Company Law Notes (uk) 64x5d

Lectures 1 & 2 Legislation: t Stock Companies Act 1844 and 1856 1844: Quick and easy registration process to create Company (separate entity) 1856: Established limited liability Companies Act 1862, 1929, 1948, 1985 Companies Act 2006 (s.1-16) 1 Companies (1)In the Companies Acts, unless the context otherwise requires— “company” means a company formed and ed under this Act, that is— (a) a company so formed and ed after the commencement of this Part, or (b) a company that immediately before the commencement of this Part— (i) was formed and ed under the Companies Act 1985 (c. 6) or the Companies (Northern Ireland) Order 1986 (S.I. 1986/1032 (N.I. 6)), or (ii) was an existing company for the purposes of that Act or that Order, (which is to be treated on commencement as if formed and ed under this Act). (2)Certain provisions of the Companies Acts apply to— (a)companies ed, but not formed, under this Act (see Chapter 1 of Part 33), and (b)bodies incorporated in the United Kingdom but not ed under this Act (see Chapter 2 of that Part). (3)For provisions applying to companies incorporated outside the United Kingdom, see Part 34 (overseas companies). 2 The Companies Acts (1)In this Act “the Companies Acts” means— (a)the company law provisions of this Act, (b)Part 2 of the Companies (Audit, Investigations and Community Enterprise) Act 2004 (c. 27) (community interest companies), and (c)the provisions of the Companies Act 1985 (c. 6) and the Companies Consolidation (Consequential Provisions) Act 1985 (c. 9) that remain in force. (2)The company law provisions of this Act are— (a)the provisions of Parts 1 to 39 of this Act, and (b)the provisions of Parts 45 to 47 of this Act so far as they apply for the purposes of those Parts. 1

Types of company 3 Limited and unlimited companies (1)A company is a “limited company” if the liability of its is limited by its constitution. It may be limited by shares or limited by guarantee. (2)If their liability is limited to the amount, if any, unpaid on the shares held by them, the company is “limited by shares”. (3)If their liability is limited to such amount as the undertake to contribute to the assets of the company in the event of its being wound up, the company is “limited by guarantee”. (4)If there is no limit on the liability of its , the company is an “unlimited company”. 4 Private and public companies (1)A “private company” is any company that is not a public company. (2)A “public company” is a company limited by shares or limited by guarantee and having a share capital— (a)whose certificate of incorporation states that it is a public company, and (b)in relation to which the requirements of this Act, or the former Companies Acts, as to registration or reregistration as a public company have been complied with on or after the relevant date. (3)For the purposes of subsection (2)(b) the relevant date is— (a)in relation to registration or re-registration in Great Britain, 22nd December 1980; (b)in relation to registration or re-registration in Northern Ireland, 1st July 1983. (4)For the two major differences between private and public companies, see Part 20. 5 Companies limited by guarantee and having share capital (1)A company cannot be formed as, or become, a company limited by guarantee with a share capital. (2)Provision to this effect has been in force— (a)in Great Britain since 22nd December 1980, and (b)in Northern Ireland since 1st July 1983. (3)Any provision in the constitution of a company limited by guarantee that purports to divide the company's undertaking into shares or interests is a provision for a share capital. This applies whether or not the nominal value or number of the shares or interests is specified by the provision. 6 Community interest companies (1)In accordance with Part 2 of the Companies (Audit, Investigations and Community Enterprise) Act 2004 (c. 27)— (a)a company limited by shares or a company limited by guarantee and not having a share capital may be formed as or become a community interest company, and (b)a company limited by guarantee and having a share capital may become a community interest company. (2)The other provisions of the Companies Acts have effect subject to that Part.

General 7 Method of forming company 2

(1)A company is formed under this Act by one or more persons— (a)subscribing their names to a memorandum of association (see section 8), and (b)complying with the requirements of this Act as to registration (see sections 9 to 13). (2)A company may not be so formed for an unlawful purpose. 8 Memorandum of association (1)A memorandum of association is a memorandum stating that the subscribers— (a)wish to form a company under this Act, and (b)agree to become of the company and, in the case of a company that is to have a share capital, to take at least one share each. (2)The memorandum must be in the prescribed form and must be authenticated by each subscriber. Requirements for registration 9 Registration documents (1)The memorandum of association must be delivered to the registrar together with an application for registration of the company, the documents required by this section and a statement of compliance. (2)The application for registration must state— (a)the company's proposed name, (b)whether the company's ed office is to be situated in England and Wales (or in Wales), in Scotland or in Northern Ireland, (c)whether the liability of the of the company is to be limited, and if so whether it is to be limited by shares or by guarantee, and (d)whether the company is to be a private or a public company. (3)If the application is delivered by a person as agent for the subscribers to the memorandum of association, it must state his name and address. (4)The application must contain— (a)in the case of a company that is to have a share capital, a statement of capital and initial shareholdings (see section 10); (b)in the case of a company that is to be limited by guarantee, a statement of guarantee (see section 11); (c)a statement of the company's proposed officers (see section 12). (5)The application must also contain— (a)a statement of the intended address of the company's ed office; and (b)a copy of any proposed articles of association (to the extent that these are not supplied by the default application of model articles: see section 20). (6)The application must be delivered— (a)to the registrar of companies for England and Wales, if the ed office of the company is to be situated in England and Wales (or in Wales); (b)to the registrar of companies for Scotland, if the ed office of the company is to be situated in Scotland; (c)to the registrar of companies for Northern Ireland, if the ed office of the company is to be situated in Northern Ireland. 10 Statement of capital and initial shareholdings 3

(1)The statement of capital and initial shareholdings required to be delivered in the case of a company that is to have a share capital must comply with this section. (2)It must state— (a)the total number of shares of the company to be taken on formation by the subscribers to the memorandum of association, (b)the aggregate nominal value of those shares, (c)for each class of shares— (i)prescribed particulars of the rights attached to the shares, (ii)the total number of shares of that class, and (iii)the aggregate nominal value of shares of that class, and (d)the amount to be paid up and the amount (if any) to be unpaid on each share (whether on of the nominal value of the share or by way of ). (3)It must contain such information as may be prescribed for the purpose of identifying the subscribers to the memorandum of association. (4)It must state, with respect to each subscriber to the memorandum— (a)the number, nominal value (of each share) and class of shares to be taken by him on formation, and (b)the amount to be paid up and the amount (if any) to be unpaid on each share (whether on of the nominal value of the share or by way of ). (5)Where a subscriber to the memorandum is to take shares of more than one class, the information required under subsection (4)(a) is required for each class. 11 Statement of guarantee (1)The statement of guarantee required to be delivered in the case of a company that is to be limited by guarantee must comply with this section. (2)It must contain such information as may be prescribed for the purpose of identifying the subscribers to the memorandum of association. (3)It must state that each member undertakes that, if the company is wound up while he is a member, or within one year after he ceases to be a member, he will contribute to the assets of the company such amount as may be required for— (a)payment of the debts and liabilities of the company contracted before he ceases to be a member, (b)payment of the costs, charges and expenses of winding up, and (c)adjustment of the rights of the contributories among themselves, not exceeding a specified amount.

12 Statement of proposed officers (1)The statement of the company's proposed officers required to be delivered to the registrar must contain the required particulars of— (a)the person who is, or persons who are, to be the first director or directors of the company; (b)in the case of a company that is to be a private company, any person who is (or any persons who are) to be the first secretary (or t secretaries) of the company; (c)in the case of a company that is to be a public company, the person who is (or the persons who are) to be the first secretary (or t secretaries) of the company. 4

(2)The required particulars are the particulars that will be required to be stated— (a)in the case of a director, in the company's of directors and of directors' residential addresses (see sections 162 to 166); (b)in the case of a secretary, in the company's of secretaries (see sections 277 to 279). (3)The statement must also contain a consent by each of the persons named as a director, as secretary or as one of t secretaries, to act in the relevant capacity. If all the partners in a firm are to be t secretaries, consent may be given by one partner on behalf of all of them. 13 Statement of compliance (1)The statement of compliance required to be delivered to the registrar is a statement that the requirements of this Act as to registration have been complied with. (2)The registrar may accept the statement of compliance as sufficient evidence of compliance. Registration and its effect 14 Registration If the registrar is satisfied that the requirements of this Act as to registration are complied with, he shall the documents delivered to him. 15 Issue of certificate of incorporation (1)On the registration of a company, the registrar of companies shall give a certificate that the company is incorporated. (2)The certificate must state— (a)the name and ed number of the company, (b)the date of its incorporation, (c)whether it is a limited or unlimited company, and if it is limited whether it is limited by shares or limited by guarantee, (d)whether it is a private or a public company, and (e)whether the company's ed office is situated in England and Wales (or in Wales), in Scotland or in Northern Ireland. (3)The certificate must be signed by the registrar or authenticated by the registrar's official seal. (4)The certificate is conclusive evidence that the requirements of this Act as to registration have been complied with and that the company is duly ed under this Act. 16 Effect of registration (1)The registration of a company has the following effects as from the date of incorporation. (2)The subscribers to the memorandum, together with such other persons as may from time to time become of the company, are a body corporate by the name stated in the certificate of incorporation. (3)That body corporate is capable of exercising all the functions of an incorporated company. (4)The status and ed office of the company are as stated in, or in connection with, the application for registration. (5)In the case of a company having a share capital, the subscribers to the memorandum become holders of the shares specified in the statement of capital and initial shareholdings. (6)The persons named in the statement of proposed officers— (a)as director, or 5

(b)as secretary or t secretary of the company, are deemed to have been appointed to that office. PART 38 COMPANIES: INTERPRETATION … Meaning of “subsidiary” and related expressions 1159 Meaning of “subsidiary” etc (1)A company is a “subsidiary” of another company, its “holding company”, if that other company— (a)holds a majority of the voting rights in it, or (b)is a member of it and has the right to appoint or remove a majority of its board of directors, or (c)is a member of it and controls alone, pursuant to an agreement with other , a majority of the voting rights in it, or if it is a subsidiary of a company that is itself a subsidiary of that other company. (2)A company is a “wholly-owned subsidiary” of another company if it has no except that other and that other's wholly-owned subsidiaries or persons acting on behalf of that other or its wholly-owned subsidiaries. (3)Schedule 6 contains provisions explaining expressions used in this section and otherwise supplementing this section. (4)In this section and that Schedule “company” includes any body corporate.

The Partnership Act 1890 Nature of Partnership 1 Definition of partnership. (1) Partnership is the relation which subsists between persons carrying on a business in common with a view of profit. (2)But the relation between of any company or association which is— (a)ed as a company under the Companies Act 1862, or any other Act of Parliament for the time being in force and relating to the registration of t stock companies; or (b)Formed or incorporated by or in pursuance of any other Act of Parliament or letters patent, or Royal Charter; is not a partnership within the meaning of this Act. 2 Rules for determining existence of partnership. In determining whether a partnership does or does not exist, regard shall be had to the following rules: (1)t tenancy, tenancy in common, t property, common property, or part ownership does not of itself create a partnership as to anything so held or owned, whether the tenants or owners do or do not share any profits made by the use thereof.

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(2)The sharing of gross returns does not of itself create a partnership, whether the persons sharing such returns have or have not a t or common right or interest in any property from which or from the use of which the returns are derived. (3)The receipt by a person of a share of the profits of a business is primâ facie evidence that he is a partner in the business, but the receipt of such a share, or of a payment contingent on or varying with the profits of a business, does not of itself make him a partner in the business; and in particular— (a)The receipt by a person of a debt or other liquidated amount by instalments or otherwise out of the accruing profits of a business does not of itself make him a partner in the busines or liable as such: (b)A contract for the remuneration of a servant or agent of a person engaged in a business by a share of the profits of the business does not of itself make the servant or agent a partner in the business or liable as such: (c)A person being the widow or child of a deceased partner, and receiving by way of annuity a portion of the profits made in the business in which the deceased person was a partner, is not by reason only of such receipt a partner in the business or liable as such: (d)The advance of money by way of loan to a person engaged or about to engage in any business on a contract with that person that the lender shall receive a rate of interest varying with the profits, or shall receive a share of the profits arising from carrying on the business, does not of itself make the lender a partner with the person or persons carrying on the business or liable as such. Provided that the contract is in writing, and signed by or on behalf of all the parties thereto: (e)A person receiving by way of annuity or otherwise a portion of the profits of a business in consideration of the sale by him of the goodwill of the business is not by reason only of such receipt a partner in the business or liable as such. 3 Postponement of rights of person lending or selling in consideration of share of profits in case of insolvency. In the event of any person to whom money has been advanced by way of loan upon such a contract as is mentioned in the last foregoing section, or of any buyer of a goodwill in consideration of a share of the profits of the business, being adjudged a bankrupt, entering into an arrangement to pay his creditors less than in the pound, or dying in insolvent circumstances, the lender of the loan shall not be entitled to recover anything in respect of his loan, and the seller of the goodwill shall not be entitled to recover anything in respect of the share of profits contracted for, until the claims of the other creditors of the borrower or buyer for valuable consideration in money or money’s worth have been satisfied.

4 Meaning of firm. (1)Persons who have entered into partnership with one another are for the purposes of this Act called collectively a firm, and the name under which their business is carried on is called the firm-name. (2)In Scotland a firm is a legal person distinct from the partners of whom it is composed, but an individual partner may be charged on a decree or diligence directed against the firm, and on payment of the debts is entitled to relief pro ratâ from the firm and its other . 5 Power of partner to bind the firm. Every partner is an agent of the firm and his other partners for the purpose of the business of the partnership; and the acts of every partner who does any act for carrying on in the usual way business of the kind carried on by the firm of which he is a member bind the firm and his partners, unless the partner so acting has in fact no authority to act for the firm in the particular matter, and the person with whom he is dealing either knows that he has no authority, or does not know or believe him to be a partner. 9 Liability of partners. 7

Every partner in a firm is liable tly with the other partners, and in Scotland severally also, for all debts and obligations of the firm incurred while he is a partner; and after his death his estate is also severally liable in a due course of istration for such debts and obligations, so far as they remain unsatisfied, but subject in England or Ireland to the prior payment of his separate debts.

The Limited Partnership Act 1907 4 Definition and constitution of limited partnership. (1) limited partnerships may be formed in the manner and subject to the conditions by this Act provided. (2)A limited partnership must consist of one or more persons called general partners, who shall be liable for all debts and obligations of the firm, and one or more persons to be called limited partners, who shall at the time of entering into such partnership contribute thereto a sum or sums as capital or property valued at a stated amount, and who shall not be liable for the debts or obligations of the firm beyond the amount so contributed. (3)A limited partner shall not during the continuance of the partnership, either directly or indirectly, draw out or receive back any part of his contribution, and if he does so draw out or receive back any such part shall be liable for the debts and obligations of the firm up to the amount so drawn out or received back. (4)A body corporate may be a limited partner. 6 Modifications of general law in case of limited partnerships. (1)A limited partner shall not take part in the management of the partnership business, and shall not have power to bind the firm: Provided that a limited partner may by himself or his agent at any time inspect the books of the firm and examine into the state and prospects of the partnership business, and may advise with the partners thereon. If a limited partner takes part in the management of the partnership business he shall be liable for all debts and obligations of the firm incurred while he so takes part in the management as though he were a general partner. (2)A limited partnership shall not be dissolved by the death or bankruptcy of a limited partner, and the lunacy of a limited partner shall not be a ground for dissolution of the partnership by the court unless the lunatic’s share cannot be otherwise ascertained and realised. (3)In the event of the dissolution of a limited partnership its affairs shall be wound up by the general partners unless the court otherwise orders. (4) (5)Subject to any agreement expressed or implied between the partners— (a)Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the general partners; (b)A limited partner may, with the consent of the general partners, assign his share in the partnership, and upon such an assignment the assignee shall become a limited partner with all the rights of the assignor; (c)The other partners shall not be entitled to dissolve the partnership by reason of any limited partner suffering his share to be charged for his separate debt; (d)A person may be introduced as a partner without the consent of the existing limited partners; (e)A limited partner shall not be entitled to dissolve the partnership by notice.

The Limited Liability Partnerships Act 2000 8

1 Limited liability partnerships. (1)There shall be a new form of legal entity to be known as a limited liability partnership. (2)A limited liability partnership is a body corporate (with legal personality separate from that of its ) which is formed by being incorporated under this Act; and— (a)in the following provisions of this Act (except in the phrase “oversea limited liability partnership”), and (b)in any other enactment (except where provision is made to the contrary or the context otherwise requires), references to a limited liability partnership are to such a body corporate. (3)A limited liability partnership has unlimited capacity. (4)The of a limited liability partnership have such liability to contribute to its assets in the event of its being wound up as is provided for by virtue of this Act. (5)Accordingly, except as far as otherwise provided by this Act or any other enactment, the law relating to partnerships does not apply to a limited liability partnership. (6)The Schedule (which makes provision about the names and ed offices of limited liability partnerships) has effect. 6 as agents. (1)Every member of a limited liability partnership is the agent of the limited liability partnership. (2)But a limited liability partnership is not bound by anything done by a member in dealing with a person if— (a)the member in fact has no authority to act for the limited liability partnership by doing that thing, and (b)the person knows that he has no authority or does not know or believe him to be a member of the limited liability partnership. (3)Where a person has ceased to be a member of a limited liability partnership, the former member is to be regarded (in relation to any person dealing with the limited liability partnership) as still being a member of the limited liability partnership unless— (a)the person has notice that the former member has ceased to be a member of the limited liability partnership, or (b)notice that the former member has ceased to be a member of the limited liability partnership has been delivered to the registrar. (4)Where a member of a limited liability partnership is liable to any person (other than another member of the limited liability partnership) as a result of a wrongful act or omission of his in the course of the business of the limited liability partnership or with its authority, the limited liability partnership is liable to the same extent as the member.

Promoters: An individual who persuades others to invest capital to a company to be incorporated for the purpose of carrying on a venture. A person who solicits people to invest money into a corporation, usually when it is being formed. An investment banker, an underwriter, or a stock promoter may, wholly or in part, perform the role of a promoter. Promoters generally owe a duty of utmost good faith, so as to not mislead any potential investors, and disclose all material facts about the company's business. A promoter is a person who does the preliminary work incidental to the formation of company. 9

The primary remedy for breach of fiduciary obligation by a promoter is “an of profits (sometimes referred to as an ing for profits or simply an ing) is a type of equitable remedy most commonly used in cases of breach of fiduciary duty. It is an action taken against a defendant to recover the profits taken as a result of the breach of duty, in order to prevent unjust enrichment. Twycross v Grant (1877): A promoter, I apprehend is one who undertakes to form of a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose…and so long as the work of formation continues, those who carry on that work must, I think, retain the character of promoters. Of course, if a governing body, in the shape of directors, has once been formed, and they take…what remains to be done in the way of forming the company, into their hands, the functions of the promoter are at an end. Erlanger v New Sombrero Phosphate Co (1878) [Fiduciary Duty]: “The have in their hands the creation and moulding of the company; they have the power of defining how, and when, and in what shape, and under what supervision, it shall start into existence and begin to act as a trading corporation.” A promoter’s undisclosed profit is usually called a ‘secret profit’; failure to disclose the interest of the company’s promoter in a transaction with the company is voidable at the company’s option. The company may rescind the transaction. Gluckstein v Barnes [1900]: Mr Gluckstein and others formed a syndicate to promote a company. They purchased a (Olympia) hall for the price of 120,000.00, but the prospectus (for the public) gave the impression they had actually paid 140,000. Macnaghten L found this to be dishonest and Mr Gluckstein (the only promoter proceeded against) was ordered to pay the company his share of the profit. [Because the fiduciary relationship/duty of the Promoter does not exist in Statute, and exists only in Equity, one must apply maxims in order to determine if a wrong has transpired] *A promoter usually makes money by selling an asset to the company at an enhanced price, and then disclosing that profit. If not, the promoter may be subject to repay this profit. Alternatively, if the asset was purchased many years prior to the deal and with no intention to sell to the company then those profits [are personal] and need not be disclosed. *A promoter cannot enter into a contract with the company (and be paid through agreement/contract) as the company has yet to be formed and “Past Consideration is Not Good Consideration”. That said, the promoters can be paid through the company’s Constitution – but this is unsafe if they do not control the board (as they will have no power over levels of remuneration).

Pre-Incorporation Contracts: Companies Act 2006 s.51: 51 Pre-incorporation contracts, deeds and obligations (1)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. (2)Subsection (1) applies— 10

(a)to the making of a deed under the law of England and Wales or Northern Ireland, and (b)to the undertaking of an obligation under the law of Scotland, as it applies to the making of a contract. Two possibilities: 1) Either, pursuant to s.51 above, the person acting as agent for the anticipated company is personally liable (Kelner v Baxter (1866) – Guy buys wine for hotel which has yet to incorporate; wine supplier sues principle (company) claiming that entrepreneur is acting as agent for the principle; judge however finds entrepreneur liable as principle); or a. A person may avoid liability by entering into an ‘agreement to the contrary’ – though this concept was rejected by the CoA. 2) The contract is between the contractor and the company, in which case, the company being nonexistent, there is no contract and no one is liable. (Newborne v Sensolid (Great Britain) Ltd [1954] – Mr. Newborne, founder of intended company, as it was, signed contract for purchasing equipment in companies’ name.) a. Position depends on INTENTION of parties at contract formation (Phonogram Ltd v Lane [1982]). It was suggested that, for the purposes of s 51(1), a contract is ‘purported’ to be made by a company only when there has been a representation that the company is already in existence. i. Promoters are now personally liable in respect of pre-incorporation contracts made for the benefit of the unformed company, irrespective of the capacity in which they purport to contract and irrespective of their subjective beliefs. b. It makes no difference that the shelf company (a company with no activity) did not have the right name at the time the contracts were made (Oshkosh B’Gosh Inc v Dan Marbel Inc Ltd. [1989] – s.51 Held not to apply) Novation: “What may be provided in a pre-incorporation contract is that the person making it will be released from liability on it if the company, after incorporation, enters into a second contract with the contractor in the same as the pre-incorporation contract.

Registration/Incorporation: In the UK, a company is created by ing it with a government agency call Companies House (the executive agency of the Department of Business, Innovation and Skills). www.companieshouse.gov.uk The Chief Executive of the Companies House is the registrar of companies. To a company you must have at least ‘2’ .

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Lecture #3: Corporate Personality and the Veil of Incorporation Piercing the Corporate Veil: It’s when the courts ignore the concept of the company having a ‘separate corporate personality’ and find the individual responsible. On page 127 there is a more precise definition: ‘Where the Courts ignore the separate legal personality and treat a company’s property, rights and obligations as belonging to a person who owns and controls the company’. There is probably only one circumstance in which veil piercing is possible: where it is necessary in order to apply the evasion principle. Salomon v A Salomon & Co Ltd [1897] AC 22 Landmark UK company law case. The effect of the Lords' unanimous ruling was to uphold firmly the doctrine of corporate personality, as set out in the Companies Act 1862, so that creditors of an insolvent company could not sue the company's shareholders to pay up outstanding debts. Salomon conducted his business as a sole trader (owning a shoe company). He sold it to a company incorporated for the purpose called A Salomon and Co Ltd (advised by solicitor to “sell business” to an incorporated company – at this time the requirement was that there be 7 ). The only were Mr Salomon, his wife, and their five children. Each member took one £1 share each. The company bought the business for £39,000. Mr Salomon subscribed for 20,000 further shares. However, £10,000 was not paid by the company, which instead issued Salomon with series of debentures (with a security device – the factory) and gave him a floating charge (v fixed charge) on its assets. £8,993 was paid to Mr Salomon in cash. When the company failed the company's liquidator contended that the floating charge should not be honoured, and Salomon should be made responsible for the company's debts. (Raw materials, ie, leather and coal, were supplied to Mr Salomon by Trade Creditors, later sold to the Company.) Upon sale, Mr. Salomon is no longer the owner, but becomes the director (manager and major shareholder with 20,001 shares, and the owner of the debenture). The ‘floating charge’ attaches to all assets of the company, and anything of value: acts as a security device upon insolvency of company giving priority to debenture (floating charge) holder. Lord Halsbury LC stated (at 30-31): “… it seems to me impossible to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are.” From this case comes the fundamental concept that a company has a legal personality or identity separate from its . A company is thus a legal ‘person'. As long as the company has filed the requisite documents and has been ed via Companies House (compliance with the Rules), they become a separate identity. In the instant case, after establishing there was a bona fide, properly incorporated company, they would examine whether the debenture was issued correctly – which it had. At first instance under heading Broderip v Salomon [1895] it was held that the company conducted the business as agent for Mr. Salomon, so he was responsible for all debts incurred in the course of the agency for him. The HoL’s rejected this approach. At the CoA, under the same heading, it was held that Mr. Salomon had incorporated contrary to the ‘true intent’ and meaning of CA 1862, and because of Mr. Salomon’s fraud, the company should be declared to have operated the business as trustee for Mr. Salomon, who should therefore indemnify the company for all debts incurred in carrying out the trust. (In a trust, if the trustee loses the property, the beneficiary is entitled to sue for the full amount of that loss). The HoL’s also rejected this argument. 12

Debenture: is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories. Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.

Floating charge: is a security interest over a fund of changing assets of a company or a limited liability partnership (LLP), which 'floats' or 'hovers' until the point at which it is converted into a fixed charge, at which point the charge attaches to specific assets of the company or LLP. This conversion into a fixed charge (called "crystallisation") can be triggered by a number of events; inter alia, it has become an implied term (under English law) in debentures that a cessation of the company's right to deal with the assets in the ordinary course of business leads to automatic crystallisation. Additionally, according to express of a typical loan agreement, default by the chargor is a trigger for crystallisation. Such defaults typically include non-payment, invalidity of any of the lending or security documents or the launch of insolvency proceedings. Floating charges can only be granted by companies or LLPs. If an individual person or a partnership was to purport to grant a floating charge, it would be void as a general assignment in bankruptcy. Floating charges take effect in equity only, and consequently are defeated by a bona fide purchaser for value without notice of any asset covered by them. In practice, as the chargor has power to dispose of assets subject to a floating charge, this is only of consequence in relation to disposals that occur after the charge has crystallised. The floating charge has been described as "one of equity's most brilliant creations."

The Corporate Veil: Pg 127: Can the court ignore the separation between the separate legal personality and treat a company’s property, rights and obligations as belonging to a person who owns and controls the company. This has been called ‘piercing the corporate veil’. There are specific legal principles that can be used to attribute one person’s property to another person, whether the persons are natural or legal: 1) Statutory; 2) Contract; 3) Agency; 4) Trustee. 1) Statutory Provisions: The separate personality of a company is created by a statute, CA 2006, and can be modified by other statutes, for example, Landlord and Tenant Act 1954, s30, the Inheritance Tax Act 1984, Inheritance Act 1986 s. 213. “…it is submitted that these provisions to not represent a desire on the part of the legislature to disregard the company’s separate personality, but merely impose additional liability on those responsible for the expression of the corporate personality in these circumstances.” (pg 129) 13

2) Contract: Nothing in company law prevents a person from contracting out of any benefit the person could derive from the principle of separate corporate personality. 3) Agency: Principle – Agent relationship is a question of fact, and agency can be inferred from the surrounding circumstances, though it can only be established by the consent of the principle and the agent. The liability arises under agency law, and not company law. Agency cannot be inferred, however, from the control exercisable by the over the company – either by virtue of their votes in general meeting or because they are also directors – or from the fact that the sole objective of the company is to benefit the . (Smith Stone Knight Ltd v Birmingham Corp [1939]) 4) Property held in Trust: Prest v Petrodel Resources Ltd UKSC [2013] (Pg 128): Mrs Yasmin Prest claimed under Matrimonial Causes Act 1973 sections 23 and 24 for ancillary relief against the offshore companies solely owned by Mr Michael Prest. Mrs Prest said they held legal title to properties that he beneficially owned, including a £4m house at 16 Warwick Avenue, London. They had married in 1993 and divorced in 2008. He did not comply with orders for full and frank disclosure of his financial position, and the companies did not file a defence. The Matrimonial Causes Act 1973 section 24 required that for a court to be able to order a transfer a property, Mr Prest had to be ‘entitled’ to the properties held by his companies. Mr Prest contended that he was not entitled to the properties. The SC heard three arguments: 1) no relevant impropriety therefore not entitled to pierce corporate veil; 2) Court could not claim special (or wider) jurisdiction under Matrimonial Act (but under evidence) 3) Mr Prest had been beneficial owner of property and therefore held on trust. SC held, unanimously, that piercing the corporate veil could not be used to treat the companies’ assets as belonging to Mr. Prest as there was no impropriety. However, the evidence showed that the companies held the properties as a trustee for Michael Prest, not simply because he was the owner and controller of the companies, but because of the circumstances in which the properties were acquired by the companies.

Lord Sumpton in Prest at para 28: The difficulty is to identify what is a relevant wrongdoing. References to a “facade” or “sham” beg too many questions to provide a satisfactory answer. It seems to me that two distinct principles lie behind these protean , and that much confusion has been caused by failing to distinguish between them. They can conveniently be called the concealment principle and the evasion principle. The concealment principle is legally banal and does not involve piercing the corporate veil at all. It is that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding the “facade”, but only looking behind it to discover the facts which the corporate structure is concealing. The evasion principle is different. It is that the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement. Many cases will fall into both categories, but in some circumstances the difference between them may be critical. This may be illustrated by reference to those cases in which the court has been thought, rightly or wrongly, to have pierced the corporate veil. Concealment Principle: when a company is used as a device or façade to conceal the true facts and avoid or conceal the liability of the individual controlling the company (e.g. Prest v Petrodel Resources Ltd 14

[2013]). In that vein, the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the courts is not disregarding the ‘façade’, but only looking behind it to discover the facts which the corporate structure is concealing. Evasion Principle (pg 134): When an individual interposes a company so as to evade, or frustrate the enforcement of, an existing legal obligation, liability or restriction. In this scenario, rather than looking behind the façade, here the Courts disregard the corporate veil, depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s separate legal personality. (Eg Jones v Lipman)

Gilford Motors Ltd. v Horne [1933] ch 935 Facts: Mr EB Horne was formerly a managing director of the Gilford Motor Co Ltd. His employment contract stipulated (clause 9) not to solicit customers of the company if he were to leave employment of Gilford Motor Co. Mr. Horne was fired, thereafter he set up his own business and undercut Gilford Motor Co's prices. He received legal advice saying that he was probably acting in breach of contract. So he set up a company, JM Horne & Co Ltd, in which his wife and a friend called Mr Howard were the sole shareholders and directors. They took over Horne’s business and continued it. Mr. Horne sent out fliers saying, Spares and service for all models of Gilford vehicles. 170 Hornsey Lane, Highgate, N.6. Opposite Crouch End Lane…No connection with any other firm. The company had no such agreement with Gilford Motor about not competing, however Gilford Motor brought an action alleging that the company was used as an instrument of fraud to conceal Mr Horne's illegitimate actions.

Jones v Lipman [1962] 1 WLR 832 [Evasion Principle] (Pg 134) The defendant had contracted to sell his land. He changed his mind, and formed a company of which he was owner and director, transferred the land to the company, and refused to complete. The plaintiff sought relief. Held: Specific performance is available against a contracting vendor who has it in his power to compel another person to convey the property in question. An order for specific performance was made against both the director and the company. The company could not escape from or divest itself of its knowledge gained through the director. The company was: ‘A creature of [the controlling director], a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity.’ Parent v subsidiary distinction: sometimes ‘risky’ investments are placed in the subsidiary in the event that this company runs up debts which they are unable to pay the parent company simply allows that subsidiary to become insolvent, as the parent company remains intact. Subsidiary: A company whose voting stock is more than 50% controlled by another company, usually referred to as the parent company or holding company. A subsidiary is a company that is partly or completely owned by another company that holds a controlling interest in the subsidiary company. If a parent company owns a foreign subsidiary, the company under which the subsidiary is incorporated must 15

follow the laws of the country where the subsidiary operates, and the parent company still carries the foreign subsidiary's financials on its books (consolidated financial statements). For the purposes of liability, taxation and regulation, subsidiaries are distinct legal entities.

DNH Foods v. London Borough of Tower Hamlets [1976] WLR 852 [Subsidiaries – Evasion Principle – Group Entity/Single Entity] LBTH made a ‘compulsory purchase’ of land in which ‘Golden Foods’ operated – which was a subsidiary of DNH Foods. Under the legislation compensation was to be paid: whatever the value of the land. However, the parent company, DNH Foods, carried on some of its business at this Golden Foods location, which the legislation did not address. CoA Lord Denning: ‘Group Entity’ – if part of entity is damaged, all the parts that are damaged must be compensated. Prof. Ryan suggests this is not a ‘lifting of a veil’ but rather ‘piercing the veil’ – which is different. The positive public reception was short-lived as the distinction between the parent and subsidiary was muddied… “A company may operate its business in separate branches at geographically separate locations. It is possible for a company to incorporate separate companies, as subsidiaries, to operate each branch and each of those subsidiaries will be a separate legal person. If that is not done, company law does not treat each branch as a separate person, even if it is in another country: instead there is just one legal person operating the whole business.” (pg 124 MF&R)

**Adams v Cape Industries Plc [1990] ch 433 [Subsidiaries]**(READ PG 143) Facts: The defendant was an English company and head of a group engaged in mining asbestos in South Africa. A wholly owned English subsidiary was the worldwide marketing body, which protested the jurisdiction of the United States Federal District Court in Texas in a suit by victims of asbestos. The defendant took no part in the United States proceedings and default judgments were entered. Actions on the judgment in England failed. [Question: Should parent company be liable for actions/debts of subsidiaries (in the instant case, the default judgment against it)? Three arguments advanced: (1) this is a group entity; and (2) the subsidiary was an agent for the parent. If there is a contract of ‘agency’ between them, or by implication, the latter argument may be accepted. (3) The last argument advanced was that the Company was a sham/facade (entity), and so not a separate legal entity. All three arguments were rejected] Held: The court declined to pierce the veil of incorporation. It was a legitimate use of the corporate form to use a subsidiary to insulate the remainder of the group from tort liability. There was no evidence to justify a finding of agency or facade. There is an exception to the general rule, that steps which would not have been regarded by the domestic law of the foreign court as a submission to the jurisdiction ought not to be so regarded here, notwithstanding that if they had been steps taken in an English Court they might have constituted a submission to jurisdiction.

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Slade LJ said: ‘Two points at least are clear. First, at common law in this country foreign judgments are enforced, if at all, not through considerations of comity but upon the basis of the principle explained thus by Parke B. in Williams v Jones. Secondly, however, in deciding whether the foreign court was one of competent jurisdiction, our courts will apply not the law of the foreign court itself but our own rules of private international law. .’ and ‘First, in determining the jurisdiction of the foreign court in such cases, our court is directing its mind to the competence or otherwise of the foreign court ‘to summon the defendant before it and to decide such matters as it has decided:’ see Pemberton v Hughes [1899] 1 Ch. 781, 790 per Lindley M.R. Secondly, in the absence of any form of submission to the foreign court, such competence depends on the physical presence of the defendant in the country concerned at the time of suit... we would, on the basis of the authorities referred to above, regard the source of the territorial jurisdiction of the court of a foreign country to summon a defendant to appear before it as being his obligation for the time being to abide by its laws and accept the jurisdiction of its courts while present in its territory. So long as he remains physically present in that country, he has the benefit of its laws, and must take the rough with the smooth, by accepting his amenability to the process of its courts.’ [*Must Read Judgment, in particular, Lord Slade’s reasoning, and why he did not find the ‘group entity’ argument convincing] Following this decision, more miners were diagnosed with asbestosis, and before litigation commenced, the parent company dissolved the subsidiary. Instead of trying the case in South Africa, the HoL’s, rather surprisingly, allowed the matter to be heard in front of them. Before the trial commenced Cape Industries settled, fearing the corporate veil would be lifted. Bank of Montreal v Canadian Westgrove Ltd (1990): demonstrates an incredibly high threshold for a finding of Parent company liability for (contractual relations) made by a wholly owned subsidiary. The CoA stated that “one would need pretty clear – possibly overwhelming – evidence of agency or something else.” (Pg 145)

Smith Stone Knight Ltd v Birmingham Corp [1939] 4 ALL ER 116 [Company carrying on business as agent of its – agency through implication - SUFFICIENT CONTROL] (Pg 131) Facts: An application was made to set aside a preliminary determination by an arbitrator. The parties disputed the compensation payable by the respondent for the acquisition of land owned by Smith Stone and held by Birmingham Waste as its tenant on a yearly tenancy. Birmingham Waste was a wholly owned subsidiary of Smith Stone and was said in the Smith Stone claim to carry on business as a separate department and agent for Smith Stone. As a yearly tenant, Birmingham Waste, however, had no status to claim compensation. The question was whether, as a matter of law, the parent company could claim compensation for disturbance to the business carried on at the acquired premises. The arbitrator’s award answered this in the negative. Smith Stone applied to set the award aside on the ground of technical misconduct. Held: An implied agency existed between the parent and subsidiary companies so that the parent was considered to own the business carried on by the subsidiary and could claim compensation for disturbance caused to the subsidiary’s business by the local council. In determining whether a subsidiary was an implied agent of the parent, Atkinson J examined whether, on the facts as found by the arbitrator and after rejecting certain conclusions of fact which were uned by evidence, Smith Stone was in fact the real owner of 17

the business and was therefore entitled to compensation for its disturbance. Accordingly, the parent company was entitled to compensation both for the value of land and for disturbance of the business because it owned both the land and the business. The rule to protect the fact of separate corporate identities was circumvented because the subsidiary was the agent, employee or tool of the parent. The subsidiary company was operating a business on behalf of its parent company because its profits were treated entirely as those of the parent company’s; it had no staff and the persons conducting the business were appointed by the parent company, and it did not govern the business or decide how much capital should be embarked on it. In those circumstances, the court was able to infer that the company was merely the agent or nominee of the parent company. Atkinson J formulated six relevant criteria, namely: (a) Were the profits treated as profits of the parent? (b) Were the persons conducting the business appointed by the parent? (c) Was the parent the head and brain of the trading venture? (d) Did the parent govern the venture, decide what should be done and what capital should be embarked on the venture? (e) Did the parent make the profits by its skill and direction? (f) Was the parent in effectual and constant control?’

