Contract Between the Members of the Company and the Company - Coursework Example

Introduction Section 14 of the Companies Act 1985 creates a contract between the members of the company and the company, as well as between the members themselves.1 The terms of the contract are set out in the company’s Articles of Association.2 The binding nature of the contract however is statutory and not based on the doctrine of party autonomy. Moreover, as a statutory contract, terms may not be implied 3 In other words the statutory contract is interpreted by reference to the provisions contained in the Companies Act 1985.4 For example, it was held in Re Peveril Gold Mines Ltd that a company’s articles of association could not bar an application for winding up by a shareholder because such a petition was permissible under the Companies Act.5 It therefore follows that the precise effect of Section 14 of the Companies Act 1985 was unclear. Section 33 of the Companies Act 2006 was intended to clarify the meaning and effect of Section 14. This paper explores the effect of Section 14 of the 1985 Act and what if any difference Section 33 makes in clarifying the contractual implications of Section 14. The Articles of Association: The Effect of Section 14 (1985 Act) and Section 33 (2006 Act) The Articles of Association is a document that makes provision for the internal governance of the company.6 Essentially, the articles lay out the framework for how corporate decisions are made, identification of the company’s officers and how these officers are to be elected.7 To this end, the company’s Articles forms the basis of the legal relationship between the company and its members8 and it also binds the members to each other.9 Ultimately the shareholders of the company are at liberty to force the company to adhere to the provisions contained in the Articles of Association.10 To this end the Articles will serve as evidence of the contract between the members of the company and the company.11 Evan so, by virtue of a special resolution, the Articles of Association may be altered by special resolution.12 The Memorandum of Association, and Companies Acts dictate the manner in which an alteration may legally occur. The Memorandum is very important since it sets out the company’s objects and what the company may or may not do.13 The main purpose of the Memorandum is to provide external notice to outsiders of the company’s structure and permissible dealings.14 Therefore if a provision of the Articles of Association do not comport with the Memorandum that provision is voidable.15 For example, the Articles may not authorize any transaction that are inconsistent with the object clauses, as provided for in the Memorandum as that transaction would be ultra vires.16 Judicial precedent has evolved to such an extent that it has become a general rule of law that, any alteration of the company’s Article of Association must ultimately be conducted in good faith and for the overall benefit of the company.17 Overall, the effect of Section 14 of the Companies Act 1985 has come to be interpreted as a mandate that essentially limits the majoritys power in order to prevent minority oppression by the majority.18 Essentially, common law and equitable principles ensure that the majority may, subject to exceptions, bind the majority shareholders in the manifest exercise of their powers at the expense of minority shareholders.19 The approach taken by the courts with respect to the company’s Articles of Association has been one of consistent caution.20 To start with the courts have developed a penchant for balancing the company’s interests against the interests of the members of the company. To this end, the courts have adapted the doctrine of majority rule but remain guarded against the risk of leaving the minority vulnerable to oppression by the majority21. Guided by Section 9 of the Companies Act 1985 which permits a majority to alter the Articles of Association, the courts tend to ensure that the alteration is conducted by fraudulent means, methods or motives. Ultimately, the doctrine of majority rule as introduced by the rule in Foss v Harbottle continued to prescribe the full effect of Section 14 of the Companies Act 1985. The position ultimately taken in Foss was that any difficulties within the structure of the company is properly disposed of by ratification by the majority shareholders.22 Ultimately the majority rule doctrine dictates that in the event the company is wronged, the proper plaintiff is the company itself.23Tied to the majority rule principle as enunciated by the rule in Foss v Harbottle, is the common law position that a company ultimately is entitled to alter its Articles of Association.24 The majority rule doctrine, which dictated the interpretation of Section 14 is found in the words of Jenkins LJ who stated that if an “alleged wrong” is a “transaction which might” be binding on the company and its member by virtue of a “simple majority” it was not possible for a single member to challenge that transaction.25 This was so because: “…if a mere majority of the members of the company or association is in favour of what has been done, then cadit quaestio”.26 However, when a transaction is outside the company’s power it can be challenged by an individual member of the company. For example, in Hutton v Scarborough Cliff Hotel Co. it was held that the company did not have the authority to interfere with share equality.27 Likewise, if a director’s tenure is provided for in the Articles the company has no authority to remove the director.28 Section 459 of the Companies Act 1985 offered some clarification for the statutory contract between the company and its members and between the members as contained in Section 14.29 Section 459 provides that each of a company’s members is at liberty to make an application to the court via a petition for an order in respect of a claim that the company’s affairs “are being or have been conducted” in such a way that it is “unfairly prejudicial to some part of the members” or “that any actual or propose act or omission…is or would be so prejudicial.”30 Despite Section 459 of the 1985 Act, altering the company’s Articles of Association is distinct from other conduct by majority shareholders.31 The majority rule doctrine by and large refers to conduct that can be legitimately ratified by ordinary resolution, whereas altering the company’s Articles of Association requires a special resolution.32 Drury maintains that in a typical case: “the automatic barrier to suit has been set at the level of an ordinary majority of the general meeting. It will thus have no application when the rules of company law require some higher majority, or where the matter is