Fundamental Laws in the UK - Assignment Example

? Question-Answers on Laws in UK Answer a) Section 560 of the Companies Act 2006 starts by defining ‘equity shares’ and goes on to the rightof pre-emption for existing shareholders. It states that “a company that is proposing to allot equity securities must offer them to existing shareholders first (that is, on a pre-emptive basis)”. (Companies Act 2006, 2008, P.134) The basic reason for this is that an existing shareholder should be given the right to protect and maintain his share of total equities of company by having the opportunity to buy out a new supply of equity shares. Also, it puts the existing shareholders in a more commanding position. An example of this is the Dutch Bureau of Agricultural Land Management which is responsible for the buying of plots of a farmland in rural areas. This organization, as existing shareholders also enjoys pre-emptive rights over the purchase of all such land. Another example is the Flemish Land Company in Belgium who are entitled to override other candidates and buy out farmland should it be up for sale. (OECD, 1998, p.22) b) There are certain exceptions or disapplication of pre-emption rights. They are as follows. The right of pre-emption is not applicable to the sale of treasury shares, held by the company, i.e. issue of equity shares as given by section 560(2) (b) of the Companies Act 2006. Since Treasury shares are bonds or gifts of the government, no pre-emptive rights may be applied to them. If the directors of a company are given the power to allot equity shares by an article of the government or by a special resolution adopted by the concerned company (as stated in section 561 of the Companies Act), the pre-emption will not apply. Even if it does apply, the allotment of equity shares will be done with some modifications as per the directors’ decisions. For example, in 1935, a special decree was enacted in France that put aside the pre-emption rights upon the request of members of the Board of public sector companies. (Bahnemnn, 2008, p.31) As the pre-emption rights are inside affairs for a company, it has the right to decide whether or not to follow them and in which cases to follow them and vice versa. However, if pre-emption rights are disapplied due to an act of the government, the decision may or may not prove to be beneficial for the company. It is advisable for a company to take its own decisions for optimality. A company may decide that the pre-emption rights will not apply to a specified allotment of shares or it shall apply with some modifications stated in the resolution. The company may do this by putting a special resolution into effect. (Companies Act 2006, Elizabeth II, Part 46, n.d, p.276) If the resolution of the company benefits it and all its shareholders, it this move is welcome but if it is taken due to personal grudges between members of the management, it will lead to injustice and unfairness and harm the company. Answer: 2 a) “A Business Angel investor is a high-net-worth individual, who typically provides capital, in the form of debt or equity from his or her own funds to a small private business owned and operated by someone else who is neither a friend nor a family member”. (Talmor & Vasvari, 2011, p.16.1) A Venture Capitalist, on the other hand, is “not only a financier but also either an intelligent evaluator who performs due diligence on ventures, a venture’s partner who can add value to the venture, or both”. (Cumming, 2010, p.299) There are some advantages enjoyed by the Business Angels over Venture Capitalists. They are given as follows. i) The transaction costs incurred by business angels are much less than the transaction cost of venture capitalists. The transaction cost for business angels lies between the ranges of $100,000-2,000,000 whereas that for venture capitalists is higher than $2,000,000. ii) The operations of business angels are geographically more dispersed than those of venture capitalists. The existence of venture capitalists is limited to a few areas where there are many financial technology organizations. iii) Business angels invest in a variety of low-technology companies with low start-up costs whereas the venture capitalists invest in only hi-technology and bio-technology industries. The companies with low start-up costs may yield high dividends. So, the profit levels of business angels may be higher than the venture capitalists in spite of investing less than them. (Talmor & Vasvari, 2011, p.16.1) For example, the Techshop Venture was started by an investment from the business angels. Another example is Trakus, a company manufacturing monitory systems, that began with a start-up cost of $4 million borrowed from a combination of business angels and a venture capitalist firm called Venture Investment Management Company. (Leach & Melicher, 2009, p.108) However, there