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Structure: Analysis, Legal rules and Application Introduction and General Analysis   Abbey Limited has three directors, Jo, Keira and Lin who hold the shares equally. The main objective of the company is to import exotic fruit from Malaysia. To diversify, a subsidiary company, Baja Ltd was set up with equal shareholding to import dried fruits from Africa. Baja Ltd is in financial difficulties and its Board decided to turn down a contract from Zylo Ltd to import wooden bowls although Lin wanted to go ahead with it. Lin takes the contract over and sets up a small business without disclosing this to other directors. Baja Limited’s auditors have told the directors that the company is in bad financial position and its creditors want Abbey Limited to pay its debts   A company has a separate legal entity from its owner and has its own debts and liabilities and own property in its own name. As a consequence a subsidiary’s debts and obligations are not generally being enforceable against its parent company. However, only in certain circumstances courts will be prepared to “lift the veil of incorporation”[1] to establish who is hiding behind the legal personality of a company. Under the new proposals for “Modernising Company Law” white paper which contains important proposal with regard to a contract which a company itself is unable to accept due to lack of resources for example, then a director may be able to take that contract personally for his own benefit. This allows directors to make full use of information, property etc which belong to the company for their own benefit without the consent of the shareholders and members provided they obtain the authorisation from the Board of Directors to do so. The important difference here which must be noted is, in case of private companies, the board of directors will have such powers to authorise a director to exploit a corporate opportunity like that unless it has been expressly denied in the company’s constitution. On the other hand, in case of Public limited companies, the board of directors will not have such powers bestowed upon them as they need authorisation from the shareholders first unless a specific provision to authorise such transaction has been made in the company’s constitution.   1. Baja Ltd is a creditor of a Subsidiary company of Abbey Ltd, who is in financial trouble does this makes the parent company liable for its debts? 2. Was the behaviour of other two directors prejudicial to her as a minority shareholder? 3. Can Lin be prevented from taking the contract rejected by the Company? 3. The procedure to remove a director The object clause of the company states, to import exotic fruits from Malaysia which is very specific to its business, therefore any acts beyond those set out in its object clause would be ultra vires. However, generally object clauses are drafted so widely which covers every possible business and activity a company may wish to carry out. Therefore, the company’s decision to diversify in to import of dried fruit market is unlikely to be ultra vires. In addition to this under the new proposals[2] the doctrine of ultra vires does not exist. As a subsidiary of Abbey Limited, Baja Limited will have a separate legal personality from it parent company. Thus the parent company, Abbey limited will not be liable for the debts and obligations of the subsidiary, Baja Limited, beyond the amount of the subsidiary’s share capital. In this case, all directors hold equal share holding in Baja Limited and therefore their liability is limited to the amount of share capital of Baja Limited. However, this is based on an assumption that none of the directors have given any express guarantee or indemnity for Baja Limited’s debts. If it can be established that one party, the Abbey Limited and its directors, are responsible for encouraging other party, its subsidiary, unlawfully to break its contract with the third party that is its creditors and not pay, then the Abbey Limited would be held liable to the third party, Baja Limited’s creditors, for its damages arising out of the breach. Clearly company has arranged its corporate structure in such a way as to limit its financial exposure. Under normal circumstances the parent company or the other subsidiary will not be liable for the debts of the other subsidiary with certain exceptions. The courts will only impose liability on parties involved in the contract other than the company itself, if it has a substantial proof of fraud. However, in Stoczina Gdanska SA V Latvian Shipping Co & Others[3] there was no direct contractual relationship between the parent company and the third party therefore the claim was brought under tort. In “CMS Dolphin Ltd v Simonet[4] it was held by Lawrence Collins J that a director was liable for breach of fiduciary duty in diverting a business opportunity from his company although the director in question had left the company. However, even after leaving the company a director’s fiduciary duties continue and therefore he may not divert business opportunities from the company or misuse information while he was acting as a director of his previous company. In this particular case the director took all the company’s staff and its main clients with him and set up in business on his own”. It has been established in certain cases by the courts that a holding / parent companies with subsidiaries, were in fact carrying on business through the agency of their subsidiary companies. Although this was only found in a case where the business activities of those subsidiaries were closely controlled and directed by the subsidiary companies and therefore the latter can be considered as merely an agent carrying on that holding or parent company’s business. It should be noted that if a subsidiary company is acting as an agent of its parent company then it is likely that it may be liable for the same rights and liabilities of its holding company. However, no subsidiary company has been held responsible for its holding company’s debts. In Smith Stone and Knight Ltd (“SSK”) v Birmingham