COMMERCIAL TRANSACTIONS LAW NOTES

Notes Outline: 

1. PARTNERSHIPS
2. COMPANY LAW
3. BANKING LAW
4. BANKRUPTCY & INSOLVENCY
5. TAX LAW

 TOPIC 1: PARTNERSHIPS

The statutory principles and regulations on the law of partnerships will be found in Chapter 29 of the Laws of Kenya which is the Partnership Act (PA). This Act is based on the English Partnership Act of 1890, the main object of which was to codify the main principle of the pre-existing partnership law.

The rules of the common law and the doctrines of equity will therefore continue to apply only in so far as they are not inconsistent with the express provisions of the Act.

In interpreting partnership law therefore, one must always look at the Act first and if its provisions are clear then there is no need to revert to case law. However, the cases decided after 1890 would also help in understanding the interpretation of the Act.

Section 49 of the PA states that the rules of equity and common law, applicable to partnerships in England shall apply to parts in Kenya.

Sec 3(1) PA defines partnership as the relation which subsists between persons carrying on a business in common with a view of profit. If this relation exists in point of law, whatever arrangements the partners may have made between themselves and however much they may have tried to reject the notion of partnership, each of them will be regarded as a partner. Therefore, once a relationship of partnership is established even if the business was run by one party and the other partner(s) only participated in the profits, even such sleeping partners will bear as much liability as the active partners for the debts and liabilities of the firm.

The term partner is a term of law and all partners are agents of each other.

Who is a Partner?

There is no statutory definition of the word partner but bearing in mind the statutory definition of partnership it may safely be said that a partner is a person who has entered into a relation of partnership and since partnership is the relation subsisting between persons carrying on a business in common with a view of profit it follows that there are three essential ingredients in a partnership i.e.

1. There must be a business

2. The business must be carried on with a view of profit

3. The business must be carried on by or on behalf of the alleged partners

 

The term business is very crudely defined in sec 2 PA as including every trade, occupation or profession. This is a very uncertain definition.

Probably the term business should best be confined to what is recognized among business persons as commercial or professional business that is to say, callings in which persons hold themselves out as willing to sell to everybody goods, skills, assistance or any other services. The term common covers the sleeping partners and the term profits means the net profit that is the difference between the net returns and the outgoings of the business i.e. that which remains after the firms liabilities have been discharged.

Sec 4 PA lays down the rules for determining the existence of a partnership and paragraph b thereof states that the sharing of gross returns does not of itself create a partnership. However, all the rules in this section are very negative in tone and they do not state specifically when a partnership exists but rather state when a partnership cannot be said to exist. But until the end of the 19th century it was generally assumed that the mere sharing of profits, constituted all recipients partners in the business. This rule was changed in the case of:

Cox v Hickman [1860] 8 HLC 268

In which it was held that although a right to participate in profits is a strong taste of partnership and though there may be cases where from such participation alone, partnership would be inferred, yet whether that relationship exists or not must depend on the real intention and contract between the parties and not upon that one term of the contract which provides for participation in the profits. So in order to determine the existence or the non-existence of a partnership we must therefore look at all the facts and not just a mere participation in the profits.

Sec 4[c] PA provides that a receipt by a person of a share of the profits in the business is prima facie evidence that he is a partner in the business but the receipt of such a share or in the payment contingent on or varying with the profits of a business does not itself make him a partner in the business.

This appears to be a contradictory section and this apparent conflict was explained in the case of:

Davis v Davis [1894] 1 Ch 393

North J observed that “Although the language in this clause appears somewhat conflicting the true meaning of the clause is that the receipt by a person of a share of the profits of a business, is prima facie evidence that he is a partner in it and if the matter were to rest there it is evidence upon which the court must find the existence of a partnership. But if there are other relevant circumstances to be considered, they ought to be considered fairly together without attaching undue weight to any of them but drawing on inference from the whole. It would therefore appear that the import of paragraph c in sec 4 is that sharing of profits without more implies

partnerships but if it is only one of several facts, then all the facts must be considered together and so specific weight is to be given to the fact of profit sharing.

Sec 4 PA states by way of illustration that in particular, certain facts do not of themselves constitute partnership namely:

1. The receipt of a debt by installments or otherwise out of accruing profits.

2. The receipt by a servant or agent of a share in the profit by way of remuneration

3. The receipt by a widow or child of a deceased partner of a portion of the profits by way of annuity

4. The receipt of a portion of the profits by the vendor of a goodwill of a business

5. The receipt of a share of the profits or interest on the loan, the rate of which varies with the profit by a person who has advanced money by way of loan to a person engaged or about to engage in any business provided that the contract is in writing and signed by or on behalf of the parties thereto. See:

 

Re Forte Ex Parte Schofield [1897] 2 QB 455

There is dicta to suggest that where the benefit of this section is desired by the person who lends the money then the contract must be in writing and if this dicta is correct it would mean that a person who was never intended to be a partner but only a creditor may easily be regarded to be a partner in the absences of a written contract and this notwithstanding that sec 4 opens by saying that the receipt of profits itself is not conclusive in determining whether one is a partner or not. Therefore, the effect of sec 4 is not very clear.

In certain circumstances a person will be deemed to be a partner merely upon receipt of profits and unless he rebuts the presumption by contrary evidence.

In general, it is reasonable to conclude that before one can tell whether or not parties to a transaction are partners, one should probe into that real intention of the parties and ask oneself whether the parties honestly intended any advance of money from one to the other to be in the nature of a true loan or whether it was intended to be a contribution to a joint venture.

CREATION OF PARTNERSHIPS

1. The Law prohibits the creation of a partnership consisting of more than 20 persons. See:

 

Fort Hall Bakery Supply Co v Wangoe [1959] EA 474

This was an organisation of more than 40 people. The manager of this organisation misappropriated some money. An action was filed against him. The organisation was not registered either under the Companies Act or the Registration of Business Names Act. The Court held that it could not take cognizance of it except for penal matters.

2. A partnership may be illegal if it formed for a purpose forbidden by law or if it is contrary to good morality or against public policy. The court will not enforce the rights against one another.

 

Purposes which are legal at the inception of the partnership may subsequently become illegal e.g. by the passing of an Act of Parliament. In such cases the partnership is automatically dissolved upon the passing of such an Act.

Capacity of the Partners

Generally everyone is capable of being a partner in a firm. However as regards infants although they often carry on business, it is risky to deal with them because they cannot be sued for trade debts and can only be held bankrupt in respect of debts legally enforceable against them.

In the event of a partnership between an adult and an infant, judgment on such debt will either be against the partners alone or preferable against the firm but excluding the infant partners. In a judgment under any of these forms, a receiving order must be obtained against adult partners and in subsequent bankruptcy proceedings, partnership assets will be given for distribution to creditors.

On attaining the age of majority, an infant partner could either terminate the partnership in order to exclude liability or else he will be equally liable with his adult co-partners.

Persons of unsound mind

When a person of unsound mind enters into a contract for partnership and afterwards alleges that he was insane at the time and did not know what he was doing, even if he succeeds on proving the allegation, the contract is binding in every respect as if he had been sane when he made it unless he can prove further that the person with whom he contracted knew him to be insane so as not to be capable of knowing what he was doing. Unsoundness of mind therefore is not of itself a bar for entry into partnership and even the subsequent insanity of a partner does not

automatically dissolve the partnership but it is a ground for applying to court for dissolution of a partnership.

Upon such application if the court is satisfied that the alleged insane person is actually so, then the court will grant an injunction restraining him from interfering with the business.

Partnership agreements

Legally, it is not necessary that a partnership agreement should be written. In practice however, many of them are invariably reduced to writing. The document containing the terms of partnership is called the partnership deed or the articles of partnership. Such a document is evidence that the parties will carry on business on the terms stated thereof. Some of the matters provided for in the partnership agreement include:

a. The name of the firm

b. The nature of the business

c. The place of business

 

The nature of partnership business should be stated because it is that business and that alone which partners agree to carry on and in regard to which each partner is an agent of the firm and can bind his co-partners. It is therefore imperative that there should be no possibility of conflict as to what constitutes the real business of the firm. Unless a definite period is stated the general rule is that a partnership lasts only during the will of the partners. The rule is now embodied in sec 30[I] PA which enables any partner to terminate the partnership at any time by notice to the others if no fixed period has been agreed upon for its duration. But if there should be a provision that the partnership can only be terminated by mutual agreement then such provisions will displace the general rule and the partnership cannot be terminated at the will of a single party.

Moreover under section 31 PA where a partnership entered into for a fixed term is continued after that term has expired without any express new agreement, the rights and duties of partners remain the same as they were at the expiration of the term so far as it is inconsistent with the incidents of the partnership will.

The only exception to this principle is that where a partnership is formed to carry out some work or some specific project, then the partnership is presumed to last until the completion of that undertaking which is the subject matter of the partnership. This is rebuttable by evidence showing that the partnership was to continue even after the completion of the project.

Firm Name

Sec 6 PA provides that the name under which the business is to be carried on is called the firm name. Here partners may trade under any name they please, whether it be a combination of their own several names or a name which is merely descriptive of their business so long as they do not fraudulently imply that their business is identical with some other company business.

Where the firm name does not consist of the true name of all the partners then it must be registered under the Registration of Business Names Act.

The principle that a sole trader may carry on business under his own name or else under a fancy name, applies equally to partnerships and the partners may adopt any name not calculated to deceive either by diverting customers from other business or causing confusion between the two businesses e.g. by suggesting that their business is an extension, branch or agency or otherwise connected with the old business. See:

Ewing v Buttercup Margarine Co. Ltd [1917] 2 Ch 1

The plaintiff one Andrew Ewing had since 1904 carried on a business dealing with margarine under the name and style of Buttercup Dairy Co. The business was largely carried on in Scotland and to some extent in the North of England but it was gradually extending southwards.

The defendant company was registered in November 1916 and as soon as the plaintiff heard of it he complained promptly and sought an injunction to restrain the defendant form carrying on a business under the name of Buttercup Margarine Co. Ltd. He argued that such a name would likely cause confusion and serious injury to his business.

HELD: The name chosen by the defendant so nearly resembled that under which the plaintiff was trading that people who had dealings with the plaintiff were likely to believe that the defendant business was a branch of or connected with the plaintiffs business. An injunction was therefore granted.

Where the intention of the parties is therefore expressly to deceive the court will restrain from using a name similar to that in existence and to that extent the court may also go as far as preventing persons from trading even under their own proper names. See:

Croft v Day [1843] 7 Bear 84

In 1801, Charles Day and one Martin entered into partnership as manufacturers of a substance called “blacking” for a period of 21 years. They carried on their business at 97 High Holborn. In 1808 Martin transferred his interest to Day who was given liberty to use Martins name for the remainder of the 21 years. This term was afterwards extended to 25 years from 1820.

Martin died in 1834 and Day died in 1836 but the business was carried on in the name of Day and Martin by the executors of Day. The defendant in this case Day who was the testators nephew obtained the authority of somebody else called Martin to use his name in business. The defendant thereupon set up a business for the manufacture of “blacking” at 90 ½ Holborn Hill.

They sold “blacking” in similar bottles to those used by the earlier firm of Day and Martin and those used by Day’s executors.

HELD: No man has a right to sell his own goods as the goods of another.

Consequently although the defendant had a right to carry on the business over “blacking” manufacture honestly and fairly and had a right to use of his own name and although the court could not do anything to bar him from the use of that or any other name calculated to benefit himself in an honest manner nevertheless he must be prevented from using his name in such a way as to deceive or defraud the public and thereby obtain for himself at the expense of the plaintiff an undue or unfair advantage.

The fact of a new trader carrying on a business in the name of an old trader is not in itself unlawful unless the new trader is doing so for fraudulent purposes of passing on his goods as the goods of his rival. However, even in the absence of a fraudulent intention, if it is evident that the public will be deceived and if the effect of such a deception is that the goods of a new trader will be purchased in mistake for the goods of an older trader, then the new trader will be estopped from using that name which is likely to cause confusion. See:

North Cheshire and Manchester Brewery Co. Ltd v Manchester Brewery Co. Ltd [1899] AC 83

The Manchester Brewery Co. had carried on business under that name for about eight years. The appellants bought an old business called North Cheshire Brewery Ltd and without any intention to deceive they got themselves incorporated and registered under the name North Cheshire and Manchester Brewery Co. Ltd.

The respondent objected to the use of that name and it was held that even if there was no fraudulent intention on the part of the appellants nevertheless the public were likely to be deceived that the two companies had been amalgamated and place their orders with the new company causing injury to the old company. An injunction was granted against the appellants.

Thomas Turton and Sons v John Turton and Sons [1899] 2 ChD128

It was held that there was no possibility of confusion in these two business names.

If the new person or firm is not using his own name that is evidence that he is acting in bad faith. But if there is a likelihood of the two firms being confused it matters not that there is no bad faith. An injunction will be granted.

NOTE: The firm name does not constitute the firm a legal entity as in the case of a company. Therefore if a contract is entered into in the firm name, the contract is construed and takes effect as if the names of all the members were substituted throughout for the firm name.

But the firm name may be used in litigation so that the parties may be sued in that name or they may sue in that name.

RELATION OF PARTNERS TO THIRD PARTIES

The liability of partners to third parties is governed by the law of Agency. Generally every partner is an agent of the firm and also of each of his co-partners for the purpose of the business of partnership. Consequently, all the partners are collectively liable for the acts or omissions of each other. However, just as an agent does not bind the principal if the agent exceeds his authority so a partner can only bind a firm and his co-partners when he acts within the scope of his authority. This is embodied in section 7 PA.

Thus, in order to bind the firm a partner must have had ‘actual authority’ to do the act in question. But the term ‘actual authority’ in this context is not restricted to ‘express authority’, it also includes the general authority with which in the absence of express authority the law gives every agent for the purpose of doing all acts which are necessary/proper to the carrying on of the principal’s business in the manner usual in businesses of a similar nature. This general authority is the ‘ostensible authority’.

In many businesses those acts which are usual are not prohibited in which case the actual authority and the ostensible and apparent authority are co-extensive. In some other businesses, it is usual to find some provisions in the Article of partnerships prohibiting some partners from doing certain acts. Such is particularly the position where there are senior and junior partners. Here the term junior partner includes those under 18 years and also those who have recently joined the firm e.g. it is quite usual to find an article prohibiting a partner from buying/ordering goods the value of which exceeds a certain stated amount without the consent of the others. In such cases the actual authority is much less than

the apparent authority and if a partner in fact exceeds his actual authority by doing a prohibited act, the question that arises for determination is whether what he has done is within the ambit of his apparent authority. If it is within the ambit of that authority and even if it was expressly prohibited the firm will be bound unless the third party knew of the prohibition. If the third party knew he was dealing with a partner who had no authority then the firm cant be bound – sec 10 PA

If a dispute arises as to whether the firm is bound by the acts of a party, then it must be ascertained whether the act in question is one which in the absence of notice to the contrary the third person will be justified in regarding it as being within the ostensible/apparent authority of each of the parties and if the question is answered in the affirmative then the lack of actual authority is immaterial.

See Watten v Fenwick (1893) 1 QB 346

Here the defendants who were a firm of brewers were also the owners of the business of a pub for which they appointed a manager to run. The licence was always taken out in the name of the manager whose name also appeared on the door. By agreement between the defendants and their manager, the manager was forbidden from purchasing certain articles for the purpose of the business. Such acts were to be supplied solely by the defendants. In contravention of these instructions, the manager ordered the articles from the plaintiff for use by the business. The manager did not pay for them therefore the action was filed against the defendants for the recovery of the price thereof.

Held that the principal is liable for all the acts of the agent which are within the authority usually conferred in an agent of that character and not withstanding limitations put on that authority as between the principal and the agent.

Also an undisclosed principal is liable for all the acts of the agent even those in excess of the agent’s authority. This also applies in the area of partnership. In order that a firm be bound by the acts of the party, three conditions must be satisfied.

1. The act must be done in relation to the partnership business

2. It must be an act for carrying on business in the usual way

3. The act must be done by the party acting as a partner and not as a private individual

LIABILITY IN TORT

A firm is liable for torts committed against third parties by any of the partners in the course of the partnership business. Whereas liability in respect of debts and other contractual obligations is joint, liability in respect of torts is both joint and several. Therefore, with regards to debts and other contractual obligations the plaintiff can bring only one action but in tort he may file separate action against each party.

Duration of liability

Liability lasts from the time one becomes a partner until resolutions and winding up of the business. Consequently, a new partner is not liable for old debts and a retired partner is generally not liable for future debts.

This principle may however be negated by the doctrine of NOVATION which is an arrangement whereby a new partner agrees to be liable for existing debts or whereby a retiring partner undertakes to be liable for future debts.

HOLDING OUT

Sec 18 P.A. provides that every person who by words spoken or written or by conduct represents himself or who knowingly suffers himself to be represented as a partner in a particular firm, is liable as a partner to anyone who has on the faith of such representation given credit to the firm.

The word ‘knowingly’ here does not include carelessness in allowing oneself to be represented.

Sec 40 P.A. When a person deals with a firm after a change in its constitution, he is entitled to treat all apparent members of the old firm as still being members of the real firm until he has notice of the change.

For this purpose, an advertisement in a gazette is construed as notice only to those persons who did not have any dealings with the firm before the date of the change so advertised.

See Tower Cabinet Co. Ltd v Ingram (1949) 2 K.B. 397

In 1946, Christman and Ingram entered into a partnership and carried on the business of household furnitures under the name ‘Merrys’. The partnership was dissolved in April 1947 but Christman continued to carry out business under the same name. In 1948 Tower Co Ltd which had not previously dealt with Merrys received an order to supply Merrys some furniture. The price for the furniture was never paid and the company obtained judgment against Merrys. It thereafter sought to enforce the judgment against Ingram.

The only knowledge the company had of Ingram was that his name appeared in some old headed note paper used by Christman without Ingram’s authority in confirming an order for the furniture and which Ingram forgot to destroy by leaving the firm.

Qn: Did Ingram knowingly suffer himself to be held out as a partner? Held – under sec 18 P.A. Ingram was not liable as he had not knowingly suffered himself to be represented as a partner. It thus appears that there should be conscious knowledge that a person is being held out before being held as a partner. Negligence per se is not adequate to hold him liable.

RELATIONS OF PARTNERS AMONG THEMSELVES

The rights and obligations of partners may be governed by express agreement among themselves. In the absence of any agreement, the rights and duties are as such as may be defined in the P.A. However, no matter what the terms of the agreement may be or even in the absence of any agreement, there’s one element which the law implies in every partnership i.e. the element of utmost good faith. Every partner is under a duty to observe utmost fairness of good faith towards his co-partners.

The fundamental basis of partnership is that they are founded on mutual trust and confidence. Where a person reposes trust and confidence in another, equity insists that such trust and confidence shall not be abused.

It is not clear whether it is open to the partners to exclude this principle but it would appear that the principle is too fundamental to be dispensed with. If a partnership agreement provides that a partner may be expelled for breach of certain stated articles, the other partners cannot use that provision to expel a fellow partner otherwise than in good faith.

They can’t e.g. expel a partner if their real intention is to force the sale of that partner’s interest on unfavourable terms. But if there was a blatant breach of the articles such provision would justify the expulsion of the offending partner even without preliminary warning.

See Clifford v Timms (1907) 2 Ch.36

The partners carried on business as dentists, the articles of partnership contained a provision that if any partner should be guilty of professional misconduct, the others should be at liberty to give notice in writing terminating the partnership.

The plaintiff as a director in an American company of some other dental surgeons was a party to the publications by that company which amounted to self-puffing advertisements and which were a disparagement of other dentists and their mode of operations. Among other things they alleged that only their instruments were always sterilized before being used and that they’d engaged a trained lady nurse to be present at all dental operations so as to prevent any scandal arising between an operator and a lady patient. The other partners issued a notice to the plaintiff to terminate the partnership. The plaintiff filed this action for a declaration that the notice was ineffective and could not therefore terminate the partnership. Held – this publication contained elements of disgraceful connotations in a professional respect. Therefore the notice was effective and the partnership duly terminated and there was no evidence of bad faith on the part of the defendants.

A partner is also precluded from making a secret profit at the expense of the firm, thus a partner is duty bound to account to a firm for any commission on any sale/purchase on the firm’s property.

If a partner sells his own property to the firm he should not make any profit out of that sale without full disclosure to the other partners.

However, unless expressly restricted by the partnership agreement, a partner may carry on another business so long as it does not compete with and is not connected with the business of the firm and as long as he does not represent it to be the business of the firm. He must account if he competes. See sections 33 and 34 P.A.

Sec 28 P.A. lays down rules for determining the interests of partners in the partnership property. In relation to management, every partner is entitled to take part in the management of the business but no partner is entitled to any remuneration for acting in the partnership business. But sec 28 applies subject to any agreement express/implied between the partners. In many partnerships it is common practice to find an article authorizing each working partner to take a salary as a manager in addition to his own share of profits.

Since such a salary must be paid before profits are shared it follows that the working partners end up receiving more than the sleeping ones. As an incident of management, it is only proper that each partner should have access to the books of account. Under sec 28 therefore, the partnership books are required to be kept at the place of business of the partnership or at the principal place if they are more than one and every partner has a right to access and inspect those books and make copies of any.

As regards capital and profits, all partners are entitled to share equally in the capital or profits of the business. They must also share equally the losses sustained by the firm. This rule applies in the absence of an agreement to the contrary between the partners.  If a partner makes any actual payment/advance for the purposes of the partnership business, he is entitled to business at the rate of 6% p.a. as such an advance is treated as a loan in respect of which interest is payable. Where a partner makes any payment or incurs personal liability in the ordinary and proper conduct of the business of the firm, then such a partner is entitled to indemnity from the firm.

It is sometimes necessary to distinguish between the partnership property and the private property of every partner. This may be of importance particularly as between the partners themselves or between the creditors of the firm and the creditors of individual person(s) taking a deceased partners real estate and those taking personal estate.

For instance, partnership business may be carried on in a building owned by one of the partners. Is this building part of partnership property? The principle in law is that whether property is or is not partnership property depends on the agreement express or implied between the partners.

Assignment of Partnership interest

Without the consent of all the partners, a partner can’t transfer his share in the partnership so as to place another person in his shoes with all the rights of a partner. This may be contrasted with sec 75 of Company Act where a company’s shares are freely transferable.

If an article provides that one or more of the partners shall have the option of introducing a new partner either as his successor or otherwise, the other partners will be bound to accept his nominee because the consent required by law may always be given in advance.

However, the law allows a partner to assign either absolutely or by way of mortgage his share in the assets and profits. In that situation, the assignee is not entitled to interfere in the management of the business or to require any accounts from the business or to inspect the partnership books or to exercise any of the functions of a partner.

The only right such third party is entitled to is to receive the share of the profits to which the assigning partner would otherwise be entitled to.

However, on the application by a judgment-creditor of one of the persons, the courts may under sec 27 P.A. make an order charging that partners’ interest in the assets and profits with payment of the judgment debt and for that purpose the court may appoint a receiver of that partners share of the profits. Under sec 37 P.A., this is one of the grounds for which the partnership may be dissolved by an order of the court. 

 DISSOLUTION OF PARTNERSHIP

A partnership may be brought to an end either by death of one or more of the partners or by dissolution. Dissolution may be effected by agreement between the partners themselves or by an order of the court. The circumstances in which a partnership may be dissolved without any reference to the court are set out in s.36-38 P.A. Here subject to any agreement between the partners:

1. If a partnership is entered into for a fixed term, it comes to an end upon the expiration of that term.

2. If it is entered into for a single venture or undertaking, it comes to an end upon the completion of that venture/undertaking

3. Where it is entered into for an undefined period, then it is brought to an end by any partner giving notice to in writing to the others for his intention to dissolve partnership. No specific period of notice is required.

 

A partnership is always dissolved from the date mentioned on notice as the date of dissolution and if there is no date mentioned, the partnership is dissolved on the date of receipt of notice. Once notice to dissolve is received, it can’t be withdrawn except with the consent of all the parties.

Under sec 37 P.A. subject to any agreement between the partners, every partnership is dissolved by the death or bankruptcy of any of them. It is possible that the death of a partner may not lead to dissolution if the articles provide for continuation by survivors either alone or in partnership with the representatives of the deceased partner. This also applies in the case of bankruptcy of a partner.

A partnership is in any case dissolved by the happening of any event, which makes it unlawful for the business of the firm to be carried on or for the members of a firm to carry it on in partnership.

Dissolution by court – s.139 P.A

In the absence of any agreement between the partners any partner may apply to court for an order that the partnership be dissolved. This procedure may be resulted to in the following cases:

1. When a partner is adjudged a lunatic or is shown to the satisfaction of the court to be of permanently unsound mind. In either of these events, the application may be made on behalf of the lunatic by his guardian ad litem.

2. When a partner other than the suing partners becomes in any way permanently incapable of performing his part of the partnership contract

3. When a partner other than the suing partner has been guilty of such conduct as in the opinion of the court is calculated to affect prejudicially the carrying on of the business.

4. When a partner other than the partner suing willfully or persistently commits a breach of the partnership agreement or otherwise conducts himself in matters other than those of the business in such a way that it is not reasonably practicable for the other partners to carry on the business with him.

5. When the business of the partnership can only be carried on at a loss

6. Whenever in any case circumstance have arisen which in the opinion of the court renders it just and equitable that the partnership be dissolved.

Under s.41 P.A. on dissolution or retirement of a partner, any partner may publicly advertise this and may also require the other partners to assist in any other acts for dissolution.

S.42 – After dissolution, the authority of any partner to bind the partnership and the other rights and obligations of the partners continue as far as may be necessary to wind up the affairs of the partnership and to complete any transactions begun but unfinished at the time of dissolution.

GOODWILL

Goodwill may be defined as the benefit or advantage which a business has in its connection with the customers. It is based on the probability that all the customers will continue to come back to the old place of business or will continue to deal with a firm of the same name.

It is the attractive force which brings in customers and which distinguishes between an old establishment and a new business at its start.

Goodwill is a partnership asset and like other assets, on dissolution of the firm, it must be sold so that the proceeds may be applied towards the firm’s debts and liabilities.

LIMITED PARTNERSHIP

As in ordinary partnerships, the number of members is limited to 20. In every case however, there must be at least one general partner and one limited partner.

A general partner is liable for all the debts and obligations of the firm. The limited partner’s liability for debts and obligations of the firm is limited to the amount he contributes. A body corporate may become a limited partnership if so authorized by its memo of association.

Unlike an ordinary partnership, a limited partnership must be registered as such in accordance with the requirements of sec 4 of the Ltd Partnership Act Cap 30 Laws of Kenya. Registration is effected by the delivery to the registrar of companies a statement signed by the partners containing the following particulars

1. The firm name

2. The general nature of the business

3. The principal place of business

4. The full names of each of the partners

5. The terms if any for which the partnership is entered into and the date of commencement

6. A statement that the partnership is limited and the description of each limited partner as such

7. The sum contributed by each limited partner and whether such a sum is paid in cash or by which method.

 If a proposed limited partnership is not registered it is deemed to be an ordinary partnership and any proposed limited partner will be regarded as a general partner.

Generally, the common law and rules of equity applicable to partnerships also apply to limited partnerships subject to modifications set out in sec 5 of the Ltd Partnership Act.

1. Under this section a limited partner may not take part in the management of the partnership business and he has no power to bind the firm. If he takes part in the management, he thereby ceases to enjoy limited partnership liability and becomes liable for all. However, the limited partner may also always inspect the books of account of the firm and also examine the state and prospects of the partnership business.

2. Unless specifically provided in the partnership agreement, a limited partnership can’t be dissolved by the death or bankruptcy of a limited partner. The lunacy of a limited partner is not a ground for dissolution by the court.

3. In the event of dissolution of a limited partnership, its affairs should be wound up by the general partners unless the court otherwise orders

4. Subject to any agreement between the partners any differences arising as to ordinary matters connected to the partnership may be decided by a majority of the general partners.

5. With the consent of general partners, a limited partner may assign his share in the partnership and upon such assignment, the assignee becomes a limited partner with all the rights of the assignor

6. The general partners are not entitled to dissolve the partnership by reason of any limited partner suffering to be charged for a separate debt. It should also be noted that a person may be introduced as a partner without the consent of the existing limited partner. A limited partner may not dissolve a partnership by notice.

TOPIC 2: COMPANY LAW

Section 2 (1) of the Companies Act Cap 486 Laws of Kenya states what company means as 'a company formed and registered under this Act or an existing company. This is a very vague definition, in the statute the word company is not a legal term hence the vagueness of the definition. The legal attributes of the word company will depend upon a particular legal system.

In legal theory company denotes an association of a number of persons for some common object or objects in ordinary usage it is associated with economic purposes or gain. A company can be defined as an association of several persons who contribute money or money’s worth into a common stock and who employ it for some common purpose. Our legal system provides for three types of associations namely

1. Companies

2. Partnerships.

3. Upcoming is the cooperative society.

The law treats companies in company law distinctly from partnerships in partnership law. Basically company law consists partly of ordinary rules of Common law and equity and partly of statutory rules. The common law rules are embodied in cases. The statutory rules are to be found in the Companies Act which is the current Cap 486 Laws of Kenya. It should denote that the Kenya Companies Act is not a self contained Act of legal rules of company law because it was borrowed from the English Companies Act of 1948 which was itself not a codifying Act but rather a consolidating Act.

Exceptions to the Rules are stated in the Act but not the rules themselves. Therefore fundamental principles have to be extracted from study of numerous decided cases some of which are irreconcilable. The true meaning of company law can only be understood against the background of the common law.

FUNDAMENTAL CONCEPTS OF COMPANY LAW

There are two fundamental legal concepts

1. The concept of legal personality; (corporate personality) by which a company is treated in law as a separate entity from the members.

2. The concept of limited liability;

 

Concept of legal personality

(i) A legal person is not always human, it can be described as any person human or otherwise who has rights and duties at law; whereas all human persons are legal persons not all legal persons are human persons. The non-human legal persons are called corporations. The word corporation is derived from the Latin word Corpus which inter alia also means body. A corporation is therefore a legal person brought into existence by a process of law and not by natural birth. Owing to these artificial processes they are sometimes referred to as artificial persons not fictitious persons.

Concept of Limited Liability

Basically liability means the extent to which a person can be made to account by law. He can be made to be accountable either for the full amount of his debts or else pay towards that debt only to a certain limit and not beyond it. In the context of company law liability may be limited either by shares or by guarantee.

Under Section (2) (a) of the Companies Act, in a company limited by shares the members liability to contribute to the companies assets is limited to the amount if any paid on their shares.

Under Section 4 (2) (b) of the Companies Act in a company limited by guarantee the members undertake to contribute a certain amount to the assets of the company in the event of the company being wound up. Note that it is the members’ liability and not the companies’ liability which is limited. As long as there are adequate assets, the company is liable to pay all its debts without any limitation of liability. If the assets are not adequate, then the company can only be wound up as a human being who fails to pay his debts. Note that in England the Insolvency Act has consolidated the relationships relating to …. That does not apply here. Nearly all statutory rules in the Companies Act are intended for one or two objects namely

1. The protection of the company’s creditors;

2. The protection of the investors in this instance being the members.

These underlie the very foundation of company law.

FORMATION OF A LIMITED COMPANY

This is by registration under the Companies Act

In order to incorporate themselves into a company, those people wishing to trade through the medium of a limited liability company must first prepare and register certain documents. These are as follows

a. Memorandum of Association: this is the document in which they express inter alia their desire to be formed into a company with a specific name and objects. The Memorandum of Association of a company is its primary document which sets up its constitution and objects;

b. Articles of Association; whereas the memorandum of association of a company sets out its objectives and constitution the articles of association contain the rules and regulations by which its internal affairs are governed dealing with such matters as shares, share capital, company’s meetings and directors among others;

 

Both the Memorandum and Articles of Associations must each be signed by seven persons in the case of a public company or two persons if it is intended to form a private company. These signatures must be attested by a witness. If the company has a share capital each subscriber to the share capital must write opposite his name the number of shares he takes and he must not take less than one share.

c. Statement of Nominal Capital – this is only required if the company has a share capital. It simply states that the company’s nominal capital shall be xxx amount of shillings. The fees that one pays on registration will be determined by the share capital that the company has stated. The higher the share capital, the more that the company will pay in terms of stamp duty.

d. Declaration of Compliance: this is a statutory declaration made either by the advocates engaged in the formation of the company or by the person named in the articles as the director or secretary to the effect that all the requirements of the companies Act have been complied with. Where it is intended to register a public company, Section 184 (4) of the Companies Act also requires the registration of a list of persons who have agreed to become directors and Section 182 (1) requires the written consents of the Directors.

 

These are the only documents which must be registered in order to secure the incorporation of the company. In practice however two other documents which would be filed within a short time of incorporation are also handed in at the same time. These are:

1. Notice of the situation of the Registered Office which under Section 108(1) of the statute should be filed within 14 days of incorporation;

2. Particulars of Directors and Secretary which under Section 201 of the statute are normally required within 14 days of the appointment of the directors and secretary.

The documents are then lodged with the registrar of companies and if they are in order then they are registered and the registrar thereupon grants a certificate of incorporation and the company is thereby formed. Section 16(2) of the Act provides that from the dates mentioned in a certificate of incorporation the subscribers to the Memorandum of Association become a body corporate by the name mentioned in the Memorandum capable of exercising all the functions of an incorporated company. It should be noted that the registered company is the most important corporation.

STATUTORY CORPORATIONS

The difference between a statutory corporation (or parastatal) and a company registered under the companies Act is that a statutory corporation is created directly by an Act of Parliament. The Companies Act does not create any corporations at all. It only lays down a procedure by which any two or more persons who so desire can themselves create a corporation by complying with the rules for registration which the Act prescribes.

TYPES OF REGISTERED COMPANIES

Before registering a company the promoters must make up their minds as to which of the various types of registered companies they wish to form.

1. They must choose between a limited and unlimited company; Section 4 (2) (c) of the Companies Act states that ‘a company not having the liability of members limited in any way is termed as an unlimited company. The disadvantage of an unlimited company is that its members will be personally liable for the company’s debts. It is unlikely that promoters will wish to form an unlimited liability company if the company is intended to trade. But if the company is merely for holding land or other investments the absence of limited liability would not matter.

2. If they decide upon a limited company, they must make up their minds whether it is to be limited by shares or by guarantee. This will depend upon the purpose for which it is formed. If it is to be a non-profit concern, then a guarantee company is the most suitable, but if it is intended to form a profit making company, then a company limited by shares is preferable.

3. They have to choose between a private company and a public company. Section 30 of the Companies Act defines a private company as one which by its articles restricts

(i) the rights to transfer shares;

(ii) restricts the number of its members to fifty (50);

(iii) prohibits the invitation of members of the public to subscribe for any shares or debentures of the company.

A company which does not fall under this definition is described as a public company. In order to form a public company, there must be at least seven (7) subscribers signing the Memorandum of Association whereas only two (2) persons need to sign the Memorandum of Association in the case of a private company.

ADVANTAGES OF INCORPORATION

A corporation is a legal entity distinct from its members, capable of enjoying rights being subject to duties which are not the same as those enjoyed or borne by the members.

The full implications of corporate personality were not fully understood till 1897 in the case of Salomon v. Salomon [1897] A C 22

Facts of the case

Salomon was a prosperous lender/merchant. He sold his business to Salomon and Co. Limited which he formed for the purpose at the price of £39,000 satisfied by £1000 in cash, £10,000 in debentures conferring a charge on the company’s assets and £20,000 in fully paid up £1 shares. Salomon was both a creditor because he held a debenture and also a shareholder because he held shares in the company. Seven shares were then subscribed for in cash by Salomon, his wife and daughter and each of his 4 sons. Salomon therefore had 20,101 shares in the company and each member of the family had 1 share as Salomon‘s nominees. Within one year of incorporation the company ran into financial problems and consequently it was wound up. Its assets were not enough to satisfy the debenture holder (Salomon) and having done so there was nothing left for the unsecured creditors. The court of first instance and the court of appeal held that the company was a mere sham an alias, agents or nominees of Salomon and that Mr. Salomon should therefore indemnify the company against its trade loss.

The House of Lords unanimously reversed this decision. In the words of Lord Halsbury “Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Salomon. If it was not, there was no person and no thing at all and it is impossible to say at the same time that there is the company and there is not”

In the words of Lord Mcnaghten “the company is at a law a different person altogether from the subscribers and though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them nor are the subscribers as members liable in any shape or form except to the extent and manner prescribed by the Act. … in order to form a company limited by shares the Act requires that a Memorandum of Association should be signed by seven (7) persons who are each to take one share at least. If those conditions are satisfied, what can it matter, whether the signatories are relations or strangers? There is nothing in the Act requiring that the subscribers to the Memorandum should be independent or unconnected or that they or anyone of them should take a substantial interest in the undertaking or that they should have a mind and will of their own. When the Memorandum is duly signed and registered though there be only seven (7) shares taken the subscribers are a body corporate capable forthwith of exercising all the functions of an incorporated company.

… The company attains maturity on its birth. There is no period of minority and no interval of incapacity. A body corporate thus made capable by statutes cannot lose its individuality by issuing the bulk of its capital to one person whether he be a subscriber to the Memorandum or not.”

There were several other Law Lords who decided business in the House.

The significance of the Salomon decision is threefold.

1. The decision established the legality of the so called one man company;

2. It showed that incorporation was as readily available to the small private partnership and sole traders as to the large private company.

3. It also revealed that it is possible for a trader not merely to limit his liability to the money invested in his enterprise but even to avoid any serious risk to that capital by subscribing for debentures rather than shares.

Since the decision in Salomon’s case the complete separation of the company and its members has never been doubted.

Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619

The Appellant owner of a timber estate assigned the whole of the timber to a company known as Irish Canadian Sawmills Company Limited for a consideration of £42,000. Payment was effected by the allotment to the Appellant of 42,000 shares fully paid up in £1 shares in the company. No other shares were ever issued. The company proceeded with the cutting of the timber. In the course of these operations, the Appellant lent the company some £19,000. Apart from this the company’s debts were minimal. The Appellant then insured the timber against fire by policies effected in his own name. Then the timber was destroyed by fire. The insurance company refused to pay any indemnity to the appellant on the ground that he had no insurable interest in the timber at the time of effecting the policy.

The courts held that it was clear that the Appellant had no insurable interest in the timber and though he owned almost all the shares in the company and the company owed him a good deal of money, nevertheless, neither as creditor or shareholder could he insure the company’s assets. So he lost the Company.

Lee v Lee’s Air Farming Ltd. (1961) A.C. 12

Lee’s company was formed with capital of £3000 divided into 3000 £1 shares. Of these shares Mr. Lee held 2,999 and the remaining one share was held by a third party as his nominee. In his capacity as controlling shareholder, Lee voted himself as company director and Chief Pilot. In the course of his duty as a pilot he was involved in a crash in which he died. His widow brought an action for compensation under the Workman’s Compensation Act and in this Act workman was defined as “A person employed under a contract of service” so the issue was whether Mr. Lee was a workman under the Act? The House of Lords Held:

“that it was the logical consequence of the decision in Salomon’s case that Lee and the company were two separate entities capable of entering into contractual relations and the widow was therefore entitled to compensation.”

Katate v Nyakatukura (1956) 7 U.L.R 47A

The Respondent sued the Petitioner for the recovery of certain sums of money allegedly due to the Ankore African Commercial Society Ltd in which the petitioner was a Director and also the deputy chairman. The Respondent conceded that in filing the action he was acting entirely on behalf of the society which was therefore the proper Plaintiff. The action was filed in the Central Native Court. Under the Relevant Native Court Ordinance the Central Native Court had jurisdiction in civil cases in which all parties were natives. The issue was whether the Ankore African Commercial Society Ltd of whom all the shareholders were natives was also a native.

The court held that a limited liability company is a corporation and as such it has existence which is distinct from that of the shareholders who own it. Being a distinct legal entity and abstract in nature, it was not capable of having racial attributes.

ADVANTAGES OF INCORPORATION

1. Limited Liability – since a corporation is a separate person from the members, its members are not liable for its debts. In the absence of any provisions to the contrary the members are completely free from any personal liability. In a company limited by shares the members liability is limited to the amount unpaid on the shares whereas in a company limited by guarantee the members’ liability is limited to the amount they guaranteed to pay. The relevant statutory provision is Section 213 of the Companies Act.

2. Holding Property: Corporate personality enables the property of the association to be distinguishable from that of the members. In an incorporated association, the property of the association is the joint property of all the members although their rights therein may differ from their rights to separate property because the joint property must be dealt with according to the rules of the society and no individual member can claim any particular asset to that property.

3. Suing and Being Sued: As a legal person, a company can take action in its own name to enforce its legal rights. Conversely it may be sued for breach of its legal duties. The only restriction on a company’s right to sue is that it must always be represented by a lawyer in all its actions.

In East Africa Roofing Co. Ltd v Pandit (1954) 27 KLR 86 here the Plaintiff a limited liability company filed a suit against the defendant claiming certain sums of money. The defendant entered appearance and filed a defence admitting liability but praying for payment by instalments. The company secretary set down the date on the suit for hearing ex parte and without notice to the defendant. This was contrary to the rules because a defence had been filed. On the hearing day the suit was called in court but no appearance was made by either party and the court therefore ordered the action to be dismissed. The company thereafter applied to have the dismissal set aside. At the hearing of that application, it was duly represented by an advocate. The only ground on which the company relied was that it had intended all along to be represented at the hearing by its manager and that the manager in fact went to the law courts but ended in the wrong court. It was held that a corporation such as a limited liability company cannot appear in person as a legal entity without any visible person and having no physical existence it cannot at common law appear by its agent but only by its lawyer. The Kenya Companies Act does not change this common law rule so as to enable a limited company to appear in court by any of its officers.

4. PERPETUAL SUCCESSION As an artificial person, the company has neither body mind or soul. It has been said that a company is therefore invisible immortal and thus exists only intendment consideration of the law. It can only cease to exist by the same process of law which brought it into existence otherwise, it is not subject to the death of the natural body. Even though the members may come and go, the company continues to exist.

 

5. TRANSFERABILITY OF SHARES Section 75 of the Companies Act states as follows “ The Shares or any other interests of a member in a company shall be moveable property transferable in the manner provided by the Articles of Association of the Company.” In a company therefore shares are really transferable and upon a transfer the assignee steps into the shoes of the assignor as a member of the company with full rights as a member. Note however that this transferability only relates to public companies and not private companies.

6. BORROWING FACILITIES: in practice companies can raise their capital by borrowing much more easily than the sole trader or partnership. This is enabled by the device of the ‘floating charge’ a floating charge has been defined as a charge which floats like a cloud over all the assets from time to time falling within a certain description but without preventing the company from disposing of these assets in the ordinary course of its business until something happens to cause the charge to become crystallised or fixed. The ease with which this is done is facilitated by the Chattels Transfer Act which exempts companies from compiling an inventory on the particulars of such charges and also by the bankruptcy Act which exempts companies from the application of the reputed ownership clause. As far as companies are concerned the goods in the possession of the company do not fall within the reputed ownership clause.

The only disadvantages are three

(i) Too many formalities required in the formation of the company (ii) There is maximum publicity of the company’s affairs;  (iii) There is expense incurred in the formation and in the management of a company. In order to form a company, certain documents must be prepared whereas no such documents need to be prepared to establish business as a sole proprietor or partnership and throughout its life a company is required to file such documents as balance sheets and profits and loss accounts on dissolution of the company it is required to follow a certain stipulated procedure which does not apply to sole traders and partnerships. IGNORING THE CORPORATE ENTITY (LIFTING THE VEIL OF INCORPORATION) Although Salomon’s case finally established that a company is a separate and distinct entity from the members, there are circumstances in which these principle of corporate personality is itself disregarded. These situations must however be regarded as exceptions because the Salomon decision still obtains as the general principle Although a company is liable for its own debt which will be the logical consequence of the Salomon rule, the members themselves are held liable which is therefore a departure from principle. The rights of creditors under this section are subject to certain limitations namely (under statutory provision)

(i) REDUCTION IN THE NUMBER OF MEMBERS - Section 33 refers to membership that has fallen below the statutory minimum in a public company. The Act provides that only those members who remain after the six month during which the company has fallen below the provided minimum period can be sued; Even these members are liable if they have knowledge of the fact and only in respect of debts contracted after the expiration of the six months. Moreover the Section is worded in such a way as to suggest that the remaining members will be liable only in respect of liquidated contractual obligations.

(ii) FRAUDULENT TRADING – the provisions of Section 323 of the Companies Act come into operation here. It is provided that if in the course of the winding up of the company it appears that any business has been carried on with the intent to defraud the creditors, or for any fraudulent purpose, the courts on the application of the official receiver, the liquidator or member may declare that any persons who are knowingly parties to the fraud shall be personally responsible without any limitation on liability for all or any of the debts or other liabilities of the company to the extent that the court might direct the liability. This Section does not define the term fraud nor have the courts defined it. However, in Re William C. Leitch Ltd (1932) 2 Ch. 71 the company was incorporated to acquire William’s business as a furniture manufacturer. The directors of the company were William and his wife and they appointed William as the Managing Director at a Salary of £1000 per annum. Within the period of one month, the company was debited with an amount which was £500 more than what was actually due to William. By that time the company had made a loss of £2500. Within 2 years of formation, and while the company was still in financial problems, the directors paid to themselves the dividends of £250. By the end of the 3rd year since incorporation the company was in such serious difficulties such that it could not pay debts as they fell due. In spite of this William ordered goods worth £6000 which became subject to a charge contained in a debenture held by them. At the same time he continued to repay himself a loan of £600 (six hundred pounds) which he had lent to the company at the beginning of the 4th year the company with the knowledge of William owed £6500 for goods supplied. In the winding up of the company the official receiver applied for a declaration that in no circumstances William had carried on the company’s business with intent to defraud and therefore should be held responsible for the repayment of the company’s debts. It was held that since that company continued to carry on business at a time when William knew that the company could not comfortably pay its debts, then this was fraudulent trading within the meaning of Section 323 and William should be responsible for repaying the debts. These are the words of Justice Maugham J. “if a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospects of the creditors ever receiving payments of those debts, it is in general a proper inference that the company is carrying on business with intent to defraud.”

The test is both subjective and objective. In the Case of Re Patrick Lyon Ltd (1933) Ch. 786 on facts which were similar to the Williams case, the same Judge Maugham J. said as follows: “the words fraud and fraudulent purpose where they appear in the Section in question are words which connote actual dishonesty involving according to the current notions of fair trading among commercial men real moral blame. No judge has ever been willing to define fraud and I am attempting no definition.”

 

The statutes are not clear as to the meaning of fraud the question arises that once the money has been recovered from the fraudulent director, is it to be laid as part of the company’s general assets available to all creditors or should it go back to those creditors who are actually defrauded.

