Shareholders and Directors

Question 1

A company (the first company) has three directors: the managing director, the finance director and the purchasing director. Last year, the company entered into a transaction with a second company to purchase goods under the terms of five-year supply contract.

Last week, the finance director’s husband acquired a majority shareholding in the second company.

Which of the following statements correctly summarises the duty of the finance director?

A-The finance director must declare his interest in the transaction under section 175 of the Companies Act 2006, and seek the approval of the board to the purchase by his husband.

B-The finance director must declare his interest in the transaction under section 177 of the Companies Act 2006, and will be in breach of duty to the first company if he fails to do so.

C-The finance director must declare his interest in the transaction under section 177 of the Companies Act 2006, and will commit an offence if he fails to do so.

D-The finance director must declare his interest in the transaction under section 182 of the Companies Act 2006, and will be in breach of duty to the first company if he fails to do so.

E-The finance director must declare his interest in the transaction under section 182 of the Companies Act 2006, and will commit an offence if he fails to do so.

Answer 1

Option E is correct. The transaction concerns the director’s interest in an existing transaction or arrangement (CA2006, s.182), in respect of which a breach of the obligation to disclose the nature and extent of the director’s interest is an offence.

Options B and C are wrong because the transaction concerns an existing, rather than a proposed, transaction or arrangement (CA2006, s.177).

Options B and D are wrong because the obligation imposed by CA 2006, s.182 gives rise to an offence if breached, rather than being a breach of a duty to the company.

Option A is wrong because CA2006, s.175 does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company, which the finance director’s conflict does; and the approval by the board is therefore irrelevant.

Business Law Manual paragraphs 3.16 and 3.20

Question 2

A woman holds 4% of the shares in a private company. The other 96% of the shares are split equally between three men who are also the company’s directors. Last year, the company entered into a transaction with a partnership in which the finance director had an interest. The finance director failed to disclose their interest in the transaction at the time it was entered, and only did so afterwards. The two other directors have no conflicting interest and are unconnected with the finance director. They are of the view that the transaction was beneficial to the company. The breach of duty was purportedly ratified at a valid meeting attended by all of the shareholders, at which only the woman voted against the ratification. The woman wishes to commence a derivative claim. (derivative claim is legal action brought in relation to a company director for a breach of duty, usually by shareholders. It may be brought if the director is believed to be negligent or has breached duty or trust)

Which of the following statements concerning the claim is correct?

A-The ratification of the breach of duty will not be valid if the finance director voted at the meeting at which it was passed.

B-The woman can bring a derivative claim only if she can establish that the finance director is in breach of an actionable duty to her.

C-The woman does not have sufficient shares to bring a derivative claim.

D-The court must refuse permission to continue the claim as the breach of duty by the finance director has been ratified.

E-The court must strike out the claim as the woman has standing to bring an unfair prejudice petition against the company.

Answer 2

Option D is correct: under the Companies Act 2006, section 263(2), permission to continue a derivative claim must be refused if the court is satisfied where the act or omission giving rise to the cause of action has been ratified by the company.

Option A is wrong, because it does not matter that the finance director voted in favour of the ratification, if the decision would have passed without their votes (Companies Act 2006, section 239(4)).

Option B is wrong because the cause of action must be one vested in the company.

Option C is wrong, because there is no minimum shareholding requirement to bring a derivative claim, so.

Option E is wrong, because the fact that a party may bring unfair prejudice proceedings as an alternative to a derivative claim is a factor which may be taken into account by the court in deciding whether to give permission or to refuse it, but there is no requirement to refuse the claim where this possibility exists.

Business Law Manual 2.9.3.2

Question 3

Which of the following statements best explains the position in relation to the directors of a company?

A-Non-executive directors are employees of the company.

B-A company cannot have only one director as it will not be able to hold a board meeting.

C-A company cannot be a director of another company.

D-A non-executive director has the same duties and liabilities as an executive director.

E-Every company must have a mixture of executive and non-executive directors.

Answer 3

Option D is correct. A non-executive director is subject to the same rights and responsibilities as an executive director. If a company acts wrongfully or illegally, all directors may be held liable.

Option A is wrong as non-executive directors are appointed to the board but will not have a service contract and so are not employees of the company. Most executive directors will have contracts of employment and so will also be employees of the company.

Option B is wrong as private companies need only have one director, although a public company must have at least two (s.154 CA 2006). Many small companies are single-director companies. Article 7 MA expressly provides that many of the rules relating to board meetings do not apply to single-director companies.

Option C is wrong as (currently) a company can be a director. A company must have at least one director who is a natural person (s.155).

Option E is wrong as there is no requirement for a company to have non-executive directors on the board. They are more suitable for larger companies, and most small private companies will not have any non-executive directors on the board.

Question 4

A private company limited by shares proposes to grant a service contract (‘the Contract’) for a fixed term of three years (‘the Term’) to an existing non-executive director. The contract contains the following clause (‘the Clause’):

“6. The Company may not terminate the Contract before the expiry of the Term except:

6.1 if the Director is guilty of gross misconduct affecting the business of the Company.”

The Company has unamended Model Articles. There are six shareholders.

Which of the following best states the procedure for granting the Contract?

A-The Contract may be granted by board resolution as the Clause provides for early termination of the Contract.

B-The Contract must be granted by ordinary resolution of the shareholders.

C-The Contract must be granted by special resolution of the shareholders.

D-The Term must be approved by ordinary resolution of the shareholders.

E-As the director is presently a non-executive director, he is not entitled to be granted the Contract.

Answer 4

Option D is correct. The Contract is for a guaranteed term of more than two years and can only be terminated for a specific reason therefore it requires an ordinary resolution of shareholders to approve the Term (s 188 CA 06) so that the board can then grant the Contract.

Option A accordingly is wrong. The Term must be approved by the shareholders.

Options B and C are not the best answer as the shareholders only approve the Term; they do not grant the Contract.

Option E is wrong as a non-executive director can be granted a service contract to become an executive director.

