Company Constitution, Separation of Power and Corporate Management Lecture Slides PDF

LU2036: Company Law Lecture 3: Company Constitution & Separation of Power and Corporate Management Dr Min Yan [email protected]  What is the constitution of a Part 1 company? THE What are the articles of association? CONSTITUTION What are the legal...

LU2036: Company Law Lecture 3: Company Constitution & Separation of Power and Corporate Management Dr Min Yan [email protected]  What is the constitution of a Part 1 company? THE What are the articles of association? CONSTITUTION What are the legal effects of the OF A COMPANY articles of association? How and for what purposes can the articles of association be amended? The Need for a Constitution Recall the question: how to set up a company? s.7(1): A company is formed under this Act by one or more persons (a) subscribing their names to a memorandum of association (see section 8) and (b) complying with the requirements of this Act as to registration (see ss.9-13) Company’s constitution Memorandum of association Application for registration: registration documents (s.9); statement of capital and initial shareholdings (s.10); statement of proposed officers (s.12); statement of compliance (s.13) As the company is an artificial legal person, provisions must be made for that legal person to take decisions to act upon them  S.17 of CA 2006 defines the term “company’s constitution” (when that term used in the Act and “unless the context otherwise requires”) as (a) the company’s articles, and Definition (b) any resolutions and agreements to which Chapter 3 applies (see s.29)” o e.g. any special resolution; any resolution or agreement agreed to by all the members; any resolution or agreement agreed to by all the members of a class of shareholders… A body of rules that specifies how power is distributed between shareholders and the board and how it is to be exercised and expressed. The Memorandum of Association Historically, this was also an important constitutional document (in particular, it set out the companies “objects” and hence capacity to contract) But this is no longer the case. S.8(1) of CA 2006 merely says that the memorandum of association “is a memorandum stating that the subscribers (a) wish to form a company under the Act and (b) agree to become members of the company and, in the case of a company that is to have a share capital, to take at least one share each.’  The Articles of Association s.18(1): ‘A company must have articles of association prescribing regulations for the company’ s.18(2): Unless 'model' (i.e. default) articles apply, ‘it must register the articles’ (also see s.20 default application of model articles: unless articles registered, model articles apply) s.18(3)(a): Articles ‘must be contained in a single document’ (new provision) Model Articles Model Articles under CA 2006 and Companies (Model Articles) Regulations 2008, SI 2008/2339 There are three types of Model Articles: Model articles for private companies limited by shares: Schedule 1 Model articles for private companies limited by guarantee: Schedule 2 Model articles for public companies limited by shares: Schedule 3 The Model articles apply unless they have been excluded (in whole or in part) by tailor-made registered articles. (s.20) ❑ their almost universal adoption has meant that they form the core organisational structure of the UK registered company  Typical Contents of Articles oE.g. see Model Articles for private companies limited by shares Part 2: Directors Art.3: ‘Directors’ general authority Art.4: Shareholders’ reserve power Arts.7-16: Decision-making & conduct of board meetings; Arts.17-20 Appointment (& termination) & pay Part 3: Shares & Distributions Arts. 21-25: Issue Arts. 26-29: Transfer Arts. 30-36: Dividends (and other distributions) Part 4: Decision-making by shareholders Arts. 37-47: conduct of general meetings Effect of Constitution CA 2006, s.33(1) “The provisions of a company’s constitution, when registered, bind the company and its members to the same extent as if there were covenants, signed and sealed on the part of the company and of each member, to observe those provisions.” A contract between members and company? A contract between members?  A Contract between Company and Member? Wood v Odessa Waterworks (1889) 42 Ch D 636 Per Stirling J: “[t]he articles of association constitute a contract not merely between the shareholder and the company, but between each individual shareholder and every other.” Hickman v Kent or Romney Marsh Sheep-Breeders' Association 1 Ch 881 Per Astbury J: “articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the company respectively.” Despite the judiciary clarification after Hickman, CA 2006 s.33 has conclusively resolved this question, namely the company should be treated as a party to the contract contained in its own articles. A Contract between Members inter se? Rayfield v Hands Ch 1 Article 11 of the articles of association of Field-Davis Ltd provided: “Every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at a fair value…” Rayfield, a member, sought to compel the defendants, the three directors of the company, to purchase his shares in accordance with this provision. Vaisey J considered all the conflicting authorities on the issue and concluded that there was a contract inter se which was directly enforceable by one member against another. Who can Enforce the Articles? A wrong to the company? Corporate organs A wrong to the member? Individual shareholders Pender v Lushington (1877) 6 Ch D 70 (a matter of internal management) MacDougall v Gardiner (1875) 1 Ch D 13 (a member’s personal right involved)  Establishing Members’ Personal Rights Pender v Lushington (1877) 6 Ch D 70 (splitting shares) Jessel MR: “This is an action by Mr. Pender for himself. He is a member of the company, and whether he votes with the majority or the minority he is entitled to have his vote recorded—an individual right in respect of which he has a right to sue.” C.f. MacDougall v Gardiner (1875) 1 Ch D 13 (adjournment of general meeting) Mellish LJ: “In my opinion, if the thing complained of is a thing which in