Alteration for Benefit of the Company: Allen v. Gold Reefs - Essay Example

Question (a The Companies Act, 1985 (the “Act man s that a company may by special resolution alter its articles of association The stipulation also mandates that this power cannot be taken away or limited by any provision its memorandum of association.2 Further the amendment to the articles of association of the company should be consistent with its memorandum,3 and to the extent of any repugnancy with the memorandum, the articles shall be void and without effect. Though these are certain fundamental limitations imposed by the Act upon the alteration of articles of association of a company, judicial interpretations have enlarged the scope of discussion of the issue of limitation of powers to amend the articles of association. The basis of these limitations on the powers to amend the articles is that they must benefit the company as a whole; however, the criteria to determine what constitutes “benefit to the company as a whole” has evolved through a series of case-law, which are analyzed in the following parts. A. Alteration for Benefit of the Company: Allen v. Gold Reefs The facts in Allen v. Gold Reefs of West Africa Ltd4 are briefly as follows: the company, by way of purchase-money for the property acquired by it, allotted fully paid shares to Z, a nominee of the vendor to the company. Z also applied for and had allotted to him shares not paid up. He was the only holder of fully paid-up shares. At his death he was indebted to the company in arrears of calls on the unpaid shares, but his assets were insufficient to pay the arrears. Thereupon the company, by special resolution under s. 50 of the Companies Act, 1862, altered the above articles by omitting therefrom the words “not being fully paid,” thus creating a lien on Z.’s fully paid shares. The issue for determination by the Court of Appeal was whether the company had the power to amend the articles of association in order to impose a lien on the company’s shares. Lindley MR, speaking for the majority, observed that the power thus conferred on companies to alter the regulations contained in their articles is limited only by the provisions contained in the statute and the conditions contained in the company’s memorandum of association. However, he added that the power of alteration of the articles conferred by the statute must be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must, in opinion of the majority judges, be exercised not only in the manner required by law, but also bona fide for the benefit of the company as a whole.5 The decision of the Court in Allen v. Gold Reefs is therefore an authority to legal principle that power of alteration of the articles is restricted only by: (1) the statute; (2) the memorandum of association; and (3) the bona fide exercise of the power for the benefit of the company as a whole. Though the majority opinion in this case emphasized the fact that alteration of the articles the company facilitated the collection of the debts, no substantial justification was offered as to why the rights of an individual shareholder should not be covered by the term “for the benefit of the company as a whole”. If the alteration of the articles defeat an existing right of an individual shareholder or operates oppressively, then principles of equity require that the interests of the shareholder be protected.6 Moreover, as the dissenting judge pointed out, a resolution to alter the articles of association of the company cannot be said to be bona fide if it is being passed to merely defeat the pre-existing rights of an individual shareholder.7 Cases that followed Allen v. Gold Reefs attempted to lay down the tests that would determine what constitutes ‘benefit of the company as a whole’. B. Shuttleworth to Greenhalgh: From majority’s good faith to company’s interest In Shuttleworth v. Cox Bros & Co Ltd8, the Court applied a more subjective test9 to determine what amounts to ‘benefit of the company as a whole’. In the words of the Court:10 “when persons, honestly endeavoring to decide what will be for the benefit of the company to act accordingly, decide upon a particular course, then, provided these are grounds on which reasonable men could come to a decision, it does not matter whether the court [would come to a different decision]…” In brief, this means that the court’s function is not to ascertain whether the alteration will be for the company’s benefit, nor would the court go into the question of whether the belief of the members who voted for the alteration that it would be in the company’s benefit is a reasonable belief. The restricted function of the court is therefore to ensure that the majority has voted honestly without improper motives. The Court also made it sufficiently clear that the unreasonableness of the alteration of the articles can be used only as one of the evidences to show bad faith