In the case of Re William Justice Eve J. stated that such money should form part of the company’s general assets and should not be refunded to the defrauded creditors.

In the case of Re Cyona Distributors Ltd (1967) Ch. 889 the Court of Appeal ruled that if the application under Section 323 is made by the debtor then the money recovered should form part of the company’s general assets but where the application is made by a creditor himself, then that creditor is entitled to retain the money in the discharge of the debts due to him.

Lifting the Veil –

 Lifting the veil of corporate entity under statute

 Lifting the veil of corporate entity under common law.

 

IGNORING THE CORPORATE ENTITY UNDER STATUTE

HOLDING AND SUBSIDIARY COMPANIES

One of the most important limitations imposed by the Companies Act on the recognition of the separate personality of each individual company is in connection with associated companies within the same group enterprise. In practice it is common for a company to create an organisation of inter-related companies each of which is theoretically a separate entity but in reality part of one concern represented by the group as a whole. Such is particularly the case when one company is the parent or holding company and the rest are its subsidiaries.

Under Section 154 of the Companies Act Cap 486 a company is deemed to be a subsidiary of another if but only if

(a) That other company either

(i) is a member of it and controls the composition of its board of directors or

(ii) Holds more than half in nominal value of its equity share capital or

(b) The first mentioned company is a subsidiary of any company which is that other’s subsidiary.

Under Section 150 (1) where at the end of the financial year a company has subsidiaries, the accounts dealing with the profit and loss of the company and subsidiaries should be laid before the company in general meeting when the company’s own balance sheet and profit and loss account are also laid. This means that group accounts must be laid before the general meeting.

The group accounts should consist of a consolidated balance sheet for the company and subsidiary and also of a consolidated profit and loss account dealing with the profit and loss account of a company.

Section 151(2) – it may be observed that the treatment of these accounts in a consolidated form qualify an old rule that each company constitutes a separate legal entity. The statute here recognises enterprise entity rather than corporate entity i.e. the veil of incorporation will be lifted so that they will not be regarded as separate legal entities but will be treated as a group.

MISDESCRIPTION OF COMPANIES

Under Section 109 of the Companies Act it requires that a company’s name should appear whenever it does business on its Seal and on all business documents. Under paragraph 4 of this Section, if an officer of a company or any person who on its behalf signs or authorises to be signed on behalf of the company any Bill of Exchange, Promissory Note, Cheque or Order for Goods wherein the Company’s name is not mentioned as required by the Section, such officer shall be liable to a fine and shall also be personally made liable to the holder of a Bill of Exchange Promissory Notes, Cheque or order for the goods for the amount thereof unless it is paid by the company. The effect of this section is that it makes a company’s officer incur personal liability even though they might be contracting as the company’s agents. Liability under this Section normally arises in connection with cheques and company officers have been held liable where for instance the word limited has been omitted or where the company has been described by a wrong name.

IGNORING THE CORPORATE ENTITY UNDER COMMON LAW

WHERE THERE IS AN AGENCY RELATIONSHIP

Generally there is no reason why a company may not be an agent of its share holders. The decision in Salomon’s case shows how difficult it is to convince the courts that a company is an agent of its members. In spite of this there have been occasions in which the courts have held that registered companies were not carrying on in their own right but rather were carrying on business as agents of their holding companies. Reference may be made to the case of

Smith Stone & Knight v. Birmingham Corporation (1939) 4 All E.R. 116

In this case the Plaintiffs were paper manufacturers in Birmingham City. In the same city there was a partnership called Birmingham Waste Company. This partnership did business as merchants and dealers in waste paper. The plaintiffs bought the partnership as a going concern and the partnership business became part of the company’s property. The plaintiffs then caused the partnership to be registered as a company in the name of Birmingham Waste Company Limited. Its subscribed capital was 502 pounds divided into 502 shares. The Plaintiff holding 497 shares in their own name and the remaining shares being registered in the name of each of the Directors. Thereafter the Directors executed a declaration of trust stating that their shares were held by them on trust for the Plaintiff company. The new company had its name placed upon the premises and on the note paper invoices etc. as though it was still the old partnership carrying on business. There was no agreement of any sort between the two companies and the business carried on by the new company was never assigned to it. The manager was appointed but there were no other staff. The books and accounts of the new company were all kept by the plaintiff company and the manager of this company did not know what was contained therein and had no access to those books. There was no doubt that the Plaintiff Company had complete control over the waste company. There was no tenancy agreement between them and the waste company never paid any rent. Apart from the name, it was as if the manager was managing a department of the plaintiff company.

The Birmingham Corporation compulsorily acquired the premises upon which the subsidiary company was carrying on business and the Plaintiff company claimed compensation for removal and disturbance. Birmingham Corporation replied that the proper claimants were the subsidiary company and not the holding company since the subsidiary company was a separate legal entity. If this contention was correct the Birmingham Corporation would have escaped liability for paying compensation by virtue of a local Act which empowered them to give tenants notice to terminate the tenancy.

The court held that occupation of the premises by a separate legal entity was not conclusive on a question of a right to claim and as a subsidiary company it was not operating on its own behalf but on behalf of the parent company. The subsidiary company was an agent. Lord Atkinson had the following to say

“It is well settled that the mere fact that a man holds all the shares in a company does not mean the business carried on by the company is his business nor does it make the company his agent, for the carrying on of that business. However, it is also well settled that there maybe such an arrangement between the shareholders and the company as will constitute the company. The shareholders agents for the purpose of carrying on the business and make the business that of the shareholders. It seems to be a question of fact in each case and the question is whether the subsidiary is carrying on the business as the parents business or as its own. In other words who is really carrying on the business.

His Lordship then stated that in order to answer the question six points must be taken into account.

1. Are the profits treated as the profits of the parent company?

2. are the persons conducting the business appointed by the parent company?

3. Is the parent company the head and brain of the trading venture?

4. Does the parent company govern the venture decide what should be done and what capital should be embarked on in the venture?

5. Does the company make the profits by its skill and direction?

6. Is the company in effectual and constant control?

If the answers are in the affirmative, then the subsidiary company is an agent of the parent company.

Reference may also be made to the case of RE F G FILMS LTD [1953] 1 W.L.R.

Here a British company was formed with a capital of 100 pounds of which 90 pounds was contributed by the president of an American Film Company. There were 3 directors, the American and 2 Britons. By arrangement between the two companies, a film was shot in India nominally by the British Company but all the finances and other facilities were provided by the American Company. The British Board of Trade refused to recognize the Film as having been made by a British company and therefore refused to register it as a British film.

The court held that insofar as the British company had acted at all it had done so as an agent or nominee of the American company which was the true maker of the film.

Firestone Tyre & Rubber Company v. Llewellin (1957) 1 W.L.R 464

Again in this case an American company had an arrangement with its distributors on the European continent whereby the distributors obtained the supplies from the English manufacturers who were a wholly owned subsidiary of an American company. The English subsidiary credited the American company with a price received after deducting costs and a certain percentage. It was agreed that the distributors will not obtain their supplies from anyone else. The issue was whether the subsidiary company in Britain was selling its own goods or whether it was selling goods of an American company.

The court held that the substance of the arrangement was that the American company traded in England through the subsidiary as its agent and that the sales by their subsidiary, were a means of furthering the American company’s European interests.

There have been cases where Salomon’s case has been upheld that a company is a legal entity.

Ebbw Vale UDC V. South Wales Traffic Authority (1951) 2 K.B 366

Lord Justice Cohen L.J “Under the ordinary rules of law, a parent company and a subsidiary company even when a hundred percent subsidiary are distinct legal entities and in the absence of an agency contract between the two companies, one cannot be said to be an agent of the other.

 

FRAUD & IMPROPER CONDUCT

Where there is fraud or improper conduct, the courts will immediately disregard the corporate entity of the company. Examples are found in those situations in which a company is formed for a fraudulent purpose or to facilitate the evasion of legal obligations.

Re Bugle Press Limited [1961] Ch. 270

This was based on Section 210 of the Companies Act where an offer was made to purchase out a company if 90% of shareholders agreed. There were 3 shareholders in the company. A, B and C.

A held 45% of the shares, B also held 45% of the shares and C held the remaining 10% of the shares. A and B persuaded C to sell his shares to them but he declined. Consequently A and B formed a new company call it AB Limited, which made an offer to ABC Limited to buy their shares in the old company. A and B accepted the offer, but C refused. A and B sought to use provisions of Section 210 in order to acquire C’s shares compulsorily.

The court held that this was a bare faced attempt to evade the fundamental principle of company law which forbids the majority unless the articles provide to expropriate the minority shareholders.

Lord Justice Cohen said “the company was nothing but a legal hut. Built round the majority shareholders and the whole scheme was nothing but a hollow shallow.” All the minority shareholder had to do was shout and the walls of Jericho came tumbling down.

Gilford Motor Co. v. Horne (1933) Ch. 935

Here the Defendant was a former employee of the plaintiff company and had covenanted not to solicit the plaintiff’s customers. He formed a company to run a competing business. The company did the solicitation. The defendant argued that he had not breached his agreement with the plaintiffs because the solicitation was undertaken by a company which was a separate legal entity from him. The court held that the defendant’s company was a mere cloak or sham and that it was the defendant himself through this device who was soliciting the plaintiff’s customers. An injunction was granted against the both the defendant and the company not to solicit the plaintiff’s customers.

Jones v. Lipman (1912) 1 W.L.R. 832

This case the Defendant entered into a contract for the sale of some property to the plaintiff. Subsequently he refused to convey the property to the plaintiff and formed a company for the purpose of acquiring that property and actually transferred the property to the company. In an action for specific performance the Defendant argued that he could not convey the property to the Plaintiff as it was already vested in a third party.

Justice Russell J. observed as follows

“the Defendant company was merely a device and a sham a mask which he holds before his face in an attempt to avoid recognition by the eye of equity”

GROUP ENTERPRISE

In exercise of their original jurisdiction, the courts have displayed a tendency to ignore the separate legal entities of various companies in a group. By so doing, the courts give regard to the economic entity of the group as a whole.

Authority is the case of Holsworth & Co. v. Caddies [1955]1W.L.R. 352

The Defendant Company had employed Mr. Caddies as their Managing Director for 5 years. At the time of that contract the company had two subsidiaries and Caddies was appointed Managing Director of one of those subsidiaries. He fell out of favour with the other Directors consequent upon which the board of directors stated that Caddies should confine his attention to the affairs of the subsidiary company only. He treated this as a breach of contract and sued the company for damages. It was held that since all the companies form but one group, there was no breach of contract in directing Caddies to confine his attention to the activities of the subsidiary company

DETERMINATION OF A COMPANY’S RESIDENCE

De Beers Consolidated Mines Ltd (1906) K.C. 455

Lord Lorenburn said “in applying the conception of residence to a company, we ought to proceed as nearly as possible on the analogy of an individual. A company cannot eat or sleep but it can keep house or do business. A company resides for purposes of Income Tax where its real business is carried on. The real business is carried on where the central management and control actually abides.”

The courts also look behind the façade of the company and its place of registration in order to determine its residence.

THE DOCTRINE OF ULTRA VIRES

A Company which is registered under the Company’s Act cannot effectively do anything beyond the powers which are either expressly or by implication conferred upon in its Memorandum of Association. Any purported activity in excess of those powers will be ineffective even if agreed to by the members unanimously. This is the doctrine of ultra vires in company law.

The purpose of this doctrine is said to be twofold

1. It is said to be intended for the protection of the investors who thereby know the objects in which their money is to be applied. It is also said to be intended for the protection of the creditors by ensuring that the Company’s assets to which the creditors look for repayment of their debt are not wasted in unauthorised activities. The doctrine was first clearly articulated in 1875 in the case of Ashbury Railway Carriage v. Riche (1875) L.R. CH.L.) 653

 

In this case the Company’s Memorandum of Association gave it powers in its objects clause

1. To make sell or lend on hire railway carriages and wagons.

2. To carry on the business of mechanical engineers and general contractors

3. to purchase, lease work and sell mines, minerals, land and realty.

The directors entered into a contract to purchase a concession for constructing a railway in Belgium. The issue was whether this contract was valid and if not whether it could be ratified by the shareholders.

The court held that the contract was ultra vires the company and void so that not even the subsequent consent of the whole body of shareholders could ratify it. Lord Cairns stated as follows:

“The words general contractors referred to the words which went immediately before and indicated such a contract as mechanical engineers make for the purpose of carrying on a business. This contract was entirely beyond the objects in the Memorandum of Association. If so, it was thereby placed beyond the powers of the company to make the contract. If so, it was not a question whether the contract was ever ratified or not ratified. If the contract was going at its beginning it was going because the company could not make it and by purporting to ratify it the shareholders were attempting to do the very thing which by the act of parliament they were prohibited from doing.”

The courts construed the object clause very strictly and failed to give any regard to that part of the Objects clause which empowered the company to do business as general contractors. This construction gave the doctrine of ultra vires a rigidity which the times have not been able to uphold. At the present day, the doctrine is not as rigid as in Ashbury’s case and consequently it has been eroded.

The first inroad into the doctrine was made five years later in the case of

Attorney General V. Great Eastern Railway 1880) 5 A.C. 473

Lord Selbourne stated as follows:

“the doctrine of ultra vires as it was explained in Ashbury’s case should … but this doctrine ought to be reasonably and not unreasonably understood and applied and whatever may fairly be regarded as incidental to or consequential upon those things that the legislature has authorised ought not to be held by judicial construction to be ultra vires.”

An act of the company therefore will be regarded as intra vires not only when it is expressly stated in the object’s clause but also when it can be interpreted as reasonably incidental to the specified objects. As a result of this decision, there is now a considerable body of case law deciding what powers will be implied in a case of particular types of enterprise and what activities will be regarded as reasonably incidental to the act.

However businessmen did not wish to leave matters for implication. They preferred to set up in the Memorandum of Association not only the objects for which the company was establish but also the ancillary powers which they thought the company would need. Furthermore instead of confining themselves to the business which the company was initially intended to follow, they would also include all other businesses which they might want the company to turn to in the future. The original intention of parliament was that the companies object should be set out in short paragraphs in the Memorandum of Association. But with a practice of setting out not only the present business but also any business which the promoters would want the company to turn to, the result is that a company’s object’s clause could contain about 30 or 40 different clauses covering every conceivable business and all that incidental powers which might be needed to accomplish them.

In practice therefore the objects laws of practically every company does not share the simplicity originally intended in favour of these practice it may be argued that the wider the objects the greater is the security of the creditors since it will not be easy for the company to enter into ultra vires transactions because every possible act will probably be covered by some paragraph in the Objects clause.

Unfortunately this does not ensure preservation of the Companies assets or any adequate control over the director’s activities thus the original protection intended vanishes, the highpoint of this development came in 1966 in the case of Bellhouse v. City Wall Properties (1966) 2 Q.B 656

In this case the Plaintiff company’s business was requisitioned for vacant land and the erection thereon of Housing Estates. Its objects as set up in the Memorandum of Association contained the Clause authorising the company to “carry on any other trade or business whatsoever which can in the opinion of the Board of Directors be advantageously carried on by the company in connection with or as ancillary to any of the above businesses or a general business of the company”.

In connection with its various development skills the company’s managing director met an agent of the Defendants who required some finance to the tune of about 1 million pounds. The Plaintiff’s Managing Director intimated to the Defendant’s agent that he knew of a source from which the Defendant could obtain finance and accordingly referred them to a Swiss syndicate of financiers. In this action the Plaintiffs alleged that for that service, the Defendants had agreed to pay a  commission of 20,000 pounds and in the alternative they claimed 20,000 pounds for breach of contract. The Defendants argued that there was no contract between the parties. In the alternative they argued that even if there was a contract such contract was in effect one whereby the Plaintiffs undertook to act as money-brokers which activity was beyond the objects of the plaintiff company and which was therefore ultra vires.

The issues were

1. Whether the contracts were ultra vires

2. Whether it was open to the defendant to raise this point;

The court of first instance decided that the company was ultra vires and it was open to the defendant to raise the defence of ultra vires. However a unanimous court of appeal reversed the decision and hailed that the words stated must be given their natural meaning and the natural meaning of those words was such that the company could carry on any business in connection with or ancillary to its main business provided that the directors thought that could be advantageous to the company.

Lord Justice Salomon L.J stated as follows:

“It may be that the Directors take the wrong view and infact the business in question cannot be carried on as they believe but it matters not how mistaken they might be provided that they formed their view honestly then the business is within the plaintiff’s company’s objects and powers.”

ULTRA VIRES DOCTRINE

The courts have introduced 2 methods of curbing the evasion of the ultra vires doctrine.

1. EJUSDEM GENERIS RULE

The ejusdem generis rule is also referred to as the main objects rule of construction. Here a Memorandum of Association expresses the objects of a company in a series of paragraphs and one paragraph or the first 2 or 3 paragraphs appear to embody the main object of the company all the other paragraphs are treated as merely ancillary to this main object and as limited or controlled thereby. Business persons evaded this method by use of the independent objects clause. The objects clause will contain a paragraph to the effect that each of the preceding sub-paragraphs shall be construed independently and shall not in any way be limited by reference to any other sub-clause and that the objects set out in each sub-clause shall be independent objects of the company. Reference may be made to the case of Cotman v. Brougham [1918]A.C. 514

In this case the objects clause of the company contained 30 sub-clauses. The first sub-clause authorised the company to develop rubber plantations and the fourth clause empowered the company to deal in any shares of any company. The objects clause concluded with a declaration that each of the sub clauses was to be construed independently as independent objects of the company. The company underwrote and had allotted to it shares in an oil company. The question that arose was whether this was intra vires the company’s objects. The court held that the effect of the independent objects clause was to constitute each of the 30 objects of the company as independent objects. Therefore the dealing of shares in an oil company was within the objects and thus intra vires. However the power to borrow money cannot be construed as an independent object of the company in spite of this decision.

Re Introductions (1962) W.L.R. 791

In this case the company was formed to provide accommodation and services to those overseas visitors going to a festival in Britain. The company did this during the first few years of existence. Later the company switched over to pig breeding as its sole business. While so engaged it borrowed money from a bank on a security of debentures. The bank was given a copy of the company’s Memorandum of Association and at the material time knew that the company’s sole business was that of pig breeding. The issue was, whether the loan and debentures were valid in view of the fact one of the sub clauses empowered the company to borrow money and the last sub clause was an independent object clause.

The court held that borrowing was a power and not an object. The power to borrow existed only for furthering intra vires objects of the company and was not an object in itself.

Therefore

1. The exercise of powers which will be intra vires is exercised for the objects of the company and is ultra vires only if used for the objects not covered by the company’s Memorandum of Association.

2. Even an independent object clause cannot convert what are in fact powers into objects.

2. LOSS OF SUBSTRATUM

Where the main object of a company has failed, a petitioner will be granted an order for the winding up of a company. Such a petitioner must however be a member or shareholder in the company.

The object of the ultra vires rule is to make the members know how and to what their money is being applied. This is the rationale of members’ protection.

RE GERMAN DATE COFFEE CO. (1882) 20 Ch. 169

In this case the major object of the company was to acquire a German Patent for manufacturing coffee from dates. The German patent was never granted but the company acquired a Swedish Patent for the same purpose. The company was solvent and the majority of the members wished to continue in business. However, two of the shareholders petitioned for winding up of the company on the grounds that the company’s object had entirely failed.

The court held that upon the failure to acquire the German patent, it was impossible to carry out the objects for which the company was formed. Therefore the sub stratum had disappeared and therefore it was just inevitable that the company should be wound up.

Kay J. stated “where a company is formed for a primary purpose, then although the Memorandum may contain other general words which include the doing of other objects, those general words must be read as being ancillary to that which the Memorandum shows to be the main purpose and if the main purpose fails and fails altogether, then the sub-stratum of the association fails.”

This substratum rule is too narrow and cannot sufficiently uphold the ultra vires rule. Questions are, are members or shareholders really protected? Do they know what the objects are? The Directors may choose any amongst the many. Secondly a member has to petition first and the court has to decide

John Beauforte (1953) Ch.d 131

A company was authorised by its Memorandum of Association to carry on the business of costumiers, gown makers and other activities ejusdem generis. The company decided to undertake the business of making veneered panels which was admittedly ultra vires and for this purpose, it constructed a factory at Bristol. The company later went into compulsory liquidation. Several proofs of debts were lodged with the liquidator which he rejected on the ground that the contracts which they related to were ultra vires.

Applications by way of Appeal were lodged by the 3 creditors one of whom had actual knowledge that the veneer business was ultra vires. The 3 creditors were a firm of builders who built the factory, a firm which supplied the veneers to the company and a firm which had contractual debts with the company.

The courts held dismissing the applications that no judgment founded on an ultra vires contract could be sustained unless it embodied a decision of the court on the issue of ultra vires or a compromise on that issue. The contracts being founded on an ultra vires transaction were void.

3. GRATUITOUS GIFTS

Can a company validly make a gift out of corporate property or asset? The law is that a company has no power to make such payments unless the particular payment is reasonably incidental to the carrying out of a company’s business and is meant for the benefit and to promote the property of the company.

This issue was first decided in the case of

Hutton V West Cork Railway Co. (1893) Ch.d

A company sold its assets and continued in business only for the purpose of winding up. While it was awaiting winding up, a resolution was passed in the company’s general meeting authorising the payments of a gratuity to the directors and dismissed employees.

The court held that as the company was no longer a going concern such a payment could not be reasonably incidental to the business of the company and therefore the resolution was invalid. In the words of the Lord Justice Bowen said “The law does not say that there are not to be cakes and ale but there are to be no cakes and ale except such as are required for the benefit of the company”

The question is, suppose there is a clause in the Memorandum of Association that such payments shall be made, is payment ultra vires? The authority that dealt with this position was the case of RE LEE BEHRENS & CO. [1932] 2 Ch. D 46

The object clause of the company contained an express power to provide for the welfare of employees and ex employees and also their widows, children and other dependants by the grant of money as well as pensions. Three years before the company was wound up, the Board of Directors decided that the company should undertake to pay a pension to the widow of a former managing director but after the winding up the liquidator rejected her claim to the pension.

The court held that the transaction whereby the company covenanted to pay the widow a pension was not for the benefit of the company or reasonably incidental to its business and was therefore ultra vires and hence null and void.

Justice Eve stated as follows

Whether they reneged an express or implied power, all such grants involved an expenditure of the company’s money and that money can only be spent for purposes reasonably incidental to the carrying on of the company’s business and the validity of such grants can be tested by the answers to three questions:

(i) Is the transaction reasonably incidental to the carrying on of the company’s business?

(ii) Is it a bona fide transaction?

(iii) Is it done for the benefit and to promote the prosperity of the company?

These questions must be answered in the affirmative. The question may be posed as to whether these tests apply where there is an express power by the objects. This is one area where the courts are still insistent that creditors’ security must be reserved.

Sometimes ultra vires can be excluded by good and clever draftsmanship

Parke v. Daily News [1962] 2 Ch.d 927

In this case the company transferred the major portion of its assets and proposed to distribute the purchase price to those employees who are going to become  redundant after reduction in the stock of the company of the company’s business. The company was not legally bound to make any payments by way of compensation. One shareholder claimed that the proposed payment was ultra vires.

The court held that the proposed payment was motivated by a desire to treat the ex-employees generously and was not taken in the interest of the company as it was going to remain and that therefore it was ultra vires.

The Court observed as follows “the defendants were prompted by motives which however laudable and however enlightened from the point of view of industrial relations were such as the law does not recognise as sufficient justification. The essence of the matter was that the Directors were proposing that a very large part of its assets should be given to its employees in order to benefit those employees rather than the company and that is an application of the company’s funds which the law will not allow.”

Evans v. Brunner Mound & Co. 1921 Ch.d 359

The company carried on the business of chemical manufacturers. Its object clause contained a power to do all such things as maybe incidental or conducive to the attainment of its objects. The company distributed some money to some universities and scientific institutions, which was meant to encourage scientific education and research. The company thereby hoped to create a reservoir of qualified scientists from which the company could recruit its staff.

The court held that even though the payment was not under an express power, it was reasonably incidental to the company’s business and therefore valid. This is one of the few cases where payment was recognised as being valid.

THE RIGHTS OF THE COMPANY & 3RD PARTIES UNDER ULTRA VIRES TRANSACTIONS:

Remedies

Whether or not a contract is ultra vires depends on the knowledge of the party’s dealing with that company. Such is the case as regards borrowing contracts. Consider the case of David Payne & Co. (1904) 2 Ch.d 608 X was a director of company B and at the same time had some interests in company A. He learnt that company B wished to borrow some money which it intended to apply to unauthorised activities. He urged company A to lend the money on the security of debentures. The issues were

(a) Whether the debentures were valid security;

(b) Whether the knowledge of X as to the intended application of the money could be imputed to the company.

The court held that X was not company A’s agent for obtaining such information and therefore his knowledge was not the company’s knowledge and consequently the debentures were valid security.

This loophole however will be applied very rarely because everybody is presumed to know the contents of a company’s public documents. Where a contract with that company is ultra vires, generally speaking the party dealing with that company has no rights under the contract. The transaction being null and void cannot confer rights on the 3rd party nor can it impose any obligation on the company.

In many instances however, property will be transferred under an ultra vires transaction. Such transaction cannot vest rights in the transferee and cannot divest the transferor of his rights.

1. At common law therefore, the first remedy of a person who parts with property under an ultra vires transaction is that he has a right to trace and recover that property from the company as long as he can identify it.

This principle also applies to money lent to the company on an ultra vires borrowing so long as the money can be traced either in law or in equity. The basis of this principle is that the company is deemed to hold the money or the property as a trustee for the person from whom it was obtained.

Therefore, if the money received is paid into a separate account, or is sufficiently earmarked e.g by the purchase of some particular items, it can be followed and claimed by the lender. Where tracing is impossible, because the money has become mixed with other money, the lender is entitled in equity to a charge on the mixed fund together with the other creditors according to the respective amounts otherwise money obtained on ultra vires transaction generally cannot be followed once it has been spent. But if such money has been spent by discharging the company’s intra vires debts then the lender is entitled to rank as a creditor to the extent to which the money has been so applied. Since the company’s liabilities are not increased but in fact decreased, equity treats the borrowing as valid to the extent of the legal application of such money.

2. The 3rd party has a personal right against the directors or other agents with whom he has dealt. The rationale is that such directors or other agents are treated as quasi trustees from which it follows that a 3rd party is entitled to a claim against them for restitution.

TO WHAT EXTENT ARE MEMBERS PROTECTED BY THE ULTRA VIRES DOCTRINE?

The intra vires creditor does not have the locus standi to prohibit ultra vires actions. Again there is the presumption of knowledge of a company’s documents and activities. In spite of the fact that the doctrine of ultra vires is over due for reform, it has not undergone any reform in Kenya unlike in the United Kingdom where it has been severely eroded.

All the company can do is to alter its objects under the power conferred by Section 8 of the Companies Act Cap 486. The effect of the Section is that a company may by special resolution alter the provisions in its Memorandum with respect to the objects of the company.

Section 141 defines Special Resolution as a resolution which is passed by a majority of not less than three quarters of those members voting at a company’s general meeting either in person or by proxy and of which notice has been given of the intention to propose it as a special resolution.

Within 30 days of the date on which the resolution altering the objects is passed, an application for the cancellation of the Resolution may be made to Court by or on behalf of the holders who have not voted in favour of the Resolution, of not less than 15% of the nominal value of the issued share capital of any class and if the company does not have a share capital, the application can be made by at least 15% of the members of the company.

If such an application is made, the alteration will not be effective except to the extent that it is confirmed by a court. Normally a court has an absolute discretion to confer, reject or modify the alteration.

Re Private Boarding House Limited (1967) E.A. 143

In this case, it was held that the registrar of companies is entitled to receive a notice of any such application and to appear and be heard at the hearing of the Application on the ground that such matters affect his record.

Under Section 8 (9) of the Companies Act Cap 486 if no application is made to the court, within 30 days the alteration cannot subsequently be challenged. The effect of this provision is that as long as an alteration is supported by more than 85% of the shareholders or so long as no one applies to the court within 30 days of the resolution, companies have complete freedom to alter their objects.

Note however, that such alterations do not operate retrospectively. Their effect relates only to the future.

ARTICLES OF ASSOCIATION

A Company’s constitution is composed of two documents namely the Memorandum of Association and the Articles of Association. The Articles of Association are the more important of the two documents in as much as most court cases in Company Law deal with the interpretation of the Articles.

Section 9 of the Companies Act provides that a Company limited by guarantee or an unlimited company must register with a Memorandum of Association Articles of Association describing regulations for the company. A company limited by shares may or may not register articles of Association. A Company’s Articles of Association  may adopt any of the provisions which are set out in Schedule 1 Table A of the Companies Act Cap 486.

Table A is the model form of Articles of Association of a Company Limited by Shares. It is divided into two parts designed for public companies in part A and for private companies in part B (II) thus a company has three options. It may either

(a) Adopt Table A in full; or

(b) Adopt Table A subject to modification or

(c) Register its own set of Articles and thereby exclude Table A altogether.

 

In the case of a company limited by shares, if no articles are registered or if articles are registered insofar as they do not modify or exclude Table A the regulations in Table A automatically become the Company’s Articles of Association.

Section 12 of the Companies Act requires that the Articles must be in the English language printed, divided into paragraphs numbered consecutively dated and signed by each subscriber to the Memorandum of Association in the presence of at least one attesting witness.

As between the Memorandum and the Articles the Memorandum of Association is the dominant instrument so that if there is any conflict between the provisions in the Memorandum and those in the Articles the Memorandum provisions prevail. However if there is any ambiguity in the Memorandum one may always refer to the Articles for clarification but this does not apply to those provisions which the Companies Act requires to be set out in the Memorandum as for instance the Objects of the Company.

Whereas the Memorandum confers powers for the company, the Articles determine how such powers should be exercised.

Articles regulate the manner in which the Company’s affairs are to be managed. They deal with inter alia the issue of shares, the alteration of share capital, general meetings, voting rights, appointment of directors, powers of directors, payment of dividends, accounts, winding up etc.

They further provide a dividing line between the powers of share holders and those of the directors.  

LEGAL EFFECTS OF THE ARTICLES OF ASSOCIATION

Under Section 22 of the Companies Act it is provided that subject to the provisions of the Act, when the Memorandum and Articles are registered, they bind the company and the members as if they had been signed and sealed by each member and contained covenants for the part of each member to observe all their provisions. This Section has been interpreted by the courts to mean that the Memorandum gives rise to a contract between the Company and each Member.

Reference may be made to the case of Hickman v. Kent (1950) 1 Ch. D 881

Here the Articles of the Company provided that any dispute between any member and the company should be referred to arbitration. A dispute arose between Hickman and the company and instead of referring the same to arbitration, he filed an action against the company. The company applied for the action to be stayed pending reference to arbitration in accordance with the company’s articles of association.

The court held that the company was entitled to have the action stayed since the articles amount to a contract between the company and the Plaintiff one of the terms of which was to refer such matters to arbitration.

Justice Ashbury had the following to say: “That the law was clear and could be reduced to 3 propositions

1. That no Article can constitute a contract between the company and a third party;

2. No right merely purporting to be conferred by an article to any person whether a member or not in a capacity other than that of a member for example solicitor, promoter or director can be enforced against the company.

3. Articles regulating the right and obligation of the members generally as such do not create rights and obligations between members and the company”.

Eley v. Positive Government Security Life Association Co. (1876) Ex 88

In this case, the company’s articles provided that Eley should become the company Solicitor and should transact all legal affairs of the company for mutual fees and charges. He bought shares in the company and thereupon became a member and continued to act as the company’s solicitor for some time. Ultimately the company ceased to employ him. He filed an action against the company alleging breach of contract.

The court held: that the articles constitute a contract between the company and the members in their capacity as members and as a solicitor Eley was therefore a third party to the contract and could not enforce it. The contract relates to members in their capacity as members and the company so its only a contract between the company and members of that company and not in any other capacity such as solicitor. But note that there can be an intra member contract.

Wood v. Odessa Waterworks Company [1880] 42 Ch. 636

Here the Plaintiff who was a member of the company petitioned the court to stay the implementation of a resolution not to pay dividends but issue debentures instead. Holding that a member was entitled to the stay of the implementation of the Resolution Sterling J. had the following to say: “the articles of association constitutes a contract not merely between shareholders and the company but also between the individual shareholders and every other.”

This case was followed in

Rayfield v. Hands (1960) Ch.d 1

Here the company’s articles provided that every member who intends to transfer his shares shall inform the directors who will take those shares between them equally at a fair value. The Plaintiff called upon the directors to take his shares but they refused. The issue was did the articles give rise to a contract between the Plaintiff and the directors. In their capacity as directors they were not bound.

The court here held that the Articles related to the relationship between the Plaintiff as a member and the Defendants not as directors but as members of the company. Therefore the Defendants were bound to buy the Plaintiff shares in accordance with the relevant article.

ALTERATION OF ARTICLES

Section 13 of the Companies Act gives the company power to alter the articles by special resolution. This is a statutory power and a company cannot deprive itself of its exercise. Reference may be made to the case of Andrews v. Gas Meter Co. (1897) 1 Ch. 361

The issue herein was whether a company which under its Memorandum and Articles had no power to issue preference shares could alter its articles so as to authorise the issue of preference shares by way of increased capital

The court held that as long as the Constitution of a Company depends on the articles, it is clearly alterable by special resolution under the powers conferred by the Act. Therefore it was proper for the company to alter those articles and issue preference shares. Any regulation or article which purports to deprive the company of this power is therefore invalid, on the ground that such an article or regulation will be contrary to the statute. The only limitation on a company’s power to alter articles is that the alteration must be made in good faith and for the benefit of the company as a whole.

Allen v. Gold Reefs of West Africa (1900) 1 Ch. 626

In this case the company had a lien on all debts by members who had not truly paid up for their shares. The Articles were altered to extend the Company’s lien to those shares which were fully paid up.

The court held that since the power to alter the Articles is statutory, the extension of the lien to fully paid up shares was valid. These were the words of Lindley L.J.

“Wide however as the language of Section 13 mainly the power conferred by it must be exercised subject to the general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised not only in the manner required by law but also bona fide for the benefit of the company as a whole.”

Further reference may be made to the case of Shuttleworth v. Cox Brothers Ltd (1927) 2 KB 29

Here the Articles of the Company provided that the Plaintiff and 4 others should be the first directors of the company. Further each one of them should hold office for life unless he should be disqualified on any one of some six specified grounds, bankruptcy, insanity etc. The Plaintiff failed to account to the company for certain money he had received on its behalf. Under a general meeting of the company a special resolution was passed that the articles be altered by adding a seventh ground for disqualification of a director which was a request in writing by his co- directors that he should resign. Such request was duly given to the Plaintiff and there was no evidence of bad faith on the part of shareholders in altering the articles.

The Plaintiff sued the company for breach of an alleged contract contained in their original articles that he should be a permanent director and for a declaration that he was still a director.

The court held that the contract if any between the Plaintiff and the company contained in the original articles in their original form was subject to the statutory power of alteration and if the alteration was bona fide for the benefit of the company, it was valid and there was no breach of contract. Lord Justice Bankes observed as follows

“In this case, the contract derives its force and effect from the Articles themselves which may be altered. It is not an absolute contract but only a conditional contract.”

The question here is who determines what is for the benefit of the company? Is it the shareholders or the Courts?

Scrutton L.J. had the following to say

“to adopt such a view that a court should decide will be to make the court the manager of the affairs of innumerable companies instead of shareholders themselves. It is not the business of the court to manage the affairs of the company. That is for the shareholders and the directors.”

Sidebottom v. Kershaw Leese & C0.[1920]1 Ch. 154

Director controlled share company had a minority shareholder who was interested in some competing business. The company passed a special resolution empowering the directors to require any shareholder who competed with the company to transfer his shares at their fair value to nominees of the directors. The Plaintiff was duly served with such a notice to transfer his shares. He thereupon filed an action against the company challenging the validity of that article.

The court held that the company had a power to re-introduce into its articles anything that could have been validly included in the original articles provided the alteration was made in good faith and for the benefit of the company as a whole and since the members considered it beneficial to the company to get rid of competitors, the alteration was valid..

Contrast this case with that of Brown v. British Abrasive Wheel Co. (1990) 1 Ch. 290. Here a public company was in urgent need of further capital which the majority of the members who held 98% of the shares were willing to supply if they could buy out the minority. They tried persuasion of the minority to sell shares to them but the minority refused. They therefore proposed to pass a Special Resolution adding to the Articles a clause whereby any shareholder was bound to transfer his shares upon a request in writing of the holders of 98% of the issued capital.

The court held that this was an attempt to add a clause which will enable the majority to expropriate the shares of the minority who had bought them when there was no such power. Such an attempt was not for the benefit of the company as a whole but for the majority. An injunction was therefore granted to restrain the company from passing the proposed resolution.

EFFECT OF ALTERATION ON CONTRACT OF DIRECTORS

Sometimes the Articles may be altered in such a way that the implementation of those articles in the altered form would give rise to breach of an existing contract between the company and a third party and particularly so as regards contracts between companies and their directors.

A director may hold office either

1. Under the Articles without a service contract;

2. Under a contract of service which is entirely independent of the articles; or

3. Under a service contract which expressly or by implication embodies the relevant provisions in the Articles.

 

Where a director holds office under the Articles without a contract of service, then his appointment is conditional on the footing that the articles may be altered at any time in exercise of statutory power.

If however, a director’s appointment is entirely independent of the articles then any alterations which affects his contract with the company will constitute a breach of contract for which the company will be liable in damages.

Southern Foundries v. Shirlaw (1940) A.C. 701 The Plaintiff by a written contract was appointed the company’s Managing Director for 10 years. The agreement was not expressed to be subject to the Articles in any way. The Articles provided various grounds for the removal of a director from office subject to the terms of any subsisting agreement. The Articles further provided that if the Managing Director ceased to be a director, he would ipso facto cease to be Managing Director. The Company’s Articles were subsequently changed to give the Directors power to remove a fellow director from office by notice. Such notice was given to the Plaintiff who thereupon filed an action claiming damages from the company for breach of contract.

It was held that since his appointment was not subject to the articles, he could only be removed from office in accordance with the terms of his appointment and not by way of alteration of the articles. Damages were therefore payable.

Lord Atkins said “if a party enters into an arrangement which can only take effect by the continuance of an existing state of circumstances there is an implied undertaking on his part that he shall be done of his own motion to put an end to that state of circumstances which alone the arrangement can be operative.”

If a director is appointed in very general terms and without limitation of time, then the provisions in the Articles are deemed to be incorporated in the appointment and in the absence of any provision in the articles to the contrary, the company may dismiss him at any time and even without notice.

Read v. Astoria Garage (1952) 1 All.E.R 922 A Company’s Articles provided that the appointment of a Managing Director shall be subject to termination if he ceases for any reason to be a director or if the company in general meeting resolved that his tenure of office as managing director be terminated. The Plaintiff was appointed as the company’s Managing Director 17 years later the directors decided to relieve him of his duties as Managing Director. The decision was subsequently ratified by the company in general meeting. He claimed damages for wrongful dismissal.

The court held that on a true construction of the company’s articles the Plaintiff’s appointment was immediately and automatically terminated on passing of the Resolution at the general meeting since the company had expressly reserved to itself the power to dismiss the Managing Director. The question is, can a company be restrained by injunction from altering its articles if the alteration is likely to give rise to a breach of contract?

Part of the answer to this question was given in the case of

British Murac Syndicate Ltd v. Alperton Rubber Co. Ltd. 1950 2 Ch. 186

By an agreement binding on the Defendant company it was provided that so long as the operative syndicate should hold over 5000 shares in the Defendant’s company, the Plaintiff’s syndicate should have the right of nominating two directors on the Board of the Defendant Company. A clause to the same effect was contained in Article 88 of the Defendant Company’s Articles of Association.

Another Article provided that the number of directors should not be less than 3 nor more than 7. The Plaintiff syndicate had recently nominated 2 persons as directors. The Defendant company objected to these two persons as directors and refused to accept the nomination and a meeting of shareholders was called for the purpose of passing a special resolution under Section 13 of the Companies Act cancelling the article.

The court held that the defendant company had no power to alter its articles of association for the purpose of committing a breach of contract and that an injunction ought to be granted to restrain the holding of the meeting for that purpose.

Punt v. Symens & Co. 1903 2 Ch.d 506

This case had words to the effect that the company cannot be restrained but this was overruled in the case of British Equitable Assurance Co. v. Baily (1906) S.C. 35

Allen v. Goldreef

In this case an article was altered in such a way as to prejudice one shareholder. The article gave a lien on partly-paid shares for debts of members. Zuccani owed money in respect of unpaid calls on partly-paid shares but was the only holder of fully paid shares as well. The court held that it was for the benefit of the company to recover moneys due to it and the alteration in its terms related to all holders of fully-paid shares. The fact that Zuccani was the only member of that class at that moment did not invalidate it.

VARIATION OF CLASS RIGHTS

Although the Companies Act recognises the existence of class of shareholders, it does not define the term ‘class’ the best definition is found in the case of

Sovereign Life Assurance Co. v. Dodd (1892) 2 QB 573

In that case Bowen L.J. stated as follows: “The word Class is vague it must be confined to those persons whose rights are not dissimilar as to make it impossible for them to concert together with a view to their common interest.”

Under Article 4 of Table A where the Share Capital is divided into different classes of Shares, the rights attached to any class may be varied only with a consent in writing of the holders of three quarters of the issued share of that class or with assumption of a special resolution passed at a separate meeting of the holders of the shares of that class.

However, under Section 25 (2) if the rights are contained in the Memorandum of Association and if the Memorandum prohibits alteration of those rights, then class rights cannot be varied.

THE COMPANIES ORGANS & OFFICERS

Since a company is an artificial person, it can only act through an agency of a human person. For this purpose, a company has two primary organs.

1. The general Meeting;

2. The Board of Directors.

The authority to exercise a company’s powers is normally delegated not to the members nor individual directors but only to the directors as a Board. The directors may however delegate powers to an individual Managing Director.  Section 177 of the Companies Act requires every public company to have at least two directors and every private company at least one director. The Act does not provide for the means of appointing Directors but in practice the Articles of Association provide for initial appointments by subscribers to the Memorandum of Association and thereafter to annual retirement of a certain number of directors and the filling of vacancies at the annual general meeting.

Under Section 184 (1) of the Companies Act every appointment must be voted on individually except in the case of private companies or unless the meeting unanimously agrees to include two or more appointments in the same resolution. The appointment is usually effected by an ordinary resolution. However, no matter how a director is appointed, under Section 185 of the Companies Act he can always be removed from office by an ordinary resolution in addition to any other means of removal which may be embodied in the articles.

Unless the Articles so provide Directors need not be members of a company, but if the articles require a share qualification, then the shares must be taken up within two months otherwise the office will be vacated. Undischarged Bankrupts are not allowed to act as directors without leave of the court. A director need not be a natural person. A company may be appointed a director of another. The disqualifications of directors are set out in article 88 of Table A. The division of powers between the general meeting and the Board of Directors depends entirely on the construction of the Articles of Association and generally where powers of management are vested in the Board of Directors, the general meeting cannot interfere with the exercise of those powers.

Automatic Self-cleaning Filter Syndicate v. Cunningham (1906) A.C. 442

The company’s articles provided that subject to such regulations as might be made by extra ordinary resolution, the Management of the company’s affairs should be vested in the Directors who might exercise all the powers of the company which were not by statute or articles expressly required to be exercised by the company in general meeting. In particular the articles gave the directors power to sell and deal with any property of the company on such terms as they must deem fit. At a general meeting of the company, a Resolution was passed by a simple majority of the members for the sale of the company’s assets on certain terms and instructing the directors to carry the sale into effect. The Directors were of the opinion that a sale on  those terms was not of any benefit to the company and therefore refused to carry it into effect. The issue was, whether the directors were under an obligation to act in accordance with the directives.

The court held that the Articles constituted a contract by which the members had agreed that the Directors alone should manage the affairs of the company unless and until the powers vested in the Directors was taken away by an alteration in the Articles they could ignore the general meeting directives on matters of management. They were therefore entitled to refuse to execute the sale.

The division of the power to manage the company’s affairs is embodied in Article 80 of Table A which states that the business of the company shall be managed by the directors who may exercise all such powers of a company as are not by the Act or by these regulations required to be exercised by the company in general meeting. Where this article is adopted as it is invariably done in practice the general meeting cannot interfere with a decision of the directors unless they are acting contrary to the provisions of the Companies Act or the particular company’s articles of association.

Shaw & Sons Ltd v. Shaw (1935) 2 KB 113

Here the Directors were empowered to manage the company’s affairs. They commenced an action for and on behalf of the company and in the company’s name, in order to recover some money owed to the company. The general meeting thereafter passed a resolution disapproving the commencement of the suit and instructing the Directors to withdraw it

It was held that the resolution of the general meeting was a nullity Greer L.J. stated

“A company is an entity distinct from its shareholders and its directors. Some of its powers may be according to its articles exercised by the Directors and certain other powers may be reserved for shareholders in general meeting. If powers of management are vested in the Directors, they and they alone can exercise these powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the articles in the directors is by altering the articles or if opportunity arises under the articles by refusing to re-elect the directors or whose actions they disapprove. They cannot themselves reserve the powers which by themselves are vested in the Directors any more than the directors can reserve to themselves the powers vested by the articles in the general body of shareholders.”

To this there are two exceptions

1. in relation to litigation – here a general meeting can institute proceedings on behalf of the company if the board of directors refuses or neglects to do so.

2. When there is a deadlock in the Board of Directors as for instance in the case of

 

Barron v. Porter (1914) 1 Ch. 895

The articles of association vested the power to appoint additional directors in the Board of Directors. There were only two directors namely, Barron and Porter and the conduct of the company’s business was at a standstill as Barron refused to attend any Board meeting with Porter.

The court held that it was competent for the general meeting to appoint additional directors even if the power to do so was by articles vested in the Board of Directors.

CORPORATES’ LIABILITIES FOR ACTS OF ITS ORGANS & OFFICERS

There are certain situations in which the law does not recognise vicarious liability but insists on personal fault as a prelude to liability. In such cases a company could never be liable if the courts applied rigidly the rule that a company is an artificial person and therefore can only act through the directors. In practice and for certain purposes the courts have elected to treat the acts of certain officers as those of the company itself. This is sometimes referred to as THE ORGANIC THEORY OF COMPANIES.

The theory sprung from the case of Lennard’s Carrying Co. v. Asiatic Petroleum Co. Ltd. (1950) A.C. 705

In this case a ship and her cargo were lost owing to unseaworthiness. The owners of the ship were a limited company. The managers of the company were another limited company whose managing director a Mr. Lennard managed the ship on behalf of the owners. He knew or ought to have known of the Ship’s unseaworthiness but took no steps to prevent the ship from going to sea. Under the relevant shipping Act the owner of a sea going ship was not liable to make good any loss or damage happening without his fault. The issue was whether Lennard’s knowledge was also the company’s knowledge that the ship was unseaworthy.

