Overview of the Companies Act 2006 - Essay Example

? Company Directors Question Advise Ben and Holly on the ways in which Gaston and Poppy’s potential investments can be accommo d in light of thewishes of Ben, Holly, Gaston and Poppy. In order to advise Ben and Holly in respect of the accommodation of potential investments by Gaston and Poppy, the relevant provisions of the Company Act 2006 have to be examined. In addition, relevant provisions in respect of allotment of shares have to be scrutinised. The Companies Act 2006, under section 171, requires directors to act as per the provisions of the constitution of their company. Moreover, directors have to exercise their powers only for the purposes for which these powers had been conferred on them. 1 Thus, in Rolled Steel Products (Holdings) Ltd v British Steel Corporation the disputed transaction was not held to be void. The court came to this decision as the transaction was not wholly beyond the capacity of the company.2 The directors of a private company with just one class of shares are permitted to allot the same class of shares. In addition, they can convert securities into such shares. 3 Moreover, such directors can grant rights to subscribe to such shares. However, these share allotment activities are subject to the prohibitions of the Companies Act 2006. 4 In all other instances, share allotment is permitted to the directors of the company, only if there is specific authorisation to do so by the Articles of Association of the company or there is a company resolution to that effect. Such authorisation has to specify the maximum number of shares that can be allotted under the authorisation. 5 As such, directors are instrumental in decision making and other critical functions of the company. The law relating to conflict of interests is intricate, and the director of a company should seek legal advice in this regard. In addition, it is necessary to ensure that the company’s constitution provides the required authority to a director in a specific situation. 6 However, Section 175 of the Companies Act 2006 does not cover all the functions of the directors. For instance, it does not deal with instances, where a director intends to have transactions with his company. This should be permitted by the constitution of the company. Moreover, under the provisions of section 177, the director has to make proper disclose to the board of the company. 7 There should be proper flow of information to the directors of a company. This is indispensable for the proper and efficient functioning of the company. As such, it is obligator for the company board to ensure that the directors have a proper flow of information. This is essential, as there is a statutory obligation on directors to take into consideration particular matters at the time of taking decisions. 8 Companies formed prior to the enactment of the Companies Act 2006, can acquire the same status regarding the issue of shares, by resolving to excise the clause relating to authorised share capital from their articles of association. In addition, these companies should resolve to bestow upon their directors the powers granted under section 550 of the Companies Act 2006.9 Companies formed under the Companies Act 2006 are not limited with regard to the number of shares that they can issue. 10 Section 550 of this Act provides that in the absence of a specific prohibition in the articles of association, the directors of a company with only one class of shares are at liberty to allot shares without requiring the authorisation of the shareholders.11 In addition, section 550 of the Companies Act 2006 empowers the allotment of shares by the directors of a private company that has only one class of shares. Such allotment of shares does not require prior authority from the members of the company. Furthermore, this power can be precluded or restricted by the members, via the Articles of Association of the company.12 In our problem, Ben and Holly realized that the Kingdom Ltd company would not be in a position to grow without the obtention of further financing for the latter. As a result, they came to the decision to allot shares to Gaston who had offered to invest ?10000 in the business. In return, he had asked for a guaranteed seat on the board of the company. Thus, Gaston invested a large amount towards the share capital of the company. Moreover, he sought an assurance from Ben and Holly that the company would only utilise wood that had been procured from environmentally sustainable sources. As per the provisions of section 172(1)(d) the Companies Act 2006, a director of a company must act in a manner that promotes the success of the company and its members. However, the director has to ensure that the operations of the company are not detrimental to the community or the environment. Therefore, Gaston’s insistence upon employing materials that do not the harm the environment is commendable. With regard to this aspect, making Gaston a member of the company’s board is to the benefit of the company. Consequently, it is not inequitable to make him a member of the company’s board. Moreover, Gaston has a substantial proportion of the share capital of the company. However, it should be ensured that the interests of the company are not compromised, due to making Gaston a member of the company’s board. For example, in Kregor v Hollins, the principle that a director cannot allow his discretion to be influenced, by a contract with some external party, was established. The defendant had come to an agreement with the plaintiff, whereby he would pay the plaintiff to function as his nominee director. Subsequently, the defendant did not pay Kregor, who succeeded in a suit. The court found that their agreement did not require Kregor to accord greater importance to Hollin’s interest, in comparison to