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Legal Issues in the Transfer of Contracts and Shareholder Claims

  • 13 Pages
  • Published On: 31-10-2023

Introduction

The current case involves issues concerning the transfer of the remaining contracts of Valhalla to Heimdall and whether such transfer is valid. In this regard, the issue will be regarding the rights of novation and its implication of the rights of the members of Valhalla and Valhalla. The case also shows that Loki, Thor, Freyja, Frigg and Balder are recorded as shareholders in the shareholders’ register, although except for Thor who has fully paid for his shares, the other shareholdings are unpaid. In this regard, this issue will be analysing the claims of Loki, Freyja, Frigg and Balder to determine whether they are shareholders or not. The case also shows that Valhalla is into liquidation. Based on the Companies Act 2006, Section 589, 581 and 582 and the Insolvency Act 1986, Section 74(1), Valhalla can call on the members to pay for the unpaid shares. The issue is to determine who amongst the listed individuals owes money for their shares.

A. What possible claims does Valhalla plc have?

1. Issues:

This issue is regarding the transfer by Loki of the last remaining contracts of Valhalla plc to Heimdall Ltd. In this regard, the later paragraphs will analyse the rights of Valhalla to prohibit or restrict the transfer of the existing contract of Valhalla to another when Valhala is in liquidation. In this context, the issues will also cover determining the transferability of the contract, the conflict of interests rules and the exceptions to the conflict of interests rul.

2. Rules

2.1. Novation and principle of agency

Novation occurs when the original contract between a party and another party is extinguished and replaced by the creation of a new contract between the party and a third party. Roger LeRoy Miller in Cengage Advantage Books: Business Law: The First Course - Summarized Case Edition (2014) writes that in novation, all the obligations and rights in the contract of an existing company will be transferred to another business.

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Some cases are referred here for better clarity. In Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd & Ors (2020), it was held that all parties must consent to the novation. In Habibsons Bank Ltd v Standard Chartered Bank (Hong Kong)(2010), it was held that the consent may be given in advance of the novation and that the consent must be clearly expressed. This means that the three parties must give a clear consent to the novation. Clear words must express the intention and the terms of the new contract. Unless these requirements are met, the novation cannot be enforceable. These rules are confirmed in Kakara Estate Ltd v Savvy Vineyards (2013), where the Court of Appeal held that consent must be there whether expressed or inferred and there must be consideration, including the form of mutual promises.

The question regarding the novation is whether it was entered with valid authority. In other words, whether Loki was authorised to bind Valhalla to the novation. Section 126 (1) empowers Valhalla to make, vary, ratify or discharge a contract and this power may be exercised by an individual authorised by Valhalla and on behalf of the company. Sections 128 and 129 provide the assumptions that can be made by outsiders. Such assumptions can be that a director or a company secretary of Valhalla is authorised to exercise the powers and perform the duties and that the director or the company secretary held out by Valhalla to be an officer or agent who is duly appointed and the authority to exercise the powers and perform the duties.

Further, the common law doctrine provides the principle of agency where the company (the principal) is bound by the contracts entered into by directors or officers of the company (agents). Peter Gillies, in Business Law, NSW : Federation Press (2004) writes that the agent must be an actual agent with actual power to enter into contract on behalf of the company. The agent may also be an ostensible agent expressly or impliedly authorised as was held in Panorama Developments (Guildford) Ltd. v Fidelis Furnishing Fabrics Ltd. (1971) where the company secretary entered into contracts on behalf of the company. A third party must have known and acted on such representation and the agent must have purported to act as the agent. This principle, however, does not apply if the third party acted thinking that the agent was the principal himself entering into the contract on his own account.

2.2. Conflict of Interest

Another aspect relevant with the issue here is regarding conflict of interest. The Companies Act 2006, Section 175(1) provides for fiduciary duties of the directors who are obligated to avoid a conflict of interest. In Bray v. Ford (1896), A was the vice-chairman of the Yorkshire College, of which the respondent was the vice-chairman. At the same time, A was also the solicitor to the college due to which he was receiving money. This contradicts A’s fiduciary duty as the vice-chairman. The court ruled that ‘a person in a fiduciary position is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict.’

Accordingly, based on Section 175(1), Loki “must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”.

The Companies Act 2006, Section 175(4), (5), and (6) provide for allowing conflict of interest.

