STRATHMORE UNIVERSITY

FACULTY OF COMMERCE
Bachelor of Commerce
END-OF-SEMESTER EXAMINATIONS

HRM 3203 : COMPANY LAW

DATE: TIME:
INSTRUCTIONS
ANSWER QUESTION ONE AND ANSWER ANY OTHER TWO QUESTIONS

QUESTION ONE
a) Fill in the following table showing aspects of company law under the 2015 Act
ASPECT PUBLIC COMPANY PRIVATE COMPANY
Company Secretary Must have a company Does not have to
secretary appoint a secretary
unless with paid up
capital of at least
Kshs. 5 million
and above
Allotment of shares Cannot allot shares No restrictions on
unless at least one- allotment of shares
quarter of their
nominal value and
the whole of any
premium has been
paid up.
Assignment.

Number of Members Minimum one Maximum Minimum one maximum

unlimited 50
Minimum Capital Authorised No minimum
minimum capital capital
of Kshs. requirement.
6, 750,000/=
Transfer of shares to May transfer to the public Strict restriction on public
the public transfer – only private
transfer allowed
(10 Marks)
b) ‘Upon incorporation , the company becomes the owner of its capital and assets. The
members are not the several or joint owners of the company’s property since the
company is a real person in which all its property is vested, and which it is
controlled, managed and disposed of. A member does not even have an insurable
interest in the property of the company. This was illustrated in Macaura vs Northern
Insurance Company’
With the use of case law explain the circumstances under which a member of the
company can be deemed to have insurable interest in the assets that belong to the
company.

Kosmopoulos v Constitution Insurance Co of Canada

Mr. Kosmopoulos had a leather goods company for which he was the sole shareholder
and director. His lease for the company office was under his own name from when he
originally ran the business as a sole proprietor. The insurance on the office was also
under his own name. His insurance agency knew that he was under the lease and and
that he carried on business as a corporation. A fire in a neighbouring lot damaged his
office.

The insurance company refused to indemnify him on the grounds that the corporation
owned the property, even though he was the sole-shareholder. The insurers position
was consistent with the 1925 decision of the House of Lords in Macaura v Nothern
Assurance Co Ltd. The position of the plaintiff was that Mr. Kosmopoulos was a
bailor i.e he was ‘taking care’ of the property for the company and as such deserved to
be indemnified. The plaintiff also argued, in the alternative, that the veil of
incorporation should be lifted such that it could be concluded that Mr. Kosmopoulos
was one and the same thing with the company and therefore the property belonged to
him.

In the court of first instance the judge held that Mr. Kosmopoulos could not recover
damages as owner for the assets of the business as they were owned by the company
and not him, but the he could recover as insured because if his insurable interest in the
building. This ruling was upheld on appeal, with the court noting that as companies
could, thanks to recent laws, have a sole shareholder, Macaura could be restricted to
cases involving multiple shareholders.

Upon appeal, The Court of Appeal upheld the ruling of the lower courts. First of all,
the Court decided that this was not a situation where they should "lift the corporate
veil". To reach this conclusion the Court examined the requirements to "lift the veil".
Wilson J. explained:

‘The law on when a court may disregard this principle (the principle of separate
entity) by “lifting the corporate veil” and regarding the company as a mere
 “agent” or a “puppet” of its controlling shareholder or a parent corporation
follows no consistent principle. The best that can be said is that the “separate
entities” principle is not enforced when it would yield a result “too flagrantly
opposed to justice, convenience or the interest of the Revenue".

The Court decided that in the current case, lifting the veil would unfairly allow the
owner to enjoy the benefits of incorporation while avoiding the costs. The court also
rejected the owner's argument that he was a bailor (i.e., taking care) of the companies'
assets. Since the company still "possessed" the assets, they could not be considered as
bailed without "lifting the veil".

However, the court found that the owner, as insured, held an insurable interest in the
assets—that is, he had enough of a link to the assets to validly insure them (one
cannot insure, for example, a building they have nothing to do with).

