LW Corporate and Business Law (Global)

A. Essential elements of legal systems

Law is a set of rules, made and enforced by the state, that regulates behaviour. Criminal law deals with offences against the state, which the state prosecutes and punishes, and the standard of proof is beyond reasonable doubt. Civil law deals with disputes between private parties, such as breach of contract, which are settled by awarding remedies such as damages, and the standard is the balance of probabilities. A legal system also depends on the economic and political system, because the way a state is governed shapes how laws are made and applied.

The doctrine of the separation of powers divides state power between the legislature (makes laws), the executive (carries out laws) and the judiciary (interprets and applies laws), so that no one body has complete control. Common law systems rely on judicial precedent and developed through court decisions, civil law systems are based on codes of written law, and Sharia law is based on religious sources and is part of the legal system in some states.

Different countries have different laws, which causes conflicts of laws in international trade. International treaties, conventions and model laws help by creating common rules. A treaty or convention binds the states that sign and ratify it, while a model law is a template that states can adopt in their own legislation. Organisations that promote and regulate trade law include the United Nations, the International Chamber of Commerce (ICC), the World Trade Organization (WTO), the OECD, UNIDROIT and UNCITRAL.

Disputes can be settled by the courts or by alternative dispute resolution (ADR). Negotiation, mediation, conciliation and arbitration are forms of ADR. Arbitration is a private process in which an independent tribunal makes a binding decision, called an award. Its advantages are privacy, speed, choice of expert arbitrators and easier international enforcement, and its disadvantages include cost and limited rights of appeal. The UNCITRAL Model Law on International Commercial Arbitration sets out rules for the arbitral tribunal and awards, and the International Court of Arbitration of the ICC is an institution that administers international arbitrations.

Key terms

• Separation of powers: The division of state power between the legislature, the executive and the judiciary.
• Model law: A template law that countries can adopt into their own legislation.
• Arbitral award: The binding decision of an arbitral tribunal.

Study tip: Learn the difference between a convention (binding once ratified) and a model law (a template). It is a common objective test question.

Practice questions for section A

B. The UN Convention on Contracts for the International Sale of Goods and Incoterms

The UN Convention on Contracts for the International Sale of Goods (CISG) governs contracts for the sale of goods between parties whose places of business are in different states that have adopted the Convention, or where the rules of private international law lead to the law of such a state. It does not cover sales to consumers for personal or household use, auctions, or the sale of services. The parties can exclude or change it by agreement.

Formation. A contract is formed by an offer and an acceptance. An offer must be addressed to specific persons and be sufficiently definite, which means it describes the goods and fixes or makes provision for working out the quantity and the price. An offer can be withdrawn before it reaches the offeree, and it can be revoked before the offeree sends an acceptance, unless it is irrevocable because it states a time for acceptance or the offeree reasonably relied on it. Silence or inactivity does not by itself amount to acceptance. An acceptance takes effect when the indication of assent reaches the offeror, and the contract is concluded at that moment.

The seller must deliver the goods, hand over any documents relating to them and transfer ownership. The goods must match the contract in quantity, quality and description, be fit for the purposes for which goods of that kind are normally used, be fit for any particular purpose that the buyer made known to the seller, and be packaged in the usual way. The buyer must examine the goods as soon as practicable and give notice of any lack of conformity within a reasonable time, and in any case within two years of receipt, or the right to rely on it is lost. The seller must also deliver goods free from third-party rights and claims, including intellectual property claims.

The buyer must pay the price and take delivery. If the seller breaches the contract, the buyer can require performance, fix an extra period for performance, reduce the price, claim damages, or declare the contract avoided if the breach is fundamental. If the buyer breaches, the seller has similar remedies. Provisions common to both include anticipatory breach (when it is clear that the other party will commit a fundamental breach, the contract can be suspended or avoided), instalment contracts, damages (the loss suffered including loss of profit, limited to what the party in breach could foresee), the duty to mitigate loss, interest on sums not paid, exemption where a failure is caused by an impediment beyond a party's control, the effects of avoidance and the preservation of goods.

Risk of loss passes from the seller to the buyer under rules that depend on the contract. Where the contract involves carriage of the goods, risk generally passes when the goods are handed to the first carrier. If the goods are sold in transit, risk generally passes when the contract is concluded. Otherwise, it generally passes when the buyer takes over the goods, or when they are placed at the buyer's disposal and the buyer breaches by not taking them.