are disadvantages suffered by business angels as well, in comparison to venture capitalists. i) Business angels do not invest consistently in the same firms whereas venture capitalists spend two-thirds of their resources on expansion of their existing portfolio firms. This is a more professional and stable approach to business and may prove to be more lucrative. ii) Business angels dictate some terms of business. This limits the power of the entrepreneur. Since business angels seldom follow the same line of investments, their expertise on a certain industry would also be less, resulting in faulty business decisions. Venture capitalists, on the other hand, are knowledgeable about they invest in since they specialize in hi-tech and bio-tech industries. So, their suggestions to business may prove beneficial. iii) Business angels do not enjoy the high level of prestige and good reputation enjoyed by most venture capitalists. This deprives them of gaining assistance in their ventures, from investment banks. (Federick & Hegarty, 2006, p.73) b) It will be advantageous for a company to raise fresh capital with the aid of a venture capitalist. This is due to a number of reasons. The company will have to bear only a minimum amount of risk or no risk in the investment as venture capitalists bear almost all risks. This will provide insurance to the company. However, the company can claim a part of the dividends from risk-taking by monitoring investments and decisions taken. (Reid, 2003, p.64) In addition to this, venture capitalists are industry-specific. So, they have a sizable amount of knowledge about the workings of the industries. They may organize themselves into Board of Directors for the company they have invested in and use this knowledge for business networking and for policy formulation of business. The reason for such active involvement is, as stated before, an immediate financial stake in the shares of the invested company. Thus, using a venture capitalist to gather capital is not only advantageous in the fundamental sense but also has added benefits. (Frankel, 2005) For example, the US GAO studied the development and sales of some companies that had borrowed $209 million from venture capitalists in 1970s and found that these companies showed a sales growth of 33 percent per annum and created 130,000 jobs in the economy. (Green, 1991, p.70) Answer: 3 A third party is one who is not directly in association with the auditor but who may have received an auditor’s report and assuming it fully credible, had used it in some of his work. Thus, a negligent audit report would have an adverse effect on the third party as well making him eligible for compensation for damages. In order to claim damages, the third party must prove the duty of the auditor and the breach of that duty, in the context of the audit report, the causal relationship and the actual damages caused due to the negligence of the auditor. (Auditing: A Business Risk Approach, 2008, p.731) In the case of Bily Vs Arthur Young & Co., the plaintiff had invested on the shares of Osborne Computer Corporation, based on the report given by the auditor, Arthur Young, hired by the company. However, he suffered damages as the company sales fell. The case was went on for 13 weeks at the end of which the jury concluded that the accused will have to pay compensation for damages to the plaintiff as the auditor can be held liable to foreseeable third parties who rely on such reports. (Lucas, 1992, p.377) However, in this case the auditor can defend himself, citing ‘lack of privity’ counter-accusation on the third party. The auditor can prove that the terms of the contract stated that no third party can use the audit report as a reference. Hence, he cannot be held responsible for any damages accruing from the negligent report, to the third party. In fact, the Ultramares Rule states that the auditor is liable only to his direct client, i.e. the parties whose primary benefits are intended to be served by the report. If this law is applicable, then a third party cannot demand compensation for damages. (Whittington & Delaney, 2000, p.84) For example, in Landell Vs Lybrand in 1919, the accounting firm Lybrand Ross Bro. and Montgomery was sued by a plaintiff who claimed that he had suffered losses by investing in Employers’ Indemnity Company, based on an audit report from Lybrand, but the case was dismissed on the pretext that the auditor is liable only to the client who hired him, no third parties. (Clikeman, 2009, p.161) Again, another viable defense for the auditor will be to claim that the third party may have misinterpreted the facts and results given by him in the report. This would actually allow him to accuse the plaintiff on charges of defamation. An example will make this clear. In the case of Hughes Vs Merrett, the audit firm claimed that the damages suffered by the