ACCA - LW
CORPORATE AND BUSINESS
LAW
Study Notes
CONTENTS
Chapter
01
Title
Business, Political & Legal Systems
Page No.
01
02
International Trade, Legal Regulations & Conflict of Laws
11
03
Alternate Dispute Resolution Mechanism
21
04
Contracts for the International Sale of Goods
34
05
Obligations and Risk in Contracts for International Sales
43
06
53
07
Transportation and Payment of International Business
Transactions
Agency Law
08
Partnership
75
09
Corporation & Legal Personality
82
10
Company Formation
92
11
Constitution of a Company
98
12
Share Capital
105
13
Borrowing and Loan Capital
113
14
Capital Maintenance and Dividend Law
121
15
Company Directors and other Company Officers
127
16
Other Company Officers
141
17
Company Meetings and Resolutions
147
18
Insolvency and Administration
154
19
Fraudulent Behavior
165
68
Business, Political & Legal Systems
Chapter ‐01
Chapter
01
Business, Political & Legal Systems
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IN THIS CHAPTER
ECONOMIC SYSTEMS
POLITICAL SYSTEMS
LEGAL SYSTEMS
COMMON LAW
SOURCES OF COMMON LAW
DOCTRINE OF JUDICIAL PRECEDENT
STATUTORY INTERPRETATION
CIVIL LAW SYSTEM
SHARIA LAW SYSTEM
JURISPRUDENCE IN SHARIA LAW
OTHER MEHTHODS OF EXERCISING IJTIHAD
IJTIHAD
PRE‐REQUISITES TO BE A MUTAHID
TAQLID
CONCEPT OF USURY IN SHARIA
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ECONOMIC SYSTEMS
Economic systems are the means by which countries and governments distribute resources and trade goods and
services.
Types of Economic Systems:
There are three main types of economic systems:
a) Planned Economy. It is an economic system in which production, investment, prices, and incomes are
determined centrally by the government.
The planned economy is a key feature of any communist society. Countries such as Cuba, North Korea and the
former Soviet Union are the main examples of countries that have command economies. China also had a
planned economic system but it then transitioned to a mixed economy that features both communistic and
capitalistic elements.
b) Market Economy: It is an economic system in which there is free competition and prices are determined by
the interaction of supply and demand i.e. by the aggregate interactions of a country's individual citizens and
businesses. It is also known as Capitalist or Free market economy (Opposite of a planned economy).
c) Mixed Economy: A mixed economic system combines elements of the market and command economy. Many
economic decisions are made by free market forces but the government also plays a role in the allocation and
distribution of resources. The main countries having a mixed economic system are France, the United
Kingdom, the United States, Russia and China. These countries have a blend of both the systems in a way that
the government spending and free‐market systems are based on the share of the government spending as a
percentage of gross domestic product.
Knowledge Test:
In which of the following types of economic system the decisions regarding investment, production, and
distribution are guided by the price signals created by the forces of supply?
A. Planned economy
B. Mixed economy
C. Market economy
Solution:
Market Economy
POLITICAL SYSTEMS
There are mainly two types of political systems:
a. Democratic Political System
b. Dictatorial Political System
Two important factors in any political system are:
a) Rule of Law
Dictatorial Systems ‐ dominated by state made laws and individual freedom is subject to it
Democratic Systems ‐ guarantee individual freedom and in a more traditional sense is a political system that
allows for each individual to participate. Citizens elect legislators who, in turn, make laws.
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b) Separation of Powers
Separation of powers refers to the division of government responsibilities into distinct branches to limit any
one branch from exercising the core functions of another. The main three branches are the:
(i)
Legislature: Responsible for enacting the laws of the state
(ii)
Executive: Responsible for implementing and administering the public policy enacted and funded by the
legislative branch.
(iii)
Judiciary: Responsible for interpreting the constitution and laws and applying their interpretations to
controversies brought before it.
LEGAL SYSTEMS
Legal system refers to a procedure or process for interpreting and enforcing the law.
Law is a system of rules that govern a society with the intention of maintaining social order, upholding justice and
preventing harm to individuals and property.
Types of Law
The major types of law prevailing in the world consist of:
 International Law: Body of legal rules governing interaction between sovereign states and the rights and
duties of the citizens of sovereign states towards the citizens of other sovereign states.
 National Law: Domestic law, which can also be called national law or municipal law, comes from legislature
and customs and regulates rights and duties between individuals and the state.
 Conflict of Laws: A specialized branch of law which resolves cases which have an element of conflicting
foreign law.
 Common Law: Common law system developed in England. It arose out of traditional customs and practices
which latter turned out to be very rigid and unfair. Common law is based upon amalgamating local customary
laws into law of the land. Remedies under common law are monetary such as damages.
 Sharia Law: It is the code of law derived from the Quran and from the teachings and examples of Mohammed
(P.B.U.H).
 Criminal Law: Criminal law relates to conduct which the State considers with disapproval and which it seeks to
control. Criminal law involves the enforcement of particular forms of behaviour, and the State, as the
representative of society, acts positively to ensure compliance. Thus, criminal cases are brought by the State in
the name of the Crown and cases are reported in the form of Regina v ... (Regina is simply Latin for ‘queen’
and case references are usually abbreviated to R v ...). In criminal law, the prosecutor prosecutes a defendant
(or ‘the accused’) and is required to prove that the defendant is guilty beyond reasonable doubt.
 Civil Law:
Civil law is a form of private law and involves the relationships between individual citizens. It is the legal
mechanism through which individuals can assert claims against others and have those rights adjudicated and
enforced. The purpose of civil law is to settle disputes between individuals and to provide remedies; it is not
concerned with punishment as such. The role of the State in relation to civil law is to establish the general
framework of legal rules and to provide the legal institutions to operate those rights, but the activation of the
civil law is strictly a matter for the individuals concerned.
Contract, tort and property law are generally aspects of civil law. Civil cases are referred to by the names of
the parties involved in the dispute, for example, Smith v Jones . In civil law, a claimant sues (or ‘brings a claim
against’) a defendant and the degree of proof is on the balance of probabilities.
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Knowledge Test (ACCA Past Exam Dec. 2014)
Which of the following describes civil law?
(1) A legal system which relies heavily on statutory codes
(2) A classification of law which applies between private individuals
(3) A legal system which relies on law made by judges
(4) A classification of law which applies between private individuals and the State
A.
B.
C.
D.
(1) and (2)
(2) and (3)
(1) and (4)
(3) and (4)
Solution:
A (1) and (2)
Knowledge Test (ACCA Past Exam Dec. 2014)
Which TWO of the following are private law actions?
(1) Those between individuals
(2) Those between business organizations
(3) Those between individuals and the state
A. (1) and (2)
B. (1) and (3)
C. (2) and (3)
Solution:
A (1) and (2)
Knowledge Test:
James has been arrested for murder. What is the standard of proof upon which the prosecution has to establish
case against James?
A. Balance of probability
B. Beyond reasonable doubt
C. Reasonable guilt
Solution:
Beyond reasonable doubt
Knowledge Test:
Ahmed has failed to deliver goods to Smith on the date specified in the contract. Smith wishes to file a case for
breach of contract against Ahmed. Advise Smith on what standard of proof will he have to prove his case?
A. Beyond reasonable doubt
B. Beyond all possibility
C. Balance of probabilities
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Solution:
Balance of probabilities
COMMON LAW
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The common law is the body of law formed through court decisions, as opposed to law formed through
statutes or written legislation. A common law system is the system of jurisprudence that is based on the
doctrine of judicial precedent, the principle under which the lower courts must follow the decisions of the
higher courts, rather than on statutory laws.
The common law legal system originated in England, was later adopted in the United States and Canada and is
in place in most Commonwealth countries. While the English common law system has its roots in the 11th
century, the present system has evolved over the past 350 years, with judges basing their decisions on those
made by predecessors.
SOURCES OF COMMON LAW
A. Common Law & Equity:
Common law is based upon merging local customary laws into law of the land. Remedies under common law
are monetary such as damages.
The concepts of equity developed in later years which were based on fairness. Equity steps in whenever
monetary compensation is not an adequate remedy. Specific Performance, Injunction, rescission are the main
equitable remedies.
Whenever there is a conflict between common law and equity then equitable principles would prevail.
B. Statute: This is law produced through the Parliamentary system. It upholds the doctrine of parliamentary
sovereignty within the United Kingdom means that Parliament is the ultimate source of law and, at least in
theory, it can make whatever laws it wishes.
C.
Customs: Local customs also act as a source of law.
D. European Union Law: Since joining the European Community, now the European Union, the United Kingdom
and its citizens have become subject to European Union law. In areas where it is applicable, European law
supersedes any existing United Kingdom law to the contrary
Knowledge Test (ACCA Past Exam Dec. 2014)
Which of the following is NOT a source of English law?
A. Custom
B. Equity
C. Public law
D. European Union directives
Solution:
C Public Law
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DOCTRINE OF JUDICIAL PRECEDENT
The doctrine of binding precedent, or stare decisis, lies at the heart of the English legal system. The doctrine refers
to the fact that, within the hierarchical structure of the English courts, a decision of a higher court will be binding
on a court lower than it in that hierarchy.
In general terms, this means that when judges try cases, they will check to see if a similar situation has come
before a court previously. If the precedent was set by a court of equal or higher status to the court deciding the
new case, then the judge in the present case should follow the rule of law established in the earlier case. Where
the precedent is from a lower court in the hierarchy, the judge in the new case may not follow but will certainly
consider it. This doctrine is known as stare decisis.
Judicial Present can only be considered as a binding precedent if:
A. It is a Ratio Decidendi. The ratio decidendi of a case may be understood as the statement of the law applied in
deciding the legal problem raised by the facts before a judge.
B. The material facts are similar
C. Decision must have been by a superior court
Knowledge Test:
Judges have the greatest scope to create law in which of the following legal systems?
A. Common law
B. Sharia law
C.
Civil law
Solution:
A Common law
Knowledge Test:
What is the role of judges in the judicial system?
A. To interpret the law
B. To make new laws
C. To codify the law
Solution:
To interpret the law
Knowledge Test:
Police has recently arrested Kailash for the crime of theft. In the criminal law by what legal term will Kailash be
called?
A. The plaintiff
B. The defendant
C. The claimant
D. The accused
Solution:
The accused
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Knowledge Test:
The person who files a case against another under civil law is called:
A. Accused
B. Prosecution
C. Defendant
D. Claimant
Solution:
Claimant
STATUTORY INTERPRETATION
It is the process of interpreting and applying legislation. In most cases, there is some ambiguity or vagueness in the
words of the statute that must be resolved by the judge. To find the meanings of statutes, judges use various tools
and methods of statutory interpretation.
Following are the techniques of statutory interpretation:
 Literal Rule: Is a type of statutory interpretation, which dictates that Acts are to be interpreted using the
ordinary meaning of the language of the Act.
 Purpose Approach: Is a theory of statutory interpretation that suggests that courts should interpret
legislation in light of the purpose behind the legislation keeping in view the ordinary, literal and grammatical
sense of the words.
 Contextual Rule: Words in statute should be interpreted keeping in view their context.
Presumptions of Statutory Interpretation:
A. Statue does not over ride existing law
B. Statute does not alter existing common law
C. Statute is not intended to deprive a person of his liberty
D. Statute does not have a retrospective effect
E. Statute does not bind the crown
CIVIL LAW SYSTEM
The civil law system is a codified system of law. It takes its origins from Roman law. Features of a civil law system
include:
 There is generally a written constitution based on specific codes (e.g., civil code, codes covering corporate
law, administrative law, tax law and constitutional law) protecting basic rights and duties; administrative law is
however usually less codified and administrative court judges tend to behave more like common law judges.
 Only legislative enactments are considered binding for all. There is little scope for judge‐made law in civil,
criminal and commercial courts, although in practice judges tend to follow previous judicial decisions;
constitutional and administrative courts can nullify laws and regulations and their decisions in such cases are
binding for all.
 In some civil law systems, e.g., Germany, writings of legal scholars have significant influence on the courts.
 Courts specific to the underlying codes – there are therefore usually separate constitutional court,
administrative court and civil court systems that provide opinion on consistency of legislation and
administrative acts and interpret that specific code.
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Less freedom of contract as many provisions are implied into a contract by law and parties cannot contract
out of certain provisions.
A civil law system is generally more prescriptive than a common law system. However, a government will still need
to consider whether specific legislation is required to either limit the scope of a certain restriction to allow a
successful infrastructure project, or may require specific legislation for a sector.
SOURCES OF CIVIL LAW
As regards civil law systems, the main source of law is the various codes which provide the law relating to
particular areas of activity. Such codes differ from United Kingdom legislation in that they are written in broad
terms in the pursuit of general principles and the implicit power of the courts to make, or change, the law is
reduced.
Such systems also tend to operate with written constitutions, which provide a fundamental basis for legal activity
and allows the courts to challenge any legislation that they decide is contrary to the constitution.
SHARIA LAW SYSTEM
It is the code of law derived from the Quran and from the teachings and examples of Mohammed (P.B.U.H).
Sources of Sharia law:
The main source of Sharia law is the Quran, which is accepted as the revealed dictate of Allah as revealed to his
prophet Muhammad (P.B.U.H). In addition the Sunnah, which is derived from the sayings of the Prophet (the
Ahadith), is also a primary source of law in Sharia systems
As secondary sources of law, Sharia systems refer to the Madhab, which is the opinions of leading early jurists on
the meaning and effect of Sharia law. Such systems also have written constitutions and these specifically
subordinate law to the religious rules.
Judicial system in Sharia Law:
 Clerics known as Imam act as judges
 In some Muslim countries they also appoint secular judges along with clerics.
Scope of Interpretation in Sharia Law:
 Sharia law is interpreted in accordance with the rulings in The Quran
 The Quran, being the fundamental source of law upon which even the Hadith is based, is primary precedent:
its rulings are binding and not subject to any dispute or further interpretation.
 In order to seek further clarity in the rulings judge may turn towards the secondary source i.e. The Ahadith
which were collected and written down by humans. It is recognized that due to human imperfection the
sources were prone to error, and this gave rise to the different categories of Ahadith depending on their
authority.
o The most guaranteed Ahadith are called Muwatir
o The less certain ones are called Mashtur
o Where the Ahadith’s authenticity is very less than the same will be categorized as Ahad.
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Jurisprudence in Sharia Law:
 After the Prophet’s death, there was a need to develop a system of jurisprudence that would serve the dual
purpose of safeguarding the system of Islam and to deal with previously unprecedented matters, not dealt
with directly in the Quran or the Hadith texts. This necessary process gave rise to the development of the
science of understanding and interpreting legal rulings known as fiqh.
 Fiqh in Arabic means ‘knowledge’, ‘understanding’ or ‘comprehension’.
 The scholars of fiqh generated a body of additional rulings. The tools involved in giving life to this third body of
rules were:
a) Ijma’ (consensus)
The universal consensus on religious issues of the scholars of the Muslim community as a whole can be
regarded as conclusive Ijma.
b) Istihsan (legal extrapolation)
Istihsan is a method of exercising personal opinion (ray) in order to avoid any rigidity and unfairness that
might result from literal application of law. Istihsan as a concept is close to equity in western law. This rule
permits exemption from strict and/or literal legal reasoning in favor of the public interest (maslahah).
c)
Ijtihad (interpretation)
Ijtehaad is the process where the scholars of Islam strive to find a solution to an issue on which the Quran and
Sunnah are silent.
d) Qiyas (analogy)
Qiyas is a process whereby a clear ruling of the permissibility or impermissibility of an act or thing is applied to
an issue closest related to it. An example of Qiyas would be that the use of alcohol is forbidden in islam as it is
an intoxicant and therefore this also covers the buying and selling of it.

The other methods of exercising ijtihad are:
a) Maslahah Mursalah
Maslahah Al Mursalah is a concept in traditional Islamic Law. The world Maslahah is taken from the root
word “Saluha” or “Salaha” which means to be good or to repair or to do good. Istislah on the other hand
refers to the methods used by Muslim jurists to solve problems (a good deed) especially when there is no
explicit guidance from the Qur’an and the Sunnah on such matters. Al Ghazali (d. 505/111 CE) defined
Maslahah as the considerations which secure the benefit or prevent harm but is in harmony with the aims
and objective of the Shariah.
b) Urf
ʿUrf is an Arabic Islamic term referring to the custom, or 'knowledge', of a given society. To be recognized
in an Islamic society, ʿurf’ must be compa ble with the Sharia law. When applied, it can lead to the
deprecation or inoperability of a certain aspect of fiqh.
c)
Istishab
This term refers to a situation in Islamic jurisprudence where the jurist presumes that the situation or a
fact continues or discontinues to hold applicable until the contrary is proven. A scholar can use the
concept of istishab in deducing a ruling if other proofs are absent.
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d) Ijtihad:
The requirements for ijtihad are:
i.
Its exercise cannot be done on certain issues such as on the existence of Allah
ii.
Judge (Mutahid) must be qualified.
Pre‐requisites to be a Mutahid:
a. Practicing Muslim
b. Honest and reliable person
c. Knowledge of Quran
d. Knowledge of Sunnah of Prophet (P.B.U.H)
e. Understanding of the principles of Ijma and Qiyas
e) Taqlid
Doctrine of Taqlid, requires the adherence to the legal principles established by the legal scholars of the
second and third centuries of Islam and the refusal to further develop through the use of itjihad.
CONCEPT OF USURY IN SHARIA
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The word used for 'interest' in the Quran is Ar‐Riba, an Arabic.
The literal meaning of riba is excess or increase. In Islamic terminology, interest means effortless profit or
profit which comes free from compensation or that extra earning obtained that is free of exchange.
Knowledge Test (ACCA Past Exam Dec. 2014)
Which of the following is NOT a source of Sharia law?
A. Fiqh
B. Hadith
C. Riba
D. Court judgments
Solution:
C
Riba
Knowledge Test:
The main source of Sharia Law is:
A. Ijtihad
B. Ijma
C. Qiyas
D. Quran
Solution:
Quran
Knowledge Test:
Interest in Sharia Law is termed as:
A. Ijtihad
B. Ijma
C. Qiyas
D. Riba
Solution:
D
Riba
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Chapter
Chapter ‐02
02
International Trade, Legal Regulations &
Conflict of Laws
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IN THIS CHAPTER
INTERNATIONAL LAW
INTERNATIONAL TRADE AND DOMESTIC LAWS
MODES TO PROTECT DOMESTIC MARKET
PRIVATE INTERNATIONAL LAW (CONFLICT OF LAWS)
INTERNATIONAL TRADE AND THE FUNCTION OF INTERNATIONAL
ORGANIZATIONS
UNITED NATIONS
UNITED NATIONS BODY FOR DRAFTING INTERNATIONAL LAW
THE UNITED NATIONS COMMISSION ON INTERNATIONAL TRADE LAW
(UNCITRAL)
ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT
(OECD)
INTERNATIONAL INSTITUTE FOR THE UNIFICATION OF PRIVATE LAW
(UNIDROIT)
STRUCTURE OF UNDROIT
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INTERNATIONAL LAW
International law is the term commonly used for referring to laws that govern the conduct of independent nations
in their relationships with one another.
Types of International Law
a) Public International law
Public international law is the body of rules that is legally binding on States in their interactions with other
States, individuals, organizations and other entities. Public International Law is also referred to as the "law of
nations”. It is different to Private International Law, as Private international Law is mainly concerned with
determining the applicability of the law of a country on a particular situation.
b) Private international law , or conflict of laws, helps to determine which country's substantive law will be used to
decide the dispute between the parties
It addresses the questions of:
i)
In which legal jurisdiction may a case be heard; and
ii)
The law concerning which jurisdiction(s) apply to the issues in the case
Example:
A dispute has arisen between a French company and an African company. Now private international law will help
to determine whether the case be brought before the French court or the African Court. Secondly, which law will
govern to decide the dispute French or African? Thirdly, once a dispute has been decided by a court the
mechanism in which the decision can be enforced in another country.
Knowledge Test:
Select from the following options the type of law which is applicable to the relationship between countries and
international organizations:
a) Roman law
b) International treaties
c) Private international law
d) Public international law
Solution:
Public international law
INTERNATIONAL TRADE AND DOMESTIC LAWS
International trade is the exchange of capital, goods, and services across international borders or territories. In
most countries, such trade represents a significant share of gross domestic product (GDP). However, countries
enact laws to protect their domestic market and/or industry. These laws sometimes act as a barrier to the free
international trade.
Modes to Protect Domestic market
The countries laws act as a barrier to free international trade in order to protect their domestic market. The most
common barriers to trade to protect their domestic market from foreign competition are tariffs, quotas, and non‐
tariff barriers.
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a.
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Tariffs
A tax imposed on imported goods and services. Tariffs are used to restrict trade, as they increase the price of
imported goods and services, making them more expensive to consumers
b. Quotas
A quota is a government‐imposed trade restriction that limits the number, or monetary value, of goods that
can be imported or exported during a particular time period. Quotas are used in international trade to help
regulate the volume of trade between countries
c.
Non‐Tariff Barriers
A non‐tariff barrier is a form of restrictive trade where barriers to trade are set up and take a form other than
a tariff. Nontariff barriers include quotas, embargoes, sanctions, levies and other restrictions and are
frequently used by large and developed economies.
Knowledge Test:
Indonesia wishes to totally impose a ban on the goods being imported from Country B. Which type of barrier
would it apply?
a) Embargo
b) Tariff
c) Import restriction
d) Import quota
Solution:
Embargo
PRIVATE INTERNATIONAL LAW (CONFLICT OF LAWS)
In the modern world citizens of different countries enter into business contracts. However, domestic laws of
countries differ from the other thereby causing conflict in dispute arising situations. The situations in which
conflicts of law can arise can be numerous such as:
a) Legal enforceability of contract in other countries
b) Remedies for breached contracts
c) Application of law on contracts
The rules of Private International law are the outcome of different state laws which are enacted by their
legislatures. The countries in order to overcome these differences enter into treaties and conventions to regulate
their matters. For example Rome Convention1980
However, the conventions have not been able to address all the issues in relation to the conflict of laws. The
United Nations has also enacted Model Laws which the countries can incorporate into their own domestic or
national laws.
Knowledge Test:
The disagreement of which of the following best applies on the conflict of laws?
a) Disagreement between India and amnesty international
b) Disagreement on trade policies between different neighboring states
c) Disagreement between companies of Austria and New Zealand doing business together
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Solution:
Disagreement between companies of Austria and New Zealand doing business together
Knowledge Test:
A country by adopting which of the following rules can avoid the issues of conflict of laws:
a)
b)
c)
d)
WTO Rules
UN Treaties
UN Model Laws
ICC Rules
Solution:
UN Model laws
INTERNATIONAL TRADE AND THE FUNCTION OF INTERNATIONAL ORGANIZATIONS
International organizations have a major role in the international trade and the drafting of international law.
The main organizations concerned with drafting of international law are:
UNITED NATIONS
The founding document and the multilateral treaty on which United Nations is based was signed on26th June 1945
in San Francisco. It was singed at the conclusion of the United Nations Conference on International Organization,
and came into force on 24 October 1945. The United Nations Charter has been amended three times in 1963,
1965, and 1973.
The United Nations is an international organization founded in 1945. It is currently made up of 193 Member
States. Each of the 193 Member States of the United Nations is a member of the General Assembly. States are
admitted to membership in the UN by a decision of the General Assembly upon the recommendation of the
Security Council.
UNITED NATIONS BODY FOR DRAFTING INTERNATIONAL LAW
The UN states that its member states should codify and develop international law. The two bodies in the UN
involved in drafting international law are The United Nations Commission on International Trade Law and
International Chamber of Commerce.
a) The United Nations Commission on International Trade Law (UNCITRAL)
The United Nations Commission on International Trade Law (UNCITRAL) is the core legal body within the
United Nations system in the field of international trade law. It was established by the General Assembly in
1966 (Resolution 2205(XXI)).
In establishing the Commission, the General Assembly recognized that disparities in national laws governing
international trade created obstacles to the flow of trade, and UNCITRAL was given the task of furthering the
progressive harmonization and unification of the law of international trade.
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This was to be achieved by: –
i)
Co‐ordinating the work of organizations active in this field and encouraging co‐operation among
them;
ii)
Promoting wider participation in existing international conventions and wider acceptance of existing
model and uniform laws;
iii)
Preparing or promoting the adoption of new international conventions and promoting the
codification and wider acceptance of international trade terms.
iv)
Promoting ways and means of ensuring a uniform interpretation and application of international
conventions and uniform laws in the field of the law of international trade;
v)
Collecting and disseminating information on national legislation and modern legal developments,
including case law, in the field of the law of international trade;
vi)
Establishing and maintaining a close collaboration with the United Nations Conference on Trade and
Development;
vii)
Maintaining liaison with other United Nations organs (General assembly, Security Council etc.) and
specialized agencies concerned with international trade;
viii)
Taking any other action it may deem useful to fulfill its functions.
The Commission is composed of 60 Member States elected by the General Assembly. Members of the
Commission are elected for terms of six years, the terms of half the members expiring every three years.
The Commission carries out its work at annual sessions, which are held in alternate years at United Nations
Headquarters in New York and in Vienna.
The following are some of the most important outcomes of the work conducted by UNCITRAL:
i. United Nations Convention on Contracts for the International Sale of Goods (Vienna, 1980). This
Convention establishes a comprehensive code of legal rules governing the formation of contracts for the
international sale of goods, the obligations of the buyer and seller, remedies for breach of contract and
other aspects of the contract.
ii. United Nations Convention on the Carriage of Goods by Sea, 1978 (the ‘Hamburg Rules’). This
Convention establishes a uniform legal regime governing the rights and obligations of shippers, carriers
and consignees under a contract of carriage of goods by sea.
iii. UNCITRAL Model Law on International Commercial Arbitration (1985). These provisions are designed to
assist States in reforming and modernizing their laws on arbitral procedure so as to take into account the
particular features and needs of international commercial arbitration.
iv. United Nations Convention on International Bills of Exchange and International Promissory Notes (New
York, 1988). This Convention provides a comprehensive code of legal rules governing new international
instruments for optional use by parties to international commercial transactions.
v. UNCITRAL Model Law on Electronic Commerce. This Model Law, adopted in 1996, is intended to facilitate
the use of modern means of communications and storage of information.
vi. UNCITRAL Model Law on Cross‐Border Insolvency. This Model Law seeks to promote fair legislation for
cases where an insolvent receivable (debtor) has assets in more than one State.
Knowledge Test:
If a dispute has arisen between countries, which of the stated type of international law would be automatically
binding on the country?
A. Municipal law
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B. International Treaties & UN Conventions
C. Domestic law
Solution:
International Treaties & UN Conventions
b) International Chamber of Commerce (ICC)
It was established in 1919. The ICC aims to promote international trade, responsible business conduct and a
global approach to regulation through a unique mix of advocacy and standard setting activities—together with
market‐leading dispute resolution services.
ICC is the largest and the most diverse business organization in the world. The ICC has hundreds of thousands
of member companies that represent more than 130 countries. Its members include many of the world’s
largest companies, SMEs, business associations and local chambers of commerce.
It performs three primary activities: establishment of rules, resolution of disputes and policy advocacy. The
ICC also fights against commercial crime and corruption in order to boost economic growth, creation of jobs
and steady employment, as well as overall economic prosperity. Because members of the ICC, and their
associates, take part in international business, the ICC has unparalleled authority in setting rules that govern
how business is conducted across all borders. While these rules are voluntary, thousands of transactions on a
daily basis operate by these ICC‐established rules, as part of regular international trade.
The organization’s international secretariat was also established in Paris, and its International Court of
Arbitration was formed in 1923.
WORLD TRADE ORGANISATION
The World Trade Organization (WTO) deals with the global rules of trade between nations. Its main function is
to ensure that trade flows as smoothly, predictably and freely as possible. The World Trade Organisation
(WTO) was set up to continue to implement the General Agreement on Tariffs and Trade (GATT), and its main
aims are to reduce the barriers to international trade. It has 164 members.
The WTO encourages free trade by applying the most favoured nation principle between its members, where
reduction in tariffs offered to one country by another should be offered to all members.
The World Trade Organization is ‘member‐driven’, with decisions taken by General agreement among all
members of governments and it deals with the rules of trade between nations at a global or near‐global level.
Key objectives
The WTO has six key objectives:
(1) To set and enforce rules for international trade
(2) To provide a forum for negotiating and monitoring further trade liberalization
(3) To resolve trade disputes
(4) To increase the transparency of decision‐making processes
(5) To cooperate with other major international economic institutions involved in global economic
management
(6) To help developing countries benefit fully from the global trading system.
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Structure
Ministerial Conference
 Composed of all members of the WTO, which is to meet at least once every two years
 Top level decision‐making body
General Council
Between sessions of the Ministerial Conference, its functions are exercised by the General Council, made up of the
full membership of the WTO. It has two additional specific tasks: Dispute Settlement Body and as the Trade Policy
Review Body
Goods, services and TRIPS councils
Three separate sets of subsidiary bodies report to the General Council:
a) Council for Trade in Goods
b) the Council for Trade in Services
c) the Council for Trade‐Related Aspects of Intellectual Property Rights (known for short as the Council for TRIPS)
Committees reporting to General Council (Second group)
Committee on Trade and Development, the Committee on Balance‐of‐Payments Restrictions, and the Committee
on Budget, Finance and Administration
Dispute Settlement Body (DSB)
Countries bring disputes to the WTO if they think their rights under the agreements are being infringed. Judgments
by specially appointed independent panel of experts are based on interpretations of the agreement.
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The system encourages countries to settle their differences through consultation. Failing that, they can follow a
carefully mapped out, stage‐by‐stage procedure that includes the possibility of the ruling by a panel of experts and
the chance to appeal the ruling on legal grounds.
Consensus is required for DSB’s rejection of panel’s report or appeal.
Secretariat
The WTO secretariat, based in Geneva, is headed by a Director‐General. Main duties are to supply technical
support for the various councils and committees and the ministerial conferences, to provide technical assistance
for developing countries, to analyze world trade and to explain WTO affairs to the public and media.
The Ministerial Conference shall appoint the Director‐General who will then appoint the members of the staff of
the Secretariat. In the discharge of their duties, the Director‐General and the staff of the Secretariat shall not seek
or accept instructions from any government or any other authority external to the WTO.
Knowledge Test:
Which of the following organizations is mainly concerned with setting up the rules for international trade?
a) United Nations
b) World Trade Organization
c) Organization for Economic Cooperation and DEVELOPMENT
Solution:
World Trade Organization
Knowledge Test:
A major dispute regarding trade has arisen between Country A & B. Both the countries wish to resolve the dispute.
Which of the following international organizations can help them in settlement of the dispute?
A. WTO
B. Amnesty International
C. OECD
D. UNCITRAL
Solution:
WTO
ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD)
The Organization for Economic Cooperation and Development (OECD) is a unique forum where the governments
of 35 countries with market economies work with each other, as well as with more than 70 non‐member
economies to promote economic growth, prosperity, and sustainable development.
It was setup in 1961 to administer American and Canadian aid to Europe after World War II. It is a forum of
countries describing themselves as committed to democracy and the market economy, providing a platform to
compare policy experiences, seeking answers to common problems, identifying good practices and coordinate
domestic and international policies of its members.
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INTERNATIONAL INSTITUTE FOR THE UNIFICATION OF PRIVATE LAW (UNIDROIT)
The International Institute for the Unification of Private Law (UNIDROIT) is an independent inter‐governmental
organization established in 1926 based in Rome. Its purpose is to study needs and methods for modernizing,
harmonizing and co‐ordinating private and, in particular, commercial law as between States and groups of States.
Membership of UNIDROIT is restricted to States complying with the UNIDROIT Statute. Its 63 Member States,
alphabetically ranging from Argentina to Venezuela, are drawn from the five continents and represent a variety of
different legal, economic and political systems as well as different cultural backgrounds.
UNIDROIT’s basic statutory objective is to prepare modern, and where appropriate harmonised, uniform rules of
private law understood in a broad sense.
Uniform rules prepared by UNIDROIT are concerned with substantive law rules; they will only include rules relating
to issues of a conflict of law nature when they arise out of the appellation of such rules.
The rules produced by UNIDROIT assume one of three types:
(i)
Conventions These documents are designed to apply automatically in preference to a State’s municipal
law upon the completion of all the formal requirements of that State’s domestic law for their entry into
force. However, as UNIDROIT itself recognizes, the low priority, which tends to be accorded by
governments to the implementation of such Conventions and the time it therefore tends to take for them
to enter into force, has led to the increasing popularity of alternative forms of unification in areas where a
binding instrument is not felt to be essential.
(ii)
Model laws These documents are designed to allow states to adopt or adapt them, when drafting
domestic legislation on the subject covered by the model law.
(iii)
General principles This form is addressed directly to judges, arbitrators and contracting parties who are,
however, left free to decide whether to use them or not.
STRUCTURE OF UNIDROIT:
A. Secretariat: Mainly responsible for the daily functioning and work of the organization.
B. Governing Council: Its main task is to supervise the policy of UNIDROIT and the work of the secretariat. It has
25 elected members and a president.
C. General Assembly: It is the main decision making organ. It is responsible for approving budget, work program
and electing the governing council. The governing council has one member representative.
Conventions and Model Laws
The following list sets out the most important Conventions and Model Laws, drawn up by UNIDROIT:
a) 1964 Convention relating to a Uniform Law on the Formation of Contracts for the International Sale of Goods
(The Hague);
b) 1964 Convention relating to a Uniform Law on the International Sale of Goods (The Hague);
c) 1970 International Convention on the Travel Contract (Brussels);
d) 1973 Convention providing a Uniform Law on the Form of an International Will (Washington);
a) 1983 Convention on Agency in the International Sale of Goods (Geneva);
b) 1988 UNIDROIT Convention on International Financial Leasing (Ottawa);
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c)
d)
e)
f)
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1988 UNIDROIT Convention on International Factoring (Ottawa);
1995 UNIDROIT Convention on Stolen or Illegally Exported Cultural Objects (Rome);
2001 Convention on International Interests in Mobile Equipment (Cape Town);
2001 Protocol to the Convention on International Interests in Mobile Equipment on Matters specific to Aircraft
Equipment (Cape Town).
UNIDROIT is a sponsor of two essential legal databases:
 UNILAW is a database providing access to up‐to‐date information regarding uniform law conventions and
other instruments.
The database is in both English and French and covers a large number of uniform law instruments.
 UNILEX is a database of international case law and bibliography on the UNIDROIT Principles of International
Commercial Contracts and on the United Nations Convention on Contracts for the International Sale of Goods.
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Chapter
03
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IN THIS CHAPTER
COURT BASED ADJUDICATION
ENGLISH LEGAL SYSTEM
CIVIL PROCEDURE CLAIMS
INTERNATIONAL COURT
ALTERNATE DISPUTE RESOLUTION
UNICITRAL MODEL ON INTERNATIONAL COMMERCIAL ARBITRATION
INTERNATIONAL COMMERCIAL ARBITRATION
LAW ON RECEIPT OF COMMERCIAL ARBITRATION
COMPOSITION OF ARBITRAL TRIBUNAL
PROCEDURE FOR ARBITRAL PROCEEDINGS
STATEMENT OF CLAIMS AND DEFENCE
HEARINGS AND WRITTEN PROCEEDINGS
CHALLENGING THE JURISDICTION OF THE ARBITRAL AWARDS
TERMINATION OF PROCEEDINGS
POWER OF ARBITRAL TRIBUNAL TO ORDER INTERIM MEASURES
MAKING OF AWARD
FORM AND CONTENTS OF AWARD
RECOURSE AGAINST AWARD
RECOGNITION AND ENFORCEMENT OF AWARDS
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COURT BASED ADJUDICATION
Adjudication (settlement) is carried out in various forms, but most commonly occurs in the court system.
Adjudication by courts involves several different functions: the establishment of the facts in controversy, the
definition and interpretation of relevant rules of law.
Adjudication in courts starts from the court of first instance and then the appellate court (a higher court of
appeal) if the decision by the lower court is contested.
Countries have different court adjudication methods. Some countries have different courts for criminal and civil
proceedings. Some countries have a judge only system but some countries follow the jury system like in the United
Kingdom. The court based adjudication in the United Kingdom shall be analyzed for reference purposes.
ENGLISH LEGAL SYSTEM
The system of courts differ according to the nature of the claim (whether a claim is civil or criminal in nature) and
also on the value of the claim (in civil cases).
Civil court structure:
The hierarchy of the civil courts is as follows:
Magistrate Courts
County Court
High Court
Courts of Appeal
The Supreme Court/ House of Lords
a) Magistrate Courts mostly deal with small domestic matters
b) County Court deals with matters relating to contract and tort, equitable matters and all other claims. Majority
of the cases go to County Court as it is the court of first instance. The presiding officer/judge of the court is
called Circuit Judge.
c) High Court is presided by puisne judges and is further divided in three divisions
i.
Queens Bench Division
ii.
Family Division
iii.
Chancery Division
d) Court of Appeal is presided by the judges called the Lord Justices of Appeal. The Civil Division of the Court of
Appeal hears appeals from County Court and High Court.
e) The Supreme Court/House of Lords is the highest court which hears appeals from the Court of Appeal and
may hear cases directly from the High Court. The presiding judges are called Justices of Supreme Court and
include a President and Deputy President.
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Criminal Courts Structure:
The hierarchy of criminal courts is as follows:
Magistrates Court
Crown Court
High Court (Queens Bench Division)
Court of Appeal Criminal Division
House of Lords/ Supreme Court
a) Magistrates Court: For less serious offences, known as summary offences, the
a. Defendant is tried by magistrates. Appeal is to the Crown Court or QBD of High Court ‘by way of case
stated’ on a point of law or that the magistrates went beyond their proper powers
b) Crown Court: Conducts trial of serious offences, known as indictable offences. Trials are conducted in the
presence of jury. Appeals can be heard by criminal division of Court of Appeal and on the point of law be
heard by QBD of High Court.
a.
b.
c)
For ‘either way’ offences, the defendant can be tried by magistrates if they agree, but
The defendant may elect for jury trial.
High Court (Queens Bench Division): Hear appeals from Crown Court/Magistrate Court
d) Court of Appeal Criminal Division: Hear appeals from the Crown Court and High Court.
e) House of Lords/Supreme Court: Hear appeals from Court of Appeal.
The essential criminal trial courts are the magistrates’ courts and Crown Courts. In serious offences, known as
indictable offences, the defendant is tried by a jury in a Crown Court. For less serious offences, known as summary
offences, the defendant is tried by magistrates; and for ‘either way’ offences, the defendant can be tried by
magistrates if they agree, but the defendant may elect for jury trial.
Knowledge Test:
In the English civil law system, the President and Deputy President sit as judges in which court?
a) Court of Appeal
b) Supreme Court
c) High Court
d) County Court
Solution:
Supreme Court
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Knowledge Test:
In which court of the English criminal law system does the jury hear cases?
a) Magistrate's Court
b) Crown Court
c) Divisional Court of Queen's Bench
d) Supreme Court
Solution:
Crown Court
CIVIL PROCEDURE CLAIMS
It is governed by Civil Procedure Rules (CPR). Small claims are heard under the small claims track and the hearing
process is quick. The County Courts and High Courts hear substantial/larger claims. Pretrial Disclosure procedure is
a feature of English legal system where documents are disclosed to the opposing party before trial.
Pros and Cons of Court Based Adjudication:
Pros:
 Court orders and rulings can be effective than arbitration in certain circumstances
 Establishment of judicial Precedent by courts helps in the certainty & uniformity in the judgments on similar
matters.
Cons:
 Court based adjudication is expensive than arbitration as parties have to bear the costs of the legal
practitioners, the court fees and the costs of the pre‐trial disclosures.
 Time taking and lengthy procedure than arbitration
INTERNATIONAL COURT
International Courts play an important role in resolving the matters relating to conflicts of law and enforcement of
settlements.
The two main important Courts are:
a) European Court of Justice (ECJ)
The Court of Justice interprets EU law to make sure it is applied in the same way in all EU countries, and
settles legal disputes between national governments and EU institutions. It is the highest court of law for all
European Union member states. Appeals from decisions of courts in the member states can also be filed in the
ECJ.
b) International Court of Arbitration (ICA)
The International Court of Arbitration established by International Chamber of Commerce (ICC) resolves
international commercial and business disputes, administering more than half of all arbitration disputes
worldwide. It played significant role in the New York Convention of 1958 in which all the states ratifying the
treaty agreed not to take disputes to courts in presence of written arbitration agreements.
The Court of Arbitrations' role lies in providing an organizational framework for the procedures and offer, if
necessary, support to arbitrators. It oversees procedures, helps to resolve problems and guarantees the
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Enforcements of awards. Support is granted in French, English, Arab, German, Spanish, Italian, Portuguese,
and Russian.
Knowledge Test:
Select the correct statement concerning the International Court of Arbitration (ICA)?
a) The ICA forms trade policies of United Nations
b) The ICA is a branch of ECJ
c) The rules which the ICA applies are stated by the International Chamber of Commerce
Solution:
The rules which the ICA applies are stated by the International Chamber of Commerce
ALTERNATE DISPUTE RESOLUTION
The term "alternative dispute resolution" or "ADR" is often used to describe a wide variety of dispute resolution
mechanisms that are alternative to full‐scale court processes. ADR systems may be generally categorized as
negotiation, conciliation/mediation, or arbitration systems.
Arbitration
Arbitration is a procedure in which a dispute is submitted, by agreement of the parties, to one or more arbitrators
who make a binding decision on the dispute. The solution can be in the form of compensation payment, behavioral
change, apology etc.
Islamic Arbitration
 Arbitration in Islam is called Takhim
 Arbitrator is called Hakam
 Arbitrator must be Muslim, well versed of sharia law and should be able to arbitrate.
Mediation and Conciliation:
Mediation and conciliation systems are very similar in that they interject a third party between the disputants to
mediate a specific dispute. The decisions are not legally binding. In Islam mediation is called wasta and conciliation
is called soth.
Pros of Alternate Dispute Resolution:
 Takes far less time to reach a final resolution
 Arbitrator of choice
 Cost of Arbitration is low.
 The parties can also have their dispute arbitrated or mediated by a person who is an expert in the relevant
field.
UNICITRAL MODEL ON INTERNATIONAL COMMERCIAL ARBITRATION
The Model Law on international commercial arbitration was adopted by United Nations Commission on
International Trade Law in 1994.
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INTERNATIONAL COMMERCIAL ARBITRATION
International commercial arbitration is a means of resolving disputes arising under international commercial
contracts. According to Article 1 Arbitration can be categorized as international if parties conduct business in
different countries or the business is in the same country but arbitration is designated to be in a different country
and it is commercial if their business is commercial in nature.
LAW ON RECEIPT OF WRITTEN COMMUNICATIONS
Article 3 states that communication will be deemed to be delivered if it is sent to the addressee personally or at his
business or mailing address. If the above are not possible then written communication sent at the addressee last
known place of business would be deemed to be valid.
EXTENT OF COURT INTERVENTION


