Kingston cotton mill case 1986

Coursework Week 8

Documentary Film - Enron: The Smartest Guys in the Room (2005)

Film Summary

‘Enron: The Smartest Guys in the Room’ is a 2005 documentary film detailing the biggest corporate scandal and collapse in American history. Enron is the story of insatiable greed made possible by the perpetrators’ ingenious ability to invent highly questionable methods to portray the company as a successful company and win the trust and admiration of a gullible public with devastating outcomes. The outcomes include: suicides by corporate executives, jail sentences, the dismissal of more than 20,000 employees and the loss of life savings by thousands more while the company’s top executive walk away with more than $1 billion. The company gave itself an appearance of profitability by inflating its profits and concealing its losses through corrupt bookkeeping practices, with the acquiescence of its highly paid firm of accountants, Arthur Anderson.

Within two years of its founding in 1985 by Kenneth Lay, the company becomes embroiled in a scandal after two of its traders begin betting on the oil market resulting in consistent profits. But betting and the publication of consistent profits, which very few questioned, would be the hallmark of the company right up to its collapse.

Enron’s ambition was to reinvent the energy industry as a market place where gas and electricity could be traded like shares and bonds. Put simply, Enron gambled in the energy market and manipulated it and other commodities and even considered ‘trading weather’ at some point.

Its executive officers were involved in the company’s unethical and often criminal activities. These include:

its founder Kenneth Lay who gambled away all of the company’s assets and reserves and encouraged the company’s president to gambled more in trading and also claimed that the company was the ‘best energy company in the world’ when he should have known that the company was bankrupt and had been worthless for years;

its president Louise Bourget who diverted the company’s profits into his personal bank account, destroyed the company’s record and gambled the company’s money;

its new CEO, Jeffrey Skilling who used an accounting tactic, mark-to-market, to record the company’s projected future profits as its current income as soon as a contract was signed regardless of the actual profit that the contract would generate;

Lou Pai, the elusive CEO of Enron Energy Services who had an obsession of gambling and visiting strip clubs using shareholder money and who left suddenly with a $250 million pay-out when his department was $1 billion in debt.

Andrew Fastow the Chief Financial Officer who breached his duty to Enron and its shareholders and made more than $45 million through the creation of a number of front companies designed to hide Enron’s losses.

By maintaining an appearance of profitability, the company’s executives were able to consistently reward themselves with huge bonuses.

Question

Assume that Mr Kenneth Lay, the founder of Enron had provided a loan of £1 million to the company and that following the collapse of the company Mr Lay attempted to recover his money from the company but the liquidator resisted his claim on the ground that there was no difference between Mr Lay and the company since he had overall control over the company and that instead of trying to claim money from the company he should be made liable for its debts.

In the film, Mr Louis Bourget the president of Enron diverted the company’s profit into his personal account, destroyed the company’s records, and gambled the company’s money. Mr Andrew Fastow, the company’s Chief Financial Officer created a number of front companies which he uses to defraud Enron of tens of millions of dollars.

You are a legal team summoned to attend a case conference. The liquidator of the company has asked your team to prepare a legal analyses of the company law issues raised in the film and advise on:

The merits of the liquidator’s arguments, in British company law, that Mr Lay cannot recover his loan from the company and that he should instead be made to contribute to the company’s debt on the ground that there is no difference between him and the company. Do not deal with any criminal element involved, (40 marks).

Mr Louis Bourget’s and Mr Andrew Fastow’s duties as directors of Enron, explaining which duty, if any, they breached under the Companies Act 2006, (60 marks).

The answer should be between 750 – 1000 words long and should address all the issues raised in the question. The written answer carries 50% of the marks available for this case conference. The group presentation carries the remaining 50%. Marks may be deducted if you do not keep within the word margin. You are expected to word count your work and make a note of this at the end. You are reminded that you must support your answer with relevant company law cases and statutory provisions.

Assessment Rationale and Criteria

The assessment method for this part of the module is designed to meet the objectives of the module and facilitate its outcomes. The coursework will allow students to develop their research and data interpretation skills both as members of a team, in respect of the group presentation, and as individuals in respect of the written answers. The written part of the coursework will allow students to develop their legal writing skills. Students must ensure that they satisfy the assessment criteria their work will be marked against.

Grade A

Precise identification of the legal issue.

Precise identification of all the relevant areas of law.

Demonstration of a thorough knowledge and understanding of the relevant principles and case law including a critical analysis thereof.

