The
general prohibition against the provision of financial
assistance is based on the case of Trevor
and Whitworth(1887)
where it was established that a company limited by shares
could not buy its own shares since this would amount to a
reduction in the company’s capital.
Trevor
and Whitworth established the principle that returning capital
to members must be approved by the courts as a means of
protecting creditors of the company.(s658(1)
CA2006)
However,
a limited liability company may acquire its own shares if it is in
accordance with the statutory provisions of CA 2006,part 18.In other
words, redemption in accordance with ss684-689
or purchase under ss690-737.
Financial
assistance is defined broadly to cover a variety of
transactions including, financial assistance by way of a gift,
guarantee security or indemnity, release, or waiver or a loan and
so on, all of which are listed in in the provisions on financial
assistance in 677(1) CA 2006.The condition is that the transaction
be of the type mentioned and amount to financial assistance.
Firstly,
financial assistance is prohibited where it is given by a
public company or any of its subsidiaries for the
acquisition of its own shares.(s.678CA06)
Secondly,
it is unlawful where it is given for the acquisition of a
private company’s shares by any subsidiary of a private
company which is a public company.(s.679CA06).The current rule
against it is outlined in s680
CA06
. Owing to difficulties in the implementation of the Second EC
Law Directive with respective to public companies, a company law
review of the statutory provisions(ss151-158CA1985) recommended that
the provisions on financial should not apply to private
companies which have been adopted in ss 677-683 CA2006.
Although
the provision on the giving of financial assistance have been
repealed, the broader protective rules on distribution and
reduction of capital as well as the common law principle(Trevor
and Whitworth)
still remain. As Arden LJ states in Chaston
v SWP Group plc(2003)1
1 BCLC 675 at 689,there is no requirement of detriment with regard
to these elements.
Financial
assistance given by a company for the purchase of its shares can
arise in many circumstances including the acquisition of a company
by a bidder who borrows to fund the acquisition and then uses
the company’s assets once control has been secured to repay the
funding According to Arden LJ in Chaston
v SWP Group plc
“ the mischief remains the same, namely the resources of the
target company and its subsidiaries should not be used directly or
indirectly to assist the purchaser.”
The
consequences of breach are both criminal and civil. A company and
officer in default is liable to a fine and/or two years
imprisonment.(s680CA06)
Transactions
leading to a reduction in net assets of the company which cannot
be covered by distributable resources will be caught by the rules
against financial assistance.
Thus
in Heald
v O’Connor (1971)2
1 WLR 497 it was held that lending cash to a buyer of their
company which was secured by a floating charge over the companies
assets amounted to financial assistance for the purchase of the
company’s shares which was unlawful and void.’
In
Acatos
and Hutheson plc v Watson(1995)3
it was held that it was lawful for Watson’s company to buy the
assets of the sole asset holder in Acatos Ltd and that doing so did
not infringe the rule in Trevor
and Whitworth
against a company acquiring or dealing in its own shares .While in
Steen
v Law (1964)4
it was held that advancing a loan to a private company which was a
subsidiary of the target company by the appellants for the
acquisition of shares in their company amounted to unlawful
financial assistance.
The
potential scope of the prohibition is wide but the courts tend
to look at the transaction as a whole. Hoffmann J noted in
Charterhouse Investment Trust v Tempest
Diesels
Ltd(1996)5
in it is the commercial realities that are essential in deciding
whether or not a transaction amounts to financial assistance. In
addition, to the assistance being financial assistance, the
assistance must be given for the purpose of the acquisition or to
reduce or discharge a liability incurred for the purpose of the
acquisition.
The
law recognises two types of financial assistance, namely
contemporaneous financial assistance and subsequent financial
assistance.s678(1)
CA2006
covers the former while
S678(3)
CA 2006 covers the latter.In
Belmont Finance Corp Ltd v Williams Furniture Ltd
(1979)6
it was held that the principal purpose of the transaction was to
provide the defendant company with funds to acquire the
plaintiff company which breached s.678(1).