The court held that Lennard was the Directing mind and will of the company his knowledge was the knowledge of the company, his fault the fault of the company and since he knew that the ship was unseaworthy, his fault was also the company’s fault and therefore the company was liable. As per Viscount Haldane

“My Lords a corporation is an abstraction. It has no mind of its own anymore than it has a body of its own. Its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation.

Bolton Engineering Co. v. Graham

Here the Plaintiffs who were tenants in certain business premises were entitled to a renewal of their tenancy unless the landlords who were a limited company intended to occupy the premises themselves for their business purposes. The issue was whether the Defendant company had effectively formed this intention. There had been no formal general meeting or Board of Directors meeting held to consider the question but the managing director’s clearly manifested the intention to occupy the premises for the company’s business.

The court held that the intention manifested by the Directors was the company’s intention and therefore the tenants were not entitled to a renewal of the tenancy.

Denning L.J. as he then was stated as follows:

“a company may in many ways be likened to a human being. It has a brain and nerve centre which controls what it does. It also has hands which hold the tools and act in accordance with the directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind and will of the company. Other are directors and managers who represent the directing mind and will of the company and control what it does. The state of mind of these managers is the state of mind of the company and are treated by the law as such. Whether their intention is the company’s intention depends on the nature of the matter under consideration, the relative position of the officer or agent and other relevant facts and circumstances of the case.” 

 RULE IN TURQUAND’S CASE

Crossly connected with this aspect is the so called rule in Turquand’s case:

This rule deals with a company’s liability for acts of its officers. The question as to whether or not the company is bound or not depends on the normal agency principles. If a company’s officer or a company’s organ does an act within the scope of its authority, the company will be bound. The problem which might arise is that even if the Act in question is within the scope of the organs or officers authority, there might be some irregularity in the action of the organ concerned and consequently in the exercise of authority. For example, if a particular act can only be valued if done by the Board of Directors or the general meeting, the meeting might have been convened on improper notice or the resolution may not have been properly carried. In the case of the Directors, they may not have been properly appointed. In these circumstances can the company disclaim an act which was so done by arguing that the meeting was irregular? Must a third party dealing with the company always ascertain that the company’s internal regulations have been complied with before holding the company liable?

The answer to this question was given in the negative in the case of The Royal British Bank v. Turquand (1856) 6 E & B 327

Here under the Company’s constitution the directors were given power to borrow on bond such sums of money as from time to time by a general resolution be authorised to be borrowed. Without any such resolution having been passed, the directors borrowed a certain sum of money from the Plaintiff’s bank. Upon the company’s liquidation the bank sought to recover from the liquidator who argued that the Bank was not bound to recover it as it was borrowed without authority from the general meeting.

The court held that even though no resolution had been passed, the company was nevertheless bound by the act of the directors and therefore was bound to repay the money.

The words of Jarvis C.J. were as follows:

“a party dealing with a company is bound to read the company’s deed of settlement (Memorandum of Association) but he is not bound to do more. In this case a third party reading a company’s documents will find not a prohibition from borrowing but permission to do so on certain conditions. Finding that the authority might be made complete by resolution, he would have had a right to infer the fact of a resolution authorising that which on the face of the document appeared to be legitimately done.”

This is the rule in Turquand’s Case which is often referred to as the rule as to indoor management.

This rule is based not on logic but on business convenience.

1. A third party dealing with a company has no access to the company’s indoor activities;

2. It would be very difficult to run business if everyone who had dealings with the company had first to examine the company’s internal operations before engaging in any business with the company;

3. It would be very unfair to the company’s creditors if the company could escape liability on the ground that its officials acted irregularly.

 

But should the company always be held liable for the act of any people purporting to act on the company’s behalf? Suppose these persons are impostors, what happens?

In order to avoid this some limitations have been imposed on the rule. Later cases have refined the rule to a point where the position appears to that ordinary agency principles will always apply

Anybody dealing with a company is deemed to have notice of the contents of the company’s public documents. Therefore any act which is contrary to those provisions will not bind the company unless it is subsequently ratified by the company acting through its appropriate organ. The term public document is not defined in the companies Act but so far as registered companies are concerned, the expression is not restricted to the Memorandum and Articles but it also includes some of those documents filed at the companies registry. These include special resolutions, particulars of directors and secretary, charges etc. provided that everything appears to be regular, so far as can be checked from the public documents, a third party dealing with a company is entitled to assume that all internal regulations of the company have been complied with unless he has knowledge to the contrary or there are suspicious circumstances putting him on inquiry. Reference is made to the case of Mahoney v. East Holyford Mining Co. (1875) L.R. 7 HL 869

Here a mining company was founded by W and his friends and relatives. Subscriptions were obtained from applicants for shares. These monies were paid into the bank which had been described in the prospectus as the company’s bank. The communication of the letter was sent to the Bank by a person describing himself as the Company’s secretary to the effect that in accordance with a resolution passed on that day, the bank was to pay out cheques signed by either two of the three named directors whose signatures were attached and countersigned by the Secretary. The bank thereafter honoured cheques so signed. When the company’s funds were almost exhausted, the company was ordered to be wound up. It was then discovered that no meeting of the Shareholders had been held, and no appointment of Directors and Secretary met but that with his friends and relatives, W had held themselves to be secretary and directors and had appropriated the subscription money. The issue was whether the Bank was liable to refund the money it had paid back to the borrower.

The court held that the bank was not liable to refund any money to the company as it had honoured the company’s cheques in reliance on a letter received and in good faith.

Lord Hatherly stated

“When there are persons conducting the affairs of a company in a manner which appears to be perfectly consonant with the articles of association, then those dealing with them externally are not to be affected by any irregularities which may take place in the internal management of the company.”

Directors will not necessarily and for all purposes be insiders. The test appears to be whether the acts done by them are so closely related to their position as directors as to make it impossible for them not to be treated as knowing the limitations on the powers of the officers of the company with whom they have dealt. Otherwise a third party dealing with a company through an officer who is or is held out by the company as a particular type of officer e.g. a Managing Director and who purports to exercise a power which that sort of officer will usually have is entitled to hold the company liable for the officer’s acts even though the officer has not been so appointed or is in fact exceeding his authority as long as the third party does not know that the company’s officer has not been so appointed or has no actual authority. A third party however, will not be protected if the circumstances are such as to put him on inquiry. He will also lose protection if the public documents make it clear that the officer has no actual authority or could not have authority unless a resolution had been passed which requires filing in the Companies Registry and no such resolution had been filed. These are normal agency principles.

Freeman & Lockyer V Buckhurst Park Properties (1964) 2 Q.B. 480

In this case Kapool & Hoon formed a private company which purchased Buckhurst Park Estate. The Board of Directors consisted of Kapool, Hoon and two others. The Articles of the company contained a power to appoint a Managing Director but none was appointed. Though never appointed as such, Kapool acted as Managing Director. In that capacity he engaged the Plaintiffs who were a firm of Architects to do certain work for the company which was duly done. When the Plaintiff’s claimed remuneration, according to the agreement, the company replied that it was not liable because Kapool had no authority to engage them.

The Court held that the act of engaging Architects was within the ordinary ambit of the authority of a Managing Director of a property company and the Plaintiffs did not have to inquire whether a person with whom they were dealing with was properly appointed. It was sufficient for them that under the Articles, the Board of Directors had the power to appoint him and had in fact allowed him to act as Managing Director. Four conditions must however be fulfilled in order to entitle a third party to enforce a contract entered to on behalf of the company by a person who has no actual authority.

1. It must be shown that there was a representation that the agent had authority to enter into a contract of the kind sought to be enforced;

2. Such representation must be made by a person or persons who had actual authority to manage the company’s business either generally or in respect of those matters to which the contract relates;

3. It must be shown that the contract was induced by such representation;

4. It must be shown that neither in its Memorandum or under its Articles was the company deprived of the capacity either to enter into a contract of the kind sought to be enforced or to delegate authority to do so to the agent.

Emco Plastica International vs Freeberne (1971) E.A. 432 Here by a resolution of the company at a meeting of the Board of Directors, the Respondent was appointed as the company’s secretary. Nothing was decided at the meeting as regards his remuneration or other terms of service. The terms of his appointment were contained in a letter signed on behalf of the company by its Managing Director which provided that the appointment was for a maximum period of 5 years. The Managing Director dealt with the day to day affairs of the company but had no express authority to appoint a Secretary or to offer such unusually generous terms as contained in the letter. After two years service the company purported to dismiss the Respondent by five days notice. The Secretary sued for benefits under the Contract. The Company contended that the Managing Director had no authority from the Company to offer the terms of the contract. There being no resolution of the board to support it and nothing in the company’s articles conferring any such powers on a Managing Director.

The court held that as a chairman he performed the functions of the Managing Director with a full knowledge of the Board of Directors and that a contract of service as the one entered into with the Secretary was one which a person performing the duties of a Managing Director would have power to enter into on behalf of the company. Therefore, the contract was genuine, valid and enforceable. If however, the officer is purporting to exercise some authority which that sort of officer would not normally have, a third party will not be protected if the officer exceeds his actual authority unless the company has held him out as having authority to act in the matter and the third party has relied thereof i.e. unless the company is estopped. However, a provision in the Memorandum or Articles or other public document cannot create an estoppel unless the third party knew of the provision and has relied on it. For this purpose, regulations at the Companies Registry do not constitute notice because the doctrine of constructive notice operates negatively and not positive. If a document purporting to be received by or signed on behalf of the company is proved to be a forgery, it does not bind the company. However, the company may be estopped from claiming the document as a forgery if it has been put forward as genuine by an officer acting within his usual or ostensible authority.

Look at Rama Corp v Proved Tin & General Investment (1952) 2 Q.B. 147

PROMOTERS

The Companies Act does not define the term promoter but Section 45(5) says

“A promoter is a promoter who was a party to the preparation of the prospectus. Apart from the fact that this definition does not speak much, it nevertheless shows that the definition is only given for the purposes of that section.

At common law the best definition is that by Chief Justice Cockburn in the case of

Twyfords – v – Grant (1877) 2C.P.D. 469

Cockburn says “a promoter is one who undertakes to form a company with reference to a given project and to set it going and who takes the necessary steps to accomplish that purpose.”

The term is also used to cover any individual undertaking to become a director of a company to be formed. Similarly it covers anyone who negotiates preliminary agreements on behalf of a proposed company. But those who act in a purely professional capacity e.g. advocates will not qualify as promoters because they are simply performing their normal professional duties. But they can also become promoters or find others who will. Whether a person is a promoter or not therefore, is a question of fact. The reason is that Promoter of is not a term of law but of business summing up in a single word the number of business associations familiar to the commercial world by which a company is born.

It may therefore be said that the promoters of a company are those responsible for its formation. They decide the scope of its business activities, they negotiate for the purchase of an existing business if necessary, they instruct advocates to prepare the necessary documents, they secure the services of directors, they provide registration fees and they carry out all other duties involved in company formation. They also take responsibility in case of a company in respect of which a prospectus is to be issued before incorporation and a report of those whose report must accompany the prospectus.

DUTIES OF A PROMOTER

His duty is to act bona fide towards the company. Though he may not strictly be an agent, or trustee for a company, anyone who can be properly regarded as a promoter stands in a fiduciary relationship vis-à-vis the company. This carries the  duties of disclosure and proper accounting particularly a promoter must not make any profit out of promotion without disclosing to the company the nature and extent of such a Promotion. Failure to do so may lead to the recovery of the profits by the company.

The question which arises is – Since the company is a separate legal entity from members, how is this disclosure effected?

Erlanger v New Sombrero Phosphates Co. (1878) 3 A.C. 1218

The facts were as follows:

The promoters of a company sold a lease to the company at twice the price paid for it without disclosing this fact to the company. It was held that the promoters breached their duties and that they should have disclosed this fact to the company’s board of directors. As Lord Cairns said

“the owner of the property who promotes and forms that company to which he sells his property is bound to take care that he sells it to the company through the medium of a Board of Directors who can exercise an independent judgment on the transaction and who are not left under belief that the property belongs not to the promoters and not to another person.”

Since the decision in Salomon’s case it has never been doubted that a disclosure to the members themselves will be equally effective. It would appear that disclosure must be made to the company either by making it to an independent Board of Directors or to the existing and potential members. If to the former the promoter’s duty to the company is duly discharged, thereafter, it is upon the directors to disclose to the subscribers and if made to the members, it must appear in the Prospectus and the Articles so that those who become members can have full information regarding it.

Since a promoter owes his duty to a company, in the event of any non-disclosure, the primary remedy is for the company to bring proceedings for

1. Either rescission of any contract with the promoter or

2. recovery of any profits from the promoter.

As regards Rescission, this must be exercised with keeping in normal principles of the contract.

1. the company should not have done anything to ratify the action

2. There must be restitutio in intergram (restore the parties to their original position),

REMUNERATION OF PROMOTERS

A promoter is not entitled to any remuneration for services rendered for the company unless there is a contract so enabling him. In the absence of such a contract, a promoter has no right to even his preliminary expenses or even the refund of the registration fees for the company. He is therefore under the mercy of the Directors. But before a company is formed, it cannot enter into any contract and therefore a promoter has to spend his money with no guarantee that he will be reimbursed.

But in practice the articles will usually have provision authorising directors to pay the promoters. Although such provision does not amount to a contract, it nevertheless constitutes adequate authority for directors to pay the promoter.

PRELIMINARY CONTRACTS BY PROMOTERS

Until a company is formed, it is legally non-existent and therefore cannot enter into any contract or even do any other acts in law. once incorporated, it cannot be liable on any contract nor can it be entitled under any contract purported to have made on its behalf before incorporation.

Ratification is not possible when the ostensible principle is non-existent in law when the contract was entered into.

Price v. Kelsall (1957) E.A. 752

One of the issues in this case was whether or not a company could ratify a contract entered into on its behalf before incorporation. The alleged contract was that the Respondent had undertaken to sell some property to a company which was proposed to be formed between him and the Appellant. In holding that a company cannot ratify such an agreement, the Eastern Africa Court of Appeal as then constituted O’Connor President said as follows

“A company cannot ratify a contract purporting to be made by someone on its behalf before its incorporation but there may be circumstances from which it may be  inferred that the company after its incorporation has made a new contract to the effect of the old agreement. The mere confirmation and adoption by Directors of a contract made before the formation of the company by persons purporting to act on behalf of the company creates no contractual relations whatsoever between the company and the other party to the contract.”

However, acts may be done by a company after its formation which give rise to an inference of a new contract on the same terms as the old one.

The question whether there is a new contract or contracts is always a question of facts which depends on the circumstances of each individual case.

Mawagola Farmers & Growers Ltd. V Kanyanja (1971) E.A. 272

Here, prior to the incorporation of a company the promoters held public meetings at which members of the public were asked to purchase shares in a proposed company. The Respondents paid for the shares both before and after incorporation of the company but the company did not allot any shares to them. Instead after incorporation, it allotted shares to other people.

The Respondents filed actions praying for orders that the shares they paid for be allotted to them and the company’s registered members be rectified accordingly.

The Company argued that as the Respondents had paid money for the purchase of their shares before incorporation, their claim could only be directed against promoters because no pre incorporation agreement could bind the company and the company could not even after incorporation ratify or adopt any such contract.

Mustafa J.A. replied as follows:

“in order that the company may be bound by agreements entered into before incorporation, there must be a new contract to the same effect as the old agreements. This contract may however be inferred from the acts of the company when incorporated.”

The allotment of shares to the Respondents after the incorporation was held to be sufficient evidence of a new contract between the company and the Respondents. Therefore the Respondents were entitled to be allotted the shares agreed upon.  If any preliminary arrangements are made, these must therefore be left to mere gentlemen’s agreements or otherwise the promoters might have to undertake personal liability.

Although the principle is clear, those engaged in the formation of companies often cause contracts to be entered into on behalf of their proposed companies.

As to whether the promoters will be personally liable on such contracts of nought might depend on the terminology employed. In the case of

Kelner v. Baxter (1886) L.R. 2 C.P. 174

In this case, A, B and C entered into a contract with the Plaintiff to purchase goods “on behalf of the proposed Gravesand Royal Alexandra Hotel Company” the goods were duly supplied and consumed. Shortly after incorporation the company in question collapsed and the Plaintiff sued A B and C for the price of the goods supplied.

It was held that A B and C were liable. Chief Justice Erne stated as follows:

“where a contract is signed by one who professes to be signing as agent but who has no principal existence at the time, then the contract will hold together the inoperative unless binding against the person who signed it. He is bound thereby and a stranger cannot by subsequent ratification relieve him from that responsibility. When the company came afterwards into existence, it had rights and obligations from that time but no rights or obligations by reason of anything which might have been done before.”

Contrast this case with the case of

Newborn v. Sensolid (G.B Ltd) (1954) 1 Q.B. 45

Here a contract was entered into between Leopold Newborn London Ltd and the Defendant for purchase of goods by the latter. The defendant subsequently refused to take delivery of the goods and an action was commenced by Leopold Newborn Ltd.

It was discovered that at the time the contract was entered into, the company had not been incorporated. Leopold Newborn thereupon sought personally to enforce the contract.  It was held that the signature on the document was the company’s signature and as the company was not in existence when the contract was signed, there never was a contract and Mr. Newborn could not come forward and say that it was his contract. The fact was that he made a contract for a company which did not exist.

PROSPECTUSES

Basically when the public is asked to subscribe for shares or debentures in a company the invitation involves the issue of documents which set out the advantages to accrue from an investment in the company. This document is called a prospectus and may be issued either by the company itself or by a promoter. It is only in the case of a public company that a prospectus may be issued.

A private company must always raise its capital privately as required by Section 13 of the Companies Act Cap 486.

Section 20 of the Statute defines Prospectus as “any prospectus notice circular advertisement or other invitation offering to the public for subscription or purchase of any shares or debentures in the company.”

The word invitation and offering in that definition are loosely used because when a company issues a prospectus it does not offer to sell any shares but rather invites offers from members of the public. A prospectus is therefore not an offer but an invitation to treat.

The word prospectus is thus a vague and uncertain term. Whether an invitation is made to members of the public is always a question of fact. The question “public” is not restricted to a certain section of the public but includes any members of the general public. Reference may be made to the case of Re South of England Natural Gas Co. (1911) 1 Ch. 573

A newly formed company issued 3000 copies of a document which offered for subscription shares in a company and which was headed “for private circulation only”. These copies were then circulated to the shareholders of a number of gas companies and the question arose Was this a prospectus? The court held that this was an offer to the public and therefore constituted a prospectus.

CONTENTS OF A PROSPECTUS

The object of the Companies Act is to compel a company to disclose in a prospectus all the necessary information which will enable a potential investor in deciding whether or not to subscribe for a company shares or debentures. Therefore Section 40 requires that every Prospectus shall state the matter specified in Article 1 of the 3rd Schedule to the Act and that it will also set out the report specified in Part II of that Schedule. The provisions in that Schedule are designed mainly to provide information about the following matters:

1. Who the directors are; and What benefits they will get from the Directorship;

2. In the case of a new company, what profits are being made by the promoters;

3. the amount of capital required by the company to be subscribed, the amount actually received or to be received, the precise nature of the consideration which is not paid in cash;

4. In the case of an existing company, what the company’s financial records has been in the past.

5. the company’s obligations under any contracts it has entered into;

6. the voting and dividend rights of each class of shares;

7. If a Prospectus includes any statement by an expert, then the expert must have given his written consent to the inclusion of the statement and the prospectus must state that he has done so as per Section 42 of the Companies Act.

Contravention of these requirements renders the company and every person who was knowingly a party to the issue of the prospectus to a fine not exceeding 10,000/-

Section 42 defines Expert as including “Engineer, Valuer, Accountant or any other person whose profession gives authority to the statement made by him.”

In addition to these requirements the prospectuses must also be dated and the date stated therein is taken to be the date of publication of the prospectus. However, there are two instances when a prospectus need not contain the matter set out in Schedule III namely

1. When the prospectus is issued to existing members or shareholders of the company;

2. When the prospectus relates to shares or debentures uniform with previously issued shares or debentures.

LIABILITY IN RESPECT OF PROSPECTUS

If a prospectus contains untrue statements, the Companies Act prescribes both penalty at Criminal Law and also Civil Liability for payment of damages. As concerns Criminal Liability, under Section 46 where a prospectus includes any untrue statement, any person who authorised the issue of the prospectus is guilty of an offence and liable to imprisonment of a term not exceeding two years or a fine not exceeding 10,000/- or both such a fine and imprisonment unless he proves either that the statement was immaterial or that he had reasonable grounds to believe and did up to the time of issue of the prospectus that the statement was true.

A statement is deemed to be untrue if it is misleading in the form and context in which it is included.

R. v. Kylsant (1932) 1 K.B. 442

In this case the company had sustained continuous loses for over 6 years from 1921 to 1927. The company issued a prospectus which in all material facts was correct. It further specified that the dividends being paid were high. But these dividends were being paid out of abnormal profits made after World War 1. Therefore the Prospectus was misleading in its context.

CIVIL REMEDIES

There are two primary remedies for those who subscribe for shares in a company as a result of a misrepresentation in a prospectus

(a) Damages;

(b) Rescission of any resulting contract.

DAMAGES

Section 45 provides for compensation to all persons who subscribe for any shares or debentures on the faith of the Prospectus for loss or damage they may have sustained by reason of untrue statements included therein. If the statement is false to the knowledge of those who made it, then this amounts to fraud and damages will be recoverable from all those who made the statement intending it to be acted upon. Refer to the case of Derry v. Peek (1889) 14 A.C. 337

Herein a company had power to construct tramways to be moved by animal power and with the consent of the British Board of Trade by steam or mechanical power. The Directors issued a prospectus stating that the company had power to use steam or mechanical power.

In reliance on this misrepresentation, the Plaintiff bought shares in the company. Subsequently the Board of Trade refused to give consent to the use of Steam or mechanical power and as a result the company was wound up. The Plaintiff brought an action for deceit alleging fraudulent misrepresentation.

The Court held that the Defendants were not liable as they had made the incorrect statement in the honest belief that it was true. Lord Herschell said “the authorities establish two major propositions.

(i) In order to sustain an action of Deceit, there must be proof of fraud and nothing short of that will suffice;

(ii) Fraud is proved when it is shown that a false representation has been made either;

(a) Knowingly or

(b) Without belief in its truth; or

(c) Recklessly not caring whether it be true or false.

In order to succeed in an action for damages for fraud the plaintiff must show that the Misrepresentation was made to him or that he was one of a class of persons who were intended to act upon it. The ordinary purpose of a prospectus is to invite members of the public to become allottees of shares in a company. Once the shares have been allotted therefore the prospectus will have served its purpose and thereafter it cannot be used as a ground for filing an action for fraud in respect of shares bought at a later date from another source. Reference made to the case of Peek v. Gurney (1873) L.R. 377

The allotment of shares in the company began on July 24th and was completed on 28th July. In October, the Plaintiff bought shares on the stock exchange. He subsequently found that the prospectus issued in July contained some untrue statements and therefore brought an action in respect thereof. The issue was could he sue?

The court held that the Plaintiff could not base his action on the prospectus which was intended to be addressed only to the original company subscribers to the company shares. The Directors of a company are not liable after the full original allotment of shares for all the subsequent dealings which may take place with regard to those shares on the stock exchange.

However, the rule in Peek v. Gurney will not apply where a prospectus is intended to induce not only the original subscribers for the company shares but also to influence the subsequent purchase of those shares

Andrews v. Mockford (1896) 1 QB 372

Here the Plaintiff alleged that the Defendant sent him a prospectus inviting him to buy shares in the company which they knew would be a sham but the Plaintiff did not subscribe for the shares. The prospectus eventually produced a very scanty subscription and the Defendant caused a telegram to be published in the local Newspaper to the effect that they had struck a vain of Gold. And this they alleged had confirmed the statistics in the prospectus.

The Plaintiff immediately bought shares on this basis. The company was wound up. The question arose, Had the Prospectus served its purpose.

The court held that the prospectus was intended to induce the Plaintiff both to subscribe for shares initially and also to buy them in the Market thereafter. The telegram was part of the prospectus.

Lord Justice Smith stated as follows

“there was proved against the Defendant a continuous fraud on their part commencing with ascending of the prospectus to the Plaintiff and culminating in the direct lie told in a telegram which was intended by the defendant to operate upon the Plaintiff’s mind and minds of others and did so operate to his prejudice and the advantage of the Defendant. In this case the function of the prospectus was not exhausted and a false telegram was brought in to play by the Defendant to reflect back upon and countenance the false statements in the prospectus.”

The purchaser of shares induced to buy shares by the misstatement in the prospectus has an action for damages in negligence. He has also an action for negligent misstatement under the Hedley Byrne & Co. v. Heller & Partners (1974) A.C. 465 All these actions are directed to the Directors personally.

RESCISSION

As against the company a person induced to buy shares by a misrepresentation in the prospectus may rescind the contract. On buying shares ones contract is with a company itself. The remedy is available only against the company. To be entitled to this remedy, it is not necessary for the purchaser of the shares to show that the statement was fraudulent or negligent. Even if the misrepresentation was innocent, rescission lies. However, the rights to rescind is subject to two limitations

1. The allotee loses the right to rescind if he shows any election to affirm the contract; e.g. by attending and voting at the company’s meetings or by accepting dividends or by selling or attempting to sell the shares.

2. If the allotee does not rescind the contract before the company is wound up, he loses the right to do so as from the moment the winding up proceedings commenced. The rationale is the protection of the other company’s creditors.

DIRECTORS’ DUTIES

First, three preliminary observations

1. Whereas the Directors’ authority to bind the company depends on their acting collectively as a Board, their duties to the company are owed by each Director individually. These duties are owed to the company and the company alone and not to individual shareholders.

Percival v. Wright (1902) 2 Ch. 421

Certain Shareholders wrote to the Company’s Secretary asking if he knew anyone willing to buy their shares. Negotiations took place and eventually the company chairman and two other directors bought the Plaintiff Shares at £12 10s per share. The Plaintiff subsequently discovered that prior to and during their own negotiations for sale, the Chairman and the Board of Directors had been approached by 3rd Party with a view to the purchase of the entire company’s assets at more than the price of 12 pounds 10 shillings per share.

The Plaintiff brought an action to set aside the share sales on the ground that the directors owed them a duty to disclose the negotiations with the 3rd Party.  It was held that the Directors were not agents for the individual shareholders and did not owe them any duty to disclose. Therefore the sale was proper and could not be set aside. However, if the Directors are authorised by the members to negotiate on their behalf e.g. with a potential purchaser then the Directors will be in a position of agents for such members and will owe them a duty accordingly.

Allen v. Hyatt (1914) 30 T.L.R. 444

These duties except where expressly stipulated in the Companies Act are not restricted to directors alone but apply equally to any officials of the company who are authorised to act as agents of the company and in particular to those acting in a managerial capacity. This is particularly so as regards fiduciary duties.

DIRECTORS’ DUTIES PROPER

These fall into two broad categories

1. Duties of care and skill in the conduct of the company’s affairs; and

2. Fiduciary duties of loyalty and good faith.

 

DUTIES OF CARE & SKILL

Duties of care and skill were summed up by Romer J. in the case of

Re City Equitable Fire Insurance Co. (1925) Ch. D 447

Here the Directors of an insurance company left the management of the company’s affairs almost entirely to the Managing Director. Owing to the managing Director’s fraud, a large amount of the company’s funds disappeared. Certain items appeared in the balance sheet under the heading “loans at call or short notice and “Cash in Bank or in Hand”. The Directors did not inquire how these items were made up. If they had inquired they would have found that the loans were chiefly to the Managing Director himself and to the Company’s General Manager and the cash at Bank or in hand included some £13,000 in the hands of a firm of stockbrokers at which the managing director was a partner.

On the company’s winding up, an investigation of its affairs disclosed a shortage in its funds of more than £1.2 million incurred mainly due to the delinquent fraud of the  Managing Director for which he was convicted and sentenced. The other Directors had all along acted in good faith and honestly but the liquidator sought to make them liable for the damages.

It was held that the Directors were negligent. Justice Romer reduced the Directors duties of care and skill as follows

“A Director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.”

This proposition prescribes the standard of skill to be exhibited in actions undertaken by directors. The test is partly objective and also partly subjective because a reasonable man would be expected to have the knowledge of a director with his experience. Refer to

Re Brazilian Rubber & Plantations Estates Ltd. (1911) 1 Ch. 405

In this case a company had five directors and one of them confessed that he was absolutely ignorant of business. A second one was 75 years old and very deaf. A third one said he only agreed to become a director because he saw one of his friends names on the list of directors. The other two were fairly able businessmen. The directors caused a contract to be entered into between the company and a certain syndicate for purchase by that company of some rubber plantation in Brazil. The prospectus issued by the company contained false statements about the acreage of the Plantation, the types of trees and so forth. The information given therein was given to the Directors by a person who had an original option to purchase that property. He had never been to Brazil and the data was based on his own imagination. The Directors caused the company to purchase the property. The question arose, were they negligent in so doing?

The court held that their conduct did not amount to gross negligence. Neville J. had the following to say:

“It has been laid down that so long as they act honestly, Directors cannot be made responsible in damages unless they are guilty of gross negligence. A Director’s duty requires him to act with such care as is reasonably expected from his having regard to his knowledge and experience. He is not bound to bring any special qualifications to his office. He may undertake the Management of a Rubber Company in complete ignorance of anything connected with Rubber without incurring responsibility for the mistakes which  may result from such ignorance. While if he is acquainted with the Rubber business, he must give the company the advantage of his knowledge when transacting the company’s business. He is not bound to take any definite part in the conduct of the company’s business but insofar as he undertakes it he must use reasonable care. Such reasonable care must be measured by the care an ordinary man might be expected to take in the same circumstances on his own behalf.”

3. A director is not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical Board Meetings and at meetings of any committee of the Board on which he is placed. He is not bound to attend all such meetings though he ought to attend whenever in the circumstances he is reasonably able to do so. Refer to the case of Re Denham & Co. Ltd (1883) 2 Ch. D 752

 

Here a company was incorporated in 1873. Under the Articles 3 Directors were appointed namely, Denham, Taylor and Crook. A fourth Director was appointed later. The articles conferred on Denham supreme control of the company’s affairs. He was given power to override decisions of the general meeting and a Board of Directors. He was responsible for declaring dividends and he managed the company’s affairs entirely alone and without consulting the other directors. Between 1874 and 1877 a dividend of 15% per annum was recommended and paid and the total amount paid was some £21,600. In 1880 the company went into liquidation and an investigation revealed that the money paid as dividends had been paid not out of profits but out of capital. Thereafter Denham became bankrupt, Taylor was dead and his estate was worthless and the third man was a man of straw. The creditors directed their claims against Crook who had property. Crooks argued that since the formation of the company, he had never attended Board Meetings and therefore could not be accountable for fraudulent statements in the Company’s Balance Sheets. He attended one meeting in 1876 where he formally put forth a Resolution for the payment of a dividend for that year.

The Court held that a Director is not bound to attend every Board meeting and that he is not liable for misfeasance committed by his co-directors at Board meetings at which he was never present.

Marquis Of Butes (1892) 2 Ch. 100 Here the Director never attended any Board meetings for 38 years. It was held that he was not liable.

3. In respect of all duties which having regard to all exigencies of business and articles of association may properly be left to some other official. A Director in the absence of grounds for suspicion will not be liable in trusting that other official to perform that other duty honestly.

Dovey v. Cory (1901) A.C. 477

A bank sustained heavy losses by advances made improperly to customers. The irregular nature of advances was concealed by means of fraudulent Balance Sheets which were the work of the General Manager and the Chairman in assenting to the payment of dividends out of capital and those advances on improper security were done on the advice of the general manager and chairman.

The court held that the reliance placed by the co-director on the general manager and chairman was reasonable. He was not negligent and therefore was not liable for not having discovered the fraud as he was not in the absence of circumstances of suspicion bound to examine entries in the Company’s Books to see that the Balance Sheet was correct.

It may be said that the duties of care and skill appear to be negative duties. What about fiduciary duties?

FIDUCIARY DUTIES

Basically a Director’s fiduciary duties are divisible into 4 sub categories

1. The Directors must always act bona fide in what they consider and not what the courts may consider to be in the best interest of the company. In this context, the term company means the present and future members of the company on the basis that the company will be continued as a going concern thereby balancing long-term view against short term interests of existing members.

2. The directors must always exercise their powers for the particular purpose for which they were conferred and not for extraneous purposes even if the latter are considered to be in the best interests of the company. For example the Directors are invariably empowered to issue capital and this power should be exercised for only raising more funds when the company requires it. Hence it will be a breach of the Directors’ duties to issue the company shares for the purpose of entrenching themselves in the control of the company’s affairs. Refer to the case of Punt v. Symons (1903) 2 Ch. 506 in this case the directors issued shares with the object of creating a sufficient majority to enable them to pass a special resolution depriving the other shareholders of some special rights conferred upon them by the company’s articles. It was held that a power of a kind exercised by the Directors in this case was a power which must be exercised for the benefit of the company. Primarily this power is given to them for the purpose of enabling them to raise capital for the purposes of the company. Therefore a limited issue of shares to persons who are obviously meant and intended to secure the necessary statutory majority in a particular interest was not a fair and bona fide exercise of the power.

Piercy v. Mills & Co. (1920) 1 Ch. 78

A company had two directors. They fell out of favour with the majority of the shareholders who were therefore threatened with the election of 3 other directors to the Board. The directors issued shares with the object of creating a sufficient majority to enable them to resist the election of the 3 additional directors whose election would have put the two directors in the minority on the Board.

The Court held that the Directors were not entitled to use their powers of issuing shares merely for the purpose of maintaining their control or the control of themselves and their friends over the affairs of the company or even merely for the purpose of defeating the wishes of the existing majority of shareholders. The Plaintiff and his friends held the majority of shares in the company and as long as that majority remained, they were entitled to have their wishes prevail in accordance with a company’s regulations. Therefore it was not open to the directors for the purpose of converting a minority into a majority and purely for the purpose of defeating the wishes of the existing majority to issue the shares in dispute.

In those circumstances where the directors have breached their duty to exercise their powers for the proper purpose, the shareholders may forgive them by ratifying their action

Hogg v. Cramphorn Ltd. (1967) Ch. 254  In this case the company had two classes of shares, ordinary and preference shares. Each share carried 1 vote. The power to issue the company shares was vested in the Directors. They learnt that a takeover bid was to be made to the Shareholders. In the Bona fide belief that the acquisition of control by the prospective take over bidder will not be the interest of the company or its staff. The Directors decided to forestall this move. They therefore attached 10 votes to each of the unissued preference shares and allotted to a trust which was controlled by the Chairman of the Board of Directors and one of his partners in the company’s audit department and an employee of the company. To enable the trustees to pay for the shares, the directors provided them with an interest free loan out of the company’s reserve fund.

An action challenged by the Plaintiff who was an associate of the prospective take-over bidder and registered holder of 50 ordinary shares in the company was started. After finding that it was improper for the directors to attach such special voting rights, the Court stood over the action in order to enable a general meeting to be held and to debate whether or not to ratify the Director’s actions. The general meeting ratified the action.

Bamford v. Bamford (1969) 1 All ER. 969

There were similar facts as in the former case but a meeting was held before proceeding to court and that general meeting ratified the Director’s action. The question also arose in this case, could a decision of the general meeting cure the irregularity?

The court held if the allotment was made in bad faith, it was voidable at the instance of the company because it was a wrong done to the company and that being so, the company which has the rights to recall the allotment has also the right to approve it and forgive the breach of duty.

3. They must not fetter their displeasure to act for the company for example, the directors cannot contract either among themselves or with third parties as to how they will vote at future Board meetings. However, where they have entered into a contract on behalf of the company they may validly agree to take such further action at Board meetings as maybe necessary to carry out such a contract.

4. As fiduciaries the Directors must not place themselves without consent of the company in a position in which there is a conflict between their duties to the company and their personal interests. Good faith must not only be done but it must also manifestly be seen to be done. The law will not allow the fiduciary to place himself in a position where he will have his judgments to be biased and then argue that he was not biased. This principle applies particularly when a Director enters into a contract with his company or where he makes any secret profit by being a Director. As far as contracts are concerned a contract entered into by the Board on behalf of the company and another Director is governed by the equitable principle which ordains that a fiduciary relationship between the Director and his company vitiates such contracts. Such contract is therefore voidable at the instance of the company. Reference may be made to the case of Aberdeen Railway v. Blaikie (1854) 1 Macc. 461

The Defendant company entered into a contract to purchase a quantity of chairs from the Plaintiff partnership. At the time that the contract was entered into a Director of the company was also one of the partners. The issue was, was the company entitled to avoid the contract? The court held that the company was entitled to avoid the contract. The Judge said that as a body corporate can only act by agents and it is the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such an agent has a duty of a fiduciary nature to discharge towards his principal. It is a rule of universal application that no one having such duties to discharge shall be allowed to enter into or can have a personal interest conflicting or which may possibly conflict with the interests of those whom he is bound to protect. This principle is strictly applied no question is entertained as to the fairness or unfairness of the contract so entered into. However, it is possible for such contract to be given effect by the articles of association. At their narrowest the Articles might provide that a Director who is interested in a Company contract should disclose his interests and he will not be counted to decide that a quorum is raised and his votes will also not be counted on the issue. At their widest the articles might allow the director to be counted at Board meeting.

In order to create a balance between these two extremes and ensure that a minimum standard prevails Section 200 was incorporated into the Companies Act. Under this Section it is the duty of a director who is interested in any contract or proposed contract to disclose the nature and extent of his interest to the Board of Directors when the contract comes up for discussion. Failure to do so renders the defaulting director liable to a fine not exceeding 2000 shillings. In addition the failure also brings in the equitable doctrine whereby the contract becomes voidable at the option of the company and any profit made by the director is recoverable by the company.

The shortcoming of the Section is that the Director has to disclose to the Board of Directors and not to the general meeting. It is not sufficient for a Director to say that he is interested. He must specify the nature and extent of his interests. If the company’s articles take the form of Article 84 of Table ‘A’ then a Director who is so interested is required to abstain from voting at the Board meeting and his vote will not be taken in determining whether or not there is a quorum on the Board. Once the Director has complied with Section 200 and Article 84 then he can escape liability.

In respect of all other profits which a Director may make are out of his position as a Director the equitable principle which requires the Directors to account for any such profits is vigorously enforced. This is because the Courts have equated Directors to trustees and their duties have also been equated to those of Trustees. The question is, are they really trustees?

Selanger United Rubber Estates v. Craddock (1968) 1 All E.R. 567

Re Forest of Dean Coal Mining Company (1879) 10 Ch. D 450

In the latter case, the directors of a company were seen to be trustees only in respect of the company’s funds or property which was either in their hands or which came under their control. But this does not necessarily make directors trustees. There are two basic differences between Directors as Trustees and Ordinary Trustees.

(a) The function of ordinary trustee is to preserve the Trust Property but the role of a director is to explore possible channels of investment for the benefit of the company and these necessitates some elements of having to take a risk even at the expense of the company’s property.

(b) Whereas trust property is vested in the Trustees, a company’s property is held by the company itself and is not vested in the trust.

Nevertheless if the directors make any secret profits out of their positions then the effect is identical to that of ordinary trustees. They must account for all such profits and refund the company.

Regal Hastings v. Gulliver (1942) 1 All E.R. 378 Herein the company owned a cinema and the directors decided to acquire two other cinemas with a view to the sale of the entire undertaking as a going concern. Therefore they formed a subsidiary company to invite the capital of 5000 pounds divided into 5000 shares of 1 pound each. The owners of the two cinemas offered the directors a lease but required personal guarantees from the Directors for the payment of rent unless the capital of the subsidiary company was fully paid up. The directors did not wish to give personal guarantees. They made arrangements whereby the holding company subscribed for 2000 shares and the remaining shares were taken up by the directors and their friends. The holding company was unable to subscribe for more than 2000 shares. Eventually the company’s undertakings were sold by selling all the shares in the company and subsidiary and on each share the Directors made a profit of slightly more than two pounds. After ownership had changed the new shareholders brought an action against the directors for the recovery of profits made by them during the sale.

The court held that the company as it was then constituted was entitled to recover the profits made by the Directors. Lord Macmillan had the following to say:

“The directors will be liable to account if it can be shown that what they did is so related to the affairs of the company that it can properly be said to have been done in the course of their management and in utilisation of the opportunities and special knowledge and what they did resulted in a profit to themselves.”

Phipps v. Boardman (1966) 3 All E.R. 721

In this case Boardman was a solicitor to the trust of the Phipps family. The trust held some shares in the company. Boardman and his colleagues were not satisfied with the company’s accounts and therefore decided to attend the company’s general meeting as representatives of the Trust. At the meeting they received information pertaining to the company’s assets and their value. Upon receipt of the information, they decided to buy shares in the company with a view to acquiring the controlling interest. Their takeover bid was successful and they acquired control. Owing to the fact that Boardman was a man of extraordinary ability, the company made progress and the profits realised by Boardman and his friends on the one hand and the trusts on the other were quite extensive. One of the beneficiaries of the Trust brought an action to recover the profits which were realised by Boardman and his friends.

The court held that in acquiring the shares in the company, Boardman and his friends made use of information obtained on behalf of the trust and since it was the use of that information which prompted them to acquire the shares, then the shares were also acquired on behalf of the trust and thus the solicitors became constructive trustees in respect of those shares and therefore liable to account for the profits derived therefrom to the trust.

Peso Silver mines v. Cropper (1966) 58 D.L.R. 1

The Defendant was the company’s Managing Director. The Board of Directors was approached by a prospector who offered to sell his claims to the company. The company’s consulting geologists advised that it was in order for the company to acquire the claims. The directors decided that it was inadvisable for the company to acquire the same mainly because of its strained financial resources. Subsequently at the suggestion of the geologists, some of the Directors agreed to purchase the claims at the price at which they had been offered to the company. Thereafter they formed a company which took over the claims and a second company for developing the resources. After the control of Peso Silver Mines had changed the new directors brought an action against the Defendant to account to the company for the shares held by them in the new companies. But here the court held that since the company could not have taken over the claims, there was no conflict of interest between the Directors and the Company and therefore the Defendant was not liable to account for the shares.

Directors may make use of opportunities originally offered to the company and thereby make profits provided that some 4 conditions are satisfied namely

1. The opportunity must have been rejected by the company;

2. If the directors acted in connection with that rejection, they must have acted bona fide in the best interests of the company.

3. The information about that opportunity should not have been given to them confidentially on behalf of the company.

4. Their subsequent use of that information must not relate to them as directors but as any other ordinary person.

Industrial Development Consultants v. Cooley (1972) 2 All E.R. 162

The Defendant who was an architect was appointed the company’s Managing Director. The company’s business was to offer design and construction services to industrial enterprises. One of the defendant’s duties was to obtain new business for the company particularly from the gas companies where he had worked before joining the Plaintiff. While the Defendant was still so employed by the Plaintiff a  representative of one gas company came to seek his advice on some personal matters. In the course of their conversation the Defendant learnt that the gas company in question had various projects all requiring design and construction services of the type offered by the Plaintiff. Upon acquiring this information and without disclosing it to the company, the Defendant feigned illness as a result of which he was relieved by the company from his duties. Thereafter, he joined the gas company and got the contract to do the work. Two years previously, the Plaintiff had unsuccessfully tried to obtain that work. After the Defendant acquiring the contract, the company sued him alleging that he obtained the information as a fiduciary of the company and he should therefore account to the company for all the remuneration fees and all dues obtained.

The court held that until the Defendant left the Plaintiff, he stood in a fiduciary relationship to them and by failing to disclose the information to the company, his conduct was such as to put his personal interests as a potential contracting party to the gas company in conflict with the existing and continuing duty as the Plaintiff’s Managing Director.

Roskill J.

“It is an overriding principle of equity that a man must not be allowed to put himself in a position where his fiduciary duty and interest conflict. It was the defendant’s duty to disclose to the plaintiff the information he had obtained from the Gas Board and he had to account to them for the profits he made and will continue to make as a result of allowing his interests and duty to conflict. It makes no difference that a profit is one which the company itself could not have obtained. The question being not whether the company could have acquired it but whether the defendant acquired it while acting for the company.”

CONTROLLING SHARE HOLDERS

By controlling share holders is meant those who hold the majority of the voting rights in the company. Such share holders can always ensure control of the company’s business by virtue of their voting power to ensure that the controlling shareholders do not use their voting power for exclusively selfish ends, the Law requires that in exercise of their voting power, these shareholders must not defraud a minority. For example by endeavouring directly or indirectly to appropriate to themselves any money property or advantage which either belong to the company or in which the minority shareholders are entitled to participate.

Brown v. British Abrasive Wheel Co. (1919) 1 Ch. 290

Menier v. Hoopers Telegraphy Works (1874) L.R. Ch. A 350

In the latter case the company brought action against its former Managing Director for a declaration that the concessions for laying down a telegraph cable from Portugal to Brazil was held by that former Director as a trustee for the company. While this action was still pending, the Defendants who were the majority shareholders in the company approached that former Managing Director with a view to striking a compromise. It was agreed between the parties that if that director surrendered the concessions to the Defendants then the Defendants would use their voting power to ensure that the action was discontinued. At a subsequent general meeting of the company, by virtue of the defendant’s voting power, a resolution was passed that the company should be wound up.

The court said that the resolution was invalid since the defendants had used their voting power in such a way as to appropriate to themselves the concessions which if the earlier action had succeeded should have belonged to the whole body of shareholders and not merely to the majority. Lord Justice Mellish stated as follows:

“although the shareholders of the company may vote as they please and for the purpose of their own interest, yet the majority of the shareholders cannot sell the assets of the company itself and give the consideration but must allow the minority to have their share of any consideration which may come to them.”

Cook v. Deeks (1916) 1 A.C. 554

The Toronto Construction Company carried on business as Railway Construction contractors. The Shares in the company were held equally among Cook, G S Deeks and G M Deeks. And another party called Hinds. The company carried out several large construction contracts for the Canadian Pacific Railway. When the two Deeks and Hinds learnt that a new contract was coming up, they obtained this contract in their own names to the exclusion of the company and then formed a new company to carry out the work. At a general meeting of the shareholders of Toronto Construction company a resolution was passed owing to the two powers of Deeks and Mr. Hinds declaring that the company was not interested in the new contract of the Canadian Pacific Railway. Cook brought an action and the court held: that the benefit of the contract belonged properly to the Company and therefore the Directors could not validly use their voting power as shareholders to vest it in themselves.

