Company Law: Problem Question and Analysis - Essay Example

? Company Law – Problem Question- Analysis Issue Michael, Kevin and James are the directors of the Standard Constructions Ltd. They took a decisionto purchase a piece of land for ?500,000 that is to be used for a building development. Despite the fact that the land having an enclosure on its three-sides by present developments but on the fourth side , there are two separate two-meter strip of land runs parallel to the land in the fourth side , and this prevents access to the road, and makes development impossible. Hence, it is presumed that there will be a substantial financial loss that may arise to the company due to their inadequate diligence, care, skill and negligence. S 171 to 177 of CA 2006 speaks about the duty owed by a director of a company to the company. On the footing of equitable principles and on some common rules, these general duties have been imposed on a director, and director has to act in accordance with the same without showing any negligence while performing his duty as a director of a company. The general duties will be construed and extended in the same way as under equity principles and under common law rules and due weight will be given to the appropriate equitable rules and common law rules in construing and applying the general duties. As per section 172(1) , a director of a company must function in the style he regards , in good trust , which is most probably to enhance the growth of the company for the advantages of its shareholders in its entirety, and in exercising so, should give due consideration to the following: The probable outcome of any business decision in the long run. The requirement to function fairly as between the shareholders of the company. Further, under CA 2006, statutory statements on directors’ duties have been included, which covers the following provinces concerning the director’s duties. Duty to work hard for the success of the company Duty to apply independent judgment while making business decisions Duty to exercise adequate diligence , care and skill The above sections of the CA 2006 expect that a director of a company must function in a style that he regards, in good faith and trust. Further, the other key feature is that the director’s duty to make judgments which are most probable to advance the growth of their company. In other words, it is the duty of the director not to act negligently. However, casual failures or sincere commercial misjudgments will not tantamount to the claims of negligence. It is to be remembered that the directors owe their duty to the company and not to any individual. However, in Dorchester Finance Co Ltd v Stebbing,1 a director was found to be negligent in his duty as he left signed blank cheques with another director. In Cohen v Selby, 2 a director was held liable for assigning a task to a specific employee who is not fit for that duty assigned3. In case of business judgment, the courts have been ever unenthusiastic to interfere. Further, the CA 2006 is not precise about how board of directors of a company should report their adherence under section 172 in board minutes. It is advised that companies may find it secure to add a reference to the fact that the directors have adhered to the decision making provisions as demanded in section 172 in their board minutes to escape any charges of negligence later. 172 of CA 2006 demands that a director should function bona fide in a manner that would kindle the success of the company for the advantage of its member in their entirety. In Rgentcrest Plc (in liq) v Cohen , it was held that the directors should act in what they think and should not act in what the court may think, and it should be for advantage of the whole of its members4. The section 173 requires the director of a company to use his independent judgment while making business decisions. This section facilitates the director to take an opinion from experts or in certain case, if a director fails to take proper advice from an expert will be regarded as an infringement of their fiduciary duty. However, after analysing the opinion of such experts, the director should take a final decision on any issue by applying his independent judgment. In this case, all the directors have not applied their independent judgment while buying the piece of land by not looking into the obstruction for the common way in such site5. Further, a director is needed to exhibit a duty of skill and care while exercising his duty as a director. In the famous case of Re City Equitable Fire Insurance Co Ltd6, the following two yardsticks were considered to test whether a director applied a duty of skill and care while executing his duty as a director. If a director has been appointed due to his professional characteristics, he is expected to render necessary professional standard that is ordinarily expected from caliber of such a profession. For mere judgments of error, directors were not liable to be held accountable. Further, a director is not expected to exhibit a greater magnitude of skill than what is expected from an individual possessing of such experience and knowledge7. If a director has left signed blank cheques with another director and a fraud has occured , then such director cannot escape the liability