In
addition, where a person is acquiring or proposing to acquire
shares in a private company,it is unlawful for a public company that
is subsidiary of that company to give financial assistance for
the purpose of that acquisition s679(1)
CA2006
or to give financial assistance for the purpose of reducing or
discharging a liability incurred for the purpose of making the
acquisition.
One
exception is that the law does not prohibit a subsidiary
which is a foreign Company from giving assistance for the
acquisition of shares in its holding company,s679(3).
In
Arab
Bank v Mercantile Holdings Ltd(1994)7
Millett J held that s151 CA 1985 did not prohibit a subsidiary from
giving financial assistance for the acquisition of shares in its
English parent company.
Even
where the assistance is given for the purpose of the acquisition, the
prohibition
would
not apply if the company’s principal purpose in giving the
assistance is not for the purpose of making any such acquisition
or the giving of the assistance for that purpose is incidental to
a larger purpose and that the assistance is given in good faith
in the interests of the company. The larger purpose exceptions
are outlined in ss678(2)
(4) and 679(2)(4)
CA06
.A breach of the provisions is a criminal offence.ss680(2)CA06.
The
conditional and unconditional exceptions to the rule are
outlined in
ss681 and
682CA
06
respectively. The conditional exceptions are that either the company
giving financial assistance(f/a) is a private one or if public
the net assets are not reduced by the giving of f/a or the
assistance is provided out of distributable profits. The
unconditional exceptions include dividends lawfully made, bonus
shares, reduction of capital under s641,
redemption under s684
or
purchase of shares under s.690.
The
scope of the larger purpose defence has been reduced by
the House of Lords decision in Brady
v Brady(1989)8
where it rejected the decision of the High court and court
of Appeal that financial assistance as part of a larger
company reorganization to resolve the conflict between two
brothers who controlled it and avert the imminent liquidation
of the company fell within the exception. It stressed that the
larger purpose must be something more than why the
transaction was entered into.The transaction did not fall
within the larger purpose exemption but
specific
performance was granted as it fell within the private
company exemption for providing financial assistance within
ss155-158CA
1985.
One
implication of the narrow interpretation in
Brady v Brady
is that it is difficult to determine what circumstances will
fall within the exemption.
Secondly,
s680
CA 2006
has abolished the provision of financial assistance only for
private companies but has retained it for public companies.
In
conclusion, the statement is true to the extent that the
prohibition against the giving of lawful financial assistance
only affects public companies.
The
statement is valid to the extent that private companies are
exempted from s678(1).Furthermore,
where there are a combination of private and public companies it
is the nature of the relationship between them as well as the
mechanics of the transaction as a whole that is decisive.
Nevertheless, on account of the severe restrictions placed on
the application of the purpose exceptions by the decision in Brady
v Brady it may be difficult for public companies to apply this
exemption in concrete situations, notwithstanding the fact that
lawful financial assistance is allowed for public companies under
certain circumstances.
2.
a)Zed
Ltd is the target of a compulsory winding up or
liquidation(s124IA
1986)
where the company gives up its business, sells off its
assets, pays its debts and distributes whatever whatever surplus
remains amongst its members or otherwise as its constitution
may provide. The granting of a winding up order on 18
December 2011 means
Zed
Ltd owes the creditor at least £750,has been served with
a written demand which it has failed to satisfy after 21
days(s123(1)(a)
or there has an execution or a judgement in his favour
(s123(1)(b)
or Zed is unable to pay its debts as they fall
due(s123(1)(e)
or the value of the company’s assets is less than its
liabilities(s123(2)(balance
sheet test.)
Under
s238 IA86 transactions at under value means the
company makes a gift to a person or enters into a transaction
for which it gets no consideration, or
the
company enters into a transaction with that person for a
consideration the value of which, in money or money’s worth, is
significantly less than the value, in money or money’s worth, of
the consideration provided by the company.
