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DISGUISED RETURNS OF CAPITAL – AN ARM'S LENGTH APPROACH

Published online by Cambridge University Press:  11 March 2010

Eva Micheler
Eva Micheler
Affiliation:
Department of Law, London School of Economics.
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The Cambridge Law Journal , Volume 69 , Issue 1 , March 2010 , pp. 151 - 185
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Copyright © Cambridge Law Journal and Contributors 2010

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References

1 Progress Property Company Ltd v. Moorgarth Group Ltd [2009] EWCA Civ 629.

2 Trevor v. Whitworth (1887) 12 App. Cass. (HL) 409, 423.

3 Progress Property Company Ltd v. Moorgarth Group Ltd [2009] EWCA Civ 629.

4 See also The City of London Law Society, The Implications for Leveraged Transactions of the Repeal of the Statutory Prohibition of Financial Assistance by Private Companies, Joint Memorandum of the Financial Law and Company Law Committees of the City Of London Law Society, September 2008, available from http://www.citysolicitors.org.uk/Default.aspx?sID=914&lID=0 (last visited 12 Jan 2010).

5 [1932] 2 Ch. 46.

6 In re George Newman & Co [1895] 1 Ch. 674, 689; In re Walters Deed of Guarantee. Walters' ‘Palm’ Toffee, Limited v. Walters [1933] 1 Ch. 321, 322; see also Lord Wedderburn, “Ultra Vires in Modern Company Law” (1983) 56 M.L.R. 204, 207–8.

7 See for example Hutton v. West Cork Railway Company (1883) 23 Ch.D. 654; Parke v. Daily News [1962] Ch. 927.

8 [1932] 2 Ch. 46.

9 [1932] 2 Ch. 46, 51.

10 [1967] 1 All E.R. 427; see also Kerr v. Walker [1933] S.C. 458.

11 [1982] Ch. 442 (CA).

12 [1967] 1 All E.R. 427, 431–2.

13 Re Horsley & Weight Ltd [1982] Ch. 442, 449–450.

14 Re Horsley & Weight Ltd [1982] Ch. 442, 451–2.

15 Len Sealy and Sarah Worthington, Cases and Materials in Company Law (Oxford 2008), at p. 149; John Armour, “Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law” in John Armour and Howard Bennett, Vulnerable Transactions in Corporate Insolvency (Oxford 2003), at pp. 309–310; Colin Baxter, “Ultra vires and agency untwined” (1970) 28 C.L.J. 280; Lord Wedderburn, “Ultra Vires in Modern Company Law” (1983) 46 M.L.R. 204, at p. 206–209; Giora Shapira, “Ultra vires redux” (1984) 100 L.Q.R. 468; Richard J Calan, “Corporate gifts and creditor rights” [1990] Company Lawyer 91, at p. 92.

16 [1982] Ch. at p. 454.

17 Ridge Securities Ltd v. IRC [1964] 1 All E.R. 275; Charterbridge Corporation v. Lloyds Bank [1970] Ch. 62.

18 [1964] 1 All E.R. 275.

19 Ridge Securities Ltd v. IRC [1964] 1 All E.R. 275, 287 per Pennycuick J.

20 [1932] 2 Ch. 46, 51.

21 Charterbridge Corporation v. Lloyds Bank [1970] Ch. 62, 74.

22 Ibid. at p. 69.

23 Ibid. at p. 71.

24 Ibid. at p. 71; see also Re Halt Garage [1982] 3 All E.R. 1016, 1030–1034.

25 Ibid. at p. 74.

26 Admittedly the groups were structured in different ways. In Ridge Securities v. I.R.C., the companies were organised as subsidiaries and parent company. In Charterbridge v. Lloyds the companies had the same shareholders, the same directors and shared one office. The group was led and directed by one of these companies. This organisational difference, however, does not appear to be a fact justifying the different outcomes of the case on the ultra vires point. The transactions involved were also different. In Ridge Securities v. IRC, the transaction in question was a debenture. In Charterbridge v. Lloyds the transaction was a guarantee and a legal charge. When examining whether the directors in Charterbridge v. Lloyds had breached their duties, Pennycuick J. observes that while the sums involved were large, the company would, if all went well, not have incurred any liability, [1970] Ch. 62, 75. While this is true, it does not have an impact on the financial position of the company. The company nevertheless undertook an obligation and that had an effect on its finances irrespective of whether or not the guarantee was going to be exercised. It seems that this fact in itself would not have been sufficient to justify the different outcome on the ultra vires point in Charterbridge v. Lloyds.

