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Review Your SQE 1 Practice Records

Examination Timing: 00H02M23S

Michael operated a business printing logos on sports clothing and equipment. Initially, he operated as a sole trader but then incorporated a company, M.J. Ltd., and sold his business to the company in exchange for the entire issued share capital of 50,000 shares with a nominal value of £1 each. His business had been independently valued at £70,000 before the sale, so Michael excluded a range of plant and machinery from the sale agreement. He then leased this equipment to the company for an agreed fee. Michael also loaned the company an additional £10,000 to purchase new computer equipment and software, securing a charge over the equipment as collateral for the loan. Due to various reasons, the company failed and owed money to several creditors. 

Michael wants to know how much of his investment in the business, if any, would be returned to him.

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The principle of separate legal personality, as confirmed by the landmark case Salomon v A Salomon & Co Ltd, dictates that a company is a distinct legal entity from its shareholders. Therefore, even though Michael is the sole shareholder and sold his business to the company, M.J. Ltd. is treated as an independent entity. As a creditor, Michael can recover the plant and machinery he leased to the company because he retains ownership. Additionally, since he has a charge over the equipment purchased with his loan, he can recover his £10,000 loan by seizing the collateral or from the company's assets during liquidation, provided the charge is valid and properly registered. 

Key Point: The doctrine of separate legal personality protects shareholders by limiting their liability to their investment in the company. However, as secured creditors, shareholders can recover loans made to the company based on the security provided, ensuring their rights are protected even in the event of the company's insolvency.

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Certainly! Let's explore other potential scenarios or considerations in Michael's situation.

In addition to recovering the plant and machinery he leased to the company and the £10,000 loan secured by collateral, Michael should consider the following possibilities:

1. **Unsecured Creditors and Proceeds from Liquidation**: If there are any remaining assets after secured creditors (including Michael, in this case for his £10,000 loan) and preferred creditors (such as employees and certain tax authorities) are paid, Michael, as a shareholder, may receive a portion of those assets. However, this often amounts to very little in a failed company scenario.

2. **Possible Personal Guarantees**: If Michael provided any personal guarantees for the company's debts, he might be personally liable to the extent of those guarantees. Conversely, if he did not, his liability remains limited to his investment in the company's shares.

3. **Misfeasance or Wrongful Trading Claims**: Directors can be held personally liable if found guilty of misfeasance or wrongful trading. However, since Michael appears to have conducted transactions transparently and with appropriate security measures, this is less likely to apply unless there is evidence of misconduct.

4. **Creditors' Voluntary Arrangements (CVA)**: If a CVA is proposed and accepted by creditors, it might allow the company to continue trading and repay debts over time. This, however, is more relevant to the company's operations rather than Michael's immediate recovery.

5. **Equitable Charges and Debts**: If any other contracts or debts provided a form of security not formally registered, they could still be considered during liquidation, albeit with lower priority than registered charges.

6. **Possible Directors' Loans**: If Michael had injected further funds into the company in the form of directors' loans rather than share capital, these loans might be treated as liabilities of the company.

In conclusion, while the most straightforward recovery for Michael would be through the leased equipment and secured loan, paying careful attention to the structuring of any further investments or transactions is crucial for protecting his interests.

I hope this gives you a comprehensive understanding of other possibilities in Michael's scenario. Feel free to ask if you have more questions!

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