In Yukong Lind Ltd v Rendsburg Investments Corp. [1998] Toulson J rejected the submission that these points should determine whether a company is carrying on business as another person’s agent.

Chandler v Cape Plc [2012] EWCA Civ 525 [Tortious Liability] The Court of Appeal has upheld a decision of the High Court which found that a parent company owed a direct duty of care to an employee of one of its subsidiaries.(This case is not about lifting the Corporate Veil – this is about finding liability for negligence re Cape (parent) undertaking to regulate the Health & Safety across its subsidiaries) In this case, the claimant, Mr Chandler, was employed by a subsidiary of Cape plc for just over 18 months from 1959 to 1962. During the course of his employment, Mr Chandler was exposed to asbestos fibres and in 2007 Mr Chandler was diagnosed with asbestosis. By this time, the subsidiary entity had been dissolved. Mr Chandler’s estate brought a claim against Cape plc alleging it had owed (and breached) a duty of care to Mr Chandler. It was held at first instance that Cape plc owed Mr Chandler a duty of care. Cape plc appealed, but its appeal was dismissed. The key points to note are as follows: The Court of Appeal stated that Cape plc assumed responsibility to Mr Chandler and owed a direct duty of care to Mr Chandler which it breached. The Court of Appeal stressed that the duty of care from a parent company to subsidiary employees did not exist automatically and only arose in particular circumstances. That is, there was no imposition or assumption of responsibility to the employee by reason only that the defendant was the parent company: parent companies have a separate legal personality and it should, as a rule, not be possible to “pierce the corporate veil”. However, in the case of Cape plc, the Court of Appeal identified parallel duties of care between the parent company and subsidiary employees and the subsidiary company and its employees. This was because: (i) the parent company and subsidiary had relatively similar businesses; 18

(ii) (iii) (iv)

the parent has, or ought to have, superior knowledge on some relevant aspect of health and safety in the particular industry; the subsidiary’s system of work is unsafe as the parent company knew, or ought to have known; the parent company knew (or ought to have foreseen) that the subsidiary or its employees would rely on its using that superior knowledge the employees’ protection.

The case results in case law catching up with the group/subsidiary corporate structures that are now relatively common. It is likely that courts will look at group structures holistically. Moreover, the country of incorporation of a subsidiary is unlikely to make a difference if the parent entity is a UK plc. In particular, in the case of M&A transactions involving the sale or purchase of a subsidiary entity, parties will need to think about contingent and residual liability issues arising for parent companies. Daimler AG v Bauman et al [2013] [Parent-Subsidiary liability; Extra-territorial jurisdiction] Plaintiffs (respondents here) are twenty-two residents of Argentina who filed suit in California Federal District Court, naming as a defendant DaimlerChrysler Aktiengesellschaft (Daimler), a German public stock company that is the predecessor to petitioner Daimler AG. Their complaint alleges that Mercedes-Benz Argentina (MB Argentina), an Argentinian subsidiary of Daimler, collaborated with state security forces during Argentina’s 1976–1983 “Dirty War” to kidnap, detain, torture, and kill certain MB Argentina workers, among them, plaintiffs or persons closely related to plaintiffs. Based on those allegations, plaintiffs asserted claims under the Alien Tort Statute and the Torture Victim Protection Act of 1991, as well as under California and Argentina law. Personal jurisdiction over Daimler was predicated on the California s of Mercedes-Benz USA, LLC (MBUSA), another Daimler subsidiary, one incorporated in Delaware with its principal place of business in New Jersey. MBUSA distributes Daimler-manufactured vehicles to independent dealerships throughout the United States, including California. Daimler moved to dismiss the action for want of personal jurisdiction. Opposing that motion, plaintiffs argued that jurisdiction over Daimler could be founded on the California s of MBUSA. The District Court granted Daimler’s motion to dismiss. Reversing the District Court’s judgment, the Ninth Circuit held that MBUSA, which it assumed to fall within the California courts’ all-purpose jurisdiction, was Daimler’s “agent” for jurisdictional purposes, so that Daimler, too, should generally be answerable to suit in that State. Held: Daimler is not amenable to suit in California for injuries allegedly caused by conduct of MB Argentina that took place entirely outside the United States. Today, the Supreme Court of the United States held in Daimler AG v. Bauman, et al. that due process prevents a court from applying an "agency" theory to exercise general personal jurisdiction over a foreign corporation based solely on unrelated s of its domestic, wholly-owned subsidiary, if the subsidiary is not otherwise an alter ego of the parent corporation. Justice Ginsburg delivered the opinion of the Court, in which Chief Justice Roberts and Justices Scalia, Kennedy, Thomas, Breyer, Alito and Kagan ed. Justice Sotomayor wrote a concurring opinion. The Court's ruling reversed a 2011 decision of Judge Stephen Reinhardt of the United States Court of Appeals for the Ninth Circuit. The Court held that the Ninth Circuit’s two-part "agency" test did not satisfy the requirements of due process. Under the Ninth Circuit test, a court could exercise general personal jurisdiction over a foreign parent corporation for activities that occurred entirely outside of the U.S. if (1) it would perform the tasks of the subsidiary if the subsidiary did not exist and (2) it had the “right to control” the subsidiary. Applying this test, the Ninth Circuit had held that the foreign parent (the corporate predecessor to Daimler AG) would perform all the tasks of its domestic subsidiary, Mercedes Benz USA, i.e., selling cars in the American market, if the subsidiary did not exist, and that the parent had the right to control virtually every function of the domestic subsidiary. Thus, the Ninth Circuit held that it could exercise general personal jurisdiction over the foreign parent based on the activities of its subsidiary in California. 19

The Supreme Court rejected the Ninth's Circuit's "agency" test for general personal jurisdiction. The Court found that the "Ninth Circuit's agency theory … appears to subject foreign corporations to general jurisdiction whenever they have an in-state subsidiary or , an outcome that would sweep beyond even the 'sprawling view of general jurisdiction'" that the Court previously rejected in its decision in Goodyear Dunlop Tires Operations, S.A. v. Brown, 564 U.S. __ (2011). The Court noted that "[i]f Daimler's California activities sufficed to allow adjudication of this Argentina-rooted case in California, the same global reach would presumably be available in every other State in which MBUSA's sales are sizable. Such exorbitant exercises of all-purpose jurisdiction would scarcely permit out-of-state defendants 'to structure their primary conduct with some minimum assurance as to where that conduct will and will not render them liable to suit.'" The Court concluded that "[i]t was therefore error for the Ninth Circuit to conclude that Daimler, even with MBUSA's s attributed to it, was at home in California, and hence subject to suit there on claims by foreign plaintiffs having nothing to do with anything that occurred or had its principal impact in California." The Court also emphasized the transnational context of the dispute in reaching its holding, and found that the Ninth's Circuit's decision "paid little heed to the risks to international comity its expansive view of general jurisdiction posed…. Considerations of international rapport thus reinforce our determination that subjecting Daimler to the general jurisdiction of courts in California would not accord with the 'fair play and substantial justice' due process demands." Choc v HudBay Minerals Inc. & Caal v HudBay Minerals Inc. [2013] [Parent-Subsidiary liability; Extra-territorial jurisdiction] Agency & Façade arguments advanced in Canadian cases, but not Group-Entity of the indigenous Mayan Q’eqchi’ population from El Estor, Guatemala have filed three related lawsuits in Ontario courts against Canadian mining company HudBay Minerals over the brutal killing of Adolfo Ich, the gang-rape of 11 women from Lote Ocho, and the shooting and paralyzing of German Chub – abuses alleged to have been committed by mine company security personnel at HudBay’s former mining project in Guatemala. In a precedent-setting ruling with national and international implications, Superior Court of Ontario Justice Carole Brown has ruled that Canadian company Hudbay Minerals can potentially be held legally responsible in Canada for rapes and murder at a mining project formerly owned by Hudbay’s subsidiary in Guatemala. As a result of Justice Brown’s ruling, the claims of 13 Mayan Guatemalans will proceed to trial in Canadian courts. As a result of this ruling, Canadian mining corporations can no longer hide behind their legal corporate structure to abdicate responsibility for human rights abuses that take place at foreign mines under their control at various locations throughout the world. There will now be a trial regarding the abuses that were committed in Guatemala, and this trial will be in a courtroom in Canada, a few blocks from Hudbay’s headquarters, exactly where it belongs. Hudbay argued in court that corporate head offices could never be held responsible for harms at their subsidiaries, no matter how involved they were in on-the-ground operations. Justice Brown disagreed and concluded that “the actions as against Hudbay and HMI should not be dismissed.” This is the second significant legal victory for the Mayan plaintiffs in 2013. In February 2013, Hudbay abruptly dropped its argument that the lawsuit against it should be heard in Guatemala.

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Two judgments handed down in the last year have caused renewed interest in the court's ability to 'pierce the veil of incorporation'. The starkly contrasting decisions given by Mr Justice Burton in Antonio Gramsci Shipping Corp v Stepanovs [2011] EWHC 333 (Comm) ("Gramsci"), and by Mr Justice Arnold in VTB Capital plc v Nutritek International Corp [2011] EWHC 3107 (Ch) ("VTB Capital") have provoked debate about the scope of the concept. In VTB Capital, the plaintiffs sued originally in Tort (for deceit) and then in Contract. VTB declined to follow Gramsci, and the Courts found that they could not lift the Corporate veil. Proceedings should have taken place in Russia, where Torts were committed, and all of the evidence and testimony would be in Russian. What’s important to note, however, is that Burton’s judgement in Gramsci is overruled by VTB Capital. In VTB Capital Arnold concluded, quoting a age from Justice Mumby in Ben Hashem v Ali Shayif, that the courts have only taken the step of piercing the corporate veil when 'the company was being used by its controller in an attempt to immunise himself from liability for some wrongdoing which existed entirely dehors the company'. He went on to explain that a wrongdoing 'dehors' the company is one which is 'anterior or independent' of it. This was the case in both Gilford and Jones; both Mr Horne and Mr Lipman attempted to avoid liability for their own wrongdoing by using a company that they controlled as a shield. In those circumstances the courts were willing to grant relief against their respective companies in order to prevent the claimants being denied an effective remedy. It is important to note that in both cases it was an equitable remedy, rather than damages, which the court awarded after piercing the corporate veil. In Gramsci the claimants successfully argued that the corporate veil should be pierced and Mr Stepanovs treated as a party to certain agreements entered into between the claimants and five companies ed in the British Virgin Islands and Gibraltar, one of which was beneficially owned by Mr Stepanovs. Mr Justice Burton held that there was a good arguable case that the claimants should be able to enforce a contract against Mr Stepanovs, the 'puppeteer', despite the contracts being entered into by his 'puppet' company. This was a potentially radical decision as it raised the prospect of non-parties being made liable on a contract to which it was not a signatory and at the same time raising the issue as to whether the 'puppeteer' was bound by all the of the contract. In reaching his conclusion Burton made a number of findings regarding the court's ability to pierce the corporate veil, which have subsequently received strong criticism from Mr Justice Arnold in VTB Capital. In VTB Capital, the claimants applied to amend their particulars of claim in order to bring a contractual claim against Mr Malofeev, Marcap BVI and Marcap Moscow, despite these defendants not being parties to the loan facility under which the claimants claimed to have been defrauded. Arnold J was therefore required to consider the law regarding piercing the corporate veil, and in declining to follow Gramsci took the opportunity to criticise the judgment given by Burton and to set out the circumstance he believed would justify the courts taking this step and the remedies available once the corporate veil is pierced. In Gramsci, Burton J held that the corporate veil could be pierced, and a claim for damages made, if the conditions in Trustor v Smallbone (No 2) [2001] WLR 1177 ("Trustor") were satisfied. These are (1) fraudulent misuse of the company structure, and (2) a wrongdoing committed 'dehors' the company.12 Arnold J rejected this finding, stating in particular that he did not agree that there can be a claim for common law damages, as distinct from an equitable remedy, whenever the Trustor conditions are satisfied. Arnold J went on to say that a number of authorities show that it is 'inappropriate', where a claim of wrongdoing is made against the controller of a company, to pierce the corporate veil to enable 21

a contractual claim against that person. In Arnold J's eyes, Trustor is instead authority for the proposition that, in a claim for knowing receipt, the court will treat receipt by a company as receipt by the individual who controls it if both conditions above are satisfied. Finally, Arnold J was dissatisfied with Burton J's acceptance of the submission that the notional puppeteer can be made liable for a contract, but that "as a matter of public policy" he cannot enforce it. Arnold J asked why such a defendant, who is being treated by the courts as a party to a contract, should not be able to enforce rights within it such as a set off or cross claim for unpaid sums.

Macaura v Northern Assurance Co Ltd [1925] AC 619 *A company’s property is the property of the company as a separate person not the . Facts: Owner of Timber estate sold all the timber property to a company in which he owned almost all the shares. He was also the largest creditor. He insured the timber against fire by policies taken out in his own name. Timber was destroyed and he sued the insurance company. The HoL held that in order to have an insurable interest in property a person must have a legal or equitable interest in the property not merely a moral certainty of profiting or losing from the property. Lord Wrenbury: “My Lords, this appeal may be disposed of by saying that the corporator even if he holds all the share in the corporation, and that neither he nor any creditor of the company has any property legal or equitable in the assets of the corporation.”

Lee v Lee’s Air Farming Ltd [1961] AC 12: [A company can employ one of its under a contract of service] A company employed Mr. Lee who owned 2,999 of 3000 shares, was its only director and have been appointed ‘governing director’ for life. He was killed in the course of his work for the company. The company’s insurers alleged that there was no contract of service so that no claim could be made. Lord Morris of Borth-y-Gest: In their lordships’ view it is a logical consequence of the decision in Salomon that one person may function in dual capacities. There is no reason, therefore, to deny the possibility of a contractual relationship being created as between the deceased and the company. The Privy Council also rejected the insurers’ arguments. Lord Morris said “there appears to be no greater difficulty in holding that a man acting in one capacity can give orders to himself in another capacity than there is in holding that a man acting in one capacity can make a contract with himself in another capacity”.

LIABILITY FOR FRAUDULENT TRADING: “A person who is found to have been knowingly party to the carrying on of a business of a company with intent to defraud its creditors, or creditors of any other person, or for any other person, of for any fraudulent

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purpose, may be declared by the court to be liable to make such contributions (if any) to the company’s assets as the court thinks proper” (Insolvency Act 86 s.213)( pg. 690) “A person who was knowingly party to a company’s fraudulent trading may be may be made liable to contribute to its assets only when it is wound up, but such a person may at any time be prosecuted for the criminal offence of knowingly being a party to fraudulent trading (CA 2006, s. 993). Section 214 Insolvency Act – ‘Wrongful Trading’ – comes into operation ONLY if a company goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of winding up (s.214). In order to establish liability to elements must be proved (1) knowledge that insolvent liquidation was unavoidable (2) and failure to take every step to minimise potential loss to creditors.

COMPANIES ACT 2006 PART 29 FRAUDULENT TRADING 933 Offence of Fraudulent Trading (1)If any business of a company is carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, every person who is knowingly a party to the carrying on of the business in that manner commits an offence. (2)This applies whether or not the company has been, or is in the course of being, wound up. (3)A person guilty of an offence under this section is liable— (a)on conviction on indictment, to imprisonment for a term not exceeding ten years or a fine (or both); (b)on summary conviction— (i)in England and Wales, to imprisonment for a term not exceeding twelve months or a fine not exceeding the statutory maximum (or both); (ii)in Scotland or Northern Ireland, to imprisonment for a term not exceeding six months or a fine not exceeding the statutory maximum (or both). CHAPTER 2 MINIMUM SHARE CAPITAL REQUIREMENT FOR PUBLIC COMPANIES 767 Consequences of doing business etc without a trading certificate (1)If a company does business or exercises any borrowing powers in contravention of section 761, an offence is committed by— (a)the company, and (b)every officer of the company who is in default. (2)A person guilty of an offence under subsection (1) is liable— (a)on conviction on indictment, to a fine; (b)on summary conviction, to a fine not exceeding the statutory maximum. (3)A contravention of section 761 does not affect the validity of a transaction entered into by the company, but if a company— (a)enters into a transaction in contravention of that section, and 23

(b)fails to comply with its obligations in connection with the transaction within 21 days from being called on to do so, the directors of the company are tly and severally liable to indemnify any other party to the transaction in respect of any loss or damage suffered by him by reason of the company's failure to comply with its obligations.

Insolvency Act 1986 Penalisation of directors and officers 213 Fraudulent trading. (1)If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect. (2)The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper. 214 Wrongful trading. (1)Subject to subsection (3) below, if in the course of the winding up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper. (2)This subsection applies in relation to a person if— (a)the company has gone into insolvent liquidation, (b)at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and (c)that person was a director of the company at that time; but the court shall not make a declaration under this section in any case where the time mentioned in paragraph (b) above was before 28th April 1986. (3)The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken. (4)For the purposes of subsections (2) and (3), the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both— (a)the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and (b)the general knowledge, skill and experience that that director has. (5)The reference in subsection (4) to the functions carried out in relation to a company by a director of the company includes any functions which he does not carry out but which have been entrusted to him. (6)For the purposes of this section a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up. 24

(7)In this section “director” includes a shadow director. (8)This section is without prejudice to section 213. 216 Restriction on re-use of company names. (1)This section applies to a person where a company (“the liquidating company”) has gone into insolvent liquidation on or after the appointed day and he was a director or shadow director of the company at any time in the period of 12 months ending with the day before it went into liquidation. (2)For the purposes of this section, a name is a prohibited name in relation to such a person if— (a)it is a name by which the liquidating company was known at any time in that period of 12 months, or (b)it is a name which is so similar to a name falling within paragraph (a) as to suggest an association with that company. (3)Except with leave of the court or in such circumstances as may be prescribed, a person to whom this section applies shall not at any time in the period of 5 years beginning with the day on which the liquidating company went into liquidation— (a)be a director of any other company that is known by a prohibited name, or (b)in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of any such company, or (c)in any way, whether directly or indirectly, be concerned or take part in the carrying on of a business carried on (otherwise than by a company) under a prohibited name. (4)If a person acts in contravention of this section, he is liable to imprisonment or a fine, or both. (5)In subsection (3) “the court” means any court having jurisdiction to wind up companies; and on an application for leave under that subsection, the Secretary of State or the official receiver may appear and call the attention of the court to any matters which seem to him to be relevant. (6)References in this section, in relation to any time, to a name by which a company is known are to the name of the company at that time or to any name under which the company carries on business at that time. (7)For the purposes of this section a company goes into insolvent liquidation if it goes into liquidation at at time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up. (8)In this section “company” includes a company which may be wound up under Part V of this Act. 217 Personal liability for debts, following contravention of s. 216. (1)A person is personally responsible for all the relevant debts of a company if at any time— (a)in contravention of section 216, he is involved in the management of the company, or (b)as a person who is involved in the management of the company, he acts or is willing to act on instructions given (without the leave of the court) by a person whom he knows at that time to be in contravention in relation to the company of section 216. (2)Where a person is personally responsible under this section for the relevant debts of a company, he is tly and severally liable in respect of those debts with the company and any other person who, whether under this section or otherwise, is so liable. (3)For the purposes of this section the relevant debts of a company are— (a)in relation to a person who is personally responsible under paragraph (a) of subsection (1), such debts and other liabilities of the company as are incurred at a time when that person was involved in the management of the company, and

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(b)in relation to a person who is personally responsible under paragraph (b) of that subsection, such debts and other liabilities of the company as are incurred at a time when that person was acting or was willing to act on instructions given as mentioned in that paragraph. (4)For the purposes of this section, a person is involved in the management of a company if he is a director of the company or if he is concerned, whether directly or indirectly, or takes part, in the management of the company. (5)For the purposes of this section a person who, as a person involved in the management of a company, has at any time acted on instructions given (without the leave of the court) by a person whom he knew at that time to be in contravention in relation to the company of section 216 is presumed, unless the contrary is shown, to have been willing at any time thereafter to act on any instructions given by that person. (6)In this section “company” includes a company which may be wound up under Part V. Re Patrick Lyon Ltd [1933] [Fraudulent Trading/ Wrongful Trading] Ch 786 [s.213 – Fraudulent] Maugham J said: "I will express the opinion that the words 'defraud' and 'fraudulent purpose,' ... are words which connote actual dishonesty involving, according to current notions of fair trading among commercial men, real moral blame." Re Produce Marketing Consortium Ltd (No 2) [1989] 5 BCC 569 (Pg 696) [s.214 – Director Liability] *First UK company law or UK insolvency law case under the wrongful trading provision of s 214 Insolvency Act 1986. Facts: Eric Peter David and Ronald William Murphy ran Produce Marketing Consortium Ltd, importing fruits from Cyprus. They were the only employees by the end (except David’s wife who did clerical work for £70 per month). PMC was incorporated in 1964 as an amalgamation of three smaller businesses. David was director from the start, and owned half the shares. As other directors left and died, Murphy became the other director in 1974. He had no ancy qualifications, but was an experienced bookkeeper. The company earned profit through a 3.5% commission on the gross sale price of the fruit which was imported through its agency. But the business was dropping because they lost business of a large Spanish exporter. They made losses of £14K, £25K and £21K in 1981, 1982 and 1983, and a profit of £43 in 1984, by which time there was a bank overdraft of £91K. The report for that year was that, “At the balance sheet date, the company was insolvent but the directors are confident that if the company continues to trade, it will be able to meet its liabilities.” The auditor said the company’s continuation depended on the bank’s continued facilities. Banco Exterior SA took a secured debenture in 18 October 1983 on all property and assets, present and future, including good will, book debts and uncalled capital (but fixed assets were only £5000). They also took a personal guarantee from David for £30K. The draft s for 1984-6 were produced by auditors six months late in January 1987. They showed a £55K loss and £29K loss, with liabilities over assets reaching £175K. Auditors warned of insolvent trading, if the bank did not give more credit. The bank did oblige in March, but less than before. The overdraft decreased, but debt to its most important Cypriot shipper increased to £175K. The company was put in creditors’ voluntary liquidation on 2 October 1987, with debts of £317,694, half owed to one Cypriot shipping firm, as a trade creditor that brought them fruit. In 1988 the liquidator asked David and Murphy why there was trading while insolvent. David replied that they knew liquidation was inevitable in February with the s, and trading was continued because there was perishable fruit in cold store. The liquidator sought them to contribute £107,946 each, plus costs the court saw fit. The liquidator argued that the right measure to contribute was the reduction in net assets caused by the wrongful trading. 26

Judgment: The Insolvency Act 1986 now has two separate provisions: s 213 dealing with fraudulent trading – to which the ages which I have quoted from the judgments of Maugham J and Buckley J no doubt are still applicable – and s. 214 which deals with what the side-note calls “wrongful trading”. It is evident that Parliament intended to widen the scope of the legislation under which directors who trade on when the company is insolvent may, in appropriate circumstances, be required to make a contribution to the assets of the company which, in practical , means its creditors.

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LECTURE #4 (week 6): CORPORATE CRIME (CRIMINAL, TORTIOUS AND CONTRACTUAL LIABILITY) A Reiteration of the Salomon Principle. Can a company have mens rea or malice? Two Methods at Common Law: 1) Vicarious Liability: when an employee (or agent) commits a tort, the employer (or principle), whether an individual or a company, may be held vicariously liable. It is imposed where the closeness of the connection between the nature of the employment and the particular tort, and looking at the matter in the round, it is just and reasonable to hold the employer liable. 2) Identification doctrine (sometimes called the ‘alter ego doctrine’ or ‘doctrine of attribution’): Man civil law rights and liabilities attach only to persons who have requisite knowledge. To make these concepts applicable to companies as separate persons it is necessary to attribute to companies the knowledge of humans identified with them. Lennard’s Carrying Co v Asiatic Petroleum Co Ltd [1915] [Identification Theory]: The company’s state of mind (its mens rea) is the state of mind of its “directing mind and will” . The shipowner (appellant) argued that it should not be liable for fire damage to goods on board the ship which happened ‘without his actual fault or privity’ as set out in the Merchant Shipping Act 1894. The evidence showed that Mr. Lennard, a director of the shipowning company, knew, or ought to have known, that the ship was unseaworthy. Held: …If Mr Lennard was the directing mind of the company, then his action must, unless a corporation is not to be liable at all, have been an action which was the action of the company itself within the meaning of s. 502 [of the Merchant Shipping Act].

**Tesco v Natrass [1972] (Pg 637) [Directing Mind and Will – Criminal Liability]: The directing mind and will or the controlling mind of the company is limited to individual employees with some power of control in the company including some discretion over the activities with which the offence is concerned. HoL stated that ‘board may delegate authority, which may make those delegated part of the mind (and operation) of the company’. (i.e.: the board of directors; the CEO or managing director and possibly other senior officers if they speak and act as the company.) Lord Reid: “A living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these: it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that guilt is the guilt of the company.” Stone and Rolls Ltd v Moore Stephens [2009] UKHL [Attribution Principle]: “And individual’s knowledge of his or her own wrongdoing will be attributed to a company if the individual is the only person 28

beneficially interested in the company’s shares (or if any other persons so interested are complicit in the wrongdoing). Facts: Mr. Stojevic, only individual interested in shares, defrauded bank of 90 million. Company tried to sue auditor for negligence in not discovering the fraud, but doing so would assist the company to benefit from its wrongdoing contrary to ex turpi causa (therefore attribution found for the purpose of upholding ex turpi causa principle). Attempts to Widen the “Mind” Concept: 1) Director General of Fair Trading v Pioneer Concrete [1995]: sometimes it is necessary to attribute liability to a company the acts or thoughts of individuals who are not part of its directing mind and will because otherwise the persons who formed its directing mind and will could insulate the company from liability by delegating their functions. An Order against Pioneer was disputed as the defendants argued that the employees (area manager and plant manager) entered into contracts against the express prohibition of their employers. The House of Lords rejected this argument and attributed liability. 2) EI Ajou v Dollar Land Holdings [1994] Especially – 3) Meridian Global Fund Management v Securities Commission [1995]: where a statutory offence is involved the concept of a directing mind may vary depending on the interpretation of the statute. Lord Hoffman emphasised that choosing whose thoughts and/or action will be attributed to a company or the purpose of applying a rule of law to it depend on interpreting that rule… In the instant case the PC finds that the individual attributable for the wrongdoing was not a director but they individual who ‘had authority to acquire the securities for the company, regardless of whether that individual was the company’s directing mind and will.’

Corporate Manslaughter: It has been held that the ‘identification theory’ can be used to make a company liable for criminal offences requiring mens rea. “The bigger the company the easier it is to escape liability” (pg 639). Less than 10 work-related death prosecutions have been successful, and then only against small companies. Attribution is a key issue in this area!: 1) R v Kite and OLL Ltd 144 NLJ 1735: An interesting case in that it identifies management’s failure to ensure a safe activity, leading to a conviction for gross negligence manslaughter, when evidence showed that warnings about safety had been given. The company, known as Active Learning and Leisure Limited and which operated as a leisure centre at St Alban's Centre in Lyme Regis, was charged with corporate manslaughter and as a result of the trial, convicted of that offence. The corporate structure was that Mr Kite was the managing director, 29

and Mr Stoddart was the manager. Therefore the company was a one man operation so the directing mind was that of its managing director and the company's liability came from the 'directing mind' having formed the mens rea. A company can only act and be criminally responsible through its officers or those in a position of real responsibility in conducting the company's affairs. In other words if it is proved that some person or persons who were the controlling minds of the company were themselves in the case guilty of manslaughter then the company is likewise guilty. 2) R v P & O Ferries Ltd (1991): an example of a large company evading liability under the common law test because a single ‘directing mind’ could not be identified despite eight defendants being brought to trial. It is arguable that theoretically the company would be held liable under the CMCHA. However, it should be noted that this case was unique due to eight ‘directing minds’ being identified. Whether the CMCHA would remedy situations where less defendants were identifiable is still questionable. In Canada it has been held that a company on trial for a criminal offence cannot call evidence that it is of good character: it is in the nature of the corporation that it does not have a character and the character of humans associated with the corporation cannot be attributed to it. Besides the ‘identification theory’ there are two general principles of criminal law that can be used to impose liability: (1) strict liability offences and (2) vicarious liability. In relation to many vicarious-liability offences, Parliament has provided employers with a ‘due diligence’ defence – that is, the employer is relieved of liability if it is shown that the employer had exercised all due diligence to avoid commission of the offence. As with strict liability, vicarious liability is a concept of criminal law not company law!

Corporate Manslaughter & Corporate Homicide Act 2007 •

Creates a single, new offence of corporate manslaughter. (S20 abolishes corporate manslaughter at common law).

1 The offence (1)An organisation to which this section applies is guilty of an offence if the way in which its activities are managed or organised— (a)causes a person's death, and (b)amounts to a gross breach of a relevant duty of care owed by the organisation to the deceased. (2)The organisations to which this section applies are— (a)a corporation; (b)a department or other body listed in Schedule 1; (c)a police force; (d)a partnership, or a trade union or employers' association, that is an employer. (3)An organisation is guilty of an offence under this section only if the way in which its activities are managed or organised by its senior management is a substantial element in the breach referred to in subsection (1). (4)For the purposes of this Act— 30

(a)“relevant duty of care” has the meaning given by section 2, read with sections 3 to 7; (b)a breach of a duty of care by an organisation is a “gross” breach if the conduct alleged to amount to a breach of that duty falls far below what can reasonably be expected of the organisation in the circumstances; (c)“senior management”, in relation to an organisation, means the persons who play significant roles in— (i)the making of decisions about how the whole or a substantial part of its activities are to be managed or organised, or (ii)the actual managing or organising of the whole or a substantial part of those activities. 2 Meaning of “relevant duty of care” (1)A “relevant duty of care”, in relation to an organisation, means any of the following duties owed by it under the law of negligence— (a)a duty owed to its employees or to other persons working for the organisation or performing services for it; (b)a duty owed as occupier of premises; (c)a duty owed in connection with— (i)the supply by the organisation of goods or services (whether for consideration or not), (ii)the carrying on by the organisation of any construction or maintenance operations, (iii)the carrying on by the organisation of any other activity on a commercial basis, or (iv)the use or keeping by the organisation of any plant, vehicle or other thing; (d)a duty owed to a person who, by reason of being a person within subsection (2), is someone for whose safety the organisation is responsible. •

•

•

S8 if an organisation owed a duty of care •

The jury must decide – was there a gross breach of it

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Was there evidence of a breach of H&S – how serious was it and the risk of death posed

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The attitudes, policies, systems, practices which encouraged the breach or toleration of it ( & other matters considered relevant).

S9 : if Corp is convicted the court (usually will punish by imposing a fine) but additionally may order corp to take remedial action within a specified time •

AND supply evidence to authority that it has been done.

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Failure to comply is an indictable offence.

S10 : the court may order Corp to publicise in a specific manner: •

The conviction

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Particulars

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of any remedial order. 31

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(Time limit for compliance).

Liability for individuals who contributed to corporate offence not included in legislation but still subject to common law… Recent Cases: 1) Cotswold Geotechnical Holdings Ltd 2011 [First case under 2007 Act]  The company was found guilty of corporate manslaughter and fined £385,000, where a geologist working for the company was killed in a pit when its walls collapsed on him as he was taking soil samples. 2) Lion Steel Ltd 2012 

Lion Steel had pleaded guilty to the offence of corporate manslaughter arising from the death of Stephen Berry at the company’s premises in Hyde. Mr Berry fell some 30 metres to his death through a skylight in a roof. He had gone onto the roof to repair a leak.

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The company was fined £480,000 in relation to the offence. It was given an extended period for payment of the fine and costs (up to three years).

3) MNS Mining 2013 4) Mobile Sweepers (Reading) Ltd 2014 

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The Company only had £12,000 left in the bank when Winchester Crown Court came to sentence it for a breach of section 1 of the Corporate Manslaughter and Homicide Act 2007 last week (26 February 2014). However, His Honour Judge Boney noted that the corporate failing was the "most serious of its kind the Court is ever likely to hear" and accordingly fined the company all it had to pay. The Judge also required the company to publish details of its failings (a "demonstrably unsafe" system of work) in two local papers and fined its sole director £183,000 plus £8,000 costs for his itted failing under s37 of the Health and Safety at Work etc. Act 1974 as well as disqualifying him from being the director of another company for the next five years. Further offences charged initially including gross negligence manslaughter against Mr Owen (the company director) were not pursued but left to lie on file. The case related to an incident on 6 March 2002 when one of the company's employees, Malcolm Hinton was crushed to death as he carried out repairs to a road sweeper. The findings of the investigation were that a prop designed to the weight of a hopper when it was raised in the tipping position could not be used because of the poor condition of the vehicle. As a result, when Mr Hinton had removed a hose being used, the hopper fell backwards to the main chassis of the vehicle and crushed him as he worked underneath. Mobile Sweepers (Reading) Limited ceased trading soon after the incident, a scenario that has been seen all too often as the courts hear Corporate Manslaughter cases. What appears clear from this latest case is that the investigating authorities will not be satisfied to simply charge a 'shell' company and will pursue individuals where they consider evidence exists of 32

significant failings. Mr Owen, the company director, avoided a prison sentence in this case but the fine and disqualification of him as a director of any company for five years seems likely to have a significant punitive impact on him personally. The Court is sometimes willing to stretch legal concepts to impose criminal liability on company directors, eg. Brown v DPP (1998) in which the company’s managing director was found liable for an offence even though he did not take part in the actual act (which was the editing of a paper which released personal details of a victim of sexual assault).

Health & Safety at Work Act 1974 Need to know this legislation exists, but do not need to know anything about this Act in detail – just know it operates in connection with a work-place death! •

Sets out general duties re: health, safety and welfare in connection with work and control of dangerous substances and emissions

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Set up H&S Commission and Executive - including investigation and inquiry powers

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Authorises H&S Regulations and Codes

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Extensive provisions as to offences and prosecution.

Also Tortious Liability, eg, Chandler v Crane or VTB Liability via various legislation, eg, Prest [Matrimonial Act] (Court suggests may attach liability by other legislation as well!) Insolvency Act.

Contractual Liability CA 2006 s.43(1), sets out two ways in which a company may become contractually bound: 1) written contract to which the company’s common seal is affixed or if a written contract is signed by two authorized signatories, or by a director in the presence of two witnesses; or 2) where a person who was acting under the express or implied authority of the company has made a contract on behalf of the company. a) consider ultra vires doctrine: describes acts attempted by a corporation that are beyond the scope of powers granted by the corporation's objects clause, articles of incorporation or in a clause in its Bylaws, in the laws authorizing a corporation's formation, or similar founding documents. Acts attempted by a corporation that are beyond the scope of its charter are void or voidable. 1. An ultra vires transaction cannot be ratified by shareholders, even if they wish it to be ratified. 2. The doctrine of estoppel usually precluded reliance on the defense of ultra vires where the transaction was fully performed by one party. 3. A fortiori, a transaction which was fully performed by both parties could not be attacked. 4. If the contract was fully executory, the defense of ultra vires might be raised by either party.

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5. If the contract was partially performed, and the performance was held to be insufficient to bring the doctrine of estoppel into play, a suit for quasi contract for recovery of benefits conferred was available. 6. If an agent of the corporation committed a tort within the scope of his or her employment, the corporation could not defend on the ground the act was ultra vires. *Important to distinguish ultra vires (going beyond objects of incorporation) v excess of authority (where an employee of the company commits an act beyond the powers delegated to them.) The former cannot be ratified by whereas the latter may be!