under negligence. If a director is held liable for assigning a task to a specific employee who is not fit for that duty assigned as he has not exhibited duty of care . Hence , a director should refrain from such activities to prove his innocence. Issue II One of the directors of Standard Constructions Ltd, James is working as a consultant for another rival company that also develops property in Oldchester. As per s 175(1) of the CA 2006, a director of a company is having a duty to avoid conflict of interest. In Aberdeen Rly Ltd v Blaikie Brothers8, it was viewed that a director was barred to enter into any business dealings for his own interest as it would tantamount to conflict of interest of the other shareholders of the company9. In Industrial Development Consultants v Cooley, a director came to know a business opportunity while he was a director of a company and then, he later resigned from the directorship of the company and availed that business opportunity in his personal capacity. Thus, in this case, it was held that the director was accountable for not only the profit he made but also the loss sustained by the company in this respect10. If a director causes financial losses to the company due to his personal interest, then such contracts can be voidable at the option of the company unless the such business dealings has been endorsed or ratified by the members in the general meeting of the company where full disclosure about such contract is made by the company about the nature of his interest in such contract as held in DEG-Deutsche Investitions v Konshy. 11 It is to be noted that in J.J. Harrison (Properties) Ltd v Harrison, a director was held liable for buying his company’s property at a low value12. In the given case, no disclosure of information by James to the board and shareholders of the company and Mathews also colluded with him. Thus, both the James and Mathews will be held liable for making secret profit and as James having a personal interest in the rival company which will fall under conflict of interest. Under English company law, it is well ascertained that a shareholder in principle cannot personally sue for the loss as the loss has been incurred by the company and not by the member concerned. For example, the loss that emanates from a wrong unleashed on the company, then it is the company that is entitled to sue. This view was established in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)13. The same view was also confirmed in Johnson v Gore Wood & Co 14 Nonetheless, in Giles v Rhind15, and in this case, a shareholder was permitted to sue personally for reflective loss by a Court of Appeal. In this case, the company was bankrupt and was unable to initiate proceedings since it did not have adequate finance to offer security for costs. A shareholder was permitted to raise a claim as the company had no cause of action to recover this loss. Under English law, a shareholder is barred from raising personal claims as it is the company that can sue for its own losses. This rule is applicable regardless whether the company really kicks off any action or regardless the fact, whether a derivative claim for the sake of the company can be initiated or not. This is also known as the Prudential Principle. In case of any act or omission which involves a default ?negligence, breach of trust or breach of duty by a director of company, before the introduction of Part II CA 2006, only the company is the proper claimant for a cause of action against such a director .However, after the introduction of Part II CA 2006, the shareholders of a company are empowered to initiate a derivative action on behalf of the company. Thus, this statutory derivative action has, in reality, substituted the traditional rules on derivative actions available under common law, which is known as famously as the ruling in Foss v Harbottle16. Further to the statutory protection in the form of derivative action available under Part II CA 2006, there is another statutory derivative action is available under s.996 (2) (c) of CA 2007. Under this section, the court may permit an applicant under the unfair prejudice relief which is very occasionally employed for this type of claim. Why this route is not preferred is that it is not only time-consuming but also expensive in nature and also involves a circuitous route when contrasted with the relief of a derivative action available under Part II CA 200617. A petitioner before initiating with a derivative action, he must first initiate proceedings under the unfair prejudice relief. It is to be noted that only very little number of cases, the order was requested for and there are very few cases that had been reported under s.966 (2) (C) CA 2006. It is to be observed that despite the existence of a statutory derivative action claim, some courts have permitted petitioners to look for relief under the unfair prejudice relief through an order for financial compensation. As held in Lowe v Fahey18 and Clark v Cutland19, the relief can be sought against erstwhile members, present members, and directors who are associated in the misuse of company’s funds or properties, or it can be sought against third parties, when they improperly helped or have knowingly received in such wrongful diversion of funds or assets of the