Company Law Course Notes 7-8 PDF

59 7 Company law Topic List 1 Characteristics of a company 2 Legal personality 3 Types of company 4 Formation of a company 5 A company's name 6 Articles of association 7 Administration and...

59 7 Company law Topic List 1 Characteristics of a company 2 Legal personality 3 Types of company 4 Formation of a company 5 A company's name 6 Articles of association 7 Administration and consequences of incorporation 8 Comparison of the key features of a sole trader, partnership an LLP and a company Learning Objectives Identify the differences between unincorporated businesses (sole traderships and partnerships), limited liability partnerships and companies, show the advantages and disadvantages of incorporation and recognise the circumstances when the veil of incorporation can be lifted Identify the procedures required to form a registered company or a limited liability partnership, including any practical considerations, and the nature and contractual force of a company's memorandum and articles of association and identify the advantages and disadvantages of off- the-shelf companies Identify the administrative consequences of incorporation or the formation of a limited liability partnership including requirements regarding statutory books, accounts, meetings and the role of the company secretary Identify the requirements of the Companies Act 2006 in respect of companies' statutory accounts and audit, including the exemptions for small and medium-sized companies and micro- entities 60 7: Company law Law 1 Characteristics of a company For the purposes of these notes, a company is an entity registered under the Companies Act 2006 ('CA'06') or any earlier Companies Act. References to ‘the Act’ are to this statute and section numbers are given for ease of reference only (the exam will not require you to know section numbers). 2 Legal personality 2.1 Introduction A company is a separate legal entity to its shareholders and its directors. This means: It is an artificial person Its members have limited liability It has the ability to hold property It continues in existence (despite changes in membership) known as continual succession A company, as a separate legal entity, may also have liabilities in tort and crime. However, it is currently extremely difficult to prosecute a company successfully for a criminal offence. The first case that clearly demonstrated the separate legal personality of companies is of great significance to any study of company law and is therefore set out in some detail below. Salomon v Salomon & Co Ltd 1897 The facts: The claimant, Salomon, had carried on business as a leather merchant and boot manufacturer for 30 years. He decided to form a limited company to purchase the business. He and six members of his family each subscribed for one share. The company then purchased the business from Salomon for £38,782, the purchase price being by way of the issue of 20,000 £1 shares, the issue of debentures for £10,000 (effectively making Salomon a secured creditor) and the balance in cash. The company did not prosper and was wound up a year later, at which point its liabilities exceeded its assets. The liquidator, representing unsecured trade creditors of the company, claimed that the company's business was in effect still the claimant's (since he owned all but six of the issued shares), that he should bear liability for its debts and that payment of the debenture debt to him should be postponed until the company's trade creditors had been paid. Decision: The Court of Appeal held that since the other shareholders were 'mere puppets' and that the company had been irregularly incorporated, Salomon should indemnify the company against its liabilities. The House of Lords however held that the business was owned by, and its debts were liabilities of, the company. The claimant was under no liability to the company or its creditors, his debentures were validly issued and the security created by them over the company's assets was effective. This was because once the company had been found to have been formed in compliance with the formal procedures set out in the Companies Act, the company was regarded as a legal entity in its own right, notwithstanding the dominant position of Salomon within the company. Law 7: Company law 61 2.2 Liability As mentioned above, one of the key consequences of the fact that the company is distinct from its members is that its members may enjoy limited liability. Members will only be asked to contribute identifiable amounts to the assets of the business, even though they are, essentially, the ones who own the business. The amounts that members may be required to pay, in the event of a winding up, depend upon the type of limited company. Type of company Amount owed by member at winding up Company limited Fully paid If the member's shares are fully paid, there is no further liability to by shares shares contribute. Partly paid Any outstanding amount of the nominal value of any share which has not shares been paid either by the original or a subsequent holder of the shares. Share Any unpaid premium (over the nominal value) will also be owed unless premium the shareholder at the time is not the original shareholder (since the amount of premium is a debt that does not pass with the shares). Company limited The amount they guaranteed to pay in the event of a winding up. by guarantee 2.3 Veil of incorporation As a result of the law stated in Salomon's case, a 'veil of incorporation' is said to be drawn between the members and the company, separating them for the purposes of liability and identification. This be problematic. This is illustrated in a case from 1925 where an individual insured property owned by a company in his own name rather than the company’s name. When the property was destroyed by fire, it was held that the company had no insurable interest and should have insured its own assets. Because this sort of rigid application of the principle of separate legal personality can sometimes produce harsh or inequitable results, the law sometimes 'lifts the veil' in order to expose the commercial reality of the situation while retaining the general legal principle. This is usually to expose sharp practice, while retaining the benefit of separate personality for those engaged in business fairly. You need to understand the principles rather than to learn each item on this list. Groups of companies – Situations where the veil may lifted by the courts Groups of companies Where the subsidiary can be regarded as the agent of the holding company and the courts see a justification. To produce a tax Firestone Tyre & Rubber Co Ltd v Lewellin 1957: liability English subsidiary (S) deemed to be agent of American holding company (H) (thus rendering H liable to UK tax). To prevent tax evasion Re H and others 1996: Where evasions were alleged to have been committed by H, the court also allowed restraint of S's assets, refusing to recognise the companies as separate. To give entitlement to Smith, Stone & Knight Ltd v Birmingham Corporation 1939: compensation Compensation for compulsorily-acquired premises was payable to an owner- occupier (H in this case) but not a tenant-occupier (S). Held that S occupied the premises as an agent of H since it was wholly owned and the directors of H and S were the same. But not: where creditors of an insolvent subsidiary are not paid in full even though the holding company remains solvent, or where a claimant proceeds against a subsidiary company that is not as asset- rich as its holding company. 62 7: Company law Law Other situations when the court has lifted the veil To reveal true national identity Daimler Co Ltd v Continental Tyre & Rubber Co (GB) Ltd 1916: and expose illegality A company was registered and had its registered office in England. However, since all of its members with control of the company (except one) were German, the veil could be lifted to expose the company as an enemy alien. Therefore trading with this company was against the law (in wartime). (See too Re F G Films below.) Quasi-partnership Ebrahimi v Westbourne Galleries 1972: In this case, the courts lifted the veil to reveal a company so completely in the nature of a partnership, that a winding-up of the company could be ordered on the grounds of it being just and equitable. Where a company is a sham: To prevent an evasion of obligations Gilford Motor Co Ltd v Horne 1933: An employee was contractually bound not to solicit customers from his ex-employer after leaving its service. In order to get round this, he formed a company and carried on his work, soliciting his ex- employer's customers in the process. The veil was lifted to reveal his company as a 'mere cloak or sham’ and an injunction was granted against it and the employee. To reveal national identity Re F G Films Ltd 1953: An English company was formed to make an English film. In fact the staff and finance were American, the film was produced in India and there were neither premises nor employees in England. The veil was lifted to expose a 'sham' company with the result that the marketing and other advantages available to British films were not available in this case. Situations where legislation provides for the veil to be lifted Where director is disqualified Directors who participate in the management of a company in contravention of an order under the Company Directors Disqualification Act 1986 will be jointly or severally liable along with the company for the company's debts. Fraudulent and wrongful trading Where a company is being wound up (ss 213, 214 Insolvency Act 1986) All persons who are knowingly parties to carrying on business with the intent of defrauding creditors or for some other fraudulent purpose (fraudulent trading) and Directors who carry on business when they knew or should have known that the company would not avoid insolvent liquidation (wrongful trading) can be held personally liable to make such contribution to the company's assets as the court thinks fit. Trading without a trading A public company must obtain a certificate from the Registrar before certificate (s 767) it commences to trade. Failure to do so leads to personal liability for the directors for any loss or damage suffered by a third party to a transaction entered into by the company in contravention of this section. Law 7: Company law 63 3 Types of company 3.1 Limited and unlimited companies Limited Companies – by shares or by guarantee Public companies Private companies Unlimited companies – very rare Companies may change status once Limited to unlimited requires the consent of all shareholders Unlimited to limited requires a special resolution It is not possible to change from a company limited by guarantee to a company limited by shares (or vice versa). 