Question 5

A private limited company is proposing to buy some new IT equipment from an IT supply company owned by the daughter of one of its directors. The other directors of the company are not aware of this connection. The board of directors are proposing to enter into this transaction at the next board meeting. The company has adopted the Companies (Model Articles) Regulations 2008 (MA) with one amendment, being the disapplication of MA14, as its articles of association. Directors, therefore, are able to count in the quorum and vote at board meetings despite their personal interest.

Is the director under a duty to make a declaration of interest before the company enters into the transaction to buy the IT equipment?

A-No, because the director is not directly interested in the proposed transaction and the interest cannot be reasonably be regarded as likely to give rise to a conflict of interest.

B-No, because MA14 has been disapplied, the director does not have to declare his interest as he is able to vote and count in the quorum at the board meeting.

C-Yes, because the director is indirectly interested in the proposed transaction and the other directors are not aware of this interest.

D-No, because this is a personal interest that conflicts with the interests of the company, which should be approved by the directors passing a board resolution before the transaction is entered into.

E-Yes, because MA14 has been disapplied and the other directors are not aware of this interest.

Answer 5

Option C is the correct answer because the director has an indirect interest in the proposed transaction and the other directors are not aware of this interest and so he is under a duty to declare this interest (s177 Companies Act 2006).

Option A is wrong because the duty to declare an interest in a proposed transaction relates to both direct and indirect interests and the interest is likely to give rise to a conflict of interest.

Option B is wrong because even though MA14 relates to directors’ interests, disapplication of it does not constitute an exception to the duty to declare a direct or indirect interest in a proposed transaction with the company.

Option D is wrong because this is an interest in a proposed transaction with the company not an interest which conflicts with the interests of the company which can be authorised by the other directors (s175(3) Companies Act 2006).

Option E is wrong because it is a director’s duty to declare an interest in a proposed transaction with the company and the obligation to comply with this duty is set out in statute not in the company’s articles (s177 Companies Act 2006). It has nothing to do with the disapplication of MA14.

Question 6

A private limited company is trading as an organic fruit and vegetable supplier. The company has adopted the Companies (Model Articles) Regulations 2008 (unamended) as its articles of association. There are two directors, who are also shareholders, and four shareholders in total. Each of the four shareholders has a 25% shareholding in the company.

Which of the following best describes respective decision-making obligations of the directors and shareholders within the company?

A-Whenever a decision is to be taken by the directors, at each board meeting, the directors will need to declare that they are also shareholders in the company.

B-In order to pass any shareholder resolution, at least three of the shareholders must vote in favour.
selected

C-The directors will need to unanimously agree every decision, otherwise the resolution will fail.

D-The shareholders do not need to declare any personal interests when they vote at general meetings.

E-The directors and shareholders will need to be involved in all decisions that affect the company.

Answer 6

Option D is the correct answer because the directors are subject to duties that are owed to the company, which include the duty to declare an interest in a transaction with the company. However, the shareholders are not subject to the directors’ duties.

Option A is wrong because the directors who are also shareholders in the company and not required to declare this at board meetings. Directors are required to declare an interest in a proposed transaction with the company to the other directors (s177 Companies Act 2006).

Option B is wrong because, at general meetings, resolutions are passed if the appropriate majority is reached by those present and voting. The quorum for a general meeting is two shareholders. Therefore, if only two of the shareholders attend a general meeting and both vote in favour of a resolution, it will pass. The same principle applies if any shareholders abstain on a vote.

Option C is wrong because the directors’ decisions taken at board meetings are passed by simple majority.

Option E is wrong because most decisions within the company will be taken by the board of directors alone, some decisions will be taken by the shareholders alone and some matters will require decisions by both the directors and the shareholders.

Question 7

The client is a manufacturing company with three directors, an IT director, a managing director and an operations director. The client has the Model Articles with no amendments and its net asset value is £95,000. The IT director has 49% of the shares in a distribution company. The IT director wishes to sell a van to the client for £6,000 and the distribution company wishes to purchase a warehouse from the client for £80,000.

Assuming that there are no agreements in place and no relevant resolutions have been passed, which of the following best describes what shareholders’ resolutions the client would need to pass in order that the transactions described above could validly go ahead?

A-An ordinary resolution to authorise the sale of the warehouse.

B-Two ordinary resolutions, one to authorise the sale of the warehouse and one to authorise the purchase of the van.

C-An ordinary resolution to authorise the purchase of the van.

D-A special resolution to authorise the IT director’s involvement in the purchase of the warehouse.

E-A special resolution to authorise the IT director’s involvement in the purchase of the warehouse and two ordinary resolutions, one to authorise the sale of the warehouse and one to authorise the purchase of the van.

Answer 7

Option A is correct. The purchase of the van does not need to be authorised by the shareholders because its value is less than £100,000 and less than10% of the client’s net asset value of £95,000. The sale of the warehouse is a substantial property transaction (‘SPT’) and therefore does need to be authorised by the shareholders, by ordinary resolution under s 190. It is an SPT because:

 It is a transaction between the company and a person connected to the company (the distribution company, because the IT director owns over 20% of the shares in the distribution company);

 It involves a non-cash asset (the warehouse); and

 It is of substantial value (over £5,000 and over 10% of the client’s net asset value of £95,000)

The IT director’s involvement in the sale of the warehouse does not need to be authorised as a separate issue from the ordinary resolution to authorise the sale of the warehouse.

Question 8

A client is Finance Director of a construction company, which has Model Articles of Association for private companies with no amendments. There are two other directors. The company is proposing to buy timber worth £2,000 from a timber company. The client’s brother owns all of the shares in the timber company. The client has told the other directors about this.

A board meeting has been called to approve the terms and enter into the timber contract.

Which of the following statements best reflects the position concerning the client’s duties as a director at the board meeting?

A-As the client has an interest in the timber contract, she must make a declaration of interest.

B-As the client has an interest in the timber contract, she can ask the board to authorise her to count in the quorum and vote.

