INSOLVENCY ACT
SUBMITTED BY: GROUP FOUR (4)
Meckedah Henry
Cassandra Lowe
Dana Russell
Submitted in partial fulfillment of the requirements for the course:
Business Law and Ethics
INTERNATIONAL UNIVERSITY OF THE CARIBBEAN
(IUC)
OCTOBER 2013
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QUESTION 1
Mr. Trusty had for 20 yrs. carried on a successful business as sole trader in the manufacture of
bulbs. In 1991 he formed a company registering himself his wife and his children as shareholders
with one share each with wife and children holding their as nominees. He transferred his
business to the company at a value of $200,000 which was in excess of the partly in $150,
000.00, $1.00 shares. Partly in cash withdrawn from the company in transfer and partly in a
$40,000 debenture issued by the company and secured by floating charge on its assets. The effect
of this is to make Mr. Trusty as secured creditor. The business began failing and so Mr. Trusty
pledged his debenture to Mr. Conman who lent him $10,000 in cash which paid over to the
company. The company became insolvent and if the debenture was paid out in full there would
be nothing for the other creditors. The other creditors brought a claim in court claiming Mr.
Trusty was the owner of the company and liable for its debts.
Critically assess the transaction of Mr. Trusty and explain
(I)Whether Mr. Trusty acted legally and whether the creditors can have a successful claim
against Mr. Trusty.
(II) What is Ethics and whether in this case Mr. Trusty behaved ethically in this transaction.
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In the business arena, individuals and companies are not only expected to behave legally
but also ethically. It is very important that both aspects be combined as any mishap in either of
these variables can directly impact the other.
(I) THE LEGAL FRAMEWORK
Mr. Trusty operated as a sole trader before forming a company with his wife and children
as shareholders. However, his wife and children held their shares as nominees (not the true
shareholder). This made him the owner of two businesses (the sole trader and the company). Mr.
Trusty transferred the sole trader business to the company at a value of $200,000. He did not get
a straight cash payment; he got part of the payment through shares, cash transfer and a debenture
(loan certificate) secured by a floating charge on the company’s assets. The debenture
automatically made him a secured creditor.
The company was failing and so Mr. Trusty pledged his debenture and was granted a loan
of $10, 0000 from Mr. Conman which he paid over to the company hoping to assist it in its
failure. Unfortunately the company became insolvent and the other creditors were upset because
if Mr. Trusty’s debenture was paid in full the other creditors would suffer financial losses. They
brought a claim in court stating that Mr. Trusty was the owner of the company thus should be
liable for its debts.
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The company is a separate legal entity from its owner/s. This means that it has some of
the same rights in law as a person. When a company becomes insolvent (cannot pay its debts),
then it ceases to trade because of the lack of financial power. But the owner's liability is strictly
limited. The owner is protected by law; his personal possessions cannot be used to repay the
company's debts. Even though the creditors claim that Mr. Trusty is the owner of the company,
legally he is not liable for the company’s debts. Contracts are made to the company therefore it
can be sued for breach of the contract; members are not liable to the creditors for the company’s
debts.
Mr. Trusty is also a shareholder in the company. Again because companies (either with
shareholders or owners), have limited liability, the most they stand to lose when their company
becomes insolvent is the value of the shares they hold. The mere fact is whenever the company
becomes insolvent the shares automatically become worthless. However, he had a debenture
issued by the company and secured by a floating charge on its assets.
A debenture is a document issued by a company setting out the terms of a loan; such
loans are usual medium or long term borrowings, a debenture holder is automatically a secured
creditor. Mr. Trusty took part of the payment through a $40,000 debenture secured by a floating
charge. Floating charges are used to secure borrowing by a company. Such borrowing is often
done under the terms of a debenture issued by the company. A floating charge is a particular type
of security, available only to companies. It is a charge on usually all the company's assets both
present and future. Occasionally the charge is over just a class of the company's assets, such as
its stock. The floating charge is useful for many companies, allowing them to borrow even
though they have no specific assets, such as freehold premises, which they can use as security. A
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floating charge allows all the company's assets, such as stock in trade, plant and machinery,
vehicles, etc., to be charged. Legally Mr. Trusty’s secured debenture entitles him to some of the
company’s remaining assets even though trade creditors remained unpaid.
