Company law (Longman law series)

Ben Pettet

LONGMAN

LAW

SERIES

LONGMAN LAW SERIES

Editorial Advisory Board

Professor I.H. Dennis (University College London)

Professor J.A. Usher (University of Exeter)

The second edition of this popular book on company law combines theoretical and

jurisprudential issues with an up-to-date account of legal developments across the field of

company law. The author demonstrates that the needs of shareholders in companies

which have dispersed ownership of shares cannot be properly understood without an

analysis of the law relating to securities regulation and capital markets.

Company Law is arranged in six sections: Foundation and Theory; The Constitution of the

Company; Corporate Governance; Corporate Finance Law; Securities Regulation;

Insolvency and Liquidation. Strong coverage of theory and policy is provided, together

with analysis of core legal problems at an appropriate depth for modular courses. The role

of self-regulation is examined in some depth and discussion of law reform in the shape of

the DTI's Company Law Review is included.

There is also a companion website for the book at www.pearsoned.co.uk/pettet, which

features regular updates to the law so that lecturers and students will remain up to date

with new legislative and case developments.

New to this edition

• Inclusion of the EC Directive on Takeover Bids

• Major changes brought about by the Enterprise Act 2002

• Standard Chartered Bank v Pakistan National Shipping Corporation 2002 and other

important case law developments

• Details of the EC Financial Services Action Plan legislation

• Coverage of the Companies (Audit, Investigation and Community Enterprise) Act 2004

Company Law is essential reading for LL.B. courses in universities and also covers the

requirements of the University of London (External) LL.B. The book offers excellent

foundation reading for postgraduate LL.M.s in company and capital markets law and is an

excellent critical survey of a dynamic field of law for students qualifying professionally in

the fields of accounting, finance and company secretaryship.

Ben Pettet LL.B., Barrister, is Professor of Company and Capital Markets Law, University

College London. He is a well-known researcher and writer in the field of company law.

www.pearson-books.com

Company Law

second edition

Company Law

Ben Pettet

second edition

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Free updates for this book at

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Company Law

second edition

Ben Pettet

0582894182_Cover(Pettet) 4/2/05 9:52 am Page 1

COMPANY LAW

LONGMAN LAW SERIES

GENERAL EDITORS

PROFESSOR I.H. DENNIS, University College London

PROFESSOR J.A. USHER, University of Exeter

PUBLISHED TITLES

ERIC BARENDT AND LESLEY HITCHENS, Media Law: Cases and Materials

R. HALSON, Contract Law

JONATHAN HERRING, Family Law

NICHOLAS J. MCBRIDE AND RODERICK BAGSHAW, Tort Law

BEN PETTET, Company Law

ROGER J. SMITH, Property Law

ROGER J. SMITH, Property Law: Cases and Materials

MAURICE SUNKIN AND ANDREW LE SUEUR, Public Law

MARTIN WASIK, THOMAS GIBBONS AND MIKE REDMAYNE, Criminal

Justice: Text and Materials

WILLIAM WILSON, Criminal Law: Doctrine and Theory

Visit the Company Law, second edition Companion Website at

www.pearsoned.co.uk/pettet

to find regular updates in the field of Company Law

COMPANY LAW

SECOND EDITION

BEN PETTET

Pearson Education Limited

Edinburgh Gate

Harlow

Essex CM20 2JE

England

and Associated Companies throughout the world

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First published 2001

Second edition published 2005

© Pearson Education Limited, 2001, 2005

The right of Ben Pettet to be identified as author of this work has been asserted by

him in accordance with the Copyright, Designs and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval

system, or transmitted in any form or by any means, electronic, mechanical, photocopying,

recording or otherwise, without either the prior written permission of the publisher or a

licence permitting restricted copying in the United Kingdom issued by the Copyright

Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP.

ISBN-13: 978-0-582-89418-1

ISBN-10: 0-582-89418-2

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library

Library of Congress Cataloging-in-Publication Data

Pettet, B. G.

Company law / Ben Pettet.––2nd ed.

p. cm.––(Longman law series)

Includes index.

ISBN 0-582-89418-2

1. Corporation law––Great Britain. I. Title. II. Series.

KD2079.P48 2005

346.41′066––dc22

2005043015

10 9 8 7 6 5 4 3

10 09 08 07 06

Typeset in 10/12pt Plantin by 3

Printed in Great Britain by Henry Ling Ltd., at the Dorset Press, Dorchester, Dorset.

The publisher’s policy is to use paper manufactured from sustainable forests.