Asbury Railway Corriage and Iron Co Ltd v Riche (1875): HoL decided that a ed company did not have the contractual capacity to enter into contract outside its objects, which, at that time, had to be stated in the company’s memorandum. This came to be known as the ‘ultra vires rule’. The fact that of the company approve the transaction cannot cure the company’s lack of capacity, even if they approve it unanimously. CA 1989 s. 108 nullified the ultra vires rule (except for charitable companies): The validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s constitution. The effect of this provision is that companies cannot refuse to honour a contract simply because it is incapable within the company’s objects. *The memorandum no longer restricts the activities of a company. Since 1 October 2009, if a company's constitution contains any restrictions on the objects at all, those restrictions will form part of the articles of association. Historically, a company's memorandum of association contained an objects clause, which limited its capacity to act. When the first limited companies were incorporated, the objects clause had to be widely drafted so as not to restrict the board of directors in their day to day trading. In the Companies Act 1989, the term "General Commercial Company" was introduced which meant that companies could undertake "any lawful or legal trade or business." Freeman and Lockyer v Buckhurst Park Properties Ltd [1964]: The actual authority of an agent of a company is the authority conferred on the agent by the contract governing the agency which has been agreed between the agent and the company. Thus, if any person acting within the scope of his or her actual authority makes a contract on behalf of a company then the company will be bound by it. Doctrine of ‘Ostensible Authority’ set out herein: principle is bound by an agent’s exercise of ostensible authority even if that exceeds the agent’s actual authority. In the instant case it was said that ‘a contract made by an agent (or person represented to be an agent) of a company outside the agent’s actual authority would be binding if: a) the ostensible authority of the person acting as agent to make such a contract was represented to the contractor; b) representation made by person who had actual authority to manage business of company; 34

c) contract actually relied on the representation a reason for entering into contract; d) under its constitution i) company had capacity to enter into contract; and ii) company was no precluded from authorizing person acting as agent to make contract in question. Hely Hutchinson v Brayhead Ltd [1968] [Agency]: Case demonstrated problem in showing how a representation by conduct is made by the directors to the contractor: Now there is not usually any direct communication…between board of directors and the outside contractor. The actual communication is made…by the agent…It is, therefore, necessary in order to make a case of ostensible authority to show in some way that such communication which is made directly by the agent is made ultimately by the responsible parties, the board of directors. That may be shown by inference from the conduct of the board…(pg 611) Royal British Bank v Turquand [1856]: case that held people transacting with companies are entitled to assume that internal company rules are complied with, even if they are not. This "indoor management rule" or the "Rule in Turquand's Case" is applicable in most of the common law world. It originally mitigated the harshness of the constructive notice doctrine, and in the UK it is now supplemented by the Companies Act 2006 sections 39-41. Facts: Mr Turquand was the official manager (liquidator) of the insolvent ‘Cameron’s Coalbrook Steam, Coal, and Swansea and London Railway Company’. It was incorporated under the t Stock Companies Act 1844. The company had given a bond for £2000 to the Royal British Bank, which secured the company’s drawings on its current . The bond was under the company’s seal, signed by two directors and the secretary. When the company was sued, it alleged that under its ed deed of settlement (the articles of association), directors only had power to borrow what had been authorised by a company resolution. A resolution had been ed but not specifying how much the directors could borrow. Cotman v Brougham [1918] AC 514 is UK company law case concerning the objects clause of a company, and the problems involving the ultra vires doctrine. It held that a clause stipulating the courts should not read long lists of objects as subordinate to one another was valid. This case is now largely an historical artifact, given that new companies no longer have to objects under the Companies Act 2006 section 31, and that even if they do the ultra vires doctrine has been abolished against third parties under section 39. It is only relevant in an action against a director for breach of duty under section 171 for failure to observe the limits of their constitutional power. b) Tracing EU Contract Regulations (Pg 619 – 19.5.5) 1) Pre-Incorporation Contracts; 2) Abolition of ‘ultra vires’ doctrine – UK didn’t abolish it but introduced ‘remedy’ measures = ‘goodfaith’ transaction. Ultra vires doctrine no longer a concern, however, as company able to opt into 35

‘unrestricted objects’ in addition to s.40 CA 2006 which precludes a company from relying on constitution as means for arguing act ‘ultra vires’.

Companies Act 2006 Capacity of company and power of directors to bind it 39 A company's capacity (1)The validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company's constitution.

40 Power of directors to bind the company (1)In favour of a person dealing with a company in good faith, the power of the directors to bind the company, or authorise others to do so, is deemed to be free of any limitation under the company's constitution. (2)For this purpose— (a)a person “deals with” a company if he is a party to any transaction or other act to which the company is a party, (b)a person dealing with a company— (i)is not bound to enquire as to any limitation on the powers of the directors to bind the company or authorise others to do so, (ii)is presumed to have acted in good faith unless the contrary is proved, and (iii)is not to be regarded as acting in bad faith by reason only of his knowing that an act is beyond the powers of the directors under the company's constitution. (3)The references above to limitations on the directors' powers under the company's constitution include limitations deriving— (a)from a resolution of the company or of any class of shareholders, or (b)from any agreement between the of the company or of any class of shareholders. (4)This section does not affect any right of a member [shareholder] of the company to bring proceedings to restrain the doing of an action that is beyond the powers of the directors. But no such proceedings lie in respect of an act to be done in fulfilment of a legal obligation arising from a previous act of the company. (5)This section does not affect any liability incurred by the directors, or any other person, by reason of the directors' exceeding their powers. (6)This section has effect subject to— section 41 (transactions with directors or their associates), and section 42 (companies that are charities).

41 Constitutional limitations: transactions involving directors or their associates [Actually an antifraud measure!]

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(1)This section applies to a transaction if or to the extent that its validity depends on section 40 (power of directors deemed to be free of limitations under company's constitution in favour of person dealing with company in good faith). Nothing in this section shall be read as excluding the operation of any other enactment or rule of law by virtue of which the transaction may be called in question or any liability to the company may arise. (2)Where— (a) a company enters into such a transaction, and (b) the parties to the transaction include— (i) a director of the company or of its holding company, or (ii) a person connected with any such director, the transaction is voidable at the instance of the company. (3)Whether or not it is avoided, any such party to the transaction as is mentioned in subsection (2)(b)(i) or (ii), and any director of the company who authorised the transaction, is liable— (a)to to the company for any gain he has made directly or indirectly by the transaction, and (b)to indemnify the company for any loss or damage resulting from the transaction. (4)The transaction ceases to be voidable if— (a)restitution of any money or other asset which was the subject matter of the transaction is no longer possible, or (b)the company is indemnified for any loss or damage resulting from the transaction, or (c)rights acquired bona fide for value and without actual notice of the directors' exceeding their powers by a person who is not party to the transaction would be affected by the avoidance, or (d)the transaction is affirmed by the company. (5)A person other than a director of the company is not liable under subsection (3) if he shows that at the time the transaction was entered into he did not know that the directors were exceeding their powers. (6)Nothing in the preceding provisions of this section affects the rights of any party to the transaction not within subsection (2)(b)(i) or (ii). But the court may, on the application of the company or any such party, make an order affirming, severing or setting aside the transaction on such as appear to the court to be just. (7)In this section— (a)“transaction” includes any act; and (b)the reference to a person connected with a director has the same meaning as in Part 10 (company directors).

10 November 2014 & 17 November 2014 DIVISION OF POWERS 37

LECTURE #5

1) Division of Powers, General Meeting v Board a. These cases establish the modern separation of corporate powers! General Meeting: a meeting (one required every year) that all the of a company are entitled to attend (whereas a meeting which only one class of may attend is called a ‘class’ meeting). If a special resolution is sought, full details of resolution must be supplied in the notification. (Shareholders): definition contained in s 112 of CA2006: (1)The subscribers of a company's memorandum are deemed to have agreed to become of the company, and on its registration become and must be entered as such in its of . (2)Every other person who agrees to become a member of a company, and whose name is entered in its of , is a member of the company. *The CA 2006 calls a resolution (the decisions of are embodied in statements known as ‘resolutions’) which may be ed by a simple majority an ‘ordinary’ resolution, but resolutions on many important topics require ‘special’ resolutions, for which a 75% majority is required (from those who are Present & Voting) (s.283) (pg 372). *You can vote by raising your hand, where the number of shares held is irrelevant (each person’s vote is worth the same amount), or by Poll, whereby number of shares is commensurate with voting weight. You can also vote by Proxy (which is typically controlled by the Board!) *CA 2006 does not require that the company’s directors to manage its business, leaving matters of management to be determined by the in their articles of association In corporate governance, a company's articles of association (called articles of incorporation in some jurisdictions) is a document which, along with the memorandum of association (in cases where the memorandum exists) form the company's constitution, defines the responsibilities of the directors, the kind of business to be undertaken, and the means by which the shareholders exert control over the board of directors.

*Isle of Wight Rly Co v Tahourdin (1883) 25 ChD 320: case on removing directors under the old Companies Clauses Act 1845. In the modern Companies Act 2006, section 168 allows shareholders to remove of directors by a majority vote on reasonable notice, regardless of what the company constitution says. Before 1945, removal of directors depended on the constitution; however this case contains some useful guidance on how to properly construe the provisions of a constitution. *Automatic Self-Cleansing Filter Syndicate Co v Cunninghame [1906] 2 Ch 34: The Court of Appeal affirmed that directors were not agents of the shareholders and so were not bound to implement shareholder resolutions, where special rules already provided for a different procedure. There were 2700 shares and the plaintiff, Mr McDiarmid, owned 1202 of them. The company was in the business of purifying and storing liquids. He wanted the company to sell its assets to another company. At a meeting he got 1502 of the shares to vote in favour of such a resolution, with his friends. The directors were 38

opposed to it. They declined to comply with the resolution. So Mr McDiarmid brought this action in the name of the company, against the company directors, including Mr Cuninghame. The constitution stated that only a three quarter majority could remove the directors. It said the general power of management was vested in the directors ‘subject to such regulations as might from time to time be made by extraordinary resolution’ (art 96). They were also explicitly allowed to sell company property (art 91). In this case the words ‘regulations’ referred to the articles of association. So the articles could be changed by a three quarter majority of votes. It did not say anything about issuing directions to the directors. *Marshall’s Valve Gear Co Ltd v Manning, Wade & Co Ltd [1909] 1 Ch 267 [‘Interested Directors’ – Dual Director/Shareholder]: Three out of the four company directors refused to sanction legal proceedings against another company over a patent dispute. The fourth director, who owned a majority (but not three-quarters) of the shares in the company, commenced an action in the name of the company. The other three, who were ’interested’ in the rival patent (they were proprietors of the rival patent), moved to strike out the name of the company as plaintiff and to dismiss the action on the ground that the company’s name had been used without authority. Neville J refused. On an interpretation of the management article, he decided that the majority of the shareholders had the right to control the directors’ action in the matter. Neville J would not interfere with the action initiated by the one director ’because it is brought with the approval of the majority of the shareholders in the company, and, upon the decisions which I have referred to, they are the persons who are entitled to say, aye or no, whether the litigation shall proceed’. The key to the reconciliation of this decision with those in the mainstream of ‘non-interference’ cases is that here the directors who were trying to stop the litigation were ’interested’ in the litigation: ‘their duty and their interests are in direct conflict’. In such circumstances, on traditional theory, it would be a fraud on the minority for the ‘controlling’ directors to refuse to, sanction litigation when they were in such a position of breach of duty or ‘fraud’.

*Scott v Scott [1943] 1 All ER 582: The articles of association provide clearly defined boundaries of powers to the directors which cannot be usurped by shareholders. In the instant case the court declared that a resolution in general meeting requiring directors to exercise the powers in a particular fashion will be inconsistent with the articles of association.

*Breckland Group Holdings Ltd v London & Suffolk Properties [1989] BCLC 100: Ryan: the shareholders cannot interfere with the day-to-day operations of the Company. While articles of company may specify that the general meeting can give direction to Board via ‘special direction’ that does not relate to dad-to-day business (operational management) of Company and cannot be used on everyday basis. Held – Since the company's articles of association adopted reg 80 of Table A of Sch 1 to the Companies Act 1948, the jurisdiction to conduct the business of the company was vested in the board of directors, and the shareholders in general meeting could not intervene to adopt unauthorised proceedings. Accordingly it was irrelevant that a majority of the shareholders of London and Suffolk might want to adopt the action which had been commenced without authority since the only organ of the company which could do so was the board of directors.

General Meeting as Last Resort [Power to Litigate]:

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*General power to litigate in the name of ed company is one of the general powers of management assigned to directors by Art 3 of the model articles (detailed below), so it cannot be exercised by its . John Shaw & Sons Ltd v Shaw [1935]: Peter, John and Percy Shaw had a company together. They had an argument over owing the company money, and the result was a settlement. Peter and John would resign as governing directors, promised they would not take part in financial affairs, and independent directors would be appointed and given control over the company's financial affairs. When the independent directors required John and Peter to pay money to the company, John and Peter refused. The independent directors resolved to bring a claim against them. Just before the hearing, an extraordinary general meeting was called, whereas the majority shareholders Peter and John procured a resolution to discontinue the litigation. The company, and Percy, contended the resolution was ineffective. At first instance Du Parcq J disregarded the resolution and gave judgment for the company. John appealed. Held: The Court of Appeal upheld the judge, so that the shareholders could not circumvent the company's constitution and order the directors to discontinue litigation. Greer LJ said the following: I am therefore of opinion that the learned judge was right in refusing to dismiss the action on the plea that it was commenced without the authority of the plaintiff company. I think the judge was also right in refusing to give effect to the resolution of the meeting of the shareholders requiring the chairman to instruct the company's solicitors not to proceed further with the action. A company is an entity distinct alike from its shareholders and its directors. Some of its powers may, according to its articles, be exercised by directors, certain other powers may be reserved for the shareholders in general meeting. If powers of management are vested in the directors, they and they alone can exercise these powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the articles in the directors is by altering their articles, or, if opportunity arises under the articles, by refusing to re-elect the directors of whose actions they disapprove. They cannot themselves usurp the powers which by the articles are vested in the directors any more than the directors can usurp the powers vested by the articles in the general body of shareholders. The law on this subject is, I think, accurately stated in Buckley on Companies as the effect of the decisions there mentioned: see 11th ed., p. 723. For these reasons I am of opinion that the Court ought not to dismiss the action on the ground that it was instituted and carried on without the authority of the plaintiff company

Companies (Model Articles) Regulations 2008 (s1 2008/3229) (Directors General Power of Management) Art (or Regulation) 3 – Directors Powers & Responsibilities: “Subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.” *Shareholders’ reserve powers: For both public and private companies, Art 4 provides that: 1) shareholders [ of the company] may, by special resolution, direct the directors to take, refrain from taking, specified action; 2) no such special resolution invalidates anything which the directors have done before the ing of the resolution.

Re Halt Garages [1982] 3 All ER 1016 [The Benefit Rule]: Case concerning reduction of capital and executive pay. It held that money can be ordered to be returned if a sum paid to a director is in substance a 40

reduction of capital, because the amounts cannot seriously be regarded as remuneration. (The proper procedure for reduction of capital is now found in CA 2006 sections 641-653.) Facts: The dispute was regarding Director compensation paid to the Wife who was ill and did no work but was still compensated.

Question: Whether shareholders, when acting collectively (like when amending the Constitution), whether they too (along with Directors) need to act in the benefit or interest of the company as a whole?! Objective assessment. Clemens v Clemens Brother [1976] [The Benefit Rule]: Generally, majority rule exists in decisions, but courts have the power to restrict any shareholder’s right to vote if these shareholders are not acting “in good faith” [or in the best interests (or to the benefit) of the company as a whole!]. Facts: One shareholder had 55% of the shares [the Aunt], and used the voting rights these held to a resolution issuing new shares. The effect of this new issue was not proportional on existing shareholding, and pushed the minority shareholding from 45% [the niece] down to below 25%. This therefore allowed the majority shareholder to special resolutions. The court held that this issue of new shares was not needed and reversed the resolution. *The interest of the company (sometimes company benefit or commercial benefit) is a concept that the board of directors in corporations are in most legal systems required to use their powers for the commercial benefit of the company and its . At common law, transactions which were not ostensibly beneficial to the company were set aside as being void as against the company. Companies Act 2006 - Ratification Power of the General Meeting 239 Ratification of acts of directors (1)This section applies to the ratification by a company of conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company. (2)The decision of the company to ratify such conduct must be made by resolution of the of the company. (3)Where the resolution is proposed as a written resolution neither the director (if a member of the company) nor any member connected with him is an eligible member. (4)Where the resolution is proposed at a meeting, it is ed only if the necessary majority is obtained disregarding votes in favour of the resolution by the director (if a member of the company) and any member connected with him. This does not prevent the director or any such member from attending, being counted towards the quorum and taking part in the proceedings at any meeting at which the decision is considered. (5)For the purposes of this section— (a)“conduct” includes acts and omissions; (b)“director” includes a former director; (c)a shadow director is treated as a director; and 41

(d)in section 252 (meaning of “connected person”), subsection (3) does not apply (exclusion of person who is himself a director). (6)Nothing in this section affects— (a)the validity of a decision taken by unanimous consent of the of the company, or (b)any power of the directors to agree not to sue, or to settle or release a claim made by them on behalf of the company. (7)This section does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to acts that are incapable of being ratified by the company. Re Horsley Weight Ltd [1982]: The may ratify a contract which an individual director has entered into when it should have been decided on by the entire board.

Directors: Appointments/Qualifications: The companies Act 2006 does not prescribe who is to be responsible for appointing the directors of a company though it requires the first directors to be appointed by a statement signed by, or on behalf of, the subscribers of the memorandum, and it gives the company’s a right to dismiss directors of the company. Provision for appointment is normally made in the company’s articles. In the absence of any provision, directors are to be appointed by the company’s . At least one director must be a human being! Section 157 sets a minimum age of 16 years for directors (The Marquis of Bute’s Case [1892]). This revision came into effect under the 2006 Act. “Qualification: unlike the Company Secretary who is required to have qualifications, directors do not need to have any qualifications. Having said that, you will find that in very large companies, the company expects (or sets standards) for directors; so while no ‘formal’ qualifications are needed, a certain level of experience is mandatory. (Ryan) Executive v Non-executive Directors: the UK Governance Code states that ‘the board shall be comprised of a combination of both executive and non-executive directors so that no individuals can dominate the board’s decision taking.’ The difference between the two are that the former works full time typically under a ‘service contract’ (contract of employment) and may occupy the role of a ‘managing director’ (eg CEO, COO, CFO), whereas the latter are part-time (pg 420) and act as a ‘supervisory board’ and monitor the Executive Directors. Two-Tier Boards: non-executive and executive directors (in the UK and USA) of a company participate in regular board meetings equally with the executive directors, though they meet separately in the remuneration and audit committees from which executive directors are normally excluded. Under EU law, the constitution must adopt either a one or two-tier system. Types: 1) Shadow; 2) De Facto; 3) Alternate (pg 426) Shadow: a person in accordance with whose directions or instructions the directors of the company are accustomed to act (CA 2006, s 251(1)) but advice given in a professional capacity does not make the advisor a shadow director (s. 251(2)). A body corporate is not to be regarded as a shadow director of any of its

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subsidiary companies…by reason only that the directors of the subsidiary are accustomed to act in accordance with its directions or instructions (s.251(3)). 

Involvement has a cumulative effect. The imposition of conditions might not amount to control when each condition is viewed in isolation but may when too many conditions are imposed together. This was expressly recognised in the English case of Re Tasbian Limited (No. 3) [1992] BCC 358.

Secretary of State for Trade & Industry v Deverell [2000]: it was concluded that: a. the term should not be narrowly construed [thereby widening the net whereby one may be considered a ‘shadow director’ – this allows creditors to be better protected]; b. the giving of non-professional advice could result in a shadow directorship; c. the concepts of “direction “ and “instruction” also included advice, as the common feature these all share is guidance; d. it would be sufficient to show directors had subordinated themselves or surrendered their discretion in the face of guidance from the shadow director (although this element may not always be present); e. such guidance did not need to stretch across the whole of the Company’s activities; f. the communication did not necessarily have to be understood or expected to constitute a direction; g. it was not necessary to show a degree of compulsion in excess of that implicit in the fact the company was accustomed to act in accordance with them (although the most clear example of a shadow directorship is where there is a penalty for not complying with the shadow director’s instructions); and h. it is not necessary for the shadow director to “lurk in the shadows”, but this may often be the case. “Following Deverell: a shadow director is a person involved in the internal management or external control of companies affairs, despite the name ‘shadow’ which connotes exerting influence from outside internal management conditions.” Recent Cases on Shadow Directors: **Ultraframe (UK) Ltd v Fielding [2005] EWHC [Shadow & De Facto Directors]: considered the statutory definition of shadow director and expressed the view that a person at whose direction a governing majority of the board is accustomed to act is capable of being a shadow director, and that the mere fact that a person falls within the statutory definition of shadow director is not enough to impose on him the same fiduciary duties as are owed by a de jure or de facto director. In this case, however, it was held that the relevant individual had not been a shadow director of either company in question, because the boards had not been not "accustomed to act" on his instructions or directions at the relevant times: he was held to have subsequently become a de facto director from the time when he had at least an equal voice with the de jure directors in important business decisions and was part of the corporate structure of governance. The High Court also considered the application of section 320 of the Companies Act 1985 in relation to certain transactions and stated that in principle section 320 could apply to the sale of assets by an istrative receiver.

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Re Coroin [2012] EWHC: Coroin Limited was established by a group of investors to acquire four well-known hotels: The Savoy, Claridges, The Connaught and The Berkeley. One of the investors, McKillen, who held 36 per cent of Coroin's shares, believed that two further shareholders, the Barclay brothers, were trying to gain control of the company. McKillen claimed that the Barclay brothers had appointed directors to the board purely to represent their interests, which amounted to unfair prejudice against him. McKillen sought later to amend this claim, alleging amongst other things that the Barclay brothers were in fact shadow or de facto directors. The Barclay brothers responded by arguing that their influence did not extend to the whole of the company; they could not, therefore, be shadow directors. The court disagreed with the Barclay brothers on the first issue, holding that it was not fatal to the argument that someone was acting as a shadow director if they had not influenced the entire scope of the company activities, and that the fact that they had only been involved in a narrow range of decisions was not something that would contradict the argument that they were in fact shadow directors. It was held that it was not necessary that all directors acted in accordance with the directions of a shadow director; it was enough that a majority did. Nor was it necessary that a shadow director exercise control through his instructions over all board matters. On the question of de facto directorship, which had only been argued in relation to one Barclay brother, the court found that the evidence was insufficient. The brother had never held himself out as a director of Coroin and had never attended board meetings. In addition, there was no suggestion that he had been involved in any decision of the board other than those specifically pleaded, and it had not been suggested that he had been involved in more than a few decisions.

Alford v Barton [2012] EWHC: gives a valuable contrast to the decision in Re Coroin on the issue of de facto directorship. In Barton, an individual who had been disqualified as a director, had a conviction for false ing and for cheating the Revenue, was identified by the court as a de facto director of an insolvent company in a claim by a creditor for misapplication of funds. On the face of it, the individual concerned was acting as a consultant to the insolvent company but according to the court he had in fact been "involved in the company's day-today running, dealt with its financial and VAT affairs, communicated with the ants, and dealt with the receivers as if he were in sole charge. He was a signatory on the company's bank , had full power to act under the bank mandate and could withdraw money without limit. There was no evidence of any delegation of powers by the sole shareholder to the individual, as might be expected if he was truly a consultant; there was no evidence of any consultancy appointment; the individual was unpaid; and he did most things that might be expected of a director. In particular, he had made all the decisions about whether the company should repay the sum due to the purchasers, stalling repayment, against the ants' advice, until the insolvency proceedings". The court found little difference between the individual's actual role in the company and that of a director; hence he was a de facto director.

Vivendi SA v Richards [2013] EWHC: The decision of Newey J in Vivendi SA v Richards has important implications for shadow company directors. The authority which had been regarded as the leading case on shadow directors’ duties, Ultraframe (UK) Ltd v Fielding was 44

held to understate the fiduciary duties owed by shadow directors. As a consequence shadow directors will more commonly owe fiduciary duties. Furthermore, a breach of the duty of good faith in common law in relation to insolvency situations will more likely be found where directors fail to consider the interests of creditors.

Re UKCL Ltd v Chohan [2013] EWHC: has served as a reminder that those who act as directors of companies cannot avoid the duties and liabilities imposed on directors just because they are not formally appointed. Facts: concerned a company, UKCL, that had offered two land banking schemes to investors. The land was purchased on the speculation that planning permission might at some point be granted on the land, thereby increasing its value. The schemes were unauthorised and prohibitive investment schemes under the Financial Services and Markets Act 2000 and the Secretary of State sought to disqualify the directors for unlawful operation of the schemes. Action was also brought against

**Holland v Revenue & Customs (Paycheque) [2010] UKSC: Lord Hope, Lord Collins and Lord Saville held that because the parent company and Holland were separate legal persons, simply acting as a director of a corporate director was not enough to make Holland a de facto director. Holland needed to have assumed responsibility in relation to the subject companies, but he had only discharged his duties as director. If he was the "guiding mind" then that would be true in all cases of corporate directors. Lord Walker and Lord Clarke dissented and would have held that if Holland deliberately procured dividend payments he was a de facto director of the composite companies and owed them a fiduciary duty Ryan: the structure was designed so that each of the 42 companies paid tax at the ‘small company’s rate’ – this didn’t work and they went into insolvency, where Customs then sought unpaid taxes. Court allowed claim against Mr Holland and dismissed against Mrs Holland. The majority held that Mr Holland was doing no more than fulfilling his role as director of the company, and not been a de facto director of the other 42 companies. It’s an important distinction, looking at the IA, where lifting the veil applied to both shadow and de facto directors whereas the CA liability does not apply to shadow directors.”

De Jure: (a) if the person has been appointed to the office of director in accordance with the rules governing such appointment; (b) person agreed to hold office; (c) person is not disqualified from holding that position; and (d) the person has not vacated office. De Facto: a person who acts as a director of a company but is not a de jure director of it is called a de facto director. More recently, the term has been used to describe people whom the courts have treats as directors despite never being appointed as such at all. They have the same liabilities as ‘legally appointed’ directors, and also have fiduciary duties.

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Equal Footing Test: the de facto director is identifiable if they are the sole person running the company, or acting with others, all equally acting without legal appointment, and running the company. In re Hydrodam (Corby) Limited ChD 1994: ET plc wholly owned M Ltd which wholly owned Landsaver M Limited, which wholly owned Hydrodam (Corby) Limited (‘HCL’). The only de jure directors of HCL were two Channel Island companies. HCL went into compulsory liquidation and its liquidator brought claims under section 214 of the 1986 Act for wrongful trading against 14 defendants, including ET, one of its subsidiaries and all its directors. Two of those directors were Mr Thomas and Dr Hardwick, who applied for the proceedings against them to be struck out. Held: The liquidator had failed to plead or adduce any evidence to the allegation that the directors of Eagle Trust were at any material time directors of Hydrodam, and the proceedings were struck out. “A shadow director… does not purport or claim to be a director. On the contrary, he claims not to be a director. He lurks in the shadows, sheltering behind others who, he claims, are the only directors of the company to the exclusion of himself. He is not held out as a director by the company.” Directors may be of three kinds: ‘de jure directors, that is to say those who have been validly appointed to the office; de facto directors, that is to say, directors who assume to act as directors without having been appointed validly or at all; and shadow directors who are persons falling within the definition I have read ['a person in accordance with whose directions or instructions the directors of the company are accustomed to act']. Millett J then explained that liability under section 214 extended to de facto as well as to de jure and shadow directors, but the statutory liability was ‘imposed exclusively upon directors of one or other of the three kinds that I have mentioned.’ That meant that the liquidator had to plead and prove against each defendant that he was such a director of HCL. He explained the difference between a shadow and a de facto director, saying that the latter ‘is one who claims to act and purports to act as a director, although not validly appointed as such.’ A shadow director does not so claim or purport. HCL had two titular directors, namely the two Channel Island companies, a fact that might itself justify the inference that they were accustomed to act in accordance with the directions of others, in which case those others would be shadow directors. But no such case was pleaded. Millett J said: ‘The liquidator submitted that where a body corporate is a director of a company, whether it be a de jure, de facto or shadow director, its own directors must ipso facto be shadow directors of the company. In my judgment that simply does not follow. Attendance at board meetings and voting, with others, may in certain limited circumstances expose a director to personal liability to the company of which he is a director or its creditors. But it does not, without more, constitute him a director of any company of which his company is a director.’ 46

Corporate Director: where a company has another company as their de jure director. It is possible for a parent company to be a shadow director of a subsidiary company. Any action taken in exercising the powers of a corporate director of company must be taken by a human being acting on the corporate director’s behalf. Alternate: permits a director to appoint an alternate – that is a person who can attend meetings that the appointing director is unable to attend, and can generally act in place of the appointing director. That alternate must be approved by resolution of the directors. (pg 433)

Powers: Model Articles 2008, Art. 2-15 Remuneration: a director does not have a right to be remunerated for any services performed for the company except as provided by its constitution or approved by the company’s . (15.9 – pg 448) Service Contract: the fact that a person is a director of a company does not in itself make that person an employee of the company. Being a director of a company is usually categorised as ‘holding an office’ rather than being an employee. **Removal of Directors: s.168-169 CA 2006 168 Resolution to remove director (1)A company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him. (2)Special notice is required of a resolution to remove a director under this section or to appoint somebody instead of a director so removed at the meeting at which he is removed. (3)A vacancy created by the removal of a director under this section, if not filled at the meeting at which he is removed, may be filled as a casual vacancy. (4)A person appointed director in place of a person removed under this section is treated, for the purpose of determining the time at which he or any other director is to retire, as if he had become director on the day on which the person in whose place he is appointed was last appointed a director. (5)This section is not to be taken— (a)as depriving a person removed under it of compensation or damages payable to him in respect of the termination of his appointment as director or of any appointment terminating with that as director, or (b)as derogating from any power to remove a director that may exist apart from this section. 169 Director's right to protest against removal (1)On receipt of notice of an intended resolution to remove a director under section 168, the company must forthwith send a copy of the notice to the director concerned. (2)The director (whether or not a member of the company) is entitled to be heard on the resolution at the meeting. (3)Where notice is given of an intended resolution to remove a director under that section, and the director concerned makes with respect to it representations in writing to the company (not exceeding a reasonable length) and requests their notification to of the company, the company shall, unless the representations are received by it too late for it to do so— (a)in any notice of the resolution given to of the company state the fact of the representations having been made; and

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(b)send a copy of the representations to every member of the company to whom notice of the meeting is sent (whether before or after receipt of the representations by the company). (4)If a copy of the representations is not sent as required by subsection (3) because received too late or because of the company's default, the director may (without prejudice to his right to be heard orally) require that the representations shall be read out at the meeting. (5)Copies of the representations need not be sent out and the representations need not be read out at the meeting if, on the application either of the company or of any other person who claims to be aggrieved, the court is satisfied that the rights conferred by this section are being abused. (6)The court may order the company's costs (in Scotland, expenses) on an application under subsection (5) to be paid in whole or in part by the director, notwithstanding that he is not a party to the application.

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17 November 2014 Lecture #6 Lecture # 6 - Corporate Constitution #1: Internal Effect of the Articles and Alteration

Companies Act 2006: 17 A company's constitution Unless the context otherwise requires, references in the Companies Acts to a company's constitution include— (a) the company's articles, and (b) any resolutions and agreements to which Chapter 3 applies (see section 29) [any ‘special resolution’ – which has to be ed at Companies House and viewed by the public, along with the Articles of Association] 18 Articles of association [Rules of ‘Indoor Management’] (1) A company must have articles of association prescribing regulations for the company. (2) Unless it is a company to which model articles apply by virtue of section 20 (default application of model articles in case of limited company), it must articles of association. (3) Articles of association ed by a company must— (a) be contained in a single document, and (b) be divided into paragraphs numbered consecutively. (4) References in the Companies Acts to a company's “articles” are to its articles of association. 28 Existing companies: provisions of memorandum treated as provisions of articles (1) Provisions that immediately before the commencement of this Part were contained in a company's memorandum but are not provisions of the kind mentioned in section 8 (provisions of new-style memorandum) are to be treated after the commencement of this Part as provisions of the company's articles. (2) This applies not only to substantive provisions but also to provision for entrenchment (as defined in section 22). (3) The provisions of this Part about provision for entrenchment apply to such provision as they apply to provision made on the company's formation, except that the duty under section 23(1)(a) to give notice to the registrar does not apply.

Memorandum: external relations (pre-CA 2006). Articles: internal relations Now all relations are covered under the Articles! Hence, importance of s.28 above which deals with pre-CA 2006 and detailed memorandums. Scope of Constitution: 33 Effect of company's constitution (1)The provisions of a company's constitution bind the company and its to the same extent as if there were covenants on the part of the company and of each member to observe those provisions. 49

(2)Money payable by a member to the company under its constitution is a debt due from him to the company. In England and Wales and Northern Ireland it is of the nature of an ordinary contract debt. The Constitution binds the company and each member. Though a constitution is a statutory contract it differs from typical contracts insofar as an amendment to it only requires ‘special resolution’ whereas in usual contractual relationships, both parties must be in unanimous agreement. AG of Belize v Belize Telecom Ltd [2009]: “The court has no power to improve upon the instrument which it is called upon to construe, whether it be a contract, a statute or articles of association. It cannot introduce to make it fairer or more reasonable…” (78) Because articles of association are public, ed with Companies House for anyone to inspect, the courts, when construing the articles, will not consider matter known only to those who formed the company. For example, they will not exercise its power to rectify a document to give effect to the true intent of those who made it [whereas they would if it were a standard private contract]. That said” when construing the words actually used in the articles of association of a company, it should be regarded as a commercial or business document to which the maxim ‘validate if possible’ applies. Another way of putting this is to say that the articles should be construed so as to give them reasonable business efficacy. The court must reject even the plain and obvious meaning of the words if that meaning would be commercially absurd.” (78) **Hickman v Kent or Romney Marsh Sheep-Breeders' Association [1915] 1 Ch 881 [‘Outsider rights']: The question of whether a person who is not a member of the company has rights to sue on the ‘statutory contract' provided by what is now section 33 of the Companies Act 2006 was considered. It was held that an outsider to whom rights are purportedly given by the company's articles in his capacity as an outsider cannot sue in that capacity, whether he is also a member of the company or not. *(1) Constitution is a contract between and the company. (2) That contract is only for ‘hip rights’. (3) S.33 contract is also a contract between of the company, individually. Beattie v E and F Beattie Ltd [1938] [only provisions relating to hip are contractual by virtue of s 33]: Greene MR: …the contractual force given to the articles of association is to define the position of the shareholder as shareholder, not to bind him in his capacity as an individual. (80) Company brought proceedings against one of its directors, who was also a member of the company, concerning his conduct as a director. He asked the court to stay the proceedings in favour of arbitration. He claimed the proceedings were covered by a provision in the Articles that any dispute between the company and member was to be referred to arbitration. The CoA held that the arbitration article was not enforceable as the contract was only in relation to hip matters. [This case can be contrasted with Rayfield v Hands] **Eley v Positive Life [1876]: Articles stated that C [Eley] was to be the solicitor of Positive Life for life. However after several years he was terminated from this position and sued for breach of the Articles – that he could not be removed. At time articles were created, C was not a member. However by time C brought action, C was a member. Held: C could not enforce the articles (lifelong employment) because the obligation to maintain him in that position was one that did not affect the constitutional right of the shareholding body – it was a contract for a 50

non-hip right (often called outsider rights, whereas hip rights are insider rights), not available to any shareholder. *It is important to note that although the article requiring the company to employ Mr Eley was a matter between shareholders and directors, and not them and the plaintiff, it may also suggest that every member of the company (including Mr Eley) had a hip right to prevent the directors appointing anyone else as solicitor. (86) Browne v La Trinidad (1887) (81): being a director is not a hip right – it is outsider right and therefore unenforceable by member! “If a non-hip provision in a company’s articles states the of an agreement which was made before the company was incorporated, the courts usually require very clear evidence that the company, after incorporation, had made a new contract (novation) to make itself liable. The mere fact that the alleged contractor has become a member of the company does not prove that a new contract has been made.” (81) “It has been decided that the articles of association are a contract between the of the company inter se [between themselves]. That was settled finally by the case of Browne v Law Trinidad, if it was not settled before. (89) Mr Browne agreed with the promoters of a company that when the company was incorporated, he would sell a mine in Mexico to it in return for fully paid shares and that he should become a director of the company for a period of at least four years at least. The company was ed with Articles which provided that this agreement was ‘incorporated with and shall be construed as part of’ the articles. Browne was allotted his shares and was appointed a director of the company, but, before the end of the four year period, the company’s adopted an extraordinary resolution dismissing Browne as director. (The Articles provided that any director could be removed by this measure). CoA refused injunction and held: ‘Having regard to the of CA 2006 s.33, that being a member, the contract which is referred to in the articles has become binding between the company and him. Of course, there could be no contract between him and the company until the shares were allotted to him…’ Salmon v Quin and Axtens Ltd [1909] [outsider rights – injunction possible if sought by member]: It is possible for a member of a company to obtain an injunction to prevent it acting in a way that is inconsistent with a non-hip provision of the articles. In the instant case a bulk of share in Quin and Axtens were owned by Raymond Axtens and Joseph Salmon, who were also appointed as ‘managing directors’ and the articles contained a provision that they could veto any board decision on a range of matters. Salmon latter issued such a veto, but it was disregarded by the Company who attempted to proceed with their resolution. The CoA granted an injunction as the company was trying to by rules on decision-making contained in its constitution without following the procedure therein contained. The court would prevent the company acting on a decision taking unconstitutionally. Indirectly, Salmon enforced his outsider rights as a managing director to veto certain board decisions by suing as a member for the enforcement of the relevant articles. **Rayfield v Hands [1960] (90): it was held that in a quasi-partnership company, which is formed on the basis that certain shall be directors, provisions in the articles referring to ‘directors’ can be interpreted as referring to a class of member who are directors and therefore can be regarded as being concerned with hip rights. 51

Mr. Rayfield was a member of a company whose articles of association provided that a member who intended to transfer his shares had to inform the directors of the company who would take the shares equally between them at a fair value. Mr Rayfield wanted to transfer his 725 shares but Mr Hands and his fellow directors refused to take them. Vaisey J interpreted the reference to the directors in the article as a reference to the class of who were directors and so held that the article concerned hip and had contractual force. He granted Mr Rayfield an order requiring the directors to take the shares but said: “The conclusion to which I have come may not be of so general application as to extend to the articles of association of every company, for it is, I think, material to that this private company is one of the class of companies which bears a close analogy to a partnership.” Exeter City Football v Football Conference [2004] - Can a term in the articles, deny a member or shareholder a statutory right?