The Incoterms rules of the ICC are standard trade terms that say who arranges and pays for transport and insurance and where risk passes. They do not deal with ownership or the price. Terms for any mode of transport include EXW (ex works), FCA (free carrier), CPT, CIP, DAP, DPU and DDP, and terms for sea and inland waterway transport include FAS, FOB, CFR and CIF. The parties must name the version of Incoterms they are using in the contract.

Key terms

• Offer: A proposal to enter a contract that is definite and shows an intention to be bound on acceptance.
• Fundamental breach: A breach that deprives the other party of what it was entitled to expect under the contract.
• Incoterms: ICC standard trade terms that allocate transport, cost and risk between buyer and seller.

Study tip: For CISG scenarios, ask in order: was a contract formed, what did each side have to do, who breached, and what remedy fits?

Practice questions for section B

C. Transport and payment in international trade

A bill of lading is issued by a carrier of goods by sea. It has three functions: it is a receipt for the goods, it is evidence of the contract of carriage and, if it is in negotiable form, it is a document of title, which means that whoever holds it can claim the goods and can transfer the right to them by transferring the document.

A bank transfer moves money between accounts without cash or a cheque. The UNCITRAL Model Law on International Credit Transfers sets out rules for a transfer in which an originator instructs its bank to pay money to a beneficiary, including the obligations of the banks and who bears the loss if the transfer fails.

The UN Convention on International Bills of Exchange and International Promissory Notes creates rules for these instruments when they are used in international trade. A bill of exchange is a written order from one person (the drawer) to another (the drawee) to pay a sum on demand or at a fixed time to a named person (the payee). A promissory note is a written promise to pay.

A letter of credit is a promise by a bank, at the request of a buyer, to pay the seller when the seller presents documents that comply with the terms of the credit. It protects the seller from the risk of not being paid and the buyer from paying before the documents are produced. The bank deals with documents and not with the goods. A letter of comfort, in contrast, is a statement by a parent company or another party that it is aware of a debt or obligation, and it is generally not intended to be a legally binding guarantee.

Key terms

• Document of title: A document whose holder has the right to claim the goods it represents.
• Letter of credit: A bank's undertaking to pay the seller against compliant documents.
• Letter of comfort: A statement of support that is generally not a legally binding guarantee.

Study tip: Remember that a letter of credit is about documents, not goods. The bank does not inspect the goods.

Practice questions for section C

D. The formation and constitution of business organisations

Agency is a relationship in which one person (the agent) is authorised to act for another (the principal) and can create legal relations between the principal and third parties. An agent can be appointed by agreement, by ratification afterwards, by conduct (implied authority) or by necessity. Authority can be actual (express or implied) or apparent (when the principal's conduct leads a third party to believe the agent has authority). A principal is bound by what its agent does within authority, and an agent who acts without authority can be liable to the third party for breach of warranty of authority. Directors and partners are examples of agents.

A partnership is a relationship between persons carrying on business with a view to profit. In an ordinary (unlimited) partnership, the partners are agents for each other and for the firm, and they are jointly liable for the debts of the firm, without a limit, even with their personal assets. A limited partnership has at least one general partner with unlimited liability and one or more limited partners whose liability is limited to what they invested, provided that they do not take part in management. A partnership ends by agreement, by the death or bankruptcy of a partner, by illegality or by a court order, and the partners remain liable for earlier debts.

A company is a separate legal person from its members. It can own property, sue and be sued in its own name, and it continues despite changes in its members. Limited liability means that the members' liability is limited to any amount unpaid on their shares or the amount they guaranteed. The veil of incorporation is the legal separation between a company and its members, and the courts will lift it only in limited cases, for example where a company is used as a sham to avoid an existing legal obligation, or where a statute provides for it. A public company can offer its shares to the public and has stricter requirements than a private company.

Before a company is formed, promoters carry out the work needed to set it up. They owe duties to the company, including a duty to disclose any profit made, and the company has remedies if they breach them. A pre-incorporation contract cannot be ratified by the company after its formation, and the person who signed it may be personally liable. A company is registered by filing documents, including the constitution and details of the members and officers, and public and private companies may have separate procedures, and in some systems a streamlined registration. A company must keep statutory books and records and make returns, such as a confirmation statement and a register of people with significant control.

The constitution of a company is made up of the articles of association and may be supported by other documents. It is a contract between the company and its members. Model articles provide default rules that apply unless a company adopts its own. The articles can generally be changed by a special resolution, subject to protections for minority shareholders. A company's name must meet legal requirements, and it cannot use names that are already registered, misleading or offensive.