3.2 Key differences between private and public companies Feature Public Private Liability Must be limited May be limited or unlimited Share capital Subject to authorised minimum No minimum (currently £50,000) Ability to commence trading Must have trading certificate before May commence trading once it can commence trading (s 761) incorporated Public offers Can offer its securities to the public Prohibited from offering its securities (and may obtain a listing from the to the public (s 755) Stock Exchange or other investment exchange) Name Must end with ‘public limited Must end with 'limited' or 'ltd' (or company' or 'plc' (or Welsh Welsh equivalent) if a limited equivalent) (s 58) company, although certain companies (including charities, promotion of education, and promotion of science) may be exempt from this requirement (ss 59-62) Loans etc Loans to persons connected with These rules do not apply (unless the directors and quasi-loans and credit company is associated with a public transactions to directors or company) connected persons need members' approval (ss 198-202) Directors Must have at least two directors Must have at least one (s 154) Company Secretary Must have one (s 271) Need not have one (s 270) Written resolutions Not applicable May pass written resolutions instead of calling meetings (s288) AGMs Must hold AGM (s 336) Need not hold AGM 64 7: Company law Law Feature Public Private Accounts and reports Must lay these before general Need not do so. meeting. Must file within 9 months (s 442) Must file within 6 months (s 442) Small and medium sized Not applicable May qualify as small or medium sized, companies audit exemptions and take advantage of audit exemptions (small companies) and less stringent regime for filing Appointment of auditors Must appoint auditors each year if Existing auditors may be deemed to necessary (s 489) be re-appointed, subject to conditions (s 487) Pre-emption rights May not be excluded May be excluded Payment for shares Additional rules apply to public Not applicable companies, including that shares must be at least ¼ paid up (s 586) and concerning valuations for non- cash consideration (s 593) Reduction of capital Needs special resolution confirmed Needs only special resolution and by the court (s 641) directors' solvency statement (s 642) Power to redeem or Not applicable May do so, subject to conditions purchase shares out of (s 709) capital There are also additional rules that apply to quoted (listed) companies. INTERACTIVE QUESTION 13: TYPES OF COMPANY Alex, Barry and Carol have operated as a partnership for five years trading in domestic carpets. The business has been successful and they are now considering expanding the business operations by opening three new shops and an additional wholesale unit. The partners are aware that the expansion will require new business capital. They are considering the formation of a company rather than continuing as a partnership. What types of company may be formed under the Companies Act 2006? Which type of company is suitable for this business? SOLUTION Law 7: Company law 65 4 Formation of a company 4.1 “Off the shelf” company It is possible to buy a company that has already been incorporated. Advantages It is obviously a quicker way of achieving the result of having a company 'ready to go'. It avoids any potential liability arising from pre-incorporation contracts (see section 4.3 below) as the company already exists. Disadvantages Change of name Transfer of subscribers' shares Change of directors and possibly company secretary Alteration of articles 4.2 Formation of a company In order to form a company, the documents in the table below must be sent to the Registrar of Companies The Company Registrar will register the company and will issue a certificate of incorporation, naming and describing the company and giving its date of incorporation and registered number. This certificate is conclusive evidence that the company is registered in accordance with the Act and is a body corporate. If irregularities in formation procedure or an error on the certificate are later discovered, it is nonetheless valid and conclusive (Jubilee Cotton Mills Ltd v Lewis 1924). Note that a public company also needs to obtain a trading certificate before it can commence trading. It must submit: An application stating (amongst other things) that the nominal value of the company's allotted share capital is not less than the 'authorised minimum' and A statement of compliance (s 762). Any transaction in contravention of this provision will render any company officer in default liable to a fine and potentially personally liable for the debt, but the transaction will remain valid. Failure to obtain a trading certificate within a year of incorporation may result in a compulsory winding up (s 122 Insolvency Act 1986). 66 7: Company law Law 4.3 Documents to be submitted to the Company Registrar Document Description Memorandum of association A memorandum in the prescribed form stating that the subscribers (a) wish to form a company and (b) agree to become members of the company and, in the case of a company with a share capital, agree to take at least one share each. It must be authenticated by each subscriber. Application This must state The company's proposed name (which is subject to certain rules designed to prevent the company misleading the public regarding its identity and/or activities) Whether the liability of the members is to be limited and, if so, whether by shares or guarantee Whether the company is to be private or public Whether the registered office is to be in England and Wales or Wales or Scotland or Northern Ireland The intended address of the registered office (the registered office is the address for delivery of legal documents which may need to be served on a company and also where company registers must or may be kept (see section 6)) Statement of capital and It must state initial shareholdings The total number of shares (applicable to a company Their aggregate nominal value with a share capital) Details of individual classes of shares The amount to be paid and unpaid on each share Statement of guarantee It must state the maximum amount which each member undertakes to (applicable to a company contribute to the net assets of the company if the company is wound up limited by guarantee). while he is a member or within one year thereafter. Statement of proposed This must give particulars of and the consent of officers The first director(s) of the company The first company secretary (optional in the case of a private company). Statement of compliance A statement that the provisions of the Act have been met Articles of Association are also required if the company does not want to use the default articles (which will apply if no other articles are submitted). 4.4 Promoters and pre-incorporation contracts KEY TERMS Promoter – in addition to the person who takes the procedural steps to get a company incorporated, the term 'promoter' includes anyone who makes business preparations for the company. 4.4.1 Duties which the promoter owes to the company (1) A general duty to exercise reasonable care and skill (2) A fiduciary duty to disclose any personal interest in a transaction and, sometimes, to account for monies received. Generally speaking, any profits which he makes from promoting the company and fails to disclose must be surrendered to the company. Law 7: Company law 67 However, if he discloses them and the company gives consent, he may retain any legitimate profits. Disclosure may be made through the listing particulars or prospectus. Disclosure in a private company should be to existing and prospective members or to the board of directors. 