substance the majority of the company are entitled to do, or if something has been done irregularly which the majority of the company are entitled to do regularly, or if something has been done illegally which the majority of the company are entitled to do legally, there can be no use in having a litigation about it, the ultimate end of which is only that a meeting has to be called, and then ultimately the majority gets its wishes.” Outsider Rights Eley v Positive Government Security Life Assurance Company Ltd (1876) 1 Ex D 88 Held, that the articles of association were a matter between the shareholders inter se … and did not create any contract between the claimant (who was not a party to them) and the company Browne v La Trinidad (1887) 37 Ch D 1 the articles being only a contract between the companies and members, the members inter se, and not between the company and a member ‘as director’ Hickman no article can constitute a contract between the company and a third person Some further cases Only parties to the constitutional ‘contract’ can enforce its provisions, i.e. company and its shareholders. Directors, employees and other ‘outsiders’ cannot. Salmon v Quin & Axtens Ltd ▪ The articles provided that the consent of the two managing directors was required for all transactions. ▪ One of the MD’s, suing as a member, sought an injunction to prevent the company entering into a transaction in breach of this provision of the articles. ▪ The injunction was granted, showing that a member had a membership right to require the company to act in accordance with its articles, which right could be enforced by the member even thought the result was indirectly to protect a right given to him as director. Beattie v E and F Beattie Ltd Ch 708 ▪ Articles require disputes between members and the Company to go to arbitration ▪ Director also a member sought to restrain legal proceedings relying on the Articles ▪ Failed as he was seeking to enforce terms of the Articles as an outsider, as a director not a member  Alteration of Articles S 21 Companies Act 2006 Alteration of Articles may be made by special resolution (75%) passed by members at General Meeting Subject to the provisions of the Companies Act & conditions in the Articles Restrictions on the Alteration of Articles ▪ Entrenchment of articles (s 22 CA 2006) - A company's articles may contain provision (“provision for entrenchment”) to the effect that specified provisions of the articles may be amended or repealed only if conditions are met, or procedures are complied with, that are more restrictive than those applicable in the case of a special resolution. ▪ Void if conflicts with Companies Act ▪ Cannot alter Articles which conflict with Court Order  Restrictions on the Alteration of Articles The shareholders must exercise their power to alter the articles in good faith - Alteration may be void if majority who approve it are not acting bona fide in best interests of company as a whole Per Lindley MR in Allen v Gold Reefs of West Africa Ltd 1 Ch 656: “the power [of alteration]…must, like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded.” Per Atkin LJ in Shuttleworth v Cox Bros (Maidenhead) 2 KB 9: “The only question is whether or not the shareholders, in considering whether they shall alter articles, honestly intended to exercise their powers for the benefit of the company…” Some further cases on good faith check Greenhalgh v Ardene Cinemas Ltd ▪ Proposal to delete provision in Articles which gave members a right of pre-emption over shares that a member wanted to sell ▪ Majority shareholder prompted out of his own interests. However, Evershed MR maintained that individual shareholders were not entitled to expect that the articles would never change. ▪ Alteration must benefit Company as a whole ▪ CoA held alteration valid “the phrase “the company as a whole” does not….mean the company as a commercial entity, distinct from the corporators; it means the corporators as a general body. That is to say, the case may be taken of an individual hypothetical member and it may be asked what is proposed, in the honest opinion of those who voted in its favour, for that person’s benefit” Sidebottom v Kershaw Leese & Co Ltd Clemens v Clemens Brothers Ltd & Anor  Shareholder Agreements Typically provide protections/special rights for (certain) shareholders. For example: right to sit on Board of Directors or appoint nominee exercise special voting rights in general meeting pre-emption rights on transfer of shares  Pros and Cons of Shareholder Agreement Pros: Enforceable as of right (the agreement creates rights and obligations between members) Unanimity needed for variation (all parties to the agreement should agree) Privacy (no need to register) Cons: Privity (new owner of the shares is not bound by the agreement) Not always binding on company (If the subject matter of the agreement affects a statutory obligation of the company it may not be enforceable) Legal Importance of Articles – A Summary Bind members to company, company to members and members to other members Do not bind company to third persons There are important restrictions on alteration to protect other interested parties  Corporate Part 2 Management and Separation of Power  Those who, according to the constitution, can act as the company. The ‘Organs’ of a the members (shareholders in case of company with share Company capital) in “general meeting” the director(s) (i.e. the “board of directors”) The Role of the Articles and CA 2006 The articles of association as backbone of the company’s constitution tell where power lies & hence which ‘organs’ have powers to act determine the division of power as between the two provide how these organs “act” Default rules and mandatory rules in the CA 2006 ❑Default rules are rules expressed to apply “subject to any provision of the company’s articles”, e.g. general rules of voting s.284) ❑Mandatory Rules: e.g. amendment of articles (s.21); removal of directors (s.168) Allocation of Power between ‘Organs’ UK company law legislation Articles of association Model articles Art 3 Directors’ general authority Subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company. Art 4 Shareholders’ reserve power (1) The shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action. (2) No such special resolution invalidates anything which the directors have done before the passing of the resolution.  