merely oppressive of their rights as directors. I cannot accept this . It appears to me that the sons as members and not merely as directors were oppressed by the singular conduct of the father the oppression must be no doubt be oppression of members as such, but it does not follow that the fact that the oppressed members are also directors is a disqualifying circumstance when the question of relief under section 210 arises. I think there may well be oppression from the point of view of member-directors where a majority shareholder (that is to say, a share holder with a preponderance of voting power) proceeds, on the strength of his control, to act contrary to the decision of, or without the authority of, the duly constituted

board of directors of the company. Fourthly, Mr. Harold Brown said that the acts complained of may have been restrained by injunction in so far as they were acts without the authority of the board. As to this I do not think a wrongdoer in this field can well complain that the person wronged might have chosen another remedy. Then fifthly, Mr. Harold Brown said that the acts complained of were not in their result oppressive, because it cannot be demonstrated that the company suffered any loss from any of them.I cannot agree. The acts complained of were, I should say for the most part, calculated to damage the company in one way or another. Sixthly, Mr Harold Brown said that the acts complained of might have been lawfully done by calling a general meeting and passing the requisite resolutions, ordinary or special. As to this, I think the sons were at least entitled to require that the proper procedures should be applied. Then seventhly, Mr. Harold Brown said that this is not a case of discrimination between different shareholders or classes of shareholders. I agree, but see no reason for holding that section 210 is necessarily confined to cases of discrimination, though it is to be expected that cases calling for its application would most usually take that form. Finally he submitted that the father got no pecuniary benefit out of what he did. that is not literally true, but even if it was, I do not think it is essential to a case of oppression that the alleged oppressor is oppressing in order to obtain pecuniary bene fit.If there is oppression, it remains oppression even though the oppression is due simply to the controlling shareholder's overwhelming desire for power and control, and not with a view to his own advantage in the pecuniary sense. It seems to me the result rather than the motive is the material thing. Then on the other side, Mr. Millner Holland's submissions were to this effect: (i) The question is whether the course of conduct complained of was `burdensome, harsh or wrongful' to shareholders, that is to say, a part of the shareholders,including the petitioners. (ii) if a person, relying on majority control in point of voting power, dispenses with proper procedure for producing the result he desires to achieve, and simply insists on this or that being done or omitted ,his conduct is oppressive because it deprives the minority of their right as members of the company to have its affairs conducted in accordance with its articles of association. (iii) It is not shown that if the father had acted strictly in accordance with the articles of association he could have achieved his object.the proper procedure cannot be put on one side as mere machinery. It is the duty of the board to consider any proposal. if a majority shareholder desires to override the board, there must be a proper meeting,whether of the board or of the company, and at least an opportunity of discussion. Moreover, if a majority shareholder sets about asserting his power in accordance with the articles and succeeds in point of numbers, he may be faced with questions as to fraud on the minority and so forth, which are backed by the expedient of simply doing as he chooses without ceremony on the ground that if it came to a vote he could outvote anyone. In his judgement, Roxburgh J., after saying that he adopted the reasoning of the Lord President, Lord Cooper in Mayer v. Scottish Co-operative Wholesale Society Ltd, said: " That being so, for my part the section seems to admit of no ambiguity. The word "oppression" is a word of common use and understanding in the English language. But I would just observe in passing that it does not

say "who complains of acts of oppression"; it says "that the affairs of the company are being conducted in a manner oppressive". In other words, I think it invites attention not to events considered in isolation, but to events considered as part of a consecutive story; and it is because, I take the view that I have not dealt (and do not propose to deal) with each of the items which I have enumerated one by one....It remains, in my view, a question for the court to decide on the whole story, as revealed in the evidence, whether the affairs of the company are being - it has to be a state of affairs continuing at the date of the petition - conducted in a manner oppressive to some part of the members. i do not know that it has any particular bearing on the case, but this case is curious in that it is not a minority beneficial interest that is being oppressed, and that would be the normal case; it is a majority beneficial interest which is being oppressed because the voting control is placed in the hands of a minority beneficial interest. In my judgement, I reach the opinion - because that is what I have to do - that at the date of the presentation of this petition the affairs of the company were being conducted in a manner oppressive to the petitioners'. having given the best consideration I can to this not altogether easy case, I have come to the same conclusion, preferring the reasoning of Mr. Milner Holland to that of Mr. Harold Brown, and accepting the reasoning and conclusion of the judge.....