Accurate application of law to question so as to address precisely legal issues raised therein.

Use of authority (that is, cases and statutes) to support the arguments advanced and conclusions reached.

Presentation of work which is legible.

Clarity of expression.

INFORMATION BELOW MIGHT BE USEFUL AS A GUIDE. PLEASE FIND DIFFERENT CASES IF POSSIBLE WHICH SHOWS YOU HAVE DONE A RESEARCH

5. DIRECTORS’ DUTIES

To Whom do Directors Owe their Duties

1. The Shareholders as a General Body

Traditionally, directors owe their duties to the company’s shareholders (s. 170(1) CA 2006), that is to the shareholders as a general body and not to individual shareholders. See: Percival v Wright [1902]

Peskin v Anderson [2001] 1 BCLC 372. Percival v Wright applied.

Mutual Life Insurance Co. of York v Rank Organisation Ltd [1985] BCLC 11.

Re BSB Holdings Ltd (No. 2) [1996] 1 BCLC 155.

Multinational Gas and Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258

Exceptionally, directors may owe fiduciary duties to individual members of a small private company, e.g. when they undertake to act as the member’s agents.

Coleman v Myers [1977] 2 NZLR 225

2. The Creditors’ Interests

Apparently, no duty owed to company’s creditors when company is solvent.

Multinational Gas and Petrochemical Co. and Multinational Gas and Petrochemical Services Ltd [1983] Ch 258.

However, where a company is insolvent or facing insolvency, it is bound to have regard to the interest of its creditors, s. 172(3) CA 2006.

Liquidator of West Mercia Safetywear Ltd v Dodd [1988] BCLC 250.

Rubin v Gunner [2004] LTL 15/3/2004;

3. Employees’ Interests

S. 172(1)(b) CA 2006. The matters to which directors of a company should have regard include the interests of their employees.

The Codification of Directors’ General Duties

The Companies Act 2006 codified, in sections 170 to 181 the equitable principles of fiduciary duty and the common law of negligence as they apply to directors. Sections 171 to 177 state seven general duties of directors:

a. Duty to act within powers – s. 171

Based on the equitable principle that a director of a company has a duty to exercise his powers for the purposes for which they were given. For example, the only purpose for which directors can exercise their powers to issue shares is to raise capital.

Pergamon Press v Maxwell [1970] 2 All ER 809

Punt v Symonds & Co [1903] 1 Ch 506. Held the issue of shares was not a bona fide exercise of directors’ power.

Piercy v S. Mills & Co Ltd [1920] 1 Ch 77. Held the issue of shares was a breach of directors’ duty to act for a proper purpose.

Hogg v Cramphorn Ltd [1967] Ch 254

*Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821

b. Duty to promote the success of the company – s. 172

Based on the equitable fiduciary duty to act bona fide in the interest of the company. Directors have a duty to act honestly and in good faith in the best interest of the company.

Re Smith & Fawcett Ltd [1942] Ch 304.

Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald (No 2) [1995] BCC 1000

Regentcrest plc v Cohen [2001] 2 BCLC 80.

Extrasure Travel Insurance Ltd v Scattergood [2003] 1 BCLC 598.

Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244.

c. Duty to exercise independent judgment - s. 173 _____________________________

________________________________________________________________________

d. Duty to exercise reasonable care, skill and diligence – s. 174

Based on common law rules and equitable principles. Uses both an objective and a subjective standard.

Re Cardiff Savings Bank: The Marquis of Bute’s case [1892] 2 Ch

*Re City Equitable Fire Insurance Co [1925] Ch 407. Subjective standard used.

Re Barrings plc (No. 5) [2000] 1 BCLC 523.

Equitable Life Assurance Society v Bowley [2003] EWHC 2263 Re Barrings applied.

Re Love Fish Ltd [1993] BCC 348

Rubin v Gunner [2004] LTL 15/3/2004; [2004]

Re Firedart [1994] 2 BCLC 340

Re Queens Moat Houses plc [2004] LTL 20/7/2004; [2005] 1 BCLC 136

In addition to the duties imposed on the company and directors, statute has also increased the potential and criminal liability of directors and officers.

More rules are found in separate status such as the Insolvency Act 1986, the Company Directors’ Disqualification Act 1986

The statutory rules are designed to protect creditors and investors.

Note Section 214 of the Insolvency Act 1986 re: making directors liable to contribute to the company’s assets for wrongful trading.

e. Duty to avoid conflicts of interests – s. 175

Based on the equitable no-conflict and no-profit rules. S. 175(2) – the duty applies in particular to the exploitation of any property, information or opportunity. Breach will render director liable to account for the secret profits.

