Company Law

Company Law

The United Kingdom (UK) company law is complex. It was developed in the nineteenth century to provide a framework for corporations. Over the years, various directives, statutes and case law were added to the law in reaction to corporate scandals or specific issues. These additions resulted in a complicated law that has no consistency or coherence. This lack of consistency and coherence created confusion and frustration among those required to comply with the law.[1] Consequently, the Secretary of State for Trade and Industry observed that there was a need to perform a comprehensive review of the country’s national law. A Company Law Review Steering Group (CLRSG) was established to conduct the review and produced several reports. The final report was published in 2001.[2] The main concern for the review was the simplification of company law for small companies since the existing legal framework focused on large companies. The Review had established that the exemptions for modifying the company regime for the small companies had been complicated and adopted haphazardly.[3]

Another area of concern is shareholder value. Maximization of shareholder value is an obligation for companies under company law.[4] However, the Review revealed that the CLRSG did not observe any resolution to the rights of shareholders. Dingam and Lowry asserted that the critical question of the personal rights of shareholders was not addressed.[5] This is because the Company Law is not clear with regard to these rights. The CLRSG proposed reforms to address this question but dropped some of the reforms after consultation. Instead the CLRSG recommended one solution to make all articles enforceable by shareholders against each other and the company until contrary issues had been established. The Committee’s final report supported this position after weighing the benefits and the risks of exclusionary articles. However, the proposal had a lower practical effect because it sought to reduce the personal rights of shareholders. The government decided not to adopt the reform and instead maintained the unsatisfactory position on the personal rights of shareholders.[6]

Company law is not clear on the personal rights of minority stakeholders. Although the Companies Act of 2006 defines the statutes related to the rights of shareholders, these rights are not articulated in a clear manner, which has contributed to the confusion and frustration among stakeholders and shareholders. The general principal of the Act is that directors manage a company and that the decisions by majority shareholders during general meetings are binding on minority shareholders.[7] The Companies Act also allows a minority shareholder to make a claim against mismanagement of a company, just winding up of a company or unfair prejudice from some or all shareholders. These claims can be made for any type of company. The remedy for unfair prejudice claim is an order from the court stating that the majority shareholders should purchase the shares of the claimant at a particular price.[8] The remedy for just winding up of a company would be a court order requiring the winding-up of the company during solvency and distribution of net assets to shareholders.[9] Lastly, the remedy for derivative claim (such as a claim against a director) is enforcement of a claim that seeks to improve the value of a company’s assets that are available for shareholder distribution.[10] However, these claims are only successful when the shareholder has reasonable expectation to be included in the management of the company. Furthermore, these claims are not against the company and the minority shareholder would have to make such claims when the corporation is solvent and the shares of the claimant have significant value. In addition, the claimant shareholder would need to demonstrate that the company failed to comply with the provisions and the articles of the Companies Act.[11] This is a challenge for minority shareholders who often have no right to question the decisions of majority shareholders or the directors of the company.

The personal rights of shareholders are difficult to prove in unfair prejudice claim. Section 994 of the Companies Act contains the provisions unfair prejudice. The provisions outline the procedures for minority shareholders who feel that they are victims of a company’s unfair prejudicial action. To make this claim, the shareholder would have to demonstrate that the affairs of the company were conducted in an unfairly prejudicial manner to the shareholder(s).[12] The difficulty with this provision is that it gives the court wide discretion to choose the remedy to grant to the aggrieved shareholder once unfair prejudicial conduct is established. The most common remedy is an order to the majority shareholders to purchase the shares of minority shareholders at a specific value provided by the Court. In Franbar Holdings Ltd v Patel and others, the members of the company alleged unfair prejudice claiming that the company’s business with an insolvent debtor had prejudiced their interests.[13] The court held that the insolvency rules applied so long as the evidence provided by the petitioners was probative and the company was not in a position to produce countervailing prejudice. The court inspected the circumstances and confirmed that the case was consistent with the requirements for shareholder rights’ protection.[14]