4.4.2 Pre-incorporation contracts KEY TERMS Pre-incorporation contracts – A contract which the promoter enters into purportedly in the name of the company before the company has come into existence (i.e. received the certificate of incorporation). Consequences The company has no capacity to enter into contracts and therefore cannot be bound by the contract. The company cannot ratify the contract since it did not exist when the contract was made. The company cannot enforce the contract against the third party unless the promoter and third party have given rights of action to the company under the Contracts (Rights of Third Parties) Act 1999. The contract takes effect in the same way as one made with the promoter and he is personally liable on it (s 51). The promoter can avoid liability by: Not making contracts until the company has been incorporated Using an off-the-shelf company Agreeing a draft only with the third party on the basis that the company, once formed, will enter into the agreed form with the third party Novation 4.4.3 Expenses A promoter usually incurs expenses in preparations, such as drafting legal documents, made before the company is formed. He cannot legally claim any remuneration or indemnity for his services or expenses but, in practice, will generally arrange that the first directors, of whom he may be one, agree that the company shall make such payment to him. INTERACTIVE QUESTION 14: PRE-INCORPORATION CONTRACTS Imran is in the process of setting up a new company, Silver Stumps Ltd. Before submitting the application for registration, he enters into a contract on behalf of the company with Greenfields plc for the purchase of a cricket ground on the banks of the River Avon. Shortly after the company is registered and a certificate of incorporation issued, Silver Stumps Ltd finds that it is unable to raise sufficient funds and so fails to complete on the purchase on the due date. Which of the following best describes the legal position? 68 7: Company law Law SOLUTION A Greenfields plc may enforce the contact against Silver Stumps Ltd because Silver Stumps Ltd automatically assumes responsibility for contracts entered into on its behalf upon incorporation. B Provided Silver Stumps Ltd ratifies the contract with Greenfields plc, Greenfields plc may enforce the contract against Silver Stumps Ltd. C Greenfields plc may enforce the contract against Imran personally because Silver Stumps Ltd cannot ratify the contract. D Imran's liability on the contract ceased because he has transferred all rights to Silver Stumps Ltd in accordance with the Contracts (Rights of Third Parties) Act 1999. 5 A company’s name 5.1 Prohibited names Name of a public company should end with 'public limited company' (or 'plc') and a private limited company should end with 'limited' or 'ltd'. The company will not be registered if the Registrar considers the name to be offensive, or if its use could constitute a criminal offence. The approval of the Secretary of State is required if the name is sensitive in some way or likely to suggest some connection with central or local government, or any public authority. Words such as 'British' or 'International', for example, are only likely to be sanctioned if the size of the company matches its pretensions. Words which indicate that the company is of another type or legal form are not permitted. A company cannot be registered if its name is the same as or virtually the same as the name of an existing company. 5.2 Change of company name A company may choose to alter its name at any time by passing a special resolution to that effect or otherwise as provided for in its articles (s 77). The company must notify the Registrar accordingly and obtain a new certificate of incorporation. The Secretary of State may order a company to change its name for a number of reasons, including where it is considered to be the same as or virtually the same as an existing company name or that it might otherwise mislead the public. 5.3 Disclosure of company name The name of the company must be displayed in certain locations and on certain documents in accordance with regulations made by the Secretary of State (s 82). The name must also be engraved legibly on the company seal (s 45). Breach of either provision may result in a fine. 5.4 Business name Most companies carry on business under their registered names. However, a company, just like an individual or partnership, may adopt a 'business name'. Business names are subject to similar rules as to words or names that are misleading or otherwise prohibited or that require the approval of the Secretary of State in the case of company names. Law 7: Company law 69 INTERACTIVE QUESTION 15: FORMATION OF A COMPANY What are the documents that must be delivered to the Registrar on formation of a private company limited by shares? SOLUTION 6 Articles of association 6.1 Model (default) articles Model articles are available for private and listed companies. However, a company may adopt alternative articles. 6.2 The contractual effect of the company’s constitution Under s 33 CA06, the provisions of a company's constitution (i.e. articles and relevant resolutions and agreement) bind the company and its members as if each had covenanted to the other to observe those provisions (i.e. as if they had entered a contract with each other). Binds the company to its members Binds members to members They do not bind the company to third parties. And only to members in their capacity as members. Eley v Positive Government Security Life Assurance Co 1876 The facts: Eley, a solicitor, drafted the original articles and included a provision that the company must always employ him as its solicitor. Eley became a member of the company some months after its incorporation. He later sued the company for breach of contract in not employing him as a solicitor. Decision: Eley could not rely on the article since it was a contract between the company and its members and he was not asserting any claim as a member. In certain cases, if a contract contains no specific term on a particular point but the articles do, then the contract may be deemed to incorporate the relevant term of the articles, E.g. to director’s remuneration. Changes to the articles do not affect rights which have already accrued under a contract. 6.3 Alteration of articles A company may normally alter its articles by passing a special resolution to that effect (s 21). However, where the articles contain 'provision for entrenchment' such provisions can only be altered with the agreement of all company members or by court order (ss 21, 22). A company cannot provide that a provision for entrenchment can never be replaced or amended and must give notice to the Registrar whenever one is included or removed. A copy of any amended article must be sent to the Registrar within 15 days. 70 7: Company law Law A member will not be bound by any alteration made after he became a member insofar as the alteration requires him to take more shares or increases his liability in any way to pay money to or contribute to the company (s 25). 7 Administration and consequences of incorporation Non-compliance with the following requirements could result in a fine for the company and its relevant officer as well as, in some cases, imprisonment. 7.1 Company records The term 'company records' refers to any register, agreement, minutes, accounting records or other documents required to be kept by the Act. They may be kept in hard copy or electronic form usually at the registered office and available for inspection as required by the Act. In particular, a company is required to keep the following company records: A register of members A register of directors and (if applicable) company secretaries A register of people with significant control A register of directors' residential addresses (this information is 'protected information' and must not be made available for public inspection.) Copies of directors' service contracts and indemnity provisions restricting directors' liabilities Records of resolutions and minutes (for a period of ten years) Directors' statement and auditor's report A register of charges and copies of charges A company is not required to keep a register of debenture holders. A company can be required to give a copy of articles and other constitutional documents to shareholders and creditors free of charge on request 7.2 The register The Registrar of Companies maintains a 'register' in respect of each company at Companies House. This register contains: The certificate of incorporation The trading certificate (if it is a public company) Certificates of registration of charges The information contained in documents delivered to the Registrar in accordance with any statutory provision, including annual accounts and return, special and some ordinary resolutions and changes of directors. Subject to exceptions listed in the Act (s 1087), any person has the right to inspect the register and, with payment of a fee, to require a copy of any material on the register. The exceptions to this right to inspect include the following: Protected information on directors' residential addresses The contents of any charges Law 7: Company law 71 7.3 Confirmation statement Certain key information must be confirmed to the Company Registry every year in a Confirmation Statement. This document either confirms that there have been no changes to key particulars listed below or just gives details of the changes. This statement can be sent at any time but no more than 12 months must pass in between statements. Examples of information Address of registered office or of address where statutory books are kept Type of company and its principal activities Share capital Details of members of the company and of those who have ceased to be members Changes to those with significant control Changes to directors and secretaries 7.4 Accounts and reports A company must comply with the following provisions. Failure to do so may render the company and any relevant officers liable to a fine and, in some cases, imprisonment. 