Company Decision-Making: The Company's Officers and Shareholders PDF

2 Company Decision-​making, the Company’s Officers and Shareholders 2.1 Introduction 26 2.2 Decision-​making 27 2.3 Sha...

2 Company Decision-​making, the Company’s Officers and Shareholders 2.1 Introduction 26 2.2 Decision-​making 27 2.3 Shareholders’ resolutions 29 2.4 How can I tell who is responsible for making a decision? 35 2.5 When the shareholders take matters into their own hands 36 2.6 The company’s officers 38 2.7 Shareholders 40 2.8 Shareholders’ rights 42 2.9 Types of share 45 SQE1 Syllabus This chapter, combined with Chapter 1, will enable you to achieve the SQE1 Assessment Specification in relation to Functioning Legal Knowledge concerned with the following procedures and processes: business and organisational characteristics (private and unlisted public companies) procedures and documentation required to incorporate a company and other steps required under companies legislation to enable the entity to commence operating: ∘ constitutional documents; and ∘ Companies House filing requirements corporate governance and compliance: ∘ rights, duties and powers of shareholders of companies; ∘ company decision-​making and meetings: procedural, disclosure and approval requirements; ∘ documentary, record-​keeping, statutory filing and disclosure requirements; and ∘ minority shareholder protection Note that for SQE1, candidates are not usually required to recall specific case names, or cite statutory or regulatory authorities. In this chapter, statutory references and case law are provided for information only. 25 Business Law and Practice Learning outcomes By the end of this chapter you will be able to: identify who makes certain company decisions; advise on the different methods directors and shareholders have for making decisions; advise on the rules governing the holding of directors’ and shareholders’ meetings; advise on the rules governing shareholders’ written resolutions; advise on the rights granted to shareholders by the law; understand who the officers of a company are and their role; and understand the different types of shareholder and the role of shareholders in a company. 2.1 Introduction Since a company cannot make decisions itself, its directors and shareholders do so on its behalf. The company’s directors are responsible for the day-​to-​day running of the company and the shareholders are only involved in a limited number of decisions, most of which do not relate directly to the day-​to-​day running of the company. Putting it simply, the directors run the company and the shareholders provide the money to allow the business to operate and are responsible for some of the decisions the company can make. The directors’ authority to run the company is set out in MA 3. The decisions which are for shareholders to make fall into two categories: 1. The first category is decisions which the shareholders alone make. Two key examples of such a resolution are changing the articles of association of the company and changing the name of the company, both of which are special resolutions (ss 21 and 77 CA 2006). These decisions are explained at 1.13.2 and 1.19.4. Once the shareholders have formally decided to do this, the directors cannot reverse the decision or decide not to go ahead: they must ensure that the correct paperwork is completed and that Companies House is notified. 2. The second category of decision reserved for shareholders is decisions which give the directors permission to enter into certain types of contract which carry particular risks for the company, or where the directors could potentially use their position as a director to benefit personally from the contract. An example would be where the company is buying a property from a director. Clearly there would be potential for the director to vote in favour of such a purchase to make sure that they received a high price for the property. Such a purchase would probably need shareholder approval to ensure that the transaction would benefit the company. The key point with this type of decision is that the shareholders give permission to the directors to proceed with the contract; the shareholders do not decide to enter into the contract themselves. They do not have the power to enter into contracts on the company’s behalf; only the directors have the power to do this. Examples of this type of shareholders’ resolution are in Chapter 3. In this chapter we consider how shareholders and directors make decisions on the company’s behalf, the role of the company’s officers (its directors, the company secretary and the auditor), and the shareholders’ role and rights. The focus of this chapter is private companies limited by shares, but many of the principles covered also apply to public companies limited by shares. 26  Company Decision-making, the Company’s Officers and Shareholders 2.2 Decision-​making It is crucial for solicitors to understand who is responsible for making a particular company decision. This is set out in the CA 2006, and if the correct authorisation for a particular decision is not obtained there may be serious consequences. For example, a transaction entered into without the necessary approval may be voidable. We will firstly address how directors make decisions, and then move on to how shareholders make decisions. 2.2.1 Directors’ decision-​making Directors make decisions collectively in board meetings. The decisions they make in board meetings are called board resolutions. The CA 2006 and the Model Articles set out various requirements which must be satisfied in order for a board meeting to be valid, which are explored below. As explained in 1.13.2, companies can, and often do, amend the Model Articles and so it is important to consider the company’s articles as a whole when considering the decision-​making process. Not all of the day-​to-​day decisions which need to be made by a company are made in board meetings. This would be an inefficient and unworkable way of operating. Under MA 5, the directors can delegate their powers as they see fit, so employees will be allowed to make decisions within their job description and certain directors will have specific areas of responsibility, for example, a human resources director, finance director or managing director. 2.2.2 Notice of board meetings Rule (MA 9) When a director calls a board meeting, they must give notice to the other directors. Notice must be reasonable (Re Homer District Consolidated Gold Mines, ex parte Smith (1888) 39 Ch D 546). What is reasonable will depend on the facts. It may be reasonable to give a few minutes’ notice of a board meeting if all of the directors work in the same building for a small company. The notice period will need to be longer for a multi-​national organisation with directors in different time zones. There is no need for the notice to be in writing, but the notice must include the time, date and place of the meeting (MA 9(3)). If it is not intended that the directors should meet in the same place, the notice must state the method of communication –​ for example, Teams, Skype or an instant messaging service could be acceptable, as long as the directors can each communicate to the others any information or opinions they have on any particular item of the business of the meeting (MA 10(1)(b)). 2.2.3 Quorum at board meetings Rule (MA 11) A quorum of two directors must be present at all times during a board meeting. 27 Business Law and Practice The quorum is the minimum number of directors who must be present in order for the meeting to be valid. Requiring two directors to be present reduces the risk of one director turning up and making rash or fraudulent decisions without another director present to rein in that director or give an alternative point of view. If there is a quorum present at a board meeting, we say the meeting is quorate. 2.2.4 Directors’ personal interests Rule (MA14) A director may not count in the quorum or vote if a proposed decision of the board is: concerned with an actual or proposed transaction or arrangement with the company in which a director is interested The above rule is logical: directors are supposed to make their decisions based on what best promotes the success of the company, and directors with a personal interest in a matter could easily make decisions which benefit them rather than the company (for example, where a company is buying a property from a director). It is important to note that a director who is prevented from counting in the quorum or voting on a resolution by virtue of MA 14 can count in the quorum for the part of the meeting where other resolutions are being passed, and can also vote on other resolutions. Rule (s 177 CA 2006) Where a director has a personal interest in a proposed transaction or arrangement with the company, they must declare the nature and extent of this interest to the board. The above rule is logical: it is important for the board to be aware of any potential bias the director may have when carrying out their role as a director as a result of their personal interest in something in which the company is involved. There are various exceptions to the obligation to declare an interest, and these are set out in s 177(6). In summary, a director does not need to declare their interest in a proposed transaction or arrangement with the company: 1. if it cannot reasonably be regarded as likely to give rise to a conflict of interest; 2. if, or to the extent that, the other directors are already aware of it; or 3. if, or to the extent that, it concerns terms of a service contract that have been or are to be considered…by a meeting of the directors. In practice, if there is any doubt at all, best practice is always to declare a personal interest, even if one of the exceptions may apply. This is because, if that director’s actions are being scrutinised at a later date, it is useful for the director to be able to prove that they declared the interest. 