- if we take the hierarchy of regulation, at the top is statutory law (in the Companies Act) - below that is the company’s constitution - the articles of association. - there are a hierarchy of rules with statutory law at the TOP - In this case, there was a term in the articles, which was the same provision as in HICKMANS CASE - That is what is called an arbitration clause - if there is a dispute - member cannot go direct to court but instead submit the claim to arbitration. - arbitration is also private which is the most important issue - clause said if there was a dispute between member and company then it would have to go to arbitration first

- said this was a denial of a statuary right that he had - referring to S995 of the companies act - which is the unfair prejudice action

- can also apply to court on grounds that companies acting on way that is prejudicial to its - clearly any individual shareholder is given a right to go to court on basis that his rights are being unfairly prejudiced by the way the company is being run /managed

- claim was that arbitration clause was denying member right to justice to go to court - argument was that statute is superior to the articles which are subordinate to the statute - therefore he should have statutory right that should not be denied.

- under s 995 could go directly to court and not have to go to arbitration - same issue reappears in ****FULHAM FOOTBALL V RICHARDS [2011]

- shift towards American type attitude that companies are simply a nexus of contracts and that the relationships between and companies are governed by contract and therefore freedom of contract must prevail, and therefore if shareholder freely signs up by buying shares in the company, knowing that he was to go to arbitration if there is a dispute, then that should prevail.

- while the contract prevails in this case (Articles term which says you have to go to arbitration prevails over a s 995 right, it does so only if there is no consequence to third parties)

- would ing contractual effect have an effect on third parties? (creditors). - This case has overturned Exter - it would appear that a contract takes precedence subject to whether or not those rights would be damaging to the creditors of the companies. 52

24 November 2014. Lecture # 7 - CORPORATE CONSTITUTION #2: ALTERATION 

Alteration of the Constitution o (1) Procedure o (2) Potential Limitations on alteration o (3) Effect of an alteration on outsiders

(1) Procedure  Certain statutes that you need to be familiar with o Start at 17 – the constitution S. 21 – Amendment of Articles  (1) A company may amend its articles by special resolution [75% vote of ].  (2) In the case of a company that is a charity, this is subject to— o (a) In England and Wales, [sections 197 and 198 of the Charities Act 2011]; o (b) In Northern Ireland, Article 9 of the Charities (Northern Ireland) Order 1987 (S.I. 1987/2048 (N.I. 19)).  (3) In the case of a company that is ed in the Scottish Charity , this is subject to— o (a) Section 112 of the Companies Act 1989 (c. 40), and o (b) Section 16 of the Charities and Trustee Investment (Scotland) Act 2005 (asp 10). Trethowan’s case -> Court held that while a provision couldn’t state that a statute could never be changed in the future, it could make it very difficult for a future parliament to do so by imposing procedural requirements. S. 25 – Effect of alteration of articles on company’s  (1) A member of a company is not bound by an alteration to its articles after the date on which he became a member, if and so far as the alteration— o (a) Requires him to take or subscribe for more shares than the number held by him at the date on which the alteration is made, or o (b) In any way increases his liability as at that date to contribute to the company's share capital or otherwise to pay money to the company.  (2) Subsection (1) does not apply in a case where the member agrees in writing, either before or after the alteration is made, to be bound by the alteration. S. 29 – Resolutions and agreements affecting a company’s constitution  (1) This Chapter applies to— o (a) Any special resolution; o (b) Any resolution or agreement agreed to by all the of a company that, if not so agreed to, would not have been effective for its purpose unless ed as a special resolution; o (c) Any resolution or agreement agreed to by all the of a class of shareholders that, if not so agreed to, would not have been effective for its purpose unless ed by some particular majority or otherwise in some particular manner; o (d) Any resolution or agreement that effectively binds all of a class of shareholders though not agreed to by all those ; o (e) Any other resolution or agreement to which this Chapter applies by virtue of any enactment.  (2) References in subsection (1) to a member of a company, or of a class of of a company, do not include the company itself where it is such a member by virtue only of its holding shares as treasury shares. 53

S. 30 – Copies of resolutions or agreements to be forwarded to registrar  (1) A copy of every resolution or agreement to which this Chapter applies, or (in the case of a resolution or agreement that is not in writing) a written memorandum setting out its , must be forwarded to the registrar within 15 days after it is ed or made.  (2) If a company fails to comply with this section, an offence is committed by— o (a) The company, and o (b) Every officer of it who is in default.  (3) A person guilty of an offence under this section is liable on summary conviction to a fine not exceeding level 3 on the standard scale and, for continued contravention, a daily default fine not exceeding one-tenth of level 3 on the standard scale.  (4) For the purposes of this section, a liquidator of the company is treated as an officer of it. S. 34 – Notice to registrar where company’s constitution altered by enactment  (1) This section applies where a company's constitution is altered by an enactment, other than an enactment amending the general law.  (2) The company must give notice of the alteration to the registrar, specifying the enactment, not later than 15 days after the enactment comes into force. o In the case of a special enactment the notice must be accompanied by a copy of the enactment.  (3) If the enactment amends— o (a) The company's articles, or o (b) A resolution or agreement to which Chapter 3 applies (resolutions and agreements affecting a company's constitution),  The notice must be accompanied by a copy of the company's articles, or the resolution or agreement in question, as amended.  (4) A “special enactment” means an enactment that is not a public general enactment, and includes— o (a) An Act for confirming a provisional order, o (b) Any provision of a public general Act in relation to the ing of which any of the standing orders of the House of Lords or the House of Commons relating to Private Business applied, or o (c) Any enactment to the extent that it is incorporated in or applied for the purposes of a special enactment.  (5) If a company fails to comply with this section an offence is committed by— o (a) The company, and o (b) Every officer of the company who is in default.  (6) A person guilty of an offence under this section is liable on summary conviction to a fine not exceeding level 3 on the standard scale and, for continued contravention, a daily default fine not exceeding one-tenth of level 3 on the standard scale S. 35 – Notice to registrar where company’s constitution altered by order  (1) Where a company's constitution is altered by an order of a court or other authority, the company must give notice to the registrar of the alteration not later than 15 days after the alteration takes effect.  (2) The notice must be accompanied by— o (a) A copy of the order, and o (b) If the order amends—  (i) The company's articles, or  (ii) A resolution or agreement to which Chapter 3 applies (resolutions and agreements affecting the company's constitution), o A copy of the company's articles, or the resolution or agreement in question, as amended.  (3) If a company fails to comply with this section an offence is committed by— o (a) The company, and o (b) Every officer of the company who is in default. 54

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(4) A person guilty of an offence under this section is liable on summary conviction to a fine not exceeding level 3 on the standard scale and, for continued contravention, a daily default fine not exceeding one-tenth of level 3 on the standard scale. (5) This section does not apply where provision is made by another enactment for the delivery to the registrar of a copy of the order in question.

S 21(1) provides that, subject to any provision for entrenchment, articles can be amended by the by a 75% majority vote.

(2) Potential Limitations on alteration (i) Entrenchment provisions 

Companies Act 2006 s. 22-24

S. 22 – Entrenched provisions of the articles  Just came about in the 2006 Act  Provisions may be amended and repealed only if conditions are met and procedures are compiled with that are more restrictive than applicable procedures for special resolutions o Allowing companies to have constitutions that are difficult to change  Important to note that subsection (2) and (3) o (2) – Provisions for entrenchment may only be made to the companies article on formation … o (3) Agreement of all of the company or by orders of the court o New provision which didn’t exist before  

Told by the Act that the company can alter its provisions unless there are entrenchment provisions Prior to the 2006 Companies Act, it was possible to make the alteration of the articles and constitution of the company very difficult o The best example is contained in weighted voting provisions or weighted voting rights o Case that established that weighing voting rights were permissible was Bushell v Faith (1970)

S.23 – Notice to registrar of existence of restriction on amendment of articles  (1) Where a company's articles— o (a) On formation contain provision for entrenchment, o (b) Are amended so as to include such provision, or o (c) Are altered by order of a court or other authority so as to restrict or exclude the power of the company to amend its articles,  The company must give notice of that fact to the registrar.  (2) Where a company's articles— o (a) Are amended so as to remove provision for entrenchment, or o (b) Are altered by order of a court or other authority—  (i) So as to remove such provision, or  (ii) So as to remove any other restriction on, or any exclusion of, the power of the company to amend its articles, o The company must give notice of that fact to the registrar. S. 24 – Statement of compliance where amendment of articles restricted  (1) This section applies where a company's articles are subject— 55

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o (a) To provision for entrenchment, or o (b) To an order of a court or other authority restricting or excluding the company's power to amend the articles. (2) If the company— o (a) Amends its articles, and o (b) Is required to send to the registrar a document making or evidencing the amendment, The company must deliver with that document a statement of compliance. (3) The statement of compliance required is a statement certifying that the amendment has been made in accordance with the company's articles and, where relevant, any applicable order of a court or other authority. (4) The registrar may rely on the statement of compliance as sufficient evidence of the matters stated in it.

(ii) Voting Power / Agreements: Bushell v Faith (1970)  Facts: Small Company. Shareholders were family , brothers and sisters. Each held 100 shares in the company, but after a series of disagreement between them, an extraordinary meeting was called and one of the proposed resolutions was to remove the brother from his directorship of the company. The meeting was held and after the meeting, the sisters claimed that the brother had been validly removed by a meeting which had 200 votes for dismissal versus 100 votes against this proposal  majority should prevail o Brother disagreed on the basis that the articles included “in the event of a resolution being proposed at a general meeting of the company for the removal of the director, any shares held by that director shall on a poll, carry the right of 3 votes per share” o The brother was claiming that he had won the vote bc he had 300 votes to the sisters’ 200  Decision: First instance judge said he was validly removed. Both the CoA and the HoL disagreed with the first instance judge – they overruled the trial judge and upheld the validity of art. 9 of the companies constitution gave way to a weighted voting clause, Clause in question was solely concerned with the allocations of the company voting rights and therefore it would be wrong for the courts to interfere with that matter  Legal Principle: So a weighted voting clause (if one is included in a company’s constitution) may have the effect of restricting a company in respect of restricting a type of provision o Weighted votes acted as a denial of their s21 rights Cane v Jones (1980)  Facts: Two brothers, P and H, formed a company, of which they were the “life directors”; they were the only directors. All of the shares were owned by close family or on trust for such . The articles provided that the chairman of directors had a casting vote at directors’ and general meetings of the company. o In 1967, all of the then shareholders agreed that the chairman would not use his casting vote and that, where the director-brothers could not agree, an independent chairmen (with a casting vote) would be appointed. o The two sides of the family fell out and P’s side claimed that P, as chairman, had a casting vote. o H’s daughter, the claimant, who was not a party to the 1967 agreement (although trustees acting for her were), sought to rely on that agreement and petitioned for a declaration that P’s casting vote had disappeared and abrogated. o Michael Wheeler QC determined that P’s casting vote had disappeared and held that the 1967 agreement was in essence, a general meeting, which was effective to override the articles.  Decision: Judge seemed to say that, where all the alteration of the articles, despite the failure to comply with s.9 (meeting and special resolution required), because s.9 was merely a way, but not the only way, of altering the articles 56

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Legal Principle: Unanimous consent of the o The directors should elect Chairman and he should have a casting vote at board and general meetings. Shareholders were divided into two factions. Agreement that the chairman was no longer to have a casting vote was entered into between the two factions. The procedure laid down by Section 9 was not followed. Agreement was a valid way of altering the articles o S.9 is not the only method of servicing the company’s articles, all it does is replace unanimity as the requirement with a special majority requirement

Many cases about the constitution deal with rights of pre-emption –usually standard in private companies but not written into public companies. Pre-emption provisions are in the articles of the company that allow the directors to ensure that hip is consistent with the ethos of the company Requires that anyone who wants to sell their shares must offer to pre-existing shareholders, BoD etc… (iii) Private companies only  

Unless clause is entrenched, there can just be a resolution called to remove a provision In relation to private companies only, you can now have a special procedure which is governed by section 288 of Companies Act 2006 o Written resolutions of private company  A written resolution means a resolution of a private company proposed in accordance with the Act o In section 288, private companies are told that there are certain things they cannot do through written resolution  They cannot remove a director from office by written resolution  Similarly with auditor  In effect, the company secretary send out written letters to the with the proposed resolution to the with a proposed time for them to return the form

Written Resolution – S. 288-300  A detailed new procedure is set out in the Act for the use of written resolutions [s 288 – 300]. One key change is the removal of the need for written resolutions to be ed unanimously. Ordinary resolutions still require a 50% majority [s 282] and special resolutions still require a 75% majority [s 283], but all resolutions of a private company may be ed in general meeting or by written resolution [s 281]. A written resolution will include a resolution circulated in electronic form and companies cannot exclude the use of written resolutions in their articles [s 300]. 

Any written resolution may be proposed by the directors or [s 288] and must be sent to all eligible in hard copy or electronic form or by website [s 291 or 293]. Where the resolution is to be ed as a special

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Resolution, this must be stated in the text and then can only be ed as a special resolution [s 283]. The may require that a 1000 word statement on the subject of the resolution accompany the resolution [s 292] and there must be included a statement of the procedure for agreeing and a date by which the resolution must be ed. A resolution will lapse if not ed by that date; if no date is specified this period is 28 days from the circulation date [s 297]. Agreement may be sent in hard copy or electronic form using the form of authentication specified by the company. Once sent the agreement cannot be revoked and the resolution is ed when the required majority of eligible have signified their agreement [s 296].

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(iv) Court imposed restrictions under statutory powers S. 35 – Notice to registrar where company’s constitution altered by order  (1) Where a company's constitution is altered by an order of a court or other authority, the company must give notice to the registrar of the alteration not later than 15 days after the alteration takes effect.  (2) The notice must be accompanied by— o (a) A copy of the order, and o (b) If the order amends—  (i) The company's articles, or  (ii) A resolution or agreement to which Chapter 3 applies (resolutions and agreements affecting the company's constitution), o A copy of the company's articles, or the resolution or agreement in question, as amended.  (3) If a company fails to comply with this section an offence is committed by— o (a) The company, and o (b) Every officer of the company who is in default.  (4) A person guilty of an offence under this section is liable on summary conviction to a fine not exceeding level 3 on the standard scale and, for continued contravention, a daily default fine not exceeding one-tenth of level 3 on the standard scale.  (5) This section does not apply where provision is made by another enactment for the delivery to the registrar of a copy of the order in question. (v) Companies Act 2006, s.25 

Section 25 of the Companies Act is one to be aware of o It does constitute a restriction on the alteration of the articles o Prevents companies from altering their articles S. 25 – Effect of alteration of articles on company’s  (1) A member of a company is not bound by an alteration to its articles after the date on which he became a member, if and so far as the alteration— o (a) Requires him to take or subscribe for more shares than the number held by him at the date on which the alteration is made, or o (b) In any way increases his liability as at that date to contribute to the company's share capital or otherwise to pay money to the company.  (2) Subsection (1) does not apply in a case where the member agrees in writing, either before or after the alteration is made, to be bound by the alteration. o Without this consent, the company can’t force an existing member to contribute more capital to the company or take out more shares. It’s not uncommon to have new issues of shares (vi) The Common Law (“bona fide in best interests of the company as a whole”) Test  The intervention of the common law in the alteration process o The common law (judges) back at the turn of the 20th century realized that Lord Atkin’s famous statement could be useful in company law  Famous statement “Power corrupts and absolute power corrupts absolutely”  Judges realized that there was nothing that provided any protection for minorities  So judges decided to protect the minority by imposing additional requirements  This alteration must also be bona fide in the best interest of the company as a whole o Their way of providing protection for the company

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All of the cases on the reading list from Allen v Gold Reefs to Dafen Timple Co v Llanley 58

**Allen v Gold Reefs of West Africa Ltd (1901)*  Facts: The Company’s articles granted it a lien over partly paid shares. The articles were amended to extend the lien to cover fully paid up shares  Legal Principle: An alteration to the articles will only be valid if it is bona fide for the benefit of the company as a whole **Shuttleworth v Cox Bros Ltd (1927)  Facts: The company wished to alter its articles in order to remove a director who had engaged in financial irregularities  Decision: The Court held that the alteration was valid, as the other directors did believe that it was for the company’s benefit.  Legal Principle: The test imposed in Allen was primarily subjective, although an alteration would not be valid if no reasonable man could consider it to be for the benefit of the company Clemens v Clemens Bros  Facts: Small prosperous family company in which the claimant held 45% of the shares and her auntie held 55% of the shares. The auntie was 1 of 5 directors at Clemens Brothers Limited. Under the aunt’s influence, the directors proposed to issue more shares – increasing the capital of the company. But, they wanted to issue them in a way that they reduced the nieces holding from 45% to 25%. o This was so that the niece could no longer block a special resolution – with 45% she could block a special resolution proposition o Her negative control is taken away from her o So the niece sought a declaration against the company and her aunt saying the proposed resolution should be set aside because he showed a fraud on the minority – namely herself o Company argued that if there was a difference in provision the majority should prevail  Decision: Foster LJ said that the aunt could not exercise her majority vote in whatever way she pleased. He said the right of a shareholders to exercise voting rights is subject to equitable circumstances o “Whether I say that these proposals are oppressive to the P or no one could honestly believe that they are for her benefit or for the fraud of the minority, matters not”  Basically saying it doesn’t matter what you call the conduct, it all means the same thing. If the conduct falls under any of those headings, the court can prevent the resolution from taking place  Legal Principle: Not favorable viewed by many people because they said the aunts not doing anything illegal so what’s all the fuss about Greenhalgh v Arderne Cinemas (1952)  Facts: The company’s managing director and majority shareholder sought to alter the articles to remove the ’ pre-emption rights, and allow them to sell shares to an outsider, without first offering them to existing  Decision: The alteration was deemed valid o There was clear discrimination on Mr. Greenhalgh – the provisions were bona fide in the best interest of the company  Legal Principle: The phase “the company as a whole” refers to the shareholders as a body. The court should ask whether or not the alteration was for the benefit of a hypothetical member Brown v British Abrasive Wheel Co (1919)  Facts: British Abrasive Wheel Co needed to raise further capital. The 98% majority were willing to provide this capital if they could buy up the 2% minority. Having failed to effect this buying agreement, the 98% purposed to change the articles of association to give them the power to purchase the shares of 59

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the minority. The proposed article provided for the compulsory purchase of the minority’s shares on certain . o However, the majority were prepared to insert a provision regarding price which stated that the minority would get a price which the court thought was fair Decision: Astbury J held that the alteration was not for the benefit of the company as a whole and could not be made o One reason for this was that there was no direct link between the provision of the extra capital and the alteration of the articles Legal Principle: Concerns the validity of an alteration to a company’s constitution, which adversely affect the interests of one of the shareholders

Sidebottom v Kershaw (1920)  Facts: Proposed alteration to the articles in the companies constitution that would allow the company (the directors) to confiscate the shares if he was involved in a business that was competing with the business of another company o There should not be any power to take someone’s shares away from them o But you can impose special requirements on someone who wants to sell their shares and get out  Decision: Court didn’t feel that this was bona fide in the best interest of the company Dafen Timplate Co v Llanelly Iron & Steel Ltd (1920)  Facts: Find a similar proposed alteration as above – giving the directors power to confiscate a shares o The difference perhaps shows the weariness which your lordship uses  Shows in an extreme situation that it was mindful of the protection of the minority interest and of the protection of any interest o There is some difficulty in relation to the best interest of the company test  What does “bona fide in the best interest of the company” mean? Is it the company today? Is it the of the company? Should it take into only short interests  that the company has perpetual succession  Best interest of the company is the best interest of the current or future shareholders (vii) Class Rights  Class rights o Private companies can at list issue different voting right from other classes of shares in the company o The provisions which deal with class rights are set out in the Companies Act s. 629 onwards (to 640)  S. 629 tells us that for the purposes of the companies act tells us that shares of one class are in all respects uniform (the same)  Shares in the company all have the same rights attached to them – making only on class of shares  Where you have a number of classes, look at the provisions of 630 onwards o Don’t need to know the provisions in detail  60(2) – right me only be carried in the provisions of the companies rights o Subsection 5  Statutory protection provision together with the standard procedure to be followed o Even if that procedure is followed – the owner must follow too o Statutory minority protection provision  Leaves it up to the court to decide whether or not to approve the variation  S. 629 – 640 60

o S. 629-640 of the CA 2006 restates and amends the provisions of the CA 1985 on variation of class rights. They are simplified and include some changes of substance:  (a) Class rights will no longer be set out in the memorandum and there are only ordinary or special resolutions. Extraordinary resolutions no longer exists  (b) The method required for variation is no longer dependent on the rights to be varied. In all cases, rights may be varied in accordance with the company’s articles or where the articles make no provision for variation of class rights, by special resolution or written consent of the holders of at least three-quarters in nominal value of the issued shares of the class (s. 630). Thus, if the articles require a simple majority, this will suffice. In addition, as s. 630(3) provides that the provisions are without prejudice to other restrictions on variation, if the articles require a higher percentage, this must be fulfilled or if the class rights are entrenched in the articles, that protection must be respected.  (c) Section 631 makes provision for variation of class rights in companies without share capital o Section 633 replaces the right to object to court previously in CA 1985, s.127 and s.634 gives a similar right in respect of variation of class rights in companies without share capital. Cumbrian Newspapers Group Ltd v Cumbria & Westmoreland Herald etc (1986)*  Facts: CNG published the Penrith Observer with a 5500 weekly circulation. The chairman Sir John Burgess also had 10.67% of the share in CWHNP since 1968. Under the constitution CNG had negotiated special rights which it had bargained for in return for closing down a competing paper, the Cumberland Herald, when it had ed, and for acting as CWHNP’s advertising agent. It had the right to preferences on unissued shares (art 5) to not be subject to have a transfer of shares to it refused by the directors (art 7) pre-emption rights (art 9) and the right to appoint a director if shareholding remained above 10% (art 12). The CWHNP directors wanted to cancel CNG’s special rights. CNG argued that they were class rights that could only be varied with its consent.  Decision: Scott J held the CNG’s rights as a shareholder could not be varied without its consent because they were class rights when they were conferred “special rights on one or more of its in the capacity of member or shareholder”  Legal Principle: Case concerning variation of the class rights attached to shares. o Scott J set out three main categories of “special rights” that might exist:  (1) Rights annexed o shares  (2) Rights for particular people under the constitution  (3) Rights unattached to particular shares but conferring a benefit on a group of White v Bristol Aeroplane Co Ltd (1953)  Facts: company's articles of association provided that the Rs attached to any class of shares may be 'affected, modified, varied, dealt with, or abrogated in any manner' with the approval of an extraordinary resolution ed at a separate meeting of the of that class. The preference shareholders argued that an issue of additional shares, both preference and ordinary, 'affected' their voting Rs and therefore fell within article 68. However, the company contended that the proposal did not amount to a variation of class Rs but rather it was the effectiveness of the exercise of those Rs that had been affected and therefore a separate meeting of the preference shareholders was not required.  Decision: CA rejected the preference shareholders’ contention. Romer LJ explained that the proposal would not affect the Rs of the shareholders: “the only result would be that the class of persons entitled to exercise those Rs would be enlarged…” John Smith’s Tadcaster Brewery Ltd (1953)  Facts: Both this case and White v Bristol Aeorplane Co Lts (1953) were cases concerning new share issues that diluted the voting power of the complaining preference shareholders and did but not change the voting rights attached to the preference shares. In both cases, the courts drew a distinction between a 61

variation of rights and a variation in the enjoyment of those rights, and held that the share issues fell into the latter category. Greenhalgh v Arderne Cinemas (1952)  Facts: The company’s managing director and majority shareholder sought to alter the articles to remove the ’ pre-emption rights, and allow them to sell shares to an outsider, without first offering them to existing  Decision: The alteration was deemed valid o There was clear discrimination on Mr. Greenhall – the provisions were bona fide in the best interest of the company  Legal Principle: The phase “the company as a whole” refers to the shareholders as a body. The court should ask whether or not the alteration was for the benefit of a hypothetical member Re House of Fraser (1987)*  Facts: A company ed in Scotland ed a special resolution at an EGM, attended by ordinary shareholders only, reducing its capital by paying off the whole preference share capital of the company. Its petition to the Court of Session for confirmation of reduction of the capital was opposed by the holders of certain preference shares on the ground, inter alia, that the failure of the company to hold a class meeting of preference shareholders was in breach of the requirement to that effect in art 12 of the company's articles of association wherever the special Rs attached to a class of shares where 'modified, commuted, affected or dealt with'. The Court of Session confirmed the reduction in capital. The preference shareholders appealed. Re Holders Investment Trust Ltd (1971)*  Legal Principle: At a class meeting, the majority must vote for the benefit of the class as whole

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1 December 2014 Lecture # 8 - CORPORATE CONSTITUTION #3: AGREEMENTS OUTSIDE ARTICLES Summary of Last Week: *Bushell v Faith *Entrenchment: makes alteration to Constitution more difficult, eg, by requiring special resolution (75%) or higher number of votes. *Courts intervene by adding additional requirement that amendment be in the bona fide interests of the company. This was brought into effect (initially) by the court as a form of minority protection. Eg: Shuttleswoth v Cox; Clemens v Clemens

AGREEMENTS OUTSIDE ARTICLES: 1. Shareholder Agreements: Nowhere in the Act does it specify that there must be ‘shareholder agreements’ – just a constitution (articles of association). In other jurisdictions, such as Canada, there is a statutory footing. This is important to minority shareholders as well as directors, as it provides for a shifting of responsibilities of the director to the shareholders. These unanimous shareholder agreements shift responsibility (of liability) as management of the company is delegated to shareholders – these are not required by statute, they are optional. Weighted votes are a similar mechanism (as shareholder agreements) as the latter can block the statutory right to alter its Constitution, eg, Bushell v Faith. Shareholder Agreements: A private contract between some or all of the shareholders of a company. Sometimes it includes the company as a party, itself. What this agreement is designed to do, is typically to govern the relationship between parties concerned, and in particular may set out how the company is to be managed and controlled. Essentially, it can be a very significant minority protection device; but, it’s not just for that. Sometimes minority shareholders may want an agreement because they don’t want to be involved in the management of the company, but may be able to appoint to the board instead. Why would you enter?: Certainty: disputes between parties are less likely to arise in circumstances where the conduct of and relationship between the parties is clearly regulated by parties; Shareholder agreements are confidential: unlike Articles of Association which are public so anyone can see what the rules governing the relationship between shareholder and the company is, shareholder agreements are PRIVATE; Flexibility: agreements can be easily adapted to changing needs of the parties. Constitutional documentation can only be varied by special resolution by its which are later ed at the Companies House.

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Enhance Rights: the constitution provides BASIC RIGHTS for shareholders; an agreement can bolster those rights or confer additional protections and entitlements. This is of course where the minority may benefit (and sometimes the majority, as well); Protective Provisions: can be contained in agreements and in the Constitution, eg: Confidentiality agreements (which bind the company and shareholders); Restrictive Covenants: so if people leave they won’t start up a competing company for a certain period of time or within a certain jurisdiction; Non-solicitation clause so that former /directors are unable to solicit employees; Pre-Emption Provisions for selling shares to existing . These are prohibitions or restrictions on transfer of shares, eg: First-buy provisions; Right of first refusal; Right of first offer; Shotgun Provisions: right to set price or (or both) for selling shares. The invoking party will have incentive to be fair when setting price as once they’ve invoked ‘shotgun provision’ they can now be sold shares by other at same price; Drag along or tag-along provision: whereby majority shareholders have to make sure that the potential buyer (of shares) buys the minority shares at same price. Mechanisms for valuation; Agreed exit roots and time scales (for key personnel); Dividend proportions; Levels of funding; Voting restrictions (at meetings) [one of the most common agreements]

Not an exhaustive list of benefits of shareholder agreements. [Ryan suggests that we do further reading on benefits of shareholder agreements]. Shareholders agreements won’t be found within big public listed companies. However, they can be seen between two large companies, entered into for t ventures, when two companies engage in enormous contracts (eg building bridges between islands). The companies enter into a shareholder agreement to create a new company called ‘NewCo’, where the shares are held and the work carried out. *Russell v Northern Bank Ltd [1992]: company enters into shareholder agreement with its four shareholders. It stipulated that no further increase of share capital (or alteration of rights) was allowed without written agreement of the parties. Provision also said agreement should also take precedence over Constitution. A Company is entitled to raise capital if it follows the appropriate procedures, eg, ordinary resolution. Mr. Russell, one of the shareholders, sought injunction restraining other shareholders from considering resolution proposed by company to raise capital. The HoL said the agreement was invalid 64

because it unlawfully fettered on companies right to raise capital. However, the HoL went on to say that it was invalid insofar as company was concerned. So they took out ‘blue pencil’ and took out the company as a party to the agreement. However, independent of that, having severed references to the company, the agreement between the shareholders was binding (and so shareholders could not break contract, and Russell’s injunction upheld). What this case shows is that you must be careful if drafting a shareholder agreement using the Company as a party! Second, the signatories are bound contractually and can be prevented of breaching the contract by injunction, and one can be compensated via damages. A shareholders’ agreement not to increase the share capital of a company was enforceable against the shareholders but not against the company. It could take effect only as a personal contract. Liability to the conflicts rule for nominee directors representing outside interests can be limited by a company’s constitution or the unanimous approval of its shareholders. An agreement by a company to fetter its statutory powers is unenforceable. **Welton v Saffery [1897]: Lord Davey said: ‘Of course, individual shareholders may deal with their own interests by contract in such way as they may think fit. But such contracts, whether made by all or some only of the shareholders, would create personal obligations, or an exceptio personalis against themselves only, and would not become a regulation of the company, or be binding on the transferees of the parties to it, or upon new or non-assenting shareholders.’ *Shareholder agreements only bind the signatories to the contract! Unless you sign the contract, you are not bound by it. There are also ‘Deeds of adherence’: short document for use where an individual becomes a shareholder in a company. The deed is required to become a party to a shareholders' agreement, entered into before he can obtain his shares. *The case also made clear that “any provision in the Articles that is inconsistent with the general law is void.” (77) Re Peveril Gold Mines Ltd [1898] 1 Ch 122 [Articles cannot remove ’ statutory rights]: is a UK insolvency law case concerning liquidation when a company is unable to repay its debts. It held that a member cannot be prevented by a company constitution from bringing a winding up petition. It is, however, possible for a member to make a shareholder agreement and thus contract out of the right to bring a winding up petition outside of the company. Facts: The articles of association of Peveril Gold Mines Ltd said no member should petition for winding up unless two directors had consented or the general meeting had resolved or a petitioner held at least 20% of issued capital. A member asked for winding up without satisfying any of these conditions. Held: A provision in the articles of a company cannot limit a right given to the by statute, that is the of a company cannot agree with the company to contract out of the statute.

2. Directors’ Service Contract: Directors can be compensated by cash or other financial incentives (bonuses or shares) – but not entitled, as a right, to any remuneration unless they hold a service contract under which a level of remuneration is specified. With a service contract the and conditions of that contract are determined in accordance with the Articles, eg, typically by the Board of Directors. This is a dilemma insofar as the Board is setting 65

their own levels of remuneration. That said, the Director is precluded (from the quorum and voting on) their own remuneration discussions. of the remuneration package must be made available at the general meeting (for review by shareholders). Since December 2002 listed companies must publish directors’ remuneration report, and file this with the Companies House – so this information is public. CA 2006 ss227-230 Re New British Iron CO, ex parte Beckwith [1898] 1 ch 442: B was a director and a shareholder. The company failed to pay its directors, who sued for their salary (since they had contractual rights to it). However, they did not sue for a breach of the Articles, since there was no direct contract there. Their employment contract did not give an indication of how much they should be paid; the Articles gave a figure of £1000 per annum. The courts implied this sum into their employment contract. *Remuneration is payable by virtue of the of the director’s appointment which come into operation on acceptance of that appointment, the being the relevant provisions from the articles. Hence, director remuneration which are incorporated into the company’s articles are in fact a separate contract between the company and the director, which comes into effect on appointment. (84) Directors Remuneration: Re Halt Garages [1982] 3 All ER 1016 [The Benefit Rule]: Case concerning reduction of capital and executive pay. It held that money can be ordered to be returned if a sum paid to a director is in substance a reduction of capital, because the amounts cannot seriously be regarded as remuneration. (The proper procedure for reduction of capital is now found in CA 2006 sections 641-653.) Facts: The dispute was regarding Director compensation paid to the Wife who was ill and did no work but was still compensated.

3. Effect of an alteration on outsiders: Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 is an important English contract law and company law case. In the field of contracts it is well known for MacKinnon LJ's decision in the Court of Appeal, where he put forth the "officious bystander" formulation for determining what should be implied into agreements by the courts. In the field of company law, it is known primarily to stand for the principle that damages may be sought for breach of contract by a director even though a contract may de facto constrain the exercise of powers to sack people found in the company's constitution. Facts: Mr Shirlaw had been the managing director of Southern Foundries Ltd, which was in the business of iron castings. But then another company called ‘Federated Foundries Ltd’ took over the business. The new owners had altered article 8 of Southern Foundries Ltd's constitution, empowering two directors and the secretary (who were friends of Federated Foundries) to remove any director. Then they acted on it, by sacking Mr Shirlaw. Mr Shirlaw's contract, signed in 1933 stated that he was to remain in post for ten years. Mr Shirlaw sued the company for breach of contract, claiming for an injunction to stay in office or substantial damages. Re Horsley Weight Ltd [1982]: The may ratify a contract which an individual director has entered into when it should have been decided on by the entire board. 66

4. Removal of Directors: s.168-169 CA 2006 168 Resolution to remove director (1)A company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him. (2)Special notice is required of a resolution to remove a director under this section or to appoint somebody instead of a director so removed at the meeting at which he is removed. (3)A vacancy created by the removal of a director under this section, if not filled at the meeting at which he is removed, may be filled as a casual vacancy. … 169 Director's right to protest against removal (1)On receipt of notice of an intended resolution to remove a director under section 168, the company must forthwith send a copy of the notice to the director concerned. (2)The director (whether or not a member of the company) is entitled to be heard on the resolution at the meeting.

