Corporate Social Responsibility: Company Law - Article Example

Corporate Social Responsibility: Company Law Abstract In the interest of the subject and the critical analysis of an argument, this article initially highlights a few basic definitions, its origins and its future. There are sections later that invariably deal with Prof Rajak’s comment about shareholder’s rights and obligations being directly proportional to their capacity in the firm and then the after math of that comment in modern business scenario obviously in the new light of Corporate Constitution and Company Act 2006. However the intent throughout has been to develop a few themes, not necessarily to craft logical reasoning in favor or against the comment but to ensure the evolution of a concept to suit the current company legal landscape, duly respecting interests of all stake holders involved in the exercise and supporting those interests of corporate citizens. This Article dwells on existing company law, its critiques, assists in developing a clear understanding after thorough research on relevant topics of Company Law and urges to grow beyond the subject and argument to dive deep and determine elements responsible for the welfare of stake holders. Table of Contents Table of Contents 3 1. Corporate Constitution 4 2. Memorandum/ Articles of Association 4 3. The Objects Clause 5 4. Shareholder’s Rights 6 5. Modernizing Company Law – The Company Law Review. 7 6. Closely held companies 9 7. Controlling Interest 10 8. Shareholders Agreement 10 9. Powers of Board of Directors. 12 10. Minority Shareholder 13 11. Corporate Social Responsibility and Outside Creditors 15 1. Corporate Constitution The world is acquainted with the concept of Constitution in a country, however the introduction of a similar concept in company is still not a common man’s buzz word. While we are familiar with the fact that a country’s constitution is primarily a document which can be labeled as a rule book with strict definitions and clauses to ensure the power is not exploited by a selected few and the welfare of the citizens are taken care. With similar objective, company directors who are the privileged lot to have the required power need to be appropriately regulated to protect the interests of the shareholders and make sure the directors do not act beyond their authority. The two documents that governs company operations and controls director are the Memorandum of Association and Articles of Association.1 2. Memorandum/ Articles of Association The Memorandum of Association and Articles of Association are the documents that form the “constitution” of the company and regulate the powers of the company and the rights of its shareholders. The contents of the Memorandum of Association is shorter than the Articles of Association and under CA 2006, some material from the memorandum has been transferred to the articles. While memorandum under 1985 (s 2) had clauses like name, registered office, objects clause, limited liability, capital statement and association clause, the memorandum under CA 2006 has been considerably reduced to only the statement that the promoters wish to form a company along with an agreement to become members of the company and in the case of a company with share capital, to take at least one share each. A company’s Articles of Association remain fundamental and crucial in regulating how a company lawfully conducts its business and is a much more important document than the memorandum. It is company’s procedural handbook, including shareholder and company relationship regulation, Internal Relations, shareholder’s rights, powers, voting, the Board’s powers, composition, structure and operation, dividend payments, capital structure alterations. The articles also acts as contract for the shareholders. Before we go ahead to understand other basic definitions in Company Law and related terms and conditions for shareholders or any other entity holding stake in the firm, we can analyze Professor Rajak’s comment on shareholders2 her to test if it holds true in the current scenario with modified statements in the corporate constitution. While we have indicated in section 3 that a significant part of memorandum has moved to articles under CA 2006, object clause can be set apart as an example to further explore the interest of share holders. 3. The Objects Clause3 While we know the objects clause in company constitution states what is to be the purpose of the company, the type of business in which the company intends to be engaged - primarily designed to protect shareholders by ensuring that their investment was used only for the company’s stated purpose, the contracts made by the company for purposes not included in the objects clause could be deemed void under the doctrine of ‘ultra vires’4 – beyond powers. In the statement of company’s objects – general commercial company if it is indicated that the object of the company is to carry on any trade or business whatsoever, it becomes increasingly difficult to view an action as ‘ultra vires’ and Companies Act 2006, has affected the interest of the share holder to some extent by creating a presumption that the company’s objects are unlimited unless the company expressly states otherwise. 