The personal rights of shareholders are not clear in solvency cases. In particular, the personal rights of minority shareholders are often missed when a company is winding up or a petition has been made to wind up a corporation in accordance with section 125 of the Insolvency Act of 1986. If a minority shareholder makes this claim, the petitioner has to prove that the company would have substantial surplus upon winding-up. The court can order the company to wind up on the same basis as it would grant relief on unfair prejudice claim. However, the circumstances in which the minority shareholder can have an advantage on a winding-up claim are quite limited. The company can be a party to the claim even thought the petition is not against the company and the assets of the company cannot fund the defense or the claim. For instance, in Wood v Odessa Waterworks Co, the claimant made a claim to prevent the company’s payment through debentures. The petitioner claimed that the constitution of the company, under the Companies Act, constituted a contract between shareholders and the company, and between shareholders inter se. The petitioner enforced the company constitution to claim his contractual rights and block payment of debentures. The court held that the petitioner was entitled to the injunction with regards to dividend payments. The court observed that the petition could enforce his contractual rights from the company’s articles of association.[15] A similar petition on winding up was made in Ebrahimi v Westbourne Galleries Ltd where the petitioner claimed that he had become a minority shareholder on the board and the general meeting after another shareholder introduced his son as a shareholder and director to the company. The two shareholders voted the petitioner off the board using section 303 of the Companies Act 1985.[16] The court held that the shareholders had breached the personal rights of the petitioner by excluding him from management and breaching their partnership that formed the basis for the business relationship. Lord Wilberforce ruled that the petitioner had a right to request for an equitable winding-up of the company. He argued that within company law the individual rights and expectations inter se are not necessarily submerged in a company structure. Further cases established that petitioners need to be honest with the court so that they are not guilty of misconduct that may have led to breakdown of relations that caused their petition.[17]

Another concern is the handling of disputes between shareholders (minority and majority) and the company. In Hickman v Kent or Romney Marsh Sheep-Breeds Association, the claimant shareholder sued the company for failing to register his sheep and including the sheep in a published book. The claimant sought to have the court to enforce his personal rights as a shareholder to have the sheep registered in the company’s book. The court enforced the arbitration clause based on the articles of association that provided for an arbitration process between shareholders and the company. The court held this ruling claiming that an article constituted a contract between members and the shareholders’ contractual rights against other shareholders.[18] The right of shareholders with regard to contract inter se and the enforcement against other shareholders was also considered in Rayfields v Hands. In the case, the petitioner had sought clarification on the direct enforceability of a contract inter se between two members. The court considered the conflicting authorities and held that there was actually contract inter se that could be enforced directly by one shareholder against another.[19] The Court held that under common law, a shareholder could only enforce these rights if he or she falls within the scope of the Companies Act. A contrasting observation was made in London Sack and Bag v Dixon where there was a conflict between two shareholders of UK Jute Association. Although the shareholders claimed that they were both members of the articles of association, the Court held that the petitioners did not adequately prove their binding submission to an arbitration process.[20]

Derivative claims are statutory remedies for shareholders provided by the Companies Act.[21] The provisions of the Act allow a shareholder to make a derivative claim on the company’s behalf. However, the claim must demonstrate negligence, breach of duty, breach of trust or default by a director. Once a claim has been issued, the claimant shareholder would have to seek the court’s permission to advance with the claim. The rights of the claimant shareholder are not upheld when the court finds that the derivative claim does not protect the company’s interests. In addition, the court may deny the derivative claim if the alleged conduct has been ratified or authorized by the company. In such a case, the company’s authorization holds greater importance than the rights of the shareholder.[22] In Hughes v Weiss and another, the petitioner had applied for permission for derivative claims and sought the court to grant permission to carry the claim against the company.[23] The High Court issued the permission to one shareholder but did not grant permission to the second shareholder in the company to continue with the derivative claims. The first shareholder was given permission to continue with the derivative claim against another shareholder since the claim aimed to protect the company’s interests. Judge Keyser QC rejected alternative remedies such as voluntary winding up under the Act and argued that a derivative claim was more suitable since the claimant was seeking a solution for a director’s misfeasance. [24] An interesting observation from the proceedings was that the shareholder had made a personal claim against the firm and that this claim was included in the court order to avoid the costs associated with two proceedings. The judge was initially attracted to the simplicity of combining a derivative and personal claim in one proceeding. He later concluded that combining the claims was inappropriate and delayed the personal claim in favor of the derivative claim.