CONTENTS

Prefaces xv

Acknowledgements xviii

Table of cases xvix

Table of statutes xxx

Table of statutory instruments xli

Tables of European legislation xliii

1 Treaties and conventions xliii

2 Secondary legislation xliii

PART I FOUNDATION AND THEORY 1

1 THE NATURE OF COMPANY LAW 3

1.1 Preliminary 3

1.2 Rationale, abstract and agenda 4

1.3 Scope of this work 8

1.4 The genesis of company law 9

1.5 The present companies legislation 10

1.6 European community legislation 11

A The harmonisation programme 11

B The Company Law Programme: UK Implementation 11

C The EC Commission’s Company Law Action Plan 13

1.7 Company law, corporate law or corporations law? 14

1.8 Focus – the main business vehicle 15

A Company limited by shares 15

B Public or private 15

C Small closely-held and dispersed-ownership companies 16

D The Company Law Review and law reform 17

1.9 Other business vehicles 18

A Other types of companies 18

B Other organisations and bodies 20

C Partnerships 20

2 CORPORATE ENTITY, LIMITED LIABILITY AND

INCORPORATION 23

2.1 Corporate entity 23

A The ‘Salomon’ doctrine 23

B Piercing the corporate veil 24

C Corporate liability for torts and crimes 28

2.2 Limited liability 31

A The meaning of limited liability 31

B The continuing debate about the desirability of limited liability 31

C Fraudulent trading and wrongful trading 33

v

2.3 Groups of companies 37

2.4 Incorporation 39

A Formal requirements 39

B Certificate of incorporation 42

C Publicity and the continuing role of the Registrar 43

D Promoters and pre-incorporation contracts 44

E Right of establishment 46

2.5 Company Law Review and law reform 46

3 LEGAL THEORY AND COMPANY LAW 47

3.1 The role of theory in company law 47

3.2 The nature and origins of the corporation 48

A The theories 48

B Rationale and application of the theories 49

3.3 Managerialism 50

3.4 Corporate governance 53

A Alignment 53

B The Cadbury Report and self-regulation 54

C Global convergence in corporate governance 55

3.5 Stakeholder company law 58

A Social responsibility 58

B Industrial democracy 60

C Stakeholder company law 61

D The Company Law Review and stakeholders 64

3.6 Law and economics 66

A Efficiency as a moral value 66

B The theory of the firm 67

3.7 Future issues 75

4 CURRENT REFORM MECHANISMS 77

4.1 Modern company law 77

4.2 The agencies of company law reform 77

A Department of Trade and Industry 77

B The Law Commission 80

C City and institutional input 80

D Academics 81

E European Commission 81

4.3 The 1998 Review 81

A Structure 81

B Guiding principles 82

C Swift progress 82

D The Final Report and subsequent developments 83

E Treatment in this book 84

PART II THE CONSTITUTION OF THE COMPANY 85

5 ENTRENCHMENT OF RIGHTS 87

5.1 Entrenchment of expectation versus flexibility 87

Contents

vi

5.2 Memorandum of association 87

5.3 Articles of association 88

5.4 Shareholder agreements 94

5.5 Changing the constitution and reconstruction 97

A Introduction 97

B Contract 98

C Alteration of articles 98

D Alteration of the memorandum 100

E Variation of class rights 101

F Compromises and arrangements under s. 425 106

G Other methods of reconstruction 110

5.6 Company Law Review and law reform 111

6 ORGANISATION OF FUNCTIONS AND CORPORATE POWERS 112

6.1 Introduction 112

6.2 The institutions of the company: the board and the

shareholders 112

6.3 The ultra vires doctrine 114

A Introduction 114

B Reform of the rule – an overview 115

C Underlying complications – objects and powers 116

D Shareholder intervention 121

E The current legislation – background matters 121

F Core provisions of the legislation 123

G Ratification 127

H Pulling it together 127

I An alternative approach 129

6.4 Company Law Review and law reform 130

7 RELATIONS WITH THIRD PARTIES: AGENCY AND

CONSTITUTIONAL LIMITATIONS 131

7.1 Contractual relations with third parties 131

7.2 Agency 131

7.3 The Turquand doctrine 134

7.4 The ‘relationship’ between Turquand and agency 135

7.5 Sections 35A and 35B 138

7.6 Company Law Review and law reform 142

PART III CORPORATE GOVERNANCE 143

8 THE GOVERNANCE PROBLEM AND THE MECHANISMS OF

MEETINGS 145

8.1 Alignment of managerial and shareholder interests 145

8.2 The role and functioning of the board of directors 146

A Directors as managers and ‘alter ego’ 146

B Appointment and retirement of directors 147

vii

Contents

C Proceedings at directors’ meetings 148

D Remuneration of directors 149

8.3 The role and functioning of the shareholders in general

meeting 151

A The general meeting as the residual authority of the

company 151

B Resolutions at meetings 152