In doing so, the court rejected the Macaura principle that limited an insurable interest
to those having legal or equitable title to an asset. Instead, they applied the "factual
expectancy test" (another test proposed by the House of Lords in Lucena v. Craufurd,
the 1806 case relied on for the Macaura decision). According to this test, in order to
insure something and recover for it, one must have "some relation to, or concern in
the subject of the insurance, which relation or concern by the happening of the perils
insured against may be so affected as to produce a damage, detriment, or prejudice to
the person insuring". Ownership, or title, to the insured asset is not required under this
test. (10 Marks)

c) Mutua is a director at Panda Mbegu Company Ltd. He holds an MBA from a

prestigious university and also holds the highest certification in procurement. He is
the head of the procurement and finance departments of the company. He recently
made a negligent procurement decision that resulted in heavy losses for the company.
In addition, six months ago Mutua approved a contract to purchase very expensive
cleaning material and equipment for Klin Klinx Co Ltd. The cleaning material is to
be used to clean the offices and premises of Panda Mbegu Co Ltd. The C.E.O of Klin
Klinx Co Ltd is an old friend of Mutua called Mutisya. Mike the managing director
of Panda Mbegu Co Ltd has just discovered that Mutisya secretly gave Mutua Kshs
500,000 as a ‘thank you’. Advice Panda Mbegu Co Ltd.

 Directors have a number of duties which they owe to the company. One of
then is to exercise reasonable care, skill and diligence - this must be
exercised to the standard expected of someone with the general knowledge,
skill and experience reasonably expected of a person carrying out the
 functions of the director (the objective test) and also the actual knowledge,
skill and experience of that particular director (the subjective test)

 In addition, directors are not supposed to make secret profits. This refers to
any personal advantage enjoyed by a Director over and above his entitlement
by way of remuneration. Directors must not benefit by virtue of their
position unless such benefit has been disclosed.

 Mutua has breached both these duties. He has not acted with the skill and
knowledge expected with someone with his qualifications. He has also
clearly made a secret profit which he has not disclosed.

 The company should sue Mutua. The remedies available to it are damages or
compensation and recovery of profit or account. Mutua can also be
summarily dismissed if his contract authorizes the same. (10
Marks)

(TOTAL 30 Marks)

QUESTION TWO
a) In the Salomon case Lord Macnaghten stated that the company is not at law the
agent of the subscribers. Under what circumstances would a court of law hold that a
company is an agent of another?

 On the rare occasions when they do find an agency relationship, they will
do so in order to frustrate some grave impropriety.
 In such cases, they have coupled the description of a company as an agent
with more (pejorative) uncomplimentary descriptions such as ‘sham’ ,
‘cloak’, ‘device’, ‘puppet’ or ‘creature’.
 In the case of Smith, Stone & Knight Ltd v. Birmingham Corporation ,
Lord Atkinson laid down the necessary questions one need to ask to know
if the company will constitute the shareholders’ agent for purpose of
carrying on its business;
i. Were the profits treated as the profits of the parent
company?
ii. Were the persons conducting the business appointed by the
parent company?
iii. Was the parent company the head and the brain of the
trading company?
iv. Did the parent company govern the adventure; decide what
should be done and what capital should be embarked on the
venture?
 v. Did the trading company make the profit by its skill and
direction?
vi. Was the parent company in constant and effectual control?

If in considering the answers to the questions, there is constant and

effectual control, then a relationship of agency would be inferred or
there would be no functioning autonomy.

(10 Marks)

a) State and briefly explain five consequences of incorporation

1. Corporate Entity or Independent Corporate Existence

The outstanding feature of a company is its independent corporate existence. A
partnership for instance has no existence apart from its members; it is nothing but a
collection of the partners.

On the other hand, a company is a juristic person/ a legal entity. It is a distinct legal
‘persona’ existing independent of its members. By incorporation under the Act, the
company is vested with a corporate personality which is distinct from the members
who compose it.

2. Limited Liability
The privilege of limiting liability for business debts is one of the principal advantages
under the corporate form of organization. The company being a separate person is the
owner of its assets and bound by its liabilities. Members even as a whole, are neither
the owners of the company’s undertakings, nor liable for its debts.

Where members (subscribers) exercise the choice to be registered as a company with

limited liability, the members’ liability becomes limited or restricted to the nominal
value of the share taken by them or the amount guaranteed by them.

3. Owning of Property or Separate Property

A company, being a legal person is capable of owning, enjoying and disposing of
property in its own name. The relevant part on owning property (section 16(2))
provides that “From the date of incorporation mentioned in the certificate of
incorporation … members of the company shall be a body corporate ... capable of
exercising all the functions of an incorporated company, with power to hold land ...”