28  Company Decision-making, the Company’s Officers and Shareholders It is important not to confuse the obligation to declare a personal interest under s 177 with the MA 14 prohibition on counting in the quorum and voting when the director has a personal interest in the subject of the resolution. The obligation to declare a personal interest cannot be disapplied by the company’s articles: the director must always declare the nature and extent of their interest unless one of the exceptions above applies. However, a company can disapply MA 14 in its articles, enabling directors to count in the quorum and vote even when they have a personal interest in the subject of the resolution. Disapplication is common practice in the articles of small companies, where there are so few directors that preventing a director from voting or counting in the quorum would mean that a valid board meeting could not be held. If a company’s articles have excluded MA 14, the directors would still be able to vote and count in the quorum, even when they have a personal interest in a resolution connected with an actual or proposed transaction or arrangement with the company. This does not affect the operation of s 177: the director(s) would still need to make a declaration of interest under this section (or, depending on the facts, s 182 –​declaration of an interest in an existing transaction), unless one of the exceptions in s 177(6) applied (or, depending on the facts, s 182(6)). 2.2.5 Voting at board meetings Rule (MA 7) Board resolutions are passed by a simple majority, which means that over half of those present must vote in favour in order for the board resolution to be passed. Voting is carried out by a show of hands and each director has one vote. If the board has appointed one of its directors to act as chair of the board, that director will have a casting vote (ie one extra vote) in the event of a tie. The chair will only need to use this casting vote if they are in favour of the resolution, because if there is a tie, the resolution will not be passed. 2.2.6 Unanimous decisions Directors do not have to call board meetings to make decisions. It is possible under MA 8 to pass a board resolution in the form of a resolution in writing or any other method which shows that all eligible directors have indicated to each other that they share a common view on a matter. Directors’ written resolutions are common in practice, as they remove the need for directors to spend time in a board meeting. It is important to remember that in order to use this method of making decisions, the directors must vote unanimously in favour of a resolution, or it will not be validly passed. 2.3 Shareholders’ resolutions Some company decisions are reserved for shareholders. There are two types of shareholders’ resolution: ordinary resolutions and special resolutions. The difference between the two is the majority required in order for the resolution to be passed. Rule (s 282 CA 2006) For an ordinary resolution to be passed, over half of the votes cast at a shareholders’ general meeting must be in favour of the resolution. 29 Business Law and Practice If the resolution is proposed as a written resolution instead, the voting mechanism is slightly different –​please see 2.3.7. The term ‘ordinary resolution’ refers only to shareholders’ resolutions. Whilst the same majority is required to pass ordinary resolutions and board resolutions, it is crucial to remember that the term ordinary resolution can only be used to describe shareholders’ resolutions and cannot be used to describe board resolutions. Rule (s 283 CA 2006) For a special resolution to be passed, 75% or more of votes cast at a shareholders’ general meeting must be in favour of the resolution. There are two ways of passing shareholders’ resolutions: in a general meeting or by written resolution. These methods of passing shareholders’ resolutions are alternatives to one another and the board will choose which method is more appropriate in the circumstances. Both methods are covered in turn below. 2.3.1 General meetings Shareholders’ meetings (other than annual general meetings, or AGMs) are called general meetings. General meetings are called by the board of directors by passing a board resolution (s 302 CA 2006). The board will call a general meeting when they want the shareholders to pass a shareholders’ resolution, or sometimes when the shareholders have requested that the board call a meeting in order that the shareholders can pass one or more resolutions (see 2.5.2). Public companies must hold a general meeting every year but there is no such requirement for private companies (s 336 CA 2006). Companies formed under the CA 2006 will hold general meetings only, and not AGMs, unless they decide to include a provision in their articles which requires or allows for an AGM. In this book, the term general meeting refers to both general meetings and AGMs. In order for a general meeting to be valid, the notice requirements under the CA 2006 must have been complied with (s 301 CA 2006), and the quorum must be met. 2.3.2 Contents of the notice of general meeting The CA 2006 sets out various rules regarding the notice of a general meeting. Firstly, the directors must give notice to every shareholder and every director (s 310), and to the auditor if there is one (s 502). It must be given in hard copy, in electronic form, or by means of a website, or a combination of these means (s 308). The notice must set out, pursuant to s 311(1) and (2): the time, date and place of the meeting (s 311(1)); the general nature of the business to be dealt with at the meeting (s 311(2)); if a special resolution is proposed, the exact wording of the special resolution (s 283(6) (a)); and each shareholder’s right to appoint a proxy to attend on their behalf (s 325). A proxy is a replacement who will vote in accordance with the absent shareholder’s wishes. 30  Company Decision-making, the Company’s Officers and Shareholders 2.3.3 Notice period Rule (s 307 and s 360 CA 2006) The minimum notice required for a general meeting is 14 clear days. What ‘clear’ means is that the day that notice is deemed received by the shareholders and the day of the general meeting itself are not counted for the purposes of the notice. Only the days between these two dates are counted in calculating the notice period. This means that there will be 14 days which are ‘clear’ of anything happening between the day notice is deemed received and the day of the meeting itself. Everybody makes sense of this in their own way, but by way of illustration, an example of the calculation is set out below. Example –​calculating the notice period for a general meeting The board of ABC Limited wishes to hold a general meeting. The directors hand the notice of general meeting to all of the shareholders on Monday 1 March, and so notice is deemed received by the shareholders on that day. The day notice is given (1 March) is not counted when calculating the notice period. There must be 14 full days in between 1 March and the day of the general meeting. The earliest date the meeting can be held is Tuesday 16 March. A simple way of double-​checking the correct date for a general meeting is by checking that the general meeting is held on the day of the week after the day of the week the meeting was called. So if notice is handed out on a Monday, the general meeting will be on a Tuesday. If notice is handed out on a Thursday, the general meeting will be on a Friday. A complicating factor is when the notice of general meeting is sent out by post or email. If notice is given in this way, it is deemed received 48 hours after the notice was posted or emailed. This means that 48 hours must be added on to the 14 clear days to allow for posting or receipt (s 1147(2) CA 2006). So using the example above, if the notice was posted on the Monday instead of being handed out, the general meeting would take place two weeks and three days later, on Thursday 18 March. 2.3.4 Quorum and voting Rule (s 318 CA 2006) Subject to the company’s articles, the quorum of a general meeting is two. Note that where a company has only one shareholder, the quorum is one. At the general meeting, voting will be on a show of hands (MA 42) and each shareholder has one vote. Unlike with board meetings, shareholders are generally not prevented from counting in the quorum or voting if they have a personal interest in the matter. This is because the shareholders own the company and their interests are seen as being the same as the company’s interests: if the company performs well, the shareholders get more of a return on their investment in the company, by way of increased dividends or an increase in the value of their shares. There are two key shareholders’ resolutions where the votes of a shareholder with a personal interest in the matter are effectively not counted. In these situations, the shareholder is free to vote, but their votes will not be counted if it is their votes which make the 31 Business Law and Practice difference as to whether the resolution is passed or not. The resolutions where this restriction applies are: a resolution to buy back some or all of a shareholder’s shares (see 4.6), because the shareholder in question could be voting in their own interests, not the company’s, when voting; and an ordinary resolution to ratify a director’s breach of duty under s 239 CA 2006, where the director in question is also a shareholder (see 3.19), because they would almost certainly vote in favour of ratifying their breach of duty as a director. You may be wondering what happens when a shareholder with a personal interest in a matter is also a director. In this situation (assuming the company has the Model Articles as its articles) they would be prevented from counting in the quorum and voting at the board meeting. However, at the general meeting, they would be acting as a shareholder, not a director, so could vote and count in the quorum (unless the resolution in question was one of the two resolutions described in the preceding paragraph). Test your understanding –​passing shareholders’ resolutions ABC Limited has three shareholders, Anna, Ben and Chiara. They are voting on an ordinary resolution. Given that a majority is required in order for the ordinary resolution to be passed, how many of Anna, Ben and Chiara must vote in favour of the resolution? Answer: Two out of three must vote in favour in order for the resolution to be passed. If two out of three vote in favour, this will be a majority of over 66%, but one out of three votes in favour will not meet the required majority. Let’s say that Anna, Ben and Chiara are now voting on a special resolution. Given that 75% or more of the votes cast must be in favour of the resolution, how many of Anna, Ben and Chiara must vote in favour of the resolution? Answer: All three shareholders must vote in favour of the resolution in order for it to be passed. Two out of three is not enough because it does not meet the required 75%. 