Company Law. Case Study - Essay Example

Background: Alison Belfield (AB) is a minority shareholder in Commercial Chemical Applications Limited (CCA). Based on AB’s concerns regarding the activities of directors of CCA and the company operations the following facts have come to light. Tom Stockley is a director in CCA who also owns 3% of the shares in Amalgamated Property Holdings Ltd (APH). He introduced the transaction to CCA and is helping in negotiations to buy out APH. AB feels that CCA is not faring well commercially, being burdened with an overdraft of £3 million, excessive capacity and the need to close down five smaller plants around the country. Any move to acquire APH could push CCA into insolvency. AB, having a financial and property background also feels that the proposed price of APH is too high and in her opinion the financial director, Rachel Nash has over-estimated the worth of APH by £500,000 to £600,000. But since Rachel is a chartered accountant by profession, all other directors, who do not have a financial background, rely upon her judgement. APH also has a poor track record of environmental issues, already having being convicted twice for allowing chemicals to leak into the nearby river and under close scrutiny of environmental authorities. The factory too is fairly old and requiring substantial expenditure for its refurbishment which may never happen. The acquisition of APH will inevitably result in the closure of the CCA’s other small plants located in rural areas thereby causing loss of several hundred jobs with very little possibility of being re-employed. Even more disturbing to AB is confidential information received from within CCA that the Managing Director, Nadine Williams is fully aware of another opportunity to acquire alternative premises situated nearby which are more suited to CCA’s needs, more modern and far less expensive than APH. But Nadine Williams has connived with APH to keep the information regarding the alternative opportunity from the Board of CCA, and as consideration, would receive a ‘thank you’ payment of £5,000 from APH. Lately, Nadine Williams and another director of CCA, Michael Lynch have also been seen regularly in the company of APH directors and enjoying their hospitality. Introduction: In order to advise Alison Belfield (AB) we shall discuss the rights and duties of company directors and shareholders, the breach of these duties, consequences of breach and the rights of shareholders to prevent directors from causing any loss to the company due to negligence, default, breach of duty or breach of trust under The Companies Act 2006 (CA06). In CA06 the duties of a director have been set out as statutory statements described as the ‘director’s general duties’ and have rewritten the common law. There are seven general duties of a director under CA06: A duty to act in accordance with the company’s constitution, and to use the powers conferred by it only for the purposes for which they were conferred. A duty to promote the success of the company for the benefit of its members. A duty to exercise independent judgment. A duty to exercise reasonable care, skill and diligence. A duty to avoid conflicts of interest. A duty not to accept benefits from third parties. A duty to declare to the company’s other directors any interest a director has in a proposed transaction or arrangement with the company. Now we discuss the roles, rights and duties of each individual in the present Fact Pattern: Tom Stockley (TS): is a director of CCA and is the owner of 3% shares in APH. He has introduced the transaction of APH to CCA without divulging his interest in APH to the Board of Directors or the remaining directors. A director must declare an interest in a proposed or existing transaction with the company under CA06 and any failure to declare his interest in an existing arrangement is a criminal offence which, if convicted of, can attract a financial penalty. Two separate provisions require such an interest to be disclosed: the first (one of the general duties) applies where a director is interested in a transaction or arrangement that the company is proposing to enter into; the second (part of the replacement for Part X Companies Act 1985) applies where a director is interested in a transaction or arrangement that has already been entered into. Rachel Nash (RN): she is the financial director of CCA and is a Chartered Accountant by profession and the other directors, who do not have any financial qualifications, rely on her judgement. As such her duty of care towards CCA must be construed in a stricter manner than the other directors as she is a professional financial director and because the common law already lays a strict application to solicitors and professionals in their area of trade. However the other directors too must have the standard of skill and care required to be a director and individuals should think carefully before accepting directorships. Do they have the necessary skills to perform the task? Even non-executive directors are expected to have a reasonable degree of knowledge and competence. All directors should give the company the full benefit of their actual experience and knowledge. Nadine Williams (NW): Firstly, therefore, NW is guilty of one of the most important ‘general duties’ of a director, that of a duty to promote the success of the company for the benefit of its members. This would be as a consquence of her failure to add value