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1 December 2014 Derivative Actions /Claims Lecture #9

Consider the ‘internal management rule’ that the company is the proper claimant in a matter concerning its internal management. “It is difficult to explain why, despite the internal management principle, a member of a company can succeed in a case like Salmon v Quin and Axtens…we will suggest that the common feature of the cases in which are allowed to bring legal proceedings in respect of their companies’ internal affairs, as an exception to the internal management principle, is that they are proceedings about decisions taken unlawfully. (87)

a) Common law position **Foss v Harbottle: reiteration of Salomon principle (which was decided after Harbottle) whereby any wrong suffered by the company must be brought by the company, not the individual . So in a legal claim the named claimant will be the company – therefore it is the company suing and the company who will receive compensation. NEED TO KNOW FOSS AND THE EXCEPTIONS TO IT. NEED TO KNOW THE RATIONALE AND FOUR EXCEPTIONS: BUT ONLY ONE ‘TRUE EXCEPTION’ AS THE OTHER ‘EXCEPTIONS’ WERE REALLY PERSONAL ACTIONS. The real true exception is ‘Fraud on the Minority’! Fraud on the Minority: refers to an improper exercise of voting power by the majority of of a company. It is the evidence of failure to cast votes for the benefit of the company as a whole. A majority in control of a company perpetrates a fraud on the minority. A resolution ed upon such voting is voidable. For example, a resolution for alteration of the articles of association to allow the compulsory purchase of ' shares. Fraud on the minority permits a derivative suit when the plaintiff sufficiently pleads that a majority who are in control of a company perpetrated a fraud on the minority of the company. [Tomran, Inc. v. ano, 159 Md. App. 706, 714 (Md. Ct. Spec. App. 2004)] Fraud in the context of derivative action means abuse of power whereby the directors or majority, who are in control of the company, secure a benefit at the expense of the company

Clemens v Clemens Brother [1976] [The Benefit Rule & Fraud on the Minority]: Generally, majority rule exists in decisions, but courts have the power to restrict any shareholder’s right to vote if these shareholders are not acting “in good faith” [or in the best interests (or to the benefit) of the company as a whole!]. Facts: One shareholder had 55% of the shares [the Aunt], and used the voting rights these held to a resolution issuing new shares. The effect of this new issue was not proportional on existing shareholding, and pushed the minority shareholding from 45% [the niece] down to below 25%. This therefore allowed the 68

majority shareholder to special resolutions. The court held that this issue of new shares was not needed and reversed the resolution. b) Distinction between personal and derivative actions (the reflective loss principle): What happens if the Directors are the ones responsible for damages? Why would they bring a suit in the company’s name against themselves? There must be an exception! Hence the derivative action at common law whereby shareholders can bring derivative actions on behalf of the company (so it can have redress against those wrongdoers who fail to bring an action). It is a personal action if the sue the company for breach of Articles (or service contract, et cetera). Of course, any compensation is recoverable to the member, rather than the company as in the derivative claim. Reflective loss is a concept used in company law for losses of individual shareholders that are inseparable from general losses of the company. The rule against recovery of reflective loss states that there should be no double recovery, so a shareholder can only bring a derivative action for losses of the company, and may not allege she has suffered a loss in her personal capacity for a personal right. These claims usually arise where consider Directors actions to be wrong when their share valuation drops…

Johnson v Gore Wood & Co [2000] UKHL 65 is a leading UK company law decision of the House of Lords concerning (1) abuse of process relating to litigating issues which have already been determined in prior litigation or by way of settlement, (2) estoppel by convention, and (3) reflective loss of a shareholder with respect to damage which was done to the company in which he holds shares. Held: In relation to the issue of reflective loss, Lord Bingham summarised the existing case law in three key propositions: 1. Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder's shareholding where that merely reflects the loss suffered by the company. 2. Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it. 3. Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other. Applying these tests, the House of Lords held that one of Mr Johnson's claimed heads of loss should be struck-out (diminution in the value of his shareholding in WWH, and amounts which WWH would otherwise have paid into his pension), and the remaining claims were allowed to proceed (these included the cost of personal borrowing by Mr Johnson to fund his outgoings and those of his business, the value of shares lost when the bank foreclosed upon security which he provided, and additional tax liability). The court held that the claims for cost of borrowing would need to be scrutinised carefully at trial to ensure that they were not merely claims for lost dividends (which were not allowable) in disguise. The court also 69

allowed a claim for losses on other investments which Mr Johnson made based upon advice from Gore Wood. The court also struck out claims for mental distress and aggravated damages on other grounds.

8 December 2014 Derivative Actions/Claims – Con’t REVIEW: *Any remedy obtained in a derivative action is returned to the Company (who is the ‘proper plaintiff’), whereas in a personal claim (fraud on the minority), the remedy is returned to the ‘shareholder’ member(s). *CA 2006 ss.260-264 – Derivative Action details the procedure (which requires permission from a judge to proceed) for a derivative action/claim. We need to know this! *At common law there are four exceptions to Foss v Harbottle (which was before Soloman v Soloman and confirmed the separate entity principle), but the ‘fraud on the minority’ is the only true exception. Fraud used in this respect includes both criminal, eg, Clemens v Clemens, and inequitable actions (equity in action), eg, Pavladays v Jetson (where the Directors undervalued the sale of company assets) – which makes the concept somewhat controversial. Now, under the 2006 Act, negligence also falls under ‘fraud on the minority’ – where Directors favour their friends or family. *Business Judgement Rule: courts are unwilling to impose remedies for negligence claims as directors have been selected by the shareholders and the most appropriate remedy for a breach is removal of that director. Moreover, courts are not a suitable body to review actions of directors who are supposedly business experts.

c. Multiple Derivate Claims/Actions Re Fort Gilkicker Ltd [2013] EWHC: multiple actions had not been abolished by 2006 Act therefore procedural devices created at common law still existed: In a recent decision the High Court has held that the old common law still permits a member of a parent entity of a wronged subsidiary company to bring a derivative action on the subsidiary company’s behalf – a so-called “multiple derivative action” – where the wrongdoer is also in control of the parent entity

d. Statutory Derivate Claim CA 2006 ss.260-264 (which replaces common law derivative action) Notes: CA 2006 Including negligence in the Act has not resulted in a flood of litigation and, according to Ryan, likely will not – he says it’s nonsense to conclude otherwise. s.260(3) allows a shareholder to make a claim against a director or another party in the company responsible for the wrongdoing. Permission to leave from the courts is required under s.261 which details the procedure. 70

Permission must be rejected if a person acting in accordance with s.172 would not seek to continue the claim (we will return to this section next term – statutory duty of directors). DERIVATIVE CLAIMS IN ENGLAND AND W ALES OR NORTHERN IRELAND 260 Derivative claims (1)This Chapter applies to proceedings in England and Wales or Northern Ireland by a member of a company— (a)in respect of a cause of action vested in the company, and (b)seeking relief on behalf of the company. This is referred to in this Chapter as a “derivative claim”. (2)A derivative claim may only be brought— (a)under this Chapter, or (b)in pursuance of an order of the court in proceedings under section 994 (proceedings for protection of against unfair prejudice). (3)A derivative claim under this Chapter may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company. The cause of action may be against the director or another person (or both). (4)It is immaterial whether the cause of action arose before or after the person seeking to bring or continue the derivative claim became a member of the company. (5)For the purposes of this Chapter— (a)“director” includes a former director; (b)a shadow director is treated as a director; and (c)references to a member of a company include a person who is not a member but to whom shares in the company have been transferred or transmitted by operation of law. 261 Application for permission to continue derivative claim (1)A member of a company who brings a derivative claim under this Chapter must apply to the court for permission (in Northern Ireland, leave) to continue it. (2)If it appears to the court that the application and the evidence filed by the applicant in of it do not disclose a prima facie case for giving permission (or leave), the court— (a)must dismiss the application, and (b)may make any consequential order it considers appropriate. (3)If the application is not dismissed under subsection (2), the court— (a)may give directions as to the evidence to be provided by the company, and (b)may adjourn the proceedings to enable the evidence to be obtained. (4)On hearing the application, the court may— (a)give permission (or leave) to continue the claim on such as it thinks fit, (b)refuse permission (or leave) and dismiss the claim, or (c)adjourn the proceedings on the application and give such directions as it thinks fit. 71

262 Application for permission to continue claim as a derivative claim (1)This section applies where— (a)a company has brought a claim, and (b)the cause of action on which the claim is based could be pursued as a derivative claim under this Chapter. (2)A member of the company may apply to the court for permission (in Northern Ireland, leave) to continue the claim as a derivative claim on the ground that— (a)the manner in which the company commenced or continued the claim amounts to an abuse of the process of the court, (b)the company has failed to prosecute the claim diligently, and (c)it is appropriate for the member to continue the claim as a derivative claim. (3)If it appears to the court that the application and the evidence filed by the applicant in of it do not disclose a prima facie case for giving permission (or leave), the court— (a)must dismiss the application, and (b)may make any consequential order it considers appropriate. (4)If the application is not dismissed under subsection (3), the court— (a)may give directions as to the evidence to be provided by the company, and (b)may adjourn the proceedings to enable the evidence to be obtained. (5)On hearing the application, the court may— (a)give permission (or leave) to continue the claim as a derivative claim on such as it thinks fit, (b)refuse permission (or leave) and dismiss the application, or (c)adjourn the proceedings on the application and give such directions as it thinks fit. 263 Whether permission to be given (1)The following provisions have effect where a member of a company applies for permission (in Northern Ireland, leave) under section 261 or 262. (2)Permission (or leave) must be refused if the court is satisfied— (a)that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim, or (b)where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or (c)where the cause of action arises from an act or omission that has already occurred, that the act or omission— (i)was authorised by the company before it occurred, or (ii)has been ratified by the company since it occurred. (3)In considering whether to give permission (or leave) the court must take into , in particular— (a)whether the member is acting in good faith in seeking to continue the claim; 72

(b)the importance that a person acting in accordance with section 172 (duty to promote the success of the company) would attach to continuing it; (c)where the cause of action results from an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be— (i)authorised by the company before it occurs, or (ii)ratified by the company after it occurs; (d)where the cause of action arises from an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company; (e)whether the company has decided not to pursue the claim; (f)whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company. (4)In considering whether to give permission (or leave) the court shall have particular regard to any evidence before it as to the views of of the company who have no personal interest, direct or indirect, in the matter. (5)The Secretary of State may by regulations— (a)amend subsection (2) so as to alter or add to the circumstances in which permission (or leave) is to be refused; (b)amend subsection (3) so as to alter or add to the matters that the court is required to take into in considering whether to give permission (or leave). (6)Before making any such regulations the Secretary of State shall consult such persons as he considers appropriate. (7)Regulations under this section are subject to affirmative resolution procedure. 264 Application for permission to continue derivative claim brought by another member (1)This section applies where a member of a company (“the claimant”)— (a)has brought a derivative claim, (b)has continued as a derivative claim a claim brought by the company, or (c)has continued a derivative claim under this section. (2)Another member of the company (“the applicant”) may apply to the court for permission (in Northern Ireland, leave) to continue the claim on the ground that— (a)the manner in which the proceedings have been commenced or continued by the claimant amounts to an abuse of the process of the court, (b)the claimant has failed to prosecute the claim diligently, and (c)it is appropriate for the applicant to continue the claim as a derivative claim. (3)If it appears to the court that the application and the evidence filed by the applicant in of it do not disclose a prima facie case for giving permission (or leave), the court— (a)must dismiss the application, and (b)may make any consequential order it considers appropriate. (4)If the application is not dismissed under subsection (3), the court— (a)may give directions as to the evidence to be provided by the company, and (b)may adjourn the proceedings to enable the evidence to be obtained. 73

(5)On hearing the application, the court may— (a)give permission (or leave) to continue the claim on such as it thinks fit, (b)refuse permission (or leave) and dismiss the application, or (c)adjourn the proceedings on the application and give such directions as it thinks fit. “Weddenburn’s theory is that the ratifiability principles applies both where the company could be a claimant and where it could be a defendant: a member cannot complain to a court about an act that is ratifiable by a simple majority of , but there is a class of acts which cannot be raitified by a simple majority, and a member can complain to a court about any act of that class. So he says: ‘…there is, after all, one “rule in Foss v Harbottle”; and the limits of that rule lie along the boundaries of majority rule’ (548).

Kleanthous v Paphitis & Ors [2011] EWHC: [Unsuccessful Action under CA 2006] In short, the facts of the case are as follows. Mr Paphitis was a director and shareholder of Ryman Group Limited (Ryman Group). In early 1998 Ryman Group considered the acquisition of lingerie chain, La Senza, but for various reasons it did not proceed with the purchase. Mr Paphitis and a number of his codirectors saw potential in the lingerie business and, with the approval of his fellow Ryman Group directors, acquired shares in La Senza themselves. Ryman Group lent significant sums of money to finance the acquisition of La Senza. This was successful resulting in La Senza declaring dividends in favour of Mr Paphitis of £4 million in 2006. In the same year 90% of the shares in La Senza were sold to a private equity group for an estimated £100 million. Following the sale, a Ryman Group shareholder claimed that Mr Paphitis had committed fraudulent breaches of his fiduciary duties owed as a director by diverting a substantial business opportunity from Ryman Group to develop for his own benefit, using assets of the Ryman Group to do so. The High Court refused to allow the shareholder to bring a derivative claim as the transaction had been approved by the directors of Ryman Group and there was nothing to show that the decision to approve the transaction was done on anything but proper grounds. In this case it was key that Ryman Group had kept detailed records of the decisions it was making. This action was discussed at a number of Ryman Group board meetings, which approved this proposal. These showed the reasons the directors gave for not wanting to acquire La Senza but being prepared to Mr Paphitis` acquisition of it. The minutes also showed that Mr Paphitis had the interests of Ryman Group in mind, had notified Ryman Group of his plans and had essentially obtained its blessing for the acquisition. This proved invaluable to defend the action by the shareholder. *One thing, in the common law that was clear, that the company COULD NOT RATIFY a fraud on the minority. It could ratify excess of power (of the director) but not if that exceeding constituted a fraud on the minority. Section 239 CA 2006 - ratification of acts giving rise to liability – conduct of director including negligence and breach of duty: contains same words as s.260. At common law, if the wrongful conduct constituted a fraud on the minority it could not be ratified. Section 239 ratification must be made by resolution of of the company. Where it is proposed by written resolution, directors cannot vote on that resolution (even if they are a member). If proposed at a meeting, it will be ed if there is a majority vote, disregarding the directors’ votes. That said, they can still attend the quorum and be counted as having attended. This section does not affect the Cane v Jones principle: unanimous consent of company is binding. Still unclear – looks to be saying that any wrongdoing can be ratified – but this cannot be so. For example, ultra vires (and criminal) acts cannot be ratified under section 239. 74

Lecture 10: Unfair Prejudice and Other Minority Remedies *Need to know successful actions made under s.994 – reiterated twice in class!! 1) Unfair Prejudice Action Section 994 CA 2006: section endows any member in a company against prejudicial actions by the company against that member or . Protection of Against Unfair Prejudice 994 Petition by company member (1)A member of a company may apply to the court by petition for an order under this Part on the ground— (a)that the company's affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of generally or of some part of its (including at least himself), or (b)that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial. [F1(1A)For the purposes of subsection (1)(a), a removal of the company's auditor from office— (a)on grounds of divergence of opinions on ing treatments or audit procedures, or (b)on any other improper grounds, shall be treated as being unfairly prejudicial to the interests of some part of the company's .] (2)The provisions of this Part apply to a person who is not a member of a company but to whom shares in the company have been transferred or transmitted by operation of law as they apply to a member of a company.

*This has become the pre-eminent form of claim against the Company as the derivative action is for the company, not the member bringing the claim, and the procedure is too cumbersome. In this claim, the remedy goes to the shareholder member.

If the Courts is satisfied that claim is well-founded, the Court may make any such order as it deems fit to satisfy the claimant: 996 Powers of the court under this Part (1)If the court is satisfied that a petition under this Part is well founded, it may make such order as it thinks fit for giving relief in respect of the matters complained of. (2)Without prejudice to the generality of subsection (1), the court's order may— (a)regulate the conduct of the company's affairs in the future; (b)require the company— 75

(i)to refrain from doing or continuing an act complained of, or (ii)to do an act that the petitioner has complained it has omitted to do; (c)authorise civil proceedings to be brought in the name and on behalf of the company by such person or persons and on such as the court may direct; (d)require the company not to make any, or any specified, alterations in its articles without the leave of the court; (e)provide for the purchase of the shares of any of the company by other or by the company itself and, in the case of a purchase by the company itself, the reduction of the company's capital accordingly.

Examples of unfair prejudice: exclusion from management; mismanagement; breach of a director’s fiduciary duties; paying directors’ remuneration at the expense of shareholder dividends; where a parent company cuts of supply to a subsidiary. *Must show that conduct complained of is both unfair & prejudicial. These words in general are flexible, prejudice must cause harm (to relevant interest) and/or unfairly so. Conduct can be one or the other, but must be both! Harm, as laid down in Saul, means harm in a commercial sense and not a personal one.

Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, [1994] BCC 475: Action for unfair prejudice under s.459 Companies Act 1985 (now s.994 Companies Act 2006). It was decided in the Court of Appeal and deals with the concept of of a business having their "legitimate expectations" disappointed. Vinelott J at first instance had denied the petition, and the Hoffmann LJ, Neill LJ and Waite LJ in the Court of Appeal upheld the judgment. Facts: Saul D Harrison & Sons plc ran a business that was established in 1891 by the petitioner's great grandfather. It made industrial cleaning and wiping cloths, made from waste textiles. It operated from West Ham and after 1989 from Hackney. The petitioner had "class C" shares, which gave her rights to dividends and capital distribution in a liquidation. But she had no entitlement to vote, and the company had been running at a loss. She alleged that the directors (who were her cousins) had unfairly kept running the business just so they could pay themselves cushy salaries. Instead, she said, they should have closed down the business and distributed the assets to the shareholders. Held: On the facts, there was no unfairly prejudicial conduct. The board of directors were bound to manage the company in accordance with their fiduciary obligations, the articles of association and the Companies Act. The unfair prejudice action does protect certain legitimate expectations, akin to those which may affect one's conscience in equity, from being disappointed. But here there was no legitimate expectation for more than the duties discharged, and so no obligations had been breached.

***O’Neill and another v Phillips [1992]: Mr Phillips owned a company called Pectel Ltd. It specialised in stripping asbestos from buildings. Mr O'Neill started to work for the company in 1983. In 1985, Phillips was so impressed with O'Neill's work that he made him a director and gave him 25% of the shares. They had an informal chat in May 1985, and Mr Phillips said that one day, he hoped Mr O'Neill could take over the whole management, and would then be allowed to draw 50% of the company's profits. This happened, Phillips retired and O'Neill took over management. There were further talks about increasing O'Neill's actual shareholding to 50%, but this did not happen. After five years the construction industry went into decline, 76

and so did the company. Phillips came back in and took business control. He demoted O'Neill to be a branch manager of the German operations and withdrew O'Neill's share of the profits. O'Neill was miffed. He started up his own competing company in in 1990 and then he filed a petition for unfairly prejudicial conduct against Phillips, firstly, for the termination of equal profit-sharing and, secondly, for repudiating the alleged agreement for the allotment of more shares. The judge rejected the petition on both grounds. There had been no firm agreement for an increase in shareholding, and it was not unfair for Phillips to keep a majority of company shares. Also, it was held that O'Neill suffered nothing in his capacity as a member of the company. His shares were unaffected. It was merely a dispute about his status as an employee. He had been well rewarded. In the Court of Appeal, Nourse LJ (with whom Potter and Mummery LLJ agreed) O'Neill won his appeal. Nourse LJ said that in fact Phillips had created a legitimate expectation for the shares in future. Moreover a global view of the relationship should be taken, and so O'Neill did suffer as a member. On further appeal to the House of Lords, the Court of Appeal was overturned, and Phillips won. Held: The most important feature of the case was that Mr Phillips had never actually agreed to transfer Mr O'Neill the shares of the company, so it could not be unfair that he had decided not to, because he had never decided to actually do so. Lord Hoffmann also recanted on his previous use of the terminology of "legitimate expectations" [which he used in Saul]. "I meant that it could exist only when equitable principles... would make it unfair for a party to exercise rights under the articles." As to capacity, although irrelevant after deciding that there had been no agreement, disagreeing with the first instance judge, Lord Hoffmann pointed out that O'Neill may have had a claim in his capacity of shareholder (rather than just an employee) because he had invested his money and his time into the company. Notes: HoL held that unfairness had to be established, and it had not been in this situation. There was no evidence of a breach of an agreed term. The majority shareholder never agreed that he would be entitled to 50% shareholding, and it had not been agreed that he would remain a 50% shareholder for an indefinite period – but only while acting as a managing director. Hence, when he was removed from that position, the majority shareholder was entitled to revoke his shares. Moreover, his entitlement to shares was only assured under an employment contract, and not as a member of the company and so the relevant statutory provision was not applicable. The of a company were entitled only to such protection as offered under the Constitution, or between some fundamental understanding between the which formed the basis of their association – in other words, no longer general notions of unfairness; there must be an ‘actual breach’ of the constitution or agreement. What had transpired was simply an ‘oral discussion’ about the sharing of profits and possibility of increase in shareholder profits. Lord Hoffman also makes clear that there is no concept of ‘no fault divorce’, it does not exist! He went on to say is that solicitors in drafting articles or shareholders agreements should include exist provisions in addition to pre-emption clauses. Also, you must sensible have valuation provisions; otherwise courts become flooded with claims as to correct valuation of shares now that company is being forced to buy-out shares. This suggestion has been followed through as the number of unfair prejudice cases have fallen dramatically.

Nicholas v Soundcraft Electronics Ltd [1993]

2) Just and Equitable Winding Up Remedy: IA 1986 s.122(1) & s.125(2) 77

**Ebramhimi v Westbourne Gallaries Ltd [1972]: revolved around the fall out between two business partners based in London. They had decided to incorporate their rug business due to its continued success. Owning 50% shares each Mr Ebrahimi and Mr Nazar were the sole shareholders in the company and took a director's salary rather than dividends for tax reasons. The profits from the business went only to the directors and there were restrictions in place to prevent Mr Enrahimi from selling his shares. In due course Mr. Nazar's son ed the business, appointed to the board of directors and allocated 10% of the company shares. After a falling out between the directors Mr Nazr and his son voted to remove Mr Ebrahimi as a director and excluded him from the management of the business. Mr Ebrahimi decided to petition the court for relief. The judgement: The House of Lords held that parties who are bound by contractual agreements in a company (i.e. shareholders agreements and/or the articles of association) can also rely on a pre-existing situation for equitable purposes. The Lords believed that because the company was so similar in its operation as it was when it was a partnership, they created what is now known as a quasi-partnership. Outcomes of the judgement: Based on the close personal relationship between the parties involved, the Lords decided it would be inequitable to allow Mr Nazar and his son to use their rights to force Mr Ebrahimi out of the company. It was deemed just and equitable to wind the company up and give Mr. Ebrahimi his money. The case identified the factors which the court should consider when determining if there is a quasipartnership. These include: An association formed or continued on the basis of a personal relationship involving mutual confidence An agreement that all or some (there may be sleeping ) of the shareholders will be involved in the conduct of the business Restrictions on the transfer of a member's interest (i.e. on disposal of shares) Companies Act 2006: According to this act when the court is satisfied there has been unfair prejudice towards a shareholder, the court may make such order as it thinks fit for giving relief in respect of the matters complained of.

Yenidje Tabacco Co Ltd [1916]: falling out between brothers who were directors or a successful tobacco company. *Winding up is an important remedy (of last resort) for small and quasi-partnership companies.

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09.Feb.2015 TUTORIAL 4 – Derivative Claims and Other Minority Protection Remedies “The rule in Foss v Harbottle is used to describe the policy of the courts of not hearing a claim concerning the affairs of a company brought by a member or of the company.” (546) When a wrong is suffered by a company the proper claimant to pursue the claim is the company and not the member shareholders who may or may not have also suffered a damage. In a derivative claim the member shareholder pursues a claim ading the company as co-claimant, and the company recovers and compensation, whereas in a section 994 petition or in a personal action, the member shareholder recovers compensation. This is one reason why derivative actions are so rare. Additionally, the costs are borne by the member shareholder advancing the claim, and those in a position of power in the company are unlikely to take legal actions against the wrongdoers as they are the ones who have typically perpetrated the act and are unlikely to want to sue themselves. Jenkings J “referred to the rule in Foss v Harbottle as applying only where a wrong had been done to the company as a separate person and said that is had two elements: 1) the proper claimant principle and the proper claimant aspect of the internal management principles, and (2) a principle that if a wrong is done to a company is ratifiable by a simple majority of then a member cannot sue in respect of it because when it has been ratified it no longer is a wrong and if member decide against ratification there is no valid reason why the company itself should not sue (Ratification Principle).” (546-7) Proper Claimant Principle: If a wrong is done to a company (as a person separate from its ), only the company can sue for redress. Section 260 permits derivative claims as an exception to this principle. Whether or not a company sues to enforce its legal rights must be decided by the persons who, under the company’s constitution, have authority to institute legal proceedings in the company’s name. This will normally be the directors. Internal Management Principle: The court will not interfere with the internal management of companies acting within their powers. The internal management principle has a ‘proper claimant aspect’, which is that the court will not determine a questions concerning what it regards as the internal management of a company except in proceedings brought by the company itself. Irregularity Principle: A member cannot sue to rectify a mere informality or irregularity if the act when done regularly would be within the powers of the company and if the intention of the majority of is clear. In Browne v La Trinidad, at first instance it was found that the directors’ meeting had been improperly convened due to inadequate notice to one of the directors, Mr Browne, who was removed from office. The CoA doubted that the notice provided was inadequate but were unwilling to overturn the finding of the judge below on this ground. The CoA refused to rule that the proceedings have been invalidated by the irregularity, seeing how if the meeting was held again, the resolution would . Four exceptions to the rule in Foss v Harbottle, but the only actual/true exception is Fraud on the Minority which allows member shareholders to bring a derivative action under CA 2006 s.260-264. A derivative action is when a member shareholder commences litigation in the name of the company, and accordingly, is a right derived from the company. The other three ‘exceptions’ contain personal actions, eg. (s.33); s.39 (ultra vires/illegality).

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“The ultra vires or decision not taken by special majority are permitted as exceptions to the proper claimant aspect of the internal management principle. This is an example of the court permitting a claim in respect of a member’s interest in having the affairs of the company conducted constitutionally – and it seems that such a claim should not be classified as a derivative claim.” (563)

A derivative claim is defined at s260(1) as a proceeding by a member of a company: a) in respect of a cause of action vested in the company; and (b) seeking relief on behalf of the company. “A member of a company may bring a statutory derivative claim under s.260 only in respect of a cause of action specified under s260. The cause of action must be vested in the company. It must arise from a proposed act or omission which involves negligence, default, breach of duty or breach of trust by a director, former director or shadow director of the company. The cause of action may be against the direct of another person or both. It may have arisen before the claimant became a member of the company: this rule arises from the principle that it is the company’s claim which is being pursued, not the member’s.” (553) *Anything that is a fraud on the minority cannot be ratified by shareholders in general meeting. Three reasons for the rule in Foss v Harbottle: 1) refusal to be involved in disputes over business policy; 2) disputes among should be settled by the themselves in general meeting where the majority should prevail; 3) a fear of multiplicity of claims. 2. (a) Shareholder bringing derivative action (typically) bears the costs. Denning J. in Wallersteiner suggested the company should be liable for costs, and allows for a pre-emptive costs order – now (Wallersteiner orders) (557). And, any monies recovered will go to the company itself, rather than the shareholder member bringing the claim. (b) Derivative (compensation paid to company) v Personal (s.33) (s.994) (compensation paid to individual private litigant). “A person is not debarred from obtaining damages or other compensation from a company by reason only of holding or having held shares in a company. In Prudential Assurance Co Ltd v Newman Industries (No 2) [1982] the CoA gave the following example: …if directors convene a meeting on the basis of fraudulent circular, a shareholder will have a right of action to recover any loss which he has been personally caused in consequence of the fraudulent circular; this might include the expense of attending the meeting. If a claim brought by a member of the company is not in respect of the company’s rights (so the member is not pursuing a derivative claim), it must be enforcing the legal rights of the member. Accordingly, the cases in which of companies are allowed to bring proceedings in respect of their companies’ internal affairs are often regarded as being concerned with the ‘personal right’ of the .” (see page 561-2). “We suggest that the common factor in the personal rights cases is that a member is alleging that a decision is unlawful in the sense that it fails to comply with the general law or with the constitution of the company or with the Companies Acts. We suggest that a member of a company has standing to challenge the lawfulness of any decision of the member or the directors or the chairman of a meeting of , subject only to the irregularity principle. 80

3. CA 2006 260-264: bringing a derivative claim. Keep in mind that s.260 gives the grounds for a derivative claims (where before it was fraud on the minority, now it is any alleged fraud, breach of duty, breach of trust, default.)

4. Breach of Fiduciary Duty – Common law v Statutory Claim Under the common law negligence was not a cause for a derivative action, but in Statute, it is: Pavlides v Jensen: negligence did not ground derivative claim (negligence by director which did not benefit director personally (555)) BUT in Daniels v Daniels: equitable considerations came into play for sale by Director to family member.

5. Section 944(1) a petition for relief of unfairly prejudicial conduct of a company’s affairs may be presented by a member of the company in respect of conduct which unfairly prejudices the interests of (a): the generally, or (b) a section of the hip which includes at least the petitioner. (568) The most common complaint is that a controlling majority of have unfairly prejudiced the minority, and the most common remedy sought is an order that the majority must purchase the minority’s shares at a price which reflects their proportion of the company’s value. **O’Niell v Phillips [1999]: significance is that (1) it led to the reduction in the ‘unfair prejudicial’ claim: action must be both unfair and prejudicial; (2) only judgement by the highest court related to unfair prejudice; (3) Lord Hoffman is the only judgement, legitimate expectation is limited. (Whereas in the past oral agreements may have led to ‘legitimate expectations’. Now, the of a company are entitled only to such protection as offered under the Constitution, or between some fundamental understanding between the which formed the basis of their association – in other words, no longer general notions of unfairness; there must be an ‘actual breach’ of the constitution or agreement). (4) Hoffman introduces concept of No-Fault Divorce – exit clause for disgruntled shareholders, and mechanism for ensuring proper and fair value is paid for shares.

6. Insolvency Act 1986 s.122(1)(g) – “A company may be wound up if the court is of the opinion that it is just and equitable that the company should be wound up. (584) “Unless the article of association of a company provides otherwise, a member cannot make it wind up voluntarily other than by obtaining a three quarters majority at a general meeting”. (584) Examples of just and equitable winding up orders: a) company was promoted fraudulently b) cases where there is a deadlock; c) serious breach of mutual understandings; etc “In order to succeed with a petition for the relief of unfairly prejudicial conduct of a company’s affairs it is not necessary to show that the circumstances justify winding up the company.” (569). 7. Insolvency Act winding up is a last resort remedy – usually courts will refer claimants to s.994: The winding up under s.994 is a drastic remedy and often what is sought is being bought out for fair value. Ebramhimi v Westbourne Gallaries Ltd [1972].

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8. Confidential Investigation: informal unpublicised inquiry usually conducted by CIB officials (Companies Investigations Branch). Power is derived under CA 1985 s447. Public Investigations: investigation by inspectors and is a much more serious affair. Appointments are public and the result of the investigation made public in a published report. Power is derived from CA 1985 s431 9. Shareholder Protection: Section 33 – shareholder personal rights; Common law – alteration to constitution must be bona fide in the best interest of the company; derivative claims and unfair prejudice claims; etc.

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26 January 2015 LECTURE 11: DIRECTORS DUTIES Review: Must know difference between executive and non-executive directors, as well as shadow directors and the repercussions/effects of being labelled as one: Section 161 CA and the case of Morris v Kanssen [1946]. Power (of management and control) is allocated by the shareholders/ to the Directors under the Constitution. Harmar 1959: Romer J: of shareholders are entitled to expect that the board will perform its functions as a board, and entitled to benefit from the collective experience of those directors… Public Listed Companies must meet regularly and monitor executive management. Gilfillen v ASIC (2012) – provides guidance on how board meetings should be conducted. If what the judge sets out is followed by directors, than they will have protection against ‘breach of duty’. Directors at board meetings must actively vote ‘for’ or ‘against’ or ‘abstention’ on propositions in front of the , who should have been provided all necessary information in advance, and these votes must be recorded in the minutes.

Directors’ seven general duties: 1) Duty to act within powers; 2) Duty to promote the success of the company; 3) Duty to exercise independent judgement; 4) Duty to exercise reasonable care, skill and diligence; 5) Duty to avoid conflicts of interest 6) Duty not to accept benefits from third parties; 7) Duty to declare interest in proposed transaction or arrangement. Bristol and West Building Society v Mothew [1998]: The word ‘Fiduciary’ refers to trust and confidence. A fiduciary is someone who acts for, or on behalf of, another person, in a relationship of trust and confidence, which equity protects by imposing on the fiduciary a duty of loyalty.

Do Directors Owe Duties to the Following: Shareholders, Employees, and Creditors? /Shareholder: **Percival v Wright [1902]: (General Rule: Directors only owe duties of loyalty to the company, and not to individual shareholders. This is now codified in the United Kingdom's Companies Act of 2006 section 170.) Facts: Mr Percival owned shares per value of £10 in a company whose shares neither had a market price nor were they quoted on the stock exchange and were only transferable with the director's approval. Mr Percival through his solicitors inquired from the company if anybody was willing to purchase their shares £12.55 a priced based on independent valuation. Mr Wright who was the chairman of a company, with two other directors, agreed to buy shares from Mr Percival at £12.10 each. Mr Percival then found out the directors had been negotiating with another person for the sale of the whole company at far more than £12.10 a share. The directors had not told Percival. Percival claimed breach of fiduciary duty. 83

Percival v Wright is still considered to be good law, and was followed by the House of Lords in Johnson v Gore Wood & Co [2000] UKHL 65. However, it has been distinguished in at least two subsequent cases. In Coleman v Myers [1977] 2 NZLR 225 and Peskin v Anderson [2001] BCLC 372 the court described this as being the general rule, but one which may be subject to exceptions where the circumstances are such that a director may owe a greater duty to an individual shareholder, such as when that shareholder is known to be relying upon the director for guidance, or where the shareholder is a vulnerable person. In that scenario the director is acting as an agent!

Allen v Hyatt (1914): (Directors are not agent of , but it is possible in particular circumstances that the director of a company may be acting as agent of of the company). In the instant case the directors made an undisclosed profit from selling the shares of the of the company and were made liable to them.

Coleman v Myers [1977]: (Exception to general rule) small family company; one brother with main control; similar to Allen v Hyatt, sisters wanted to sell shares under constitution, which he could buy, but he did not disclose information which would substantially affect the price of the shares – as they were only shareholders he believed he wasn’t obligated to tell them anything. Judge held that in this structure a fiduciary relationship arises and it was inequitable for him not to disclose information.

Gething v Kilner [1972]: (Takeover of a Target Company) – duty to keep shareholders advised about whether or not takeover should be accepted! Facts: minority shareholders in a company facing a takeover bid (the offeree) objected on the basis that the offer document and the board's recommendation of acceptance of the bid were misleading. The offer document did not disclose that the offeree company's financial advisers recommended rejection of the offer. The board did not provide any rational explanation for its refusal to accept the advice. The minority shareholders sought an interlocutory injunction to restrain the offeror company from declaring the offer unconditional, thereby relieving any assenting shareholder of the offeree from any assent that had already been given. Brightman J refused to grant the relief. He considered that the evidence demonstrated that the offeree's board honestly believed the offer to be advantageous, and that it was a reasonable view to adopt. He referred to 'other remedies' available to the claimants should a wrong have been committed. However, he continued by saying: 'I accept that the directors of an offeree company have a duty towards their own shareholders, which in my view clearly includes a duty to be honest and a duty not to mislead. I also accept that a shareholder in an offeree company may be prejudiced if his co-shareholders are misled into accepting the offer. I express this view because as soon as the appropriate percentage of shareholders have been misled and have assented, the minority become subject under section 209 [of the Companies Act 1948] to statutory powers of compulsory purchase. It therefore seems to me that a minority could complain if they were being wrongfully subjected to that power of compulsory purchase as a result of a breach of duty on the part of the board of the offeree company.'

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Employees: CA s 172(1)(b)

Parke v The Daily News [1962]: The company which had sold its business, through its Board of Directors, had resolved to pay £1 million to its former workers and the widows of such former workers. A shareholder sought to prevent this happening on the ground that such a payment went beyond the articles of association of the company, and such payment to ex-employees was not reasonably incidental to the carrying on of the business of the company. Held: The application succeeded. The making of an ex gratia payment as the company intended to do, and in the circumstances where that company no longer operated, was not reasonably incidental to the conduct of its business and was therefore ultra vires the company’s memorandum and articles. In such circumstances a shareholder has the right to bring the action which the plaintiff in Parke’s case did. 172

Duty to promote the success of the company

(1)A director of a company 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 as a whole, and in doing so have regard (amongst other matters) to— (a)the likely consequences of any decision in the long term, (b)the interests of the company's employees, (c)the need to foster the company's business relationships with suppliers, customers and others, (d)the impact of the company's operations on the community and the environment, (e)the desirability of the company maintaining a reputation for high standards of business conduct, and (f)the need to act fairly as between of the company. (2)Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its , subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its were to achieving those purposes. (3)The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

Creditors: (Once directors know the company is in financial distress they owe a duty of care to creditors: Insolvency Act 1986) Multinational Gas Case [1983]: Liquidator of the Property of West Mercia Safetywear Ltd v Dodd [1988]: general duty owed by directors to creditors once they realize the company is in financial difficulty.

Directors Role & Avoidance of Breach of Duty: “The board of any company listed on the Stock Exchange should meet regularly, retain full and effective control over the company and monitor the executive management”. (There is no reason why, as a matter of best practice, this principle should not apply to private companies). See also Gilfillin v ASIC [2013] 85

170

Scope and nature of general duties

(1)The general duties specified in sections 171 to 177 are owed by a director of a company to the company. (2)A person who ceases to be a director continues to be subject— (a)to the duty in section 175 (duty to avoid conflicts of interest) as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director, and (b)to the duty in section 176 (duty not to accept benefits from third parties) as regards things done or omitted by him before he ceased to be a director. To that extent those duties apply to a former director as to a director, subject to any necessary adaptations. (3)The general duties are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director. (4)The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties. (5)The general duties apply to shadow directors where, and to the extent that, the corresponding common law rules or equitable principles so apply.

