What is the nature of the company and thus what rules apply to it?
Based on the case study, it can be concluded that Creative Pty Ltd is a private limited company and this is attributed to the fact that that it has five members of the board of directors which is considered as the maximum number for a private company. The director is charged with the administration and management of the company. Statistics indicate that the company has been doing well and this is exhibited by the huge profits generated and therefore it is expected to continue operating indefinitely. The continuous operation of the company is the key objective of the directors, and they are therefore seeking to obtain some additional finances to support the activities of the firm. In every particular enterprise, the circumstance of insolvency often results in the inability of such an organization to meet its dues when they arise and this could be the case for the Creative Pty Ltd. Harry as one of the directors of the company is thinking to get more funds to help in running the operations of the business.
There are certain rules which must be complied with during the formation of a private company, and this was followed during the formation of the Creative Pty Ltd. Such rules entail, a minimum number of two directors and a maximum of seven directors and the first two of the directors are typically appointed by the shareholders during a general meeting convened. A critical rule is on the transfer of shares where the share of the company are not easily transferred to the public typically without the consent of the other shareholders and this, therefore, restricts the buying and selling of the shares to the public (Light, 2015).
Another rule is that during the formation of the company, the minimum number of shareholders required should be two and a maximum of 200. Such a number is required to help in proper control, coordination and even raise adequate capital for the company. The shareholders are also required to contribute a certain amount of capital during the formation of the company to enable a variety of task to be accomplished such as registration and payment of other expenses. The shareholders of the company are also liable for the debts and loss when they arise, and therefore they have limited liability (Light, 2015).
During the formation of such a company, all the stakeholders are informed about their limited liability to the firm. However, there are certain exceptions of limited liability and such members usually have the general liability in the sense that their assets are not to be sold due to the existing loss or debts. Further, there is the rule on the minimum subscription by the members of the company. During the formation of a private limited company, the members are expected to subscribe with a certain amount as stipulated in the companies act. In regards to the act, once a minimum subscription has been attained, the shares can be exchanged within the public arena.
Can the company issue shares? What are the pros and cons of holding a share issue?
Based on the rules of the Company Act, a private company can issue shares, however not to the public since they are not liquid and therefore hard to value (Means, 2017). The holding of shares is a strategy by an investor which entails putting of shares at a particular position for a particular period in regards to the technical indicators and the various fluctuations in the stock prices. There are certain benefits and limitations which are associated with such a process and this as discussed below.
When a particular investor sells a security in a year, he or she will typically receive gains which are taxed as an ordinary income. Additionally, such a tax rate could rise the longer the investor sells the securities (Oranburg, 2016). However, under the circumstances in which the shares are held for some time, the tax rates are likely to decline resulting in low capital gains tax rates. It is therefore concluded that the capital gains tax rates are likely to be low when the shares are held instead of being invested.
According to Allayannis et al., (2017), the recent examination of the class of securities has revealed an increase in the returns on those shares which have been held for a long time of period. Such shares have been considered to be some of the most riskier and have resulted in high returns compared to other conservative shares. Often there are fluctuations in the share markets which have resulted in greater impacts on the returns. However, holding of the shares can be considered as an escape from the fluctuations and hence high returns.
Investors are often emotional, and this is an inherent behavior associated with them. They tend to believe that they are good timers of the share markets, but they only withdraw from the investment upon realizing that the market is falling (Oranburg, 2016). However, when the shares are held, the investors can easily determine the right time to put their investment of shares into the market.
Shares are typically considered to be long term investments, and hence their prices are likely to drop or even rise in value over a certain period (Allayannis et al., 2017). However, when the shares are held for some time, the investors are given the opportunity to ride out some of the lows and highs during which they can obtain better returns on investment.
When shares are held for a particular period, it provides for the potential of an investor to earn dividend income, and this is typically in the form of stock allocations or cash. Such a passive income improves the return on investment over time (Ramos, 2014). Based on the above mentioned advantage, it can be concluded that non-holding of shares mitigate the chance to earn dividends.
What are the relevant rules which apply to the different forms of financing and what approval does Harry need to obtain on behalf of the company in order to proceed?
The holding of shares may result in low profits being generated by a company, and this can be attributed to the inflations in the market. Such inflations may at times reduce the fair values of the shares and thus low profits (Ramos, 2014). The other key limitation of holding shares is that it results in a decline of prices of shares in the market. The decline in the prices of the shares leads to loss of value which further cause a loss to a firm. There are also chances that such a holding of shares will lead to high costs being incurred by the concerned company. The costs may include, carrying cost and cost of purchase.
The relevant rules which apply to a variety of financing techniques are classified into five Cs and include the following;
The amount of the principal and the rate of interest are basic conditions of a loan which the lender of finance takes into account (Shoup, 2017). They typically entail how the borrower will use the money. Under this rule, the lender does not use the signature loan.
Buchanan (2014), argues that under this rule, the lender looks into the track record of paying the loan and the reputation of the borrower. Such a piece of information usually appears in the borrower’s credit reports.
Under the earnings stripping rule, the amount of interest by the lender is limited based on the amount of earnings. The interest which is deducted depends on the earnings before interest, taxes, and depreciation (Shoup, 2017).
According to Niskanen (2017), the general anti-bias rule is generally used on transactions whose capital structure is used to restore an equity instrument which is outstanding the amount of interest usually deducted during such a process is considered to be in excess.
The rule on capacity is used to measure the ability of the borrower to repay his or her debts. It involves making a comparison of recurring debts with the incomes of the borrower (Shoup, 2017). The length of time is also taken into account by the lenders of debt finance.
