Notes Outline:
- PARTNERSHIPS
- COMPANY LAW
- BANKING LAW
- BANKRUPTCY & INSOLVENCY
- 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
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.
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
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
(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
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-Ã -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
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.
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