4. Shareholder’s Rights An understanding of the shareholder’s rights would be important at this stage before we proceed further to evaluate contention of Professor Rajak’s comments in the current company law landscape. While articles of association earlier had provided share holders rights to raise concerns and issues, empowered them to pass an elective resolution, elect to grant authority to directors to allot shares5, elect to dispense with laying of accounts and reports before the Company in General Meeting6, elect to dispense with the holding of AGMs, elect as to majority required to authorise the holding of general meetings or class meetings upon short notice, we will see its diminishing significance once we are acquainted with the power of directors to bind the company under Companies Act 2006, s 40 (1).7 Companies exist to make profits for shareholders however the directors ought to and are bound to consider a long term view of the interests of the company as a whole and its sustenance in the competitive market. They have to take into account the need to foster relationships with various other stakeholders. In this endeavor, if there are contracts with a third party, it is almost impossible to challenge based on the appeal that it conflicts with the objects clause. The objection from a shareholder who can apply to the court to prevent the company from entering into a contract labeling as ‘ultra-vires’ would not really apply if the contract has been agreed in the name of company fulfilling a legal obligation.8. This briefly hints at how shareholder’s rights cannot necessarily assist in attaining a favorable response by voicing a concern related to contracts that the shareholder does not view in the interest of the company and thus considers superfluous or against the interest of shareholders or inappropriate use of share capital. Rajat’s claim that the [s.14 Companies Act 1985] contract between the company and the shareholders gives rise to mutual rights and obligations, but these lie in favour of and against the shareholder in his capacity as a member of the company obviously does not hold much water here. 5. Modernizing Company Law – The Company Law Review. The need to modernize or review company law arose from various attempts to make piece meal changes here and there and then to finally review the Company Law as a whole. The three most important components on which the company law needs to be based upon are mainly from the shareholder’s perspective, the community and outside creditors. Company law can only “in reality be properly understood only if put into historical and economic context” (Gower’s entry in ODNB). In order to critically analyse Rajat’s comments and its relevance or contention in the context of closely held corporations, it is important to take into consideration the changing business and its legal environment. However prior to that dissertation, gathering other facts about shareholders theory and policy would highlight the already limited scope of shareholder’s ability to protect their interest. The question of whether and to what extent shareholders might bring a personal action in tort against company officials has been a subject of a considerable amount of litigation, the only English judicial authorities which raise the issue squarely concern the protracted litigation between the Prudential Assurance Company and Newman Industries Ltd.9 The basic reasoning behind review, revising and reforming company law10 was to suit its concepts to modern economic times and ensure the welfare of all involved stake holders in an enterprise are well protected however over a period of time, several other priorities like Community Social Responsibility and other creditors interests took over while the liberty of shareholders to exercise in the capacity of being a member of the company was considerably reduced due to the amendments in Company Law. 6. Closely held companies An universally accepted definition of a closely held corporation is yet to evolve and most definitions available now only tend to focus on the number of shareholders. Closely held companies have a small group of controlling shareholders and no active trading market for its shares. In these firms, also called closed corporation, the shares of common stock are owned by relatively few individuals and are generally unavailable to outsiders. In contrast, a widely-held firm has many shareholders due to which there is a potential for the separation of ownership and control. Our legislation addresses this potential separation of ownership and control through mechanisms such as the mandatory solicitation of proxies, proxy circulars, financial disclosure, audit committees, shareholder proposals, etc. however a few of these platforms and mechanisms primarily shaped to deal with widely-held corporation might not make sense in close corporations. Apart from having relatively few shareholders, other distinct characteristics of closely-held corporations are the shareholders are generally active in the management of the business, there is no established market for the shares of the corporation and there is usually a restriction on the transfer of shares. By their nature, they are resistant to hostile takeovers and proxy wars. They tend to be more stable than other companies because their share prices are not determined by investment decisions, but by the value of the company itself. However, closely held companies do not have access to as much working capital. Rajat’s comment is fairly out of place in case of closed corporations mainly because shareholder’s responsibility of the Corporation is extensive here and not limited to shareholder’s profit alone as the shareholder’s capacity as a member of the company would require to foresee Company interests as a whole apart from their individual interests. To understand this further, a little detail of controlling interest would substantiate irrelevance of Rajat’s comments in closed corporations. 