Brady v Brady Case Summary [1988] 2 All ER 617 HL

Brady v Brady [1988] 2 All ER 617 HL Case Summary

The maintenance of share capital is an important principle in company law. ^[1] Paid up share capital must not be returned to the shareholders; that money becomes the company’s capital, and it must be maintained because it is the fund to which creditors will turn to over debts owed; therefore, if a shareholder wants to claim his investment in the company, he must sell his shares to another investor rather than selling them back to the company. ^[2]

As a consequence of the maintenance of share capital, a company must not purchase its own shares and a public company must not give financial assistance for the purchase of the company’s shares. ^[3] Financial assistance means a gift, a loan, guarantee, assignment or any other transaction by which the purchaser is directly or indirectly put in funds.^[4] Any other transaction may, however, amount to assistance if it reduces the company’s assets. ^[5]

In Brady v Brady ^[6] a company with an established business in haulage and drinks ran into difficulties because of disagreements between the two brothers who were majority shareholders. In order to save the business an agreement was reached to divide it between them: one would keep the haulage business and the other one the drinks business. To effect this, a scheme of corporate reorganisation was formulated: the businesses were to be divided equally but the main company was left in existence. The defendants felt that the assets had not been distributed equally and they refused to complete the transaction, claiming that the financial operation involved unlawful financial assistance; the claimants started an action for specific performance.^[7]

The Court of Appeal ruled in favor of the defendants and stated that the scheme, which required financial assistance for the purchase of its own shares was not in the interest of the company.^[8] Furthermore, they considered the way in which the scheme was carried out by creating indebtedness of Motoreal, one of the subsidiary companies to Brady, the main company, was ‘worthless and incapable of amounting to consideration’.^[9]

The House of Lords overruled the decision of the Court of Appeal, and stated that there was no misfeasance and furthermore, the interests of the creditors would improve in the long term. The transaction was therefore in good faith and in the interest of the company. However the House of Lords gave a narrow meaning to ‘some larger purpose’ and therefore severely restricted the use of the provision.^[10]

Under s 151 of the Companies Act 1985 (CA 1985), which was the legislation applicable to Brady, it is unlawful for a company to give financial assistance to buy its own shares or for discharging a liability incurred for the acquisition of the shares.^[11] Exemptions are provided in s 153. Apart from that, there is a ‘whitewash’ procedure under ss 155 and 158 enabling companies to give financial assistance through a shareholder’s special resolution and directors giving a statutory declaration stating the company was solvent.^[12]

Under current company legislation, s 151 CA 1985 has been replaced by s 678 of the Companies Act 2006 (CA 2006). However, under s 678(1) CA 2006 it must be shown that financial assistance was given before or at the same time as the acquisition. ^[13] There are two exceptions from s 678(1) under s 678(2): (a) where the principal purpose of the transaction is not to give financial assistance, and (b) where the financial assistance is incidental to some larger purpose. The assistance must be given in good faith in the interest of the company.^[14] The general prohibition about financial assistance under the 1985 Act was repealed if related to financial assistance from a private company; therefore the exemptions do not apply to a private company either.^[15]

In common law, the courts looked at financial assistance in a more liberal way after Brady, particularly in borderline cases.^[16] In Parlett v Guppys (Bridport) Ltd^[17] the Court of Appeal did not find a breach of s 151 CA 1985 as the main assets of the company had not been reduced. The courts took a similar view regarding the infringement of s 151 if there were two ways of effecting the transaction and only one of them would infringe s 151 as seen in Grant v Lapid Development Ltd.^[18]

In more recent cases, the courts have considered in detail the commercial transaction per se in order to decide whether there is financial assistance for the purpose of acquiring shares. ^[19] In MT Realisations Ltd (in liquidation) v Digital Equipment Co Ltd ^[20] the Court of Appeal did not find financial assistance. This case concerned inter-company loans payable on demand which were secured by fixed and floating charges. There was no other alternative but to pay the loans or allow the creditors to enforce their security; therefore, as the company had no choice in the matter, there was no financial assistance.^[21]

The legal position of companies regarding financial assistance has changed since the enactment of the CA 2006. Not only has financial assistance been repealed for private companies but the Act allows for financial assistance in public companies in some cases, for instance, when it is connected to an Employee Benefit Trust under s 682(2)(b), providing that the share scheme falls within the statutory definition and providing the assistance comes out of distributable assets. ^[22]

Finally, the CA 2006 has codified the duties of directors under ss 171-177; these duties must be complied with when directors are considering giving financial assistance, particularly the duty to act within the powers given to them by the constitution under s 171 and the duty to promote the success of the company for the benefit of its members under s 172. Apart from that, the directors are under a duty to consider the company’s creditors; therefore if the giving of financial assistance would cause the company to become insolvent, the director has to refrain from allowing such assistance.^[23]

In conclusion, the CA 2006 has simplified transactions for private companies, for instance, entering into certain kind of loans, guarantees, indemnities and funding arrangements, but public companies are under a more stringent regime within the Act and must ensure that they do not contravene the financial assistance provisions in the legislation.

Footnotes

^[1] Alexis Mavrikakis, Helen Watson, Christopher Morris, Nick Hancock, Business Law and Practice (College of Law Publishing 2013) 189

^[2] Ibid, 190

^[3] Ibid

^[4] Anthony Arlidge, Jacques Parry, Arlidge and Parry on Fraud (Sweet & Maxwell 2013) Chapter 14, Company Fraud, Financial assistance for the acquisition of shares, 14-045. Available through Westlaw UK> search books> Arlidge and Parry on Fraud. Accessed on 13 September 2015

^[5] Mavrikakis (n 1) 196

^[6] [1988] 2 All ER 617 HL

^[7] D L Morgan, Brady v Brady – a family feud (1988) Journal of Business Law, 412-415

^[8] Ibid

^[9] Ibid

^[10] Mavrikakis (n 1) 196

^[11] Mavrikakis (n 1) 196

^[12] Natalie Smith, Sarah Spencer, Financial Assistance under CA 2006 (2009) 993 Tax Journal, 2

^[13] Ibid

^[14] Mavrikakis (n 1) 196

^[15] Smith (n 12)

^[16] David Milman, Financial assistance in the acquisition of shares: a continuing concern (2003) 11 Company Law Newsletter 1-4

^[17] [1996] BCC229

^[18] [1996] BCC 410

^[19] Mavrikakis (n 1) 196

^[20] [2003] EWCA Civ 494

^[21] Mavrikakis (n 1) 197

^[22] Smith (n 12)

^[23] Smith (n 12)