The company becomes the owner of its capital and assets. The members are not the
several or joint owners of the company’s property since; “The company is a real
person in which all its property is vested, and which it is controlled, managed and
disposed of.”

4. Perpetual Succession
An incorporated company never dies. It is an entity with perpetual succession.
Perpetual succession will therefore mean that the membership of a company
may keep changing from time to time, but that does not affect the company’s
continuity.

Illustration: A, B and C are the only members of a company, holding all its
shares. Their shares may be transferred to, or inherited by X, Y and Z, who may,
therefore become the new members and managers of the company. But the
company will remain the same entity, in spite of the total change in membership.

5. Capacity to Sue and to be Sued

The company as a legal person can take action to enforce its legal rights and can
be sued for breach of its legal duties. Because the company is at law a different
person from its members, it follows that a wrong to or by the company doesn’t
legally constitute wrong to or by Company’s members. Therefore
a) A member can’t institute legal proceedings to redress a wrong to the
company.
b) A member cannot be sued to redress a wrong by company.

6. Transferable Shares
Incorporation and resulting separation of company and its members greatly
facilitates transfer of members’ interest. The freedom to transfer is both legally
and practically easy to attain. When a company is incorporated with its
liability limited by shares, these shares constitute items of property, which are
freely transferable. Transfer of shares is done in such a way that the transferor
drops out and the transferee steps into his shoes.

7. Capacity to contract
A registered company has capacity to enter into contractual relations. For
instance, in furtherance of the objectives set out in the memorandum of
association and in exercise of the powers set upon it. As a legal person a
company has capacity to hire and fire.
(Any five correct answers two marks each…. 10 Marks)

(TOTAL 20 Marks)
QUESTION THREE

a) Write brief notes on the following market segments of the Nairobi Securities
Exchange.
i) Main Investments Market Segment (MIMS)
It is the main quotations market with more stringent listing requirements
similar to past structure of the exchange.

ii) Alternative Investments Market Segment (AIMS)

This is for medium sized enterprises which have a share capital of between 20
Million and 49 Million Shillings. AIMS were set up so as to provide access to
the capital markets for medium sized companies with high growth potential.
This provided an alternative method of raising capital to those companies
that find it difficult to meet the more stringent listing requirements of the
MIMS.

iii) Growth Enterprise Market Segment.(GEMS)

GEMS was launched in 2013 by NSE to provide more options for SMEs
finance, especially long term funding. The GEMS provides favorable listing
requirements that were tailored for SMEs. GEMS can admit companies that
have been in operation for only a year. It does not impose a requirement for
having turned a profit recognizing that some SME’s often have a difficult
inception. This was particularly necessary in order to respond to changing
needs of issuers and to provide access to capital markets to younger
innovative companies with high growth potential. These companies are
mainly start ups or new companies with no profit operational track record.

iv) Fixed Income Securities Market Segment (FISMS)

It was introduced as a special trading window for fixed income securities. It
aims at providing a separate independent market for fixed income securities
such as treasury bonds, corporate bonds, preference shares and debenture
stocks. It expanded the bond market at the exchange.

v) Futures And Options Market Segment (FOMS)

FOMS is to be introduced at a future date. It will provide a mechanism to
market participants to hedge against the risk associated with market
reliability. The market segment will be developed and implemented after
further research on necessary operational systems.

(10 Marks)
b) State and briefly explain five corporate governance considerations that must be
adhered to by a company that wants to be listed in the Nairobi Securities
Exchange.

1) The company must have at least a third of the Board as nonexecutive

directors.

2) The company should establish an audit committee in compliance with

guidelines on corporate governance issued by the Capital Markets Authority.

3) The Chairman of the company shall not hold such position in more than two
listed companies at any one time, to ensure effective participation in the board.

4) The Chief Financial Officer and the head of accounting department shall be
members of the Institute of Certified Public Accountants established under the
Accountants Act.

5) The Company Secretary of every issuer shall be a member of the Institute of

Certified Public Secretaries of Kenya established under the Certified Public
Secretaries of Kenya Act.
6) The auditor of the company should be a member of the Institute of Certified
Public
Accountants and shall comply with the International Standards of Auditing.
7) The directors and senior management of an applicant must collectively have
appropriate expertise and have relevant experience for at least one year prior
to the listing.