C The shareholders’ general meetings 152

D Convening of meetings and notice 153

E Shareholder independence – meetings and resolutions 154

F Procedure at meetings 155

8.4 Problems with the meeting concept 157

8.5 Meetings in small closely-held companies 158

8.6 Company Law Review and law reform 159

9 DUTIES OF DIRECTORS 160

9.1 Introduction 160

9.2 Common law duties of care and skill 161

9.3 Fiduciary duties 164

A The scope of the duty of good faith 164

B The no-conflicts rule 166

C Duty in respect of employees 176

9.4 Relief for directors 176

A Ought to be excused 176

B Exemption and insurance 176

9.5 Duty not to commit an unfair prejudice 177

9.6 Company Law Review and law reform 178

10 OTHER LEGAL CONSTRAINTS ON DIRECTORS’ POWERS 179

10.1 Constraints on directors’ powers 179

10.2 Statutory controls affecting directors 179

A Introduction 179

B Part X enforcement of fair dealing 179

C Controls over issue of shares 181

D Statutory provisions in terrorem 182

10.3 Monitoring of directors 184

A Introduction 184

B The policy of disclosure of the financial affairs of the

company 185

C Accounts and reports 185

D Publicity 188

E Non-statutory reports 188

F The role of the auditors 189

G Company secretary 190

H Government and other agencies 191

10.4 Conclusions 192

10.5 Company Law Review and law reform 193

Contents

viii

ix

11 ROLE OF SELF-REGULATION 194

11.1 Reliance on self-regulation 194

11.2 Techniques of Cadbury 196

A Different approaches 196

B Structural and functional alterations 196

C Assumptions of responsibility 197

D Enhanced quality of disclosure 197

11.3 The Greenbury Report 198

11.4 The Hampel Report: evolution of the Combined Code 1998 198

11.5 The Higgs Review and the Combined Code 2003 199

11.6 The Combined Code 2003 201

A Listing Rules compliance statements 201

B Excerpts and summary of the main provisions 202

11.7 The ‘profession’ of director? 209

11.8 Conclusions 210

11.9 Company Law Review and law reform 210

12 SHAREHOLDER LITIGATION: COMMON LAW 212

12.1 Introduction: shareholder litigation generally 212

12.2 The doctrine of Foss v Harbottle 213

12.3 The principle of majority rule 214

12.4 The ‘exceptions’ to Foss v Harbottle 215

12.5 Meaning of ‘fraud on a minority’ 217

12.6 The striking out of derivative actions 219

A Introduction 219

B Types of action and costs 219

C Striking out derivative actions 221

12.7 The Breckland problem 226

12.8 Company Law Review and law reform 228

A The work of the Law Commission 228

B Company Law Review and law reform 229

13 SHAREHOLDER LITIGATION: STATUTE 231

13.1 Winding up 231

13.2 Unfair prejudice 232

A The alternative remedy failure 232

B Unfair prejudice 233

PART IV CORPORATE FINANCE LAW 251

14 TECHNIQUES OF CORPORATE FINANCE 253

14.1 Some basic concepts of corporate finance 253

A Assets and capital 253

B The aims of the company 254

C Cash flows and capital raising 254

14.2 Financing the company 255

A Initial finance 255

Contents

B Venture capital financing 256

C Public offerings of securities 257

14.3 The law relating to shares 263

A Definitions of share capital 263

B Increase and alterations of capital 265

C Authority to issue share capital 266

D Preferential subscription rights 266

E Nature of shares and membership 267

F Classes and types of shares 268

G Transfer of and transactions in shares 271

14.4 The legal nature of debentures (and bonds) 275

14.5 Company Law Review and law reform 275

15 RAISING AND MAINTENANCE OF CAPITAL 276

15.1 Introduction 276

15.2 The raising of capital – discounts and premiums 276

A Introduction 276

B Discounts 276

C Premiums 278

15.3 The maintenance of capital 280

A The meaning of the doctrine 280

B Reduction of capital 282

C Company purchase of own shares 286

D Dividends and distributions 290

15.4 Company Law Review and law reform 292

16 FINANCIAL ASSISTANCE FOR THE ACQUISITION OF

SHARES 294

16.1 Background to the present law 294

16.2 The modern scope of the prohibitions 296

16.3 Meaning of financial assistance 299

16.4 Principal/larger purpose exceptions 299

16.5 Private company exception 303

16.6 Other exceptions 304

16.7 Civil consequences of breach 305

16.8 Company Law Review and law reform 308

PART V SECURITIES REGULATION 311

17 POLICY AND THEORY IN SECURITIES REGULATION/CAPITAL

MARKETS LAW 313

17.1 The relationship between traditional company law and

securities regulation 313

17.2 The birth of securities regulation 315

17.3 The SEC 316

17.4 The Financial Services Authority 318

A The self-regulation era – the SIB 318

x

Contents

B Statutory securities regulation: accountability issues 321

