LEVEL 4 - UNIT 5 CORPORATE INSOLVENCY SUGGESTED ANSWERS JUNE 2015

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1 LEVEL 4 - UNIT 5 CORPORATE INSOLVENCY SUGGESTED ANSWERS JUNE 2015 Note to Candidates and Tutors: The purpose of the suggested answers is to provide students and tutors with guidance as to the key points students should have included in their answers to the June 2015 examinations. The suggested answers do not for all questions set out all the points which students may have included in their responses to the questions. Students will have received credit, where applicable, for other points not addressed by the suggested answers. Students and tutors should review the suggested answers in conjunction with the question papers and the Chief Examiners reports which provide feedback on student performance in the examination. Question 1 Under the Partnership Act 1890, (the Act) s.1, if two or more people carry on business in common with a view of profit, then a partnership subsists. No formality is required for this relationship to come into being under the Act. In this instance, if Brenda (B) and Aoife (A) started trading together at the Bridal Shop, then a partnership would come into existence under s.1 of the Act. (i) Firstly under s.6 of the Act, an act done in the firm s name by an authorised person intended to bind the firm is binding on the firm whether that person is a partner or not. So if A is authorised, the firm would be liable for any orders she placed under this section. Even without express authority, A could bind the firm under s.5 of the Act provided the four conditions set out in s.5 are met: the transaction must relate to the firm s business, it must be within the usual authority of a partner, the other party must not know of any restrictions on that partner and the other party must think the person they are dealing with is a partner. Ordering wedding dresses meets the first two criteria so, as long as the other party knew or believed A to be a partner and was not aware of any restriction on her, the firm will be bound. (ii) B can restrict A s power to order stock. First, a restriction will remove A s express authority under s.6 of the Act. Second, under s.8 the firm can give notice to third parties that the firm will not be bound by acts of a partner, and this prevents the implied authority in s.5 applying. Therefore, B can give express notice to suppliers that A is not authorised to order stock. Page 1 of 5

2 (c) (d) Under s.24 of the Act all partners have the right to participate in partnership decisions. However, s.24 is subject to agreement to the contrary, so this provision can be expressly excluded by agreement. A partnership is not liable generally for the debts of partners because under the Act (ss. 5 and 6) the debt must either be authorised or within the usual business of the firm. Section 23 of the Act provides that a judgment creditor may get an order charging the assets of the partnership. However, this is only in respect of the debtor partner s share. Although B can dissolve the partnership under s.33 of the Act if this happens, this will not release the charge. Question 2 There are a number of advantages to trading as a limited company that are relevant to B s situation. Ownership and management are separated for a company, which better reflects B and A s different level of ownership and different roles within the business, including A s power to order stock. There is no commonality or equality implied into ownership of a company, so B can be in control. As the company has separate legal personality, B can invest or lend her money to the company without A being able to gain access to it and the company can give security of the loan. Separate legal personality means that the company cannot be liable for A s debts. Separate legal personality means that the company can employ A without B becoming A s employer. The articles contain a detailed constitution that would apply in the event of dispute between B and A, and allow B to exercise her controlling interest. (c) Salaried directors are employees, and the company is responsible for deducting tax and national insurance on a PAYE basis and accounting to HMRC for it. Partners are self-employed. They must complete selfassessment returns each year and pay their own tax and national insurance. Draft paragraph to be inserted into a letter to B:- Company directors are officers of the company and as such are responsible for a number of record keeping duties. Registers must be kept at the registered office detailing the directors, the members (shareholders) and any charges over the company s property. These registers must be kept up to date. Additionally, minutes must be kept of meetings both at board and shareholder level. The company is legally bound to prepare accounts once a year to the accounting year end notified to Companies House, and both these accounts and the annual return have to be filed at Companies House within strict time frames. If this is not done all the directors (and the company) will be liable to fines because failure to carry out any of these duties is a criminal offence and the company itself may be struck off the register of companies by the Registrar of Companies. Page 2 of 5

