Question

business law and ethics

Case Study

Salvador, Frida, Wassily, Leonardo and Jackson became friends while they were in the same year group at art school. They all graduated in 2015, and together set up a small business selling low-priced arts supplies, initially from a market stall in Bradford before they developed an online shop. The business slowly grew, and they recognised that there was a demand for their competitively priced products. They identified a need for investment in their business in order to reach a wider market through advertising and the opening of shops, and so incorporated their business, Chintz Arts Supplies Ltd. in September 2018.

At a trade fair Salvador was approached by a board member of Gigantic Arts Shops Ltd, who told him that Gigantic Arts Shops wanted to sell a shop that it owned on land close to their old art school. The shop however had recently suffered a major fire and Gigantic now did not want to be associated with the location. It had previously been a very profitable shop and could again be economically viable after a significant amount of work to repair the premises had been carried out. At a board meeting Salvador gave an accurate account of the difficulties that would be faced. The four other directors thought the risks involved with this location were too great compared to the potential benefits for Chintz Arts Supplies Ltd and decided not to pursue it. At this same meeting Salvador said he ‘ought to to buy the shop for himself and would run his own arts supplies shop, café and art gallery’. This he has done and it looks as if he will make a significant profit.

Chintz Arts Supplies later opened up three shops in the Yorkshire area and their business became very successful both in store and online. The five directors reward themselves with generous salaries as directors. No dividends are paid. Recently, however, tension has arisen between the five as to the future direction of the business. Salvador, Frida, Wassily and Leonardo want to expand the business nationally and propose to increase capital to do so. Jackson is opposed to this, believing that any expansion should be done locally. The other four directors think that Jackson is holding them back and vote at a board meeting, which Jackson does not attend, to go ahead with the national expansion. They begin to call board meetings without informing Jackson and to implement the expansion plans without consulting him. At one of these meetings it is decided to increase the share capital of Chintz Arts Supplies Ltd by issuing another 100 shares in the company at the price of £2,000 per share to reflect the current value of the business. Once Jackson hears of this decision he objects vehemently because, as the other four directors know, he has just purchased a new house and is unable to raise the necessary cash to buy his allocation of shares. Despite Jackson’s objections the share issue goes ahead. At the next meeting of all of the board, including Jackson, a proposal to remove Jackson from the board is put to a vote and passed despite his protests.

Answer all Three of the Following Questions;

1. Explain the legal background to limited liability and corporate personality and critically evaluate the situations when the court will ignore the veil of incorporation.

(50% of the marks available)

Answer 1

A limited liability company is an incorporated firm which will be formed by one on many shareholders. The company will achieve the position of a separate legal entity or a corporate personality. The company will be like a standalone artificial person with its own capacities like entering into contracts, conduct business, hire and fire people etc. It will also be responsible for its liabilities. The owners may or may not be board members. Board members will be entrusted with the duty to serve the company and its shareholders in the best interests of the company by overseeing in its day to day operations and by making strategic decisions.

Here, the business started off as a sole proprietorship firm, while it is not explicitly stated. It was incorporated in September 2018, which gave the firm the status of a corporate entity. The five shareholders Salvador, Frida, Wassily, Leonardo and Jackson were directors of the company. They operated the company the in a fashion a sole proprietorship is governed. The incorporation was merely a veil to cover their risks and for generating capital. There is nothing stated about an “articles of association”, which all incorporated firms are supposed to have. The articles of association is a document that details the share holding structure, decision making structure, how notice for board meeting will be given to directors, dividend strategy etc. There was no appointed chairman as well. Chairman has the responsibility to address the board, conduct voting etc.

All the five directors rewarded themselves with high salaries thereby reducing the company’s value. There was no dividend pay system in the organization. Directors are supposed to hold high morals and they shall act in the best interest of the company. It was the company’s interest to expand and grow national while the directors were busy paying themselves high salaries, which is unethical.

All board members are supposed to be informed of making strategic decisions. The decision-making structure is supposed to be there in the articles of association and the chairman is supposed to act according to that. Here Jackson was not informed of the board meetings and the decision to go ahead with nationalization was made during Jackson’s absence. The other four directors know that Jackson had purchased a house recently and he will not be able to raise the money. This is an unethical use of information from the other four directors.

Removal of directors shall need the shareholders’ approval as well which was also not adhered to while ousting Jackson.

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