to the company since her decision to acquire another plant is likely to push CCA into insovency, and would also be a breach of her duty to consider the long term consequences of her actions, her duty to safeguard the interest of her employees and shareholders. By negotiating to acquire an old plant which already has a poor environmental track record and a criminal history of two convictions she is also exposing CCA to these adverse issues. Health & Safety regulation is also a major issue in the UK and should be of serious concern to a diligent director as breaches of this regulation could have highly demoralising effects on employees, third parties, the reputation and brand of the business as well as on the director’s personal standing and career. Lack of compliance with Health & Safety legislation can lead a guilty director to being fined, imprisoned and disqualified. And in case the environmental damage leads to expensive clean-up by the company and the company is also penalised with a fine, then NW is liable for any damages that the company has to bear. Secondly, she is guilty of not exercising independent judgment as she is blindly depending on RN, the financial director, and a professional chartered accountant. As the Managing Director of CCA it was NW’s duty to also get the valuation of the plant done by independent valuers. Here NW is also guilty of a breach of her duty to exercise reasonable care, skill and diligence. Every director before taking up the job of a director must have the standard skill, care and competence. All directors are required to give the company the benefit of their actual experience and knowledge. A director has a duty to disclose a business opportunity arising out of her capacity as director. If a director wishes to exploit this opportunity for her personal benefit she must inform the Board of Directors through the relevant officers of the company by which she is employed. Should she fail to do this, she will have a fiduciary duty to account to the company for any profits made: Crown Dilmun v Nicholas Sutton [2004] EWHC 52 (Ch). A director must also not accept benefits from third parties which come to her as a director either because she is a director or because she agrees to do or omit do to something when acting as a director. A director is also under a duty to prevent any situation where a conflict may arise between her personal interests and the interests of the company. This applies in particular to the exploitation of any property, information or opportunity. Secret commissions, or bribes, also come under the no profit rule. There is a serious conflict of interest here as NW is guilty of promoting her own interest above that of the company. ODonnell v Shanahan [2009] EWCA Civ 751 is a UK company law case concerning the strict prohibition on any possibility of a conflict of interest between a directors duty to promote her companys success and her own gain. Lastly, NW needs to maintain a reputation for high standards of business ethics; this she is guilty of breaching by hobnobbing with and enjoying the hospitality, on several occasions, of the APH directors in the company of ML. Michael Lynch (ML): Those accepting a position as directors must ensure that they familiarise themselves with, and participate in the business, particularly the decision making processes. Directors must exercise independent business judgement and be prepared to challenge others on the board - whoever they are. If they disagree with a board decision they should ensure this is evidenced in the companys minutes.When a fiduciary duty is imposed, equity requires a stricter standard of behavior. It is said the fiduciary has a duty not to be in a situation where personal interests and fiduciary duty conflict, a duty not to be in a situation where his fiduciary duty conflicts with another fiduciary duty, and a duty not to profit from his fiduciary position without express knowledge and consent of the board. A fiduciary must not profit from the fiduciary position.This includes any benefits or profits which, although unrelated to the fiduciary position, came about because of an opportunity that the fiduciary position afforded. Here ML is clearly guilty of not fulfilling his fiduciary duties as a director of CCA as in a recent case the Court of Appeal has ruled that, where a director commits fraud, his or her fellow directors are in breach of their own duties to the company in allowing the fraud to happen. As a director it was his duty to suspect the impropriety and intention of NW in getting overly familiar with the directors of APH while the transaction to acquire the plant of APH is still under consideration by CCA. It was the duty of ML to bring this to the notice of the other directors and the board instead of repeatedly enjoying the hospitality of the directors of APH in NW’s company. CA06 requires that directors act in the interests of their company and not in the interests of any other parties including other directors or shareholders. Alison Belfield (AB): In the event of breach of duty or likely breach of a director’s duty, a shareholder has been granted some additional rights under the CA06, such as of written resolutions as an alternate to calling a shareholder meeting. Written resolutions need not be signed by all the shareholders. Instead, the required majority will be similar to that for shareholder meetings – a simple majority of the eligible shares for ordinary