99.

CLEMENS VS CLEMENS BROS LTD AND ANOTHER (1976) 2 ALL E.R. 268 The plaintiff held 45% and her aunt 55% of the issued share capital of a family company. The company had been incorporated in 1913 and carried on a highly successful business in the building trade. the capital of the company consisted of 200 preference shares, of which the plaintiff and the aunt each held 100, and 1,000 ordinary shares of 1 each fully paid,of which the plaintiff held 800 and the aunt 1,000. under the articles of association members of the company had a right of pre-emption if another members wished to transfer his shares. The aunt was a director of the company but the plaintiff was not. There were four other directors. The total director's emoluments exceeded the company's net profits before taxation in each of the years 1971 to 1974. The directors proposed to increase the company's shareholding from 2,000 to 3,650 by the creation of a further 1650 ordinary shares all of which were to carry voting rights. The directors other than the aunt would receive 200 shares each and the balance of 350 shares would be placed in trust for long service employees of the company. The secretary wrote to the plaintiff on 1st November 1974 setting out the proposals and enclosing a notice of an extraordinary meeting to be held on 27th November to approve the setting up of a trust for the company's employees, to increase the company's capital and to provide for the proposed allotment. resolutions to that effect were out in the notice and a draft of the proposed trust deed was enclosed. On 22nd november the plaintiff's solicitor wrote a letter to the aunt pointing out that the scheme would reduce the plaintiff's shareholding to under 25% and stating that the plaintiff was opposed to it. The aunt wrote that she was fully aware of the implications of the changes in the company's structure but intended to support the scheme. The plaintiff's solicitor attended the meeting on 27th November as her proxy, and proposed an adjournment. The aunt voted against an adjournment, and the three resolutions were then passed. The plaintiff brought an action against the company and the aunt, seeking a declaration that the resolutions were oppressive of the plaintiff and an order setting them aside.

HELD (The company's Chairman's remuneration was 17,500 p.a) the Managing director's 29,510 in 41,189 in 1974, excluding benefits in kind).

The aunt was not entitled as of right to exercise her majority votes as an ordinary shareholder in any way she pleased. Her right was subject to equitable considerations which might make it unjust to exercise it in a particular way. although it could not be disputed that she would like to see other directors have shares in the company and a trust set up for long service employees, the inference was irresistible that the resolutions had been framed in order to put complete control of the company into the hands of the aunt and her fellow directors, to deprive the plaintiff of her existing rights as a shareholder with more than 25% of the votes and to ensure that she would never get control of the company. those considerations were sufficient in equity to prevent her aunt using her votes as she had, and the resolutions would accordingly be set aside. Dicta of Sir Richard Bagallay in North-west Transportation Co. Ltd. v Beatty, of Lindley Mr. in Allen v Gold Reefs of Africa Ltd. of Evershed Mr. in Greenhalg v Arderne Cinemas Ltd. of the Lord President in Meyer v scottish Textile and Manufacturing Co. Ltd and of Wilberforce in Abraham v westbourne Galleries Ltd. applied. FOSTER J.: "This action arises from unhappy differences which have arisen between an aunt (aged around 68) and her niece (aged about 50), who together hold all the issued shares in Clemens Bros Ltd..... by August 1967 both the plaintiff and Miss Clement (the aunt) were directors, but the plaintiff resigned on 5th November, 1968 as a result of disagreements with the chairman... The general meeting duly took place on 27th November 1974 and at that meeting Mr. Barnes, who attended as proxy for the plaintiff, read a prepared statement which is in these terms: "(The plaintiff) has, since she was instrumental in disclosing the fraudulent acts of the Company's managing director, been excluded from the board and refused detailed information of the Company's accounts which would have enabled her to judge whether the company was being properly run by the Board and whether the remuneration which was voted to them was fair and reasonable. She retained, however, her dividend income, her right to prevent any step being taken which required a special resolution and her right to acquire any of the existing shares in the company on the occasion of their transmission. The present proposals, in whatever terms the board chooses to put it has the following effects upon (the plaintiff) : (1) Instead of receiving 4/9 th of the dividend on the ordinary shares she will receive fractionally less than 2/9 ths of future dividends so that her future from her ordinary shareholding will be more than halved. Her accountants conservatively estimate the current value of the ordinary shares of the company to be 60.00 each. If the proposal os carried out it is the auditor's view that the value of the ordinary shares will then be 19.50 so they presumably put the current value at about 37.00 . She will therefore suffer a capital loss of about 14,000 at the lowest estimate. It takes away her power to oppose a special resolution so that fundamental changes in the nature and undertaking of the company may take place without her concurrence. It so reduces her right of acquisition of shares on transmission as to relegate her permanently to the position of a minority shareholder. The proposal is that all this will be done (to the plaintiff) without any compensation whatsoever.....

