Company Law Minority Shareholders - Assignment Example

COMPANY LAW MINORITY SHAREHOLDER’S Question: ‘The Current laws in England and Wales Relating to the Protection of Minority Shareholders’ Interests are unfit for purpose’ Critically Discuss this Statement. STUDENT NAME PROFESSOR’S NAME COURSE TITLE DATE Introduction It is a long standing principle set out in Salomon v Salomon & Co1, that a company is a separate legal entity from its shareholders and promoters. A company once incorporated, it has the ability to sue and be sued, acquire property and do all actions that a legal person can do. In short, it is a legal person with rights and capable of accruing duties and liabilities under the law. The fact that a company is a separate legal entity implies that in the case of wrongs done to the company by its directors, the company is the only legal person that can institute legal proceedings against the wrong doers2. The separate legal entity aspect limited the instances whereby a minority shareholder or a member of the company would institute proceedings on behalf of the company. The Companies Act 2002, seeking to codify common law and rules created by precedents in corporate governance, deemed it fit to provide protections for minority shareholders and individuals. The basis of protection was in recognition that behind the corporate structure, there are individuals with rights, duties and obligations that needed protection3. The reform brought under Company Act 2006 allows shareholders to institute claims against other shareholders of the company, the directors of company or third parties. This paper discusses the protection of minority shareholders in England and Wales under the Companies Act 2006. It seeks to determine whether the laws are adequate for the protection of minority shareholders that is the laws fitness for purpose. It will highlight sections in the Companies Act that limit minority protection as well as study of common law and case law on minority protection. Who is a Shareholder? A share in corporate law refers to “the interests of a shareholder in a company always measured by the sum of money for liability purposes, interest and consisting of mutual covenants entered into by the shareholder”4. The term shareholder draws its name from the two words” a share and holder”, that means a share must be a property giving rise to rights and obligations. In corporate governance, the rights of a shareholder or class rights are protected by the Articles of Association and the company’s memorandum. However, certain companies are allowed to incorporate another instrument the Shareholder Agreements in regards to protection of shareholders rights and their voting rights5. A shareholders’ agreement gives additional protection to the interests that shareholders have in running the company as opposed to those given in the articles of association and the memorandum. The existence of a shareholders’ agreement can allow for adequate protection of minority rights in individual shareholders having veto power over any proposal that is contrary to the terms of the shareholders agreement. Shareholders agreements are secretive as opposed to the articles of association that are open to public scrutiny. The most amounts of shares a shareholder would have in a company are more than 50%. This would guarantee that the shareholder can block resolutions depending on the actual shareholding held. A minority shareholder will have less than 50% of the voting rights and hence unable to influence the decision of the shareholders during the company’s general meeting. In England and Wales, the law limits the ability of minority shareholders to bring actions against directors or the majority shareholders. In any case, shareholder’s barrier to an effective action in the court of law is predicated by the rules of Foss v Harbottle6. However, the Companies Act 2006 applies mandatory unless stated otherwise by the Act7. The Companies Act 2006 sets out the rights of the shareholders regarding decision making in the General Meeting8 , the collective rights of the shareholders in dismissing the board9, which a mandatory despite the existence of majority controlling the affairs of the company. The Rule in Foss v Harbottle Common Law perspective During the general meeting of a company, the shareholders of the company have the ultimate control on what the company should do and what it does. It is during this period that the directors give their report on the company’s solvency, liabilities and the projections. There are certain instances when the directors have a majority voting shares, or it represents the majority shareholders and therefore the minorities are left with no remedy, unless the company constitution has rules for minority protection. In the case of Foss v Harbottle10 the directors of the company had arranged that it would purchase land from the directors at an overvalued price and then enter into an utra-vires loan arrangement. The action against the directors was brought by two shareholders. They sought to enforce rights belonging to the company. The court held that the shareholders could not