Contract law and business law and practice

In order for there to be a binding contract, what three conditions must be present?

• offer and acceptance

• intention to create legal relations

• consideration

Role of offeror (in offer and acceptance)

To make a clear and certain offer displaying an intention to be bound.

Role of offeree

To communicate an unequivocal acceptance.

For an agreement exist, will the court be concerned with:

a) the inward mental intent of the parties; or

b) what a reasonable person would say was the intention of the parties, having regard to all the circumstances

b) what a reasonable person would say was the intention of the parties, having regard to all the circumstances.

What two principles are established in Gibson v Manchester City Council (1979)?

a) An offer mist be clear and certain; and

b) an offeror must show an intention to be legally bound.

The Council’s letter stating that it ‘may be prepared to sell’ was not sufficiently clear and certain to be an offer, it was merely the first step in negotiations and lacked the requisite intention to be legally bound.

The court takes an objective approach to ascertaining whether there was an intention to be bound. True or false?

True.

What is a bilateral contract?

• The most common type of contract.

• Each party assumes an obligation to the other party by making a promise to do something (e.g. a promise to sell an item to the other party in exchange for a payment).

What is a unilateral contract?

• One party makes an offer or proposal in terms which call for an act to be performed by one or more other parties (e.g. for specific lost property to be returned in exchange for a reward).

• Does not involve mutual promises - only the party making the offer assumes an obligation.

• Only actual performance of the required act will constitute acceptance.

How is a bilateral contract offer accepted?

By unequivocal communication of acceptance, at which point each party would be bound to do what they promised to do.

How is a unilateral contract offer accepted?

By performance of the required act, at which point the other party becomes bound to do what they promised to do.

What is an invitation to treat?

A first step in negotiations which may or may not lead to a firm offer by one of the parties - it usually takes the form of an invitation to make an offer.

What is an offer?

An undertaking to be contractually bound by the terms of that offer in the event of an unconditional acceptance being made by the offeree.

Can an invitation to treat be accepted to form a binding contract?

No.

Invitation to treat or offer: advertisements?

Generally regarded as invitations to treat (Partridge v Crittenden (1968)).

What is the exception to the general rule of advertisements being regarded as an invitation to treat?

Carlill v Carbolic Smoke Ball Co (1893) - the general rule does not apply where the advertisement amounts to a unilateral offer.

What are the two requirements of a unilateral offer under Carlill v Carbolic Smoke Ball Co (1893)?

• a prescribed act

• a clear intention to be bound

Invitation to treat or offer: display of goods for sale?

Generally, price-marked goods displayed in a shop window are an invitation to treat (Fisher v Bell (1961)) regardless of whether the shop expressly designates that the goods are an ‘offer’.

E.g. where goods are age-limited, a trader would be obliged to sell the goods to anyone who accepted the offer (if it was not an invitation to treat).

Invitation to treat or offer: display of goods in a self-service store?

Generally, the display of goods on the shelves is an invitation to treat (Pharmaceutical Society of GB v Boots Cash Chemists (1953)).

Invitation to treat or offer: websites?

Generally regarded as an invitation to treat - equivalent to a display of goods.

What is an invitation to tender?

A requestor invites tenders (i.e. offers) from those interested in supplying the goods or services required, typically where a major item or service is being purchased.

Invitation to treat or offer: invitations to tender?

The action of inviting parties to tender is generally deemed an invitation to treat (Spencer v Harding (1870)) - the requestor can accept or reject any tender, even if it is the most competitive.

In what four scenarios may an invitation to tender be deemed an offer?

• Where the intitation to tender expressly contains an undertaking to accept the highest or lowest bid (Harvela Investments Ltd v Royal Trust Co. of Canada (CI) Ltd (1985)) - this is a unilateral contract; and

• where the tenders have been solicited from specified parties who were known to the requested party;

• where there was an absolute deadline for submission; or

• where the party requesting tenders had laid down absolute and non-negotiable conditions for submission,

  (all Blackpool & Fylde Aero Club Ltd v Blackpool Borough Council (1990)).

Invitation to treat or offer: auction sales?