Article 5 states that in matters governed by this Law, no court shall intervene except where so provided in this
Law.
Article 6 states that the states which adopt the law should specify the court competent to perform functions
such as of appointment of arbitrators etc.
FORM OF ARBITRATION AGREEMENT
Article 7 defines the “Arbitration agreement” as an agreement by the parties to submit to arbitration all or certain
disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether
contractual or not. An arbitration agreement may be in the form of an arbitration clause in a contract or in the
form of a separate agreement.
Article 7(2) states that the arbitration agreement shall be in writing. Article 7(3) states Agreement is in writing if it
is in written form or is referred in legal proceedings and the other party has not denied it or a written contract
between parties makes reference to an arbitration agreement.
The model law goes on to explain that an agreement is in writing if it is contained:
(i)
in a document signed by the parties or
(ii)
in an exchange of letters, telex, telegrams or other means of telecommunication which provide a record
of the agreement,
(iii)
in an exchange of statements of claim and defence in which the existence of an agreement is alleged by
one party and not denied by another.
The reference in a contract to a document containing an arbitration clause constitutes an arbitration agreement,
provided that the contract is in writing and the reference is such as to make that clause part of the contract.
As the explanatory notes to the Model Law, provided by the UNCITRAL Secretariat, explain, Article 7(1) recognizes
the validity and effect of a commitment by the parties to submit to arbitration an existing dispute or a future
dispute. This provision is significant, as the latter type of agreement is not given full effect under certain national
laws. While oral arbitration agreements are found in practice and are recognized by some national laws, such as
the English law, Article 7(2) follows the 1958 New York Convention in requiring written form before arbitration is
enforced. It also widens and clarifies the definition of written form of Article 11(2) of the New York Convention by
adding ‘telex or other means of telecommunication which provide a record of the agreement’, and by including the
submission‐type situation of ‘an exchange of statements of claim and defence in which the existence of an
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agreement is alleged by one party and not denied by another’, and by providing that ‘the reference in a contract to
a document’ (e.g. general conditions) ‘containing an arbitration clause constitutes an arbitration agreement
provided that the contract is in writing and the reference is such as to make that clause part of the contract’.
ARBITRATION AGREEMENT AND SUBSTANTIVE CLAIM BEFORE COURT
Article 8 states that a matter which is subject to arbitration in terms of arbitration agreement is brought before the
court, the court shall refer the same for arbitration unless the arbitration clause is null and void.
Article 8(2) arbitral proceedings can be commenced and award can be granted even if the court proceedings have
been initiated. (UN CASE 57)
Knowledge Test:
Smith in a dispute has to approach the International Commercial Arbitration and seeks your advice regarding the
validity of an agreement under the UNCITRAL Model Law on International Commercial Arbitration?
a) Arbitration agreements in order to be valid must be in writing
b) Arbitration agreement in order to be valid can be both oral or in writing
c) Arbitration agreements must be filed with the International Court of Arbitration
Solution:
a. Arbitration agreements in order to be valid must be in writing
COMPOSITION OF ARBITRAL TRIBUNAL (ARTICLE 10)
(1) The parties are free to determine the number of arbitrators.
(2) Failing such determination, the number of arbitrators shall be three.
 Each party shall appoint one arbitrator within 30 days and the two appointed arbitrators shall appoint the
third arbitrator.
 Parties can agree upon a sole arbitrator. If the same cannot agree on the choice of person then the court
can be requested to make the appointment.
Knowledge Test:
James and Smith entered into an agreement which also contained a dispute settling mechanism of arbitration.
However, the agreement does not specify the number of arbitrators for settlement of their dispute. In case of a
dispute between James and Smith how many arbitrators will settle their dispute according to the UNCITRAL Model
Law on International Commercial Arbitration?
a) Two
b) Six
c) Three
d) One
Solution:
c)
Three
Knowledge Test (ACCA Past Paper 2014):
Under UNCITRAL Model Law on International Commercial Arbitration, what is the default number of arbitrators?
a) One
b) Two
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Three
Solution:
Three
APPOINTMENT OF ARBITRATORS (ARTICLE 11).
The parties are free to agree on a procedure of appointing the arbitrator or arbitrators; however, the same is
subject to the following provisions of Article 11.
a) Nationality is not a bar to be an arbitrator
b) Upon failure of the parties to appoint an arbitrator court can be requested to do the same by any party.
c) If an arbitrator fails to fulfill his duties any party can apply to the court to take action.
d) The actions taken by court in relation to b and c shall not be appealable.
e) The arbitrator appointed shall be independent and impartial arbitrator.
GROUNDS FOR CHALLENGING THE APPOINTMENT (ARTICLE 12)
a) The party seeking to challenge appointment must send within 15 days a written statement of grounds of
challenge to the arbitral tribunal.
b) Unless the challenged arbitrator withdraws from his office or the other party agrees to the challenge, the
arbitral tribunal shall decide on the challenge.
c) If the above mentioned withdrawal or agreement between parties doesn’t take place then arbitral tribunal
shall decide the challenge.
d) If the challenge is unsuccessful then the challenging party may within 30 days request the court to decide
upon it.
e) The decision of the court shall not be appealable.
f) While a request for challenge is pending, the arbitral tribunal, including the challenged arbitrator, may
continue the arbitral proceedings and make an award.
Failure or Impossibility for the Arbitrator to Act
 If the arbitrator withdraws from his office or if the parties agree on the termination.
 If the arbitrator vacates office then a substitute arbitrator can be appointed.
COMPETENCE OF ARBITRAL TRIBUNAL TO RULE ON ITS JURISDICTION
The arbitral tribunal may rule on its own jurisdiction, including any objections with respect to the existence or
validity of the arbitration agreement. An arbitration clause which forms part of a contract shall be treated as an
agreement independent of the other terms of the contract.
A decision by the arbitral tribunal that the contract is null and void shall not cause the invalidity of the arbitration
clause.
PROCEDURE OF ARBITRAL PROCEEDINGS
There should be equality of treatment and full opportunity to present the case. There exists a freedom to adopt
procedure of arbitration subject to law of arbitration. If there is a failure of agreement on procedure of arbitration
then the tribunal shall conduct the proceedings.
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Other clauses of Law of Arbitration
 Article 20: Parties can choose place of arbitration otherwise the tribunal shall select the place
 Article 21:Parties can agree on commencement of proceedings or the proceedings shall start when the referral
notice is received by the respondent
 Article 22: Language of proceedings can be agreed between the parties
 Article 26: Arbitral tribunal can appoint experts
 Article 27: Court assistance in matters of evidence can be requested
STATEMENTS OF CLAIM AND DEFENCE (ARTICLE 23)
Article 23 of the Model Law in International Commercial Arbitration specifically refers to statements of claim and
defence. As regards the statement of claim, the Article provides that, within the period of time agreed by the
parties or decided on by the arbitral tribunal, the claimant has to state the facts supporting their claim, the points
at issue and the relief or remedy sought.
In response, the respondent should state their defence in respect of these particulars, unless the parties have
otherwise agreed as to the required elements of such statements. In addition, the parties may submit with their
statements all documents they consider to be relevant or may add a reference to the documents or other evidence
they will submit.
However, unless otherwise agreed by the parties, either party may amend or supplement their claim or defence
during the course of the arbitral proceedings, unless the arbitral tribunal considers it inappropriate to allow such
amendment having regard to the delay in making it.
Article 24 makes it clear that all statements, documents or other information supplied to the arbitral tribunal by
one party shall be communicated to the other party. Also any expert report or evidentiary document on which the
arbitral tribunal may rely in making its decision also has to be communicated to the parties.
Article 25 makes clear the different consequences for the parties if they fail to submit their statements of claim or
defence. Thus unless otherwise agreed by the parties, if, without showing sufficient cause, the claimant fails to
communicate their statement of claim in accordance with Article 23(1), then not surprisingly as there will be no
claim to determine, the arbitral tribunal shall terminate the proceedings. However, where the respondent fails to
communicate their statement of defence in accordance with Article 23(1), the arbitral tribunal shall continue the
proceedings, but it will not treat such failure in itself as an admission of the claimant’s allegations.
Article 25 provides further that where either party fails to appear at a hearing or to produce documentary
evidence, the arbitral tribunal may continue the proceedings and make the award on the evidence before it. These
provisions, which empower the arbitral tribunal to carry out its task even if one of the parties does not participate,
are of considerable practical importance since they allow the tribunal to perform its function even where one of
the parties has little interest in co‐operating or expediting its operation.
Knowledge Test:
Select from the following the consequences if the claimant fails to produce his statement of claim under the
UNCITRAL Model Law on International Commercial Arbitration
a) Proceedings will continue
b) Proceedings will be terminated and decision will be made in favor of defendant
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Proceedings will be terminated
Solution:
Proceedings will be terminated
Knowledge Test (ACCA Past Paper 2014):
In the event of the respondent failing to appear at an arbitration hearing, under the UNCITRAL Model Law on
International Commercial Arbitration which of the following consequences will follow?
a) The hearing will be postponed until the respondent can ensure attendance
b) The hearing will be cancelled and the decision will be declared in favour of the claimant
c) The hearing will continue on the basis of the evidence supplied by the claimant
d) The hearing will be cancelled and the respondent will have to pay all the costs relating to the arbitration
Solution:
a. The hearing will be postponed until the respondent can ensure attendance
HEARINGS AND WRITTEN PROCEEDINGS (ARTICLE 24)
Subject to any contrary agreement by the parties, the arbitral tribunal shall decide whether to hold oral hearings
for the presentation of evidence or whether the proceedings shall be conducted on the basis of documents and
other material.
CHALLENGE TO THE JURISDICTION OF THE ARBITRAL TRIBUNAL
Plea by a party to challenge jurisdiction of tribunal shall be raised before the submission of statement of defence.
The decision of the arbitral tribunal on its jurisdiction can be challenged within 30 days before the court.
TERMINATION OF PROCEEDINGS (ARTICLE 32)
The arbitral proceedings are terminated by the final award or by an order of the arbitral tribunal.
The arbitral proceedings can be terminated by the order of arbitral tribunal if:
a) Claimant withdraws his claim
b) Parties mutually agree to terminate proceedings
c) Arbitration has become unnecessary
POWER OF ARBITRAL TRIBUNAL TO ORDER INTERIM MEASURES (ARTICLE 17)
The arbitral tribunal may, at the request of a party, order any party to take such interim measure of protection as
the arbitral tribunal may consider necessary in respect of the subject matter in dispute.
MAKING OF AWARD