ENFORCEMENT OF DIRECTORS’ DUTIES

As the company is a distinct entity from the members and since directors owed their duties to the company and not to individual shareholders, in the event of breach of those duties any action for remedies should be brought by the company itself and not by any individual shareholder. The company and the company alone is the proper Plaintiff. This is generally referred to as the rule in Foss V. Harbottle (1843) 2 Hare 461

In this case the Directors who were also the company’s promoters sold the company’s property at an undisclosed profit. Two shareholders brought action against them alleging that in so doing, that the directors had breached their duties to the company. It was held that if there was any breach of duty, it was a breach of duty owed to the company and therefore the Plaintiffs had no locus standi for the company was the proper plaintiff. This rule has two practical advantages namely:

1. Insistence on an action by the company avoids multiplicity of actions;

2. If the irregularity complained of is one which could have been effectively ratified by the company in general meeting, then it is pointless to commence any litigation except with the consent of the general meeting.

However there are four exceptions to this rule in which an individual member may bring action against the directors namely:

(a) Where it is complained that the company through the directors is acting or proposing to act ultra vires;

(b) Where the act complained of even though not ultra vires, the company can effectively be done by a special resolution;

(c) Where it is alleged that the personal rights of the Plaintiff have been infringed and/or are about to be infringed;

(d) Where those who control the company are perpetuating the fraud on the minority;

The problem likely to arise is that if the directors themselves are also controlling shareholders, the rule in Foss v. Harbottle if strictly applied in exercise of their voting  powers, the Directors may easily block any attempt to bring an action against themselves. In such cases a shareholder will be allowed to bring an action in his own name against the directors even if the wrong complained of has been done to the company. Such an action is called a derivative action.

In order to be entitled to commence a Derivative Action, it must be shown that

1. The wrong complained of was such as to involve a fraud on the minority which is not ratifiable by the company in general meeting;

2. It must be shown that the wrong doers hold the controlling interests

3. The company must be joined as a nominal defendant;

4. The action must be brought in a representative capacity on behalf of the plaintiff and all other shareholders except the Defendant.

The question is are these exceptions effective?

There are situations where the rule does not apply.

Another remedy against directors for breach is found in Section 324 of the statute which provides as follows:

“If in the course of the winding up of the company it appears that any person who has taken part in the formation or promotion of the company or any past or present director has misapplied or retained any money or property of the company, or been guilty of any breach of trust in relation to the company on the application of the liquidator, a creditor or member or a court may compel such person to restore the money or property to the company or to pay damages instead.”

This section is designed to deal with actual breaches of trust which come to light in the winding up proceedings or during the winding up proceedings but winding up itself may be used as a means of ending a course of oppression by those formally in control. Among the grounds for the winding up is one which is particularly appropriate for such circumstances.

Under Section 219 (f) of the Companies Act the court may order a company to be wound up if it is of the opinion that it is “just unequitable” the courts have so ordered when satisfied that it is essential to protect the members or any of them from oppression in particular they have done so when the conduct of those in control suggests that they are trying to make intolerable the position of the minority so as to be able to acquire the shares held by the minority on terms favourable only to the majority. But a member cannot petition under this section if the company is insolvent. If the company is solvent to wind it up, contrary to the majority wishes will only be granted where a very strong case against the majority is established.

Winding up a company merely to end oppression appears rather awkward as it may not be of any benefit to the petitioners themselves. Owing to these shortcomings, Section 211 was incorporated into the Companies Act as an alternative remedy for the minority of the shareholders. Section 211 provides that any member who complains that the affairs of a company are being conducted in a manner oppressive to some part of the members including himself may petition the court which if satisfied that the facts will justify a winding up order but that this will unduly prejudice that part of the members, may make such order as it thinks fit. Such an order may regulate the conduct of the company’s affairs in the future or may order the purchase of member shares by others or by the Company itself. This remedy is available only to the members. An oppressed director or creditor cannot obtain any remedy under Section 211 of the Companies Act for this is expressly restricted to oppression of the members even if a director or creditor also happens to be a member.

Elder V. Elder & Watson (1952) AC 49

The two Plaintiffs were the company director and secretary and factory manager respectfully. As this was a small family concern, serious differences arose between the plaintiffs and the beneficial owners of the undertaking. Consequently the Plaintiff brought action under Section 211 alleging oppression. It was held that if there was any oppression of the Plaintiffs, it related to them as directors and the remedy under Section 211 is only available to members. The suit was dismissed.

WHAT IS OPPRESSION?

This term has been defined to mean something burdensome, harsh or wrongful.

Scottish Cooperative Wholesale Society v. Meyer (1959) AC 324

Here the Society wished to enter into the retail business. For this purpose a subsidiary company was formed in which the two Respondents and 3 Nominees of the Society were the directors. The society had majority shareholders and the Respondents were the minority. The Company required 3 things namely;

1. Sources of supplies of raw material;

2. A licence from a regulatory organisation called cotton control

3. Weaving Mills.

The Respondents provided the first two but weaving Mills belonged to the society. For several years, the business prospered because of mainly the knowhow provided by the Respondent. The company paid large dividends and accumulated substantial results. Due to the prosperity, the society decided to acquire more shares and through its nominee directors offered to buy some of the shares of the Respondent at their nominal value which was one pound per share but their worth was actually 6 pounds per share. When the Respondents declined to sell their shares to the society, the society threatened to cause the liquidation of the company. About 5 years later, Cotton control was abolished which meant that the society would obtain the raw materials and weave cloth without a licence. It accordingly started to do the same and also started starving the subsidiary by refusing to manufacture for it except for an economic crisis. As all the other Mills were fully occupied, the subsidiary company was being starved to death and when it was nearly dead the Respondent brought the petition claiming that the affairs of the company were being conducted in an oppressive manner.

It was held that by subordinating the interests of the company to those of the society, the nominee directors of the society had thereby conducted the affairs of the company in a manner oppressive to the other shareholders. The fact that they were perhaps guilty of inaction was irrelevant. The affairs of the company can be conducted oppressively by the Directors doing nothing to protect its interests when they ought to do so.

Re Hammer(1959) 1 WL.R. 6

In this case Mr. Hammer senior was a Philatelist (stamp collector) dealer and incorporated business in 1947 forming a company with two types of ordinary shares class A shares which were entitled to a residue of profit and Class B Shares carrying all the votes. He gave out the shares to his two sons and at the time of the petition each son held 4000 Class A shares and the father owned 1000 shares. Of the Class B Shares, the father and his wife held nearly 800 to the 100 held by each son. Under the Company’s articles of association, the father and two sons were appointed directors for life and the father was further appointed chairman of the Board with a casting vote. The father assumed powers he did not possess ignored decisions of the Board and even in court, during the hearing asserted that he had full power to do as  he pleased while he had voting control. He dismissed employees using his casting vote to co-opt self directors, he prohibited board meetings, engaged detectives to watch the staff and secured payment of his wife’s expenses out of the company’s funds. He negotiated sales and vetoed leases all contrary to the decisions and wishes of the other directors.

The sons filed an action claiming that the father had run the affairs of the company in a manner oppressive to them. The father was 88 years.

The court held that by assuming powers which he did not possess and exercising them against the wishes of those who had the major beneficial interests, Mr. Hammer senior had conducted the company’s affairs in an oppressive manner.

These two cases are among the few where an application under Section 211 has succeeded. This is because section 211 has been subjected to a very restrictive meaning. To succeed under Section 211, one must establish a case of oppression.

There is no clear definition of the term and therefore it is not easy to tell when a company’s affairs are being conducted oppressively. For example in the case of Re Five Minute Car Wash Ltd (1966) 1 W.L.R. 745

The petitioner alleged oppression on grounds that the company’s Managing Director was extremely incompetent. The court ruled that even though the allegation suggested that the Managing Director was unwise inefficient and careless in the performance of his duties, this did not mean that he had at any time acted unscrupulously, unfairly or with any lack of probity towards the petitioner or to other members of the company. Therefore his conduct was not oppressive.

1. The conduct which is complained of must relate to the affairs of the company and must also relate to the petitioner in his capacity as a member. Personal representatives cannot petition nor can trustees in bankruptcy petition.

2. the wording of the section suggests that there must be a continuous cause of conduct and not merely isolated acts of impropriety.

3. The conduct must be such as to make it just and equitable to wind up the company. In other words, the members must be entitled to a winding up order.

Re Bella Dor Sick Ltd (1965) 1 All E.R. 667  In a small family concern, there developed two factions among shareholders. Owing to these personal differences the petitioner filed a petition under Section 211 complaining inter alia that the distribution of profits had not been fairly made. That he had been excluded from the Board of Directors and that the affairs of the company were being conducted irregularly. In particular, he alleged that the company had failed to repay its debts to another company in which he had some interests.

It was held that the petitioner had not made a case of oppression and the petition must be dismissed.

Three reasons were given

(a) This petition had been brought for the collateral purpose of enforcing repayment of debts to some third party;

(b) The conduct complained of and particularly the removal of the petitioner from the Board related to him as a director not as a member;

(c) That the circumstances were not such as to justify a winding up order at the instance of the petitioner because the company was insolvent and therefore the shareholders had no tangible interests.

It is an unfortunate mistake to link up Section 211 with winding up. The courts are construing the Section very restrictively. Section 211 has therefore failed to live up to expectations. It is no real remedy.

RAISING AND MAINTENANCE OF CAPITAL

The basis of the whole concept or a company’s capital was explained by Jessel M.R. in the Flitcrafts Case 1882 21 Ch. D 519 in this case for several years the directors had been in the habit of laying before the meeting of shareholders reports and balance sheets which were substantially untrue inasmuch as they included among other assets as good debts a number of debts which they knew to be bad. They thus made it appear that the business had produced profits whereas in fact it had produced none. Acting on these reports, the meetings declared dividends which the directors paid. It was held here that since the directors knew that the business had not made any profit, they were liable to refund to the company the monies paid by way of dividends.

Jessel M.R said as follows “when a person advances money to a company, his debtor is that artificial entity called the corporation which has no property except the assets of the business. The creditor therefore gives credit to that capital or those assets. He  gives credit to the company on the faith of the implied representation that the capital shall be applied only for the purposes of the business and he has therefore a right to say that the corporation shall keep its capital and shall not return it to the shareholders.”

The capital fund is therefore seen as a substitute for unlimited liability of the members. Courts have developed 3 basic principles for ensuring that the company’s represented capital is actually what it is and for the distribution of that capital.

1. Once the value of the company’s shares has been stated it cannot subsequently be changed the problem which arises in this respect is that shares may be issued for non-monetary consideration. For instance for services or property in such cases the company’s valuation of the consideration is generally accepted as conclusive. If the property has been over valued, provided the valuation has been arrived at bona fide, the courts will not question the adequacy of the consideration but if it appears on the face of the transaction that the value of the property is less than that of the shares, then the court will set aside that transaction. For this reason the shares in a company must be given a definite value. The law tries to ensure that the company initially receives assets at least equivalent to the nominal value of the paper capital. Refer to Section 5 of the Companies Act. Unfortunately if in the insistence that shares do have a definite fixed value is not an adequate safeguard because there is no legal minimum as to what the nominal value of the shares should be.

2. The Rule in Trevor v. Whitworth [1887] 12 A.C 449 Under this rule a company is not allowed to purchase its own shares even if there is an express power to do so in its Memorandum of Association as this would amount in a reduction of its capital. This principle is now supplemented by Section 56 of the Companies Act which prohibits any direct or indirect provision of any form of assistance in the purchase of the company shares. However, there are 3 exceptions to this broad prohibition.

a. where the lending of money is part of the ordinary business of the company;

b. Where the company sets a trust fund for enabling the trustees to purchase or subscribe for the company shares to be held or for the benefit of the employees of the company until where the company gives a loan to its employee other than directors to enable them to purchase shares in the company.

3. Payment of Dividends: In order to ensure that the company’s capital is not refunded to the shareholders under the guise of dividends, the basic principle is that dividends should not be paid otherwise than out of profits. Refer to Article 116 of Table A of the Companies Act. The legal problem in this respect has been the lack of an adequate definition of what constitutes profits. To avoid the problem of definition the courts have formulated certain rules for the payment of dividends. These are as follows

(i) Before a company can declare dividends, it must be solvent. Dividends will not be paid if this will result in the company’s inability to pay its debts as and when they fall due;

(ii) If the value of the company’s fixed assets has fallen thereby causing a loss in the value of those assets, the company does not need to make good that loss before treating revenue profits as available for dividends. It is not legally essential to make provision for depreciation in the fixed assets. However Losses of circulating assets in the current accounting period must be made good before a dividend can be declared. The realised profits on the sale of fixed assets may be treated as profit available for distribution as a dividend. Unrealised profits on evaluation of the company’s assets may also be distributed by way of dividends. Refer to Dimbula Valley (Ceylon) Tea Co. V. Laurie [1961] Ch. D 353 Losses on circulating assets made in previous accounting periods need not be made good. The dividend can be declared provided that there is a profit on the current year’s trading. Each accounting period is treated in isolation and once a loss has been sustained in one trading year, then it need not be made good from the profits over subsequent trading periods. Undistributed profits of past years still remain profit which can be distributed in future years until they are capitalised by using them to pay a bonus issue.

CORPORATE SECURITIES

Basically securities are a collective description of the various forms of investment which one can buy for sale at the stock exchange. A company can issue two  primary classes of securities. These are shares and debentures. The basic distinction between a share and a debenture is that a share constitutes the holder. A shareholder is a member of the company whereas a debenture holder is a creditor of a company and not a member of it.

The best definition of the term share is that given by Farwell J. in the case of Borlands Trustee v. Steel [1901] Ch. D 279 stated “ a share is the interest of a member in a company measured by a sum of money for the purpose of liability in the first place and of interest in the second and also consisting of a series of mutual covenants entered into by all the shareholders among themselves in accordance with Section 22 of the Companies Act.”

The contract contained in the Articles of Association is one of the original incidents of a share. A share is therefore not a sum of money but an abstract interest measured by a sum of money and made up of various rights contained in a contract of membership.

In contrast a debenture means a document which either creates or acknowledges a debt and any document which fulfils either of these conditions is called a debenture. A debenture may take any of 3 forms

1. It may take the form of a single acknowledgment under seal or the debts;

2. It may take the form of an instrument acknowledging the debt and charging the company’s property with repayment; or

3. It may take the form of an instrument acknowledging the debt charging the company’s property with repayment and further restricting the company from creating any other charge in priority over the charge created by the debenture.

The indebtedness acknowledged by a debenture is normally but not necessarily secured by charge over the company’s property. Such charge could either be a specific charge or a floating charge. Both were defined by Lord Mcnaghten in the case of Illingsworth v. Houlsworth [1904] A.C. 355 AT 358 He stated

“ a specific charge is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined. A floating charge on the other hand is ambulatory and shifting in its nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach or grasp.”

A floating charge has 3 basic characteristics.

1. It must be a charge on a class of a company’s assets both present and future;

2. That class must be one which in the ordinary cause of business of the company keeps changing from time to time;

3. By the charge it must be contemplated that until future step is taken by or on behalf of those interested, the company may carry on its business in the ordinary way as far as concerns the particular class of the assets charged.

CRYSTALISATION

A floating charge will crystallise under the following

(a) Where the company defaults in the payment of any portion of the principal or interest thereon, when such portion or interest is due and payable. In that event however, the debenture holders rights will not crystallise automatically. After the expiry of the agreed period for repayment, the debenture still remained a floating security until the holders take some step to enforce that security and thereby prevent the company from dealing with its property;

(b) Upon the appointment of a receiver in the course of a company’s winding up;

(c) Upon commencement of recovery proceedings against the company;

(d) If an event occurs upon which by the terms for the debenture the lender’s security is to attach specifically to the company’s assets.

Section 96 of the Companies Act requires every Charge created by a company and conferring security on the company’s property to be registered within 42 days. Under this Section what must be registered are the particulars of the charge and the instrument creating it. Failure to register renders the charge void as against the liquidator or any creditor of the company.

Under Section 99 of the Companies Act the registrar is under a duty to issue a certificate of the registration of a charge and once issued, that certificate is conclusive evidence that all the requirements as to registration have been complied with. Re C.L. Nye [1970] 3 AER 1061

National Provincial & Union Bank V. Charmley [1824] 1 KB 431

SHARES

In a company with a share capital it is obvious that the company must issue some shares and the initial presumption of the law is that all the shares so issued confer equal rights and impose equal liabilities. Normally a shareholder’s right in a company will fall under 3 heads.

1. Payment of dividends;

2. Refund of Capital on winding up;

3. Attendance and voting at company’s general meetings.

Unless there is indication to the contract all the shares will confer the same rights under those heads. In practice companies issue shares which confer on the holders some preference over the others in respect of either payment of dividends or capital or both. This is the method by which classes of shares are created i.e. by giving some of the shareholders preference over others.

In practice therefore most companies with classes of shares will have ordinary shares and preference shares. The preference shares being those that enjoy some preference with reference to voting rights, refund of capital or payment of dividends.

There are certain rules that courts use to interpret or construe on shares.

(a) Basically all shares rank equally and therefore if some shares are to have any priority over the others, there must be provision to this effect in the regulations under which these shares were issued. Refer to the case of Birch V. Cropper (1889) 14 AC 525 here the company was in voluntary winding up. The company discharged all its liabilities and some money remained for distribution to the members. The Articles being silent on the issue, the question was on what principle should the surplus be distributed among the preference and ordinary shareholders? The ordinary shareholders argued that they were entitled to all the surplus. Alternatively the division ought to be made according to the capital subscribed and not the amount paid on the shares. It was held that once the capital has been returned to the shareholders, they thereafter become equal and therefore the distribution of the surplus assets should be made equally between the ordinary and preference shareholders.

(b) However if the shares are expressly divided into separate classes thereby rebutting the presumed equality, it is a question of construction in each case what the rights of each class are. Hence if nothing is expressly said about the rights of one class in respect of either dividends, return of capital or attendance and voting at meetings, then that class has the same rights in that respect as the other shareholders. The fact that a preference is given in respect of any of these matters does not imply that any right to preference in some other respect is given e.g. a preference as to dividends will not apply a preference as to capital i.e. the shares enjoy only such preference as may be expressly conferred upon them.

(c) If however, any rights in respect of any of these matters are expressly stated, the statement is presumed to be exhaustive so far as that matter is concerned. For instance the preference dividend is presumed to be non-participating in regard to other dividends. Refer to Re Isle of Thanet Electricity Supply Co. (1950) Ch. 1951 where Justice Wynn Parry stated “the effect of the authorities as now in force is to establish two principles. First that in construing an article which deals with the rights to share all profits, that is dividend rights and rights to shares in the company’s property in liquidation, the same principle is applicable and secondly that principle is that where the articles sets out the rights attached to a class of shares to participate in profits while the company is a going concern or to share in the property of a company in liquidation, prima facie the rights so set out are in each case exhaustive.”

(d) Where a preferential dividend is provided for it is presumed to be cumulative for instance if no preferential dividend is declared the arrears of dividend are carried forward and must be paid before any dividend is paid on the other shares. But these presumption may be rebutted by words tending to show that the shares are not intended to be cumulative or words indicating that the preferential dividend is only to be paid out of the profits of each year i.e. if the company sustains any financial loss during any year, there will be no dividend for that year. Even then preferential dividends are payable only if and when declared. Therefore arrears of cumulative dividends are not payable on winding up unless the dividend has been declared. This presumption could be rebutted by any indication to the contrary.

WINDING UP

Section 212 of the Companies Act provides that a company may be wound up as follows

1. Voluntarily;

2. Order of the Court;

3. By supervision of the Court.

The circumstances under which the company may be voluntarily wound up are outlined in Section 217 of the Companies Act. Here a company may be wound up

a. When the period fixed for its duration by the articles expires or the event occurs on the occurrence of which the articles provide that the company is to be dissolved and thus a company passes a resolution in general meeting that it should be wound up voluntarily;

b. If it resolves by special resolution that it should be wound up voluntarily;

c. If the company resolves by special resolution that it cannot by reason of its liabilities continue its business and that it be advisable that it be wound up.

Basically the second circumstance is the most important because in practice at least the first circumstance does not arise and in the 3rd circumstance the creditors themselves will resolve that the company be wound up.

In any winding up those in need of protection are the creditors and the minority shareholders. Where it is proposed to wind up a company voluntarily Section 276 of the Companies Act requires the directors to make a declaration to the effect that they have made a full inquiry in to the affairs of the company and having so done have found the company will be able to pay its debts in full within such period not exceeding one year after the commencement of the winding up as may be specified in the declaration. Such declaration suffices as a guarantee for the repayment of the creditors. If the directors are unable to make the declaration, then the creditors will take charge or the winding up proceedings in which case they may appoint a liquidator.

WINDING UP BY THE COURT

Winding up after an order to that effect by the court is the most common method of winding up companies.

Section 218 of the Companies Act gives the High Court jurisdiction to wind up any company registered in Kenya. The circumstances under which a company may be wound up by a court order are spelt out in Section 219 of the Companies Act.

These cover situations in which

1. The company has by special resolution resolved that it be wound up by court;

2. Where default is made by the company in delivering to the registrar the statutory report or on holding the statutory meeting;

3. When the company does not commence business within one year of incorporation or suspends its business for more than one year;

4. Where the number of members is reduced in the case of a private company below 2 or in the case of a public company below 7;

5. Where the company is unable to pay its debts;

6. Where the court is of the opinion that it is just and equitable to wind up the company;

7. In the case of a company registered outside Kenya and carrying on business, the court will order the company to be wound up if winding up proceedings have been instituted against the company in the country where it is incorporated or in any other country where it has established business.

Under Section 221 of the Companies Act an Application for winding up by an order of the court may be presented either by a creditor or a contributory. However a contributory cannot make the application unless his name has appeared on the register of members at least 6 months before the date of the application and in any event he can only petition where the number of members has fallen below the statutory minimum.

In practice the creditors will petition for a compulsory winding up where the company is unable to pay its debts. The company’s inability to pay its debts under Section 220 is deemed in the following circumstances

1. If a creditor to whom the company is indebted in a sum exceeding 1000 shillings demands payment from the company and 3 weeks elapse before the company has paid that sum or secured it to the reasonable satisfaction of a creditor;

2. If execution issued on a judgment against the company is returned unsatisfied;

3. If it is proved by any other method that a company is unable to pay its debts.

Before a creditor can petition it must be shown as a preliminary issue that he is in fact a creditor or a company creditor. This is a condition precedent to petitioning and the insolvency of the company is a condition precedent to a winding up order.

PETITION BY A CONTRIBUTOR

Section 221 of the Companies Act speaks not of members but of contributories.

Section 214 defines the term contributory as follows “every person liable to contribute to the assets of the company in the event of its being wound up”. The persons falling under this category are defined in section 213 of the Companies Act and include both present and past members. A past member however, is not liable to contribute if he ceased to be a member one year or more before the commencement of the winding up and he is not liable to contribute for any debt or liability contracted after he ceased to be a member. Even then he is not liable to contribute unless it appears to the court that the existing members are unable to satisfy the contributions required.

The most important limitation on liability of contributories is found in Section 213 (1) (d) of the Companies Act. Under that clause no contribution shall be required from any member exceeding the amount unpaid on their shares in respect of which he is liable as a present or past member.

The petitioning contributor must establish that on winding up there will be prima facie a surplus for distribution among the members i.e. he must establish a tangible interest. If therefore the company’s affairs have been so managed that there would be no assets available for distribution among the members then a shareholder has no locus standi and will not be allowed to petition for winding up.

Another possible limitation is that stated under Section 22(2) of the Act. Here the court has a discretion not to grant the winding up order where it is of the opinion that an alternative remedy is available to the petitioners and that they are acting  unreasonably in seeking to have the company wound up instead of pursuing that other remedy.

WINDING UP ON JUST AND EQUITABLE GROUNDS

It is now established that the just and equitable clause in Section 219 of the Act confers upon the court an independent ground of jurisdiction to make an order for the compulsory winding up of the company. The courts have exercised their powers under this clause in the following circumstances:

1. In order to bring to an end a cause of conduct by the majority of the members which constitutes oppression on the minority;

2. The courts have also exercised this power where the substratum of the company has disappeared;

3. The courts have applied the partnership analogy to the small private companies particularly those of a kind which makes an analogy with partnerships appropriate.

 

In case of domestic private companies, there is normally an understanding between the members that if not all of them, then the majority of them will participate in the management of the company’s affairs. Such members impose mutual trust and confidence in one another just as in the case of partnerships.

Also usual in such companies is the restriction of the transfer of a member’s shares without the consent of all the other members.

If any of these principles were violated in a partnership, the courts will readily order the partnership to be dissolved. In the case of a small private company, the courts have also held that such companies are run on the same principles as partnerships and therefore if the company was run on such principles it is just and equitable to wind it up where a partnership would have been dissolved in similar circumstances.

RE YENIDGE TOBACCO CO. LTD [1916] 2 Ch. 426

Here W and R who traded separately as Tobacco and Cigarette manufacturers agreed to amalgamate their business. In order to do so, they formed a private company in which they were the only shareholders and the only directors. Under the Articles both W and R had equal voting powers. Differences arose between them resulting in a complete deadlock in the management of the company. The issue was whether it was just and equitable to wind up the company. Lord Justice Warrington stated as follows

“It is true that these two people are carrying on business by means of the machinery of the limited company but in substance they are partners. The litigation in substance is an action for dissolution of the partnership and we should be unduly bound by matters of form if we treated the relations between them as other than that of partners or the litigation as other than an action brought by one for the dissolution of the partnership against the other.”

The Model Retreading Co. [1962] E.A. 57

Here the petitioner who was a shareholder in a small private company petitioned for winding up mainly on the ground that this was just and equitable. The Affidavits sworn by the petitioner and his co-shareholders disclosed that there had been bitter and unresolved quarrelling between the parties going to the root of the companies business but none of these stated that the company’s affairs had reached a deadlock. It was however conceded by all the parties that as a result of the quarrelling the petitioner had been prevented from participating in the management of the company’s affairs.

The issue was it just and equitable to wind up the company? Sir Ralph Winndham C.J. said as follows:

“in these circumstances the principle which must be applied is that laid down in re-Yenidge Tobacco namely that in the case of a small private company which is in fact more in the nature of a partnership a winding up on the just and equitable clause will be ordered in such circumstances as those in which an order for dissolution of the partnership would be made. In that case the shareholders were two and they had quarrelled irretrievably. In the present case, if this were a partnership an order for its dissolution ought to be made at the instance of one of the quarrelling partners. The material point is not which party is in the right but the very existence of the quarrel which has made it impossible for the company to be ran in the manner in which it was designed to be ran or for the parties disputes to be resolved in any other way than by winding up. Mitha Mohamed V. Mitha Ibrahim [1967] EA 575

4. Finally the just and equitable clause will also be applied where there is justifiable loss of confidence in the manner in which the company’s affairs are being conducted Continuous Cause of Conduct

CONSEQUENCES OF A WINDING UP ORDER

Once a company goes into liquidation, all that remains to be done is to collect the company’s assets, pay its debts and distribute the balance to the members.

Under Section 224 of the Companies Act, in a winding up by the Court, any dealing with the company’s property after the commencement of the winding up is void except with the permission of the court.

The purpose is to freeze the corporate business in order to ensure that the company’s assets are not wasted. Once the company has gone into liquidation, the directors become functus officio.

Thereafter a liquidator is appointed whose duty is to collect the assets, pay the debts and distribute the surplus if any. In so doing, he must always have regard to the interests of the creditors.

The powers of the liquidator are set out in Section 241 of the companies Act.

BANKING LAW

THE HISTORICAL BACKGROUND OF BANKING

The law of banking dates back to 4,000 BC and can be traced back to Rome, Greece, Babylon, China, Egypt, Lombardy, Venice and Genoa. The main preoccupation of businesses resembling banking at the time were of safekeeping deposits of money and valuables for the rich elite in the earlier cities.

The merchants also played an important role by looking for safe places for the custody of the jewellery of which the safest were churches. Priests acted as bankers, the temples and churches as banking halls and the valuables in form of gold and silver constituted the items kept. In England, banking dates back to the Norman conquest mainly carried out by Jews who introduced money lending and currency. The goldsmiths also played a big role by acting not only as depositories but also issued receipts acknowledging deposits subsequently used by the holders to procure goods.

As a consequence of use of receipts and their circulation, they evolved into present day currency notes. The system of letter writing by persons who had deposited goods with the goldsmith requesting handover to other persons developed to become cheques and what are called in banking law ‘letters of credit’.

The letters would request handover of goods to the bearer of letter from whom the letter writer had probably received service.

A letter of credit is a facility by a bank normally given to traders enabling them to purchase without using won money – a financial facility through a written document authorizing person to whom it is issued to receive certain services or goods.

Modern banking goes back to 1826 when there was an economic recess which led to a crisis in the banking sector in that the banks were not able to meet their obligations as and when they were due leading to a ‘run on the banks’ – this occurs when all customers of a bank demand to have all their money paid in cash. Ordinarily, banks are for safekeeping but in practical terms they invest the money and keep only a small amount in liquid assets.

Some banks were able to meet the requirement but most collapsed and thus there was a need to rethink their roles. Prior to this, there were no regulations and banks were mainly operated through partnerships limited to six people who had to raise capital and thus they were constrained. To change this, there was enacted The Banking Co-Partnership Act also known as the Joint Stock Bank Act. It led to the incorporation of companies banks as limited liabilities.

The main characteristics were:

(i) allowed for unlimited number of partners

(ii) introduced the concept of limited liability at the root of modern companies

 

As a consequence, it broadened the base for access of capital by persons wanting to form a bank.

The Joint Stock Bank Act of 1826 laid the legal foundation for the emergence in banking law of a bank as a company understood within the meaning of the Company’s Act. It enlarged the capital base and generally extended the operation’s base of the bank both nationally and internationally.

NOTE: At this point in time UK banks were created on a provincial/regional basis and the Act attempted to move from regionalism to banks operating nationally. This enabled the banks to operate within the general ambit of the Bank of England which had been created in 1694 with the objectives:-

(i) to issue currency

(ii) to raise funds for Government through trading stocks

(iii) to be charged with Government’s responsibility to operate the main accounts of Government

The Bank of England had all along issued notes alongside other notes from regional banks. Initially, regional banks dealt accounts of the rich landowners and merchants but following the Act, a legislation was passed in 1833 that made only the notes issued from the Bank of England legal tender.

The Current Position In England (UK)

A new legal framework has been put in place through the Financial Services and Markets Act of 2000 which is a one-stop point in so far as banking or financial services are concerned. This act repeals most legislation relating to banking and financial services and puts into place new institutions for the regulation of banking and financial institutions.

Besides it, there’s the 1985 Trustee Savings Bank Act which deals with a specific kind of bank referred to as Trustee banks and then there is the ‘National Savings Bank Act’ which confirms this bank as an entity supervised directly by the Director of Savings. It is supposed to mobilize savings from the general populace (It’s equivalent here would be Postbank).  The Building Societies Act deals with Building Societies and was enacted in 1986 with an amendment in 1997. In Kenya, we have

(i) The Banking Act - the central legislation in banking

(ii) The Central Bank Act – establishes the Central Bank

(iii) The Building Societies Act – deals with building societies

(iv) The Companies Act – deals with companies established under the Act

(v) The Co-operatives Act

TYPES OF BANKS

Generally speaking, there are two types:-

i) Savings Bank

ii) Commercial Banks

Savings Banks

Savings Banks generally are meant for the general public, to collect deposits from the lower cadre of society where a lot of resources exist but may not be tapped. They are thus closely supervised and in most cases have statutory regulations of their operations. The assumption is that the people dealing with such banks do not understand their rights and may be exploited.

Commercial Banks

They are divided into two:-

i) Deposit banks

ii) Merchant banks

Deposit banks exist to collect large sums of deposits from the public and from the merchants through borrowing and then lending out such money for an interest. The understanding is that they will eventually return the money borrowed from this persons and thus they:

i) use money borrowed from customers for purposes of investment

ii) promise/undertake to return the money to the depositors at an interest or on such terms as is agreed between them and the customers or depositors.

Such banks also operated as Banks of Issue until 1833 when the role of issuing notes/currency was vested absolutely with the Bank of England.  Merchant banks mainly use their own money and borrowed money to a limited extent for purposes of financing business. They’ll normally finance specialized types of business(es) in which they have exceptional type of expertise such as financing of foreign trade of provision of loans at national and international levels.

To some extent, their operations include those of Deposit banks. Although these merchant banks tend to finance businesses, they are in essence corporations. They will not normally open accounts for any member of the public but for specific groups of people. They will also not normally issue cheque books to their customers.

SERVICES RENDERED BY BANKS

1. The most important service rendered by the banks is that of honoring of cheques presented to them for payment either by the customer himself or persons to whom the customer may issue such cheques.

2. Safekeeping of customer’s valuables.

3. Acting as references to customer’s financiers or persons who may generally be interested in the financial standing of a particular customer. (Townier v National Provincial and Union Bank[1924] 1 KB 461)

4. Investment advising.

5. Executors and trustees or administrators of estates

6. Providing foreign currency

7. Issuing letters of credit

8. Banks will also provide loans and overdrafts to their clients where banks will also need security in form of mortgages, liens, pledges, charges and bailments.

NOTE; In providing these services banks may incur liabilities towards third parties and to minimize this most banks have specialized departments dealing with these matters.

PARTIES TO THE TRANSACTION

Customers may be artificial or natural with special regards to certain types e.g. infants, trustees, executors etc. In the operation of the account there will be instruments like cheques, negotiable instruments, letters of credit, promissory notes etc and the account which will form a strong basis for the relationship between bank and customer/client.

DEFINITIONS IN THE LAW OF BANKING

No legislation including the current Acts in the UK defines bank, banker or banking business in such a manner to indicate what they are about. Each legislation defines the bank/banking business for specific purposes.  At common law, a bank was defined as an institution set up for the purposes of carrying out the business of banking.

For a long time however, common law did not define what banking was all about. The Bills of Exchange Act s.2 defines bank as to include ‘a body of persons whether incorporated or not who carry out the business of banking.

This definition would have been adequate then but for now it cannot work since there is a requirement that for an institution to operate as a bank it must be registered as a company under the Companies Act so in so far as the law is concerned only the first set (incorporated bodies) would qualify as banks. Courts have also tended to come up with definitions both of banking and banking business.

Woods v. Martins Bank [1959] 1 QB 55

The issue was whether the giving of investment advice constituted banking business. The court held, that indeed the provision of investment advice would constitute an individual/institution into a bank.

SAMWEL L.J. said “the limits of a banker’s business cannot be laid down as a matter of law. The nature of such business must in each case be a matter of fact and accordingly it cannot be treated as if it were a matter of pure law.” The judge concluded that an institution that constitutes a bank in one country or at one point in time may be a bank in that place and at that point in time and not a bank in a different place and time. An institution which therefore qualifies to be a bank in Kenya may not thus be so in Uganda.

NOTE: An institution’s reputation and presentation to the public may determine whether such an institution is a bank or not so that in the case of United Dominion Trust v. Kirkwood [1966] 1 All ER 968 Denning L. stated:

“The fact that member of the public trusted United Dominion Trust as a bank was in itself sufficient to have such institution be qualified to be classified as a bank.”

Generally therefore, the meaning varies though a bank must carry out certain basic functions associated with banks:-

a. Must accept deposits from customers

b. Must be able to pay customer’s demands from those deposits either to the customer himself or to persons they have requested to be paid normally in form of a cheques

c. Should be able to give back the money when the customer demands

Re Shields Estates [1901] Irish Reports 173

Fitzgibson J., in his judgment said: “the business of banking from the banker’s point of view is to traffic with the money of others for the purposes of making a profit”; and in

Commissioner of State Savings Bank of Victoria v Permewan Wright & Co

Isaacs J., described the business of banking as: “the collection of money by receiving deposits repayable when and as expressly or impliedly agreed upon and the utilization of the money so collected by lending it again in such sums as are required.”

WHAT IS BANKING BUSINESS?

Neither the Banking Act nor the Central Bank of Kenya Act initially defined what was banking business. The Bills of Exchange Act(CAP 27) however did define what banking is and what bank means in section 2.

A bank “includes a body of persons whether incorporated or not who carry out the business of banking.” Two types of institutions can do this:

- Companies formed under the Companies Act

- Unincorporated associations which includes partnerships

Under The Banking Act a bank means “a company which carries on or proposes to carry on banking business in Kenya and includes the Co-operative Bank of Kenya Ltd but does not include Central Bank.” There is thus an apparent contradiction (non incorporated bodies are not companies under the Act) as between the Banking Act and the Bills of Exchange Act but the difference is reconciled whereby when you look at the Companies Act it refers to institutions which had operated as companies before 1948 to continue operating as they were and as such there are partnerships operating as banks.

S.2 of the Banking Act

Banking business means:-

(i) The acceptance from members of money on deposit on condition that such money is repayable on demand or at the expiry of a fixed period after notice.

(ii) The acceptance from members of the public moneys on current account and acceptance of cheques.

(iii) Involving the employing of money held on deposit or on current account or any part of the money by the bank for lending or investment or for any other use at the risk of the person so employing the money.

Summarily, for an institution to carry out banking business, it must receive monies from the public; pay out that money to the depositors; employ the money to other use.

The CBK Act (Cap 491)

A bank is:

“a body corporate or other body of persons carrying on whether on their own behalf or as agents of other banking business within the meaning of the Banking Act whether in Kenya or elsewhere, the business of banking..

The Bank of England Act defines banks in the light of the controls that the Bank of England has over those banks.

THE COMMON LAW DEFINITION

S.2 of the Banking Act is a reflection of the common law definition which actually was a ruling derived from

United Dominion Trust v. Kirkwood (1966) All ER 963

The company was involved in money lending activities, issuance of securities and discounting bonds, making out payments in return for cheques but had not been established as a bank and it had not manifested itself as carrying out banking business. This decision came just after Dr. Hart had in his Law of Banking offered the definition of a banker or bank as a person carrying on the business of receiving money and collecting drafts (cheques) for customers subject to the obligation of honouring cheques drawn upon them from time to time by the customer to the extent of the amounts available on their current accounts.

A bank thus:

 Receives money

 Collects drafts/cheques

 Honours cheques drawn by customers – pay out money in exchange for the cheques

The Dominion Trust case drew three different opinions from the judge who presided over the case – Denning L., Diplock LJ., Harnan J.,  Denning L identified basically two characteristics which must exist before an institution can be said to be carrying on banking business:

i) such institution must accept money from and collect cheques for their customers and place them to their credit

ii) such institution must be able to honour cheques drawn on them by their customers when presented for payment and debit their customer accordingly.

THE BANKER CUSTOMER RELATIONSHIP

This revolves around the questions:

i) Who is a customer?

ii) Who is a bank or a banker?

iii) What obligations and rights do those two people have towards each other?

See: Joachimson v. Swiss Bank Corporation

The banking relationship revolves around the banker and the customer. An effective understanding of these two parties is important.

Who is a customer?

Like bank and banker, none of the statutes which are available offers a definition of who a customer is. The Bills of Exchange Act makes reference to customers in so far as they are involved in the encashment of cheques with banks. A customer here is strictly, telling us who qualifies to write a cheque and who the bank may pay as a customer. Consequently, we have to go back to common law in order to get some directions on who a customer is .

Generally, a customer has been said to be any person whether incorporated or not who has some kind of account with a bank.

Note: Banker-customer relationship will arise as soon as a person opens an account with a bank L.C. Mather in his book on Banker-Customer relationship and the accounts of personal customers says while comparing the meaning of a customer in banking law with that of other meanings of customer –

“The Banker – Customer differs somewhat from the normal undertakings of the term in that the word customer usually denotes a relationship resulting from habit or continued dealing.”

It will be difficult sometimes to define or precisely to identify a person or a customer of a bank because under normal circumstances the services provided by the bank are of different types. They are the kind of services that may involve a one day, two days, weeks or years dealings.

The determining factor as to whether or not the relationship is that of bank and customer will be the existence of some type of account either a credit account or a deposit account in favour of the person who claims to be a customer of the bank.

Commissioner of Taxation v. English Scottish and Australian Bank [1920] AC 683

The court held that the word ‘customer’ signifies a relationship in which duration or longevity of that relationship is not of the essence. i.e. to establish that one is a customer of a bank it is not necessary for one to show that he has dealt with the bank for two or three years. It is enough to show that they had a relationship with that particular bank.

The House of Lords held:

“the customer whose money has been accepted by the bank on the footing that they undertake to honour cheques upto the amount standing in his credit is a customer of the bank in the sense of the statute (the Bills of Exchange) irrespective of whether his connection is of a short or long time.

On the other hand, in the case of: Great Western Railway Company Ltd v. London & County Banking Corporation (1901) AC 414

(Higgins held one will not be a customer because he had no account with the bank though it paid him a cheque)

A Mr. Higgins who was a clerk with Great Western Railway Co. fraudulently obtained a cheque from his employer and fraudulently cashed it with the defendant bank. Higgins had dealt with the bank over a period of years and had during that time encashed cheques with the defendant and was therefore fairly well known with them.

The cheque in question was a crossed cheque and was marked ‘Not negotiable’. Ordinarily this cheque would not have been paid across the counter.

QUESTION: Was the bank right in paying Higgins that cheque? HELD: The Bank was not right in paying this cheque. It having been a crossed cheque anyway. Another issue was whether the mere encashing of cheques by Higgins across the counter over years at the defendants bank constituted Higgins a customer of the Bank.

HELD: Higgins was not a customer because although it is true that there is no definition of a customer in the Act, but it is a well know expression and I think that there must be some sort of an account either a deposit or a current account or some similar relation to make a man, a customer of a bank.

1. Therefore, once an account is opened, the relationship of a banker and the customer is established.

2. The relationship begins as soon as money is deposited on the account or cheques are deposited on the account for payment.

3. It will not be necessary once the account is opened to show that the account has actually been operated. The position was further elaborated in:

Ladbroke & Co. v. Todd (1914) TLR 433

Upto the time this case was decided, although the general position was that an account was needed for the existence of a bank-customer relationship. This case breaks from the tradition of presuming some kind of continued relationship between two people in order that one may be a customer and the other a bank.

This continuity supplemented the existence of a bank account without going against the principle that a person did become a customer by simply having an account opened for him.

FACTS: A person stole a cheque and opened an account with the defendant bank under the name of the payee of the cheque. The thief had the cheque cleared and he subsequently withdrew money from the account. The rightful owner of the cheque brought an action against the bank and the bank argued that the mere opening of an account by the thief at their branch did not constitute the thief a customer of the bank and that therefore the bank could not be responsible for having paid to a customer of the bank in good faith as provided for in s.82 of the Bill of Exchange Act.

HELD: The thief became a customer of the bank the moment the bank agreed to open an account in his name.

Woods v. Martins Bank (1958) Vol 3 All ER 166 It introduces the idea that a person may in fact become a customer of a bank even though the bank has not opened an account for him.

FACTS: Woods sought the advice of the managers of one of the defendants branches regarding investments of £5,000 in a company that was a customer of the defendant bank. The manager of the branch then dictated a letter to the customer Woods by which Woods authorized some money to be transferred to the defendants so that they could use it for investments in the company i.e. he authorized them to purchase shares for him in the company. The amount involved by far exceeded, the £5,000 initially given by the plaintiff. He sued the bank for the duty to take care and skill in the investment of his money. The bank argued that they did not owe the plaintiff any duty because he was not a customer of the bank.

HELD: As per Salmon J., that:-

“In my view, the defendant bank accepted instructions contained in this letter as the plaintiff’s bankers and that at any rate from that date the relationship of banker and customer existed between them.”

Stoney Santon Supplies (Coventry) Ltd v. Midland Bank Ltd (1965) 109 Solicitors Journal 255

An account was opened in the name of Stoney Santon Supplies Ltd by a Mr. Fox who purported to act for the company although he neither had the authority of the company nor had he been acknowledged by the directors of the company to open such an account. He forged the signature of the chairman and secretary of the company for opening account and also the mandate for the signatures to the cheques. He deposited the cheques in the account and subsequently forged cheques to draw out money from the account. The company went into liquidation and the liquidator in his dealings found the anomalies and wanted the bank to pay back £10,000.

ISSUE: Whether the liquidator would succeed against the bank.

HELD: Although the account had been opened in the company’s name, the circumstances in this case were such that there could not have been a banker-customer relationship. The position would have been different if the bank had actually authorized Fox to open the account.

THEREFORE, in summary a customer of a bank is:

- A person will be a customer when it can be established that such a person has an account with the bank or as in Woods v. Martins Bank the nature of the relationship between that person and the bank is such that it constitutes that person a customer of the bank.

What is conclusive, however, is that a person will not be a customer of the bank just because he/she has held casual dealings with the bank no matter how long that dealing may have been.

The relationship between the bank and a customer is based on a contract between the bank and a customer. Ordinarily, a contract can be based on either express terms or implied terms but in most commercial cases the contract will be based on a mixture of the two.

In so far as the banker customer relationship is concerned, the relationship is built basically on implied terms between the banker and customers. This position was clearly illustrated in Joachimson v. Swiss Bank Corporation

The implied terms in a Banking Contract (Bank-customer) relationship are as follows:

1. The bank is under an obligation to receive the customer deposits and collect cheques on his behalf.

2. The bank is also under an obligation to comply with the customers written orders provided always there are sufficient funds in the customer’s account.

3. The bank is obligated to repay the entire balance on a customer’s account on demand by the customer made during normal working hours.

4. The bank is obligated to give reasonable notice to the customer before closing his account.

The customer has an obligation:

1. To demand for payment of balances on his account before the bank can actually pay or become liable to the customer for non-payment.

2. To draw his cheques in such a manner as not to allow for fraudulent alterations

3. To pay a reasonable commission for the services rendered by the bank for keeping the account.

NOTE: The Banker – Customer relationship will vary according to the types of transactions that the bank carries out for customers.

There are situations in which a bank may operate as an agent of its customer. This role, the bank performs e.g. when it collects proceeds of cheque and credits the customer’s account. In this capacity, the bank will be acting as an agent of the customer. In some cases, a bailor-bailee relationship exists between banks and its customers. This will happen where a person deposits his goods or valuables with a bank for safekeeping-dealing. It may also carry out functions of a mortgage by giving out money to a person in return for securities that a customer may deposit. The more accepted way of looking at the bank-customer relationship is to look at it as a debtor-creditor relationship in that as L.C. Mather says, a banker is basically one who receives money on deposit or current account from customers and lends part of the money to other customers.

To be able to do this, the assumption is that the bank must have full control over the money that is deposited with it. Thus it cannot hold it as an agent or trustee because in the case of a trustee he has to use the money entrusted to him with regard to instructions given.

Because of this consideration, the relationship that is created between the banker and the customer being the creditor and the bank being the debtor.

THE NATURE OF THE BANK-CUSTOMER RELATIONSHIP

This was first considered in full in the case of Foley v. Hill (1848) V.2 House of Lords 281 V.9 ER 1002

A customer brought an action against a bank requiring the bank to account for all monies it had received on the ground that the relationship between B & C was like that of principal agent and therefore the customer was entitled to an explanation of what happened to his money. The customer had argued inter alia that the relationship between the bank and him had created a trust and made the bank accountable to him.