• Generally, the auctioneer’s request for bids is an invitation to treat (Payne v Cave (1789)) - the bidder makes an offer which the auctioneer can accept or reject.

• Acceptance of a bidder’s offer is indicated by the fall of the auctioneer’s hammer and the offer can be revoked by the bidder at before the hammer falls (s57 SGA 1979).

What is an auction 'without reserve’?

The seller promises to sell to the highest bidder, whatever that offer turns out to be.

What contracts are formed in an auction without reserve and what are the effects of these?

• Bilateral contract - the bidder makes an offer which is capable of acceptance or rejection by the auctioneer, and determines who is entitled to the goods.

• Unilateral contract - based on the promise that the auction will be without reserve. If the goods are withdrawn from sale, there is a breach of the unilateral contract.

What is the highest bidder entitled to if goods are withdrawn from sale in an auction without reserve?

• Entitled to be compensated by the payment of damages.

• Not entitled to the goods - this is dictated by the bilateral contract for sale.

• CoA approved this approach in Barry v Davies (2000).

In what three ways can an offer be terminated if it is not accepted?

• Rejection

• Lapse

• Revocation

Can an offer be accepted once it has been rejected?

No, unless the offeror makes the same offer again.

When does a rejection of an offer take effect?

When it is actually communicated to the offeror - only then will the offeror know that they are free from the offer.

What happens to the original offer once a counter-offer has been made?

The original offer is deemed to have been rejected and cannot be subsequently accepted (Hyde v Wrench (1840)).

Will a counter-offer be accepted on the original terms or the terms of the counter-offer?

The terms of the counter-offer.

What is a request for information?

• Seeking clarification of the extent and terms of the offer, or to ascertain if the offeror would consent to changing certain ancillary aspects of the offer.

• Stevenson, Jacques & Co. v McLean (1880) - the response was not a counter-offer but rather an enquiry which did not serve to reject the offer. A binding contract was made when the claimant subsequently accepted the offer.

In what two ways can an offer lapse?

• By passage of time

• By the death of one of the parties

In what two circumstances will an offer lapse through the passage of time?

• where acceptance is not made within the period prescribed by the offeror.

• where no period is prescribed and acceptance is not made within a reasonable time (what is reasonable will depend on the circumstances).

What will happen to an offer if the offeror dies?

• If the offeree knows that the offeror has died, the offer will lapse.

• If the offeree is unaware of the offeror’s death, the offer will probably not lapse.

What will happen to an offer if the offeree dies?

The offer will lapse - the offer cannot be accepted after the offeree’s death by their representatives.

At what point can an offeror withdraw/revoke their acceptance?

At any time before acceptance (Payne v Cave (1789)) - once a valid acceptance has been made, the offeror is bound.

When does revocation of an offer become effective?

Upon actual notice of it reaching the offeree - where communicated by post, from the moment it is received by the offeree (not from the time of posting (Byrne v Van Tienhoven (1880)).

What constitutes indirect communication of revocation?

The revocation will be effective provided the offeror has shown, by words or conduct, a clear intention to revoke their offer and notice has reached the offeree.

Will a revocation be effective if communicated by a third party?

Yes (Dickinson v Dodds (1876)).

When can a unilateral offer be revoked?

At any time prior to the completion of the required act (Great Northern Railway Company v Witham (1873)).

Can a unilateral offer be revoked where the offeree has partly performed the obligation and is willing and able to complete?

Potentially not, as it would undoubtedly cause hardship to the offeree to allow the offeror to withdraw the offer. The offeror may be under an implied obligation not to revoke the offer once performance has commenced - the offeree’s acceptance and consideration for this implied promise is the act of starting to perform the required act (Errington v Errington & Woods (1952)).

Can a unilateral offer made to the whole world be revoked?

Communication of revocation is almost impossible - revocation will likely only be effective if the offeror takes reasonable steps to bring the revocation to the attention of all those who may have read the offer.

What are the full aspects to identify whether unequivocal acceptance has been communicated?