Article 28: Decision of the tribunal shall be based upon the rules of law chosen by parties
Article 28: If rules not chosen by parties then the tribunal shall apply law it sees fit
Article 29: Decision shall be reached by majority of the arbitrators
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Knowledge Test:
Alisa from Indonesia and Jack from United Kingdom entered into a contract. However, the disputes have led them
to initiate Arbitral proceedings. Their agreement states that law of United Kingdom shall be applicable for the
settlement of their dispute. However, Alisa disagrees to this. Advise which law will apply?
a) The law chosen by Alisa
b) The rules set out by the parties in the agreement
c) The rules of law set out by the International Court of Arbitration
Solution:
The rules set out by the parties in the agreement
SETTLEMENT
Article 30: If, during arbitral proceedings, the parties settle the dispute, the arbitral tribunal shall terminate the
proceedings.
FORM AND CONTENTS OF AWARD (ARTICLE 31)
The award shall be made in writing and shall be signed by the arbitrator or arbitrators. In arbitral proceedings with
more than one arbitrator, the signatures of the majority of the members of the arbitral tribunal shall suffice.
Article 33: Additional award may also be requested by the party within 30 days of the receipt of the award which
has not been mentioned in the award.
RECOURSE AGAINST AWARD (ARTICLE 34)
Paragraph 1 of Article 34 establishes categorically that recourse to a court against an arbitral award may only be
made in line with the conditions set out in the subsequent paragraphs of the Article.
Paragraph (2) goes on to provide that an arbitration award may be set aside by the court only if the party making
the application furnishes proof that:
(i)
A party to the arbitration agreement was under some incapacity; or the agreement is not valid under the
laws to which the parties have subjected it. If there is no indication of applicable law, then the law of the
state hearing the application will be the referent;
(ii)
the party making the application was not given proper notice of the appointment of an arbitrator or of
the arbitral proceedings or was otherwise unable to present their case;
(iii)
The award dealt with a dispute not contemplated by or not falling within the terms of the submission to
arbitration, or contained decisions on matters beyond the scope of the submission to arbitration.
However, if the decisions on the matters submitted to arbitration can be separated from those not
submitted, then only that part of the award relating to the issues not submitted to arbitration may be set
aside;
(iv)
The composition of the arbitral tribunal or the arbitral procedure was not in accordance with the
agreement of the parties;
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(v)
The subject‐matter of the dispute is not capable of settlement by arbitration under the law of the state
required to enforce the award;
(vi)
The award is in conflict with the public policy of that state.
The court, when asked to set aside an award, may, where appropriate and so requested by a party, suspend the
setting aside proceedings for a period of time determined by it in order to give the arbitral tribunal an opportunity
to resume the arbitral proceedings or to take such other action as in the arbitral tribunal’s opinion will eliminate
the grounds for setting aside.
The grounds for setting aside a decision are almost identical to those for refusing recognition or enforcement
under Article 36, but there are significant practical differences between the two procedures. First, the grounds
relating to public policy ((vi) above), including non‐arbitrability, may differ depending on the state in question.
Second, the grounds for refusal of recognition or enforcement are valid and effective only in the state where the
successful party seeks enforcement, whilst the setting aside of an award at the place of origin prevents
enforcement of that award in all other states under Article 36(1)(a)(v) of the Model Law.
Knowledge Test (ACCA Past Papers 2014):
Under the UNCITRAL Model Law on International Commercial Arbitration, which of the following will NOT allow a
party to apply to court to have the arbitral award set aside?
A. Substantive injustice in relation to the decision of the panel
B. Incapacity on the part of the claimant or respondent
C. Lack of appropriate notice to either party
D. Lack of validity of the claim in the state under which the action is heard
Solution:
A. Substantive injustice in relation to the decision of the panel
Knowledge Test:
Arbitral proceedings commenced in the dispute between the parties A and B. Both the parties failed to determine
the number of arbitrators to adjudicate their matter. However, the arbitrators appointed by the relevant authority
were two. On which ground can the award be set aside?
Solution:
The award can be set aside as the composition of the tribunal was incorrect. As stated in Article 10 that in case the
parties fail to determine the arbitrators than the number of arbitrators settling the dispute should be three.
RECOGNITION AND ENFORCEMENT OF AWARDS
The UNCITRAL Model Law on International Commercial Arbitration does not lay down procedural details of
recognition and enforcement, but merely sets certain conditions for obtaining enforcement: application in writing,
accompanied by the award and the arbitration agreement. Article 35 of the Model Law provides that any
arbitration award made under its auspices, irrespective of the country in which it was made, shall be recognised as
binding and is to be enforced in the competent court within the state in which it is sought to be implemented. The
party seeking to enforce the award must provide the authenticated original award or a certified copy of it, plus
either the original or a certified copy of the arbitration agreement.
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In order to enforce the award the party will have to make application to the court.(Article 36)
The court may refuse enforcement of award if:
a) Party to the arbitration agreement referred to in article 7 was under some incapacity; or the said agreement is
not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law
of the country where the award was made.
b) The party against whom the award is invoked was not given proper notice of the appointment of an arbitrator
or of the arbitral proceedings or was otherwise unable to present his case.
c) The award deals with a dispute not contemplated by or not falling within the terms of the submission to
arbitration. It contains decisions on matters beyond the scope of the submission to arbitration, provided that,
if the decisions on matters submitted to arbitration can be separated from those not so submitted, that part
of the award which contains decisions on matters submitted to arbitration may be recognized and enforced.
d) The composition of the arbitral tribunal or the arbitral procedure was not in accordance with the agreement
of the parties or, failing such agreement, was not in accordance with the law of the country where the
arbitration took place.
e) The award has not yet become binding on the parties or has been set aside or suspended by a court of the
country in which, or under the law of which, that award was made.
If the court finds that:
i.
The subject‐matter of the dispute is not capable of settlement by arbitration under the law of this State;
or
ii.
The recognition or enforcement of the award would be contrary to the public policy of this State.
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Contracts for the International Sale of Goods
Chapter ‐04
Chapter
04
Contracts for the International Sale of Goods
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IN THIS CHAPTER
APPLICATION OF UN CONVENTION ON THE CONTRACTS FOR THE
INTERNATIONAL SALE OF GOODS (UNCISG)
SALES OF GOODS
BUSINESS RESIDENCE
CONVENTION RATIFICATION
CONTRACT FORMATION FOR THE INTERNATIONAL SALE OF GOODS
OFFER
TERMINATION OF OFFER
ACCEPTANCE
COUNTER OFFER
COMMUNICATION OF ACCEPTANCE
WITHDRAWL OF ACCEPTANCE
TERMINATION OR MODIFICATION OF CONTRACT
ICC INCOTERMS
RULES FOR SEA & INLAND WATERWAY TRANSPORT
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Chapter ‐04
APPLICATION OF UN CONVENTION ON THE CONTRACTS FOR THE INTERNATIONAL SALE OF
GOODS (UNCISG)
This
Convention
applies
to
contracts
of
sale
of
goods
between
parties whose places of business are in different States (Article 1):
a) when the States are Contracting States; or
b) when the rules of private international law lead to the application of the law of a Contracting State
personal injury caused
This Convention does not apply to the liability of the seller for death or
by the goods to any person (Article 5). According to Article 6 parties have the option to
exclude the application of this Convention. Convention is based upon the basic principle that it is
international, uniform and based on good faith. According to Article 9 the parties are bound by the customs or
the practices of trade.
SALES OF GOODS
A contract of sale of goods is a contract by which the seller transfers or agrees to transfer the property in goods to
the buyer for a money consideration, called the price.
Article 2: This Convention does not apply to sales:
a) Of goods bought for personal, family or household use, unless the
seller, at any time before or at the conclusion of the contract, neither knew
nor ought to have known that the goods were bought for any such use;
b) By auction;
c) On execution or otherwise by authority of law;
d) Of stocks, shares, investment securities, negotiable instruments or money;
e) Of ships, vessels, hovercraft or aircraft;
f) Of electricity.
Therefore the convention does not apply to sales of commodities for personal use. The Convention will not be
applicable to the supply of services or where the essential obligation of one of the parties in the contract would be
provision of labour. (Article 3) (UN Case 105)
The Convention will not be applicable when the buyer supplies substantial part of the materials for manufacture or
production.
(Article
3).
According
to
Article
4
the Convention governs only the formation of the contract of sale and the rights and obligations of the
seller
and
the
buyer
arising
from
such
a
contract. In particular, except as otherwise expressly provided in this Convention, It is not concerned with the
contract’s validity or usage, nor with the effect of the contract on the property in goods sold.
Knowledge Test (ACCA Past Paper 2014):
Which TWO of the following are examples of goods NOT covered by the UN Convention on Contracts for the
International Sale of Goods?
1) Services
2) Negotiable instruments
3) Food
4) Commodities not yet in existence
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Contracts for the International Sale of Goods
a)
b)
c)
d)
Chapter ‐04
(1) and (2)
(2) and (3)
(3) and (4)
(1) and (4)
Solution:
a. (1) and (2)
BUSINESS RESIDENCE (ARTICLE 10)
If a party has more than one place of business, the one with closest relationship to the contract and its
performance will be the place of business. If either of the parties does not have a place of business, reference is to
be made to his habitual residence.
CONVENTION RATIFICATION
The member states must ratify (approve) the convention; however, they can also declare to be not bound by parts
of convention but this declaration will make them a non‐contracting state. Two or more contracting states which
have the same or closely related legal rules on matters governed by this Convention may at any time opt out of the
convention in relation to each other or in relation to persons whose place of business is in each other’s states.
(Article 94)
Contracting States whose national legislation requires contracts of sale to be concluded or evidenced in writing
may at any time dis‐apply the convention which allows the contracts not to be in writing.
CONTRACT FORMATION FOR THE INTERNATIONAL SALE OF GOODS
Contract is formed once offer is validly accepted. Article 11 of the Convention states that the contract of sale need
not be in writing and it can be proved by any means, including witnesses. (Article 12)
OFFER
Article 14(1) of the UN Convention on Contracts for the International Sale of Goods provides that:
‘A proposal for concluding a contract addressed to one or more specific persons constitutes an offer if it is
sufficiently definite and indicates the intention of the offeror to be bound in case of acceptance. A proposal is
sufficiently definite if it indicates the goods and expressly or implicitly fixes or makes provision for determining the
quantity and the price.’
Thus in order for a proposal for concluding a contract to constitute an offer:
(i)
It must be addressed to one or more specific persons. Consequently the offer cannot be made to ‘the
world at large’ as it can in common law jurisdictions.
(ii)
It must be sufficiently definite.
(iii)
It must indicate that the offeror intends to be bound on those terms in the case of acceptance.
The offer becomes effective when it reaches the offeree (Article 15). Any communication which does not comply
with the stated requirements for an offer is to be treated as merely an invitation to make offers, or an invitation to
treat in English law.
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Knowledge Test (ACCA Past Paper 2014):
Which of the following statements in relation to an offer is correct under the UN Convention on Contracts for the
International Sale of Goods?
A. It must be in writing
B. It must refer to price and quantity
C. It can be made to the world at large
Solution:
B. It must refer to price and quantity
TERMINATION OF OFFER
Offers may be terminated before acceptance and the consequent formation of a binding agreement, in one of
three distinct ways:
a. Withdrawal: Article 15(2), which simply states that an offeror may withdraw their offer as long as the
withdrawal reaches the offeree before or at the same time as the offer.
b. Rejection: The offeree may reject the offer, in which case it comes to an end and cannot be subsequently
reactivated and accepted by the offeree.
c. Revocation: Offers may be revoked as long as any revocation reaches the offeree before he has dispatched an
acceptance.
However, an offer cannot be revoked if:
It indicates that it is irrevocable, which it may do by stating a fixed time for acceptance or otherwise. If it was
reasonable for the offeree to rely on the offer as being irrevocable and the offeree has acted in reliance on the
offer. An offer becomes effective when it reaches the offeree. Even if the offer is irrevocable, it may be withdrawn
if the withdrawal reaches the offeree before or at the same time as the offer (Article 15(2)). Thus the difference
between withdrawal and revocation is a matter of time rather than intention.
ACCEPTANCE
Article 18 of the UN Convention on Contracts for the International Sale of Goods provides that acceptance takes
place where the recipient of the offer indicates their agreement to its terms.
Acceptance may occur in a number of ways:
a. By conduct
b. By words
Silence or inactivity does not amount to acceptance.
COUNTER‐OFFER
Article 19 provides that:
(1) A reply to an offer which purports to be an acceptance but contains additions, limitations or other
modifications is a rejection of the offer and constitutes a counter‐offer.
(2) However, a reply to an offer which purports to be an acceptance but contains additional or different terms
which do not materially alter the terms of the offer constitutes an acceptance, unless the offeror, without
undue delay, objects orally.
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COMMUNICATION OF ACCEPTANCE
Where a time period has been fixed, acceptance must reach the offeror within that period of time. If no time
period is fixed, then the acceptance must reach the offeror within a reasonable time. If the offeree can accept the
offer by performing an act, without notice to the offeror, the acceptance is effective at the moment the act is
performed, provided it is done within any period of time laid down by the offeror.
Where the offeror has fixed a period of time for acceptance in either a telegram or a letter, that period begins to
run from the moment the telegram is handed in for dispatch or from the date shown on the letter. If no date is
shown on the letter, the time runs from the date shown on the envelope. A period of time for acceptance fixed by
the offeror by telephone, telex or other means of instantaneous communication, begins to run from the moment
that the offer reaches the offeree.
Knowledge Test (ACCA Past Paper 2014):
Where one party writes a letter of offer to another party giving them three days to accept the offer, which of the
following states when the time period for accepting will start under the UN Convention on Contracts for the
International Sale of Goods?
A. On the date the letter is posted
B. On the date the letter is received
C. On the date shown on the envelope
D. On the date that the recipient reads the letter
Solution:
On the date shown on the envelope
WITHDRAWAL OF ACCEPTANCE
An acceptance may be withdrawn if the withdrawal reaches the offeror before or at the same time as the
acceptance would have been effective.
TERMINATION OR MODIFICATION OF CONTRACT
A contract may be modified or terminated by the mere agreement of the parties (Article 29).
ICC INCOTERMS
‘Incoterms’ is an abbreviation of International Commercial Terms. These terms have been published by the
International Chamber of Commerce (ICC) since 1936 and have been subject to review and updating since that
date. The most recent updates were announced in Paris by the ICC on 16 September 2010. Although earlier
versions of Incoterms may still be incorporated into future contracts if the parties agree, it is likely that most
contracts made now will refer to this latest edition of Incoterms. In order to avoid the possibility of confusion,
contracts should refer specifically to the ‘Incoterms 2010’ rather than just Incoterms, if the parties wish the new
terms to apply. This will avoid any subsequent dispute as to which set of rules apply. The assumption is that the
new version of the ICC terms will apply to F4 (GLO).
The Incoterms are often to be found in international contracts, and they seek to provide a common set of rules for
the most frequently used international terms of trade with the aim of removing confusion over their
interpretation. For example, the terms set out exactly who is under the obligation to take control of and/or insure
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Contracts for the International Sale of Goods
Chapter ‐04
goods at a particular point in the shipping process. The terms also deal with the obligation for the clearance of the
goods for export or import, and requirements on the packing of items.
Classes of terms
Among the changes made in the 2010 rules is the reduction in the overall number from 13 to 11. This is the result
of the removal of four previous terms and the inclusion of two new ones. In effect, this is a replacement of four
previous rules, DAF, DES, DEQ and DDU, by two new rules that may be used irrespective of the agreed mode of
transport. These new rules are DAT (Delivered at Terminal), and DAP (Delivered at Place) (see below for more
details).
Changes have also been made to better deal with cargo security and insurance, and the language has been
changed to reflect the modern usage in international trade.
The new rules have been separated into two classes rather than the previous four categories. The current two
classes of terms are:
(i)
Rules
for
use
in
relation
to
any
mode
or
modes
of
transport
These can be used in cases where either maritime transport is not involved in the carriage of the goods, or
where maritime transport is used for only part of the carriage. This first class includes the following seven
Incoterms that can be used irrespective of the mode of transport selected and irrespective of whether
one – or more than one – mode of transport is employed:
Terms in relation to Mode of Transport:
a) EX WORKS (EXW) ‘Ex works’ means that the seller fulfils his obligation to deliver when he has made
the goods available at his premises (i.e. works, factory, warehouse, etc) to the buyer. This means that
the seller is not responsible for loading the goods on to the buyer’s vehicle or for clearing the goods
for export, unless otherwise agreed.
b) Free Carrier (FCA) means that the seller delivers the goods to the carrier or another person
nominated by the buyer at the seller’s premises or another named place. The parties are well advised
to specify as clearly as possible the point within the named place of delivery, as the risk passes to the
buyer at that point.
c) Carriage Paid To (CPT) means that the seller delivers the goods to the carrier or another person
nominated by the seller at an agreed place (if any such place is agreed between parties) and that the
seller must contract for and pay the costs of carriage necessary to bring the goods to the named place
of destination.
d) Carriage and Insurance Paid to (CIP) means that the seller delivers the goods to the carrier or
another person nominated by the seller at an agreed place (if any such place is agreed between
parties) and that the seller must contract for and pay the costs of carriage necessary to bring the
goods to the named place of destination.
e) Delivered at Terminal (DAT)
DAT replaces the more specific DEQ (Delivered ex Quay). It requires the seller to pay for carriage to
the terminal, except for costs related to import clearance, and to assume all risks up to the point that
the goods are unloaded at the terminal. The seller delivers when the goods, having been unloaded
from the arriving means of transport, are placed at the buyer's disposal at a named terminal at the
named port or place of destination. As indicated, DAT requires the seller to clear the goods for export
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where applicable but the seller has no obligation to clear the goods for import, pay any import duty
or carry out any import customs formalities.
f)
Delivered at Place (DAP)
DAP (Delivered at Place) replaces DAF (Delivered at Frontier), DES (Delivered ex Ship) and DDU
(Delivered Duty Unpaid). Under DAP, a seller bears all the costs, other than import clearance costs
and risks involved in bringing the goods to the named destination. Consequently, the seller assumes
all risks and costs prior to the point that the goods are ready for unloading by the buyer at the agreed
destination.
It should be emphasised that although all the terms listed apply when there is no maritime transport,
they can be used in cases where a ship is used for part only of the carriage.
g)
Delivered Duty Paid (DDP) means that the seller delivers the goods when the goods are placed at the
disposal of the buyer, cleared for import on the arriving means of transport ready for unloading at
the named place of destination. The seller bears all the costs and risks involved in bringing the goods
to the place of destination and has an obligation to clear the goods not only for export but also for
import, to pay any duty for both export and import and to carry out all customs formalities.
Knowledge Test (ACCA Past Paper 2014):
Which of the following ICC Incoterms places the GREATEST burden on the purchaser in respect of responsibility for
transport costs and risks incurred in transit?
a) EXW
b) DAP
c) DAT
d) FCA
Solution:
a. EXW
Knowledge Test
In relation to the ICC Incoterm FCA, which of the following is correct?
a) The seller is liable for loading goods and export clearance
b) The buyer is liable for loading goods and export clearance
c) The seller is liable for loading goods and the buyer is responsible for export clearance
d) The seller is liable for export clearance and the buyer is responsible for loading good
Solution:
The seller is liable for loading goods and export clearance
RULES FOR SEA AND INLAND WATERWAY TRANSPORT
These rules apply where the point of delivery and the place to which the goods are carried to the buyer are both
ports. There are four substantives rules:
 Free Alongside Ship (FAS) means that the seller delivers when the goods are placed alongside the ship
nominated by the buyer at the named port of shipment. The risk of loss of or damage to the goods passes
when the goods are alongside the ship, and the buyer bears all costs from that moment onwards.
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
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
Chapter ‐04
Free On Board (FOB) means that the seller delivers the goods on board the ship nominated by the buyer at
the named port of shipment or procures the goods already so delivered. The risk of loss of or damage to the
goods passes when the goods are on board the vessel, and the buyer bears all costs from that moment
onwards.
Cost and Freight (CFR) means that the seller delivers the goods on board the vessel (ship). The risk of loss or
damage to the goods passes when the goods are on board the vessel. The seller must contract for and pay the
costs and freight necessary to bring the goods to the named port of destination.
Cost, Insurance and Freight (CIF) Seller clears the goods for export and delivers them when they are onboard
the vessel at the port of shipment. Seller bears the cost of freight and insurance to the named port of
destination. Seller's insurance requirement is only for minimum cover. Buyer is responsible for all costs
associated with unloading the goods at the named port of destination and clearing goods for import. Risk
passes from seller to buyer once the goods are onboard the vessel at the port of shipment.
None of these rules has been changed in practice, although in relation to the last three – FOB, CFR and CIF –
reference to the ‘ship's rail’ as the point of delivery has now been deleted and this has been replaced with the
goods being delivered when they are ‘on board’ the vessel. This is clearly done in the pursuit of updating language
and as the ICC’s own introduction to the new rules states: ‘This more closely reflects modern commercial reality
and avoids the rather dated image of the risk swinging to and fro across an imaginary perpendicular line.’
Sphere of application
A further change and recognition of existing practice is that the new rules apply to domestic as well as
international trade, whereas previous Incoterms applied to international sale contracts. As a result, the new rules
state that the obligation to comply with export/import formalities exists only where applicable. This alteration is in
recognition of the fact that some trade blocs, such as the European Union, have minimized – if not removed – the
significance of border formalities. It is also expected that this particular alteration should lead to greater use of the
Incoterm rules within the US.
Sale of goods in transit
Reflecting the fact that commodities may be sold several times over during transit, through a string of sale
contracts, the new rules have been amended to indicate that in reality a purchaser/seller in the middle of the
string of contracts does not actually ship the commodities, as they are already on board when they acquire title
over them. Consequently, under the new the rules, only the first seller will be responsible for shipping the goods
and subsequent sellers will be under the obligation to ‘procure goods shipped’. This is not a major change but it
does tidy up the rules.
Security
Given the context of uncertainty regarding potential terrorism and the need for heightened security, many
countries have introduced security checks in relation to goods crossing their boundaries. The new Incoterm rules
now require both sellers and buyers to provide sufficient information to one another so that export/import
clearance can be obtained.
Terminal handling charges
The new rules look to clarify responsibility for costs arising at the end of the journey. Under the old Incoterms rules
CPT, CIP, CFR, CIF, DAT, DAP, and DDP , the seller was required to make arrangements for the carriage of the goods
to the agreed destination but it was actually the buyer who actually paid the costs, as these were included in the
total selling price. This gave rise to problems where the carrier or terminal operator charged further handling costs
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Chapter ‐04
to the buyer/receiver of the goods. The new Incoterms rules seek to avoid this eventuality by clearly allocating
such costs between the parties.
Electronic documentation
The previous rules provided for the use of electronic data interchange, where the parties had agreed its use. The
new rules provide for the use of paper communications or ‘equivalent electronic record or procedure’ where
agreed or customary, with customary indicating recognition of current practice in this regard.
Knowledge Test (ACCA Past Paper 2014):
Which of the following ICC Incoterms would be used by a seller willing to clear goods for export but not to insure
them for the journey?
A. FOB
B. FAS
C. CIF
Solution:
A. FOB
42 | P a g e
Obligations & Risk in Contracts
Chapter ‐05
Chapter
05
Obligations and Risk in Contracts for
International Sales
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IN THIS CHAPTER
OBLIGATION OF THE SELLER
CONFORMITY OF THE GOODS AND THIRD PARTY CLAIMS
BREACH OF CONTRACT
REMEDY OF THE BREACH OF CONTRACT BY THE SELLER
REMEDY BY SELLER
EARLY & EXCESS DELIVERY BY THE SELLER
AVOIDANCE
DAMAGES
BREACH OF CONTRACT
INSTALLMENT CONTRACT
EFFECTS OF AVOIDANCE
PRESERVATION OF GOODS
PASSING OF RISK
CONTRACTS INVOLVING CARRIAGE
GOODS SOLD IN TRANSIT
SITUATIONS NOT INVOLVING TRANSIT OR CARRIAGE
LIABILITY & RISK ON NON‐CONFORMITY
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Obligations & Risk in Contracts
Chapter ‐05
OBLIGATION OF THE SELLER
The UN Convention on Contracts for the International Sale of Goods provides a number of rules that implement
the seller’s obligations in respect of the quality of the goods.
Article 35(1) states that, in general, the seller must deliver goods that are of the quantity, quality and description
required by the contract and that are contained or packaged in the manner required by the contract.
Delivery Obligations:
Article
30
states
that
the seller must deliver the goods, hand over any documents relating to
them and transfer the property in the goods, as required by the contract and the United Nation Convention for
the Contract on international Sale of Goods (UNSIGS).
Place of Delivery (Article 31):
If the seller is not bound to deliver the goods at any other particular place, his obligation to deliver consists of
following:
a) If the contract of sale involves carriage of the goods—in handing
the goods over to the first carrier for transmission to the buyer;
b) If the parties are aware that goods would be in a particular place then the seller discharges the obligation by
placing the good at the buyer’s disposal at that place.
c) If the above situations do not apply then the seller discharges his duty of delivery by placing the goods at the
place where the seller had their business at the time contract was concluded.
Identification of Goods in Carriage (Article 32):
If the seller hands over the goods to the carrier and if the same are not identifiable then the identification of goods
can be done by markings on them and by the shipping documents.
The mode of transportation of goods selected by the seller must be reasonable and in accordance with the usual
terms.
Insurance of Goods (Article 32):
If the seller is not bound to insure the goods then he must at the buyer’s request provide all the information to the
buyer to enable him to insure the goods.
Delivery Time (Article 33):
The seller must deliver the goods on the date fixed and determined by contract. If a date is to be determined from
a period in the contract then at any time within that period or if it is to be determined by the buyer then the date
so determined by him. However, if no date or time is stated in contract then it should be within reasonable time.
Handing over the Documents (Article 34):
Seller must hand over documents at the time and place as required in contract. If the documents have been
handed over before time, then any correction may be made in documents, if necessary, before the required time
provided it does not cause the buyer unreasonable expense.
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CONFORMITY OF THE GOODS AND THIRD PARTY CLAIMS (ARTICLE 35):
The seller must deliver goods which are of the quantity, quality and description required by the contract and which
are contained or packaged in the manner required by the contract.
The goods do not conform with the contract unless they:
a) are fit for the purposes for which goods of the same description would ordinarily be used; Goods are not fit
under this case where they lack specific ordinary characteristics, or when they have defects which impede
their material use. Goods are also unfit for ordinary use when the defects, though not affecting the material
use of the goods, considerably lessen their trade value;
b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of the
conclusion of the contract, except where the circumstances show that the buyer did not rely, or that it was
unreasonable for him to rely, on the seller's skill and judgment; If the goods in question are to be used for
other, non‐ordinary purpose, the buyer has no rights if he has not indicated the specific use;
c) possess the qualities of goods which the seller has held out to the buyer as a sample or model;
d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner
adequate to preserve and protect the goods
 The seller is not liable under above paragraphs a‐d for any lack of conformity of the goods if at the time of
the conclusion of the contract the buyer knew or could not have been unaware of such lack of conformity.
 There is no obligation on the seller to sell goods in conformity with all the provisions in force in the
buyer’s state unless:
a) The same provisions are applicable in the seller’s state
b) The buyer made the seller aware about the provisions
c) The seller was aware of the provisions
 The seller is liable for any lack of conformity which exists at the time when the risk passes to the buyer,
even though the lack of conformity becomes apparent only after that time.
 The seller is also liable for any lack of conformity which occurs after the time indicated in the preceding
paragraph and which is due to a breach of any of his obligations.
If the seller has delivered goods before the date for delivery, he may, up to that date, deliver any missing
part or make up any deficiency in the quantity of the goods delivered, or deliver goods in replacement of
any non‐conforming goods delivered or remedy any lack of conformity in the goods delivered, provided
that the exercise of this right does not cause the buyer unreasonable inconvenience or unreasonable
expense. However, the buyer retains any right to claim damages (Article 37).
Knowledge Test (ACCA Past Paper 2014):
In relation to the UN Convention on Contracts for the International Sale of Goods requirements as to conformity of
goods, which of the following is INCORRECT?
a) The seller must ensure the goods conform to all laws in force in the buyer’s state
b) The goods must be fit for any purpose the buyer made known to the seller
c) The goods must be fit for the purpose for which such goods are ordinarily used
Solution:
a) The seller must ensure the goods conform to all laws in force in the buyer’s state
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EXAMINATION OF GOODS BY BUYER (ARTICLE 38)
The buyer must examine the goods, or cause them to be examined, within as short a period as is practicable in the
circumstances. If the contract involves carriage of the goods, examination may be deferred until after the goods
have arrived at their destination. If goods have to be dispatched immediately by the buyer then the same can be
examined at the next destination.
THIRD PARTY CLAIM AND RIGHT ARTICLE 41&42)
The seller must deliver goods which are free from any right or claim of a third party, unless the buyer agreed to
take the goods subject to that right or claim. However, if such right or claim is based on industrial property or
other intellectual property, the seller's obligation is governed by article 42.
INTELLECTUAL PROPERTY
Intellectual property is any product of the human intellect that the law protects from unauthorized use by others.
Intellectual property is traditionally comprised of three categories: patent, copyright and trademark. The seller has
the obligation of delivering the goods to the buyer which are free from any claim of a third party based on
industrial or intellectual property. However, if the goods are subject to such claim then the buyer must have
agreed to receive such goods. (Article 42)
BREACH OF CONTRACT
A breach of contract committed by one of the parties is fundamental if it results in such detriment to the other
party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach
did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen
such a result. (Article 25).
REMEDIES FOR BREACH OF CONTRACT BY THE SELLER
The buyer has the following remedies:
Performance, Avoidance of contract & Reduction of price in case of non‐conformity.
1. Performance (Article 46):
a) The buyer can require performance by the seller unless the buyer has resorted to an inconsistent remedy.
b) The buyer may fix an additional period of time of reasonable length for performance by the seller of his
obligations. (Article 47).
2. Non‐Conformity of Goods (Article 46):
 If the goods do not conform to the contract, the buyer may require delivery of substitute goods.
 If the goods do not conform to the contract, the buyer may require the seller to remedy the lack of
conformity by repair.
Knowledge Test (ACCA Past Paper 2014)
Under the UN Convention on Contracts for the International Sale of Goods, where only part of the goods delivered
conformed to the requirements of the contract, which of the following rights can the buyer NOT enforce?
a) To give the seller additional time to correct the non‐conformity
b) To refuse delivery of the total consignment
c) To reduce the price due under the contract
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Solution:
b. To refuse delivery of the total consignment
REMEDY BY SELLER (ARTICLE 48)
The seller may, even after the date for delivery, remedy at his own expense any failure to perform his obligations,
if he can do so without unreasonable delay and without causing the buyer unreasonable inconvenience or
uncertainty. However, the buyer retains any right to claim damages as provided for in this Convention.
The seller can do the above by sending notice to the buyer as a request to let him know whether late performance
would be acceptable.
EARLY & EXCESS DELIVERY BY SELLER (ARTICLE 52)
If the seller delivers the goods before the date fixed, the buyer may take delivery or refuse to take delivery. If the
seller delivers a quantity of goods greater than that provided for in the contract, the buyer may take delivery or
refuse to take delivery of the excess quantity. However if delivery in excess is accepted then the same should be
paid at the contract price.
Knowledge Test (ACCA Past Paper 2014):
Ki entered into a contract with Li for 1,000 tonnes of coal, but Li actually delivered 2,000 tonnes.
Which of the following correctly states Ki’s situation under the UN Convention on Contracts for the International
Sale of Goods?
a) Ki can keep the excess and pay the agreed unit price
b) Ki can keep the excess but must agree a new price with Li
c) Ki must return the excess and claim any expense
d) Ki must return the whole amount and claim damages
Solution:
a. Ki can keep the excess and pay the agreed unit price
AVOIDANCE
Avoidance can be declared by the buyer if:
a) Notice of avoidance given to other party (Article 24)
b) Failure to performance by seller constitutes fundamental breach of contract (Article 51)
c) Non‐delivery of goods by the seller (Article 49)
REDUCTION OF PRICE
Buyer is entitled to reduce price in proportion to the lack of conformity of goods. The above remedy can be
exercised if the seller does not correct the non‐conformity of goods or this correction is not accepted by the buyer.
OBLIGATION OF BUYER
The buyer must pay the price for the goods and take delivery of them as required by the contract. (Article 53) The
buyer's obligation to pay the price includes taking such steps and complying with such formalities as may be
required under the contract. (Article 54) If parties concluded the contract without determining the price then the
parties are deemed to have concluded the price which is generally charged at the time of conclusion of contract.
(Article 55) If the price is fixed according to the weight of the goods, in case of doubt it is to be determined by the
net weight. (Article 56)
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If the place of payment of price has not been specified in the contract then:
a) Price will be paid at seller’s place of business or
b) If the payment is to be made at the time of handing over the goods and documents then the place and time
when goods and documents are handed over.
Taking Delivery (Article 60):
The buyer's obligation to take delivery consists:
a) in doing all the acts which could reasonably be expected of him in order to enable the seller to make delivery;
and
b) In taking over the goods.
SELLER’S REMEDIES FOR BREACH OF CONTRACT BY THE BUYER
If the buyer fails to perform any of his obligations then seller may:
a) Require the buyer to make payment, take delivery or perform their obligations (Article 62)
b) Seller may grant additional time in which buyer can fulfill his obligations (Article 63)
c) Declaration of avoidance of the contract if:
i.
The buyer has committed fundamental breach
ii.
Buyer has failed to make payment or accept goods in the additional time provided
iii.
Buyer has declared not to accept the goods or make payment in the time
The right of avoidance will be lost if the buyer paid for the goods.
BUYER’S DUTY OF SPECIFICATION OF GOODS
If under the contract the buyer is to specify the form, measurement or other features of the goods and he fails to
make such specification the seller may, make the specification himself in accordance with the requirements of the
buyer that may be known to him.
If the seller makes the specification himself, he must inform the buyer of the details thereof and must fix a
reasonable time within which the buyer may make a different specification.
DAMAGES
Damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by
the other party as a consequence of the breach. (Article 74) Damages may not exceed the loss which the party in
breach foresaw or ought to have foreseen at the time of the conclusion of the contract, in the light of the facts
known. If the contract is avoided and if, within a reasonable time after avoidance, the buyer has bought goods in
replacement or the seller has resold the goods, the party claiming damages may recover the difference between
the contract price and the price in the substitute transaction as well as any further damages recoverable. If,
however, the party claiming damages has avoided the contract after taking over the goods, the current price at the
time of such taking over shall be applied instead of the current price at the time of avoidance.
MITIGATION (REDUCTION) OF LOSS (ARTICLE 76)
A party who relies on a breach of contract must take such measures as are reasonable in the circumstances to
mitigate the loss. (Payzu Ltd vs Saunders 1919) If the party fails to mitigate the loss, the party in breach may claim
a reduction in the damages in the amount by which the loss should have been mitigated.
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BREACH OF CONTRACT
One party's failure to fulfill any of its contractual obligations is known as a "breach" of the contract.
Anticipatory Breach (Article 71):
In Anticipatory Breach one party informs in advance that he will not be able to perform his side of the contract, the
injured party may treat this as repudiation and claim damages or only claim damages and continue with a revised
schedule of performance.
A party may suspend the performance of his obligations if, after the conclusion of the contract, it becomes
apparent that the other party will not perform a substantial part of his obligations due to a serious deficiency in
their ability to perform or creditworthiness and their conduct in preparing to perform the contract.
A party suspending performance, whether before or after dispatch of the goods, must immediately give notice of
the suspension to the other party and must continue with performance if the other party provides adequate
assurance of his performance.
If the seller has already dispatched the goods but has an indication that buyer does not wish to fulfill his
obligations he may prevent the handing over of the goods to the buyer even if he holds title documents.
Fundamental Breach (Article 72):
A fundamental breach is a breach of contract where the offending party fails to complete a contractual term that
was so fundamental (hence the name of the breach) to the contract that another party was prevented from
fulfilling their own responsibilities. If prior to the date for performance of the contract it is clear that one of the
parties will commit a fundamental breach of contract, the other party may declare the contract avoided.
If time allows, the party intending to declare the contract avoided must give reasonable notice to the other party
in order to permit him to provide adequate assurance of his performance
Knowledge Test (ACCA Past Paper 2014):
Under the UN Convention on Contracts for the International Sale of Goods, which of the following is NOT a
potential outcome of a fundamental breach of contract?
a) The aggrieved party can avoid the contract and claim damages
b) The aggrieved party can avoid the contract but cannot claim damages
c) The aggrieved party can require substitute goods
Solution:
The aggrieved party can avoid the contract but cannot claim damages
INSTALMENT CONTRACT
If the failure of one party to perform any of his obligations in respect of any instalment constitutes a fundamental
breach of contract the other party may declare the contract avoided with respect to that instalment.
If one party's failure to perform any of his obligations in respect of any instalment gives the other party good
grounds to conclude that a fundamental breach of contract will occur with respect to future instalments, he may
declare the contract avoided for the future.
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A buyer who declares the contract avoided in respect of any delivery may, at the same time, declare it avoided in
respect of deliveries already made or of future deliveries if, by reason of their interdependence.
Interest:
If a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it.
Exemptions (Article 79):
A party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an
impediment beyond his control and that he could not reasonably be expected to have taken the impediment into
account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.
If the party's failure is due to the failure by a third person whom he has engaged to perform the whole or a part of
the contract, that party is exempt from liability only if:
a) He is exempt under article 79(1); and
b) The person whom he has so engaged would be so exempt if the provisions of that paragraph were applied to
him.
The party who fails to perform must give notice to the other party of the impediment and its effect on his ability to
perform. If the notice is not received by the other party within a reasonable time after the party who fails to
perform knew or ought to have known of the impediment, he is liable for damages resulting from such non‐
receipt. Nothing in this article prevents either party from exercising any right under this Convention other than to
claim damages.
EFFECTS OF AVOIDANCE (ARTICLE 81)
Avoidance of the contract releases both parties from their obligations under it, subject to any damages which may
be due. Avoidance does not affect any provision of the contract for the settlement of disputes or any other
provision of the contract governing the rights and obligations of the parties consequent upon the avoidance of the
contract.
Avoidance does not affect the right of a party to claim restitution from the other party of whatever the first party
has supplied or paid under the contract.
The buyer loses the right to declare the contract avoided if it is impossible for him to make restitution of the
goods. (Article 82)
PRESERVATION OF GOODS
A party which has possession of the goods belonging to the other party, it is under a duty to preserve them.
Following are the situations in which the duty to preserve the goods arises:
a) If the buyer has delayed in taking the delivery of the goods or, where payment of the price and delivery of the
goods are to be made concurrently, if he fails to pay the price, and the seller is either in possession of the
goods or otherwise able to control their disposition, the seller must take such steps as are reasonable in the
circumstances to preserve them. He is entitled to retain them until he has been reimbursed his reasonable
expenses by the buyer. (Article 85)
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b) If the buyer has received the goods and intends to exercise any right under the contract or this Convention to
reject them, he must take such steps to preserve them as are reasonable in the circumstances. He is entitled
to retain them until he has been reimbursed his reasonable expenses by the seller. (Article 86)
c) If goods dispatched to the buyer have been placed at his disposal at their destination and he exercises the
right to reject them, he must take possession of them on behalf of the seller.
d) A party who is bound to take steps to preserve the goods may deposit them in a warehouse of a third person
at the expense of the other party provided that the expense incurred is not unreasonable. (Article 87)
e) A party who is bound to preserve the goods in accordance with article 85 or 86 may sell them by any
appropriate means if there has been an unreasonable delay by the other party in taking possession of the
goods or in taking them back or in paying the price or the cost of preservation, provided that reasonable
notice of the intention to sell has been given to the other party.
f) If the goods are subject to rapid deterioration or their preservation would involve unreasonable expense, a
party who is bound to preserve the goods must take reasonable measures to sell them. To the extent possible
he must give notice to the other party of his intention to sell.
PASSING OF RISK
Loss of or damage to the goods after the risk has passed to the buyer does not discharge him from his obligation to
pay the price, unless the loss or damage is due to an act or omission of the seller.( Article 66)
CONTRACTS INVOLVING CARRIAGE (ARTICLE 67)
If the contract of sale involves carriage of the goods the risk passes to the buyer when the goods are handed over
to the first carrier for transmission to the buyer in accordance with the contract of sale.
If the seller is bound to hand the goods over to a carrier at a particular place, the risk does not pass to the buyer
until the goods are handed over to the carrier at that place.
The risk does not pass to the buyer until the goods are clearly identified to the contract, whether by markings on
the goods, by shipping documents, by notice given to the buyer.
Knowledge Test (ACCA Past Paper 2014):
In the context of the UN Convention on Contracts for the International Sale of Goods, which of the following is the
place of delivery in contracts involving carriage, if the contract is silent on the matter?
A. The seller’s place of business
B. The place where the goods are handed to the first carrier for transmission to the buyer
C. The purchaser’s place of business
Solution:
B. The place where the goods are handed to the first carrier for transmission to the buyer
GOODS SOLD IN TRANSIT (ARTICLE 68)
The risk in respect of goods sold in transit passes to the buyer from the time of the conclusion of the contract.
However, if the circumstances so indicate, the risk is assumed by the buyer from the time the goods were handed
over to the carrier who issued the documents expressing the contract of carriage.
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If at the time of the conclusion of the contract of sale the seller knew or ought to have known that the goods had
been lost or damaged and did not disclose this to the buyer, the loss or damage is at the risk of the seller.
SITUATIONS NOT INVOLVING TRANSIT OR CARRIAGE
The risk passes to the buyer when he takes over the goods or, if he does not do so in due time, from the time when
the goods are placed at his disposal and he commits a breach of contract by failing to take delivery. If the buyer is
bound to take over the goods at a place other than a place of business of the seller, the risk passes when delivery is
due and the buyer is aware of the fact that the goods are placed at his disposal at that place.
LIABILITY AND RISK ON NON‐CONFORMITY
The seller is liable in accordance with the contract and this Convention for any lack of conformity which exists at
the time when the risk passes to the buyer, even though the lack of conformity becomes apparent only after that
time.
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Chapter
06
Transportation and Payment of International
Business Transactions
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IN THIS CHAPTER
OPERATIONS OF BILLS OF LADING
MODES OF PAYMENT
UNICITRAL MODEL LAW ON INTERNATIONAL CREDIT TRANSFERS
LIABILITITES IN RELATION TO UNAUTHORIZED PAYMENT ORDER
PAYMENT TO RECEIVING BANK
OBLIGATIONS OF RECEIVING BANK
CONSEQUENCES OF FAILED, ERRONEOUS OR DELAYED CREDIT TRANSFERS
BILLS OF EXCHANGE
INTERNAITONAL BILLS OF EXCHANGE
TRANSFER OF BILL OF EXCHANGE
ENDORSEMENT
PRESENTMENT OF BILL FOR PAYMENT
DISHONOUR BY NON‐PAYMENT
PROTEST
LETTERS OF CREDIT
LETTERS OF COMFORT
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OPERATIONS OF BILLS OF LADING
A bill of lading is a document which is issued by a carrier to the shipper acknowledging that they have received the
shipment of goods and that they have been placed on board a particular vessel which is bound for a particular
destination.
The document states the terms on which the goods are to be carried. Separate bills of lading are issued for
domestic transportation and ocean or air transportation, although a through bill of lading can be issued covering
all modes of transport to the destination.
There are four types of bills of lading:
a) Inland Bill of Lading – refers to a contract for transporting goods overland to an exporter’s international
carrier.
b) Ocean Bill of Lading – refers to a contract for transporting goods from an exporter to a specified foreign
market overseas
c) Through Bill of Lading – refers to a contract for transporting goods covering both the domestic and
international transport of export goods between specified points.
d) Air Waybill – refers to a contract for transporting goods by way of domestic and international flights to a
specified destination. The air waybill is a non‐negotiable document and only serves as a receipt for the
shipper.
A bill of lading has a threefold purpose:
a) Formal receipt by the ship‐owner for goods;
b) Evidence of the contract of carriage; and
c) Document of title to goods.
Bills of lading can be either negotiable or non‐negotiable. In relation to negotiable bills of lading, ownership to
the goods and the right to re‐route the shipment are with the person who has legal ownership of the bill of lading
properly issued or negotiated to it. Negotiable bills of lading are issued to shipper’s order, rather than to a specific,
named consignee. If the bill of lading is in negotiable form, the carrier will hold the goods until it receives an
original bill of lading that has been endorsed by the shipper (seller). The exporter must endorse the bill of lading
and deliver it to the bank in order to receive payment.
As regards non‐negotiable bills of lading, the carrier is required to deliver the goods only to the consignee named
in the bill of lading. The person to whom the goods are being sent normally needs to show the bill of lading in
order to obtain the release of the goods
Knowledge Test (ACCA Past Papers Dec. 2014):
Which of the following is a function of a non‐negotiable bill of lading?
a) Proof of ownership of the goods
b) An indicator that risk may have passed from seller to buyer
c) Confirmation of the right to take custody of the goods
Solution:
b) An indicator that risk may have passed from seller to buyer
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MODES OF PAYMENT
International sales payments are made by International Bank Transfers, Bills Of Exchange and Letters of Credit.
International Bank Transfers: Buyer directs his bank in his country to transfer funds to the seller’s bank in another
country. This is done electronically.
UNICITRAL MODEL LAW ON INTERNATIONAL CREDIT TRANSFERS
This law applies to credit transfers where any sending bank and its receiving bank are in different States.
"Credit transfer" means the series of operations, beginning with the originator's payment order, made for the
purpose of placing funds at the disposal of a beneficiary. The term includes any payment order issued by the
originator's bank or any intermediary bank intended to carry out the originator's payment order. A payment order
issued for the purpose of effecting payment for such an order is considered to be part of a different credit transfer.
Article 2 of the UNCITRAL Model Law on International Credit Transfers contains the following definitions:
i.
Originator means the issuer of the first payment order in a credit transfer and may include the sender and
the sender’s bank.
ii.
Sender means the person who issues a payment order, including the originator and any intermediary bank
involved in the passage of the credit transfer.
iii.
Receiving bank means a bank which receives a payment order and may include the beneficiary’s bank or
any intermediary bank involved in the series of transactions facilitating the credit transfer.
Payment order means an unconditional instruction, in any form, by a sender to a receiving bank to place at the
disposal of a beneficiary a fixed or determinable amount of money if:
I.
The receiving bank is to be reimbursed by debiting an account of, or otherwise receiving payment from, the
sender, and
II.
The instruction does not provide that payment is to be made at the request of the beneficiary.
Article 3 ‐ Conditional instructions
When an instruction is not a payment order because it is subject to a condition but a bank that has received the
instruction executes it by issuing an unconditional payment order, it then becomes a full credit transfer.
Applicability of Model law:
According to Article 4 the applicability of the Model law about the rights and obligations of parties in relation to
credit transfers may be varied by their agreement. Therefore the application of Model Law is not mandatory.
Obligations of Parties (Article 5):
A sender becomes obligated to pay the receiving bank for the payment order when the receiving bank accepts it,
but payment is not due until the beginning of the execution period.
LIABILITIES IN RELATION TO UNAUTHORIZED PAYMENT ORDER
The UNCITRAL model law allocates responsibility for unauthorized payment between sender and receiving bank
differently depending on the circumstances of the case. Article 5 of the model law makes it clear that the sender is
bound by a payment order if they, or some other person who had their authority to bind them, issued it. However,
the issue arises as to liability where the person who issues the payment order is neither the sender, nor has the
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sender’s authority to do so. In such a situation, responsibility depends on whether authentication is by way of
signature or a process such as encryption or the use of a code or some other process.
Article 5.2 of the model law provides that where a payment order is subject to authentication, other than by
means of comparing signatures, then the sender will be bound by the payment order, if
1)
The authentication is in the circumstances a commercially reasonable method of security against
unauthorized payment orders; and
2)
The receiving bank complied with the authentication.
Although this provision appears to lay the onus on the sender, by indicating when they will be liable, in reality it
reverses that onus, as the receiving bank will only avoid liability where it has used a commercially reasonable
authorisation procedure.
It is important to emphasize that the form of authentication must be commercially reasonable in the
circumstances. The determination of what is commercially reasonable will vary from time to time and from place
to place depending on the technology available, the cost of implementing the technology in comparison with the
risk and such other factors as may be applicable at the time.
What this provides is that if the bank accepts a transfer after carrying reasonable authorization procedures, then
the sender will be required to honour the payment.
The assumption is that, in the case of an electronic payment order, the receiving bank decides the authentication
procedures it is prepared to implement. Consequently, the bank bears all the risk of an unauthorised payment
order where it has not required and operated ‘commercially reasonable’ authentication procedures. Article 5(3)
goes on to provide that the protection offered to the sender cannot be avoided by any agreement to the contrary.
Article 5.4 of the model law considerably narrows the protection afforded to the receiving bank by providing that it
does not apply where the supposed sender can prove that the payment order did not originate from either:
I.
a present or former employee of theirs, or
II.
a person whose relationship with them enabled that person to gain access to the authentication
procedure.
If the receiving bank can show that the authentication procedure was revealed to the unauthorized sender
through the fault of the sender themselves, then once again the purported sender will be liable to honour the
payment.
ARTICLE 6 ‐ PAYMENT TO RECEIVING BANK
Payment of the sender's obligation under article 5(6) to pay the receiving bank occurs by making debit to the
account of the sender held by the receiving bank.
In another case an account of the sender bank is maintained by the receiving bank and the payment can be made
by the sending bank by crediting the receiving bank account.
Receiving bank can also net the obligations of the sending bank with other obligations. This can be done by a
bilateral netting agreement between the receiver and the sender bank.
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OBLIGATIONS OF RECEIVING BANK
A receiving bank that accepts a payment order is obligated under that payment order to issue a payment order,
within the time required by article 11, either to the beneficiary's bank or to an intermediary bank that is consistent
with the contents of the payment order. (Article 8(2)). The beneficiary's bank is, upon acceptance of a payment
order, obligated to place the funds at the disposal of the beneficiary, or otherwise to apply the credit, in
accordance with the payment order. Article 10(1)
Payment order may be accepted by the receiving bank in some other way before it executes it:
a) The payment order is accepted when it is received by the receiving bank.
b) The receiving bank upon accepting the payment order will debit the account of the sender.
A receiving bank that is obligated to execute a payment order is obligated to do so on the banking day it received.
If it does not, it shall do so on the banking day after the order is received. (Article 11).
CONSEQUENCES OF FAILED, ERRONEOUS OR DELAYED CREDIT TRANSFERS
Until the credit transfer is completed, each receiving bank is requested to assist the originator and each
subsequent sending bank, and to seek the assistance of the next receiving bank, in completing the banking
procedures of the credit transfer. (Article 13)
If the credit transfer is not completed, the originator's bank is obligated to refund to the originator any payment
received from it, with interest from the day of payment to the day of refund. The originator's bank and each
subsequent receiving bank is entitled to the return of any funds it has paid to its receiving bank, with interest from
the day of payment to the day of refund. Chain of responsibility is at the bank which has failed to complete the
credit transfer.
LIABILITY OF INTEREST FOR DELAYED PAYMENT
The liability of bank for causing delay is the payment of interest. The bank which caused delay must pass on the
payment plus interest of the delay to the receiving bank. If the interest has not been passed on to the beneficiary
bank then the beneficiary has the direct right of receiving it from the bank which holds it.
COMPLETION OF CREDIT TRANSFER (ARTICLE 19)
A credit transfer is completed when the beneficiary's bank accepts a payment order for the benefit of the
beneficiary. When the credit transfer is completed, the beneficiary's bank becomes indebted to the beneficiary to
the extent of the payment order accepted by it.
Knowledge Test (ACCA Past Papers 2014)
Under the UNCITRAL Model Law on International Credit Transfers, which of the following is NOT considered to be
an originator?
A. The sender’s bank
B. The sender
C. Any intermediary bank between the sender’s bank and the beneficiary’s bank
Solution:
C Any intermediary bank between the sender’s bank and the beneficiary’s bank
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BILLS OF EXCHANGE
A bill of exchange is an order in writing by one person to another to pay a specified sum to a specified person or
bearer on a particular date. A bill of exchange is a substitute for money. Consequently, a bill of exchange can be
understood as a form of commercial credit instrument, or IOU, used in international trade. A bill of exchange may
be stated to be payable on demand or at a given time on presentation. A cheque is a bill of exchange drawn on a
banker, payable on demand.
In England, a bill of exchange is defined in the Bills of Exchange Act 1882, which provides that a bill of exchange is:
‘an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring
the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in
money to or to the order of a specified person, or to bearer.’
The following terms apply:
a) The person making the order or drawing the bill is known as the drawer.
b) The person to whom the bill is addressed is the drawee (for example a bank).
c) The person to whom the bill is payable is the payee.
d) The person to whom a bill is transferred by endorsement is called the endorsee.
e) The generic term ‘holder’ includes any person in possession of a bill who holds it either as payee, endorsee or
bearer.
f) A bill which in its origin is payable to order becomes payable to bearer if it is endorsed in blank
If the drawee assents to the order, he is then called the acceptor. An acceptance must be in writing and must be
signed by the drawee. The mere signature of the drawee is sufficient. By the acceptance of a bill, the drawee
becomes the principal debtor on the instrument and the party primarily liable to pay it.
Acceptance may be either general or qualified. As a qualified acceptance is so far a disregard of the drawer’s order,
the holder is not obliged to take it; and if he chooses to take it, he must give notice to antecedent parties, acting at
his own risk if they dissent.
INTERNATIONAL BILLS OF EXCHANGE
Article 2 of the Convention provides that a bill of exchange is international if it specifies at least two of the
following places and indicates that they are situated in different States:
a) The place where the bill is drawn;
b) The place indicated next to the signature of the drawer;
c) The place indicated next to the name of the drawee;
d) The place indicated next to the name of the payee;
e) The place of payment.
However, to comply, the place where the bill is drawn or the place of payment must be situated in a contracting
State.
Article 3 defines a bill of exchange as a written instrument which:
a) Contains an unconditional order whereby the drawer directs the drawee to pay a definite sum of money to the
payee or to their order;
b) Is payable on demand or at a definite time;
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c) Is dated;
d) Is signed by the drawer.
Bill should be of a Definite Sum:
It is important to note that Article 7 of the Convention provides that the sum payable is deemed to be a definite
sum, although the instrument states that it is to be paid:
a) with interest, which may be paid at a fixed or variable rate (Article 8);
b) by installments at successive dates;
c) by installments at successive dates when the unpaid balance becomes due upon default in payment of any
installment;
d) according to a rate of exchange indicated in the instrument or to be determined as directed by the
instrument; or
e) in a currency other than the currency in which the sum is expressed in the instrument.
 It should be noted that the Convention does not apply to international cheques.
 If there exists an error in the amount to payable in words or in figures then the one expressed in words is
deemed to payable by instrument. (Article 8(1))
 If the bill states that interest is to be paid with sum and the exact date of the payment of interest is not
mentioned then the interest is to be paid from the date of the bill. (Article 8(4))
Payment of Bill:
A bill is said to be payable on demand if it is payable at sight or presentation or demand or even if no time of
payment is mentioned. The time for payment is the date on which the bill is presented for payment.
Payment of bill on a definite time is if it states that:
a) It is payable on the stated date or at a fixed period after a stated date or at a fixed period after the date of the
instrument,
b) At a fixed period after sight,
c) By installments
PARTIES IN THE BILL OF EXCHANGE
a) Payee: A person to whom the drawer has instructed to make payment. Bill may be payable to two or more
persons.
b) Drawer: Person who instructs to make payment.
The Drawer is liable on the bill once he signs it. However signatures if forged bear no liability. If the bill gets
dishonored the drawer agrees to pay it to the holder or endorser. Drawer can also limit his liability on the payment
of bill if another party becomes liable.
a) Drawee and Acceptor:
Drawee is the bank which has the drawer's checking account from which a check is to be paid.
The drawee is not liable on the bill until he accepts it (Article 40(1))
The acceptor engages that he will pay the bill in accordance to the terms of his acceptance to the holder, or to
any party who takes up and pays the bill.
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Article 41: An acceptance must be written on the bill on its front and back and may be effected:
a. By the signature of the drawee accompanied by the word "accepted" or by similar words; or
b. By the signature alone of the drawee.
A bill may be accepted before, at or after maturity, or after it has been dishonored by non‐acceptance or
by non‐payment. (Article 42)
An acceptance must be unqualified. An acceptance is qualified if it is conditional or varies the terms of the
bill. (Article 43)
a.
b.
If the drawee stipulates in the bill that his acceptance is subject to qualification (Article 43):
He is nevertheless bound according to the terms of his qualified acceptance;
The bill is dishonored by non‐acceptance.
A bill may be presented for acceptance. (Article 49 (1))
A bill must be presented for acceptance: (Article 49 (2))
(a) If the drawer has stipulated in the bill that it must be presented for acceptance;
(b) If the bill is payable at a fixed period after sight; or
(c) If the bill is payable elsewhere than at the residence or place of business of the drawee, unless it is
payable on demand.
A bill is duly presented for acceptance if it is presented in accordance with the following rules (Article 51):
(a) The holder must present the bill to the drawee on a business day at a reasonable hour;
(b) Presentment for acceptance may be made to a person or authority other than the drawee if that person
or authority is entitled under the applicable law to accept the bill;
(c) If a bill is payable on a fixed date, presentment for acceptance must be made before or on that date;
(d) A bill payable on demand or at a fixed period after sight must be presented for acceptance within one
year of its date;
(e) A bill in which the drawer has stated a date or time‐limit for presentment for acceptance must be
presented on the stated date or within the stated time‐limit.
If a bill which must be presented for acceptance is not so presented, the drawer, the endorsers and their
guarantors are not liable on the bill.(Article 53(1)). Failure to present a bill for acceptance does not discharge
the guarantor of the drawee of liability on the bill. (Article 53(2))
Article 54: A bill is considered to be dishonoured by non‐acceptance:
(a) If the drawee, upon due presentation, expressly refuses to accept the bill or acceptance cannot be
obtained with reasonable diligence or if the holder cannot obtain the acceptance to which he is entitled
under this Convention.
(b) If a bill is dishonored by non‐acceptance the holder may exercise an immediate right of recourse against
the drawer, the endorsers and their guarantors, (Article 54)
(c) If a bill payable on demand is presented for acceptance, but acceptance is refused, it is not considered to
be dishonored by non‐acceptance.(Article 54(3))
Knowledge Test (ACCA Past Papers 2014):
Which party to an international bill of exchange instructs the payment to be made?
A. The payee
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B. The drawer
C. The drawee
Solution:
B The drawer
The Guarantor:
Payment of an instrument, whether or not it has been accepted, may be guaranteed, as to the whole or
part of its amount, for the account of a party or the drawee. A guarantee may be given by any person,
who may or may not already be a party. (Article 46(1)). A guarantee must be written on the instrument
or on a slip affixed thereto ("allonge"). (Article 46(2)).
A guarantor may specify the person for whom he has become guarantor. In the absence of such
specification, the person for whom he has become guarantor is the acceptor or the drawee in the case
of a bill, and the maker in the case of a note. Article 46(5)
Article 47: The liability of a guarantor on the instrument is of the same nature as that of the party for
whom he has become guarantor.
Article 48(2): The guarantor who pays the instrument may recover from the party for whom he has
become guarantor and from the parties who are liable on it to that party the amount paid and any
interest.
TRANSFER OF BILL OF EXCHANGE


Article 13:An instrument is transferred:
(a) By endorsement and delivery of the instrument by the endorser to the endorsee; or
(b) By mere delivery of the instrument if the last endorsement is in blank.
Article 24: An instrument may be transferred in accordance with article`13 after maturity, except by the
drawee, the acceptor or the maker.
ENDORSEMENT
Endorsement relates to the way in which international bills of exchange are transferred and in effect it allows the
original payee of the instrument to transfer the benefit of it to some other party by signing it.
Article 13 of the UN Convention on International Bills of Exchange and International Promissory Notes provides a
bill of exchange is transferred either by:
(a) Endorsement and delivery of the instrument by the endorser to the endorsee; or
(b) Mere delivery of the instrument if the last endorsement is in blank.
By virtue of Article 14, an endorsement must be written on the instrument attached to it. Any such endorsement
may be:
(a) In blank, that is, by a signature alone or by a signature accompanied by a statement to the effect that the
instrument is payable to a person in possession of it;
(b) Special, that is, by a signature accompanied by an indication of the person to whom the instrument is payable.
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A signature alone, other than that of the drawee, is an endorsement only if placed on the back of the instrument.
An endorsement must be unconditional and in the light of any conditional endorsement, the bill of exchange will
still be transferred whether or not the condition is fulfilled (Article 18). An endorsement must relate to the entire
sum of the bills or it is ineffective (Article 19). If there are two or more endorsements, it is presumed, unless the
contrary is proved, that each endorsement was made in the order in which it appears on the instrument (Article
20).
An instrument may be transferred in accordance with Article 13 after maturity, except by the drawee, the acceptor
or the maker (Article 23). Under Article 17(1), a bill cannot be transferred if the bill or an endorsement on the bill
contains words such as not negotiable/not transferable/not to order/pay x only.
Under Article 25, if an endorsement is forged, the person whose endorsement is forged, or a party who signed the
instrument before the forgery, has the right to recover compensation for any damage which they may have
suffered because of the forgery. This right may be exercised against: (a) the person who forged the endorsement;
(b) the person to whom the instrument was directly transferred by the forger; (c) a party or the drawee who paid
the instrument to the forger directly or through one or more endorsees for collection.
However, an endorsee for collection is not liable if they have no knowledge of the forgery:
(a) At the time they pay the principal or advises them of the receipt of payment; or
(b) At the time they receive payment, if this is later, unless their lack of knowledge is due to their failure to act in
good faith or to exercise reasonable care.
The endorser
Article 44: The endorser engages that upon dishonour of the instrument by non‐acceptance or by non‐payment,
and upon any necessary protest, he will pay the instrument to the holder, or to any subsequent endorser or any
endorser's guarantor who takes up and pays the instrument.
Article 45(1): Unless otherwise agreed, a person who transfers an instrument, by endorsement and delivery or by
mere delivery, represents to the holder to whom he transfers the instrument that:
(a) The instrument does not bear any forged or unauthorized signature;
(b) The instrument has not been materially altered;
(c) At the time of transfer, he has no knowledge of any fact which would impair the right of the transferee
to payment of the instrument against the acceptor of a bill or, in the case of an unaccepted bill, the
drawer, or against the maker of a note.
Holder: The holder of a bill of exchange, promissory note, or check is the person who has legally acquired the
possession of the same, from a person capable of transferring it, by endorsement or delivery, and who is entitled
to receive payment of the instrument from the party or parties liable to meet it.
 Article 15(1): A person is a holder if he is:
(a) The payee in possession of the instrument; or
(b) In possession of an instrument which has been endorsed to him, or on which the last endorsement is in
blank, and on which there appears an uninterrupted series of endorsements, even if any endorsement
was forged or was signed by an agent without authority.

