Directors Duties, Minority Protection of Shareholders - Coursework Example

 Consider the following: a) The formation of a company; b) The duties that directors owe to a company; c) The protection of a minority shareholder in a company; Briefly describe how Company law operates with respect to two of the above. In particular, how does the Companies Act 2006 impact on the two areas you describe? Introduction The Companies Act 2006 (CA) codifies previous legislation regulating company law1and the focus of this paper is to briefly analyse the impact of the Companies Act 2006 to the duties directors owe to a company and the protection of a minority shareholder in a company. Various sections of the CA have come into force over a staged process. In section 1, I shall evaluate the central changes impacting directors’ duties and in section 2, I shall analyse the impact of the CA on protection of minority shareholders and the new statutory claim replacing the pre-2006 Act common law position. Section 1: Directors’ Duties The issue of directors’ duties is inherently intertwined with the authority to bind the company and enforceability of contracts against a company. The relevant provisions relating to authority are sections 39 and 40 of the CA 2006, which came into force on 1 October 2007. Section 39(1) of the CA provides that “the validity of any 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.” Additionally, section 40(1) provides that: “In favour of a person dealing with a company in good faith, the power of the board of directors to bind the company, or authorise others to do so, shall be deemed to be free of any limitation under the company’s constitution”. Moreover, prior to the CA 2006, the 1989 Companies Act and the Companies Act 1985 provisions pertaining to directors’ duties provided positive obligations for directors to act in good faith and in the best interest of the company, to avoid conflicts of interest and not to profit form their office2. These statutory provisions applied in conjunction with established principles of common law and equity in relation to directors duties3. However, in the consultation phase leading to the implementation of the CA 2006, the Government expressed dissatisfaction at the inherent uncertainty of these provisions and have attempted to codify both the common law and statutory provisions pertaining to directors duties under the CA 20064. With regard to directors’ duties, Section 171 of the CA provides that “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”. Moreover, the duty on directors to act within their powers codifies the common law principles regarding exercise of power for a proper purpose. Under section 172 of the CA, there is a new duty deriving from the equitable fiduciary duty principle expressed as a duty to promote the success of the company. To this end, section 172(1) sets out a non-exhaustive list of guidelines that a directors should refer to including (without limitation) the relationship with suppliers and customers, impact of decision on environment and members of the company. Furthermore, section 173 of the CA 2006 imposes a positive duty on a director of a company to exercise independent judgment. Section 174(1) sets out the common law duty of care and skill and section 174(2) sets out an objective test similar to the dual obligations test extrapolated under section 214 of the Insolvency Act 1986 in relation to the wrongful trading provisions. Section 177 requires disclosure of interests however goes further by requiring nature and extent of interest to other directors and disclosure extends to person connected with the director. The previous conflict of interest provisions under the Companies Act 1985 were criticised for being complex and the CA 2006 aims to simplify the previous provisions with the intention of reflecting contemporary commercial practice5. Section 175 further imposes a positive obligation on directors to “avoid a situation in which he has, or can have, a direct or indirect interest that conflict, or possibly may conflict, with the interests of the company.” Section 176 further prohibits directors from taking benefits from third parties and that a director must declare all interests in proposed transactions and arrangements under section 177 of the CA. Moreover, the common law and equity impose duties on directors and section 179 of the CA expressly states that “the consequences of any breach… of sections 171 to 177 are the same as would apply if the corresponding common law rule or equitable principle applied”. Equitable duties of a director arise from the fiduciary relationship between a director and company and as such, directors have a general duty to act in good faith and exercise their discretion bona fide in the interests of the company6. Moreover, directors must exercise independent judgment in order to prevent a claim for breach of duty of good faith7. The fiduciary duty to act in good faith and in the interests of the company is a duty as a whole and the duty is subjective. For example, in the case of Re Smith v Fawcett Ltd8it was held that directors must act “bona fide in what they consider is in the best interests of the company9”. Directors must also make proper use of their position and the information they acquire through their position10 and the case of Cook v Deeks11 asserted that directors cannot take advantage of an opportunity or information that belongs to the company without prior approval of the company. The common law fiduciary duty is further bolstered by the provisions of the Company Directors Disqualification Act 1986, where the courts can disqualify directors whose companies have failed as a direct result of their misconduct for periods up to 15 years. Additionally, a breach of fiduciary duty will impose a liability a director to account for profits made. The problem in the common law is that here funds are mixed it is very difficult to make a proprietary claim against the funds limited to complex principles of the rule in Clayton’s case, pari passu or the North American Rolling charge. Nevertheless, due to the breach of fiduciary duty, equity will impose a constructive trust, by imposing a duty on the fiduciary to hold the money on trust for the company 12. This was asserted by the ratio of the Court of Appeal case in Agip Africa v Jackson13 where it was held that that equity will allow tracing through mixed bank accounts. In the case of Barnes v Addy14, Selborne LC stated that “strangers are not to be made constructive trustees unless (they) receive