C-Although the client has an interest in the timber contract, she can count in the quorum at the board meeting but cannot vote on the timber contract.

D-The client need not make a declaration of interest, but she cannot count in the quorum at the board meeting or vote on the timber contract.

E-As the client herself does not own any shares in the timber company, she does not need to declare her interest in the timber contract.

Answer 8

Option D is correct. The general rule under s.177(1) of the Companies Act 2006 is that where a director has an interest in a transaction with the company, she must declare her interest. However, under s.177(6)(b) where the other directors are aware of the interest, there is no need for a declaration – but it is still good practice to do so.

Option A is therefore wrong.

Option B is wrong as the directors cannot authorise the client to count in the quorum and vote. The client has an interest in a proposed transaction. This is not the same as a conflict of interest, where authorisation is possible.

Option C is wrong as under Model Article 14 the client cannot vote or count in the quorum.

Option E is wrong. s.177 applies whether the interest is direct or indirect. Here it is likely her brother will profit from this relationship and contract.

Question 9

A client is a director of a dog grooming company. There are two other directors, an Operations Director and a Finance Director. Recently, the Operations Director married a property developer, who she met on the internet. The other directors were surprised when she told them of the marriage. They did not attend the wedding, know very little about the property developer and do not know that he has a daughter.

A board meeting has been convened to approve the terms of, and enter into the contracts, for:

The purchase of office premises from the property developer;
The sale of a field to the property developer’s daughter;
The award of a two year service contract to the Finance Director;
The purchase of dog grooming equipment for £50 from a company in which the Finance Director’s wife has shares.
The company has Model Articles for private companies limited by shares unamended.

Which of the following circumstances best reflects the position in relation to declarations of interest at the board meeting?

A-The Operations Director must declare her interest in the contract for the purchase of the premises.

B-The Operations Director must declare her interest in the contract for the sale of the field.

C-The Finance Director must declare his interest in the service contact.

D-The Finance Director need not declare his interest in the contract for the purchase of the grooming equipment as the contract is for less than £100.

E-The two directors must declare interests in the proposed transactions as otherwise they will be guilty of a criminal offence.

Answer 9

Option B is correct. On the facts, it appears that the other directors are unaware that the property developer has a daughter. The connection (step-daughter) is close enough that the Operations Director should declare her interest as required by s.177(1) CA 2006.

Option A is wrong as under s.177(6)(b), there is no need for a director to declare an interest where the other directors are aware of it. They know that she has married the property developer. Nevertheless, it is good practice for a director to declare known interests.

Option C is wrong. This is covered by the exception in s.177(6)(c) as it relates to the Finance Director’s service contract. Nevertheless, it is good practice for a director to do so.

Option D is wrong. The size of the transaction is not a relevant factor.

Option E is wrong. It is not a criminal offence to fail to make a declaration of interest in a proposed transaction. (This contrasts with s.183, where it is a criminal offence to fail to make a declaration of interest in an existing transaction.)

Question 10

A company was set up last year. It has an issued share capital of 100 ordinary £1 shares. It has six directors, who were all granted fixed term service contracts for a term of five years when the company was set up. It has adopted Model Articles for private companies limited by shares with no amendments.

Which of the following decisions to be taken by the directors at their next board meeting requires shareholder involvement?

A-The allotment of an additional 500 ordinary £1 shares.

B-Borrowing £1.5 million from the bank to purchase new office premises.

C-Changing the company’s registered office.

D-Appointing a new director.

E-Dismissing one of the directors.

Answer 10

Option E is correct. A director can only be dismissed before the expiration of their period of office by an ordinary resolution of the shareholders (s.168 Companies Act 2006).

Option A is wrong. The directors of a private company with one class of share, as here, can allot shares without the approval of the shareholders (s.550 Companies Act 2006).

Option B is wrong. The company has Model Articles for private companies limited by shares. Borrowing falls within the directors’ general powers under Model Article 3. As there are no amendments to the articles, there is no cap on the amount that the directors can borrow, so this is within their authority.

Option C is wrong. The directors can take the decision to change the company’s registered office (s.87 Companies Act 2006).

Option D is wrong. A director may be appointed either by the board or by an ordinary resolution of the shareholders (Model Article 17), so shareholder approval is not necessarily needed. It is usually quicker and more convenient for the board to make the appointment.

Question 11

Quick Q:

Where a breach of any of the general duties has occurred, the breach may be ratified by a resolution of the shareholders.

Answer 11

Option E is the correct answer. Under s.239 CA 2006, the shareholders may by (ordinary) resolution usually ratify a breach of duty (as well as negligence, default or breach of trust) once it has occurred. [Note the wording is ‘may be ratified’ – not all breaches can be ratified, e.g. if there is fraud or a bribe under s.176.]

Question 12

Quick Q:

Which of the following is unlikely to assist in showing that the director took every step to minimise loss to creditors?

-Ensuring that the company only purchases goods on credit rather than for cash.

Answer 12

Things which typically would be done by a director taking steps to minimise loss to creditors:
-Seeking professional advice on whether to continue trading.

-Ensuring that regular management accounts are drawn up.

-Taking steps to collect in debts owed to the company.

-Considering whether to put the company into administration.

Question 13

Section 177 and 182 (directors interests)

Answer 13

CA 2006, s.177 - director’s interest (directly or indirectly) in PROPOSED, transaction or arrangement

If a director is, in any way, directly or indirectly interested in a proposed transaction, they must declare the nature and extent of this by making a declaration at the board meeting, or by written notice to the directors before the company enters into the contract (s177).

CA 2006, s.182 - director’s interest in an EXISTING transaction or arrangement

Where the company is already involved in an arrangement, and a director subsequently becomes interested in this, the director must declare the nature and extent of that interest (s182(5)).

Question 14

Quick Q:
Which of the following statements best explains the theory of separation of ownership and control within a company?

The role of shareholders of companies who own the company has become separated from the role of directors who control the company.

