Introduction
In corporate governance, it has been established that directors and shareholders are separated from the companies they represent in terms of assets they own or credits of the business. The idea of having the limited company has a separate entity from owners and managers was instituted in 1897. The case of Salomon v Salomon & Co [1897] AC 22 was monumental for this law formulation. The case helped to determine that the company responsible was separate from shareholders’ responsibilities and so were the liabilities even when shareholding was entrusted to the same shareholders. Furthermore, a company will not be described as a shareholder’s representative unless there is strong proof that the company was working as a representative in a specific transaction; Ebbw Vale UDC v South Wales TALA [1951] 2 KB 366. Basically, there is no way the company property belongs to the shareholders, Bank voor Handel en Scheepvaart NV v Slatford [1953] 1 QB 248. Shareholders are just creditors to the said company. There are several ways the concept of separation of liability from directors and company shareholders has been described. Some scholars’ term is a legal personality while others refer to it as a corporate veil. This means that a company has a totally separate legal entity from workers and owners.
Responsibilities of Directors in Private Company
In corporate law, a company is an entry to the system just like any other individual is. And that its activities are separate from those of the owners (Griffin, 2000, p. 45). Nonetheless, a company does not have a mind of its own; it cannot, therefore, make decisions, run operations, and carry out transactions on its own. It has to utilize the services of real people. This is achieved by the directors who are the company managers and the shareholders who own the company. Their investments are loans to the company. In some instances, the directors and the shareholders can be the same but they have different roles and responsibilities in the specific categories (Griffin, 2000, p. 45).
Despite the separation of the roles and rights of the business from those of the directors, it’s important for Andy, Roberts and Sugar to realise that there are some incidences when the directors of a company can be liable for the company’s debts. In such cases, the responsible director is required to personally make the payments in total or part of the total sum (Griffin, 2000, p. 45). This means that a director can be culpable of certain corporate offences especially when the director carries out a business deal that he/she knows that it would land the company into a ditch of insolvent liquidation. The only defence in such a case would be when the director responsible can present an attestation beyond reasonable doubt that he/she made all the possible corrections to avoid a greater loss to shareholders (Grier, 1998, p 34). Moreover, resignation does not exonerate or absolve the responsibility from the director.
In order to alleviate possible risks of accusations for illegal trade, any director must ensure that all possible problems that relate to the solvency of the company have conversed with other directors (Dean, 2001, p. 65). From that, a record of the discussion should be documented and the company up-to-date information on finances reviewed. Andy being a director of Freedom did not inform his fellow directors and shareholders of a business deal proposed to him offering Freedom an opportunity to purchase boats at a fair price. He quickly suggested to the prospective seller that Freedom was not in a position to purchase the two boats and in its place, he suggested another company, ‘Ocean’ which he was a shareholder as well. Essentially it is the responsibility of a director to offer expert advice or to disclose any useful knowledge for the good of the company (Dean, 2001, p. 65). Andy as a director failed to do this.
When shareholders get disgruntled, they will automatically go for the director responsible for the said problem in their company. The expenses that can be encountered in defence of such claims and the subsequent damages can be too much (Dean, 2001, p. 65). It’s advisable to avoid such problems when still possible to do so.
Just like many other institutions, Freedom allowed and required that a director can enter a personal deal to try and save the company by acquiring a loan for the company. This was evident in the case of Robert when his father offered to bail Freedom from trouble. However, such guarantees usually end up being personally responsible for the loans as specified (Muchlinski, 2002, p. 46). Basically, it’s presumed that the director should have known or ought to have suggested that the company did not have viable prospects to would help it circumvent the liquidation.
