Sportive Plc Governance and Compliance

Chapter 1 - Introduction

This document is provided to the CEO of Sportive Plc (Sportive) a bicycle manufacturing company as a discussion, which forms the basis of advice regarding the propriety of decisions that were taken by the board of directors of the company between the period of 2010 to 2018. These decisions encompass various aspects of the company’s actions and decisions during this time period. At this time, the company is faced with a possible liquidation and therefore, this document is a comprehensive consideration of litigation risks, rescue options and assessment of the compliance by the company with the relevant laws and the various Corporate Governance Codes (CGG) that are applicable to the company through this period. To provide a brief background of the company, Sportive commenced business in 2001 as a sole proprietorship, and in 2005, it became a private limited liability company. In 2010, Sportive became a public company and its shares were listed on the London Stock Exchange (LSE) in 2016. In order to adapt to its changing status from a one person private company to a public company, Sportive made changes to its articles of association and governance structures starting with 2010 induction of new directors into the board. Other changes were made over the years, including division of shares and members into classes, appointment of auditor, and setting up of board committees. These changes were effected through decisions taken at the board meetings, and these decisions will be reviewed for propriety in this advice document. Sportive is currently faced with a possible insolvency as its debts exceed its assets and the board is divided as to the future course of the company, including on rescue mechanisms and liquidation. The opinion is divided on whether to have Sportive liquidated or to be subjected to a rescue procedure. This advice document considers both the options and determines the best possible course for the company given the circumstances. The case scenario relates to different aspects of company law and corporate governance. The principal issues that are involved in this case scenario relate to governance, membership and class rights, dividends, external auditor and debt financing and liquidation. The essay will discuss specific issues related to appointment and removal of directors, appointment and removal of company secretary, and appointment of external auditor, establishment of board committees, unlawful dividends and its consequences, kinds and suitability of different debt financing options and liquidation and priority of claims. The essay is structured as follows: Chapter 1 is the introduction; Chapter 2 relates to governance and board; Chapter 3 relates to membership and class rights; Chapter 4 relates to dividends and external auditor; Chapter 5 relates to debt financing and liquidation. Dig deeper into Private Sector Anticorruption Legislation with our selection of articles.

Chapter 2 - Governance and the Board

This chapter considers the legal issues involving the governance and the Board. As such, the principal issues that are discussed in this chapter concern the appointment and removal of directors, the appointment and removal of Company Secretary, and establishment of board committees.

Appointment of Directors

The issues that arise from the appointment of the directors of the company are:

Whether the appointment of executive directors is proper?

Whether the appointment of non-executive directors is proper?

Executive Directors

The appointment of directors, both executive and non executive, is one of the essential aspects of corporate governance. As noted by Brenda Hannigan, “the starting point, however, is that good corporate governance primarily stems from internal structures.” The Cadbury Report defines corporate governance as the system by which companies are directed and controlled with the board of directors responsible for the governance of the company and the shareholders ensuring that the appropriate structure is in place for which they have the power to appoint the directors and auditors. The structure and the role of the board of directors, including and in particular, the role of the non executive directors is an important aspect of corporate governance. The Cadbury Report recommended that the members of the committees have by majority the non-executive directors; while the Board of directors should appoint an Audit Committee having at least three non-executive directors. There are some differences in the roles of executive and non executive directors. An executive director is a member of the board with management responsibilities, and as such, the executive directors are concerned with the day to day management of the company. The executive directors have extensive management powers that are delegated to them by the Articles of Association of the company. Non executive directors are also members of the board of directors, but these directors do not have vested in them any responsibilities for the daily management of the company. Rather, non executive directors are vested with the responsibilities for strategy for the company and also for scrutinising the functioning of the executive directors. Having understood the role of the executive and non executive directors in the company, it is pertinent to note that the Companies Act 2006 does not distinguish between executive and non executive directors in terms of their legal duties, responsibilities and liabilities, and all the directors, be these executive and non executive, have the same general duties as are provided in the Companies Act 2006, Part 10. The Quoted Companies Alliance Code, which is a widely accepted Code for the smaller companies with standard listing, or companies which are not on a regulated market can be appropriate to the scenario as Sportive fits the classification of companies that are regulated by the referred Code. The latest Code was published in 2018. Both executive and non executive directors are highly responsible board-level roles in a company, with fiduciary duties and the duty to act in the best interests of the company. However, the role of the non executive directors goes to the heart of corporate governance as they are the ones who scrutinise the working of the executive directors and provide objective criticism or “constructive challenge” to board decisions. Moreover, non executive directors facilitate strategic decisions and have a mentoring role in advising and guiding the chairman of the company. Therefore, even though the UK board structure is unitary and even if there is no legal distinction between executive and non-executive directors, non executive directors are essential to corporate governance of the company. This has been stressed by a number of important reports on corporate governance, such as The Cadbury, and the Hampel and Higgs reports, all of which have emphasised the need for the board to include independent non executive directors who can effectively contribute in the deliberations and ensure that independent and strategic decisions are undertaken by the board. Here, independence is defined as “apart from directors' fees and shareholdings [are] independent of the management and free from any business or other relationships which could materially interfere with the exercise of the independent judgement”. The fundamental idea behind balancing the number of executive and non-executive directors is that the board’s decision making should not dominated by any individual or groups and must remain relatively objective. The UK Corporate Governance Code of 2010 (‘2010 Code’) is applicable in the scenario for the appointment of Mrs Allen and Mr Wrench. As per the 2010 Code, there is a requirement to have a “formal, rigorous and transparent procedure for the appointment of new directors to the board”. To further clarify this, the 2010 Code specifies that board candidates should be appointed on merit and with due regard for the benefits of diversity on the board, including gender. The 2010 Code also requires that the board appointments are made by the nomination committee leading the process and making recommendations. The nomination committee is to be consisted of independent non-executive directors. However, as Sportive was at the time a small company, the 2010 Code was not applicable in its entirety to it and it could decide which of the provisions of the 2010 Code were appropriate for it. The 2010 Code clearly notes this at the outset, where it provides that smaller listed companies may judge that some of the provisions are disproportionate or less relevant in their case and that some of the provisions do not apply to companies below the FTSE 350.

The UK Corporate Governance Code 2014 (‘2014 Code’) is applicable to appointments of Mr Most, Mr Stretch, Mr Red and Mrs Frame, who were appointed to the board in January 2016. The 2014 Code was applicable at the time. Similar to the 2010 Code, the 2014 Code also mandates that the appointments to the board are done as per the recommendations of the nomination committee. However, like the 2010 Code, the 2014 Code also does not apply completely to small companies. The question that arises is whether smaller companies can appoint directors without the nomination committee? It may be noted that the requirement for nomination committee is mandatory for listed companies. In 2010, Mr Wrench and Mrs Allen were appointed directors on 5 year contracts. In 2016, after the company became listed, two new executive directors were appointed, namely Mr Most (Finance Director) and Mr Stretch (Director of Retail Operations). In 2010, when Mr Wrench and Mrs Allen were appointed, the company was not a listed company, therefore, the requirement for nomination committee did not apply to them. In 2016, when the company decided to get listed, the new directors were appointed. At this time also, the company was bound and mandated to make the appointments through the nomination committee as per the 2014 Code, Para B.2.1.