that accorded to the company.13 In our problem, Gaston has insisted that the provisions of section 550 of the Companies Act 2006 are not to be applied. This condition imposes a restriction on the powers of the company’s board, in the context of allotting shares. Financial compulsions compelled Ben and Holly to agree to this condition, although with great reluctance. As such, shares cannot be allotted, without the prior authorisation of the board of the company. Similarly, Poppy’s investment should also be accommodated with prior authorisation from the members of the board only, since Ben and Holly had agreed to such a clause with Gaston. Despite this state of affairs, Ben and Holly allotted shares to Holly’s sister Daisy and that too during the absence of Gaston. The latter had at that time left the country, in order to review sources supplying wood by means that were not harmful to the environment. In addition, he was in a place where communications were difficult. During that time, Ben and Holly sent an electronic mail to Gaston, knowing fully well that the latter would not obtain the information. With regard to shareholder meetings for private companies, there should be a notice period of a minimum of 14 days. This is as per the provisions of section 307(1) of the Companies Act 2006. However, this need not be insisted upon if the Articles of Association of the company specify differently in this regard, and this has been provided for under section 307(3) of the Act. With regard to new companies that had not yet conducted an annual general meeting, there is the choice of passing special resolutions in a general meeting. 14 In our problem, this requirement of notice period for an offer of allotment was not adhered to by Ben and Holly. They had breached the provisions of the Companies Act 2006. This related to the issuance of notice, in the context of meetings involving the members of the company. As a result they are liable for breach of the Companies Act 2006. Question 2 Advise Ben and Holly on whether the issue of shares to Daisy was lawful and if it wasn’t, what the consequences might be for them and for Kingdom Ltd. It is incumbent upon a director to adopt a course of action, in good faith, that he considers the best for promoting the success of the company and the interests of the all the members. During the course of such action, the director has to take cognisance of the possible outcomes of any decision in the long term, the interests of the employees of the company and the necessity to promote and preserve business relationships of the company with customers, suppliers and others.15 A statutory right of pre – emption is granted to the existing shareholders of a company, whereby they have to be offered new shares first, in proportion to their shareholding. Most importantly, shareholders have to be provided written notification regarding any new share issue, and such offer has to be kept open for a minimum of 21 days. 16 Sections 560 to 577 of the Companies Act 2006 relate to pre – emption. This has in the main, been modelled after the regime prescribed in the 1985 Act. All the same, some significant changes have been effected to pre – emption. First, the erstwhile 21 day mandatory period for pre – emptive offer s has been reduced to a period that is not less than 14 days.17 The second change relates to the commencement of the period of the pre – emptive offer. This can begin when the offer is sent, whether it is in the electronic form or hard copy. However, the period of the pre – emptive offer cannot start, until and unless all the shareholders are in receipt of the offer.18 In our problem, Gaston was not offered new shares at the time of their allotment to Daisy. As per the provisions of the Companies Act 2006, new shares should be first offered to the existing shareholders. Such offer should be open for a minimum period of 14 days, prior to their allotment to a third party. In our case, proper notice was not sent to Gaston. This is because; Ben and Holly sent an electronic mail to Gaston, knowing fully well that Gaston was not in a position to receive electronic mail in the place where he was residing at that time. The following discussion provides an assessment of a director’s power under the Companies Act 2006, to allot shares to members of the company. Any grant of discretion to directors, regarding refusal to transfer shares, has to be exercised bona fide. Section 771 of the Companies Act 2006, enjoins upon directors to register transfer of shares or provide the transferee reasons for refusal or notice of refusal. This has to be done within two months. 19 Thus, in Re Smith and Fawcett Ltd, it was held that the directors of a company had to act bona fide with regard to what was in their considered opinion, in the best interests of the company. This duty to act in good faith is not subjective, as has been demonstrated in several cases, wherein directors have been deemed to have breached their duty to act in the interests of the company. In these cases, the courts were of the opinion that the directors had failed to give proper consideration to the matters on hand. 20 With regard to transfers governed by pre – emption rights, the directors of the company should abstain from registering transfer of shares to outsiders, till such time as the existing shareholders have not been offered the shares. Failure to do so, renders the equitable interest of existing shareholders in the shares of higher priority in comparison with the equitable interest of the transferee. 21 Thus, in Tett v Phoenix Property and Investment Co Ltd and Others, shares of the company were not to be transferred to outsiders, as long as an existing member of the company was desirous of purchasing the same. This condition in the Articles of Association of the company was violated and shares were transferred to the plaintiff. 