Answer 14

Option C is correct. The theory of separation of ownership and control states that those who control companies (the directors) have become separated from the owners of companies (the shareholders).

Question 15

Quick Q:

Four individuals have just set-up a private company limited by shares.

A children’s entertainer owns 25% of the voting shares, a receptionist owns 26% of the voting shares, a porter owns 24% of the voting shares and a tradesman owns 25% of the voting shares. All the shareholders are directors of the company. The company has Model Articles with one amendment. Under a Special Article, the tradesman has the right to appoint or remove a majority of the board of directors of the company.

The shareholders would like advice to as whether any of them are ‘Persons with Significant Control’.

Which of the following is correct?

The receptionist and the tradesman are both ‘Persons with Significant Control’. The porter and the children’s entertainer are not ‘Persons with Significant Control’.

Answer 15

Own or control more than 25% of the voting rights in the company; orHave the right to appoint or remove a majority of the board of directors of the company; orHave the right to exercise, or who actually exercise, significant influence or control over the company.

Option E is therefore the correct answer as the receptionist owns more than 25% of the voting shares and the tradesman, whilst owning only 25% of the voting shares, has the right to appoint or remove a majority of the board of directors.

Options A to D are all wrong as the criteria listed above is not satisfied.

Question 16

Quick q:

A private limited company, with unamended Model Articles, currently has two directors. Those directors also own 90% of the shares in the company between them. The company plans to appoint a new director to the board and award her a service contract for a fixed period of three years. The company also plans to sell one of its factory sites to the son of one of the current directors for £160,000. The sale is part of a re-branding of the company which will also involve a change of the company name.

Which of the following statements best describes the shareholder decisions that will be needed for the company’s plans to be activated?

The shareholders must pass two ordinary resolutions, one to approve the service contract and the other to approve the sale of the factory. They must also make a final decision as to the change of name by special resolution.

Answer 16

The service contract exceeds a period of two years (s.188 of the Companies Act 2006) so needs an ordinary resolution to approveThe sale is a substantial property transaction under s.190 and also needs an ordinary resolution to approveThe change of name is a final decision for the shareholders by special resolution (s.77).

Question 17

Quick Q:

A man is a director of a private company limited by shares. He is also a shareholder. The man is proposing that the company buys a piece of machinery from his sister, for use in the business. His sister is also a shareholder but not a director.

Which of the following best describes the duties that arise from this situation?

The man should declare his interest before the transaction proceeds.

Answer 17

Option A is correct. Where a director has a personal interest in a proposed transaction with the company, they must declare the nature and extent of that interest to the board, s. 177 of the Companies Act 2006.

Option B is wrong. The sister is not a director and so no duty of disclosure arises for her.

Question 18

Quick Q:

A 17-year-old shop assistant is heavily in debt, has never been a director before, and has little work experience. An elderly man, aged 75, declared himself bankrupt in 1990. He has since been discharged from bankruptcy and currently works in a cake shop. A businessman, aged 50, is a director in several companies. He currently attends hospital weekly for treatment for a behavioural problem, related to brain trauma.

It has been proposed that the shop assistant, the elderly man and the businessman should become directors of a private limited company. The company has adopted the Companies (Model Articles) Regulations 2008 (unamended) as its articles of association.

Which one of the following best describes who could be the directors in the company?

The shop assistant, the elderly man and the businessman could be directors in the company.

Answer 18

Option A is the correct answer. There are very few statutory restrictions on who may be a director. A director must be at least 16 (s.157 Companies Act 2006), so the shop assistant is old enough to be a director. There is no maximum age limit. A director must not be an undischarged bankrupt (s.11 Company Directors Disqualification Act 1986) without the leave of the court, but as the elderly man has been discharged, he can be appointed.

The articles may place restrictions on who can be a director. Article 18 of the company’s articles of association (Companies (Model Articles) Regulations 2008) prevents a person who is certified by a medical practitioner as likely to be physically or mentally incapable of acting as a director (and likely to remain so for more than three months) from being appointed. There is nothing on the facts to suggest that the businessman has been certified as incapable of acting and it seems that he is a director of several companies.

Therefore, the shop assistant, the elderly man and the businessman may all be appointed as directors of the company.

Option B is wrong as the shop assistant can also be appointed as director of the company.

Option C is wrong as the businessman can also be appointed as director of the company.

Option D is wrong as the elderly man can also be appointed as a director of the company.

Option E is wrong as the shop assistant and the elderly man can also be appointed as directors of the company.

Question 19

Quick Q:

A private limited company is interested in purchasing a piece of land to further its expansion plans. The land is owned by one of the company directors but only some of the other directors are currently aware of this. The proposed purchase is to be discussed at the next board meeting of the company.

The company’s articles of association are the Companies (Model Articles) Regulations 2008 with one amendment. This provides that directors may vote and count in the quorum on matters in which they are interested. None of the directors are shareholders in the company.

Which of the following best describes the position of the land-owning director in relation to the proposed purchase of the land?

The director must declare the nature and extent of his interest in the purchase to the other directors to avoid being in breach of duty.

Answer 19

Option E is correct because the director must declare his interest in the purchase as it represents a proposed transaction with the company (s177 Companies Act 2006 (CA 06)).

This answer is incorrect:
The director will be guilty of a criminal offence if he does not declare his interest in the purchase to the other directors.

because….
Option D is wrong because criminal liability does not arise from a breach of the duty to declare an interest in a proposed transaction with the company.

Question 20

Quick Q:

A private limited company, based in Manchester, is planning to expand geographically by opening an office in Wales. The new office will be run by the current finance director who will relocate. To assist with the relocation, the company has offered to act as guarantor for a £40,000 loan which the finance director will use for accommodation until his current property sells. The company has adopted the Companies (Model Articles) Regulations 2008 (unamended) as its articles of association.

Does the loan require shareholder approval?

No, because the guarantee is being provided by the company to enable the director to perform his duties.