Non Executive Directors

With respect to the proportion of executive and non-executive directors, the requirement is that at least half of the board should consist of non-executive directors. Companies that are below FTSE 350 must have a minimum of 2 non executive directors. The London Stock Exchange report notes that companies “should have at least two independent non-executive directors (one of whom may be the chairman, provided he or she was deemed independent at the time of appointment) and the board should not be dominated by one person or a group of people.” Two new non-executive directors were appointed in 2016, namely Mr Red and Mrs Frame. Mrs Frame has worked as a mechanic for Sportive since it was incorporated (but resigned from this role prior to becoming a NED), and so was also given the title of ‘Director of Product Development’. A point of relevance here is with respect to appointment of non executive directors who have previous involvement in the company. The London Stock Exchange Report has noted that there is a “degree of criticism has been levelled at companies for the appointment of so- called independent non-executives where there is an existing relationship with company management and this is seen as being too close.” This issue gains significance with respect to the appointment of Mrs Frame as the non executive director in 2016 when the company was listed. Mrs Frame has prior association with the company as she had worked as a mechanic for Sportive since it was incorporated. Although, she resigned from this role before she became a non executive director, her prior association is an important fact that may have implications for corporate governance compliance by Sportive. As per the 2014 Code, para B.1.1, the annual report of the company is required to identify the non executive directors in the company and also note on their consideration as ‘independent’ by the board of directors. The important issue for consideration here is whether the non executive director is independent in character and judgement or whether there are any circumstances or relationships that may compromise the independence of the non executive director. In the event that there are such relationships and circumstances that may seem to compromise the independence of the non executive director, then the board of directors is to state that whether in their opinion, the non executive director still continues to be independent. While making such determination, the board should specify the details of the circumstances and relationships, including whether the non executive director was employed by the company in the previous 5 years. The non executive directors are to be appointed through a formal process and subject to specific terms, including re-election. In the present case, the non executive directors, Mr Red and Mrs Frame were appointed by the board in 2016. The specific terms for their appointment are not mentioned, nor is there is a mention of the re-election terms for them. However, it is mentioned that the non executive directors were appointed for a period of five years. This is in conformity with the 2014 Code, which provides that any tenure beyond six years should be subject to rigorous review. As the appointment of the two non executive directors is for a period less than six years, it does not violate the 2014 Code. With regard to Mrs Frame’s appointment, it may be noted that although she is appointed as a non executive director, her appointment cannot be said to be independent because she was associated with the company as an employee for a significant period of time prior to her appointment as a non executive director. As one the principal reasons why non executive directors must be independent is to ensure that they are able to have a critical approach to the board’s decisions, this reason is not satisfied in the appointment of Mrs Frame, who will not be able to have such an approach because of her close association with the company.

Board Committees

The principal issue that arises in this regard is the setting up of the board committees and whether this was in accordance with the 2014 Code, which was applicable in January 2016, when the board committees were established. It is essential for companies to have nomination committees, with a majority of non executive directors so that it can nominate the names of the directors for filling up the vacancies in the board. The audit committee is a key part of the corporate governance as per Section C of the 2014 Code. As per Section C.3.1, the audit board of a small company should consist of at least 2 independent non executive directors. Small companies can also have the Chairman of the company as a member, but not Chair, of the audit committee. At least one member of the audit committee should have relevant financial experience.The audit committee which was appointed in January 2016 consisted of Mr Most and Mr Red and Mrs Frame, the latter two being the non executive directors of the board. Mr Most has financial experience as he has been a partner in Elite Accounts LLP. Therefore, on that count, the composition of the audit committee is in accordance with the 2014 Code, para C.3.1. However, as discussed earlier, Mrs Frame’s appointment as an non executive director is not to the purpose of her being an independent non executive director. Therefore, the requirement of the 2014 Code for there to be at least 2 independent non executive directors in the audit committee are not met in this case scenario. A nomination committee is to consist predominantly of independent non executive directors. The chairman of the board or an independent non executive director can chair the nomination committee. Once again, in a manner similar to the audit committee, the nomination committee also have a higher membership of independent non executive directors. Again, independence of directors is very germane to the entire governance structure. The nomination committee in Sportive consisted of Mr Mason and Mrs Frame and Mr Red. Again, as Mrs Frame cannot be said to be an independent director of the board, due to her close association with the company prior to her appointment as director, it can be argued that the nomination committee was not properly constituted. The Remuneration Committee is to consist of at least 2 non executive directors who are independent. Again, as Mrs Frame was one of the 2 non executive directors appointed to the Remuneration Committee, it may be argued that the committee is not properly constituted as she was not an independent member of the board.

Removal of Directors

In the present case, the following issues with respect to removal of directors merit attention:

Whether Mrs Allen’s removal as a director was proper;

Whether Mrs Allen has claim unfair prejudice for her removal as a director;

Whether Mrs Mason’s removal as a director was proper.

Removal of Mrs Allen from the position of Director

The procedure of the removal of directors from the company, is provided in the Companies Act 2006, Sections 168(1), in the event the Articles of Association do not provide a process by which the directors are to be removed. Where the power of removal of directors is provided in the Articles of Association, removal will have to follow the procedure laid down, which may be the removal by the majority of the shareholders or directors to serve a written notice to the director that is to be removed. In absence of such procedure, the Companies Act 2006, provides the statutory procedure, which enables the shareholders to remove a director by passing an ordinary resolution at the company’s general meeting. In either case, the director being removed has certain rights and protections that are provided in the contract of employment. Under Section 168(1) of the Companies Act 2006, a director can be removed by an ordinary resolution at a meeting. This is the power given to the members of the company. When a director is removed using this method, he or she cannot be deprived of compensation payable. The resolution has to be passed by the members in a simple majority. The written resolution procedure is not applicable, and a general meeting resolution is required. As it is a general meeting, all members, including the director being removed is allowed voting rights. However, there may be an arrangement of shares that deny voting rights to members. Ordinary shares in a company may be divided into two categories: voting and non voting shares. Although, this kind of arrangement is not common in the UK, it is not barred by law. Nevertheless, where such an arrangement exists, the members with non voting shares will not have to the right to vote for the removal of the director. The issue is that of the removal of Mrs Allen as a director in 2015, following an interview given by her to a local newspaper in which she stated: “Sportive is considering listing its shares, but this would be premature and commercially unwise. Unfortunately, the company’s CEO does not care about the company’s best interests, and refuses to listen to the views of other directors”. This led to an intimation of her removal from the board with immediate effect and also to her being asked to sell her shares to Sportive. As Mrs Allen is a member holding class B shares in the company, this would seem to be in accordance with Article 43A of the Articles of Association. However, both Article 22(g) as well as Article 43A require that the decision for the removal of director should proceed from the majority of the class A shareholders. In 2011, Sportive’s Articles of Association were amended and two new provisions were inserted. These two provisions are central to the removal of directors and are noted as follows: Article 22(g): ‘a director will be required to vacate office if a majority of the class A members so provide. Any director so removed is entitled to three months’ notice or, if the director so prefers, payment in lieu of notice.’ In the present case, the procedure for removal of directors is provided in the Articles of Association, which is that the majority of Class A members may remove the director with three months’ notice or payment in lieu of notice. The question is whether it is this procedure that will apply in the present case or whether the Companies Act 2006, Section 168 (1) will be applicable in this case. The use of the word “may” in Section 168 (1) of the Act gives the Company the latitude to exercise its discretion in removing a director in line with the provision of the Act or not. Thus, it is quite conclusive that by instituting Article 22 (g), the Company has provided a clear and unequivocal stricture to remove a director, especially as Section 168 (1) is not mandatory, but permissive. In Jackson, the court held that directors may serve notice on a director for his removal from office if it is in the best interest of the company that the director be removed. Therefore, it is not necessary to remove a director only under Section 168(1); and instead articles of association may prescribe the method of removal, which shall be binding. In this case, Mrs Allen was removed from her position as the director of the company as per the provisions of Article 22(g) of the articles. Therefore, the company may rightly claim that the removal of Mrs Allen was properly concluded by Mrs Mason who was the majority class A member, in consonance with the Articles of Association of the Company. In the present case, three points must be noted: first, Mrs Allen had a contract with Sportive which appointed her a director for a period of five years beginning 2010, when she was appointed. As she was removed in 2015, it is to be assumed that the period of contract was not quite at an end at the time of her removal. Second, the Articles of Association provide a procedure for removal of directors and as such, it is this that is applicable and not the Companies Act 2006, Sections 168(1). Third, that irrespective of the appointment or removal as a director, the same person may also have an employment status in the company and even if removed as a director, can claim constructive dismissal with regards to the employment.