It is pertinent for the three directors of Freedom; Andy, Sugar and Roberts to know that a director or directors will be held legally responsible in case of a concealing or fraudulently shifting company assets, falsifying or covering up debts, destroying or making fraudulent omissions in records of the company (Muchlinski, 2002, p. 46)…“To try to further improve Freedom’s credit problems, in January 2010 Robert approached Risk It Finance Limited and applied for a short-term loan of £30,000. In support of the loan, Robert takes along a set of accounts. These accounts had not been audited and Robert knew that they contained some erroneous figures concerning Freedom’s balance sheet. In fact, they gave the impression that Freedom had assets worth approximately £50,000 more than it actually had. On the strength of the accounts Risk, It agreed to lend Freedom £30,000 repayable over two years at 15% interest per annum, and the money was transferred to Freedoms Bank account on 29th January 2010”.
Even when the directors did not actively participate in the fraudulent acquisition of the loans, they knew what was taking place and as such, they are still liable for the offence. They conspired in the act. The company’s act demands that directors and business officers of a certain company maintain the records updated. Failing to do this means that they are acting against the law and in case of problems arising from the same then they will be held responsible for the respective offences (Muchlinski, 2002, p. 46). This would be failing to maintain up-to-date records and deceitful acquirement of money. The directors will pay the fine in default.
Regarding the duty of care, the directors’ duties are fiduciary to the company. This, therefore, means that they are ethically accountable and hold legal responsibility to act with the best interest of the business owners at heart. On the same note, their decisions and advices are expected to be in good faith and towards the betterment of the corporation (Muchlinski, 2002, p. 46). When a director fails to exercise due care, it translates that the director will be personally responsible. Andy can be held answering to such offence since he is guilty of acting on his personal interest to benefit himself and leave freedom to collapse, after all, his shares were less than 50% and he had only paid part of it.
The case was that the seller had initially contacted Andy to find out whether Freedom was interested in purchasing the boats but as Andy told the seller, Freedom did not have available cash at that time to make the purchase (Goulding, 1999, p. 49). Andy did not bother to tell the other directors of Freedom about the potential deal. Instead, Andy told the seller that Ocean would make the purchase in place of Freedom. Ocean completed the purchase of the boats in November 2009. Ocean has now re-sold the boats in France, at a healthy profit, to contacts known to Andy through his dealings in Freedom. The value of Andy’s shareholding in Ocean has increased by £60,000 as a result of the profits made on the re-sale of the boats. There situation here is that Andy increased his shares by sixty thousand pounds. However, the other shareholders in Ocean are not mentioned, this seems to be a good deal that would have helped Freedom spring back into operation considering that it was going for loans much less than 60,000 pounds. Furthermore, the buyer he was dealing with in France, he only got to know them through Freedom. There is a very high possibility that these buyers took his thinking that it was a Freedom deal. Andy did not act in good faith.
Fiduciary Duties
Despite the fact that companies are separate entities from their owners and directors, the administration is entrusted to them. Directors are therefore managers acting as company agents and fiduciaries. From Aberdeen Rlwy Co V Blaikie Bros [1854], it was defined that directors have the responsibility of managing a business. For this reason, they had only a ‘simple duty’ which was to do everything under their power for the company with the interest of shareholders at heart (Goulding, 1999, p. 49). Basically, it’s from the definition of the responsibilities of directors that problems usually stem out. Great Eastern Railway Co. v. Turner (1872) case derived the explanation that directors were trustees of the properties and money that the specified company held. From this case, Lord Selborune confirmed what was suggested by Lord Johnson that directors’ rights and duties were twofold in McLintock v Campbell; company trustee and agent. However, acting as an agent was the main priority (Goulding, 1999, p. 49).
Comparatively, it’s important to suggest to Robert, Sugar and Andy that as directors, their duty was a direct consequence of what has been generated by equity courts as loyalty on fiduciary codes. The tort law addresses business in terms of negligence regarding duty of care and professional responsibility (Pass, 2004, p. 52).
The three directors have the right to enter into any contract on behalf of their business since the law provides for that moral authority. However, if their actions can extend outside what they are required to do, then they will be responsible for breach of the pledge of authority. When directors regard themselves as agents of creating companies and happen to make profits, then they have the moral obligation to account for how the profits were made to the shareholders (Pass, 2004, p. 52). If the directors are shareholders, then it’s important for the involved director to inform others about the deal still.