company. Secret Profit The notion of secret profit is a rather intangible one and it bar directors from obtaining remuneration for their services. By virtue of the position as a director, if profit accrues to a director, then it will be known as secret profit. In Cook v Deeks20, a construction contract was negotiated by two directors for the company and later, they took those contracts in their personal name. It was held by the Privy Council that they were liable to their company for the enrichment of profits by them. These directors were able to make the profit purely due to their position as directors of the company21. By virtue of their fiduciary position of a director, any monetary gains they enjoy due to their status in the company are considered as belonging to the company as held in Warman International Ltd v Dwyer22, in Real Estate Pty Ltd v Valerie Dellow & Wayne Arnold 23 and in Natural Extracts Pty Ltd v Stotter.24A secret profit earned by a director means that he failed to inform the same to the board of the company. It is the fiduciary duty of a director to hand over what are all called as secret profits; it appears that secrecy in this background connotes failure to receive approval instead of actual secrecy. In Regal (Hastings) Ltd v Gulliver25, both under the companies Act and under the common law, the directors are barred from availing corporate opportunities or inside information for their personal profit or employing their status in the company, and in Paul A Davis (Australia) Pty Ltd v Davies & Sons26 , the directors were barred from employing the company property, and in Furs Ltd v Tomkies27 , directors are barred from employing the company information28 . In this case, James worked in the rival company, and Michael also colluded with him without disclosing the same to the board. These acts were serious in nature, and they are liable to be disqualified from acting as a director of a company in the future under the Company Directors Disqualification Act 1986 .In Blackspur Group Plc29, it was observed by Lord Woolf MR that the main objective of the 1986 Act is the safeguard of the public through the propitiatory remedial action though the expected restraint impact on further delinquency and to impose higher norms of diligence and honesty in administration of companies, mainly to bar those unfit persons from managing the company30. In Re Sevenoaks Stationers (Retail) Ltd, it was viewed that the company disqualification act is an effective tool to punish those directors who are misusing or abusing their position as director of a company. Further , in Re Lo-Line Electric Motors Ltd , it was viewed that main aim of the s6 of the Company Directors Disqualification Act 1986 is not to punish the director but to safeguard the gullible public against future misconduct of such mischievous director whose erstwhile records showed that he was responsible for bad administration31, One another remedy available for the shareholders of Standard Constructions Ltd to initiate an action against the wrongdoing directors namely Kevin, Michael under unfair prejudice remedy relief. Under section 994 of the Companies Act 2006, any individual member or group of shareholders can approach the court for requesting an order through a petition that the affair of the company is being handled in an unfairly prejudicial manner of a shareholder or group of shareholders of such company. In 32O Neill v Phillips33, it was observed by the House of Lords that the relief under the unfair prejudice will not be available unless there is a strong proof that the company’s affairs have been conducted against the equitable principals or not in a good faith, and these actions by directors are unfair especially for the shareholders of the company34. Thus, a derivative action against James and Michael can be initiated by the members of the company or a relief under section 994 of Companies Act 2006 (unfair prejudice) can be initiated against James and Michael. Further, shareholders can initiate an action against James and Michael under the company Director’s Disqualification Act for the mischief or making secret profit. If a director made a full disclosure about the contract in which he is interested and the nature of his interest in such contract to the board or the members and, if he obstained from voting on such resolution , he may escape the from the charge of clash of interest. If approval from members has been obtained , then he will not be regarded as acting aginst the interest of the company. In case of a secret profit?it is the duty of the director to make full disclosure to the board else he would be accountable to the company. Bibliography Cassidy J A, Concise Corporations Law (Federation Press 2008) Hicks A & Hoo S H, Cases and Materials on Company Law (Oxford University Press 2008) Lacy J D, The Reform of United Kingdom Company Law (Routledge Taylor & Francis Group 2009) Pacces A M, The Law and Economics of Corporate Governance: Changing Perspectives. (Edward Elgard Publishing 2010) Storach J S & Ellis J G, Business Law 2007 -2008 (Oxford University Press 2010) The City Law School, Company Law in Practice (Oxford University Press 2009) Vries P P, Exit Rights of Minority Shareholders in a Private Limited Company (Kluwer Law International 2010) Read More