(2)

(3)

(4)

"There is no suggestion that the company requires an injection of capital - indeed it is self evident that it does not since the carrying from the company's ready moneys in order to pay for the shares to be allocated to the employee's trust against an immediate net inflow of 800.00. the proposal is not, therefore in the best financial interest of the company involving as it does the depletion of the company's capital at a time of grave economic crises in the country as a whole and, in particular

the construction industry". "There has been no discussion whatsoever of the Board's far reaching and fundamental proposals with (the plaintiff). Indeed she was kept in ignorance of the proposal until it was fully formulated. The proposal is directly contrary to the best interests of all shareholders and particularly weakens the position of the plaintiff, the minority shareholder, still further. After this there is nothing to prevent her interest being progressively eroded in a similar way. "As a matter of common sense and basic honesty, the proper approach to any such scheme is one of consultation between all the affected parties, each of whom should have the benefit of fully independent professional advice. To present the plaintiff with this package as a fait accompli brushing aside a request for discussion of the proposals.........is contrary to morality unjust, inequitable and oppressive". Oppressive that the meeting be adjourned for the specific purpose of consultation between the shareholders..... ...At present the plaintiff... has 900 votes (45%) of the total votes and Miss Clemens has 1,100 votes (55%) out of the total number of 2000 votes.... It is proposed that each of the for directors should be issued with 200 ordinary shares, a total of 800 shares, and the employees' trust fund should be given 850 ..if the new shares are added together, totalling 1650, they have a percentage of 452,056. This gives Miss Clemens and her fellow directors together an overall majority of 52% and, if the trustees join them, more than 75% ... what inferences can be drawn from these figures?....I for my part am driven to the conclusion that the figure of 850 was arrived at in order that the plaintiff's percentage of votes be below 25 per cent. this is clearly shown since, there is no reason why the shares given to the employees' trust should have a vote.... I accept the evidence of Mr Wilson that not only Mr. Bennet (the chairman) but also the other directors are overpaid. the increase in the emoluments of Miss Clemens as a non-executive director from 500 in 1970 to 3,000 in 1973 and 4,600 in 1974 is startling. there can I think be no doubt that Miss Clemens has wholeheartedly thrown in her lot with Mr. Bennet and the other directors and for some considerable consideration....I have no hesitation in saying that on such information as I was allowed to see or hear Miss Clemens places complete confidence in Mr Benett and is willing to do as he wishes. It appears that neither the plaintiff nor Miss Clemens has any dependants, so that at least to Miss Clemens the enormous increase in her emoluments must be of great interest and she has no incentive to preserve the value of her shares for anyone except the present directors ... "The directors have a fiduciary duty, but is there any similar restraint on the shareholders exercising their powers as members at general meetings? MENIER V HOOPER'S TELEGRAPH WORKS is a very clear case, since it involved the majority shareholders expropriating the company's assets to the exclusion of the minority. In North-West Transportation Co. Ltd. v Beatty Sir Richard Baggalay said:"The general principles applicable to cases of this kind are well established. Unless some provision to the contrary is to be found in the charter or other instrument by which the company is incorporated, the resolution of a majority of shareholders, duly convened, upon any question with which the company is legally competent to deal, is binding upon the minority, and consequently upon the company, and every shareholder has a perfect right to vote upon any such question although he may have a personal interest in the subject-matter opposed to, or different from, the general or particular interests of the company. On the other hand, a director of a company is precluded from dealing, on behalf of the company, with himself, and from entering into engagements in which he has a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound by fiduciary duty to protect; and this rule is as applicable to the case of one of several directors as to a managing or sole director. Any such dealing or engagement may, however, be affirmed or adopted by the company, provided such affirmance or