resolutions, or 75% for special resolutions. To speed-up decisions companies can also choose to make more use of electronic methods. Private companies are no longer required to hold an AGM and 10% of shareholders can demand a meeting (5% in certain circumstances). For a private company meeting to take place they require a 14 day notice period. In the first option available to AB we have noted that she holds 14,000 shares out of a total of 100,000 shares of the company total ordinary shares. Thus the 14% shares she holds allows AB to call for a shareholders meeting in which she can raise the issue of the breach of their fiduciary duties by all the directors and more particularly the disturbing circumstances that have come to her notice. When the directors and officers have wronged the company, the company is well within its rights to sue them and recover damages, an ironical situation arises; the very people who are running the company have damaged the company and deserve to be sued. This is the situation, in which the law permits a shareholder (the “derivative plaintiff”) to sue the directors and officers for and on behalf of, the corporation. The derivative plaintiff only needs to demonstrate that a majority of the board of directors lack independence of judgment in the dispute. This is the second option that AB can exercise under the CA06, that of derivative action. By law, the court must approve the initiation and settlement of a shareholder’s derivative case. Here AB is a shareholder of CCA which is likely to be harmed through a breach of fiduciary duty by its directors, and she would be eligible to bring a legal action on the company’s behalf against the directors who are dishonestly involved in negotiating a deal which is bound to harm the company. Conclusion: We need to discuss the rights and duties of company directors and shareholders as enumerated under the Companies Act 2006 (CA06) since CCA has adopted the Model Articles under this act. When we study the actions of the various directors of CCA, we realise that all of them are guilty of breaching one or the other of the statutory duties enshrined as a statutory provision in CA06. One of the primary duties of directors under this act is to act in accordance with the duties of the directors as given in the articles of the company and to use them only for the purpose for which they were conferred. However, perhaps the most important changes made in the CA06 as compared to the common law, is the duty of the director to promote the success of the company for the benefit of its members. The earlier common law duty was to act in ‘good faith’ in the company’s interests. This becomes all the more important when NW, one of the directors being referred to here, is the Managing Director of the company. We have seen here that CCA is already burdened with a heavy overdraft, over-capacity and the prospects of closing down five of its plants located in various parts of the country. It is obvious that the company is not being run in a way as to add value to it, its employees or its shareholders. There is imminent danger of its being pushed into insolvency. Under these circumstances it’s the foremost duty of the board of directors, the managing director and the individual directors to take decisions of far reaching consequences beneficial to the company. We then find that an opportunity has presented itself to CCA in the shape of the availability of a modern plant which is cheaper, situated nearby to the existing plant and is suited to the requirements of the Company. TS, who already has an interest in another company APH, has introduced another transaction to CCA for a plant of APH. He has failed to inform the board of CCA or its directors of his interest in APH. As seen above he is clearly breaching his duty under CA06 to reveal his interest in a proposed or existing transaction with the company. We also see that the plant owned by APH which is offered for consideration by CCA is not suitable to the requirements of CCA and its acquisition is not only likely to expose CCA to several issues, primarily of environment and health and safety but also burdening it with a plant whose criminal track record would inevitably bring it into conflit with the authorities. It would also reduce its brand value in the eyes of its employees, shareholders and creditors. And if, as a result of the acquisition of this plant of APH, CCA is pushed into insolvency, then it shall be forced to shut its five plants situated in rural areas with the resultant loss of jobs of several hundred of its employees. NW, who because of her being in the capacity of a director of CCA, learnt about the second more beneficial plant, but intentionally failed to bring its availability to the knowledge of the board of directors. Instead, she has dishonestly agreed with the directors of APH to push for purchase of their plant, for a personal consideration from them of a ‘thank you’ payment of £5,000. She is thereby breaching her fiduciary duty not to accept benefits from third parties. She has also ignored her duty to maintain a reputation for high standards of business ethics by frequently enjoying the hospitality of the directors of APH in the company of ML. NW and the other directors have shown a lack of independent judgement and exercising of reasonable care, skill and diligence by blindly relying on RN and not getting independent valuation of the plant of APH. RN, the financial director who