The prohibition or transfer of shares must be for the best interests of the company. In Re Smith & Fawcett (1942), Mr. Smith and Mr. Fawcett were the directors and the only shareholders of the company. Fawcett expired. A new director was appointed. The new director refused to register Mr. Fawcett’s shares in the name of executor unless the executor sells half the shares to Mr. Smith. The articles of association allowed directors with their absolute and uncontrolled discretion, to refuse any transfer of shares. The court held that the restriction was to be exercised bonafide for the interest of the company. Similarly, in Boardman v Phipps (1967), Mr. Boardman was the solicitor of Philpps family trust and at the same time, he was in the fiduciary duty as the advisor to the Phipps family. The assets of the trust include a 27% holding in a company. Boardman and Tom Phipps purchased a majority shareholding in the company themselves without the consent of all the beneficiaries. They capitalised some of the assets and the company made a distribution of capital without reducing the shares values of the shares. The trust Boardman and Phipps benefitted. The court held that Boardman was on a fiduciary duty, and he should have held the profits on constructive trust for the beneficiaries. He did not do so, leading to a conflict of interests.

Section 175(4)(a) provides that if “the situation cannot reasonably be regarded as likely to give rise to a conflict of interest”, then the fiduciary duty is not infringed. This also means that even though there are restrictions, the transfer can be allowed if it is for the long-term good of Valhalla plc.

Alternatively, Section 175(4)(b) provides that the conflict of interest is allowed by the directors. This authorisation is effective where, as Section 175(5)(a) provides, Valhalla’s constitution does not invalidate the authorisation, and as Section 175(6)(a) and (b) provides, it is approved through a meeting and was agreed upon.

The approval of the conflict of interest has to pass a resolution. The Companies Act 2006, Sections 281-283 provide for the kinds of resolutions and voting rights. Thus, the majority shareholders with 75% can pass any resolution including a special resolution that could alter the articles of association. Majority shareholding with 50% can pass ordinary resolution. A shareholding with over 25% can block any special resolution. In the current case, unless the transfer of contract is not approved through a resolution, the transfer cannot be valid.

3. Application and Conclusion

3.1. Novation

Applying the rules to the current case, firstly in regard to novation, the facts of the case show that Loki took an unilateral decision to transfer the remaining contracts to Heimdall. Even where the consent of the two companies were present in the transfer of the contract, the issue is whether the consent by Loki can bind Valhalla. In this case, the facts do not show the Loki has been authorised to transfer the contracts. The question now is whether he acted as an ostensible agent.

Based on Sections 128 and 129, Heimdall could have assumed that Loki was authorised to make the transfer, or was the authorised officer or agent to bind Valhalla to the transfer. However, the facts of the case show that Valhalla plc’s sole director was Loki, which makes it clear the Heimdall entered into the contract of transfer thinking that Loki was the principal himself entering into the contract on his own account, and not as an ostensible agent expressly or impliedly authorised by Valhalla.

Hence, Valhalla can claim that the transfer is not valid.

According to market factor, for example, the environmental awareness of the modern people has been upgraded unceasingly, so customer or social media shows great attention to whether the corporation undertakes CSR to be environment-friendly or not. Thus, the corporations bear a lot of pressures.

3.2. Conflict of interest

The second consideration is regarding the conflict of interest. In this case, Loki has used the entire company’s funds of £13,000 were paid to Norn plc in the full and final settlement of their claim and costs. Due to the fiduciary duties under Section 175(1), Loki must ensure to avoid any situation in which he has a direct or indirect interest that could cause a conflict of interests of Valhalla.

In this case, Loki has transferred the last remaining contracts of Valhalla plc to Heimdall Ltd basing its claim on the ground that Valhalla in its current situation would not be able to complete the contracts and the transferring would prevent Valhalla plc from breaching the contract.

The transfer has breached the conflict of interest rules.

  1. Firstly, the transfer is not an appropriate action given that Valhalla is at a phase with no capital and requires all resources to revive.
  2. Secondly, Loki is appointed a director of Heimdall, which makes the transfer violate Section 175(1). The transfer has created a situation in which he has a direct interest that conflicts with the interests of the Valhalla.
  3. Thirdly, the transfer is not benefitting Valhalla, which does not have any funds remaining after paying off its entire funds of £13,000 to Norn.
  4. Fourthly, the facts of the case do not show that transfer is approved through the required quorum, as per the requirement of resolution provided under Section 281-283.