• acceptance must be in response to the offer

• acceptance must be unqualified

• it may be necessary to follow a prescribed mode of acceptance

• acceptance must be communicated

Who can accept an offer?

• The person/people to whom an offer has been made (the offeree(s)); and/or

• a third party, with the offeree’s authority.

What constitutes acceptance of an offer made to the whole world?

A valid acceptance made by any person with notice of the offer (Carlill v Carbolic Smoke Ball Co. (1893)).

What is the 'mirror image’ rule?

That acceptance must be unqualified and correspond exactly with the terms of the offer (Hyde v Wrench (1840)) - an assent which is qualified in any way does not take effect as an acceptance.

How may acceptance be communicated?

In any manner whatsoever, generally decided by the offeree.

If an offeror prescribes a certain mode of acceptance, will communication in any other manner be sufficient?

If an offeror intends that he shall be bound only if his offer is accepted in a particular manner, it must be for him to make this clear. If the offeror makes it clear that they will not be bound by any other method of communication, only acceptance by the prescribed mode of communication will suffice.

When does acceptance apply from?

The moment it is communicated.

Can silence be taken as acceptance of an offer?

No - the offeror may not stipulate that they will take silence as acceptance to bind the offereee.

What is the postal rule?

Where post is deemed to be a proper means of communication, the acceptance takes effect from the moment the letter of acceptance is properly posted, not from the moment it is received from the offeror (Adams v Lindsell (1818)).

A letter is properly posted when it is put into an official letter box or into the hands of a postal operative who is authorised to receive letters.

What transactions with directors require approval by shareholder resolution? What type of shareholder resolution does each require?

• Directors’ long-term service contracts

  • contracts which are, or may be, for a guaranteed term of more than 2 years

• Substantial property transactions

  • acquisitions or disposals by a director of a substantial non-cash asset

• Loans, quasi-loans and credit transactions

  • loans to directors, holding company directors or connected persons

All to be approved by ordinary resolution. Shareholders must be sent a memorandum of information in respect of the transaction 15 days prior to the general meeting and the memorandum must also be tabled at the shareholder meeting.

What action can be taken by shareholders to remedy issues within a company, where they don’t believe it is being run as it should be?

• Removal of directors (most commonly used in practice)

• Derivative actions

• Unfair prejudice actions

• Just and equitable winding up

What is the difference between an allotment vs transfer vs transmission of shares?

Allotment - contract between the company and a new/existing shareholder for new shares issued in return for a subscription price paid by the shareholder (purchaser).

Transfer - contract to sell existing shares in the company between an existing shareholder and a purchaser, company is not party to the contract (other than in the case of a sale of treasury shares).

Transmission - an automatic process in the event of death or bankruptcy of a shareholder.

What are the 6 steps for allotting shares in a company?

1. Check whether there is a cap on the amount of shares that the company can issue

2. Check what authority the directors need to allot the shares

• If necessary, disapplying pre-emption rights (where the share is an equity security - i.e. the dividend and/or capital payout is not capped (there is any unknown amount/amount to be determined))

1. If a new share class is being created, amending the new articles to incorporate new class rights

2. Pass board resolution to allot the shares (and likely an ordinary resolution too)

3. Any administrative matters (e.g. CH filings and updating company books)

What is financial assistance?

• A company providing financial assistance for the purchase of its own shares

• Restrictions if the target is a PLC are much more strict than for a limited company

• s678 (holdco is a PLC) and 679 (holdco is a LTD) set out the prohibitions on a company providing financial assistance for the purchase of its own shares where the target is a PLC (i.e. holdco can be PLC or LTD, target must be PLC)

• Conditional exceptions to prohibitions (s681) and conditional exceptions (s682)

FA is a criminal offence - the company and defaulting options are liable to:

• a fine; and/or

• up to 2 years’ imprisonment

What are the unconditional and conditional exceptions to the prohibitions on financial assistance, set out under s681 and 682 of the CA 2006?