Mrs Allen’s possible claim for unfair prejudice for her removal as a director

If the director is also a shareholder in the company and he/she is removed from directorship, there is a possibility of unfair prejudice, which may be claimed by the director being removed that the affairs of the company are being conducted in a manner which is unfairly prejudicial to its shareholders. The Companies Act 2006, Section 994 allows unfair prejudice petition where the conduct of the directors in removal of one director is unfair and prejudicial. Section 994 (1)(a) allows a member of a company to apply to the court for an order on the ground that the company's affairs are being conducted in a manner that is unfairly prejudicial to the interests of himself or other members. However, the interest should be related to membership and not directorship. AJ Boyle has called unfair prejudice remedy as one of the most significant forms of minority shareholders’ remedies. In smaller companies, it is possible that the removal of a director who is a member may lead to the filing of an unfair prejudice petition. In O Neill, the court held that unfair prejudice petition by a minority shareholder who is removed as a director may hold if the individual can show that removal from directorship is unfair to his interests as a member, unless there is a reasonable or fair arrangement as to the shares of the members. This principle was also held in Brownlow. Applying this principle to the present situation, Mrs Allen may claim that her removal as a director sought to affect her rights as a shareholder in a prejudicial manner. This can be substantiated by the fact that her shares were required to be sold and she was not given a fair arrangement for the shares that she held in the company. The company on the other hand may claim that the shares were taken back as per the articles of the company, as Article 43A provides: “members holding class B shares will be required to sell those shares to the class A holders, if the majority of class A holders so require”, which is the constitution of the Company. Therefore, there is an existing arrangement provided in the articles of association that members with class B shares may be asked to sell their shares to class A shareholders if so required. As per this, the company is in the stronger position as compared to Mrs Allen because the articles of association allowed the request for sale of shares.

Removal of Mrs Mason as a director

The issue is whether the directors had the power to remove Mrs Mason as a director of the company. As per the articles of the company, specifically Article 22(g) directors of the company could only be required to vacate office if the majority of the class A members so decide. Apart from that, the Companies Act, Section 168(1) provides that a director can be removed by an ordinary resolution at a members’ meeting. This is the power given to the members of the company. Directors may remove a director if the articles of the company provide such a power and they exercise such power in good faith. The facts presented show that in June 2018, the other directors informed Mrs Mason that her appointment as a director is to be terminated on the 31 July, and thereafter, Mrs Mason was not informed of board meetings and the company was run without any reference to her. The articles of the company did not allow the power of removal of directors to the board of directors. Therefore, the correct procedure for removal was the one that was prescribed in Article 22(g) of the articles of association. As this procedure was not followed, Mrs Mason may challenge the decision of the board to remove her.

Appointment of Company Secretary

The issue that arises with relation to the appointment of the company secretary, Mrs Kicker is:

Whether the simultaneous appointment as company’s General Counsel and Company Secretary in January 2016 is proper?

Companies Act 2006, Section 271, requires all public companies to appoint a company secretary. The role of the company secretary is not defined in the statute as the Companies Act 2006 does not provide any specific directions as to the tasks of the secretary. This leaves the role of the secretary to the agreement between the company and the secretary. However, the 2014 Code does provide guidance as to the role of the company secretary and it may be noted here that the 2014 Code, Section B.5, the company secretary works under the direction of the chairman, to ensure good information flows within the board and its committees and between senior management and non-executive directors, and is also responsible for advising the board through the chairman on all governance matters. Also noted in case law is that the role of the secretary is no longer that of a ‘mere servant’ as described in a 1887 case by Lord Esher MR. Rather, the secretary is an officer of the company with extensive responsibilities and it is one of the most important in the company. A recent report has stated that the CEO, Chairman, and Company Secretary form a ‘triumvirate at the top’. This brings up the question of the manner in which Mrs Kicker was appointed by the company. With regard to this issue, the appointment of Mrs Kicker as both the General Counsel and Company Secretary in 2016 is not something out of the ordinary as the Companies Act 2006 does not bar companies from appointing company secretaries that play dual role in the company, such as, director or general counsel along with being company secretaries. Therefore, the appointment of Mrs Kicker is proper and does not run contrary to established law in this area.

Removal of Company Secretary

The issues that arise with relation to the removal of the company secretary, Mrs Kicker are:

Whether Mrs Kicker’s removal as company secretary is as per the corporate governance code?

Whether the removal of Mrs Kicker in February 2018 with immediate termination effect without a notice is proper?

Whether the refusal to provide appropriate or accurate reference to Mrs Kicker is proper?

Removal of Mrs Kicker and corporate governance code

The UK Code of Corporate Governance 2016 (‘2016 Code’) is applicable here as it applies to the period when Mrs Kicker was removed as the company secretary. As per para B.5.2 of this Code, “the appointment and removal of the company secretary should be a matter for the board as a whole”. Mrs Kicker was not removed by the board; she was removed by Mrs Mason. This would mean that the removal of Mrs Kicker as company secretary was in violation of the 2016 Code provisions. At the time when Mrs Kicker was removed as the company secretary, there were seven directors in the board: Mrs Mason, Mr Mason, Mr Wrench, Mr Most, Mr Stretch, Mr Red, and Mrs Frame. Two of these directors, Mr Red and Mrs Frame, were non executive directors. The removal of company secretary, as per the 2016 Code was to be done only by the board as a whole and not by Mrs Mason acting alone. Therefore, on this count, the removal of Mrs Kicker is contrary to corporate governance code.