on the part of the majority, and is not conclusive evidence on which the validity of the amendment can be assailed. The Shuttleworth test therefore amounts to the determination of the requirement of good faith on the part of the majority members who voted for the alteration. This subjective test was replaced with an objective criterion for determining the limitations on the power of amendment of the articles of the company in Greenhalgh v. Arderne Cinemas Ltd11. In this case the effect and consequence of the alteration of the articles were: (i) the majority shareholders, who had sufficient voting power to pass a special resolution to alter the articles would be able to pass a resolution to allow the sale of their own shares to an outsider; and (2) the minority shareholder would be always bound by the right of “first refusal” vested with the other members of the company. Holding this alteration to be valid, the Court laid down the principle as follows: … “‘bona fide for the benefit of the company as a whole’ means… that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole…..[it] does not mean that the company as a commercial entity, distinct from the incorporators….the case may be taken of an individual hypothetical member and it may be asked whether what is proposed is in the honest opinion of those who voted in its favour, for that person’s benefit….[the resolution for alteration of the articles] would be liable to be impeached if the effect of it were to discriminate between the majority shareholders and the minority shareholders, so as to give the former an advantage of which the latter were deprived.” [Italics supplied] The role accorded to the ‘hypothetical member’ is not merely that of a particular member having a specified number of shares, but a test devised to evaluate the benefit to the company itself. His role has to be viewed in light of the long term effect of the alteration of the articles, because the altered articles will continue to govern the company in future too. Perceived in this context, the hypothetical member is one who is not affected by the distribution of voting powers vis-à-vis other members of the company. Since, a hypothetical member placed within the facts of the case might benefit equally with any other member by the extension of his power to sell the shares, the alteration of the articles may be considered to be sufficiently justified. C. Overreaching Greenhalgh: The case of Stylo Shoes Ltd The error underlying the principle laid down in Greenhalgh was clearly demonstrated by the decision in Rights and Issues Investment Trust Ltd v. Stylo Shoes Ltd12, where the plaintiff unsuccessfully challenged the validity of the resolutions altering the articles of the company so as to double the votes which are cast in respect of the management shares held by the directors of the company. We shall leave out of discussion the ratio of the case, since it is the obiter observations of Pennycuick J. regarding the application of the objective test laid down in Greenhalgh that is likely to interest us more. Citing the above-mentioned extract from Greenhalgh, Pennycuick J. posed the case of a company which originally has only a single class of shares carrying equal voting rights, and which subsequently alters its articles to give controlling voting rights to the minority shareholders. This is a direct application of the test of the ‘hypothetical member’ whose role extends to the long term effects of the alteration of the articles on the company. Based on this hypothetical case-reasoning, the Court observed that such alteration is also valid, since under this new circumstance the minority shareholders would benefit by the alteration. It is submitted that the entire purpose of incorporating the principles of bona fide and equity in order to protect the interests of all classes of shareholders would be completely defeated if the test laid down in Greenhalgh is allowed to be applied in this lax manner. D. Objective Test And Minority Shareholders The objective test can well be applied effectively when the alterations to the articles have the effect of compelling the minority to sell their shares at a fixed price. One of best illustrations would be Dafen Tinplate Co Ltd v. Llanelly Steel Co (1907) Ltd.13, wherein the defendant company altered its articles to enable the company by an ordinary resolution to require any member to sell its shares to other members at a price fixed by the directors, except one member who was exempted from this provision. Declaring the resolution to alter the articles as void, the Court observed, on the issue of appropriation of shares, that:14 “It may be for the benefit of the majority of the shareholders to acquire the shares of the minority, but how can it be said to be for the benefit of the company that any shareholder against whom no charge of acting to the detriment of the company can be urged…. and there is no