22 Subsequently, the directors of the company refused to issue a share certificate to the plaintiff. In addition, they did not enter the plaintiff’s name on the register. The lower court held that the transfer of shares to the plaintiff was valid and directed the company to register his name as a member of the company. On appeal, the higher court held the transfer to be invalid as the Articles of Association placed an unambiguous and enforceable condition, which could not be violated at the time of transferring shares to an outside.23 Similarly in our case, Ben and Holly transferred the shares to Daisy, without offering the same to Gaston. As per the above discussion and case law, Ben and Holly are under a legal obligation to offer the shares to Gaston prior to allotting the same to an outsider. As such, they have violated the provisions of the Companies Act 2006, relating to pre – emptive rights. Gaston can make a claim for his pre – emptive rights and make Ben and Holly liable under the provisions of the law. Gaston was incensed over this allotment of shares to Daisy, without being offered to him. Consequently, Gaston can approach a court of law, claiming redressal under the provisions of the Companies Act 2006, for the losses suffered by him. Furthermore, he can obtain a court order for declaring invalid, the allotment of shares to Daisy. Question 3 Advice the directors of Kingdom Ltd on the redress that might be available to the company in respect of the two issues outlined above. If the company’s directors are not willing to take action to recover for the company’s losses, might the shareholders have any alternative methods of recovery? Derivative action against a company director is permitted, under section 260 of the Companies Act 2006, with regard to omissions or acts that are tantamount to breach of duty or trust, default, and negligence.24 This section widens the circumstances under which shareholders can initiate derivative action against directors. 25 For instance, there is no necessity for a director to have benefitted from negligent behaviour for derivative action to be initiated against that director.26 All the same, the courts have been provided with considerable control and discretion with respect to the procedural features of derivative claims. Section 261 of the Companies Act 2006 enjoins a two phase procedure for exercising control over derivative suits. In the initial phase, the shareholder has to provide a prima facie case to court, in order to obtain permission to continue the derivative action.27 The court decides solely on the basis of such evidence provided by the shareholder. If the company had ratified or authorised the act or omission by the director, then the shareholder’s claim has to be dismissed by the court.28 Similarly, if the shareholder is unable to make a prima facie case, the action will be dismissed by the court. Thereafter, the second phase commences, which occurs prior to the commencement of the substantive action. At this stage of the process, the court may direct the company to respond to the claim by producing evidence.29 With the enactment of the Companies Act 2006, shareholders were empowered to initiate civil action on behalf of the company against a third party or company director. This right pertains to the conduct of the director. However, no action can be brought if the company itself does not have a claim in this regard. Such claims can be in the context of an alleged breach of duty or trust, such as the duty to exercise reasonable care, skill and diligence or to promote the success of the company. This Act includes shadow and former directors under the ambit of the term director. 30 In such claims, the court takes into account several factors. These include the possibility of the act or omission of the director being ratified by the company, and whether the company itself evinces interest in bringing the claim. If the member brings the claim personally, the usual course to be adopted is for the shareholder to resort to a personal action, rather than a derivative claim. Most importantly, the court will take into consideration, the views of members of the company who have neither a direct nor indirect interest in the matter.31 Section 171 of the Companies Act 2006 stipulates that directors, during the discharge of their functions, should not exceed the powers conferred upon them by Articles of Association of the company. Moreover, directors should ensure that the company does not act in a manner that is contrary to what has been permitted in its Memorandum of Association. 32 Section 172 of the Companies Act 2006, requires the directors of a company to promote the success of the company. Thus, a director should act in good faith for the success of the company and the best interests of its shareholders. 33 In this endeavour, some of the requirements of directors are that they should consider the interests of the employees of the company, business relationship with suppliers, customers, and others who have transactions with the company. Moreover, directors have to take into account the impact of the functions of the company on the community and the environment. The director should always strive hard to maintain the reputation of the company. 