Hence, Valhalla can claim that the transfer is against the fiduciary duties of Loki and it leads to conflict of interests to invalidate the transfer.

B. Who are the company’s shareholders?

The question in this case is whether Loki, Thor, Freyga, Frigg and Balder qualify as shareholders of the company. The later paragraphs will deal with paid or unpaid shares or payment or non-payment of the shares allotted to determine whether the parties mentioned here are shareholders.

Before determining who the shareholders are in Valhalla , it is important to note the threshold that qualifies whether any of the listed individuals is a shareholder.

A shareholder can be a person, company, or institution owning shares in a company's stock. Section 558 provides that shares are allotted ‘when a person acquires the unconditional right to be included in the company's register of members’. In other words, the person’s names and other particulars delivered to the registrar and registered in respect of the shares. In the current case, all of them are registered as shareholders of Valhalla in the company’s shareholder register. As such, they must all be considered as shareholders. However, the facts show that each of them have different claims as to them being a shareholder of the company. In this regard, the later paragraphs will deal with them to determine whether Loki, Thor, Freyga, Frigg and Balder are shareholders.

1. Sweat equity - Loki

In this case, Loki states that he receives his shares as sweat equity.

A company can issue sweat equity where the recipient can be involved as a shareholder. As written by Dean A. Shepherd and Evan J. Douglas, Attracting Equity Investors: Positioning, Preparing, and Presenting the Business Plan (1999) and by Modwenna Rees-Mogg, Crowd Funding: How to Raise Money and Make Money in the Crowd (2013), sweat equity are given for unpaid work including their efforts, know-how, IP rights or value additions.

In case of recipients of sweat equity, who the company desires to involve them as shareholders, Stuart F. Bollefer and Jack Bernstein in Shareholders' Agreements: A Tax and Legal Guide. (2009) write that they can be involved in the day-to-day operations of the company. Thus, their shares can have certain rights as those of a shareholder, such as rights to attend meetings, vote, and dividends among others.

Shareholders usually pay for the shares they are issued. Section 582 provides the rules of payment. The issue of sweat equity involves payment for services by shares. This is related with could Section 582(1), which states that shares may be paid in money or money's worth, which may include goodwill and know-how.

In the current case, Loki was the sole director of Valhalla. This means that he was the sole member to be responsible for the company’s operation, management and decision making to that effect. Therefore, the sweat equity allotted to him is that of a shareholder making him responsible and entitled to the right to vote and make decisions on behalf of the company. Thus, Loki is a shareholder.

2. Shares for receiving dividends - Frigg

In case of Frigg, she claims that she bought the shares in exchange for two years’ worth of dividends from Valhalla plc. Basically, a shareholder could be a preferred shareholder. and they do not have any voting rights. They received a fixed annual dividend. This financial return is likely to be the most important. The holders of such shares are not entitled to vote and cannot influence decisions made at the shareholder and general meetings. Thus, Lord Macnaghten in Birch v Cropper (1889) stated that preference shareholders ‘must be treated as having all the rights of shareholders, except so far as they renounced these rights on their admission to the company.’

3. Paid Shares - Thor

Thor is the only shareholder who has paid for his share.

It is to be noted that a shareholder could be a common shareholder who owns a company’s common or ordinary stock and so is entitled to the right to vote on matters concerning the company. They have control over how the company is managed and can take corrective legal action in case of any wrongdoing that may harm the company.

In this regard, since Thor owns 13,000 ordinary shares for which he has paid £13,000, he is a common shareholder.

4. Doctrine of mistake and shareholding - Freyja

Freyja relies on the doctrine of mistake to set aside the contract regarding the allotment of shares as ‘she knows now that buying the shares was a bad business deal’.

The doctrine of mistake in contract law encompasses both mistakes of law and mistakes of fact. Based on what John Cartwright, in his book Misrepresentation, Mistake and Non-disclosure

By John Cartwright (2012), there are broadly three types of mistakes of fact. The first is the common mistake where parties make the same mistake because of a shared misconception of the fact. The second is the unilateral mistake, where a party makes a mistake, and the other party knows about the mistake. The third is a mutual mistake where the parties have a genuine misunderstanding regarding purposes of the contract.