2.3.5 Poll votes A poll vote is where the shareholders vote in a general meeting on the basis of one vote for each share that they own, instead of the usual one vote per person. This means that the more shares a shareholder has, the greater power they may have when voting at a general meeting. This can be seen as a way of ensuring a fairer outcome for those shareholders who have invested more money in the company and therefore feel entitled to more of a say when it comes to voting on resolutions. Under MA 44(2), a poll vote may be demanded by: (a) the chair of the meeting; (b) the directors; (c) two or more persons having the right to vote on the resolution; or (d) a person or persons representing not less than one tenth of the total voting rights of all the shareholders having the right to vote on the resolution. The poll vote can be demanded before a general meeting, or during the meeting, either before voting takes place, or after the shareholders have already voted on a show of hands. 32  Company Decision-making, the Company’s Officers and Shareholders If a poll vote is called after the shareholders have already voted on a show of hands, the outcome of the poll vote, if different from the vote on a show of hands, will override the vote on a show of hands. Often there is no point in calling a poll vote, because the shareholders or directors know that it will not change the outcome of the vote on a show of hands. Sometimes, though, calling a poll vote and voting on that basis instead will change the outcome. Those with more shares may be able to influence whether a resolution is passed or not by voting on a poll basis. Example –​poll votes Let’s return to ABC Limited. The company has issued a total of 1,000 shares. Anna has 500 shares, Ben has 200 shares and Chiara has 300 shares. Anna and Chiara would like to pass a special resolution to change the name of the company. Ben does not want to change the company’s name and will vote against it at the general meeting. This means that the resolution will not be passed on a show of hands, because Anna and Chiara between them have two votes and Ben has one. If Anna and Chiara vote in favour of changing the company’s name, they will between them have a majority of just over 66%, not the required 75% to pass the special resolution to change the company’s name. Understandably, Anna and Chiara may be aggrieved if Ben, who only owns 20% of the company’s shares, can prevent them from passing the special resolution to change the company’s name. It is open to Anna and Chiara to request a poll vote. On a poll vote, the shareholders will vote again, but this time, votes will not be counted on the basis of one per person. Instead, each shareholder has one vote for each share they own. So in this example, Anna will have 500 votes, Chiara will have 300 votes and Ben will have 200 votes. If Anna and Chiara vote in favour of the special resolution, then, on a poll vote, it will be passed because between them they can meet the required 75% majority (they own 80% of the shares between them). 2.3.6 Short notice Sometimes a company may want a decision to be passed very quickly. Waiting 14 clear days for a general meeting to take place is not always a practical, commercial way to operate for a company. For this reason, it is possible to hold a general meeting on short notice (s 307(4) CA 2006). Rule (s 307(5)–​(6)) For a general meeting to be validly held on short notice: a majority in number of the company’s shareholders; who between them hold 90% or more of the company’s voting shares must consent. This percentage is increased to 95% for public companies. Once the requisite percentage of shareholders has consented, the general meeting can be held straight away, although it may be held at a later date, for example, seven days later instead. 33 Business Law and Practice Test your understanding –​short notice of a general meeting Let’s assume that ABC Limited has issued a total of 1,000 shares. Anna has 500 shares, Ben has 200 shares and Chiara has 300 shares. Anna and Ben want to hold a general meeting on short notice, but Chiara does not. Will Anna and Ben’s consent be enough for the general meeting to be held on short notice? Answer: No. Anna and Ben do constitute a majority of the company’s shareholders –​ together they are two out of three of the company’s shareholders, so the first of the two criteria for valid consent to short notice are met. Unfortunately for them, they do not between them have the necessary 90% of the company’s shares, so the general meeting cannot be held on short notice. 2.3.7 Written resolutions Sometimes it may not be convenient for the shareholders of the company to attend a general meeting, or the board may deem that there is no need for the shareholders to spend time attending a meeting. Instead, they will propose that the shareholders pass a resolution or resolutions by way of a written resolution (permitted under s 288 CA 2006 for private companies, but not for public companies). This is an alternative to a general meeting. Instead of issuing a notice of general meeting, the board will instead hand out, post or email a written resolution or place the resolution on a website. This document will set out the text of the ordinary and/​or special resolution(s) which the board is proposing and the shareholder will have to sign and return the written resolution if they would like to vote in favour of it. If the written resolution is sent out by post or email, each shareholder will receive their own copy to sign and return. The written resolution must be circulated to every eligible member (s 291(2) CA 2006). ‘Eligible member’ means the shareholders who are entitled to vote on the resolution as at the circulation date of the resolution (s 289). Section 291(4) of the CA 2006 sets out certain information which must be included on the written resolution, which is: how to signify agreement; and the deadline for returning the written resolution, otherwise known as the lapse date. Unless the articles state otherwise, the lapse date is 28 days from circulation of the written resolution (s 297 CA 2006). Unlike with the notice of general meeting, the method of circulation of the written resolution is irrelevant for the purposes of calculating the lapse date. The lapse date is the 28th day following circulation of the written resolution, whether it is handed to the shareholders, posted or circulated by email. The deadline is generally interpreted as meaning midnight of the 28th day following circulation of the written resolution. If an eligible member signifies their agreement after the lapse date, their agreement will not be counted. Example –​lapse date The company secretary of ABC Limited posts a written resolution to each of the company’s shareholders on Monday 1 June. Anna receives her written resolution the next day. Ben and Chiara receive their written resolutions on Wednesday 3 June. The lapse date is Sunday 28 June. This is the 28th day with the circulation date counting as day one. It does not matter when the shareholders actually received the written resolution, and no time is allowed for deemed delivery. 34  Company Decision-making, the Company’s Officers and Shareholders 2.3.8 When are written resolutions passed? Rule (s 296 CA 2006) Written resolutions are passed when the required majority of eligible members have signified agreement to the resolution. Unlike at general meetings, where the default method of voting is one vote per person, with written resolutions each shareholder has one vote for each share that they own (ss 282(2) and 283(2) CA 2006). This means that whether a resolution is passed or not can sometimes depend on whether it was proposed as a written resolution or a resolution at a general meeting. This is because when voting at general meetings, each shareholder has one vote per person and only the votes of those who attend the meeting are taken into account. The position with written resolutions is different: for an ordinary resolution, over half of the votes of all of the company’s eligible members are needed to pass the resolution. For special resolutions, 75% or more of all of the votes of all of the company’s eligible members are required in order to pass the resolution. Sometimes this can lead to a different outcome from voting at a general meeting. Example –​different outcomes, depending on voting methods ABC Limited now has four shareholders, Anna, Ben, Chiara and Deya. All of the shareholders have 500 shares each. Anna and Ben wish to change the company’s name, which requires a special resolution. The board has called a general meeting in order that the shareholders can vote on this resolution. Anna and Ben attend the general meeting but Chiara and Deya do not. The special resolution to change the company’s name is passed because Anna and Ben both vote in favour –​two votes to zero. Imagine that the special resolution to change the company’s name is proposed by written resolution instead. Anna and Ben sign and return their copies of the written special resolution to indicate that they are in favour of it. Chiara and Deya do not return their copies of the written resolution. Anna and Ben have between them only 1,000 of the company’s 2,000 shares, so there are only 1,000 votes in favour of the special resolution out of a total 2,000 votes of all eligible members. The special resolution is not passed because the required 75% majority has not been met. 2.4 How can I tell who is responsible for making a decision? Interpretation of the CA 2006 is required to ascertain whether the responsibility for a particular decision is that of the directors or shareholders. If the section states that a special resolution is required, then that is obviously a decision for shareholders. If the section states that a resolution of the members is required, but does not state what type of resolution, then an ordinary resolution of the shareholders is needed (s 281(3) CA 2006), unless the company’s articles require a higher majority. If the section states that the company may decide something, it is by default a decision for the directors, who run the company day to day. 35 Business Law and Practice 2.5 When the shareholders take matters into their own hands Usually it is the board that decides whether to call a general meeting or circulate a written resolution, but sometimes shareholders want a general meeting or a written resolution and the board will not call a general meeting or circulate a written resolution, so the shareholders do have certain powers to take matters into their own hands. 