reason except the will of the majority [that he] should be forced to transfer his shares to the majority or anyone else.” Holding that the exemption of one shareholder from the provision to be illegal, the Court reasoned that:15 “The power ought to apply to all the shares unless perhaps it could be established that it is for the benefit of the company that certain shares should be exempt…the majority cannot alter its articles in such a way as to place one or more of the minority in a position of inferiority or superiority….nor can it confer on one or more of its own number benefits or privileges in which other shareholders of the same class do not participate.” The above reasoning tallies perfectly with the test of the hypothetical individual member laid down in Greenhalgh. It is impossible for a power of appropriation of shares to be in the benefit of the individual hypothetical member, for he is always subject to the risk of losing his investment without any corresponding gain. Also, if we consider the exemption given to a single member, the conclusion remains the same since such permanent discrimination cannot benefit the hypothetical member, and therefore on the Greenhalgh test the alteration of the articles is void. E. Concluding observations We had opened our discussion by citing the observation of Lindley MR in Allen v. Gold Reefs that the principles of equity and bona fide benefit of the company should guide the court in determining the permissible limits on the power to alter the articles of association of a company. However our analyses of the evolution of the law on this point leaves us in considerable doubt as to how far have principles of equity come to be binding on the shareholders (or, rather majority shareholders) vis-à-vis other members or minority shareholders of that company. It seems sufficiently clear that English law has not developed the principle that a controlling shareholder owes an obligation/duty in equity16 to the company or to the other shareholders, and that his freedom to consult only his own interests is correspondingly not limited to that extent. However, with the same consistency the courts have held that resolutions to alter the memorandum and articles of association and resolutions affecting class rights are valid only if passed in good faith in the interests of the members or class of members as a whole. Therefore, we may surmise the foregoing analyses in the following points: [1] The alteration must be made in good faith, and the shareholders who vote for it must not be guilty of fraud on the minority shareholders. [2] If the alteration patently discriminates between members of the same class of shares, it is sufficient ground to be held void.17 [3] The alteration must be for the benefit of any individual hypothetical member of the company, which means that, viewed from a long term perspective, any member must be equally likely to benefit from, or be adversely affected by, the alteration of the articles as any other member. Question (b): (1) Advise whether Abbey Ltd is liable for the debts of Baja Ltd In our understanding the pertinent facts upon which our advise has been sought are: (1) That Jo, Keira and Lin are the directors of Abbey Ltd, a company incorporated under the laws of UK, and they have incorporated another subsidiary company Baja Ltd under the applicable laws of UK; (2) that it is evident Jo, Keira and Lin are also the directors of the subsidiary company, Baja Ltd.; and (3) that Baja Ltd has become unable to repay its debts and the creditors are seeking to enforce the claim against Abbey Ltd. Our opinion has been sought in relation to the question of whether the creditors of Baja Ltd can have recourse to Abbey Ltd (as the parent company) for the repayment of the debts owed by Baja Ltd. In our opinion, Abbey Ltd would not and shall not be liable for the debts of Baja Ltd, and consequently the creditors of Baja Ltd cannot have recourse to the assets of Abbey Ltd , on the grounds below-mentioned: A. Baja Ltd has a distinct and separate corporate personality independent of Abbey Ltd It is a well-established principle of law that a company is a corporation, and is therefore a person in the eyes of law quite distinct and separate from its shareholders or members.18 As a distinct person the company can own property, have rights and can be subject to liabilities, and it does not hold its property merely as an agent or trustee of its members.19 This principle of separate legal personality was clearly established in Salomon v. Salomon & Co. Ltd20 wherein the House of Lords dealt with the issue of whether the shareholders of a company (even if it be the only shareholder) are liable for the debts of the company. In response to this question Lord Herschell observed:21 “A company may in every case be said to carry on business for and on behalf of its shareholders; but this certainly does not in point of law constitute