The rights of shareholders may be described in shareholder agreements between shareholders.[25] Shareholders may have an agreement between themselves or with the company. These agreements bundle the rights of shareholders in the form of shares. This implies that a shareholder, based on his share ownership, can exercise the rights to this share in a specific way. The shareholder can agree with a second shareholder to exercise his rights to his shares in favor of the second shareholder during an election to the board. Alternatively, a shareholder can draft an agreement to sell his shares to a second shareholder, thereby forfeiting the ability to exercise the rights that are attached to those shares.[26] The benefit of an agreement is that it is easier to enforce compared to altering and then enforcing the articles of association. In addition, a shareholder agreement is a private agreement between two or more shareholders who have agreed to transact with each other. In such a case, the shareholder can have secret contracts with other shareholders to exercise control through the majority voting rights in a firm without necessarily owning the majority of shares in the company. This agreement therefore provides an alternative for shareholders to exercise their rights by agreeing to sell or buy shares. The drawback of this approach is that the shareholder agreement does not bind new owners of shares. Once a shareholder agrees to sell shares to a second shareholder, the second shareholder is not obligated by the agreement. This is contrary to the CA that binds any future shareholders to the constitution of a company.[27]

The problem with shareholder agreements was observed in Euro Brokers Holdings Litd v Monecor (London) Ltd and Puddephatt v Leith where shareholders had to go to court to have their agreements enforced or formally altered.[28] In Puddephatt v Leith, the court had to compel one shareholder to vote as had been agreed in the shareholder agreement. These shareholder agreements can only regulate their rights but have no impact on the operation of the company. Where the company’s operation is a concern to shareholders, then the company would have to a party to an agreement. The inclusion of the company to an agreement adds more security to the agreement because the company is legally bound to whatever the shareholders agree even if some shareholders decide to sell their shares.[29] This practice is common in medium-sized and small businesses that have no separation of control and ownership, such as where the directors and shareholders are the same people.[30] However, including the company in the agreement is a challenge especially when the subject matter cannot be enforced by law. This challenge was observed in Punt v Symons and Company Ltd where the court held that the company could not use shareholder agreements to alter the articles of association. The court observed that the components of the shareholder agreement that bound the company could not be enforced to alter the articles because the firm would have breached contract.[31]

Conclusion

While shareholder agreements allow all shareholders to enter into agreements among themselves or with the company, the agreements do not necessarily address the statutory rights of the minority shareholders. Company law allows shareholders to complain that their personal rights have been infringed. However, the company cannot sue especially in cases where the majority shareholders have perpetrated wrongdoing or infringed on the rights of minority shareholders. The remedy for the minority shareholder would be to bring an action. This is especially where the minority shareholder depends on the company for a living or works for the company or management. Such a shareholder would not have little sentimental attitudes towards the business because they work for or are vested in the private company.

References

Legislation

Companies Act 1985, s 459

Euro Brokers Holdings Ltd v Monecor (London) Ltd [2003] EWHC (Ch)

The Company Law Reform (HL) Bill 2005-2008 [190]

Insolvency Act 1986, s 125

Puddephatt v Leith [1916] Ch

Books and Cases

Company Law Review Steering Group, Modern company law: F or a competitive economy- Final report (HC 2001 I)

Dignam, Alan and John Lowry, Foundation and constitutional issues in company law: Section D- Company law constitutional issues II (University of London Press 2008)

Dignam, Alan and John Lowry, Company law (12th edn, Oxford University Press 2012)