2.5.1 Shareholders’ request for the company to circulate a written resolution Rule (s 292 CA 2006) A shareholder or shareholders who have 5% or more of the voting rights in the company are entitled to require the company to circulate a written resolution. Under s 292(5) CA 2006, the company’s articles can reduce this percentage below 5% but cannot increase it to more than 5 per cent. The shareholders who have asked the company to circulate a written resolution can require the company to circulate with it a statement of up to a thousand words on the subject matter of the resolution (s 292(3)). The company must then circulate a copy of the resolution and any accompanying statement to all eligible shareholders, within 21 days of the shareholders’ request. The shareholders who requested the circulation of the resolution must pay the company’s expenses in complying with the request (s 294 CA 2006). 2.5.2 Requisitioning a general meeting The shareholders can require the directors to call a general meeting (s 303 CA 2006). The directors are required to call the general meeting once they have received requests to do so from shareholders representing at least 5% of such paid-​up capital of the company as carries the right of voting at general meetings (s 303(2)(a). The request must state the general nature of the business to be dealt with at the meeting (s 303(4)(a)). If the shareholders exercise their right to request the board to call a general meeting, the directors must call it within 21 days of the request (s 304(1)(a)). As described in 2.3.3, the minimum period of full notice of a general meeting is 14 clear days, but of course the board will often give more notice. To prevent the board from trying to delay the general meeting to frustrate the shareholders’ intentions, the notice period for the general meeting called in response to the shareholders’ s 303 request must be no more than 28 days (s 304(1)(b)). So the maximum period of time from the shareholders requesting the board to call a general meeting and the general meeting itself is seven weeks. This is because the board must call the general meeting within 21 days of the shareholders’ request, and the meeting must be held no later than 28 days from the date of the notice of general meeting. 2.5.3 Post-​decision requirements 2.5.3.1 Filing at Companies House The fact that a company’s shareholders benefit from limited liability for the company’s debts is a disadvantage for third parties entering into contracts with the company. For example, if those third parties issue invoices and the invoices are not paid because the company does not have any money, there is little that the third party can do about this. To make it easier for third parties to make informed decisions about whether to enter into a business relationship with the company, companies must make a great deal of information public. The CA 2006 requires companies to notify the Registrar of Companies when certain decisions are made. The penalty for failing to comply with the notification requirements in the CA 2006 is a fine for the company 36  Company Decision-making, the Company’s Officers and Shareholders and all of its officers. Further, under ECCTA 2023, the Registrar of Companies now has the power to query filings, reject filings and/or request further evidence, and to remove material from the register more swiftly than before. Finally, while it has for some time been a criminal offence to provide, knowingly or recklessly, misleading, false or deceptive information to Companies House, this offence has been expanded under ECCTA 2023. It will now also apply where any person provides misleading, false or deceptive information without reasonable excuse. There is a new aggravated offence under ECCTA 2023 of knowingly providing misleading, false or deceptive information. Clearly, then, it is an important part of a lawyer’s job to ensure that the client receives the correct advice regarding filing and administration. Companies House has produced forms which companies must fill in and send to the Registrar of Companies, and these will suffice as notification to the Registrar of Companies. In addition, copies of all special resolutions must be filed at Companies House (s 29 and s 30 CA 2006). Some ordinary resolutions must also be filed, and you will learn about these as you progress through this book. A summary of the Companies House forms covered in this book is provided in Appendix 1. 2.5.3.2 Internal administration There are numerous internal documents, that is, documents which are not sent to the Registrar of Companies, but which the company must, under CA 2006, keep up to date. These include the register of members (see 2.7.2) and register of directors (see 3.16). The registers (known as statutory books) can be kept at the company’s registered office or a Single Alternative Inspection Location (SAIL). A SAIL address is notified to Companies House on form AD02, while movement of company records to the SAIL address is notified on form AD03. A form AD04 is used to notify Companies House of company records moving from the SAIL address back to the registered office. Companies must also keep board minutes for every board meeting which takes place (s 248 CA 2006), and minutes of every general meeting (s 355 CA 2006). Companies must keep these, along with a record of the outcome of any written resolutions, at the company’s registered office (or SAIL) for ten years. As an alternative to keeping statutory books at the company’s registered office or SAIL, companies can elect to keep these records on the central register at Companies House instead. 2.5.4 Company decision-​making in practice In practice, solicitors regularly advise company clients on the legal requirements for making valid decisions. Trainee solicitors are often asked to prepare board minutes in advance of board meetings, and clients will use the draft minutes as a guide for conducting the meeting, and amend and finalise the minutes once the board meeting has been held. When advising clients on company procedure, it is important to remind clients of their obligation to file certain documents at Companies House, maintain the necessary registers, and draft minutes and keep them for ten years at the company’s registered office. Failure to do so is usually a criminal offence, the penalty for which is a fine for the company and every officer in default. See also 2.5.3.1 for an explanation of the relevant potential criminal offences in relation to inaccurate filing. 2.5.5 Companies’ annual responsibilities Every company must keep adequate accounting records (s 386(1) CA 2006). What is adequate is set out in s 386. Failure to do so is an offence under s 387 CA 2006. It is the directors’ responsibility to ensure that accounts are produced for each financial year (s 394 CA 2006). The accounts must give a true and fair view of the state of affairs at the company as at the end of the financial year (s 393(1) and s 396(2) CA 2006). Under s 415 CA 2006, the directors of every company (apart from private companies classed as a small company or micro-​entity under s 382(3) CA 2006 or s 384 CA 2006) must prepare a 37 Business Law and Practice directors’ report for each financial year to accompany the accounts. ‘Small company’ means a company with a balance sheet total of not more than £5.1 million, a turnover of not more than £10.2 million, and no more than 50 employees in a particular financial year (s 382 CA 2006). ‘Micro-​entity’ means a company with a balance sheet total of not more than £316,000, a turnover of not more than £632,000, and no more than ten employees in a particular financial year (s 384A CA 2006). It is the directors’ responsibility to circulate the accounts, directors’ report and, if required, an auditor’s report to every shareholder and debenture holder, and anyone else who is entitled to receive notice of general meetings. Every company must file its accounts and, unless it is a small company or micro-​entity, the directors’ report, for each financial year at Companies House (s 441 CA 2006). The time limit for filing accounts and reports at Companies House is nine months from the end of the accounting reference period for a private company (s 442(2) CA 2006), and six months from the end of the accounting reference period for a public company. Newly incorporated companies have the option of filing the accounts and report three months after the end of the company’s first accounting reference period instead (s 442(3) CA 2006). Every company must file a confirmation statement, on form CS01, within 14 days from the company’s confirmation date, which is the anniversary of its incorporation (s 853A CA 2006). The purpose of the confirmation statement is to make sure that the information held at Companies House, particularly regarding directors, shareholders and persons with significant control, is correct and up-​to-​date. It is a criminal offence to file the confirmation statement late, or not at all. 2.6 The company’s officers The company’s officers are the directors, company secretary and auditor. You will know by now that the directors are responsible for running the company. The power to run the company comes from MA 3. Directors have numerous rights and responsibilities, and are also subject to some restrictions to make sure that they cannot exceed their powers and thereby harm the company. All of these rights, responsibilities and restrictions are explained fully in Chapter 3. This part of Chapter 2 covers the other officers of the company, that is, the company secretary and auditor. 