Companies act2006. Revised

Facts: Ulrich, Emily and Nadine are directors of EnCom Ltd.  Before its incorporation, they previously established as a partnership between Ulrich and Emily who are joint managing partners.  Nadine, on the other hand served as an employee of the partnership.

Later on, their company was incorporated with all the three serving as directors.  Ulrich and Emily were given 49% shareholdings each while Nadine received 2% shareholding.  Being the company needed funds before it could start to operate, Nadine entered into a loan agreement with the Bank of Rutland to fund the company.

She signed the loan agreement form “For and on behalf of EnCom.”  Eventually, there was disagreement between the directors and she was dismissed from her position.  Nadine was later sued by the Bank of Rutland for defaulting in the payment of the loan she entered into For and on behalf of EnCom.

Nadine blames both Ulrich and Emily for the financial distress the company had suffered.  She claimed that both Ulrich and Emily appointed their family members to assist in the running of the business despite their lack of knowledge and expertise.  There was also evidence that both Ulrich and Emily spent substantial amount of company funds on flowers, chocolates and other gifts for the staff.

Issues: What are the remedies available to Nadine as a shareholder of EnCom Ltd and whether Nadine is liable to the Ban of Rutland for the loan agreement he signed for and in behalf of the company

The Board of Directors

The Board of Directors of a company are the official representative of the company and are vested with the authority to exercise corporate powers, conduct all business and control and hold all properties of the corporation. Such issues include the hiring/firing of executives, dividend policies, options policies and executive compensation.

The supreme authority insofar as the management of the business regular and ordinary affairs of the corporation is vested with the Board of Directors.  This is the reality in every company.  In fact the larger the company, the less its shareholders have in the management of the company.  Such as in this case where two of the directors own 98% of the shares of EnCom Ltd.

The shareholders of a corporation elect people who have been nominated to direct or manage the corporation as a board. In the past nearly all states required that at least three directors run a corporation. The laws have changed. Today all companies must at least have one director and at least two in a public company. This is enshrined in Section 282 of the Companies Act 1985. Virtually anyone can be a director as there are very few statutory restrictions.

Presently, the duties of a director are set forth in the common law rules and also in statutes such as the Companies Act of 1985 as amended by Companies Act of 1989. Under these rules, the duties of a direct include: the duty to act in good faith to the best interest of the company, the duty to avoid conflicts of interest, the duty not to profit from their offices and the duty of care and skill.  In addition to these common-law duties, directors also owe a duty to protect the interests of the creditors in case of insolvency[1]   and the duty of obedience by not exceeding the powers and objects of the company.[2]

However, despite the developments and improvements in case law and common law duties of directors, one of its limitation is that it keeps on changing and evolving.  Another important concern for the directors is the accessibility of duties required of the directors.  This has caused confusion on the directors as they are forced to consult professional advice just so that could ensure that they will not unintentionally breach their duty.

Thus,   the Companies Act of 2006 was codified to make the law not only clear and accessible but also certain and consistent.  (“Companies Act 2006 and Directors Duties”) Under the Companies Act of Sections 170 to 181 of the said law, the duties of directors are clearly stated.

The first duty is the duty to act within their powers.  Though this has been a part of the common-law duties of directors, this law gave certainty to the duty of the director not to exceed his authority in dealing with the third persons.  Usually, the powers and the limitations of the powers of each director are found in the company’s articles of association.

The second duty is the duty to promote the success of the company.  Before the Companies Act of 2006 was enacted, the directors may still escape their liability for negligence or incompetence committed by merely proving that they did their best to run the company.  Before, the duty to prove that the director committed negligence falls upon the petitioner.[3]  This was the ruling of the court in one case where it ruled that the directors are not liable provided they used ‘fair and reasonable diligence’ and ‘honestly’ in running the affairs of the company.[4]

Sec 171 (1) of the Companies Act 2006 imposes greater responsibility to the directors in maintaining a harmonious relationship with the suppliers, customers, and in its interaction with the community and the environment and the in maintaining its reputation in the business industry, the long term consequences of the company’s decision and the interest of its employees.[5]

Thus it is widely regarded that the codified duties of directors provided for a radical departure from the old manner by which companies conduct their business wherein it was thought that “business success and the interest of the shareholders were thought to be in conflict with the society’s aspirations for people who work in the company or forth e long-term well-being of the community and the protection of the environment.”[6]

Section 173 also imposes upon the directors the positive duty to exercise independent judgment.  The purpose of this provision is to finally put a to ‘shadow directors’ or the ‘sleeping directors’ who do not decide what is best for the company but merely follow another director’s judgment on any matter affecting the company.