7.4.1 Accounting records A company must keep 'adequate accounting records' that are sufficient to show the company's financial position at any time with reasonable accuracy, including: Daily entries of income and expenditure Record of assets and liabilities (If applicable) statements of stock and stock takings 7.4.2 Annual accounts A company must prepare annual accounts i.e. a statement of financial position and statement of profit or loss. Consolidated group accounts are normally required where the company is a parent company. The accounts must give a 'true and fair view' of the company's financial position in respect of its financial year. Notes to the accounts must deal with employee numbers and costs and directors' benefits. The accounts must be: Approved by and signed on behalf of the board of directors Filed at the Registry within 9 months (private company) or 6 months (public company) after the end of the accounting period 7.4.3 Director’s report A director’s report must be prepared in respect of the financial year, including the following details: Names of directors Principal activities of the company Statement that the auditor is not unaware of any relevant audit information. (A consolidated report should be produced where group accounts are prepared). The directors' report must be approved by and signed on behalf of the board of directors. 72 7: Company law Law 7.4.4 Director’s remuneration report Quoted companies must disclose directors’ remuneration. 7.4.5 Auditor’s report Where accounts are audited the report must: Identify the accounts audited and the financial reporting framework applied in their preparation Describe the scope of the audit State that, in the auditor's opinion, the accounts give a true and fair view of the company's financial affairs State that the directors' report is consistent with the accounts 7.4.6 Strategic report Large and medium sized companies must prepare a strategic report as part of their financial statements. This includes a fair review of the company’s business as well as a description of the principal risks and uncertainties facing the business. Its purpose is to allow members to assess how well the directors have performed their duty to promote the success of the company. Must also report on environmental matters, to the extent that this environmental information is necessary for an understanding of the development, performance or position of the companies business 7.4.7 Companies (Miscellaneous Reporting) Regulations 2018 This act introduces a number of new reporting requirements: Disclosures on the extent of engagement with employees, suppliers, customers and others Large companies must include a statement in the strategic report describing that the directors have regard to the matters set out in s.172 of the Companies Act 2006 when performing their duties Companies that either have over 2,000 employees globally, or Global turnover > £200 million and Global balance sheet of > £2 billion must include a statement of corporate governance arrangements Quoted companies with more than 250 employees must also include additional disclosures on remuneration 7.4.8 Companies (Directors’ Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018 This act introduced additional directors’ report disclosures requirements concerning company emissions, energy consumption and energy efficiency for quoted and large unquoted companies. 7.5 Audit requirements All companies are required to carry out an annual audit unless they fall within the following exceptions: Micro and small companies unless insurance or banking (see below) Dormant companies (unless insurance or banking) Non-profit making companies subject to a public sector audit. Subsidiaries whose parent company guarantees their liabilities at the balance sheet date 10% of the shareholders can request an audit even where an exemption applies. Law 7: Company law 73 KEY TERMS Micro, small or medium sized companies Must comply with 2 or more of the tests in the table below Are subject to less stringent reporting requirements Micro entities may take advantage of further exemptions from accounting requirements (known as minimum accounting terms). Micro Small Medium Turnover k m m Balance Sheet m m Employees Auditors are appointed for each financial year by the shareholders or directors, and in a private company are deemed to be reappointed unless the company decides otherwise. An auditor can be removed by ordinary resolution on special notice. The auditor has a right of access to the company’s books and accounts. Any person who knowingly or recklessly causes an auditor's report to include any matter that is misleading, false or deceptive commits an offence punishable by a fine. (See also Chapter 4 regarding auditors' liability for negligent misstatement.) 7.6 Company secretary Every public company must appoint a company secretary who satisfies the qualification requirements contained in the Act (s 273). Private companies may choose to have a company secretary but are not obliged to do. The company secretary is usually appointed by the directors. A company secretary Is an employee of the company Is an 'officer' of the company and therefore faces potential civil and criminal liability alongside the directors Will convene the meetings of the board of directors, issue the agenda and draft the minutes He will also be responsible for the various statutory registers and for filing documents with the Registrar Has the power to contract on behalf of the company in respect of its administrative operations, including the employment of office staff and management of the office generally. Thus he may bind the company by his actions on the basis of implied actual authority as well as any express or ostensible authority. However, a company secretary's implied authority is limited and does not extend to buying land, for example, nor to borrowing money, nor to doing other acts usually undertaken by the directors. 74 7: Company law Law 8 Comparison of the key features of a sole trader, partnership an LLP and a company Feature Sole trader Partnership LLP Company Formation No formality No formality Register with Register with required required Company Registrar Company Registrar Legal entity Has no Has no independent Separate legal entity Separate legal entity independent existence distinct from its distinct from its existence members members Liability Owner is liable Partners LLP liable on its Company liable on on business (personally) are contracts its contracts contracts jointly and severally liable on partnership contracts Limit on liability Owner’s liability Partners' liability Members liability is Members' liability is unlimited unlimited limited to the can be limited by amount members shares or guarantee agreed to contribute Ownership Sole trader Partners own assets LLP owns assets and Company owns owns all jointly ownership is not assets and business assets affected by a change ownership not of members affected by change of members Finance A sole trader An ordinary In addition to fixed In addition to fixed cannot raise partnership cannot charges, a company charges, a company floating charges raise floating can raise finance by can raise finance by charges creating a floating creating a floating charge over its charge over its undertaking or undertaking or assets, allowing it to assets, allowing it to deal with them deal with them without the lender’s without the lender’s consent prior to any consent prior to any crystallisation crystallisation Change of N/A The death, LLP has perpetual Company has membership retirement or succession (i.e. it is perpetual succession bankruptcy of a unaffected by a (i.e. it is unaffected partner dissolves change in its by a change in its the partnership members) members) (subject to the terms of any partnership agreement) Transferability of The sole trader A partner may A partner may assign Members' shares ownership can transfer any assign his interest his interest but the freely transferable assets but the assignee assignee does not (subject to articles) does not become a become a partner as partner as a result a result Limit on membership Sole trader only No maximum, No maximum, Minimum 1 no minimum two minimum two maximum Law 7: Company law 75 Feature Sole trader Partnership LLP Company Management rights Sole trader Each partner has Each partner has the Members have no the right to manage right to manage the right to manage the the business business business Administration Limited Limited formalities Annual returns and Annual returns and formalities accounts filed with accounts filed with Company Registrar Company Registrar are public are public documents. documents. Withdrawal of No restrictions No restrictions Capital maintenance Capital maintenance capital rules apply rules apply INTERACTIVE QUESTION 16: COMPANY V PARTNERSHIPS Indicate whether or not each of the following is true or false SOLUTION True False A A benefit for the participants of a partnership over a company is that because it has separate legal personality, they have limited liability. B A benefit for the owners of a company over a partnership is that because it has separate legal personality, they have limited legal liability C A benefit of a limited company over a partnership is that a company's liability is limited D A benefit of a partnership over a company is that a partnership is not subject to any legislative regulation. Knowledge diagnostic Before you move on to the next chapter, complete the following knowledge diagnostic and check you are able to confirm you possess the following essential learning from this chapter. If not, you are advised to revisit the relevant learning from the topic indicated. Confirm your learning Yes/No Do you know the principle of law that was decided by the Salomon v Salomon case? Can you list five differences between a private and public company? Do you know what a memorandum of association is? Do you know how a company may change its name? Do you know what model articles are? Can you list five records that companies must keep? Do you know the criteria that companies must meet in order to be classified as a micro, small and medium? 