Often before an individual is given the loan, he or she has to attach security. Such security gives the lender an assurance that in case of default by the borrower, the lender can have the collateral (Buchanan, 2014)
The thin capitalization rule sets a maximum debt to equity ratio which is to be used. When estimating the amount of tax to be charged and it is found out that the interest on the debt is above ratio, it is not subtracted (Brooks, 2014). The debt to ration often varies based on the economic conditions.
What are the risks of insolvency faced by all directors if the company cannot obtain the necessary funds?
The above rules typically provide for certain terms and conditions which must be met by the borrower and thus Harry should get the approval of the other directors on the type of financing. Such a financing scheme should have the capacity to allow the company to operate continuously.
There a variety of consequences which usually arise in the case of insolvency of a particular company especially to the directors. Some of the risks to the directors due to the insolvency of the firm are as discussed below;
Elyasiani & Zhang (2015), argues that when a company becomes insolvent, the directors will automatically lose the power as directors. They will therefore not be in a position to run and manage the affairs of the company. The liquidator will take over and begin to sell the assets of the company to pay the creditors owed by the company.
As a director, you will get disqualified, and the official receiver of the company will be appointed to run the affair of the company. Such an official receiver will be charged with assessing the financial books and records of the company to check for any irregularities by the director (Gerner-Beuerle & Schuster, 2014). The key examples of the director disqualification entail, wrongful trading, being insolvent as a result of certain illegal actions, on-payment of taxes and operating on crown debts, disposing of the company’s property and failure to send the returns made to the companies house among others.
When obtaining finance on behalf of the company, you are required to provide a personal guarantee. In the case of insolvency, as a director, you will be expected to be personally liable for the amount based on the personal funds (Huebner & Klein, 2015).
According to Chan, Koh & Karim, (2016), when the liquidator after the completion of his investigation and it is found out that the director might have sold the company’s property leading to insolvency. Such an asset will be returned to the company and later disposed to pay off the creditors since such an action is considered as detrimental to the company.
According to Finch & Milman (2017), the law provides clearly some of the steps which can be taken by a director of a company under the circumstances of insolvent trading liability. Harry and his fellow directors have a wide variety of measures to mitigate themselves from insolvent trading liability. For instance, the directors can use safe harbor to protect themselves. The safe harbor typically allows the directors to be only liable for the particular debts which arose when the company became insolvent (Aier, Chen, & Pevzner, 2014). Under such a measure the directors will be expected to ascertain whether the actions they took during the insolvency and hence liquidation of the company would have led to far much better outcomes instead of terminating the company.
The use of directors’ defense is also another step and measure which Harry and his fellow directors can resort to. The directors’ defenses enable them to defend their actions which would have been able to stop the company from becoming insolvent. In their defenses, they should state clearly the actions they undertook which would have resulted in better performance of the company (Omar, 2016). Also, they have to indicate that Creative Pty Ltd is solvent and will, therefore, continue with its operations for a long period of time. The directors should also seek independent legal advice from a lawyer. Such a lawyer should have the capacity to critical advice on the way forward for them. However, the advice must be aligned with the key objectives of the company.
References
Aier, J. K., Chen, L., & Pevzner, M. (2014). Debtholders’ demand for conservatism: Evidence from changes in directors’ fiduciary duties. Journal of Accounting Research, 52(5), 993-1027.
Allayannis, G., Eaker, M. R., Bocock, A., & Allayannis, G. (2017). The Dynamis Fund: An Energy Hedge Fund. Darden Business Publishing Cases, 1-12.
Brooks, C. (2014). Introductory econometrics for finance. Cambridge university press.
Buchanan, J. M. (2014). Public finance in democratic process: Fiscal institutions and individual choice. UNC Press Books.
Chan, S. G., Koh, E. H., & Karim, M. Z. A. (2016). The Chinese banks’ directors and their risk-taking behavior: A corporate governance and finance perspective. Chinese Management Studies, 10(2), 291-311.
Elyasiani, E., & Zhang, L. (2015). Bank holding company performance, risk, and “busy” board of directors. Journal of Banking & Finance, 60, 239-251.
Finch, V., & Milman, D. (2017). Corporate insolvency law: perspectives and principles. Cambridge University Press.
Gerner-Beuerle, C., & Schuster, E. P. (2014). The evolving structure of directors’ duties in Europe. European Business Organization Law Review (EBOR), 15(2), 191-233.
Huebner, M. S., & Klein, D. S. (2015). The Fiduciary Duties of Directors of Troubled Companies. American Bankruptcy Institute Journal, 34(2), 18.
Light, R. S. (Ed.). (2015). Structuring venture capital, private equity and entrepreneurial transactions. Wolters Kluwer Law & Business.
Means, G. (2017). The modern corporation and private property. 2nd edn. New York: Routledge. eBook ISBN 9781351479356
Niskanen, J. (2017). Bureaucracy and representative government. 1st edn.New York:Routledge. eBook ISBN 9781351530415
Omar, P. (Ed.). (2016). International insolvency law: Themes and perspectives. Oxford, UK: Routledge.
Oranburg, S. C. (2016). Start-up financing. Start-Up Creation (pp. 57-73). doi: 10.1016/B978-0-08-100546-0.00004-2
Ramos, B. M. V. (2014). PCV Holding: Who’s next?-Planning the Succession (Doctoral dissertation).
Shoup, C. (2017). Public finance. New York: Routledge. eBook ISBN 9781351495738
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