Section 174 (1) imposes the duty to exercise reasonable care, skill and diligence which is a mere codification of the common law duty of care and skill.  Although it is acknowledged that directors are not insurers of the success of the business undertaking of the company, the Companies Act 2006 requires that they possess “general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried bout by the director in relation to the company.” [7]

This was confirmed in the case of City Equitable Fire Insurance Co Ltd[8] which established the following guidelines in determining whether the director complied with his duty of care in running the affairs of the company: a) he is expected to show the degree of skill which should reasonably be expected from a person of his knowledge and experience; b) he is expected to attend board meetings when able but has no duty to concern himself with the operation of the company at other times; c) he is expected to leave the normal day-to-day business of the company to the management team of that company.

The duty to avoid conflicts of interest springs from the fiduciary duty of directors.  As managers, loyalty to their own company demands that they put the interest of the company first and personal interest later.  In one case[9] the three directors of a railway company used their controlling interest in the company to pass a resolution at a general meeting to declare that the company had no interest in the contract.  The court ruled that any profit obtained by the directors belong in equity to the company.

The duty not to accept benefits from third parties is connected with the duty to avoid conflicts of interest as directors are not permitted to accept benefit from third parties by reason of his being a director and in exchange for something that he should not or not do as a director.  In another case,[10] one of the directors of a company received a secret commission.  The court dismissed the direct not only for the secret commission he obtained which the company discovered but also because the director was accountable for the secret commission.

Common law rules and statutory rules do not prohibit the director from having a personal interest in a company contract.  The Companies Act 1985 only provide for the duty to disclose the interest of the director in any transaction entered into between the director and the company.  However Section 177 of the Companies Act of 1985 requires that the director not only to disclose his interest but also to reveal the nature and extent of his interest in the transaction or arrangement.  This duty is confirmed in the case of Neptune Ltd v. Fitzgerald where the court ruled that the interest of the director in company contract has to be declared and recorded in the minutes.[11]

In this case, though the act of Ulrich and Emily were not necessarily unlawful and though there was no shareholder agreement which will prevent the directors from performing the acts mentioned, e.g. entering into a loan agreement appointing family members to participate in the affairs of the company and the giving of gifts to the staff, there are still remedies available to the shareholder to prevent the directors from performing these acts.

As a general rule, the director only owes fiduciary duty and his duty of skill and care to the company.  He will not generally be held liable to the shareholders for any injury, loss or damage he may have caused to the corporation.  However, the company, as the injured party has several remedies.

One of the remedies available to the company who suffers loss as a result of the director’s breach of his duty of care and skill or a breach of his fiduciary duty is a suit for damages.  The award of damages is given to the corporation for the purpose of compensating it for the loss it suffered as a result of the director’s breach of duty.  In this suit, the company will only have to prove that there was a breach committed by the director and that the same resulted to losses to the company without which the company would not have suffered loss.  In this case, the company may recover from Ulrich and Emily by way of damages the losses it suffered.

If Ulrich and Emily continues to spend the funds of the company for any purpose other than for the benefit of the company, such as in this case where Ulrich and Emily continues to pay flowers, gifts and chocolates for the staff and for the other directors, the company may go to court and ask for an injunction.  The idea is to restrain and prevent the directors from continuing with their action and thus avoid the total dissipation of company assets.

If in the course of the transactions entered into by Ulrich and Emily, the company property was misappropriated to such an extent that there no longer remains any property for the use of the company, the company may also ask the court for the restoration of the property mismanaged by the director.  This remedy can be availed of by the company provided no third person will be injured thereby.  The theory is that as between the company and a third person it should be the company which should bear the loss for the negligent acts of its directors.

Derivative Suits

The Companies Act 2006 also provided a major change as it allowed for the first time the shareholders to pursue a derivative action on behalf of the company if they feel that the board has failed to perform the duties.[12] In exceptional circumstances, a shareholder maybe permitted to file suit against the directors by virtue of derivative action.  A derivative suit is one that is filed by a shareholder of a corporation on behalf of the corporation.

The shareholder files suit not because of the injury he suffered but he files suit as a representative of the corporation due to the injury it suffered. In reality, this is seldom availed of since most directors who authorized an act will not necessarily file a suit against themselves.  Also, this remedy is seldom availed of by shareholders for several reasons.

Under the law, any amount a shareholder may recover from the directors in suits filed against directors will be awarded in favor of the corporation.  Thus, no matter how much was spent by a shareholder in the suit, the award will be granted to the company.  Secondly, the case of Foss v. Harbottle, [13]greatly discouraged shareholders from availing of this remedy.  In this case, two minority shareholders filed suit against the directors of a company for having misapplied the company assets.  The court dismissed the suit on the ground that when a company is injured it is only the company that has the legal standing and personality to file suit.  The court explained the principle of proper plaintiff rule and the majority rule principle.