sue to enforce the company’s rights against the directors. The position of common law in favouring minority shareholders has not been forthcoming with those aggrieved with the decision of the court bringing their suit in cases of illegality, infringing on the personal rights of the shareholder or an act is ultra vires11 In the case of Foss v Harbottle, it stated that there are only two elements in respect to an action. The proper plaintiff in such an action is the company itself “the proper plaintiff”. Moreover, the duties of the directors were owed to the company and not individual shareholders hence the company was the proper plaintiff to sue. Secondly the court reiterated that if the majority shareholders in the company ratified a transaction and thus binding the company and its members, no individual member can bring an action. The rule in the case generally aimed at limiting instances for which directors decisions would be subject to review. The exceptions in common law are as set out in the case of Edwards v Halliwell12 . The brief facts of the case were that union’s constitution stated that contributions by the members could only be altered by two-thirds majority in a ballot of the membership. However a general meeting of delegates passed a resolution which increased contributions of members without the taking of a ballot. In the decision of Jenkins LJ he stated that there are only four exceptions to the rule in Foss v Harbottle13: the act is ultra vires14 there is fraud by the majority in control15, the act violates the article by a special majority16 and that the act invades the personal rights of the members17. The limitations in the protection of minority rights under case laws and common law were inadequate since the minority remained vulnerable to the control by the majority. Current Legal Framework for the Protection of Minority Shareholders Prior to the enactment of the Companies Act 2006, derivative litigation for minority shareholders was governed by the precedent in Foss v Harbottle (the proper plaintiff rule). The Companies Act Part 11 and the common law rules present a challenge to courts in terms of its applications. The protection granted to minority shareholders under the Companies Act 2006 mainly are mainly remedial in nature. That is, the shareholders are seeking recourse to the acts or omissions done by the majority in the company. It is often a last resort for shareholders if the shareholder’s agreements, the articles of association and the memorandum fail to give remedies for such actions. The type of rewards granted by the courts are discretionary, that is the judge gives awards as it deems fit, and in any case one succeeds in the claim, then the awards devolve the company unless it relates to personal claims. Unfair Prejudice The Companies Act under section 994 allows a shareholder to seek an order for allegations of unfair prejudice. According to section 994 of the Companies Act 2006, it states that the member of a company can petition the court for an order on two grounds. The first ground is that “the company’s affairs are being conducted in a manner that is unfairly prejudicial to the interest of its members some members or himself”18. The second instance where a member can file a petition is where “the actual or proposed act or omission of the company would be prejudicial”19. The wording of section 994 does not only limit to how the directors conduct the affairs of the company, but also means that it relates to the general controllers of the company20. Further the Act uses the word “any member of the company” denoting that it can be either a majority shareholder or a minority shareholder of the particular company. Section 994 of the Companies Act 2006 replaced sections 459 of the 1985 Companies Act, and sections 210 of the 1948 Companies Act. In the previous cases, it was allowable for a petition to find a remedy for complaints arising from the way in which the affairs of the company were managed21. In instituting a claim under unfair prejudice, then both unfairness and prejudice needs to be established. In many instanced, the court takes into consideration prior knowledge of the petitioner in regards to the claim, his conduct and any other matter that is complained about22. The court in setting the threshold for unfairness stated in the case of O’Neill v Phillips23 that the unfairness complained off must fall within the context of company law and not only unfairness in general considerations. Unfairness in this context needs to be in a commercial context24 An unfair prejudice suit arises when majority conduct the business affairs of the company in a way that unfairly prejudices the interest of the members or part of the members. This means that the conduct must lead to unfair prejudice. In this case it arises out of breach of legal bargain of the shareholders, fiduciary duty, equitable agreement or quasi-partnership principles. The order issued allows the minority shareholders to purchase the shares from the majority at a fair value. However, the discretion of the court can allow a minority shareholder to purchase the shares of a major