Answer 20

Option C is the correct answer because the guarantee is for £40,000 which falls within the exception for expenditure on company business for the purpose of enabling a director to properly perform his duties (s204(2)(b) Companies Act 2006).

Option A is wrong because the general authority of directors to run the company set out in the articles does not apply to this situation as it is a guarantee given by the company in connection with a loan made to a director. It therefore needs approval by ordinary resolution of the shareholders unless it falls within one of the exceptions (s197(1) Companies Act 2006).

Option B is wrong because even though the value of the guarantee exceeds the relevant amount permitted for minor and business transactions (s207(2)(b) Companies Act 2006) it still falls within one of the other exceptions.

Option D is wrong because shareholder approval is required when a company makes a loan to a director or gives a guarantee or provides security for a loan made to a director (s197(1) Companies Act 2006).

Option E is wrong because a company can act as a guarantor for a director without shareholder approval if the value and purpose of the guarantee falls within one of the relevant exceptions.

Question 21

Quick Q:

The client is the managing director of what was until three months ago a flourishing catering company. Three months ago, several guests had food poisoning following their attendance at an event for which the company provided the catering, and the company has lost a lot of business and money since then. It appears that some of the food used at the event was out of date because the client had not checked the date the food had been supplied to the company. From then on, the client took every step she should have done with a view to minimising the potential loss to the company’s creditors if it went into insolvent liquidation. However, the company has just gone into insolvent liquidation as a result of the loss of business following the food poisoning incident. Three months ago the client was working both as managing director and purchasing manager.

Assuming that the court accepts the facts stated above, which of the following best describes whether the client will be liable for wrongful trading?

No, she will not be liable for wrongful trading because she has a defence.

Answer 21

Option E is correct. Liability for wrongful trading is personal to the director, and the employer is not vicariously liable. It may be that the client’s mistake will result in liability being established for wrongful trading under s 214 IA 1986, but in any event she will be able to use the defence under s 214(3). This is that she took every step she should have done with a view to minimising the potential loss to the company’s creditors if it went into insolvent liquidation – and we are told in the question that she did do this.

Question 22

Quick Q:

The client is a food distribution company with seven directors. The client has the Model Articles with no amendments and its net asset value is £285,000. The contracts director has 25% of the shares in a food wholesale company. The marketing director wishes to sell a van to the client for £30,000 and the food wholesale company wishes to purchase office premises from the client for £150,000.

Assuming that there are no agreements in place and no relevant resolutions have been passed, which of the following best describes what shareholders’ resolutions the client would need to pass in order that the transactions described above could validly go ahead?

An ordinary resolution to authorise the sale of the office premises and an ordinary resolution to authorise the purchase of the van.

Answer 22

Option D is correct. The purchase of the van needs to be authorised by the shareholders as a substantial property transaction (‘SPT’) because its value (£30,000) is more than £5,000 and more than 10% of the client’s net asset value of £285,000, it is a non-cash asset and it is a transaction between the company and a person (the marketing director) connected to the company.

The sale of the warehouse is also an SPT so needs to be authorised by the shareholders, by ordinary resolution. It is an SPT because:

 It is a transaction between the company and a person connected to the company (the food wholesale company), because the contracts director owns over 20% of the shares in the food wholesale company);

 It involves a non-cash asset (the office premises); and

 It is of substantial value (over £100,000)

The contracts director’s involvement in the sale of the office premises does not need to be authorised as a separate issue from the ordinary resolution to authorise the sale of the office premises.

Question 23

Last year an investor bought 20% of the issued share capital of a private limited company and became a non-executive director of the company. Before making the investment, the investor negotiated the following protections:

-Weighted voting rights in the articles of association, multiplying a director’s shareholding by 10 votes per share on a shareholder resolution to remove the director and on a shareholder resolution to amend the weighted voting rights.
-A clause in the articles of association providing that the investor’s appointment to the board would be permanent.
-A clause in a shareholders’ agreement under which the parties agreed not to vote in favour of a resolution to remove each other from the board of directors. The shareholders’ agreement was signed by the investor, and all the other shareholders and directors in the company.

Would it be possible for the shareholders to remove the investor from the board of directors of the company?

A-No, because the articles of association provide that the investor’s appointment to the board is permanent.

B-No, because the provision in the shareholders’ agreement prevents the parties from voting to remove the investor from the board.

C-No, because the investor has sufficient votes to demand a poll vote and could block the resolution for her removal.

D-Yes, because the negotiated articles do not concern membership rights and would therefore be unenforceable by the investor.

E-Yes, because a shareholders’ agreement cannot be enforced unless signed only by shareholders.

Answer 23

Option C is correct because the investor has sufficient votes to demand a poll, and on a poll vote the multiplier would provide sufficient weighted votes to block the ordinary resolution (Bushell v Faith).

Option A is wrong because the articles are enforceable only in respect of membership rights.

Option B is wrong because the restriction in the shareholders’ agreement acts as a deterrent to voting for the director’s removal, in that a breach of the shareholders’ agreement would give rise to a claim for breach of contract.

Option D is wrong because the negotiated articles would entitle the investor to weight her shareholder voting rights, and the company and its shareholders would be bound by the article.

Option E is wrong because anyone can be party to a shareholders’ agreement.

Question 24

A minority shareholder in a private limited company believes that the company directors have been awarded excessive pay and wishes to bring an unfair prejudice claim.

Which of the following best describes the unfair prejudice claim process?

A-The claim will involve a two stage court process.

B-The court will apply a subjective test to ascertain whether there has been unfair prejudice.

C-The minority shareholder may find it difficult to obtain some of the evidence required to bring the claim.

D-The excessive pay award will automatically be deemed unfairly prejudicial.

E-The court will apply both a subjective and an objective test to ascertain whether there has been unfair prejudice.

Answer 24

Option C is correct. The minority shareholder will have to gather a great deal of evidence and some of it may be difficult to obtain because it will be held by the company.

Option A is wrong because the claim will not involve a two stage court process. Derivative claims, not petitions for unfair prejudice, involve a two stage court process.