The proper plaintiff rule is that only the company may file a suit.  However, even if the directors committed a breach of their duty, a suit against them cannot be allowed if the act was done with the consent of the majority of the members of the board.  If there was no consent prior to the act complained of, suit may not be availed of still if the act was ratified by a simply majority of the members of the board in a meeting.

Remedies Under 459-461 of the Companies Act of 1985

When the shareholder feels that the affairs of the company are being conducted in a manner that is unfairly prejudicial to his interest, the shareholder may also bring an action under the Companies Act of 1985.  Section 459 of the Companies Act of 1985 gives the shareholder who feels that she has been unfairly prejudiced by the directors such as in this case where the director has misappropriated or diverted the corporate assets the right to file suit under the said provision.[14]

The case of Re Saul D. Harrison & Sons plc controls on the issue of what constitutes an unfairly prejudicial conduct of the directors

Facts: Petitioner owns the non-voting shares in a small family-owned company whose main business was manufacturing, selling, cleaning and wiping clothes.  Petitioner file suit arguing that the business was conducted in an unfairly prejudicial manner since the profits of the company are being used for the salaries and fringe benefits of its directors.

Issue: whether the conduct of the Board of Directors constitutes an unfairly prejudicial conduct.

Ruling: The court ruled that for a conduct to be considered as unfairly prejudicial to the interest of the shareholders there must be a “visible departure from the standards of fair dealing and a violation of the conditions of fair play on which every shareholder who entrusts his money to the company is entitled to rely.”  An objective standard of fairness must be utilized to determine whether the conduct was unfairly prejudicial so as to entitle the shareholder to avail of this remedy.

The first standard is whether there was a breach of what the parties originally agreed as provided in the articles of association.  The second standard would be whether the act which may not be a breach of the agreement in the articles of association may be considered a breach of the fiduciary duties of a director.  The third standard is whether the act may be considered unfair for the majority shareholders.

Once the shareholder successfully established that the act is unfairly prejudicial to the interest of the company, the court is given sufficient discretion to make such order that it thinks fit and proper so that the petitioner may be given to the relief he asked for.[15]

In such cases, under Sec. 461 of the Companies Act of 1985 provides that the court may order that the share of Nadine should be purchased by Ulrich and Emily at a particular value to be agreed upon by both parties.  If the court in the exercise of its discretion determines that the action of the directors would not prejudice the company then it may order the other directors/shareholders to purchase the stocks of the complaining stockholder.  The reason behind this is that courts will generally not interfere with the management of the company.

If the court determines that the action of the board of directors will not be to the best interest of the company, the court may directly intervene and issue an order requiring the company or the directors to do or refrain from doing certain acts.  Or, the court may issue an order authorizing civil proceedings to be brought in the name and on behalf of the company by such persons as the court may direct.

There are several reasons when the court may directly intervene in the management of the corporate affairs, these are: a) “when the creditors of the company would be prejudiced by the scheme; b) The other minority shareholders shared the opinion of the complaining shareholder, c) The directors were acting in breach of their fiduciary duties and not in the best interests of the company; d) the scheme was unlawful or had an unlawful purpose. “[16]

Winding Up Remedy of Shareholder

In most cases, the shareholder injured by the conduct of the directors file suit in court praying for Section 459 of the Companies Act and Section 122 (1) (g) of the Insolvency Act of 1986 and ask for winding up on just and equitable grounds in the alternative.  If Nadine feels that both Ulrich and Emily will not be prevented from dissipating the assets of the company, Nadine may have the option of asking for winding up of the company.  The effect of this petition on the company is serious since it renders any disposition of company assets and property after the winding up has been commenced void unless the court orders otherwise.

Any sale or mortgage entered into by Ulrich and Emily involving the property upon filing of this petition will therefore by considered void.  Also, any payments made by the directors after the winding up has been commenced can be rendered void and recovered by the liquidator after the winding up has been completed.

2) Nadine is personally liable for the loan agreement she entered into prior to the incorporation of EnCom. Section 51 (1) of the Companies Act of 2006 is clear on the liability of a promoter for pre-incorporation contracts, to wit: “A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly.”

The law requires that for the promoter to escape personal liability from the contract, the said contract must be ratified by the corporation after it has come into existence.  In this case, there is nothing in the facts of the case that states that the contract entered into was ratified by the company after it was incorporated.  This same theory was applied in the case of Kelner v. Baxter, [17] In this case, the court ruled that for the promoter to escape liability the contract must first be ratified by the company and that the ratification shall only be valid if it was made at the time the company is already in existence.

Conclusion

I will advise Nadine to avail instead of the remedy of file suit under Sec 459-461 of the Companies Act on the ground that the act of the directors in dismissing her from her position as director and in dissipating company assets constitute an unfairly prejudicial conduct.  This will authorize the court to actually intervene in the management of the business by issuing an order refraining the directors from further wasting away the company funds and assets and by issuing an order for the recovery of the funds lost against the directors.