plaintiffs were partly due to their faulty interpretation of the report and in the process they had brought the firm a bad name. Thus, they demanded compensation for those damages. However, the case was dismissed by the court. (Turley, 2005, p.122) Answer: 4 a) A company is required to disclose financial information about its assets and liabilities, in order to be registered. There are three main reasons for this requirement. i) A summary of the financial record of the company will help the reader or authority to decide upon the level of credibility to be given to the company under scrutiny. ii) A record of financial information for a period of time will enable the authority to understand the magnitude and composition of change in the calculations of assets and liabilities. iii) The disclosed financial information will also help evaluate the impacts on the assets and liabilities of the company from one period to another. (Kieso, Weygandt & Warfeild, n.d, p.1025) For example, Disclosure has been the most defining principle of the British Company Law. (Mantysaari, 2010, p.190) The fatal effects of not disclosing financial information by companies or organizations is evident from the financial crisis that occurred in the emerging Latin American market. This occurred due to inefficient communications about finances. (Inter-American Development Bank, 1999, p.1) b) The differences in Financial Reporting between the public and private sector occurs in purpose, scope and performance measure method and other issues like the nature of audit report. The fundamental points of difference between these two sectors have been highlighted as follows. For examples, the terms of disclosure of public sector banks and private sector banks will show much difference. i) A number of non-financial measures that take into account social and economic issues are applied to disclosure of financial information by the public sector. Private sector, on the other hand, is evaluated only by financial measures. ii) The public sector is expected to disclose financial information to a greater extent than the private sector. This may even include disclosing detailed financial estimates for plans. Due to the lack of competition in the public sector, such a degree of disclosure is possible. iii) The financial records of the private sector companies is studied more carefully and put to more rigorous methods of measurement than those of the public sector. This is due to the fact that there is a greater probability and extent of records being manipulated, in case of private companies. (Henley, 1989, p.16) There are difference in standards of disclosure of financial information between the public and private sector due to the existing differences in their structures and operations. Although some aspects are common, the totality of the subject is so multi-dimensional and complex that no generalization is possible and thus, there are no common standards of disclosure and measurement. (Henley, 1989, p.16) References Auditing: A Business Risk Approach (2008). USA: Thomson South-Western. Bahnemnn, B (2008).Rights Issue related Discounts in France, Germany, Switzerland, and the United Kingdom. Germany: GRIN Verlag. Clikeman, P.M (2009). Called to Account. New York: Routhledge. Companies Act 2006 (2008), Deutschland: Verlag Goyang Media Ltd. Companies Act 2006, Elizabeth II, Part 46 (n.d), Britain: Great Britain. Cumming, D (2010). Venture Capital: Investment Strategies, Structures and Policies. New Jersey: John Wiley and Sons Inc. Federick, H & Hegarty, C (2006). Sources of Funding for Ireland’s Entrepreneurs. Ireland: Cecilia Hegarty & Howard Federick. Frankel, M.E.S (2005). Mergers and Acquisitions Basics. New Jersey: John Wiley and Sons. Green, M.B (1991). Venture Capital: International Comparisons. London: Routhledge. Henley, D (1989). Public Sector Accounting and Financial Control. Great Britain: T.J Press (Padstow) Ltd. Inter-American Development Bank (1999). Financial Disclosure. New York: Inter-American Development bank. Kieso, D.E, Weygandt, J.J & Warfeild, T.D (n.d). Intermediate Accounting, Volume 2. Leach, J.C & Melicher, R.W (2009). Entrepreneurial Finance. USA: South Western Cengage Learning. Lucas, C.J (1992). Bily Vs Arthur Young & Co. Supreme Court of California, 370, p.377 Mantysaari, P (2010). The Law of Corporate Finance. Berlin: Springer Verlag. OECD (1998). Adjustment in OECD Agriculture. France: OECD Publications. Reid, G.C (2003). Venture Capital Investment: An Agency Analysis of UK Practice. USA & Canada: Routhledge. Turley, S (2005). Current Issues in Auditing. London: Paul Chapman Publishing Ltd. Talmor, E & Vasvari, F (2011). International Private Equity. UK: John Wiley and Sons Ltd. Whittington, O.R & Delaney, P.R (2000). Wiley CPA Exam Review 2009: Regulation. USA: The American Institute of Certified Public Accountants, Inc. Read More