ISSUE: Was the relationship between the B and C that of Principal and Agent?

HELD: The relationship created in this case is that of debtor and creditor. It observed that “money paid into a bank is money known by the principal to be placed and therefore for purposes of being under the control of the banker, it’s then the banker’s money. He deals with it as his own, makes what profits he can which he retains to himself. He has contracted having received that money to repay to the principal when demanded a sum equivalent to that paid into his hands.”

Foley’s case is important for the following reasons:

1. It holds that the bank does not hold a customer’s deposit as an agent. This is important because it removes from the bank the necessity to account to the principal for the use of the money deposited by a customer.

2. It does not hold the banker to be a trustee and therefore the banker will not be bound by the usual strict rules that a trustee has or is bound by in respect of trust money.

3. It generally absolves the bank from being a bailee except in those circumstances where the bank has actually been so appointed by the person.

Note: However, this will not bar the bank from acting as a trustee, agent or bailee in specific instances where the bank is called upon to exercise those functions.

The nature of the Banker-customer relationship was summarized by Atkin L in Joachimson v. Swiss Bank Corporation as follows:

“The question seems to turn upon the terms of the contract made between B and C in the ordinary course of business when a current account is opened by the bank. It is said on the one hand that it is a simple contract of law. It is admitted that there is added or super added an obligation of the bank to honour the customer’s drafts to any amount not exceeding the credit balance at any material time.”

i.e.

- Based on implied terms

- Bank receives deposits from the customers

- Bank should meet customer’s payments and demands so long as there is sufficient funds in the customer’s account.

QUESTION: What is the nature of the Banker-Customer relationship?

Atkin L concluded it as a debtor-creditor relationship with the bank having an obligation to honour drafts that have been issued by the customer.

The position was agreed to by Goddard L, C.J., in: R v. Davenport (1954) Vol 1 All ER 602

The secretary to the company fraudulently inserted the names of his personal creditors as beneficiaries or payees of cheques properly drawn on the account of the company by two directors of the company and counter-signed by him. He had the cheques paid and when his fraud was discovered, he was tried and convicted of theft.

QUESTION: Was the ownership of the money that had been paid into the bank the secretaries? Or was it the banks?

Goddard L held unhesistantly that the money in account belongs to the bank and not Davenport, the thief. He said, “ I think the fallacy that led to the charge of stealing money was this: It was thought that because the master’s account became debited that was enough to make a theft.. but although we talk about people having money in a bank, the only person who has money in the bank is the banker. If I pay money into my account by  cash or cheque, that money at once becomes the bankers. The relationship between B & C is that of debtor and creditor.

See: Lloyds Bank Ltd v. Bundy (1974) V. 3 All ER

Summary:

The relationship between B & C is that of debtor and creditor but subject to a number of other obligations that are imposed upon the bank, the major one being that of honouring cheques provided that there is sufficient money in the customer’s account to meet the cheques in question.

The relationship between a banker and customer can be in existence even if an account has not been opened. The debt accrues from the time the relationship between the B & C comes to effect. The debt is due for payment only when a customer has made a request for payment to the bank and the bank either pays or fails to pay in which case the customer can start proceedings against the bank.

Joachimson v. Swiss Bank Corporation where a debt is owed by a bank, it does not become due and payable until the customer actually makes a demand.

OBLIGATIONS OF THE PARTIES TO THE BANKER – CUSTOMER RELATIONSHIP

A number of obligations are imposed on both parties. The most important of these obligations is the obligation on the bank not to disclose any information relating to the customer’s account unless the customer has specifically authorized its release or the bank has good reason to disclose. These obligations plus others attach immediately to B-C relationship when put in place.

Other duties the bank owes to its customers include the duty to:

1. Comply with the customer’s mandate

2. Inform the customer of any known or possible attempts of forgery relating to his account.

3. Receive money and collect cheques on behalf of the customer.

4. Allow the customers to draw money on the account at the branch at which the customer has the account.

5. Issue a customer with a cheque book or pass book and to provide the customer with regular statements.

6. Duty of care and skill

7. Give the customer’s reasonable notice before ceasing to carry out business with him/closing his account.

 

 

Duty of confidentiality

The fact that a bank owes its customer, it’s responsibility not to divulge information relating to the account goes to the very beginning of banking law was first recognized in Tassel v. Cooper (1850) CB 509

Although this case did not discuss the duty in detail or give the kind of significance to the duty that it carries in banking it none the less did recognize that information between the banker including advices that the bank gives to the customer are confidential.

The case of Forster v. Bank of London also helps in illustrating this point. A holder for value of a bill for £530 presented the bill at the defendant’s bank for payment. He was told by a cashier at the bank that the balance on the account of the drawer of the bill at the bank was insufficient to take tune of £104. The holder of the bill then paid the £104 into the account and had the bill paid. When the holder of the account knew of it, he sued the bank for breach of secrecy and the court held that the bank was actually in breach and plaintiff was entitled to damages.

Hardy v. Veasy (1868) LR 3 Exchequer 107

The plaintiff was arranging for a loan from a money lender. It was found out by the court that the proceeds of the loan would have been used to smoothen/sort out the plaintiff’s account with his bank. The bank somehow passed information to the money lender which information led him not to give the loan and the plaintiff sued for damages and the court held that he was entitled to damages.

Although the above three cases discuss the principles of confidentiality in banking they do not go far enough in determining what the rights of the plaintiff and defendant are, how they accrue, how the parties are released from the obligations.

The case of Townier v. National Provincial and Union Bank of England Ltd gives the closest expose in so far as the law relating to the confidentiality of information had by a banker with regards to its customer concerns.

Townier had an account with the defendant bank and he overdrew on the account but made arrangements with the manager of the branch to pay the money owed in installments but he failed to do so. The manager of the bank being worried by the failure to honour obligation telephoned Townier in his office, but Townier was not in office. The person he talked to asked to know why; in the process he mentioned that Townier’s account was overdrawn and some of the cheques Townier had written in relation to that account had been drawn in the name of bookmakers or gambling. When Townier’s employer heard that he was actually involved in gambling they dismissed him. Townier sued and claimed defamation (slander), the bank was in breach of confidentiality. The court had no difficulty in finding that the bank was actually in breach. Atkins L in his judgment said, “I further think that the obligation not to divulge information extends to information obtained from other sources that the customer’s actual account if the occasion upon which the information was obtained arose out of the banking divisions of the bank and its customers, for example, with a view to assisting the bank in conducting the customer’s business or in coming to decisions as to its treatment of its customer.”

From the quotation:

 The obligation is not restricted to information on the customer’s accounts

 The obligation extends to information which a bank may receive from another bank or other banks regarding the customer but which it receives in it’s capacity as the customer’s banker.

Bankes L.J., on his part decided it was the position that the duty to keep as confidential information relating to the customer’s account is a legal duty and that this duty is not an absolute duty but one that can be qualified. As to the actual duration of the relationship he said.:

“It is more difficult to state what the limits of the duty are either as to time or as to the nature of the disclosure. I certainly think that the duty does not cease at the moment the customer closes his account. Information gained during the currency of the account remains confidential unless released under circumstances bringing the cases of qualification (exception) into play.

The significance of this duty lies in the fact that the customers credit stand will depend to a large extent upon the banks holding in strict confidence the information they have coz the question of whether or not a customer will be treated as credit wise depends to a large extent on what his bank has to say about him.

According to Atkins L, therefore he summarises by saying:

“It seems to me inconceivable that either party would contemplate that once the customer had closed his account the bank was at liberty to divulge as it pleased the particular functions which it had conducted for the customer while he was such.”

The case of Townier really emphasizes the importance of the duty of confidentiality by the bank with respect to the customer’s account. However, Bankes L.J., listed a number of exceptions to this rule:

a) Where a bank is under a legal duty or obligation

b) Where it is in the public interest to disclose

c) Where disclosure is in the interest of the bank

d) Where a customer has given his consent to the disclosure

A) Bank under a legal duty or obligation to give information

This is looked at from the following perspectives:

i) where the bank has to give evidence in court. In most jurisdictions there is always allowance for the fact that persons (artificial or natural) comply with the court order. Where a court issues an order requiring the bank to give evidence in respect to a particular offence or cause of action the bank will have no obligation than to obey the order. Provided for under the Books of evidence under the UK, Drugs trafficking offences Act UK, Criminal Offences Act UK.

 

This position also obtains in this country.

Under the Evidence Act, Income Tax Act, there are instances where banks are required to produce Books of account in court and in the event expose a customer’s account information to scrutiny.

ii) Where an authorized official requests information from the bank claiming statutory authority. Unlike the first instance this would make the bank liable to the customer if the official doesn’t have authority. Therefore, one should carry out thorough clarification before giving information if it is to avoid liability.

iii) Where there is neither a court order or an official request. There is no outright compulsion on the part of the bank to give information but it would constitute an offence if the bank has some information but it does not provide it and an offence is committed – there is suspicion.

Nderitu v. Standard Chartered Bank

Court found that there was no breach. The safest situation in which a bank may disclose is that in which there is a court order.

B) Public interest to disclose

A bank will be under an obligation to disclose information regarding the customer’s account in circumstances where there is suspicion that the operation of the account is likely to prejudice public security.

This relates to disclosures in cases of:

 Preservation of state security

 War

Under normal circumstances citizens of a particular country at war with another should not engage in any kind of trade with the aliens. Where such happens and the person happens to be a customer of a particular bank, it may disclose this information and not be in breach of the duty of confidentiality. This was discussed in:

Libyan R. Foreign Bank v. Bankers Trust Co. (1988)

Which involved the confiscation of Libyan assets by the US following the shooting by Libyan citizens of an aircraft over a town called Lockerbie. Bankers Trust Co. had given information regarding Libyan Arab Foreign Bank to the Federal Reserve Bank of the US. Qn: whether or not there was a breach? The court did not decide on this issue although it was clear that there was in fact a breach of the duty of confidentiality and “the bank was exempted under the helm of public interest.”

C) Disclosure in the interest of the bank

This will arise where the bank has to prove it’s own case against a customer e.g where a bank has given a loan to a customer but he refuses to acknowledge it. The bank may disclose the contents of the customer’s account as evidence to show that the amount is owed. This was discussed in:

Sutherland v. Barclays Bank Ltd V.5 Legal Decisions affecting bankers 163

Where Du Parq L.J., held that a bank will be acting within it s rights where ti makes a disclosure in order to sustain it’s own action. This case also illustrates situation where a customer gives consent.

FACTS: Plaintiff held an account with the defendant. She drew a cheque on the bank which was returned by the bank on account that there were no sufficient funds in the account. Mrs. Sutherland was unhappy and explained the situation to the husband who advised her to discuss the matter with the bank. She telephoned it and in the course of the discussion the husband took the phone and asked the manager what the problem in relation to the account was. The manager explained that the bank had returned a cheque by the wife to a dressmaker on account that there were no sufficient funds on the account. The manager also explained that she had been drawing cheques on the account in favour of a bookmaker. The husband got angry. The wife on learning this sued the bank on ground that the bank was in breach of its duty of confidentiality. The bank pleaded that they were not liable coz either they had acted in their public interest or they had acted with the consent of the wife.  HELD: Yes, there was consent by having let the bank talk to her husband, and that the bank had acted in it’s interest.

It was noted that the bank was authentic coz Sutherlands husband had an account with the bank in which the wife withdrew and by making the disclosure the bank protected itself in case the wife withdrew further in favor of the bookmaker.

D) Customer gives consent

It can either be express or implied.

Where there is express authority no problem arises but where the bank claims implied authority then the issue should be looked at on a case to case basis. As in Sutherland’s case it will depend on the position of the customer in each case.

Hannah Insurance Co. of Israel v. Mew [1993] Vol. 2 Lloyds reports 243

When Coleman J said that the bank should be able to disclose the information if to withhold it would or might prejudice the bank in the establishment or protection of its own legal rights vis a vis the customer or third parties. The essence of the matter is that it might need to disclose the information either as the foundation of a defense to a claim by a third party or as the basis of a cause of action against the third party.

Duty to honour the customer’s mandate

When a customer opens an account with the bank he gives a mandate to the bank to apply whatever monies the customer may deposit with the bank in accordance with instructions from the customer. A bank is therefore under a duty to ensure that it complies with the customer’s original mandate which includes having to honour cheques or orders authorized by the customer through his signature.

Where the bank fails to honour it will be held liable to the customers and if the customer has made a loss then the bank will pay damages to the customer.

In deciding whether or not to meet a customers mandate a bank may where the customer has more than one account with the bank at a particular branch combine the accounts in order to decide whether or not there are sufficient funds to meet the customer’s demand. However, the basic obligation of the bank is to pay from the account against which the cheque or order or draft is drawn.  Barclays Bank Ltd v. Okarnahe 1962 V.2 Lloyds LR 95

Bradford Old Bank Ltd v. Suttcliffe 1918 V.2 KB 133

These two cases illustrate that:

1. Combination is possible but as decided in the case of Barclays Bank Ltd v. Okarnahe such combination may be ruled out by an express agreement between the parties.

2. In Bradford Old Bank Ltd v. Sutcliffe the court held that combination is possible although it can be excluded by an implied term of the contract.

Combination will not be possible where money has been deposited on an account for a specific purpose and the bank is aware of that particular purpose e.g. the money is trust money, money held by a person as a solicitor, administrator

Where a bank dishonours a cheque without any reasonable cause it will be held liable to the customer and the amount of damages payable will depend on the customer that one is dealing with.

Gibbons v. Westminster Bank [1939] V.2 QB 882

Held: Where the account in question is that of a trader, the bank stands to pay substantial damages to the customer especially where the dishonour leads to the customer having to lose trade deals or his general credit worth standing, his respectability as a trader.

It observed that this might not be the case, as those given to traders. The word traders in this case was taken to exclusively mean merchants.

QUESTION. Whether it can only be restricted to commercial merchants e.g. whether if a respectable man should not draw substantial amounts from his account? If it bounces can he claim substantial damages?

Apart from suing for damages, a customer who is injured may also sue for libel under the law of torts and the general law of torts takes effect. The amount of damages depends on the ability of the customer to prove that he lost.

This notwithstanding there will be circumstances where the bank may refuse to honour the customer’s mandate and not be held liable. A bank will not be held liable:

i) Where the customer’s order/instructions are unclear

ii) Where a cheque is presented long after the time/after an unreasonably long time from the date of issue of the cheque (refusal of payment in respect of stale cheques) A bill or cheque must be presented in a reasonable time from the date of issue. Any cheque presented within six months will be honoured. Where a cheque is stale, the onus is on the bank. The bank can remedy the stalemate by consulting the customer – the bank wouldn’t like to dishonour the cheque on a technicality or lack of signature.

iii) The bank will also be exonerated from liability where payment of the cheque would result in breach of the duty of care owed to the customer by the bank. E.g. the bank is supposed to ensure that it has been properly drawn and if it suspects otherwise it is under no obligation to pay.

iv) Where there is a restraint order issued by a court e.g Shaw v. D.P.P – accounts restrained coz of immoral money, prostitution

v) Where there is a garnishee order (order granted by the court to a person who is indebted to attaching the property of a third party who is holding on behalf of a debtor. Where there is such an order, the bank will be entitled not to make payment.

Rogers v. Whiteley [1892] AC 118

A garnishee order will not apply in so far as trust accounts are concerned especially where the bank knows that the account is held by a customer as such.

vi) In cases of Mareva injunctions – A Mareva injunction freezes the customer’s asset where there is danger that the customer will spend or otherwise dissipate those assets to avoid execution of a judgment that has been made against him or is likely to be made against him i.e. it is basically to restrain a person involved in a legal suit likely to be involved in compensation from disposing off any assets to be used in discharging compensation in that suit.

However, the bank has to show that it was actually aware of that injunction.

vii) Where there is a winding up order. A winding up order has the effect of restraining dealings with respect to the organization whose business is being wound up, in respect of selling or disposal of that property.

Since the bank’s duty to honour the customer’s obligations are based on agreement, express or implied, the banks mandate terminates where in the case of cheques there is countermounting of the cheques (the stopping of payment of the cheque by the customer) or in respect of the entire mandate when the bank has notice of the customer’s debt.

S.15 of Bills of Exchange Act deals with cheques

Curtis v. London City and Midlands Bank Ltd [1908] V.1 KB 293

Illustrates what is a countermount.

The person who had issued a cheque, decided that he would stop the payment of that particular cheque. He sent a telegram to the bank against whom the cheque had been issued and the telegram arrived after the bank had closed but it was left by the messages in the letterbox of the bank. The bank meanwhile payed the cheque. Two days later, they found the telegram. Qn. Whether the telegram was an effective countermount?

 

Held: For there to be a countermount, there must be effective communication. There wasn’t such communication.

The duty to inform the customer of any forgeries in relation to the customer’s account

The mandate of the customer is signified by a sign by the customer to the bank a specimen which is kept by the bank. Any species of cheque which bear the signature of the customer will be presumed to be bonafide instruction by the customer for the bank to pay. However, the bank should make sure the sign is not forged or not written in such a way to personate forgeries.

It is the responsibility of the customer to ensure that whenever there is a forgery or loss of a cheque book to inform the bank immediately to take precautions.

The duty to receive money and to collect cheques on behalf of the customer and credit the amount received on the customer’s account

Accompanying this duty, is the obligation of the bank to allow the customer to draw money from his account from the branch where he holds the account.

Only caveat: the customer will only be allowed to draw if there are sufficient funds; where there are no funds where the customer has made credit facilities for his account with the bank.

To facilitate the withdrawal of money from the account and an inspection of the customer’s account the bank is under an obligation to issue the customer with a cheque book in cases of current account or pass book, in instances of saving and deposit account. The cheque book acts as a means of drawing money from the account and also as a way of drawing money from third parties who owe the bank.

The pass book:

a) Is a way though which the customer pays money

b) A record of the customer’s transaction

The bank will also be under obligation with regular statements/breakdowns of transactions relating to the customer’s account.

Question has arisen whether once the bank issues the customer with a statement the customer is under an obligation to actually read it. The conclusive legal position as decided in:

Tai Hing Cotton Mills Ltd v. Lieu Chong Hing Bank Ltd & Others [1986] AC 80  The legal position as articulated in this case although the bank is under an obligation to provide the customer with regular statements in respect of his account the customer is not under any legal obligation to read such statements.

Similarly held in: Greenwood v. Martins Bank

The fact the customer is not under any obligation to read doesn’t mean the bank is relieved from its obligations.

Duty of care and skill

A bank exercises a duty of care and skill in circumstances where:

a) It acts as an agent

b) It is acting as a trustee

Acting as an Agent

Although ordinarily the relationship between the bank and a customer is of creditor and debtor, there are circumstances where it acts as agent for customer. This is where the bank pays the customers cheques and collects cheques on behalf of the customer.

Where the bank undertakes the duty, it has to exercise the normal responsibilities of care and skill that are expected of an agent in agency relationship.

Only in such circumstances will it exercise care and skill

Lipkin Gorman v. Karpnale Ltd [1989] V.1 WLR 1340

A man called Cass was a partner in a firm of solicitors and he drew cheques on his solicitors account for his own use. He had authority to sign cheques in respect of his account. All the cheques that were drawn by him totaling £200,000 were paid by the bank. It was established that the bank knew that Cass was drawing cheques largely for the purposes of gambling and that the method of paying the cheques was irregular. The bank never informed the solicitors and they subsequently discovered the fraud and they brought an action against the bank and the gambling house.

QUESTION – Whether the bank among other things was negligent and in breach of its duty as an agent of the customer.

Held:

(1) The bank – customer relationship is a debtor – creditor relationship

(2) As a consequence the command/instruction of the customer are sacrosanct. May L.J. noted that “In the absence of any notice of fraud or irregularity, a bank is bound to honour its customer’s cheque.”

As a consequence therefore of this decision a bank as agent for payment or collection of customers cheques must act with care in order to avoid injuries to the customer.

A bank will also be acting as an agent and be required to exercise the duty of care and skill where it GIVES PROFESSIONAL ADVICE TO ITS CUSTOMERS.

Acting as Trustee:

Ordinarily a bank does not act as a trustee to its customers but a bank may become a constructive trustee where though it has not been appointed as a trustee, it becomes involved in the affairs of a trust and therefore becomes liable to the beneficiaries just as if it had been appointed as a trustee in the initial stages.

According to Ladlaw in his book on “The law relating to Banking Services” a bank may become a constructive trustee if it permits unauthorized signatories to withdraw funds where it knows the funds are being misapplied.

Belmont Finance Corporation v. Williams Furniture Ltd No. 2 [1980] V.1 All ER 393

As regards instances when a bank may be liable as a constructive trustee

CUSTOMERS’ DUTIES TOWARDS THE BANK

Duty to exercise care when drawing cheques so as to prevent forgery or alteration: London Joint Stock Bank v. McMillan & Arthur where it was held that if a customer fails to exercise reasonable care when drawing cheques so as to prevent forgery, he will be estopped from denying the genuineness of the signature.

Duty to pay reasonable bank charges and commission

Banking Act S.44 – banks are supposed to seek the authority from Finance Ministry in determining the charges they are supposed to impose on the customer. Basically, banks charges what is reasonable & there are no legal requirements of minimum and maximum.

Duty to allow bank to combine his account

Duty to permit the bank to exercise the right of lien [read requirements as to lien – when it may be exercised]

In summary

1. The relationship is basically a contractual relationship but in the initial stages this contract was “unwritten but currently there is an attempt to reduce it into writing especially with special types of bank-customer relationships – involving overdraft facilities, loan facilities. Same is true where bank offers the customer specialized service especially, investment advice.

2. The relationship has traditionally remained that of debtor and creditor with the roles reversing sometimes especially in situations where the customer borrows money from bank.

The case of Joachimson v. Swiss Bank Corporation Summarizes the nature of bank customer relationship.

Townier v National Provincial and Union Bank

It deals with the issue of confidentiality

As regards the termination of the relationship, the Banker-Customer relationship arises “The moment the parties agree to enter into a contractual relation with one another and continues until brought to an end by consent or perhaps by revocation by either party. It is a contract which is unwritten and undefined by the parties. In other words it is implied.”

Termination of the contract

In the final analysis, the following will be considered to terminate the relationship between the bank and customer.

1. Agreement

2. Notice given by one of the parties

3. Death of the customer

4. Mental disability of the customer

5. Bankruptcy of the customer

NOTICE:

Either the bank or the customer may bring the relationship to an end by giving notice. In so far as the customer is concerned he may close account by simply withdrawing the balance on the account so long as the withdrawal leaves in account sufficient funds to cover any  charges and to meet any cheques that the customer may have drawn and which may have not been presented at the time he withdrew money from his account.

It does not appear necessary in law that the customer will give any particular notice. All the customer has to do is to withdraw any money remaining on the account and give some indication to that effect. Normally the bank will treat the account as operational until there is an indication to the effect that the customer has closed the account.

The bank must give a customer a reasonable notice before they close that account. This was clearly articulated by Atkins L.J. in Joachimson v. Swiss Bank Corporation when he said that: “It is a term of the contract that the bank will not cease to do business with the customer except upon a reasonable notice.”

What is reasonable will vary from one case to another and the longevity of the notice will be determined by the kind of relationships between bank and customer. Ordinarily, one month has been taken to be reasonable coz it is sufficient to give the customer enough time to make alternative banking arrangements.

Prosperity v. Lloyds Bank Ltd [1923] TLR 372

The bank was engaged by the plaintiffs who were an insurance firm to receive applications and proposals for insurance, process them for the purposes of establishing a contractual relationship between the applicants and the insurance firm. The response by the public was so overwhelming and the publicity associated with it so advanced that the bank decided to terminate the relationship and gave a one month notice. The plaintiff established that the scheme had attracted so much attention both nationally and internationally that one month was not sufficient. Lloyds bank argued that one month was more than sufficient.

Held: Notice was insufficient and that the bank was not entitled to close the account.

The plaintiff had wanted an injunction to restrain the bank from closing the account but the court held that an injunction would not be an appropriate remedy in cases relating to closure of account. The appropriate remedy would be damages where the bank insisted on closing the account. Such notice is necessary to enable the customer to organize himself for alternative banking. When a bank can give notice of termination of account with a credit balance

a) Money illegally obtained e.g. laundering, drugs

b) Winding up

c) Merger

 

NOTE: The issue of notice or lack of it will not apply in fixed term accounts e.g. fixed deposit account where the date of maturation of deposit is indicated. It will be presumed that the account comes to an end on the agreed date. Strictly speaking, withdrawals on savings account will be done on specified periods; they therefore bring problems. If you withdraw out of the specified period you then pay a penalty.

Where a bank demands on the repayment of an overdraft such a deed does not necessarily constitute closure of account and the bank will not therefore give any notice. Similarly, where a bank combines two accounts, the effect of the combination will be to close one of the but it does not require the giving of a reasonable notice by the bank.

Garnett v. Mackewan [1872] LR 8 Exchequer Division 10

National Westminster Bank Ltd v. Halsowen Press Work and Assemblies Ltd [1972] AC 785

DEATH OF THE CUSTOMER

Hooley & Sealey in their book Texts & Materials on Commercial Law said “Since the relationship between banker and customer is regarded as personal it will automatically terminate on the customer’s death, bankruptcy, dissolution of a partnership or liquidation of a company.”

This position very aptly summarizes the effect of death on the banker-customer relationship given that the relationship is dependent on the existence of the customers mandate/instructions. A dead customer cannot give instructions. Lord Chorley & Paget in his book on The Law of Banking agree on the above position.

One point however arises – must the bank know or have notice of the death? In so far as the payment of cheques are concerned s.75(2) of Bills of Exchange Act clearly indicates that the death of customer itself is not enough. It is necessary for the bank to have received notice to refuse to honour to pay. From a general point of view the relationship terminates on death.

INSANITY OF CUSTOMER

It is argued that since an insane person cannot enter into a valid contract, the issue of insanity terminating the relationship does not arise.

BANKRUPTCY

To be looked at when dealing with special types of customers.

THE ACCOUNT

Before opening an account, the bank must be satisfied of the general characteristics and standing of the person seeking to open it. To do this, banks will normally seek to know; applicants employer, nature of employment, kind of remuneration. This information is given to the bank through a letter of introduction by the employer.

Where the prospective customer is self employed the bank must be satisfied as to the nature of the business and the genuineness of that business.

This information is important coz the future of the relationship will revolve around this matter. The case of the unemployed person cannot be very difficult to deal with. Apart from the information, the bank will seek specimen signature from the customer which they keep, the mandate (persons who may withdraw), letters of reference (from persons who know the customer) and general information/background of customer.

Once the bank is satisfied it will be possible for the bank to open an account with that customer and issue him/her either with a pass book or cheque book depending on the account opened.

Once opened, an account is basically a statement of the various transactions between the bank and the customer. It is a facility through which the bank makes known to the customer the kinds of transactions that have been effected in his ledger. It is a system of accounting between the banker and the customer. There are different types of accounts which can be opened for the customer which will vary from bank to bank and time to time. Basically, they can be divided into:

(1) Those where demand for payment can be made immediately – current accounts

(2) Those accounts where payment can be made after giving of notice – deposit or savings account.

Current accounts and deposit accounts are distinguished in one basic way. Whereas the drawing of cheques is allowed for on current accounts, no such allowance is provided for with respect to deposit or savings account.

The cases of deposit accounts require some notice before withdrawal. Such notice can be agreed upon in advance or it could be agreed upon between the parties as the relationship progresses, but in most cases the agreement is arrived at at the time the account is opened.

By far, the most important account is the current account because it is the one that most people:

a) carry their business transactions

b) make payments for services rendered

c) banks collect cheques on behalf of customers

d) banks make payments to third parties in whose names the customer has drawn cheques

The bank will have many other different types of accounts; except for special customer accounts most accounts will take the form of current or deposit accounts. There will be loan accounts, children accounts, et al depending on the bank.

The statement of account of the customer will normally be given either in a statement or through a pass book both of which are issued by the bank. The question which arises is ‘are the entries and balances shown in the statements or in the pass book subject to errors or are they absolute in so far as the customer is concerned?’

This issue is important because there are times they will have errors then the question arises if there is an error of entry must the customer be presumed to know of such an error? Or is there an obligation on the customer to read his statement once presented to him by the bank? Clearly, any entries in the statement or pass book constitute prima facie evidence against the bank. They present a correct representation of the status of his accounts and the customer is therefore entitled to act on the basis of the statement or pass book.

Given that the statement is evidence against the bank, there is no obligation on the customer to read it and as a consequence if a customer honestly relies on an error in the statement and draws on his account or writes out cheques in favour of third parties relying on the statement the bank will be estopped from denying the customer from drawing from that account.

The legal position: Entries in a customer’s statement/ pass book are definite and conclusive and a customer can rely on them honestly unless the bank is able to make adjustments or alterations before the customer relies on those entries.

Skyring v. Greenwood [1825] 4 B & C 281

Chatterton v. London County Bank [1891] TLR

Deals with forged cheques and the basic issue here is – what happens where forged cheques are paid on a customer’s account, the customer examines his statement and returns the statement / pass book to the bank without any indication that he is aware of the forgery ; is the bank absolved of responsibility?

In this case, forged cheques were presented to the defendant’s bank in respect of the plaintiff’s account. The cheques were paid. It was established that the bank actually sent statements to the customers who actually looked through them ticking out the entries before returning it to the bank but without indicating that in fact there were forgeries.

The bank wanted to raise an estoppel against the customer arguing that since he had read the account and ticked out the entries he had accepted the forged cheques and in effect induced the bank to pay further forged cheques.

Held: No duty on the customer to inspect his passbook or statement and therefore the principle of estoppel cannot apply. It has however been noted that a bank will only be bound:

(i) Where a bank has not corrected the error

(ii) Where a customer is aware of the error and has in fact acted in bad faith

Generally, where a bank makes an error in the entries it will be bound by those entries.

MISTAKES IN RESPECT OF CUSTOMER’S ACCOUNT

When a customer receives the statement, the presumption is that he will read the statement and hopefully find out the errors that have been made. There is no legal obligation on the customer to read the statement, he can either: -

i) Surcharge the statement i.e. add the items to the statement he believes have been wrongfully omitted.

ii) Falsify the statement i.e. having to strike out those items which he thinks are wrongfully placed there.

These two processes become a reality in terms of entry of that account once the customer and the bank have sat together and reconciled those entries. Where there is an agreement between the two then the account becomes an account stated. Where there is no agreement, a dispute will arise between the customer and the bank where the customer complains of the mistakes.

MISTAKES IN FAVOUR OF CUSTOMER

Where the mistakes are in favour of the customer, the complaint will only arise where the bank is denying the customer the right to rely on those entries. Mistakes in favour of the customer relate to all credits that a bank wrongfully extends to its customers. The position of the law is, where a bank makes a mistake in favour of a customer and the customer bona fide relies on that statement so as to alter his position, the bank will be estopped from denying the customer the right to access the credit on his account.

Holland v. Manchester & Liverpool District Banking Co. [1909] Vol 14 Commercial Cases 241

A customer of the defendant bank was given his pass book and it read to have a balance of £70, Sh 17 and a pence. On the basis of this entry, the plaintiff drew a cheque in favour of third party for £67& Sh 11.

When the cheque was presented for payment, the defendant bank dishonoured it. The plaintiff brought an action against the bank for damages.

From the evidence adduced in court, it was shown by the defendant that in fact the correct balance in favour of the plaintiff was £60, Sh 9 & 9 pence. It was admitted that the bank clerks had made an error in crediting the customer’s account.

Held: The defendants were entitled to ultimately correct the error/wrong entry. But so long as the errors stood uncorrected and the plaintiff acted on it without any fault on his part, he was entitled to do so. Therefore, defendants were wrong to dishonour the plaintiff’s cheque.

Skyring v. Greenwood

Customer was a military officer. His account was credited with sums of money which he was not entitled to. The customer brought this to the attention of the bank and he continued to give the erroneous credit so when the bank subsequently discovered that there was an error, they wanted to withhold the customer’s money, the customer sued.

Held: The money had been received for the customer’s use by relying on advice a bank, the but since the customer had relied on their representation and altered his position by spending more finances on his account.

The principle of estoppel will not operate unless/until the customer actually acts on the representation. The bank will be within it’s rights to alter/correct the error anytime before the customer acts on it and inform the customer of it. Estoppel will also not apply where the customer knows that there is in fact an error and the onus of showing that the customer knew lies exclusively with the bank.

British and North European Bank v. Zalzstein [1972] V.2 KB92

It discusses this particular point.

United Overseas Bank v. Jiwani

United Overseas Bank mistakenly credited a customer’s account with the same remittance twice. The sum of money involved was quite substantial and during the hearing of the case, it was established that the customer was not expecting any particular sums of money and the amount involved would not fall within his normal receipts.

The question was whether the customer would rely on the mistake with the bank. In this particular case, the bank was not liable because the plaintiff should have known that the amount involved was by far higher than his expectation or normal expectation and should not have acted on it.

MISTAKES WHICH ARE TO THE DETRIMENT OF THE CUSTOMER

Here the customer explains that a smaller sum of money has been placed in his account than actually what he expects. The customer will be complaining that the bank has debited his account either by cheque etc sums of money in excess of what he authorized (mandated). Normally, where this happens the customer will demand a correction by the bank and in a majority of cases, the bank will oblige for two reasons:

(1) Because the bank wants to save its reputation from prospective customers who if they know of the errors would be hesitant to enter into a relationship with the bank.

(2) The bank will also correct because the sums involved will not be substantial and the bank will not want to engage in litigation so pays out of their reserves.

However, the bank will always press for litigation in two situations:

(1) Where the bank suspects collusion with the customer and the bank employee(s)

(2) Where a fairly long time has elapsed since the error was made before the plaintiff made a complaint.

A customer is still entitled to demand the correction of the wrong and as already indicated, if the bank believes that there is no problem, the bank will make a correction. This is based on the principle in the Law of Banking that where there is no fraud problem on the part of the customer, he is entitled either to benefit from his mistakes/have them corrected in the cases of mistakes to his detriment.

The fact that a customer has actually read his statement and returned to the bank that statement will not bar him from claiming or from benefiting from errors made and this particular case was clearly illustrated in:

Tai Hing Cotton Mills Ltd v. Lieu Chong Ching Bank Ltd [1986] AC 80

A customer of a bank, Tai Hing Cotton Mills Ltd allowed its employees to keep custody of the company’s cheque books. The employee happened to be a clerk to the company and on a number of occasions he forged the signature of the general manager of the company on cheques which he had paid at various banks with which the company had had an account. The cheques were paid without the company’s knowledge and when the company discovered the forgeries they sued the banker in order to have the money paid back. During the hearing it was established that the company did not have a proper system of checking on the various cheques that were paid by the company and this resulted in the fact of the company’s failure to detect the forgeries.

The court of first instance i.e. Hong Kong supreme court held that since the error was a result of the company’s inefficient control system the banks were not liable and they could therefore not correct the entries in favour of the customers. However, in an appeal to the Privy Council Scarman L., held that, in the absence of an express agreement to the contrary the risk of wrongful payments was borne by each of the three banks. It was also observed by the Privy Council that “the banks offer a service which is to honour their customer’s cheques when drawn upon an account in credit or with an agreed overdraft limit. If they pay out upon cheques which are not his they are acting outside their mandate and cannot plead his authority in justification of their debit to his account. The risk is a risk of service which it is their business to offer.”

The position in the US is different in the sense that in that country sec 4 – 406 of the Uniform Commercial Code makes it clear that “the customer must exercise reasonable care and promptness to examine the statement and items attached to it to discover his authorized signature or any alteration on an item and must notify the bank promptly after discovery thereof,” In the US therefore, there is an obligation that the customer must actually look at the statement and inform the bank of any entries which might be misinterpreted and considered to be wrong entries.

It has been argued in the common law system probably the legal position in the US should be the practical position in the commonwealth countries as it would be meaningless for the bank to issue statement to the customer unless the intention was for him to familiarize himself of any irregularities that may be and inform the bank where there are errors/mistakes.

Once a customer knows that there is an error in the case of US he will be under an obligation to indicate this to the bank for verification. At common law, the position still seems to be that even where a customer detects and fails to inform the bank he/she will still be in his/her right. The limitation is where a customer knows that the entry is wrong and remains silent; he cannot rely on that error once the bank has taken steps to correct it.

In similar circumstances a customer who knows his chequebook has been stolen has obligation to inform the bank to take appropriate measures.

Greenwood v. Martins Bank [1933] AC 51

The plaintiff’s wife drew a number of cheques on the husband’s account. The plaintiff (holder of account) discovered the fraud by wife but coz of pleadings from the wife he decided not to report the matter to the bank. Despite assurances that she would no longer draw cheques from the account, she went ahead and did so and when husband discovered he went ahead and reported, she committed suicide. The bank refused to act. He sued. Question is whether bank was liable. The court held exceptionally that the plaintiff was under an obligation to inform the defendant bank of the forgery as soon as he discovered it and having failed to do so the bank had been relieved of responsibility.

Can a bank be held responsible on the basis of negligence? In the Tai Hing case the court argued this particular issue and came to the conclusion that in a purely contractual situation remedies in tort law would not avail. More importantly, where a person argues liability in negligence they will be implying a duty of care on the part of the customer by reading his statement and since it has already been seen, established that the customer does not have an obligation to read his cheque book the principle of duty of care will not be applicable in this particular case.

Charton v. London County Bank

Summary

1. Banks must take absolute care to avoid wrong entries on the customer’s ledger for where entries do occur and they’re either in favour or detriment of the court the courts will almost invariably rule in favour of the customer.

Brewer v. Westminster Bank Ltd and Stevens [1952] All ER 650

It clearly shows the reluctance of the courts to assist banks in situations where they’re wrong entries which a customer has relied on.

2. But it must also be noted that before the courts assist the customer he must show that he acted honestly and actually relied on the error made by the bank. A customer cannot claim to have been misled if he was not aware of the error.

British and North European Bank v. Zalzstein [1927] V.2 KB 92

THE LAW OF BANKRUPTCY & COMMERCIAL SECURITIES

HISTORICAL REVOLUTION OF BANKRUPTCY LAW

1. Bankruptcy Act Cap 53 Laws of Kenya

2. Ian Macneil – Bankruptcy in East Africa

3. Fridman Bankruptcy Law and Practice

4. Thomspson J.H. The principles of Bankruptcy Law

5. Holdsworth on Historical Development

Basically the law of bankruptcy has a long history and only a summary of the main developments may be highlighted

Summary

1542 Act - aimed mainly at securing the property of the debtor for his creditors.

1834 Act - extended bankruptcy law to non-traders. Some landowners had

become debtors and had to be catered for by the law.

1869 Act - to amend and consolidate the existing law was passed. This Act

contained many of the substantive bankruptcy law principles which are

now in operation today and broadly seek to free the bankrupt from any

claim or liability except personal torts.

1883 Act - laid the basis of modern Bankruptcy administration & separated the

judicial and administrative functions. The judicial functions remained

vested in the High Court and County Courts while the administrative

functions were transferred to a Board of Trade. It introduced the present

day law on the following

1. The public investigation by the Court into the debtor’s conduct;

2. Punishment for Bankruptcy offences committed by the bankrupt;

3. Strict investigation and prove of debt;

4. General supervision of proceedings including the control of funds and independent audits of trustee’s accounts.

1890 Act – laid down the conditions for the discharge of a bankrupt

1913 Act - made offences by Bankrupts punishable summarily and tightened the law as

to their criminal liability.

1914 Act – Consolidating Act of Bankruptcy legislations

1915 - The Bankruptcy Rules of 1915;

1926 - The Bankruptcy Amendment Act of 1926;

1. In the English medieval and mercantilist periods the law commences with a statute enacted during the reign of King Henry VIII which largely dealt with fraudulent traders. This legislation was passed in 1542 and it aimed mainly at securing the property of the debtor for his creditors. It did nothing to relieve the debtor of his obligations if his debts exceeded the value of his property. If this occurred the debtor remained liable for the debt and could even be imprisoned for failure to repay. It should be noted that the law was introduced specifically to protect creditors. However, each creditor proceeded against the debtor individually and the debtor’s property was acquired on the principle of first come first served.

2. Early bankruptcy law only applied to traders. It should be recalled that this was the mercantilist free trade era of the 16th and 17th centuries. The traders complained against the unfairness of the law but their outcry for protection led only to piecemeal reforms and amendments but the punishment of debtors was not alleviated or mitigated in any way. Non-traders who could not pay their debts were subject to another set of statutes relating to insolvent debtors.

3. In the 18th and 19th centuries there was great expansion in the availability of credit. This was the era of the formation of Joint Stock Companies which preceded the modern limited liability companies. Debtors were therefore on the increase. This is as a result of the historical development of capitalism as a mode of production where competition is emphasised culminating in monopoly capitalism hence those who cannot compete within the system fallout and many become debtors. However, it was discovered that people do not become debtors of their own free will. A distinction is sought to be made between dishonest debtors who should be punished and the honest but unfortunate ones who should somewhat be protected. In 1834 the bankruptcy law was extended to non-traders. Some landowners had become debtors and had to be catered for by the law.

4. In 1869 an Act to amend and consolidate the existing law was passed. This Act contained many of the substantive bankruptcy law principles which are now in operation today. The broad principle of the Act was that the Bankrupt should be a freed person. He should be freed not only from his debts but also from every possible claim or liability except for personal torts committed by him. On the other hand, all creditors were grouped together for purposes of proceeding against the debtor. The Act also provided for the administration of bankruptcy law and matters in the London Bankruptcy District by Judges of the High Court specially appointed by the Lord Chancellor and in the Counties by County Court Judges. There was no separation between the judicial and administrative functions both of which were exercised by the court. The administration of bankruptcy matters under the 1869 Act did not work well due to the lack of official control over the Trustees in Bankruptcy which was a new office created by the Act in the place of the former system of Official Assignees.

In 1883 another Act was passed in England which repealed the 1869 Act and amended and consolidated the law. This is the Act that laid the basis of modern Bankruptcy administration. It separated the judicial and administrative functions. The judicial functions remained vested in the High Court and County Courts while the administrative functions were transferred to a Board of Trade. The 1883 Act also introduced the present day law on the following

 The public investigation by the Court into the debtor’s conduct;

 Punishment for Bankruptcy offences committed by the bankrupt;

 Strict investigation and proof of debt;

 General supervision of proceedings including the control of funds and independent audits of trustee’s accounts.

No important reforms were introduced by the Bankruptcy Act of 1890 and the Bankruptcy and Deeds of Arrangement Act of 1913. The main reforms made by the 1890 Act was in respect of the conditions for the discharge of a bankrupt. The 1913 Act made offences by Bankrupts punishable summarily and tightened the law as to their criminal liability.

The present law of bankruptcy in England is contained in the following:-

1. The Bankruptcy Act of 1914 which was a consolidating Act of Bankruptcy Legislation;

2. The Bankruptcy Rules of 1915;

3. The Bankruptcy Amendment Act of 1926;

4. The Judicial Decisions on the construction of these statutes.

However, it is important to note that there have been subsequent developments in England culminating in the enactment of the 1986 Insolvency Act which contains all provisions relating not only to individual bankruptcy but also corporate insolvency. In Kenya, Bankruptcy is governed by the Bankruptcy Act 1930, the present Chapter 53 of the Laws of Kenya.

1. This Act is largely identical to the English Bankruptcy Act of 1914 and the Bankruptcy Amendment Act of 1926.

2. The Bankruptcy Rules are again similar to the English Bankruptcy Rules of 1952 which do not differ significantly from the English bankruptcy rules of 1915.

3. Legislation dealing with Deeds of Arrangement is again patterned on the English Act of 1914 and this is the Deeds of Arrangement Act of 1930 which is the current Chapter 54 of the Laws of Kenya;

Bankruptcy & Insolvency

Bankruptcy is the legal status of an individual against whom an adjudication order has been made by the court primarily because of his inability to meet his financial liabilities. An Adjudication Order in Bankruptcy is a judicial declaration that the debtor is insolvent and it has the effect of imposing certain disabilities upon him and of divesting him of his property for the benefit of his creditors.

Bankruptcy must be distinguished from insolvency which may be defined as the inability of a debtor to pay his debts as and when they fall due. Whether or not a person is insolvent is purely a question of fact thus a person can be insolvent without being bankrupt but he cannot be bankrupt without being insolvent.

Today we talk of Insolvency Law because of the developments that have taken place which have unified personal bankruptcy and corporate insolvency. Kenya still operates two systems i.e.

1. Personal bankruptcy – which relates to individuals and partnerships

2. Corporate insolvency – which relates to companies being wound up

OBJECTS OF BANKRUPTCY LAWS

The three main objects of Bankruptcy Laws within the common law jurisdiction have been identified as follows:

1. To secure an equitable distribution of the property of the debtor among his creditors according to their respective rights against him;

2. To relieve the debtor of his liability to his creditors and to enable him to make a fresh start in life free from the burden of his debts and obligations;

3. To protect the interests of the creditors and the public by providing for the investigation of the conduct of the debtor in his affairs and for the imposition of punishment where there has been fraud or other misconduct on his part.

Professor Freidman in his book Bankruptcy Law and Practice has given some reasons for the growth of Bankruptcy. He says, “The alleviation of the plight of the debtor by a more merciful though rigorous provision of Bankruptcy Law has several causes

(a) The rise in importance of trading on credit and the need to encourage such trading for commercial purposes thus increasing chances for financial embarrassment for traders which would make trading more difficult if the harshness of the older law of debt still remained in force;

(b) The change in outlook of society towards those who fail to pay their debts from regarding them as criminals to looking at them only as unfortunate;

(c) The need to protect creditors by giving them some relief though not as great as they are justly entitled to expect rather than punishing the debtor;

(d) The benefit to the community as a whole in that :

(i) The creditors should get something rather than lose all if the debtor could escape with the assets he has or is imprisoned so as to be unable to obtain any assets in the future and

(ii) In that an opportunity is afforded to the debtor to make a fresh start.

Professor Fridman thus asserts that the modern law of bankruptcy is a compromise which is intended to benefit all the parties.

BASIC PRINCIPLES UNDERLYING THE LAW

1. The Debtor must surrender all his properties to the creditors;

2. After payment of a percentage of his liabilities, the debtor may obtain a full discharge from his past debt;

3. The creditors may grant a debtor a discharge even where the debtor pays them less than what is prescribed by the law;

4. The court is the arbitrator in all matters relating to the Bankruptcy;

5. Once discharged, a debtor is freed from his financial obligations and reverts to his former status in society.

PROCEEDINGS IN BANKRUPTCY

The proceedings in bankruptcy are begun by the presentation to the court of a Bankruptcy Petition. This petition asks the court for a Receiving Order to be made in respect of a debtor’s property. The petition may be presented either by the Debtor himself or by a Creditor. If it is presented by a creditor the petition must be founded or based on an alleged act of Bankruptcy which has occurred within 3 months before the presentation of the petition. Indeed the acts of Bankruptcy are in effect statutory tests of insolvency. If it is the debtor himself who presents the petition that in itself constitutes an act of bankruptcy.