2.6.1 Company secretary Private companies are not required to have a company secretary (s 270(1) CA 2006), but public limited companies must have one (s 271 CA 2006). In practice, small private companies formed under the CA 2006 do not usually have them. Companies use company secretaries to deal with the company’s legal administrative requirements. The company secretary is an officer of the company (s 1121 CA 2006). It is possible to have a corporate company secretary, in which case, the secretary will act through a human being authorised by the company appointed as company secretary. Sometimes companies have more than one company secretary, and they will act as joint company secretaries. Company secretaries of private companies do not have to have any specific qualifications, and the role they are expected to fulfil will vary from company to company. Very large companies will have a full-​time company secretary who may run an administrative department. In other, smaller companies, the company secretary may also be a director, and will just be the person responsible for ensuring that the company keeps up to date with its filings at Companies House. The company secretary will generally also be responsible for writing up the company’s board minutes and minutes of general meetings. The board of directors will decide the contractual terms upon which the company secretary will hold office. In smaller, private companies, there will be no remuneration: the individual’s 38  Company Decision-making, the Company’s Officers and Shareholders company secretarial duties will just be another task they are expected to do as well as carry out their role as a director. In companies without a company secretary, if the CA 2006 requires a company secretary to do something, it can be performed either by the directors or someone authorised by them (s 270(3)(b)). Company secretaries will normally have apparent authority to enter into contracts of an administrative nature, but not trading contracts, for example, borrowing money. For an explanation of apparent authority, see 3.12. The company’s first company secretary will often be the person named on the IN01 form. Any company secretary appointed after incorporation will be appointed by board resolution. Often the power to appoint a company secretary will be expressly stated in the company’s articles, although there is no such power in the Model Articles for private companies because these are more suited to small private companies that do not have a company secretary. However, the directors can use their powers under MA 3 to appoint a company secretary. 2.6.1.1 Removal from office The company secretary can resign from their position, or the directors can remove the company secretary from office by board resolution. Sometimes there will be a written contract between the company and company secretary, which will set out the consequences of removal from office, and this may include compensation for breach of contract. It may also give rise to employment law claims. There are a number of administrative and notification requirements set out in the CA 2006 with regard to company secretaries: The company must notify the Registrar of Companies on form AP03 (for a human secretary) or AP04 (for a corporate secretary) within 14 days of the appointment of a company secretary (s 276(1)(a) CA 2006). Every company that has a company secretary must keep a register of secretaries (s 275(1)) with certain specified particulars (s 275(2)), which are set out in s 277 (human secretaries) and s 278 (corporate secretaries). Section 279A of the CA 2006 permits private companies to elect not to keep their own register of secretaries, and instead ensure that the information is filed and kept up-​to-​date on the central register for the company at Companies House. When a company secretary resigns or is removed from office, the company must notify the Registrar of Companies within 14 days of their resignation or removal, on form TM02 (s 276(1)(a) CA 2006). The register of secretaries will then need to be amended to reflect the fact that the company secretary has left office. The company must notify the Registrar of Companies within 14 days of any change in particulars of the company secretary kept in the register of secretaries (s 276(1)(b) CA 2006), on form CH03 (for a human secretary) and form CH04 (for a corporate secretary). Again, the register of secretaries will need to be amended to reflect the changes. 2.6.2 The auditor The company’s auditor will be an accountant whose main duty is to prepare a report on the company’s annual accounts, to be sent to its shareholders (s 495(1) CA 2006). The auditor’s report must state whether, in the auditor’s opinion, the accounts have been prepared properly and give a true and fair view of the company (s 495(3) CA 2006). Essentially, they must ensure that the shareholders, whose money is invested in the company, are not defrauded or misled by the directors. If the auditor’s report is qualified in any way, this is a warning to the shareholders that there may have been some unethical business dealings, or even fraud. 39 Business Law and Practice The obligation for private companies to appoint auditors to review their accounts comes from s 485 CA 2006. Small companies are exempt from the statutory audit requirements (s 477 CA 2006). See 2.5.5 for the definition of ‘small company’. Companies which do not trade, known as dormant companies, are also permitted to file abbreviated accounts and are exempt from audit (s 480 CA 2006). If the company must have an auditor, the auditor must be someone who is qualified, that is, a certified or chartered accountant, and independent, that is, not connected with anyone involved in the company (ss 1212–​1215 CA 2006). Usually companies appoint a firm of accountants to be the company’s auditor, meaning that any qualified member of the accountancy firm can undertake the audit. 2.6.2.1 Appointment of the auditor The directors of a private company usually appoint the company’s first auditor (s 485(3) CA 2006), and after that the shareholders also have the power to appoint the auditor, by ordinary resolution (s 485(4) CA 2006). The terms upon which the auditor is to hold office, and the auditor’s fee, are a matter of negotiation between the auditor and the company. An auditor of a private company is usually deemed to be reappointed automatically each year (s 487). The exceptions to this are set out in s 487 and include a situation where the auditor was appointed by the directors, as the first auditor will have been, or when the company’s articles of association require the auditors to be reappointed every year. 2.6.2.2 Auditors’ liability Case law has established that auditors do not owe a duty of care either to the shareholders or to potential new shareholders when conducting their annual audit. For liability to be imposed, there would also have to be proximity between the relevant parties. Auditors can be sued for negligence by the company they are auditing. There are two criminal offences relating to auditors under s 507 CA 2006. The first is knowingly or recklessly including misleading, false or deceptive material in the auditor’s report. The second is omitting certain statements from the report which are required to be included by the CA 2006. 2.6.2.3 Removal of the auditor The shareholders can remove the auditor from office at any time by ordinary resolution (s 510 CA 2006). The shareholders must give special notice to the company of the proposal to remove the auditor (s 511 CA 2006). Special notice is explained at 3.14.1. The auditor can resign at any time by notice in writing sent to the company’s registered office (s 516 CA 2006). The consequences of removal of the auditor will depend on the terms of the contract between the company and the auditor. Whenever an auditor ceases to hold office, whether as a result of removal or resignation, they must deliver a statement to the company explaining the circumstances connected with ceasing to hold office (s 519 CA 2006). This can be useful in situations where the auditor suspects unethical behaviour by the company and it is a way of making questionable behaviour by the company public. 2.7 Shareholders 2.7.1 Becoming a shareholder The two people who sign the memorandum of association as subscribers automatically become the first shareholders of the company, and must be entered on the company’s register of members (s 112 CA 2006). 40  Company Decision-making, the Company’s Officers and Shareholders Once the company is up and running, a person or a company can become a new shareholder in one of two ways. Firstly, the new shareholder could obtain shares from an existing shareholder, by: buying some of the shares of an existing shareholder; receiving some of the shares of an existing shareholder as a gift; or receiving the shares by way of transmission when a shareholder dies or becomes bankrupt, and electing to become a shareholder rather than transferring the shares to a third party. Alternatively, a company may allot new shares. This means creating new shares and selling them to new or existing shareholders. Transfer, transmission and allotment are covered fully in Chapter 4. 2.7.2 Register of members Every company must keep a register of members (s 113 CA 2006). Alternatively, it may elect to keep the information on the central register at Companies House instead (s 128B). Note that under ECCTA 2023, the option of keeping the information on the central register at Companies House will soon be removed, but at the time of witing, this provision had not yet come into force. All shareholders have the right to have their name on the register of members (s 113 CA2006) and a company must register the transfer (ie enter the new shareholder on the register of members or reflect an existing shareholder’s increased number of shares) as soon as practicable and, as a long stop, within two months of the transfer being lodged with the company (s 771 CA 2006). When a company allots new shares, it must enter the new shareholder on the register of members or reflect an existing shareholder’s increased number of shares as soon as practicable and, as a long stop, within two months of the allotment (s 554 CA 2006). If the company has elected to keep the information at Companies House, it must instead notify the registrar of the share registration as soon as practicable or, as a long stop, within two months. If the company has only one member, there must be a statement to that effect on the register of members (s 123 CA 2006). It is a criminal offence if the register of members is incomplete or incorrect (s 113), including where there is no reference to the fact that it is a one-​member company (s 123). Where the company keeps its register of members at its registered office or SAIL, it must be available for inspection to shareholders free of charge and to anyone else for a fee (s 116 CA 2006). Again, failure to allow someone to inspect the register under s 113 is a criminal offence (s 118 CA 2006). 2.7.3 Share certificates All shareholders have the right to receive a share certificate (s 769(1)(a) and s 776(1) (a) CA2006). This is important because the share certificate is prima facie evidence of the holder’s title to the shares (s 768 CA 06). Companies must issue share certificates within two months of the allotment of shares (s 769 CA 2006) or within two months of a transfer of shares being lodged with the company (s 776 CA 2006). 