the relation of principal and agent between them or render the shareholders liable to indemnify the company against the debts which it incurs.” A parent company holds sufficient shares in its subsidiary company to determine who shall be its directors and how its affairs shall be conducted.22 It is well established that in law the holding company is merely a large, or the only, shareholder of each subsidiary, so that the rule which distinguishes the legal personality of a company from that of its shareholders also separates the holding company from its subsidiaries. In light of the above, it is sufficiently clear that the separate legal personality of Abbey Ltd precludes any liability on its part for the debts incurred by Baja Ltd. B. The instant case is not an exception to the rule of separate legal personality and therefore the corporate veil cannot be lifted It is not disputed that there exists certain exceptions to the rule of separate legal personality whereby the court may pierce the corporate veil and treat the subsidiary as a de facto entity of the parent company, thereby making the parent company liable for the acts of the subsidiary. However, under English Law a parent company will only be deemed by a court to be acting as a de facto agent of its subsidiary in a very exceptional range of circumstances.23 These exceptional grounds in which the parent company will be liable for the acts or liabilities incurred by the subsidiary are: (1) “sham” or “façade” ground – this will arise in cases where an existing company uses another company as nothing more than an artificial device for the purpose of “shielding” themselves from their pre-existing liabilities under contract, tort or statute;24 and, (2) “agency” ground – the autonomous identity of a company will be disregarded on this basis only in the exceptional case where a subsidiary is totally and utterly under the control of its parent to the extent that the subsidiary cannot be said to be carrying on its own business in distinction from its parent.25 From the facts of the instant case it is amply clear that the stringent criteria to be fulfilled for both these grounds are not satisfied, and therefore there is no justification for lifting the corporate veil in order to disregard the separate legal personality of Baja Ltd. C. The principle of asset consolidation is not well-established in law, and in any case, is inapplicable in the instant case The creditors of Baja Ltd may try to resort to a consolidated approach towards the enforcement of money due to them. This approach of consolidating the assets of group companies – that is, the parent company and its subsidiary (ies) – is known as asset consolidation, and has primarily evolved through US case law. However, it may be noted that the principle of asset consolidation has not received overall approval owing to its direct conflict with the well-established principle of separate legal personality of the parent company and its subsidiary. One of the best examples to highlight the doubtful validity of this principle is the successful challenge to the application of asset consolidation in the WorldCom Case.26 Academic debates on centralizing creditors claim in a group company within the European legal framework also portrays asset consolidation as a potential future law, rather than as an existing legal principle.27 In any event, the principle of asset consolidation, assuming it is valid in law, is not applicable in the instant case. The principle of asset consolidation can be applied only on the fulfillment of two tests:28 (1) whether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit; or (2) whether the affairs of the debtors are so entangled that consolidation will benefit all creditors. Since these two tests are prima facie not satisfied in the instant case, there can be no ground on which the creditors of Baja Ltd can validly take recourse to the assets of Abbey Ltd for realization of the amount due to them. (2) Advise Jo and Keira whether they can prevent Lin from being involved with Zylo Ltd in the import of wooden bowls. Under English law, directors of a company can exercise their powers only collectively by passing resolutions at the board meetings, unless the articles of the company permit otherwise.29 The exception to this rule is where all the directors agree informally on a certain matter without a board meeting, and that decision is binding on the company.30 The decision taken by the Board through a board resolution is taken to be in the interest and benefit of the company, unless the contrary is expressly proved.31 In this case, Jo and Keira has voted against the proposal to purchase wooden bowls from Zylo Ltd. Thus it must be presumed that it was in the best interests of the company not to enter into the transaction with Zylo Ltd especially considering the financial position of the company. Lin has however entered into the transaction