Option B is wrong because the court will apply an objective test.

Option D is wrong because the excessive pay will not automatically be deemed unfairly prejudicial. Removal of the company auditor by the shareholders, on the grounds of divergence of opinion on accounting or audit procedures, will, for example, be deemed to be unfairly prejudicial (s994 Companies Act 2006).

Option E is wrong because the court will apply an objective test (see above).

Question 25

A client has been operating his business as a sole trader for a number of years, but was recently advised to incorporate into a private company limited by shares. His company has adopted, in unamended form, the Companies (Model Articles) Regulations 2008 (the ‘Model Articles’) as its articles of association. He is the sole director and sole shareholder of his company. Which of the following statements best describes how he must run the company? A-As sole director, he can manage the day to day operations of the business as he sees fit. B-As sole shareholder, he can vote as he sees fit. C-As sole director and shareholder he does not need to distinguish between director decisions and shareholder decisions. D-As shareholder, he must promote the success of the company. E-He will need to appoint an additional director, as the required quorum for a valid board meeting under the Model Articles is two.

Answer 25

Option B is the correct answer. Shareholders are free to vote as they wish and may promote their own interests. Option A is wrong because directors have to act in accordance with the directors’ duties set out in the Companies Act 2006 (CA06). Even where there is only one director, the director has to act in accordance with these duties and within the powers set out in the Companies Act and the Model Articles. Option C is wrong because even though the same person is the sole shareholder and sole director, you cannot merge these two roles within a company. Records must be kept of director decisions (s248 CA06) and of shareholder decisions (ss 355, 357 CA06). Option D is wrong because it is directors who must promote the success of the company; shareholders are free to vote and promote their own interests. Option E is wrong. Whilst the Model Articles generally require a quorum of two for a board meeting to be valid, in companies with a sole director, the director can still validly take company decisions – see Model Article 7(2).

Question 26

A minority shareholder holds 5% of the voting shares in a private limited company. He is not a director. The director with responsibility for insurance for the company failed to renew the fire insurance. A small workshop suffered fire damage due to an electrical problem. As there is no insurance it will cost the company £50,000 to repair the workshop. The minority shareholder believes that the director has been negligent, in that the director has breached the duty of a director to exercise reasonable care. skill and diligence. The board of directors supports the director and says this was simply an administrative error and is willing to excuse him. The other shareholders, who form the majority, are proposing to ratify the breach in any event at the next general meeting. Which of the following statements best reflects the position of the minority shareholder? A-The minority shareholder could bring a statutory derivative claim on behalf of the company but needs permission from the court to continue the claim, and permission is unlikely to be granted. B-The minority shareholder could prevent the majority shareholders ratifying this breach of duty as ratification needs a unanimous vote of the shareholders. C-The minority shareholder could immediately bring and continue with a statutory derivative claim on behalf of the company as there is prima facie evidence of the breach of duty and permission to continue must therefore be granted. D-The minority shareholder is unable to bring a statutory derivative claim on behalf of the company as he does not hold 10% or more of the shares in the company. E-The board have the power to authorise the breach of duty and therefore, as the board supports the director, any statutory derivative claim would fail because permission to continue the claim would not be granted.

Answer 26

Option A is the correct answer. There has been a breach of a directors’ duty but, although the company has a cause of action, the company is not likely to sue the director as the board supports the director and the decision to sue is in the power of the board. However, as a member, the minority shareholder could bring a derivative claim on behalf of the company. Permission is needed to continue the claim (s261 Companies Act 2006 (CA06)). As the shareholders are likely to ratify this breach the court is unlikely to give permission (ss263(2) (3) CA06). Permission must be refused if ratification has taken place by the time of the permission hearing (s263(2)(c) CA06). If ratification has not yet taken place by the time of the hearing, the court must take into account the fact that the breach is likely to be ratified (s263(3)(d)). The court is unlikely to grant permission if there is clear evidence that the majority shareholders are likely to ratify this breach as here. Option B is wrong as ratification requires an ordinary resolution (s239 CA06) not unanimity. The minority shareholder cannot block the ordinary resolution with only 5% of the shares. Option C is wrong as, although there is evidence of a prima facie case, permission is needed to continue the claim and permission must be refused if the breach has been ratified and is likely to be refused if ratification is likely to happen as here (see above) . Option D is wrong as a minority shareholder can bring a derivative claim regardless of the size of his shareholding. Option E is wrong as a board of directors has no power to authorise a breach of the duty to exercise reasonable care, skill and diligence. It only has power to authorise a breach of the duty to avoid conflicts of interests.

Question 27

A director of a company is not married or in a civil partnership but has lived with his partner for 10 years. He has a sister. His father died several years ago. The director’s mother and grandfather have lived with the director since the father’s death. Which one of the following most accurately describes who would be a person connected to the director for the purposes of deciding whether shareholder approval is required for a substantial property transaction? A-The director’s partner only. B-The director’s partner and his sister. C-The director’s partner, his sister and his mother. D-The director’s partner and his mother. E-The director’s partner, his mother and his grandfather.

Answer 27

Option D is correct. Shareholder approval for a substantial property transaction is only required if the transaction involves a director or a person connected to a director. Connected persons include the following members of a director’ family: their husband, wife or civil partner or partner with whom they have an ‘enduring relationship’, parents, children (and step-children) (ss.252 and 253 CA 2006). The director’s partner and his mother are therefore connected persons. Options A, B and C are therefore wrong. Wider family such as brothers and sisters or grandparents are not connected persons. Option E is wrong. Grandparents who live with a director are specifically excluded (s.253(3) CA 2006).

Question 28

Minimum and maximum time period a director can be disqualified for?

Answer 28

Minimum period is two years. Maximum period of disqualification is 15 years.