Distinguish between ‘Organs’ and ‘Agents’ of Company Organs act as the company Agents (e.g. CEO) are appointed by organs to act on behalf of (not as) company. ❑Note: in the 19th century, principal/agent analysis → directors mere agents Isle of Wight Railway Company v Tahourdin (1883) 25 Ch D 320 from 20th century, the courts break with the traditional view of mere agents Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame 2 Ch 34 Gramophone and Typewriter Ltd v Stanley 2 KB 89  The Rise of Board Autonomy Per Buckley LJ in Gramophone and Typewriter Ltd v Stanley 2 KB 89,105- 106 The directors are not servants to obey directions given by the shareholders as individuals; they are not agents appointed by and bound to serve the shareholders as their principals. They are persons who may by the regulations be entrusted with the control of the business, and if so entrusted they can be dispossessed from that control only by the statutory majority which can alter the articles. Directors are not, I think, bound to comply with the directions even of all the corporators acting as individuals. Separation of ‘control’ (directors) from ‘ownership’ (members) As observed by Berle and Means in the 1930s in The Modern Corporation and Private Property, the dispersed shareholders in large modern companies are both unable and uninterested in exercising control  The Effect of Board Autonomy As summarised by Greer LJ in John Shaw and Sons (Salford) Ltd v Shaw 2 KB 113,134: If powers of management are vested in the directors, they and they alone can exercise these powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the articles in the directors is by altering their articles, or if opportunity arises under the articles, by refusing to re-elect the directors of whose actions they disapprove They cannot themselves usurp the powers which by the articles are vested in the directors any more than the directors can usurp the powers vested by the articles in the general body of shareholders Also see Quin & Axtens Ltd v Salmon AC 442 The House of Lords held that the members’ resolutions were inconsistent with the articles and granted an injunction restraining the company from acting on them Matters Reserved to Members by Statute Alteration of articles: s.21 Approval by GM of certain transactions between company and directors: ss.188-231 s.188: ‘long-term’ (i.e. over 2 – reduced from 5- year) service contracts s.190: substantial ‘non-cash asset’ ‘arrangements’ ss.197-214: loans, quasi-loans, credit transactions ss.215-222: payments for loss of office (‘golden handshakes’) Provisions as to Capital (e.g. s. 551: authorisation to allot share) Removal of directors by ordinary resolution: s.168 Other instances where Members can Exercise Executive Power Alexander Ward & Co Ltd v Samyang Co Navigation Ltd (1975) - in the absence of an effective board the general meeting of members has residual authority to use the company’s powers Appointment of directors Per Warrington J in Barron v Potter 1 Ch 895 : “… the company in general meeting has power to make the appointment.” Board of Directors becomes incapable or unable to act Deadlock e.g. Barron v Potter Affirmation/ratification of unlawful act by Board of Directors (e.g. s.180(4) s.239) ❑Considered in more detail under the topic of Directors’ duties Options For Shareholders Who Do Not Agree With the Board of Directors Exit the company Altering the articles (but it requires special resolution) Refusing to re-elect directors Removing directors by an ordinary resolution (s 168) Derivative action.  Resolutions S 282 - Ordinary resolutions - An S 283 - Special resolutions - A ordinary resolution of the special resolution of the members members (or of a class of (or of a class of members) of a members) of a company means a company means a resolution resolution that is passed by a passed by a majority of not less simple majority. than 75%. Directors S.250 : In the Companies Act 2006 “director” includes any person occupying the position of director, by whatever name called. S.154: minimum number requirement private companies: 1 public companies: 2 at least one natural person, but now see s.87 of SBEEA 2015 (i.e. all directors are natural person) S.157: minimum age requirement: 16 Categories of Directors Executive and non-executive directors De jure and de facto directors Shadow directors A person in accordance with whose directions or instructions the directors of the company are accustomed to act Note: advice provided by professionals All above are subject to the same duties Removal of Directors S.168: A company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him. Bushell v Faith AC 1099 Article 9 of the articles of association of defendant’s company provided: “In the event of a resolution being proposed at any general meeting of the company for the removal from office of any director, any shares held by that director shall on a poll in respect of such resolution carry the right to three votes per share…” The House of Lords upheld the effectiveness of the article.  Board Structures UNITARY BOARDS Comprised of a single governing body. Executive and/or non-executive directors all sit on one board. The board is responsible for all decision making. Shareholders usually elect directors at the AGM TWO-TIER (DUAL) BOARDS Comprised of a supervisory board and an executive management board that work together in order to govern a business. The management board is responsible for the running of the business. The supervisory board, often comprised of representatives of Source: https://kfknowledgebank.kaplan.co.uk/risk-ethics-and- various stakeholders, such as employees or unions, banks, governance/governance/the-board-of-directors large investors, oversees strategy and monitors the management board. The supervisory board appoints the members of the management board. The UK system of corporate governance features a unitary board.