Removal of Mrs Kicker as Company Secretary and Employment Law

With regard to the first issue, that is the immediate termination without notice, the applicable law is the Employment Rights Act 1996 (ERA 1996). The notice requirement under this law is “not less than one week’s notice for each year of continuous employment if his period of continuous employment is two years or more but less than twelve years”. In this situation, the notice requirement for Mrs Kicker is 2 weeks (1 week for each year completed in employment). Generally, part IX of the ERA 1996 provides the employment termination procedure which includes the need for giving sufficient notice to the employee. For a contract of employment to be terminated in the proper manner, a notice of termination which specifies the date of termination or makes it possible for the employee to ascertain the date of termination must be given. Under the Act, a summary dismissal is wrongful unless the employee’s conduct has led to the dismissal. The latter will be considered where the employee has wilfully refusal to obey orders; failed to show professed skill; committed serious negligence; or breached duty of good faith. In case of misconduct, the ERA 1996, Section 98(4) is applicable and it concerns whether it is unfair to dismiss an employee. The Burchell test, which was laid down British Home Stores, is the long standing test on unfair dismissal. This test, in the words of the Arnold J. is as follows: “[t]he tribunal has to consider whether there was a genuine belief on the part of the employer that the employee was guilty of the alleged misconduct, whether that belief was reasonably founded as a result of the employer carrying out a reasonable investigation, and whether a reasonable employer would have dismissed the employee for that misconduct.” There are three parts of this test: first, the employer has a genuine belief that the employee is guilty of misconduct; second, that the belief is based on a reasonable investigation, and third that it is reasonable on the employer’s part to dismiss the employee for the misconduct. In a recent case, Reilly v Sandwell Metropolitan Borough Council, further guidance is provided on what amounts to misconduct justifying dismissal in case there is no breach of the employment contract. In that case, like the present one, the employee was dismissed without having breached a specific condition of the employment contract. However, in Reilly, the dismissal was upheld on the basis of it being reasonable for the employer to dismiss the employee where the employee is involved in misconduct even if the conduct does not breach any condition of the employment contract. In a recent case decided by the Employment Appeal Tribunal, Game Retail Ltd., in which it was reviewing the decision of an employment tribunal which had upheld the dismissal of the employee on the ground of his having used his personal Twitter handle to post some offensive tweets, the facts were similar to the present case scenario. In this case as in the present case scenario, the employer deemed could be harmful to the image of the company. Like Mrs. Kicker, the employee in that case did not have any affiliation to the employer on his Twitter account, but that was found to be irrelevant as the account was not set to private settings and the employee both followed and was followed by a number of people who were affiliated to the company. The Employment Appeal Tribunal did not give general guidance on social media use by employees and its possible consequence in dismissal, but it did specify that the tribunal should apply the range of reasonable responses test, which is used in unfair dismissal cases. More clarity is found in another decision given by the Employment Appeal Tribunal in Creighton, where the tribunal held that the employee had been fairly dismissed for a number of offensive tweets, even if these tweets were made considerable time ago. However, the Tribunal did take note of the fact that before dismissing the employee, the company had conducted disciplinary proceedings and investigations into the allegations of misconduct. The company had also provided an opportunity to the employee to be heard during the disciplinary proceedings. This was an important consideration in favour of the lawful dismissal by the company. Part X of the ERA 1996 provides the right of the employees to not be unfairly dismissed by the employer. Section 98 of the ERA 1996 provides the conditions for determining whether the dismissal was fair: capability or qualifications of employee; conduct of the employee; substantial reason justifying the dismissal. Where the conditions of capability or qualifications are met, the employer is required to give a written warning of the sub-standard performance and allow an opportunity to the employee to explain or improve. In case the dismissal is based on the misconduct of the employee, then disciplinary grounds are used to terminate the employee. The Supreme Court laid down the disciplinary hearing procedure in Connolly v McConnell, in which the court held that the reasons for dismissal and an adequate opportunity to defend themselves should be given to the employee. In this case, as Mrs Kicker was terminated with immediate effect, this would be a dismissal without notice or a summary dismissal under the ERA 1996. Therefore, the issue comes back to the tweets by Mrs Kicker and whether these amounted to fundamental breach of contract on her part. In this case, there is no condition in the contract that prevents Mrs Kicker from writing tweets from her personal Twitter handle. Therefore, there is no direct or indirect breach of a contractual condition by her. The immediate removal of Mrs Kicker from Sportive followed series of offensive tweets in February 2018. These were sent outside work hours and were unrelated to her work and were sent from her personal Twitter account, which made no mention of her employment with Sportive plc. As Mrs Mason considers these tweets to be highly inappropriate and reflecting poorly on the company, she thought it fit to terminate the employment of Mrs Kicker in the company with immediate effect. At the time of her termination, Mrs Kicker had been employed in the company for more that 2 years (January 2016 to February 2018). Therefore, as per the ERA 1996, the notice requirement that was to be met by Sportive would be 2 weeks (1 week for each year completed in employment). In this case, as Mrs Kicker was terminated with immediate effect, this would be a dismissal without notice or a summary dismissal under the ERA 1996. Even if Mrs Kicker’s conduct in posting those tweets did not breach contract but amounted to misconduct, then the summary dismissal would not be wrongful under the ERA 1996. Therefore, the issue can be based on whether it was reasonable for Sportive to dismiss Mrs Kicker for the latter’s tweets. As per Creighton, it is necessary that the company conducts disciplinary proceedings and investigations into the allegations of misconduct before dismissing the employee. The distinction between these cases and the present one is that in these cases company had provided an opportunity to the employee to be heard during the disciplinary proceedings and no such disciplinary proceedings or investigations have been carried out by Sportive and Mrs. Kicker has been dismissed with immediate effect without providing a notice. Therefore, even though offensive tweets were the reason for fair dismissal in the aforementioned two cases decided by the Employment Appeal Tribunal and the present case of Mrs Kicker, the court may not consider the latter’s dismissal as fair because no such disciplinary proceedings have been conducted and Mrs. Kicker was not provided a fair opportunity of presenting her case before the dismissal. In the present situation, Part X of the ERA 1996 termination procedure was also not followed with respect to Mrs. Kicker.

Refusal to provide appropriate or accurate reference to Mrs Kicker

With regard to the third issue concerning Mrs Kicker, that is, the failure of Sportive to provide appropriate reference to her, reference may be made to TSB Bank, in which the court held that an employee leaving her place of employment has a right to a fair and accurate reference. In TSB Bank Ltd, inaccurate reference led to the employer being held liable for constructive dismissal. The employer making a false or negligent statement in the reference letter, with regard to the conduct of the employee or the reasons of the employee’s dismissal can be held in breach of duty of care as per the decision in Hedley Byrne & Co. Although that case was not concerned with employee reference, the decision has led to the contention that there is a duty of care upon referees and employers not to make negligent misstatements. This duty of care has been specifically articulated by the court in Guardian Assurance plc, wherein the employer’s duty of care was upheld and the breach of the duty was held to lead to a right to legal redress against the negligent reference in case of it being the reason for not getting the job. Therefore, there is an implied duty on the employer for providing a fair and accurate reference, the breach of which could lead to liability for economic loss to the employee. Another related point here is the actual reference that was provided by Sportive to Mrs Kicker in which the reference letter states: “Mrs Kicker was terminated for engaging in inappropriate conduct whilst on company business.” This is an allegation against Mrs Kicker which was not raised with her before her termination and was not investigated prior to her termination. This raises the issue of inclusion of facts or allegations in the reference letter, which were not addressed while Mrs Kicker was still in employment with Sportive. In Cox, the reference letter included complaints against the employee that were not investigated before the termination of the employee. This was held to be unfair. Similarly, in Jackson, the reference was given with facts that were not addressed and inquiry or investigation into the facts was not conducted before the termination of the employee. The court held this to be unfair. More recently, in AB v A Chief Constable, a second reference with facts which were not disclosed to the employee before the termination, was held to be a violation of the Data Protection Act 1998, as per which all such facts must be disclosed to the employee. The established principle with regard to reference letters and termination is as provided in Jackson which is “requiring fairness in the form of some procedural mechanism which might permit the ex-employee to challenge an adverse opinion.” Considering the case law on reference letters, it may be noted that the failure to provide Mrs Kicker with an appropriate reference letter, amounted to a breach of her rights as an employee. The incorrect statement that Mrs Kicker was dismissed due to inappropriate conduct whilst on company business is also a problematic issue because this may be inferred to show that Mrs Kicker was not afforded reasonable opportunity to present her case before being dismissed as there are no disciplinary proceedings that can substantiate the remark that she was dismissed due to inappropriate conduct. On the contrary, this reference letter is likely to be used by Mrs Kicker to argue that she was unfairly and summarily dismissed on grounds that were not investigated or presented in any disciplinary proceedings against her before she was dismissed from her position.

Membership and Class Rights

There are two issues that arises under this section:

Whether classes of members can be created?

Whether it is proper for Mrs Allen to be asked to sell back her shares on her removal as the director of the company?

Classes of members

Within the company, classes of members can be created with each class being provided specific roles and privileges in the company. Classes of shares and class rights are not defined in the Companies Act, except in Section 629 of the Act, which defines a class of shares as a class in which the rights attached to it are in uniform in all respects. The shares in a company can be divided into different classes, by the constitution of the company, or through the terms of share issue. The differing rights within classes of shares within the same company may relate to voting rights, rights to dividends, and return of capital on the winding up of the company. There is no fixed formula for defining shares and it is only through construction of the terms of issue for each case can the determination of the class of shares be done. Ordinarily, shares may be described as ordinary shares and preference shares. There are other categories of shares as well which may be allotted in a company. In case a company so desires, articles of association may be altered before allotment of shares to issue shares ranking in preference to its existing shares. However, there is a general presumption of equality as between shares unless there is a specific and express distinction that is made between the rights of different categories of shares. However, if such a distinction is made, then it will hold. In the present case, the facts of the case show that there are two classes of shares that were created to accommodate Sportive plc’s expansion, when two new directors were appointed by Mrs Mason, namely Mr Wrench and Mrs Allen and they were also allotted 50 ‘class B’ shares each. As Mrs Mason wished to retain control of Sportive, prior to the shares being allotted, she changed the articles to provide that (i) the shares she held were to be known as ‘class A’ shares and would have the usual rights, and; (ii) class B shares are non-voting ordinary shares, and their holders shall accordingly have no voting rights in their capacity as members. As such, the change was effected in the articles of association and therefore, the change created two classes of shares. Membership rights were varied as between these two classes of shares as the class B shares were non voting shares. As per the provisions of Section 629 of the Companies Act 2006, there is nothing that bars the creation of such categories of shares and therefore, this change to the articles is valid.