Unconditional exceptions - if the transaction is:

• a distribution of the company’s assets by way of:

  • a lawful dividend; or

  • a distribution in the course of a company’s winding up

• an allotment of bonus shares

• a reduction of capital

• a redemption of shares or purchase of shares

• anything done in pursuance of a court order (sanctioning compromise or arrangement with members or creditors)

• anything done under an arrangement of a liquidator in winding up accepting shares as consideration for sale of company’s property

• anything done under an arrangement made between a company and its creditors that is binding on the creditors

Conditional exceptions (for limited companies and PLCs where (i) the company has net assets that are not reduced by giving the assistance; or (ii) to the extent that they are reduced, the assistance is provided out of distributable profits):

• where the lending of money is part of the ordinary business of the company

• the provision by the company, in good faith in the interest of the company or its holdco, of financial assistance for the purposes of an employee’s share scheme

• provision of financial assistance to enable or facilitate transactions in the target or its holdco and involving the acquisition of beneficial ownership of those shares by:

  • bona fide employees or former employees of that company (or another company in the group)

  • spouses/CPs, widows, widowers, minor children or step-children of any such employees or former employees

• the making by the company of loans to persons (other than the directors) employed by the company with a view to enabling those persons to acquire filly paid shares to be held by them by way of beneficial ownership

What is the doctrine of maintenance of share capital?

• The share capital of a company is seen as a permanent fund available to its creditors - companies are generally not allowed to purchase their own shares

• Companies may, however, buyback their own shares (or redeem redeemable shares) provided it follows the relevant procedures

In what 3 ways can a company buyback its own shares?

A buyback takes place when a company purchases its own shares from an existing shareholder, through either:

1. distributable profits

2. proceeds of a fresh issue of shares made for the purpose of financing the buyback (less common)

3. capital (private companies only, and can only be used when 1 and 2 are not available)

What is the general prohibition under s19(1) FSMA? What are the four steps to consider in relation to this?

No person may carry on a regulated activity in the UK unless he is (a) an authorised person or (b) an exempt person.

• Regulated activity = specified investment + specified activity

Steps to consider:

1. Is the investment ‘specified’ under FSMA? If YES,

2. Is the activity a ‘specified activity’ under FSMA? If YES,

3. Is the activity excluded under FSMA? If NO,

4. Does the activity fulfil:

   • the basic conditions in s327 FSMA; and

   • SRA Scope Rule 22?

If yes - exemption is possible

If no - authorisation is required

What are the 7 steps/formula for calculating income tax?

1. Total Income

2. Less available tax reliefs (interest on qualifying loans and pension contributions) = Net Income

3. Less Personal Allowance (i.e. £12,570 for those earning under £100k per annum, if over, reduce this amount by £1 for every £2 of net income above £100k) = Taxable Income

4. Split the Taxable Income into:

   • non-savings (residual amount once below 2 have been deducted)

   • savings

   • dividend income (current allowance of £500 tax-free per tax year)

     MUST BE TAXED IN THIS ORDER

5. Calculate whether personal savings allowance is available (i.e. refer to Taxable Income figure to determine tax band)

6. Apply relevant tax rates

7. Add together tax amounts calculated = Total Tax Liability

What is the formula for calculating an individual’s CGT liability?

1. Sale proceeds/market value

2. Deduct disposal expenditure (e.g. money spent getting rid of asset, such as professional fees) = Net Sale Proceeds

3. Deduct initial expenditure and Deduct subsequent expenditure (money spent purchasing asset, including fees etc.) = Total Chargeable Gain

4. Deduct carried forward or carried-across losses (e.g. any loss of value of the asset) and Deduct annual exemption (£3,000 in current tax year) = Taxable Chargeable Gain

Apply CGT to the TCG at the applicable rate - typically two rates, basic tax payer rate and higher tax payer rate.

CGT reliefs may also be applied on TCG if applicable.

What are the four main reliefs that may be applicable in respect of CGT payable?

1. Business Asset Disposal Relief - reduces higher rate of CGT for gains arising on qualifying disposals (usually where shareholders are also directors or employees of the business)

2. Investors’ Relief - reduces higher rate of CGT for gains arising on disposals of qualifying shares, subject to a lifetime limit (usually where shares are held purely as an investment

3. Rollover Relief (replacement of business assets) - defers liability to CGT, will have to pay eventually

4. Hold-over Relief (gift of business assets) - defers liability to CGT, someone will have to pay eventually

What is Business Property Relief and when may it be available?

