Business Organisation Law - Case Study Example

Business Organisation law Legality of the action of the Directors of ABC Plc By selling the newly formed subsidiary company keeping in which majority of shares for themselves, the directors of ABC Plc have apparently acted against the interests of the holding company Plc as well as its members. Prior to coming into force of The Companies Act 2006 (CA 2006), common law decisions were mostly being applied to such cases. Each decision being unique to particular facts of the case, the duties of the directors have now been codified in the CA 2006. They, numbering seven, are briefly stated below. 1) Section 171: The directors must act within the confines of the company’s constitution and should exercise the powers only for specific acts for which they been given. 2) Instead of the earlier conception that they should act in good faith keeping in their view the interests of the company, they are now required to work to promote the company and such actions should be beneficial to the shareholders of the company as per section 172. 3) Section 173: They should judge independently without being influenced by others or extraneous circumstances. This is a new requirement which common law did not have though they had the obligation under the common law not to abuse their discretion while taking decisions. 4) Section 174: Instead of displaying duty of care and skill under common law, they are now required to show reasonable care, skill and diligence. 5) Section 175: They should refrain from indulging in acts which are in conflict of interest of the company. Earlier under common law, if they had acted in conflict of interest of the company but with the shareholders’ consent, they need not account for any secret profit made for themselves and the company also need not avoid the contract so made. 6) Section 176: They should not receive any benefits from third parties which duty was not there under common law earlier. And 7) Section 177: They should declare to other directors of the company if a director has any personal interest a proposed transaction with the company. Now, dealing with the conflict of interest which the instant case is concerned with, a prior authorisation by the board of the holding company is required to allow them to have majority of shares in the subsidiary company and later to sell the same in the open market at huge profit. It is enough if the directors concerned declare their interests in the proposed transaction, in this case to sell the subsidiary company, rather than avoiding the transaction altogether. However if the transaction does not involve the holding company, the new rule requires that they should avoid the situation conflicting with the interests of the company unless there has been a prior authorisation by the company’s board for the directors to do so. For a public limited company, the articles should have a provision for such an authorisation. And the authorisation should be supported by sufficient quorum without counting the number of interested directors (Freshfields 2008). While the above sections from 171 to 174 have come into force from 1 October 2007, the others from 175 to 177 have come into force from 1 October 2008 (aic). Sections 168 and 170 deal with the removal of erring directors. As per the section 168 (1), an ordinary resolution is enough to remove a director but it should be at a meeting so that the director concerned can defend himself. Therefore section 169 provides for the affected director to register his protest against the move for his removal. Unlike earlier, the subsection 169(5) provides that the court need not look into the fact whether the right is being abused for publicity (Explanatory Notes, 2006) The above brief would show that the directors of ABC Plc have acted in concert without an authorisation of the board though the authorisation must come from those not interested in the deal. Perhaps due to this, they could not take an authorisation. Therefore, the Company as a separate legal entity must take action against the director for the wrong committed by them through what is called a derivative action since the directors themselves would not initiate action against themselves. Earlier, this power of derivative action was available to minority shareholders through courts who have the discretion to allow the action based on the majority of the shareholders who are independent supporting the action. The new CA 2006 enables a member to apply to court as a derivative claim against a director or other person for the act of negligence, default, breach of trust or duty already committed or likely to committed by a director. The member has to take permission from the court which can allow or disallow depending on the evidence made available. The company can be directed by the court to answer the claim. In this regard, the claimant does not have to show that the alleged wrong committed by the director is a fraud on minority nor the said directors are in full control of the company. The court shall ensure that the member is acting in good faith. It will also weigh against a number of factors whether the company is likely to ratify the wrong, whether the company has decided not initiate by itself or whether the member can initiate on his own right rather than on behalf of the company. And it will also hear the views of the other members who are disinterested (Salarman, No date p 7). Generally a director is required to declare his interest in a transaction to the other directors as per section 182 of the CA 2006. He need not declare any such interest if the other directors already know about it. And if there is only a single director, there is no need for him to declare the interest. In the instant case, the question of interest declaration does not arise since all the director are reported to have committed the wrong and all of them were in the know of things (Explanatory notes p 55). The above mentioned derivative claims by the members are provided for in the section 260 of the CA 2006. The essential characteristic of a derivative claim is that even though it is brought by a member of the company, cause of action should be that of the company and the member is treated as claiming