17.5 Legal theory in securities regulation 323

A Aims of securities regulation 323

B Techniques of securities regulation 326

C The statutory objectives and the FSA’s duties 327

D IOSCO and global convergence 329

E Financial market integration in the EU 330

18 THE REGULATORY MACHINERY OF THE FINANCIAL

SERVICES AND MARKETS ACT 2000 338

18.1 Introduction and assumptions 338

18.2 Scope of the Act 338

A The general prohibition 338

B Regulated activities 339

C Examples of prescribed ‘activities’ and ‘investments’ 341

D Territorial scope of the general prohibition 341

E The financial promotion regime 342

18.3 Authorisation and exemption 343

A Methods of authorisation 343

B Part IV permissions 344

C The Register 345

18.4 Exempt persons and exemption of appointed representatives 345

18.5 Conduct of business 346

A Textures of regulation 346

B The FSA Handbook of Rules and Guidance 347

C The FSA Principles for Businesses 348

D Ancillary regimes 349

18.6 Collective investment schemes 350

A Background 350

B The basic regulatory position under the FSMA 2000 353

C The marketing of collective investment schemes: restricted 354

D Authorised unit trust schemes 354

E Open-ended investment companies 354

F Overseas collective investment schemes 355

18.7 Enforcement 355

A ‘Policing the perimeter’ 355

B Disciplinary measures 356

C Restitution, private actions for damages and insolvency 357

18.8 Investor compensation 358

18.9 Financial ombudsman service 359

18.10 Regulation of investment exchanges and clearing houses 359

18.11 Final matters 360

19 THE REGULATION OF PUBLIC OFFERINGS OF SHARES 361

19.1 Migration into capital markets law 361

19.2 Before the EC Directives 361

19.3 The Listing Directives and the Prospectus Directive 362

Contents

xi

19.4 UK implementation 363

A The ‘competent authority’ 363

B Prospectuses and listing particulars 364

19.5 Listed securities 365

A Introduction 365

B Background conditions 366

C Methods of issue 367

D Application procedures 367

E Contents of the prospectus 368

F Continuing obligations 369

G Other provisions 369

19.6 Unlisted securities 370

A The Alternative Investment Market (AIM) 370

B Prospectuses 370

19.7 The new Prospectus Directive and the FSA’s Review of the

Listing Regime 371

19.8 Remedies for investors 372

20 THE REGULATION OF INSIDER DEALING AND MARKET

ABUSE 374

20.1 Regulation of market conduct 374

20.2 Insider dealing and market egalitarianism 374

20.3 Development of regulation against insider dealing 375

A The cradle: SEC r. 10b-5 375

B UK legislation 377

20.4 Enforcement 382

20.5 UK regulation against market abuse 384

A The criminal law background 384

B Civil penalties for market abuse 384

20.6 The new EC Market Abuse Directive 386

21 THE REGULATION OF TAKEOVERS 389

21.1 Takeover battles 389

21.2 Disciplining management – the market for corporate control 390

21.3 Goals of takeover regulation 390

A The struggle for a Europe-wide regulatory policy 390

B The ideas in the new Directive 392

21.4 The UK system 393

A The Takeover Panel and self-regulation 393

B The operation of the City Code 395

C Other provisions applying to takeovers 397

D Defences 398

21.5 UK implementation of the Directive 399

21.6 The future in Europe under the Directive 400

PART VI INSOLVENCY AND LIQUIDATION 401

22 INSOLVENCY AND LIQUIDATION PROCEDURES 403

Contents

xii

22.1 The development of corporate insolvency law 403

22.2 Pre-insolvency remedies 405

A Corporate rescue 405

B Administration 405

C Administrative receivers 406

D Company voluntary arrangement or other reconstruction 406

22.3 Types of winding up and grounds 408

A Voluntary winding up 408

B Winding up by the court 408

C Procedure and scope 409

22.4 Effects of winding up, purpose and procedure 410

A Immediate effects of winding up 410

B Aims and purpose of liquidation 411

C Procedure 411

D Misconduct, malpractice and adjustment of pre-liquidation

(or pre-administration) transactions 415

23 DISQUALIFICATION OF DIRECTORS 417

23.1 Background 417

23.2 The disqualification order 417

23.3 Grounds – unfitness and insolvency 419

A The s. 6 ground 419

B Unfitness 420

23.4 Other grounds 425

A Disqualification after investigation 425

B Disqualification on conviction of an indictable offence 425

C Disqualification for persistent breaches of the companies

legislation 425

D Disqualification for fraud in a winding up 426

E Disqualification on summary conviction 426

F Disqualification for fraudulent or wrongful trading 426

23.5 Human rights challenges 426

23.6 Epilogue 427

Index 429

Contents

xiii

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