27 Oliver J in Re Halt Garage [1982] 3 All E.R. 1016, 1032.

28 Re Halt Garage [1982] 3 All E.R. 1016, 1032.

29 Rolled Steel Products v. British Steel Corporation [1986] 1 Ch. 246 (CA); MacPherson v. European Strategic Bureau [2000] 2 B.C.L.C. 683.

30 Rolled Steel Products v. British Steel Corporation [1982] 1 Ch. 478 at p. 497.

31 [1986] 1 Ch. 246, 288.

32 Ibid. at p. 296.

33 Ibid.

34 [2000] 2 B.C.L.C. 683.

35 [2000] 2 B.C.L.C. 683, 701.

36 [1932] 2 Ch. 46.

37 [1932] 2 Ch. 46, 50–1.

38 Section VI.C will argue that the approach adopted by In re Lee, Behrens can be used as an inspiration for formulating a test identifying disguised returns of capital against the background of the modern law. Section VII will conclude that the fact that the rule evolved under the umbrella of the ultra vires doctrine means that the rule continues to be an independent rule after the ultra vires doctrine has been abolished. As a result, CA 2006, s. 842 determining the circumstances in which a member having received an unlawful distribution needs to return what he has received does not apply to disguised returns of capital.

39 [1982] 3 All E.R. 1016.

40 Ibid. at p. 1042.

41 Ibid. at p. 1039.

42 [1989] B.C.L.C. 626.

43 Ibid. at p. 631.

44 Ibid. at p. 632.

45 Ibid. at p. 633.

46 Re BAT Industries plc; BAT Industries plc v. BAT Reconstructions Ltd, 9 September 1998 All England Official Transcripts per Neuberger J.; see also Progress Property Company Ltd v. Moorgarth Group Ltd [2009] EWCA Civ 629.

47 Armour, “Avoidance of Transactions”, above note 14, at p. 282.

48 These interests of the company are normally equal to the interests of the shareholders of the company. When the company is near insolvency the interests of the company become the collective interests of its creditors rather than its shareholders. Directors of an insolvent company who cause it to enter into an undervalue transaction do not act in the interests of the company's creditors and are in breach of their duties.

49 Armour, “Avoidance of Transactions”, above note 14, at p. 314.

50 The doctrine was applied by the Supreme Court of New South Wales in Kinsela v. Russel Kinsela (1986) 10 A.C.L.R. 395 to a transaction between the company and its shareholders. But in that case illegality based on capital maintenance had not been pleaded by the liquidator (see the reference to the pleadings on page 398).

51 Armour, “Avoidance of Transactions”, above note 14, at pp. 308–310.

52 [2000] 2 B.C.L.C. 683, 701 cited by John Armour, ibid., at pp. 325–326.

53 John Armour, ibid., at p. 326.

54 See also Walter Horrwitz, “Company Law Reform and the Ultra Vires Doctrine” (1946) 62 L.Q.R. 66.

55 [1986] 1 Ch. 246 (CA).

56 [1986] 1 Ch. 246, 296.

57 Re Halt Garage [1982] 3 All E.R. 1016, 1032.

58 Re BAT Industries plc; BAT Industries plc v. BAT Reconstructions Ltd, 9 September 1998 All England Official Transcripts; see also Progress Property Company Ltd v. Moorgarth Group Ltd [2009] EWCA Civ 629 para. 23.

59 Walker v. Wimborne (1976) 50 A.J.L.R. 446 (misfeasance); Nicholson v. Permakraft [1985] 1 N.Z.L.R. 24; Re Welfab Engineers [1990] B.C.C. 600 (misfeasance); Facia Footwear Ltd v. Hinchchiff [1998] 1 B.C.L.C. 218 (misfeasance); Kinsela v. Russel Kinsela [1986] 4 N.S.W.L.R. 722 (shareholder transaction); ANZ Executors & Trustee Company Ltd v. Qintex Australia Ltd (1990) 8 A.C.L.C. 980 (parent trying to cause subsidiary to enter into a transaction).