2.7.4 The PSC register You first encountered the concept of persons with significant control in 1.14. As well as disclosing information about persons with significant control in the IN01, all private companies and non-​traded public companies must keep a register of persons with significant control (‘PSC register’). The purpose of the PSC register is to enable third parties to understand who holds power in the company. Any shareholder who owns more than 25% of the shares or controls more than 25% of the voting rights in the company must appear on the PSC register. This applies not only to individual shareholders but also to shareholders which are ‘relevant legal entities’ such as companies. 41 Business Law and Practice Companies must keep a PSC register even if there are no shareholders entered on it because there are no shareholders with significant control. People with significant control, like directors, can apply to keep their residential address private, so that it does not appear on the public register at Companies House. They can also apply to have their name private, so all that will appear on the register of persons with significant control is that there is a person with significant control but that they have successfully applied to have their personal information kept private. If their application is successful, the PSC register will state how many shares a person has, but not their identity or address. Under s 790 CA 2006, private companies can keep the information regarding persons with significant control on the central register at Companies House instead. There are a number of Companies House forms which must be completed when the information on the PSC register changes. The most significant ones are: Form PSC01 must be completed by any individual who is to appear on the PSC register for the first time. Form PSC02 must be completed by any relevant legal entity who is to appear on the PSC register for the first time. Any shareholder who already appears on the PSC register but whose details change must complete form PSC04, and any relevant legal entity who already appears on the PSC register but whose details change must complete form PSC05. Anyone ceasing to be a person with significant control must complete form PSC07. The deadline for filing the forms is 14 days from the date the company made the change in its PSC register (s 790VA CA 2006). 2.8 Shareholders’ rights 2.8.1 Articles of association Under s 33(1) of the CA 2006, the company’s constitution is a statutory contract between each shareholder and the company, and between each shareholder and every other shareholder. This gives the shareholders a remedy for breach of contract if one or more shareholders, or the company itself, does not abide by the terms of the constitution. We have seen that the company’s constitution consists mainly of its memorandum of association and its articles of association. Given that under the CA 2006, the significance and length of the memorandum were greatly reduced, it is the articles of association which provide the terms of this statutory contract. The effect of s 33(1) is that it allows shareholders to take action against other shareholders of the company where that shareholder’s membership rights have been infringed. A shareholder’s membership rights include their voting rights and their right to share in the company’s profits by receiving dividends. 2.8.2 Shareholders’ agreements Whilst shareholders have rights under the company’s articles of association, it is always open to them to enter into a shareholders’ agreement as well. A shareholders’ agreement will bind all of the parties to the agreement and provide a remedy if one of its terms is breached. It is important to remember that it only binds those shareholders who have entered into the shareholders’ agreement. In contrast, the company’s articles of association bind every shareholder, present and future. Despite this, entering into a shareholders’ agreement does have its advantages. The main advantages are privacy and protection of minority shareholders. Anyone can look at the company’s articles of association on the Companies House website, but 42  Company Decision-making, the Company’s Officers and Shareholders a shareholders’ agreement will be private. Under the company’s articles, minority shareholders will have very little power but provisions to protect them can be included in shareholders’ agreements. An example would be a clause stating that the shareholders who are party to the shareholders’ agreement must not vote in favour of changing the company’s articles unless all of the parties to the shareholders’ agreement are in favour of this. Examples of matters which are commonly included in shareholders’ agreements are: restrictions on transferring shares; Bushell v Faith clauses (from Bushell v Faith AC 1099). They give shareholders weighted voting rights (ie more votes than they would normally be entitled to) when the resolution under consideration is a resolution to remove that shareholder from their office as director; and a non-​compete clause, preventing the shareholder from involvement in a business which competes with the company. Whilst there are many provisions which could be included either in the articles or in the shareholders’ agreement, the key point is that shareholders can only take action under the articles where it relates directly to their rights as a member. There are limitations as to what the shareholders’ agreement can contain. For example, the shareholders’ agreement cannot restrict shareholders from voting a particular way in board meetings if they are also a director, because this could lead to the shareholder being in breach of their directors’ duties. 2.8.3 Voting rights Shareholders’ primary way of exercising control is by voting at general meetings. As we have seen, the default voting method at general meetings is a show of hands, with each shareholder having one vote. As well as being entitled to attend general meetings and vote, shareholders have the following rights with regard to exercising their power to vote: 1. Right to send a proxy to a general meeting on their behalf (see 2.3.2). 2. Right to a poll vote (see 2.3.5). 3. Right to receive notice of general meetings (see 2.3.2). 4. Right to requisition a general meeting (see 2.5.2). 5. Right to apply to the court to call a general meeting, if for some reason it is not possible for one to be held otherwise (s 306 CA 2006). An example would be where the other shareholders are refusing to attend a general meeting and so it is not possible to hold a meeting which is quorate. 6. Right for a shareholder or shareholders with 5% or more of the voting rights in the company (or 100 or more shareholders with the right to vote, as long as they have paid up an average of £100 or more on their shares) to require the circulation of a written statement of up to a thousand words with respect to any resolution or business to be dealt with at a general meeting. 7. Right for shareholders holding 5% or more of the company’s shares to require the company to circulate a written resolution and accompanying statement (see 2.5.1). 2.8.4 Other rights Shareholders also have the following rights: 1. Right to receive dividends, as long as there are profits available for the purpose (s 830 CA 2006) and as long as the directors have made a recommendation as to its amount (MA 30(2)) and this has been approved by the shareholders. 43 Business Law and Practice 2. Right to apply to the court for the company to be wound up, on the grounds that it is just and equitable to do so (s 122(g) Insolvency Act 1986 (‘IA 1986’)) –​for example, because the management is in deadlock and there is no way of resolving the situation other than winding up the company. 3. Right to remove a director by ordinary resolution (see 3.14.1). 4. Right to remove an auditor by ordinary resolution (see 2.6.2.3). 5. Right to inspect, without charge: the company’s minutes of general meetings and all shareholders’ resolutions passed otherwise than at general meetings; all of the company’s statutory registers (see, eg, s 116(1) CA 2006); directors’ service contracts and any directors’ indemnities; and any contracts relating to the company’s purchase of its own shares. 6. Right to receive a copy of the company’s annual accounts and reports. 7. Right to seek an injunction under s 40(4) of the CA 2006 to restrain the company from doing something prohibited by its constitution. 2.8.5 Types of shareholder 2.8.5.1 Corporate shareholders and groups of companies When thinking about shareholders, it is natural to imagine human beings, but often a shareholder will be a company. As companies cannot act without an individual to act on their behalf, s 323 CA 2006 provides that a corporate shareholder may authorise a person to act as its representative at any company meeting. Often several companies will be linked together because they form a network of companies where some of the companies own shares in the other companies. When a company owns shares in another company, it may be that one of the companies is classed as a subsidiary of the other. Under s 1159(1) of the CA 2006, a company is a ‘subsidiary’ of another company, its ‘holding company’, if: (a) that other company holds a majority of the voting rights in it; or (b) that other company is a member of it and has the right to appoint or remove a majority of its board of directors; or (c) that other company is a member of it and controls alone, pursuant to an agreement with other members, a majority of the voting rights in it; or (d) it is a subsidiary of a company that is itself a subsidiary of that other company. Under s 1159(2) of the CA 2006, a company is a ‘wholly-​owned subsidiary’ of another company if it has no members except that other and that other’s wholly owned subsidiaries or persons acting on behalf of that other or its wholly owned subsidiaries. Consider Figure 2.1. Assume that all companies have the Model Articles of Association with no amendments, and that there are no agreements in place and no resolutions have been passed affecting voting rights. A Limited is called the holding (or parent) company, because it is at the head of this structure. B Limited is a subsidiary of A Limited, because A Limited owns more than half of its shares. C Limited is a wholly owned subsidiary of B Limited, because B Limited owns all of the shares in C Limited. D Limited is not a subsidiary of B Limited, because B Limited owns only 33% of the shares in D Limited. Large businesses often operate several companies linked in a group structure to divide up liability between the companies: if one company becomes insolvent and is wound up, the other companies can still operate (although the shares in the insolvent company will be 44  Company Decision-making, the Company’s Officers and Shareholders Figure 2.1 Groups of companies Another A Limited Company No.1 60% 40% Another B Limited Company No.2 100% 33% 67% C Limited D Limited worthless). If the businesses were all run by one company and one part of the business failed, the risk is that the whole company would become insolvent and be wound up. 2.8.6 Public companies The description of shareholders’ rights above focuses on private limited companies. Shareholders in public companies have additional rights and responsibilities, particularly if the company is publicly traded. Those rights are outside the scope of this book. 2.8.7 Single-​member companies Many companies have only one shareholder. Typically this will be a company where one individual is both the sole director and the sole shareholder –​a person running his or her business through the medium of a company. If the company is a single-​member company, there must be a statement to this effect on the register of members (s 123 CA2006). Similarly, if the number of shareholders increases from one, there must be a statement stating that the company has ceased to have only one member, and the date on which that event occurred. It is an offence to breach s 123. 