adoption is not brought about by unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who oppose it." Here I find for the first time the word "oppressive,' but in that case the question in issue was whether a director could exercise his vote as a shareholder in general meeting to ratify a voidable contract to which he was a party. In Allen v Gold Reefs of West Africa Ltd. Lindley M.R. Said:"The power this conferred on companies to alter the regulations contained in their articles is Limited only by the provisions contained in the statute and the conditions contained in the company's memorandum of association. Wide, however, as the language of s.50 is, the power conferred by it must, like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded. The conditions are always implied, and are seldom, if ever, expressed." In Greenhalgh v Arderne Cinemas Ltd. Evershed MR said:Certain things, I think, can be safely stated as emerging from those authorities. In the first place, it is nw plain that "bona fide for the benefit of the company as a whole" means not two things but one thing. It means that the shareholder must proceed on what, in his honest opinion, is for the benefit of the company as a whole. Secondly, the phrase, "the company as a whole," does not (at any rate in such a case as the present) mean the company as a commercial entity as distinct from the corporators. It means the corporators as a general body. That is to say, you may take the case of an individual hypothetical member and ask whether what is proposed is, in the honest opinion of those who voted in its favour, for that person's benefit." If that is right, the question in the instance case which must be posed is this: did Miss Clemens, when voting for the resolutions, honestly believe that those resolutions, when passed, would be for the benefit of the plaintiff? In the Scottish case of Meyer v Scottish Textile and Manufacturing Co. Ltd Scottish Cooperative Wholesale society Ltd. which was a case under s.210 of the Companies act 1948. the Lord President (Lord Cooper) said:"The section is not concerned with the results to the oppressor but with the results to those who complain of the oppression. When the section inquires whether the affairs of the company are being conducted in a manner oppressive to some part of the members including the complainer, that question can still be answered in the affirmative even if a member of the company, the oppressor has suffered the same or even a greater prejudice." That case went to the House of Lords, where Viscount Simmonds took the dictionary meaning of the word "oppressive" as "burdensome, harsh and wrongful". In Ebrahim v Westbourne Galleries Ltd. lord Wilberforce said:The "just and equitable " provision does not. .... entitle one party to disregard the obligation he assumes by entering a company, nor the court to dispense him from it. It does, as equity always does, enable the court to subject the exercise of legal rights to equitable considerations; considerations that is , of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights, or to exercise them in a particular way". "I think that one thing which emerges from the cases to which I have referred is that in such

a case as the present Miss Clemens is not entitled to exercise her majority vote in any way she pleases. The difficulty is in finding a principle, and obviously expressions such as "bona fide" for the benefit of the company as a whole, "fraud on a minority" and "oppressive" do not assist in formulating a principle. "I have come to the conclusion that it would be unwise to try to produce a principle, since the circumstances of each case are infinite. I cannot escape the conclusion that the resolutions have been framed so as to put into the hands of miss Clemens and her fellow directors complete control of the company and to deprive the plaintiff of her existing rights as a shareholder with more than 25% of the votes and greatly reduce her rights under article 6. They are specifically and carefully designed to ensure not only that the plaintiff can never get control of the company but to deprive her of what has been called her negative control. Whether I say that these proposals are oppressive to the plaintiff or that no one could honestly believe they are for her benefit matters not. A court of equity will in my judgement regard these considerations as sufficient to prevent the consequences arising from Miss Clemens' using her legal right to vote in the way that she has and it would be right for a court of equity to prevent such consequences taking effect." Order that the three resolutions be set aside.