(Article 16)The holder of an instrument on which the last endorsement is in blank may:
(a) Further endorse it either by an endorsement in blank or by a special endorsement;
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(b) Convert the blank endorsement into a special endorsement by indicating in the endorsement that the
instrument is payable to himself or to some other specified person; or
(c) Transfer the instrument by delivery: Article 13(b)
Rights of holder:
The holder of an instrument has all the rights conferred on him by this Convention against the parties to the
instrument.
 The holder may transfer the rights in accordance with article 13.
 Article 31: The transfer of an instrument by a protected holder vests in any subsequent holder the rights to
and on the instrument which the protected holder had.
PRESENTMENT OF BILL FOR PAYMENT
The holder must present the instrument for payment to the drawee or to the acceptor or to the maker on a
business day at a reasonable hour (Article 55)
The presentment of bill for payment can be (Article 55):
i. At the place of payment specified on the instrument;
ii. If no place of payment is specified, at the address of the drawee or the acceptor or the maker indicated in the
instrument; or
iii. If no place of payment is specified and the address of the drawee or the acceptor or the maker is not
indicated, at the principal place of business or habitual residence of the drawee or the acceptor or the maker;
Presentment for payment is dispensed with if the bill has been protested for dishonour by non‐acceptance.
(Article 56). If an instrument is not duly presented for payment, the drawer, the endorsers and their
guarantors are not liable on it. (Article 57)
DISHONOUR BY NON‐PAYMENT (ARTICLE 58)
An instrument is considered to be dishonoured by non‐payment:
(a) If payment is refused upon due presentment or if the holder cannot obtain the payment to which he is
entitled under this Convention.
(b) If presentment for payment is dispensed with and the instrument is unpaid at maturity.
If an instrument is dishonoured by non‐acceptance or by non‐payment, the holder may exercise a right of recourse
only after the instrument has been duly protested for dishonour (Article 59)
PROTEST
Article 60:A protest is a statement of dishonour drawn up at the place where the instrument has been dishonoured
and signed and dated by a person authorized in that respect by the law of that place. The statement must specify:
(a) The person at whose request the instrument is protested;
(b) The place of protest;
(c) The demand made and the answer given, if any, or the fact that the drawee or the acceptor or the maker
could not be found.
 A protest may be made on the instrument or on a slip affixed thereto ("allonge"); or on a separate
document.
 Article 61: Protest for dishonor of an instrument must be made on the day on which the instrument is
dishonored or on one of the four business days which follow.
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Article 63: If an instrument which must be protested for non‐acceptance or for non‐payment is not duly
protested, the drawer, the endorsers and their guarantors are not liable on it.
Article 64: The holder, upon dishonor of an instrument by non‐acceptance or by non‐payment, must give
notice of such dishonor:
(a) To the drawer and the last endorser;
(b) To all other endorsers and guarantors whose addresses the holder can ascertain on the basis of
information contained in the instrument.
Article 68: If a person who is required to give notice of dishonour fails to give it to a party who is entitled
to receive it, he is liable for any damages which that party may suffer from such failure.
Amount payable
 Article 69(1). The holder may exercise his rights on the instrument against any one party, or several or all
parties, liable on it and is not obliged to observe the order in which the parties have become bound. Any party
who takes up and pays the instrument may exercise his rights in the same manner against parties liable to him.
 Article 70: After maturity the amount payable to holder of the instrument is the amount with interest, if
interest has been stipulated for, to the date of maturity at the rate stipulated for plus any interest expenses of
protest.
 The bill which on which the amount is paid before maturity often entails discount from the date payment was
made to the date of maturity.
 Article 71: A party who pays an instrument and is thereby discharged in whole or in part of his liability on the
instrument may recover from the parties liable to him:
(a) The entire sum which he has paid;
(b) Interest on that sum from the date on which he made payment;
(c) Any expenses of the notices given by him
 Article 75: An instrument must be paid in the currency in which the sum payable is expressed.
 Article 72: A party is discharged of liability on the instrument when he pays the holder, or a party subsequent
to himself who has paid the instrument and is in possession of it, the amount due:
(a) At or after maturity; or
(b) Before maturity, upon dishonour by non‐acceptance.
Knowledge Test (ACCA Past Papers 2014):
Which of the following is the drawer of an international bill of exchange?
A. The receiving bank
B. The sender’s bank
C. The buyer’s bank
D. The buyer
Solution:
D The buyer
Knowledge Test (ACCA Past Papers 2014):
In relation to international bills of exchange, which of the following may be an acceptor?
A. The buyer
B. The buyer’s bank
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C.
D.
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The seller’s bank
The recipient of an endorsed bill
Solution:
B The buyer’s bank
LETTERS OF CREDIT
A letter of credit is an undertaking by a bank to make a payment to a named beneficiary within a specified time,
against the presentation of documents which comply strictly with the terms of the letter of credit.
The parties to a letter of credit are:
i.
The buyer (the applicant)
ii.
The buyer’s bank (the issuer)
iii.
The beneficiary (the seller/payee)
iv.
The beneficiary’s bank.
A letter of credit is opened by an importer (applicant). The terms of the underlying sales contract may be made
conditions of the letter of credit, in order to ensure that the seller has performed as required under that contract
before they can receive payment
The issuing bank has two main roles. First it provides security for the seller. Thus, it promises the seller that if
compliant documents are presented, the bank will pay the seller the amount due. However, it also provides a
measure of security for the buyer as it undertakes to examine the documents, and only pay if they comply with the
terms and conditions set out in the letter of credit.
The main advantage of letters of credit in international trade is that they provide security to both the exporter and
the importer. The risk of non‐payment by the buyer rests with the issuing bank. As far as the exporter is concerned
the letter of credit, apart from cash in advance, is the most secure method of payment in international trade as
long as the terms of the credit are met. Most letters of credit are subject to the terms of the International
Chamber of Commerce’s Uniform Customs and Practice for Documentary Credits (UCP 500), which are the
universally recognized set of rules governing the use of the documentary credits in international trade.
The procedure for creating and using letters of credit is as follows:
I. The exporter and importer agree the terms of their contract;
II. The importer/buyer applies to their bank for issue of letter of credit;
III. The issuing bank issues letter of credit, sending it to the seller’s bank, the advising bank;
IV. The advising bank establishes the authenticity of the letter of credit and informs exporter. The advising bank
may confirm the letter of credit, which means that it will undertake to ensure payment in any event;
V. The exporter ships the goods;
VI. The exporter presents the documents called for in the letter of credit (invoice, transport document, etc) to the
advising bank;
VII. The advising bank checks the documents against the letter of credit. If the documents are compliant, the bank
pays the seller and forwards the documents to the issuing bank;
VIII. The issuing bank checks the documents itself. If they are in order it reimburses the exporter’s/seller’s bank;
IX. The issuing bank debits the buyer and releases the documents (including transport document), so that the
buyer can claim the goods from the carrier.
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Letters of credit may assume any of the following forms:
Revocable:
 A revocable letter of credit can be amended or cancelled at any time by the importer without the exporter’s
agreement.
Irrevocable:
 An irrevocable letter of credit cannot be amended or cancelled without the agreement of all parties to the
credit.
Unconfirmed
 An unconfirmed letter of credit is forwarded by the advising bank directly to the exporter without adding its
own undertaking to make payment or accept responsibility for payment at a future date, but confirming its
authenticity.
Confirmed
 A confirmed letter of credit is one in which the advising bank, on the instructions of the issuing bank, has
added a confirmation that payment will be made as long as compliant documents are presented, even if the
issuing bank or the buyer fails to make payment.
A standby letter of credit
It is used as support where an alternative, less secure, method of payment has been agreed. Thus, should the
exporter fail to receive payment from the importer he may claim under the standby letter of credit?
Revolving Letter of Credit
This type of letter of credit is used where there are regular shipments of the same commodity to the same
importer and is used to avoid the need to be continually opening or amending letters of credit.
Transferable Letter of Credit
A transferable letter of credit is one in which the exporter has the right to request the paying, or negotiating, bank
to make either all or part of the payment due to a third party who was not a party to the original contract, for
example the actual supplier of the goods that are the subject of the international contract.
Back‐to‐Back Letter of Credit
A back‐to‐back letter of credit can be used as an alternative to the transferable letter of credit. Rather than
transferring the original letter of credit to the supplier, once the letter of credit is received by the exporter from
the opening bank, that letter of credit is used as security to establish a second letter of credit drawn on the
exporter in favour of his supplier.
Knowledge Test (ACCA Past Papers 2014)
Which of the following provides the greatest assurance of being paid?
A. International bill of exchange
B. International promissory note
C. Letter of credit
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Solution:
C Letter of credit
LETTERS OF COMFORT
A parent company may be unable or unwilling to guarantee the borrowings of its subsidiary but it might be
prepared to issue a “comfort letter” to the lenders.
A comfort letter is normally a letter given by a parent company to a lender whereby the parent company
undertakes certain limited responsibilities but it falls short of being a guarantee. Sometimes comfort letters
specifically provide that they are not intended to be legally binding. However absent such a provision, in a
commercial context there will normally be little doubt that a comfort letter is intended to create legal relations.
Accordingly, in establishing what avenues of recourse are available to the lenders in the event of a breach of the
undertaking in the comfort letter by the parent, the question will normally be one of interpretation as to what the
comfort letter means.
Knowledge Test (ACCA Past Papers 2014)
Which of the following is by definition non‐negotiable?
A. A bill of lading
B. A bill of exchange
C. A letter of credit
D. A letter of comfort
Solution:
D A letter of comfort
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Agency Law
Chapter ‐07
Chapter
07
Agency Law
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IN THIS CHAPTER
ROLE OF AGENT
TYPES OF AGENT
FORMATION OF AGENCY RELATIONSHIP
CONCEPT OF RETROSPECTIVE RATIFICATION IN AGENCY LAW
ESTABLISHMENT OF AGENCY RELATIONSHIP WITHOUT CONSENT
AUTHORITY OF THE AGENT
HOW CAN AN AGENT’S AUTHORITY EFFECTIVELY BE REVOKED?
HOW CAN AN AGENCY RELATIONSHIP BROUGHT TO AN END?
WHEN DOES THE PERSONAL LIABILITY OF AGENT ARISE?
BREACH OF WARRANTY OF AUTHORITY
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ROLE OF AGENT
An agent is a person who is empowered to represent another legal party, called the principal, and to bring the
principal into a legal relationship with a third party. Any contract entered into is between the principal and the
third party each of whom may enforce it. In the normal course of events the agent has no personal rights or
liabilities in relation to the contract
This branch of law separates and regulates the relationships between:
 Agents and principals;
 Agents and the third parties with whom they deal on their principals' behalf; and
 Principals and the third parties when the agents purport to deal on their behalf.
For example:
 An in order to sell his property to C asks B to finalize the deal on A’s behalf. Here B acts as agent of A to finalize
the sale of property to C (third Party).
 A asks B to get car repaired. B acts as A’s agent in making a contract between A and the garage person.
TYPES OF AGENT
a.
b.
c.
d.
e.
f.
Partners: Partners in a partnership firm act as agents of each other.
Company Directors: They work on behalf of the company as its agent.
Promoters: Person who undertakes to form a company.
Factor: A person who buys or sells goods on behalf of another person. Also called a mercantile agent.
Brokers: They are intermediaries who arrange contracts or meeting for commission as payment.
Auctioneers: Person who act as agents to auction another person’s property.
FORMATION OF AGENCY RELATIONSHIP
The principal/agent relationship can be created in a number of ways. It may arise as the outcome of a distinct
contract, which may be made either orally or in writing, or it may be established purely gratuitously where some
person simply agrees to act for another.
It is usually formed by an express agreement; however it may be formed by an implied agreement due to the
relationship or conduct of the parties.
 Express Agreement: By writing or orally
 Implied Agreement: It may be implied by reason of their relationship and conduct.
CONCEPT OF RETROSPECTIVE RATIFICATION IN AGENCY LAW
A principal may ratify an act of an agent retrospectively. If the principal agrees to the acts of the agent after the
event, he may approve the acts of the agent by ratifying them retrospectively.
The principal may only ratify if the following conditions are satisfied:
1. Principal must have been in existence at the time of agent’s act.
2. Principal must have legal capacity to make the contract
3. Agent must at the time of making the contract sufficiently identify or name the principal.
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Knowledge Test (ACCA Past Paper 2014):
An agency relationship which is made retrospectively is referred to by which of the following terms?
A Agency by estoppel
B Agency by ratification
C Agency by necessity
Solution:
B Agency by ratification
Knowledge Test:
Jones while acting as an agent for Ahmed entered into a contract with a third party namely Cesa Ltd. Select which
of the following option is INCORRECT if Ahmed decides to ratify Jones’ contract?
a) Ahmed must tell the third party (Cesa Ltd) the agent is acting for him
b) Ratification of contract by Ahmed should take place within a reasonable period of time
c) Ahmed must have the legal capacity to enter into contract
Solution:
a) Ahmed must tell the third party (Cesa Ltd) the agent is acting for him
ESTABLISHMENT OF AGENCY RELATIONSHIP WITHOUT CONSENT
An agency relationship may be created without express consent. This happens by the principle of estoppel.
i)
Implied agreement: The effect of an agency relationship created vide an implied agreement might result
in agent with more authority than what the principal consented to.
ii)
Agent by Estoppel: An agency that is not created as an actual agency by a principal and an agent but that
is imposed by law when a principal holds out to the third party to reasonably believe that another is the
principal's agent and the third party is injured by relying on and acting in accordance with that belief.
If the principal could have corrected the misunderstanding but failed to do so, he or she is estopped from
denying the existence of the agency and is bound by the agent's acts in dealing with the third party. To
rely on agency by estoppel, there must have been a representation by the principal as to the authority of
the agent (Freeman and Lockyer v Buckhurst Park Properties Ltd (1964)) and the party seeking to rely on
it must have relied on the representation.
For example, if limited company allows its employee namely A to use official letterhead to send out
correspondence to third parties then agency by estoppel may exist. Because the company is holding A out
as its official agent to third parties and the (presumed) principal may be legally bound by the agent's
actions.
Knowledge Test:
Jones has appointed Ali as the managing executive at his construction company and has told all his suppliers that
from now onwards Ali has the full authority in all the dealings concerning the business on his behalf.
What kind of agency relationship has Jones created with Ali:
a. Agent by necessity
b. Agent by estoppel
c. Express agent
Solution:
b. Agent by estoppel
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Agency Law
iii)
Chapter ‐07
Agent by Necessity: The usual situation which gives rise to agency by necessity occurs where the agent is
in possession of the principal’s property and, due to some unforeseen emergency, the agent has to take
action to safeguard that property.
In order for agency by necessity to arise, there needs to be a:
a. Genuine emergency (Great Northern Railway Co v Swaffield (1874)) and
b. There must also be no practical way of obtaining further instructions from the principal (Springer v Great
Western Railway Co (1921)).
c. The person seeking to establish the agency by necessity must have acted bona fide in the interests of the
principal (Sachs v Miklos (1948)).
d. The person acting as an agent of necessity must have some existing contractual relationship with the
principal.
For instance, A sends goods to B in Italy by air with directions to transport them by road to C in a remote village in
France. B may sell goods at Italy if the goods will not be able to bear the journey to C living in France.
Knowledge Test:
Casa and his wife while on a vacation gave the keys of their house to a close friend Saku to look after it while they
were away. Saku one day while doing routine inspection of the house discovered a major leakage along with the
main sewerage pipe line of the house. The same required immediate fix otherwise would cause major damage to
the property. Saku spent £1000 to get the repairs done.
What kind of agent Saku is and will he be entitled to recover the amount spent for the repairs?
Solution:
Saku is an agent of necessity and he will be entitled to recover the amount spent for repairs from Casa and his
wife.
AUTHORITY OF THE AGENT
An agreement is binding only if the agent acts within the limits of his authority.
There are three kinds of agent’s authority:
i)
Express Authority:
Express actual authority means an agent has been expressly told he or she may act on behalf of a
principal. In this instance, when the principal/agency relationship is established, the agent is instructed as
to what particular tasks are required to be performed and is informed of the precise powers given in
order to fulfill those tasks. If the agent subsequently contracts outside of the ambit of their express
authority then they will be liable to the principal and to the third party for breach of warrant of authority.
The consequences for the relationship between the principal and third party depends on whether the
third party knew that the agent was acting outside the scope of their authority. For example, an individual
director of a company may be given the express power by the board of directors to enter into a specific
contract on behalf of the company. In such circumstances the company would be bound by the
subsequent contract but the director would have no power to bind the company in other contracts.
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ii)
Chapter ‐07
Implied Authority:
Implied authority is the authority which derives from a person’s position. It arises from the relationship
which exists between the principal and the agent and from which it is assumed that the principal has
given authority to the other person to act as their agent. Thus, it is implied from the particular position
held by individuals that they have the authority to enter into contractual relations on behalf of their
principal and third parties are entitled to assume that agents holding a particular position have all the
powers which are usually provided to such an agent.
This refers to the way in which the scope of express authority may be increased. Third parties are entitled
to assume that agents holding a particular position have all the powers that are usually provided to such
an agent. Without actual knowledge to the contrary they may safely assume that the agent has the usual
authority that goes with their position.
In Watteau v Fenwick (1893) the new owners of a hotel continued to employ the previous owner as its
manager. They expressly forbade him to buy certain articles including cigars. The manager, however,
bought cigars from a third party who later sued the owners for payment as the manager’s principal. It was
held that the purchase of cigars was within the usual authority of a manager of such an establishment and
that for a limitation on such usual authority to be effective it must be communicated to any third party.
iii)
Apparent/ostensible authority
This type of authority, which is an aspect of agency by estoppel, can arise in two distinct ways:
(i)
(ii)
Where a person makes a representation to third parties that a particular person has the
authority to act as their agent without actually appointing them as their agent. In such a case the
person making the representation is bound by the actions of the ostensible/apparent agent. The
principal is also liable for the actions of the agent where they are aware that the agent claims to
be their agent and yet does nothing to correct that impression.
Where a principal has previously represented to a third party that an agent has the authority to
act on their behalf.
Even if the principal has subsequently revoked the agent’s authority they may still be liable for
the actions of the former agent unless they have informed third parties who had previously dealt
with the agent about the new situation (Willis Faber & Co Ltd v Joyce (1911)).
In Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd (1964), although a particular
director had never been appointed as managing director, he acted as such with the clear
knowledge of the other directors and entered into a contract with the plaintiffs on behalf of the
company. When the plaintiffs sought to recover fees due to them under that contract it was held
that the company was liable: a properly appointed managing director would have been able to
enter into such a contract and the third party was entitled to rely on the representation of the
other directors that the person in question had been properly appointed to that position.
Knowledge Test:
Carl, Jones & James are directors of Bee Ltd. The Articles of Association of Bee Ltd expressly state that each
contract on behalf of the company will be executed collectively by all three directors. However, Carl has been
executing all the contracts on behalf of the company and Jones and James have never objected to it. One contract
which Carl entered into was opposed by Jones and James on the ground that he does not have the authority to
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Chapter ‐07
solely enter into contracts on behalf of the company. Advise Carl about the fate of the contract and the authority
which he has been exercising.
Solution:
Carl has been exercising Apparent & Ostensible authority and Bee Ltd would be bound by the contracts he had
executed.
HOW CAN AN AGENT’S AUTHORITY EFFECTIVELY BE REVOKED?
The authority of an agent to bind his principal may cease by revocation of that authority by the principal. However,
the revocation of authority will only be valid if the principal has informed the third parties regarding the revocation
of an agent’s authority.
HOW CAN AN AGENCY RELATIONSHIP BROUGHT TO AN END?
An agency relationship can be brought to an end in the following ways:
i)
Principal or agent dies
ii)
Principal or agent becomes insane
iii)
Principal or agent becomes bankrupt
Third parties are allowed to enforce contracts made later by agent until they are actively or constructively
informed of the termination of the agency relationship.
WHEN DOES THE PERSONAL LIABILITY OF AGENT ARISE?
It arises in three situations:
a. Where he intended to take personal liability
b. Where there exists common business practice or custom that he would be personally liable.
c. Where he acts in his own capacity.
BREACH OF WARRANTY OF AUTHORITY


Definition of breach of warranty of authority: Creating an impression of authority as an agent where no such
relationship exists.
An agent who enters into a contract with a third party (for and on behalf of a principal) by implication
warrants that he or she has the authority to do so. If this is not the case, the third party has the right to sue
the agent for breach of warranty of authority.
Knowledge Test (ACCA Past Paper 2014)
In relation to agency law, ‘warranty of authority’ is provided by which of the following?
A The agent
B The principal
C The third party
Solution:
A The agent
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Knowledge Test:
David is working as an agent for Steve. David has entered into a contract with a third party regarding sale of goods
manufactured by Steve.
In which situation below will David be personally liable for the contract?
1. If David intends to take personal liability
2. If it is usual business practice for David to be personally liable as an agent
3. If David only negotiates the contract but the same is signed by Steve
a.
b.
c.
1&3
1,2&3
1&2
Solution:
c. 1&2
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Partnership
Chapter ‐08
Chapter
08
Partnership
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IN THIS CHAPTER
DEFINITION OF PARTNERSHIP
COMMENCEMENT OF PARTNERSHIP
FORMATION OF PARTNERSHIP
TYPES OF PARTNERSHIP
ORDINARY PARTNERSHIP
AUTHORITY AND LIABILITY OF PARTNERS IN RELATION TO PARTNERSHIP
ACTIVITY
HOW CAN A PARTNERSHIP BE BROUGHT TO AN END?
DISTRIBUTION OF PROCEEDS OF ASSETS UPON TERMINATION OF
PARTNERSHIP
PARTNER’S LIABILITY
PARTNERSHIP CHARGE
LIMITED LIABILITY PARTNERSHIP
DIFFERENCE BETWEEN LLP & COMPANIES
LIMITED PARTNERSHIP
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DEFINITION OF PARTNERSHIP
“It is the relation which subsists between persons carrying on business in common with a view of profit.”
There are three elements for a partnership to be established, namely, “the carrying on of a business", “in
common" and “with a view to profit", missing any one of which there cannot be a partnership.
COMMENCEMENT OF PARTNERSHIP
The House of Lords in the case of Miah v Khan stated that when any activity is done by the parties for furtherance
of the business of the partnership then the partnership would be deemed to have commenced from that date. For
example the opening of a joint bank account or obtaining of a bank loan or acquiring premises were considered to
be business activities.
FORMATION OF PARTNERSHIP
Partnership can either be a formal (written) or an informal (oral) arrangement. Partnership is formed when a
minimum of two or more people decide to run a business together.
A written partnership agreement is not a mandatory requirement in order to form a partnership. If a partnership is
formed informally then the basic rights and duties of partners mentioned in the Partnership Act 1890 would apply
to the partnership arrangement.
A written partnership agreement has various advantages because the Partnership Act 1890 is silent on a number of
matters such as expulsion of a partner. Therefore a written arrangement brings with it the following advantages:
i)
It overrides the implied terms of the Partnership Act.
ii)
It can include the clause of the expulsion of partners.
TYPES OF PARTNERSHIP
The three distinct types of partnership are as follows:
 The ordinary partnership
 The limited liability partnership
 The limited partnership
THE ORDINARY PARTNERSHIP
This is the most common form of partnership. Ordinary partnerships involve potential unlimited liability for their
members, should the business run into financial difficulties. It is possible to attempt to limit individual liability
within the partnership by setting specific limits on the liability of the individual partners.
This, however, has no effect on the external liability of the various members of the partnership who will remain
liable for the full extent of the partnership debts. As a result, any partner who has to pay more than the amount
agreed internally will be in the position to raise an action to recover any amount paid out in addition to their
agreed limit from the other members of the partnership.
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AUTHORITY AND LIABILITY OF PARTNERS IN RELATION TO PARTNERSHIP ACTIVITY
Partners are jointly liable for all the partnership debts that result from the contracts made by other partners which
bind the firm. Each Partner is agent of the firm and partners are jointly liable for the acts of their fellow partners so
far as they bind the firm unless the partner so acting
i)
Has no authority to act for the firm
ii)
The third party knows that he has no authority
Furthermore, the act specifically states that where the partner of the firm specifically pledges the credit of the firm
for a purpose which has no connection with the firm’s ordinary business, the firm will not be bound to that
transaction unless he has express authority to do so.
The authority of a partner in any partnership is based upon the laws of agency. Where a third party genuinely
believes that partner has authority to bind the firm, even if the partner has no such authority, the third party may
rely on their genuine belief that the partner did have the authority to bind the firm to such contract. This is known
as ostensible authority.
If authority of the partner is terminated, it will only be effective if the third party has had notice of it. Authority of
the partner mostly depends upon the perception of the third party.
Knowledge Test:
1. A & B are partners in a firm namely Zanic partners engaged in the business of making chairs.
(1) To receive payment of debts due from Wo Limited to the Zanic Partners
(2) To borrow money for personal use from Barclay’s Bank on behalf of Zanic Partners
(3) To sell the manufactured chairs belonging to Zanic Partners
(4) To engage employees for the Zanic Partners
What are the implied authorities of partners?
a. 1,2 and 3
b. 1,2 and 4
c. 1,3 and 4
d. 2,3 and 4
Solution:
c. 1,3 and 4
HOW CAN A PARTNERSHIP BE BROUGHT TO AN END?
Partnership is dissolved in the following instances:
i)
By death or bankruptcy of the partner
ii)
Expiry of the term or time of partnership
iii)
Order of the court
iv)
Notice given by one partner to another
v)
Termination of venture
vi)
Subsequent illegality
vii)
Agreement between partners
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Knowledge Test:
Which of the following is not the ground for termination of partnership?
a. On the expiration of the fixed term for which the partnership was created
b. On bankruptcy or death of a partner
c. Subsequent Illegality
d. On failing to attend the meeting of the partners
Solution:
d. On failing to attend the meeting of the partners
DISTRIBUTION OF PROCEEDS OF ASSETS UPON TERMINATION OF PARTNERSHIP
The partnership assets are realized and proceeds are applied in this order:
a. Paying off external debts
b. Repayment of loans to partners which they had made to the partnership firm
c. Repayment of capital contribution to partners
d. Any leftover proceeds are distributed amongst partners in accordance to their profit sharing ratio.
If the assets are insufficient to meet debts, partners’ advances and capital repayments, then the deficiency has to
be made good out of any profits held back from previous years, or out of partners’ capital or by the partners
individually in the proportion to which they were entitled to share in profits.
PARTNER’S LIABILITY
a.
New Partners: Partner is only liable for the debts of the partnership firm which are incurred after his date of
admission as a partner.
b. Retired partners: A retiring partner is only liable for debts which were incurred while he was a partner.
PARTNERSHIP CHARGE
Partnership cannot grant floating charge but it can grant fixed charge or mortgage.
Knowledge Test (ACCA Past Paper 2014)
Which of the following are ordinary partnerships UNABLE to create in relation to their property?
A Mortgages
B Fixed charges
C Floating charges
Solution:
C Floating charges
LIMITED LIABILITY PARTNERSHIP
Limited liability partnership (LLP) is a partnership in which some or all partners (depending on the jurisdiction)
have limited liability.
The main shortcoming with regard to the standard partnership is the lack of limited liability for its members. The
Limited Liability Partnerships Act 2000 provided for a new form of business entity, the limited liability partnership
(LLP).
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LLP’s are created under Limited Liability Partnership Act 2000. LLP’s are similar to limited companies in that they
have a separate legal identity and unlimited liability for debts but the liability of the individual partners is limited to
the amount of their capital contribution.
Although stated to be a partnership, the new form is a corporation, with a distinct legal existence apart from its
members. As such it has the ability:
 To hold property in its own right;
 To sue and be sued in its own name.
It has perpetual succession and consequently an alteration in its membership does not have any effect on its
existence. Most importantly, however, the new legal entity allows its members to benefit from limited liability as
they will not be liable for more than the amount they have agreed to contribute to its capital.
To form a limited liability partnership:
 Two or more persons must subscribe to an incorporation document;
 The incorporation document must be delivered to the companies registry;
 A statement of compliance must be completed by a solicitor or subscriber to the incorporation document.
The incorporation document must include:
 The name of the LLP (subject to restrictions);
 The address of the registered office;
 The names and addresses of those who will be members on incorporation of the LLP;
 The names of at least two designated members, whose duty it is to ensure that the administrative and filing
duties of the LLP are complied with. If no such members are designated, then all members will be assumed to
be designated members.
Knowledge Test (ACCA Past Papers 2014):
Which of the following exists as a separate legal entity from its members?
A An ordinary partnership
B A limited partnership
C A limited liability partnership
Solution:
C A limited liability partnership
DIFFERENCE BETWEEN LLP AND COMPANIES
The main difference between an LLP and companies is that the former have less statutory rules and they require
no board of directors. All contracts with the third parties will be with the LLP.
i)
Formation: LLP can be formed by anyone but it must be incorporated in order for it to come into
existence. LLP’s have an unlimited number of partners.
ii)
External Relationships: Where the member has authority, the LLP will be bound by the acts of the
member.
LLP will not be bound where: a member has no authority and ceased to be a member and third party is
aware of these facts.
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iii)
Chapter ‐08
Dissolution: LLP does not dissolve when the member leaves or dies. LLP must be wound up when the time
has come for it to be dissolved.
Knowledge Test:
What is the pivotal requirement stated in the Limited Liability Partnerships Act 2000 in order for the limited
liability partnership to be legitimately formed.
(1) The persons carrying on business with a view to profit must have subscribed their names to an incorporation
document.
(2) Name of the LLP must be stated on the incorporation document and it should end with the words “Limited
Liability Partnership” or the abbreviation “LLP”
a. 1 only
b. 2 only
c. Neither 1 nor 2
d. Both 1 and 2
Solution:
b. 2 only
LIMITED PARTNERSHIP: (FORMED UNDER PARTNERSHIP ACT 1907)
The Limited Partnerships Act (LPA) 1907 allows for the formation of limited partnerships. For members of a
partnership to gain the benefit of limited liability under this legislation, the following rules apply:
 Limited partners are not liable for partnership debts beyond the extent of their capital contribution, but in the
ordinary course of events they are not permitted to remove their capital;
 At least one of the partners must retain full, that is unlimited, liability for the debts of the partnership;
 A partner with limited liability is not permitted to take part in the management of the business enterprise and
cannot usually bind the partnership in any transaction. If a partner acts in contravention of this rule, they will
lose the right to limited liability;
 The partnership must be registered with the Companies Registry.
Very few limited partnerships were ever registered as partnerships could access the advantages available under
the LPA 1907, and more, by simply registering their business as a private limited company.
Knowledge Test:
Jack, John and Alisa form a partnership firm. Jack manages the firm and has the authority to enter into all the
contracts on behalf of the firm. Jack also has unlimited liability for debts of the firm. John & Alisa have each
contributed a sum of £50,000 and have their liability limited to the extent of their capital contribution. What kind
of partnership have they formed?
a. Traditional partnership under Partnership Act 1890
b. Limited Liability Partnership
c. Limited Partnership
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Solution:
c. Limited Partnership
Which one of them would be regarded as the general partner?
a. Jack
b. John
c. Alisa
Solution:
a. Jack
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Corporation & Legal Personality
Chapter ‐09
Chapter
09
Corporation & Legal Personality
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IN THIS CHAPTER
SOLE TRADER
THE CONCEPT OF COMPANY’S SEPARTE LEGAL PEROSNALITY
TYPES OF CORPORATIONS
TYPES OF COMPANIES
DIFFERENCE BETWEEN PUBLIC AND PRIVATE COMPANIES
SMALL COMPANIES
CONCEPT OF SEPARATE LEGAL PERSONALITY
VEIL OF INCORPORATION
LIFTING THE VEIL OF INCORPORATION
CONCEPT OF SEPARATE LEGAL PERSONALITY IN GROUP COMPANIES AND
LIFITNG THE VEIL IN GROUP SITUATIONS
COMPANY AND PARTNERSHIP DISITNCTION
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DEFINITION OF A SOLE TRADER
A sole proprietorship, also known as the sole trader or simply a proprietorship, is a type of business entity that is
owned and run by one individual and in which there is no legal distinction between the owner and the business.
Advantages of a Sole Trader
 It is easy to organize and needs only a small amount of capital.
 It permits a high degree of flexibility for the owner since he/she is the boss of the business establishment.
 Due to its unlimited liability, some creditors are more willing to extend credit.
 The owner gets all the profit of the business.
Disadvantages of a Sole Trader:
 Has limited resources. Banks are reluctant to grant loans to single proprietorship considering its small assets
and high mortality rate.
 Unlimited liability for business debts. The single owner is responsible for paying all debts and damages of his
business.
 If the firm fails, creditors may force the sale of the proprietor's personal property as well as his business
property to satisfy their claim.
THE CONCEPT OF COMPANY’S SEPARATE LEGAL PERSONALITY




Definition; Company is an entity formed and registered under the Company’s Act 2006.
Legal personality (also artificial personality, juridical personality, and juristic personality) is the characteristic of
a non‐living entity regarded by law to have the status of personhood.
A legal person (Latin: persona ficta) (also artificial person, juridical person, juristic person, and body corporate)
has a legal name and has rights, protections, privileges, responsibilities, and liabilities under law, just as
natural persons (humans) do. The concept of a legal person is a fundamental legal fiction.
Liability of the members to contribute to the debts of the entity is significantly limited.
Example: A,B & C have incorporated a company under the Companies Act 2006 under the name of Zee Ltd.
Companies House have issued a certificate of incorporation of Zee Ltd. Once certificate of incorporation has been
issued this is evidence of the fact that Zee Ltd is a separate Legal entity an artificial person. A, B& C will merely be
its shareholders or directors and all the business and activities will be carried on in the name of Zee Ltd. Zee Ltd
will be liable for its own loss and will be able to own property.
Limited Liability of Members:
 Company is distinct from its members and its members have limited liability.
 It is a protection offered to members of certain types of company.
Security of Members Against Creditors
 Limited liability prevents the creditors from demanding the company’s debts from members of the company.
Security from Business Failure
 Limited liability only becomes an issue in the event of a business failure when the company is unable to pay its
own debts. Result is winding up which enables the creditors to be paid from the proceeds of any assets
remaining in the company.
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TYPES OF CORPORATIONS
I.
II.
III.
IV.
V.
Corporation Sole:
Public office (created usually by an act of parliament) or ecclesiastical office (usually the owner of church
land) that has a separate and continuing legal existence, and only one member (the sole officeholder).
Chartered Corporations:
These are charities or bodies formed by the Royal Charter.
Statutory Corporations:
The statutory companies are also known as statutory corporations or public corporations, these are
actually public bodies established and operated by Statute.
Registered Companies:
Companies formed under the Companies Act 2006.
Community Interest Companies:
These are formed by social enterprises for the benefit of the community. These are established by the
Companies (Audit, Investigations and Community Enterprise) Act 2004 and regulated by The Community
Interest Company Regulations 2005.
TYPES OF COMPANIES
I.
Company Limited by Shares
"Limited by shares" means that the company has shareholders, and that the liability of the shareholders
to creditors of the company is limited to the capital originally invested, i.e. the nominal value of the
shares and any premium paid in return for the issue of the shares by the company.
A shareholder's personal assets are thereby protected in the event of the company's insolvency, but
money invested in the company will be lost.
II.
Company Limited by Guarantee
A company limited by guarantee does not usually have a share capital or shareholders, but instead has
members who act as guarantors. The guarantors give an undertaking to contribute a nominal amount
(typically very small) in the event of the winding up of the company.
III.
Unlimited Liability Companies:
The liquidator can require members to contribute as much as may be required to pay the company’s
debts in full.
Knowledge Test:
A Ltd was incorporated under the Companies Act 2006 in the year 2008 as a company limited by shares. It has
three directors namely directors Zara, Zaha and Tata. The company’s financial position is deteriorating and is
not able to pay its debts. If creditors claim their debts then which one of the following is correct?
a. A Ltd is fully liable for all its debts
b. Shareholders will be liable for the debts of A Ltd
c. Directors will be liable for the debts of the A Ltd
Solution:
a. A Ltd is fully liable for all its debts
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Private and Public Companies:
 A public company is a company whose constitution states that it is public and that it has complied with the
registration procedures for such a company.
 A private company is a company which may not offer its securities to public.
Requirements for a Public Company:
 A public company must hold a Registrar’s trading certificate and must have a minimum capital of £50,000.
 Private company which is converted into a public company will not be permitted to trade until it has an
allotted minimum share capital of £50,000 out of which only a quarter of its nominal i.e. £12,500 has to be
paid and whole of its premium.
 A public company must always have share capital and therefore one cannot be created without share capital.
Companies limited by guarantee do not have share capital and therefore a public company cannot be limited
by guarantee
Minimum membership and Directors:
Public company must have a minimum of one member and same is the case with private company. However
minimum of two directors are required for public company and one for private company.
DIFFERENCES BETWEEN PUBLIC AND PRIVATE COMPANIES
i)
Capital:
a) Minimum of £50,000 capital for public company and no minimum for private.
b) Public company may offer shares to public but private is prohibited to do so.
c) Public and Private Companies must generally first offer its existing members any ordinary shares it
issues for cash. This is also known as pre‐emption right. Private company may permanently disapply
this rule.
ii)
Dealing in Shares
Public company can obtain listing for its shares on the stock exchange.
iii)
Accounts:
a) Pubic company has six months to produce its statutory audited accounts and private company has
nine months.
b) Listed public company must publish its full accounts and reports on website.
c) Public companies must lay their accounts before the general meeting annually but no such
requirement for private company.
iv)
Commencement of business: Public Company can only commence business once it has obtained the
trading certificate from the registrar, however private company can commence business as soon as it is
incorporated.
v)
Annual General meetings:
d) Private companies are not required to hold annual general meetings but public companies must hold
one within six months from its financial year end.
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vi)
Chapter ‐09
Names and Identification
e) Words limited or Ltd must appear. Company should be identified as public or private company.
Knowledge Test (ACCA Past Paper 2014)
Which TWO of the following apply to shares of companies whose names end in ‘Ltd’?
(1) They may not be issued to non‐members
(2) They may not be offered to the public
(3) They may not be transferred
(4) They may not be traded on the stock exchange
A (1) and (2)
B (2) and (3)
C (1) and (4)
D (2) and (4)
Solution:
D (2) and (4)
Additional Classifications:
i) Parent (Holding) and subsidiary companies:
A company will be a parent company of its subsidiary if:
i)
It holds majority voting rights
ii)
It has majority in the subsidiary and can exercise dominant control over the subsidiary
A parent and its subsidiary are separate legal entities with separate legal personalities. Even if the subsidiary is
wholly owned (100% holding), parent is not liable to make payments on its behalf.
Knowledge Test:
How much time does private and public limited company have to file its accounts after the end of its financial
year?
a. 8 months for private limited and 12 months for public limited company
b. 6 months for public 9 months for private
c. 11 months public and 6 months private
Solution:
b. 6 months for public 9 months for private
What are Quoted Companies:
 Quoted companies are referred to as listed companies.
Knowledge Test:
Which of the following is incorrect?
a. A company incorporated under the companies act 2006 is a legal person
b. It is mandatory that every public company must be quoted on stock exchange
c. Public limited company must have a minimum capital of £50,000
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Solution:
b. It is mandatory that every public company must be quoted on stock exchange
SMALL COMPANIES
A company is small if:
a) Statement of financial position is not more than £3.26 million
b) Turn over less than £6.5 million
c) 50 employees or less.
A company must fulfill the first two conditions to be classified as small.
CONCEPT OF SEPARATE LEGAL PERSONALITY
Salmon v Salmon
The Claimant S had carried on his business. He decided to form a limited company to purchase the business so he
and six other members of his family each subscribed for shares of the company. The limited company then
purchased Claimant’s business for £38,782 . The Claimant was paid £8,782 in cash by the company. Further, 20,000
shares of £1 each were issued to him and debentures of £10,000 were also issued. The company did not prosper
and its liabilities exceeded its assets. The liquidator stated that company was incorporated by the claimant and he
himself should bear the liabilities of the company and payments of debentures to him should be postponed until
the company’s creditors are paid.
House of Lords held that the business was owned by and its debts were liabilities of the company. The claimant
was under no liability to the company or its creditors, his debentures were validly issued and the security created
by them over the company’s assets was effective. This was because company was a legal entity separate and
distinct from S.
VEIL OF INCORPORATION AND ITS PURPOSE
As a result of the Salmon’s case, a veil of incorporation is said to be drawn between the members and the
company separating them for the purposes of liability and identification.
Knowledge Test
Select the correct option below keeping in view the concept of separate corporate personality?
(1) The company once incorporated will be liable to pay its debts
(2) A shareholder of a company limited by shares has a liability limited to the extent of his shareholding
(3) If a fraud is committed with the company and the company has suffered a loss then the general rule will be
that the only the company is entitled to sue
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. All of the above
Solution:
d. All of the above
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Instances where Separate Personality can be Ignored
Separate legal personality can be ignored to:
i)
Identify the company with its members and/or directors
ii)
Treat a group of companies as a single commercial entity
The main instances for lifting veil are to enforce law, prevent evasion of obligations. When a company is
established as a sham to evade liabilities, separate personality can be ignored to prevent evasion of liabilities.
LIFTING OF VEIL BY STATUE TO ENFORCE LAW
i)
ii)
Failure to obtain a trading certificate from the Registrar leads to personal liability.
Fraudulent and wrongful trading
Fraudulent Trading is committed when affairs of the company are carried out with the intent to defraud the
creditors. It is a criminal offence under sec 993 of the companies act 2006 and any person guilty of it is liable for a
fine or imprisonment upto 10 years. It is also a civil offence under the Insolvency Act 1986.
Under UK insolvency law, wrongful trading occurs when the directors of a company have continued to trade a
company past the point when they:
a. "knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation";
and
b. they did not take "every step with a view to minimising the potential loss to the company’s creditors".
Wrongful trading is an action that can be taken only by a company's liquidator, once it has gone into insolvent
liquidation. (This may be either a voluntary liquidation ‐ known as Creditors Voluntary Liquidation, or compulsory
liquidation). It is not available to the directors of a company while it continues in existence, or to other insolvency
office‐holders such as an administrator. Court may order such directors to make a contribution to the company’s
assets as per sec 214 of the Insolvency Act 1986.
Consequence of Piercing the Corporate Veil
If a court pierces a company's corporate veil, the owners, shareholders, or members of a corporation or LLC can be
held personally liable for corporate debts. This means creditors can go after the owners' home, bank account,
investments, and other assets to satisfy the corporate debt. But courts will impose personal liability only on those
individuals who are responsible for the corporation or LLC's wrongful or fraudulent actions; they won't hold
innocent parties personally liable for company debts.
Liability of Disqualified Directors
Directors who are disqualified under the Directors disqualification Act 1986 and still participate in the affairs of the
company’s management will be jointly liable along with the company for the company’s debts.
How can Directors be held liable for abusing the Company Names:
It is a criminal offence under the Insolvency Act sec 217 and directors are held personally liable where; they are a
director of a company that goes into solvent liquidation and they become involved with the directing, managing or
promoting of a business which has an identical name to the original company or a name similar enough to suggest
a connection.
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Ignorance of the Veil of incorporation in case of evasion of Obligations
Gilford Motor Co v Horne
EB Horne was formerly a managing director of the Gilford Motor Co Ltd. His employment contract stipulated
(clause 9) not to solicit customers of the company if he were to leave employment of Gilford Motor Co. Mr. Horne
was fired, thereafter he set up his own business and undercut Gilford Motor Co's prices. He received legal advice
saying that he was probably acting in breach of contract. So he set up a company, JM Horne & Co Ltd, in which his
wife and a friend called Mr. Howard were the sole shareholders and directors. They took over Horne’s business
and continued it. Mr. Horne sent out fliers saying,
“
Spares and service for all models of Gilford vehicles. 170 Hornsey Lane, Highgate, N. 6. Opposite Crouch
End Lane... No connection with any other firm.
”
The company had no such agreement with Gilford Motor about not competing, however Gilford Motor brought an
action alleging that the company was used as an instrument of fraud to conceal Mr. Horne's illegitimate actions.
Held. An injunction was granted in favour of the claimant and against the Defendant and the sham company he
had formed. The Defendant was directed to comply with the obligations contained in the contract with the
claimant.
Avoidance of Tax:
Unit Construction ltd v Bullock
The UK parent company owned subsidiaries incorporated in Kenya and carried on trading activities there. The
managing director of the parent company concluded that 'the situation of the Kenya subsidiaries was becoming so
serious that it was unwise to allow them to be managed in Kenya any longer, and that their management must be
taken over by the directors of [the parent company] in London.'
Held the companies were resident in the UK and liable to UK tax. The Kenyan connection was a sham, the question
being not where they ought to have been managed but where they were actually managed.
Pubic Interest:
If in times of war with the enemy, the court may lift the veil of incorporation to determine if the company is being
controlled by aliens.
Quasi Partnership:
Many small companies are regarded by the law as 'quasi‐partnerships' ‐ in other words, they are, in effect, small
partnerships of a limited number of individuals which, although operating as a limited company, are in practical
terms run as if they were a partnership between those individuals at the helm.
CONCEPT OF SEPARATE LEGAL PERSONALITY IN GROUP COMPANIES AND LIFTING THE VEIL IN
GROUP SITUATIONS
Companies even in groups retain their status of separate legal personalities. In the case of Adams v Cape
Industries Plc three situations were stated under which the courts would consider the group as one and then lift
the veil of incorporation. The three reasons are:
I)
The subsidiary is acting as the agent of the holding company
II)
The group is to be treated as a single economic entity
III)
The corporate structure is sham or façade.
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Knowledge Test
Which of the following statements about a company limited by shares is correct?
(1) The Directors have the main responsibility of managing the company and the shareholders are the owners of
the company
(2) Company being a separate legal entity and an artificial person is entitled to own property in its own name.
(3) The shareholders can never be personally liable for the debts of the company even if the veil of incorporation
is lifted
a.
b.
c.
d.
1 and 2
1 and 3
2 and 3
All three statements
Solution:
a. 1 and 2
COMPANY AND PARTNERSHIP DISTINCTION
Some of the major distinction between partnership and a company are as follows:
1. Regulating Act: A company is regulated by Companies Act, 2006, while a partnership firm is governed by the
Partnership Act, 1890.
2. Registration: A company cannot come into existence unless it is registered, whereas for a partnership firm
registration is not compulsory.
3. Liability: In case of company the liability of shareholders is limited (except in case of unlimited companies) to
the extent of face value of shares or to the extent of guarantee, whereas, in case of partnership the liability of
partners is unlimited.
4. Management: The affairs of a company are managed by its directors. Its members have no right to take part in
the day to day management. On the other hand every partner of a firm has a right to participate in the
management of the business unless the partnership deed provides otherwise.
5. Capital: The share capital of a company can be increased or decreased only in accordance with the provisions
of the Companies Act, whereas partners can alter the amount of their capital by mutual agreement.
6. Legal Status: A company has a separate legal status distinct from its shareholders, while a partnership firm has
no legal existence distinct from its partners.
7. Transfer of Interest: Shares in a public company are freely transferable from one person to another person. In
private company the right to transfer shares is restricted, while a partner cannot transfer his interest to others
without the consent of other partners.
8. Insolvency/Death: Insolvency or death of a shareholder does not affect the existence of a company. On the
other hand a partnership ceases to exist if any partner retires, dies or is declared insolvent.
9. Winding up: A company comes to an end only when it is wound up according to the provisions of the
Companies Act. A firm is dissolved by an agreement or by the order of court. It is also automatically dissolved
on the insolvency of a partner.
10. Accounts: The provisions of Companies Act, 2006 have their bearing on the preparation of accounts books of a
company but in case of firm there is no specific legal direction to this effect.
11. Audit: Audit of accounts of a company is compulsory whereas it is generally, discretionary in case of a
partnership firm.
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12. Authority of Members: A shareholder is not an agent of a company and has no power to bind the company by
his acts. A partner is an agent of a firm. He can enter into contracts with outsiders and incur liabilities so long
as he acts in the ordinary course of firm’s business.
13. Commencement of Business: A company has to comply with various legal formalities and has to file various
documents with the Registrar of Companies before the commencement of business while a firm is not
required to fulfill legal formalities.
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Company Formation
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Chapter
10
Company Formation
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IN THIS CHAPTER
PROMOTER
DUTIES AND RESPOSIBILITIES OF THE PROMOTER
CLAIM OF PRE‐INCORPORATION EXPENSES
LIABILITY OF PROMOTER
PROCESS OF REGISTRATION OF A COMPANY
ESSENTIAL DOCUMENTS FOR REGISTRAITON OF A COMPANY
OFF THE SHELF COMPANY
PROCESS OF RE‐REGISTRATION OF A COMPANY FROM PRIVATE TO PUBLIC
& VICE VERSA
REQUIREMENT FOR COMMENCEMENTOF BUSINESS FOR PUBLIC & PRIVATE
COMPANIES
STATUTORY RECORDS
STATUTORY BOOKS
REGISTER OF MEMBERS
SIGNIFICANCE OF THE REGISTER OF CHARGES
REGISTER OF PEOPLE WITH SIGNIFICANT CONTROL
RECORDS OF DIRECTORS SERVICE CONTRACTS
ACCOUTING RECORDS
ANNUAL ACCOUNTS
THE CONFIRMATION STATEMENT
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DEFINITION OF A PROMOTER
Person who forms a company is called a promoter. It includes anyone who makes business preparations for the
company.
Promoter also presents an idea for starting a business at a given place and he can be assigned a task of performing
various formalities required for starting a company. Promoter can be a natural person or a firm.
DUTIES AND RESPONSIBILITIES OF PROMOTERS IN LAW
Promoters have the following duties:
i)
Duty to exercise reasonable care and skill
ii)
He must account for the benefits obtained.
iii)
Must not place themselves in a conflict of interest position
iv)
Disclosure of benefits and transactions and accounts.
Promoter may make a profit as a result of their position.
a) Legitimate profit is when before promoting a company they sell the property to the promoted company,
provided they disclose it.
b) Wrongful profit is when the promoter enters into and makes a profit personally in a contract as a promoter.
Promoters are in breach of their fiduciary duty if they make wrongful profit.
Knowledge Test
Alex as a promoter incorporated a company Kash Ltd. The directors of Kash Ltd have recently discovered that Alex
made secret profit while setting up the business for Kash Ltd. Select the correct option which the directors of Kash
Ltd can exercise against Alex.
a. Directors cannot file a suit as it is a past transaction
b. As Alex has made secret and illegitimate profit the directors can recover the money
c. The secret profit was made by Alex and he is entitled to it
Solution
b. As Alex has made secret and illegitimate profit the directors can recover the money
CLAIM OF PRE‐INCORPORATION EXPENSES
The expenses in preparations such as drafting and legal documents cannot be obtained as an automatic right but
they may agree with company that it shall reimburse them.
 Pre‐incorporation contract cannot be ratified by the company as a company cannot ratify a contract made on
its behalf before it was incorporated.
LIABILITY OF PROMOTERS FOR PRE‐INCORPORATION CONTRACTS
Promoter as an agent is liable for the pre‐incorporation contracts made on behalf of the company.
Methods of avoidance of the liability as a Promoter for pre‐incorporation Contracts
Various ways for promoters to avoid liability for a pre‐incorporation contract are:
a) If contract remains a draft until the company is formed.
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b) If the company after its incorporation enters a new contract on identical terms. This is known as novation.
Novation is the act of either replacing an obligation to perform the new obligation or replacing a party to an
agreement with a new party.
c) Promoter buys off the shelf company.
Knowledge Test
Zara has been tasked by Ali, Ahmed and Asif who are also the potential directors to form a company and setup the
business. Zara started preparing the company documents and formalities and in the meanwhile also entered into
two contracts. The company was incorporated on 20th January 2018 with the name of Zash Ltd. The details of
contracts are as follows:
a. Zara entered into contract to buy furniture for the company from Fitwell Furniture but the directors think that
it is an over‐priced deal therefore they do not wish to honor it
b. Zara on 30th January entered in an agreement in the name of Zash Ltd with the landlord to lease out a
property
Which of the above stated contracts entered upon by Zara will bound the Company?
Solution:
a. Contract A: Company is not bound by the agreement as it was entered before its incorporation and therefore
it was not party to the contract. Therefore the Fitwell Furniture can have a claim against Zara
b. Contract B: Company will be bound by the contract as it was entered into in its name and therefore it would
be bound to honor it.
PROCESS OF THE REGISTRATION OF COMPANY
Company is formed and registered when it is issued with the certificate of incorporation and when persons
subscribe to the memorandum of association and comply with the requirements regarding registration.
ESSENTIAL DOCUMENTS FOR REGISTRATION OF COMPANY
Documents to be delivered for registration of company are memorandum of association, articles of association,
statement of proposed officers, statement of capital and initial shareholdings. Once the documents are submitted
a registration fee is payable for company registration.
Knowledge Test (ACCA Past Papers 2014)
Which of the following must a private company ALWAYS have?
A
Shares
B
Limited liability
C
A company secretary
D
A registration certificate
Solution:
D A registration certificate
Knowledge Test
Peter and Carl want to register for a private limited company but they are not aware of the documentation
required to form the company. Please advise Peter and Carl.
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Solution:
Peter and Carl need to file the following documents in order to form a company:
a. memorandum of association
b. articles of association
c. statement of proposed officers
d. statement of capital
e. Initial shareholding
f. Statement of Compliance
g. Registration Fee
OFF THE SHELF COMPANY
It is a company which was created and left with no activity ‐ metaphorically put on the "shelf" to "age". The
company can then be sold to a person or group of persons who wish to start a company without going through all
the procedures of creating a new one.
Advantages for the purchase of off the shelf company
The following documents need not be filed with the Registrar by the purchase:
i)
Memorandum and articles
ii)
Application for registration
iii)
Statement of proposed officers
iv)
Statement of compliance
v)
Statement of capital and initial shareholdings
vi)
Fee
Disadvantages:
i)
Directors may have to amend the model articles
ii)
They may want to change the name of the company
iii)
The subscriber shares will need to be transferred and the transfer recorded in the register of members.
Stamp duty will be payable
PROCESS OF RE‐REGISTRATION OF A COMPANY FROM PRIVATE TO PUBLIC AND VICE VERSA
A private company may be able to re‐register as public company if its allotted share capital requirement of 50,000
pounds is met. Quarter of it must be paid plus the whole of any premium.
I)
Special resolution is required of 75 percent to alter the constitution and a general meeting.
II)
Additional documents are required for re‐registration purposes.
III)
If the share capital of a public company falls below 50,000 pounds then it must re‐register as a private
company.
Knowledge Test
The directors of Delta Ltd have decided to re‐register as a public limited company. Please advise the directors of
Delta Ltd the future course they should adopt in light of the Companies Act 2006.
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Solution
As the Directors of Delta Ltd want to re‐register their company as a public limited company they would have to
convene a general meeting of the company and propose a special resolution for the company to re‐register as a
public limited company. The articles of the company would be altered.
REQUIREMENTS FOR COMMENCEMENT OF BUSINESS FOR PUBLIC AND PRIVATE COMPANIES