the relief on behalf of the company. The claim can also be brought in pursuance of a court order under section 994 under the provisions of unfair prejudice which deal with proceedings for protection of members against unfair prejudice. The subsection (3) of section 260 provides that derivative claim can only be brought for negligence, default, breach of duty or trust by a director. A third party can also be implicated where it can be shown that the loss was caused to the company because of the director’s breach which the third party was knowingly a party to the director’s breach. Here the company solicitor was in league with the directors in the above said act of selling the subsidiary for personal profit. As the company solicitor, hw should have safeguarded the company’s interests. The derivative claim is so effective that a member can bring it for the wrongs committed even before the period of his membership. And the director also includes a former director and a shadow director. The company solicitor may therefore be treated as having acted as a shadow director though he may be separately tried for professional misconduct. (Explanatory notes p 74-75) An almost identical issue was involved in Regal (Hastings) Ltd v Gulliver (1942). The allegation was that the directors of the company involved in cinemas in their anxiety to acquire additional cinemas as part of their business expansion had to start a subsidiary Hastings Amalgamated Cinemas Ltd (Amalgamated) to buy two cinemas on long lease since the owner of the cinemas was insisting on a minimum fully paid up capital of £ 5,000 or personal guarantees of the directors for the rent. The directors of Regal were unwilling to give personal guarantees and the Regal could only contribute £ 2,000 for the shares in subsidiary. Therefore the Gulliver who was the Chairman arranged share contribution from outsiders for 500 shares and another 500 shares from the company solicitor Garton. After the deal went through successfully, both the Regal and the subsidiary Amalgamated were sold for windfall profit and was shared by the four directors. The new management caused a claim by the company Regal requiring the directors to account for their profit. It was held that the directors should account for the profit made on the ground that persons in a fiduciary capacity should not make profit out of their vantage position as applicable to trustees. The four directors were therefore required to account for the profit made even though they had acted bona fide. There need not be a fraud or absence of good faith for establishing directors’ liability. This ensured that new owners would get back the windfall profit made by the ex-directors as otherwise they have enjoyed a reduction in price when shares were acquired. Thus the “no-profit rule” applied strictly though it was absurd to hold so (Hicks and Goo 2008 p 399) This “no profit rule” has been replaced by section 175 (1) of the CA 2006 dealing with conflicts of interest. The directors are therefore held liable unless they had expressed their interest before making the deal. This strict rule is analogous to trust law and does not require fraud or lack of good faith as precondition (Hicks and Goo 2008). Sanctions Failure to declare interest is dealt with in section 183 of the CA 2006 and is considered an offence on the part of the persons committing it. If convicted summarily of the offence, the director shall be fined a maximum of £ 5,000 which is independent of civil consequences. If convicted on indictment there is limit to maximum penalty (Formacompany) Further section 232 of the CA 2006, no director can be exempted by a company by its articles from the consequences of negligence, breach of duty or breach of trust. Section 239 provides that a company can ratify an action of the director in a meeting without counting the votes of the director or any person connected to him (Talbot 2007 p 190) On other hand if the aggrieved members fail to invoke their derivative claim as stated above, the CA 2006 enables the member to invoke section 994 by which the members can move petitions before the appropriate court stating that the act of the directors of the ABC Plc committed is prejudicial to the company. Under section 996, the court can consider the petition and if it is satisfied of the genuinity of the complaint and pass orders giving relief to the petitioners (Sheik 2008 p 352-353). Besides, the directors can also removed by holding a meeting of the company’s shareholders as mentioned elsewhere. Conclusion In view of the foregoing, the members John and Doe are advised that they can successfully make derivative claim as a result of the directors’ and the solicitor’s acting in concert deliberately to make windfall profit abusing the fiduciary position they have held in the company ABC Plc. However, their success depends up on the rest of the members not ratifying the action of the directors. Unlike in the case of Regal Hastings, where the new management brought the action through the company for the past acts committed by the directors and the solicitor who left the company, the present case of ABC Plc is slightly in favour of the directors if they are not disowned by the members. References AIC; Association of Investment Companies January 2008 accessed 16 August 2010 Regal (Hastings) Ltd v Gulliver: [1942] UKHL 1, [1942] 1 All ER 378, [1967] 2 AC 134 Explanatory Notes Companies Act 2006 Department of Trade and Industry < www.opsi.gov.uk/acts/acts2006/en/ukpgaen_20060046_en.pdf - >accessed 16 August 2010 Freshfields Bruckhaus Derringer 2008 Companies Act 2006 Directors’ Duties accessed 16 August 2010. Formacompany, Chapter 3: Declaration of interest in existing transaction or arrangement Companies Act 2006 < http://www.formacompany.com/en/uk/uk-companies-act-2006/companies-act-2006-notes-182-187>accessed 16 August 2010. Hicks Andrew and Goo S H 2008 Cases and materials on company law 6 Ed Oxford University Press, Oxford Salarman Bridget, No date Directors’ Liability The Companies Act 2006: Your essential guide to the new regime The Chartered Secretary Focus p 7 Sheik Saleem 2008 A guide to Companies Act Taylor and Francis Oxon Talbot Lorraine 2007 Critical company law Routledge Oxon UK Read More