Upon hearing the petition the court may dismiss it, if it has no merit or make a receiving order if it is found to be with merit. This order does not make the debtor bankrupt all it does is to place his property in safe custody pending the outcome of the proceedings.

The first meeting of creditors is then held at which it is determined whether a composition or scheme of arrangement if one is submitted by the debtor shall be accepted or whether application shall be made to the court to adjudicate the debtor’s bankruptcy. If the court decides to adjudicate the debtor bankrupt it makes an Adjudication Order and the debtor will then become bankrupt. The debtor’s property will then vest in his trustee in bankruptcy who will collect the property and distribute it among those creditors who have proved their debts.

The bankrupt must also submit himself to a Judicial Public Examination and at any time after conclusion of this public examination the bankrupt can apply for his Discharge.

If the court makes an order of discharge the bankrupt is released from all his debts with certain exceptions provable in bankruptcy and is freed from disabilities against some exceptions which were imposed upon him by the bankruptcy.

WHO IS A CREDITOR & WHO IS A DEBTOR

A creditor is any person who is entitled to enforce payment of a debt at law or in equity. The BA Section 3(2) defines who a debtor is. “A debtor includes any person whether domiciled in Kenya or not who at the time when any act of Bankruptcy was done or suffered by him

(a) Was personally present in Kenya; or

(b) Ordinarily resided or had a place of residence in Kenya; or

(c) Was carrying on business in Kenya personally or by means of an agent or manager or

(d) Was a member of a firm or partnership which carried on business in Kenya and includes a person against whom bankruptcy proceedings have been instituted in a reciprocating territory and who has property in Kenya

WHO MAY BE ADJUDGED BANKRUPT

1. Infants - Generally apart from contracts for necessaries, infants are not liable in respect of debts that they have incurred.

See; Re Davenport [1913] 2 All E.R. 850

Re A Debtor [1950] Ch. 282

But if an infant fraudulently contracts a debt during his infancy he will be held liable for the debt and the creditor may claim in bankruptcy on his acquiring the age of majority. This is as per the Infants Relief Act of England 1874, which is a statute of general application to Kenya.

2. Insane Persons

These are also subject to bankruptcy proceedings. Generally persons of unsound mind cannot be adjudicated bankrupt without the court’s consent. Refer to the Bankruptcy Rule 247.

3. Married Women

Section 117 of the BA provides that every married woman shall be subject to the law relating to bankruptcy as if she were ‘femme sole’.

4. Aliens & Persons Domiciled Abroad

They are also subject to bankruptcy proceedings as of Section 6(1) (d) of the B A if within a year before the date of presentation of the petition has ordinarily resided or had a dwelling house or place of business or has carried on business in Kenya personally or by means of an agent or manager or is or within that period has been a member of a firm or partnership of persons which has carried on business in Kenya by means of a partner or partners or an agent or manager.

5. Companies/Corporations

Bankruptcy proceedings are not applicable to companies in Kenya. These are specifically dealt with under liquidation and winding up provisions of the Companies Act Cap 486. Section 118 of the BA provides that a “Receiving Order shall not be made against any corporation or against any association or company registered under the Companies Act or any enactment repealed by that Act.” The position in England has been reformed by the Insolvency Act.

6. Partnerships

Whether the partnership is general or limited, it is subject to the provisions of the Bankruptcy Act. Section 119 thereof states as follows “subject to such modifications as may be made by rules under Section 122 this Act shall apply to limited partnerships in the same manner as if limited partnerships were ordinary partnerships and on all the general partners of a limited partnership. Being adjudged bankrupt the assets of the limited partnership shall vest in the Trustee in Bankruptcy.

7. Deceased Persons

There is a provision for administration in bankruptcy of the estate of a deceased person under Section 121 (1) of the BA. Section 107 BA also enables proceedings already commenced to continue as if the debtor were alive. Where the debtor is dead a petition may be presented by his personal representative when its purpose is to obtain an administration order.

8. Judgment Debtor

The BA does not prevent an undischarged bankrupt from creating valid debts and since he may commit an act of bankruptcy, institution of subsequent bankruptcy proceedings before he is discharged from a prior bankruptcy is permissible.

THE ACTS OF BANKRUPTCY

These are basically covered under Section 3(1) BA. A debtor commits an act of bankruptcy in each of the following cases:-

1. Conveying or assigning all property to a Trustee for the benefit of his creditors generally; Section 3(1) (a) provides that if in Kenya or elsewhere a debtor makes a conveyance or assignment of his property to a trustee or trustees for the benefit of his creditors generally, he commits an act of bankruptcy. To constitute an act of Bankruptcy hearing there must be a conveyance or an assignment of the whole or substantially the whole of the debtor’s property. Refer to Re Spackman (1890) 24 QBD 128. The assignment must be for the benefit of all creditors generally and not just a class of creditors. Refer to Re Meghji Nathoo (1960) E.A. 560 A creditor who has recognised a Deed of Arrangement wherein a debtor has agreed on a plan of repaying the debt cannot rely on that Deed as an act of bankruptcy. Refer to Re A Debtor (1939) 2 All E.R. 338

2. Fraudulent Conveyance within the meaning of Section 3(1)(b)

If a debtor makes a fraudulent conveyance gift, delivery or transfer of his property or any part thereof he commits an act of bankruptcy. Under the BA a conveyance is fraudulent if it confers on one creditor an advantage which he would not have under the Bankruptcy Laws or which tends to defeat or delay creditors irrespective of whether the debtor had any dishonest intention although this may be present. The transaction may be “a conveyance, gift, delivery or transfer” of property and this includes mortgages or pledges as well as actual conveyances and assignments. The conveyance need not be for the benefit of any creditor and such transfers are frequently made for example to a member of the debtor’s family. The conveyance need not be of the whole of the debtor’s property. The principles for determining whether a conveyance is fraudulent under the Bankruptcy Act may be summarised as follows: -

i. Where a debtor transfers all or virtually all his assets in payment of an antecedent debt (previously incurred) without receiving any present return for them this necessarily defeats or delays his other creditors and is a fraudulent conveyance even when the transaction is honestly entered into;

ii. Where a debtor transfers all his assets for a full present consideration this is not per se a fraudulent conveyance since the effect is merely to change the nature of the property to which the creditor look for satisfaction but a fraudulent intent for example to abscond with the proceeds of the sale could be proved if it is in fact existed or it might be shown that that so called sale was a sham designed to turn a creditor from an unsecured into a secured creditor at the expense of other creditors and in this latter case that will be fraudulent.

iii. Where a debtor transfers part of his assets in payment of an antecedent debt, the fraudulent intent must be proved and this will depend on several factors:

 Whether or not there is sufficient property remaining after the transfer to enable the debtor to continue in business and thus satisfy his other creditors;

 Secondly this will depend upon whether the debtor is insolvent or not at the time and;

 Lastly it will depend upon whether or not the conveyance has the effect of leaving him insolvent.

iv. Where a debtor mortgages or otherwise charges all his property to secure an antecedent debt, this is conclusively presumed fraudulent as against the other creditors.

3. Fraudulent preference within the meaning of Section 3 (1) (c) of the BA as read with Section 49(1):

If in Kenya or elsewhere he makes any conveyance or transfer of his property or any part thereof or creates any charge thereon which would under the BA or any other Act be void as a fraudulent preference if he were adjudged bankrupt, this constitutes an act of Bankruptcy and basically under Section 49(1) it is provided as follows:

“Every conveyance or transfer of property or charge thereon made, every payment made, every obligation incurred and every proceeding taken or suffered by any person unable to pay his debts as they become due from his own money in favour of any creditor with a view of giving such creditor or any surety or guarantor for the debt due to such a creditor a preference over the other creditors is deemed to be fraudulent and is void as against a trustee in bankruptcy, if the person effecting the transaction is adjudged bankrupt on a petition presented within 6 months after the date of the transaction.

4. Leaving Kenya, keeping house & similar acts BA Section 3(1) (d) is yet another act of bankruptcy which provides that if a debtor departs from Kenya or if out of Kenya remains outside Kenya or departs from a dwelling house or otherwise absents himself or begins to keep house, all those will constitute acts of bankruptcy.

In order to establish these particular acts of bankruptcy the creditor must prove that it was the debtor’s intention to defeat or delay his creditors but it is not necessary to show that any creditor was actually defeated. The intent may be presumed if it is a natural consequence of the debtor’s act that the creditors will be defeated or delayed. Refer to the case of Re Cohen (1950 2 All ER 36

This act of bankruptcy has 3 limbs:

a. Departing from or remaining out of Kenya, where a person domiciled in Kenya leaves the country after being pressed for payment by his creditors, there is a strong presumption that his intention is to defeat creditors. However, this is not so if he has a permanent residence abroad at which he remains or if a person domiciled abroad leaves Kenya to return to the country of his domicile. Refer to Ex parte Brandon (1884) 25 Ch. D 500

b. Departing from a dwelling house or otherwise absenting oneself. The absenting must be from the debtor’s place of business or usual abode or from one or more particular creditors elsewhere. It is an act of bankruptcy under this head if a debtor having made an appointment to meet a creditor at a particular place fails to attend to the appointment with intent to defeat it. Refer to the case of Re Worsley (1901) K.B. 309 - here where a married woman left her place of business without paying her creditors or notifying her change of address, this was held to be an act of bankruptcy although she left at her husband’s request to live with him elsewhere.

c. Beginning to keep house. A debtor keeps house if he refuses to allow his creditors to see him or retires to some remote part of his house or business premises where they cannot gain access to him. It must be shown that some creditor has been denied an interview in this way but the creditor must seek the debtor at a reasonable hour.

5. Levying execution against goods

Section 3(1)(e) of the Bankruptcy Act states, where a judgment against a debtor remains unsatisfied, the judgment creditor will usually seek to enforce it by levying execution on the debtor’s goods. This will constitute an act of bankruptcy available to any other creditor if the goods are sold by the Bailiff or retained by them for 21 days excluding the date of seizure. The petition founded on this act must be presented within 3 months thereof. Refer to the case of Re Beeston (1899) 1 QB 626. The Bailiff is in possession for the purpose of this section where under a ‘walking possession’ agreement he withdraws his officer upon the debtor’s acknowledging that the goods have been seized and allows the debtor to continue normal trading in the goods provided that a limit is imposed on the value of the goods which can be dealt with in this way by the debtor. Refer to the case of Re Dalton (1963) Ch. 336.

If a 3rd party makes a claim to any of the goods seized, the bailiff must take out an inter pleader summons to determine the ownership of the goods. The period occupied in dealing with these summons is not to be counted in the 21 days.

6. Declaration of inability to pay debts

B A Section 3 (1) (f) as read with Bankruptcy Rules 98. Here a formal declaration by the debtor that he is unable to pay his debts or a bankruptcy petition presented against himself the latter being the most common constitutes an act of bankruptcy upon delivery of the document to the proper official of the court. A declaration of inability to pay debt is required to be in Form No. 2 of the Bankruptcy Rules while a declaration of bankruptcy [debtor’s] petition is required to be in Form No. 3 of the Bankruptcy Rules.

7. Bankruptcy notice

Section 4 as read with Section 3(1) (g) of the BA. Here if the debtor fails to comply with the provisions of a bankruptcy notice, within 7 days, he commits an act of bankruptcy. A bankruptcy notice is a notice issued by the court and served on the judgment debtor calling upon the debtor to pay the amount of the judgment debt or else satisfy the court that he has a counter-claim, set-off or cross-demand which equals or exceeds the amount of the judgment debt and which the debtor could not set up in the action in which the judgment was obtained. A bankruptcy notice must be preceded by a request of issue of the notice and this is in Form No. 4 of the Bankruptcy Rules.

A bankruptcy notice must be in the prescribed form and must state the consequences of non-compliance. It can only be issued at the instance of a creditor who has obtained a final judgment in a Kenyan court or foreign court where there is reciprocity. The prescribed form of a bankruptcy notice is Form No. 5 under the Bankruptcy Rules. The period of 7 days for compliance applies where the notice is served in Kenya. If served abroad the court will fix the time for payment in order to give leave to serve it abroad. The notice must require payment to be made in exact accordance with the terms of the judgment. Therefore if by agreement with a creditor payment is to be made by instalments, a notice cannot issue on the failure to pay one instalment for the whole of the unpaid balance unless it was provided but the whole balance should become due on failure to pay any instalment. If a portion of the judgment debt has been paid, there not being any agreement to take payment by instalments, the bankruptcy notice must issue for the balance unpaid and not for the whole debt.

But a bankruptcy notice will not be invalidated by reason only that the sums specified in the notice as the amount due exceeds the amount actually due unless the debtor within the time allowed for payment gives notice to the creditor that he disputes the validity of the notice on the ground of such misstatement. If the debtor does not give such notice he is deemed to have complied with the bankruptcy notice if within the time allowed he takes such steps as would have constituted a compliance with the notice had the actual amount due been correctly specified therein. It should be noted that two separate judgment debts cannot be included in one notice.

A bankruptcy notice cannot be issued if execution on the judgment-debt has been stayed. The debtor after service of the notice may seek to have it set aside if he has a counter-claim, set-off or cross-demand which equals or exceeds the amount of the judgment debt and which he could not have set up in the action on which the judgment was obtained or for any other reasons. If the debtor does not successfully challenge the notice or does not pay the debt or provide satisfactory security for it within the specified time he commits an act of bankruptcy which is available not only to the creditors issuing the notice but to any other creditor provided that he obtains an affidavit of non-compliance from the creditor issuing the notice.

8. Giving notice to creditors of suspension or intention to suspend debts

Section 3(1) (h) BA provides that a statement by a debtor that he has suspended or is about to suspend payment of his debts needs no particular formality but the notice must be given in such a manner as to show that his intention was to give information that he has suspended or was about to suspend payment. That will constitute an act of bankruptcy for example notice of suspension has been inferred where a trader summoned a meeting of his creditors with a view to proposing a composition. Refer to the case of Crook V. Morley [1891] A.C. 316.

It has also been inferred where a debtor made a verbal statement to the managing clerk of the solicitors acting on behalf of his creditors that he was unable to pay his debts. Re a debtor [1929] 1 Ch. 362.

A notice given “without prejudice” has been held to be admissible as proof of the acts of bankruptcy in Re Daintrey [1893] 2 Q.B. 116.

PROCEDURE OF ADJUDICATION

1. PETITION

Bankruptcy proceedings are commenced by the presentation of a petition by the debtor himself or by a creditor against the debtor. This is in accordance with the provisions of Section 5 of the BA.

(i) Petition by the debtor against himself:

Under Section 8(1) of the Bankruptcy Act as read with Bankruptcy Rules 105 a debtor may present his own petition.

1. The filing of which is deemed to be an act of bankruptcy.

2. The petition must state that the debtor is unable to pay his debt and must request that a receiving order or an adjudication order be made. The form which it must comply with is Form No.3 under the Bankruptcy Rules.

3. A receiving order is made at once without any hearing in accordance with BR 125. An adjudication order may also be made at once.

4. Thereafter, the debtor must file with the official receiver a statement of affairs prepared in accordance with the provisions of Section 16 of the BA.

5. The petition must further comply with the provisions of BR 106 to 108. A debtor’s petition shall not after presentation be withdrawn without leave of the court.

(ii) Petition by the creditor

As noted, any person entitled to enforce payment of a debt at law or equity may be a petitioning creditor. A creditor may petition if the following conditions are satisfied under section 6(1) BA and the BR 110:

(a) The amount owed is not less than £50 or Kshs. 1000 as fixed under the English Bankruptcy Act of 1914; (in UK now the actual amount is £750)

(b) The debt is a liquidated sum payable either immediately or at some certain future time;

(c) The act of bankruptcy on which the petition is grounded has occurred within 3 months before the presentation of the petition;

(d) The debtor is domiciled in Kenya or within a year before the date of the presentation or the petition has ordinarily resided or had a dwelling house or a place of residence in Kenya or has carried on business in Kenya personally or by means of an agent or manager or is or within that period has been a member of a firm or partnership of persons which has carried on business in Kenya by means of a partner or partners or an agent or manager.

The debt due to the petitioning creditor must have existed as a liquidated sum i.e. a fixed sum or one capable of being computed with certainty at the date of the act of bankruptcy. It is not sufficient that the debt should have become liquidated at the date of presentation of the petition if it had in fact been un-liquidated at the earlier date. Refer to Re Debtors [1927] 1. Ch. 19 and Mohammed V. Lobo [1953] EACA 117.

2. THE HEARING OF THE PETITION

Under the BR 125(1) where a petition is filed by a debtor, the court shall forthwith make a receiving order thereof. Under the BR 125(2), the hearing of a creditor’s petition takes place after the expiration of 8 days from the date of service thereof on the debtor but a hearing within the 8 days may be ordered, where the debtor has filed a declaration of inability to pay his debts or where the debtor has absconded or for any good cause shown.

Opposition by the debtor; Under BR 128, if the debtor wishes to oppose the petition he must file a notice with the registrar of the court specifying the statements in the petition which he denies. Further he must also send a copy of the notice to the petitioning creditor(s) 3 days prior to the date of the hearing.

At the hearing set by the registrar under BR 126 the petitioning creditor must prove:

1. The debt.

2. Service of the petition on the debtor.

3. The act of bankruptcy being relied on

Thereupon the court may make a receiving order as per section 5 BA for the protection of the Estate.

DISMISSAL OF THE PETITION

1. If the court is not satisfied with proof of any of these matters or is satisfied by the debtor that he is able to pay his debt or that for other sufficient cause no order ought to be made it may dismiss the petition under Section 7 (3) of the BA.

2. If the Act of bankruptcy which is being relied upon is non-compliant with a bankruptcy notice the court may if it thinks fit stay or dismiss the petition if an appeal is pending from the judgment or order. Section 7(4) as read with 7(5) BA.

The court may also stay all proceedings on the petition if the debtor denies indebtedness to the petitioner or the amount of the debt until that has been determined. Where proceedings are stayed the court may if by reason of the delay caused by the stay of proceedings or for any other cause it thinks just make a receiving order on the petition of some other creditor and shall thereupon dismiss on such terms as it thinks fit the petition in which proceedings have been stayed.

A creditor cannot rely upon an act of bankruptcy committed before his debt came into existence but the debt need not have been due to the petitioning creditor at the date of the act of bankruptcy. A petition once presented cannot be withdrawn without leave of the court.

3. APPOINTMENT OF INTERIM RECEIVER:

BA Section 10. At any time after the presentation of the petition and before a receiving order is made the court may if it is shown to be necessary for the protection of the estate appoint the official receiver to be interim receiver of the property. The official receiver may himself appoint a special manager to conduct the business of the debtor. The court may also stay any action execution or other legal process against the property or person of the debtor. Refer to BR 119 TO 124.

4. THE RECEIVING ORDER:

Section 9 of the BA as read with BR 138 to 148

If the court does not dismiss or stay the petition, it will make a receiving order. Upon the making of the receiving order, the official receiver becomes receiver of the debtor’s property. Thereafter no legal proceedings may be brought of the debts provable in the bankruptcy except by leave of the court.

Once the official receiver steps in no proceedings can be brought against the debtor except with the leave of the court. This however does not prejudice a secured creditor’s rights to deal with his security according to Section 9(2) as read with Section 6(2) BA. The receiving order does not make the debtor bankrupt. It also does not deprive him of the ownership of his property. It is only the possession and control of his property that are taken away from him. Thus any transactions subsequently entered into by the debtor are prima facie invalid whether or not the other party to the transaction had/has notice of the receiving order.

The notice of the receiving order stating the name address and description of the debtor, the date of the order, the courts by which the order was made and the date of the petition must be published in the Kenya Gazette and one of the local daily papers. Section 13 of the BA as read with BR 145. The production of a copy of the Gazette containing any notice of the receiving order is conclusive evidence that the order was duly made on the stated date. Even after the making of the receiving order the debtor may apply for its rescission in accordance with BR 147 to 148.

5. DEBTOR’ STATEMENT OF AFFAIRS:

Upon the making of a receiving order the debtor must attend a private interview to determine how the Estate should be administered and to receive instructions as to the preparation of his statement of affairs. The debtor must submit his statement of affairs to the official receiver within 3 days of the receiving order if the order is made on the debtor’s own petition or within 14 days if the order is made on the creditor’s petition. Time may be extended by the court or official receiver on application of the debtor. BA 16(1) & BR 149 to 150. The statement of affairs must be in the prescribed form verified by affidavit and must show the following:

(a) The particulars of the debtor’s assets, debts and liabilities;

(b) The names, residencies and occupations of the creditors;

(c) The securities if any held by them respectively and the dates when they were given and

(d) Such further or other information as may be prescribed or as the official receiver may require.

Under Section 16(3) BA if the debtor fails without reasonable excuse to comply with these requirements, the court may on the application of the official receiver or of any creditor adjudge him bankrupt.

Any person stating himself in writing to be a creditor of the bankrupt may personally or by agent inspect the statements of affairs at all reasonable times and take a copy thereof. But if any person untruthfully states that he is a creditor, then he shall be guilty of contempt of court and be punished accordingly on the application of the trustee in bankruptcy or the official receiver.

6. THE FIRST MEETING OF CREDITORS:

It is provided under section 14 and 15 of the BA as read with the first schedule to the BA. As soon as may be after the making of the receiving order against a debtor a general meeting of his creditors referred to as the first meeting shall be held for the purpose of considering whether a proposal for a composition or scheme of arrangement shall be accepted or whether it is expedient that the debtor shall be adjudged bankrupt and generally as to the mode of dealing with a debtor’s property with respect to the summoning of and proceedings at the first and other meetings of creditors the rules in the first schedule to the BA apply.

The official receiver must summon the first meeting of creditors not later than 60 days after the date of the receiving order. He must give not less than 6 clear days notice of the time and place in the Kenya Gazette and in a local daily paper. Furthermore he must send a note to each creditor mentioned in the statement of affairs. Together with this notice he must also send a summary of the statement of affairs with comments which he may wish to make as well as a form of proof if a composition or scheme of arrangement is to be considered at the meeting, he must also send a copy of the scheme and his remarks thereof. Notice must also be sent to the debtor to attend the meeting.

The official receiver or his nominee chairs the meeting. All creditors may attend but a creditor who has not previously lodged proof of his debt may not vote at the meeting. The purpose of the meeting is to decide whether the debtor should be adjudged bankrupt or whether any composition or scheme which he may have submitted should be accepted and in the former case the creditors may appoint a trustee and a committee of inspection.

7. COMPOSITION OR SCHEME OF ARRANGEMENT

This is provided for under section 18 BA and BR 160-169. A composition is an arrangement between two or more persons for the payment of one to the others of a sum of money in satisfaction of an obligation to pay another sum differing either in amount or mode of payment.

A scheme of arrangement is a proposal for dealing with his debts by an insolvent debtor by applying his assets or income in proportionate payment of them which proposal if agreed by his creditors or the requisite majority of them. Therefore the scheme or composition is on the debtor’s initiative. If the debtor wishes to make a proposal for a composition or for a scheme of arrangement of his affairs then the provisions of section 18 BA come into operation:

1. He must lodge his proposal with an official receiver within 4 days of submitting his statement of affairs or within such further time as the official receiver may allow. The proposal must be in writing and signed by the debtor.

2. The official receiver must summon a meeting of creditors before the public examination of the debtor is concluded and send to each creditor before the meeting a copy of the debtor’s proposal with his report attached thereto.

3. The proposal must be approved by a majority in number and three-quarters in value of all the creditors who have proved their debts. Creditors may vote by letter in the prescribed form addressed to the official receiver so as to be received by him not later than the day preceding the meeting. Creditors who do not vote are regarded as voting against the resolution of the proposal of scheme of arrangement.

4. The debtor may at the meeting amend the terms of his proposal if the amendment is in the opinion of the official receiver calculated to benefit the general body of creditors.

5. After the proposal is accepted by the creditors it must be approved by the court. Either the debtor or the official receiver may apply to the court to approve it and three days notice of the time appointed for hearing the application must be given to each creditor who has proved his debts.

6. The application cannot be heard until after the conclusion of the public examination of the debtor. Before approving the proposal the court must hear the report of the official receiver as to its terms and the conduct of the debtor and any objections which may be made by or on behalf of any creditor. A creditor may oppose the application not withstanding that he voted for its acceptance at the meeting of creditors.

7. The court must refuse to approve the proposal in the following cases:

(a) if in its opinion the terms of the proposal are unreasonable or not for the benefit of the general body of creditors.

(b) If any facts are proved which would require the court either to refuse, suspend or attach conditions to the discharge of the debtor were he to be adjudged bankrupt unless the scheme provides reasonable security for the payment of not less than Shs 5 in the pound on all the unsecured debts provable in the bankruptcy

(c) If provision is not made for the payment of the preferential debt in priority to all other debts

8. In any other case, the court may either approve or refuse to approve the proposal.

9. Once a composition or scheme is approved by the court it is binding on all creditors whose debt are proved with the exception unless the creditor accepts the proposal of those debts from which the debtor will not be released by an order of discharge. Section 19 BA.

10. If the scheme is approved, the receiving order is rescinded and subject to payment of the official receiver’s costs, the debtor or the trustee under the scheme is put in possession of the property.

11. The scheme may be annulled in the following cases:

(i) If default is made in payments of any instalments due under the scheme; or

(ii) If it appears to the court that the scheme cannot in consequence of legal difficulties or for any sufficient cause proceed without injustice or undue delay to the creditors or the debtor; or

(iii) If the consent of the court was obtained by fraud.

If the scheme is annulled the court may adjudge the debtor bankrupt but any dispositions or payments made under the scheme remain valid. The creditors may also accept a proposal for a composition or scheme at any time after adjudication. The procedure is the same as in the case of a composition or scheme accepted before adjudication and upon approving the scheme the court may annul the adjudication order. Where the adjudication is annulled any assets remaining after payments to the creditors of the amount owed them under the scheme in respect of which no order has been made reverts in the debtor.

8. PUBLIC EXAMINATION OF THE DEBTOR:

Section 17 BA as read with BR 151-159. Where a receiving order has been made the official receiver applies to the court for the appointment of a time and place for the public examination of the debtor. The examination must be held as soon as is convenient after the expiration of the time for the submission of the debtor’s statement of affairs. The court may adjourn it from time to time.

The official receiver must notify the debtor and creditors of the time and place of the examination and must advertise the order in the Kenya Gazette and in a local daily. The public examination may be dispensed with under the provisions of section 17(11) BA where the debtor suffers from any mental or physical affliction or disability which makes him unfit to attend or where a composition or scheme has been proposed by joint debtors and one of the joint debtors is unavoidably prevented from attending because of illness or absence from Kenya.

If the debtor fails without sufficient cause to attend the examination the court may issue a warrant for his arrest under BR 142. In this case and also if the debtor fails to disclose his affairs or comply with an order of court in relation to his affairs the court may adjourn the examination sine die (indefinitely). It may then adjudge the debtor bankrupt forthwith and he will be unable to obtain discharge until he can obtain an order of the court for the examination to be continued. Any creditor who has lodged proof of his debt or his representative authorized in writing may put questions to the debtor concerning his affairs and the causes of his failure.

The official receiver or trustee if one has been appointed and the court take part in the examination and put questions to the debtor. The debtor’s advocate may also attend the examination but not ask any questions or address the court. The debtor is examined on oath and must answer all questions which the court may put or allow to be put to him. Notes of the examination are taken down in writing and after being read over to or by the debtor and signed by him may be used in evidence against him in other proceedings. These notes are open to examination by the creditors’ at all reasonable times.

When the court is of the opinion that the affairs of the debtor have been sufficiently investigated it makes an order declaring that the examination is concluded but the order cannot be made until after the day appointed for the first meeting of creditors. The power to arrest the debtor

Under section 26 BA the court may order the arrest of the debtor and the seizure of any books, papers or goods in his possession in the following circumstances:

1. If after a bankruptcy notice has been issued or after a petition has been presented by or against him, there is a probably reason for believing that he has absconded or is about to abscond with a view to avoiding payment of the debt in respect of which the bankruptcy notice was issued or avoiding service of a bankruptcy petition or attending an examination or otherwise delaying or embarrassing the proceedings against him

2. The debtor may also be arrested if after presentation of a petition by or against him there is cause to believe that he is about to remove his goods with a view of preventing or delaying possession being taken of them by the official receiver or trustee or that there is ground for believing that he has concealed or he is about to conceal or destroy any of his goods or any books, documents or writings which might be of use to his creditors

3. If after service of a petition or the making of a receiving order he removes any goods in his possession above the value of five pounds without the leave of the official receiver or trustee

4. If without good cause shown he fails to attend any examination ordered by the court.

It should be noted that no arrest is valid upon a bankruptcy notice unless the notice is servable upon the debtor before or at the time of his arrest.

THE ADJUDICATION ORDER

Reference may be made to the BA Section 20 and BR 180 – 185.

(a) The Grounds for Making an Adjudication Order

When a receiving order has been made the official receiver or any creditor may apply to the court to adjudge the debtor bankrupt.

The court may adjudge the debtor bankrupt in the following cases:

1. If the creditors at their first meeting or at any adjournment thereof so resolve by ordinary resolution;

2. If they pass no resolution;

3. If they do not meet at all;

4. If a composition or scheme is not approved within 14 days after the conclusion of the public examination of the debtor or such further time as the court may allow;’

5. If the debtor applies to be made Bankrupt;

6. If a quorum of creditors has not attended the first meeting of creditors or one adjournment thereof;

7. If the court is satisfied that the debtor has absconded or does not intend to propose a composition or scheme;

8. If the public examination is adjourned sine die;

9. If the debtor without reasonable cause fails to submit his statement of affairs;

10. If a composition or scheme is annulled by the court.

Upon the making of an adjudication order, notice thereof must be gazetted and advertised in a local paper.

(b) Annulment of the Adjudication Order:

This is canvassed under section 33 BA. The adjudication order may be annulled in the following cases:

1. If in the opinion of the court the debtor ought not to have been adjudged bankrupt;

2. If his debts are paid in full;

3. If a composition or scheme is accepted by the creditors and approved by the court;

The court has a discretion as to annulling the adjudication order and may do so where the bankrupt has committed bankruptcy offences even if the debts are paid in full. Here a voluntarily lease by a creditor is not equivalent to payment in full by the debtor.

Under Section 33(b) any debts disputed by the debtor is considered as paid in full if he enters into a bond in such sum and with such sureties as the court approves to pay the amount to be recovered in any proceedings for its recovery with costs. Also any debts due to a creditor who cannot be found or cannot be identified is considered as paid in full if paid into court. It should be noted that the annulment of an adjudication order does not affect the validity of any sales or dispositions of property or payments or other acts properly done by the official receiver, trustee or any person acting under their authority or by the court. The property of the debtor vests in such a person as the court directs or failing such direction, reverts to the debtor on such terms as the court may order.

The annulment of an adjudication order releases the debtor from the personal disabilities imposed upon him by the bankruptcy but it does not prevent criminal proceedings from being brought against the debtor for commission of Bankruptcy offences. DISABILITIES OF A BANKRUPT

Upon adjudication the bankrupt becomes subject to the following disabilities:

1. All property belonging to him including property acquired by him prior to his discharge vests in the trustee in Bankruptcy for distribution among his creditors;

2. He must not either alone or jointly with any other person obtain credit to the extent of 100 shillings or upwards from any person without informing that person that he is an undischarged bankrupt; Section 139 (a) BA;

3. He must not engage in any trade or business under a name other than that under which he was adjudicated bankrupt without disclosing to all persons with whom he enters into any business transactions the name under which he was adjudicated; Section 139 (b) of the BA;

4. Under Section 188 of the Companies Act he cannot act as a director of a company or directly or indirectly take part in the management of a company except by leave of the court by which he was adjudged bankrupt, which leave the official receiver may object to;

5. He cannot act as a receiver or manager of the property of a company on behalf of the debenture holders except under appointment made by order of the court;

6. Under Section 35 (1) (d) of the current Constitution a bankrupt is disqualified from being a member of parliament or a member of a local authority and if elected he will have to relinquish his seat;

7. He cannot act as an advocate under Section 32 of the Advocates Act Cap 16 of the Laws of Kenya.

DISCHARGE OF A BANKRUPT

Application for Discharge:

Section 29 BA and BR 186 to 197.

 The Bankrupt can apply for his discharge at any time after adjudication but the application cannot be heard until after the public examination is concluded.

 The registrar of the court must give 28 days notice of the time and place of the Hearing to the official receiver and the Trustee.

 The official receiver must forthwith send notice thereof for gazetting and must give 14 days notice or the Hearing to every creditor.

 At the hearing of the application which is held in open court the official receiver submits a report as to the bankrupt’s conduct during the proceedings of his bankruptcy.

 A copy of this report must be forwarded to the bankrupt not less than 7 days before the hearing and if the bankrupt wishes to dispute any statement therein, he must notify the official receiver of this fact not less than 2 days before the hearing.

A creditor who wishes to oppose the discharge on any ground other than those mentioned in the official receiver’s report must not less than two days before the hearing file in the court a written notice of his intended opposition stating the grounds thereof and serve a copy on the official receiver and the bankrupt.

Courses Available to the Court:

At the Hearing the court may do any of the following things:

1. Grant an absolute and immediate discharge;

2. Refuse the discharge;

3. Grant an order of discharge but suspend its operations for a specified time

4. Grant an order of discharge subject to conditions with respect to any earnings or income which may afterwards become due to the bankrupt or with respect to his after-acquired property;

The court will normally only grant an unconditional absolute discharge where the bankrupt is entitled to a certificate of misfortune i.e. a certificate of the court to the effect that the bankruptcy was brought about by causes beyond the debtor’s control without any misconduct on his part. This has the effect of releasing the debtor from those statutory disqualifications which will otherwise attach to him after discharge. There are no cases in which the court is bound to refuse a discharge but it cannot grant an immediate and conditional discharge. Where the bankrupt has been convicted of any offence connected with his bankruptcy or where any of the following facts as contained in Section 30 BA have been proved against him:

(a) That his assets are not of a value equal to 10 shillings in the pound on the amount of his unsecured liabilities unless this is due to circumstances for which he cannot justly be held responsible;

 

(b) That he has omitted to keep such books of accounts as are usual and proper in the business carried on by him within 3 years immediately preceding his bankruptcy;

(c) That he has continued to trade after knowing himself to be insolvent;

(d) That he has contracted any debt provable in the bankruptcy without having at the time of contracting any reasonable or probable expectation of being able to pay it;

(e) That he has failed to account satisfactorily for any loss of assets or for any deficiency of assets to meet his liabilities;

(f) That he has brought on or contributed to his bankruptcy by rash and hazardous speculations or by unjustifiable extravagance in living or by gambling or by neglect of his business affairs;

(g) That he has put any of his creditors to unnecessary expense by frivolous or vexatious defence to any action properly brought against him;

(h) That he has brought on or contributed to his bankruptcy by incurring unjustifiable expense in bringing a frivolous or vexatious action;

(i) That he has within 3 months preceding the date of the receiving order when unable to pay his debts as they became due given undue preference to any of his creditors;

(j) That he has within 3 months preceding the date of the receiving order incurred liabilities with a view to making his assets equal to 10 shillings in the pound on the amount of his unsecured liabilities;

(k) That he has on any previous occasion been adjudged bankrupt or made a composition or arrangement with his creditors; and

(l) That he has been guilty of any fraud or fraudulent breach of trust.

Where any such facts or offences are proved the court may either

(i) Refuse the discharge or;

(ii) Suspend the discharge for such period as it thinks fit; or

(iii) Suspend the discharge until a dividend of not less than 10 shillings in the pound has been paid to the creditors; or

(iv) Grant a discharge subject to the condition that the bankrupt consents to a judgment being entered against him for any balance or part of any balance of the debts still remaining unpaid to be discharged out of his future earnings or after acquired property. Section 29 BA

Under Section 30 BA the court has a similar power where the BANKRUPT has made a settlement of property before and in consideration of marriage at a time when he was unable to pay his debts without the aid of such settled property or has contracted in consideration of marriage to settle on his wife or children, property to be subsequently acquired by him and it appears to the court that the settlement or contract was made in order to defeat or delay creditors or was unjustifiable having regard to the state of affairs at the time it was made. (This is called a fraudulent settlement within the context of Section 30 of BA)

Where a bankrupt is discharged conditionally, it is his duty until the judgment or condition is satisfied to give the official receiver any information he may require about his earnings or after acquired property and to file in court an annual statement verified by affidavit giving particulars of any property or income acquired since discharge.

At any time after the expiration of 2 years from the date of the order, the terms and conditions of that order may be varied by the court if the bankrupt can satisfy the court that there is no reasonable probability of his being in a position to comply with them. A discharged bankrupt notwithstanding his discharge must continue to give the trustee any assistance he may require in the realisation and distribution of the estate and if he fails to do so, he is guilty of contempt of court. The court may also revoke his discharge if it thinks fit but without prejudice to the validity of any disposition of this property which occurred after the discharge and before its revocation.

(c) Effect of Order of Discharge: An order of discharge under Section 32 BA releases the bankrupt from all debts provable in bankruptcy except the following:

1. Any debt on a recognisance from a debt entered into by the bankrupt relating to the government or against any law relating to a branch of the KRA or any bond entered into unless the Permanent Secretary to the Treasury certifies in writing his consent to the bankrupt being discharged thereof;

2. An order of discharge shall not release a bankrupt from any debt or liability incurred by means of any fraud or fraudulent breach of trust to which he was a party nor from any debt or liability whereof he has obtained forbearance by any fraud to which he was a party. Section 32(1) B

3. An order of discharge shall not release a bankrupt from any liability under a judgment against him in an action for seduction or under an affiliation order or under a Judgment against him as a correspondent in a matrimonial cause except and under such conditions as the court expressly orders in respect of that liability. Section 32 (1) C;

 Sec 32(2) – An order of discharge shall release the bankrupt from all other debts provable in bankruptcy

 Sec 32(3) – An order of discharge shall be conclusive evidence of the bankruptcy and of the validity of the proceedings therein and in any proceedings that may be instituted against a bankrupt who has obtained an order of discharge in respect of any debt from which he is released by the order, the bankrupt may plead the cause of action occurred before his discharge.

 Sec 32(4) – An order of discharge does not release any person who at the date of the receiving order was a partner or co-trustee with the bankrupt or was jointly bound or had made any joint contract with him or any person who was surety in the nature of a surety for him. The order releases the bankrupt from all personal disabilities imposed upon him as a result of the adjudication other than those which by statute continue to apply for a fixed period after his discharge. He is only released from this if he obtains a certificate of misfortune. The Order will not however free him from any liability to be prosecuted for any bankruptcy offences which he may have committed.

(d) Revocation of Discharge

The order of discharge may be revoked or varied at the discretion of the court. The grounds for revocation include;

1. Failure by the debtor to give all necessary aid to the trustee in realising the estate; or

2. Failure to file a verifying statement or to attend the court for examination when required to do so or to answer any proper question put to him by the court

BANKRUPTCY OFFENCES:

Generally while the fact that a person has been adjudicated bankrupt does not in itself give rise to any criminal liability, the bankrupt may be guilty of one or more or the offences specified in the BA if he has misconducted himself with regard to his affairs either before or during the currency of the Bankruptcy.

There are various categories of offences the most elaborate ones are in the first category

1. Miscellaneous offences;

They are basically 20 such offences. Here under section 138(1) it is provided that any person who has been adjudged bankrupt or in respect of whose estate a receiving order has been made shall be guilty of an offence unless he proves that he had no intent to defraud

(a) Non-disclosure [Non discovery of property]: - If he does not to the best of his knowledge and belief fully and truly disclose to the trustee all his property and how and to whom and for what consideration and when he disposed of any part thereof except such part as has been disposed off in the ordinary way of his trade or laid out in the ordinary expense of his family;

(b) Non –delivery of property: - If he does not deliver up to the trustee or as he directs all or such part of his property which is in his custody or under his control and which he is required by law to deliver up

(c) Non-delivery of books or documents: - If he does not deliver up to the trustee or as he directs all books, documents, papers and writings relating to his property or affairs

(d) Concealment of property: - If after the presentation of a bankruptcy petition or within two years next before presentation he conceals any part of his property to the value of 200/- or more or conceals any debts due to or from him

(e) Removal of property: - If after presentation of a bankruptcy petition or within two years next before presentation he fraudulently removes any part of his property to the value of 200/- or more;

(f) Omission in statement of affairs: - If he makes any material omission in any statement relating to his affairs;

(g) Not informing trustees of false claims: - If knowing or believing that a false debt has been proved by any person under the Bankruptcy he fails within one month to inform the trustee thereof;

(h) Preventing production of books or documents: - If after presentation of a petition he prevents the production of any book, document, paper or writing affecting or relating to his property or affairs unless he proves that he had no intent to conceal the state of his affairs or to defeat the law;

(i) Destruction of books or documents: - If after presentation of a petition or within two years next before presentation he conceals, destroys, mutilates or falsifies or is privy to the concealment, destruction, mutilation or falsification of any book or document affecting or relating to his property or affairs unless he proves that he had no intent to conceal the state of his affairs or to defeat the law;

(j) False entries in books or documents: - If after presentation of a bankruptcy petition or within two years next before presentation he makes or is privy to the making or any false entry in any book or document affecting or relating to his property or affairs unless he proves that he had no intent to conceal the state of his affairs or to defeat the law;

(k) Parting with or altering of documents: - If after presentation of a bankruptcy petition or within two years next before presentation he fraudulently parts with, alters or makes any omission in or is privy to fraudulently parting with, altering or making any omission in any document affecting or relating to his property or affairs;

(l) Accounting for property by fictitious losses: - If after presentation of a bankruptcy petition or at any meeting of his creditors within two years next before presentation he attempts to account for any part of his property by fictitious losses or expenses;

(m) Obtaining property on credit by fraud: - If within two years next before the presentation of a petition or after presentation but before the making of a receding order he by any false representation or other fraud has obtained any property on credit and not paid for it;

(n) Obtaining property on credit on pretence of carrying on business: - If within two years next before presentation of a petition or after presentation but before the making of a receiving order he obtains under the false pretence of carrying on business and if a trader or dealing with the ordinary way of his trade, obtains any property on credit and does not pay for it;

(o)Pawning property obtained on credit: - If within two years next before presentation of a petition or after the presentation but before the making of a receiving order he pawns, pledges or disposes of any property which he has obtained on credit and not paid for it unless in the case of a trader, the pawning, pledging or disposing is in the ordinary way of his trade;

(p) Obtaining consent of creditors by fraud: - If he is guilty of any false representation or other fraud for the purpose of obtaining the consent of his creditors or any of them to an agreement with reference to his affairs or his bankruptcy;

(q) Default in payment: - If he makes default in payment for the benefit of creditors of any portion of a salary or other income in respect of the payment of which the court is authorised to make an order;

(r) Trading when insolvent: - If within one year immediately preceding the date of the making of the receiving order he has continued to trade or carry on business after knowing himself to be insolvent;

(s) Selling goods below cost price: - If within 6 months before the making of a receiving order he sells goods at a price lower than cost unless he proves that he had no intention to defraud his creditors;

(t) Improper contracting of debts: - If he has contracted any debt provable in the bankruptcy without having at the time of contracting it, any reasonable or probable ground or expectation of being able to pay it.

Section 138(2) BA provides that any person guilty of an offence under subsection 1 shall be liable to imprisonment for a term not exceeding 3 years except in the cases mentioned respectively in paragraphs (m), (n) and (o) thereof when he shall be liable to imprisonment for a term not exceeding five years.

2. Fraud by the Bankrupt:

Section 140(1) states that any person who has been adjudged bankrupt or in respect of whose estate a receiving order has been made is guilty of an offence in the following cases;

(a) If in incurring any debt or liability he has obtained credit under any false pretences or by means of any other fraud;

(b) If with intent to defraud any of his creditors he has made or caused to be made any gift or transfer of or charge on his property;

(c) If with intent to defraud his creditors he has concealed or removed any part of his property since or within two months before the date of any unsatisfied judgment or order for payment of money obtained against him.

(d) If with intent to defraud any of his creditors, the debtor has caused or connived at the levying of any execution against his property he is deemed to have made a transfer or charge to his property.

3. Obtaining Credit:

An undischarged bankrupt is guilty of an offence under Section 139(b) in the following two cases:

(a) If either alone or jointly with any other person obtains credit over a 100/- or more from any person without disclosing that he is an undischarged bankrupt; or

(b) If he engages in any trade or business under a name other than that under which he was adjudicated without disclosing to all persons with whom he enters into any business transactions the name under which he was adjudicated bankrupt.

4. Gambling:

Section 141(1) provides that any person who has been adjudged bankrupt or in respect of whose Estate a receiving order has been made shall be guilty of an offence if having been engaged in any trade or business and having outstanding at the date of the receiving order any debts contracted in the course and for the purposes of that trade or business:

(a) He has within two years prior to the presentation of the petition materially contributed to or increase the extent of his insolvency by gambling or by rash and hazardous speculation and the gambling or speculations are unconnected with his trade or business or;

(b) He has between the date of presentation of the petition and the date of the receiving order lost any part of his estate by gambling or rash and hazardous speculation or

(c) On being required by the official receiver at any time or in the cause of his public examination by the court to account for the loss of any substantial part of his Estate incurred within a period of a year next preceding the date of the presentation of the petition or between that date and the date of the receiving order he fails to give a satisfactory explanation of the manner in which the loss was incurred.

In determining whether any speculations were rash and hazardous the financial position of the business at the time they were entered into must be taken into consideration. No prosecution may be instituted except by order of the court.

5. Failure to keep proper books:

Section 142 (1) BA provides that any person who has been adjudged bankrupt or in respect of whose estate a receiving order has been made shall be guilty of an offence if having been engaged in any trade or business during any period in the 3 years immediately preceding the date of presentation of the petition he has not kept proper books of account throughout that period and throughout any further period in which he was so engaged between the date of the presentation of the petition and the date of the receiving order or has not preserved all books of accounts so kept.

6. Bankrupt Absconding with Property:

Section 143 BA provides that if any person who is adjudged bankrupt or in respect of whose estate a receiving order has been made after the presentation of a petition or within 6 months before presentation quits Kenya or attempts or makes preparation to quit Kenya, he shall unless he proves that he had no intent to defraud be guilty of an offence.

NOTE; Under section 144 BA if any creditor or any person claiming to be a creditor in any bankruptcy proceedings makes any false claim or any proof, declaration or statement of account which is untrue in any material particulars, he shall be guilty of an offence unless he proves that he had no intention to defraud.