An exemption applicable to the value of qualifying business assets, available to lifetime transfers and the death estate, including:

• a business or interest in a business (e.g. a sole trader or partnership)

• shares in an unquoted company

• shares in a quoted company

• land or buildings, machinery or plant owned by a transferor but used for business purposes by either:

  • a company or which the transferor has control, or

  • a partnership of which the transferor was a partner

The transferor must have owned the business assets for at least 2 years immediately prior to the transfer.

BPR is not available if the business consists wholly or mainly for making or holding investments.

What are the types of supply for VAT purposes?

1. Standard Rated - 20%

2. Reduced Rated - 5% (e.g. domestic heating fuel, certain energy-saving products)

3. Zero Rated - 0% (e.g. new homes)

4. Exempt - 0% (e.g. provision of insurance)

What effect does input/output tax have on VAT for HMRC’s purposes?

The business will offset input tax it has suffered (on goods/services it has purchased) against input tax it has charged customers and clients (on its own supplies) and only accounts for the difference in these amounts to HMRC.

What is Corporation Tax payable on?

Essentially a combination of income tax and CGT for companies, payable on:

• all Income Profits - income receipts, less:

  • deductible expenditure

  • capital allowances (stems from a capital purchase but is charged as income)

  • trading losses; and

• Chargeable Gains of a body corporate that arise in its accounting period - sale proceeds, less:

  • allowable expenditure

  • indexation allowance (works against effects of inflation)

  • capital/trading losses

Taxable Total Profits = the sum of a company’s profits and gains - used to determine the amount of corporation tax payable by a company.

What is the current corporation tax rate?

• 25% for companies with profits greater than £250,000.

• 19% for companies with profits no greater than £50,000.

• If a company’s profits fall between £50 - 250,000, marginal relief applies with a tapering effect.

For the purposes of corporation tax, when does a company’s financial year run from/to?

01 April - 31 March.

What is a close company?

A company under the control (i.e more than 50%) of:

• 5 or fewer participators (a person with a share or interest in capital or income of the company (e.g. shareholders and some creditors); or

• any number of participators who are also director

What is a derivative claim?

• A claim initiated by a member of a company, rather than the company itself:

  • in respect of a cause of action vested in the company itself; and

  • seeking relief on behalf of the company

• A claim may only be brought in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company

• court must give permission for the claim to continue - if it does, it will give directions for how the claim will proceed (onus is on the member to make out a prima facie case)

• Any remedy brought is granted on behalf of the company, not the member who brought the claim

What is an unfair prejudice action?

s994 CA allows a member to bring an action on the grounds that the company is being run in such a way that they have suffered unfair prejudice.

What is just and equitable winding up?

The right for a disgruntled shareholder to apply for the company to be wound up on the grounds that it is just and equitable to do so under s122 IA.

Court will need evidence that the company cannot carry on operating.

What is the difference between the profit and loss account vs the balance sheet?

Profit and loss account

• Records the income of a business throughout an accounting period, minus the expenses incurred in that period, to arrive at a profit (or loss) figure for the period

• A summary of the fortunes of a business over the passage of time

Balance sheet

• Records:

  • the net worth/net asset value of the business in the top half (i.e. the value of the assets it has - the liabilities it owes)

  • the capital invested in the business to achieve that net worth in the bottom half

• These two figures should always be the same (i.e. as the top half demonstrates how the money invested by owners, set out in the bottom half, has been used)

What are year-end adjustments?

• Transactions/modifications to the account entries on the trial balance needed to apply the ‘accruals concept’ to the preparation of financial statements

• The ‘accruals concept’ requires that:

  • all income and expenditure must be ‘matched’ to the relevant accounting period; and

  • all current obligations must be anticipated as liabilities and all asset values must be assessed to make sure they can be received through future profits in conditions of uncertainty

• The 5 types of year-end adjustments are:

  • depreciation

  • accruals

  • prepayments

  • bad debts

  • doubtful debts

What are the two methods of depreciation?