THE CREDITOR’S CLAIM
From the juristic point of view, a company is a legal person distinct from its members
[Salomon v. Salomon and Co. Ltd. (1897) A.C 22]. This principle is usually known as the ‘Veil
of incorporation’. The courts in general consider themselves bound by this principle. The
company has a corporate personality which is distinct from its members but in a number of
circumstances, the Court will pierce the corporate veil or will ignore the corporate veil to reach
the person behind the veil or to reveal the true form and character of the company in question.
In the scenario, Mr. Trusty was an established secured creditor and entitled to the
company’s assets however, Mr. Trusty pledged his debenture to Mr. Conman who lent him
$10,000 which paid over to the company when it was failing. This goes to show that Mr.
Conman also had interest in the debenture and he is also entitled to some of the company’s asset;
Mr. Conman is also a secured creditor.
The other creditors were unsecured creditors because in the scenario there was no
mention of any legal documentation that deemed them any security. . Unsecured debts could be
credit card bills, unpaid insurance premiums and bank loans that weren't backed up by property.
It also includes payments to bondholders. In law there is an Act called rights of priority. The
purpose of this Act is to preserve as many of the debtor’s asset for the benefit of creditors and
other members in the case of insolvency. It shows the order in which persons are paid if
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insolvency should exist. Secured creditors are ranked first priority in this instant. Generally
speaking after the company handles its bankruptcy costs, it starts paying off its business
creditors. The company first pays off its secured creditors. Secured creditors gave loans based on
physical pieces of property or any other assets. These are debts like the mortgage on company
buildings, leases on company cars and loans for unpaid pieces of equipment. Secured creditors
get their money back first, usually by taking back their property. If this isn't enough to pay off
the debt, the secured creditors get first dibs on any remaining company money. So Mr. Conman
and Mr. Trusty would get first preference in the issuing of any asset of equal monetary value of
their loan from the company.
The unsecured creditors in the scenario was concerned about the debenture being paid in
full would result in them not getting anything. They brought a claim to the court but based on
researched done these person’s claim will not be successful because of the right of priority act;
they are only paid if anything is left over after the secured creditors are fully paid. Generally
unsecured creditors charge higher interest than secured creditors because of this higher
bankruptcy risk. When the company declares bankruptcy, the unsecured creditors have no
guaranteed payment. They need to wait until the secured creditors are paid off to reap from a
financial surplus.
(II) THE ETHICAL FRAMEWORK
Ethics refer to the fundamental concepts and principles of acceptable human behaviour. It
includes the study of universal values such as the essential equality of individuals, human or
natural rights, obedience to the law of the land, concern for health and safety and the natural
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environment. Business or corporate ethics is a form of applied ethics or professional ethics that
examines ethical principles and moral/ethical problems that arise in a business environment. It
applies to all aspects of business conduct and is relevant to the conduct of individuals and entire
organizations.
By law, Mr. Trusty did not behave wayward; however his modus operandi is
questionable. Having been in business for over twenty years, it is assumable that he could
identify the signs of a failing company. Additionally, he would understand how becoming a
secured creditor would safeguard his investment at the expense of the others.
It is important to note that the shareholders were Mr. Trusty’s relation; hence, the matter
need not escalate to the courts. It can be deduced by the scenario that although he acted legally,
Mr. Trusty did not follow ethical guidelines. It is important to note that when discussing ethics,
the technicalities of human interaction must be considered. This includes the whole emotional
aspects characterizing a human being.
According to ethical principles, it is observed that Mr. Trusty displayed a lack of
Compassion. Having understood that his relations; (individuals that are bound to him outside of a
courtroom); would have nothing to gain from the dissolution of the company-because of his
actions, Mr. Trusty should not have taken that route. According to the Insolvency Ethical
Principles (P. 1.1) He acted without “courtesy and consideration” In this matter, he can be
considered of an unethical persuasion because he sought to secure his own interest alone with no
regard for the unsecured creditors.
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REFERENCES
1. (1987), Salomon v. Salomon and Co. Ltd.
Retrieved on 24/10/2013- from: http://www.lawteacher.net/business-law/essays/articleon-lifting-of-the-law-.
2. (2012), Library & Information Service
Retrieved on 24/10/2013- from http://www.icaew.com/en/archive/library/subjectgateways/law/insolvency/legal-alert/when-directors-can-be-personally-liable-oncompany-insolvency.
4. (2010), Conyers Dill & Pearman Retrieved on 24/10/2013-from
http://www.conyersdill.com.
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