and become chargeable with some part of the trust property or unless they assist with knowledge that it is a dishonest and fraudulent design on the part of the trustees”. Knowing receipt occurs when property has been received knowingly in breach of trust15. Fiduciary duty is a generic term that covers a wide range of situations that occur where someone is held to have particular obligations to another party because of their relationship with them16. Overall, the intention of the 2006 Act’s reforms was to clarify the parameters of directors’ duties by codification of both the previous statutory provisions and common law principles within one framework. However, the CA 2006 highlights the fact that the provisions are to be interpreted in accordance with precedence, which in turn has been criticised for undermining the purpose of codification17. It remains to be seen how far the new provisions on director’s duties will manifest in practice, however whilst welcome in attempting to simplify the framework, it is submitted the new provisions on directors’ duties create uncertainty with the inherent ambiguity of the obligation to promote a company’s success, which increases the risk of litigious shareholders particularly in light of the CA 2006’s new provisions regarding derivative actions. Section 2: Minority protection of Shareholders. It is a well established principle that company law offers added protection to minority shareholders18 however, the fraud on the minority principle for the purpose of the exception established in Foss v Harbottle,19 has been further limited by the ability of companies to ratify any acts that are ostensibly ultra vires20. However, section 994(1) of the CA (which came into force on October 2007) enables a company member to “apply to the court by petition for an order under this Part on the ground of……… unfair prejudice”. This includes acts that have been committed by a company or proposed acts which may be unfairly prejudicial. The provisions of section 994 are the same as the previous section 459 provisions under the Companies Act 1985 and case law decisions under the previous section are likely to be applied to CA applications. With regard to the definition of “unfair prejudice”, there is no statutory definition under section 994 this is ultimately a question of fact and it is not necessary to establish a lack of good faith21. Furthermore, in the case of Re R A Noble & Sons (Clothing) Ltd,22 Nourse J asserted that the relevant test for unfair prejudice was whether there was unfairly detrimental effect on the interests of the member making the application. It was further asserted that the decision should be based on fact and degree, which involved a consideration of whether reasonable directors would have decided the action was unfair23. It is evident that many applications for unfairly prejudicial conduct have in practice arisen from exclusion of directors and discrimination against a minority24. Alternatively, new sections 260-269 of the CA introduced a wider range of circumstances in which a derivative claim may brought by a shareholder and enable shareholders to pursue derivative claims in respect of an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director. As the directors’ duties have been arguably widened under the CA, the new statutory right for shareholders has fuelled debate as theoretically any breach of duty appears to be actionable under the CA irrespective of whether the director has benefited personally from the breach25. Furthermore, a significant change under the CA is the fact that shareholders no longer have the burden of establishing that directors actually control the majority shareholding. Indeed, under the statutory procedure, section 263(4) of the CA provides that in considering whether to grant permission for the statutory action, the court will have “particular regard to any evidence before it as to the views of the members of the company who have no personal interests, direct or indirect, in the matter”. The statutory provisions of sections 260-269 do not replace the rule in Foss v Harbottle, however they set out new rules for derivative claims. In particular, the sections implement a two-stage procedure for derivative claims: 1) the claimant has to establish and present a prima facie case for their claim, which the court considers and at this stage the courts can dismiss the application; 2) If a case is established, the court will consider a range of other factors before granting permission as highlighted above. Under this derivative claim, the claimant’s action is effectively on behalf of the company’s rights and therefore if successful, any benefits will accrue to the company and not then member personally. Whilst arguably widening the ambit of minority shareholder protection, which pre-2006 had been restricting the rule in Foss v Harbottle, the CA 2006 does nevertheless implement some protection mechanisms by requiring shareholder claimants to establish a prima facie case. Moreover, the procedural requirements combined with the courts’ rights to refuse permission and award costs against a claimant arguably provide built in protection mechanisms against floodgate claims triggered. Nevertheless, it remains to be seen how courts will apply the new provisions. In any event, there appears to be a general consensus amongst commentators that the majority of shareholder actions will most likely be brought under the section 994 unfair prejudice provisions due to the potential of recovering personal damages as opposed to the statutory derivative action26. Nevertheless, it is questionable how far the legal position regarding fraud on a minority and protection of minority shareholders has been clarified by the CA provisions. BIBLIOGRAPHY N Bourne., (2007). Bourne on Company Law. Routledge-Cavendish. Dignam & Lowry (2006). Company Law.4th Edition Oxford University Press. Butterworths Company Law Handbook. 22nd Edition. Farrar (1999). Farrar’s Company Law. 4th Edition Butterworths. Brenda Hannigan (2003). Company law. 5th Revised Edition. Oxford University Press Hannigan “Contracting with Individual Directors” in Rider (eds) The Corporate Dimension (1998). Keenan (2005). Company Law. Pearson. Mayson, French and Ryan., (2007). Company Law. 24th Revised Edition Oxford University Press. G Morse., (2007). Palmer’s Company Law. Sweet & Maxwell. L.Sealey., & S.Worthington., (2007). Cases and Materials in Company Law. 8th Edition Oxford University Press. Companies Act 2006 www.companieshouse.gov.uk Read More