Franbar Holdings Ltd v Patel and others [2008] All ER (D) 14 (Jul)

Hickman v Kent or Romney Marsh Sheep-Breeds Association [1915] 1 Ch 881

Hughes v Weiss and another [2012] EWHC 2363 (Ch)

Keay, Andrew, The enlightened shareholder value: Principle and corporate governance (2nd edn, Routledge 2013)

London Sack and Bag v Dixon & Lughton [1943] 2 All E.R. 763

Punt v Symons and Company Ltd [1903] 2 Ch 506

Rayfields v Hands [1960] Ch 1

Reisberg, A, Shareholders’ remedies: In search of consistency of principle in English law (2005) European Business Law Review 1063.

Trade and Industry Committee, The White Paper on modernising company law (HC 2002-2003, 5-439)

Wood v Odessa Waterworks Co [1989] 42 Ch D 636

[1] Trade and Industry Committee, The White Paper on modernising company law (HC 2002-2003, 5-439)

[2] Trade and Industry Committee, The White Paper on modernising company law (HC 2002-2003, 4-439); Company Law Review Steering Group, Modern company law: F or a competitive economy- Final report (HC 2001, ix-I)

[3] Trade and Industry Committee, The White Paper on modernising company law (HC 2002-2003, 5-439)

[4] The Company Law Reform (HL) Bill 2005-2008 [190]

[5] Dignam, Alan and John Lowry, Company law (12th edn, Oxford University Press 2012) 166; Keay, Andrew, The enlightened shareholder value: Principle and corporate governance (2nd edn, Routledge 2013) 147

[6] Keay, Andrew, The enlightened shareholder value: Principle and corporate governance (2nd edn, Routledge 2013) 147

[7] Trade and Industry Committee, The White Paper on modernising company law (HC 2002-2003, 5-439)

[8] Companies Act 1985, s 459

[9] Insolvency Act 1986, s 125

[10] Companies Act 2006, s 239; Reisberg, A, Shareholders’ remedies: In search of consistency of principle in English law (2005) European Business Law Review 1063.

[11] Companies Act 2006, s 239

[12] Companies Act 2006, s 994.

[13] Franbar Holdings Ltd v Patel and others [2008] All ER (D) 14 (Jul).

[14] Franbar Holdings Ltd v Patel and others [2008] EWHC 1534 (Ch)4

[15] Wood v Odessa Waterworks Co [1989] 42 Ch D 636

[16] Ebrahimi v Westbourne Galleries Ltd [1973] AC 360

[17] Dignam, Alan and John Lowry, Foundation and constitutional issues in company law: Section D- Company law constitutional issues II (University of London Press 2008) 25-26.

[18] Hickman v Kent or Romney Marsh Sheep-Breeds Association [1915] 1 Ch 881.

[19] Rayfields v Hands[1960] Ch 1

[20] London Sack and Bag v Dixon & Lughton [1943] 2 All E.R. 763

[21] Companies Act 2006, ss 260-264.

[22] Companies Act 2006, ss 238-239.

[23] Hughes v Weiss and another [2012] EWHC 2363 (Ch)

[24] Companies Act 2006, s 994.

[25] Dignam, Alan and John Lowry, Company law (12th edn, Oxford University Press 2012) 167

[26] Dignam, Alan and John Lowry, Company law (12th edn, Oxford University Press 2012) 167

[27] Companies Act 2006, s 33; Dignam, Alan and John Lowry, Company law (12th edn, Oxford University Press 2012) 167

[28] Euro Brokers Holdings Ltd v Monecor (London) Ltd [2003] EWHC (Ch); Puddephatt v Leith [1916] 1 Ch 200.

[29] Dignam, Alan and John Lowry, Foundation and constitutional issues in company law: Section D- Company law constitutional issues II (University of London Press 2008)

[30] Dignam, Alan and John Lowry, Company law (12th edn, Oxford University Press 2012) 168

[31] Punt v Symons and Company Ltd [1903] 2 Ch 506

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