Question 29

Quick Q: A man is the only director and shareholder of a private limited company. His company has recently been struggling financially and may be balance sheet insolvent. His sister is highly experienced in finance and has been giving advice to her brother about how to run his company. The brother has tended to act in accordance with his sister’s instructions. She is worried she may have inadvertently become a shadow director of her brother’s company. Which statement below best describes the position of the director’s sister within the company? She could be considered a shadow director as her brother has been acting upon her advice in running the company.

Answer 29

Option B is correct because the definition of shadow director is someone who has given instructions to a company director and the director is accustomed to act in accordance with those instructions (s.251 Companies Act 2006).

Question 30

Quick Q: The auditors of a private company limited by shares were negligent when carrying out their recent annual audit of the company’s accounts. One of the shareholders of the company, who is particularly aggrieved by the poor standard of work provided by the auditors, wishes to sue them in her capacity as shareholder of the company. Can the shareholder of the company, in her capacity as shareholder, sue the auditors for negligently carrying out their audit of the company’s accounts? No, because the auditors’ general duty of care is owed only to the company.

Answer 30

Option C is correct. Auditors can be sued for negligence by the company they are auditing but auditors do not owe a general duty of care to the shareholders or directors when conducting their annual audit.

Question 31

Disqualification order limitations (aka what they cannot take part in)

Answer 31

A disqualified director cannot take part in the promotion, formation or management of a company without leave of the court (s1(a) Company Directors Disqualification Act 1986 (CDDA 1986)).

Question 32

Quick Q: A private limited company has three directors, all of whom work for the company. Two of the directors also have minority shareholdings in the company. There is a third shareholder with a majority shareholding but this shareholder is not a director. He owns and runs a separate small business. The two director shareholders are greatly influenced by the majority shareholder and typically follow the majority shareholder’s directions when making decisions at both board and shareholder level. The third director, who does not hold any shares in the company, does not have a close working relationship with the majority shareholder and is not influenced by him. Will the majority shareholder fall within the definition of a shadow director? Yes, because he is a person in accordance with whose directions the directors are accustomed to act.

Answer 32

Option E is correct because the definition of a shadow director is a person with whose directions the directors are accustomed to act (s251(1) Companies Act 2006). The facts say that the two director shareholders are greatly influenced by the majority shareholder and typically follow his directions when making decisions at board level. Option A is wrong because a shadow director need not hold shares in the company and so it is irrelevant that he is the majority shareholder. Option B is wrong because it is not a requirement that a shadow director should be employed by the company in relation to which he is a shadow director. KEY POINT:::::::::::::: (the option:No, because he could only be classed as a shadow director if he is a person with whose directions the whole of the board is accustomed to act.)...... Option C is wrong because only a governing majority needs to act in accordance with the majority shareholder’s directions for him to be classed as a shadow director, not the entire board. Here, two out of three typically act in accordance with his directions so that majority is achieved. Option D is wrong because a shadow director is a person who has not been appointed to the board but who is a person with whose directions or instructions the board is accustomed to act.

Question 33

Quick Q: A private company limited by shares has a board of five directors. They have not had a managing director for quite some time and the board have been looking to appoint someone. They recently found the perfect candidate who met with the board. The company has now appointed this person as the new managing director and entered into a two-year service contract with her. Is the new managing director an employee of the company? Yes, because the service contract constitutes a contract of employment between the managing director and the company.

Answer 33

Option D is correct because the new managing director has an employment contract with the company – the two-year service contract. This will set out the terms of her employment as an executive director with the company.

Question 34

Quick Q: The shareholders, who comprise five of the six directors of a private limited company, wish to remove the marketing director from office. The shareholders give notice to the company that they wish to remove the marketing director from office. Due to other pressing matters no immediate action is taken. Three weeks later, a board meeting is convened on reasonable notice. At the board meeting a resolution is passed to call a general meeting, on 14 clear days’ notice, for the purpose of passing an ordinary resolution to remove the marketing director from office. The notice for the general meeting is sent to the board (including the marketing director), the shareholders and the auditor. The marketing director is invited to make written representations which can be circulated to the shareholders ahead of the meeting and to speak at the general meeting itself if he chooses to do so. Has the company complied with all company procedure planning requirements in respect of the removal of the marketing director? No, because the company did not send a copy of the notice of intention to remove the marketing director from office immediately upon receipt.

Answer 34

Option C is correct because the company must, on receipt of a notice of an intended resolution to remove a director, send a copy of the notice to the director forthwith (s169(1) Companies Act 2006 (CA06)). Option A is wrong as shareholders can remove a director by ordinary resolution passed at a general meeting (s168 CA06). Option B is wrong because special notice is required for a resolution to remove a director (s168(2) CA06). Such notice must be given to the company at least 28 clear days before the general meeting where the resolution will be moved (s312 CA06). Therefore 28 clear days is the minimum period for special notice rather than the maximum period. Options D and E are wrong because, whilst not wrong statements in themselves, they do not resolve the issue that the director was not sent a copy of the notice of intention to remove him forthwith (see answer to option C above).

Question 35

A company has Model Articles for private companies limited by shares unamended. Which one of the following statements best reflects the position in relation to the payment of dividends by the company. A-The directors can declare the amount of a final dividend at a board meeting. B-The directors do not have authority to pay an interim dividend without the approval of the shareholders. C-The shareholders declare a final dividend by passing a special resolution but may only do so if the directors have made a recommendation. D-Once a final dividend has been declared, it must be paid to the shareholders. E-If an unauthorised dividend is paid to the shareholders, the shareholders may be required to repay it but the directors will not be personally liable.

Answer 35

Option D is correct. Once declared, a final dividend [but not an interim dividend] becomes a debt of the company owed to the shareholders. Options A is wrong. The directors recommend the amount of the final dividend, but it is the shareholders who will declare the dividend. Option B is wrong. The directors have the power to pay interim dividends without the approval of the shareholders. Option C is wrong. A dividend is declared by passing an ordinary, not a special, resolution. Option E is wrong. The statement is partly correct – shareholders who knew or ought to have known that the dividend was unauthorised will be required to repay it. Under the common law, if the directors knew or ought to have known that the dividend was unauthorised, they will be liable to repay it.