7. Controlling Interest A shareholding in excess of 50% of issued share capital will be enough to control the company, dictate the structure of the Board of Directors and to be able to execute functions necessary to run the company in its day to day affairs. It is possible for those owning less than 50% of a company to protect themselves from being at the mercy of those holding over 50% of the shares in the company and this is one reason why shareholders should give serious consideration to agreeing a shareholders agreement or adopting professionally drafted Articles of Association. This leads to explore shareholders agreement in closely held corporations to evaluate Rajat’s comments in this scenario. 8. Shareholders Agreement In closed corporations shareholders can and have entered into agreements as to how they will vote their shares and these agreements were challenged on the basis that such agreements fettered the discretion of shareholders and were thus contrary to public policy. Courts, however, rejected these arguments with respect to shareholder agreements that constrained voting and such agreements were held to be valid11. In the closely-held corporation the voting agreement can be used to make sure certain persons continue to be elected director in the corporation or otherwise have involvement in the management of the corporation which nullifies Rajat’s comment to some extent. By using voting agreements to constrain directors powers, shareholders are stepping on a very thin line of difference between individual and corporate interests which ideally is another remarkable observation defeating Rajat’s comments. Directors have a duty to act in the best interests of the corporation. They cannot bind their discretion in advance by agreeing to vote in a way they may later turn out to be not in the best interests of the corporation. The effect of this was that shareholders in a closely-held corporation could agree to vote their shares to make each other directors of the corporation. However, they could not agree on how they would vote as directors when it came to appointments of corporate officers or other major management decisions. Another significant aspect in closed corporations are constraining directors’ powers under the CBCA. The CBCA sought to rectify this by allowing the management powers of directors to be reallocated to shareholders under a unanimous shareholder agreement.12 Such an agreement is only likely to be practical in the context of a closely-held corporation. The unanimous shareholder agreement can thus provide that certain management decisions normally made by the directors can be allocated to the shareholders. The shareholders’ agreement can then go on to provide for how the shares are to be voted on the particular management issue. A common provision to put in a unanimous shareholder agreement is a provision to the effect that the shareholders, and not the directors, will decide who the officers of the corporation are to be and will then go on to say that the shares will be voted so that X will be president, Y will be vice-president and so on. Other powers can also be reallocated from the directors to the shareholders. Specific management powers such as the declaration of dividends or issuance of shares could be allocated to the shareholders. The general approach is to first identify the power that is to be reallocated to the shareholders. Then one needs to determine the provision under which such a power is provided in the Act. The third step is to see what methods can be used to reallocate the power. Then one needs to assess which of these documents would be the most appropriate document for reallocating the power which in a closely-held corporation will normally be a unanimous shareholder agreement. Once one has reallocated the power to the shareholders in the document considered most appropriate there may the question of determining how shareholders agree to vote on the matter and put the terms of that agreement in the shareholders’ agreement. The after math of this implementation strongly confirms Rajat’s comments that shareholder’s rights, duties and obligations are direct derivative of their capacity in the company, and thus lie in their favor or against them cannot be a natural conclusion under the circumstance where as shareholders they would enjoy additional powers which in widely held corporation is normally a director’s privilege to exercise. Section 12 provides information on Board of Directors powers and boils down to explain the necessity of shareholders to utilize their powers judiciously when allocated Director’s powers. 