8) As at the date of application and for a period of at least two years prior to the date of
the application, no director of the issuer shall have
a) any petition under bankruptcy or insolvency laws in any authority pending or
threatened against any director (for individuals), or any winding- up petition
pending or threatened against it (for corporate bodies) .
b) any criminal proceedings in which the director was convicted of fraud or any
criminal offence, nor be named the subject of pending criminal proceeding, or
any other offence or action within or outside Kenya; or
c) been the subject of any ruling of a court of competent authority or any
government body in any authority, that permanently or temporarily prohibits such
a director from acting as an investment advisor or as a director or employee of a
stockbroker, dealer, or any financial service institution or engaging in any type of
business practice or activity in that authority

9) The issuer shall ensure continued retention of qualified management during

listing and no change of management for a period of twelve months following
the listing other than for reason of a serious offence that may be considered to
affect the integrity or be inappropriate for management of a listed company
 (Any five correct answers two marks each…. 10 Marks)
(TOTAL 20 Marks)

QUESTION FOUR

a) ‘According to the Companies Act, a small company does not have to prepare annual
financial statements or appoint an auditor. However, other incidental laws will
require such a company to prepare these statements.’
i) State two requirements for a company to be termed as a small company
 A small company is the one which has two or more of the following
requirements;
 Has a turnover of less than fifty million shillings (KES 50,000,000)
 Net assets value in balance sheet at the end of the year is not more
than twenty million shillings (KES 20,000,000)
 Does not have more than fifty employees. (4 Marks)

ii) State and briefly explain three incidental laws or reasons that can compel a
small company to draw annual financial reports.
 Tax Law.
 Bankruptcy Law.
 In order to attract investors through publication in a prospectus.
 In order to acquire a bank loan
(6 Marks)

b) Outline in detail the procedure for the dissolution of a company.

 If the Registrar reasonably believes that a company is not carrying on business
or is not in operation, the Registrar may send to the company by post a letter
inquiring whether the company is carrying on business or is in operation.
 If the Registrar does not within one month after sending the letter receive any
answer to it, the Registrar shall, within fourteen days after the end of that
month, send to the company by post a registered letter
 Stating that no answer has been received in respect to the first letter
 If no answer is received to the second letter within one month after its date, a
notice will be published in the Gazette with a view to striking the name of the
company off the Register.
 If at the end of the period specified in the letter the Registrar or the fails to
receive an answer referring to the letter sent, or receives an answer that the
company is no longer in operation, the registrar strikes of the company’s name
from the Register
 The Registrar shall publish in the Gazette a notice to the effect that the name
of the company has been struck off the register
 On publication of the notice in the Gazette, the company is dissolved
 (10 Marks)
(TOTAL 20 Marks)

QUESTION FIVE
Write detailed notes under the following headings on the topic of Insider Trading.
i) An Insider
 Has access to valuable non-public information about a corporation
(this includes a company’s directors and high level executives insiders)
 Ownership of stocks that equals more than 10% of a firms equity
(5 Marks)
ii) Trading
 Buying or disposing shares
 Buying or selling company securities
 Subscribing or agreeing to subscribe to company securities
 Pledging or dealing in any company securities (5 Marks)

iii) Why insider trading is wrong

 Insider trading can lead to a market plunge which can hurt the
economy and in extreme cases lead to a depression.
 Need for fair competition
 To inspire investor confidence in the stock market.
 The greatest beneficiaries are almost always the big wigs (5 Marks)

iv) Penalties/Fines
 The Capital Markets Authority has authority to prosecute crimes of
Insider Trading
 Section 32 E indicates that if an individual is found guilty of the
crime of insider trading, the individual will be liable to a fine not
exceeding two million five hundred thousand shillings or to
imprisonment for a term of 2 years and payment of the amount of
the gain made or loss avoided.
 If it is a company it will be fined up to five million shillings and
payment of the amount of the gain made or loss avoided.
 On any subsequent offence, in the case of an individual to a fine
not exceeding 5 million shillings or to imprisonment for a term of
7 years and payment of the amount of twice the gain made or loss
avoided.
 If it is a company it will be fined up to ten million shillings and
payment of twice the amount of the gain made or loss avoided
(5 Marks)
(TOTAL 20 Marks)