Public companies must obtain a registrar’s trading certificate before commencement of business.
Private companies can commence business immediately after obtaining certificate of incorporation.
STATUTORY RECORDS


Company is identified by its name and serial number which is always mentioned on every document sent to
Companies House for filing.
On incorporation of company its files include its certificate of incorporation and the original documents
presented to secure its incorporation.
STATUTORY BOOKS
Some documents including the constitution, register of members, charges and directors must be kept at its
registered office or at single alternative inspection location.
REGISTER OF MEMBERS
Record of all the members must be maintained by a company in a register. The record must state the name and
address of the member. Furthermore, it should also state the number of shares held by the member and the class
of those shares.
Any member of the company has a right to inspect the register free of charge.
SIGNIFICANCE OF THE REGISTER OF CHARGES
Under the UK corporate legislation, the register that records all charges (judgments, liens, mortgages) on an
incorporated or registered firm's assets, and which must be kept at the registered office of the firm.
It must contain:
i)
Details of fixed or floating charges
ii)
Description of property charged
iii)
Amount of charge
iv)
Name of person entitled to charge
Records of People with Significant Control (PSC)
 People with significant control are those who hold over 25% of shares or voting rights or exercise control over
the company.
 It is mandatory upon both public and private company to maintain a register of people with significant control.
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What is a Corporate Director?
A corporate director is not a natural or real person, instead it is a company. Note that all companies must have at
least one natural director (i.e. a real person) to ensure that the company has an individual that can be held
responsible and accountable for the actions of the company.
Where a company is a director, the register of directors must contain:
i)
The corporate or firm name
ii)
Its registered or principal office
RECORDS OF DIRECTORS SERVICES CONTRACTS
The company should keep copies or written memoranda of all service contracts for its directors, including
contracts for services which are not performed in the capacity of director. Members are entitled to view these
copies for free or request a copy on payment of a set fee.
The director's service contract is to be used for executive directors ‐ i.e. company directors who are also
employees of the company. The template has a dual purpose: it sets out the basis for the director's employment
by the company, and regulates his role as a director.
Examples of common executive director posts, in respect of which this director service contract template may be
suitable for use, include finance directors, operations directors and managing directors.
ACCOUNTING RECORDS

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
Company is required to keep accounting records sufficient to show and explain the company’s transactions. At
any time the company should be able to disclose its financial position for the past six months and directors
should ensure that any accounts required to be prepared comply with the Act.
Accounting records to be kept for 3 years in case of private company and six years in case of public company.
Accounting records should be kept at company’s registered office.
ANNUAL ACCOUNTS
Public companies must file their annual accounts within six months of their financial year end and the period for
private companies is nine months.
THE CONFIRMATION STATEMENT


Confirmation statements are prepared to inform the registrar of changes, if any, in the company within the
previous 12 months. The changes can be in the address of registered office of company, particulars of
members, class of shares, rights of shares etc.
It is mandatory for every company to send a confirmation statement every 12 months to the registrar.
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Constitution of a Company
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Chapter
11
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IN THIS CHAPTER
MEMORANDUM OF ASSOCIAITON
COMPANY’S CONSTITUTIONAL DOCUMENTS AND MODEL ARTICLES
ARTICLES OF ASSOCAITON
MODEL ARTICLES
AMENDEMENTS OF ARTICLES
UNALTERABLE COMPANY’S CONSTITUTION
LIMITATION ON ALTERATION OF ARTICLES
EXPULSION CASES
FILING OF ALTERATION
RELATIONSHIP BETWEEN STATUTE AND ARTICLES
SIGNIFICANCE OF THE COMPANIES OBJECTS, CAPACITY AND ULTRA VIRES
THE CONSTITUTION AS A CONTRACT
COMPANY NAME
PROCEDURE TO CHANGE THE COMPANY NAME
CONCEPT OF PASSING OFF ACTION
ROLE OF COMPANY’S NAME ADJUDICATOR
COMPANY’S REGISTERED OFFICE
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MEMORANDUM OF ASSOCIATION
It is a simple document which states that the subscribers wish to form a company and become members of it.
After the Company’s Act 2006 the essence of the memorandum has been retained and it mainly includes that the
subscribers:
i)
Wish to form a company
ii)
Agree to become members of the company and to take at least one share each if the company is to have
share capital.
 Memorandum must be signed by each subscriber.
COMPANY’S CONSTITUTIONAL DOCUMENTS AND MODEL ARTICLES
The Constitution of the Company mainly consists of the following:
i)
The Articles of Association
ii)
Resolutions and Agreements that it makes that affect the constitution.
ARTICLES OF ASSOCIATION
The Articles of Association is a document that contains the purpose of the company as well as the duties and
responsibilities of its members defined and recorded clearly. It is an important document which needs to be filed
with the Registrar of companies.
The articles of association are the main element of a company’s constitution and, in effect, they are the rules
which govern a company’s internal affairs. Companies are free to make such rules about their internal affairs as
they think appropriate, subject to the proviso that any such rules must not contain anything that is either contrary
to:
a. The general law, or
b. The specific provisions of the Companies Act 2006.
MODEL ARTICLES
Section 19 gives the Secretary of State the power to prescribe ‘default’ model articles for the different types of
company. Such model articles apply to companies where they have not registered any articles of their own, or
have not specifically excluded the operation of the model article in question. The articles of association for private
and public companies are different in content, in recognition of the essential distinction between the ways in
which the two business forms operate
AMENDMENTS OF ARTICLES
The amendment in the articles can only be allowed if it is for the benefit of the company as a whole.
The articles may be amended by a special resolution i.e. 75 percent. Copies of the amended articles must be sent
to the Registrar within 15 days of the amendment taking effect.
UNALTERABLE COMPANY’S CONSTITUTION
Articles of association cannot be altered where the alteration would be contrary to specific provisions of the
company’s legislation or general law.
In addition,
Following are the methods through which the provisions of the company’s constitution can be made unalterable:
a) The articles may give a member additional votes so that he can block a resolution to alter articles.
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Bushell v Faith: Three members each had 100 shares. Article 9 of the company constitution said that under a
resolution to remove a director, that directors’ shares would carry three votes each. When the two sisters
tried to remove him, Mr. Faith recorded 300 votes and the other two, 200 votes together. The House of Lords
held that the provision was valid.
b) Articles may provide that when meeting is held the quorum present must include the member concerned.
They can then deny the meeting quorum by absenting themselves.
c) Section.22 CA 2006 permits companies to ‘entrench’ provisions in their articles. This means specific provisions
may only be amended or removed if certain conditions are met which are more restrictive than a special
resolution. For example, any such entrenched right may require the agreement of all the members before it
can be altered or removed. However, such rights must not be written so that the articles can never be
amended.
LIMITATIONS ON ALTERATION OF ARTICLES
Alteration of articles is restricted by the following principles
A) If alteration conflicts with Companies Act
B) To protect a minority under section 994, court may order alteration or restrict it.
C) Existing member may not be compelled by alteration to buying more shares unless consents
D) Alteration on the rights of class of shares can only be made only if correct variation procedure has been
adopted. However, a 15 percent minority may apply to court to cancel the variation.
E) A person whose contract is contained in the articles cannot obtain an injunction to prevent the articles being
altered but may be entitled to damages. Southern Foundries v Shirlaw
Mr Shirlaw sued the company for breach of contract, claiming for an injunction to stay in office or substantial
damages. High Court awarded £12,000 to Mr Shirlaw for breach of contract
F)
An alteration may be void if not done in bone fide
Any alteration has to be made ‘bona fide in the interest of the company as a whole’. This test involves a
subjective element in that those deciding the alteration must actually believe they are acting in the interest of
the company. There is additionally, however, an objective element requiring that any alteration has to be in
the interest of the ‘individual hypothetical member’ (Greenhalgh v Arderne Cinemas Ltd (1951). Whether any
alteration meets this requirement depends on the facts of the particular case.
Knowledge Test;
A Ltd has made the following alterations to its articles of association:
a. Mr. Brown will compulsorily acquire 10 more shares
b. A clause has been altered which is in conflict with the Companies Act 2006
State which of the above mentioned alteration is valid.
Solution:
Both the alterations are invalid. As no member can be compelled to buy more shares. Alteration cannot be against
the law i.e. Companies Act 2006.
Expulsion Cases:
Expulsion cases are concerned with;
a) Alteration of articles for the purpose of removing a director from office
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b) Alteration of the articles to permit a majority of members to enforce a transfer to themselves of a
shareholding of a minority
The action to achieve expulsion will be treated as valid even if discriminatory if it is beneficial for the
company. However, if the majority blatantly seeks to secure an advantage to themselves by their
discrimination, the alteration made to the articles by their voting control of the company will be invalid.

Shuttleworth v Cox Bros & Co Held: Expulsion of director who had failed to account for the funds was held to
be valid.

Sidebottom v Kershaw, Leese & Co The Company's articles were changed to allow for the compulsory
purchase of shares of any shareholder who was competing with the company. One shareholder was
competing with the company and challenged the alteration. Held: The Court of Appeal held that the article
alteration was clearly valid and very much for the benefit of the company. The important question was
whether the alteration for the benefit of the company as a whole.

Brown v British Abrasive Wheel Co The Company needed to raise further capital. The 98% majority were
willing to provide this capital if they could buy up the 2% minority. Having failed to effect this buying
agreement, the 98% proposed to change the articles of association to give them the power to purchase the
shares of the minority. The proposed article provided for the compulsory purchase of the minority’s shares on
certain terms. However, the majority were prepared to insert a provision regarding price which stated that the
minority would get a price which the court thought was fair. Held; That the alteration was invalid since it was
merely for the benefit of the majority.
Knowledge Test:
The articles of the company were altered to give the directors following powers:
a. To purchase shares of any shareholder who competed the business of the company
b. To compulsorily purchase shares of a dissenting minority
c. To expel minority whenever the majority shareholders desire.
Which of the above alteration is valid?
Solution:
To purchase shares of any shareholder who competed the business of the company
FILING OF ALTERATION
If any alteration is made to the articles, the copy of altered articles must be delivered to the Registrar within 15
days together with the signed copy of the special resolution making the alteration.
RELATIONSHIP BETWEEN STATUTE AND ARTICLES
a)
Companies act will permit the company to take an action if its articles authorize. However, if the authorization
to do a specific act is not contained in the articles then the company would first be required to alter the
articles and then carry out the specific act.
b) The Companies Act will over ride the articles if a prohibition to do something is contained in the Companies
Act. Furthermore, if a specified procedure to do a certain act is stated in the Companies Act then the company
101 | P a g e
Constitution of a Company
Chapter ‐11
would have to follow that specified procedure. For example if something is permitted by the Act only by a
special resolution.
SIGNIFICANCE OF THE COMPANIES OBJECTS, CAPACITY AND ULTRA VIRES

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Objects: Under 2006 Act company’s objects are completely unrestricted unless where company itself wishes
to restrict it under sec 31.
Alteration of Objects: Objects can be altered by special resolution under section 21.
Capacity and ultra vires
If directors permit an act which is restricted by the company’s objects then the act is ultra vires.
Ashbury Railway Carriage & Iron co ltd v Riche Held: Constructing a railway was not within the company’s objects
so the company did not have the capacity to enter into the contract.
Following is the recent approach taken by the Companies Act 2006 regarding a Company’s capacity.
Section 39: A company’s capacity
This section provides that the validity of a company’s acts is not to be questioned on the ground of lack of capacity
because of anything in a company’s constitution. It replaces the present section 35(1) and (4) of the 1985 Act,
which made similar provision for restrictions of capacity contained in the memorandum.
Section 40: Power of directors to bind the company
This section provides safeguards for a person dealing with a company in good faith and restates section 35A and
35B of the 1985 Act. The power of the directors to bind the company, or authorize others to do so, is deemed not
to be constrained by the company’s constitution. This means that a third party dealing with a company in good
faith need not concern itself about whether a company is acting within its constitution.
Dealings with Directors
Section 41: Constitutional limitations: transactions involving directors or their associates
This section restates section 322A of the 1985 Act. It applies to a transaction if, or to the extent that, its validity
depends on section 40 and provides that where the party to a transaction with a company is an “insider” (for
example, a director of the company or person connected to such a director – see subsection (2)(b)(i) and (ii)), then
the protection afforded by that section will not apply. Instead, the transaction will be voidable at the instance of
the company.
Whether or not the contract is avoided, the party and any authorizing director is liable to repay any profit they
made or make good any losses that result from such a contract.
THE CONSTITUTION AS A CONTRACT
A company’s constitution binds
i)
Member to company
ii)
Company to Members
iii)
Members to Members
 But not to third parties.
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Constitution of a Company
Chapter ‐11
Constitution as a Contract between Members
Under s.33 CA 2006, articles of association constitute a contract between the members and the company, and vice
versa, as well as a contract between the members. An essential point to bear in mind, however, is that the contract
between members and the company only applies to membership rights and the articles cannot form a contract
between the company and either a non‐member, or a member acting in some other capacity than that of a
member (Eley v Positive Government Security Life Assurance Co (1876))
Knowledge Test:
The articles of association of Zee ltd would form a contract between which of the following:
a. Shareholders and the third parties
b. Zee ltd and Shareholders
c. Zee ltd and third parties
Solution:
Zee ltd and Shareholders
COMPANY NAME
Name of the Company must comply with the following rules:
a) It should end with the words Plc or ltd
b) Company must not have a name similar to any other company
c) No company must have a name which is offensive, sensitive or depicts a criminal offence
d) Approval is required if the name of the company is similar to that of the government department.
PROCEDURE TO CHANGE THE NAME OF A COMPANY
A company can change its name by:
i)
Passing a resolution
ii)
By any other means provided in the articles
Special resolution or any other procedure is to be notified to the Registrar.
Knowledge Test:
Sazz Ltd wishes to change its name to Daer Ltd.
What kind of resolution should be passed to alter the name Sazz?
a. Ordinary resolution
b. Special resolution
c. Ordinary resolution with special notice
Solution:
b. Special resolution
CONCEPT OF PASSING OFF ACTION
A company can be prevented by an injunction issued by the court in a passing‐off action from using its registered
name.
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Constitution of a Company
Chapter ‐11
Ewing v Butter Cup Margarine: Claimant traded as The Butter Cup Dairy Co and the Defendant as Buttercup
Margarine Co ltd. It was held that an injunction would be granted to restrain the defendants from the use of its
name since the Claimant had an established connection under the Buttercup name.
If the nature of business of two companies is different, confusion is not likely to occur. Injunction will not be
granted in this case. (Dunlop Pnemumatic Tyre Co ltd v Dunlop Motor Co Ltd)
ROLE OF THE COMPANY NAMES ADJUDICATOR
Adjudicator can review a case if the name of a company is similar to that of the existing and must decide within 90
days. He can also determine the new name.
Knowledge Test:
Alan is a sole director of his company namely Daewoo Transporters Ltd. He has recently discovered that Smith
without any authorization has been using his company’s name on his transport business.
Advise Alan what remedies he has against Smith.
Solution:
Alan can file a case of passing off and obtain injunction against Smith thereby restraining him from using
his registered name Daewoo Transporters Ltd.
COMPANY REGISTERED OFFICE