76 7: Company law Law  77 8 Companies: ownership and management Topic List 1 Types of director 2 Directors’ duties 3 Other statutory controls on directors’ behaviour 4 Members 5 Meetings and resolutions Learning Objectives Identify the administrative consequences of incorporation or the formation of a limited liability partnership including requirements regarding statutory books, accounts, meetings and the role of the company secretary Recognise how a shareholder can influence the management of a company through meetings and resolutions, including shareholders' rights to requisition a meeting Identify the various statutory rights of shareholders to challenge the management of the company under the Companies Act 2006 and the Insolvency Act 1986 Identify the ways in which a director may be appointed and removed Identify directors' duties, explaining the consequences of any major breach Identify the powers of directors and in what circumstances they will bind the company in a contract with third parties 78 8: Companies: ownership and management Law 1 Types of director The Companies Act applies equally to anyone who occupies the role of director howsoever he qualifies as one. Type of director How such a director comes to be in office Director (on As provided by the articles, usually appointed incorporation or By existing directors or subsequently) By ordinary resolution (directors of public companies should be voted on individually (s 160)) De facto director Anyone who acts as a director, although not validly appointed as one. He has the (literally 'director in same powers as a properly appointed director. fact') Shadow director Someone 'in accordance with whose directions or instructions the directors are accustomed to act' (not professional adviser). Whether someone is a shadow director is a question of fact. Alternate director The articles usually provide that a director may appoint an alternate director to attend and vote at board meetings which he himself is unable to attend. Executive director A director who is also charged with performing a specific role, e.g. a finance director, usually as an employee of the company. The articles usually provide for the directors to appoint one or more of their number to any executive function and on such terms as to remuneration and powers as they see fit. If an executive director ceases to be a director, his office will also terminate, but without prejudice to any claim he may have for breach of any service contract. Non-executive director A director (appointed or otherwise as above) who does not have a particular function but generally just attends board meetings. The chairman of the board of directors is usually regarded as a non-executive director. Managing director (MD) The articles usually provide for the directors to appoint one or more of their number to be managing director(s), charged with carrying out day-to-day management functions. 1.1 Key points A director should be aged sixteen or more. Must not be disqualified from acting, either by the Company Directors Disqualification Act 1986 or by the articles of association. Every company is required to have at least one director who is a natural person and a public company must have at least two directors (s 154). Hashmi v Lorimer-Wing 2022 Private companies with a sole director and model articles will need to change the model articles to allow for board meetings with a single director. A director's actions are valid even if his appointment is subsequently found to have been defective or void (s 161). Any change in the directors of a company should be recorded in the company's register of directors and notified to the registrar within 14 days. Law 8: Companies: ownership and management 79 1.2 Removal of a director A director might leave office in any one of the following ways: Death of the director or winding up of the company Removal (see below) Disqualification Resignation Where required to do by articles: Prohibition by law As a result of bankruptcy or a written medical opinion of being physically or mentally unable to act as a director 1.2.1 Removal of a director A company may remove a director from office by passing an ordinary resolution to that effect (s 168). Special notice (of 28 days) must be given of the intended resolution and the director then has the right to address the meeting and to request that any written representations that he makes be circulated to members or read out at the meeting. If a director has a service contract with the company removal may allow him to sue for breach of contract. A director who is also a member may have weighted voting rights given to him under the constitution for such an eventuality, so that he can automatically defeat any motion to remove him as a director (Bushell v Faith 1970). It is possible to draft a shareholders' agreement stating that a member holding each class of share must be present at a general meeting to constitute a quorum. If so, a member holding shares of a certain class could prevent a director from being removed by not attending the meeting. INTERACTIVE QUESTION 17: RESOLUTION FOR THE REMOVAL OF A DIRECTOR A company has three members who are also directors. Each holds 100 shares. Normally the shares carry one vote each, but the articles state that on a resolution for a director's removal, the director to be removed should have 3 votes per share. On a resolution for the removal of Jeremy, a director, Jeremy casts 300 votes against the resolution and the other members cast 200 votes for the resolution. Has Jeremy validly defeated the resolution? SOLUTION A No, the articles are invalid insofar as they purport to confer extra votes. B Yes, the proceedings and articles are valid. C Yes. Whilst the articles are invalid and the voting is therefore 200 to 100 in favour, a special resolution is required and the necessary 75% majority has not been obtained. D No. A director is not entitled to vote on a resolution for his own removal. 80 8: Companies: ownership and management Law 1.3 Director’s powers The powers of the directors are defined by the company's articles. Normally directors are authorised, in general terms, to manage the business of the company and to exercise all the powers of the company. The directors' powers are to be exercised properly and within the company’s’ constitution, but the directors are not agents of the members and subject to their instruction as to how to act. The powers are vested in them as a collective body and are usually exercised in board meetings. There are no formal rules governing board meetings and directors need not be physically present. A meeting cannot be held if any of the directors reasonably object. There are the following restrictions on how director’s powers are exercised. Type Example Statutory (general) The directors are statutorily bound to exercise powers only 'for the purpose for which they are conferred' Statutory (specific) For example alteration of the articles and reduction of capital need a special resolution, which the directors must secure from the shareholders in general meeting before they can act. Articles For example the articles may set a maximum amount that the directors are entitled to borrow, any greater amount needing approval of the company in general meeting. Members The members can exercise control over the directors' powers By passing a special resolution to alter the articles, thereby re-allocating the powers between the board and the general meeting. Ultimately by removing directors from office. 