100.

EDWARDS V HALLIWELL (1950), Court of Appeal

The plaintiffs as members of trade union sued the union and members of a trade union sued the union and the members of its executive committee claiming a declaration that a decision to increase the union dues payable by members was invalid on the ground that the union's rules, requiring a two-thirds vote on a ballot of members, had not been observed. Vaisley J. granted the declaration, and his decision was affirmed by the Court of Appeal. Jenkins L.J... The rule in Foss v. Harbottle, as I understand it, comes to no more than this; first the proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself. Secondly where the alleged wrong is a transaction which might be binding on the company or association and on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company or association is in favour if what has been done, then cadit quaestio. No wrong had been done to the company or association and there is nothing in respect of which anyone can sue. If, on the other hand, a simple majority of the members of the company or association is against what has been done,then there is no valid reason why the company or association should not sue. in my judgement, it is implicit in the rule that the matter relied on as constituting the cause of action should be a cause of action properly belonging to the general body of corporators or members of the company as opposed to a cause of action which some individual member can assert in his own right. The cases falling within the general ambit of the rule are subject to certain exceptions. It has been noted in the course of argument that in cases where the act complained of is wholly ultra vires the company or association the rule has no application because there is no question of the transaction being confirmed by any majority. It has been further pointed out that where what has been done amounts to what is generally called in these cases a fraud on the minority and the wrongdoers are themselves in control of the company, the rule is relaxed in favour of the aggrieved minority who are allowed to bring what is known as a minority shareholders action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievances could never reach the

court because the wrongdoers themselves, being in control, would not allow the company to sue. Those exceptions are not directly in point in this case, but they show, especially the last one, that the rule is not an inflexible rule and will be relaxed where necessary in the interests of justice. There is a further exception which seems to me to touch this case directly: That is the exception noted by Romer J. in Cotter v. National Union of Seamen. He pointed out that the rule did not prevent an individual member from suing if the matter in respect of which he was suing was one which could be validly done or sanctioned, not by a simple majority of the members of the company or association, but only by some special majority, as, for instance, in the case of a limited company under the Companies Act, a special resolution duly passed as such. As Homer J. pointed out, the reason for that exception is clear, because otherwise, if the rule were applied in its full vigour, a company which,by its directors , had broken its own regulations by doing something without a special resolution could assert that it alone was the proper plaintiff in any consequent action and the effect would be to allow a company acting in breach of its articles to do de facto by ordinary resolution that which according to its own regulations could only have been validly done, not by a simple majority, but by a two-thirds majority obtained on a ballot vote. In my judgement, therefore, the reliance on the rule in Foss v. Harbottle in the present case may be regarded as misconceived on that ground alone. I would go further. In my judgement, this is a case of a kind which is not even within the general ambit of the rule. It is a case where what is complained of is a wrong done to the union, a matter in respect of which the cause of action would primarily and properly belong to the union. It is a case in which certain members of a trade union complain that the union, acting through the delegate meeting and the executive council in breach of the rules by which the union and every member of the union are bound, has invaded the individual rights of the complainant members, who are entitled to maintain themselves in full membership with all the rights and privileges appertaining to that status so long as they contributions in accordance with the tables of contributions as they stood before the purported alterations of 1943, unless and until the scale of contributions is validly altered by the prescribed majority obtained on a ballot vote. Those rights, these members claim, have been invaded. The gist of the case is that the personal and individual rights of membership of each of them have been invaded by a purported, but invalid, alteration of the tables of contributions. In those circumstances, it seems to me that the rule in Foss v. Harbottle has no application at all, for the individual members who are suing sue, not in the right of the union, but in their own right to protect from invasion their own individual rights as members..... Evershed M.R. and Asquith L.J. delivered concurring judgements.