The
gift of a minibus breaches s238I(4)A86
because it is made within the relevant period which is two
years before the presentation of the petition and amounts to
a transaction undervalue..Under 129(2)IA86 August 1 is the date
for the commencement of the winding up (Blight
Builders Ltd,2008)9
The
court on the application of the liquidator may make such an
order as it thinks fit to restore the pre-transaction
position.In Phillips
v Brewin Dolphin Lawrie Ltd (2001)10
the sale of BD’s shares to a bidder was undervalue.The
consideration paid under the agreement was the value of the
shares(valued by the court at £1,050,000 less than the amount
of the redundancy payments paid by BD(£325,000) resulting in
transaction at an undervalue amounting to £725,000.While in
ReMC
Bacon
Ltd(1990)11
the liquidators’ argument that the granting of a floating
charge to secure an overdraft was a transaction under value
failed.
However,under
s238(5) transactions made in good faith for the purpose of
the business and in the reasonable belief that Zed would
benefit would not be invalid.The sale of a machine for £10,000
that was worth £9000 is unlikely to be challenged by the
court because the parties were unaware of the petition.Factors
that the court takes into account in approving a transaction
include whether or not the transaction was made in good
faith and if Zed obtain full market value or more for the
asset.
S423
IA1986
also covers transactions at an undervalue(as defined in
s238IA86).There
is no time limit for the liquidator to make an
application for a court order for restoring the pre-transaction
position. The difficulty here is that the liquidator must
show that the aim of the transaction was to put assets
beyond the reach of creditors or otherwise prejudicing their
interests.| s238 would be more appropriate because the
liquidator need not prove that there was an attempt toplace
assets beyond the reach of beyond the reach of creditors,
Furthermore,
the liquidator would be advised that in order to preserve the
property of Zed any dispositions of Zed’s property under
the relevant period is void unless the court otherwise
orders(s127IA86).
The
issue here is whether or not the sale of the machine
amounts to a disposition within the meaning of s127IA86.In Re
Gray’s Inn Construction Co Ltd(1980)12
the court of Appeal held that the transactions which were
challenged were dispositions within the meaning of s127 and
were void.However,Buckley LJ noted that a disposition carried
out in good faith when the parties are unaware that a
petition has been presented may normally be validated by the court.
b)Janice
as director of Zed is a connected person.
The issue here is whether the creation of the floating charge
amounts to a preference within the meaning of s239IA86 with the
effect of putting Janice in a better position in the event of
the company going into insolvent liquidation(s239(4)IA86.Such a
desire is presumed unless rebutted in the case of Janice since
he is a connected person.(s239(6).
The relevant time for floating charges for connected persons
is two years before the onset of insolvency.Thus,the creation of
the floating charge on8 Nov 2009 fell within the relevant time
and is invalid .The
liquidator would be advised to make an application to the
court for restoration of the pre-preference position.In
Power v Sharp Investments
Ltd(199313)BCC
609 the liquidator was successful in setting aside the
creation of a floating charge .The charge has been registered
with the Registrar of companies in line with s870CA06 but not in
Zed’s own charges register in breach of s876(1) which is a
criminal offence punishable by a fine(s876(4)CA06 but
nonregistartion in this case does not affect the validity of the
charge against liquidators.
In Re
Fairway Magazines14
(1993)
it was held that the applicant who was a director of the
company was only motivated by a desire to raise money
quickily.While in MC
Bacon Ltd (1990)15
it was held that there was no preference; the directors
were influenced by a desire to stay in business not by a
desire to improve the bank’s position as required by s.239.
The
liquidator would be advised that the creation of a floating
charge did not amount to a transaction undervalue within the
meaning of s238IA86 because doing so did not did not diminish or
reduce the assets of the company.(
ReMC
Bacon
Ltd(1990)In
Paramount Airways
Ltd
(1991)16
an administrator was able to claim in respect of funds paid
into
a
bank account in Jersey.
c)
The liquidator would be advised that an application under
fraudulent trading(FT;s213IA86)
and wrongful trading(WT;s214IA86)
if successful creates personal liability and can form the
basis for the summary remedy outlined in s212IA86
which
is available to the liquidator on application to the court.