34 In Regentcrest plc v Cohen, a director’s breach of his fiduciary duty resulted in considerable loss to the company. The director was hard pressed to convince the court about his firm and honest belief that his act was in the best interests of the company.35 Furthermore, fiduciary duty is not breached on account of mere incompetence, as was decided in Extrasure Travel Insurances Ltd v Scattergood.36 The case of In Plus Group Ltd v Pyke related to the fiduciary duties of directors, with special focus on corporate opportunities. The In Plus Group Ltd developed strong animosity towards one of its partners, namely Pyke, who had strongly objected to tendering his resignation. This company excluded Pyke from the management and severed his salary. The much harried Pyke formed his own company and obtained a contract from one of the major customers of In Plus Group Ltd. The latter company initiated legal action for breach of fiduciary duty. The court held that Pyke had been effectively excluded from the company and was therefore relieved of any liability towards the In Plus Group Ltd.37 A company director is not required to declare an interest, as long as it cannot be reasonably expected to generate a conflict of interest. This has been stipulated in section 177(6) of the Companies Act 2006. In some companies, it is necessary for the shareholders to approve of the non – declaration of interest by a director. 38 On the other hand, some other companies have excised this requirement from their Articles of Association. It is not incumbent upon a director to disclose facts that the other directors should be aware of or can be reasonably expected to know. On coming to know about the inaccuracy in the information declared prior to the arrangement or transaction, the director making such declaration should rectify the defect. 39 Prior to the enactment of the Companies Act 2006, it had been noticed that the courts were adopting a broader perspective with regard to the interpretation of the term company. As a result, interests other than merely that of the shareholders’ were also being considered.40 Thus, in Dawson International Plc v Coats Paton Plc (No 1 case), it was opined by the court that directors had to take into account the interests of stakeholders, while conducting the affairs of the company. 41 The court observed that among other things, the directors of the company owed a fiduciary duty towards the company to safeguard the interests of members and employees. This clearly indicated that members constituted one of the several categories whose interests had to be taken into account by the directors. 42 Another major trend noticed with regard to the perspective of the court was the change in focus from determining whether the improper conduct of a director was in good faith to whether it was for appropriate objectives. This transition provided the courts with a test that was based on objective criteria. As a consequence, directors could be held liable to the company if they had acted for a purpose that had not been permitted under the powers granted to them. Such determination of liability was not influenced by the fact that the directors in question had acted in an honest manner.43 In Re Gilt Edge Safety Glass Ltd, the share capital of the company had be reduced, which resulted in reducing the share qualification of two directors, below the permissible limit.44 Despite this development, these directors continued with their service for 2 years. Subsequently, this company was acquired by the Triplex Safety Glass Ltd, which made a claim for recovery of the remuneration drawn by these directors for those 2 years.45 The court provided total relief from liability, on the grounds that despite the negligence involved, it was reasonable to relieve the directors of the wrongful act. Moreover, in the case of Item Software v Fassihi,46 one of the directors advised another director with regard to negotiations with a supplier. The advice provided was aimed at dissuading that supplier from negotiating with the company. This director had the intention of setting up his own business and obtaining the custom of that supplier. The court held the director in breach of his duty of loyalty towards the company. 47 This is an example of the various adaptations and applications of the fiduciary duty of loyalty. In our problem, Ben and Holly recommended the purchase of a sophisticated lathe from Thistle Ltd, which proved to be a great success. However, after three months Ben and Gaston came to know that Holly was a director of Thistle Ltd. To promote the interests of the Thistle Ltd, Holly had recommended the purchase of the lathe from Thistle Ltd. This act was detrimental to the interests of the Kingston Company, since the cost of the machine was substantially higher. Moreover Holly, breached her duty of loyalty under the provisions of the Companies Act 2006. As per the decision in Item Software v Fassihi, Holly had depicted an intention to promote her own company. Since Holly was working as the director of another company Thistle Ltd, she had breached the fiduciary duties of trust and loyalty, owed by her to the Kingston Ltd, company. In turn, she had breached the provisions of the Companies Act 2006, which are meant to promote the success of the company in question. In our problem, if the company directors are unwilling to take action against a fellow director for an infringement of the company’s rights, the shareholders of the company can make a claim on behalf of the company, against that director. Gaston had recommended a contract with the Elfmill Ltd, in order to acquire wood, Ben and Holly consented to this and the wood was procured. Subsequently, it came to light that Gaston had obtained a commission in this transaction. Moreover, the quality of the wood purchased was not of the desired quality. This clearly depicted the fact that Gaston had infringed the fiduciary duties owed by him to the Kingston Ltd Company. In addition, Ben and Holly recommend the purchase of a new lathe from Thistle Ltd. This lathe was a large and sophisticated piece of machinery that cost ?110,000. Ben, Holly and Gaston agreed to the purchase of the lathe, which was duly installed and proved to be a great success. After 3 months, Ben and Gaston discovered that Holly was a director of Thistle Ltd. Hence, Holly has breached the fiduciary duties owed by her