Key terms

• Apparent authority: Authority that arises when the principal leads a third party to believe that the agent has authority.
• Limited liability: A member's liability is limited to the unpaid amount on shares or the amount guaranteed.
• Veil of incorporation: The separation in law between a company and its members.
• Promoter: A person who takes the steps needed to form a company.

Study tip: For lifting the veil, remember that courts do it only in exceptional cases. 'The company was controlled by one person' is not enough on its own.

Practice questions for section D

E. Capital and the financing of companies

Share capital is the money invested by members in return for shares. The main types are authorised (or nominal) capital where used, issued capital, paid-up capital (the amount paid on shares) and called-up capital (the amount the company has asked for). Shares can have different classes, such as ordinary shares and preference shares, with different rights to dividends, votes and repayment. Treasury shares are shares that a company has bought back and holds, where the law allows it. Class rights can be changed only by following the procedure in the articles or the law, which usually requires the consent of the class.

A rights issue offers new shares to existing members in proportion to their holdings, usually at a discount, so that existing members have a chance to keep their percentage. A bonus issue gives members new shares for no payment from reserves. Shares are allotted by the directors, who need authority to allot. Shares must not usually be issued at a discount to nominal value, and an issue at a premium puts the extra amount into a share premium account, which can be used only for specified purposes.

Loan capital is money borrowed by the company. Companies have the power to borrow if the constitution allows it. A debenture is a document that acknowledges a debt, and debenture holders are creditors, not members, who are entitled to interest and repayment of the loan whether or not the company makes a profit. Share capital differs from loan capital because shareholders own the company and have votes, and they are paid dividends only if profits are available, and they are paid after creditors if the company fails.

A charge is a security given over a company's assets to a lender. A fixed charge is over a specific asset, such as land, and the company cannot sell the asset without the lender's consent. A floating charge is over a class of assets that changes over time, such as inventory, and the company can deal with the assets in the ordinary course of business until the charge crystallises, for example when the company defaults. A fixed charge usually ranks ahead of a floating charge. Charges must be registered, and an unregistered charge is generally void against a liquidator and creditors.

The doctrine of capital maintenance says that a company must not return its capital to members except in ways the law permits, because creditors rely on the capital as a fund. A company can reduce its capital only by following a statutory procedure, for example with a special resolution and, where required, a solvency statement or court approval. Dividends may be paid only out of distributable profits, and a public company has extra restrictions based on its net assets. Dividends paid unlawfully may have to be repaid by members who knew about it, and directors may be liable.

Key terms

• Paid-up capital: The amount of the nominal value of shares that has been paid.
• Floating charge: Security over a class of changing assets that crystallises on default.
• Capital maintenance: The rule that capital must not be returned to members except in permitted ways.
• Debenture: A document acknowledging a company's debt.

Study tip: Shareholders are owners, debenture holders are creditors. Many objective test questions rest on this distinction.

Practice questions for section E

F. Management, administration and regulation of companies

Directors manage the company. Executive directors work full time in the business, and non-executive directors take part in oversight and are not employees. A de jure director is validly appointed. A de facto director acts as a director without being validly appointed, and a shadow director is a person whose instructions the directors habitually follow. Directors are appointed under the articles, normally by the members, and they can be removed by an ordinary resolution of the members, whatever the articles say, although there may be compensation rights. A person can be disqualified from acting as a director, for example for unfit conduct or wrongful trading.

The powers of directors are set out in the articles. The board acts collectively. A managing director or chief executive has the powers delegated by the board, and individual directors can bind the company only within the authority given to them, express, implied or apparent. People who deal with a company in good faith are generally protected where a director acts outside authority.

Directors owe duties to the company. These include the duty to act within their powers, to promote the success of the company, to exercise independent judgement, to use reasonable care, skill and diligence, to avoid conflicts of interest, not to accept benefits from third parties, and to declare an interest in a proposed transaction. There are statutory controls on dealings between a company and its directors, such as loans and substantial property transactions, which generally require the approval of the members.

The company secretary is an officer who carries out administrative tasks, such as keeping statutory records, making returns and organising meetings. A private company may not be required to have one, while a public company usually must. The auditor is appointed by the members to report on the financial statements. The auditor has a right of access to records and information and the right to attend meetings, and can be removed by the members by ordinary resolution, or can resign, with certain notices and statements.