3 Question 3 Under the Insolvency Act 1986 (IA) only a licensed insolvency practitioner may act in an insolvency (i.e. an administration or an insolvent liquidation). Under s.389, it is a criminal offence for anyone who is not qualified and licensed to so act, so the Company could not appoint Steven to sort out its debts and organised payment to creditors, because in doing so he would be acting as an insolvency practitioner. IA contains a number of provisions to protect the creditors of an insolvent company. One of those is that certain transactions carried out in anticipation of an insolvency may be set aside. IA s.239 provides that a creditor (or surety) cannot be given a preference i.e. put in a better position than he would otherwise have been or than the other creditors of the company. The conditions that need to be met for s.239 to apply are that at the relevant time the company gave the preference the company was unable to pay its debts (or became so in consequence of the transaction). Tony and Maz are creditors because they lent the Company money. The relevant time, under s.240, is two years because Tony and Maz are directors of the Company and hence come within the definition of being connected with the Company. s.239(5) stipulates that there must have been a desire to prefer, but where the person preferred is connected with the company, that desire is presumed, as would be the case here because Tony and Maz are directors. If a preference is found, the court can make a number of orders, the most appropriate of which here would be that the money is restored to the Company by Tony and Maz. (c) (i) A moratorium is a feature of administration. The most appropriate route into administration here would be an out of court appointment by the directors, because it is the directors who wish to instigate the procedure and the out of court route was brought in specifically to do away with the need for a court application. (ii) The steps the directors need to take are:- A board resolution to resolve to put the company into administration; Complete Form 2.8B (intention to appoint an administrator) and serve on the qualifying charge holder (i.e. the bank) and file at court; Make a statutory declaration (contained within Form 2.8B) that the circumstances for the appointment of an administrator apply i.e. the company cannot pay its debts, it is not in liquidation and none of the statutory restrictions upon the appointment of an administrator apply; File at court Form 2.2B (administrator s consent to act); An interim moratorium comes into effect as soon as the Forms are filed at court (IA Sch B1 para 44); The bank, as qualifying floating charge holder, has five business days to decide if they wish to appoint their own administrator. Page 3 of 5

4 (iii) Any petition to wind up the company is stayed: IA Sch B1 paras 42(3) and 44 no order may be made for the winding up of the company. (d) A liquidation (winding up) is not designed to rescue the company. IA states that a company in creditors voluntary liquidation (CVL) should not trade (s.87). The purpose of liquidation is to realise all the company s assets and make a distribution to creditors (s.107). Once a CVL is completed, it results in the dissolution of the company where the company is removed from the register at Companies House and ceases to exist as a legal entity (IA Chp IX). Question 4 Ring-fencing was introduced by the Enterprise Act 2002 to set aside funds for the unsecured creditors out of money that would otherwise go to the floating charge holder, which is almost always the bank that holds a debenture over the assets and undertaking of the company. Bedford Bank PLC has a debenture which will constitute a fixed and floating charge over all the assets and undertaking of the company. The fixed element ranks first and must be satisfied in full before any funds are available for any other creditor. Employee claims are now the only claims that may rank preferentially, although this is only up to the statutory limit, which may not be the whole of the employee s claim. Preference claims rank immediately after fixed charges. Bedford Bank PLC will also have a floating charge and both trade creditors and employees (for the non-preferential element) are unsecured creditors. Therefore, next would come a consideration of ring fencing, except in this instance that is not appropriate. This is because the administration is followed by dissolution. This indicates that no funds are available for the unsecured creditors because an administrator cannot make a distribution to the unsecured (IA Sch B1 para 65(3)) so if there are sufficient funds available for a distribution to the unsecured creditors (IA Sch B1 para 83(1)) the administration must be followed by a creditors voluntary liquidation. (c) The general principle is that directors are not liable for the debts of a company. However, there are specific circumstances in which the veil of incorporation can be lifted and liability imposed. Both the Companies Act (CA) and IA impose liability in a number of these specific circumstances. However, for IA to impose liability for misconduct of directors, the company must have entered insolvency liquidation. The Company has not entered liquidation. Therefore neither of wrongful trading (IA s.214) or directors misfeasance (IA s.212) can apply. However, directors duties under CA will still apply. The directors have a duty under CA s.172 to promote the success of the Company and must consider the factors set out in that section including the likely consequences of any decision in the long term. Under s.172(3) Page 4 of 5

5 the directors have an additional duty if the company is insolvent to consider the interests of the creditors of the company. The directors also have a duty under CA s.174 to exercise reasonable skill, care and diligence in the performance of their duties. This requires the directors to both meet a general reasonable standard of skill and care, as well as to demonstrate any special skill he has. A breach of the CA duties imposes civil liability under s. 178 which would take the form of a contribution to the Company s assets or funds, however, the court can relieve a director of liability if he acted honestly (s.1157). This action is not available to an individual creditor, so he would have to apply to have the company restored to the register and then petition for its winding up. Page 5 of 5