Corporation” (BC”)[5] a subsidiary owned by SSK carried out a business activities from a piece of land owed by SSK. A compulsory purchase order was issued by BC. A compensation for loss of business was to be paid to the company and its owner. However, the subsidiary company did not own the land, BC refused to pay any compensation. It was held that the subsidiary company was an agent of SSK and therefore BC must pay compensation. Advice: 1) Baja Limited is a creditor of a subsidiary in which the company holds 100% shares. The Company holds 100% shares in Baja Limited the subsidiary company and you are the directors in both companies with equal shareholding, it is possible that the courts may decide to lift the corporate veil and impose liabilities for subsidiaries debt on you. This situation may occur especially if you ignore the warnings issued by the Auditors of Baja Limited that the company is in a very bad financial position and you carry on trading regardless. 2) Lin as a director of the company is in a fiduciary position and therefore must not make an undisclosed profit using her position as a director. The fact that she was only approached by Zylo Limited because of her position as a director of the company She must have disclosed this to other directors, Jo and Keira. The fact that Baja Limited was unable to take on the contract due to its ailing financial position and therefore could not obtain the benefit of that contract is immaterial. It would have been better to obtain consent from the company in a General meeting to take that contract and keep the profits before actually taking the contract. Furthermore, if Lin does take the contract and makes profit then she would have to account those profits to the company. In Boston Deep Sea Fishing Co v Ansell[6] A was one of the directors of B Co was paid a commission on the contract by the shipbuilders. A was also a shareholder of an Ice company who was supplying ice to the B Co. A received a bonus when he employed Ice Company in respect of B Co’s fishing smacks. It was held that A must account to B Co for the commission and the bonus he received although B co could not have received any bonus from the Ice company as it was not a shareholder in that company. Therefore, Jo and Keira may either prevent her from taking the contract by her stating that there is a conflict of interest[7] and that this must be recorded in the minutes in detail so that there is no suspicion of secret dealings. On the other hand, they could approve her involvement with Zylo Limited but insist that Lin must account to the Company Baja Limited any profits she makes as required by law. 3) The Articles of a company does not create a contract between the company and the directors. There is no information as to when company was incorporated to determine how long Lin has been a director of the Company. Also there is no information as to whether there is any provision in the Articles with regards to her directorship or service contract, if any, or whether or not it has been renewed. Therefore, the provisions of section 319(6) may apply which means either party (the company or herself) on giving reasonable notice may terminate her employment. The question is, whether reasonable amount of notice has been given to her. Any director can be removed from their office by an ordinary resolution of the members.[8] Therefore, in order to remove Lin as a director of the company a resolution in general meeting with a simple majority is needed and this applies notwithstanding the contrary provisions in the company’s Articles. However, with a majority of votes, whether that majority is on a resolution for his own removal from the office[9] a director may become virtually irremovable. If on the other hand, a director with a service contract with the company but does not have majority vote on a resolution to remove him from the office may be entitled to a substantial compensation for loss of office. If a director is removed in such a way he or she may be entitled to compensation for unfair dismissal. The procedure for removal of a director is set in section 303 of the Act, which provides for an ordinary resolution, that is, by majority of votes in the general meeting a director can be removed from his or her office. However, if the directors are the major shareholders then the minority shareholders have very limited rights to object the way the majority directors are running the affairs of the company. If the director is removed from the office it terminates any service contract it may have with the company. The amount of damages the director may be able to claim usually depends up on the remuneration package under his contract with the company. It is not clear whether or not Lin, as one of the director of the company, has a Directors’ Service Contract. If she has then it depends how long her appointment as a director is to last. If say, for example her appointment is for 5 years, that is the maximum term without shareholders approval a director could have, then a set procedure as set out above needs to followed in order to remove her as a director of the Company. Bibliography and References 1. Business Law and Practice by Scott Slorach & Jason Ellis published by Blackstone press. 2. Business Law by Stephen Judge, second edition published by Macmillan law masters. 3. Company Law, by Charles worth & Morse 16th Edition published by Thomson, Sweet & Maxwell. 4. Gower & Davies’ Principles of Modern Company Law 7th Edition, by Paul L Davies published by Thomson, Sweet & Maxwell 5. www. Nortonrose.com/articles 6. Department of Trade & Industry web site: Modernising Company law White paper 1

Footnotes

[1] Salmon v Salmon, 1897 [2] Proposed White paper on Company Law [3] 2001, 1 Lloyds Law Rep 537 [4] 2002 BCC 600 [5] [1939] 4 All ER 116, Gower and Davies’ Principles of Modern Company Law, 7th Edition, page 182 [6] 1888 ch D 339 CA, Company Law, by Charles worth & Morse page 275-276 [7] Section 317 Companies Act 1985 [8] Section 303 Companies Act 1985: [9] See Bushell v Faith, 1970 AC 1099
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