Sell back of the shares by Mrs Allen

The issue to be discussed here is whether the demand from Mrs Allen to sell her shares were proper decisions or whether these can expose the company to legal claims. Articles of association may contain provisions that stipulate that upon removal, the director must sell his shares to the other shareholders of the company. Article 22(g) as well as Article 43A require that the request for sale of shares, should proceed from the majority of the class A shareholders. In this case, the majority shareholder of class A shares is Mrs Mason, therefore, as per the articles of association, she could ask for the sale of shares by Mrs Allen. As the provision is a stipulation in the articles itself, Mrs Allen cannot claim that the sale of shares was not lawful.

Chapter 3 - Dividends and the External Auditor.

3.1 Dividends

The issues in this section are:

Whether the company can issue all of its profit as dividend for one financial year?

Whether the directors are liable for unlawful dividend?

Issue of dividend

The issue of dividend is the most common form of distribution to members and is usually payable as per the share holding of the members in the company. The payment of dividend is controlled for reasons of ensuring that they are not a way of distributing money to the members in excess of what they are entitled to. It has been held by the Supreme Court that whether a payment to the shareholder is unlawful return of capital or not is a matter of substance and not labels, and the court’s task is to ascertain the true purpose and substance of the transaction. For this, the court will have to consider all the relevant facts, which will include the facts as well as the motives and intentions of those involved. The distribution rules are meant to regulate the capital maintenance regime of the company and to ensure that the assets of the company are not whittled down. Therefore, what is prohibited is the payment of dividend out of the capital of the company. The dividends are to be paid out of the distributable profits of the company and that only after the company’s accounts have been properly prepared. The payment of dividend out of profits is not barred as held in Re Marini Ltd, that the prohibition is on making a distribution from other than profits of the company as per Companies Act 2006, Section 830(1). To the extent that distribution is out of profits, it is not unlawful. However, the preparation of accounts is required even when paying dividends out of profits. As it is, shareholders are automatically entitled to dividend payment only when there is an express provision of fixed dividends in the articles of the company. In such cases also, that is, where distributable profits are available, directors may first transfer a proportion of dividend to reserve so that the dividend is payable only from what is left after the reserve transfer has been effected. This goes to show that payment of dividend is not to be automatically done from the distributable profits. When dividend is paid without there being a distributable profit for paying it out, or where the accounting requirements are not met, then the payment of dividend is unlawful and ultra vires; as such, it cannot be ratified at the general meeting. The significance of the preparation of accounts is highlighted by the case of Re Loquitor, in which the company paid out dividends to the parent company to the tune of £5.9 million. At this time, the company was also seeking a tax relief from Inland Revenue, but of which there was no guarantee that the relief would be granted. At the time of liquidation, Inland Revenue challenged the payment of the dividend under IA 1986, Section 212, which concerns misfeasance by directors on the ground that they did not prepare proper accounts before recommending the payment of dividends. The court held the dividend to be paid in contravention of the statutory requirements as the failure to provide for the tax liability in the accounts before payment of dividend meant that the accounts were improperly prepared. In this case scenario, Sportive does not meet its sales predictions and only made a small profit of £50,000 in 2016/17. In an attempt to satisfy the shareholders, the directors recommended that all £50,000 be distributed by way of dividend and this was declared at the 2017 AGM. The accounting requirements were not met by the company before the directors recommended and the AGM authorised the payment of the dividend. As such, the payment of the dividend may be unlawful. There are two possible consequences of the payment of such unlawful dividend. First consequence is that the company may seek to recover the amount of dividend paid to the members, they being the recipients of the unlawful dividend. Second consequence may be that the action for unlawful dividend may be taken against the directors of the company for authorising the payment of the dividend. The latter can be done through the bringing of an action of misfeasance against the directors of the company under IA 1986, Section 212. This is discussed in the following section.

Directors’ liability for unlawful dividend

The directors of the company are to recommend the issue of dividend based on their prudent and diligent consideration of the matter. There are certain duties of the directors which are also related to the recommendation for payment of dividend. The first is the duty of exercising their powers for the purpose for which these powers are conferred. The second is the duty of the directors to promote the company’s success and work towards the benefit of its members as per Section 172. Section 172(3) specifically mentions the interest of company’s creditors as an important consideration for directors. The directors also have the duty to exercise care and skill, which will be especially needed when the directors are making a recommendation as to dividend as this will be done after a careful consideration of the company’s financial health. In Re Loquitor, the court held that prudent directors employing their care and skill to the matter will not recommend dividends without ensuring that the company was in a condition to meet the claims of creditors as and when such claims would be raised. In this case (facts discussed in above section), the directors were held liable for acting in breach of their duties, failing to consider the interest of the creditors and failing to exercise due care and skill by not retaining sufficient assets to meet future liabilities that could be reasonable anticipated at the time of the decision to give out dividends. In the present case scenario, the directors of Sportive were aware that the company was not making a significant profit and also that there were difficult financial times ahead for the company as there was stiff competition in the market. There is no evidence that the company prepared proper accounts taking into consideration reasonably foreseeable future liabilities or expenses before making the declaration of dividend at the AGM. Therefore, the directors failed to exercise due care and skill before making the recommendation for the payment of the dividend.

3.2 External Auditor

Whether the external auditor appointment is proper?

Whether the auditor is responsible for the unlawful dividend declared in 2017 AGM?

Appointment of external auditor

External auditor can be appointed by the company

The audit committee has some crucial role to play in the appointment, remuneration and review of the work of the external auditor. The 2014 Code, which was applicable in January 2016, provides this aspect of the audit committee’s role in Section C.3.2, wherein it is mentioned that the audit committee is to make recommendations for the appointment of external auditor to the shareholders and also to approve of their remuneration and engagement terms. The independence and objectivity of the external auditor is also to be reviewed and monitored by the audit committee. The appointment of the external auditor in this case, that is, Elite Accounts LLP, was done for the purpose of appointing a more experienced auditor to audit Sportive’s accounts on the statement by Mr Most that their audits are always thorough and independent. Mr Most had been a partner in the Elite Accounts LLP until two years ago. Mr Most was also on the audit committee of Sportive at the time of the appointment of the external auditor. It is not clear whether the appointment of the external auditor was on the recommendation of the audit committee as is mandated by the 2014 Code, Section C.3.2 or whether Mr Most made the recommendation in his individual capacity. If the recommendation was made outside of the audit committee, then there is a possibility that the appointment of the external auditor was not made in compliance with the 2014 Code. Moreover, Mr Most was a partner in the Elite Accounts LLP 2 years prior to his making the recommendation. This may mean that there is a prior connection between the director and the auditor being recommended by him. The 2014 Code is silent on whether directors can recommend external auditors who they have a prior connection with. It does require that the audit committee ensure the independence of the external auditor. The facts presented do not show that at any time the independence of the external auditor was compromised. Therefore, it may be stated that the appointment of the auditor was proper and as per the provisions of the 2014 Code.

Chapter 4 - Debt Financing and Liquidation

4.1 Charges

There are several charges against Sportive and the issue arises as to the priority in which these charges are to be paid. There are five questions that arise with respect to the charges and the ranking priority for these in the event of Sportive’s liquidation. These questions are as follows:

The first question is with regard to the fixed charge created in favour of Portsmouth Bank plc. The question is whether a fixed charge can be extinguished once the parties agree to the repayment of the loan in part and not in full towards the satisfaction of the debt.

The second question is with regard to the floating charge over all Sportive’s assets, created in favour of Mrs Mason for a loan to repay Bike Parts Ltd to the tune of £30,000. The question is whether the floating charge ‘over all assets’ can be created as some of the assets of Sportive were already subject to fixed charge. The question is whether floating charge is to be created over a class of assets or can it be created over all the assets.

The third question is with regard to the loan of £2 million from Southsea Bank plc taken in May 2018 and secured by a fixed charge over Sportive’s registered office.

The fourth question is with respect to the £30,000 in unpaid tax.

The fifth question is with respect to the £40,000 loans from assorted trade creditors.