1.4 Directors’ authority As a general rule a contract which is entered into by a director with authority is binding on the company. As we saw in chapter 3 the authority can be actual or apparent/ ostensible. Express actual Implied Ostensible The actions of a director Managing directors, and to some If the board permits a director to with express authority will extent other executive directors behave as if he were a managing bind the company (such as sales directors or finance director or give the impression that he directors), are much more likely to is one, that director will have the bind the company by their actions, apparent or ostensible authority to since greater powers are usually enter into all commercial contracts delegated to them. Thus a managing relating to the business as a managing director has implied usual authority director would have and to bind the to make general business contracts company in respect of them. on behalf of the company (in (See Freeman & Lockyer v BPP in addition to any actual authority Chapter 3) given to him by the board). A company secretary has limited authority to enter into contracts. Law 8: Companies: ownership and management 81 1.4.1 Authority under the Companies Act 2006 Legislation (section 40 Companies Act) seeks to protect a third party who acting in good faith enters into a contract with the company even where the authority of the director is limited. The following should be noted: The third party is deemed to be acting in good faith unless the contrary is proved (and will not be deemed to be acting in bad faith just because he knows of the limitation) All limitations on the director’s authority can be disregarded s 40 will not apply where the person dealing with the company is a director or person connected with a director. In such cases, the transaction becomes voidable at the instance of the company and that party is liable to account for any gain and to indemnify the party against any loss. 2 Directors’ duties These duties are common law duties which are now enshrined in the legislation. All directors owe the duties to the company as a whole – not to individual shareholders. (ASPIRIN – Accountability, Success, Act within Powers, Independent judgement, Reasonable skill and care, Declare an Interest, No benefits) 2.1 To act within powers A director must: Act in accordance with the company's constitution, Exercise powers only for the purpose for which they were conferred. If the directors infringe this rule by exercising their powers for a collateral purpose, the transaction will be invalid unless it is approved or ratified by the company in general meeting. If the irregular use of directors' powers is the allotment of shares, the votes attached to the new shares may not be used in reaching a decision in general meeting to sanction it. Howard Smith Ltd v Ampol Petroleum Ltd 1974 The facts: Shareholders who held 55% of the issued shares intended to reject a take-over bid for the company. The directors honestly believed that the bid's success was in the company's interest and so allotted new shares to the prospective bidder so that the shareholders opposed to the bid would then have less than 50% of the enlarged capital and the bid would succeed. Decision: The allotment was invalid. 'It must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority or creating a new majority which did not previously exist'. 82 8: Companies: ownership and management Law Bamford v Bamford 1969 The facts: The directors of Bamford Ltd allotted 500,000 unissued shares to a third party to thwart a take-over bid. A month after the allotment, an ordinary resolution was passed ratifying the allotment, the holders of the newly-issued shares not voting. The claimants (minority shareholders) alleged that the allotment was not made for a proper purpose. Decision: The ratification was valid and the allotment was good. There had been a breach of fiduciary duty but the act had been validated by an ordinary resolution passed in general meeting. 2.2 To promote the success of the company A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. He should have regard to: The likely long term consequences of any decision The interests of the company's employees The need to foster the company's businesses relationships with suppliers, customers and others The impact of the company's operations on the community and the environment The desirability of the company maintaining a reputation for high standards of business conduct The need to act fairly as between members of the company 2.3 To exercise independent judgement It does not mean that he is not exercising independent judgment where he acts in accordance with: An agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or The company's constitution. 2.4 To exercise reasonable skill and care This means the level of skill, care and diligence that would be exercised by a reasonably diligent person with: The general knowledge, skill and experience that may reasonably be expected of a person performing his functions as director His actual general knowledge, skill and experience. Simply attending board meetings and not attending to the company's interests in between meetings is unlikely to be sufficient. Law 8: Companies: ownership and management 83 Lexi Holdings plc (in administration) v Luqman 2009 The facts: Two sisters and their brother were directors of a company. The brother had convictions for offences of dishonesty in the past. The sisters knew this but played no part in the company, demanded no explanations from their brother of his business dealings and did not advise the other directors, auditors and the bank of his convictions. The brother took nearly £60m in fictitious loans, false facility letters and by his appropriation of company funds. Decision: The Court of Appeal held that the sisters were, or ought to have been, aware of various matters in relation to the fraud perpetrated on the company by their brother. As a result, they were liable as they were in breach of their fiduciary and common law duties of care owed to the company. 2.5 To avoid a conflict of interest A director must avoid a situation in which he has or can have a direct or indirect interest that conflicts or possibly may conflict with the interests of the company or another duty. The duty is not infringed if the matter has been authorised by the directors. This may happen: In a private company, provided the company's constitution does not invalidate such authorisation In a public company, provided the company's constitution expressly allows such authorisation In each case, the relevant director cannot be counted towards a quorum and his votes will not be included in determining whether the authorisation is given. Note that this duty will not apply where the director has declared his interest in a proposed transaction. Towers v Premier Waste Management (2012) The facts: A director accepted a personal loan of equipment from a customer free of charge. The customer then invoiced the company. The company sued the director for breach of fiduciary duty. Decision: The Court of Appeal held that the director had obtained an advantage from a potential conflict of interest and had disloyally deprived the company of the opportunity to object to the opportunity being diverted away from the company. It was irrelevant that the company had suffered no loss or that the director was not dishonest and that the benefit had been small. 2.6 Not to accept benefits from third parties A director must not accept a benefit from a third party by reason of his: Being a director, or Doing (or not doing) anything as director. Unless the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. 84 8: Companies: ownership and management Law 2.7 To declare an interest in a proposed transaction Provided the director is, or ought reasonably to be, aware of the situation, he must declare the nature and extent of any such interest (direct or indirect) to the other directors, unless it cannot reasonably be regarded as likely to give rise to a conflict of interest. The notice may be made: At a board meeting By notice in writing or By a general notice, i.e. that he has an interest in the third party and is therefore to be regarded as interested in any transaction or arrangement with that third party (in which case he should take reasonable steps to ensure that such general notice is brought up at the next board meeting). Provided such declaration is made, there is no need for approval by the members or the board, unless: The company's constitution requires it or, Unless it is an arrangement between a director and the company for the transfer of a ‘substantial non-cash asset’ (see below). INTERACTIVE QUESTION 18: DIRECTORS DUTIES Xray Ltd intends to enter into a contract for the supply of medical supplies from a firm in which Xavier, a director of Xray Ltd, is a partner. The terms of the contract are no less onerous than those of contracts between the company and other suppliers, but nonetheless Xavier is concerned that he may commit an offence if the contract goes ahead due to his interest in the firm. Advise Xavier. SOLUTION 2.8 Breach of director duties The directors’ duties are owed to the Company and not to individual shareholders. If an action is bought by the company the consequences include the following: To make good any loss suffered by the company, including secret profits Any contract entered into between the company and a director may be rendered voidable Any property taken by the director from the company can be recovered if it is still in his possession An injunction if the breach is continuing If more than one director is in breach then their liability will be joint and several. Law 8: Companies: ownership and management 85 3 Other statutory controls on directors’ behaviour The following provisions apply to penalise directors who are responsible for the mismanagement of companies. Such mismanagement often results in the company being wound up, often following insolvency. Administrators, receivers and liquidators must consider what action should be taken. They may apply to the court for an order to be made under the wrongful or fraudulent trading rules such that a director is required to contribute to the assets of the company such amount as the court considers “just and reasonable.” They also have a statutory duty to report to the Department for Business, Innovation and Skills (BIS) on directors of companies in whose affairs they have become involved, where they believe the conditions for a disqualification order have been satisfied. The Secretary of State then decides whether to apply to the court for an order, but if he does decide to apply, he must do so within two years of the date on which the company became insolvent. 