1. Straight-line method

   • most common and straight-forward

   • every year, a piece of machinery will depreciate by the same amount

   • E.g.

     • a car is worth £10k when bought and depreciates by 10% each year

     • end of Y1 = £10k - £1k (10% of £10k)= £9k

     • end of Y2 = £9k - £1k (10% of £10k) = £8k

2. Reducing balance method

   • accounts for the fact that each year, the piece of machinery will depreciate by an amount and reflecting the depreciated value from the previous year

   • E.g.

     • a car is worth £10k when bought and depreciates by 10% each year

     • end of Y1 = £10k - £1k (10% of £10k) = £9k

     • end of Y2 = £9k - £900 (10% of £9k) = £8,100

What is the year-end adjustment of prepayment?

• Arises when an expense is paid for in the current year, but all or part of the cost should be charged as an expense next year - the business has paid for something in advance during one accounting period but does not get the benefit of all or some of what it has paid for until the next (e.g. rent if paid quarterly/biannually)

• The opposite of an accrual

• If an adjustment is not made for the prepayment, the account will not be giving a true reflection of the position of the business - the profit of the business will be artificially low

What is the year-end adjustment of accrual?

• The opposite of a prepayment

• Arises when an expense has been incurred and should be charged against profit in the current year but, for some reason, by the time the accounts are drawn up, that expense has not been included in the trial balance - the business has had the benefit of something in one accounting period but will not pay for it until the next

• If an adjustment is not made for an accrual, the accounts will not be giving a true reflection of the position of the business for that year - the profit of the business will be shown as artificially high

What is a bad debt?

• Debts owed to the business that are written off because they know for certain that it is not going to be paid (e.g. where a debtor has gone insolvent, a fee reduction for services has been agreed)

• The owner of the business gives up any prospect of collecting the debt and it is removes from the ‘Receivables’ entry in the accounts

What is a doubtful debt?

• Where a business provides for the possibility that a debt/debts may not be paid

• Unlike a bad debt, the business does not write it off completely - instead makes sure that the accounts accurately reflect the fact that the business may not receive all of the money owed to it

• Two types:

  • specific doubtful debts - e.g. when a debtor is in financial trouble or is disputing its liability to pay the debt, but insolvency proceedings haven’t been started or there is a possibility that the dispute may be settled)

  • general doubtful debts - e.g. when information on a specific debtor is not known, but the business knows that the market generally is not doing well and wants to make provision in the accounts for a certain percentage of its debtors being unable to pay

How are profits from partnerships dealt with? What are the differences between accounts of a sole trader vs a partnership?

• Each partner will have their own accounts (usually a capital account (for long term capital - represents partner’s investments in partnership, cannot normally be withdrawn) and a current account (can be withdrawn at partner’s discretion, records partners shares in ongoing business profits)) and will take ‘drawings’ of profits of the partnership

• Surplus profits are distributed to partners in the following order:

  • ‘interest’ on their capital

  • ‘salaries’

  • remaining profit to be distributed according to an agreed profit share ratio

• A Profit Appropriation Statement must be completed before a balance sheet can be drawn up - shows how profits will be divided between partners

• The top half of the balance sheet will be similar to that of a sole trader

• The bottom half of the balance sheet

How are profits from companies dealt with? What are the distinguishable differences in the preparation of company accounts?

• Companies are required to prepare accounts by statute - these must be made by by the ARD

• Year-end adjustments apply as they do to other businesses

• 3 main differences in the financial statements for companies:

  • format - must take on a particular format

  • tax - profit and loss account will usually contain a statement on the tax the company will pay on its profit

  • dividends - appropriation of profit after tax, not an expense of the business

• The bottom half of the balance sheet shows Total Equity/Equity and Reserves

• Companies can make adjustments to financial statements to reflect that their assets have increased/decreased in value

What is shown on the bottom half of a company’s balance sheet?