Question 36

Quick Q: A client has been the sales director of a successful technology company which he set up with five other directors ten years ago. The company has Model articles for private companies limited by shares without amendment. The client’s sister recommended an investment scheme run by an offshore company, of which her husband is a director, claiming that the scheme offered a very attractive guaranteed return of 15%. Without conducting any further research or telling them of his connection to the offshore company, the client recommended the scheme to his fellow directors. The directors agreed to invest £100,000 relying only on the client’s recommendation. Six months’ later the offshore company has gone into liquidation and the technology company has lost its investment. Which one of the following statements best explains the liability of the client and his fellow directors for breach of their duties as a director? Correct answer D - The client is in breach of his duty to declare his interest in the proposed transaction and his duty to declare his interest in an existing transaction. Not C- The client is in breach of his duty to declare his interest in the proposed transaction, but no other duties.

Answer 36

Option D is the correct answer. By not disclosing his interest at the time of the transaction, the client has breached his duty to disclose an interest in the proposed transaction (s.177). Once the company entered into the transaction, the client would be breach of his duty to disclose his interest in an existing transaction (s.182). Option C is wrong. The client is in breach of his duty to declare an interest in a proposed transaction. Failure to disclose and may also amount to a breach of s.172, and it is likely that the client is in breach above his duties under ss.174 and 182 (as above). (Note that breach of s.174 would not in itself would not be a breach of the s.172 duty to promote the success of the company, if the directors honestly believed that the scheme was in the best interests of the company).

Question 37

Quick Q: A client is the sole director of a car repair company. He and his friend are the shareholders. The company is not a very successful business. To save money, a month ago, the client ordered a large consignment of parts from a company which he found on the internet. The spares cost less than half the amount that they would have done if the client had bought them from his regular supplier. The client placed the order over the phone and paid up front without making any enquiries about the internet company. The spares never arrived. The client has now made some enquiries about the internet company, and it seems that this was a scam. The internet company does not exist. Has the client breached his duty to act with reasonable care, skill and diligence? Yes, because both subjectively and objectively, the client would be expected to make reasonable enquiries into the internet company before placing the order.

Answer 37

Option B is the correct answer. The standard of care imposed by s.174 (Duty to exercise reasonable care, skill and diligence (s174);) imposes a subjective and an objective test. On both tests, it would be reasonable to investigate the company before placing the order for a large consignment.

Question 38

Quick Q: A client and his daughter are the only two directors of a successful company. Between them, they own 60% of the shares in the company. The remaining shares (40%) are owned by three other shareholders. The company has Model Articles for private companies limited by shares unamended. All the shareholders want to the company to expand its activities. To do so, the directors propose to borrow £5 million from the bank. The other shareholders consider that taking on substantial borrowings is risky and want to raise money by issuing new shares. The directors are against this because they wish to retain control of the company and they cannot afford to subscribe for new shares. Which one of the following statements best reflects the position of the directors in relation to financing the expansion? In deciding to borrow the money rather than issue shares, the directors are exercising their power to borrow for an improper purpose.

Answer 38

Option A is the correct answer. Although the directors do have the power to borrow and give security under the Model Articles, that power, like all directors’ powers and authority, must be exercised for the proper purpose, and borrowing a large amount in order to retain control is likely to be an improper purpose (s.171(1)(b)).

Question 39

Quick Q: A private limited company (with Model Articles unamended) has three directors. The third director was recently appointed at a board meeting. It has since been decided that the third director is to be awarded a fixed term service contract of four years. The directors want the service contract to be entered into as soon as possible and intend to call a board meeting and pass a board resolution to enter the contract and approve the four-year fixed term. Which of the following options is correct in relation to the service contract? The shareholders of the company must pass an ordinary resolution to approve the four-year fixed term of the service contract.

Answer 39

Option B is correct. S.188 Companies Act 2006 (CA 2006) states that where a guaranteed term of a director’s employment is, or may be, longer than two years, a resolution of the members of the company is required to approve this. Where the type of members’ resolution is not specified, it is an ordinary resolution by default.

Question 40

A private limited company (with Model Articles unamended) requires one of its directors to set up a new office branch. The company proposes to loan the director £45,000 to meet the expenses relating to the new office. A general meeting of shareholders has been called. A memorandum of loan terms has been made available at the company’s registered office for 15 days prior to the general meeting, and it will be available for inspection at the meeting itself. The shareholders intend to pass an ordinary resolution to approve the loan. Which of the following options is correct in relation to the loan? A-The company will enter the loan automatically when the ordinary resolution passes. B-The ordinary resolution will be void, as it needs to be passed by written resolution and not at a general meeting. C-Shareholder approval will not be required in these circumstances, as the loan is to meet expenditure incurred for the purposes of the company, and the amount is under the threshold requiring approval. D-It is unnecessary to have the memorandum of loan terms at the general meeting itself where it has been at the registered office for 15 days up to the date of the meeting. E-The company is right to seek approval by ordinary resolution as only loans less than £10,000 can be agreed by the board of directors, regardless of a loan’s purpose.

Answer 40

Option C is correct. S.197 Companies Act 2006 (CA 2006) states that it is a resolution of the members of the company that is needed to approve a loan to a director. Where it is not specified what type of member resolution is needed, it is an ordinary by default. The exception in s.204 CA 2006 applies here as the amount does not exceed £50,000 and it will be incurred to meet expenditure for the purposes of the company’s new office, and the amount is under the threshold requiring approval. Option A is wrong, as even with shareholder approval, the contract will still need to be entered. Option B is wrong, as if shareholder approval was required, it could be given at a general meeting or by written resolution. Option D is wrong, as the memorandum would need to be available for inspection at general meeting s.197(3) CA 2006. Option E is wrong, as the £10,000 exception for minor transactions (s.207 CA 2006) is not the only exception to the requirement for approval by ordinary resolution. (BLP SQE 1 Manual paras 3.22.2)