Chris Turner in Unlocking Contract Law (2013) writes that in mutual mistake, the parties make a mistake, but they are not the same. Lord Westbury, in Cooper v Phibbs (1867) noted that if such a mistake occurs as to the parties’ relative and respective rights, the agreement can be set aside as having entered upon a common mistake. In Raffles v Wichelhaus (1864), it was ruled that if there was no consensus ad idem, there is no binding contract. Thus, where a contract is formed on the basis of a mistake as to the facts, the contract can be void from its inception.

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Mistake as to quality is the most common form of common mistake. In Bell v Lever Bros (1932), Lord Atkin stated that if the mistake is by both the parties as to some quality that “makes the thing without the quality essentially different from the thing it was believed to be”, then the contract can be held void.

Applying the rules in Freyja’s case, her reliance on the doctrine of mistake cannot hold as her situation does not come under any of the three mistakes discussed here. Her explanation as to why she does not need to pay for her share shows that she ‘now knows buying the shares was a bad business deal.’ The word “now” is important here as during the share allotment, she was not mistaken about the shares. There was no mistake as to her rights and she did not know buying the shares was a bad deal at the time she was recorded as a shareholder. It is only now due to the financial position of the company that she claims it was a mistake. Hence, this mistake cannot be related to recording her as a shareholder. The share registry evidences this record.

Hence, Freyja is a shareholder.

5. Valueless shares - Balder

The issue is related to whether the shares allotted to him are adequate consideration for Balder for his shares in the company.

In this case, Balder has not paid for his shares claiming that they are valueless and cannot be a valuable consideration. This raises the question of enforceability of the consideration, which is the unpaid share. In Currie v Misa (1875), a valuable consideration was defined as consisting of ‘some right, interest, profit, or benefit accruing to the one party, or some forbearance, detriment, loss, or responsibility given, suffered, or undertaken by the other.’ James C. Fisher in Contract Law in England and Wales (2018) writes that the promise cannot enforce the promise unless they provide valuable consideration in return for the promise. Thus, consideration requires at least the form of a present or future exchange. A mere wish to confer a benefit cannot be enforced.

A consideration must have some minimum content. Mindy Chen-Wishart in Contract Law (2012) writes that a promisor will have a motive for making a promise, which is only enforceable when the motive can be construed as obtaining something valuable.

In the case, the company has received zero consideration for the unpaid shares from Balder. Balder’s claim that ‘the shares are valueless they cannot constitute valuable consideration’ shows that there is no minimum content in that there was no potential future exchange when he was allotted the shares. This means Balder did not possess any motive of paying the shares or obtaining certain rights in the company through the shares allotted. Thus, the unpaid shares are not valuable consideration in regard to Balder.

Hence, Balder is not a shareholder as his unpaid shares do not constitute a valuable consideration.

6. Conclusion

Loki, Thor, Freyja, and Frigg are shareholders. Balder is not a shareholder.

C. Who owes money for their shares?

The above sections show that Loki, Thor, Freyja, and Frigg are shareholders. Except for Thor, the others have not paid for their shares.

According to Section 589, 581 and 582, a company may also allow members to partly pay or pay at a later date. The articles of association and a shareholders’ agreement, if any, will provide for when the shares have to be paid up. The payment could be during incorporation; upon allotment; in the future, whether the date is specified or not; on a payment demand or call-in case of financial difficulty; or in case of winding up of the company. If a member receives the shares but has not paid the required nominal value and the premium, those shares are unpaid. Thus, for any unpaid shares, they need to be paid at some specified date or if the company goes into liquidation.

In this case, Valhalla is in liquidation and hence it can call for payment of the unpaid shares.

The Insolvency Act 1986, Section 74(1) provides that in the event a company is wound up, every present and past member must ‘contribute to its assets to any amount sufficient for payment of its debts and liabilities, and the expenses of the winding up, and for the adjustment of the rights of the contributories among themselves'.

Section 74(2)(d) of the Insolvency Act 1986 states that ‘no contribution is required from any member exceeding the amount (if any) unpaid on the shares in respect of which he is liable as a present or past member’. Valhalla is a company limited by shares. Thus, every shareholder is liable to contribute to the assets of Valhalla limited to the extent of the value of the shares they hold. According to Section 80 of the 1986 Act, this liability creates a debt payable at the times when calls are made for enforcing liability.