It is mandatory for the company to have its registered office.
Company can if it so desires change its registered office address but a person dealing with the company can
present documents at the previous address for a period of 14 days.
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Share Capital
Chapter ‐12
Chapter
12
Share Capital
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IN THIS CHAPTER
MEMBER
METHOD OF SUBSCRIPTION OF SHARES
CEASSATION OF THE MEMBERSHIP
NUMBER OF MEMBERS OF PUBLIC AND PRIVATE COMPANIES
DEFINITON OF SHARE AND TYPES OF CAPITAL
LOAN CAPITAL
MARKET VALUE OF SHARES
TYPES OF SHARES
PREFERENCE SHARES
REDEEMABLE SHARES
TREASURY SHARES
ALLOTMENT OF SHARES
CONCEPT OF PRE‐EMPTION RIGHTS
RIGHTS ISSUE OF SHARES
WHAT IS BONUS ISSUE OF SHARE?
VALUE OF SHARES AND DISCOUNT
PAYMENT FOR SHARES
ALLOTMENT OF SHARE AT A PREMIUM VALUE
SHARE PREMIUM ACCOUNT
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Share Capital
Chapter ‐12
MEMBER
A member is a person who has subscribed to the memorandum of association and every other person who has
agreed in writing to become a member and whose name is entered in the register of members.
METHOD OF SUBSCRIPTION OF SHARES
A person may become a member of a company by an application for shares subject to the formal acceptance by
the company.
The ordinary law of contracts applies to the agreement to take shares in a company. An application for share may
be absolute or conditional.
 If it is absolute, a simple allotment and notice thereof to the applicant will constitute the agreement.
 If it is conditional, the allotment must be on the basis of the conditions specified. A person may also subscribe
to the shares of the company as a trustee of the deceased or bankrupt member of the company.
CESSATION OF MEMBERSHIP
Following are methods in which an individual’s membership can be brought to an end:
i)
If the member dies
ii)
The company ceases to exist
iii)
Member transfers his shares to another person
iv)
Member surrenders his shares to the company
v)
Company forfeits the member’s shares
vi)
Shares of the bankrupt member are registered in the name of the trustee
NUMBER OF MEMBERS OF PUBLIC AND PRIVATE COMPANIES
Public and Private companies must have a minimum of one member. Where the issue is regarding a single member
company then the quorum required for general meetings is also one.
DEFINITION OF SHARE AND TYPES OF CAPITAL
Share:
As defined in Borland’s Trustees v Steel (1901) a share:
It is the interest of a shareholder in the company measured by a sum of money
Nominal Value of Share
It is value of the Share as indicated on the Share Certificate. This is also called face value. No share can be issued at
a value less than its nominal value. The nominal value of the shares held represents the maximum liability of a
shareholder in a limited liability company.
Once established, the nominal value of the share remains fixed and does not normally change.
TYPES OF CAPITAL
The concept of ‘capital’ refers to the financial resources raised by companies to finance their operation. The
essential distinction in company law is between share capital provided by the members of the company, and loan
capital, which the company borrows from outsiders.
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Share Capital
Chapter ‐12
Issued and Allotted Share Capital
 Allotted or issued capital represents the shares that have been applied for and the company has issued. It
represents the nominal value of the shares actually issued by the company and public companies must have a
minimum issued capital of £50,000 or the prescribed euro equivalent (s.763 CA 2006).
 The shares which the company retains are called the unissued share capital.
Called up and paid up Share Capital
When the shares are issued payment is usually required in full but not always. Sometimes the company will 'call
up' only part of the amount due. This effectively splits the issued capital into two parts ‐ the 'called up' and '
uncalled' parts. These two should, of course, add up to the issued figure. The uncalled part may be demanded later
when the company needs more working capital.
Paid up share capital is the amount which share holders have actually paid on the shares issued and called. On
allotment public companies must receive at least one quarter of the nominal value of the shares paid up plus
the whole of any premium.
There is no requirement that companies should require its shareholders to immediately pay the full value of the
shares. The proportion of the nominal value of the issued capital actually paid by the shareholder is called the paid
up capital. It may be the full nominal value, in which case it fulfills the shareholder’s responsibility to outsiders; or
it can be a mere part payment, in which case the company has an outstanding claim against the shareholder. It is
possible for a company to pass a resolution that it will not make a call on any unpaid capital. However, even in this
situation, the unpaid element can be called upon if the company cannot pay its debts from existing assets in the
event of its liquidation.
Knowledge Test
Called up share capital can be best described by which of the following?
a. The sum the company has demanded from the shareholders to pay on their existing shares
b. The amount already deposited by the shareholders on their shares
c. The amount the shareholders has not deposited as yet on their existing shares
Solution:
The sum the company has demanded from the shareholders to pay on their existing shares
LOAN CAPITAL
Capital generated through borrowing is called loan capital. It comprises of debentures and other long term loans.
MARKET VALUE OF SHARES
It is the current quoted price at which investors buy or sell a share of common stock or a bond at a given time. It is
also known as "market price. The Market Value can be either higher or lower than the Nominal Value, depending
on the performance of the company or the economic circumstances of the day.
TYPES OF SHARES
If constitution of the company states that there are no different shares, then they are all presumed to be ordinary
shares.
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Share Capital
Chapter ‐12
ORDINARY SHARES
This term is used to refer to the shares which are not given any special rights. If the company issues shares which all enjoy
uniform rights, they will be ordinary shares. These are not preferred shares and do not have any predetermined
dividend amounts. An ordinary share represents equity ownership in a company and entitles the owner to a vote
in matters put before shareholders in proportion to their percentage ownership in the company. Ordinary shares
are also called equity shares.
Ordinary shareholders are entitled to receive dividends if any are available after dividends on preferred shares are
paid. They are also entitled to their share of the residual economic value of the company should the business
unwind; however, they are last in line after bondholders and preferred shareholders for receiving business
proceeds.
If the company is profitable, not only will they enjoy dividend payments but the market value of their shares will go
up. On the other hand if the company does not do well, they may well not receive any payment and the value of
their shares will diminish.
As members of the company, ordinary shareholders are entitled to attend and vote at general meetings. One of
their most important rights is to elect and dismiss the directors of the company who are involved in its day‐to‐day
running for the general benefit of those members.
Ordinary shares usually carry rights of pre‐emption, which entitles the holders to have first call on any new shares
issued by the company.
CLASS RIGHTS
The right which is enjoyed by a particular type of shareholder is a class right. Different special rights with respect to
shares are: Dividends (Return on Capital Employed), redemption of capital, voting and the right to appoint or
remove a director.
Knowledge Test
Which of the following correctly states about the characteristic of shares in a company?
1) Shares once paid for and allotted are the personal property of a shareholder
2) Shareholder of a company can also pay and hold up to a fraction of a share
3) Alex, Alisa & John can hold the same share
a.
b.
c.
1 and 2
1 and 3
2 and 3
Solution:
b. 1 and 3
VARIATION OF CLASS RIGHTS
Variation of class rights is a change in the rights entitled to shareholders in their capacity as equity holders of the
company. Class rights can be varied by passing a special resolution by at least three quarters majority of that class.
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Share Capital
Chapter ‐12
APPLICATION OF VARIATION OF CLASS RIGHTS
It is not a variation of class rights to issue shares to new members, to subdivide shares or to create a new class of
preference shareholders.
Greenhalgh vs Arderne Cinemas ltd: It was held by the court that by dividing the 50p shares in five 10p shares did
not vary the rights of original 10p shares since they still had one vote per share as before.
RIGHTS OF A MINORITY IN CASES OF UNFAIR PREJUDICE
A minority not in favor of the variation, holding at least 15 percent or more of the issued shares, can apply to the
court within 21 days to have the variation cancelled.
Knowledge Test:
Zee ltd wishes to vary the rights of Class A of its shareholders. What procedure would it require for such a
variation?
Solution:
75 percent members of the relevant class of which variation is proposed must agree for such a variation by passing
a special resolution.
Knowledge Test:
The variation of Class A of the shareholders of Zee Ltd was approved but the minority shareholders of the class are
unhappy with the variation. Advise what remedy the minority shareholders can exercise against the variation.
Solution:
Minority shareholders affected by the variation holding more than 15% of the issued shares can apply to the court
with 21 days to set aside the variation.
PREFERENCE SHARES
Preference shares represent a more secure form of investment than the ordinary shares. The reason for this is that
preference shares receive a fixed rate of dividend before any payment is made to the ordinary shareholders and
usually they enjoy priority over ordinary shares with regard to repayment of capital (in case of liquidation). The
actual rights enjoyed by the preference will be stated in the company’s articles of association.
Preference shareholders cannot insist on receiving a dividend payment, but as their dividend rights are usually
cumulative, any failure to pay the dividend in one year has to be made good in subsequent years, subject to the
company’s profitability.
Company law enforces the strict rule that dividends, whether on ordinary or preference shares, cannot be paid out
of the company’s capital. In case of liquidation, the company has no obligation to pay previously accrued
cumulative preference dividend. The exceptions to this are that the dividend has been declared but not yet paid or
when the articles explicitly state otherwise.
REDEEMABLE SHARES
These are shares issued on terms that they may be bought back by the company in future.
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Share Capital
Chapter ‐12
TREASURY SHARES
Treasury shares or reacquired stock are the shares which are bought back by the issuing company, reducing the
amount of outstanding capital in the open market. A public listed company can purchase its own shares listed on
the stock exchange.
Knowledge Test
Select the correct option in relation to company shares?
(1) Ordinary share holders have voting right
(2) Preference shares normally do not have voting rights
(3) All preference shares carry cumulative rights
a.
b.
c.
d.
1 &2only
2 &3only
3 only
None of the above
Solution:
a. 1 &2only
ALLOTMENT OF SHARES
Allotment of shares means an appropriation of a certain number of shares to an applicant in response to his
application for shares. Allotment means distribution of shares among those who have submitted written
application.
The issue of shares is when the company formally issues the share certificate to the allotee.
CONCEPT OF PRE‐EMPTION RIGHTS
Pre‐emption rights refer to the rights of existing shareholders to be offered any new issue of shares before those
shares can be offered to non‐shareholders.
The purpose of pre‐emption rights is to ensure that existing shareholders have an opportunity to maintain their
interest in their company by preventing their percentage holding being watered down by the issue of shares to
new members. There is, of course, no compulsion on the part of the shareholder to take the shares if they do not
wish to.
Currently, by virtue of s.561 Companies Act (CA) 2006, a company cannot offer new shares for cash unless the
existing shareholders have been offered the chance to buy the shares in proportion to their existing holding.
Section 565 specifically exempts pre‐emption rights where non‐cash consideration is involved.
As it is not always cost effective to offer new shares to all existing members, pre‐emption rights can be waived by
provision in the articles of association or by a special resolution of shareholders.
 Pre‐emption rights may also be included in a company’s articles of association.
 Private Company can exclude the statutory right of first refusal.
 Any company can exclude the pre‐emption rights by passing a special resolution.
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Share Capital
Chapter ‐12
Rights issue of shares
A rights issue is the procedure through which a company raises new capital by offering new shares to its existing
members. As the shares are offered to the existing shareholders in proportion to their existing holding, it can be
seen as respecting and giving effect to the shareholders’ pre‐emption rights.
 Once again there is no compulsion to participate in the rights issue and often the rights to participate in the
allotment of new shares are usually tradable securities in themselves. Consequently shareholders who do not
want to buy the new shares themselves may sell the rights to a third party.
 The offer of rights issue should specify a period of not less than 21 days for the offer to be accepted.
WHAT IS BONUS ISSUE OF SHARES
A bonus issue of shares, sometimes referred to as a scrip issue or more accurately a capitalisation issue is similar to
a rights issue in that existing members receive new shares in proportion to their existing holdings, but it differs in
one essential point: the individuals who receive the new shares usually do not have to pay anything for them; they
are received free.
 Bonus issues must never be funded from a company’s ordinary capital.
VALUE OF SHARES AND DISCOUNT
Every share has a nominal value and a premium value (market value). A company must not issue shares at a price
lower than the nominal value of the share or at a discount to that.
It is a long‐established rule that companies are not permitted to issue shares for a consideration which is less than
the nominal value of the shares together with any premium due.
Ooregum Gold Mining Co of India v Roper [1892] Held: A company while allotting shares can give discount in the
premium value of shares but cannot give discount in the nominal value of the shares.
The common law rule is now given statutory effect in s.580 CA 2006. If a company does enter into a contract to
issue shares at a discount, it will not be able to enforce this against the proposed allottee. However, anyone who
takes shares without paying the full value, plus any premium due, is liable to pay the amount of the discount as
unpaid share capital, together with interest at 5% (s.580(2) CA 2006). Also any subsequent holder of such a share
who was aware of the original underpayment will be liable to make good the shortfall (s.588 CA 2006).
Sec 588 of the Companies Act 2006 states that if shares are allotted to the allotee at a discount to their nominal
value, the allottee will still be bound to pay the remaining nominal value of the share to the company.
PAYMENT FOR SHARES
Payment for shares in a private company can be in a variety of ways including cash, goods, services, property or
even shares in another company.
Generally, people can pay for shares in a private company;
 Wholly for cash;
 Partly for cash and partly for a non‐cash payment; or
 Wholly for a non‐cash payment.
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Share Capital
Chapter ‐12
Payment for shares in a public company must, in most instances, be for cash. However, if shares are allotted in a
public company for a non‐ cash consideration, the consideration for the shares is subject to an independent
valuation in most cases.
The following rules also apply to public companies:
 At least 25% of the nominal value and the whole of any premium on shares in a public company must be paid
on allotment,
 A public company cannot accept an undertaking to do work or perform services as consideration for the
allotment of shares. A public company may however, allot shares in order to discharge a debt for the services
already incurred.
 Within two years of receiving its trading certificate, a public company may not receive a transfer of non‐cash
asset.
 A public company should not accept non‐cash consideration for the payment of shares if it contains an
undertaking that such consideration may be performed later than 5 years after the allotment.
ALLOTMENT OF SHARES AT A PREMIUM VALUE AND SHARE PREMIUM ACCOUNT
It is possible, and not at all uncommon, for a company to require prospective subscribers to pay more than the
nominal value of the shares they subscribe for. This is especially the case when the market value of the existing
shares are trading at above the nominal value. In such circumstances the shares are said to be issued at a
premium, the premium being the value received over and above the nominal value of the shares.
Section 610 Companies Act 2006 provides that any such premium received must be placed into a share premium
account. The premium obtained is regarded as equivalent to capital and, as such, there are limitations on how the
fund can be used.
SHARE PREMIUM ACCOUNT
Section 130 provides that the share premium account can be used for the following purposes:
 To pay up bonus shares to be allotted as fully paid to members;
 To write off preliminary expenses of the company;
 To write off the expenses, commission or discount incurred in any issue of shares or debentures of the
company;
 To pay for the premium payable on redemption of debentures or redeemable shares.
Knowledge Test
Share premium account can be used to perform which of the following transaction?
a. To pay for fully paid shares under bonus issue
b. To issue new shares
c. To pay general expenses
d. To pay off the creditors
Solution:
a. To pay for fully paid shares under bonus issue
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Borrowing & Loan Capital
Chapter ‐13
Chapter
13
Borrowing and Loan Capital
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IN THIS CHAPTER
BORROWING
LOAN CAPITAL
DEBENTURE
DEBENTURE TRUST DEED & ITS REQUIREMENTS
SIMILARITIES AND DIFFERENCE BETWEEN SHAREHOLDERS & DEBENTURES
FIXED CHARGES
FLOATING CHARGES
DETECTION OF CHARGES AS FIXED OR FLOATING
CONCEPT OF THE CRYSTALLIZATION OF A FLOATING CHARGE
COMPARISON OF FIXED & FLOATING CHARGES
CHARGES OVER BOOK DEBTS
PRIORITY OF FIXED & FLOATING CHARGE
NEGATIVE PLEDGE CLAUSE
DISPOSING OFF OR SELLING OFF A CHARGED ASSET
REGISTRATION OF CHARGES and CONSEQUENCES OF NON‐REGISTRATION
OF A CHARGE
RIGHTS OF SECURED & UNSECURED DEBENTUREHOLDER
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Borrowing & Loan Capital
Chapter ‐13
BORROWING
Companies ordinarily raise the money they need to finance their operations through the issue of share capital, but
it is equally common for companies to raise additional capital through borrowing. Such borrowing on the part of
the company does not give the lender any interest in the company but represents a claim against the company.
Companies have a power to borrow money.
The power of the directors to borrow money may be restricted or limited in certain circumstances. Therefore the
contract to repay money can be unenforceable where:
i)
Borrowing by the directors is done for an ultra vires purpose or restricted purpose and the lender has
knowledge of this fact or
ii)
The directors breach their borrowing power or act beyond the limits of their borrowing power
Borrowing and Personal guarantees
Since the inception of the concept of the separate legal entity, some lenders in order to secure their lending
require directors and/or members to agree to repay a loan out of their personal wealth if the company defaults to
pay its debt.
Personal guarantee is the tool to protect the lender from the members hiding behind the protection of limited
liability.
LOAN CAPITAL
It is the capital generated through borrowing.
Loan capital may be obtained from a bank or finance company as long‐term loans, or from debt‐equity investors in
the form of debentures or preferred stock (preference shares), and is usually secured by a fixed and/or floating
charge on the company's assets.
DEBENTURE
Debentures are documents that acknowledge a company’s borrowing, although the term has been extended to
cover the loan itself. As debenture holders lend money to the company they are its creditors, they are not
members. As creditors they are entitled to receive interest, whether the company is profitable or not. It may even
be necessary to use the company’s capital to pay the debenture interest.
Three types of debentures;
i)
Single Debenture: To create charge and giving the bank various safeguards for the loan.
ii)
Debentures issued as a series and registered: It is the number of debentures issued to different lenders
who provide different amounts and each lender receives a debenture in identical form in respect of his
loan. Registered debenture is one which is registered in the name of a holder in the books of the
company. It is transferable in the same way as a share.
iii)
Debenture Stock: Public companies usually use this method to offer its debentures to the public. Public
companies usually issue a number of debentures at one time through this method. Only this form
requires a debenture trust deed.
 A company must maintain a register of all debenture holders and register an allotment within 2
months.
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Chapter ‐13
DEBENTURE TRUST DEED AND ITS REQUIREMENT
It is a formal legal document/contract that outlines the terms of the debenture issue between issuer and holders.
It states the maturity date, interest rate, interest payment, protective provisions and any other terms & conditions
between issuer & holders.
Elements of trust deed:
1) The appointment of trustee for prospective debenture stock holders. Trustee can be bank, company or
individual.
2) Trustee is authorized to enforce the security in case of default and in particular to appoint a receiver with
suitable powers of management.
3) Provisions for transfer of stock and meetings of debenture stockholders.
Advantages:
i)
The Trustee will deal with all correspondence regarding your debt.
ii)
Trustee has powers to intervene in case the borrower defaults.
iii)
Security for the debenture stock in the form of charges over property can be given to a single trustee.
iv)
Trustee has the power to call the meeting of the debenture holders and obtain a decision acceptable to
all.
SIMILARITIES AND DIFFERENCES BETWEEN DEBENTURE HOLDERS AND SHAREHOLDERS
Similarities:
i)
Both are transferable securities
ii)
The procedure of issuance of both the securities is almost similar
iii)
The procedure of the transfer of both the securities is almost similar.
Differences:
I)
II)
III)
IV)
V)
VI)
Shareholder
Is the owner of the company
Has the power to vote
Share cannot be issued below nominal value.
Dividends paid out of profits.
Restrictions on redeeming.
Paid last in the event of liquidation.
Debenture holder
Is the creditor of the company
May not vote
Debentures may be issued below nominal.
Interest must be paid.
No restrictions on redeeming.
Paid before shareholders.
Knowledge Test (ACCA Past Papers 2014)
In relation to a debenture, which of the following is NOT true?
A It may be issued at a discount
B Interest on it may be paid from capital
C It is paid after preference shares
D It is freely transferable
Solution:
C It is paid after preference shares
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Borrowing & Loan Capital
Chapter ‐13
Knowledge Test
Aliza is seeking fixed dividend on her investment from company. Anna is entitled to interest regardless of the fact
that the company is in profit or loss. Anu is entitled to participate in the company meetings and exercise voting
rights in the company.
Categorize the position of Aliza, Anna & Anu as debenture holder, preference shareholder or ordinary shareholder.
Solution:
a. Aliza is the preference shareholder
b. Anna is the debenture holder
c. Anu is the ordinary shareholder
Definition of Charges
Charge is the term used to describe any right established over a borrower's property to secure a debt or
performance of an obligation.
There are two types of security for company loans:
 Fixed charge
 Floating charge
FIXED CHARGES
In fixed charges, a specific asset of the company is made subject to a charge in order to secure a debt. Once the
asset is subject to the fixed charge the company cannot dispose of it without the consent of the debenture
holders.
 The asset most commonly subject to fixed charges is land, although any other long‐term capital asset may also
be charged.
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It would not be appropriate, however, to give a fixed charge against stock‐in‐trade, as the company would be
prevented from freely dealing with it without the prior approval of the debenture holders. Such a situation
would obviously prevent the company from carrying on its day‐to‐day business.
 If the company fails to honor the commitments set out in the document creating the debenture, such as
meeting its interest payments, the debenture holders can appoint a receiver who will if necessary sell the
asset charged to recover the money owed. If the value of the asset that is subject to the charge is greater than
the debt against which it is charged then the excess goes to pay off the rest of the company’s debts. If it is less
than the value of the debt secured then the debenture holders will become unsecured creditors for the
amount remaining outstanding.
 Fixed charges take priority over floating charges.
FLOATING CHARGES
The floating charge is most commonly made in relation to the ‘undertaking and assets’ of a company and does not
attach to any specific property whilst the company is meeting its requirements as stated in the debenture
document.
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The security is provided by all the property owned by the company, some of which may be continuously changing,
such as stock‐in‐trade. Thus, in contrast to the fixed charge, the use of the floating charge permits the company to
deal with its property without the need to seek the approval of the debenture holders. However, if the company
commits some act of default, such as not meeting its interest payments, or going into liquidation, the floating
charge is said to crystallize. This means that the floating charge becomes a fixed equitable charge over the assets
detailed, and their value may be realised in order to pay the debt owed to the floating charge holder.
DETECTION OF CHARGES AS FIXED OR FLOATING
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The company would be prevented from freely dealing with the property having a fixed charge on it without
the prior approval of the debenture holders.
Floating charge permits the company to deal with its property without the need to seek the approval of the
debenture holders. However, charge over assets will not be registered as fixed if it allows the company to deal
with the charges assets without obtaining prior consent of the chargee.
Right of British Columbia v Federal Business Development Bank
Bank had a fixed charge over the property and specific mortgage charge. A term allowed the company to make
sales until notified in writing by the bank to stop doing so. Held the charge was created as floating not a fixed
charge.
CONCEPT OF THE CRYSTALLIZATION OF A FLOATING CHARGE
Crystallization happens when a floating charge is converted into a fixed charge.
Events causing crystallization
i)
Liquidation of company
ii)
Cessation of company’s business
iii)
Intervention by chargee via a receiver
iv)
If charge contract so provides, when notice is given by the chargee that the charge is converted into a
fixed charge.
v)
Crystallization of another floating charge if it causes the company to cease business.
Floating charges sometimes make provision for automatic crystallization
COMPARISON OF FIXED AND FLOATING CHARGES
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Fixed charge is a better form of security as it grants confers immediate rights over identified assets.
Floating charge may automatically become invalid if the company creates the charge to secure an existing
debt and goes into liquidation within a year thereafter sec 245IA. This period is only six months with a fixed
charge.
CHARGES OVER BOOK DEBTS
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Charges which are created over the current and future book debts of the company.
If the money is received by the company and it deals with it without the consent of the chargee then the
charge will be categorized as floating charge.
If the money is received by the chargee and the company has no control over it then the charge will be
categorized as fixed charge.
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Knowledge Test
Zee Ltd is a company in the business of manufacturing chairs. Barclay’s Bank has lent finances to Zee Ltd and has in
turn created charge on the building of Zee Ltd. Furthermore Barclay’s Bank also seeks charge on the company’s
stocks it manufactures.
State what kind of a charge bank has on building and stocks?
Solution:
The charge on the building will be categorized as a fixed charge.
The charge on the stocks which the company is manufacturing will be floating charge.
PRIORITY OF FIXED AND FLOATING CHARGE
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As per the general rule all fixed charges have priority over the floating charge irrespective of their time of
creation.
Fixed charges take priority against each other in order of their time of creation.
Floating charges take priority according to their time of creation.
As regards charges of different types, a fixed charge takes priority over a floating charge even though it was
created after it.
A floating charge will only take priority over the fixed charge if the latter had notice that the former will take
priority charge.
Generally, there is nothing to prevent the creation of a fixed charge after the issuing of a floating charge, and,
as a legal charge against specific property, that fixed charge will still take priority over the earlier floating
charge.
Knowledge Test
Fixed charge has been created by the bank on the building owned by Doop Ltd. Which of the following is correct in
relation to the fixed charge?
a. Fixed charge holders are paid after the floating charge holders on winding up
b. Fixed charges rank lower than ordinary share holders on winding up
c. Fixed charge is a charge on a specific and identifiable asset
d. Fixed charge is a charge on current and future assets of the company
Solution:
Fixed charge is a charge on a specific and identifiable asset
NEGATIVE PLEDGE CLAUSE:
Floating charge holder can include a negative pledge clause in his agreement with the company which prohibits the
company from creating a fixed charge over the same property.
If the above agreement is breached the fixed charge holder will only obtain priority if he did not have knowledge
about the prohibition created over the property.
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DISPOSING OFF OR SELLING OFF A CHARGED ASSET
If a charged property is sold to a third party by the company then:
 The charge will be transferred with the property.
 The property will only have floating charge attached to it if the third party while purchasing it had knowledge
about it.
REGISTRATION OF CHARGES AND CONSEQUENCES OF NON‐REGISTRATION OF A CHARGE
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
All charges, including both fixed and floating, have to be registered with the Companies Registry within 21
days of their creation.
Failure to register the charge as required has the effect of making the charge void, i.e. ineffective, against any
other creditor, or the liquidator of the company.
The charge, however, remains valid against the company, which means in effect that the holder of the charge
loses their priority as against other company creditors.
In addition to registration at the Companies Registry, companies are required to maintain a register of all
charges on their property. Although a failure to comply with this requirement constitutes an offence, it does
not invalidate the charge.
Knowledge Test
1. Barclay’s Bank has created a fixed charge over Zee Ltd’s building. In how many days does the charge have to
be registered?
a. 10
b. 27
c. 21
d. 30
2.
If the charge is not registered within the stipulated time what is the effect of it?
a. Charge remains valid
b. Charge is void
c. Charge does not need to be registered for it to be valid.
Solution:
1. Charge has to be registered within 21 days
2.
If a charge has not been registered within 21 days then it will be a void charge.
RIGHTS OF SECURED AND UNSECURED DEBENTURE HOLDER
Rights of unsecured debenture holders
 Can sue the company and seize property if judgment for debt unsatisfied.
 Can present a petition to the court for compulsory liquidation of the company
 Can apply to the court for administrative order.
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Rights of Secured Debenture Holders:
 Can take possession of the assets if they have a fixed charge.
 Can sell the asset
 Can apply to the court to transfer the ownership of the asset.
 Can appoint a receiver provided no administration is in progress.
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Capital Maintenance & Dividend Law
Chapter ‐14
Chapter
14
Capital Maintenance and Dividend Law
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IN THIS CHAPTER
CAPITAL MAINTENANCE
REDUCTION OF SHARE CAPITAL
PROCEDURE FOR REDUCTION OF SHARE CAPITAL
REQUIREMENT OF APPROVAL BY COURT
REASONS FOR REDUCTION OF SHARE CAPITAL
RULES OF DIVIDENDS
DIVIDEND DECLARATION
DISTRIBUTABLE PROFIT
DIVIDENDS OF PUBLIC COMPANIES
UNDISTRIBUTABLE RESERVE
VIOLATION OF DIVIDEND RULES
RESPONSIBILITIES OF MEMBERS
LIABIILITIES OF MEMBERS
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CAPITAL MAINTENANCE
Every company is required to maintain capital for the protection of its creditors. As shareholders in limited
companies, by definition, have the significant protection of limited liability the courts have always seen it as the
duty of the law to ensure that this privilege is not abused at the expense of the company’s creditors.
Shareholders in limited liability companies enjoy the benefit of limited liability and usually cannot be required to
pay more than the value of the shares they take in their company. However, that privilege is only extended to
them on the basis that they fully subscribe to the company’s capital. In turn, that capital is seen as a fund against
which creditors can claim in the event of a dispute. Capital maintenance refers to the way in which the capital fund
of limited liability companies can be used and, most essentially, reduced. The fundamental rule is that payments
may not be improperly made out of capital to the detriment of the company’s creditors. To that end, company law
lays out rules as to what may be considered proper payment from capital and, in particular, establishes clear rules
relating to the payment of dividends and the ways in which capital can be reduced.
The doctrine of capital maintenance was developed, the specific rules of which are now given expression in the
Companies Act (CA) 2006.
There are a number of specific controls over how companies can use their capital, but perhaps the two most
important are the rules relating to capital reduction and company distributions.
REDUCTION OF SHARE CAPITAL
A reduction of share capital occurs when any money paid to a company in respect of a member's share is returned
to the member.
Section 641 sets out three particular ways in which the capital can be reduced:
(a) Removing or reducing liability for any capital remaining as yet unpaid. In effect the company is deciding that it
will not need to call on that unpaid capital in the future.
(b) Cancelling any paid up capital which has been lost through trading or is unrepresented by the current assets.
This effectively brings the statement of financial position into balance at a lower level by reducing the capital
liabilities in recognition of a loss of assets.
(c) Repayment to members of some part of the paid‐up value of their shares in excess of the company’s
requirements. This means that the company actually returns some of its capital to its members on the basis
that it does not actually need that level of capitalisation to carry on its business.
Limited companies can without restriction cancel unissued shares. It may do so if:
i)
It has power in the articles
ii)
It passes a special solution to alter its articles
PROCEDURE FOR REDUCTION OF SHARE CAPITAL
The procedures through which a company can reduce its capital are laid down by ss.641–653 Companies Act 2006.
Section 641 states that, subject to any provision in the articles to the contrary, a company may reduce its capital in
any way by passing a special resolution to that effect. In the case of a public company any such resolution must be
confirmed by the court. In the case of a private company, however, it is also possible to reduce capital without
court approval as long as the directors issue a statement as to the company’s present and continued solvency for
the following 12 months (ss.642 & 643). It is also called declaration of solvency.
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The special resolution, a copy of the solvency statement, a statement of compliance by the directors confirming
that the solvency statement was made not more than 15 days before the date on which the resolution was passed,
and a statement of capital must be delivered to the registrar within 15 days of the date of passing the special
resolution. The methods of reduction of share capital have been discussed above.
Knowledge Test
1. Zaxt Ltd directors have convened a meeting in which they want the members to agree upon the reduction of
its share capital. What kind of resolution do they have to pass?
a. Ordinary resolution
b. Special resolution
c. Resolution is not required to be passed
Solution:
b. Special Resolution
2.
What are the requirements for a private company to reduce its share capital?
a. Pass a special resolution and alter its articles
b. Declaration of solvency by directors, special resolution by members and authority to alter in articles
c. Only special resolution
Solution:
B. Directors must present a declaration of solvency and members must pass a special resolution and the
authorization to alter the articles must be in the articles
REQUIREMENT OF APPROVAL BY COURT
Under s.648 the court may make an order confirming the reduction of capital on such terms as it thinks fit. In
reaching its decision the court is required to consider the position of creditors of the company.
The court also takes into account the interests of the general public. In any case the court has a general discretion
as to what should be done. If the company has more than one class of shares, the court will also consider whether
the reduction is fair between classes.
When a copy of the court order together with a statement of capital is delivered to the registrar of companies a
certificate of registration is issued (s.649).
Knowledge Test
Sash Plc has decided to reduce its share capital. Apart from members passing a special resolution what other
requirements does a public limited company have to follow for reduction of share capital?
a. Alter its articles and get approval from court
b. Alter its articles
c. Alter articles and present a declaration of solvency
Solution:
A. Members must pass a special resolution in a general meeting if the authorization for reduction of capital is in
the articles. Once resolution is passed court order for the reduction of capital is mandatory for public limited
companies.
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Protection against creditors’ concerns
A company can address the creditors concerns regarding the reduction of its share capital by adopting one of the
following approaches:
a) Paying back all the loans taken from the creditors
b) By giving the court a bank guarantee
REASONS FOR REDUCTION OF SHARE CAPITAL
Share Capital can be reduced by the company for any of the below mentioned grounds:
i)
To bring the value of assets in line with the capital, if the assets had suffered any impairment loss.
ii)
The company makes a complex arrangement to change its financial structure by replacing share capital
with loan capital.
iii)
The company plans to completely extinguish a particular class of shares.
RULES OF DIVIDENDS
Paying a dividend is the usual way for a company to distribute a share of its profits among the shareholders. There
are detailed statutory rules as to distributions in CA 2006, sec829 to sec853.
Dividends are the return received by shareholders in respect of their investment in a company. Subject to any
restriction in the articles of association, every company has the implied power to apply its profits in the
distribution of dividend payments to its shareholders.
Although the directors recommend the level of dividend payment, it is for the company in a general meeting to
declare the dividend. This is one of the items conducted at the annual general meeting. If the directors decline to
recommend a dividend, then it is not open to the general meeting to overrule that decision and declare a dividend.
The long‐standing common law rule is that dividends must not be paid out of capital (Flitcroft’s case 1882).
The current rules relating to the payment of dividends are to be found in part 23 Companies Act (CA) 2006. The Act
governs, and imposes restrictions on distributions made by all companies, both public and private. Section 829
defines distribution as any payment, cash or otherwise, of a company’s assets to its members, except for the
categories stated in the section, which include the issue of bonus shares, the redemption of shares, authorised
reductions of share capital, and the distribution of assets on winding up.
DIVIDEND DECLARATION
Dividends can be declared by the following methods:
 In a public company, the usual practice is for the directors to declare and pay an interim dividend based on the
accounts for the first six months of the company's financial year.
 The directors recommend a final dividend to the Annual General Meeting based on the profits made in the full
year, and the AGM then passes a resolution declaring that dividend.
 Dividend declaration cannot exceed the amount recommended by the directors.
 In private companies the practice varies widely. If the company is making profits there are essentially two
ways in which those profits can be paid over to the people who own and run the company. One is for the
directors (or others, e.g. family members) to be paid salaries or fees for the work they have done for the
company. The other way of taking money out of the company is for the company to pay dividends. These are
paid to shareholders (rather than directors) and (unless the company has special articles) will be paid in
accordance with the rights of the respective shareholders.
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Knowledge Test:
Directors of a company have recommended a dividend for declaration to its members but the members in the
meeting have approved a dividend more than the amount recommended by the directors. State which of the
following is correct:
a. Dividends declaration cannot exceed the amount recommended by the directors
b. Members can approve the amount in excess of the director’s recommendation.
Solution:
a. Dividends declaration cannot exceed the amount recommended by the directors
DISTRIBUTABLE PROFIT
Section 830 goes on to provide the basic condition for distribution, applying to all companies, which, in essence, is
that they must have ‘profits available for that purpose’. This term is defined in the section as accumulated realised
profits less accumulated realised losses, with profit or loss being either revenue or capital in origin.
It is important to note that the use of the term accumulated means that any previous years’ losses must be
included in determining the distributable surplus, and the requirement that profits be realised prevents payment
from purely paper profit resulting from the mere revaluation of assets. Section 841 provides that all losses are to
be treated as realised except where a general revaluation of all fixed assets has taken place.
DIVIDENDS OF PUBLIC COMPANIES
The foregoing realised profits test applies to both private and public companies, but public companies face an
additional test in relation to distributions, in that s.831 requires that any distribution of dividend must not reduce
the value of the company’s net assets below the aggregate of its total called up share capital and undistributable
reserves (share premium, capital redemption reserve, unrealized profits’ reserve or any other capital reserve).
The effect of this rule is that public companies have to account for changes in the value of their fixed assets, and
are required to apply an essentially balance sheet approach to the determination of profits.
UNDISTRIBUTABLE RESERVE
It includes:
a. Share premium account
b. Capital redemption reserve
c. The surplus of accumulated unrealized profit over accumulated unrealized losses profit
Knowledge Test:
1. Picaso plc wishes to distribute dividends to its members from its capital redemption reserve account. State
whether the dividend distribution out of the capital redemption reserve account is:
a. Valid
b. Invalid
Solution:
Invalid as companies cannot pay dividends out of their capital. The dividends can be paid from the distributable
profits of the company.
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VIOLATION OF DIVIDEND RULES
Under the rule in Flitcroft’s case any directors of a company who breached the distribution rules, and knowingly
paid dividends out of capital, were held jointly and severally liable to the company to replace any such payments
made. The fact that the shareholders might have approved the distribution did not validate the illegal payment
(Aveling Barford Ltd v Perion Ltd (1989)).
Directors are held responsible since they either recommend to members in a general meeting that a dividend
should be declared or they declare interim dividends.
The liability of directors arises in the following circumstances:
a) The payment of dividend out of capital was done in the complete knowledge of directors.
b) The dividend was declared without the complete preparation of financial statements and subsequently
resulted in payment out of capital.
c) Declaration of unlawful dividend by misinterpretation or wrongful application of law and constitution.
RESPONSIBILITIES OF MEMBERS
i)
ii)
If members have knowledge of unlawful dividend, they can obtain an injunction to stop the company
from making the payment.
Members cannot knowingly approve payment of an unlawful dividend at AGM.
LIABILITIES OF MEMBERS
i)
ii)
iii)
Section 847 Companies Act 2006 restates the common law rule, providing that shareholders, who either
know or have reasonable grounds for knowing that any dividend was paid from capital (unlawful
dividend), shall be liable to repay any such money received to the company.
The shareholders may have the option to indemnify the directors for payments they might have already
received (Moxham v Grant (1900)).
To the extent that the distribution is made in excess of the distributable profits as determined by properly
prepared accounts, any liability of the director extends to the repayment of part which is unlawful.
Similarly, any shareholder who either knew or had reasonable grounds for knowing that the dividends
were improperly paid will have to recompense the company to the extent that their dividends were
overpaid.
Knowledge Test
It has recently been discovered that directors of Fash plc and the members holding majority shares approved and
received divided out of capital. What course can the company adopt against the unlawful dividend distribution?
Solution
The directors and members have infringed the dividend rules therefore the company is entitled to recover
unlawful dividend from the members and the directors. The only hurdle which the company can face in the
recovery of unlawful dividends is if the majority of the members are involved in receiving the unlawful dividend
and they collectively decide not to bring any action.
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Company Directors & Other Company Officers
Chapter ‐15
Chapter
15
Company Directors and other Company
Officers
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IN THIS CHAPTER
DIRECTOR
KINDS OF DIRECTORS
ROLE OF CHAIRMAN & CHEIF EXECUTIVE
DIRECTORS AGE REQUIREMENT AND THEIR METHOD OF APPOINTMENT
REMUNERATION REIMBURSEMENT & COMPENSATION FOR DIRECTORS
METHOD OF DIRECTORS VACATION FROM OFFICE
RETIREMENT & RE‐ELECTION RULES
LIMITATION ON THE REMOVAL OF DIRECTORS
DISQUALIFICATION OF DIRECTORS
POWERS OF DIRECTORS
MEMBERS CONTROL OVER DIRECTORS
CHIEF EXECUTIVE AND AGENCY
DIRECTORS DUTIES
OTHER CONTROLS IMPOSED BY STATUE OVER DEALINGS BETWEEN
DIRECTORS & THEIR COMPANIES
DIRECTORS LIABILITY FOR THE ACTIONS OF FELLOW DIRECTORS
DIRECTORS PERSONAL LIABILITY
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DIRECTOR
Section 250 of the Companies Act 2006, defines a director as including ‘any person occupying the position of a
director, by whatever name called.’
KINDS OF DIRECTORS
i)
De Jure director
It is person who is formally and legally appointed or elected as a director in accordance with the articles of
association of the firm, and gives written consent to hold the office of a director. He or she enjoys full
rights and privileges of a director, and is held individually and collectively (with other directors) liable for
the acts and/or negligence of the firm.
ii)
De‐facto Director
Any person who is not legally appointed as a director but performs the functions of a director. Whether or
not such a person fulfills the qualifications of a director, or enjoys the rights and privileges of a director,
he or she is generally held liable as a de jure director.
iii)
Shadow Director
The concept of a shadow director is introduced in s.251 CA 2006. A shadow director is a person who,
although not actually appointed to the board, instructs the directors of a company as to how to act, using
their power, say as a major shareholder, to manipulate the acknowledged board of directors.
It is a person’s function rather than their title that defines them as a director. Such individuals are subject
to all the rules applicable to ordinary directors; they are directors for legal purposes. A person is not to be
treated as a shadow director if the advice is given in a purely professional capacity. Thus, a business
consultant or a company doctor (another title given to someone called in to give advice to companies in
trouble), would not be liable as a shadow director for the advice they might give to their client company.
A shadow director would differ from a de facto director because the public and authorities are rarely
aware of their existence. A de facto director performs the everyday task a director would, while a shadow
director exerts their influence away from the day to day running of the business.
Knowledge Test:
Sacha a major shareholder of Delta Ltd exercises her influence and according to her directions the board of
directors act. Which of the following is true regarding shadow directors?
a. Shadow directors are illegal
b. A person in order to be a shadow director must be appointed by an ordinary resolution
c. Shadow director and de‐facto director have the same obligations and duties
Solution:
c. Shadow director and de‐facto director have the same obligations and duties
iv)
Executive Director
Executive directors usually work on a full‐time basis for the company and are employed through a service
contract. Section 227 of the Companies Act 2006 defines a director’s service contract as a contract under
which a director of the company undertakes personally to perform services (as director or otherwise) for
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the company. Section 228 requires a copy of every director’s service contract to be kept available for
inspection and under S.229 Company members have the right to inspect and request a copy of such
contracts. Additionally s.188 of the Companies Act 2006, relating to directors’ long‐term service contracts,
requires that no such contract may be longer than two years, unless it has been approved by resolution of
the members of the company.
v)
Non‐Executive Director
Non‐executive directors or outsider directors do not usually have a full‐time relationship with the
company; they are not employees and only receive directors’ fees. The role of the non‐executive
directors, at least in theory, is to bring outside experience and expertise to the board of directors. They
are also expected to exert a measure of control over the executive directors to ensure that the latter do
not run the company in their own interest, rather than the company’s, best interests. It is important to
note that there is no distinction in law between executive and non‐executive directors and the latter are
subject to the same controls and potential liabilities as are the former.
Knowledge Test:
John being recruited as junior staff manager at A Ltd has seen that Alex, Eva, Phil & Robert are managing the
company. Advise John in order to help him determine the type of director Alex, Eva, Phil & Robert are:
Alex: He has been formally appointed vide an ordinary resolution as a director and his name is also in the list of
directors
Eva: Eva has a major shareholding in the company but her name is not in the list of directors. Due to her major
shareholding she exercises great influence on the existing directors and they work according to her instructions.
Phil: Phil works on the position of the director but he is not formally appointed as a director nor his name is in the
list of directors.
Robert: He attends the meetings in order to overlook and oversee the working of the other directors and to ensure
that they are working in the best interest of the company.
Solution:
Alex: De‐jure Director
Eva: Shadow Director
Phil: De‐facto Director
Robert: Non‐Executive Director
Separation of role of Chairman and CEO
The UK Corporate Governance Code requires that there should be a clear division of responsibilities at the head of
a company between the running of the board of directors and the executive responsibility for the running of the
company’s business. It also requires that the roles of chairman and chief executive should not be exercised by the
same individual.
The Chairman of the Board (of Directors) of a company, is (or should be) the chief representative of the
shareholders. The CEO of the company, should be, by definition, the leader of the managers.
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ROLE OF CHAIRMAN
Article 12 of the model articles of association for public limited companies provides for the board of directors to
appoint one of their members to chair their meetings. The UK Corporate Governance Code explains that the
chairman is responsible for leadership of the board and ensuring its effectiveness on all aspects of its role. The
chairman is responsible for setting the board’s agenda and ensuring that adequate time is available for discussion
of all agenda items, in particular strategic issues.
The chairman should ensure effective communication with shareholders. In relation to general meetings, although
s.319 provides that any member may act as chair, this is subject to the provision of the articles and Model Article
31 states that if the directors have appointed a chairman, the chairman shall chair general meetings.
The chairman conducts the meeting and must preserve order and ensure that it complies with the provisions of
the companies’ legislation and the company’s articles. He or she is under a general duty at all times to act bona
fide in the interests of the company as a whole, and thus must use his or her vote appropriately.
Role of Chief executive
Under Article 5 of the model articles, the board of directors may delegate any of the powers, which are conferred
on them under the articles, to such person or committee as they think fit and any such act of delegation may
authorize further delegation of the directors’ powers by any person to whom they are delegated. In this way, the
board may appoint one or more managing directors or chief executives who will have the authority to exercise all
the powers of the company and to further delegate those powers as they see fit. Article 5 also makes provision for
the board of directors to revoke any delegation in whole or part, or alter the terms and conditions under which it
may be operated.
DIRECTORS AGE REQUIREMENT AND THEIR METHOD OF APPOINTMENT
There exists no upper age limit for the directors; however the minimum age requirement for a director is 16.
Directors are normally appointed by an ordinary resolution.
REMUNERATION, REIMBURSEMENT AND COMPENSATION FOR DIRECTORS
Directors are paid in accordance to the terms of their service contracts Directors are entitled to be reimbursed for
the expenses they incur in the exercise of their duty. Any non‐contractual compensation for the loss of office can
only be paid to the director after the same has been approved by the members in the general meeting. Approval is
not required where the company is contractually bound to make payments
Remuneration report
Quoted companies are required to include a Director’s remuneration report as part of their annual report, which is
also audited. The report must cover the following:
 The details of each individual directors’ remuneration package
 The company’s remuneration policy
 The role of the board and remuneration committee in deciding the remuneration of directors
METHOD OF THE DIRECTOR’S VACATION FROM OFFICE
A director can vacate his office in the following ways;
i)
Resignation
ii)
Death
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iii)
iv)
v)
vi)
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Dissolution of Company
Not contesting for re‐election
Disqualification
Removal of office by an ordinary resolution after giving a special notice
RETIREMENT AND RE‐ELECTION RULES
At the first AGM of the company all directors shall retire. At every subsequent AGM any directors appointed by the
other directors since the last AGM shall retire. Directors who were not appointed or re‐elected at one of the
preceding two AGMs shall retire. Therefore, the Directors are elected for a term of three years.
Knowledge Test:
Gacha, Pablo & Fernando were appointed as directors of Cesa Ltd on 20th January 2018. Gacha is 15 years old,
Pablo is 68 years old & Fernando is 66 years old. State whether the appointments of the directors are valid and
when will they retire?
Solution:
The minimum age in order for a person to appoint as a director is 16 years therefore Gacha’s appointment is
invalid. However, there is no upper age limit therefore Pablo and Fernando are validly appointed. Directors are
appointed for a term of three years therefore they will retire in 2020.
LIMITATIONS ON THE REMOVAL OF DIRECTORS
i)
ii)
iii)
In order for a shareholders to propose a resolution for directors removal they must either hold at least
10% of the paid up share capital or 10% of the voting rights where the company does not have shares.
A director can also use his own voting rights (as a member) and can defeat a resolution of his removal
Class rights agreement can be drafted that each class must be present at a general meeting to constitute a
quorum.
DISQUALIFICATION OF DIRECTORS
Unsuitable individuals can be disqualified from acting as a company director for up to 15 years under the Company
Directors Disqualification Act 1986 (CDDA).
The Act was introduced in an attempt to prevent the misuse of the company form. One of its specific aims was the
control of the 'phoenix company'. This is a company set up by a director of a very similar company which ceased
trading due to extensive debts. The new company carries on essentially the same business, but with no liability to
the creditors of the former company. Such behaviour is reprehensible and is clearly an abuse of limited liability.
The CDDA1986 seeks to remedy this practice by preventing certain individuals from acting as company director,
but the ambit of the Act's control is much wider than this one instance.
Categories of Conduct
The CDDA1986 identifies three distinct categories of conduct which may, and in some circumstances must, lead
the court to disqualify certain persons from being involved in the management of companies. These are:
a) General misconduct in connection with companies
 Misconduct is defined as:
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1.
2.
3.
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Conviction for an indictable offence in connection with the promotion, formation, management or
liquidation of a company or with the receivership or management of a company's property (S2 of the
CDDA1986). The maximum period for disqualification under S2 is five years where the order is made by a
court of summary jurisdiction, and 15 years in any other case.
Persistent breaches of companies legislation in relation to provisions which require any return, account
or other document to be filed with, or notice of any matter to be given to, the registrar (S3 of the
CDDA1986). Section 3 provides that a person is conclusively proved to be persistently in default where it
is shown that, in the five years ending with the date of the application, he has been adjudged guilty of
three or more defaults (S3(2) of the CDDA1986). This is without prejudice to proof of persistent default in
any other manner. The maximum period of disqualification under this section is five years.
Fraud in connection with winding up (S4 of the CDDA1986). A court may make a disqualification order if,
in the course of the winding up of a company, it appears that a person:
‐ has been guilty of an offence for which he is liable under S458 of the Companies Act 1985, that is, that
he has knowingly been a party to the carrying on of the business of the company either with the intention
of defrauding the company's creditors or any other person or for any other fraudulent purpose
‐ has otherwise been guilty, while an officer or liquidator of the company or receiver or manager of the
property of the company, of any fraud in relation to the company or of any breach of his duty as such
officer, liquidator, receiver or manager (S4(1)(b) of the CDDA1986). The maximum period of
disqualification under this category is 15 years.
b) Disqualification for unfitness
 This covers:
Disqualification of directors of companies which have become insolvent, who are found by the court to be
unfit to be directors (S6 of the CDDA1986). Under S6, the minimum period of disqualification is two years,
up to a maximum of 15 years
Disqualification after investigation of a company under Pt XIV of the CA1985 (S8 of the CDDA1986).
A disqualification order may be made as the result of an investigation of a company under the company’s
legislation. Under S8 of the CDDA1986, the Secretary of State may apply to the court for a disqualification
order to be made against a person who has been a director or shadow director of any company, if it
appears from a report made by an inspector under S437 of the CA or Ss94 or 177 of the Financial Services
Act 1986 that 'it is expedient in the public interest' that such a disqualification order should be made.
Once again, the maximum period of disqualification is 15 years.
The CDDA1986 sets out certain particulars to which the court is to have regard where it has to determine
whether a person's conduct as a director makes them unfit to be concerned in the management of a
company (S9). The detailed list of matters to be considered is set out in Schedule 1 to the Act.
In addition, the courts have given indications as to what sort of behaviour will render a person liable to be
considered unfit to act as a company director. Thus, in Re Lo‐Line Electric Motors Ltd (1988), it was stated
that: 'Ordinary commercial misjudgement is in itself not sufficient to justify disqualification. In the normal
case, the conduct complained of must display a lack of commercial probity, although... in an extreme case
of gross negligence or total incompetence, disqualification could be appropriate.'
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A 'lack of commercial probity', therefore, will certainly render a director unfit, but, as Vinelott J stated in
Re Stanford Services Ltd (1987): '...the public is entitled to be protected, not only against the activities of
those guilty of the more obvious breaches of commercial morality, but also against someone who has
shown in his conduct of a company a failure to appreciate or observe the duties attendant on the privilege
of conducting business with the protection of limited liability.'
Consequently, even where there is no dishonesty, incompetence may render a director unfit. Thus, in Re
Sevenoaks Stationers Ltd (1990), the Court of Appeal held that the director was unfit to be concerned in
the management of a company on the basis that: 'His trouble is not dishonesty, but incompetence or
negligence in a very marked degree, and that is enough to render him unfit; I do not think it is necessary
for incompetence to be "total" to render a director unfit to take part in the management of a company.'
c)
Other cases for disqualification
 This relates to:
Participation in fraudulent or wrongful trading under S213 of the Insolvency Act 1986 (S10 of the
CDDA1986)
Undischarged bankrupts acting as directors (S11 of the CDDA1986)
Failure to pay under a county court administration order (S12 of the CDDA1986).
Disqualification Orders
For the purposes of most of the CDDA1986, the court has a discretion to make a disqualification order.
Where, however, a person has been found to be an unfit director of an insolvent company, the court has
a duty to make a disqualification order (S6 of the CDDA1986).
The precise nature of any such order is set out in S1, under which the court may make an order
preventing any person (without leave of the court) from being:
 A director of a company
 A liquidator or administrator of a company
 A
receiver
or
manager
of
a
company's
property
in any way, whether directly or indirectly, concerned with or
 Taking part in the promotion, formation or management of a company.
However, a disqualification order may be made:
i.
with leave to continue to act as a director for a short period of time, in order to enable the
disqualified director to arrange his business affairs (Re Ipcon Fashions Ltd (1989))
ii.
with leave to continue as a director of a named company, subject to conditions (Re Lo‐Line
Electric Motors Ltd (1988)) with leave to act in some other managerial capacity but not as
director (Re Cargo Agency Ltd (1992)).
Period of disqualification
With regard to the period of disqualification, in Re Sevenoaks Stationers (Retail) Ltd (1990), Dillon LJ in the Court of
Appeal divided the potential maximum 15 year period of disqualification into three distinct brackets:
i.
over 10 years for particularly serious cases (for example, where a director has been disqualified
previously)
ii.
two to five years for 'relatively not very serious' cases
iii.
a middle bracket of between six and 10 years for serious cases not meriting the top bracket.
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Penalty for breach of a disqualification order
Anyone who acts in contravention of a disqualification order is liable for either:
i.
Imprisonment for up to two years and/or a fine, on conviction on indictment
ii.
Imprisonment for up to six months and/or a fine not exceeding the statutory maximum, on conviction
summarily (S13 of the CDDA1986).
Under S14 where a company is guilty of an offence under S13, then any person who consented or contributed to
its so doing will also be guilty of an offence. In addition S15 imposes personal liability for company debts arising
during a period when a person acts as a director while disqualified, either under an order or while personally
bankrupt. The Secretary of State is required to maintain a register of disqualification orders which is open to public
inspection (S18).
Re Uno, Secretary of State for Trade and Industry V Gill
The operation of the CDDA1986 was considered extensively in Re Uno, Secretary of State for Trade and Industry v
Gill (2004). This case related to a group of two furniture companies which, although in severe financial difficulties,
continued to trade while the directors investigated possible ways of saving the businesses. During this period one
of the companies, Uno, continued to raise its working capital from deposits taken from customers to secure orders
that were never to be met, as the company eventually went into liquidation.
Although the directors were advised that they could have safeguarded the deposits by placing the money in a trust
account for the customers, they decided not to do so, as they needed the money to keep the business going in the
short term. An application from the Department of Trade and Industry for the disqualification of the directors on
the basis of this behaviour was unsuccessful. In refusing the application, the court emphasised the fact that in
order to justify disqualification there had to be behaviour that was either dishonest, or lacking in commercial
probity. Moreover, that behaviour had to be such as to make the person concerned unfit to be involved in the
management of a company. Under the circumstances of the case the court found that the directors had pursued
realistic opportunities to save the businesses and consequently were blameless for the eventual failure of the
businesses and the loss to the customers
Mitigating circumstances in relation to disqualification
Courts can impose a lower period of disqualification due to one or more of the following reasons:
a) Lack of Dishonesty
b) Loss of director’s own money
c) Absence of personal gain
d) Efforts to mitigate
e) Likelihood of re‐offending
Knowledge Test:
Jazz Ltd is a company having ten directors. However some of the directors have recently faced some complexities
and require your advise as to whether they have to vacate their office or not?
Fuzz: He has been declared as bankrupt
Tesa: Members in a general meeting have passed an ordinary resolution to remove Tesa
Smith: He has a major shareholding in the company and members tried to remove him by an ordinary resolution
but he used his weighted voting rights to prevent him from being removed
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Hariro: He has committed an indictable offence and has been held guilty of murder by a court of competent
jurisdiction
Sharif: He has run the affairs of the company to defraud the creditors of the company. He has been declared as
being guilty of fraudulent trading.
Peter: He has consistently for last 6 years failed to follow the returns to the registrar according to the provisions of
the Companies Act 2006.
Solution:
Fuzz: He is disqualified from holding position of a director
Tesa: A director can be removed vide an ordinary resolution so she will have to vacate office
Smith: He cannot be required to vacate the office as he defeated the resolution by exercising his voting rights
Hariro: He is disqualified from being a director according to Companies Director Disqualification Act 1986.
Sharif: As he has committed fraudulent trading he is disqualified from being a director according to Companies
Director Disqualification Act 1986.
Peter: As he has failed to file the returns being in violations of the Companies Act 2006, he is disqualified from
being a director according to Companies Director Disqualification Act 1986.
POWERS OF DIRECTORS