The court can compel the directors to repay, restore or
account for money or property lost to the company as a
result of breaches of their duties under ss171-177CA06
by invoking s212(3)IA86
which is another way of swelling the company’s assets. In Re
Kudos Business Solutions
Ltd
(2011)
A sole shareholder and director of a company was guilty of
misfeasance, breach of trust and wrongful trading through allowing
the company to pay away advance payments made by its customers for
services which the company was never in a position to provide.
With
regard to WT it is not necessary to show fraud or dishonesty. What
may amount to negligent disregard of the interest of creditors is
sufficient. While dishonesty is an essential factor in fraudulent
trading. An intent to defraud must be established in FT.In Re
White & Osmond(Parkstone)Ltd
Buckley J stated that “what was wrong was allowing the company
to incur debts when it was clear that it would never be
able to satisfy creditors.”
Secondly,
both are exceptions to the corporate veil. An application from the
liquidator under s213IA86
creates a parallel liability under 993CA06.
Thirdly,
only a director can be liable for WT since it is basically
a negligent failure of managment.While any person knowingly a
party to fraudulent trading may be liable for FT; WT in itself
is not a crime, proceedings in this case are purely civil and
the court may decide to disqualify a director under s10
of the Company
directors
disqualification act(1986);
the sanctions include an order requiring the director
concerned to contribute to the assets of the company and
disqualification of the director ;while FT creates criminal
liability in s993CA06.
In
addition, the provisions relating to WT are confined to conduct
after the point of no return when the director concerned knew or
ought to have known that there was no reasonable prospect of
the company avoiding insolvent liquidation; while in FT, the
whole period of trading is relevant.
Furthermore,
the provisions relating to FT are directed against the improper
incurring of new debt where there is no reasonable prospect of
being paid; while the WT provisions are designed for the
protection of past as well as future creditors.WT applies mainly to
insolvent liquidation while FT applies to both solvent and
insolvent liquidation.
In
Re
Maidstone Building Provisions Ltd
(1971)17
the issue before the court was whether the company secretary was
party to carrying on company business with intent to defraud
creditors. The secretary who was also the company’s
financial advisor was held to be liable for FT by failing to
inform the directors that the company was insolvent and needed
to stop trading.While in Re Gerald
Cooper(Chemicals)Ltd
(1978)18
the director of the company and the directors of a loan
company were held liable for FT when they accepted payment from
money he had received from a customer to supply indigo in the
run up to liquidation when his company had no supplies of
indigo. In Re
Produce Marketing Consortium Ltd
(1989)19
,two directors were held liable for wrongful trading and
jointly and severally liable to make a contribution of £75,000
towards the assets of the company; they could not rely on the
‘every step’ defence in
s214(3)
as the evidence was that they had not limited their trading
activities to selling the perishable stock in the companies store.
Also, in Re
Purpoint Ltd(1991)20BCC
121 the director of a printing company was ordered to pay a
contribution of £53,572 towards the assets of the company for
WT because he ought to have known at the latest May 1987
that there was no reasonable prospect of avoiding liquidation
when he was warned by auditors about trading while insolvent.
In
Blin
v Johnstone (1988)21
a director was held liable for breach of trust and
misapplication of funds for receiving payment above his normal
salary when he knew the company was insolvent.
The
liquidator would be advised that the summary remedy means
s212IA86
allows him to make an application using
ss213 and 214IA86
as grounds to demand civil and criminal sanctions against the
Zed directors which if successful creates personal liability.
One difficulty would be establishing dishonesty in relation to
s.213IA
beyond reasonable doubt. But that would be at the discretion of
the court. It would be easier for
the
liquidator to use the s214 on WT where he only needs to identify
the point at which it was wrong for the directors to continue
trading knowing that liquidation was unavoidable.
under
s238(5) transactions made in good faith for the purpose of
the business and in the reasonable belief that Zed
would benefit would not be invalid. There is a defence available
to the directors if they can show that they acted honestly under
1157CA06.
If successful the court may excuse their unlawful conduct.
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