9. Powers of Board of Directors. Company Policy needs to be developed in the light of its impact on business and facilitate business opportunities and we are aware that Company Law governs higher objectives than mere policies to run business. Major decisions made by a company are made through the Board of Directors. Hence, the ability to control the Board of Directors is where the real power lies in any company. Shareholders holding over 50% of the issued shares in the company will be able to control the Board of Directors. Shareholders can enter into “Shareholder Agreements” with each other to regulate their rights and powers. In most cases, it is advisable to conclude a Shareholders Agreement at the outset of any business venture, particularly from the viewpoint of minority shareholders who can gain protection from being “out voted” under a Shareholders Agreement. This obviously cannot be relevant to closed corporations due to the limited number of share holders, their involvement in daily business for the best interest of the company, ability to vote for each other as director, the question of minority shareholders being exploited is far fetched and thus Rajat’s comment seems misplaced in case of closely held companies. 10. Minority Shareholder If a dispute arises between shareholders, the next most important legal principle for any shareholder to understand is Section 459 of the Companies Act 1985.13 The section is, in itself, worded in a very legalistic manner, however what the section seeks to do is protect minority shareholders - those with a 50% shareholding or less in circumstances where the majority shareholders seek to act in a way which is “unfairly prejudicial” to their interests. So the provision protects minority shareholders from “unfairly prejudicial” conduct. While those conducts are yet to identified as “unfairly prejudicial”, in general terms it means that minority shareholders have a right to complain to the court if the majority shareholder(s) run the Company in a manner that damages their position and the worth of their shareholding, often done deliberately and by misusing Company assets. The complaint must stand up to some objective analysis and certainly not be vague. A few examples of “unfairly prejudicial” conduct might be using company assets or money for the personal benefit of a shareholder or the majority shareholder(s) paying themselves far more than people in their position could objectively justify. Where “unfair prejudice” can be established, the Companies Act provides that the court “may make such order as it thinks fit”. By far the most common order made by the court is an order that one or more of the shareholders should purchase the shareholding of the other shareholder(s). Normally, the court will order the majority shareholders must purchase the shareholding of the minority shareholder(s) at a “fair value” The significance of the status of a “quasi-partnership” is that the courts are more willing to give certain additional rights to minority shareholders in those Companies. In particular, a minority shareholder in a “quasi-partnership”, who has been involved in the running of the business, can often claim protection from being excluded from the ongoing management of the business without any good reason. This whole concept of minority shareholders interest in close corporations is significantly reduced and almost negligible which again is not supported by Rajak’s comment. The sections below highlight Rajat’s comments might have made sense in widely held corporations however in closed corporations, it is almost non existent. Majority shareholders who control the Company have an advantage in any fight with the other shareholders in that they can pay their legal fees using Company funds. Even with a great legal case, a minority shareholder has only limited funds and is no match for the funds at the disposal of the Company. However, in most genuine shareholder disputes, the courts will not allow Company money to fund what is essentially a personal battle. Rajat’s comments applies well here while in closely held corporations with limited number of shareholders, Rajat’s thoughts does not hold true simply because the shareholders would ideally not have any such concern and they would be keen to protect company assets 11. Corporate Social Responsibility and Outside Creditors While there are questions like “Is the modern corporation a caring corporation?”14 to regulate corporate behaviour on one hand, there are issues of outside creditors that needs focus. The corporate responsibility has evolved to ensure the directors of companies satisfy wider social objectives and company law should play a vital role for its successful implementation apart from viewing at creditors needs and concerns with special interests under the roof of the companies law. With these emerging reforms in company law, it is close to impossible to validate Rajat’s comments in these circumstances as the shareholder’s horizon in closely held firms is way too broad and keeping the overall mandates in the company law, shouldering the CSR initiatives and other stake holder’s interest diffuses any comparison or similarity with widely held corporation. References Articles http://findarticles.com/p/articles/mi_7753/is_200907/ai_n32330347/pg_2/?tag=content;col1 www.oecd.org www.berr.gov.uk Gower and Davies' principles of modern company law. - http://webcat.hud.ac.uk http://www.business-standard.com/india/news/67-companies-chose-ngos-for-csr-implementation http://www.cbr.cam.ac.uk/pdf/WP226.pdf Social Science Research Network - http://papers.ssrn.com/sol3/papers.cfm?abstract_id=977582 http://www.shareholderrights.co.uk/rights_intro.htm http://www.dti.gov.uk/cld/comlaw/comlaw.pdf http://www.law.uvic.ca/mgillen/315/documents/Ch24-Closely-Held.pdf Read More