2.8.8 Joint shareholders Sometimes shares will be held by two or more individuals jointly. If this is the case, the register of members needs to record both names but only one address (s 113(5) CA 2006). Breach of this section is an offence. 2.9 Types of share There are a number of different types of share: ordinary, preference, redeemable and deferred shares are examples. Below we cover two of the most common, ordinary and preference shares. 2.9.1 Ordinary shares Companies are usually formed with ordinary shares only. Ordinary shares generally give the shareholders the right to attend and vote at general meetings. Ordinary shareholders are also entitled to receive dividends if they are declared, that is, if the directors recommend the 45 Business Law and Practice payment and the shareholders approve it. The amount of the dividend can vary depending the company’s profits. Sometimes companies will have different types of ordinary shareholder. There may be ordinary A shares and ordinary B shares, which have been created so that the shareholders can be treated differently in certain circumstances. For example, a company may wish to issue dividends to ordinary A shareholders but not the ordinary B shareholders. This is easier to manage if the ordinary shareholders are divided into different categories. The rights attaching to the shares will be set out in the company’s articles of association and if they are not, all shares rank equally. 2.9.2 Preference shares The other main category of shares is preference shares. Preference shareholders receive enhanced rights of some sort, over and above the ordinary shareholders, which, again, are set out in the company’s articles of association. For example, they may have a guaranteed right to a dividend, and the ordinary shareholders will only receive dividends if there are any profits left after the preferential shareholders have been paid. The amount of the dividend is usually expressed as a percentage of the nominal value of the preference share. If the preference share is a 5% share, then the holder will receive a fixed dividend of 5p for each £1 preference share they own. Preferential shareholders are often people who wish to invest in a company, and are willing to forego voting rights in return for greater financial returns. The other, ordinary, shareholders are often willing to grant the preferential shareholders enhanced rights on the basis that the preferential shareholders are not allowed to exert power by voting at general meetings. Example –​preference shares A company has five shareholders and wishes to expand. The company needs money to fund the expansion, but does not want to take the risk of committing to a loan. The board decides that the best way of financing the expansion is to issue more shares in the company in return for cash, but none of the existing shareholders can afford to pay for more shares. The board finds an investor who would like to invest £100,000 in the company in return for preferential rights to a dividend. The board and the investor agree that in return for investing £100,000, the investor will receive 5% preference shares. This means that if the company makes enough profit to pay dividends in a particular financial year, the investor will receive 5% of their initial investment by way of dividend, that is, £5,000. The other shareholders will only receive a dividend if there are any profits remaining after the investor has received their dividend. The other shareholders are happy with this arrangement because while they are likely to receive lower dividends, the company has received the money it needed to expand and flourish and the shareholders’ voting power has not been affected because the preferential shares carry no right to vote at general meetings. It is useful to understand the terminology that is normally used to describe different types of preference shares. Cumulative/​non-​cumulative: if a preference share is described as cumulative, this means that the preference shareholder has to be paid any missed dividends from previous financial years as well as the current financial year’s dividend, as long as there are profits available to pay the dividends. This right ranks before payment of dividends to ordinary shareholders in the current financial year. Non-​cumulative preference shares do not carry this right: if a dividend is not paid in a particular year, the shareholder loses the right to that year’s dividend and does not have the right to receive it in the future. 46  Company Decision-making, the Company’s Officers and Shareholders Participating: participating shareholders have the further right to receive profits or assets, in addition to their other preference share rights. As an example, if the ordinary shareholders receive a dividend over a specified amount, this could give the participating preference shareholder the right to an additional payment, over and above their usual entitlement. 2.9.3 Protection of minority shareholders Majority shareholders clearly have more power than minority shareholders in the form of more votes (on a poll vote or written resolution). However, there are legal mechanisms to protect minority shareholders, namely unfair prejudice actions and derivative claims, to ensure that they do have some recourse when they are unhappy with an aspect of the running of the company or their relationships with the other shareholders and/​or directors. 2.9.3.1 Unfair prejudice petitions Section 994 of the CA 2006 allows any shareholder to apply to the court for an order for a remedy where they feel that they have been unfairly prejudiced as a shareholder. The potential grounds for such a petition are that: the company’s affairs have been conducted in a manner that is unfairly prejudicial to the interests of the members generally, or some part of its members (including the claimant); or an actual or proposed act or omission of the company is or would be so prejudicial. The conduct must be prejudicial in that it causes harm to one or more shareholders, and it must also be unfair. Example of conduct which could result in an unfair prejudice action are: diverting opportunities to a competing business in which the majority shareholder holds an interest; awarding excessive pay to directors; or excluding a shareholder from management of the company, where, when the company was incorporated, the shareholders’ negotiations led to the shareholders believing they would participate in management. It is worth noting that removal of the auditor by the shareholders on the grounds of divergence of opinion on accounting or audit procedures is deemed to be unfairly prejudicial under s 994(1A) of the CA 2006. If the court is satisfied that unfair prejudice has occurred, it may make such order as it thinks fit. The most common is an order that the other shareholders must buy the shares of the unfairly prejudiced shareholder, or an order for the company to buy back the unfairly prejudiced shareholder’s or shareholders’ shares. This is a logical remedy in the circumstances, because if the relationship between the shareholders or between the directors and the unfairly prejudiced shareholder has reached the point of legal action, it is likely that the unfairly prejudiced shareholder will want to cut all ties with the company. Other possible orders include a restriction on the company altering its articles of association without the leave of the court and an order that the unfairly prejudiced shareholder has permission to bring a derivative action (see 2.9.3.2). In order to ascertain whether a shareholder has been unfairly prejudiced, the court will apply an objective test. The court will ask whether a hypothetical bystander would believe the act or omission to be unfair. It is more difficult to succeed in an unfair prejudice action if the conduct about which the claimant is complaining is in accordance with the company’s articles of association. Unfair prejudice actions are expensive because they are time-​consuming. The claimant will have to gather evidence, some of which it may be difficult to obtain, because it will be held by the company. The court will require a great deal of evidence before it will decide that 47 Business Law and Practice the claimant has been unfairly prejudiced, and the parties may need an expert’s report, for example a report from an accountant to show that a shareholder has been prejudiced and that the prejudice is unfair or to put a value on the shares. 