*Silent as to whether this list is exhaustive or non-exhaustive! Seems to Professor Ryan there are other common law duties which exist outside of this section, eg, directors duty to creditors, and not to do things unfairly prejudicial to of the company. Pre-2006 Statutory duties did impose a lot on directors, backed up by criminal sanctions and fines and imprisonment. Post-2006 does not alter those duties, and has incorporated most everything. What is new is the introduction is the codified duties of directors.

Directors General Duties: s.170-177 Substantive Duties: Duty of Care and Skill; Fiduciary Duties; Duty of Care and Skill 174

Duty to exercise reasonable care, skill and diligence

(1)A director of a company must exercise reasonable care, skill and diligence. (2)This means the care, skill and diligence that would be exercised by a reasonably diligent person with— (a)the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b)the general knowledge, skill and experience that the director has.

Marquis of Bute’s Case: a baby could be a director…so expectations in courts was quite low Re City Equitably Fire Insurance: (Superseded, to some extent) – can director delegate his duties, or not? Romer J holds that directors duties were intermittent, and not expected to attend every board meeting – standard expected was that of reasonable person, and could delegate if reasonably thought them able to handle that responsibility. However…move to CA 2006 combined objective-subjective approach! Dorchester Finance Co v Stebbings: 86

Bishopsgate Investment Management v Maxwell: Impact of s.214 IA 1986 Impact of Company Director Disqualification Act 1986

Fiduciary Duties Duty to act “bona fide in the interests of the company” CA 2006 s.171. It includes the obligation to disclose misconduct (including your own): on this point see Item Software v Fassihi [2004] EWCA 171 Duty to act within powers A director of a company must— (a)act in accordance with the company's constitution, and (b)only exercise powers for the purposes for which they are conferred.

Hence, directors should not favour some over others; or act out of self-interest. Proper Purpose Doctrine: Directors must exercise their powers for a proper purpose. While in many instances an improper purpose is readily evident, such as a director looking to feather his or her own nest or divert an investment opportunity to a relative, such breaches usually involve a breach of the director's duty to act in good faith. Greater difficulties arise where the director, while acting in good faith, is serving a purpose that is not regarded by the law as proper. The seminal authority in relation to what amounts to a proper purpose is the Privy Council decision of **Howard Smith Ltd v e Ltd [1974] AC 821**. The case concerned the power of the directors to issue new shares. It was alleged that the directors had issued a large number of new shares purely to deprive a particular shareholder of his voting majority. An argument that the power to issue shares could only be properly exercised to raise new capital was rejected as too narrow, and it was held that it would be a proper exercise of the director's powers to issue shares to a larger company to ensure the financial stability of the company, or as part of an agreement to exploit mineral rights owned by the company. If so, the mere fact that an incidental result (even if it was a desired consequence) was that a shareholder lost his majority, or a takeover bid was defeated, this would not itself make the share issue improper. But if the sole purpose was to destroy a voting majority, or block a takeover bid, that would be an improper purpose. Not all jurisdictions recognised the "proper purpose" duty as separate from the "good faith" duty however.

Tech Corp v Millar (1972): unlike Ampol, they had found that the Directors had acted in good faith and with proper purpose. Demonstrates that if directors can demonstrate they have the company’s best interest at heart, then their decision making is proper. This is a decision on a corporate director's fiduciary duty in the context of a takeover bid. Justice Berger of the British Columbia Supreme Court held that a director may resist a hostile take-over so long as they are acting in good faith, and they have reasonable grounds to believe that the take-over will cause substantial harm to the interests of the shareholders collective. The case was viewed as a shift away from the standard 87

set in the English case of Hogg v. Cramphorn Ltd. (1963). Recent scholarship has made the following observation: “The decision in Teck v Millar, a seminal case on directors' duties, is consistent with the duty to protect shareholder interests from harm. Teck Corporation, a senior mining company, had acquired a majority of voting shares in Afton Mines Ltd., a junior mining company that owned an interest in a valuable copper deposit. In doing so, Teck sought to ensure procurement of a contract with Afton to develop the copper property. Before Teck could exercise its majority voting control to replace the board of directors with its own nominees, the Afton board signed a contract with another company that effectively ended Teck’s control position in Afton. In evaluating the evidence, Justice Berger was satisfied that Teck, the majority shareholder, "would cause substantial damage to the interests of Afton and its shareholders." In determining that the directors had not breached their fiduciary duty to the corporation, shareholder interests were distinguished from control interests. Drawing this distinction is key, "because once Teck's interest in acquiring control is put to one side, its interest, like that of the other shareholders, was in seeing Afton make the best deal available." Accordingly, the directors had made a decision that, despite affecting the control interests of the majority shareholder, had protected the shareholder interests of all shareholders (including Teck's) from harm. This concern for the collective interests of shareholders, rather than strict adherence to majority rule, is consistent with the tripartite fiduciary duty.”

Fiduciary Duties: Duty to Promote the Success of the Company Detailed under s.172 CA 2006, enclosed above. Must take into not just current, but future shareholders best interests – perpetual succession! (long term v short term gains). If directors act honestly in what they genuinely believe, and have considered interests considered in s.172, then their decision will not be queried or overturned by the courts, not matter how badly those decisions end up being (justiciability).

Fiduciary Duties: Fettering Discretion – Nominee Directors Fulham Football Club v Cabra Estates CA [1992]: directors should not place themselves in position where they cannot exercise independent discretion. The directors in the instant case signed an agreement to develop the football ground and gave an undertaking that Fulham Football Club Ltd would not oppose the development at a later date or a compulsory purchase order. It was held that the directors had not improperly restricted the future exercise of their discretion.

Fiduciary Duties: Duty not to act where conflict of duty and self-interest (lecture leads seamlessly into secret profits!) Section 175 (detailed above) – duty to avoid conflicts of interest. This section is based on two equitable principles: 1) the no-conflict and the no-profit rules. One of the common most instances of the application of these rules is excluded by s.175(3) and the other provisions of the Act such as ss.177 and 182 and ss.190214 (discussed next lecture). Keech v Sandford: 88

Bray v Ford: inflexible rule – person in fiduciary position is not entitled to make a profit. Not entitled to put himself in a position where duty and interests conflict. Boardman v Phipps:

Regal Hasting v Gulliver: HoL director must take of any profit obtained through a transaction of which the company is a party, or is not a party, but is obtained in the role of the fiduciary relationship (secret profit). “‘Directors, no doubt, are not trustees, but they occupy a fiduciary position towards the company whose board they form’” (468). Regal owned a cinema in Hastings. They took out leases on two more, through a new subsidiary, to make the whole lot an attractive sale package. However, the landlord first wanted them to give personal guarantees. They did not want to do that. Instead the landlord said they could up share capital to £5,000. Regal itself put in £2,000, but could not afford more (though it could have got a loan). Four directors each put in £500, the Chairman, Mr Gulliver, got outside subscribers to put in £500 and the board asked the company solicitor, Mr Garten, to put in the last £500. They sold the business and made a profit of nearly £3 per share. But then the buyers brought an action against the directors, saying that this profit was in breach of their fiduciary duty to the company. They had not gained fully informed consent from the shareholders. The House of Lords, reversing the High Court and the Court of Appeal, held that the defendants had made their profits “by reason of the fact that they were directors of Regal and in the course of the execution of that office”. They therefore had to for their profits to the company.

Industrial Developments v Cooley: Mr Cooley was an architect employed as managing director of Industrial Development Consultants Ltd., part of IDC Group Ltd. The Eastern Gas Board had a lucrative project pending, to design a depot in Letchworth. Mr. Cooley was told that the gas board did not want to contract with a firm, but directly with him. Mr. Cooley then told the board of IDC Group that he was unwell and requested he be allowed to resign from his job on early notice. They acquiesced and accepted his resignation. He then undertook the Letchworth design work for the gas board on his own . Industrial Development Consultants found out and sued him for breach of his duty of loyalty. Roskill J held that even though there was no chance of IDC getting the contract, if they had been told they would not have released him. So he was held able for the benefits he received. He rejected the argument that because he made it clear in his discussions with the Gas Board that he was speaking in a private capacity, Mr. Cooley was under no fiduciary duty. He had ‘one capacity and one capacity only in which he was carrying on business at that time. That capacity was as managing director of the plaintiffs.’ All information which came to him should have been ed on. *Canadian Aero Services v O’Malley; Peso Silver Mines v Cropper; Queensland v Hudson: Canadian and an Australian case, respectively, allowed directors to profit when company could not take up contract, therefore not in breach of duty!

FHR European Ventures v Cedar Capital Partners [2014]: overturns Sinclair v Versailles and uphold AG for Hong Kong v Reid: bribes and secret commissions are held on proprietary constructive trust on behalf of the company. 89

16 Feb 2015 TUTORIAL 5: Directors Duties

1) Distinguishing Shadow and De Facto Directors: are they liable under the CA 2006? a. Ultraframe v Fielding: of the board whose instructions are ‘accustom to act’ b. Section 251(1) & (2) CA 2006 “Shadow Director” c. **Holland v Revenue & Customs d. Deverell Not all duties and liabilities apply to shadow directors! As such, it may be advantageous to establish that the individual is a de facto director. 2) Section 174: Duty to exercise reasonable care, skill and diligence (1) A director of a company must exercise reasonable care, skill and diligence. (2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with— (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b) the general knowledge, skill and experience that the director has.

a. Re D’Jan of London Ltd b. Gilfillen v ASIC (2012) Standard is much lower under common law – but now has objective and subjective element, and so takes into skills and experience of actual person who is the director in question. *Business Judgement Rule: courts are unwilling to impose remedies for negligence claims as directors have been selected by the shareholders and the most appropriate remedy for a breach is removal of that director. Moreover, courts are not a suitable body to review actions of directors who are supposedly business experts. Grey Area – Corporate (companies as) Directors: potential defendants could incorporate and claim the company was the director and not the individual themselves. 3) Can a director profit from their position as director: Bray v Ford; Boardman v Phipps; Queensland v Hudson; Peso Silver Mines v Cropper; Section 175 (duty to avoid conflicts of interest; Section 177 (duty to declare interest in proposed transaction); Section 182 (interest in existing transactions); Regal Hastings v Gulliver – full disclosure can be ratified by Board. 4) Directors issuing new shares to prevent takeover? Section 171 – proper purpose doctrine: Directors must exercise their powers for a proper purpose. While in many instances an improper purpose is readily evident, such as a director looking to feather his or her own nest or divert an investment opportunity to a relative, such breaches usually involve a breach of the director's duty to act in good faith. Greater difficulties arise where the director, while acting in good faith, is serving a purpose that is not regarded by the law as proper. 90

a. **Howard Smith Ltd v Ampol Ltd [1974] AC 821** (Lord Wilberforce) The case concerned the power of the directors to issue new shares. It was alleged that the directors had issued a large number of new shares purely to deprive a particular shareholder of his voting majority. An argument that the power to issue shares could only be properly exercised to raise new capital was rejected as too narrow, and it was held that it would be a proper exercise of the director's powers to issue shares to a larger company to ensure the financial stability of the company, or as part of an agreement to exploit mineral rights owned by the company. If so, the mere fact that an incidental result (even if it was a desired consequence) was that a shareholder lost his majority, or a takeover bid was defeated, this would not itself make the share issue improper. But if the sole purpose was to destroy a voting majority, or block a takeover bid, that would be an improper purpose. b. Tech Corp v Millar (1972) 5) Directors g shareholder agreements: section 173 Duty to exercise independent judgement Russell v Northern Bank 6) Section 176 – benefits from third parties; 178 – civil consequences of breach & Bribery Act (maybe); proprietary constructive trust: FHR

91

09 Feb. 2015 LECTURE 12: Directors Liabilities and Protections

232 Provisions protecting directors from liability (1)Any provision that purports to exempt a director of a company (to any extent) from any liability that would otherwise attach to him in connection with any negligence, default, breach of duty or breach of trust in relation to the company is void. (2)Any provision by which a company directly or indirectly provides an indemnity (to any extent) for a director of the company, or of an associated company, against any liability attaching to him in connection with any negligence, default, breach of duty or breach of trust in relation to the company of which he is a director is void, except as permitted by— (a)section 233 (provision of insurance), (b)section 234 (qualifying third party indemnity provision), or (c)section 235 (qualifying pension scheme indemnity provision). (3)This section applies to any provision, whether contained in a company's articles or in any contract with the company or otherwise. (4)Nothing in this section prevents a company's articles from making such provision as has previously been lawful for dealing with conflicts of interest.

175 Duty to avoid conflicts of interest (1)A director of a company 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. (2)This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity). (3)This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. (4)This duty is not infringed— (a)if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or (b)if the matter has been authorised by the directors. (5)Authorisation may be given by the directors— (a)where the company is a private company and nothing in the company's constitution invalidates such authorisation, by the matter being proposed to and authorised by the directors; or (b)where the company is a public company and its constitution includes provision enabling the directors to authorise the matter, by the matter being proposed to and authorised by them in accordance with the constitution. (6)The authorisation is effective only if— (a)any requirement as to the quorum at the meeting at which the matter is considered is met without counting the director in question or any other interested director, and (b)the matter was agreed to without their voting or would have been agreed to if their votes had not been counted. (7)Any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties.

Prior to 2006 you required shareholder agreement in general meeting; now you can have Director approval at a Board meeting, to what would otherwise be a conflict of interest. In larger companies directors will find 92

it easier to comply with s.180 – approval from board – rather than by obtaining majority shareholder authorization.

180 Consent, approval or authorisation by (1)In a case where— (a)section 175 (duty to avoid conflicts of interest) is complied with by authorisation by the directors, or (b)section 177 (duty to declare interest in proposed transaction or arrangement) is complied with, the transaction or arrangement is not liable to be set aside by virtue of any common law rule or equitable principle requiring the consent or approval of the of the company. This is without prejudice to any enactment, or provision of the company's constitution, requiring such consent or approval. (2)The application of the general duties is not affected by the fact that the case also falls within Chapter 4 (transactions requiring approval of ), except that where that Chapter applies and— (a)approval is given under that Chapter, or (b)the matter is one as to which it is provided that approval is not needed, it is not necessary also to comply with section 175 (duty to avoid conflicts of interest) or section 176 (duty not to accept benefits from third parties). (3)Compliance with the general duties does not remove the need for approval under any applicable provision of Chapter 4 (transactions requiring approval of ). (4)The general duties— (a)have effect subject to any rule of law enabling the company to give authority, specifically or generally, for anything to be done (or omitted) by the directors, or any of them, that would otherwise be a breach of duty, and (b)where the company's articles contain provisions for dealing with conflicts of interest, are not infringed by anything done (or omitted) by the directors, or any of them, in accordance with those provisions. (5)Otherwise, the general duties have effect (except as otherwise provided or the context otherwise requires) notwithstanding any enactment or rule of law.

1. Prohibitions and Liabilities: Civil Consequences of Breach of General Duties: CA 2006 ss.178-180 – Conflicts of Interest

- It is not unusual for Directors to dis-apply general rules in relation to specific transactions, as long as there is disclosure and authorisation.

- If they breach their fiduciary duty, the most common remedy is an ‘ for profit’ – whereby the director is required to disgorge (give-up) any profits obtained through breach.

Disclosure: Declaration of Interest in Existing Transactions: CA 2006 ss.182-187

- Where a director engages upon or proposes to engage an activity in which he has a direct or indirect interest, he must disclose the nature and extent of interest to other directors

- It is a criminal offence not to disclose (under 182) under s.183, liable to a fine. 93

Transactions with Directors Requiring ’ Approval: ss.188-230

- Director’s service contracts must be approved by resolution of of the company if the contract is longer than 2 years.

- If company engages in contract in contravention of s.188, to that extent it is void. Moreover, the contract is void and can be terminated at any time upon reasonable notice. a) Substantial property transactions: (s.190-196)

- “Under ss 177 and 182, a company director’s interests in a company transaction need be disclosed on to the other directors. Section 190 goes further and requires approval by resolution of the for certain transactions, which the title of the section calls ‘substantial property transactions’. The remedies in s 195 for failure to obtain approval are rescission and of profits.” (502)

- May not enter into agreement where director is set to acquire a non-cash asset. (Prohibition – unless arrangement has been approved by resolution of the , or is conditional upon such approval being obtained).

- 192 – must be aware there are exemptions, eg, transactions with ; at winding up; etc. - 195 sets out civil consequences – transaction is voidable, unless bona fide purchaser for value. - 196 ratification – where transaction is without requisite approval, but within reasonable period affirmed, then the transaction may no longer be avoided. b) Contracts for loans of guarantees (s.197-214)

- “s.197(1) requires approval by resolution of of any company for a loan to a director of the company or of its holding company. A loan by a company to a director of its holding company requires the approval by resolution of the of both the company (unless it is a wholly owned subsidiary) and the holding company (s 197(2) and (5)(b)). The same applies to guaranteeing or giving security in connection with a loan made by any other person (s 197(1)). Approval may be given within a reasonable period after a transaction or arrangement is entered into (s 214).” (pg 504)

- Contracts for loans of guarantees are not allowed unless approved by resolution of the company. c) Prohibitions for Relevant Companies (s.198 onwards)

- Quasi-loans (s198) – while companies act applies to all, it sometimes makes provisions (additional prohibitions) for one category, as in the instant case, which is limited to public companies or a company associated with a public company.

-

S.199 details quasi-loans: where one party, the creditor, agrees to pay a sum for another. S.200 extends this prohibition to people connected with the Director S.201 – credit transactions – in public companies require member approval S.204-209 – Exceptions, eg, for loans and quasi-loans for less than 10,000 GBP S.213 civil consequences for breach: contract is voidable at instance of the company provided there has not been some intervening event which makes return of the monies impossible. (“The remedies 94

for failure to obtain approval are statutory versions of the equitable remedies of rescission and of profits.” (pg 504)).

- Rescission of a transaction involves each party returning to the other what was transferred in the transaction.

- S.214 there can be affirmation by shareholders (ratification doctrine). d) Directors Loss of Office: (s.215-222)

- Payment made to a director or past director by way of compensation for loss of office. - See this in relation to s.168 – removal of director by ordinary resolution – which the shareholders have at general meeting. Need to know s.168 & 169, because although they have that power, it becomes more difficult in larger companies to a resolution! No real way to communicate with other shareholders, and directors will circulate to shareholders whether they want the resolution to or not. So, procedurally, you’re at a disadvantage (if an activist shareholder). Last, if the vote is successful, then it is likely that the directors’ contract will be breached, and the company will have to pay remuneration for damages for breach of contract. However, if they do remove the director, then you have to comply with provisions under s215-222 – approving payoff.

2. Common Law Liabilities: a) Tortious Liability for Directors: *Williams v Natural Life Health Food Ltd. [1998] [Negligent Misrepresentation]: It held that for there to be an effective assumption of responsibility, there must be some direct or indirect conveyance that a director had done so, and that a claimant had relied on the information. Otherwise only a company itself, as a separate legal person, would be liable for negligent information. Facts: Mr Williams and his partner approached Natural Life Health Foods Ltd with a proposal. They wanted to get a franchise for a health food shop in Rugby (i.e. they wanted to use the Natural Life brand to run a new store and pay Natural Life Ltd a fixed fee). Mr Williams was given a brochure with financial projections. They entered the scheme. They failed, and lost money. So Mr Williams sued the company, alleging that the advice they got was negligent. However, before the suit could be completed, Natural Life Health Foods Ltd went into liquidation. So Mr Williams sought to hold the company's managing director and main shareholder personally liable. This was Mr Mistlin, who in the brochure had been held out as having a lot of expertise. Mr Mistlin had made the brochure projections, but had not been in any of the negotiations with Mr Williams. The High Court allowed Mr Williams claim, and so did the Court of Appeal by a majority. The company and Mr Mistlin appealed to the House of Lords. The House of Lords allowed the appeal and found Mr. Mistlin was a stranger that that particular relationship and he cannot therefore be liable as a t tortfeasor with the company. If he is to be held liable to the respondents, it could only be on the basis of a special relationship between himself and the respondents.

*Standard Chartered Bank v Pakistan Shipping Co (No 2) [2003] [Fraudulent Representation]: The House of Lords considered two issues. First, can a person (such as a company director) escape liability for 95

deceit, where he commits a fraud while acting on behalf of another person (such as the company) who is also liable for the fraud? Second, is contributory negligence a defence to a claim in fraud? The tort of deceit involves a false representation made by the defendant, who knows it to be untrue, or who has no belief in its truth, or who is reckless as to its truth. If the defendant intended that the plaintiff should act in reliance on such representation and the plaintiff in fact does so, the defendant will be liable in deceit for the damage caused. Different considerations applied to a claim for negligent misstatement. As the House of Lords made clear in Williams v Natural Life Health Foods Ltd [1998] 2 All ER 577, liability in such a case depends on an assumption of responsibility by the defendant. As with contractual liability, an agent (such as a company director) can assume responsibility on behalf of another person (such as the company) without assuming personal responsibility. This reasoning cannot apply to fraud. Mr Mehra was not liable by virtue of his position as a director, but because he had himself carried out the acts of deceit. As with the criminal law (see Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 3 All ER 918), a director cannot escape liability simply because his own acts are also sufficient to fix the company with liability.

b) Constructive Trusteeship (MFR 16.17) Guinness v Saunders: directors of the company, chairman was Saunders, in the course of a takeover bid the directors wanted a strategy to avoid the takeover, thereby hiring an American lawyer (to implement a ‘poison pill’ strategy). The strategy, was in effect, an illegal one, for Mr Saunders to call on his comrades and get them to purchase shares in Guinness, raising/inflating the price of the shares and making it more difficult to ‘takeover’/purchase shares. The lawyer, Mr Ward, was paid over 2 million pounds, which was awarded by committee of the board. Mr Ward was found to be a ‘constructive trustee’ seeing that the advice was bad/illegal. Regal Hasting v Gulliver: Sankey: “The rule of equity which insists on those who by use of a fiduciary position make a profit, being liable to for that profit, in no way depends on fraud, or absence of bona fides; or upon such questions or considerations as whether the profit would or should otherwise have gone to the Plaintiff, or whether the profiteer was under a duty to obtain the source of the profit for the Plaintiff, or whether he took a risk, or acted as he did for the benefit of the Plaintiff, or whether the Plaintiff has in fact been damaged or benefited by his action. The liability arises from the mere fact of a profit having, in the stated circumstances, been made. The profiteer, however honest and well-intentioned, cannot escape the risk of being called upon to .” “If a company has actually suffered a loss from a director’s breach of duty, it may claim equitable compensation for that loss in addition to confiscation of the profits made by the director.” (508)

c) Directors’ Personal Liability to Contribute Personal Undertakings; Pre-Incorporation Contracts, Deeds and Obligations: CA 2006 s.51 (1) 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 96

person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly. CA 2006 s. 1187: The Secretary of State may find a director of a company personally liable for the debts of the company Insolvency Act 1986: s.212 Misfeasance Proceedings s.213 Fraudulent Trading – also enforceable under s.993 – Criminal Liability Petition. s.214 Wrongful Trading – when director knows or ought to have known company was becoming insolvent, director under duty to minimize losses (to creditors) and to cease trading. s.216 & 217 – using company name after liquidation.

3. Provisions Protecting Directors from Liability: In the UK some protection from liability is provided by: a) Majority rule or business judgement rule b) Insurance and Indemnity: CA 2006 ss232-238 c) Ratification; CA 2006 s239 a. Not clear how far ratification can go. b. Derivative Actions require ‘fraud on the minority’ – that conduct was something that could not be ratified. It is unclear under s.239 if that is still the case. Ryan suggests that he thinks it is: conduct which amounts to fraud on the minority cannot be ratified. Same as criminal conduct. Can ratify excess of authority. Look at Regal Hastings v Gulliver: had they held a meeting and ratified transaction they would not have been liable to . c. Cook v Deeks and Hind [1919] AC (Canadian Case decided at the PC) [Ratification Limitations]: Deeks and Hinds were the directors of a construction company. They negotiated a lucrative construction contract with the Canadian Pacific Railway. During the negotiations, they decided to enter into the contract personally, on their own behalves, and incorporated a new company, the Dominion Construction Company to carry out the work. The contract appeared to be taken over by this company, by whom the work was carried out and the profits made. A shareholder in the Toronto Construction Company brought a derivative action against the directors and the Dominion Construction Company. Because this was a derivative action, the Toronto Construction Company was also ed as a defendant. 97

Held: Deeks and Hinds were guilty of a breach of duty in the course they took to secure the contract, and were to be regarded as holding it for the benefit of the Toronto Construction Company: “while entrusted with the conduct of the affairs of the company they deliberately designed to exclude, and used their influence and position to exclude, the company whose interest it was their first duty to protect.” This led to the legal conclusion that: “men who assume the complete control of a company’s business must that they are not at liberty to sacrifice the interests which they are bound to protect, and, while ostensibly acting for the company, divert in their own favour business which should properly belong to the company they represent.” d. There exists a common law principle, known as the Duomatic principle, which provides for decision-making by shareholders by way of informal unanimous consent: “Where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be." (Re Duomatic, Buckley J) d) Relief by Court (MFR 16.16.6): CA 2006 s.1157 An officer… “[if] it appears to the court hearing the case that the officer or person is or may be liable but that he acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused, the court may relieve him, either wholly or in part, from his liability on such as it thinks fit.”

Re D’Jan of London Ltd [1994] 1 BCLC: Concerning a director's duty of care and skill, whose main precedent is now codified under s 174 of the Companies Act 2006. The case was decided under the older Companies Act 1985. Facts: Without reading it, Mr D'Jan signed a change to an insurance policy which was erroneously filled out by his insurance broker, a Mr Tarik Shenyuz. He did not read it before he signed, and it contained a mistake, which was that the answer 'no' was given to the question of whether in the past he had 'been director of any company which went into liquidation'. This meant the insurance company, Guardian Royal Exchange Assurance plc, could refuse to pay up when a fire at the company’s Cornwall premises destroyed £174,000 of stock. The company had gone into insolvent liquidation by the time Mr D'Jan realised that the form had been incorrectly completed. The liquidators sued Mr D'Jan to recoup the lost funds on behalf of the company's creditors (who together were owed £500,000). They alleged both negligence and misfeasance under s 212 of the Insolvency Act 1986.

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12 Feb 2015 LECTURE 13: Protection of Investors and the Market Investor protections are provided by the following: 1) BY DISCLOSURE S AND REPORTS Requirements Companies have to provide certain information about the company on an annual basis, twice annually, to shareholders and that can also mean to potential shareholders. These documents are filed at the Companies House and become a part of the public record. Criminal penalty imposed on the directors for failing to abide by the rules under s 451 & and also civil penalty s 458. Duty imposed by the statute on the directors to lay the annual s before the AGM. Something goes wrong, s not true, they might lose their position and their reputation. Explains vast increase in responsibilities and liabilities, and why they want to be remunerated at a very high level. At the end of their contract, it might not be renewed, another reason they want higher remuneration. S. 386 – Duty to keep ing records. Director’s duty to make sure the s are presented to the AGM. S. 387, 389 – Impose criminal penalties for contraventions for various ing requirements. Indication of purpose of s to provide true and fair information of those things. Gives options to investors whether they want to stay in or if its time they get out. s. 423 – 424 – duty to circulate of annual reports, to every member, do also finish up being recorded at Companies House s. 425 – default in sending out copies is a defence, officers and directors who could have criminal penalty – often a small fine – but conviction can be from indictment in which fine will be unlimited s. 394 – Duty on directors regarding s s. 396 – regarding contents of the s s. 409 onwards – information relating to undertakings, what is required here is disclosure that is significant in relation to s. 172 – general duties, info relating to undertakings, compliance, information about off balance sheet arrangements s. 410(a) s. 411 – info about employees, numbers and costs also requirements to diclose how many disabled ppl are employed s. 412 – disclosure of benefits and remuneration for directors s. 413 s. 414 – approval and g of the accts, signature must be on companies balance sheet. **s. 417 - Contents of directors' report: business review (1)Unless the company is [F1entitled to the small companies exemption], the directors' report must contain a business review. 99

(2)The purpose of the business review is to inform of the company and help them assess how the directors have performed their duty under section 172 (duty to promote the success of the company).

ENRON CASE - Anderson had two contracts with Enron, 1 to audit s, 1 for consultancy. Anderson, like all other big ing firms was making a lot of money on both of these contracts. What would appear to happen is their auditors did discover that things that were happening were not proper, did not disclose that to shareholders, fearful if they did, they would lose both contracts. Now requires off balance sheet information is disclosed as a requirement under the s. Effect devastating for Andersons, no longer a worldwide ing firm. It ruined that company’s reputation and all of the partners in this company would have suffered as well as the shareholders of Enron and the employees. 2) BY AUDIT – backs up, supposed to guarantee to shareholders the information that company providing you is true and fair. Damages awarded by jury in negligence actions that the amount be awarded for negligence particularly by ing firms was heading up towards a billion $. Effect of that, was global ing firms lobbied for introduction of limited liability partnership, gave in and agreed to it, why we have LLPs. They needed to give their partners for their personal assets. Partners in ing and lawfirms can protect their assets. s. 532 – Auditor’s liability – any provision that tries to prevent them from liability is void. However, similar sort of exemptions in relation to indemnity of costs relating to proceedings. s. 534-538 - New introduction, only applies to auditors Limitation agreements. Has to be approved by the of the company. Shows the power of the lobbying of the international ing firms that they could get this into the Companies Act that limits their liabilities for negligence ing. 3) INSIDER DEALING – a) Market rigging at common law R v de Berenger & Others – coffee shops in City of London where trading took place. de Berenger and friends went to coffee shop and spread rumour that Napoleon Bonaparte was dead, stocks rose dramatically, great relief, no longer have to worry about threats imposed by Bonaparte. This was a lie, it was untrue. And de Beregner and friends made a lot of money. They had rigged the market by giving false information to investors, false info that causes the value to go up or down. Death of Bonaparte would have driven the value of assets and stocks upwards. So that’s the first recorded instance of someone being convicted of a fraud through rigging the market. Conspiracy to defraud – leading case Scott v Metropolitan Police Commissioner – common law conspiracy, still is, charge that can still be brought today in relation to people who conspire together to do what de Berenger and his friends did to rig the market. That would be a conspiracy to defraud.

b) The Fraud Act 2006 – relevance to the fact that fraud can be by false representation, by failing to disclose information or by abusive position. Relevance that people who are selling investments, shares, companies when raising capital, have to provide information to potential investors. Using in the form of the prospectus – that is the ment for shares. Civil consequences that can result from false representation and failure to disclose information - *refer to knowledge from contract, criminal, tort and equity law. c) Insider dealing: criminal offences 100

Tipping off Unlawfully disclosing – People that act on information knowing that it is inside information might not be able to avoid liability. Insider dealing Act – gaps discovered, Act taken away. R v Fisher – Mr. Fisher had a control of a private company, he held all shares in it, and he wanted to make a takeover bid for another company. He approaches a merchant bank. Mr Fisher phones the merchant bank and asks for a specific employee with whom he was intimate with, phoned and asked her how his Company’s bid was progressing. She replied, but Company C’s bid is going to be accepted and your bid is going to fail. Mr. Fisher, immediately went out, bought shares in Company C, and B, and sold shares in Company A. He was making money both ways, saving on the loss that would occur in his company and making money on the strength of this inside information that was confidential, non-public information at that time. Legislation under which he was prosecuted, offence was ‘the tipping offence’ – obtaining confidential information and then acting on it. Whole case taken up with argument Oxford English dictionary about what obtained means, how it has been used in novels of Dickens, Shakespeare, whole day of argument in court, all about meaning of the word obtained. Judge decided Mr Fisher had not committed an offence. Mr Fisher’s argument that he never actively sought (obtaining means) he had simply received it unwillingly. Judge accepted that. Parliament was furious, because that made enormous loophole in what was the new insider dealing legislation. d) Market Abuse and insider dealing: civil wrongs s. 118- investments on stock exchange and falls within one of or more of the categories in subsection 2 onwards. Repeats the offences of insider dealing, market abuse under that provision. Insider dealing is a market abuse, other things that can also constitute a market abuse. 8 subsections. These are civil. Insider dealing Act is Criminal. Criminal – need mens rea of intention – explains why we have very few insider dealing convictions. To get round that, Parliament introduced market abuse, civil wrong. Don’t have to worry about mens rea as much. e) Civil liability: Percival v Wright; Boardman v Phipps; Regal Hastings, Allan v Hyatt; Chez Nico Insider dealing under the Act does not apply to private companies. All of these cases, the directors were privy to information about the prospects of the company, knew there was going to be a transaction that was going to take place that would boost companies shares. Don’t have to fall back on Misrepresentation Act, in relation to false statements in ments offering shares for sale because you have a statutory provision that provides compensation if you bought shares on the basis of a false statement. s. 90 f) Investigation and consequences g) FSA Listing Rules, continuing obligations; the Combined Code restricting directors’ purchases or sales of shares in the company h) Disclosure

4) DISQUALIFICATION ORDERS Separate piece of legislation – 6 pages long – Company Directors Disqualification Act 1986 introduced, is a good deterrent to directors’ potential misconduct. Company Directors Disqualification Act 1986, s. 1 – a court may, s. 6-9 – a court MUST make a qualification order and that order shall be for a time specified in the order prohibiting a person from being a director of the company. 101

Discretionary situation – court has ability to disqualify if it wants for persistent breaches of company registration. Carecraft Procedures – director can hold his hand up today and say I should be disqualified. By undertaking, the court will simply agree to an undertaking that the director is disqualified for a period of time. Usually be more if he doesn’t do it voluntarily as court will have to impose it via court order. A Carecraft agreement is an agreement whereby the defendant its to the allegations made against him, and reaches agreement with the SoS on a period of disqualification. This, like an undertaking, will usually involve some form of reduced period of disqualification as an incentive to settle. It stems from the 1994 case. Re Carecraft Construction Co Ltd [1993] 4 All ER 499 at 507 The Carecraft agreement, however, is a much bigger document than an undertaking, as it will set out the entire case against the defendant and all agreed mitigation from the defendant. If the defendant is able to provide evidence to convince the SoS that part of the allegations are unfounded, this fact may be recorded in the Carecraft agreement and will be a matter of record along with agreed mitigation. For this reason, a Carecraft agreement may still be the preferred option of a defendant who feels it important for his future that certain allegations or parts of allegation are not itted to in order to settle, and that his mitigation statement is a matter of public record. Effect of Breach – s 13 – criminal; s 15 – civil

02 Mar. 2015 TUTORIAL #6 – Directors Liabilities and Protection of Investors and the Market 1. Transparency – ing disclosure and reports (eg, supply chain diligence) backed up by auditing (to ensure ing accuracy) both interim and at general meeting. In particular, ing disclosure provides for profits, debts, liabilities, etc. Cost of the company expenses increase due to reporting and ing responsibilities, for example, having to hire human rights or environmental specialists. Criminal and civil sanctions for breach of fiduciary duties – protecting investors by requiring directors to act in company’s best interest. Tito v Wadell (self-dealing); proprietary constructive trusts. Target (Holdings) v Redferns. Also, Bribery Act which deters ‘bad practice’ by those in control of the company. If they are deterred, it should provide better protection and therefore better investment. Disqualification Orders – deters bad practice by directors (Carecraft procedures) Shareholder Ratification required on certain company transactions 102

S 168 – have ability to remove directors *Corporate Governance – investors feel confident and therefore invest in the company and remain invested in company. More sophisticated investors are conscience if the company’s reputation for good governance is high or not, and this can be a determinative factor. (Safer investment vehicle) 2. Insider trading/dealing, Criminal Justice Act 1993, is criminalized and those found guilty can face up to 7 years in prison – this provides confidence to investors, especially those from abroad. In addition, profits obtained are held on proprietary constructive trust. There are also in-house policies, such as ‘Chinese walls’ – on a ‘need to know basis only’. Insider trading is hard to prove – using knowledge for improper reasons. Also, because a criminal offence, difficult to establish mens rea: must prove alleged offender intended or knowingly engaged in insider dealing or in way of the ways akin to it. Common law – Conspiracy to defraud – is another criminal offence that can be used against ‘insider’s/ Market Abuse (Civil Offences) – s. 118 Financial Services and Markets Act – shift insider dealing from being a criminal offence to a civil wrong. Both insider/individual and company can be fined! 3. There is discretionary and mandatory disqualification of directors under the Company Directors Disqualification Act 1986 (CDDA). Mandatory is where the director is unfit s 6-9 due to company becoming insolvent. Section 9 sets out how to determine ‘unfitness’, referring to schedule 1 of the Act which includes reference to breach of fiduciary duty including part 10 of CA; failure in ing records; entering into transaction likely to be set aside; extent of directors responsibility in complying with various provisions of CA. Important deterrent due to section 1 because it prevents you from running a company for the period of the disqualification order. Unlike removal of director, they don’t get paid out as they have breached the contract, and therefore not entitled to remuneration/damages! 4. Encouraging investors by ensuring good directors, and deterring directors from making poor decisions and using capital wrongly. Maximum 15 year ban, minimum of 2 year. Re Sevenoakes Stationers Ltd [1991]: The court gave guidelines for the periods of disqualification to be applied for company directors under the Act. The maximum period of ten years should be reserved for only the most serious of cases. Periods of two to five years should apply to cases at the bottom end, and the middle bracket of 6 to 10 years for serious cases. The period should be fixed by the allegations made in the charge, not in the evidence coming out later. Non-payment of crown debts was to be treated more seriously than for other debts, though non-payment of Crown debts is not per se evidence of unfitness: ‘it is necessary to look more closely in each case to see what the significance, if any, of the non-payment of the Crown debt is.’ ‘(i) the top bracket of disqualification for periods over ten years should be reserved for particularly serious cases. These may include cases where a director who has already had one period of disqualification imposed on him falls to be disqualified yet again. (ii) the minimum bracket of two to five years’ disqualification should be applied where, though disqualification is mandatory, the case is, relatively, not very serious. (iii) the middle bracket of

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disqualification for from six to 10 years should apply for serious cases which do not merit the top category.’ As to the words of section 6 of the 1986 Act, these were ‘ordinary words of the English language’, and, then referring to earlier judicial statements, Dillon LJ said: ‘Such statements may be helpful in identifying particular circumstances in which a person would clearly be unfit. But there seems to have been a tendency, which I deplore, on the part of the Bar, and possibly also on the part of the official receiver’s department, to treat the statements as judicial paraphrases of the words of the statute, which fall to be construed as a matter of law in lieu of the words of the statute. The result is to obscure that the true question to be tried is a question of fact – what used to be pejoratively described in the Chancery Division as ‘a jury question’.’