A general meeting is a meeting of the members, and an annual general meeting (AGM) is a general meeting held each year, which a public company is generally required to hold. Resolutions are the decisions of the members. An ordinary resolution needs more than 50 percent of votes cast. A special resolution needs at least 75 percent of the votes cast. A written resolution is passed without a meeting, by members signing or agreeing in writing. Meetings must be called by proper notice, to all entitled members, with a quorum, and the notice must say the type of meeting and the text of special resolutions.

Key terms

• De facto director: A person who acts as a director without being validly appointed.
• Shadow director: A person whose instructions the directors are accustomed to follow.
• Special resolution: A resolution passed by at least 75 percent of the votes cast.
• Quorum: The minimum number of members needed at a meeting for it to be valid.

Study tip: Know the voting thresholds: ordinary above 50 percent, special at least 75 percent.

Practice questions for section F

G. Insolvency law

Insolvency means a company cannot pay its debts as they fall due, or its liabilities exceed its assets. Liquidation (winding up) is the process of ending a company's existence. It involves collecting assets, paying creditors in a legal order of priority and distributing any surplus to members.

Voluntary liquidation is started by the members. In a members' voluntary liquidation the directors make a declaration of solvency, saying that the company can pay its debts in full within a stated period (usually 12 months), and the members appoint the liquidator. If the company is insolvent, it is a creditors' voluntary liquidation, in which the members pass a resolution and the creditors have control and can choose the liquidator.

Compulsory liquidation is ordered by a court on a petition, which can be made by a creditor, the company, members or others. The usual grounds include that the company cannot pay its debts, for example if it has failed to pay a statutory demand, and that it is just and equitable to wind it up. The court appoints a liquidator.

On liquidation, the proceeds of assets are paid in order. The costs of the liquidation come first. Secured creditors with a fixed charge are paid from the assets over which they have security. Preferential creditors, such as employees' wages up to a limit, follow, then holders of floating charges, then unsecured creditors, and finally members receive any surplus. Where there are not enough funds, a class is paid in proportion.

Administration is an alternative to liquidation that aims to rescue the company, achieve a better result for creditors than liquidation, or realise property to pay secured or preferential creditors. An administrator can be appointed by the court, or out of court by the holder of a floating charge, the company or the directors. When an administrator is appointed, a moratorium prevents legal action against the company without consent. The administrator takes control of the business and has the duty to act in the interests of creditors as a whole.

Key terms

• Liquidator: A person who collects a company's assets and distributes them to creditors and members.
• Moratorium: A pause on legal action against the company.
• Preferential creditor: A creditor that the law pays before floating charge holders and unsecured creditors.

Study tip: Learn the order of payment as a list. Questions often ask who is paid first.

Practice questions for section G

H. Corporate fraudulent and criminal behaviour

Insider dealing is dealing in securities on the basis of inside information, which is specific, not public and likely to have a significant effect on the price if it became public. It is also an offence to encourage someone else to deal on that basis or to disclose inside information improperly. Market abuse covers behaviour that harms the fairness of a market, for example misleading statements or actions that distort the price of securities.

Money laundering is the process of dealing with the proceeds of crime so that they appear legitimate. Offences include concealing or transferring criminal property, assisting another person to retain criminal property, and acquiring or using it. There are controls to prevent it, which include risk management practices, internal controls, customer due diligence (identifying and verifying customers and understanding their business), reliance on others and record keeping, and monitoring of compliance and communicating the policies to staff. Failure to report suspicion, and tipping off a person under suspicion, can also be offences.

Bribery is giving, offering, requesting or accepting an advantage to induce or reward improper performance of a function. A commercial organisation can commit an offence by failing to prevent bribery by a person associated with it, and a defence can be that it had adequate procedures in place. A company can also commit an offence of failing to prevent the facilitation of tax evasion by an associated person, where it has not put in place reasonable prevention procedures, and similar offences for failure to prevent fraud may apply to large organisations.

Fraudulent trading is carrying on a business with intent to defraud creditors or for any fraudulent purpose. It can lead to criminal liability and also civil liability for the people knowingly involved. Wrongful trading occurs when a director continues to trade when they knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation, and did not take every step to minimise the loss to creditors. The court can order the director to contribute to the company's assets.

Key terms

• Inside information: Specific, non-public information that would significantly affect the price of securities if published.
• Customer due diligence: Identifying and verifying a customer and understanding the nature of the business relationship.
• Wrongful trading: Continuing to trade when there was no reasonable prospect of avoiding insolvent liquidation.

Study tip: Tell fraudulent trading and wrongful trading apart: the first needs dishonest intent, the second is judged on what a reasonable director would have concluded.

Practice questions for section H