shareholder at a fair value. According to Lord Wilberforce Ebrahimi v Westbourne Gallaries Ltd25 he stated that the unfair prejudice operates on the assumption that the company despite being a separate legal entity, there are actually individuals with rights, obligations and duties that need not be submerged in the corporate structure. Derivative claim The Companies Act 2006 at Sections 260-264 permits minority shareholders to file derivative claims that arise out of an omission, a proposed act involving negligence, default, a breach of duty or trust of the company’s directors. This is a significant change brought by the act, since the wrong done to the company do not injure him personally but the company. The Act extends the scope of derivative claims such that it does not entirely depend on the common law test that it must amount to fraud against the minority. The Companies Act 2006 at section 260 applies to proceedings instituted in England and Wales or Northern Ireland by the member of the company in respect to a cause of action that is vested in the company26 or seeking relief on behalf of the company27. The Act however limits the instances when a derivative claim may be brought that is under the chapter28 or in the pursuance of court proceedings under section 994 that is protecting members from action that unfairly prejudices them29. Section 239 of the Companies Act states that a share-holder director who is responsible for a negligent act will not be able to vote in a meeting aimed at ratifying the act. In this case, the claim is brought on behalf of the company by the shareholders and that any awards made will accrue to the company unlike a petition on unfair prejudice. Thus a derivative claim mainly concentrates on director’s conduct or behavior in regards to the affairs of the company, but it is filed on behalf of the company as an indefeasible right30. The Companies Act 2006 scope in terms of shareholder protection is not limited to autonomous illegalities31. Derivative claim as a remedy introduced by the Companies Act 2006 requires that the claimant need not to prove fraud on the minority shareholders, or discrimination against part or a section of the members of errors in terms of benefits accruing to directors since section 260-261 will cover this section previously under common law. The derivative action provisions overrule the long standing principle set out in Foss v Harbottle32. A derivative action also seeks to protect the claimants from wrongs that are proposed to be done. The remedy for a proposed action would be an injunction to stop the implementation of the proposal for instance if the board enters into an agreement in excess of their powers33, a self dealing contract that is yet to be entered and an interested director has failed to declare interest34 or the declaration of an illegal dividend not yet paid35. The derivative claim, present a challenge in regards to corporate principles since the loss challenged by the petitioner is a loss incurred by the company. This challenge against the wrong may be challenged if the company remedies the wrong in full. In consideration of Edwards v Halliwell36 the court stated that the proper plaintiff in respect to a wrong alleged to be done to accompany is prima facie the company. In any case if the wrong involves a transaction made binging to the members, then the majority of the members may vote in favor of the decision, and the minority would not question. Moreover in the reading of the act, the protection is not limited to the minority, despite the fact that the majority can influence their decision-making process. Personal Claims The Companies Act at section 1029 allows an application to be made to the court seeking the restoration of the company to the register that has been dissolved or has been struck off from the register37. The application can be filed by any person appearing in court to have an interest in the matter or others listed in the subsection38. In this case, reference to personal injury relates to a “disease, an impairment of the individuals physical condition”39. A general rule applies that shareholders of a company have rights enforceable against other shareholders and the company in circumstances where the shareholders agreement is breached or not. This is in regards to objections made to the alterations of the articles of association and the company memorandum, arbitrary varying class rights, issues that relate to financial assistance, breach and the enforcement of director’s duties, fraud or ultra vires transactions and prejudice regarding takeover offers. In cases where a shareholder successfully files a claim against the company, then the shareholder is not entitled to recover any amount equal to his shares or the market diminution of shares or dividends40. In the case of Prudential Assurance Co Ltd v Newman Industries Ltd41the court clearly stated that the loss suffered is not a personal loss but the loss in the company’s net assets hence the loss is on the company and any awards given devolve directly to the company’s account. This means that a shareholder filing a personal claim should not