Valhalla is a company limited by shares. Thus, every shareholder is liable to contribute to the assets of Valhalla limited to the extent of the value of the shares they hold. Hence, Valhalla can call for payment of the £1.00 of nominal value for the shares allotted to the parties.

Accordingly,

Loki is a sweat equity shareholder. As such, he does not owe to pay for his share. However, considering the facts of the case, a relevant issue is whether Loki should be personally liable for his negligent appraisal of some mead for Norn plc, which later sued Valhalla that caused the liquidation and payment of the entirety of Valhalla plc’s funds of £13,000 to Norn plc in full and final settlement. Section 232 of the Companies Act 2006 is relevant here as it states that a director can be held liable for their negligence, default, or breach of duty or trust. Any provision that attempts to exempt them from such liabilities is void. His negligence caused the debt and consequently the liquidation. He is personally liable for his negligent acts and other shareholders can bring a derivative suit against him.

Thor is the only person who has fully paid for his shares. He will not be therefore liable to pay for his shares.

Frigg, as demonstrated earlier, is a preferred shareholder. The call for payment on liquidation requires her to for paying for her shares.

Freyja, as demonstrated earlier, cannot rely on the doctrine of mistake to avoid paying for her shares. Therefore, she is liable to pay for her shares upon a call by Odin, the liquidator.

Balder, as demonstrated earlier, does not have an enforceable consideration as there was no motive, as regards him, as to obtaining something valuable in return and as regard the company as to obtaining any payment of these shares.

D. Conclusion

To conclude, firstly, the transfer of the remaining contracts by Loki cannot bind Valhalla as he was not authorised to transfer the contracts. It was against his fiduciary duties of Loki that lead to a conflict of interests. The transfer is hence not valid.

The case shows that all the shares are unpaid, except for Thor who paid in full. Thus, Thor is a common shareholder. Loki is the sole director and a shareholder holding sweat equity responsible for the company’s operation, management and decision making. He, however, is personally liable for the negligent act causing debt to the company. Freyja is also a shareholder as her reliance on doctrine of mistake cannot hold as she ‘now knows buying the shares was a bad business deal.” Frigg is a preferred shareholder with no voting rights but entitled to a fixed annual dividend. Balder is not a shareholder as there was a mere motive with no enforceable consideration when he was recorded as a member. As such, on a call for payment of the share, Frigg and Freyja must pay for their unpaid shares.

Bibliography

Legislation

  • The Companies Act 2006
  • The Insolvency Act 1986

Cases

  • Bell v Lever Bros (1932) AC 16
  • Birch v Cropper (1889) Cooper v Phibbs (1867)
  • Boardman v Phipps [1966] UKHL 2
  • Bray v Ford [1896] AC 44
  • Currie v Misa (1875) LR 10 Ex 153
  • Cooper v Phibbs (1867) LR 2 HL 149
  • Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd & Ors [2020] EWHC 2537 (TCC)
  • Habibsons Bank Ltd v Standard Chartered Bank (Hong Kong) Ltd [2010] EWCA Civ 1335
  • Kakara Estate Ltd v Savvy Vineyards 3552 Ltd [2013] NZCA 101
  • Panorama Developments (Guildford) Ltd. v Fidelis Furnishing Fabrics Ltd. [1971] 2 QB 711
  • Re Smith and Fawcett Ltd. [1942] Ch 304
  • Raffles v Wichelhaus (1864) 2 H&C 906

Books

  • Bollefer SF and Jack Bernstein, Shareholders' Agreements: A Tax and Legal Guide (C C H Canadian, Limited 2009)
  • Cartwright J, Misrepresentation, Mistake andNon-disclosure (Sweet & Maxwell 2012).
  • Chen-Wishart M, Contract Law (OUP Oxford 2012)
  • Fisher JC, Contract Law in England and Wales (Wolters Kluwer 2018)
  • Gillies P, Business Law, NSW (Federation Press 2004)
  • Miller RL, Cengage Advantage Books:Business Law: The First Course - Summarized Case Edition ( Cengage Learning 2014)
  • Rees-Mogg M, Crowd Funding: How to Raise Money and Make Money in the Crowd (Crimson 2013)
  • Shepherd DA and Evan J. Douglas, Attracting Equity Investors: Positioning, Preparing, and Presenting the Business Plan (SAGE Publications 1999)
  • Turner C, Unlocking Contract Law (Taylor & Francis 2013).

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