Bibliographies

Boston Deep Sea Fishing & Ice Co. Ltd v. Ansell LR 39 Ch D 399

“Companies Act 2006 and Directors Duties.”  Retrieved August 7, 2007 from:

http://www.bytestart.co.uk/content/legal/35_2/companies-act-directors-duties.shtml

“Companies Act 2006: Duties of Company Directors.” Retrieved August 10, 2007 from:  http://72.14.235.104/search?q=cache:xqZKPPPnzUgJ:www.berr.gov.uk/files/file40139.pdf+Directors+Duties+Companies+act+2006&hl=tl&ct=clnk&cd=4&gl=ph

“Companies Act 2006 spells major changes for business owners.” Retrieved August 9, 2007 from: http://72.14.235.104/search?q=cache:xqZKPPPnzUgJ:www.berr.gov.uk/files/file40139.pdf+Directors+Duties+Companies+act+2006&hl=tl&ct=clnk&cd=4&gl=ph

Cook v. Deeks [1916] AC 554

Foss v. Harbottle 2 Hare 461, 67 ER 189

Heley, Susana.  Shareholder Rights: Unfair Prejudice.  Retrieved August 7, 2007 from:

http://www.bytestart.co.uk/content/legal/35_2/shareholder-rights.shtml

Kelner v. Baxter, L.R. 2 C.P. 174

Lynn Beaumont.  United Kingdom: Directors’ Duties – The Companies Act 2006.  Retrieved August 9, 2007 from: http://www.mondaq.com/article.asp?articleid=50084

Miller, Sandra K. (1999)  How should U.K. and U.S. minority shareholder remedies for unfairly prejudicial or oppressive conduct be reformed?  Retrieved August 7, 2007 from:

http://www.allbusiness.com/government/business-regulations/319808-1.html

Neptune Ltd v. Fitzgerald [1985] BCLC 352

Re Continental Assurance of Co. of London Plc BPIR 733

Re Forest of Dean Coal Mining Co., 10 Ch D 450

Re: Saul D. Harrison & Sons Plc [1995] 1 BCLC 14

Selangor United Rubber Estates Limited v. Craddock All ER 1073

The Law Commission: Shareholder Remedies.  Retrieved August 7, 2007 from:

http://www.lawcom.gov.uk/docs/cp142.pdf

West Mercia Safetywear Ltd. v. Dodd BCLC 250

[1] West Mercia Safetywear Ltd. v. Dodd BCLC 250 [2] Selangor United Rubber Estates Limited v. Craddock All ER 1073 [3] Re Continental Assurance of Co. of London Plc BPIR 733 [4] Re Forest of Dean Coal Mining Co., 10 Ch D 450 [5] Lynn Beaumont.  United Kingdom: Directors’ Duties – The Companies Act 2006.  Retrieved August 9, 2007 from: http://www.mondaq.com/article.asp?articleid=50084 [6] “Companies Act 2006: Duties of Company Directors” Retrieved August 10, 2007 from:

http://72.14.235.104/search?q=cache:xqZKPPPnzUgJ:www.berr.gov.uk/files/file40139.pdf+Directors+Duties+Companies+act+2006&hl=tl&ct=clnk&cd=4&gl=ph [7] “Companies Act 2006 and Directors Duties” [8] Re City Equitable Fire Insurance Co [1925] Ch 407 [9] Cook v. Deeks [1916] AC 554 [10] Boston Deep Sea Fishing & Ice Co. Ltd v. Ansell LR 39 Ch D 399 [11] Neptune Ltd v. Fitzgerald [1985] BCLC 352 [12] “Companies Act 2006 spells major changes for business owners.” Retrieved August 9, 2007 from: http://72.14.235.104/search?q=cache:xqZKPPPnzUgJ:www.berr.gov.uk/files/file40139.pdf+Directors+Duties+Companies+act+2006&hl=tl&ct=clnk&cd=4&gl=ph [13] Foss v. Harbottle, 2 Hare 461, 67 ER 189 [14] Miller, Sandra K. (1999)  How should U.K. and U.S. minority shareholder remedies for unfairly prejudicial or oppressive conduct be reformed?  Retrieved August 7, 2007 from:

http://www.allbusiness.com/government/business-regulations/319808-1.html [15] The Law Commission: Shareholder Remedies.  Retrieved August 7, 2007 from:

http://www.lawcom.gov.uk/docs/cp142.pdf [16] Heley, Susana.  Shareholder Rights: Unfair Prejudice.  Retrieved August 7, 2007 from:

http://www.bytestart.co.uk/content/legal/35_2/shareholder-rights.shtml [17] Kelner v. Baxter, L.R. 2 C.P. 174