expect any reward for a claim instituted on behalf of the company. Just and Equitable Winding Up In the case of Ebrahimi v Westbourne Gallaries Ltd42, the court was faced with the question of what would be fair or the concept of fairness. The case concerned a winding-up petition filed under the cause of action of “just and equitable provisions”. According to Lord Wilberforce he stated that the just and equitable provision enables the court to give due consideration to the personal characters between two individual, that might make it unjust or unfair to insist in strict application of those rights43. In the application of the two principles in just and equitable winding up, it must be interpreted within the concepts of equitable doctrines. The Insolvency Act 1986 at section 122 (1) (g) requires that the Court has the power of winding up a company on ‘just and equitable’ grounds. The person filing a winding up petition needs to satisfy the court that there is sufficient surplus to distribute to the members and that the petitioner has “clean hands”. However, this remedy is limited to ‘quasi-partnership companies whereby the relationship amongst the shareholders has irretrievably broken down. This is now provided for under section 994 of the Companies Act 2006. The limitations introduced in regards to a winding up order are in cases where the petitioners unreasonably take the advantage of the remedy for other purposed. Director’s Duty and the Overlap with minority protection The duties of a director as per the Companies Act require that the director in exercise of the powers given, they have a fiduciary duty not only to act bona fide but use it for the proper o protection in corporate law. The directors of the company issued shares to pension fund trustees to prevent a takeover bid which would have been bad for the company. The shares having 10 votes each, the directors and the trustees would control the company44. In the decision of the court, it held that if the directors were acting honestly and in the best interest of the company, the directors can use the general meeting to ratify use of their powers for an improper purpose so that the allotment would be valid, with only one vote attaching to the shares. It therefore means that if directors of the company use their powers for an irregular purpose any shareholder would apply to the court in order to declare the transaction void45. However, according to case law, if the director remits the decision to the courts, and it approves, then the decision would be treated as proper since the majority control while minority submit. Are The Laws Unfit For Purpose? The Companies Act 2006 and the Common law applicable in England are inadequate in terms of protecting minority shareholders. In the case of the Companies Act 2006, the minority shareholders are given few protections under the law and most of the protections involve court proceedings. It is material that the minority shareholder must institute proceedings in court in order to assert his rights. To what extent do the minority shareholders seek protection in the company’s Articles of Association or in the Shareholder Agreement? The protection of the minority by section 994 of the Companies Act 2006 is not an alienable statutory right, this is because it can be removed or limited by contractual agreement, or instance in a limited liability partnership (LLP) or any other way46. The Act also imposes the scope for unfair prejudice suits that is meant only for small companies or those known as quasi-partnerships. These types of business usually partake their activities by agreement of all the shareholders, informal and in unwritten forms. In consideration of the case of Re Saul D Harrison & Sons Plc47 that the shareholders expect that the association will act according to their agreements not necessarily based on the contractual duties48. It is of importance to note that when both the company and its shareholders have a claim, based on the same facts then in consideration of the decision in the case of Day v Cook49 that the claim by the company will in most instances trump over that of the shareholder50. The institution of a derivative claim under section 260 of the Companies Act 2002 is only limited by two circumstances, that is the relief sought must be on behalf of the company or the cause of action is vested in the company51. This would be considered a limitation for minority protection for a cause of action that would fall out of the derivative claims actions. Moreover the same Act also limits the circumstances of instituting derivative claims that it must be under Part 11 of Chapter 1 of the Companies Act or in pursuance of proceedings instituted under section 994 of the Companies Act 200252. In any case, the protection through institution of derivative claims is not absolute but it is subject to limitations. Despite the fact that section 260 (4) of the Companies Act 2002 stating that it is material whether the cause of action arose before or after a person became a member of the company, the limitations under Part 11 can still restrict the instances of a member filing a