Company Law and Core Statutes - Essay Example

?The factual scenario raises various issues in company law relating to the legality of proposed transactions and directors duties. With regard to theproposed transactions and dissatisfaction of Ergan, Arif and Moshe as minority shareholders in the actions of Pedro and Morgan; this initially raises issues of breach of directors’ duties under the Companies Act 2006. Section 171 of the Companies Act 2006 (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” (CA). Section 175 of the CA further imposes a positive obligation on directors to “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” (Section 175 of the CA). If we apply this by analogy to the current scenario, it is evident that Pedro and Morgan have awarded themselves pay increases despite the fact the company is making marginal profits. As such, this would suggest a conflict of interest with the interest of the company. 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 company (Wild, 2009). Moreover, directors must exercise independent judgment in order to prevent a claim for breach of duty of good faith (Dignam & Lowry, 2010). 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 Ltd ([1942] Ch 304) it was held that directors must act “bona fide in what they consider is in the best interests of the company” (per Lord Greene MR at p.306). Directors must also make proper use of their position and the information they acquire through their position (Dignam & Lowry, 2010); and the case of Cook v Deeks ([1916] 1 AC 554) 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. Moreover, 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 directors should refer to including (without limitation) the relationship with suppliers and customers, impact of decision on environment and members of the company. It is important to ensure compliance with this and failure to comply cannot only result in exposing the company to potential claims, but can also lead to piercing of the corporate veil for potential actions against the director (Wild, 2009). 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. In context of the current scenario, this will have a bearing in relation to the concerns regarding the sale of the company’s property at undervalue. Firstly, it is evident that the proposed sale of the company property must be in the best interests of the company under Section 172 of the CA 2006. If the sale at undervalue is not in the best interests of the company, this will constitute breach of director’s duties under the CA. Additionally, as the facts indicate that the company is not making much profit the proposed sale of the property at undervalue could be set aside under as being “a transaction at an undervalue” under Section 238 of the Insolvency Act 1986 if the company went insolvent within two years. With regard to the concerns regarding the purchase of the premises, this will fall within the definition of a “substantial property transaction” as a non-cash asset under section 190 of the CA. As such, Section 190 only requires member approval of such a transaction if the transaction is between connected people. However, in the current scenario the transaction doesn’t appear to be between connected persons as defined by Section 253 of the CA. On this basis, the transaction itself will not need prior approval of the members. Nevertheless, Ergan, Arif and Moshe have concerns some concerns about the financial viability of the transaction and current economic stability of the company, there are clearly risks regarding the breach of director’s duties to act in the interests of the company under Section 172 of the CA and wrongful trading under section 214 of the Insolvency Act 1986. For example, Ergan, Arif and Moshe feel that the proposed purchase is not in the company’s interests. However, the difficulty is that Ergan, Arif and Moshe’s position as minority shareholders and Pedro and Morgan’s position as majority shareholders and directors makes it difficult to challenge their recommendations particularly as the transaction doesn’t require prior board approval. Therefore, alternatively, as Ergan, Arif and Moshe are minority shareholders, company law offers added protection to minority shareholders (Dine & Ervine, 2010). They would have to establish a fraud on the minority for the purpose of the exception established in Foss v Harbottle (1843) 2 Hare 461), which has been further limited by the ability of companies to ratify any acts that are ostensibly ultra vires. 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, which is pertinent to the concerns of Ergan, Arif and Moshe regarding the benefits of the proposed purchase for the company and the interests of the shareholders. 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”, this is ultimately a question of fact and it is not necessary to establish a lack of good faith (Dignam & Lowry, 2010. Furthermore, in the case of Re R A Noble & Sons (Clothing) Ltd ([[1983] BCLC 273), 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 that the action was unfair. Accordingly, in the current scenario, the success of a potential section 994 application will depend on balancing the interests of the company against the ability of Ergan, Arif and Moshe to demonstrate that this conduct is unfairly prejudicial to their interests as a shareholder. Alternatively, as there are concerns about the impact of both this transaction and the sale on the pre-existing value and share capital of the company in light of the company’s marginal profits, the CA 2006 also regulates reduction of share capital. The CA 2006 permits reduction of capital within limited circumstances and section 641(1) of the CA 2006 provides that “A limited company having a share capital may reduce its share capital- (a) in the case of a private company limited by shares, by special resolution supported by a solvency statement. Moreover, section 641(2) of the CA 2006 expressly states that a company cannot reduce its share capital “if as a result of the reduction there would not longer be any member of the company holding shares other than redeemable shares.” With regard to the current scenario, the conduct of the directors could constitute breach of section 174 of the CA where directors are meant to exercise reasonable care, skill and diligence on their duties as directors and ensure they are promoting the success of the company under section 172 of the CA. In summary, the sale of the company property at undervalue could breach the director’s duties to act in the interests of the company and promote the company’s success. Additionally, if the company goes ahead with the sale and becomes insolvent within two years, the transaction could be set aside under the Insolvency Act 1986. With regard to the proposed purchase, the transaction itself will not require prior approval, however in light of the company’s current financial situation the directors could be in breach of the express duties under the CA to act in the company’s best interest and promote the success of the company. Finally, as Ergan, Arif and Moshe are minority shareholders, the circumstances of the proposed purchase could entitle them to rely on the exception to Foss v Harbottle and claim a fraud in the minority or make a derivative application under the CA for unfair prejudice. BIBLIOGRAPHY A. Dignam & J. Lowry, Company Law (6th edition Oxford University Press, 2010) J. Dine & C. Ervine, Company Law and Core Statutes 2010-2011, (Palgrave Macmillan, 2010) C. Wild, Smith & Keenan’s Company Law, (14th revised edition Pearson Longman, 2009) Legislation Companies Act 1985 Company Directors Disqualification Act 1986 Insolvency Act 1986 Companies Act 2006 All available at www.opsi.gov.uk accessed March 2011 Read More