Directors persuaded shareholders in Allen v. Hyatt (1914) 30 T.L.R. 444 to give them an option of reinvesting the share indicating that it was very necessary at that point. As the directors exercised the said option, the profits were overwhelming. Nonetheless, they were required to account for it to the shareholders. When a person acts as an agent and at the same time possesses a special skill, then he/she must exercise the skill (Pass, 2004, p. 52). However, since being a director, in this case, is not a professional worker to the company this law is not applicable to him. The UK law does not make it mandatory that directors must have special skills. Still, when a director or a shareholder knows something that touches on the survival of the company, then he/she has the moral duty to communicate it to the rest of the directors and shareholders and together they can come up with an important decision that would see the survival of the company (Pass, 2004, p. 52).
Directors can be charged for breaching fiduciary responsibility when they divert business deals from their company entirely even when they had already left it. Collins J. Lawrence held one of the directors liable for fiduciary offence in CMS Dolphin Limited v Simonet ChD 2001 case as a result of redirecting an opportunity to do business from his company even though the said director was no longer attached to the company (Arsalidou, 2002, p. 62). Such is the case with what Andy was doing. When he was approached by a prospective seller about a potential deal for Freedom to purchase the boats, he never told the other directors but drove the seller away from Freedom and suggested another company (Ocean) instead.
Bell v Lever Brothers Ltd [1932] AC 161 case helped to determine that a director cannot be prohibited from running a competing business in which he is also a director. However, taking information obtained by dealings in Freedom to Ocean. This is a breach of fiduciary responsibility and from the above case, it was determined that even after leaving a company, a director still had the fiduciary duty and, in this regard,, he/she cannot redirect possible business deal from the company (Arsalidou, 2002, p. 62). Furthermore, the case helped to determine that the directory in such a situation cannot misuse information that he/she obtained while a director. This case accused a director (Bell) who moved with the company’s workers and customers to begin his own business (Arsalidou, 2002, p. 62). Andy has acted just the same by stooping the seller from accessing Freedoms and then leading Ocean into purchasing the boats. He even goes a head to assist in selling the boats later to a dealer he knew while carrying out Freedom Deals.
Common-Law Responsibilities
The UK common law recognized the duties of directors as trusteeship and acting as agents of a company. They are hence required to represent the interests of the shareholders. Whatever the company does is not to be charged on individuals (Ritcher, 2002, p. 32). However, when the director acts on behalf of a company, then the company is held liable for the deals or transactions undertaken by that particular director considering that he/she was representing the company. However, it’s pertinent for Andy, Sugar and Robert to take note of the fact that a director can be responsible for fraud even when they were representing a company. Briess v Wooley R [1954] is consequential in exposing this concept. Through some fraudulent trade, the managing director of a company, N Ltd acquired a lot of profits. He later negotiated the sale of shares the firm had in E Ltd without giving an explanation on how the company had become so profitable. The shareholders approved the deal and the sale was done. Upon discovery of the fraud, all the shareholders were prosecuted for colluding with the director to acquire money deceptively (Kakabadse et al, 2001, p. 4). As Robert went to acquire a loan with un-audited accounting records, he posed a bigger risk to the entire business. Fraudulent acquisition of money is a crime.
At times the best interest of the shareholder may not be the same as those of the company, for instance, when shareholders need to be paid their dividends which would, in turn, paralyze the company’s cash flow (Ritcher, 2002, p. 32). This case is dilemmatic for directors regardless of what capacity they are working in.
Common law demands that directors must not in any manner make use of the influence or powers they have due to the position they hold to carry out secret personal ventures that are profit-making at the expense of the company (Ritcher, 2002, p. 35). Such undertakings are illegal and the law will treat the profits that arise from these deals by the said director as belonging to the betrayed company. Under this law, the company can claim that the increase Andy got from diverting an opportunity from Freedom belonged to Freedom Diving and Leisure Limited. There is also the case of conflict of interest say for example another company with which a director owns or is willing to do business. Such conflict needs to be declared and the director in play should not take part in the negotiation. This is not however the case in our case. Andy does not disclose his dealings with Ocean in fact he literally hijacks Freedom’s opportunity. UK law requires that directors should take responsibility for the due skills. Though subjective, directors are not expected to be quiet on important issues for the business (Kakabadse et al, 2001, p. 4).