101.

PENDER v. LUSHINGTON (1877), Court of Chancery (Master of the Rolls) Pender has split his shareholding among nominees in order to defeat a provision in the articles which fixed a maximum number of votes to which any one shareholder was entitled. The chairman refused to accept the nominees' votes and accordingly declared lost a resolution proposed by Pender, which would otherwise have been carried. The Master of the Rolls granted Pender (who brought a representative action on behalf of himself and other shareholders, and also of the company) an injunction restraining the directors from acting on the basis that the nominees' votes had been bad. He also held that Pender had a right to sue in the company's name, at least until a general meeting resolved otherwise, and a further right to sue in his own name. Jessel M.R.......... In all cases of this kind, where men exercise their rights of property, they exercise their rights from some motive adequate or inadequate, and I have always considered the law to be that those who have the rights of property are entitled to exercise them, whatever their motives may be for such exercise. His Lordship then held that the registered shareholders were

members entitled under the articles to vote as they (or Pender) wished. He continued: I now come to the surbodinate question,not very material in the view I take of the case, namely, whether you have the right plaintiffs here. The plaintiffs may be described as three, though there are really two. There is, first, Mr.Pender himself, on behalf of himself; next, as the representative of the class of shareholders who voted with him, whose votes I hold to have been improperly rejected; and, next, there is the Direct United States Cable Company. It is said that the company ought to have been made plaintiffs. The reasons given were reasons of some singularity, but there is no doubt of this, that under the articles the directors are the custodians of the seal of the company, and the directors, who in fact are defendants, have certainly not given any authority to the solicitor for the plaintiffs on this record to institute this suit in the name of the company as plaintiffs. It is equally clear, if I am right in the conclusion to which I have come as to the impropriety of the decision of the chairman in rejecting these votes, that if a case in which the company might properly sue as plaintiffs to restrain the directors from carrying out a resolution which had not been properly carried, and then comes the question whether I ought not to allow the company now remain as plaintiffs. The first point to be considered is this: Supposing there was no objection to the right of a general meeting to direct an action to be brought, could I, even in the case, allow the company to sue? I think I could. In that case the general meeting, having a right to direct an action to be brought, would act by the majority of the members. The majority wish their rights to be protected. A meeting could be called, and, if the court was satisfied that the majority would direct an action to be brought, the company's name would not be taken away. But what is the court to do in the meantime, if it is satisfied that a real majority (would decide) in favour of bringing an action? Surely it must do something in the meantime, and it follows, I think, from that portion of the judgement, that in the meantime the court ought to grant the injunction to keep things in statu quo........... I think I ought not on this summons to take away the name of the company, but to let the summons stand over, leaving either party to call a meeting to decide whether the company's name is to be used or not. In the meantime, whether this is an action in the name of the shareholders or in the name of the company, in either case I think there should be an injunction. But there is another ground on which the action may be maintained. This is an action by Mr.Pender himself. He is a member of the company, and whether he votes with the majority or the minority he is entitled to have his vote recorded - an individual right in respect of which he has a right to sue. That has nothing to do with the question like that raised in Foss v. Harbottle and that line of cases. He has a right to say, `whether I vote in the majority or minority, you shall record my vote, as that is a right of property belonging to my interest in this company, and if you refuse to record my vote I will institute legal proceedings against you to compel you'. What is the answer to such an action? It seems to me it can be maintained as a matter of substance, and that there is no technical difficulty in maintaining it.

102.