60 Armour, “Avoidance of Transactions”, above note 14 at p. 316 citing R.C. Nolan, “The Proper Purpose Doctrine and Company Directors” in Barry A.K. Rider, The Realm of Company Law (London 1998) 1, at p. 6 and Dan Prentice, “Group Indebtedness” in Clive M. Schmitthoff and Frank Wooldridge, Groups of Companies (London 1991) 55 at p. 62.

61 [1982] 3 All E.R. 551.

62 [1982] 3 All E.R. 551, 556.

63 In re Lee, Behrens [1932] 2 Ch. 46; Re W & M Roith Ltd [1967] 1 All E.R. 427; Re Halt Garage [1982] 3 All E.R. 1016 (Ch D); Barclays Bank v. British and Commonwealth Holdings [1996] 1 B.C.L.C. 1; Australasian Oil Exploration v. Lachberg (1958) 101 C.L.R. 119; see also MacPherson v. European Strategic Bureau [2000] 2 B.C.L.C. 683; It has also been described as unenforceable (Jenkins v. Harbour View Courts [1966] N.Z.L.R. 1, Redweaver Investments Ltd v. Lawrence Field Ltd (1991) 5 A.C.S.R. 438).

64 This, of course, has implications for directors' duties. Directors have the duty to ensure that companies comply with their statutory obligations.

65 [1932] 2 Ch. 46.

66 [1967] 1 All E.R. 427.

67 [1982] 3 All E.R. 1016.

68 [1989] B.C.L.C. 626.

69 [1932] 2 Ch. 46, 51.

70 [1932] 2 Ch. 46, 53.

71 [1967] 1 All E.R. 427, 432.

72 [1989] B.C.L.C. 626, 632.

73 [1982] 3 All E.R. 1016, 1039.

74 Ibid.

75 Ibid.

76 [1982] 3 All E.R. 1016, 1042.

77 [2001] All E.R. (D) 27.

78 Ibid. at para. [25].

79 Ibid. at para. [26].

80 Ibid. at para. [32].

81 [1989] 1 B.C.L.C. 626, 633.

82 Ibid.; this was applied by David Donaldson, QC in Progress Property Company Ltd v. Cornus Moore [2008] EWHC 2577 (Ch.) at [40–42].

83 [1989] 1 B.C.L.C. 626, 632.

84 See also Bankway Properties Ltd v. Penfold-Dunsford and Leech [2001] EWCA Civ 528 (CA) at [43], per Arden L.J.

85 [2009] EWCA Civ 629.

86 Ibid.at [30].

87 Ibid. at [31].

88 Ibid. at [23].

89 [1895] 1 Ch. 674 (CA).

90 [1964] 1 All E.R. 275.

91 [1996] B.C.L.C. 1.

92 [2000] 2 B.C.L.C. 683 (CA).

93 Jenkins v. Harbour View Courts [1966] N.Z.L.R. 1; Davis Investments Proprietary Ltd v. Commissioner of Stamp Duties (NSW) (1957) 100 C.L.R. 392; Australasian Oil Exploration v. Lachberg (1958) 101 C.L.R. 119.

94 [1895] 1 Ch. 674, 684 (CA).

95 Ibid. at p. 685.

96 Ibid. at p. 686.

97 Ibid. at p. 685.

98 [1933] 1 Ch. 321.

99 [1964] 1 All E.R. 275, 287.

100 [1996] B.C.L.C. 1.

101 Ibid. at p. 17.

102 Ibid.

103 [2000] 2 B.C.L.C. 683 at [46].

104 [2000] 2 B.C.L.C. 683 at [46–49].

105 Ibid. at p. 701.

106 Ibid.

107 Ibid. at p. 704.

108 [2002] S.L.T. 109.

109 [2002] S.L.T. 109, 125.

110 (1958) 101 C.L.R. 119, 130.

111 (1958) 101 C.L.R. 119, 133.

112 Davis Investments Proprietary Ltd v. Commissioner of Stamp Duties (NSW) (1957) 100 C.L.R. 392.

113 [1966] N.Z.L.R. 1.

114 (1991) 5 A.C.S.R. 438.