THE OFFICIAL RECEIVER AND TRUSTEE IN BANKRUPTCY

1. Office of the Official Receiver

The office of the official receiver is set up under section 74 BA. This provides that there shall be an official receiver of debtor’s estate for Kenya and many deputy official receivers as may be required from time to time who shall have jurisdiction in such areas as may be specified. They are appointed by the Minister and are officers of the court to which they are attached. On the making of a receiving order, the official receiver becomes by virtue of his office, receiver of the property of the debtor. Upon the making of an adjudication order, the official receiver becomes trustee until some other trustee is appointed. He also acts as trustee in the following cases:

a. During any vacancy in the office of trustee

b. Upon release of the trustee

c. In small bankruptcies

d. In the administration in bankruptcy of the estate of a deceased person unless and until a trustee is appointed by the creditors

e. In a composition or scheme of arrangement until a trustee is appointed and during a vacancy in such office

2. Duties of the Official Receiver

The official receiver has duties as regards both the conduct of the debtor and the administration of his estate under section 75 BA.

(1) Duties as regards the debtor’s conduct

Under section 76 BA. It is the duty of the official receiver to:

i. Investigate the conduct of the debtor and to report to the court stating whether there is reason to believe that the debtor has committed an act which constitutes an offence under the act or which would justify the court in refusing, suspending or qualifying an order for his discharge.

ii. Make such other report concerning the conduct of the debtor as the court may direct

iii. Take such part as he may deem fit in the public examination of the debtor

iv. Take such part and give such assistance in relation to the prosecution of any fraudulent debtor as the AG may direct

(2) Duties as regards the debtor’s estate

As regards the estate of a debtor, it shall be the duty of the official receiver

i. Pending the appointment of a trustee to act as interim receiver of the debtor’s estate and where a special manager is not appointed as manager thereof.

ii. To authorise the special manager to raise money or make advances for the purposes of the estate in any case where in the interest of the creditors it appears necessary to do so.

iii. To summon and preside at the first meeting of creditors

iv. To issue forms of proxy for use at the meetings of creditors

v. To report to the creditors as to any proposal which the debtor may have made with respect to the mode of liquidating his affairs

vi. To advertise the receiving order, the date of the creditors first meeting and of the debtors public examination and such other matters as it may be necessary to advertise

For the purpose of his duties as receiver or manager, the official receiver has the same power as if he were a receiver and manager appointed by the court but he shall as far as practicable consult the creditors with respect to the management of the debtor’s property and may for that purpose summon meetings of the persons claiming to be creditors but shall not unless the court otherwise orders incur any expense beyond that which is necessary for the protection of the debtor’s property or the disposing of perishable goods.

3. Appointment of Trustee

Any fit person whether a creditor or not may be appointed trustee either:

a. By creditors by ordinary resolution or

b. By a committee of inspection when the creditors resolve to leave the appointment to them

In the case of an appointment by creditors or the committee of inspection, the court may object to its appointment on grounds specified inter alia in section 21 BA which requires the trustee to give security

Under section 22 BA the creditors may at their first or subsequent meeting appoint a committee of administration of the bankrupt’s property by the trustee.

4. The Powers of the Trustee

These are those powers which may be exercised with permission of the committee of inspection and those powers which may be exercised without such permission.

(1) Powers exercised with permission of the inspection committed

The trustee may under section 60:

i. Carry on the business of the bankrupt so far as may be necessary for the beneficial winding up thereof.

ii. Bring, institute or defend any action or other legal proceedings relating to the property of the bankrupt

iii. Employ an advocate or other agent to take any proceedings or do any business which may be sanctioned by the committee of inspection

iv. Accept as the consideration for the sale of any property of the bankrupt, a sum of money payable at a future time, subject to such stipulations as to security and otherwise as the committee thinks fit

v. Mortgage or pledge any part of the property of the bankrupt for the purpose of raising money for the payment of his debt

vi. Refer any dispute to arbitration and compromise any claims whether by or against the bankrupt on such terms as may be agreed on.

vii. Divide in its existing form amongst the creditors according to its estimated value, any property which may from its peculiar nature or other special circumstances, cannot readily or advantageously be sold.

viii. Appoint the bankrupt himself to superintend the management of his property or carry his trade for the creditor’s benefit or help in the administration of the property in such manner as the trustee may direct

ix. Give the bankrupt some maintenance allowance for his services

(2) Powers exercised without permission of the Inspection Committee

Under section 59, the trustee may do all or any of the following things:

a. Sell all or part of the property of the bankrupt by public auction or private contract with power to transfer the whole thereof to any person.

b. Give receipts for any money received by him, which receipts shall effectually discharge the person paying the money from all responsibility in respect of the application thereof.

c. Prove, rank, claim and draw a dividend in respect of any debt due to the bankrupt

d. Exercise any powers the capacity to exercise which is vested in the trustee under the Act and execute any powers of attorney, deeds and other instruments for the purpose of carrying into effect the provisions of the Act

e. Deal with any property to which the bankrupt is beneficially entitled in the same manner as the bankrupt might have dealt with it.

5. Control of the Trustee

Section 81 BA, subject to the provisions of the BA, the trustee must use his own discretion in the management of the estate and its distribution amongst creditors. If in difficulties, he may apply to the court for such directions as required.

He must have regard however to the directions given by the committee of inspection or creditors. If the directions conflict, those of the creditors prevail. He may from time to time summon meetings of the creditors for the purpose of ascertaining their wishes and he must do so when directed by them. Should the bankrupt, creditors or any other person be aggrieved by any Act or decision of the trustee they may apply to the court which may confirm, reverse or modify the act or decision complained of and make such order as it deems just. Section 83 BA gives the official receiver general control over trustees.

6. Meetings of Creditors

(1) Holding and Conduct of Meetings The following meetings of creditors may be held:

a. The first meeting of creditors

b. A meeting must be summoned by the official receiver on the requisition of any creditor for the purpose of filling a vacancy in the trusteeship

c. A meeting may be summoned by a member of the committee of inspection or by the official receiver to consider the removal of the trustee on the requisition of a sixth in value of the creditors

d. Meetings may be summoned by the trustee at any time

e. Meetings may be summoned by the trustee at such time as the creditors by resolution with concurrence of a sixth in value of creditors

f. The trustee must call a meeting whenever so directed by the court

(2) Proxies

A creditor may not vote at a meeting unless he has already lodged a proof of his debt. A creditor who has proved may vote in person or by proxy.

Forms of proxy in the prescribed form must be sent to the creditors together with a notice convening the meeting and must be deposited with the official receiver or trustee before the meeting at which they are to be used.

(3) Resolutions

The following resolutions may be passed at the meetings of creditors:

A. Ordinary Resolutions

These are decided by a majority in value of the creditors present, voting personally or by proxy. Whenever the word resolution is used without qualification it means an ordinary resolution.

B. Special Resolutions

These are decided by a majority in number, three-quarter in value of the creditors present voting personally or by proxy. A special resolution is required in three cases:

i. To appoint a trustee other than an official receiver in a small bankruptcy.

ii. To make an allowance to the debtor in some form other than money

iii. To require the official receiver to remove a special manager

C. Resolution for Composition or Scheme

These are decided by a majority in number and three-quarter in value of all the creditors who have proved their debt

7. Remuneration of Trustees

The remuneration of the trustee is fixed by an ordinary resolution of the creditors or if the creditors so resolve, by a committee of inspection. It must be in the nature of a commission or a percentage, one part to be payable on the amount realised by the trustee after deducting any sum paid to secured creditors out of the proceeds of their securities and the other part on the amount distributed as dividends.

8. Accounts of the Trustee

(1) In relation to Books

The trustee is required to keep the following books:

a. A record book in which he must record the minutes, proceedings and resolutions of any meetings of creditors and of the committee of inspection and any other matters that may be necessary to give an accurate record of his administration of the estate.

b. A cashbook in the prescribed form in which he must enter his receipts and payments from day to day

c. A trading account where he is carrying on the business of the debtor in which he must keep a distinct account of the trading and he must incorporate the total weekly amounts of receipts and payments on the trading account in the cashbook.

 

(2) Inspection

Any creditor may subject to the courts control, personally or by his agent inspect these books.

He may also require the trustee to supply him with a list of creditors showing the amount of the debt due to each creditor on payment of a small fee. With the concurrence of a sixth of the creditors, he may require the trustee to provide him with a statement of accounts to date. The trustee must supply the official receiver with such information and give him such access to the bankruptcy books and documents as may be requisite for enabling him to perform his duties.

(3) Audit of Accounts

The trustee must submit the record book and cash book together with any other books and vouchers to a committee of inspection if any, when required and in any case not less than once every three months. Upon resignation or release, the trustee must surrender to the official receiver or new trustee all books and documents. The moneys received by the trustee are not to be kept or paid in his private account but must be paid into the bankruptcy estate account which is to be kept by the official receiver with the prescribed bank.

9. Termination of Office of Trustee

The office of the trustee may be vacated in any of the following ways:

a. By resignation – If the trustee wishes to resign he must call a meeting of creditors to consider whether his resignation shall be accepted or not and give seven days notice of the meeting to the official receiver.

b. By removal for good cause – The trustee may be removed by ordinary resolution of the creditors at a meeting specially called for that purpose of which seven days notice has been given. Such a meeting may be summoned by a member of the committee of inspection or by an official receiver on the requisition of a sixth in value of the creditors who must deposit a sum sufficient to pay the expenses of the meeting.

c. By insolvency of the trustee – If a receiving order is made against a trustee, he thereby vacates his office.

d. By release – Under section 94 BA a trustee is released once he has realised all property of the bankrupt and paid out to the creditors.

THE PROPERTY OF THE BANKRUPT

1. Vesting of Property in the trustee

Sections 53 to 57 BA, state the property of the bankrupt rests in the trustee or in the official receiver immediately after making of the adjudication order.

2. Discovery and examination

a) Discovery of property

The debtor is required to make full disclosure of the whole of his property to deliver up possession of all property, divisible among his creditors which is in his possession or control and assists the trustee to the utmost of his power in the realisation of his property and distribution of proceeds amongst his creditors.

If he fails to perform these duties he will be punished for contempt of court in addition to any other punishment of which he may be subject.

b) Private examination At any time after the date of receiving order the official receiver or trustee may apply to the court for examination on oath of the debtor or his wife or any person known or suspected to have possession of any property of the debtor or of being capable of giving any information relating to the debtor, his dealings or property and the court may require any such person to produce any relevant documents in his custody.

If he fails to attend, the court may issue a warrant for his arrest.

If any person upon examination admits he is indebted to the debtor or is in possession of the debtor’s property, the court may order payment or delivery of property to the official receiver or trustee. Sec 28 BA

c) Seizure of property

Sec 24 BA – The court may issue warrants authorising the breaking open or searching and the seizure of any property of the debtor whether in the custody or possession of the debtor or of some other person.

d) Redirection of letters

Sec 27 BA - On the application of the official receiver or trustee, the court may from time to time and not exceeding three months as he deems fit, order that all letters, telegrams and other postal parcels to be redirected to the official receiver or trustee.

3. Property divisible among creditors

All property of the debtor passes to the trustee except the following:

a) Trust property e.g. property he holds in trust for all persons

b) The tools of the bankrupts trade

- His necessary wearing apparel

- Bedding for his wife and children not exceeding KShs 500 although the court may order an increment on this allowance

c) Certain interests determinable upon bankruptcy. Where property is transferred subject to a condition that the transferees interest shall cease upon his bankruptcy; then the transferee can make no claim to the property.

4. Doctrine of relation

Sec 42 BA – Although the debtors property may not in fact vest in the trustee until he is adjudged bankrupt, the trustees title operates retrospectively and under the doctrine of relation-back, takes effect from commencement of the bankruptcy subject to certain exceptions.

a) Protected Transactions within the meaning of section 50 BA

If the doctrine of relation-back were too rigidly be applied, no prudent person would make any payments to or have any other dealings with a person whose financial position was at all doubtful, and this might well precipitate a bankruptcy which would otherwise have been avoided.

Accordingly, certain transactions entered into by the debtor in the ordinary course of his business or private affairs are protected from operation of the doctrine. These are:

i. Transactions without notice of the act of bankruptcy

The following transactions entered into by the debtor between the commencement of the bankruptcy and the date of the receiving order are not invalidated by his being adjudged bankrupt and cant be set aside by the trustee in bankruptcy. These are:

- Any payment by the bankrupt to any of his creditors

- Any payment or delivery to the bankrupt

- Any conveyance or assignment by the bankrupt for valuable consideration

- Any contract, dealing or transaction by or which the bankrupt for a valuable consideration, provided that the transaction took place before the date of the receiving order and the person with whom the debtor was dealing had not at the time of the transaction notice of any available act of bankruptcy committed by the bankrupt before that time.

ii. Payments to bankrupt

Additional protection is given to a person who pays more or delivers property to the bankrupt or to a person claiming by assignment by him. Such person is discharged from his liability to the debtor although he had notice of the act of bankruptcy if:

- He made payment or delivery before the date on which the receiving order was made

- Without notice of the presentation of a bankruptcy petition against the debtor

- Either pursuant to the ordinary course of business or otherwise bonafide. Sec 51 BA

b) Completed Executions

This is within the meaning of Section 45 and 46. Under section 45, where a creditor has issued execution against the goods or lands of a debtor or has attached any debt due to him, he shall not be entitled to retain the benefit of the executions or attachment against the trustee of the debtor unless he has completed the execution or attachment before the date of the receiving order and before notice of the presentation of any bankruptcy petition by or against the debtor or of the commission of any available act of bankruptcy by the debtor.

Under section 46, it is provided that where any goods of a debtor are taken in execution and before the sale thereof or completion of execution by receipt or recovery of the full amount of the levy, notice is served on the bailiff that a receiving order has been made against the debtor.

The bailiff shall on request deliver the goods and any money seized or received in part satisfaction of the execution to the official receiver but the cost of execution shall be a first charge on the goods or money so delivered and the official receiver or trustee may sell the goods or an adequate part thereof for the purpose of satisfying the charge.

c) Restraint by Landlord

Subject to certain limitations, the rights of a landlord to restrain upon the goods of his tenant for arrears of rent is not affected by the tenants bankruptcy under sec 40 BA.

5. Goods in Bankrupt’s reputed ownership

Under section 43 BA, the trustee may claim property belonging to third parties which is in the hands of the bankrupt at the commencement of the bankruptcy if the property:

i) consists of goods

ii) In possession, order, or disposition of the bankrupt at commencement of bankruptcy

iii) For use in the bankrupts trade or business

iv) With the consent of the owner

v) The bankrupt must be the reputed owner thereof

6. Voidable dispositions effected before commencement of bankruptcy

Although the doctrine of relation-back does not affect the validity of transactions entered into by the bankrupt before the commencement of bankruptcy, the trustee is expressly empowered to set aside dispositions of property effected before that time which falls within the following:

a) Voidable settlements

These are basically two:

i. Voluntary settlements within the meaning of section 47[1] BA

“Any settlement of property not being a settlement made before or in consideration of a marriage or in favour of the purchaser in good faith or made for wife and children of settlor which has accrued to settlor, shall if settlor becomes bankrupt within two years be void against the trustee, bankrupt within 10 years, unless the parties can rule that the settlor at making settlement was able to pay his debts without recourse to that property.

ii. Agreements to settle after-acquired property (sec 47[2] BA)

 

“Any proven act or contract made by settlor in consideration of his or her marriage either for the future payment of money for wife/hubby/kids; wherein the settlor had no property at the date of marriage, shall if settlor is adjudged bankrupt and contract hasn’t been executed be void against trustee in bankruptcy….

You enter contract, you settle to your wife property to acquire in the future; that is “void against the trustee and is put as part of estate to be distributed.”

b) Fraudulent preference

Within the meaning of section 49[1] BA.

Any transfer 6 months prior to the bankruptcy, the transaction is declared void against trustee and that property is subject to distribution to creditors.

c) Fraudulent conveyance

Which constitute an act of bankruptcy may be set aside by the trustee under the doctrine of relation-back unless it can be regarded as protected transaction.

d) Unregistered assignment of book debts {sec 48 BA}

Where a person engaged in any trade or business, assigns to another person his existing or future book debts or any class thereof and subsequently becomes bankrupt, the assignment is void against the trustee as regards any book debts not yet paid at commencement of bankruptcy unless the assignment has been registered under section 13 (Cap 28) of Chattels Transfer Act.

7. The trustees’ right of disclaimer

The trustee takes the bankrupts property subject to any liabilities or obligations attaching thereto. If the liabilities exceed the benefit to the estate, the trustee can disclaim the property under section 58 BA.

8. Subsequent bankruptcies

Section 44 BA.

Where there is a subsequent bankrupt the first trustee becomes a secured creditor under the second bankruptcy.

Trustee in last bankruptcy shall be deemed a creditor. A bankrupt can still enter into transactions, even after being declared bankrupt. If now declared bankrupt, the trustee in previous bankruptcy can be declared a creditor in the second bankruptcy.

DISTRIBUTION OF THE ESTATE:

Provisions relating to this are to be found in the second schedule to the BA.

Any creditor who wishes to make a claim against the estate of the Bankrupt must prove his debt to the satisfaction of the Trustee. The Trustee is under a duty to convert all the Bankrupt’s property which is divisible among creditors into money and to distribute the proceeds by way of dividends among creditors who have proved in accordance with a due order of priorities and in proportion to the amounts due to them. Up until he has proved his debt a creditor is not entitled to vote at any meeting of creditors or to receive any dividend.

1. DEBTS PROVABLE IN BANKRUPTCY

(a) Provable Debts

Section 35 (3) B.A. states that all debts and liabilities present or future certain or contingent to which the debtor is subject at the date of the receiving order or to which he may become subject before his discharge by reason of any obligation incurred before the date of the receiving order are deemed to be debts provable in bankruptcy.

(b) Non – Provable Debts

The following debts are not provable in bankruptcy

(i) Claims for unliquidated damages in tort; this is under Section 35(1) B.A. herein demands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust are not provable in bankruptcy. Therefore claims arising out of a tort committed by the bankrupt cannot be proved unless the damages become liquidated by agreement or judgment before the dates of the receiving order. A claim arising out of a breach of contract fraud or breach of trust cannot be excluded merely because the claim might alternatively be founded in tort.

(ii) Debts incurred after notice of unavoidable act of bankruptcy under Section 35(2) B.A.

(iii) Debts incurred after the date of the receiving order Section 35(3) BA

(iv) Unenforceable Debts: these are debts founded on an illegal or immoral consideration or statutes-barred debts;

(v) Debts incapable of being fairly estimated under Section 35(6) of B.A

(vi) Alimony and maintenance – the common law liability of a husband to maintain his wife is not a contractual liability and therefore does not constitute a provable debt.

(c) Contingent Liabilities A contingent liability is one, which at the date of proof is not certain to arise. It is dependent upon the happening of some events, which may or may not take place. Subject to certain rules a creditor may prove for the full value of a contingent liability

(d) Periodical Payments:

Under Section 19 of the BA here where any rates or other payment falls due at stated periods and the receiving order is made at any time other than any one of those periods, the person entitled to the payment may prove for a proportionate part thereof upto the date of the order as if payment accrued due from day to day.

(e) Interest on Debts:

Under the second schedule of the BA, interest on debts is provable and payable.

 

 

2. MUTUAL DEALINGS

It would be unfair if a creditor who was himself indebted to a bankrupt to be required to pay his debt in full, while receiving himself only a small portion of the debt due to him from the bankrupt.

Accordingly section 36 provides where there have been mutual credits, debts or other mutual dealings between a debtor, against whom a receiving order has been made, and any other person proving or claiming to prove a debt under the receiving order an account must be taken of parties/ sums due from the one party to the other in respect of such mutual dealings and the sum due from the other party and the balance of the account and no more claimed or paid from either side respectively, that is, the creditor must subtract from what he is owed, what he himself owes to the debtor.

3. SECURED CREDITORS

These are those who hold mortgages, charges or a lien on the debtor’s property. On the debtor’s bankruptcy he may :

1. Rely on the security and not prove at all; or

2. Surrender the security and prove the full amount of the debt; or

3. Realise his security and prove for the balance if any; or

4. Estimate the value of the security and prove for the balance.

4. LANDLORD’S POWER OF DISTRESS

Under Section 40 B.A. It has a provision relating to the landlord’s power of distress, the position is somewhat similar to that of a secured creditor. He is entitled to seize the goods of a tenant in satisfaction of the rent due to him.

5. RULES AS TO PROOF OF DEBTS

In proving of debts the rules laid down in the 2nd schedule to the Bankruptcy Act must be observed as read with section 37 BA.

6. ORDER OF PAYMENTS: Sec 38 and 39 BA

The Assets remaining after payment of the expenses properly incurred in preserving, getting in and realising the assets of the bankrupt must be paid out in the following order of priority:

1. Costs and Charges incurred in the administration of the Estate;

2. Pre-preferential debts e.g. where a business dies then you have such debts

3. Preferential Debts;

4. Unsecured debts;

5. Deferred Debts;

6. If there is any surplus this is to be returned to the Bankrupt. Section 38-39 B.A.

As to distribution of property through dividends there are provisions in sections 66-73 BA

SMALL ESTATES:

Under Section 120 if a petition is presented and the value of the debt is not more than KShs. 12,000 the court may order that the debtor’s Estate be administered summarily whereupon the provisions of the BA will apply subject to the following qualifications.

1. Should the debtor be adjudged bankrupt, the official receiver shall be the Trustee in Bankruptcy;

2. There is no committee of inspection, everything is done by the official receiver;

3. Everything else may be modified to simplify the procedure except for the provisions relating to examination and discharge of the debtor. HIRE PURCHASE

The Kenyan Hire Purchase Law is governed by the principles of the English common law as modified by the Hire Purchase Act Cap 507 of the Laws of Kenya. At common law a hire purchase agreement is defined as a contract for the delivery of goods under which the Hirer is granted an option to purchase the goods. The agreement is a hybrid form of contract in that it is neither a simple bailment nor a contract of sale but combines elements of both.

The original position at common law is that there are no formal requirements for a hire purchase agreement. An oral agreement is valid and binding as a written agreement. The question of capacity to enter into a Hire Purchase Agreement is governed by the normal rules of contract law. Because the Hire Purchase Agreement is a form of bailment, it only applies to goods as defined in the Sale of Goods Act Cap 31. The terms of a Hire Purchase Agreement must be stated with certainty and precision so as to enable the court to ascertain the intention of the parties. The parties to the agreement must reach a consensus ad idem i.e. to say a meeting of the minds.

If the dealer of goods fraudulently completes a document signed in blank by the hirer, then no valid hire purchase contract results. Should the nature of the document which the hirer signs be misrepresented to him so that he signs in the belief that it is something essentially different from what it is the hirer can plead non est factum (it is not my deed or it is not my act) and therefore escape liability. If there is a change in the condition of the goods between the time of the offer and acceptance, again no valid agreement comes into force.

In the case of an agreement between the dealer and the hirer without the intervention of a finance company, a legally binding hire purchase agreement comes into existence when the dealer posts a letter of acceptance to the hirer or delivers the goods.

Where the finance company finances the transaction, although the dealer is supplying the goods, the owner of the goods at the relevant time is a finance company. The hirer therefore contracts with a finance company when he enters into a hire purchase agreement. Thus there must be acceptance by the finance company and communication of that acceptance to the hirer, which is normally done by posting him a copy of the agreement showing execution by the company.

A hire purchase transaction has been described as a triangular transaction with the Dealer and the Hirer at the bottom and the Finance company at the top.

The question arises as to the effect of the delivery of goods by the dealer to the hirer before acceptance by the finance company. As far as the obligations of the hirer are concerned, until acceptance of his proposal by the finance company the hirer holds the goods as a bailee of the dealer. Such bailment can be terminated at the will of the dealer or the hirer. It however continues until the finance company purchases the goods from the dealer and executes the hire purchase agreement. When this is done, the bailment as between the dealer and the hirer terminates and is replaced by the hire purchase agreement between the finance company and the hirer.

The hirer thereafter holds the goods as a bailee of the finance company under the terms of the Hire Purchase Agreement. Should the finance company refuse to accept the transaction, the bailment between the dealer and the hirer ends or is terminable by the dealer.

Before the finance company executes the hire purchase proposal the hirer in possession of the goods owes the dealer a duty to take reasonable care of the goods, the breach of which gives the dealer a right of action under the tort of negligence or if wilful damage is caused to the goods then trespass to goods. If the finance company refuses to accept the transaction the hirer could be held liable in quasi contract to pay the dealer a reasonable charge for the use of the goods.

Pending acceptance of the transaction by the finance company the hirer can use the goods at will as bailee if there are no restrictions agreed between him and the dealer. The dealer at that stage does not owe the hirer any contractual duty as to fitness of the goods or their suitability because there is no contract between them but simply a loan of the goods. Should however the hirer be injured, due to defects in the goods, which the dealer knows or ought to know, the hirer can maintain an action in tort for negligence.

If the proposal is not acceptable by the Finance Company, no contract comes into existence in relation to the goods hence the bailment between the dealer and the hirer terminates.

The liability of the finance company for the condition of the goods does not start until it has entered into a hire purchase agreement.

Note that hire purchase agreements must not be impossible to perform, contain a mistake on the part of either party or be illegal.

THE PASSING OF PROPERTY

There is no distinction between property and title under Hire Purchase. This is because property which essentially means ownership of the goods does not pass to the hirer till the option to purchase has been exercised. Thus the hirer has the right to return the goods and terminate his liability at any time. Under Section 2 of the Factories Act of England 1889 which is a statute of general application to Kenya if a Mercantile Agent disposes of the goods in his possession with the consent of the owner he passes a good title to a bona fide purchaser for value without notice. If then goods are lent to a hirer who is a mercantile agent he cannot pass a good title to a 3rd party since the goods are lent to him in his personal capacity and not in the capacity of a mercantile agent.

Section 22 of the English Sale of Goods Act of 1893 provides that a sale to a bona fide purchaser in market overt according to the usage of the market passes a good title even if the seller had no title. This therefore operates as an exception to the nemo dat principle under Hire Purchase. This exception however does not operate under Kenyan law.

Sometimes the owner of the goods hired to the hirer who has resold them may voluntarily relinquish his title to them after being paid and hence good title passes to subsequent purchasers. This is not quite an exception to nemo dat but a modification of it.

The hirer under a hire purchase agreement possesses a contractual right to acquire ownership of the goods upon payment of all instalments due and the exercise of the option to purchase. The question arises can the hirer therefore assign the benefit of the Agreement?

At common law if a contract is silent on assignment then the hirer can assign but if it specifically prohibits assignment then he should not assign. In Kenya, there is no difference between the two because the definition of a hirer includes an assignee of the hirer.

REPOSSESSION BY THE OWNER

At common law an owner of goods is entitled to repossess them once the bailment ceases or terminates. A hire purchase contract may provide that if the hirer commits a specified breach then the agreement terminates whereupon the owner is entitled to possession of the goods. In cases of resale of the goods by the hirer the hirer cannot pass a good title hence the owner can repossess the goods from the innocent purchaser. The owner’s claim to damages will be limited to the unpaid balance of the hire purchase price. Should judgment be entered against the hirer, the judgment creditor is not permitted to seize goods the subject matter of a hire purchase agreement.

If the hirer does not disclose this fact to the judgment creditor and the hire purchase goods are seized and sold the owner cannot maintain an action for conversion against an innocent purchaser but he can recover the price for which the goods were sold in an action for money had and received. If the goods have not yet been sold then the owner is entitled to possession of them from the judgment creditor. In cases where the hirer is a tenant of leasehold premises and he fails to pay rent, the landlord may re-enter the premises and seize all goods therein whether they belong to the tenant or not. For the owner of the goods hired to be protected, he must serve notice to the landlord that those goods belong to him. Only then can he repossess them.

Where the hirer is adjudged bankrupt all his property vests in the trustee in bankruptcy for distribution among creditors. But this does not apply to goods let on hire purchase when the owner serves a notice to the hirer withdrawing his consent to possession of the hired goods. The owner must do this before the hirer is adjudged bankrupt.

Finally if hired goods are delivered to a bailee for repair the bailee has a particular lien on the goods till his charges are paid by the hirer. If the owner is entitled to terminate the hiring, the repairer can still claim a lien as against the owner.

In all the foregoing circumstances if the owner of the goods repossess them, prima facie the hirer cannot claim relief against forfeiture of the goods or the payments already made.

THE MINIMUM PAYMENT CLAUSE AND DAMAGES

In addition to the common law owners right of repossession of the hired goods the owner may seek damages. Goods let on hire purchase depreciate in value because of user. The owner seeks to pass the risk of depreciation on to the hirer by providing in the Agreement that the hirer shall make a minimum payment for the period the hirer has used the goods. This is normally labelled ‘compensation for depreciation’.

The question is can the owner sue the hirer for the sums stated in the minimum payment clause or can the hirer refuse to pay because the amount is a penalty and not liquidated damages?

Common law courts took the position that it is for them to determine the measure of damages payable in the event of breach of contract. If the damages agreed between the parties is not a genuine pre-estimate of the loss likely to be incurred upon breach, the courts will strike it down as a penalty.

There are 3 circumstances under hire purchase, which invite the operation of the minimum payment clause.

1. In the case of the hirer’s breach of contract, the minimum payment clause will be regarded as a penalty and hence be struck out whereupon the court will assess the amount of damages payable.

2. In the case of voluntary termination of the contract by the hirer by returning the goods the minimum payment clause will be enforced.

3. The minimum payment clause will be enforced in the case of involuntary termination of the contract where either the hirer dies or becomes bankrupt.

DAMAGES FOR BREACH OF CONTRACT

If the hirer commits a breach of any of the terms of hire purchase agreement the owner may claim damages. The hirer has several obligations the breach of which gives rise to damages namely

1. the obligation to take delivery of the goods,

2. the duty to take care of the goods,

3. the obligation to pay the instalments and

4. the obligation to continue the hiring for the agreed period.

Here the owner’s rights upon the hirer’s breach are termination of the agreement, and a claim for damages.

CAVEAT EMPTOR UNDER HIRE PURCHASE

The obligations of the owner to the hirer are contained in the express or implied terms of the agreement. Besides express terms there are several implied terms

1. There is an implied condition in the hire purchase agreement that the owner of the goods has title to them.

2. There is an implied warranty in a hire purchase agreement that the owner in addition to putting the hirer into possession of the goods will leave him into peaceful possession of them during the currency of the agreement. Peaceful enjoyment, quiet possession

3. At common law there is an implied term in all hire purchase agreements that the goods are fit for the purpose for which they are let.

4. At common law there is an implied term that the goods will correspond with their description.

It may also be observed that there is an obligation cast on the owner to deliver goods to the hirer. If the goods let under a hire purchase agreement are not fit for their purpose, this amounts to a breach of contract that entitles the hirer to treat the contract as repudiated, reject the goods and claim for what he has paid as well as damages.

Apart from liability in contract the owner may be liable in tort for negligence if he knew or ought to have known of a defect in the goods which causes injury to the hirer. As a standard form contract drafted by the owner, the hire purchase agreement often contains clauses excluding implied terms of the contract. These are the exemption clauses or exclusion of liability clauses. The court construes exemption clauses strictly and subjects them to the doctrine of fundamental breach and breach of a fundamental term.

THE KENYA HIRE PURCHASE ACT 1968

Before the passing of the Kenyan Hire Purchase Act in 1968 the prevailing law was that English common law vide the Indian Law of Contract. The Kenyan Hire Purchase Act commenced operation on 2nd November 1970. As far as formalities are concerned, Section 3 stipulates that the Act applies to all Hire Purchase Agreements for goods whose hire purchase price does not exceed the sum of 300,000/-. This is via an amendment to the Act which was made in 1991 and at the time of the enactment the financial ceiling was only 80,000/=.

Secondly the Act does not apply to bodies corporate who are hirers. The assumption of the statute is that if you are a private limited liability company you need no protection from the Hire Purchase Act. It is assumed companies can take care of themselves. Also assumed that anyone who can enter into a hire purchase agreement for more than 300,000/- is capable of taking care of himself.

Section 4 establishes a registry of Hire Purchase Agreements presided over by a registrar, his or her deputy and assistant. By virtue of Section 5(1) of the statute all hire purchase agreements must be registered within 30 days of execution upon payment of a registration fee. But there is a discretion vested in a registrar to extend the time for registration if satisfied that the failure to register was accidental or inadvertent.

The consequences of non-registration are grave for the owner under Section 5(4).

1. No person shall be entitled to enforce the agreement against the hirer or any contract of guarantee and the owner cannot recover the goods from the hirer.

2. No security given by the hirer or guarantor shall be enforceable.

Under Section 5(2) the agreement must be in the English language.

The information that must be contained in the Agreement is provided for in Section 6 of the statute.

1. The cash price of the goods as well as the hire purchase price must be stated.

2. Secondly the amount of each instalment and a period of repayment must be stated.

The requirement as to the cash price may be satisfied in two ways as per Section 6(1)

1. If the hirer has inspected the goods or like goods and at the time of his inspection tickets or labels were attached to or displayed with the goods clearly stating the cash price either of the goods as a whole or of all the different articles comprised therein then the requirement as to the cash price is satisfied.

2. If the hirer has selected the goods by reference to a catalogue, pricelist or advertisement which clearly stated the cash price either of the goods as a whole or the different articles then the requirement as to the cash price is fulfilled.

Non compliance with the provisions of Section 6 will make the agreement unenforceable against the hirer and the guarantor. There are some other requirements under Section 6.

- The agreements must be made and signed by the hirer and by or on behalf of all the other parties. - It must contain notice in a prominent form stipulating the rights of the hirer which are basically the right of the hirer to terminate the agreement and the restriction on the owner’s rights to repossess the goods.

- A copy of the agreement must be delivered or sent by registered post to the hirer within 21 days of the date of the agreement.

Section 7 declares that certain provisions if contained in the Hire Purchase Agreement will be absolutely void. These are:

1. Any provisions that allow the owner of goods or his agent to enter the Hirer’s premises to retake possession of the goods.

2. Any provision that attempts to prevent the hirer from terminating the agreement as provided for in Section 12 of the Act or

3. Any provisions that adds extra liabilities should the hirer terminate the agreement;

4. Any provision that attempts to relieve the owner of goods from liabilities for the default of these agents;

The section therefore stands out as an attempt to reduce the doctrine of freedom of contract and to mitigate the harshness of the imposed standard form contract.

REPOSSESSION & THE MINIMUM PAYMENT CLAUSE

Section 15 (1) of the HPA provides that where goods have been let under a hire purchase agreement and two thirds of the hire purchase price has been paid, the owner shall not enforce any right to recover possession of the goods otherwise than by suit. If the owner contravenes this provision the hirer is immediately released from liability under the Agreement. Secondly the hiring terminates and the hirer can recover by suits all moneys paid out by him. It has been argued that the Section gives the hirer some protection although that protection is “half-hearted”. Mentioned by Professor Mutunga and Piciotto and Whitford and Mcneil

Section 12 (1) allows the hirer to terminate the agreement by giving notice in writing to the owner. If he does so, the minimum payment clause comes into operation whereby he will have to pay upto 50% of the Hire Purchase Price or less should the agreement so stipulate.

CONDITIONS, WARRANTIES & EXCLUSION CLAUSES

The Hire Purchase Act imposes implied terms and restricts their exclusion. Section 8 (1)(a) implies a condition that the owner will have a right to sell the goods at the time when property is to pass.

Secondly 8(1) (b) implies a warranty that the hirer shall have and enjoy quiet possession of the goods.

Thirdly Section 8(1)(c) implies a warranty that the goods will be free from any charge or encumbrance in favour of a third party at the time when property is to pass.

Under Section 8(1) (d) there is an implied condition that the goods are of merchantable quality unless they are second hand goods and the agreement says so. Furthermore this implied condition is negatived in those cases where the hirer has examined goods or a sample thereof and the examination ought to have revealed the defect or where the owner could not have reasonably detected the defect.

There is a further implied condition under Section 8(2) to the effect that the goods are reasonably fit for their purpose where the hirer whether expressly or by implication has made known the particular purpose for which the goods are required.

It should be noted that the implied conditions as to sample and description are not expressly stated in the Hire Purchase Act unlike in the Sale of Goods Act where they are. In fact Section 8(4) of the HPA refers back to the English common Law where an implied term as to description is available to hirers but it is not clearly so for the implied condition as to sample.

Finally it should be noted that Section 8(3) prohibits the parties from contracting out of the implied conditions and warranties. This section thus limits the use of exclusion clauses to exclude liability for defect in the goods and thus gives protection to the hirer.

MISCELLANEOUS PROVISIONS

Part IV of the HPA deals with aspects relating to change of address and removal of goods from premises. It also deals with removal of goods from Kenya whereupon the hirer has to inform owner of the goods of their removal and is not permitted to proceed without permission. It also deals with those situations where the court may allow goods to be removed.

Part VII of the HPA deals with licensing of Hire Purchase businesses. In order to operate one must have a licence. Where the licence is refused there are provisions for appeal to the minister and there is a provisions that the licences if granted have to be displayed.

Other miscellaneous provisions are contained in Sections 24, through to 35 but these do not fundamentally alter the hire purchase transactions.

OTHER SECURITIES

These are basically

1. Guarantee

2. Indemnity

3. Bailment

4. Pledge /Pawn

5. Lien

6. Letter of Hypothecation

7. Mortgage/Charge

8. Debentures

9. Chattels Transfer – Chattels Transfer Act Cap 28

TAX LAW

INCOME TAX

Whom do you tax? What is the basis of taxation? Is it income in which case you can only tax income earners, Is it Purchase in which case you tax everyone as in VAT?

Who is the most taxed person? Is it the wage earner who pays 30% on his income?

Ideologies of Taxation

These are 3

1. Ideology of the ability to pay;

2. Ideology of the barriers and deterrents;

3. Ideology of equity.

Ideology of ability to pay:

This ideology is based on the basis that taxes should be apportioned or distributed in accordance with the ability to pay and the ability to pay should be determined by income or wealth. It should be progressive that is the theory but is it possible to be progressive. It is not always feasible to have a progressive tax and we do the best we can. The assumption is that income is ability to pay but is it really? This is not always the case so this ideology is not applicable in full, individuals are not allowed to deduct their cost of production and this way we cannot have a progressive tax as some people have more expenditure and are left with no income whereas others are without a lot of expenditure. This ideology is not realistic.

Ideology of the barriers and deterrents:

This has 3 concepts

(a) Progressive rates diminish incentives to work; - when one is earning a salary this really does not matter because either way you still work but for a business person progressive tax might reduce the incentive to work again corporate tax is not progressive and therefore this does not apply in business, whether one earns high or low the tax is the same. But if done in partnerships, the tax is progressive as it is deemed to be income to one and rises in accordance to ones earning.

(b) Progressive rates discourage incentives to invest: -

(c) Progressive rates irreparably impair the sources of new capital -

Ideology of equity: This is the ideology that says you tax those in the same level and the same amount, equality among equals. Those who earn the same amount should be similarly treated, the more you earn the more you get taxed. Equals at income should be treated the same. The principle is supposed to be income based, but in Kenya it is not. VAT is an unfair tax as here there is no equality, everyone pays the tax irrespective of how much they earn.

GENERAL INTRODUCTION TO TAX

Tax is the only source of self-income to governments i.e. it includes donor income. Tax is their only guaranteed income and under their country. The richer one is the lower ones income could be in this country. Income from business is taxed at the level of 12% corporate tax while we tax 30% in income tax. If the government can get people to earn more, they can lower the level of taxation. The fundamental purpose of taxation is to raise the revenue necessary to provide government services.

The government has all kinds of taxes but the purpose of taxation for us is among other things to

1. Finance public expenditure;

2. Distribute income; - if the income is progressive, it can be distributed by taxing those who have and giving those who do not have.

3. It is supposed to enhance government policies one of the policies being to encourage positive behaviour.

The government uses two rationales to impose taxes

1. Benefit Rationale- the government is a shopkeeper, and people pay for the service, the government taxes and provides services security, health, education etc. The benefit rationale cannot be achieved 100% although we do expect at least 75% below that people ought to complain.

2. Ability Rationale – the government taxes people on the basis of their ability to pay. Where one gets the money, the government has no interest. In Kenya it seems the government is only using the ability rationale and not the benefit rationale.

Tax is compulsory; there is no tax that is voluntary. It is a compulsory charge by the state.

Taxes can be classified in 3 categories depending on their impact on the people

1. Regressive

2. Proportional

3. Progressive

Progressive – where the marginal rate of the tax rises with the income then it is progressive.

Proportional – if different blocks are taxed at different levels. Both progressive and proportional are equitable although progressive is more equitable than proportional. Corporate tax is a proportional tax. Takes the same from everyone.

Regressive – tax increases with ones fall of income. It requires that low and middle-income families pay a higher share of their income in taxes than upper income families.

PRINCIPLES OF TAXATION

Tax is governed by certain principles.

Simplicity and efficiency are principles of taxation. Taxpayers should be able to understand taxation. It is meant to be governed by simplicity so that people can understand it. Taxation can be made complex by inefficiency so simplicity and efficiency go hand in hand. It should be clear and understandable to the taxpayer.

Cost of complying with the tax laws should be minimal. The cost is not very high in Kenya although it could be lower. Communication system should be simplest to lower the cost of tax collection.

Accountability: - the collector should be accountable to the people for the tax they have collected. The collector should be accountable to the taxpayer. In Kenya the government has never been accountable to the taxpayer and this is because of the corruption. This is one of the principles that is furthest from reality in this country. May be in future when the people are informed on how their money is being mismanaged, then they will do something about it.

PRINCIPLE OF CERTAINTY:

There has to be certainty, it has to be understood to be the same by every taxpayer and every Minister. Taxpayer must know what they are entitled to pay. It is supposed to be extensively and adequately publicised and every Finance Act should be publicised in simple language, clearly visible and nothing should be hidden from the taxpayer. Complicated tax rules make the tax system difficult for citizens to understand. Complexity also makes it harder for governments to monitor and enforce tax collection.

PRINCIPLE OF EQUITY:

All taxes should treat all taxpayers the same. People in similar situations should be treated the same in terms of rate, the amount, collection etc. The interpretation of who is a taxpayer should be the same. They should be charged in accordance with their economic status and their ability to pay. Being treated equally. The terms of tax paid and the achievement from those taxes should be equal. No one should be allowed to avoid tax while enjoying the benefits that are being taxed for those services.

PRINCIPLE OF NEUTRALITY:

The market economy should not be interfered with. There should be no practical interference with the market economy. Taxes should not interfere with market forces. Business communities are supposed to bear minimum impact on the spending of tax. The lower the tax the better for the business community. In the Kenya situation our tax system interferes a lot with the business community and is therefore not neutral. In Africa, Botswana and South Africa may be the only countries following the principle of neutrality. VAT is not a neutral tax because it interferes with business; it has been likened to an expenditure tax.

TAX STRUCTURE:

The tax structure is made of individual elements and it is only through changes of those individual elements that a change in the level of tax can come about. Each element has a growth rate and base and each of them is related to distinct economic variables.

Tax Base

A tax base of a given tax is the source of revenue and it is that source that is taxable. Every taxation has to have a source. The basis available to any country would set the limit for the possible tax structure. In Kenya like in many poor countries the base of taxation is very narrow. Our structure here is based mainly on employment and business. Production is very little and so production tax is very low. We are traders.

The more agriculture is taxed the more they kill it. Agriculture is our main source of income but it is very heavily taxed. In the early stages of our development the tax structure was in itself a reflection of a tax base. If there was no basis for direct taxation there was more indirect taxation. Tax has now become a reflection of a political culture i.e. taxes get amended to raise campaign money etc.

The tax handle fee that relates the structure to the base. The close link of tax structure to tax bases is normal.

1. At an advanced stage (when we become rich) the problems of revenue collections shift from looking for tax bases to devising means of collecting and yielding tax more effectively. Tax is not increased but concentration is on collection. Waweru is increasing the base by sealing the loopholes of tax evasion, he is not increasing taxes.

 

The income tax lays down certain rules.

(a) Ascertainment of income – the qualifying conditions for personal allowances rules are laid down,

(b) The same rules decide which allowances qualify, whether singles relief, medical, personal etc.

(c) The rules provide for the Procedure of assessment such as self assessment – this is one way where people can avoid tax by assessing themselves on the lower side, avoidance is not illegal evasion is illegal. When one leaves the procedure of assessment to the tax collector they pay more and so the rules must provide for assessments.

(d) The rules provide for penalties. Income tax penalties can be demobilizing. Under the Income Tax Act the High Court and the Magistrate courts have no original jurisdiction on tax issues, the original jurisdiction is with the tax department and only facts of law are appealable. The tax department has denied the courts original jurisdiction on tax matters.

In addition to being revenue device taxation can be used for more, today we use it as a revenue device. We use tax to encourage or discourage certain kinds of behaviour, we might tax cigarettes more to discourage people from smoking, and taxes are also used to distribute income. In Kenya we tax because we need the revenue. In the long run tax can be used not only for tax collection but also for other activities e.g. to encourage education, to encourage investments and so on.

OVERVIEW OF INCOME TAX.

The income tax Act firstly determines what income is; note it does not even define tax as its interest and basis and source of tax. Out of the income, not all income is taxable.

What is taxable income?

Income:

Whose income do we tax? What is the source of that income? It has to be income from a specified source. In Kenya we only tax residents. Who is a resident for purposes of income tax?

Allowable deductions, every income has deductions so what are the allowable deductions..

Income Tax is payable by

1. Individuals

2. Partnerships – partners are taxed as individuals

3. Corporate Bodies – flat corporate tax

4. Trustees -

5. Cooperative Societies – pay taxes as societies

Income tax is a direct tax. It is direct because both its impact and incidences mainly fall on the same person. The impact is on the person who pays the tax to the income tax people or to the authorities while the incidence is on the one who bears the burden. When one is an employee he is the one who pays the income tax to the income tax person although the employer sends it there. The burden of any direct tax falls on any person who makes that income. Gifts are not income and therefore not taxable. Gift is not a recognised source and is not even defined.

Income tax is generally progressive to a certain level at least in Kenya it is up to 30%. The marginal rule increases with the income. If one earns an income of 300,000/- or 300,000,000/- you still pay 30%. It ought to be progressive all the way but it is not certain that we can afford that. This progressiveness is not necessarily good as the higher the income, the less tax one pays.

The base of our income tax is what we call income. Income for the purposes of our law is not clear,

Section 3 of the Income Tax Act is the definition section but does not define income. If there is a dispute between what is income between one and the income tax, it would be because income tax is payable on income. They don’t define income because sources of income keep on increasing.

The Act however defines total income – “total income in relation to a person is the aggregate amount of his income. Other than income exempt from tax under Part III of the Act.”

Part III of the Act deals with exemption of taxes. The law imposes a tax under Part II of the Act Section 3 of the Act creates a Section Charge of Tax and it says that “subject to and in accordance with this Act a tax to be known as the Income Tax shall be taxed on all income of a resident…Total income is chargeable to tax under the law if it is not exempt under Part III.