• The company’s equity

• The called- up share capital - the amount of the nominal value of its shares that the company has required its shareholders to pay

• The company’s reserves:

  • capital reserves - cannot be distributed by way of dividend or other payment to shareholders

  • revenue reserves - distributable reserves

• The share premium account - represents the difference between the nominal value of the shares and the amount the shareholders actually paid for the shares

• A revaluation reserve - created when a company’s directors, as a matter of accounting policy, wish to show more up-to-date values of non-current assets in the accounts (e.g. property)

Where in a company’s accounts will dividends usually be shown?

In a ‘statement of equity’/’statement of changes in equity’ - also shown in the balance sheet.

What is the difference between and interim vs final dividend? What is the process for declaring a dividend?

Interim dividend:

• usually paid out ahead of a company’s release of its financial statements

• can be paid out at any point in the year

Final dividend:

• paid out after the release of a company’s financial statements

• can only be paid out once a year (after the accounts have been completed)

Process for making a distribution:

• Any company can make a distribution, provided that they have profits available for that purpose

• After financial statements have been completed, the profits generated in a given accounting period can be finally determined

• Directors will make suggestions about the dividends to be declared

• Shareholders will approve these by ordinary resolution (or as articles otherwise state)

What is a debt securrity>

• The company received money from external resources - in return for financial provided by an investor, the company issues a security acknowledging the investor’s rights

• The security is a written acknowledgement of the debt, which can be kept or sold onto another investor

• At the maturity date of the security, the company pays the value of the security back to the holder

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What is the main issue with not registering security at Companies House within the required timeframe?

The security will be void against a liquidator, administrator or creditor of the company and the monies secured by it become immediately payable.

The creditor would become an unsecured creditor and would lose all ranking privileges.

How will equity finance and debt finance effect a company’s balance sheet?

Equity

• Both the net asset value of the company AND the total equity of the company will change (both halves of the balance sheet will be affected)

• Money paid by shareholder/investor will usually be paid in cash (a current asset) - this will increase the asset value of the company in the top half of the BS

• Shares issued in the company will also increase, represented in shareholder funds as equity in the bottom half of the BS

Debt

• The net asset value of the company will not change as a result of the loan and the equity will not change (only the top half of the balance sheet will be affected)

• Cash injection from loan will be balanced by the security liability in the top half of the BS

• There will be no change in the equity of the company

What is gearing?

• The ratio of liabilities to shareholder funds (total equity in the balance sheet) - the ratio of debt to equity

• An important financial indicator for the company

• The higher the ratio of debt to equity, the more highly a company is geared

• Highly geared = can be bad, less likely to be financially stable but debt finance may also increase company investment much more than equity investment could have, doesn’t require dilution of shares through investment

• Calculated as a percentage: (long term debt (non-current liabilities) / equity (Total Equity)) x 100

What are the four tests for insolvency?

1. The Cash Flow test - an inability to pay debts as they fall due

2. The Balance Sheet test - the company’s liabilities are greater than its assets

3. Failure to comply with a statutory demand for a debt of over £750

4. Failure to satisfy enforcement of a judgment debt

1 and 2 are most commonly used.

What are the 5 main options available to directors when the company is in financial difficulty?

1. Do nothing

   • directors risk personal liability under the IA and a breach of director’s duties under the CA

2. Do a deal

   • reaching either an informal or formal agreement with the company’s creditors with a view to rescheduling debts

   • informal - standstill agreements with a view to not enforce rights for a period of time to allow the company to sort itself out

   • formal:

     • pre-insolvency moratorium (application to court, gives company temporary breathing space)

     • company voluntary arrangements (agreed by creditors and members, not binding on secured creditors, no court approval needed)

     • restructuring plans (court-sanctioned compromise)

3. Appoint an administrator

   • a collective formal insolvency procedure considering the interests of all creditors

4. Request the appointment of a receiver

   • an enforcement procedure where a creditor, or small group of creditors, act to pursue their rights and recover their debt

5. Put the company into liquidation

   • a collective insolvency procedure

What are the statutory objectives of an administrator?