MENIER v. HOOPER'S TELEGRAPH WORKS (1874), Court of Appeal in Chancery Hooper's company was a substantial shareholder in the European Telegraph Co., and had contracted with it to make and lay a cable to South America under certain concessions granted to the European company by the foreign government concerned. Menier, a minority shareholder in the European company, claimed that Hooper's company had used its votes to procure the diversion of this business to a third company, to cause the abandonment of the proceedings brought by the European company to assert its right to the concessions, and to have the European company

wound up. The court, affirming Bacon V.C., held that a minority shareholder's action was properly brought in these circumstances. JAMES L.J........The defendants, who have a majority of shares in the company, have made an agreement by which they have dealt with matters affecting the whole company, the interest in which belongs to the minority as well as to the majority. They have dealt with them in consideration of their obtaining for themselves certain advantages. Hooper's company have obtained certain advantages by dealing with something which was the property of the whole company. The minority of the shareholders say in effect that the majority had divided the assets of the company, more or less, between themselves, to the exclusion of the minority. I think it would be a shocking thing if that could be done, because if so the majority might divide the whole assets of the company, and pass a resolution that everything must be given to them, and that the minority should have nothing to do with it. Assuming the case to be as alleged by the bill, then the majority have put something into their pockets at the expense of the minority. If so, it appears to me that the majority have a right to have their share of the benefits ascertained for them in the best way in which the court can do it, and given to them. It is said, however, that this is not the right form of suit, because, according to the principles laid down in Foss v. Harbottle, and other similar cases, the court ought to be very slow indeed in allowing a shareholder to file a bill, where the company is the proper plaintiff. This particular case seems to me precisely one of the exceptions referred to by Vice-Chancellor Wood in Atwool v. Merryweather, a case in which the majority were the defendants, the wrongdoers, who were alleged to have put the minority's property into their pockets. In this case it is right and proper for a bill to be filed by one shareholder on behalf of himself and all the other shareholders. Therefore the demurrer ought to be overruled. MELLISH L.J. I am entirely of the same opinion. It so happens that Hooper's company are the majority in this company, and a suit by this company was pending which might or might not turn out advantageous to this company. The plaintiff says that Hooper's company being the majority, have procured that suit to be settled upon terms favourable to themselves, they getting a consideration for settling it in the shape of a profitable bargain for the laying of a cable. I am of opinion that although it may be quite true that the shareholders of a company may vote as they please, and for the purpose of their own interests, yet that the majority shareholders cannot sell the assets of the company and keep the consideration, but must allow the minority to have their share of any consideration which may come to them. I also entirely agree that, under the circumstances, the suit is properly brought in the name of the plaintiff on behalf of himself and all the other shareholders. The appeal will be dismissed with costs.

103

ALEXANDER v. AUTOMATIC TELEPHONE CO. (1900), Court of Appeal All the subscribers to the memorandum of association of the defendant company paid 6d. per share on subscription. The five directors of the company held a meeting at which it was resolved that a call of a further 2s. 6d. per share should be made, payable upon allotment by all the shareholders except the three directors who had the largest shareholdings (about 75 per cent of the issued shares). The remaining two directors (who had in fact supported the resolution) then brought a representative action against the three directors and the company, claiming a declaration that all the shareholders were bound to pay the 2s. 6d. call. The Court of Appeal, reversing Cozens-Hardy J. granted the relief asked. LINDLEY M.R.......... The fact.... that (other) subscribers of the memorandum paid 3s. on their