Fixed Charge and Floating Charges

Fixed charges and floating charges differ with respect to the nature of the charge as well as the priority in which these charges are to be paid off by the company. Any type of security, which does not involve a transfer of possession from the debtor to the lender, is a charge. Charges are of two kinds, fixed and floating charges. At the outset, to explain fixed charges, these are charges that are created over identifiable and specific assets of the company, such as, a specific building. These charges are characterised by the debtor’s inability to sell the assets without the consent of the lender. Fixed charge is a charge in which the lender’s rights attaches immediately to the property on which the charge is being created, in an event of default of the loan. In that sense, a fixed charge is like a mortgage as the debtor becomes restricted in their power to deal with the asset without obtaining permission from the lender. On the other hand, a floating charge is one where the lender’s rights attach to assets as they are shifting in nature. The debtor can continue to deal with the assets in whichever way they deem fit without having to take permission from the lender. In other words, the debtor is in control of the assets in case of a floating charge; this control being the principal distinguishing characteristic between fixed and floating charge. Moreover, unlike the property that is made subject to fixed charge, the property subject to floating charge is constantly changing and may consist of stock in trade, book debts and any other assets and undertaking belonging to the company for the time being. The principal characteristics of floating charge are: first, a floating charge attaches to the assets as a whole and not to a specific asset; second, the class of assets is such as is constantly changing; and third, company has control over the assets and is free to deal with them as it deems fit. Thus, due to the last mentioned characteristic, a floating charge is flexible. However, it is also noteworthy that the classification of fixed and floating charges by the company itself will not mean that the courts will also accept it as such and courts may provide a different characterization of the charges than that prescribed by the company as the court is mostly concerned with the substance of the transaction and not the form. In a recent case, the court held that the court can contradict the classification provided by the company if the rights and obligations imposed by the charges are inconsistent with the labels that are accorded to the charges by the parties concerned. The House of Lords has also considered that the courts are not bound by the classification of charges as prescribed by the parties concerned; but must consider the commercial nature of the agreement as well as its substance. The distinction between fixed and floating charges becomes a significant issue during the time of liquidation of a company, wherein the competing claims of the creditors are to be settled as per the ranking of the charges made in their favour. The general rule that is applied in case of ranking of charges is qui prior et tempore, portior et jure, which means that the security interests are to be ranked as per their order of creation. However, this general rule is subject to a number of exceptions and the ranking of the charges is not merely decided as per their dates of creation. In case of fixed and floating charges, fixed charges are ranked prior to the floating charges, even where the latter were created in a later point of time. However, in case of deciding priority between floating charges, the general rule applies and the one that was created earlier will prevail, unless the parties to the charge agree that the subsequent charge will rank prior to the earlier one. Fixed charges rank before all other debts of the company, while floating charges are ranked behind fixed charges, liquidation expenses and preferential shareholders. As per the Insolvency Act 1986, Section 176 ZA fixed charges are to be paid first and then the expenses of the winding up are to be paid. Under Section 386, after the winding up expenses the preferential creditors are to be paid. The share of assets for unsecured creditors are also to be paid. Then come the payment of the floating charges and finally the payments to the unsecured creditors. As per this, the first priority is for the holders of fixed charge, which allows the holder to take the asset on which the fixed charge is created free from anybody else's interest in order to satisfy the debt. The holders of floating charges come later in priority of payment. Applying the above discussion on the law relating to the fixed and floating charges and the ranking priority of these charges in the case of liquidation, the following points are essential to be answered. Before proceeding, it is worthy to note that all charges ought to be delivered to the Registrar for it to be duly registered within 21 days of its creation.

Fixed Charge in favour of Portsmouth Bank

The first question is with regard to the fixed charge created in favour of Portsmouth Bank plc. The question is whether a fixed charge can be extinguished once the parties agree to the repayment of the loan in part and not in full towards the satisfaction of the debt. The facts of the case show that Sportive borrowed £500,000 from the Portsmouth Bank plc, for which a fixed charge was created over Sportive’s registered office. Before the satisfaction of the debt, Mrs Mason and the bank manager of Portsmouth Bank agreed that the bank will accept £450,000 in repayment, if Sportive could repay it immediately. Accordingly, Sportive paid back the loan amount. Now, Portsmouth Bank plc claims that Sportive still owes it £50,000. In this regard, the foremost operative question is whether the agreement to repay the full amount early is in writing as we were not informed of this. Assuming it is in writing, then Sportive may want to primarily rely on it as evidence of the Bank’s intention to waive the remaining £50,000. This begs the question as to whether the part payment of the debt was valid.

Part Payment of Debt

The fundamental rule in contract law as espoused in Pinnel’s case and as followed by the House of Lords in Foakes v Beer is that part payment of a debt is not good consideration and cannot serve as a bar for a creditor to claim his balance. A primary exception upon which this principle was predicated is in situations where the part payment was as a result of a request from the promisor before the due date, among others. From the scenario, it is quite clear that it was Mrs Mason that contacted the Portsmouth Bank, and the request to pay the £450,000 came from Mrs Mason, who in this case is the promisee and not the promisor. In view of the above, it can be concluded that the rule in Pinnel’s case as mentioned above will support Portsmouth Bank as the flow of transactions and communications does not fall under the exception above. Thus, Portsmouth Bank can claim the remaining £50,000 from Sportive. Most importantly, what this also means is that the operation of the fixed charge was not extinguished by the payment of the sum of £450,000 to Portsmouth Bank, but the remaining £50,000 is still secured by Sportive’s registered office.

Fixed Charge for Southsea Bank Plc

The second question is with regard to the loan of £2 million from Southsea Bank plc taken in May 2018 and secured by a fixed charge over Sportive’s registered office. Based on the fact that there is still a fixed charge over the registered office by Portsmouth Bank, it automatically affects the use of the referred office as the subject of a fixed charge for another loan. That could squarely constitute a fraudulent preference which could be challenged by Portsmouth Bank. In any case, Sportive could claim that it has no intention to prefer Southsea fraudulently, as it was in the actual belief that the charge to Portsmouth had been released by the agreement to pay the £450,000. If this is countenanced by the Court, it could lead to an alternative conclusion that the charge to Southsea Bank is subordinate to that of Portsmouth Bank.

Floating Charge for Mrs Mason

The third question is with regard to the floating charge over all Sportive’s assets, created in favour of Mrs Mason for a loan to repay Bike Parts Ltd to the tune of £30,000. The question is whether the floating charge ‘over all assets’ can be created as some of the assets of Sportive were already the subject of a fixed charge. Secondly, Mrs Mason was a person associated with the company and therefore, the floating charge made in her favour at the time when the company was struggling financially may also be relevant to deciding whether preference was given to her. The second question is dealt with in a later section. Coming to the first question, that is creation of floating charge over all the assets of the company, it may be noted that as per qui prior et tempore, portior et jure, the subsisting fixed charge will take precedence over the floating charge.

4.2 Loans

The fourth question is with respect to the £40,000 loans from assorted trade creditors. The trade creditors are unsecured creditors, therefore in order of priority, their claims will come after the satisfaction of the claims of those who have fixed and floating charges in the company assets.

4.3 Unpaid Tax

The fifth question is with respect to the £30,000 in unpaid tax. Unpaid tax is treated as an unsecured credit and it is payable as such. Earlier, tax payable to the Crown was treated as a priority payment, but the Enterprise Act 2002 removed all Crown priorities with respect to Inland Revenue and other customs and excise duties. In the list of priority of claims, unpaid tax is to be paid after the claims of floating charge holders have been paid. Therefore, £30,000 in unpaid tax is payable after the payment to floating charge holders.