An administrator must perform is functions with the objective of:

• rescuing the company as a going concern, or

• achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up, [MOST LIKELY]

• realising the property in order to make a distribution to one or more secured or preferential creditors

Schedule B1 IA 1986.

What is receivership?

• An individual enforcement procedure which benefits only the appointing creditor

• 3 types of receivership:

  • administrative receivership (rarely used)

  • fixed charge receivership - receivers are appointed by the holders of a fixed charge pursuant to the terms of the security document, to enforce security and sell assets to recover debt (most common)

  • court-appointed receivership

Receivers owe a primary liability to their appointer and a limited duty to the debtor to act in good faith in the course of their appointment.

What is liquidation?

• The process by which a company’s business is wound up and its assets transferred to creditors (and to members, if there is any surplis)

• 2 types of liquidation:

  • compulsory

  • voluntary (members’ voluntary liquidation or creditors’ voluntary liquidation)

• Company’s life is generally brought to an end automatically by dissolution

• Appointment of a liquidator terminates the management powers and fiduciary duties of the company’s directors - liquidators must act in good faith, avoid conflicts of interest etc.

• Liquidator must realise assets, determine identity of any creditors and amounts owed to them and pay dividend to the creditors on a proportionate basis, relevant to the size of the creditor’s claim

• Creditors of the same rank are said to rank ‘pari passu’

What is the statutory order of priority on a company’s winding-up?

1. Liquidator’s fees and expenses

2. Amounts due to a fixed charge creditor out of the proceeds of selling assets subject to the fixed charge

3. Other costs and expenses of the liquidation (e.g. liquidator’s remuneration, costs of pursuing litigation)

4. Preferential creditors (first tier (e.g. employee claims for unpaid remuneration, then secondary tier (e.g. Crown debt such as PAYE, NI deductions, VAT)

5. Creation of the prescribed part fund (if available) for unsecured creditors

6. Amount due to creditors with floating charges

7. Unsecured/trade creditors (including payment of the prescribed part)

8. Interest owed to unsecured creditors

9. Shareholders (rights will depend on their class of shares)

What are the two formal insolvency procedures for insolvent individuals?

1. Bankruptcy

   • A collective insolvency procedure enabling an orderly collection, sale and distribution of an insolvent individuals’ assets for the benefit of the bankrupt’s creditors

2. Individual voluntary agreements (IVAs)

   • often an alternative to bankruptcy, also a collective procedure

Both governed by the IA and Insolvency Rules 2016.

How may directors be held personally liable in an insolvency event?

• Fraudulent trading (s213/246ZA IA)

  • can be brought against any person who is knowingly party to the carrying on of any business of the company with an intent to defraud customers or for any fraudulent purpose

  • actual dishonesty must be proven for a claim for fraudulent trading to succeed

  • also a criminal offence under the CA

  • rare - high standard of proof required

• Wrongful trading (s214/246ZB IA)

  • can be brought against any person who was, at the relevant time a director

  • the court must be satisfied that, at some time before the commencement of the winding up/insolvent administration, the director knew or ought to have concluded that there was no reasonable prospect that the company could avoid insolvency

  • a director may escape liability if they can satisfy the court that they took every step (once they realised the above) to minimise the potential loss to the company’s creditors

  • court applies the ‘reasonably diligent person test’

  • a person found liable can be ordered to make such contributions to the company’s assets as the court thinks proper, and may be disqualified as a director

Directors may be held personally liable to compensate the company if found guilty of either - liquidators and administrators also have the power to bring proceedings for compensation against the directors personally

What is a voidable transaction?

• Liquidators and administrators can challenge certain transactions which have taken place within certain specified statutory periods prior to the insolvency of a company

• The aim of a challenge is to restore the company to the same position it would have been in had the transaction not taken place and thereby, increase funds available in the insolvent estate for the benefit of creditors

• Questions to ask:

  1. did the transaction involve a ‘connected person’ or ‘associate’?

  2. did the transaction take place within the ‘relevant time’?

  3. was the company insolvent at the time of the transaction, or did it become insolvent as a result of the transaction?

  4. is there a presumption available which shifts the burden of proof from the liquidator/administrator to the other party?