3.1 Wrongful trading KEY TERMS Wrongful trading Where a company goes into insolvent liquidation and, At some time before the commencement of the winding up, the director(s) knew or should have known that there was no reasonable prospect that the company could have avoided going into insolvent liquidation. The standard applied is that of a reasonably diligent person with the general knowledge, skill and experience that might reasonably be expected of a person carrying out that particular director's duties (i.e. a reasonable occupant of a similar post). Where a director has greater skill and experience than a 'normal' director, he is also judged by reference to his own capacity. Thus the standard expected of a listed company director would be higher than for the director of a small owner-managed private company. However, no declaration of wrongful trading will be made where the court is satisfied that the director(s) took every step that he or they ought to have taken in order to minimise the potential loss to creditors (s 214 Insolvency Act 1986). Consequence: Where a director is liable under s 214 the court can order him to 'make such contribution to the assets of the company as the court thinks proper'. 3.2 Fraudulent trading KEY TERMS Fraudulent trading Where any business of a company is carried on with intent to defraud creditors of the company (or of another person) or for any fraudulent purpose. 86 8: Companies: ownership and management Law The offence is committed by any person who is knowingly a party to the business being carried in that manner. Note that only persons who take the decision to carry on the company's business in this way or play some active part are liable. 'Carrying on business' can include a single transaction and also the mere payment of debts. Consequence Fraudulent trading can give rise to either a civil or a criminal offence as described below: Criminal offence Applies whether or not the company is wound up Punishable by a fine and/or imprisonment for up to 10 years Civil offence Applies only when the company is wound up The court can order the director to 'make such contribution to the assets of the company as the court thinks proper' 3.3 Disqualification of directors The Company Directors Disqualification Act 1986 (CDDA) was introduced in response to public disquiet with directors of failed companies being able to walk away from the wreckage of a company with no personal liability. The CDDA provides that a court may disqualify a person from being a director, liquidator, administrator, receiver or manager of a company and from being concerned in the promotion or management of any company (or LLP). Grounds A disqualification order for up to Where a person is convicted of a serious offence (usually in connection 15 years may be made: with the promotion, formation, management or liquidation of a company). Where it appears in the course of the winding up of a company that a person has been guilty of fraudulent trading (though not necessarily convicted of the offence). Where the Secretary of State considers it to be in the public interest. Where a director is guilty of certain breaches of competition law. Where a director has participated in wrongful trading. A disqualification order for up to Where a person has been persistently in default in relation to 5 years may be made: provisions of company legislation (and three convictions for default in five years are conclusive evidence of persistent default). A disqualification order must be Where a person has been a director of a company which has at any made, for a minimum of 2 years time become insolvent (whether while he was a director or and a maximum of 15 years: subsequently) and his conduct as a director of that company makes him unfit to be concerned in the management of a company. (The courts may also take into account his conduct as a director of other companies, whether or not these other companies became insolvent.) Directors can be disqualified under this section even if they take no active part in the running of the business. Alternative to disqualification The secretary of state may accept an undertaking from the director to refrain from acting in the management of a company in uncontested cases. Law 8: Companies: ownership and management 87 Examples from case law Re Uno, Secretary of State for Trade and Industry v Gill 2004 Facts: A group consisting of two furniture companies carried on trading while in serious financial difficulties, while the directors tried to find a way out of the situation. Uno continued to take deposits from customers for furniture to fund its working capital requirements. Decision: The directors were not disqualified for acting in this way as their behaviour was not dishonest or lacking in commercial probity and did not make them unfit to manage a company. They had been trying to explore realistic opportunities to save the businesses and were not to blame for the eventual collapse of the businesses and the subsequent loss of customers. Secretary of State for Trade and Industry v Thornbury 2008 Facts: A director failed to carry out any further investigation after receiving verbal assurances from other directors regarding the financial status of the company. The company was in breach of its statutory obligations to pay HMRC. Decision: Although the director had not been dishonest, it had not been reasonable for him to leave matters in the other directors' hands to such a degree. He was held to be unfit to be concerned in the management of a company and disqualified for two years. Consequences of breaching an order Breach of an order can result in a fine or imprisonment. The following circumstances may result in the court imposing a lower period of disqualification in mitigation: Lack of dishonesty Loss of director's own money in the company Absence of personal gain (such as excessive remuneration) Efforts to mitigate the situation Low likelihood of re-offending 4 Members Anyone entered on the company’s register of members is a member of the company. Where a member owns shares in a company, they are generally described as shareholders. 4.1 Regulation of members Members are bound by the articles of association as if it were a binding contract between all of the members and the company. In many private companies a shareholders’ agreement may also exist. 4.2 Member rights A member has the right To be sent a copy of annual accounts and reports To require directors to call a general meeting 88 8: Companies: ownership and management Law To appoint a proxy (a person or persons who may then exercise all their member rights to attend, speak and vote at meetings of the company). Such appointment will be in writing. 4.2.1 Members’ approval of director actions Certain director actions require the approval of members to be valid. Matter requiring approval Consequences of breach Directors service contracts with a term of 2 years or Contract can be terminated on the company giving more (s 188) reasonable notice. Substantial property transactions where a director The transaction is voidable at the instance of the acquires non-cash assets from the company (s 190) company, unless the members give approval within “Substantial”, means one or more one (or more) a reasonable period. whose (aggregate) value The director is liable to account to the company for Exceeds 10% of the company's asset value and is any gain and to indemnify the company against any more than £5,000 loss or damage. Or Exceeds £100,000 (Not payments under service contracts or loss of office) Loans to directors (s 197) The transaction is voidable at the instance of the Approval is required for any loan by a company to a company, unless it is approved by the company director or for any guarantee or security by a within a reasonable period. company The director is liable to account to the company for any gain and to indemnify the company against any loss or damage. Payments for loss of office (s 217) The payment is held on trust for the company. Any Approval is required for payments or benefits to be director who authorised the payment is liable to made on loss of office or retirement. indemnify the company for any loss. There are exceptions for small payments (£200 or less) and payments in discharge of legal obligations. 