derivative claim. Additionally, a derivate claim is only limited to the directors conduct and hence if the conduct or behavior is not as a result of negligence, breach of duty, default or breach of trust by a director, then a member cannot file a suit under a derivative claim53. Arguably, why would a shareholder need permission from the court to institute a derivative claim proceeding? The Act at section 261 (1) of the Companies Act expressly requires a member to seek the court’s permission in order to continue their cause of action under a derivative claim54. In any circumstance, if the derivative claim does not show a prima facie case, then the court has the discretion to dismiss that application or make a consequential order based on the courts discretion55. This means that a minority shareholder is to take precautions in applying for a derivative claim as long as there is a prima facie case. A prima facie case is a case with a high chance of success on the face of it, without necessarily having to look at the merits56. Despite the fact that the provision seeks to eliminate the application of frivolous and vexatious suits, there is a high chance that minority shareholders would abscond on their rights on the mere fact that the action in question does not meet the prima facie threshold set by the court57. The court in the decision of Franbar Holdings Ltd v Patel58 sought to determine the threshold necessary for a derivative claim. The court stated that Franbar the shareholder in the company brining the derivative claim, one ought to be satisfied by the merits of the case, where it would lead a reasonable director to conclude that continuation of the claim would be in the best interests of the company. The court use their discretion in derivative claims in determination of whether the cause of action is actionable by the interpretation of sections 263 (3) and 263 (4) of the Companies Act 2006. Conclusion In conclusion, the Companies Act 2002 is a progressive Act that grants instances where the minority can be allowed protection by acts or omissions done by the majority shareholders or acts of the directors. This is an important aspect in regards to minority protection. This follows the long standing position in common law set out in the case of Foss v Harbottle59 that the company is the only person with a legal standing to institute proceedings against those who do acts or omissions that harm or injure the company. The rule in Foss v Harbottle was not absolute, since it created the need to protect the minority in instances where the majority was unfair in the decision-making process in the company. The Companies Act 2006 allows the minority shareholders or a member to institute derivative claims, unfair prejudice claims, where there in the winding up of the company a member can institute a claim on the basis of just and equitable winding up or on personal claims. The protection given to the minority under the Act all involve court proceedings, unless the company provides for minority protection in the memorandum or articles of association. Moreover, the Companies Act 2006 also limits the instances of instituting such proceedings, hence making it a discretionary protection rather than absolute protection. The fitness of the purpose of the minority protection under the Companies Act is timely, but limitations imposed there under makes it unfit for purpose. References Books/ Articles/Journals Almadani M, Derivative actions: does the Companies Act 2006 offer a way forward?, [2009] Comp. Law. 13 140 Arad, Reisnerg, ‘Judicial Control of derivative actions’, (2005) 16 (8) ICCLR 335 Cheung R, Corporate wrongs litigated in the context of unfair prejudice claims, [2008] Comp. Law. 98–104 Davies, A, Gower and Davies Principles of Modern Company Law, (9th edn, Sweet & Maxwell, 2012) Hicks and Goo, Cases and Materials on Company Law, (Macmillan, 2006) Kershaw D, Company Law in Context (2009 Oxford University Press) 212 Mayson S, French D and Ryan C, Company Law, ( Oxford University Press, 2010). Paul Davies, Gower and Davies: The Principles of Modern Company Law, (8th edN, Sweet & Maxwell, 2008) 206 Prentice D and J Payne, ‘The corporate opportunity doctrine’ (2004) 120 LQR 198–202 Rickford, J ‘Fundamentals, developments and trends in British company law’ (2004) ECFR 391–415 Ferran, E, ‘Corporate law, codes and social norms – finding the right regulatory combination and institutional structure, (2001) JCLS 381–409 Legislations Companies Act 2006 Cases Bermuda Cablevision Ltd v Colica Trust Co.Ltd [1998] AC 198 Borland’s Trustee v Steel Bros & Co 1901 Cooks v Deeks [1916] 1 AC 554 Hicks and Good p. 430 Day v Cook [2001] EWCA Civ 592 at 38 Ebrahimi v Westbourne Gallaries Ltd [1973] A.C.360 at 379 Edwards v Halliwell [1950] 2 All ER 1064, Hicks and Goo, p.430 Franbar Holdings Ltd v Patel [2008] EWHC 1534 (Ch) Fulham Football Club (1987) Ltd v Richards [2011] EWCA Civ 855 Salomon v Salomon & Co [1897] AC 522 (HL) Smith v Croft (No.2) [1988] Ch 114 Hicks and Goo, p.30 Pender v Lushington (1877) 6 Ch D 70 Hicks and Goo, p. 430 Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 at 223 Read More