2.9.3.2 Derivative claims Derivative claims are governed by ss 260–​264 CA 2006. A derivative claim is a claim instigated by a shareholder for a wrong done to a company which has arisen from an act or omission of a director. When a company decides to issue proceedings, this is a board decision, because it relates to the day-​to-​day running of the company. The point of a derivative claim is to allow shareholders to instigate legal action instead of the board, because the board is neglecting to bring a claim or is refusing to do so. The claimant is still the company, but the shareholders and not the directors have instigated the claim. A derivative claim may only be brought in relation to a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director (s 260(3)). The defendant to a derivative claim is usually a director but can be another person. Once the claim has been issued, the first stage of a derivative claim is for the shareholder to apply to the court for permission to continue the claim. First, the court will consider the application and the evidence in support of it without a hearing. The court will only allow the claim to continue if the application and evidence disclose a prima facie case for continuing. The reason for this first stage is to filter out spurious claims by disgruntled shareholders who are seeking to cause trouble because there has been a disagreement with the board. Clearly in some circumstances the shareholders will have a potentially legitimate claim, and the fact that the claimant has to apply to court for permission to continue ensures that only those claims will be allowed to proceed. The court may dismiss the application at this first stage, on the basis that it does not disclose a prima facie case for continuing. If the court decides that the application does disclose a prima facie case, the court may: give directions as to the evidence to be provided by the company; or adjourn the proceedings to enable evidence to be obtained. The court will then list a full hearing to determine the shareholder’s application for permission to continue the claim. Section 263(2) sets out the circumstances in which the court must, at the hearing stage, refuse permission to continue. They are: where the court is satisfied that a person acting in accordance with s 172 CA 2006 would not seek to continue the claim. In effect, this means that the court will not allow an individual who is not promoting the success of the company to continue the claim. A full explanation of this directors’ duty to promote the company’s success is at 3.16.2; where the cause of action arises from an act or omission that has not yet occurred, but which has already been authorised by the company (see 3.16.5); or when the act or omission has already occurred and was authorised before it occurred or has been ratified by the company (see 3.19) since it occurred. The court must also take into account, under s 263(3): whether the shareholder is acting in good faith in seeking to continue the claim; the importance that someone acting in accordance with s 172 (somebody who is acting in good faith to promote the company’s success) would attach to continuing; 48  Company Decision-making, the Company’s Officers and Shareholders whether any past or future action or omission was authorised, or if not, would be likely to be ratified; whether the company has decided not to pursue the claim; and whether the act or omission gives rise to a cause of action that a member could pursue in their own right. In particular, the court is obliged to have particular regard to any evidence showing the views of those shareholders with no personal interest in the matter. This is because these individuals can be seen to be objective. As explained above, the court must take into account any authorisation or ratification of a director’s acts or omissions when deciding whether to let the claim continue. How such an action or omission is authorised or ratified will depend on the nature of it, but some can be authorised by board resolution, meaning that if over half of the directors authorise the act or omission or are likely to do so, the court is unlikely to give permission for the claim to continue. Other acts or omissions can be ratified by ordinary resolution, so if over half of the shareholders are happy with the board’s actions or the actions of a particular director, the shareholders will ratify the breach and it is likely that the shareholder bringing the derivative claim will be refused permission to continue. Following the hearing, the court may grant permission to the shareholder to continue the claim on terms the court thinks fit, or adjourn the proceedings. Only at this stage will the court give directions for the trial of the issues raised in the claim (ie the acts or omission giving rise to the cause of action). The legal costs of making an application to continue a derivative claim are met by the applicant shareholder if permission to continue is refused. If permission to continue is granted, the company will meet all of the legal costs of the claim, as well as the other party’s legal costs if the claim is unsuccessful. Summary: shareholders’ rights Shareholding What shareholders can do 100% pass all resolutions 75% pass or block a special resolution over 50% pass or block an ordinary resolution (shareholders can block an ordinary resolution with exactly 50% of the shares; it does not have to be over 50%, but they need over 50% of the shares to pass an ordinary resolution) 50% block an ordinary resolution over 25% block a special resolution 10% demand a poll vote 5% circulate a written resolution requisition a general meeting circulate a written statement (continued ) 49 Business Law and Practice (continued ) Shareholding What shareholders can do any shareholder vote (if they hold voting shares) receive notice of general meetings send a proxy to general meetings receive a dividend (if declared) receive a share certificate have their name on the register of members receive a copy of the company’s accounts inspect minutes and registers ask the court for a general meeting restrain a breach of directors’ duties bring an unfair prejudice petition bring winding-​up proceedings instigate a derivative action Sample questions Question 1 The board of directors of a company wants to call a general meeting on short notice. There are five shareholders with the following shareholdings: An accountant –​15,000 ordinary £1 shares A financial adviser –​4,000 ordinary £1 shares A doctor –​51,000 ordinary £1 shares A teacher –​20,000 ordinary £1 shares An estate agent –​10,000 ordinary £1 shares Which of the following best describes which shareholders would need to agree in order for the general meeting to be held on short notice? A The doctor, because they hold a majority of the company’s shares. B Any three shareholders, because between them they would constitute a majority in number of the shareholders. C The accountant, the doctor and the teacher and either the financial adviser or the estate agent, because between them they constitute the required majority in number holding between them at least 90% of the shares. D The accountant, the financial adviser, the doctor and the estate agent, because between them they constitute the required majority in number holding the majority of the shares. E All five shareholders, because they would all be needed in order for the required majority in number holding between them at least 95% of the shares. 50  Company Decision-making, the Company’s Officers and Shareholders Answer Option C is correct. A majority in number of shareholders who between them hold 90% or more of the shares are required in order to agree to a general meeting being held on short notice (s 307(4)–​(6) CA 2006). All of the other options are wrong either because they do not constitute a majority in number of shareholders or because those shareholders do not between them hold 90% or more of the shares. Question 2 A private company has the Model Articles of Association with no amendments. It has six directors. A board meeting is scheduled for next week and the chair intends to propose a resolution to appoint a new director. Four directors (the chair, the finance director, the operations director and the HR director, referred to collectively as the ‘Directors in Favour’) are in favour of the appointment and the other two directors (the IT director and the director of planning) are against it. Assume that at the board meeting everyone who attends will vote as indicated above and that none of the directors have a personal interest in the matter. Which of the following best explains who should attend the board meeting in order for the resolution to be passed? A As long as any two directors attend the board meeting, the resolution will be passed. B As long as the chair and any one other director attend the board meeting, the resolution will be passed. C As long as the chair attends the board meeting, the resolution will be passed. D As long as any two of the Directors in Favour attend the board meeting, the resolution will be passed. E As long as the chair and one of the other Directors in Favour attend the board meeting, the resolution will be passed. Answer Option E is correct. In order for the resolution to be passed, the board meeting must be quorate and a simple majority of directors must vote in favour of the resolution (MA 7). The quorum for a board meeting is two (MA 11), so two of those directors in favour must attend, to ensure there is a quorum. If they did not, the directors who are against the resolution could fail to turn up and the meeting would not be quorate. The chair of the board has a casting vote (MA 13), so at the board meeting, either three directors or the chair and another director must vote in favour to ensure that there is a majority in favour of the resolution. Option E is the only combination which makes sure the quorum is met and that enough directors are present to outvote the IT director and the director of planning. Question 3 A company has an entire issued share capital of 1,000 shares of £1 each. The original shareholders were a nurse, who had 950 shares and a dentist, who had 50 shares. Last week the nurse sold 500 of his shares to the dentist, and the rest of his shares to new shareholders: 200 shares to a local investor and 250 shares to a surgeon. 51 Business Law and Practice Which of the following best describes the amendments the company must make to the register of People with Significant Control (‘PSC register’) as a consequence of the sale described above? A The company will need to add the local investor and the surgeon to the PSC register. B The company will need to add the local investor and the surgeon to the PSC register and remove the nurse. C The company will need to add the dentist to the PSC register and remove the nurse. D The company will need to add the dentist to the PSC register. E The company will need to add the dentist, the local investor and the surgeon to the PSC register and remove the nurse. Answer Option C is correct. Only those with over 25% of the company’s shares need to be on the PSC register. Before the transfers, the nurse had 95% of the company’s shares and the dentist had 5% of the company’s shares, so the nurse will have been on the PSC register and the dentist will not have been on it. Following the transfers, the shareholdings changed to the dentist (55%), the local investor (20%) and the surgeon (25%). The local investor does not have enough shares to appear on the register and neither does the surgeon, because they do not have