Directors’ powers are stated in the articles of the company
They must exercise their powers in the best interest of the company and for the benefit of the company.
MEMBERS’ CONTROL OF DIRECTORS



They can appoint or remove directors vide an ordinary resolution
Articles can allow members to pass special resolution to make directors act in a particular manner
Members have a power to ratify any act of the director which would otherwise be regarded as a breach.
CHIEF EXECUTIVE AND AGENCY
Chief executive is also known as managing director. He has apparent authority to act as agent of the company. He
can enter into contracts with the third parties on behalf of the company. They have the authority to bind the
company into contracts. They can be terminated from office like any other director.
As in the case of Freeman &Lockyer v Buckhurst Park Properties: It was held that the company was bound by the
contract as the other directors by their actions had represented that the managing director had the authority to
enter into contracts on behalf of the company.
Knowledge Test:
Fuss is a director of Manter Ltd. Manter Ltd has sought your advice regarding the validity of the following action of
Fuss:
Fuss entered into the contract on behalf of the company to purchase 3 cars for the company. The articles of the
company expressly state that directors do not have the authority to purchase any cars.
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Solution:
Manter Ltd would be bound by the contract as Fuss had used his powers under apparent authority of him being a
director. However, company can personally sue Fuss for his breach.
DIRECTOR DUTIES
Directors have seven major duties under the company’s act 2006:
i)
Duty to act within the powers for the best interest of the company.
Section 171 CA replaces existing similar common law duties and requires directors to act in accordance
with the company’s constitution. Section 17 of the Act provides that a company’s constitution includes
not only the company’s articles of association but the resolutions and agreements specified in s.29, which
includes special resolutions passed by the company and any resolutions or agreements that have been
agreed to, or which otherwise bind classes of shareholders.
Directors are also required to use powers only for the purposes for which they were conferred. This is a
restatement of the long‐standing ‘proper purposes doctrine’.
Howard Smith v Ampol Petroleum: It was held that the allotment of shares was invalid as directors had
breached their fiduciary duty (duty of trust) for the purpose of destroying an existing majority.
Knowledge Test:
Zee Ltd wanted to takeover Manter Ltd and majority shareholders were in favour of it. However, Fuss a
director was against it. So he issued shares to minority shareholders to block the takeover.
Solution:
The issue of shares would be invalid as Fuss being in breach of his duty as a director had acted in his own
interests rather than the interests of the company. As shares can only be issued to raise capital. However,
his actions can be approved if members pass an ordinary resolution ratifying his actions in the general
meeting
ii)
Duty to promote the success of the company for the benefit of members as a whole
Section 172 CA 2006 replaces the previous common law duty on directors to act in good faith in the best
interest of the company. In the course of making their decisions directors are now required to have regard
to each of the following list of matters:
 The likely consequences of any decision in the long term,
 The interests of the company’s employees,
 The need to foster the company’s business relationships with suppliers, customers and others,
 The impact of the company’s operations on the community and the environment,
 The desirability of the company maintaining a reputation for high standards of business conduct, and
 The need to act fairly as between members of the company.
The above list is non‐exhaustive and directors must also have regard to other non‐specific matters.
Additionally, s.172 (3) makes specific reference to the need to consider the interests of the company’s
creditors where the company is operating under straightened circumstances.
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Section 172 is based on the concept of ‘enlightened shareholder value’ but, nonetheless, it clearly
privileges the rights of the shareholders over the other interests mentioned. This is especially apparent
when it is remembered that, as emphasised in s.172 (2), all duties are owed, not to the various interested
stakeholders mentioned, but to the company itself.
iii)
Duty to exercise independent judgment. They should not delegate their decision making powers to
anyone else.
iv)
Duty to exercise reasonable skill, care and diligence while exercising their duties
Section 174 CA 2006 codifies and replaces the previous common law duty but in a way that reflects the
recent tightening of control over directors in line with the standard set out in relation to wrongful trading
in the Insolvency Act 1986, s.214.
Section 174 requires that a director must exercise ‘reasonable’ care, skill and diligence and adds that the
requirement means the care, skill and diligence that would be exercised by a reasonably diligent person
with:
(a) The general knowledge, skill and experience that may reasonably be expected of a person carrying
out the functions carried out by the director in relation to the company; and
(b) The general knowledge, skill and experience that the director has.
It is expected that all directors who are performing either specific or general functions perform to a
standard appropriate to those functions. Directors who actually lack the knowledge or skills to fulfil
particular roles, or perform particular functions, will not be allowed to rely on their lack of competency as
an excuse for not showing a required measure of skill or diligence.
Thus, for example, it would be expected that a finance director would be able to understand accounts,
otherwise they should not be in that position; the function sets the standard expected, not the actual
ability of the director, as historically was the case.
Under the second, subjective, element of the test, a director’s particular professional or business skills will
have a bearing on whether they have met the standard of skill and diligence expected of them. However,
this element can only increase that basic standard. For example, a qualified lawyer or accountant would
be expected to know more about certain issues than a non‐specialist director and would be expected to
bring their particular skill to bear on company issues in the area of their particular expertise.
Knowledge Test:
David a director of the Company A ltd recommended dividend without properly checking the accounts of
the Company. Later it was known that the Company did not have sufficient profits and the Dividend was
paid out of capital.
Advise Company A ltd on the actions of David.
Solution:
David failed to exercise his powers with reasonable care skill and diligence due to which company has
suffered loss. Company can personally sue David to recover the unlawful dividend.
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Duty to avoid conflict of interest.
A director must not profit from his position of power.
Section 175 CA 2006 reflects the long‐standing common law rule that directors, as fiduciaries, must
respect the trust and confidence placed in them and should do nothing to undermine or abuse their
position as fiduciaries. The practical effect of the rule is that any conflict of interest must be authorized by
the members of the company, unless some alternative procedure is properly provided. In the case of a
private company, a conflict can be authorized by the other directors of the board unless the company’s
constitution provides to the contrary. The position is the same for public companies, except that the
constitution must expressly permit authorization by the board.
Regal Hastings v Gulliver: Held that the defendants had made their profits “by reason of the fact that
they were directors of Regal and in the course of the execution of that office”. They therefore had to
account for their profits to the company.
Industrial Development Consultants v Cooley: Managing director was held liable as he had diverted a
corporate opportunity from the company towards himself.
Knowledge Test:
Barren Plc has entered in a major construction contract with Jazz Plc. Tony a director of Barren has failed
to disclose it to the board of directors that his wife has a major shareholding in Jazz Plc. Advise Barren
whether Tony has breached his duty or not?
Solution:
Tony has breached his duty of conflict of interest by failing to disclose his interest to the board of
directors.
vi)
Directors have a duty not to accept benefit from the third parties which creates a conflict of interest.
Under s.176, a director must not accept a benefit from a third party, which is conferred by reason of (a)
his being a director or (b) his doing (or not doing) anything as director. This duty is an aspect of the
previous general duty to avoid conflicts of interest, but it has been stated separately in order to ensure
that the obtaining of a benefit from a third party by a director can only be authorized by members of the
company rather than by the board.
Knowledge Test:
Sam a director of Kash Ltd has recently been given a gift of an expensive watch worth 1 million pounds in
exchange of the contracts he would award to Perch Ltd the supplier. Sam would also receive secret
commission on the contracts he awards to Perch Ltd. Sam has not disclosed to the company the gift and
the commission he has received from the supplier. Advise whether Sam is in breach of his duty.
Solution:
Sam has accepted benefit from a third party and has made secret profit which he has failed to disclose to
the company. Sam is in breach of his duty.
vii)
Directors have a duty to declare interest in any proposed or existing transaction by written notice,
general notice or verbally at a board meeting.
Under s.177 CA 2006 a director must declare to the other directors any situation in which they are in any
way, directly or indirectly, interested in a proposed transaction or arrangement with the company. Again
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this further emphasizes the duty to avoid a conflict of interests by ensuring that directors are transparent
about personal interests, which could, even remotely, be seen as affecting their judgment.
Knowledge Test (ACCA Past Papers 2014)
Which of the following applies to the concept of enlightened shareholder value?
A It is the price shares can be expected to raise if they were to be sold
B It is the yardstick for assessing the performance of directors’ duties
C It is the standard of behavior expected of shareholders in general meetings
Solution:
B It is the yardstick for assessing the performance of directors’ duties
OTHER CONTROLS IMPOSED BY STATUTE OVER DEALINGS BETWEEN DIRECTORS AND THEIR
COMPANIES
Companies Act
2006 Reference
188
190
197
198
201
204
217
Control
Directors’ service contracts lasting more than two years must be approved by the members
Directors or any other person connected to them may not acquire a non‐cash asset from the
company without the approval of the members. This does not apply where the asset’s value
is less than £5,000, or less than 10% of the company’s asset value. All sales of assets with a
value exceeding £100,000 must be approved.
Any loans given to directors, or guarantees provided as security for loans provided to
directors, must be approved by members if over £10,000 in value.
Expands section 197 to prevent unapproved quasi‐loans to directors of over £10,000 in value
(PLCs only)
Expands section 197 to prevent unapproved credit transactions by the company for the
benefit of a director of over £15,000 in value (PLCs only)
Directors must seek approval of the members where the company loans them over £50,000
to meet expenditure required in the course of business
Non‐contractual payments to directors for loss of office must be approved by the members
Remedies against Directors
Several remedies exist for the breach of duty by the director:
i)
Account for personal gain
ii)
Indemnify the company for the loss
iii)
Rescission of the contract
iv)
Court can declare an act as ultra vires
Company can ratify a director’s breach of duty by passing a resolution or by altering its articles.
DIRECTOR’S LIABILITY FOR THE ACTIONS OF FELLOW DIRECTORS:
Directors are not liable for the actions of other directors. However, if the breach of duty of other directors is in
their knowledge they have the duty to inform members.
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PERSONAL LIABILITY OF DIRECTORS:
Personal liability of director can arise in the following manner:
i.
Where veil of incorporation is lifted
ii.
Where directors of company have unlimited liability by reason of the articles
iii.
Directors can have personal liability of creditors in situations where they extend their personal guarantee
for the repayment of loan.
iv.
If the directors commit wrongful or fraudulent trading they will be held personally liable.
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Chapter
16
Other Company Officers















IN THIS CHAPTER
COMPANY SECRETARY
APPOINTMENT
DUTIES
POWERS
COMPANY AUDITOR
QUALIFICATIONS
INELIGIBILITY FOR APPOINTMENT
APPOINTMENT AND REMUNERATION
REMOVAL OR VACATION OF AUDITOR FROM OFFICE
ACTIONS TO BE ADOPTED ONCE AUDITOR RESIGNS
RIGHTS AND DUTIES
AUDITORS ARE REQUIRED TO INVESTIGATE
AUDIT EXCEPTIONS
INDEMNIFICATION OF AUDITORS
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COMPANY SECRETARY
It is mandatory for a public company to have a company secretary but private companies are not required to have
one. Every public company is required to have a secretary, who is one of the company’s officers for the purposes
of the Companies Act 2006 and who, in addition, may, or may not, be a director of the company.
Private companies are no longer required to appoint company secretaries, although they still can do so if they
wish.
APPOINTMENT
Section 1173 Companies Act (CA) 2006 includes the company secretary amongst the officers of a company. Every
public company must have a company secretary and s.273 of the CA requires that the directors of a public
company must ensure that the company secretary has the requisite knowledge and experience to discharge their
functions. Section 273(2) & (3) sets out the following list of alternative specific minimum qualifications, which a
secretary to a public limited company must have:
 They must have held office as a company secretary in a public company for three of the five years preceding
their appointment to their new position;
 They must be a member of one of a list of recognized professional accountancy bodies, including ACCA;
 They must be a solicitor or barrister or advocate within the UK;
 They must have held some other position, or be a member of such other body, as appears to the directors of
the company to make them capable of acting as company secretary.
Sole director of a private limited company cannot appoint himself as the company secretary.
Knowledge Test:
Company A is a private limited company Jack is its sole director. Jack has also appointed himself as company
secretary. Advise whether jack’s appointment as company secretary is valid.
Solution:
In a private company sole director cannot also be a company secretary. Therefore the appointment of jack as
company secretary would be invalid.
DUTIES
The duties of company secretaries are set by the board of directors and therefore vary from company to company,
but as an officer of the company, they will be responsible for ensuring that the company complies with its
statutory obligations. The following are some of the most important duties undertaken by company secretaries:
 To ensure that the necessary registers required to be kept by the Companies Acts are established and properly
maintained;
 To ensure that all returns required to be lodged with the Companies Registry are prepared and filed within the
appropriate time limits;
 To organize and attend meetings of the shareholders and directors;
 To ensure that the company’s books of accounts are kept in accordance with the Companies Acts and that the
annual accounts and reports are prepared in the form and at the time required by the Acts;
 To be aware of all the statutory requirements placed on the company’s activities and to ensure that the
company complies with them;
 To sign such documents as require their signature under the Companies Acts.
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Knowledge Test:
Select the correct option as regards company secretaries?
a. Natural person can only be a company secretary
b. The company secretary cannot also be the director of the same company
c. It is mandatory for all types of companies to appoint a company secretary
d. Company secretary must qualify a certain exam to be appointed to the post
Solution:
A. Natural person can only be a company secretary
POWERS
Although old authorities, such as Houghton & Co v Northard Lowe & Wills (1928) suggest that company
secretaries have extremely limited authority to bind their company, later cases have recognized the reality of the
contemporary situation and have extended to company secretaries potentially extensive powers to bind their
companies. As an example consider Panorama Developments Ltd v Fidelis Furnishing Fabrics Ltd (1971). In this
case the Court of Appeal held that a company secretary was entitled ‘to sign contracts connected with the
administrative side of a company’s affairs, such as employing staff and ordering cars and so forth. All such matters
now come within the ostensible authority of a company’s secretary.’
Knowledge Test:
Alan has been appointed as company secretary for ABC Ltd. Alan while being company secretary entered in two
contracts:
a. Major construction contract on behalf of the company.
b. Contract to purchase the stationary for the company.
Advise which of the above contract would bind the company.
Solution:
Alan as company secretary can bind the company for contracts which relate to the administration of the company.
Therefore the contract for stationary is valid. However, the contract for construction is invalid as it is beyond the
powers of the company secretary to enter into contracts other than the daily administration work.
COMPANY AUDITOR
The corporate governance structure specifies the distribution of rights and responsibilities among different
participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out
the rules and procedures for making decisions on corporate affairs. Auditors have an extremely important role to
play in that regard: they are appointed to ensure that the interests of the shareholders in a company are being
met.
Their key function is to produce independent and authoritative reports confirming, or otherwise, that the
accountancy information provided to shareholders is reliable.
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QUALIFICATIONS
The essential requirement for any person to act as a company auditor is that they are eligible under the rules, and
a member of, a recognized supervisory body. This in turn requires them to hold a professional accountancy
qualification.
‘Supervisory bodies’ are ones established in the UK to control the eligibility of potential company auditors and the
quality of their operation. The recognized supervisory bodies are:
(a) The Institute of Chartered Accountants in England and Wales;
(b) The Institute of Chartered Accountants of Scotland;
(c) The Institute of Chartered Accountants in Ireland;
(d) The Association of Chartered Certified Accountants; and
(e) The Association of Authorized Public Accountants.
The first four bodies mentioned above are also recognized as ‘qualifying bodies’, meaning that accountancy
qualifications awarded by them are recognized professional qualifications for auditing purposes.
INELIGIBILITY FOR APPOINTMENT
A person is ineligible for appointment as auditor if they are either:
(a) an officer or employee of the company (the auditor being specifically declared not to be an officer or
employee); and/or
(b) a partner or employee of a person in (a) above, or is in a partnership of which such a person is a partner.
APPOINTMENT AND REMUNERATION
Every company must appoint auditors for each financial year. Auditors are usually appointed in a general meeting
vide an ordinary resolution. They hold office from 28 days after the meeting in which accounts are laid until the
end of the corresponding year. Secretary of state may appoint auditor if the members fail. Usually directors fix
their remuneration
Knowledge Test:
Z Ltd wants to appoint Alex as auditor. Alex is also a major shareholder and director of Z ltd. Advise Z ltd if it can
appoint Alex?
Solution:
A person cannot be appointed as an auditor if he is either officer or employee of the company.
REMOVAL OR VACATION OF AUDITOR FROM OFFICE
Auditor can vacate office in the following ways:
 Resignation
 By ordinary resolution with special notice
 Does not wish to be reappointed
Knowledge Test:
A Ltd wants to remove its auditor. Select which of the following options it should exercise for removal of the
auditor.
a. Special resolution
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b. Ordinary resolution with special notice
c. Written Special resolution with special notice
Solution:
b. Ordinary resolution with special notice
ACTIONS TO BE ADOPTED ONCE AUDITORS RESIGNS:
Once the auditor resigns he must:
a. Circulate a statement of circumstances of his departure if it is a quoted company.
b. If it is a non‐listed or private company then if there are no circumstances then he should state that there exists
nothing of relevance to be brought to the notice.
Company must send copy of the circumstances to who so ever entitled to receive it. Auditors have the right to
circulate statement to the members or requisition the meeting and explain the reason of his departure.
RIGHTS AND DUTIES
The auditors have the right of access at all times to the company’s books and accounts, and officers of the
company are required to provide such information and explanations as the auditors consider necessary. It is a
criminal offence to make false or reckless statements to auditors.
A company’s auditors are entitled to require from the company’s officers such information and explanations as
they think necessary for the performance of their duties as auditors. It is a criminal offence for an officer of the
company to provide misleading, false or deceptive information or explanations. However, it is not an offence for
them to fail to provide any information or explanation that the auditors require of them.
Auditors are entitled to receive notices and other documents in connection with all general meetings, to attend
such meetings and to speak when the business affects their role as auditors. Where a company operates on the
basis of written resolutions rather than meetings, then the auditor is entitled to receive copies of all such proposed
resolutions as are to be sent to members.
Auditors are required to make a report on all annual accounts laid before the company in a general meeting
during their tenure of office. They are specifically required to report on certain issues:
(a) Whether the accounts have been properly prepared in accordance with the Act; and
(b) whether the individual and group accounts show a true and fair view of the profit or loss and state of affairs of
the company and of the group, so far as concerns the members of the company;
(c) Whether the information in the Directors' Report is consistent with the accounts presented.
AUDITORS ARE REQUIRED TO INVESTIGATE:
(a) Whether the company has kept proper accounting records and obtained proper accounting returns from
branches.
(b) Whether the accounts are in agreement with the records; and state:
(i)
Whether they have obtained all the information and explanations that they considered necessary;
(ii)
Whether the requirements concerning disclosure of information about directors’ and officers’
remuneration, loans and other transactions have been met; and rectify any such omissions.
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Knowledge Test:
Carl is the auditor of Xteen Ltd Company. Carl in order to determine the correct position of the company needs to
know the powers which he can exercise.
a. Carl thinks that the directors have mislead him regarding the true position of the company and thinks that the
books of accounts have been manipulated.
b. Carl also wants to address the members of the company regarding the true position of the company.
c. Carl wants to enter into contracts on behalf of the company.
Solution:
a. Carl has the right to view the books and accounts of the company and any person misleading him will be
committing a criminal offence.
b. Carl has the authority to call a general meeting and also to speak at the general meeting.
c. Carl does not have the authority to enter into contracts on behalf of the company. As this power is exercised
by the directors of the company.
AUDIT EXCEPTIONS
Usually small companies are totally exempted from audit if its turnover is less than £6.5 million and balance sheet
is not more than £3.26 million having 50 or less employees. This exemption does not apply to a public company,
banking or insurance companies. Members holding 10% or more capital of any company can veto the exemption
INDEMNIFICATION OF AUDITORS
Any agreement between the auditor and the company which seeks to indemnify the auditor for their negligence or
breach of duty is void. However, auditor liability can be limited vide an agreement.
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Chapter
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Company Meetings and Resolutions
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IN THIS CHAPTER
COMPANY MEETINGS
KINDS OF GENERAL MEETINGS
GENERAL MEETING
PROCEDURE FOR MEMBERS REQUISITIONING A MEETING
ANNUALL GENERAL MEETING
KINDS OF RESOLUTION
TIMING OF NOTICES
SPECIAL NOTICE
PROCEDURE FOR MEMBERS TO REQUISITION A RESOLUTION
NECESSITIES FOR AN EFFECTIVE MEETING
QUORUM OF MEETINGS
PROXY AND RULES OF APPOITNEMNT
METHOD OF VOTING
MINUTES OF MEETING
CLASS MEETING
SINGLE MEMEBER PRIVATE COMPANIES
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COMPANY MEETINGS
The decision making power in the company mainly vests with the Members. The decisions reached in the meetings
are binding only if the meetings are convened in accordance with the rules and procedures prescribed.
KINDS OF GENERAL MEETINGS
There are mainly two kinds of general meetings:
i)
Other General Meetings
ii)
Annual General Meeting
GENERAL MEETINGS



Directors and the Members of the company have the power to call a general meeting
Directors have the power under the articles of association to call the general meeting
Members can make a requisition to the directors to call the general meeting under sec 303 of the Company’s
Act 2006.
Procedure of Notice:
14 days clear notice must be given to the members in advance of the meeting
PROCEDURE FOR MEMBERS REQUISITIONING A MEETING
The members of companies must hold at least 5% of the paid up share capital holding voting rights. A signed
requisition stating the objects of meeting must be sent to the registered office of the company.
Directors should send a notice to convene a meeting within 21 days of the requisition. The meeting must be held
within 28 days of the notice. If the directors fail to call a meeting within 21 days then the members may convene
the meeting within 3 months from the date of the deposit of the requisition.
ANNUAL GENERAL MEETING
An annual general meeting (commonly abbreviated as AGM) is a mandatory (required by law), yearly gathering of
a publicly traded company's executives, directors and interested shareholders. An AGM is held every year to elect
the board of directors and to inform their members of previous and future activities. At the annual general
meeting, the CEO and director typically speak, and the company presents its annual report.
Shareholders with voting rights vote on current issues, such as appointments to the company's board of directors,
executive compensation, dividend payments and auditors. Shareholders who do not attend the meeting in person
are asked to vote by proxy, which can be done online or by mail.
It is mandatory for the public companies to hold AGM within six months of the year end. However, it is not
mandatory for the Private companies.
Directors must call AGM in accordance with the rules and procedures prescribed
Knowledge Test:
1. ABC Plc seeks your advise on the validity of following actions:
a. It has requisitioned an Annual General Meeting by giving 14 days notice
b. The financial year of ABC Plc ends on 1/06/2017 but it convened AGM on 1/05/2017
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2.
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LRO a private company limited by shares is also seeking your advise whether it is mandatory upon it to hold
AGM?
Solution:
a. ABC Plc requisition of AGM would be invalid as 21 days of notice is required to convene the AGM.
b. AGM by ABC Plc is invalid as it has to be convened within 6 months after the end of financial year.
2. It is not mandatory for a private limited company to hold AGM.
Procedure for Calling AGM:
I)
Notice in writing must be sent
II)
At least 21 days of notice should be given
III)
Shorter notice is valid only if all members agree
Role of Court:
Court upon an application of a director or a member can order to hold a meeting and can also rule on the quorum
KINDS OF RESOLUTIONS
Under the provisions of the Companies Act (CA) 2006 there are three main types of resolutions: ordinary
resolutions, special resolutions and written resolutions.
(a) An ordinary resolution
Section 282 CA 2006 defines an ordinary resolution of the members generally, or a class of members, of a
company, as a resolution that is passed by a simple majority.
(b) A special resolution
A special resolution is required for major changes in the company such as the change in name, reduction of
share capital or winding up of the company.
A special resolution of the members (or of a class of members) of a company means a resolution passed by a
majority of not less than 75%, determined in the same way as for an ordinary resolution (CA s.283). If a
resolution is proposed as a special resolution, it must be indicated as such, either in the written resolution text
or in the meeting notice.
Where a resolution is proposed as a special resolution, it can only be passed as such although anything that
may be done as an ordinary resolution may be passed as a special resolution (s.282(5)). There is no longer a
requirement for 21 days’ notice where a special resolution is to be passed at a meeting.
(c) A written resolution
Private limited companies are no longer required to hold meetings and can take decisions by way of written
resolutions (s.281 CA 2006). The CA 2006 no longer requires unanimity to pass a written resolution. It merely
requires the appropriate majority of total voting rights, a simple majority for an ordinary resolution (s.282(2))
and a 75% majority of the total voting rights for a special resolution (s.283(2)).
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By virtue of s.288(5) CA 2006 anything which in the case of a private company might be done by resolution in a
general meeting, or by a meeting of a class of members of the company, may be done by written resolution
with only two exceptions:
 The removal of a director; and

The removal of an auditor.
Both of these procedures still require the calling of a general meeting of shareholders.
A written resolution may be proposed by the directors or the members of the private company (s.288 (3)).
Under s.291 in the case of a written resolution proposed by the directors, the company must send or submit a
copy of the resolution to every eligible member. This may be done as follows:
 Either by sending copies to all eligible members in hard copy form, in electronic form or by means of a
website;
 By submitting the same copy to each eligible member in turn or different copies to each of a number of
eligible members in turn;
 By a mixture of the above processes.
The copy of the resolution must be accompanied by a statement informing the members both how to signify
agreement to the resolution and the date by which the resolution must be passed if it is not to lapse
(s.291(4)). It is a criminal offence not to comply with the above procedure, although the validity of any
resolution passed is not affected.
Agreement to a proposed written resolution occurs when the company receives an authenticated document,
in either hard copy form or in electronic form, identifying the resolution and indicating agreement to it. Once
submitted, agreement cannot be revoked.
The resolution and accompanying documents must be sent to all members who would be entitled to vote on
the circulation date of the resolution. The company’s auditor should also receive such documentation (s.502
CA 2006).
 Members holding 5% of the voting rights may request a written resolution.
 The default period for agreement on a written resolution is 28 days.
Knowledge Test:
Xara Plc has decided to change its name to Tanrez Plc. For this the company has circulated a written resolution
amongst its members requiring 75% to agree. The resolution was passed. Advise if this is a valid action by Xara Plc
or not?
Solution:
This will be invalid as public companies cannot pass written resolutions. Only private companies can pass written
resolutions.
TIMINGS OF NOTICES
Members have the authority to waive the required notice period by the following method:
i)
In public companies all members must consent in respect of AGM
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ii)
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In case of general meeting members of a private company holding 90% of the issued shares or voting
rights must consent. However, 95% is required by a public company
SPECIAL NOTICE