Statutory Responsibilities
Directors hold personal responsibilities of making sure that their businesses comply with the United Kingdoms’ law regarding company operations. Company law that is dealt with here includes duties as follows;
Proper preparation of the accounting records; these accounts have to be accurate and fair and be adequately prepared according to the standard of the UK accounting body (Dulewicz & Herbert, 2004, p. 263). The accounts should be audited by an external auditor. Following such requirements, it’s a criminal offence for shareholders and directors to deceive or intentionally fails to provide critical information to auditors the way Freedom decided to use accounting record inflated by 50,000 pounds to acquire a loan from Risk It finance.
Duties to Creditors
Basically, shareholders are responsible for meeting the creditor’s demand. And directors, however, company debts are not directly on their shoulders. When a company suffers solvency, directors do not have any duty to creditors (De Lacy, 2002, p. 58). Conversely, if the company suffers a financial crisis then the directors become directly responsible for any fraudulent deals or illegal trade immediately prior to the liquidation of the company (Armour et al, 2003, p. 532). The law defines fraudulent trade as a situation where the company or directors for this matter deliberately deceives or defrauds their creditors. However, this legal action can be tough to take since the intent of fraudulence has to be proved. Liquidation means that the company closes down and sells all the properties it owns and then compensates all the creditors (Dulewicz & Herbert, 2004, p. 263). Jack can be able to get repaid through this means. In some cases, the assets cannot manage to compensate for all of them.
Directors can be held liable for letting the company trade (wrongful trade) and incur more debt even when they vividly understood or should have discovered that the company showed no practical prospects of settling its debts (Aguilera, 2005, p. 4). The fact that a company is making losses in itself does not qualify to be termed as wrongful trade. However, when there is no feasibility of it reviving again and there are also more doubts as to whether the property it has will be able to re-pay the debts as the company goes due, then that is wrongful trade. The value of the property the company has is very tricky since when in the liquidation process, the sale is forceful and as a result, the value can be very low (Armour et al, 2003, p. 539). Lower than the quotation in financial books since there is pressure to sell and compensate creditors.
Common law requires that in the event of liquidation, the liquidator has to present a report about the activities and behaviour of the directors prior to liquidation. The report includes the compliance of the company with a number of regulatory statutory as well as the performance of every director (Aguilera, 2005, p. 6). Whether the directors consulted with the insolvency practitioners is assessed to show whether the directors acted fast to mitigate the situation as soon as the signs of collapse became evident. This is because the directors have the duty to make sure that the situation was under continuous monitoring and that every decision thereafter is documented properly (De Lacy, 2002, p. 58).
Conclusion
The corporate law concept is designed to be purposeful, exercise pragmatic truth and which cannot contradict. Corporations hence present themselves as liberal and the environment in which they operate an ultimate evolution of human laws that take care of every concern. But the critical assessment of the internal organizational structure and the interaction with the legal system indicate that these corporations are legal entities built on the ideological construct, planned to progress vested interests. As a consequence, they are susceptible to transformation just like other institutions, as people understand this, the better their survival in a corporate environment.
Reference List
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Table of Cases
Aberdeen Rlwy Co V Blaikie Bros [1854] 1 Macq 461.
Allen v. Hyatt (1914) 30 T.L.R. 444.
Bank voor Handel en Scheepvaart NV v Slatford [1953] 1 QB 248.
Bell v Lever Brothers Ltd [1932] AC 161.
Briess v. Woolley [1954] A.C. 333, 353–354.
CMS Dolphin Limited v Simonet ChD 2001.
Ebbw Vale UDC v South Wales TALA [1951] 2 KB 366.
Great Eastern Railway Co. v. Turner (1872) 8 Ch App 149.
MCcLintock v Campbell Salomon v Salomon & Co [1897] AC 22.