Aberdeen Railway Co v Blackie Bros [1854] re railway company making contract for supply of goods from firm in which chairman of railway company was a partner.

Regal (Hastings) v Gulliver [1942]. Breach found by the House of Lords.

Re Bhullar Bros Ltd [2003] BCC, re directors purchasing property for themselves.

Kouroush Fassihi v Item Software (UK) Ltd [2004] LTL 31/1/2005; [2004] BCC.

John Gidman v Ronald Barron [2003] LTL 7/3/2003

Crown Dilmun v Nicholas Sutton [2004] LTL 12/3/2004; [2004] 1 BCLC 468.

Section 170(2)(a) re ex-directors

Industrial Development Consultants Ltd v Cooley [1972], re ex director.

Forster Byrant Surveying ltd v Bryant [2007] EWCA Civ 200

Quarter Master UK Ltd v John Pyke [2004] LTL 1/9/2004; [2005] 1 BCLC 245;

Alenco Ltd v Bates [2005] LTL 20/6/2005,

Cook v Deeks [1916] 1 AC 554

Queensland Mines Ltd v Hudson [1978] re corporate opportunity rejected by company.

Peso Silver Mines Ltd v Copper (1966) re corporate opportunity rejected by company.

Competing Directorships

London and Mashonaland Co Ltd v New Mashonaland Exploration Co Ltd [1891]

In Plus Group Ltd v Pyke [2002] EWCA Civ 370

f. Duty not to accept benefit from third party – s. 176

A director of a company must not accept a benefit from a third party in his position as a director.

g. Duty to declare interest in proposed transaction – ss. 177 and 182

6. AUDITORS, CORPORATE INSOLVENCY AND LIQUIDATION

AUDITORS

Appointment of Auditors

S. 485 and s. 489 CA 2006 _________________________________________________

Duties and Liabilities

Main role is to report on the accounts for a financial year of the company, s. 495 CA 2006. Auditor is to ensure that there are no financial irregularities in the company and that the directors give a true and fair account of the company’s financial performance. The auditor must perform his duties with reasonable care and skill. He is under a duty to make an exhaustive investigation if he has been, or ought to have been, put on inquiry, see;

Re Allen, Craig and Co (London) Ltd [1934] Ch 483

Re London and General Bank Ltd [1895] 2 Ch 166

Re Kingston Cotton Mill Co [1896] 2 Ch 279

Westminster Road Construction Co Ltd (1932)

Fomento (Sterling Area) Area Ltd v Seldon Fountain Pen Co Ltd [1958] 1 WLR

Re Thomas Gerrard & Son Ltd [1968] Ch 455

Sasea Finance Ltd v KPMG [2000] 1 BCLC 236

Can the auditor be made liable to an investor who bought shares in a company on the basis of a false account published by the auditor?

Ultramares Corp v Touche (1931

*Caparo Industries plc v Dickman [1990] 2 AC 605

James McNaughton Paper Group v Hicks Anderson [1991]

Abbott v Strong [1998]

Morgan Crucible Co Plc v Hill Samuel Bank Ltd [1991] CA

Dennis Hands v Coopers & Lybrand [2001] LTL 25/4/2001. Caparo applied.

Pearce v European Reinsurance Consultants & Runoff Ltd [2005] LTL 19/7/2005

Stone & Rolls Ltd v Moore Stephen [2009] 1 AC 1391, the Supreme Court held that on the facts of the case, the auditor’s duties were owed to the company as a whole and not to individual shareholders or creditors.

CORPORATE INSOLVENCY AND LIQUIDATION

Concerned with the processes by which the life of a company comes to an end, with the aim of removing the company from all its legal relationships.

The primary legislation for corporate insolvency and liquidation (winding up) is the Insolvency Act 1986.

S. 122(1) Insolvency Act 1986, reasons for which a company may be wound up,

Winding-up of the company is carried through by the liquidator.

There are two methods of liquidating a company, s. 73 IA 1986; (i) voluntary liquidation which may be either members voluntary liquidation or creditors voluntary liquidation; (ii) compulsory liquidation.

Voluntary Winding up

Section 84(1) of the Insolvency Act 1986 provides that voluntary liquidation may commence in the following ways:

Compulsory Winding up

Section 122 IA 1986 empowers the court to liquidate a company. S. 124 gives a list of possible petitioners for a liquidation order.

Section 122(3)