shares whilst the defendants did not, is difficult to reconcile with the existence of any understanding that all the subscribers should stand on their strict legal rights. The defendants rely on clause 5 of the articles as entitling the directors to issue shares on any terms they think expedient, and to make differences between some shareholders and others. But this, I am satisfied, is an afterthought. The defendants were not in fact acting on this article at all. But, even if they were, this article would not, in my opinion, justify them in making a difference in their own favour without disclosing the fact to the other shareholders and obtaining their consent to the arrangement. The Court of Chancery has always exacted from directors the observance of good faith towards their shareholders and towards those who take shares from the company and become co-adventurers with themselves and others who may join them. The maxim `Caveat emptor' has no application to such cases, and directors who so use their powers as to obtain benefits for themselves at the expense of the shareholders, without informing em of the fact, cannot retain those benefits and must account for them to the company, so that all the shareholders may participate in them........ In the present case there is no question but that, by obtaining 3s. a share from the other shareholders and paying nothing themselves, the defendants threw upon the other shareholders a burden which they did not share themselves. It is true that by clause 121 of the article dividends were only payable in proportion to the amounts paid up on the shares; and as regards dividends, had there been any, the defendants would have been at a disadvantage. But the advantage they obtained at the expense of the other shareholders was that of deferring their own contributions to the funds of the company at the expense of the other shareholders. This, in my opinion, was a clear breach of duty, unless the other shareholders knew of it and sanctioned it............. Upon the merits of the case I come to the conclusion that a breach of duty by the directors to the company and the other shareholders in it has been established. It is necessary, however, to consider the form of the action, and the relief which can be given. The breach of duty to the company consists in depriving it of the use of the money which the directors ought to have paid up sooner than they did. I cannot regard the case as one of mere internal management which, according to Foss v. Harbottle and numerous other cases, the court leaves the shareholders to settle amongst themselves. It was ascertained and admitted at the trial that, when this action was commenced, the defendants held such a preponderance of shares that they could not be controlled by the other shareholders. Under these circumstances an action by some shareholders on behalf of themselves and the others against the defendants is in accordance with the authorities, and is unobjectionable in form: see Menier v. Hooper's Telegraph Works. An action in this form is far preferable to an action in the name of the company, and then a fight as to the right to use its name. But this last mode of procedure is the only other open to a minority of shareholders in cases like the present...... RIGBY and VAUGHAN WILLIAMS L.JJ. delivered concurring judgements.

104.

BURLAND v. EARLE (1902), Privy Council The respondents, as shareholders, sued (inter alia) to compel the directors to declare a dividend, and to obtain an account from Burland of a profit made by him out of the purchase and resale to the company of certain plant and materials. The question here discussed concerns the right of minority shareholders to sue when the alleged wrongdoers are in control. The opinion of their Lordships was delivered by LORD DAVEY............. It is an elementary principle of the law relating to joint stock companies that the court will not interfere with the internal management of companies acting within their powers, and in fact has no jurisdiction to do

so. Again, it is clear law that in order to redress a wrong done to the company or to recover money or damages alleged to be due to the company, the action should prima facie be brought by the company itself. These cardinal principles are laid down in the well-known cases of Foss v. Harbottle and Mozley v. Alston, and in numerous later cases which it is necessary to cite. But an exception is made to the second rule, where the persons against whom the relief is sought themselves hold and control the majority of the shares in the company, and will not permit an action to be brought in the name of the company. In that case the courts allow the shareholders complaining to bring an action in their own names. This, however, is mere matter of procedure in order to give a remedy for a wrong which could otherwise escape redress, and it is obvious that in such an action the plaintiffs cannot have a larger right to relief than the company itself would have if it were plaintiff, and cannot complain of acts which are valid if done with the approval of the majority of the shareholders, or are capable of being confirmed by the majority. The cases in which the minority can maintain such an action are, therefore, confined to those in which the acts complained of are of a fraudulent character or beyond the powers of the company. A familiar example is where 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, as was alleged in the case of Menier v. Hooper's Telegraph Works. It should be added that no mere informality or irregularity which can be remedied by the majority will entitle the majority to sue, if the act when done regularly would be within the powers of the company and the intention of the majority of the shareholders is clear. This may be illustrated by the judgement of Mellish L.J. in MacDougall v. Gardiner. There if yet a third principle which is important for the decision of this case. Unless otherwise provided by the regulations of the company, a shareholder is not debarred from voting or using his voting power to carry a resolution by the circumstance of his having a particular interest in the subject-matter of the vote. This is shown by the case before this Board of the North-West Transportation Co. Ltd. v. Beatty. In that case the resolution of a general meeting to purchase a vessel at the vendor's price was held to be valid, notwithstanding that the vendor himself held the majority of the shares in the company, and the resolution was carried by his votes against the minority who complained.