115 Ibid. at pp. 444–445.

116 See also ANZ Executors & Trustee Company Ltd v. Qintex Australia Ltd (1990) 2 A.C.S.R. 676, 683.

117 Trevor v. Whitworth (1887) 12 App. Cas. 409, 423.

118 Progress Property Company Ltd v. Moorgarth Group Ltd [2009] EWCA Civ 629.

119 Ibid. at para. [19].

120 Progress Property Company Ltd. v. Moorgarth Group Ltd. [2008] EWHC 2577 at [5] and [38].

121 Ibid. at para. [41].

122 Clydebank Football Club Ltd. v. Steedman [2002] S.L.T. 109.

123 Armour, “Avoidance of Transactions”, above note 14, at pp. 297–298.

124 [1982] 3 All E.R. 1039, 1044.

125 [1989] 1 B.C.L.C. 626, 632; see also Sasea Finance Ltd v. KPMG [2001] All E.R. (D) 27 (excessive consideration); Australasian Oil Exploration v. Lachberg (1958) 101 C.L.R. 119, 129 (value greatly in excess of purchase price); Davis Investments Proprietary Ltd v. Commissioners of Stamp Duties (NSW) (1957) 100 C.L.R. 392, 408 (75% of the true values).

126 [1989] B.C.L.C. 626.

127 See also Sealy and Worthington, Cases and Materials in Company Law, at p. 417.

128 See also Davis Investments Proprietary Ltd. v. Commissioners of Stamp Duty (NSW) (1957) 100 C.L.R. 392, 407.

129 [1982] 3 All E.R. 1016, 1039.

130 [1932] 2 Ch. 46, 51.

131 Clydebank Football Club Ltd. v. Steedman [2002] S.L.T. 109; reasons relating to the business of the company have also been taken into account under the arm's length approach operated by German courts: Walter Bayer in Wolf Goette and Mathias Habersack (ed.), Münchener Kommentar zum Aktiengesetz 3rd ed., (Munich, 2008), § 57 para. 38 fn 103; for Austrian law see also Peter Doralt and Martin Winner in idem., § 57 para. 268; Holger Fleischer in Karten Schmidt and Marcus Lutter, Aktiengesetz Kommentar (Cologne 2008), § 57 para. 15.

132 [2009] EWCA Civ 629.

133 The statutory rules relating to public and private companies are different in German law. For both, however, the courts apply an objective arm's length approach. For an overview of the jurisprudence in relation to public companies see: Uwe Hüffer, Aktiengesetz, 8th ed. (Munich 2008), § 57 paras. 8–12; Walter Bayer, above note 131, § 57 paras. 31–45; Holger Fleischer, above note 131 § 57 paras. 11–20; for an overview of the jurisprudence in relation to private companies see: Marcus Lutter and Peter Hommelhoff in Walter Bayer, Peter Hommelhoff, Detlef Kleindiek and Marcus Lutter, GmbH-Gesetz Kommentar, 16th ed., (Cologne 2005), § 30 para. 8; Holger Altmeppen in Holger Altmeppen and Günter H Roth, Gesetz betreffend die Gesellschaft mit beschränkter Haftung, 5th ed., (Munich 2005), § 30 paras. 74–77; Mathias Habersack in Peter Ulmer, Mathias Habersack and Martin Winter, Gesetz betreffend die Gesellschaft mit beschränkter Haftung (Tubingen 2006), § 30 paras. 46–57; Harm Peter Westermann in Scholz Kommentar zum GmbH-Gesetz, 10th ed., (Cologne 2006), § 30 paras. 32–37.

134 In re Lee, Behrens [1932] 2 Ch. 46; Re W & M Roith Ltd [1967] 1 All E.R. 427; Re Halt Garage [1982] 3 All E.R. 1016; Barclays Bank v. British and Commonwealth Holdings [1996] B.C.L.C. 1; Australasian Oil Exploration v. Lachberg (1958) 101 C.L.R. 119; see also MacPherson v. European Strategic Bureau [2000] 2 B.C.L.C. 683; Such agreements have also be described as being unenforceable (Jenkins v. Harbour View Courts [1966] N.Z.L.R. 1; Redweaver Investments v. Lawrence Field (1991) 5 A.C.S.R. 438).

135 Re Halt Garage [1982] 3 All E.R. 1016.

136 MacPherson v. European Strategic Bureau [2000] 2 B.C.L.C. 683 at [59–60].

137 [1989] B.C.L.C. 626, 633.

138 [1989] B.C.L.C. 626, 632–633.

139 [2002] S.L.T. 109, 124.