Part IV deals with ascertainment of total income.

The law presumes that we know what income is. It is also a legal assumption that one is supposed to know the law is and this is an irrebutable presumption of the law.

Subject to income, income tax is income of a person. According to Section 3 it is income of a person and it uses the term sources of income, it does not define income. Income is not necessarily source and therefore not necessarily taxable. Income must be recognised as a source before it can be taxed.

INCOME TAX

Section 3 definition – it is based on sources of income

3 (2) Gains of profits from business, employment, services rendered and rent or rights granted to other persons for rent, dividends and interest, pension, annuity any amount which is deemed to be income of a person under this Act or under any other Act. Gains from petroleum companies and petroleum service sub-contractors.

3(2)(f) gains arising out of disposal of depreciable assets

it is assumed that any shares can depreciate in prices so that is why all shares are classified as depreciable interest, so when one sells that stock, that is considered income from which 30% income tax is payable. The tax is chargeable on a person, not every person pays income tax, there are specific persons who pay income tax they are considered on the basis of residency not citizenship. Any income which is earned locally or outside the country by a resident is taxable. Therefore to be taxed one has to be a person and a resident.

Not all persons pay income tax.

All taxes are payable by individuals in the long run.

For residents, income they earned abroad while in Kenya is taxable.

NON-RESIDENTS

Non-residents are also liable to tax but only for income derived in Kenya. Diplomats are residents but they are exempt from tax.

For the purposes of imposing tax, the basis is residence. What is residence, who is resident?

Section 2 of Income Tax Act – when it is applied in relation to an individual these are the categories

1. if you have a permanent home in Kenya and you are present in Kenya for any period of time in the year in question.

2. If you have no permanent home in Kenya but you are present in Kenya for a period or periods

(i) A period amounting in aggregate to 183 days during the year of income; or

(ii) Present in Kenya in that year of income and in each of the two preceding years and aggregate the number of days to 122 days in each year. E.g. 2001 = 122, 2002 = 122 and 2003 = 122

When this is applied to a body corporate, which is not a natural person the management and control of the affairs of that body is supposed to be exercised in Kenya in that particular year of income.

(iii) The body has been declared by the Minister by a notice in the Kenya Gazette to be a resident; what if the company is not registered under the laws of Kenya but its exercise and management are in Kenya? That is how the Minister comes in. Local branches of non-resident firms are classified as resident. But only for income derived in Kenya; any income derived out of Kenya is not taxable.

A parent company that is based in Kenya is treated as a resident for purposes of income tax and all its income derived from Kenya and outside is taxable.

So in order to pay tax one has to be a resident and people have raised issues at who is a resident.

In the case of Sir George Arnautoglu V Commissioner of Income Tax

[1967] EA 312

The Appellant disputed his assessment of his income tax in 1962 on the ground that he was not a resident in the territory in 1962. The facts were that in 1960 he had a home in Dar-es salaam and was there for a total of 249 days and in 1961 he sold that house but was still present there for a total of 124 days and in 1962 he had no home but was present for 62 days. On average he was there for 4 months in each of the 3 years. He argued that in relation to the definition of residence, according to Income Tax Management 1958 he argued that firstly it was not permissible to aggregate the periods of residence with periods of mere presence and secondly that averaging in accordance with (1) paragraph (b) (ii) of that Act it meant in effect that four months presence was required in each of the relevant years. The definition of residence under that Act for which the construction depended. They said that it was permissible for purposes of income tax 1958 to aggregate periods of residence with periods of presence. The court went on and said that first “an individual is defined as residing in the territory if he in fact does so.” And secondly an individual is deemed to reside in the territory if the facts are such that he would not normally be regarded as residing in the territory or there would be doubt as having done so.

The deeming provisions in Income Tax (deemed to be) according to Justice Charles Newsbold that the deeming provision only come into play if … (it is like a presumption, you are presumed to be) deemed to be is presumed to be, to bring the presumption into play is by bringing the aggregate period

BASIC CONCEPTS OF INCOME TAX

Income Tax will be on income only, it is not on assets

The only income which is provided that is taxable is that income which is from sources that are taxable, the income has to come from a classified source, there is no simple and comprehensible definition of income tax but it may be put in 3 broad categories

1. Income from personal services that are rendered by one person to another; contractual service generally, as long as it earns money it is income and the assumption is that the services have to be legal;

2. Income from property this is income, which generally when one sells property, one pays various types of tax but when the seller receives the money when declaring income at the end of the year, the proceeds from property must be declared.

3. Income from profits of a trade, profession or vocation.

Income tax is different from capital but for purposes only of paying tax but it is not always easy to distinguish between capital and income, if you cannot classify any receipt as income, it is generally classified as capital. Patent Rights in England is charged under income tax, it is capital until one sells it, then it becomes capital.

The only law that operates retrospectively is

The basic approach is that capital is considered as the tree while income is the fruit.

Liability to Income Tax arises out of

1. An assessment, to be liable there has to be an assessment as a notice to one as a taxpayer that there is a tax that is due from one. There can be a self-assessment or the assessment, which is done by the income tax. Basically all of us except for employment which is assessed in advance, the rest is basically self-assessment as in when one files returns they are assessing themselves. Where the CIT disagrees he can do his own assessment.

2. Amended assessment provided by the Commissioner of yourself

3. Instalment assessment is only applicable to corporate tax not individual tax.

4. Deduction: once you are assessed you will be deducted and the deduction is from the receipt you have already received, e.g. an employee’s PAYE is deduction. Every employer is termed as an agent of the commissioner for purposes of deducting the taxes.

Income tax is basically one tax and this was declared in 1901 by Lord Macnaghten in the case of

The London County Council V. Attorney General

(1901) AC 26 at 36

he defined income tax as “Income Tax if I may say so is a tax on income, it is not meant to be a tax on anything else. It is one tax not a collection of taxes in every case the tax is a tax on income whatever may be the standard by which the income is measured.” It means it does not matter how you measure income but it has to be income and if it is not classified as income then one cannot pay income tax on it. Profit is basically income for purposes of tax, the gross turnover is not income for purposes of tax but once you get your net income, it is income for purposes of tax. In Kenya it is an annual tax. It is not possible to make an assessment in the current year, as one has to wait until the year is over and then audit their accounts. Although the returns are filed the following year, we still call it current year of income. It is based on the source from which it comes.

One can reduce their tax as a payer either legally by an allowance or by a tax relief or by an exemption like the church gets. Or one can actually avoid tax.

Tax avoidance involves one of the following things:

1. One can claim that certain receipts do not constitute income;

2. Arguing that you were not resident in that year of income;

3. You can claim that you have deductible costs, when they agree, you increase the costs;

4. Increase the number of personal reliefs that one is claiming, if they are accepted the tax is reduced

5. Transfer income to another person, you for example transfer income to your spouse who earns less and thereby reducing the tax burden.

6. Transfer deductions from one year to the other year, All these are ways of tax avoidance, which is not illegal, if not genuine one may pay penalties but it is not illegal.

The difficulty of assessing any one individual income is also very difficult in developing countries, even fixing rates in countries where people are already overtaxed is difficult.

Tax falls under income which excludes by general rule gains and losses, losses only for purposes of business not for purposes of employment and it is expected to be progressive until it reaches a certain level except corporate tax where all are taxed at the same rate. Tax falling on income is what is called a definitive principle, when we say progressive that will be the equitable principle, the one upon whom the income falls is not equitable.

The second principle is based on a current social consideration of justice. Corporate tax do not have this principle as they all pay a fixed amount but we assume that since everyone pays a fixed amount there is no progression but lets remember corporates pay dividends to individuals that are tax and are progressive. The progression ends at 30% where after everyone pays the same amount.

People have a heavier burden to carry when it comes to income tax if they are rich. The first aspect is the ability to arrange the income tax arrangement. You pay a professional to arrange them in such a way that you pay the least, sometimes you pay only on your ability to arrange, when you have a better arrangement to arrange tax, you pay less although your income could be the same as with someone who earns the same.

INTERNATIONAL ASPECTS OF INCOME TAX

1. Competitiveness

International competition in business does pressurize our policy makers in the way they organise their tax systems. We grant tax rebates, give exemptions so that we are able to compete in the international market because taxes are an expense. Both direct and indirect taxes are used. The Export Processing Zone is a good example where tax exemptions are offered to encourage exports.

2. Reliability

The taxation and revenue should be reliable. Rules should be reliable and adequate. Income tax or taxation in general is the State diet without which the State would starve. It is vital to the economy and therefore the flow should be reliable, we should be able to know when it flows and how it flows and how much of it is there since we rely on it for services. Government expenditure ought to be anticipated so that we can hinge our tax assessment on the anticipation.

3. Interpretation

When we interpret law, the interpretation is required to be very strict. Where there are two interpretations, we take the interpretation that is most favourable to the taxpayer. You can only go to court on a question of law or on a question of mixed facts and law, on a question of fact you cannot go. In the case of T M Bell V Commissioner of Income Tax (1960) EA 224

Income Tax V Holdings Limited

(1972) EA 128

The general rule is that a taxpayers business or other ventures are considered together as one (your income is your income does not matter from what source) chargeable income should be arrived at by aggregating all the taxpayers income and then deducting all expenditure incurred from the production of this income.

In interpreting the Section (58) or any section the whole Act must be considered in relation to the particular section and especially with reference to the interpretation section and the methods set out in the Act in this case our Income Tax Act Cap 470 to arrive at what is chargeable income. One must consider the provisions of the Act and if the Act provides on what to consider as chargeable income, then you consider that if not, you look elsewhere. It does not matter how harsh the Act is, it must be followed. This is the theory, assuming that the taxpayer goes to court. The theory is that the law is pro-taxpayer but in reality, the law is pro commissioner of income tax.

ADMINISTRATION AND JUDICIAL ORGANIZATION OF INCOME TAX

TAX LAW

JUDICIAL ADMINISTRATION OF TAX

Income Tax Collection falls in two levels

1. Administrative level or main level where the bulk of the calculation is done

2. Judicial Level wherever there is a dispute one is supposed to go to court Administration aspect falls into 3 categories

1. General Administrative Management. They have to establish who ought to pay income tax and where they are. There is a legal definition of who is supposed to pay tax i.e. who falls within that definition; they also trace to find out where the taxpayers are. Where are the taxpayers? Administratively the tax collectors are supposed to establish where the taxpayers are.

2. Ascertaining the amount payable by each taxpayer by assessing the income.

3. Collecting Data – they have assessed, ascertained how much then they go ahead and collect it.

Judicial Elements are brought about by the above 3 administrative elements where disputes arise whether one is a taxpayer, whether what is being taxed is income and the amount to be collected.

Assessing and collecting taxes is what brings most arguments, it is the most complex because we have very few tax collectors.

TAX ASSESSORS

The Assessors are the people who identify one as a taxpayer and then proceed to send one their tax returns so that they can file tax. The returns are sent to the taxpayer to show that they have paid tax and also if there is any extra income that has not been paid for under the PAYE then one has to pay for it. Normally the assessors do no assess businesses and they will request that they be told what one has done, only after which they will do their own assessment. Secondly they receive the returns and then they assess the amount of tax due to one in accordance with the returns. It is the assessors who receive the appeals where there are appeals (referred to as objections) and deal with them and they are the ones who produce the Commissioner’s case to the committee and also to the courts.

TAX COLLECTOR

Done by tax collector. They receive the money that comes in and follow-up the defaulters. In the process of doing this they issue one with notices and charge penalties and interests for non-payment. They issue receipts for all the monies paid, if you have overpaid, they issue a credit note or a cheque.

JUDICIAL PART

Anywhere there is a dispute that went beyond the tribunal and went to court, it becomes official. It is not a criminal matter unless it is a matter of tax evasion but disputing is not an offence.

SOURCES OF TAX LAW IN KENYA

Tax law in Kenya is all based on statutes, it’s all statutory, and not just income tax but every tax is provided for by statutes. Wherever there is a dispute, then the courts come in to interpret the statute. The courts interpret the statutes but do not establish the taxes themselves. It is to be found in our law in Cap 470 Income Tax Act. There is no general power to delegated legislations to create any taxes. They show how exemptions are created.

There are certain areas where the law will grant the minister some powers to deal with the income tax Sec. 41 deals with Double Taxation. Where the Act imposes tax to exempt one by way of double taxation he can only do this under the power granted by the financed

Income tax is imposed each year although once it gets here it is permanent. We have provisional Acts that are created to increase rates. Section 3 of the Income Tax – Imposition of Tax (1) Income Tax from businesses, exemption falls under Part III of the Act which starts with Section 17, then we go to collection and objections. Local committees and tribunals do not have judicial binding decisions although they are followed.

OBJECTIONS & APPEALS

PART X of the Income Tax Act -

Objections and appeals are provided for in Section 82. The committees and tribunals appointed by the Minister hear the objections and their decisions are not final but their findings on facts are final. The decision of a court of law on a point of law is binding and final and no one can argue against it, neither one or the commissioner can argue against it even if it is wrong unless one seeks a review.

Interpreting tax law certain principles are used. These are principles established by English courts, which we have been following and our law is based on them

1. The onus or burden of proof is on the State to prove that there is a valid tax law which imposes the tax and that that law covers the taxpayer in question; to quote Penny quick in the case of

Reed and International Ltd V CIR [1974]

1 All ER 385, 390

he said duty is chargeable on any particular subject matter or if that subject matter falls within the words of that statute.

2. The taxing statute must be construed or interpreted strictly by reference to its actual words. This has a lot of case law and one of the earliest case is

Partington V Attorney General

(1869) L.R. 4 H L 100, 122

he said “if the person sought to be taxed comes within the letter of the law he must be taxed however great the hardship but appear to the judicial mind. However apparently within the spirit of the law the case might appear to be … a construction is not admissible in a taxing statute…” there is no question of equitableness. It looks strictly at the letter and does not care about being inequitable. In the case of

Cape Brandy Syndicate V IRC

[1921] 1 K.B. 64 71

Rowlett J. said “.. In a taxing Act one has to look merely at what is clearly said. There is no room for any internment, there is no equity about tax, there is no presumption as to a tax, nothing is to be read in, nothing is to be implied, one can only look fairly at the language imposed.” Courts have been looking at Substance rather than form. Looking at form requires a literal translation while looking at substance …it is more likely that if there is an ambiguity in any section that carries weight against the taxpayer, that ambiguity will be used in favour of the taxpayer or the ambiguity will be removed in favour of the taxpayer. The court has to give a clear meaning to the ambiguity however unreasonable it is. It is not for the court to clear the ambiguity.

3. The Object of the construction of a statute is to establish the will of parliament and so it should be presumed that neither injustice nor absurdity was intended. If interpretation will produce absurdity or injustice and the language admits such an interpretation, which would avoid it, then such an interpretation may be adopted. This means that the language of parliament has not excluded that kind of interpretation.

4. The history of an enactment like the Income Tax and the reasons that led to its being passed may be used as an aid to its construction. So one can look at the history of the Act to see why it was enacted and use that to interpret it. Mangin V IRC [1971] AC 73 CH 746 Lord Donovan said “…

PRINCIPLE OF RETROSPECTIVITY

The law can be retrospective in various ways

1. It may impose a tax on income that was acquired before the law; this type of retrospectivity has been enforced but it has been classified as “improper and immoral” nobody said that the law should be proper or moral and in tax law, it can be done. Income tax, your income can precede that law unless in the case of Kenya if the matter ever comes to court, it’s a law that needs to be changed. If the Constitution says it cannot do that then it would be unconstitutional but at the constitution declares that parliament can make any law.

James V I.R.C -[1977] STC 240

The taxpayer (James) challenged the validity of Section 8 of the Finance Act of 1974 it increased the rate of surcharge Retrospectively for the year of assessment 1972-73, the taxpayer was saying that the Crown had set that rate and in some cases had even collected the Tax, it was therefore contrary to common law and natural justice for that rate to be subsequently valid as it amount to reopening the transaction. Slade J dismissed the Case. Although he sympathised with it and he actually described that Section as retrospective legislation of extreme kind which would operate harshly on taxpayers. However he did not agree that it was illegal and this is what he said “…it is in my judgment that as the constitutional law of England stands today parliamentarians have the power to enact by-statute any fiscal law whether of a prospective or a retrospective nature and whether or not it may be thought by some persons to cause injustice to individual citizens and note.. If the wording of the legislation is clear the court must give effect to it even though it may have or will have a retrospective effect. It has no power to refuse to give effect to it on the ground that the protection private citizen required.” In the case of

Ingle V Farrand - [1927]11 TC 446

Where they were interpreting whether it was public office or employment in the case of Great Western Rly & Co. also and later parliament passed a law which changed that interpretation retrospectively. There was nothing they could do and the courts went ahead and enforced it. A statute can change provisions that may have been announced in a provisional collection of taxes Act. Our Act is Cap 495 and the Finance Act when it comes can change that, this is changing the law retrospectively and the things is our law allows that assessment be made can be changed by the Finance Act that is Section 2 which says that in relation to any year of income in respect …. Under the provision collection of taxes and duties Act.. Cap 470 can change any assessment set out in the provisional, this is legal retrospective.

A retrospection may be introduced to reverse a decision of a court i.e. an Act may be changed retrospectively to reverse the decision of a court. An example cited in England is Section 62 of the Finance Act 1987 was introduced to reverse the case of the decision of Padmore V I.R.C. S [1987] STC 36.

Law can be introduced retrospectively to clarify an old law or some confusion in a past law.

When it comes to interpretation of taxation, the consequence of a transaction one either uses form or substances but there are questions to be asked i.e. is the law being interpreted relating to a specified transaction or literally or using the rationale rule of interpretation. Do you try and read the intention of Parliament in the words, the style or form. If you use the style it means you don’t. Refer to the case of I.R.C. V Westminster (1936) C 1 - he was trying to create a trust for his employees for future payments and the question was if those people had asked for the money that he had created a trust for, could he have been taxed that amount? Was it an income or future income? It was contentious issues and according to the law they were saying no, that the law should have been interpreted using the substance doctrine and.. The special commissioners at that time held that they were wages and therefore taxable. This decision was accepted by Finley J. in the High Court who said that looking at the substance and not the form it must be regarded as the case of someone remaining in the Duke’s employ and therefore wages. The Court of Appeal reversed the decision and the House of Lord held that the C.A. was right. The document said that they were created for trust saving for after service and that is what they were, they were not wages, look at the substances. The House of Lord said Lord Atkin dissented “… I do not myself see any difficulty in view taken by the Commissioner and Finley J. that the substance of the transaction was that which was being paid was remuneration so construed the correct interpretation appears to be that they were wages but the other members of the House of Lords overruled him saying that they could not accept the substance approach.

C J CLARK LIMITED V IRC - [1973] 50 T.C 103

This case was talking about “… when parliament sweeps away one provision in amending act enacts in its place another provision which is drafted rather differently … he who says yes and later changes his mind and says no does not demonstrate for him yes means no. One is allowed to use a rational interpretation rather than a literal interpretation Consolidation Act – Finance Act, which comes out every year

Lord Diplock – the only mischief a consolidate is supposed to remove is a peace-meal Act. In the case of IRC V Joinder [1975] 50 TC 449

Any Act consolidating any law is not to be interpreted differently it is the original Act that matters, the consolidated Act.

PRINCIPLES OF STATUTORY CONSTRUCTION

The Ramsay Principle – it is important to interpret how far it is permissible when one comes to the Act they have to look at the substance of the Act as opposed to the Form.

In 1936 the House of Lords held that the Inland Revenue Authority could not invoke the supposed doctrine of substance in income tax. According to them you interpret it formally. They said that one could not invoke the substantive doctrine of interpretation so as to uphold the legal rights and interests of the parties. The legal rights of the taxpayer are to pay in accordance with the income tax law. They went on to say that the only situation in which a document could be disregarded for tax purposes was to find out whether or not it was bona fide or intended to be acted upon. They said “any attempt to pray aid in the so called doctrine of substance was merely an attempt to make a man pay tax not withstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable. They are saying that if you have filed your returns correctly, and you have not cheated but the way they are organised has resulted in the lowest profit, they are saying that using this doctrine, one would pay more than he is legally entitled to pay.” How one uses information may make a big difference.

In our case Section 110 of the Income Tax Act – incorrect returns “ a person shall be guilty of an offence if he without reasonable cause makes an incorrect statement in a return of income by omitting or.. It makes it a criminal offence to file an incorrect return. If you tailor it in such a way that you save money, this is not an offence. What is wrong information? As far as income tax is concerned, one looks at form and not substance.

In the case of the Duke of Westminster it was held that every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it would otherwise be. If he succeeds then, however unappreciative the commissioner of Inland Revenue or his taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax. Lord Tomley The subject cannot be taxed by inference but only by strict interpretation of the law. This doctrine was looked at in the case of

Ramson V Higgs- [1974] 50 TC

and then it went on to become what we live on today which is the Ramsay Principle.

W T Ramsay Ltd V IRC - [1981] 54 TC 101

RAMSAY PRINCIPLE

1. The principle is a principle of construction for words involved in taxes and

2. Secondly tax avoidance par se does not bring the Ramsay Principle into play. It is not part of the judicial function to nullify any step that one as a taxpayer chooses to organize their tax affairs although they are supposed to modify the Westminster principle. One can organize their matters so that they can avoid tax and it is not for the courts to go behind ones style to prove that one is avoiding tax unless there is a specific provision avoiding tax avoidance.

3. Thirdly a tax avoidance motive of a prior transaction does not enable it to be treated as one with a subsequent transaction i.e. tax avoidance is not an authority; one has to look at the current transaction independent of the previous transaction.

4. Fourthly, they say that there is no moral dimension to the Ramsay Principle i.e. they don’t do it for moral purposes. According to them any idea that the principle in Ramsay is a moral principle or that it is supposed to catch tax avoiders is wrong and it is defeated by the interpretation that there are, Ramsay Principle is a principle of statutory construction and not a moral principle.

5. Fifthly the principle is only concerned with ascertaining what is the reality of the transaction

6. The Ramsay Principle is not a substance doctrine; and it’s a formal interpretation

7. The basic approach where Ramsay applies was that it is not that the court looks at the behind returns but the returns were not properly done. They did not prepare a proper return.

PRINCIPLES OF STATUTORY INTERPRETATION

Principles of tax statutes interpretation. As set out in the case of Ramsay

1. A subject or taxpayer should only be taxed on clear words of the statute not in accordance with any intendment or intention;

2. A taxpayer is entitled to organize his returns in such a manner that he reduces his liability to tax as much as possible.

3. It is for the fact finding commissioners to find whether the document is genuine or not, if it is genuine they argue with it and if they find that it is a sham, that is the information they bring to court. The court can go behind the document to determine whether the document is a forgery or not. The justification of a court will only be to look behind that document only if the commissioner raises the point

4. Given that a document is genuine the court will not go behind it to look at underlying substance.

JURISDICTION OF OUR LAW

Parliament in Kenya has jurisdiction to make law. Income Tax Act applies to all Kenya including Kenya’s continental shelf. Outside Kenyan territory by exclusion one is not bound.

On the 1st January 1974 the East Africa Tax became the Kenya Income Tax Act Cap 470. It is only effected to persons who are found within its jurisdiction in accordance with its definition. Its definition includes some elements of Kenyan residence not Kenyan citizenship. It creates territorial limits, which are

1. Person to be taxed is either resident or non-resident

2. Income to be taxed – the income that should be derived from all accrued to one in Kenya

3. It is annual

Section 3 tells us how income tax is effected, annual, upon income of a person, whether resident or not that accrues to or is derived in Kenya. The type of tax, the period, the geography and the source.

The person who is to be taxed is not determined either by residence or anything but by income, without income, income tax has no interest in one. The income chargeable is provided for under Section 3(2) of the Income Tax Act. Any income that does not fall under that section is not income for the purposes of this Act. The person to be taxed is defined under Section 3(1).

What type of tax in subsection 2, is it gains or profits from business? From whatever period of time as far as business is concerned. From dividends or interests, from a pension? Definition in 3(2) a person does not include a partnership.

Section 10 gives details of what type of income, details of what gains and profits are.

What is a year of tax – 12 months from 1st January to 31st December …

A foreigner has to be in Kenya for 183 days in a year or for an average of 122 days for 3 years.

Who is a residence, can one be a resident if they have not been in Kenya for several years, according to English Law, yes one can, you can be held to be a resident although physically absent.

In the case of

Rogers V. IRC - (1879) 1 ITC 225 – Mr Rogers went out of the UK for a whole year. He was a commander of a ship and left his wife and children in England. The income tax people wanted him and he argued that he was not a resident and therefore not liable to tax and the court said no that he was a resident not on the basis of a wife but “… every sailor has a residence on land” it is a presumption which is correct. His evidence was his wife and children. They used the substantive principle and reversed their own principle of using only formal interpretation; to be resident you have to be there physically or legally declared to be resident.

In Kenyan practice the average period spent counts to be a resident, a visit to Kenya and a permanent home counts. If you don’t have a permanent home and you make a visit, you have to have stayed for a 183 days. Rogers had a permanent home in England but had not visited.

The purpose of the visit is immaterial Section 3. If the income is derived in Kenya the purpose of the visit if immaterial. Section 5 will require that income (1)(a) – an amount paid to a person who is or was at the time paid the amount for services rendered

It is not where you are paid but where you are. (2) Gains of profit – includes all that a, b, c, d, e, f. One can make a permanent visit here but the work is not being done here.

I R C V. Zorah - (1926) 11 TC 289

Zorah was a retired British worker (member of Indian Civil Services) who visited the UK for 6 months with the sole object of seeing friends. The Commissioner tried to tax him, the matter went to court and he was held not to be a resident in the UK for the purposes of Income Tax..

Where one is resident in Kenya but not of his own free will, he will still be held as resident.

In the case of IRC V Lysaght - (1928) AC 234

Lord Buckmaster stated “I understand the judgment of the Court of Appeal to mean this that they regard the objects of his visits to show that he could not be regarded as a resident. They said that it was not of his own free choice but in obedience to the necessities of his position in relation to the company that he was over there. The CA considered that as very important, the fact that he was not there. A man might well be compelled to reside here, completely against his will. The exigencies of business often forbid the choice of residence. He went on to argue that a man may have his home somewhere else and stay in England because business compelled him. But according to the House of Lords the periods of which and the conditions under which he stays are such as may be regarded as constituting residence and so he was a resident. The court went to the formal interpretation.

When it comes to the interest of the taxpayer, courts have no other business but looking at the substance but when it comes to looking at the interests of the commissioner to look at it formally.

Permanent home is not defined in the Act. We go by English decisions of ownership of accommodation. You don’t have to own any accommodation in Kenya going by authorities in order to own a home. For purposes of income tax all that is necessary is that an individual has access to the property whenever he/she wishes, it does not have to be permanent.

This was decided in the case of Lowenstein V de Salis - (1926) 10 TC 424

This man was Belgian and used to visit the UK every year where he stayed no more than six months and he stayed in a hunting box and that box belonged to a company where he was a director. Not only was he a director in this company but owned 90% of the shares so he had a place to stay in England, it was old. The court here looked at substance although we are told that substance is not applicable in income tax, the court held that the hunting box was available de facto to him whenever he came to the UK although he was neither the owner or the lessee but he had access to it whenever he wanted to and for that reason he was resident in England because he had a permanent home. The commissioners in England came to a conclusion that where a person residence turns on whether or not he has accommodation, for this purpose, ownership is immaterial. The opposite is also true that if you have a house, which you own but you have leased it out but have no access to it, then you have no home. They seem to be extending the definition of ownership. In addition the English if one has a spouse who lives some where, where she lives will be considered to be available by the Act unless of course you are separated but when you are still husband and wife whether it is owned by the wife, you still have access, a partner’s home is his/her home. We talk of permanence because in Kenya if you have a permanent home, you don’t have to be here for 183 days you just have to be here and it is enough, you are entitled to pay tax.

In England they have a rule that we have not provided i.e. if the place being rented is being rented for 2 years and it has furnished accommodation or less than one year but unfurnished accommodation then it is permanent.

INCOME FROM EMPLOYMENT

We are studying income tax for the natural and artificial person.

A natural person can be employed but an artificial person cannot be employed and thus a natural person’s income comes from employment and artificial persons income comes from business. The business a natural person does would always be individual business unless it is a partnership and unless it is a company.

An income from office can be from an individual or income from employment.

The history goes back to 1918 when Public offices and employment were charged and income tax law does not define its terminology it leaves it open so that everyone could fit in.

1922 they transferred employment charges from schedule D to E.

However it does not matter under which schedule you are charged

1956 Act charged income from all employment in schedule E and our law today charges from sources of income under part II of the Act, and this is a very important part because it affects you and imposes taxes on all incomes.

Part – II is actually called imposition of tax and they base it on all income the most famous section 2(1)

Income tax does not know citizenship whether you are an Australian you can be liable to Kenyan income tax.

Income tax is chargeable on an annual basis and it is taxed separately independently, and it is upon income it is not from anything else. But if you look at the section of the Act there is no definition of income and yet that is what you pay tax on.

You are required to pay tax as a resident and not as a Kenyan.

Section 3 (2) : What is income?

They don’t tell you but they tell you “ income upon which tax is chargeable” subsection 2 says, “gains and profits from the following:

a) Business for whatever period of time carried” even if you carry business for half a day in a year you will be taxed on it;

b) Income from employment or services rendered;

c) A right granted for another person for use or occupation of a property (this is for the landlords and the right they are taking for granted to another person is meant a tenant” if it is ex gracia then there is no income

d) The second item they classify is dividends and interest

e) A pension charged or annuity

f) An amount deemed to be an income of a person under this Act

g) Any gains accruing in the circumstances and ...in the 8th Schedule;

h) For the purposes of this section person does not include a partnership (so that they tax you as a person on gain from your partnership and then they charge you as a partnership being a company)

When they say annual income that does not mean that you have to work for a year, what it means is that income for whatever periods in a year.

From the income of employment they charge you under section 5 you look at part – II, again you assume that it is well defined. This section has A and B

Two things have to be address:

1) Whether you are taxable and

2) To what extent you are taxable

You may even be exempt from paying tax on a particular transaction such as Ndwiga.

When you are exempt from tax there are times when you as individual may be exempt from tax including even customs say when you an Ambassador, even if you are a resident in Kenya but your income does not come from Kenya. However if you are to buy from Uchumi you are not exempt even if you an Ambassador if you want tax free items you have to go to a duty free shop, but if you are a Kenyan then you will be given an identity to buy from a duty free shop.

In order to decide whether you are a taxpayer you have to look at the following:

1) Do you hold an office or employment;

2) Is that income from that office taxable

3) You have to look whether that taxable income falls within any income provisions;

4) What deduction you have to make (you are not the one making a deduction that is why you are asked to file returns and you tell them that this is what I have earned and this is my tax)

5) Then you have to look at section 5 and that is what charges you.

 

Under Part – II – imposition of tax subject to Income Tax Act income refers to gains and profits from employment or services rendered. However there is no definition in the Act for the term employment and even in England there was no statutory definition of the term office. But you get some definition in cases. Look at the case of Great Western Railway Co v. Bater - (1920) 8 TC @231 Rowlatt J SAID: “ That definition is something which is a subsisting permanent substantive position, which had an existence independent of the person who filled it, and which went on and was filled in succession by successive holders” This is the definition of the term office by Rowlatt.

However Gachuki does not agree that the office has to be permanent, but he does agree that it has to be independent of the person who is occupying it even if you retire, die or fall sick the position remains.

This definition went on until it was looked upon in the case of Edward v. Clinch (1981) 56 TC @367

In this case where a person was regularly appointed to act as an inspector of public inquiries. This was an office created by a statute but it was not a permanent job only when it was necessary.

When he was appointed the issue arose whether that office was an office within Schedule E subject to income tax.

The House of Lords decided that it is open to the courts and it is also right for the courts to consider the Rowlett definition (because this was not a dictionary definition).

According to them it was still appropriate and that they could continue using the term office under Schedule and Rowlett definition was correct except that rigid requirement of permanence cannot be accepted. And when it comes to question of continuity it does not exist even they went on to say that the terms trade or vocation they are the same as employment and office. Although in Kenya the most used term is employment.

According to their view the continuity is not necessarily permanent and it has to be independent of the employee so that any person appointed to that position may leave it and the position still remains the same.

In their case every appointment had to be personal to a taxpayer for the purposes of tax, it has to have an independent existence and has to be continuous.

If you look at these provisions and then you look at the office say the Office of the Vice – Chancellor, you will see that the office is continuous but should the University of Nairobi cease to exist the continuousness ends and the statutes provides for it and there will be no Vice – Chancellor of the University of Nairobi however, Makogha as a person will still exist.

If I sit in Makhogha’s office and I earn twice as much I will pay more tax than Makhoga paid because the tax is personal to me and even if I am exempt from tax I will not pay tax because the tax is personal to me notwithstanding that Makhoga did pay tax sitting in that office based on his employment. The term employment is more extensive than the term office because every office including casuals are employed and they don’t hold office however they are employed – this is as per Gachuki.

Employment can exist where there is no office – such car wash on the street, however in that case the judges decided differently.

The leading case in this is Davies v. Braithwaite - (1931) 18 TC @109

The facts of the case there was an actress, she contended that one of her separate theatrical clearances was.. And each separate appearance was a contract of employment and thus should be taxed as income from employment (perhaps tax from business was higher than it is today).

But Rowlett rejected this argument saying that: “When the legislator used the term employment in Schedule D and then shifted it to Schedule E, alongside offices the legislature had in mind employments which were something like offices. And I thought of the expression posts. He moved on to say that as far as he was concerned where there was any method of earning you earn of livelihood from a method and its not from a post (as you find in an office) and it is a series of engagement. Then it means that moving from one engagement to another should not be considered as employment”.

In employment the Schedule was thought to be something like office - they were similar and schedule E was where they were charging employment and Schedule D

The term employment was in Schedule E together with term office

Two factors can be taken into account when you determine whether you are employed or you are carrying out a business:

1) Whether or not the services are those of a professional and that is what you refer to as vocational services;

2) You look at whether there are a number of different engagements that that person has undertaken over a period of time;

3) However there are no conclusive decisions and this was decided in the case of: I.R.C. V. Brander and Cruinkshank - ( 1971) 46 TC @574

This was a firm of advocates and carried on legal services and at the same time they acted as registrars to a client and they would register a company occasionally.

They did two cases and they charged 2, 500 Pounds. The Commissioner argued that that money that they received was income to their firm or profession or business.

The House of Lords rejected saying that that was more of an office than the profession. And according to them they were saying that where you have a selected or an appointed person appointed to a position where he has to perform some type of work rather than where you have a category of a person who is appointed to carry out a particular task which is a profession and that is business. According to them one of the jobs is not employment. In Kenya there are professional servers instead of keeping a court clerk they offer services of a court clerk to perform service but they are not employed by anybody. However, there are certain services that can only be performed by professionals, those services are performed for the hospital to the patients

In tax law courts are very resistant to taxation.

Look at the case of Market Investigations Ltd v. Minister of Social Services

(1969) Vol II, QB, @`73

Where the court rules:

“The fundamental test to be applied in distinguishing between a contract of service and a contract for services is this person who has engaged himself to perform these services performing them as a person in business on his own account? If the answer is yes then it is a contract for services. If the answer is no then it is contract of service. And the court tells you to have regard to the following things:

1) The terms of services and if you find that those terms allow that person to exercise control of the work carried out and the manner in which it is carried out then it will be a contract for services because it is business.

2) But if the control of the work carried out and the manner in which the work is carried out is by the person who is recipient of services then it is a contract of service.”

Part timers in Gachuki’s view are providers of professional services generally.

In Fuge V. Mc Claelland - (1956)VOL 36 TC 1

Taxpayer was married and his wife was a full time teacher during the day then she agreed to teach the evening classes and the pay for the evening classes was under a different contract. The question was whether the pay for the evening classes income from employment or a business. If it s income from employment then the husband will pay or whether it is a business and then he will not have to pay.

For the some reason court said that it was income from employment.

Tax from Employment:

Lindsay V IRC - [1964] TR 167 – There was a man who held a fulltime post as a radiologist in a certain hospital. At the same time he delivered lectures in the same hospital not as a radiologist but as a different kind of job. The Income Tax argument was that the fee he received, as a teacher was taxable although according to our Income Tax Act it is any income received from employment or for services rendered so we can consider this as services rendered. The court held that this income was taxable as the argument was that it was not part and parcel of his employment income.

Walls v Sinnet -(1987) STC 236 –

A taxpayer who was an employee worked for 4 days per week for a college. The college was owned and ran by a local authority. He worked for them and they did not control him at all. The local authority did not exercise control over the way he carried out his duties at the college. The argument was since the so called employer did not exercise any control over this employee, then his income was not taxable as income under Schedule E in England and in Kenya Section 3 .

The commissioners ruled in the first place that it was taxable, then he went to the local commission and appealed and the commissioners decided that it was not employment, it was schedule D, then the matter went to court and overturned the decision saying that although no control was exercised over him on how he performed and he had income from other sources during that time, it was still taxable. So the rule is and it has been adopted here in Kenya, that one has to bring any other source of income plus the employment income so it can be taxed together as employee income. The argument is that although nobody exercises control it is tax as income from employment.

One can be held to be employed full time and at the same time carrying a professional job, it does not Matter. This was decided in the case of

Mitchell Edon v Ross - (1962) 40TC56

The taxpayer was in private practice and also held a job on which he was paid a salary under the National Health Scheme. His argument was that his private practice would not have been successful without his employment and therefore his employment should be treated as part of his profession. He wanted his income treated as business income, rather than employment income. He argued that it should be included under Schedule D but the Court refused to do that. Whether income is from employment or from professional may not be learnt easily. One has to bear certain considerations like firstly, does the taxpayer occupy an office, and the next to consider is “do you undertake any employment under that office, Do you merely render services in the course of the exercise or practice of his profession, or the office he occupies or does he only render services in the course of the private profession. Income tax is taxable on a current year basis and that is how it is assessed so that the taxpayer in any year of assessment will be charged all the income for that year in relation to employment or services rendered.

Section 3 (2) (a) (i) Subject to this Act income which is chargeable under this Act … Section defines an employer as including any resident persons responsible for … employee is not defined neither is the definition of employment.

Heaton v Bell - [1969] L46TC 211 –

The court in this case defined liability to tax of a taxpayer “it is well settled that a taxpayer or tax or liability ….

The meaning is that one is taxed on their earnings and not on net received. Income to be earned is not taxable. Even where one gives part of their earnings to charity, they are taxed on their taxed earnings.

Section 5(2) Gains or Profits from employment or services rendered for purposes of section 3 (a) (ii) gains or profits include wages, salary, leaves paid, payment in lieu on leave, fees, commission, gratuity or allowances.

Section 15 disallows donations exemptions donations are not allowed as a deduction

Section 16 – donations are expressly disallowable since they are personal and the decision is the employee’s.

Section 5 – 3 methods under which amounts payable by virtue of contracts being terminated. Where there is a contract that defined what is to happen in case of breach, where there is no contract and where there is no provision at all depending on these 3 situations, taxation of income arising out of the time a contract has ended that that amount is taxed.

In our case all income is taxed under Section 3(2) (a) (ii) – profits from employment including pension, which is earned as income. For it to be termed as tax it must be derived from that office or employment, if it is income from a harambee for example, it is not earnings and therefore does not fall anywhere and is thus not taxable.

The general principle was provided for in the case of : Hochstrasser v Mayes - (1959) 38 TC 673

IN this case Upjohn J. decided and gave the authorities and summarised them saying they seemed to have answered the question that in the light of every particular fact, every case whether or not particular payments are made or is not from employment. Not all payments made to any employee as gains or profit to an employee, the authorities said that that profit must have been in reference to the services rendered in that employment. If it was not income made in relation to services rendered in that office, then it is not taxable. It must be in the nature of a reward for services. The Court of Appeal agreed with that and it is the current definition. In Kenyan case where income tax is on earnings or for services rendered, you pay tax on it.

Payment in respect of employment or services only for an employee, services which are rendered in Kenya or outside Kenya in the case of a resident person or if the payment is made to a non-resident, all of this may be taxed but only on the following condition, if the non-resident is employed or rendering services to an employer who is resident is Kenya, his income is taxable or if he is rendering services to a non-resident who has a permanent resident in Kenya for which one works, for example if he has a company here. Which means that even if one works for World Bank but they are resident in Kenya they will be taxed.

In case of a non-resident a person is chargeable to tax only on income that is accrued or derived from Kenya. There are cases in the English system where employee’s income has been held not to be taxable. There are 3 situations

1. Where you have paid a gratuitous payment to an employee i.e. it is a gift or any other voluntary payments;

2. Where an employee has received payment under a contractual right which is considered to be outside the scope of his employment;

3. Where an employee receives payment after his employment has ceased or after it has come to an end.

The first category of gift and other voluntary payments – the case of

Seymour v Reed - (1927) 11 TC 625

In this case the House of Lords summarised the general principle in relation to income tax or chargeability of gifts to income tax as follows “it must be settled that the words salary, wages, fees … whatsoever (Section 5(2) (a) according to the judge One these profits include payments made to the holder of an office by way of remuneration for his services even if those services are voluntary so long as they are made as payment by way of remuneration for services rendered. But these do not include a mere gift or present. There are two types of voluntary gifts, when employer makes a gift to an employee; this is made on a personal ground and not by way of payment, secondly where someone other than the employer makes the gift to an employee. In the case where the gift if made by employer to employee the court went to say that they would have to be very exceptional circumstances for the gift not to be taxable, for example if one was to give their employee money to pay an ambulance for a spouse, that is a personal payment and is not a remuneration for services rendered, it is a gift being given for an employee but not in remuneration for services rendered. The other example is where an employer gives a donation for burial for an employee’s kin as a harambee, this is a free gift given not in relation to services rendered but on personal grounds. It is not in the contract.

Ball v Johnson - (1971) TC 155

In this case the taxpayer was a bank clerk and his contract of employment required him to sit for some examinations referred to as examinations of the institute of bankers, which was a condition. He fulfilled that and he studied sat for the exam and passed. He was doing this at his own time not at his employer’s time. After that the employer gave him £130 pounds, which was normal and was a gift stated in the handbook as a gift. Was this a gift in relation to employment when he had done this examination at his own time, the employee was only fulfilling a term of the contract which does not mean rendering services. The Judge held that that was not income that had arisen from his employment and therefore was not taxable. Not all judges decide this for example in

Laidler v Perry - (1966) 42 TC 351 –

In this case a group of companies gave each of their employees that had worked for them for more than a year a gift voucher of 10 pounds as a Christmas present. They could use the voucher in a shop of their choice. Was that income for services rendered? The matter went all the way to the House of Lords and they decided that the vouchers were taxable under Schedule E as income from employment in our case Section 3(2) (a) (ii). However the court went on to say that a gift by an employer on purely personal grounds and not by way of payments for the employee’s services is not taxable for example a bonus paid to a single employee for exemplary service rendered. It is not a contractual right and it is just a gift. If it is given to one person it is a personal gift, given to all employees it is not personal. Some of the courts went on to say that even tips are taxable. If an employer gives employee money under pure benevolence, that income is not taxable. The general rule is that gifts to an employee by his employer are taxable we have not reached there maybe because we are incapable of chasing those gifts.

Where a person who is not an employer makes gifts – it raises two problems, where rewards are given as a result of services rendered but as voluntary gifts by people who are not employers. Sometimes these are taxable, if earned by virtue of employment but where the gifts are given personally and on personal grounds irrespective or whether or not services have been rendered is not taxable. Good case in point is that Wangari Mathai’s gift of 110 million is not taxable.

In the case of Calvert v Wainwright (1947) 27 TC 475 – A famous good Judge Lord Atkinson held that the tips that are received by a Taxi Driver in the ordinary course of business are taxable. In Wings v O’Connell (1927) IR 84 It was held that the presents that a jockey wins are taxable. In Blakiston v Cooper (1909) STC 347 it was held that a Parson’s Easter offerings to the Church of England were taxable.

Taxability of gifts may depend on the frequency or regularity in which they are given, if they are given frequently and regularly then they may be considered as income for services rendered. Lord Jenkins in the case of

Moorehouse v Dooland - (1955) 36TC 1

Summarised it as follows:

1. That income which is voluntary or the voluntary gift should be looked at as to whether it is by virtue of his office or employment,

2. If the recipient of the gift in his contract of employment entitles him to receive that payment, in that case it will be most likely to be held that it arose out of rendering services.

3. The fact that the payment is of a periodic or recurrent character may also support taxability although that would not by itself lead to a conclusion that it is taxable.

4. Any voluntary payment which is given by way of a present on personal grounds may lead to a likely conclusion that it is not a profit accruing from employment and therefore not taxable.

CONTRACTUAL RECEIPTS NOT ARISING FROM EMPLOYMENT:

Under the common law it is possible to receive from an employer payment which one is entitled to not as payment for services rendered. The best example is one given by Lord Denning in the case of

Jarrod v Bousted - (1964) 41 TC 701

in this case he gave the example as follows: “ suppose there was a man who was an expert organist but who was very fond of playing golf on Sundays and asked to become an organist for a church for the 7 months that would follow at a salary of £10 pounds a month but this church expressly provides that he would never play golf on Sunday for those months he was working for them. The organist said that if he had to give golf on Sunday they would have to give him an extra £5 pounds for not playing golf on Sunday and they obliged. Lord Denning asked if the £5 pounds is payment for him as organist? Is it income for services rendered? Lord Denning said that this was not payment for services rendered to the church as an organist but a payment for relinquishing what the organist considered to be an advantage to him. On the basis of this reasoning, the Court of Appeal held in that case that a signing on fee for an amateur rugby player to a  professional rugby player, the signing on fee is a fee for turning professional and for agreeing to pay for that particular club. It was not income but a capital sum, which is compensation for his giving up the amateur status and not income for services rendered.

A different case decided otherwise in : Riley v Cogland - (1964) 44 TC 481

Ungoed Thomas J. held that signing on fee of a Rugby player was taxable because according to him it was paid into consideration of the taxpayer playing for the club for the rest of his career. This was in the High Court in 1964.

The House of Lords has also held that the fact that any payment would not have been made to an employee unless he was an employee is not enough to make any income taxable, one must have been paid because of that employment to be taxed the employment must be the cause of the payment for services rendered.

There are substituted forms of remuneration and an example was given in the case of

Holland v Geoghegan - (1972) 48 TC 484

Here this taxpayer was on strike with his colleagues and the employer paid him £450 pounds so that he can go back to work, there was no requirement in his contract because under contract he could only remain at work for 7 days and so the £450 pounds was meant to make him to leave his trade union friends and come back to work. The judge held that the main reason for payment of that money was to get the employment back to work and that when he received that money it is by way of a substituted form of remuneration and therefore it was taxable.