such that it is inappropriate to refer it to an ordinary majority.”33 Even so, if the alteration of the company’s Articles of Association is attributed to fraudulent methods, means or motives, certainly Section 459 can be invoked.34 Moreover, Section 14 is required to be read together with the entirety of the Companies Act 1985, thereby making it entirely possible for Section 459 to be applied. The effect of Section 14 is to reinforce the fact that the Articles regulate the relationship between the members and the company so that the obligations contained therein are entirely enforceable.35 For example, insider rights such as the right to dividend payments are capable of enforcement.36 Likewise a member’s right to have his name entered on the register is an enforceable right37 as is the right to vote.38 Gower and Davies in Principles of Modern Company Law describe the common law principles of majority rule as it relates to Section 14 of the 1985 Act as “scattered throughout the reports” with a plethora of statements insisting that members are required to “exercise their votes ‘bona fide for the benefit of the company as a whole”.39 This statement implies that members share the same level of responsibilities toward safeguarding the company’s welfare as do directors.40 Gowers and Davies note however, that this is entirely “misleading,” and cumulatively, this position is not supported by the bulk of the previous decisions.41  In fact, according to Gowers and Davies, the courts have consistently ruled that: “…that votes are proprietary rights, to the same extent as any other incidents of the shares, which the holder may exercise in his own selfish interests even if these are opposed to those of the company.”42 Gowers and Davies go on to explain that case law has developed to such an extent that majority rule gave way to “twin concepts of fraud on the minority and bona fide in the interests of the company”.43 However, further developments in company law have rendered these principles “obsolete”. 44 Ultimately, these concepts within the ambit of Section 14 have been introduced by the courts as a means of circumventing “the worse excesses of majority rule.” The result is that Section 459 of the Companies Act 1985 dismantles the effective application the ‘twin concepts.’45 In the final analysis it is now possible to challenge practically any type of irregularity on the part of the majority, however, there is little evidence that the courts have departed from previous held ‘majority rule’ concepts.46 Complicating matters with respect to the full effect of Section 14, the courts are at liberty to make an order for what ever remedy it deems fit.47 Section 33(1)of the Companies Act 2006 does not appear to alter the previous position. Section 33 (1) provides that the “company’s constitution” is binding on the company together with each of its members in the same way that covenants made by the company and its members bind both the company and its members.48 Payne maintains however, that the effect of these protections against oppression of the minority are construed in very broad terms so that the full effect of majority rule within the ambit of Section 14 may be maintained.49 Section 33(1) like Section 14 before it does not offer any clarification with the result that the remaining sections of the Companies Act 2006 must be read with Section 33(1) so as to understand its full effect. According to the framers of the 2006 Act, sections 459-461 will continue to apply to the construction of the company’s constitution. According to Lord Hodgson, Section 459 will continue to apply where members of a company have reasonable grounds to suspect that the company’s affairs have been validated by virtue of prejudicial means. Moreover, Section 459 will continue to apply as it has done previously.50 It is therefore reasonable to conclude that Section 33(1) of the Companies Act 2006 does not add to or take away from the full effect of Section 14 of the Companies Act 1985. Conclusion Section 14 of the Companies Act 1985 makes provision for the legal basis of the relationship between the company and its members and between the members themselves. Ultimately, Section 14 lays the ground work and legal regime for the Articles of Association and basically permits liberal alteration thereof. The only proviso is that any alteration or departure from the Articles is conducted by reference to the remaining provisions under the 1985 Act. The courts have developed an approach which seeks to as far as possible support the contention that a company, by virtue of the majority rule doctrine, may ratify any action taken by the company, provided it is not ultra virus the company’s objects and consistent with the Companies Act 1985. In preserving this approach, Section 33(1) of the Companies Act 2006 does not alter this position, but rather maintains it. Bibliography Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656 Asbury Railway Carriage & Iron Co. Ltd. V Riche [1875] LR 7 HL 653. Borlands Trustee v Steel Bros [1910] 1 Ch 279. Bratton Seymour Service Co v Oxborough [1992]BCLC 693. Companies Act 1985 Companies Act 2006 Companies Bill http://www.publications.parliament.uk/pa/pabills/200506/companies.htm Viewed March 28, 2009. Dine, J. (2007) Company Law. Palgrave, MacMillan, 6th Edition Drury, R.R. “The Relative Nature of a Shareholders Right to Enforce the Company Contract”. [1986] CLJ 219. Edwards v Halliwell [1950] 2 All ER 1064 Foss v Harbottle [1843] 2 Hare 461 Gowers, L.C. B & Davies, Paul. (2003) Principles of Modern Company Law. Sweet and Maxwell Guinness v Land Corpn of Ireland Ltd (1882) 22 ChD 349 Hickman v Kent & Romney Marsh Sheep Breeders Association [1915] 1 Ch 881 Hutton v Scarborough Cliff Hotel Co [1865] 2 Drew and Sm 521. Imperial Homopathic Hotel (Blackpool) v Hampson (1882) 23 ChD1 Joffe,V. (1977) “Majority Rule Undermined?” The Modern Law Review. 40(1), 71-74. MacDougall v Gardiner [1875] 1 Ch 13. Mantysaari, P. (2005) Comparative Corporate Governance: Shareholders as Rule-Maker. Springer Publishers Payne, J. “Sections 459-461 Companies Act 1985 in Flux: The Future of Shareholder Protection.” The Cambridge Law Journal (2005) 64(3), 647-677 Pender v Lushington [1877] 6 Ch.D. 70. Re British Sugar Refining [1857] 3 K and J 408. Re Peveril Gold Mines Ltd [1898] 1 Ch. 122 Rider, B. (1978) “Amiable Lunatics and the Rule in Foss v Harbottle.” The Cambridge Law Journal 37, 270-387. Sealy, L. and Worthington, S. (2007) Cases and Material in Company Law. Oxford University Press Sidebottom v Kershaw, Leese & Co [1920] 1 Ch 154 Wood v. Odessa Waterworks Co. (1889) 42 ChD 636 Worthington, S. (2003) “Reforming Directors’Duties.” The Modern Law Review 64(3), 443-438. Read More