on her own account, as far as the facts of the case demonstrate. It is worth noting that the law precludes a director from entering into a transaction where the director has an interest which conflicts with that of the company.32 Furthermore, it is well established that director’s powers are given to them to be used for the benefit of the company, and not for the benefit of the directors themselves, nor for the benefit of the parent company. It is well settled principle that every director who has a direct or indirect interest in a contract or proposed contract with his company, or in a transaction or arrangement entered into, must disclose the same at the board meeting.33 A director who fails to make such disclosure is liable to penalty and amounts to a breach of fiduciary duty. Because of this fiduciary duty, a contract made by a director with his company is in principle voidable by it in equity, even if the terms of the contract are shown to be not unfair. Also, in this case Zylo Ltd was aware of the fact that Lin was without authority to enter into the contract. It is well accepted principle of law that if the directors misuse the powers, the company may treat the resulting transaction as void, even though this may prejudice an innocent third party.34 If the third however knew that the director is without authority to enter into the transaction, then the company can set aside the transaction without paying any compensation to the inconvenience caused to that third party. Since in the instant case, Zylo Ltd was well aware of the misuse of power by Lin, the company owes no compensation to Zylo Ltd on restraining Lin from continuing with the contract. (3) Advise Jo and Keira whether they can remove Lin from the Board of both Abbey Ltd and Baja Ltd. Section 303 of the Act, which deals with the removal of directors, provides that: (1) A company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in its articles or 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 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 as derogating from any power to remove a director which may exist apart from this section. Therefore, it is clear that neither the members of the company nor the Board of Directors have an inherent power to remove directors before the normal expiration of their period of office in the absence of a power to do so in the articles of association of the company.35 If the articles do not specify the duration of the term of the director, he may be dismissed by an ordinary resolution passed by the members at any time. It is possible for the articles of the company to provide power to the Board to dismiss a fellow director, and if the power is so given by the articles then a director can be validly removed by a resolution of the board to that effect. In such cases the board has to give notice to the impugned director or pass a resolution terminating his appointment. The only limitation on the exercise of this power by the Board is that it should be exercised in good faith and in the interest of the company.36 In the instant case, it is clear from the facts that the removal of Lin from the Board would be in good faith and in the best interests of the company. In light of the above, it appears to be clear that Jo and Keira can pass a resolution for the removal of Lin as the director of the Abbey Ltd and Baja Ltd, if such authority is provided by the articles of the company. In any event, as per the Companies Act, 1985 every company has a statutory power to remove any director by an ordinary resolution passed at the general meeting of which special notice is given notwithstanding anything contained in the articles of the company.37 Bibliography STATUTE Companies Act, 1985 BOOK Pennington, Company Law, Revised ed. (London: Butterworths, 1995), 92 ARTICLES Zipora Cohen, Fiduciary Duties Of Controlling Shareholders: A Comparative View 12 U. Pa. J. Intl Bus. L. 379, 391 (1991) Marc Moore, “A Temple Built On Faulty Foundations”: Piercing The Corporate Veil And The Legacy Of Salomon v. Salomon J.B.L. 2006, MAR, 180-203, 184 (2006) Irit Ronen-Mevorach, Centralizing Insolvencies Of Pan-European Corporate Groups: A Creditor’s Dream Or Nightmare, J.B.L. 2006, AUG, 468-486 (2006) LIST OF CASES Adams v Cape Industries [1991] 1 All E.R. 929 (Slade L.J.) at 1022-26 Ashbury v. Watson (1885) 30 ChD 376 Bushell v. Faith [1969] 1 All ER 1002 Imperial Hydropathic Hotel Co v. Hampson [1882] 23 ChD 1 In Re Augie/Restivo Baking Co., 860 F.2d 506 (2d Cir. 1988) [Judge Winter] Macaura v. Northern Assurance Co Ltd. [1925] AC 619 at 626 Mercantile Bank of India v. Central Bank of India [1938] AC 287 Re Haycraft Gold Reduction and Mining Co. Ltd [1900] 2 Ch 230 Re W & M Roith Ltd [1967] All ER 427 SEC v. WorldCom Inc., No. 02 Civ. 4963 Short v, Treasury Commissioners [1948] 2 All ER 509 at 512 TCB Ltd v. Gray [1986] Ch 621 Ultraframe (UK) Ltd v Fielding [2005] EWHC 1638 Read More