Special Notice is a notice of 28 days before the meeting
This notice is given when a resolution concerns the removal or appointment of the auditor or the director.
Knowledge Test:
Members of Opet Ltd holding 10% voting rights requisitioned a meeting seeking to remove a director named Alan.
The meeting was convened with a 21 days’ notice and an ordinary resolution proposed was passed. In the meeting
a director named Ahmed was appointed vide an ordinary resolution. Advise if the correct procedure was applied
for removal and appointment of director.
Solution:
Alan could not be removed as in order to remove a director or an auditor a special notice of 28 days needs to be
served on the company and thereafter a notice of 21 days should be served for the meeting.
Ahmed has been validly appointed as a director. Ordinary resolution is required for appointment or removal of a
director.
PROCEDURE FOR MEMBERS TO REQUISITION A RESOLUTION
The members of a private company may require the company to circulate a resolution:
 If they control 5% of the voting rights (or a lower percentage if specified in the company’s articles).
 Resolution must be in hardcopy and should be sent at least 6 weeks before the AGM or General meeting.
 They can also require a statement of not more than 1,000 words to be circulated with the resolution (s.292)
NECESSITIES FOR AN EFFECTIVE MEETING
The decision of the meeting is only binding if:
i)
It is properly convened by notice.
ii)
It fulfills the quorum requirement.
iii)
The Chairman presides it. Note that chairman has a casting vote if the articles permit.
iv)
The voting procedure of the resolutions is properly complied.
QUORUM OF MEETINGS
It is the number of members of a company required to be present to transact the business legally.
Two members must be present to complete the quorum. However both the persons may not be members as
proxies can also be appointed.
Knowledge Test:
A ltd wishes to hold a general meeting. State the quorum required for a company to hold a general meeting?
a. Two persons being members or proxies for members
b. Four persons being members or proxies for members
c. One person
d. Two persons being members
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Solution:
a. Two persons being members or proxies for members
PROXY AND RULES OF APPOINTMENT
Definition: An agent legally authorized to act on behalf of another party. E.g. a person representing a shareholder
at company meetings.
Rules of appointment
 Any member can appoint proxy
 The proxy does not necessarily have to be member
 They have the right to speak at the meetings
 They have the right to vote at the meetings
 They have the right to demand a poll
 Notice of proxy appointment must be given to the company at least 48 hours before the meeting to the
company.
METHODS OF VOTING
i)
Show of hands:
Show of hands is a method of voting in which every member has one vote irrespective of his number of
shares. Chairman has the authority to call the votes by show of hands unless the other method is
demanded.
ii)
Voting by Poll
It is a method of voting which allows members to use their votes in accordance to their shareholding
rights.
Voting by poll can be demanded by:
i)
Not less than five members
ii)
Members representing not less than one tenth of the total voting rights
iii)
Members holding shares which represent not less than one tenth of the paid up capital.
MINUTES OF MEETINGS
Minutes of the meeting must be signed by the chairman. The record of the minutes of the meeting must be kept
with the company for 10 years. All the members have the right to inspect the record of the minutes of the
meeting.
Knowledge Test:
General meeting of Farex Ltd was convened in which the Chairman called for voting by show of hands. However,
the members want voting by poll. What is the requirement for members to demand voting by poll?
a. Not less than five member or members representing one tenth of total voting rights
b. Not less than two members
c. Members having one fifth of the total voting rights
Solution:
a. Not less than five member or members representing one tenth of total voting rights
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CLASS MEETINGS
Class meetings are held for either the shareholders holding shares in different classes or under arrangement with
creditors. If the company has more than one class of share, it may be necessary to call a meeting of that class to
approve a proposed variation of the rights attached to their shares. The Quorum for class meeting is fixed at two
persons (holding at least one third of nominal value of issued share capital) unless the class only consists of one
person.
SINGLE MEMBER PRIVATE COMPANIES
Special rules exist for single member private companies. Sole member should keep a written record of the
decisions that would have been taken by him at the general meeting.
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Chapter ‐18
Chapter
18
Insolvency and Administration
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IN THIS CHAPTER
LIQUIDATION
LIQUIDATOR
KINDS OF LIQUIDATION
DISTINCTION BETWEEN MEMBERS VOLUTARY LIQUIDATION
CREDITORS
MEMBERS VOLUNTARY LIQUIDATION
CREDITORS VOLUNTARY LIQUIDATION
PRINCIPLE OF CENTREBINDING
COMPULSORY LIQUIDATION
CONSEQUENCES OF COMPULSORY LIQUIDATION
INVESTIGATION POWERS OF THE OFFICIAL RECEIVER
MODES OF PAYMENT AFTER LIQUIDATION
ADMINISTRATION
ADMINISTRATION WIHTOUT COURT ORDER
ADMINISTRATION WITH COURT ORDER
CONSEQUENCES OF ADMINISTRATION
FUNCTIONS OF THE ADMINISTRATOR
POWERS OF THE ADMINISTRATOR
TENURE OF ADMINISTRATOR
ADVANTAGES OF ADMINISTRATION
AND
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LIQUIDATION
Winding up, or liquidation, is the process whereby the life of the company is brought to an end. It is a formal and
strictly regulated procedure through which the company’s assets are realized and distributed to its creditors and
members. The procedure is governed by the Insolvency Act (IA) 1986. The directors, creditors or the members can
initiate the process of liquidation.
LIQUIDATOR
A liquidator is the officer appointed when a company goes into winding‐up or liquidation who has responsibility
for collecting in all of the assets of the company and settling all claims against the company before putting the
company into dissolution.
Following factors exist when liquidation commences:
i)
All directors’ powers to manage cease
ii)
Dealing in shares is not allowed
iii)
Changes in members is not allowed
iv)
Company documents and website must state that the company is in liquidation
KINDS OF LIQUIDATION
There are two kinds of liquidation:
i)
Voluntary
ii)
Compulsory
Voluntary Liquidation
There exist two types of voluntary liquidation:
i)
Members’ voluntary liquidation (Company is solvent)
ii)
Creditors’ voluntary liquidation ( Company is insolvent)
DISTINCTION BETWEEN ‘MEMBERS’ VOLUNTARY WINDING‐UP’ AND ‘CREDITORS’
1.
2.
3.
4.
Members’ voluntary winding‐up can be resorted to by solvent companies and thus requires the filing of
Declaration of Solvency by the Directors of the company with the Registrar. Creditors’ winding‐up, on the
other hand, is resorted to by insolvent companies or by application to court.
In members’ voluntary winding‐up there is no need to have creditors’ meeting (as it is assumed that their
debts will be paid in full). But, in the case of creditors’ voluntary winding‐up, a meeting of the creditors must
be called immediately after the meeting of the members.
Liquidator, in the case of members’ winding‐up, is appointed by the members. But in the case of creditors’
voluntary winding‐up, if the members and creditors nominate two different persons as liquidators, creditors’
nominee shall become the liquidator.
In the case of Creditor’s voluntary winding‐up, if the creditors so wish, a ‘Liquidation Committee’ comprising of
up to five representatives of the creditors may be appointed. In the case of Members’ voluntary winding‐up,
there is no provision for any such Committee.
Knowledge Test (ACCA Past Papers 2014)
In which procedure does a liquidation committee operate?
(1) Compulsory liquidation
(2) A members’ voluntary liquidation
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(3) A creditors’ voluntary liquidation
(4) Administration
a. (1) and (2)
b. (2) and (4)
c. (1) and (3)
d. (3) and (4)
Solution:
c. (1) and (3)
MEMBERS VOLUNTARY LIQUIDATION
Liquidation can commence by an ordinary resolution (if articles permit) or by a special resolution. The most
essential element of this liquidation is the declaration of solvency by the directors of the company.
STATUTORY DECLARATION
A declaration of solvency is a statutory declaration made by the directors of the company, to the Registrar, which
lists the assets and liabilities of a firm, and seeks the voluntary bankruptcy to show that the entity is capable of
repaying what it owes within 12 months. It is a criminal offence if a director makes a statutory declaration without
having reasonable grounds.
The declaration must be made not more than 5 weeks before the resolution to windup is passed and it must be
delivered to the registrar within 15 days after the meeting of the members in which the resolution of winding up is
passed.
The liquidator calls meetings of members:
i)
Within three months after each anniversary of the commencement of the winding up and should lay
before it an account of his transactions during the year.
ii)
When the liquidation is complete, to lay before it his final accounts.
Knowledge Test (ACCA Past Papers 2014)
Where directors make a false statement of solvency prior to a members’ voluntary liquidation, which of the
following have they committed under the relevant legislation?
a. A breach of criminal law with criminal penalties
b. A breach of civil law with criminal penalties
c. A breach of civil law with civil liability
d. A breach of both civil and criminal law with liabilities under both
Solution:
a. A breach of criminal law with criminal penalties
Knowledge Test:
Members of Kash Ltd want to voluntarily liquidate the company. However, creditors of Kash Ltd are particularly
concerned about the solvency of the company and if their debts will be paid or not. Advise Kash Ltd what steps it
should take to satisfy its creditors.
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Solution:
The directors of Kash Ltd must sign and present in the members meeting a declaration of solvency along with the
company’s financial statement o the effect that the company will be able to pay debts of the creditors within the
period of 12 months. After presenting that declaration in the meeting the members can pass a special resolution to
windup the company.
CREDITORS VOLUNTARY LIQUIDATION
The formal process of a Creditors Voluntary Liquidation means that an insolvent company can be closed in an
official and professional manner. If the directors fail to make a statutory declaration of solvency then the winding
up is converted into the creditors’ voluntary winding up. Where a voluntary liquidation proceeds by way of
creditor's voluntary liquidation, a liquidation committee may be appointed.
Procedure:
 Directors convene a general meeting of members to pass a special resolution
 Creditors meeting must also be convened within 14 days of the members meeting.
Members in their meeting can:
a) Pass a resolution to windup the company
b) Appoint a liquidator
c) Appoint at least five of its representative to be part of the liquidation committee.
Creditors can appoint a liquidator of their choice in their meeting and their choice will prevail over the members’
choice. However, if the creditors decide not to appoint a liquidator then the members’ liquidator will continue in
the office.
Knowledge Test:
In which procedure does a liquidation committee operate?
(1) Compulsory liquidation
(2) A members’ voluntary liquidation
(3) A creditors’ voluntary liquidation
(4) Administration
a. (1) and (2)
b. (2) and (4)
c. (1) and (3)
d. (3) and (4)
Solution:
c. (1) and (3)
PRINCIPLE OF CENTREBINDING
The members’ liquidator will be in office for the interim period before the creditors decide to make their
appointment. This interim period has been exploited by the members through their liquidator for the purpose
known as centrebinding.
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Re CentreBinding ltd 1966: In this case the liquidator appointed by the members had disposed of the assets before
the creditors could make their appointment. The court held that the liquidator had the power to act from when he
was appointed until the creditors’ meeting and so could dispose of the company's assets in the meantime.
However, the powers of the members’ liquidator in the creditor’s winding up have now been restricted to:
i)
Taking control of the company’s property
ii)
Disposing of perishable goods
iii)
Doing things which are necessary for the protection of company’s assets.
 The member’s liquidator will require the leave of the court if he decides to perform any act other
than those listed above.
Knowledge Test:
The creditors of Lexi Ltd want to voluntarily liquidate the company. For that purpose members in their meeting
appointed Jack as the liquidator but creditors in their meeting appoint Alisa.
Select the correct option:
a. In a creditors liquidation members liquidator is appointed
b. Creditors choice of liquidator prevails in creditors liquidation
c. Members can veto creditors choice and appoint their own liquidator
d. If creditors and members choice conflict a third person is appointed
Solution:
b Creditors choice of liquidator prevails in creditors liquidation
Knowledge Test:
Creditors meeting is compulsorily to be held in:
a. Members voluntary liquidation
b. Creditors voluntary liquidation
c. Just and equitable winding up
Solution:
b. Creditors voluntary liquidation
COMPULSORY LIQUIDATION
A compulsory winding up is a winding up ordered by the court under s.122 IA 1986 and has to be distinguished
from the voluntary winding up procedures, either a members’ voluntary winding up or a creditors’ voluntary
winding up, neither of which involve the court action to initiate them.
The seven grounds under which a registered company may be wound up by the court under s.122 Insolvency Act
1986 (IA), are as follows:
(i)
The company has passed a special resolution that it be wound up by the court;
(ii)
It is a public company which has not within a year since its registration obtained a trading certificate with
the share capital requirements;
(iii)
It is an ‘old public company’ which has failed to re‐register;
(iv)
It has not commenced business within a year from its incorporation or has suspended its business for a
whole year;
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(v)
(vi)
(vii)
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(except in the case of a private company limited by shares or by guarantee) the number of members is
reduced below two;
The company is unable to pay its debts;
The court is of the opinion that it is just and equitable that the company should be wound up.
 The most common of these grounds are (vi) and (vii).
 If for any reason the members of the company no longer wish to continue the business they will use
(i).
Following are the statutory reasons for Compulsory liquidation:
i)
122(1)(f)
Company is unable to pay its debts
The creditor, in order to establish that the company is unable to pay its debts, must prove by one of the following
three ways mentioned under Section 123:
a)
If a company with a debt exceeding £750 fails to pay it within 21 days of receiving a written demand from
the creditor and the company neglects it, then it is deemed unable to pay its debts.
b)
Court has passed a judgment in favor of the creditor and against the company and the creditor is unable
to enforce the judgment because the company has no assets to satisfy the judgment.
If the creditor satisfies the court that the company’s assets are less than its liabilities and the company is
c)
unable to pay its debts as they fall due.
ii)
122(1)(g)
It is just and equitable to windup the company:
 A discontented member can apply to the court to windup the company on just and equitable
grounds.
 A member in order to obtain the judgment in his favor must satisfy the court that no other remedy is
available and this option has been used as a matter of last resort.
Re German Date Coffee 1882: The Company was formed only with the objective to acquire German patent for the
production of coffee. Unfortunately the patent was not obtained and the company started to manufacture coffee
with substitutes. It was held that the company be wound up on just and equitable grounds as the purpose for
which the company was formed was no longer pursued.
Knowledge Test:
A Ltd owes 900 pounds to Alex. Alex has been demanding the money since a long time but has been
unsuccessful. Advise Alex what course of action he can adopt to recover his money from A Ltd?
Solution;
If a company owes creditor more than 750 pounds then the creditor can bring proceedings for compulsory
liquidation against the company under sec 122(1) (f). However, Alex will first have to serve upon the company a
notice of 21 days demanding his money and if the company fails to respond to that then proceedings of
compulsory liquidation can be initiated against the company under sec 122(1)(f).
Knowledge Test:
Alex and Alan are the major shareholders and directors of Feefa Ltd. However, they have not been havin a cordial
relationship. There exists a lot of mistrust between them and so much so that they have not been on talking terms
aswell. Alex has also recently filed a case of fraud against Alan. James a shareholder in the company is particularly
concerned and seeks your advise as to what he can do in the prevailing situation?
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Solution:
James has the option to initiate compulsory liquidation of the company on just and equitable grounds under sec
122(1)(g) if he satisfies the court that there is no other remedy available and this petition is being presented as a
matter of last resort. left
CONSEQUENCES OF COMPULSORY LIQUIDATION
Following are the consequences of compulsory liquidation:
i)
The winding up is deemed to have started on the date the petition was presented.
ii)
Any disposition of the company’s property and any transfer of its shares after that date is void.
iii)
After commencement of liquidation process all the existing legal proceedings against the company are
halted.
iv)
Floating charge crystallizes into fixed charge.
v)
The employees are also dismissed automatically.
vi)
Management powers are vested with the liquidator.
vii)
The official receiver becomes liquidator.
viii)
The company’s property may not be seized by creditors;
ix)
No action can be taken against the company or its property without leave of the court;
x)
The directors are dismissed;
Knowledge Test (ACCA Past Papers 2014)
Which of the following is NOT an automatic consequence of a compulsory winding up order against a public limited
company?
a. Transfers of shareholdings are suspended
b. Liquidation is deemed to start on the date of the issuing of the order
c. Directors cease to exercise any management power
d. Employees are immediately dismissed
Solution:
b. Liquidation is deemed to start on the date of the issuing of the order
INVESTIGATION POWERS OF THE OFFICIAL RECEIVER
He can investigate the:
i)
The main causes of the company’s failure
ii)
Business dealing of the company
If he finds any irregularities, he can report the same to the court and he can:
a) Require public examination of the alleged persons
b) Apply to the court for public examination where half the creditors or three quarters of the shareholders
request.
MODE OF PAYMENTS AFTER LIQUIDATION
The liquidator after liquidation follows the following order in distributing the assets of the company:
i)
Costs: Liquidator’s salary and liquidation .costs
ii)
Preferential Debts: Employees wages, benefits etc.
iii)
Debts secured by floating charges
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iv)
v)
vi)
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Debts owed to unsecured ordinary creditors
Deferred debts: Interest accrued and dividends declared but not paid
Members:
Any surplus left is distributed to the members
Note: Official receiver can also apply to the registrar for an early dissolution of the company, if its realizable assets
will not cover his expenses and no further investigation is required.
Knowledge Test:
Select what kind of winding up it is:
a. Creditors have appointed a liquidator
b. A declaration of solvency has been presented
c. The employees of the company have been dismissed
Solution:
a. Creditors voluntary winding up
b. Members voluntary winding up
c. Compulsory winding up
ADMINISTRATION
Administration, on the other hand, is a means of safeguarding the continued existence of business enterprises in
financial difficulties, rather than merely ensuring the payment of creditors. Administration was first introduced in
the IA 1986. The aim of the administration order is to save the company, or at least the business, as a going
concern, by taking control of the company out of the hands of its directors and placing it in the hands of an
administrator. Alternatively, the procedure is aimed at maximizing the realized value of the business assets.
Once an administration order has been issued, it is no longer possible to commence winding up proceedings
against the company or enforce charges, retention of title clauses, or even hire‐purchase agreements against the
company.
Methods of Initiating Administration
A company can be brought into administration by the followings methods:
i)
Administration with the court order
ii)
Administration without a court order
ADMINISTRATION WITHOUT THE COURT ORDER
An application to the court for an administration order may be made by a company, the directors of a company, or
any of its creditors, but in addition the Enterprise Act allows the appointment of an administrator without the
need to apply to the court for approval.
Such ‘out of court’ applications can be made by the company or its directors, but may also be made by any floating
charge holder.
Following persons can appoint an administrator without a court order:
a) Floating charge holders
b) Directors
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c)
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Company
a) Floating Charge Holders
By virtue of the Enterprise Act 2002, which amends the previous provisions of the Insolvency Act 1986,
floating charge holders no longer have the right to appoint administrative receivers, but must now make use
of the administration procedure as provided in that Act. As compensation for this loss of power the holders of
floating charges are given the right to appoint the administrator of their choice.
A floating charge holder can appoint an administrator if:
i)
He has given a two day notice to other floating charge holders
ii)
His charge is enforceable
Upon the expiry of two day notice period, the floating charge holder will have to submit a list of documents in
the court such as notice of appointment of administrator, his statement of consent and statutory declaration
that he qualifies for the appointment.
b) Company and Directors
Company or its directors can appoint an administrator if the following exist:
a) Company has been subject to moratorium since last 12 months
b) The company is likely to be unable to pay its debts
c) Company is not in liquidation
d) No administrator or receiver has already been appointed
e) Neither petition for winding up or administrative order has been made nor any order of winding up or
administration in respect of the company has already been obtained.
Company or its directors in order to appoint an administrator out of court must give a notice to the floating
charge holder having a right to appoint an administrator.
ADMINISTRATION WITH A COURT ORDER
The following persons can apply to the court for an administrative order:
a) Company (Ordinary Resolution)
b) Directors
c) Creditors
d) Justice and chief executive of the Magistrates Court due a default committed by the company on payment of
the fine imposed by the court.
Administrative order is granted by the court on the following grounds:
a) Company is unable to pay its debts
b) Administrative order is likely to achieve the purpose of administration
Knowledge Test:
Which of the following requires court approval before the appointment of an administrator?
a. Creditors
b. Holders of floating charges
c. The directors of the company
d. The company itself
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Solution:
a. Creditors
CONSEQUENCES OF ADMINISTRATION
Administration has the following effects on the company:
a) Management powers are granted to the administrator
b) Moratorium over the debts of the company
c) Any pending petitions of winding up are dismissed
Permission of the court is required for the following:
a) To enforce a security over the property of the company
b) Initiation or continuation of legal proceedings against the company
c) To repossess the goods held under hire purchase
d) To conduct forfeiture by the landlord by peaceable entry
Procedure to be followed after appointment:
The administrator after his appointment has the following legal duties to perform:
a) Publish notice of his appointment and also send it to the company
b) Notify all the creditors
c) Within 7 days of his appointment send notice of appointment to the registrar
d) Request a statement of affairs which must be provided within 11 days of the request
e) All the business documents of the company must bear the name of the administrator
f) He must manage all the affairs of the company
g) Prepare his proposals and send the same to the registrar and to the creditors
The administrator must within 8 weeks set out his proposals for saving the company. He must call a meeting of the
creditors within 10 weeks of his appointment to approve the proposals.
FUNCTIONS OF THE ADMINISTRATOR
The main aim of the administrator is to:
a) Rescue the company as a going concern, or
b) Achieve a better result for the company’s creditors as a whole than would be likely if the company were to be
wound up, or
c) Realize the value of the property in order to make a distribution to the secured or preferential creditors.
The administrator is only permitted to pursue the third option where:
1. He thinks it is not reasonably practicable to rescue the company as a going concern, and
2. Where he thinks that he cannot achieve a better result for the creditors as a whole than would be likely if the
company were to be wound up, and
3. If he does not unnecessarily harm the interests of the creditors of the company as a whole.
POWERS OF THE ADMINISTRATOR
During the administration process the administrator has the powers to:
 do anything necessary for the management of the company
 remove or appoint directors
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


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pay out monies to secured or preferential creditors without the need to seek the approval of the court
pay out monies to unsecured creditors with the approval of the court
take custody of all property belonging to the company
Dispose of company property. This power includes property which is subject to both fixed and floating
charges, which may be disposed of without the consent of the charge holder, although they retain first call
against any money realized by such a sale.
TENURE OF ADMINISTRATOR
The administration period is usually 12 months, although this may be extended by six months with the approval of
the creditors, or longer with the approval of the court.
Following can also bring an end to the administrator’s tenure:
a) Purpose of administration has been achieved. A notice to this effect is sent to the creditors, the court and the
companies registry.
b) Period of 12 months has elapsed
c) Ulterior motive of the administration has been discovered
d) A creditor petition’s in the court to end the administration
e) If the administrator forms the opinion that none of the purposes of the administration can be achieved, the
court should be informed and it will consider ending the appointment.
Knowledge Test:
Alex has been appointed as administrator of the Gash Ltd. Alex seeks your advise for the following:
a. The creditors of the company wish to initiate legal proceedings for compulsory winding up of the company
b. Alex wants to sell an asset of the company having a floating charge
c. How much time will Alex have to revive the company as a going concern.
Solution:
a. Creditors cannot initiate winding up once company is in administration
b. Alex can sell the charged asset having floating charge
c. 12 months
ADVANTAGES OF ADMINISTRATION
1.
2.
3.
4.
5.
6.
7.
It keeps the company alive.
It provides an opportunity for the company to revive its business
It buys company time from the creditors
It prevents any person to petition in the court for compulsory liquidation
During the process of administration the members continue to hold shares in the company
Creditors can also petition in the court for administration
Floating charge holders can also appoint an administrator without applying to the court
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Chapter
19
Fraudulent Behaviour
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IN THIS CHAPTER
INSIDER DEALING
MARKET ABUSE
MONEY LAUNDERING
MONEY LAUNDERING REGULATIONS 2017
BRIBERY
DEFENCE OF ADEQUATE PROCEDURES
OFFENCES IN RELATION TO WINDING UP
OFFENCES IN RELATION TO MANAGEMENT AND OPERATION OF COMPANY
FRAUD ACT 2006
CRIMINAL FINANCES ACT 2017
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INSIDER DEALING
Definition:
Insider dealing is dealing in shares, on the basis of access to unpublished price sensitive information. Such activity
is unlawful and is governed by part V of the Criminal Justice Act 1993 (CJA).
Elements of the offence of insider dealing:
Under s.52 of the Criminal Justice Act (CJA) 1993 an individual is guilty of insider dealing if
I)
He encourages another person to deal in securities that are price‐affected securities on a regulated
market OR
II)
He deals in securities that are price‐affected securities on the regulated market OR
III)
He discloses the information, otherwise than in the proper performance of the functions of his
employment, office or profession, to another person.
Following is the explanation of the above mentioned elements:
i)
Section 54 specifically includes shares amongst the securities
ii)
Dealing is defined in s.55, as acquiring or disposing of securities, whether as a principal or agent, or
agreeing to acquire securities.
Inside Information:
Section 56 defines ‘inside information’ as:
(i)
Relating to particular securities;
(ii)
Being specific or precise;
(iii)
Not having been made public; and
(iv)
Being likely to have a significant effect on the price of the securities.
Who is an insider?
Section 57 states that a person has information as an insider only if they know it is inside information and they
have it from an inside source and covers those who get the inside information directly through either:
(i)
being a director, employee or shareholder of an issuer of securities ( primary insider); or
(ii)
having access to the information by virtue of their employment, office or profession.
 If a person receives information either directly or indirectly from the primary insider, that person is
called a secondary insider.
Defences to insider dealing:
I)
There existed no expectation of profit or loss
II)
The information had been disclosed widely enough
III)
The transaction would have taken place regardless of the information received.
Information made public?
i)
If it is published in the regulated market
ii)
If it is part of the public records
iii)
If it can be readily acquired by any person from the general public
Penalty for Insider Dealing:
On indictment the penalty is an unlimited fine and/or a maximum of seven years imprisonment.
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Knowledge Test:
Alex has recently been able to get hold of price sensitive information regarding a merger of a company which is to
take place next month. Alex received this information from his close friend Adam a director.
Is he guilty of insider dealing?
a. Not guilty, because the director’s information will be widely circulated in the market
b. will be guilty as the information is not widely circulated in the market
c. No, but the director could be
Solution:
b. will be guilty as the information is not widely circulated in the market
MARKET ABUSE
In essence, market abuse may occur when investors have been unreasonably disadvantaged, directly or indirectly,
by others who:

have used information that is not publicly available to trade in financial instruments to their advantage
(insider dealing);

have distorted the price‐setting mechanism of financial instruments; or

have disseminated false or misleading information
Directors can also be held personally liable for the public announcements made by them. (R v Bailey)
Knowledge Test:
John is a major supplier of rice in the market. John in order to the price stopped supplying rice in the market
causing the demand of the same to rise in turn causing a self manipulated rise in price of rice. John is held guilty of
Market abuse.
What kind of offence he will be liable to:
a. Criminal law only
b. Civil law only
c. Criminal and civil la
Solution:
b. Civil law only
MONEY LAUNDERING

Money laundering refers to the attempt to disguise the origin of money acquired through criminal activity in
order to make it appear legitimate. The aim of the process is to disguise the source of the property, in order to
allow the holder to enjoy it free from suspicion as to its source.

Sec 3 of the Criminal Justice Act: defines criminal property as any property which the person knows or has
suspicion that it relates to a criminal conduct.
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Criminal Offences in the Proceeds of Crime Act 2002
Money laundering was first made a criminal offence in the United Kingdom under the Drug Trafficking Offences Act
1986 and is now regulated by the Proceeds of Crime Act 2002, and the Money Laundering Regulations 2007
together with the specifically anti‐terrorist legislation, such as the Prevention of Terrorism Act 2005.
The Proceeds of Crime Act 2002 seeks to control money laundering by creating three categories of criminal
offences in relation to the activity.
i)
Laundering:
The first category of principal money laundering offences relates to laundering the proceeds of crime or
assisting in that process and is contained in ss.327–329. Under s.327, it is an offence to conceal, disguise,
convert, transfer or remove criminal property from England and Wales, Scotland or Northern Ireland.
Concealing or disguising criminal property is widely defined to include concealing or disguising its nature,
source, location, disposition, movement or ownership or any rights connected with it. These offences are
punishable on conviction by a maximum of 14 years imprisonment and/or a fine.
ii)
Failure to report:
The second category of offence relates to failing to report a knowledge or suspicion of money laundering
and is contained in ss.330–332. Under s.330 it is an offence for a person who knows or suspects that
another person is engaged in money laundering not to report the fact to the appropriate authority.
However, the offence only relates to individuals, such as accountants, who are acting in the course of
business in the regulated sector. The offences set out in these sections are punishable, on conviction by a
maximum of five years imprisonment and/or a fine.
iii)
Tipping off:
The third category of offence relates to tipping off and is contained in s.333, which makes it an offence to
make a disclosure which is likely to prejudice any investigation under the Act. The offences set out in
these sections are punishable on conviction by a maximum of five years imprisonment and/or a fine.
Every person who has knowledge of money or laundering or suspects the same must report it to the
Money Laundering Reporting Officer or to Serious Organized Crime Agency.
Process of Money laundering:
The process usually involves three distinct phases:
i)
Placement is the initial disposal of the proceeds of criminal activity into apparently legitimate business
activity or property.
ii)
Layering involves the transfer of money from business to business, or place to place in order to conceal
its initial source.
iii)
Integration is the culmination of the previous procedures through which the money takes on the
appearance of coming from a legitimate source.
THE MONEY LAUNDERING REGULATIONS 2017
The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations
replaced the Money Laundering Regulations 2007 with updated provisions that implement in part the EU Fourth
Money Laundering Directive, which in turn applied the latest Financial Action Task Force (FATF) standards.
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The FATF is an inter‐governmental body that sets the international standards for combating money laundering,
terrorist financing and other related threats to the integrity of the international financial system.
Scope
The regulations apply to financial institutions and gatekeepers’ to the financial system. It therefore covers
accountants, auditors, legal advisers and tax advisers. Essentially, those covered by MLR 2017 remain the same as
under the previous rules. However, it should be noted that the 2017 regulations have raised the base level for their
general application from £64,000 to £100,000.
Regulation 4 also makes it clear that where a relevant person (i.e. one covered by the regulations) is asked to form
a company for a customer that is to be treated as a business relationship for the purpose of the regulations,
whether or not the formation of the company is the only transaction carried out for that customer.
High value dealers – ie any business or sole trader that accept or makes high value cash payments in exchange for
goods – remain covered by the regulations but the threshold for eligible transactions (either in one transaction or a
series of linked transactions) comes down from 15,000 to 10,000 Euro (reg 14).
Supervision and the risk‐based approach
A risk‐based approach, or risk‐management practices underpins all supervisory action. At the national level, this is
conducted by HM Treasury and the Home Office (reg 16). At the level of supervisory authorities responsible for the
oversight of particular sectors, they will be required to conduct an assessment of risk across the businesses sector
they regulate and take appropriate action, such as reviewing risk profiles at regular intervals, especially if
circumstances change (reg 17).
At the individual enterprise level, any relevant individual (ie one covered by the regulations no matter their legal
form) must make an assessment as to the risk of the likelihood of money laundering arising (reg 18) and is required
to keep an up‐to‐date record in writing of all the steps taken in this regard, unless its supervisory authority notifies
it in writing that such a record is not required. In making such an assessment, the following matters must be taken
into account:
(a) Information made available to them by the supervisory authority
(b) Risk factors including factors relating to:
(i) its customers
(ii) the countries or geographic areas in which it operates
(iii) its products or services
(iv) its transactions, and
(v) its delivery channels.
The regulations clearly recognise that the potential risk of money laundering taking place will depend on the size
and nature of the business and following the assessment of potential risk, the individual or business entity is
required to put into place: policies, controls and procedures to manage and mitigate the risks of money laundering.
The regulations allow for different strategies and approaches to be adopted by different enterprises, as long as
they are appropriate and proportionate to the potential risk. The individual/enterprise is required to regularly
review and update the policies, controls and procedures established and must maintain a record, in writing, of
those policies, controls and procedures (reg 19).
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Internal controls
These matters are governed by regulation 21 to the following effect:
(1) Officer responsible for compliance
Where appropriate with regard to the size and nature of its business, a relevant person must appoint one
individual who is a member of the board of directors or of its senior management as the officer responsible for
the relevant person’s compliance with the regulations. This person bears the tile money laundering
compliance principal (MLCP). This role is distinct from the existing role of money laundering reporting officer
(MLRO) who is the person nominated to receive internal suspicious activity reports and who assesses whether
a suspicious activity report should be made to the National Crime Agency (NCA)) However, where this person
is sufficiently senior in the management structure they can combine the roles and functions of MLCP and
MLRO. Sole practitioners with no employees are obviously not bound by this requirement.
(2) Screening of relevant employees
Again, where appropriate to the size and nature of the business, a relevant person is required to assess the
skills, knowledge, conduct and integrity of those employees who are involved in identifying, mitigating,
preventing or detecting money laundering in the course of business.
(3) Training
Regulation 24 requires a relevant person to ensure that its relevant employees are:
a)
i.
Made aware of the law relating to money laundering and terrorist financing, and to the requirements
of data protection, which are relevant to the implementation of these regulations
ii.
Regularly given training in how to recognise and deal with transactions and other activities or
situations which may be related to money laundering or terrorist financing;
b) Maintain a record in writing of the measures taken under sub‐paragraph (a), and in particular, of the
training given to its relevant employees.
Application of customer due diligence (CDD)
Where required under regulation 27, customer due diligence must be carried in all circumstances and the
following steps must be taken (reg 28):
a) Identify the customer unless the identity of that customer is known to, and has been verified by, the relevant
person
b) Verify the customer’s identity unless the customer’s identity has already been verified by the relevant person,
and
c) Assess, and where appropriate obtain information on, the purpose and intended nature of the business
relationship or occasional transaction.
Where the customer is a body corporate, the relevant person must obtain and verify:
i. The name of the body corporate
ii. Its company number or other registration number
iii. The address of its registered office, and if different, its principal place of business;
The Regulations, however, recognise that, depending on their circumstances, individuals and businesses will not
need to apply the same levels of due diligence to ensure money laundering is not taking place. Consequently they
introduce two levels of due diligence based on the level of perceived risk:
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(1) Simplified due diligence (SDD under reg 37)
This arises where the regulations require the performance of CDD, but the object of the CDD complies with a
prescribed list of low risk factors, including such factors as whether the customer:
(i)
Is a public administration, or a publicly owned enterprise
Is an individual resident in a geographical area of lower risk
(ii)
(iii)
Is a credit institution or a financial institution which is otherwise appropriately regulated or
supervised?
(2) Enhanced due diligence (EDD) (reg 33)
Regulation 33 establishes a list of situations where EDD must be applied by the relevant person. Among these
are the following:
 Where there is a high risk of money laundering or terrorist financing
 In any business relationship with a client established in a high‐risk third country
 If the client is a politically exposed person (pep)
 In cases involving transactions that are complex and unusually large, or where there is an unusual pattern
of transactions that have no apparent economic or legal purpose.
When assessing whether there is a high risk of money laundering in a particular situation, and the extent of the
measures which should be taken to manage and mitigate that risk, relevant persons must take account of risk
factors including, among other things:
a) Customer risk factors, including whether:
(i) The business relationship is conducted in unusual circumstances
(ii) The customer is resident in a geographical area of high risk (see sub‐paragraph (c))
(iii) The customer is a legal person or legal arrangement that is a vehicle for holding personal assets
(iv) The customer is a company that has nominee shareholders or shares in bearer form
(v) The customer is a business that is cash intensive
(vi) The corporate structure of the customer is unusual or excessively complex given the nature of the
company’s business
b) Product, service, transaction or delivery channel risk factors, including whether:
(i) The product involves private banking
(ii) The product or transaction is one which might favour anonymity
(iii) The situation involves non‐face‐to‐face business relationships or transactions, without certain safeguards,
such as electronic signatures
(iv) Payments will be received from unknown or unassociated third parties
(v) New products and new business practices are involved, including new delivery mechanisms, and the use
of new or developing technologies for both new and pre‐existing products
(vi) The service involves the provision of nominee directors, nominee shareholders or shadow directors, or
the formation of companies in a third country
c)
Geographical risk factors, including:
(i) Countries identified by credible sources, such as mutual evaluations, detailed assessment reports or
published follow‐up reports, as not having effective systems to counter money laundering or terrorist
financing
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(ii) Countries identified by credible sources as having significant levels of corruption or other criminal activity,
such as terrorism (within the meaning of s1 Terrorism Act 2000(86)), money laundering, and the
production and supply of illicit drugs
(iii) Countries subject to sanctions, embargos or similar measures issued by, for example, the European Union
or the United Nations.
If risk assessment identifies the need for EDD, then the following measures MUST be taken:
 To understand as far as reasonably possible the background and purpose of the transaction, and
 To increase the degree and nature of monitoring of the business relationship to determine whether the
transaction or business relationship are suspicious.
Reliance and record keeping
Reliance on a third party (reg 39)
A relevant person may rely on an appropriate third party’s due diligence measures, but the relevant person
remains liable for any failure in the third party’s application of such measures.
Records (reg 40)
Any relevant person must keep the records, such as a copy of any documents and information obtained by the
relevant person to satisfy the customer due diligence requirements for a period of five years.
The controls and procedures of a firm must include monitoring and management of compliance with, and the
internal communication of the above policies, controls and procedures.
Information and investigation
Part 8 of the regulations gives supervisory authorities the powers to monitor businesses operating in their sectors
effectively. Part 9 empowers them to take appropriate action if needed such as imposing civil penalties, fines or
statements relating to relevant persons under their authority.
The Office for Professional Body Anti‐Money Laundering Supervision (OPBAS)
The office is a new regulatory body with the general oversight pf the supervisory anti‐money laundering regime
and the OPBAS has duties and powers to ensure the professional body anti‐money laundering supervisors meet
the standards required by the Money Laundering Regulations 2017. The OPBAS operates within the Financial
Conduct Authority with the stated aim of facilitating collaboration and information sharing between the
professional body anti‐money laundering supervisors, law enforcement and other statutory supervisory
authorities.
Knowledge Test:
The process in which the proceeds of criminal conduct are transferred from business to business in order to
conceal the original source is known as:
a. Placement
b. Layering
c. Integration
Solution:
b. Layering
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BRIBERY
Bribery is defined as ‘giving someone a financial or other advantage to encourage that person to perform their
functions or activities improperly or to reward that person for having already done so. So this could cover seeking
to influence a decision‐maker by giving some kind of extra benefit to that decision‐maker rather than by what can
legitimately be offered as part of a tender process.’ (Ministry of Justice Guide to the Bribery Act 2010)
There are four categories of offences of bribery under the Act:
(i) Offences of bribing another person (s.1 BA)
It is an offence to offer a financial or other advantage to another person to perform improperly a relevant
function or activity, or to reward a person for the improper performance of such a function or activity.
(ii) Offences relating to being bribed (s.2 BA)
It is an offence where a person receives or accepts a financial or other advantage to perform a relevant
function or activity improperly. ‘Relevant function or activity’ includes any function of a public nature, any
activity connected with a business, any activity performed in the course of a person’s employment, and any
activity performed by – or on behalf of a body of persons. The activity may be performed in a country outside
the UK.
(iii) Bribery of foreign public officials (s.6 BA)
It is an offence directly, or through a third party, to offer a financial or other advantage to a foreign public
official (FPO) to influence them in their capacity as a FPO, and to obtain relevant business, or an advantage in
the conduct of business. ‘FPO’ means an individual who holds a legislative, administrative or judicial position
of any kind outside the UK, or who exercises a public function outside the UK, or is an official or agent of a
public international organization.
(iv) Failure of commercial organizations to prevent bribery (s.7 BA)
It is an offence for a commercial organization (a UK company or partnership) if a person associated with it
bribes another person intending to obtain or retain business, or to obtain or retain an advantage in the
conduct of the business, for the organization. This could take place outside the UK. Section 8 defines
associated persons as someone who performs services for – or on behalf of – the commercial organization,
and, therefore, could be an employee, agent or subsidiary
Defences for bribery
If an individual is charged with bribery he can raise the following defences:
a) The act was of an intelligence agency
b) It was related to armed forces
DEFENCE OF ADEQUATE PROCEDURES
While s.7 makes it an offence for a commercial organization to fail to prevent bribery, it also provides a full
defence against any such allegation. Thus, a commercial organization will have a defence if it can show that
adequate procedures have been put in place to prevent persons associated with it from engaging in bribery. This
defence also serves the purpose of ensuring that commercial organizations have developed procedures to prevent
bribery.
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Although no definition of ‘adequate procedures’ is provided, Ministry of Justice guidance indicates six principles
which underpin the defence of adequate procedures.
These principles are:
Proportionate procedures
The procedures taken by an organization should be proportionate to the risks it faces and the nature, scale and
complexity of its activities. A small organization would require different procedures to a large multinational
organization.
(i)
Top‐level commitment
The top‐level management should be committed to prevent bribery and foster a culture within the
organization in which bribery is unacceptable.
(ii)
Risk assessment
Organizations should assess the nature and extent of their exposure to risks of bribery, including potential
external and internal risks of bribery. For example, some industries are considered higher risk than others,
such as the extractive industries; some overseas markets may be higher risk where there is an absence of
anti‐bribery legislation.
(iii)
Due diligence
The organization should apply due diligence procedures in respect of persons who perform services for –
or on behalf of – the organization in order to mitigate bribery risks.
(iv)
Communication
The organization should ensure its bribery prevention policies and procedures are embedded and
understood throughout the organization through internal and external communication, including training,
proportionate to the risks it faces. Communication and training enhances awareness and helps to deter
bribery.
(v)
Monitoring and review
The organization should monitor and review procedures designed to prevent bribery and make
improvements where necessary. The risks an organization faces may change and, therefore, an
organization should evaluate the effectiveness of its anti‐bribery procedures and adapt where necessary.
The question of whether an organization had adequate procedures in place to prevent bribery is a matter
that will be determined by the courts by taking into account the circumstances of the case. The onus will,
however, be on the organization to prove it had adequate procedures in place. If an organization is
charged with bribery it can raise the defence that it had adequate procedures designed to prevent it.
Knowledge Test:
Which of the following can be categorized as an offence under the Bribery Act 2010?
(1) The CEO of a public office directly awarded a contract to Alex without complying with the necessary
requirements in return for the commission.
(2) Bribery is only a civil offence liable to fine
a. 1 only
b. 2 only
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c. Neither 1 nor 2
d. Both 1 and 2
Solution:
a. 1 only
Knowledge Test:
A Ltd was pursuing a major construction contract from the government. Jim its managing director paid bribe to
one of the officers in order to ensure the award of contract.
In terms of the Bribery Act 2010 who will be guilty of Jim’s act ?
(1) A ltd for failing to prevent bribery
(2) Jim for giving a bribe
a. 1 only
b. 2 only
c. Neither 1 nor 2
d. Both 1 and 2
Solution:
d. Both 1 and 2
OFFENCES IN RELATION TO WINDING UP
Following are the offences relating to winding up:
a. Declaration of Solvency: It is a criminal offence if a director makes a statutory declaration without having
reasonable grounds.
b. Fraudulent Trading: This offence is committed If the company has carried on its business with the intent to
defraud the creditors of the company. Fraudulent trading can also be a civil offence but it only applied if the
company is in liquidation.
c. Wrongful Trading: According to the Insolvency Act 1986, wrongful trading refers to companies that continued
to carry on their daily business trading insolvent, that is, unable to pay their debts as they fall due. It is usually
a case of hoping that things will improve even though they continue to spiral downward. In wrongful trading
there is no intent to defraud the company’s creditors but merely a case of poor judgment or the failure of
directors to carry out their responsibilities. A judgment of wrongful trading carries with it potential
disqualification as a director for up to 15 years, plus other financial fines and penalties. Being held personally
liable for company debts is also a possibility. Although not considered a criminal offence, wrongful trading is a
civil offence which is taken very seriously by the courts.
d. Director while being disqualified: A person who continues to act as a director even after being disqualified
under the company director disqualification Act 1986 will be personally liable for the company’s debts.
e. Phoenix Companies: A phoenix company is where the assets of one Limited Company are moved to another
legal entity. Often some or all of the directors remain the same and in some cases, the new company has the
same or a similar name to the failed business. The phoenix company will operate in the same sphere as its
predecessor. It is a criminal offence to create such a company within 5 years of the original company being
liquidated.
Knowledge Test:
James a director of Kross Ltd has been found guilty of wrongful trading by a court of competent jurisidiction.
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Select the consequences which James can face?
a. Fine
b. Imprisonment
c. Contribution to assets of Kross Ltd
d. Director cannot be held guilty of wrongful trading
Solution:
c. Contribution to assets of Kross Ltd
OFFENCES IN RELATION TO MANAGEMENT AND OPERATION OF COMPANY
a.
b.
c.
d.
e.
False Accounting: A person who falsifies or conceals information required for an accounting purpose knowing
that the information is misleading may commit an offence of false accounting.
Accounting Record: The CA 2006, s 386 sets out the duties of a company to keep accounting records. Section
387 makes it an offence for a company to fail to comply with any provision of section 386 and in those
circumstances the offence is committed by every officer of the company who is in default. It is a defence for a
person charged to show that he acted honestly and that in the circumstances in which the company's business
was carried on the default was excusable.
False Information: An offence is committed if a director's report containing the statutory statement is
approved but is false. Every director who either knew that the statement was false, or was reckless to as to
whether it was false and failed to take reasonable steps to prevent the report from being approved commits
the offence.
Filling of Accounts: If the company fails to file accounts after the end of its financial year then it will be liable
to fine.
Annual Return: Failure by the officers of the company to deliver the return on time will also be an offence
under the Company’s Act 2006.
FRAUD ACT 2006
The offence of fraud can be committed in three different scenarios:
a. False Representation: A person commits the offence of fraud by false representation if he dishonestly makes a
false representation and intends, by making the representation, to make a gain for himself or another, or to
cause loss to another, or to expose another to a risk of loss.
b. Failure to Disclose information: A person commits an offence of failing to disclose information if he
dishonestly fails to disclose information to another person information which he is under a legal duty to
disclose and he intends, by failing to disclose the information, to make a gain for himself or another, or to
cause loss to another, or to expose another to a risk of loss.
c. Abuse of Position: Fraud by abuse of position is committed where a person occupies a position in which he is
expected to safeguard, or not to act against, the financial interests of another person, and he dishonestly
abuses that position and intends, by means of the abuse of that position, to make a gain for himself or
another, or to cause loss to another, or to expose another to a risk of loss.
CRIMINAL FINANCES ACT 2017
Tax avoidance is legal while tax evasion is a criminal offence. There are a number of possible criminal offences
relating to tax evasion. Some of these are statutory and others are covered by the common law, such as offence of
cheating the public revenue, which applies to where someone engages in fraudulent conduct that tends to divert
funds from the public revenue.
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Such offences apply to the individual who actually engages in tax evasion, but third parties can also be held liable
for deliberately facilitating, another person’s tax evasion and, as with other criminal activity, a third party can be
charged with aiding and abetting the crime of tax evasion. Thus, if accountants deliberately assist in their client’s
tax evasion they will be potentially liable to a criminal charge. However, previously the criminal law did not extend
to the accountant’s employer – be that a firm (a partnership of whatever kind), or company – even in
circumstances where the employer organisation benefited from, or actually encouraged, the criminal action of the
individual accountant. Such loopholes have been closed by the Criminal Finances Act (CFA) 2017.
Relevant body and failure to prevent the facilitation of tax evasion
CFA 2017, s45 (1), creates the new offence of corporate failure to prevent the facilitation of tax evasion in
relation to UK taxes. This offence is committed by ‘a relevant body’ where ‘a person acting in the capacity of a
person associated with it’ commits a tax evasion facilitation offence – that is, criminally facilitates another’s
offence of tax evasion. CFA 2017 s46 creates the related offence of corporate failure to prevent the facilitation of
foreign tax evasion offences.
CFA 2017, s44, defines the terms used in s45. Thus, a ‘relevant body’ is defined in sub‐section (2) as any
corporation or partnership whether formed in the UK or elsewhere. Subsection (4) provides that a person ‘acts in
the capacity of a person associated with a relevant body’ if they are:
1. An employee acting in that capacity
2. An agent acting in that capacity, or
3. Any other person who performs services for or on behalf of that relevant body and acts in the capacity of a
person performing such services.
It should be noted that it is only the relevant body that can commit the new offence, although the individual
concerned may well be liable for the other offences mentioned above. Indeed, the associated person’s action must
be criminal under the existing law in order to trigger the new corporate offence. The width of application of s44
(4)(c) should also be emphasised; it will apply to any person providing a service for the relevant body, be that a
contractor, subcontractor or consultant. Thus, the organisations and corporations covered by the provision are to
be held to account for the actions of those who act on its part.
It is essential to note the precise nature of the new offence: it is not related to the positive action of the relevant
body, nor is the criminal action of the other parties imputed to it; rather the relevant body is potentially made
liable for a separate and distinct negative infringement, its failure to exercise the necessary degree of supervision
and control to prevent the occurrence of tax evasion. Thus, the new offence criminalises the relevant body’s failure
to prevent those who act on its behalf from criminally facilitating tax evasion.
Given the wise scope of the new offence it is open to the relevant body to defend its actions by showing that they
took the necessary steps to prevent the action of the person performing underlying criminal activity. Thus, CFA
2017 s45 (2) provides ground for the relevant body to avoid liability by proving that, when the tax evasion
facilitation offence was committed:
a) It had in place such prevention procedures as it was reasonable in all the circumstances to expect it to have in
place, or
b) It was not reasonable in all the circumstances to expect the relevant body to have any prevention procedures
in place.
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The stated aim of the provision is not to be excessively burdensome and consequently procedures to be adopted
by relevant bodies are only required to be reasonable – ie not excessively restrictive, but proportionate to the
danger of the criminal tax evasion taking place. Section 47 requires the Chancellor of the Exchequer to publish
guidance about the procedures that relevant bodies might put in place to ensure compliance with the ‘reasonable’
procedures. The Chancellor may also endorse guidance prepared and published by others, thus allowing for the
particular needs and/or risks arising within particular sectors of industry to be addressed appropriately.
One other important provision of the CFA 2017 that requires consideration relates to the legal form of the relevant
body. As stated, the new s45 offence applies to corporations and partnerships no matter their form (ie with or
without separate legal personality), but that provision raises procedural issues relating to ordinary – ie non‐
corporate, partnerships.
CFA s50 deals with the matter by providing for the prosecutions of such partnerships by applying to them the same
rules that apply to corporations. Section 50(1) states that: proceedings for an offence under sections 45 or 46
alleged to have been committed by a partnership must be brought in the name of the partnership (and not in the
name of any of the partners) and ss(3) provides that: a fine imposed on a partnership on its conviction for an
offence under section 45 or 46 is to be paid out of the partnership assets. Thus, an ordinary partnership is to be
treated ‘as if the partnership were a body corporate.’ (s50 2(a) and (b).
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