4.3 Minority protection 4.3.1 The Rule in Foss and Harbottle The majority shareholders control the company and generally speaking the minority shareholders have no course of action if they are unhappy with a decision taken by the majority. Shareholders have no duty to act in the interests of the company. Foss v Harbottle 1843 The facts: A shareholder (Foss) sued the directors of the company alleging that the directors had defrauded the company by selling land to it at an inflated price. The company was by this time in a state of disorganisation and efforts to call the directors to account at a general meeting had failed. Decision: The action must be dismissed. The company as a person separate from its members is the only proper claimant in an action to protect its rights or property The company in general meeting must decide whether to bring such legal proceedings However there are a number of specific exceptions to this rule. Law 8: Companies: ownership and management 89 4.3.2 Where statute gives specific powers Subject Required Cancellation of variation of class rights Right to call a company meeting Notice of members' resolutions Payment out of capital by private company for Any shareholder (or creditor) can apply to court to the redemption or purchase of its shares prohibit this Registration of limited company as unlimited Any member can prevent this 4.3.3 Derivative actions A director’s duties are owed to the company which means that the company (not the members) may bring action against the directors. A member may bring a derivative claim on behalf of the company in respect of an actual or proposed act or omission by a director (or former director or shadow director) which involves negligence or breach of duty (or default or breach of trust). The member must first make out a prima facie case to the court and obtain permission to continue the claim (or to take over a claim begun by the company or another member). The court will consider the following before granting permission: Whether the member is acting in good faith The importance that a person promoting the success of the company would attach to it Whether authorisation or ratification by the company by the company is likely Whether the company has decided not to pursue the claim Whether its member could pursue the claim in his own right rather than on behalf of the company The views of members with no personal interest in the matter In any proceeding for negligence, default, breach of duty or breach of trust against an officer of the company (or auditors), the court may relieve him of any liability if it considers that he acted honestly and reasonably and that, having regard to all the circumstances of the case, he ought fairly to be excused (s 1157). Re D'Jan of London Ltd 1993 The facts: D, a director of the company, signed an insurance proposal form without reading it. The form was filled in by D's broker. An answer given to one of the questions on the form was incorrect and the insurance company rightly repudiated liability for a fire at the company's premises in which stock worth some £174,000 was lost. The company became insolvent and the liquidator brought this action under s 212 of the Insolvency Act 1986 alleging D was negligent. Decision: In failing to read the form D was negligent. However, he had acted honestly and ought therefore to be partly relieved from liability. The fact that D owned a 99% shareholding was relevant, as the risk he took might have been seen as more unreasonable if he had owned a lower stake in the company. 4.3.4 Unfairly prejudicial conduct Any member or the Secretary of State may apply to the court for relief under s 994 on the grounds that the company's affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of the members generally or of some part of the members' interests. It may be actual or proposed conduct and it is not necessary for the prejudicial effect to be intended. 90 8: Companies: ownership and management Law Examples of Unfairly Prejudicial Conduct (earlier legislation) Exclusion and removal from the board where the company was one in which the director had a legitimate expectation of being involved in management, i.e. a quasi-partnership company Re Bird Precision Bellows Ltd 1986 The facts: A minority with 26% of the shares suspected the MD of this 'quasi-partnership' company of concealing bribes paid to secure contracts. When the DTI refused to investigate the minority was removed from the board. They claimed that this unfairly amounted to prejudicial conduct. Decision: The claim was allowed as it was a 'quasi-partnership'. Improper allotment of shares, for example, an allotment by a majority shareholder simply to increase his holding Making an inaccurate statement to shareholders, for example misleading them by recommending acceptance of a bid by another company which the directors owned Diversion of a company's business to a director-controlled company Examples which were not accepted as unfairly prejudicial conduct: Failure by a parent company to pay the debts of a subsidiary Non-compliance with the Stock Exchange rules, the City Code and the Cadbury Code Failure by a fellow director and majority shareholder to increase the petitioner's shareholding A reasonable offer to buy out shares of the excluded shareholder is likely to be accepted by the courts The complaint must be based on prejudice to the member as a member and not as an employee, nor as an unpaid creditor O'Neill v Phillips 1999 The facts: P owned a 75% shareholding, although O managed the company (following P's decision to take a less active role in the affairs of the company) and, at P's suggestion, took 50% of the profits. The possibility of increasing O's shareholding to 50% was discussed but never acted upon. When business declined, P resumed control. He demoted O to the position of branch manager and withdrew his profit share. However, O remained a director. O claimed unfair prejudice for the withdrawal of his profit share and the alleged repudiation of an agreement to increase his shareholding. Decision: The House of Lords held that there was no firm agreement to increase O's shareholding and so he had no legitimate expectation of such action that the law would enforce. It was considered quite fair that P should retain a majority shareholding and exercise control in the way he did. Lord Hoffman did say (obiter) that if there had been an actual agreement in O's favour, his capacity as member (and not just as employee) might have founded a claim since he had invested time and money in the company. The provision cannot simply be invoked by shareholders when they do not like the way a company is run, even bad management alone is unlikely to amount to prejudicial conduct Law 8: Companies: ownership and management 91 Re A Company 1983 The facts: The petitioners' grievance was the directors' refusal to put forward a scheme of reconstruction or a proposal to purchase their shares (by the company). The directors were preoccupied with plans for diversification of the business. Decision: The directors' duty was to manage the company to its advantage as they saw it. It was not a case of 'unfair prejudice'. The courts may also take the petitioner's conduct into account when deciding whether certain actions are unfairly prejudicial Re R A Noble & Sons (Clothing) Ltd 1983 The facts: C had provided the capital but left the management in the hands of the other director on the understanding that he would be consulted on major company matters, but he was not consulted. He confined himself to enquiries of the other director on social occasions and accepted his vague assurances that all was well. The petition followed from a breakdown of the relationship. Decision: C's exclusion from discussion of company management questions was largely the result of his own lack of interest. His petition was dismissed. Consequences When a petition is successful, the court may make such order it thinks fit for giving relief in respect of the matters complained of, including: Regulating the future conduct of the company's affairs (for example that a controlling shareholder shall conform to the decisions taken at board meetings) Authorising any person to bring legal proceedings on behalf of the company Requiring the company to do an act that it has omitted to do or to refrain from doing an act complained of Requiring the company to make any (specified) alterations to its articles, or not to make such alterations without leave of the court Providing for the purchase of shares of the minority by other members or by the company itself at a fair price INTERACTIVE QUESTION 19: UNFAIRLY PREJUDICIAL CONDUCT Are the following likely to amount to unfairly prejudicial conduct under s 994 CA'06? SOLUTION Yes No A Failure of a parent company to pay the debts of its subsidiary. B Diversion of the company's business to a director-controlled company. C Failure to call a general meeting. D Late presentation of the company's accounts. 92 8: Companies: ownership and management Law 4.3.5 Just and equitable winding up A member who is dissatisfied with the directors or controlling shareholders over the management of the company may petition the court for a winding up on the grounds that it is just and equitable to do so. The member must show that no other remedy is available, since winding up what may be an otherwise healthy company is a drastic step. It is very much a remedy of last resort. Re A Company 1983 The facts: The parties' working relationship had completely broken down and they agreed that they would settle the dispute by a sale of the minority's shares to the majority. This settlement broke down however, because they could not agree on the price and the minority then petitioned on the just and equitable ground. Decision: An order for liquidation on this ground may only be made 'in the absence of any other remedy'. As the parties had agreed in principle that there was an alternative to liquidation the petition must be dismissed. Examples of successful claims Where the company was formed for an illegal or fraudulent purpose