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16 Feb 2015 LECTURE 14: Corporate Governance (Public Companies) This lecture focuses predominately on directors and links the previous lectures on separation of powers and directors duties. Who guards the guards – eg, who controls or supervises the Directors? What legal mechanisms are in place? America: Post-Enron – a topic discussed last week - American corporate governance really picks up. Sarbanes-Oxley Act is implemented (largely a reaction to Enron). England: 1980’s industrial unrest; Thatcher government (Conservative) attempts to break-up monopolies – De-Nationalization (privatization) of British companies (railway; telephone; airlines). The former managers (who were civil-servants and receiving payment in kind) were appointed directors of these newly privatized companies, and in turn, sought directors’ remuneration, looking at their American counterparts; salaries were jumping from $70,000 - $400,000. Shareholders had rights of participation in smaller companies, often they were ‘partnerships’ rather than the full-blown companies we now have. As they grew into these larger companies, shareholder participation became more impractical, resulting in a ‘divorce of ownership and control’, shifting from the shareholders into the hands of directors. Voting - now, shareholder powers (which include removal of directors) are not exercised as easily as attendance at shareholder meetings (general meetings) can be quite difficult, either geographically or cost or otherwise. That is why a ‘proxy’ vote has become popularized. Originally the voting procedure only allowed for a ‘yes’ vote. That has been changed and now includes ‘yes’ or ‘no’ or ‘abstain’. It is common for shareholders to vote ‘yes’ in favour of the directors. Disclosure – shareholders should have sufficient information as to whether or not to remain invested in the company or not. However, the shareholder reports are dense, legalistic and unreadable to most. Auditing is introduced – an outside body to review corporate activity and s – but we see that this can fail, eg, the Dailymail or Enron or BCCI and so on. Yet, we have still failed to obtain true Transparency and ability and Disclosure *Need a summary of the main points that came out of the various Reports: Cadbury; Greenbury; Hampel; Combined Code – located in the readings.

Current Position: s.994 claims & derivative actions & fiduciary duties (which often form the basis for these actions); UK Governance Code. Non-executive directors: (executive directors have employment contracts) whereas non-executives’ are meant to be independent and monitor (guard the guards) (Greenbury Report), so they do not have remuneration determined by the executive board (but it is usually quite low, eg, $30,000).

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Need to know the Code, generally, for the exam! Combined Code 2014: Art 4 – non-executive: role is to constructively challenge and contribute to strategy, and to monitor performance and ensure accuracy in ing. One non-executive director should be appointed the senior independent director. Chairman should hold meetings with non-executives without the executives present, and an annual meeting led by senior independent director to review the Chairman’s performance. (We need to go through the Code)! Second main feature of Code is on pg 4: **Comply or Explain**: trademark of corporate governance in UK, and strongly ed by both companies and government, alike. It means that all listed companies have mandatory compliance with the code, but, some don’t. If the company can’t comply then they must explain ‘why’ to the public (shareholders), and disclose in their reports and s. There must be clear explanation as to why they have violated certain provisions of the code – this is a self-name and shame directive. Code is a set of principles, and not a set of rigid rules. The principles are the core of the code. Good governance can be achieved by other means – alternative means are allowed to be implemented, but it would need to be disclosed when ‘explaining’. In response to ‘explanations’ the shareholders should take of the size of the company and risks with the companies’ ventures. Correspondingly, the shareholders should be flexible when deciding whether or not to accept ‘explanation’. There should be a ‘link between remuneration and performance’ – result of Greenbury and Hampel Reports

UK Stewardship Code: The Code is a set of principles or guidelines released in 2010 by the Financial Reporting Council directed at institutional investors who hold voting rights in United Kingdom companies. Its principal aim is to make institutional investors (eg Teachers’ Pension Fund), who manage other people's money, be active and engage in corporate governance in the interests of their beneficiaries (the shareholders). The Code applies to "firms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts and other collective investment vehicles." This means fund managers, but the Code also "strongly encourages" institutional investors to disclose their own level of compliance with the code's principles. The Code adopts the same "comply or explain" approach used in the UK Corporate Governance Code. This means, it does not require compliance with principles. But if fund managers and institutional investors do not comply with any of the principles set out, they must explain why they have not done so on their websites. The information is also sent to the Financial Reporting Council, which links to the information provided to it. The compulsion to, at the very least, explain non-compliance with the Code follows from the Financial Services and Markets Act 2000 section 2(4) and the Listing Rules. The seven principles of the code are as follows. Institutional investors should,  

publicly disclose their policy on how they will discharge their stewardship responsibilities. have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed. 106

    

monitor their investee companies. establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value. be willing to act collectively with other investors where appropriate. have a clear policy on voting and disclosure of voting activity. report periodically on their stewardship and voting activities.

Companies Act 2006 s.1269-1273 1269.Corporate governance rules 1270.Liability for false or misleading statements in certain publications 1271.Exercise of powers where UK is host member State 1272.Transparency obligations and related matters: minor and consequential amendments 1273.Corporate governance regulations The Higgs Non Executive Directors Review 2000 Current revised UK, Combined Code 2014 in The FCA’s Application for Listing/Listing Rules ***UK Corporate Governance Code Review Report Women on Boards Alan Yarrow – Corporate Governance: “…good corporate governance can accelerate the development of a healthy market economy, persuading governments and business that investment is a good idea. It can be the decisive factor in whether a company opens a new office or factory, or whether a sovereign wealth fund invests in an ambitious infrastructure opportunity. A McKinsey study showed that institutional investors are willing to pay a of 22% for investments in well-governed companies and markets.”

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23 Feb. 2015 LECTURE 15 – Corporate Social Responsibility S.172: requires directors to take into a list of considerations when they are making board decisions. Duty to promote the success of the company (1)A director of a company 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 as a whole, and in doing so have regard (amongst other matters) to— (a)the likely consequences of any decision in the long term, (b)the interests of the company's employees, (c)the need to foster the company's business relationships with suppliers, customers and others, (d)the impact of the company's operations on the community and the environment, (e)the desirability of the company maintaining a reputation for high standards of business conduct, and (f)the need to act fairly as between of the company. (2)Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its , subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its were to achieving those purposes. (3)The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

Corporate Social Responsibility (CSR): is significant in numerous respects, including M & As – studies indicate that companies with good CSR and corporate governance are less likely to be involved in or be the target of (hostile) M & As. Also connected with this is what can be termed ‘ethical investing’ – this can impact the shareholding body and its ‘bottom line’. A company’s reputation and longevity requires more than financial prosperity. Highly publicized corporate scandals are a threat to long term sustainability. Def’n: CSR has a variety of elements, but generally, it is an organization committing to adopt ethical behaviour and to enhance economic development with the objective of improving the quality of life of its employees, surrounding community, and society at large. CSR is a concept that evolves with society. A superficial definition is ‘giving back to society.’ Good CSR practices may encourage people to work/invest/do business with that company and in turn have a positive economic return. Workers, for example, have a higher retention rate, work harder, and a generally happier, so there are benefits in this aspect, as well. (ESCG) Environmental social and good corporate governance activities: here is growing evidence that suggests that ESG factors, when integrated into investment analysis and decision making, may offer investors potential long-term performance advantages. ESG has become shorthand for investment methodologies that embrace ESG or sustainability factors as a means of helping to identify companies with superior business models. 108

Area of focus Environment

Activity

  

Social

Resource management and pollution prevention Reduced emissions and climate impact Environmental reporting/disclosure

Potential impact on financial performance

   

Workplace

   

Workplace

   

  

Diversity Health and safety Labor-Management relations Human rights Product Integrity Safety Product quality Emerging technology issues Community Impact Community relations Responsible lending Corporate philanthropy

 

Improved productivity and morale Reduce turnover and absenteeism Openness to new ideas and innovation Reduce potential for litigation and reputational risk Product Integrity Create brand loyalty Increase sales based on products safety and excellence Reduce potential for litigation Reduce reputational risk Community Impact Improve brand loyalty Protect license to operate

1. 2. 3. 4.

Executive compensation Board ability Shareholder rights Reporting and disclosure

  

Align interests of shareowners and management Avoid negative financial surprises or “blow-ups” Reduce reputational risk

  

Corporate Governance

Avoid or minimize environmental liabilities Lower costs/increase profitability through energy and other efficiencies Reduce regulatory, litigation and reputational risk Indicator of well-governed company

   

Traditional view: Park v Daily News – companies act for shareholder who are the owners of the company, therefore only one’s entitled to a return on their investment. NO MECHANISM PROVIDED FOR THE ENFORCEMENT OF BAD CSR PRACTICES! Derivative actions can be launched for breach/failure to enforce/practice good CSR, but this is an indirect measure that can only be advanced by shareholders. But s.172 entails considerations of other stakeholders, not limited to shareholders. When, for instance, the environment is harmed, who can enforce/commence an action on their behalf? Community Interest Company: is a new type of company introduced by the United Kingdom government in 2005 under the Companies (Audit, Investigations and Community Enterprise) Act 2004, designed for social enterprises that want to use their profits and assets for the public good. CICs are intended to be easy to set up, with all the flexibility and certainty of the company form, but with some special features to ensure they are working for the benefit of the community. Institutional Investors: A non-bank person or organization that trades securities in large enough share quantities or dollar amounts that they qualify for preferential treatment and lower commissions. Institutional investors face fewer protective regulations because it is assumed that they are more knowledgeable and better able to protect themselves (eg. pension and life insurance companies). -Large investors can have an impact on stakeholder/legislative programs advancing CSR practices. For example, an institutional non-denominational religious investor group lobbied hotel companies as regards human trafficking during major sports events where trafficking becomes prolific. They refused to fund/invest in any hotel company not ing the reduction/regulation of human trafficking. What there were doing was influencing the company to adopt practices that advance the reduction of human trafficking practices – eg staff policy; / lines; company policy. 109

Supply Chains (Transparency) Act California: certain companies must disclose/audit retailers, sellers or manufacturers, and disclose risks such as slavery and human trafficking that may exist within their supply chain. They must maintain internal ability standards. Provide company employees with training as regards slavery and human trafficking, specifically how to mitigate these issues. Eg: Apple and Foxcomm scandal where workers protested against slavery like (concentration type) conditions. Under the Act, Apple needs to report on their supply chains.

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02 Mar. 2015 LECTURE 16 – Corporate Funding Methods: Capital (Equity and Loan and Capital Maintenance) & Company Securities Funding Overview: Particularly Relevant to Start-ups 1. Love Money (The three Fs): Family; Friends; Fools 2. Commercial Lenders (private lending companies; banks – must have ‘security’); i.

Lender will not be entitled to profits; sole requirement is that you pay back loan in accordance with the loan. The disadvantage is that the business may be committed to large monthly cash payments, and may lose payments if unable to meet repayment requirements.

3. Government Grants of Loans (rare); i.

Bureaucratic process, but less onerous repayment than commercial lenders, typically.

4. Peer-to-Peer and Peer-to-business lending; 5. Crowdfunding; i.

Typically sourced through online portal, eg, kickstarter

ii.

Fast access to capital; however, most campaigns struggle to meet financial goals and projects may become inflexible due to fact of changing of crowdfunding agreement is very difficult: need to obtain permission from every investor.

6. Equipment Financing (Leasing); i.

Extended rental agreement which allows the (the company) use of equipment in return for lease payments. 80% of all companies ‘lease’ at least some of their equipment. It allows companies to have access to equipment without tying up capital, as well as tax advantages.

ii.

Sometimes can cost more in the long run then purchasing agreement outright. Agreement can be complex and difficult to manage.

7. s Receivable Financing; i.

Business sells outstanding ‘receivables’ or ‘invoices’ at a discount to a financing/factoring company who buy, at a discount the invoices, who assume risk of collecting in return for upfront-cash. Frees up working capital, quick method of cash injection; frees up company resources.

ii.

Discount often exceeds interest payable on commercial loan.

8. Private Investors; i.

Angels: (also known as a business angel or informal investor or angel funder) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity.

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ii.

Venture Capitalists/private Equity: is financial capital provided to early-stage, high-potential, growth startup companies. The venture capital fund earns money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology and IT.

iii.

Business Incubators: is a company that helps new and startup companies to develop by providing services such as management training or office space. Business incubators differ from research and technology parks in their dedication to startup and early-stage companies.

Financial Services Act 2012: implements a new regulatory framework for the financial system and financial services in the UK. It replaces the Financial Services Authority with two new regulators, namely the Financial Conduct Authority and the Prudential Regulation Authority, and creates the Financial Policy Committee of the Bank of England. This framework went into effect on April 1, 2013. Under the Act, the istration of Libor becomes a regulated activity overseen by the Financial Conduct Authority. Knowingly or deliberately making false or misleading statements in relation to benchmark-setting becomes a criminal offence.

Equity/Share Capital Particularly Relevant to established and larger companies 

Issuing of securities; debt financing (borrowing money) o Company can use borrowed money to purchase increasing assets o Interest paid on loan is typically tax deductible o Lender only gets return of capital and interest payments, and not equity in the company



Issuing shares: of the public invest in the company in return for an interest in the company; shares are also called equity. o Debt and equity levels o Tax benefit of interest can lower the overall capital



Too much debt may interfere with business credit and ability to raise money in future (don’t want to over borrow); high levels of debt are desirable in some situations.



In an adverse economic climate, companies are vulnerable if they have high exposure to debt.

The Legal Nature of Shares (CA 2006 Part 17 ss.540-610) 

Shares are “personal property” – s 541 (they are categorised as “things in action” because they confer entitlements to rights, benefits and privileges.

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Issued and allotted share capital – s 546

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Issued by the directors – s 549-551 o Directors can issue shares to purchase smaller company. 112

o Allotment of shares must be ed at Company House 

Types of share – Ordinary/equity shares ( there may be different classes of ordinary shares) o Preference: on which they are allotted (or issued) will define rights of holder, eg, dividend is paid in priority to ordinary share holders 

Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a company bankruptcy, preferred stock shareholders have a right to be paid company assets first. Preference shares typically pay a fixed dividend, whereas common stocks do not. And unlike common shareholders, preference share shareholders usually do not have voting rights.

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There are four types of preference shares: Cumulative preferred, for which dividends must be paid including skipped dividends; non-cumulative preferred, for which skipped dividends are not included; participating preferred, which give the holder dividends plus extra earnings based on certain conditions; and convertible, which can be exchanged for a specified number of shares of common stock

o Deferred (don’t need to worry about these) o Non-voting ordinary (don’t need to worry about these) o Voting ordinary/equity shares (varying classes [class rights], differentiating rights between classes) (Most common form of share) o Redeemable – s 684 

Statement of capital on registration – s 9-10 o 1 GBP required on registration

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Alteration of share capital – s 617 (allotment and reduction) (Don’t need to know details, but need to be aware that when companies want to raise capital, they must alter capital structure, meaning allotting more shares under a formal process.

Maintenance of Capital: Provisions to prevent “watering down” of capital coming into the company: 

No commissions (subject to exceptions) s 553

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No discount – s 580

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Public Companies – no undertakings to do work or perform services s 585

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Penalty – s 590

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Public Companies – valuation for non-cash consideration required – s 593 ( Salomon’s case! Where some argued that he had over-valued his company as independent valuation was not a requirement and Salomon himself valued the company.) 113

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Penalty s 607

Provisions to prevent capital “going out” of the company: 

Reduction – s 641

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No purchase of own share s 658-676 and 690-708: The rule in Trevor v Whitworth 1887 – the prohibition (buy-back of share provisions were ultra vires) is now subject to exceptions set out in the statute.

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Distributions (i.e. Dividends) – s 736 and s 829 – 853: o Must ONLY be paid out of profit (not capital or reserves) o Subject to the overriding condition of solvency

The Consequences of an unlawful (ultra vires) Distribution: *Any shareholder who receives a dividend payment they know to be wrongly paid out of capital must be returned! Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC: There had been no knowledge or intention that the sale of shares by one company to another had been below their market value and no reason to doubt the genuineness of the transaction as a commercial sale, even though the sale price had been calculated on the basis of a misunderstanding by all concerned, the share sale had been genuine, lawful and intra vires, even if it was at an undervalue. The Supreme Court again dismissed the appeal and held that the transaction was sound because even though it was an extremely bad bargain in hindsight, it was negotiated in good faith and at arm's length. The court's task is to inquire into the true purpose and substance of the impugned transaction by investigating all the relevant facts, including the states of mind of the people acting on the company's behalf, though it is always possible that transactions can be unlawful regardless of the directors' state of mind. Accordingly the transaction was neither ultra vires nor an unlawful reduction of capital. Lord Walker gave the leading judgment. Power to purchase own shares: Exception to Trevor v Whitworth s 659 *Once it buys-back shares, they cannot hold them = required to dissolve or eliminate shares; *Can purchase own shares out of capital - s 709 – 723 – Public Companies MUST NOT! Prohibition on giving financial assistance to purchase own shares 

Public companies are prohibited from providing such assistance – s 678 ( Guinness v Saunders – purchasing shares to push up share price and make takeover more difficult 114

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Meaning of financial assistance set out in s 677 o Brady v Brady: T. Brady & Sons Ltd and its subsidiaries went through restructuring after the two brothers that owned the majority of shares fell out and wished to divide the company’s assets. One part of the process involved paying financial assistance to reduce liability on the company buying some of the shares. The fact that it was financial assistance was accepted, but it was argued that this was not the main purpose, relying on what is now the CA 2006 section 678(4) exception. o Lord Oliver held the requirement is the assistance is given in good faith and in the best interests of the company, a subjective standard. He rejected that a ‘larger’ purpose of freeing deadlock would suffice for almost anything, and so on this ground the exemption was not fulfilled: “The acquisition was not a mere incident of the scheme devised to break the deadlock. It was the essence of the scheme itself and the object which the scheme set out to achieve.”

Types of Security: a) Mortgages b) The fixed Charge c) The Floating Charge i.

Crystallisation

ii.

Charges over Book Debts a. Use book debts as security to get loan from bank

d) Priority Rights i.

Date of registration is crucial!

e) Distinguishing fixed and floating charges f) Registration g) Insolvency Act provisions Company Securities: *Don’t need to know details, but what’s important is the Private Companies are prohibited from offering shares for sale to public. There are exceptions, but they are very limited. If a public company wants to issue shares they must have a sponsor, merchant bank, as a form of investor protection. Methods of public issues are either 1) direct offer or offer by subscription; or 2) more commonly, offer for sale, which means issuing house/merchant bank takes over offering process, acting as agent raising money for company. This is where issue of commissions and brokerage because, obviously, issuing house is going to need to make profit. Also, another important reason, is issuing house will act as underwriter, guaranteeing that they will purchase any 115

shares not sold to public. They will also sub-underwrite that liability. In this way, the company is guaranteed to get all money they wanted from the issue of shares! Public Offers for shares: Private Companies: Methods of Public Issues: Official Listing of Securities:

16 Mar. 2015 Tutorial #7 - Raising Capital *Divide between public and private companies – pre-emption rights (first buy rights; sell to existing ) only exist in private companies! These provisions can be drafted in many different ways, for example, requiring Directors to purchase (Rayfield v Hands), or only requiring permission from Directors to sell. In public companies, pre-emption takes on different forms. Under the statute (statutory pre-emption, s 561), when company issuing new shares, it must first offer shares to current/existing . The reason for including this is to prevent diluting of certain types of shares (Clemens v Clemens – derivative action). Rights to take up new issue become valuable and can be traded on stock exchange (right to purchase new shares can be sold). 561

Existing shareholders' right of pre-emption

(1)A company must not allot equity securities to a person on any unless— (a)it has made an offer to each person who holds ordinary shares in the company to allot to him on the same or more favourable a proportion of those securities that is as nearly as practicable equal to the proportion in nominal value held by him of the ordinary share capital of the company, and (b)the period during which any such offer may be accepted has expired or the company has received notice of the acceptance or refusal of every offer so made. Share : Usually found on the balance sheet, this is the to which the amount of money paid (or promised to be paid) by a shareholder for a share is credited to, only if the shareholder paid more than the cost of the share. 116

Excess value goes into this . The importance is this is treated as capital, and all the rules of capital maintenance apply to it. Labelling them as a capital means they cannot be used to pay dividends! (Bairstow v Queens Moat House – unlawful dividends). That said, these could be used to issue bonus shares – where company gives existing free shares. Money (for these shares) are taken out of this and put into the ‘capital’ of the company. Bonus shares are worth nothing unless the company can maintain its dividend. Shares – Raising Capital: 1) Company issues shares to public in order to raise capital; 2) Then the company (directors) can issue new shares and sell to existing in order to raise more money; 3) Excess capital is then put into the share , and can be transformed into bonus shares. Keep in mind: when shares are issued, normally, to be listed on stock exchange, they have to just be of one type – ordinary shares. That said, some companies are permitted to have different shares. But these are more common in unlisted public/private companies, eg, preference shares.

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16 Mar. 2015 Lecture # 17 - Takeovers and Mergers Introduction: The process of Private M & A is largely contractual; whereas public company takeovers are regulated by statute. Part 28 CA 2006 – Takeovers - S 942-991 Soft law: Codes of conduct (takeovers, stewardship), etc - these are not laws, per se, and cannot be enforced in the courts. Prior to CA 2006 and Takeover Dir this soft law has been converted into hard law. Public takeovers were very rare. Only until recently, for example Vodaphone, was first company takeover of that type, and explains why the Britain could rely on Code without need for hard law. Now, however, this code is embodied in the CA 2006. still exists, but is legally designated regulatory, but same structure and that existed prior to legislation and Dir. And, much of the content of the Code has been regulated not only in the UK, but across Europe. Takeovers were not popular in European because shareholders could hold ‘barer shares’ which are not ed shares (meaning the names of the holders do not show up in the ). This was problematic as tax avoidance and evasion was much easier. That said, theft was much easier because no name was on the certificate. These have now been abolished in the UK. With ed shares, the takeover company can know who the shareholders are and target them directly. With the ‘barer shares’, the company would be unable to target these shareholders because they were not ed. DON’T FORGET LAW OF CONTRACT! Two ways to acquire target company: 1) buy company shares (usually referred to as share purchase); 2) purchase the assets which makes up the business (referred to as business or assets purchase). If you purchase shares then all its assets and liabilities and obligations are acquired, including all of them that the buyer doesn’t know about. In essence, you’re buying the whole company. On the other hand, if simply buying assets, it’s only buying those specific items and liabilities arising therefrom. In the share purchase shares are transferred to buyer via stock transfer form. Where assets are changing hands then assets need to be identified and transferred by specific form of transfer. Real property must be transferred by conveyance. In the latter, more consents are typically required for each piece of transferrable property. In the share transfer there may be provision for ‘change of control’; but otherwise, rarely need for third party consents. Of course, what the buyer is purchasing is quite different in the two methods. In the share purchase the buyer is acquiring a business. With the assets purchase the seller will not automatically transfer trading arrangements to the buyer, so negotiations may have to transpire is purchaser would like those. Finding out about liabilities; tax concerns (different objectives between buyer and seller with tax advantages); if only partial sale, it’s usually best done by asset sale, otherwise, it’s a sale by shares, which will require setting up of a new company, and the transferring or division of old company. We’ve already touched on consents, and third party consent in transfer. And of course, must be aware of Financial Services and Markets Act 2000 – any share transactions may be restricted by ‘financial promotions’ provisions (section 21). Last, conducting due diligence is the most important thing to do as a solicitor. This is simply information gathering – finding out about what you’re buying and whether vendor representations are in fact true.

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Contractually speaking, you’ll want warranties and indemnities in order to avoid future liabilities. Buyers want to see these warranties and indemnities in the sale agreement, and the reason for it is that the buyer usually isn’t going to have complete knowledge of target company and its business before committing to purchase. These provision protect the buying party by re-allocating risks between seller and buyer. In effect, they are price adjusters. A buyer is likely willing to pay a higher price if these protections are in place as any hidden risks will be fall onto the seller. Valuation (which also takes place in due diligence) – buyer is purchasing based on net assets, and will want warranty which states that company’s assets are valued at a certain price. There will be disclosure letters exchanged. The seller’s advisors must therefore have understanding of all material aspects of the company (and explains why advisors, ants, bankers, etc are involved in the transaction process). This financial due diligence usually leads whole process. That said, there will be lawyers handling the legal due diligence aspects of the M&A, and will be in discussion with the ants and so on, conducting questionnaires, seeking answers on a wide-range of questions including status of IP, major contracts, tax structure.

Cadbury Deal – How it Changed Takeovers:

The takeover of Cadbury by US based Kraft in 2010 prompted a revamp of the rules governing how foreign firms buy UK companies. Many in the world of mergers and acquisitions felt that it had become too easy for foreign firms to buy UK rivals and the process had become a little murky. The of Takeovers and Mergers, which regulates this area reviewed the laws and in September 2011 changes were made to the Takeover Code. Broadly it strengthened the hand of target companies, and demanded more information from bidders about their intentions after the purchase, particularly on areas like job cuts. That became a big issue when Kraft bought Cadbury. Just a week after promising to keep Cadbury's Somerdale factory, near Bristol open, Kraft backtracked and said it would close the plant. Kraft later defended itself by saying that when it had more information it realised it was not "feasible to keep Somerdale open". So changes to the takeover code mean Pfizer has given more detail about its intentions for AstraZeneca if the deal were to happen. Here are some of the key areas of the takeover process that were amended after the Cadbury deal. Under 2011 changes to the takeover code, bidding firms are required to give more information about their intentions towards the firm after the takeover. That includes potential repercussions for jobs and assets like factories. The bidder also has to offer information about the locations of company headquarters. 119

Pfizer has pledged that if the deal went ahead, 20% of the combined company's R&D workforce would be based in the UK. The US firm said its commitments would be valid for five years, unless circumstances changed significantly. Salmaan Khawaja is a corporate finance director, at Grant Thornton and worked at the takeover for two years. "The way Pfizer is conducting itself is very different from the way Kraft was perceived to have operated," he said. He says Pfizer's behaviour is not just about complying with the revised rules. "They don't want to be seen as a predator going after a UK brand aggressively". Changes in 2011 also gave greater prominence to the views of employees. Representatives of the staff of the target company can give their views on the takeover. Changes to the Takeover Code require target companies to name who is interested. Previously bidding companies could hide behind anonymity, which strengthened their position. This is not a particularly big issue in the current Pfizer bid. Although Mr Khawaja notes that Pfizer has offered a lot of detail about its possible bid. "They could have put out a few sentences and stopped there, it shows they have put in a lot more groundwork," he says. Mr Khwaja thinks that kind of detail could serve a purpose. "It could be helpful in conversations with shareholders... it could flush out their thoughts," he said. "Though, of course, the shareholders would get the opportunity to decide on the merits of the bid if and when a formal offer is made," he added. In 2011 deal protection measures were banned. Previously bidding companies could insist on an inducement fee - a payment which would be lost if the deal fell through. It would typically be 1% of the offer value and were a feature of most big deals. The banning of those payments, boosts the position of target companies and in this case AstraZeneca.

CA 2006 Part 28 – Takeovers: S 942 (2): The may do anything that it considers necessary or expedient for the purposes of, or in connection with, its functions. -this includes making rules (s 943) 120

s. 944 (1): Rules may— (a)make different provision for different purposes; (b)make provision subject to exceptions or exemptions; (c)contain incidental, supplemental, consequential or transitional provision; (d)authorise the to dispense with or modify the application of rules in particular cases and by reference to any circumstances. -very flexible rules; the rules can give directions (s 946) including restraining a person from doing something Re Bugle Press (1961) [Compulsory purchase – sell out provision]: Two shareholders held more than 90% of the issued shares of the company. To get rid of the holder of the remaining shares, they incorporated another company for the purpose of acquiring all the shares of the company. The acquiring company offered to purchase the company’s shares at a proper value. The majority shareholders accepted the offer but it was refused by the minority shareholder. The acquiring company gave notice of intention to exercise the statutory power of compulsory acquisition under the section. The minority shareholder applied that the transferee company was neither entitled nor bound to acquire his shares on the offered notwithstanding the approval of 9/10ths of the shareholders. The minority said the offer undervalued his shares. The majority shareholders did not file any evidence ing their valuation. Held: The court made the declarations sought. In circumstances where the assenting 90% majority were unconnected with the offeror the normal burden of proof rested on the dissenting minority to show grounds why the court should ‘order otherwise’, but that did not apply where there was a connection between the assenting majority and the offeror, in particular, where the acquiring company was simply the alter ego of the assenting majority. As to a submission that the respondent’s use of section 209 was contrary to the purpose of the section: ‘I am bound to say that I see very great force in that argument. Whether, in such a case, if the court were fully satisfied that the price offered to the minority shareholders was a fair price to be offered for their shares, the section ought to be allowed to operate according to its tenor is, I think, a matter which it is unnecessary for me to decide today because, in my view, on the facts of this particular case, at any rate, the onus must rest on Mr Instone’s clients [the majority shareholders] to satisfy the court that the price offered is a fair price. In the ordinary case of an offer under this section, where the 90 % majority who accept the offer are unconnected with the persons who are concerned with making the offer, the court pays the greatest attention to the views of that majority. This case, however, seems to me to be quite the reverse of that, because here, although as a matter of law the body making the offer must be regarded as distinct from the persons who hold shares in that body, nevertheless as a matter of substance the persons who are putting forward this offer are the majority shareholders. In a case of this kind it seems to me that the onus must clearly be on the other side, and that it must be incumbent on the majority shareholders to satisfy the court that the scheme is one with which the minority shareholder ought reasonably to be compelled to fall in with.’ The acquiring company had not discharged that burden.

*Major significance of Code is in textbook – general principles: all offerees be treated fairly, minorities protected in takeover, and no abuse of market, and timetable adhered to so as to ensure target company’s business is not unduly burdened, and particular, that the target company protects their shareholders and they do not breach their fiduciary duties (s170-177). Also, insider dealing is a large concern in M&A’s, and this is in breach s52 of the Criminal Justice Act.

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23 Mar. 2015 Lecture #18 - Winding Up and ‘tidying up topics’ (Chapter 20)

When a company is insolvent (s. 123 IA 1986) the directors may be displaced by a qualified insolvency practitioner (s. 390 IA 1986) (or in restricted instances by an official receiver) under one of the insolvency procedures. s.122(1)(f) Insolvency Act– most common winding up provision for when company becomes insolvent (unable to pay debts of the company). For as little as 750 debt (s 123) you can seek an order from the courts requesting winding up. s.122(1)(g) – ‘just and equitable’ winding up. Shareholders/minority shareholders claim it is just and equitable to wind up company because of how they have been treated. Of course, this is a very drastic measure: **Ebramhimi v Westbourne Gallaries Ltd [1972] (pg 76 my notes). Parke v The Daily News [1962]: payments set aside upon insolvency to be paid to ‘redundant’ employees. Mr Parke, a shareholder, went to the courts arguing this was ultra vires – and that money belonged to the shareholders. These are: istrative receivership, istration, voluntary arrangement, creditors’ voluntary winding up, winding up by the court and the appointment of a provisional liquidator. (A ’ voluntary winding up is a procedure for the liquidation of a solvent company). Liquidation or winding up is the process of removing a company from all its legal relationships prior to bringing the company to an end and removal from the by dissolution. A dissolved company is dead and buried! A. istrative Receiver. Acts to take control of company property, to sell it, in order to pay one creditor who is secured by a floating charge. (They are being gradually replaced in practice by s see below). B. (istration Orders – IMPORTANT PROCEDURE – Rescuing Device) Some of the most important aspects of insolvency law are those designed to rescue a company in financial difficulty and save it from being wound up (liquidated). Aim to put company back on a profitable basis, if possible, or disposed of more profitably than if put into liquidation. See IA 1986 s. 8 and Sch. B1. An (insolvency practitioner – powers supersede those of the board of directors) of a company likely to go into insolvency may be appointed by: 

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A floating charge holder (only companies can have this type of charge – mortgages, for example, are fixed charges. Mortgagees are therefore the secured creditors. Floating charges are subservient to fixed charges. Floating charges cover all those assets not covered by the fixed charge. Debentures are debt instruments). The company itself 122

 

The company’s directors The court

Purpose – devising a plan within 8 weeks to prevent the company going into insolvency and to have it approved by the unsecured creditors. See Sch. B1 paras 1 & 3. Powers: IA 1986 Sch. B1 para 59 – “to do anything necessary or expedient for the management of the affairs, business and property of the company”. Sch. B1, para 60 lists specific powers. Pre-pack(s): Post appointment and pre-approval of a proposal the may exercise all the powers in Sch. B1 para 59 – 60 including the power to sell the company’s property. If speed is important he can act without the approval of creditors or the court if he considers a sale to be in the best interest of the creditors: Re Transbus International Ltd [2004] EWHC 932 In reality the sale is often negotiated prior to the appointment but on the advice of insolvency practitioner who becomes the – this is a pre-packaged sale. Problems? Pros & Cons? (see para’s 7 – 9 Sch. 1B) – may be best opportunity to obtain highest price; but there is concerns as to connivance. Courts addressed the issue last in 2012, but failed to intervene. Pre-packs must be justified, but often the claims it was the best price that could have ever been obtained. Effect on Directors of istration: Sch. 1B paras 60 – 64. can remove a director and replace them. Overall, the takes over and supersedes (the powers of) directors while the istration lasts. Moratorium: Sch. 1B paras 42 – 44. No resolution (or Order) may be ed for the winding up of the company. No steps may be taken to enforce any security over the property (or repossess) without consent of the . Important provision in giving the change to get company back into good standing, as during this time creditors are held at bay – prevented from exercising their legal rights of forcing company to sell assets. End of istration: Sch. 1B para 76 1) After 12 months unless extended by creditor consent or court order. 2) At any time by the if he thinks the purpose has been sufficiently achieved. 3) By a creditor – see Sch. 1B para. 81. 4) The may, if secured creditors are paid and there is money to distribute, put the company into a creditors voluntary winding up: (para 83). If nothing to distribute – he must have the company dissolved. (para 84). C. Company Voluntary Arrangements (CVA) Insolvency Act 1986 ss. 1 – 7 available to the directors to initiate prior to the commencement of a winding up or istration (or by an or liquidator once either of those processes have commenced).