towards the company. In our problem, if the company directors are unwilling to take action against a fellow director for infringement of the rights of the company, the shareholders are entitled to make a claim against such director on behalf of the company. Question 4 Advice the directors of Kingdom Ltd. on the steps that are potentially open to Daisy should she seek to pursue legal action to dispose of her investment or to intervene in the running of the company and their likely consequences, both for the directors and for Kingdom Ltd. The Companies Act 2006 empowers shareholders to sue the directors of the company, in the name of the latter, in order to recover the loss sustained by the company due to the negligence, default, breach of duty or trust by a director.48 The limited circumstances, under which shareholders could bring actions on behalf of the company, have been expanded considerably with the advent of the Companies Act 2006. Thus, shareholders can now claim against third parties involved in a breach. However such claims have to be on behalf of the company. This is termed a derivative action49 and it simplifies the task of taking directions to court by shareholders. This change in conjunction with the statutory duties has resulted in significant risks to the directors of a company. Moreover, a derivative has been described under section 260(1) of the Companies Act 2006, as a claim by a member of the company with regard to a cause of action vested in the company. The claim should seek relief on behalf of the company. Some of the persons who constitute members of the company are trustees in bankruptcy and persons to whom shares have been transferred, as per the relevant law. In addition, a director of a company is required under the provisions of section 172(1) of the Companies Act 2006 to discharge his duties in a manner that in his opinion and in good faith would be most likely to ensure the company’s success. Such success should be aimed at all the members of the company. 50 The courts are likely to intervene and establish absence of good faith, if there is a lack of a reasonable ground for being a benefit to the company. This was clearly visible in the case Shuttleworth v Cox Brothers and Co (Maidenhead) Ltd. 51 The absence of integrity and probity on the part of the directors of a company, on being established by a shareholder, constitutes sufficient grounds for the court to pass orders for winding up the company. 52 Thus in Re Bleriot Manufacturing Aircraft Co, the court ordered the winding up of the company, as company property had been misappropriated by the directors.53 Furthermore, in Loch v John Blackwood Ltd, the Privy Council held that the company was to be wound up. The shareholders of this company had not been provided with corporate information by the directors. Moreover, these directors had not held company meetings and had run the affairs of the company, as if it were their personal property.54 Furthermore, in Re Lundie Brothers Ltd, the directors of a company had neglected the interests of the shareholders and had conducted company affairs, as if the company was their own business. The court ordered winding up of the company.55 If a claim has to be necessarily be made, then there is no insistence in the law regarding the minimum shareholding required. Moreover, in such cases, there need not be any shareholding by the person filing the claim. 56 However, as held in Harley Street Capital v Tchigirinsky, the acquisition of a near negligible shareholding, subsequent to the conduct against which a claim had been made and in order to begin a derivative claim could raise suspicions regarding the bonafide intent of the claimant. In this case, the claimant had acquired just 200 ?1 shares out of a capital of ?230 million.57 A very important rule was established in Foss v Harbottle.58 In accordance with this tenet, the value of members’ shares is affected if the company suffers a loss. In the event of the company being unable or unwilling to claim for these losses, the shareholders have to bear the loss in value to their shares, unless they can bring their own claim. 59 In our problem, Ben Holly and Gaston were not maintaining a good rapport with each other. In addition, Ben and Holly were not engaging in equitable conduct with regard to the affairs of the company Kingdom ltd. Their integrity as well as loyalty was suspect, and this could constitute sufficient grounds for the court to issue a winding up order, Vis – a - Vis the company, in accordance with the case law discussed above. For advising Daisy in respect of her remedies against the directors for losses suffered by her, the following discussion has been taken up for analysis. Under the provisions of Companies Act 2006, an aggrieved member can bring a claim under section 459 for having undergone unfair prejudice. Such unfair prejudice should have arisen from the conduct of the affairs of the company in a manner that proved to be detrimental to the interests of the members of the company. 60 As such, an unfair prejudice remedy petition is a wide ranging petition that safeguards the interests of the minority shareholders. The shareholder should make a petition in this regard to the court beseeching its intervention in the affairs of the company in question. The court may make an order on such petition, if it is satisfied with the truthfulness of the same. Similarly in our problem, Daisy, as an innocent investor, can file an unfair prejudice petition in a court of law seeking an order that regulates the conduct of the company. Thereafter, the court will evaluate the circumstances of the various issues involved and issue an order restraining the company from continuing with the same act or omission that had been complained against by the member. 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