inspite of being a professional chartered accountant, and whose duty to the company is of a far stricter nature than the other directors, is guilty of overestimating and miscalculating the price of the plant of APH by over half a million pounds. However under the provisions of CA06, even where a director’s guilt for an act of negligence, default, breach of duty or breach of trust in relation to the company is clear, the shareholders can ratify the breach by ordinary resolution (that is, a simple majority vote). If the delinquent director is also a shareholder, they cannot vote in their own favour; neither can their family or others connected with them. Thus in this case we see if such a situation arose where the shareholders could ratify the breach by NW, herself being a shareholder holding 6% shares, could not vote for herself but in case she did vote then the votes cast in her favour would be reduced to the extent of her shareholding, that is to the extent of 6%. The UK Companies Act has two key restrictions.  Firstly, a company cannot exempt a director from any liability in connection with negligence, default, breach of duty or breach of trust in relation to the company.  However, a company is allowed to purchase and maintain insurance for a director. Secondly, a company cannot indemnify a director against any liability for negligence, default, breach of duty or breach of trust in relation to the company.  This is with the exception of ‘third party indemnity provision’, whereby companies are allowed to indemnify directors in respect of proceedings brought by third parties.  A director in breach of a duty may also be relieved of any liability if they can convince the court that they acted honestly and reasonably in all the circumstances. This might happen where a director acted in good faith on the advice of a lawyer or other professional, but where the advice proved to be wrong. Duty not to benefit from third parties: Any benefits obtained in this way will have to be accounted for to the company even if the company benefits as well. All directors who face actual or possible conflicts of interest by virtue of their position must either obtain authority to act, or remove the possibility of the conflict, or resign as directors. In addition, specific rules apply where directors propose to enter into “substantial” property transactions with a company. Under the no bribe rule, the Directors should ensure that they do not receive any benefits not provided for, or allowed, under the constitution of the company. However a bribe is held under constructive trust to the company. Fiduciary duties are an aspect of equity and, in accordance with the equitable principles, equity serves those with clean hands. Remedies of Breach of duty: the company may seek the following remedies against any director guilty of breach of duty: An Injunction to stop the director from carrying out or continuing with the breach; Damages by way of compensation where the director has been negligent; Restoration of the company’s property; Rescinding of a contract in which the director had an undisclosed interest. Disciplinary Proceedings: against a person that has breached her fiduciary duties can be disciplined. Criminal Sanctions can be imposed for breach of fiduciary duties where there is criminal or fraudulent intent. References 1. BERR – Companies Act 2006: A summary of what it means for private companies http://www.berr.gov.uk/files/file42262.pdf 2. Companies Act 2006 – Duties of Company Directors http://www.bis.gov.uk/files/file40139.pdf 3. Companies Act 2006 and Directors Duties: http://www.bytestart.co.uk/content/legal/35_2/companies-act-directors-duties.shtml 4. Companies and Directors: http://www.sfo.gov.uk/media/98135/companies%20and%20directors%20web%201.pdf 5. Corporate/Company Law: http://www.mondaq.in/article.asp?article_id=76406 6. Director’s Duties: http://en.wikipedia.org/wiki/Directors_duties 7. Directors and their Fiduciary Duties: http://www.lawdit.co.uk/reading_room/room/view_article.asp?name=../articles/8612-directors-and-their-fiduciary-duties.htm 8. Duties of Directors in new Companies Act 2006: http://www.personneltoday.com/articles/2007/05/08/40470/duties-of-directors-in-new-companies-act-2006-legal-q.html 9. Freshfields.com – Companies Act 2006_Director’s Duties: http://www.freshfields.com/publications/pdfs/2006/17062.pdf 10. Law Company Shareholders equity: http://www.lawteacher.net/company-law/essays/law-company-shareholders-equity.php 11. Law Essays UK :http://www.law-essays-uk.com/resources/coursework/director-duties-company.php 12. Legislation.gov.uk http://www.legislation.gov.uk/uksi/2008/3229/schedule/1/made 13. Out-Law.com http://www.out-law.com/page-8207 14. Remedies for Breach of a Fiduciary Duty: http://www.lawdit.co.uk/reading_room/room/view_article.asp?name=../articles/8613-remedies-for-breach-of-a-fiduciary-duty.htm 15. Sfo.gov.uk: Companies and Directors: http://www.sfo.gov.uk/media/98135/companies%20and%20directors%20web%201.pdf 16. Shareholders derivative actions: http://schubertlawfirm.com/practice-areas/shareholder-derivative-actions/ 17. The Companies Act 2006 – Directors’s Duties Guidance: Corporate Responsibility http://corporate-responsibility.org/wp/wp-content/uploads/2009/09/directors_guidance_final.pdf 18. UK Essays – Codification of Directors Duties: http://www.ukessays.com/essay-fraud/321800.php 19. Wikipedia – Fiduciary: http://en.wikipedia.org/wiki/Fiduciary Read More