Corporate Rescue Mechanisms

A company facing insolvency can have recourse to one of two kinds of insolvency procedures: rescue insolvency and terminal insolvency. Rescue insolvency is a procedure which allows the company to continue in business by appointment of an administrator who can make a plan for continuing the business instead of winding up of the company. This procedure is applied where there is some merit in rescue operations, that is, a possibility for continuing the business. The rescue mechanism can be employed through one of two methods: one, the business can be allowed to continue to generate revenue; or two, the business can be sold. The latter option is appropriate where there is a possibility of realising higher values through sale as a going concern. Rescue schemes can be a Company Voluntary Arrangement (CVA) or an Administration Order procedure. Under the CVA procedure, the directors retain certain controls over the company, and the appointment of nominee is also done by the directors. The CVA involves the appointment of an insolvency practitioner, who acts as a nominee of the company. The insolvency practitioner puts forth a scheme of arrangement to the unsecured creditors. The Administration Order procedure is provided for in Insolvency Act 1986, section 8 read with the Schedule B1. As per this, the Administrator is appointed by the court on an application by the company or its directors. Under Schedule B1, the administrator may be appointed by the court, by the holder of a floating charge, or by the company or its directors. The Administrator formulates a plan for dealing with the company. Pre-pack sales can be proposed as arrangements for rescue of the company wherein the sale of the company’s assets are made by the administrator with the potential purchaser and the administrator sells the assets after his appointment. In Re Kayley Vending Ltd, the court held that on application of administration order, it must be alert to see that a pre pack procedure is not being abused to the disadvantage of the creditors. Rescue insolvency is different from terminal insolvency, as the latter involves a complete and final winding up of the company. Winding up of the company can be voluntary or compulsory. Voluntary winding up can be initiated with a resolution passed by the shareholders of the company. A company that is solvent can be wound up voluntarily and in order to do so, the company has to obtain a declaration of solvency. Compulsory winding up is done by the court for which a liquidator is appointed. This sees the dismissal of the directors from office and the taking over the control of the management and assets by the liquidator. The liquidator has to perform the function of winding up the company by liquidating its assets and making the payments to creditors and shareholders. In the present case, both the rescue as well as terminal insolvency procedures can be applied to Sportive. However, the option of creditor’s liquidation or winding up is the most appropriate. Compulsory winding up will not be appropriate because it is unfavourable to the interests of the shareholders. Terminal insolvency would mean that Finance no longer exists and it will be wound up under the provisions of IA 1986, s.122 and 124. As the conditions of the company fall within the grounds available under s.122, specifically, the company being unable to pay its debts, this is possible. Sportive has made profits in the initial years of its existence but the company has been posting losses. Nevertheless, considering the network that Sportive have established over the time, potential for recovery cannot be overlooked for the company. This means that there is a possibility for applying a rescue insolvency procedure under the Insolvency Act 1986, Part I (Company Voluntary Arrangement) or under s.8 and Schedule B1 (administration procedure). If the latter option is chosen, then Sportive may appoint an Administrator who will be charged with the responsibility to create a plan of rescue for the company. Administration procedure will be appropriate if the directors are not looking to have control over the process and are prepared to spend more. In case the directors are looking to control the process and making it less expensive, it will be more appropriate to proceed under Part I (Company Voluntary Arrangement) and appoint a nominee or supervisor. Rescue plan, either made by the Administrator under Schedule B1, or by a supervisor under Part I of the Insolvency Act 1986, may involve sale of the company or its assets. Administration procedure under Schedule B1 is the option that will be recommended on the basis of the advantages that such procedure will offer to Sportive as compared to Company Voluntary Arrangement.

Liquidation

Liquidation of a company can be done by compulsory liquidation, or voluntary liquidation. Voluntary liquidation itself may be of two types: creditors’ liquidation and members’ liquidation. The kind of liquidation that the company may be wound up by depends on the circumstances of the company. Compulsory liquidation is done when a petition for liquidation is made under IA 1986, Section 124 to the court for the liquidation of a company that is insolvent. This petition may be made by a creditor of the company, shareholder, Secretary of State, or an Official Receiver, and other parties specified in IA 1986, Section 124. A petition for such compulsory liquidation may be made when the company is in a situation where its total debts and liabilities are greater that the value of its assets; it is unable to pay debts as and when they become due; it owes taxes; membership has fallen below the minimum required, among other grounds. A Members’ Voluntary Liquidation is an option for companies that are solvent but are nevertheless sought to be wound up. The directors need to sign a declaration stating that there are no remaining creditors, including the government to whom tax arrears are to be paid by the company. This is a statutory declaration of solvency by the directors of the company, after which the members may appoint a qualified insolvency practitioner as a liquidator of the company. Throughout this process, the court need not be involved at all. The members of the company initiate this process by passing a resolution for voluntary winding up under the IA 1986, Section 84 (1) and (2). The resolution is a special resolution of 75 percent majority. The resolution can only be passed, if in the preceding 5 weeks before the date of the resolution, the directors had made the statutory declaration of solvency as per IA 1986, Section 89. Along with the declaration of the directors, there is also a need to provide a detail of the assets and liabilities of the company, which may not be perfectly correct but must be fairly described as a statement of assets and liabilities. The members must also appoint one or more liquidators in the general meeting as per IA 1986, Section 91(1). Usually, this appointment is made in the meeting wherein the resolution for winding up is adopted. The appointment of the liquidator leads to the cessation of directors’ powers, although the liquidator under IA 1986, Section 90(2), may allow some directors to continue exercising certain powers in the company. A Creditors’ Voluntary Liquidation is initiated by a shareholders’ resolution and it is an appropriate option for a company that is insolvent. This process is initiated when the members adopt the resolution for winding up without the directors having to make a statutory declaration of solvency. In other words, in the period of 5 weeks preceding the members’ meeting, if no statutory declaration of solvency is made by the directors, then the liquidation is to be a Creditors’ Voluntary Liquidation as per IA 1986, Section 90. The members may appoint a liquidator and if their choice of liquidator is not acceptable to the creditors, then the creditors may also nominate a liquidator, who is to be the liquidator of the company unless the court orders otherwise. Creditors rights are protected to the extent that if the creditors are not provided an opportunity to appoint a liquidator, the member appointed liquidator is not to exercise any powers other than taking charge of property and disposing off the perishable goods. The purpose of the Creditors’ Voluntary Liquidation is to dissolve the company and redistribute its assets to the creditors of the company. When this method of liquidation is opted for, the directors can write off unsecured debts that are not personally guaranteed. The unsecured creditors of the company also have a right to appoint a qualified insolvency practitioner as a liquidator of the company. For the purpose of assisting this liquidator, a liquidation committee may be appointed with up to five representatives of creditors. A Creditors’ Voluntary Liquidation does not displace the directors of the company, and it may be used where the company is insolvent and does not necessarily involve the court. Therefore, for the purposes of Sportive and considering its situation, this is the most appropriate method for liquidation open to it. If Sportive chooses to adopt a Creditors’ Voluntary Liquidation process, its members will be required to pass a resolution to that effect by a majority. This means that the members, that is Mrs Mason and Mr Wrench, are to decide by a majority as to whether the option of Creditors’ Voluntary Liquidation is to be taken or not. In this case, as there are only two members in the company, both directors should make the resolution for Creditors’ Voluntary Liquidation in the directors’ meeting as per IA 1986, Section 89(1).