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The process is similar to a compromise with creditors in a reconstruction (see ss. 895 - 899 C.A. 2006), but simpler. The Proposal: s.1 Appointment of a nominee (or insolvency practitioner): s.2. - Investigates the scheme and reports to the court within 28 days of its mobility - Meetings of and creditors called to approve: s.3 & 4. Approval & Effect: s.4A - 5 by simple majority of and by 75% majority of creditors. - Become binding on all ordinary creditors but not on preferred or secured creditors. Re Cancol [1996] 1 BCLC 100 – a CVA will bind all the creditors, including unknown creditors. Landmark case that established that a debtor could legitimately offer a different deal under a CVA to those landlords of premises it wished to continue to occupy for its future business and those whose premises it wished to vacate. This line of reasoning has been refined and, in more recent times, has been adopted with considerable success by retail chains overburdened by long-term, onerous, solvency-busting leases. These debtors have used CVAs as a way of retaining leases at profitable sites (perhaps on varied ) and escaping from unprofitable sites by leaving landlords to claim a dividend calculated in accordance with a specified formula from a pot of money reserved for them. JJB Sports is one of the most highprofile companies to have used a CVA to this effect—and not once, but twice. There has, however, been no challenge made to any of these CVAs. Offence for an officer of the company to try to obtain approvals to a CVA by false representations or fraudulently doing or failing to do anything: IA ss.5-6 A: Sch. 2 paras 8 & 12. Dissenting and creditors may apply to the court within 28 days to set aside the CVA on grounds of unfair prejudice or material irregularity: IA ss.5-6: If the CVA proceeds the nominee becomes the supervisor and implements the scheme. Small companies CVA plus a moratorium: IA s.1 A: Allows directors to apply for a 28 day moratorium (which can be extended). Effect – no decision to wind up can commence. No steps can be taken to enforce any security or repossess any goods or commence any other legal proceedings. Any provision in a floating charge is invalid if the charge is to crystallise on the obtaining of, or any action taken to obtain, a moratorium. D. Voluntary Winding Up a. ’ voluntary winding up – by special resolution of the following a statutory declaration of solvency by the majority of the directors: (See IA 1986 s.89). appoint the liquidator and control the solvent liquidation of the company, court involvement not required at all. b. Creditors’ voluntary winding up – by special resolution of the without a solvency declaration. This entitles the unsecured creditors to appoint the liquidator and a liquidation 124

committee to be appointed with up to 5 representatives of creditors to assist and supervise the liquidator. Declaration of Solvency: within the 5 week period preceding the adoption of the resolution a majority of directors at a board meeting must have made a statutory declaration that the company, after inquiry, is solvent (able to pay its debts in full within a maximum of 1 year of the commencement of winding-up) otherwise the liquidation becomes a creditors’ voluntary winding-up: s.90. It must include a statement of the company’s assets and liabilities as at the last practical day before making the declaration. To make a declaration without good grounds is an offence: s 89(5). The significance of the type of winding up lies in who ( or creditors) appoint the liquidator and whether or not a liquidation committee containing creditors must be appointed to assist and monitor the liquidator. E. Winding up by the Court ( aka compulsory liquidation) The court orders the company to be wound up on one of the grounds listed in IA 1986 s.122 (1) (today only grounds ‘f’ and ‘g’ are relied on). They are: i)

The company is unable to pay its debts ( this ground is very wide and flexible so as to include failure to pay one debt in excess of £750 after a written demand but see s.123 for the full scope of inability to pay its debts!).

Or ii)

The court is of the opinion that it is just and equitable that the company should be wound up.

Petition: Application on either ground must be made by petition under s 124 and in a long list includes : a creditor or creditors; the company itself; its directors; a liquidator inter alia ... THE NEXT HEADINGS REFER YOU TO UNPLEASANT POSSIBLE CONSEQUENCES OF BEING INVOLVED AS A DIRECTOR IN YOUR COMPANY’S INSOLVENCY: F. Relevant to all insolvency or liquidation proceedings(except CVAs): Duties: Duty of persons connected with the company (directors, officers etc) to provide the insolvency practitioner with information, to deliver up documents and to attend as reasonably required. Such persons can also be required to answer questions, provide affidavits by court order back by warrants for arrest and search and seizure: see IA 1986 ss 234- 235. In relation to the purpose of such powers see MF&R 20.9.5.3 and the interesting cases referred to there.

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G. Liability for Fraudulent Trading: s 213 – previously discussed in the programme. H. Wrongful Trading: s 214 – also previously discussed in detail. See also the Articles referred to in MF&R 20.12.7. I. Directors’ Disqualification: see again the CDDA 1986 and the reading for directors’ liabilities. Refresh your memories on the effect and duration of disqualification and especially the grounds that specify mandatory disqualification in relation insolvency of a company – namely unfitness. Also see disqualification undertakings. See the interesting material in MF&R 20.13.6.1- 20.13.6.9. J. Use of Insolvent Company’s Name : IA 1986 s. 216 (‘Phoenix Provision’) K. Order of Application of Assets in Liquidation: Ss. 143, 148, 175,386, 387. L. Contracting out (subordination of debt) M. Malpractice before and during liquidation: IA 1986 ch. 10 ss206 (fraud in anticipation, 12 months prior, of winding up) - 219 (including ss212, 213,214,216). See also: Transactions at an undervalue - s 238 Preferences- s 239 (selecting certain creditors for payment over others, eg, director who has provided loan to company) Extortionate credit transactions – s244 Avoidance of certain floating charges – s 245 Preferential debts – s386 Insolvency Act (employees are preferential creditors)

*Sections 213, 214, and 217 are the statutory ‘lifting’ (of the veil) provisions that impose liability on directors (to contribute to debts).

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EXAM DRAFT ESSAYS (1) Essay # 1 – Lifting and Piercing the Corporate Veil (and Parent-Subsidiary Liability) At the end of the civil war (1865) in the United States, and ing of the 14th Amendment, corporate lawyers took what was supposed to be a protective measure for newly freed slaves, and transformed it to apply to corporations. To do so, they would have to convince the Supreme Court that the corporation was a person. Of the approximately 300 cases to follow, 90% of them were brought by corporations. Similarly, in the UK, one of the fundamental principles of company law, as set out in Salomon v. Salomon [1896], is that a lawfully incorporated company has a legal personality or identity that is separate from its controllers. Therefore any liability incurred by the company is limited to the company and does not extend to its shareholders and directors, hence limited liability. Similarly, any liability incurred by its controllers is limited to them and does not extend to the company. The veil of incorporation, accordingly, is the legal concept that describes this separation of personalities. In circumstances where the corporate veil is used as a façade or sham, the courts may be willing to find the shareholders personally liable under the doctrines of lifting and piercing the corporate veil, respectively. Lord Sumpton in Prest [2013] is critical of references to a “façade” or “sham”, instead preferring the principles that lay behind these protean : the concealment and evasion principles. The former is not a piercing, simply a lifting, identifying the true individuals responsible when a company has been interposed in order to conceal ones’ identity in order to avoid liability. The former, however, is a piercing, and is where the courts disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement. Sumpton acknowledges that many cases will fall into both categories, but the differences are critical. Sumpton also identifies four other scenarios where the advantages of the corporate veil may be lost: (1) statute – for example, ss. 213&214 Insolvency Act; Companies Act s 933; and the Matrimonial Act; (2) contract; (3) agency; and (4) trustee. Often there will be overlap between these scenarios and doctrines, Prest being a salient example. The following will thus broach the subject of veil piercing from two distinct perspectives: shareholder & director liability and parent-subsidiary liability. Shareholder/Director Liability Gilford Motor v Horne is a leading example of using the corporate personality as a façade. In order to evade a non-compete covenant upon termination of this contract, Mr Horne incorporated a new company using his wife’s name and a friend and entered into activities in contravention to the covenant. The CoA granted an injunction against Mr Horne and the company from engaging in further activities in breach of covenant. Similarly, in Jones v Lipman, the defendant attempted to avoid a contract for sale to Mr Jones by transferring land to a company of which he and nominee were sole shareholders and directors. Russell J ordered specific performance against both Mr Lipman and the company on the basis that the company was “a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity.” It is important to recognize that in both Gilford and Jones the court made order against the individual and company, thus recognizing rather the ignoring the company’s separate personality. 127

In that vein, the doctrine of piercing the veil usually cannot be used to usurp the principle of privity of contract. Although in Gramsci the claimants successfully argued the corporate veil be pierced so as to treat the defendants as party to agreements entered into with various companies, the Supreme Court in VTB [2013] declined to follow it, refusing to extend veil piercing to a controller of a company who was not a party to the contract. Lord Neuberger also suggested the court can only lift the veil of incorporation when more conventional remedies ‘proved to be of no assistance’. Parent (-Subsidiary) Liability Another way the courts have circumvented the separate personality of the corporation is through the concept of agency. Agency exists between two parties, known as parent and agent, whereby acts and agreements of the agent can (legally) bind the principle. In essence, the obstacle of privity of contract is avoided and make the principle liable for contracts entered into with third parties. Whether a person is an agent is a question of fact and can be inferred from circumstances, but can only be established by consent of the principle (Garnac Grain v Fairclough). This is significant within the context of the parent-subsidiary relationship where the parent exercises ‘sufficient control’ (Smith Stone Knight). It is not an uncommon strategic tactic to place ‘risky’ investments on the books of the subsidiary. If these investments become volatile the parent company can dissolve the subsidiary without harming the parent. Although the subsidiary is a separate legal person (if incorporated), the parent is typically not found liable for its acts, debts and obligations. That said, the trend in modern Europe and in the continental law is to make the parent company liable for the debts of the wholly-owned subsidiary (Schmitthoff "The WhollyOwned and the Controlled Company"). DNH v London Tower Hamlets was anomalous insofar as it established the ‘group entity’ doctrine. Denning concluded that a group of companies was in reality a single economic entity and should be treated as one. Thus, if the subsidiary is injured, so is the parent. Dobson (Lifting the Veil in Four Countries) argues that some courts in Europe use the “unity of direction” test to assess the control relationship, which is roughly the same relationship as that assessed by Denning’s “group entity” doctrine. The HoL in Woolfson disapproved of Denning’s group entity theory, finding the veil of incorporation should be upheld unless a façade. Although expressly disapproved, Denning’s views still had considerable influence in the case of Re a Company (1985), where the CoA stated the court will use its power to pierce the veil if it is necessary to achieve justice, irrespective of the corporate structure. The CoA in Adams v Cape narrowed the way in which courts could lift the veil in the future. At issue was whether Cape was present in the US jurisdiction by virtue of its US subsidiaries. The only way the court could attach liability would be either by treating Cape group as one single entity, or finding the subsidiaries were a mere façade, or the subsidiaries were agents for Cape. Slade categorically rejected these three arguments. Speaking to Denning’s group entity argument, he held the court was not free to disregard the principle of Salomon, and although subsidiary companies were creatures of the parent company, under the law they are to be treated as separate legal entities. Moreover, structuring a corporation to avoid unfavourable tax regimes was not an abuse of the corporate personality. Ultimately, the three veil-lifting categories argued failed because Cape was found not to be present in the US through its subsidiaries. This restrictive approach was followed in Bank of Montreal v Canadian Westgrove and Yukong Line which held that “one would need pretty clear – possibly overwhelming – evidence of agency” in order to satisfy the courts. However, the courts in Creasey v Breachwood were willing to substitute the name of one company for another in order to satisfy a default judgement for a wrongfully dismissed manager. The judge 128

in the case deliberately ignored Adams due to the idiosyncrasies of the case which justified its departure. It is perhaps for this same reason that Creasey was overruled in Ord v Belhaven, because the financial restructuring was legitimate and not merely a façade. Ultimately, if the court takes the view that the veil should be lifted, then liability can flow to the parent company. In Chandler v Cape the CoA was able to avoid the veil lifting controversies by examining the issue as a tortious matter, with the standard duty of care requirements being applicable. The Court was satisfied that Cape, as parent company, owed a direct duty to Mr Chandler though employed through the subsidiary. In doing so, the Court analyzed the circumstances and found four grounds that satisfied there being a sufficient proximity (neighbourhood) to find a duty of care requirement. Conclusion: While in Daimler v Bauman (American) the courts declined to extend liability to the parent company, thereby overruling the Ninth Circuit’s agency theory, Canada has taken a different principled approach. In Choc v HudBay Minerals the Superior Court held that the parent company can potentially be held responsible for actions of its subsidiary (in another jurisdiction). In Prest Lord Sumpton concluded that the principle of piercing the corporate veil is only to be invoked to prevent the abuse of a corporate legal personality. As we have seen, whether the court will pierce the veil is not as much dependent upon precedent as it is on the circumstances which give rise to the case. Moreover, the doctrines of concealment and evasion are not the only grounds for veil lifting and piercing. In the case of insolvency (IA ss 213 & 214) or fraud (CA s 993) the courts have a statutory basis for attaching personal responsibility. This does not disregard the corporate personality, but simply holds an individual responsible, as in Gilford and Jones. Gallagher and Zeigler (Lifting the Corporate Veil in the Pursuit of Justice ) in an examination of veil piercing cases concluded that the doctrine can have negative impacts on directors’ duty to the company, individual taxation principles and the rule in Foss v Harbottle. While this may be true, the ability to hold individuals able for their actions remains a fundamental principle in the common law world. In that vein, the courts will not (and ought not) allow a statute to be used as an instrument of fraud (Rochefoucauld in Boustead).

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(2) Essay # 2 – Minority Shareholder Protection Minority shareholders hold a precarious position within large corporations because the company simply requires a majority vote for ordinary resolutions. This procedure can thus result in minority interests being disregarded. In the event the company takes action which is unfairly prejudicial to the minority shareholder the Companies Act 2006 (CA) provides for a cause of action and remedy under ss. 994 & 996, respectively. A minority shareholder can also protect their rights through a variety of statutory, common law and contractual provisions, including: s.260 derivative actions; s.122 Insolvency Act 1986 (IA); s.33 directors’ duties; alteration of the constitution; and shareholder agreements. This will focus on ex post statutory provisions. Also, I should note that a derivative action is not a prototypical minority protection device for reasons detailed below. Derivative Actions – s 260 “The rule in Foss v Harbottle is used to describe the policy of the courts of not hearing a claim concerning the affairs of a company brought by a member or of the company.” When a wrong is suffered by a company the proper claimant is the company and not the who may have also suffered damage. Though argued there are four exceptions to the rule in Foss, the only true exception is fraud on the minority because it is an exception to both the proper claimant and internal management principles – the other three “exceptions” are personal actions (eg ultra vires/illegality). Jenkings J adds a third dimension ratification principle - in Edwards v Halliwell: the principle that if a wrong is done to a company and is ratifiable by a simple majority then a member cannot sue because when it has been ratified it no longer is a wrong. Weddenburn’s theory in “Shareholders’ rights and the rule in Foss v Harbottle” suggests there are a class of acts which cannot be ratified by simple majority and a member is entitled to litigate an act of that class. What that class of actions are is unclear; presumably, however, fraud on the minority clearly falls within it. In ‘An Analysis of Foss v Harbottle’ Beck argues that majority rule is the foundation of Foss because the internal management principle is based on the idea that matters are determined by majority decision and so not reviewable by the courts. Accordingly, he states, the proper plaintiff principle is based on the common law rule that the majority in a general meeting have the right to decide whether to litigate in the company’s name. The paradox of the proper plaintiff principle is of course those who determine whether or not to litigate are (often) those who have committed the wrongdoing. Thus strict adherence to The Rule will preclude potentially meritorious actions which would otherwise be successful. In a derivative action the member shareholder pursues a claim ading the company as co-claimant, and the company recovers compensation, unlike a section 994 petition or a personal action where the member shareholder recovers the award. Actions must be both unfair and prejudicial – s 994 Section 944 petitions for relief of unfairly prejudicial conduct of a company’s affairs may be presented by a member of the company, personally, in respect of conduct which unfairly prejudices the interests of its . The most common complaint is that a controlling majority of have unfairly prejudiced the minority, and the most common remedy sought is an order that the majority must purchase the minority’s shares at a price which reflects their proportion of the company’s value. 130

In O’Neill v Phillips [1999] a disgruntled former director, O’Neill, owning 25% of shares in a company was demoted and denied a conditional 50% share ownership. He claimed that he had a legitimate expectation (as a member) to receive these shares and that denying him this allocation was unfairly prejudicial. Lord Hoffman, delivering the leading judgement, scrutinized four important aspects of the remedy’s operation, ultimately finding that O’Neill’s expectation was not legitimate in the Hoffman sense. 1) 2) 3) 4)

Concept of unfairness and equitable considerations; Nature of ‘legitimate expectations’ and scope (in ‘quasi-partnership’ companies); Concept of a ‘no-fault divorce’; and The remedy of offers to buy the petitioner’s shares at ‘fair’ value.

In doing so, he restricted the application of ‘legitimate expectation’ noting that his previous use of the term (in Saul) was perhaps a ‘mistake’ as it had unduly broadened the ambit of successful redress under what is now a s 994 petition.. Therefore, the conditional agreement to increase the director’s shareholdings was not sufficient as only an unconditional agreement (presumably) or an express provision in the constitution would have given rise to a legitimate expectation in the Hoffman sense. It is relevant to note that curtailing ‘legitimate expectation’ properly reflects the distinction that ought to be made in s. 944 between an employee and member. While a person may simultaneously occupy both roles, it is only detriments suffered in the capacity as a member which gives rise to the petition. Consequently, in Hoffman, because his share-value and holdings were unaffected, whatever grievances he had were in his capacity as employee and thus governed by an employment contract. Just and Equitable Winding up Remedy – s 122 IA A dissatisfied minority shareholder, who is unable to obtain the requisite majority vote necessary for a special resolution for voluntary winding-up can apply to the courts for an order of winding up under s 122 Insolvency Act. For this order it must be shown that one of the circumstances listed therein have been met, the most common ground being ss g): ‘the court is of the opinion that it is just and equitable…’. This order is a last resort remedy as it results in the dissolution of the company. Wilberforce L. acknowledged in Cumberland Holdings that ‘winding up a successful company that is properly managed is an extreme step and requires a strong case’. Accordingly, it is more likely to arise in a small private companies or quasi-partnerships, as in Ebramhimi v Westbourne or Yenidje Tabacco Co Ltd. In Tabacco, the company had two shareholders, both holding equal voting shares, and both directors for life. Although they had a falling out and were not on speaking , the company remained largely successful. However, the CoA upheld an order for winding up, finding the company was in a state no longer contemplated by the parties. Ebramhimi, similarly, had two shareholders who were both directors. Sometime later the one shareholders’ son ed the business as director and acquired 10% of the shares. After a falling out, the son and father voted to remove Mr Ebramhimi as director and precluded his involvement in management. Although the company was still profitable, the HoL believed the company was analogous to a partnership, and based on this, it was inequitable for the parties involved to force Mr Ebrahimi out of the company. Conclusion: The provisions listed above are not an exhaustive list of minority protection devices. As noted, s 213 and s 994 of the CA and s 122 of the IA are ex post statutory remedies. It was feared that derivative actions would 131

flood the courts with litigation. To date, this has not been empirically ed. That said, there are some reasonable concerns regarding the justiciability of business decisions made in absence of procedural defect. The business judgement rule states that courts are (or ought to be) unwilling to impose remedies for negligence claims as directors have been selected by the shareholders and the most appropriate remedy for a breach is removal of that director. The personal actions available under ss 944 and 122 do not carry this same concern as it is the member in their capacity as such that claims the affairs of the company have been conducted in a manner that is unfairly prejudicial to the shareholder. The question therefore is not whether the directors have been in breach of their duties towards the corporation, instead whether the company’s affairs have been unlawfully conducted against the member or class of . The obvious paradox in these remedies is the directors’ duties towards the corporation as a whole (s 172) on one end, and the courts deference to the business judgement, majority vote, and rule in Foss v Harbottle. Presumably these concepts should not come into conflict, but in reality, the minority shareholder may, at times, have their interests subordinated to that of the majority, and even more rarely, when the majority interest is subordinated to that of the minority as in the Canadian case of Tech Corp v Millar.

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(3) Essay # 3 – Corporate Governance Why Corporate Governance: The Sarbanes Oxley Act 2002 (SOX) was an American legislative response to a number of scandals that resulted in the collapse of major publicly held companies including Enron, Tyco, Worldcom and Arthur Anderson. Enron, in particular, was able to hide financial losses through a series of creative and morally hazardous practices, including putting projected profits on financial reports as realized profits and placing debts on the books in shell (special purpose entities) corporations. Once it was exposed, it caused the share value to plummet from almost $100 to mere pennies. The CEO, Jeffrey Skilling was imprisoned. SOX, in response, attempts to strengthen corporate oversight and improve internal corporate controls in order to prevent further abuses. Its main purpose is to protect shareholders from fraudulent representations in corporate financial statements, and to criminalize or sanction violations thereof. One way to ensure the accuracy of these financial reports is to implement independent 3rd party verification. The Companies Act 2006 has implemented similar legislative provisions under Part 15 s and Reports, Chapters 2 – 7. Companies are required to keep ing records (386 & 7) which give true and fair view (393), including off-balance sheet arrangements (410A). These reports require approval and g by the directors and carry both civil and criminal sanctions. A director may also be held liable for false or misleading statements (463). Auditors in both private and public companies can be appointed by directors during a specified time frame, but can also be appointed by through ordinary resolution (485 & 9). The legislative initiatives are meant to instill investor confidence and, in turn, attract investment. The thinking is when investors are informed and can safely rely on financial information they are more likely to invest. Accordingly, good corporate governance practices will incentive investors to invest in their company because those investments will be safer. Conversely, companies with bad corporate governance reputations will deter investment. Often there is confusion between corporate governance (CG) practices and corporate social responsibility (CSR), both of which influence investor attitudes and corporate financial stability. Nevertheless, while complimentary issues, they are conceptually distinct. Corporate Governance v Corporate Social Responsibility: an overview The Cadbury Committee provides the classic definition of CG: it is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of the companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The board’s actions are subject to law, regulations and the shareholders in general meeting. An example of corporate governance practices includes the structuring of the Board and division of powers. Under the UK Corporate Governance Code the board should include a combination of executive and nonexecutive directors in order to disperse power – the non-executive acting to oversee the executive board and act independently therefrom. It also states that there should be a clear division between running of the board and the executive responsibility of running of the company’s business. Thus, the chairman and chief executive should not be exercised by the same person. While in the UK 90% of companies follow a dual 133

strategic leadership pattern, in the US, by contrast, in 80% of US companies, the CEO is also the Chairman of the board, and consequently, this concentration of power likely inhibits effective monitoring (Aguilera “Corporate Governance and Social Responsibility: a comparative analysis of the UK and the US”). CSR, on the other hand, refers to those practices and policies within the company that are committed to ethical behaviour and the objective of improving the quality of life of its employees, community, and society at large. One topical CSR policy is effective and transparent supply chain management in order to reduce the prevalence of slave labour and environmentally degrading practices. The Modern Slavery Bill currently in UK Parliament and the Lacey Act (US) attempt to address these respective issues. Statutory provisions under the Companies Act 2006 – directors duties, s 170-177 – also for socially responsibly governance, as does Article 3(3) of the Treaty on European Union which treats economic and environmental growth as equally significant purposes of the Union. These statutory provisions also demonstrate the overlap between CG and CSR practices as often the former influences the latter, and vice versa. Shareholder voting rights – Appointment of Directors: Ryan et al in Company Law (2015) note that “…the only group actually in a position to ensure that the company is managed for their own benefit are the directors and the only group who have the opportunity to control the directors are the .” (419) Aguilera notes that largest equity investors in both the UK and US are institutional investors. These groups have significant powers in corporate behaviour because their investment capacities are enormous. The pension funds and insurance companies that dominate in the UK have long-term payout stewardship obligations and consequently will invest within companies looking for long term growth, not short term immediate gains at the expense of losses in the future. This is akin to the enlightened shareholder value approach to corporate governance (Cabrelli, The Reform of the law of Directors’ Duties in UY Company Law). The Stewardship Code directly responds to this, its aim to enhance the relationship between institutional investors and companies to improve long-term returns. Moreover, under the Pensions Act 1995, pension schemes are required to disclose the extent to which social, environmental and ethical considerations are taken into when developing their investment portfolio. This requirement in turn signals for the development of coordinated CG and CSR standards (Aguilera). Shareholder democracy is thus an important feature of company law in the UK and US. Not only does it have the ability, through capital investment, to encourage responsible standards, but they can also directly control the company by selecting, dismissing and replacing its directors (s 168) and voting on important strategic decisions. In that vein, “it is possible for large institutional shareholders to control enough shares to overcome the separation of ownership and control in large public companies and have a direct influence on their management” (Ryan et al). We should acknowledge the obvious paradox in the common law principle that directors should manage the company unfettered by the shareholder. While we can accept this extraordinary activity in investors with long-term sustainable gains, the question arises when an investor is able to control/influence the activities of the company negatively, such as a shareholder-centric perspective whereby the member exhausts all of the resources of the company for short term immediate gains, only to leave with the fruits of this abuse? Directors’ Duties s 170 & 172:

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Two key statutory provisions are ss 170(1) and 172 CA. The former states that general duties owed by a director are owed to the company whereas the later states that 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 as a whole, and in doing so have regard for certain matters including: long term consequences; interests of company’s employees; business relationships; impact on the community and environment; reputation; and the need to act fairly between of the company. (Under 172(3) a director may consider the interests of creditors of the company). Section 170 codifies the general rule detailed in Percival v Wright while s 172 expands on this rule by suggesting the company is more than a ‘nexus of contract’ between , and duties are owed to a larger stakeholder body. This does not correlate with a departure from the law and economics movement advocated for by proponents such as Posner, but simply reconceptualises the traditional paradigm of profitmaximizing activity. In that vein, the ‘triple bottom line’ s for benefits or losses that goes beyond direct monetary calculations. This type of ethical direction has garnered more attraction in the wake of the American Financial Crisis, and as the media has focused attention on corporate abuses and irresponsibility. In addition to the CA the UK has soft law codes unenforceable in the courts, but which still influence directors. Both the Corporate Governance Code and UK Stewardship Code are more akin to selfregulation guidelines, lacking teeth of legal enforcement. That said, failure to comply with the Codes requires public disclosure, hence the aptly named “comply or explain” approach. Failure to comply with the Code does not necessarily mean there has been a fundamental or unethical breach. It has been recognized that an alternative provision may be justified in particular circumstances if good governance can be achieved by other means. The advantage of the code is thus its flexibility. That said, the Financial Reporting Council have noted that explanations for non-compliance range considerably in scope, some of which comply only in procedure but not in substance. A fundamental distinction, however, is the Governance Code is directed at the corporate structure whereas the Stewardship Code is directed at institutional investors. Art 3(3) Treaty on European Union: Prof. de Sadeleer at a recent conference – Public Interest Environmental Law – noted Art 3(3) of the TEU explicitly s placing economic growth and improvement of the quality of the environment at the same level. However, there are two competing paradigms that have hampered its development: liberalization v environmental degradation and free trade v neo-protectionist policies. The issue is thus in establishing effective criteria for assessing pareto optimal activities. It is worth noting the ECJ has influenced environmental control mechanisms by allowing member states to pursue MEQRs (Dassonville - measures having equivalent effect to quantitative restrictions) that have a non-financial aim. Therefore environmental protection policies which influence product use and thus market penetration may be lawful. Supply Chain Management –Modern Slavery Bill (UK) and Lacey Act (US): Supply chain management is a salient example of the collision between CG and CSR. Simply defined, SCM is the regulation and transparency of the operations of suppliers, manufactures and all other stakeholders who become engaged with the company. A controversial supply chain exposed in recent years was that of Apple’s manufacturing by China-based Foxcomm. The Modern Slavery Bill currently in UK Parliament will require public companies, including the FTSE 350, to report on supply chains. At a recent conference, CORE, a UK NGO network specializing on corporate ability and transparency, submitted its recommendations on amendments to the MSB to 135

include all large corporations, including those not publically listed. This goes beyond what is required in the EU Dir on non-financial disclosure. Alternatively, the LA criminalizes trade of substances that have been illegally taken, possessed, transported or sold in violation of any foreign law, which makes it unique in character as few other jurisdictions attempt to regulate extra-jurisdictionally. Similarly, as more environmental legislation is enacted internationally (such as CITES and COTES) the further the reach of the Act. Conclusion: CG and CSR practices are regulated through both hard and soft law, such as the Corporate Governance, and Stewardship Codes; by domestic and international legislation such as the Companies Act 2006, Modern Slavery Bill and s. 3(3) of the TEU; by primary and secondary legislation such as CITES and COTES; and through shareholder activism. Events like Bhopal and, more recently, the collapse of the Rana Plaza factory in Bangledash have mobilized parliamentarians and civil society alike to push for more transparency in supply chain management and better corporate governance regimes. The MSB is a positive step in the right direction. Without domestic regulation, transparency and ethical institutional investors, or a fundamental cultural shift in the selfregulation of directors (power corrupts and absolute power corrupts absolutely), victims of poor CG and CSR practices will remain without effective ex ante measures. Ex post, access to justice is a matter deserving of more attention and beyond the scope of this paper. That said, our focus should be on prevention rather than compensation.

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(4) Essay # 4 – Articles and Shareholder Agreements Under the t Stock Companies Act 1844, the Memorandum and Articles of Association made up the company’s constitution, the former covering external relations and the latter internal. Post 2006 Companies Act, the constitution is comprised of the Articles and any special resolutions ed at Companies House (s 17). The constitution provides the rules governing decision-making in the company. It is the framework within which the company operates, and provides a mechanism for deciding questions: day-to-day management being determined by the Directors while the fundamental matters decided by . Section 33: It goes without saying that every company must have articles. Under s 33, the “company’s constitution bind the company and its to the same extent as if there were covenants on the part of the company and of each member to observe those provisions”. In other words, a member enters into a statutory contractual relationship with the company in his capacity as such, and between the inter se. Consequently, the company is a separate person in this contract. Accordingly, the traditional restraints of privity are applicable. Issues arise therefore when a member occupies multiple roles within the corporate structure and when determining whether a right is contractually binding or enforceable as a member (insider rights), or in a different capacity (outsider rights) – discussed below. Last, the issue of pre-incorporation contracts can be quickly dismissed with. Unless through novation a new contract is made with the company, a party cannot (save for some exceptional circumstances) enforce a contract made with the company before lawfully incorporated: Browne v La Trinidad. Statutory v Standard Contracts: A significant distinguishing feature of the statutory contract entered into with the company is an amendment to it only requires a special resolution whereas in a usual contractual relationship both parties must be in unanimous agreement. Moreover, the Contract (Rights of Third Parties) Act 1999 doesn’t apply to in the company’s articles by s 6(2) of the 1999 Act Furthermore, courts are reluctant to ‘rectify’ articles unless the outcome would be commercially absurd, whereas they would not be so with a standard contract. AG of Belize v Belize, for example, Lord Hoffman sided with the Government, holding that rules of construction would not read in provisions left silent in the articles. That said, “Common intentions which are not reflected in the wording of the articles may be taken into when providing relief for unfairly prejudicial conduct of the affairs of a quasi-partnership company.” Last, weighted voting shares provided for in the constitution provides with rights that may be disproportionate with their shareholding. For example, a person holding 100 shares (out of 500) may be able to prevent a resolution depending on the share and voting rights attributed to it. In Bushell v Faith the HoL upheld the weighted voting provision in the articles which prevented the majority shareholders from ing a special resolution because they lacked the requisite 75% vote. Consequently, weighted votes are a similar mechanism as shareholder agreements as the latter can block the statutory right to alter its Constitution.

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Unanimous Shareholder Agreements (USA): may enter into (private) unanimous shareholder agreements. These supplement the articles but do not form part of it. The question is whether they should be filed with the Companies House if they modify the articles. I would argue they should not for two reasons: (1) it does not form the constitution as set out in s 17 and must therefore fall outside the constitution; and (2) because it does not form the constitution it is merely a private contract and enforceable in the capacity as a traditional contract. That said, it would seem more fittingly described as a hybrid agreement enforceable under both contract and statute (under s 29(b)). And revolutionary in nature, able to override the common law rule that shareholders, even when acting unanimously, could not fetter the discretion of directors Insider v Outsider Rights: Authorities suggests that distinguishing between insider and outsider rights is somewhat arbitrary. A member-director, for instance, who is being dismissed contrary to the Articles, can enforce said right as a member rather than director depending on how they phrase the argument. If they attempt to enforce the articles as a director to maintain their position as such, presumably this will and ought to fail. If, however, he insists that he as a director not be dismissed based on his rights as a member to enforce a provision in the articles providing for said resistance, he is perfectly within his rights to do so. Hence, the argument is superficially constructed to avoid grounds for dispute. In Eley v Positive Government, for example, the articles provided that My Eley be appointed the company’s solicitor and should not be removed other than for misconduct. Some years later he became a member and was removed from his office. Instead of relying on his right in the capacity as a member, he attempted to obtain remedy through a supposed contract entered into between the company and himself before incorporated. As noted above, unless there was novation, this is arguable legally unsustainable. That said, it is important to note that although the article requiring the company to employ Mr Eley was a matter between shareholders and directors, and not them and the plaintiff (outsider rights), it may also suggest that every member of the company (including Mr Eley) had a hip right to prevent the directors appointing anyone else as solicitor (insider rights). In that vein, Hickman v Kent Sheep is clear that an outsider whom rights are purportedly given by the articles as an outsider, whether a member later on, cannot sue on those articles treating them as contracts between himself and the company. In Hickman, the arbitration clause was upheld as being an insider right, therefore staying the action. In Salmon v Quin and Axten, Salmon enforced his “outsider rights” as a managing director to veto certain board decisions by suing as a member for the enforcement of the relevant articles. In Rayfield v Hands, Mr Rayfield wanted to transfer his shares but Mr Hands and his fellow directors refused to take them in contravention to the articles. Vaisey J interpreted the reference to the directors in the article as a reference to the class of who were directors and so held that the article concerned hip and had contractual force. He granted Mr Rayfield an order requiring the directors to take the shares but said this conclusion was based on the fact the company was analogous to a partnership. By contrast, in Beattie v Beattie, Greene MR held: “the contractual force given to the articles of association is to define the position of the shareholder as shareholder, not to bind him in his capacity as an individual.” 138

In this case, the company brought proceedings against a director-member concerning his conduct as a director. The CoA held the arbitration article was not enforceable because it was only in relation to hip matters, whereas this concerned his personal activities as a director. (This arbitration clause can be contrasted with Exeter Football Club v Football and Fulham Football Club v Richards where the claimant argued the arbitration clause in the articles violated their statutory rights, as ). Reconciling Enforcement of Articles and the ‘Internal Management Principle’: The concept that the company is the proper claimant in a matter concerning its internal management causes friction in cases like Edwards v Halliwell or Salmon v Quin and Axtens where the court compels directors to act or refrain from acting in a certain way. Wedderburn in “Shareholders’ Rights and the Rule in Foss and Harbottle” rightly points to the attack on Harbottle (which was completely swept aside in Salmon), but acknowledges that Salmon was enforcing a (personal) contractual right stemming from the articles, thereby allowing the courts to by the internal management principle. That said, he notes that “there is a clash between the outmoded rule against internal interference and the simple principle that contracts are enforceable”. If the articles were unenforceable it would render the company’s constitution as little more than ‘guidelines’ which may or may not be followed. Contracting out of Statutory Rights: In Peveril Gold Mines it was held that the articles cannot limit a right given to by statute. In other words, contract out of statutory rights. This principle was endorsed as late as 2004 in Exeter football Club the arbitration clause was avoided in favour of the claimant’s rights exercisable under a s 994 petition. The same issue was returned to in Fulham Football v Richards. This time, however, the CoA held the arbitration clause was enforceable. The leading judgment held the clause as enforceable because the remedies sought under the s 994 petition were similarly available through direct arbitration with the Football Association. The caveat being, in obiter, that if the rights of third parties, such as creditors, were effected then the arbitration clause would unlikely be unenforceable for the same reason above, unless the remedy sought could be granted through arbitration. This case does not expressly overrule the judgement in Peveril, but it would certainly seem to limit its persuasiveness moving forwards. Whether the courts will uphold the contents of the articles in favour of statute will presumably depend on policy considerations and tension between the contract and statute. For example, in Peveril the winding-up petition sought could not be prevented by provisions in the constitution requiring satisfaction of certain conditions before authorization would be granted. The tension arises when the petitioner is unable to acquire the requisite authorization which precludes action pursuant to what is now statutory rights under s 122 IA. In Fulham, however, after arbitration, if unsatisfactory, the claimant could pursue action under s .994 petition. That said, it is possible for a member to make a shareholder agreement and thus contract out of the right to bring a winding up petition outside of the company. This would be consistent with the American “nexus of contracts” perspective. While in both arrangements – articles limiting statutory rights or by ordinary contract – the fundamental paradigm that statute is superior to contract is challenged. Why one approach is favoured over the other may be as simplistic as that in the UK USAs more frequently arise in small companies. Accordingly, this is a legitimate way to curtail an abuse of statutory rights that would not otherwise arise in a similar business structure, eg, partnership.

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Conclusion: The articles are not intended to be a complete statement of – to borrow from the traditional contractual vernacular. Instead, they provide a procedure for deciding questions as they arise. For instance, whether a resolution is to be decided specially or ordinarily; what rights shares have, and so on. Unless stated otherwise a constitution can me amended by a 75% majority. Entrenchment provisions –which require more restrictive condition than a special resolution s 22(1) CA 2006 - can make it difficult but not impossible to amend the constitution. The raison d’etre being that a constitution ought not to be easily amended so that the shareholders are confident that their rights are protected. This in turn spurs investment. Hence the wise policy decision in Russell v Northern Bank that held a contract made by a company that it will not exercise its statutory power to amend its articles is unenforceable. In the past, articles contained ‘restricted objects’ which limited the activities a company could lawfully engage in. Chartered companies, for example, were limited both in scope and frequency, and were ‘gifted’ by the people when required for the construction of large industrial projects. Now, with unrestricted objects, companies can engage in activities unfettered by their constitution. While conducive towards profitmaximizing activities, it limits ’ actionable causes to essentially procedural irregularities.

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