4.7 Wrongful Trading

Section 213 of the IA Act 1986 provides that the intent to defraud is seen where there is actual dishonesty involved according to the current notions of fair trading. This means that the conduct involved must be such that it is deliberately and actually dishonest according to the current notions of ordinary business people who conduct their business in a decent manner. Recent caselaw indicates that the court is of the opinion that when assessing dishonesty, the conduct of the ordinary and decent people be considered as opposed to the conduct of ordinary ‘commercial men’. Section 214 of the IA 1986 provides that the director of the company who may be involved in wrongful trading may be made liable to make contributions to the company’s assets. Section 214 of IA 1986 concerns wrongful trading and is engaged for the proven failure of the director to minimise the loss to the creditors by continuing to trade when they are aware of the futility of future transactions and there being no benefit to such trading. Accordingly, a director of the company can be held liable under Section 214, where he is a director of the company involved in insolvent liquidation, and who can be proved to have indulged in further trading prior to the commencement of the winding up, knowing that there is no prospect in further trading. Under Section 214(3) of the IA 1986, this liability can be avoided if the director has taken steps to minimise the loss to creditors. In ascertaining where the director might be liable, the court will also look on the standard of knowledge and skill under Sections 214(4) and 214(5). The minimum standard that is required in such cases is that which is foreseen by a reasonably diligent person. In case a director possesses specific skills, knowledge and experience, then the standard will be higher. Traditionally, the courts did not require directors to exhibit a greater degree of skill than may reasonably be expected from a person with their knowledge and experience, which was a subjective test. More recently, the courts have said that the common law standard now mirrors the tests laid down in section 214 of the IA 1986, which also includes an objective test for the directors’ conduct. In Re City Equitable, which is the foundational starting point for any discussion in this area, it was held by the court that the duty owed by the director is that of a reasonable person who does not know the business. Recently, in Re D’Jan, the court has broadened the earlier approach and widened the scope of the directors’ duties in this regard. In this case, the court has held that the duty of care owed by the director is that of a reasonably diligent person having the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions and the general knowledge, skill and experience that that director has. According to the facts of our scenario, Sportive was faced with financial difficulties. In April 2018, the company was informed by an auditor with the Elite Accounts LLP that Sportive was close to insolvency and will not be able to avoid liquidation. However, barring Mr Most, the other directors were of the opinion that the company should trade its way out. Thus, the company was trading at a loss. Despite the knowledge of the trading at loss the directors ignored the knowledge provided. The question arises whether the directors are liable under Section 214 of the IA 1986 and whether there was an intention to defraud under Section 213. Both sections impute different kinds of liability. In Section 213, the question is whether the directors defrauded the creditors, whereas in Section 214, the question is whether there was wrongful trading by the directors. The intention to defraud requires a deliberate and actual dishonesty according to the current notions of fair trading. This means that the conduct involved must be such that is deliberately and actually dishonest according to the current notions of ordinary business people who conduct their business in a decent manner. From the facts presented, as the directors did not have an intention to defraud or act dishonestly, they are not liable under Section 213. However, the directors did choose to trade when they knew that the company was not in a position to pay back its debt in the hope that it will be able to come out of its financial difficulties if it continued to trade, which may amount to defrauding under Section 213. The Grantham decision is relevant to this point. In this case, the court held that intent to defraud may be held where the directors realising that debts are incurred and there is no reasonable prospect of company creditors receiving the payment as things stand with the company at the time, and the directors knowing this continue to trade. In the present case, the directors were made aware of the financial position of the company as early as April 2018, but it continued to trade beyond this point. Therefore, there is a likelihood that the directors may be liable for defrauding under Section 213. Section 214 is also applicable as wrongful trading was done despite knowledge of the trading at loss.

4.8 Validity of preference transactions

The first issue is whether the fixed charge in favour of Southsea Bank valid or is it invalid by virtue of Section 239 of the IA Act.

The second issue is with respect to the floating charge created in favour of Mrs Mason in return for the loan taken from her to pay off Bike Parts Ltd. £ 30000 due to it.

A fixed or floating charge may be found to be invalid because it may be treated as a preference under Section 239 of the IA 1986. The period when the charge is created before insolvency is the key to deciding whether there is a preference or not. In case of people connected to the company, charges created in the period of 2 years prior to the insolvency of the company are termed as preference under Section 239 and are therefore invalid. In case of unconnected persons, charges created in the period of six months preceding the onset of insolvency leads to the invalidity of the charge as a preference. The principle behind this is to maintain the equity between creditors, which may be threatened when some creditors are given preferential treatment over the others. However, in order for Section 239 to apply, it must be shown that there was a motivation or desire to prefer one or more creditors by the creation of the charge. Therefore, the court has held that there was no preference created by a director causing a floating charge to be created in favour of a creditor from whom money was borrowed to tide over the financial difficulty by the director. The court held that as the creation of the charge was a part of the larger scheme to help the company to continue in business, therefore, it is not proved that the director was motivated by a desire to prefer a creditor. Another important point here is with regard to ‘onset of insolvency’ and when might a company be deemed to have reached this point in their financial affairs. As per Section 240(3) of the IA 1986, ‘onset of insolvency’ is defined as the time when formal insolvency proceedings are commenced as against the company. Thus, as per this provision, the onset of insolvency is a fixed point in time, clearly identifiable. Under Section 123 of the IA Act, insolvency itself is defined as the inability of the company to pay back its debts. The difference between balance sheet and cash flow insolvency is also important here as many companies may be former but still be cash flow solvent. A company that is cash flow solvent though balance sheet insolvent is one which has borrowed for the long term even though its borrowings are more than its assets. Nevertheless, cash flow insolvency may be determined on the basis of liabilities that are to arise in the near future. However, a company that is incurring more and more long-term debt only to avoid insolvency, is really insolvent in the commercial sense. Insolvency may mean both the Section 123 insolvency as well as when the company is under formal insolvency proceedings. A charge that is created in favour of a person connected to the company in the period of 2 years preceding the onset of insolvency may be invalid under Section 239 of the IA 1986. Section 245 of the IA 1986 provides that certain floating charges are to be avoided. Where transactions of this nature are entered into by the directors of the company, the liquidator can set aside the transactions. Under Section 238 of the IA 1986, any transaction by the company with any person at an undervalue, may be set aside. Under Section 239, if creditor or a surety has been given any preference by the company, actions giving such preference can be set aside. Under Section 245, there is a requirement to avoid the creation of floating charges and in particular, a floating charge created in the 2 years prior to the insolvency of the company, in favour of a person connected with the company is not valid. Under Section 239, a company can be brought back to the original position by the liquidator if the latter decides that the actions of the directors were not proper.

Fixed Charge in favour of Southsea Bank Plc

In this case, by April 2018, Sportive was not in a position to pay back its debts, unless it borrowed heavily. In order to do so, it borrowed heavily from Southsea Bank. This may be an indicator of Sportive being insolvent as per Section 123, even though formal insolvency proceedings have not commenced. The decision to borrow more money to help the company tide over a difficult financial period was taken in May 2018 after the financial problems of Sportive became more intense. Sportive borrowed from £2 million from Southsea Bank plc, and this loan is secured by a fixed charge over Sportive’s registered office. The question is whether the fixed charge is invalid by virtue of Section 239 of the IA 1986. Based on the fact that there is still a fixed charge over the registered office by Portsmouth Bank, the question of the latter fixed charge in favour of Southsea Bank may be raised. However, as it was Sportive’s actual belief that the charge to Portsmouth had been released by the agreement to pay the £450,000, the directors can claim that they did not intent to give preferential treatment to Southsea Bank Plc.

Floating charge created in favour of Mrs Mason

The floating charge in favour of Mrs Mason was created in the period of 2 years preceding the onset of insolvency for Sportive. At the time the charge was created, the company was already struggling to pay back its debts. Mrs Mason decided to loan the £30,000 to the company in order to pay back Bike Parts Ltd. This is when the directors including Mrs Mason being aware of the financial position of the company not being healthy. Therefore, the floating charge created in favour of Mrs Mason is liable to be held as a preference transaction as per the provisions of Sections 239 and 245 of the IA 1986. It can be shown here that there was a motivation or desire to prefer Mrs Mason by the creation of the charge. Although in Re Fairway Magazines, the court has held that there was no preference created by a director causing a floating charge to be created in favour of a creditor from whom money was borrowed to tide over the financial difficulty by the director as long as there was a larger scheme to tide over the company; in this case that principle will not apply because in that case the creditor was not a person connected with the company. In this case, Mrs mason was the CEO of the company at the time when the floating charge was created in her favour, therefore, there is a clear application of Sections 239 and 245 of the IA 1986. Therefore, the floating charge may be set aside by the liquidator, if appointed.

Distribution of Assets

Proceeds from Sportive’s registered office worth £700,000 will have to be distributed between Portsmouth Bank Plc (£50,000) and Southsea Bank Plc. Portsmouth Bank Plc will have priority as it is older in point of creation.

Conclusion

To conclude this advice document, it may be noted that the company may be faced with some litigation risks, and a possible insolvency as its debts exceed its assets. The important issues of concern are related to the removal of Mrs Mason and Mrs Allen from the position of director, and the removal of the company secretary, Mrs Kicker without providing a notice and appropriate reference. Some of the charges created are problematic, specifically, the floating charge in favour of Mrs Mason and the fixed charge in favour of Southsea Bank Plc.

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