Workshop 4

Question 1

Membership rights under the Articles: s 33 CA 2006

Answer 1

The Articles of a company regulate the relationship between the members and each other and between the members and the company. They act as a contract. This is enshrined in s 33 CA 2006, which provides as follows:
- The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions.
- The effect of this provision is that members can sue under s 33 CA 2006 if their membership rights are infringed. The usual remedy for breach of s 33 CA 2006 is damages.
- The meaning of membership rights is far from clear. It is necessary to look to decided case law to establish the rights that have been considered to be membership rights in the past.

Question 2

Examples of membership rights that have been enforced under s33 CA 2006

Answer 2

• right to a dividend once it has been lawfully declared;
• right to share in surplus capital on a winding up;
• right to vote at meetings; and
• right to receive notice of GMs and AGMs.

Rights of members which are not membership rights are not enforceable under s 33.

Question 3

Shareholders Agreements

Answer 3

While the parties could rely solely on the Articles to govern how the company is run, in most companies owned by more than one person a Shareholders’ Agreement will usually be entered into. The Shareholders’ Agreement acts as a kind of extension to the Articles in terms of governing how the company is run and can contain provisions that the law does not permit the Articles to contain. The specific provisions in the Shareholders’ Agreement will depend upon the reason why the parties are entering into the business venture but are likely to include provisions relating to:
* Unanimous voting over certain matters e.g. removing a director;
* Quorum for GMs;
* Dividend policy;
* Allotment of new shares, and
* New and departing shareholders.

Question 4

Shareholders Agreements vs Articles

Answer 4

A Shareholders’ Agreement is a contract between some or all of the shareholders, in which they can agree between themselves how to regulate the affairs of their company.
- They can, for instance, agree not to change the Articles of the company and not to exercise their power under s 168 CA 2006 to remove any director of the company unless they are all in agreement.
- Such provisions in a Shareholders’ Agreement will constitute personal rights and obligations on the shareholders, including how they will exercise their voting rights on certain decisions.
- Another key reason why Shareholders’ Agreements exist is because they can be kept private (unless they are explicitly referred to in the Articles).
- The Articles are treated as a contract between the company and its shareholders in their capacity as shareholders pursuant to s 33 CA 2006, and do not therefore deal with shareholders’ personal rights and obligations.
- The provisions of the Articles are subject to CA 2006, whereas a Shareholders’ Agreement is an arrangement arrived at between the shareholders in their personal capacities and gives them more freedom in respect of what they can agree to.
- Where the shareholders agree between themselves in a Shareholders’ Agreement as to how to regulate the affairs of the company, the company should not be a party to any terms which restrict its statutory powers.
- This does not mean, however, that the company should never be a party to a Shareholders’ Agreement: only that it should not be a party to those provisions that restrict it from exercising its statutory powers.

Question 6

Right of action/enforceability - shareholders agreements

Answer 6

• A Shareholders’ Agreement provides a right of action which enables one member to enforce the provisions of the Shareholders’ Agreement directly against another, whereas under the Articles this right of action may not arise. Because of the difficulties shareholders can encounter in enforcing the provisions of the articles under s 33 CA 2006, a Shareholders’ Agreement can be used in order to ensure the enforceability of provisions that would not be regarded as membership rights.
• If a term of a Shareholders’ Agreement is breached it can be enforced in the usual way under general contract law principles. A shareholder will be able to claim for breach of contract, or alternatively could apply to the court for an injunction to prevent a breach of the terms of the agreement. A Shareholders’ Agreement can also prevent the need for s 994 petitions (unfair prejudice), although it obviously cannot stop a disgruntled shareholder from bringing such a petition.

Question 7

Can shareholder agreements be kept private

Answer 7

yes

Question 8

Reserved matters in shareholders’ agreements

Answer 8

Certain matters can be reserved in a Shareholders’ Agreement as matters requiring the consent of all shareholders or certain individual shareholders and this protects minority shareholders. For example, a Shareholders’ Agreement may provide that the unanimous consent of all shareholders is required to pass a resolution to remove a director. This does not remove the right of the shareholders to remove a director under s 168 CA 2006, as a company is bound to accept the vote of a shareholder even if this is in breach of the provisions of the Shareholders’ Agreement.
Where a removal resolution is passed without the required unanimity, provided a simple majority voted in favour (in accordance with CA 2006), the resolution would still be valid, and the director would be removed from office. The director would then have a claim against the other shareholders for breach of the Shareholders’ Agreement. The threat of a breach of contract claim effectively means that the minority shareholder is able to influence whether or not the resolution is passed.

Question 9

Amendments to shareholders’ agreements

Answer 9

A further reason why parties may enter into Shareholders’ Agreements is that amendments to a company’s articles of association can be made by passing a special resolution requiring 75% approval. Changes to a Shareholders’ Agreement in contrast will require the unanimous approval of all parties to the agreement. This would consequently give a minority party a right of veto to any proposed changes.

Question 10

rights of shareholders with different shareholdings under CA 2006 - 5%

Answer 10

• Require directors to call a General Meeting (s 303)
• Require the circulation of written statements regarding proposed resolutions to be considered at a GM (s 314)
• Circulate a written resolution (s 292)

Question 11

rights of shareholders with different shareholdings under CA 2006 - 10%

Answer 11

• Demand a poll vote (MA 44)

Question 12

rights of shareholders with different shareholdings under CA 2006 - 25%

Answer 12

• Block a special resolution (s 283) (note that a special resolution is passed by 75% or more of the votes)

Question 13

rights of shareholders with different shareholdings under CA 2006 - over 50%

Answer 13

• Pass or block an ordinary resolution (s 282) (note that an ordinary resolution requires over 50% of the votes to pass, therefore a shareholder with exactly 50% of the shares can block an ordinary resolution but cannot pass the ordinary resolution alone)

Question 14

rights of shareholders with different shareholdings under CA 2006 - 75%

Answer 14

• Pass a special resolution (s 283) (note that a special resolution is passed by 75% or more of the votes)

Question 15

Appointment of directors

Answer 15

CA 2006 does not stipulate a procedure for the appointment of directors, so this is something that will be governed by the Articles of the company. The MA deal with the matter simply. Companies with MA may appoint a director:
- By an ordinary resolution of the shareholders - MA 17(1)(a)
- By a decision of the directors - MA 17(1)(b)
- It is usual for the board of directors to appoint new directors under MA17(1)(b) because is easier to put into effect. Unless there is a particular reason for using the ordinary resolution procedure, a director will be appointed by the majority of the other directors.
- Of course, companies may instead have custom Articles setting out an alternative procedure for the appointment of directors, therefore you must always check the Articles of a company before advising on the appointment of directors.

Question 16

Service contracts

Answer 16

• An executive director will be an employee of the company. As an employee, they should be given a written contract of employment (otherwise known as a service contract), setting out the terms and conditions of employment including duties, remuneration package, notice provisions etc. There is no automatic entitlement for directors to be paid for their services – this is something that the board can determine, subject to the provisions of the company’s articles.
• The Company has an obligation to keep its directors’ service contracts contracts (or, where the contracts are not in writing, memoranda of their terms) at its registered office for inspection by the members (s 228 CA 2006).
• The effect of Art 19 MA is that the terms of an individual director’s service contract, including remuneration, are for the board to determine. As a general rule, a director’s service agreement will only require the approval of a resolution of the board of directors. However, shareholder approval is required to enter into long-term service contracts under s 188 CA 2006.
  It is worth noting that one individual can be a director, a shareholder and an employee of a company. These are three separate roles.

Question 17

Disclosure of identity of directors and secretary

Answer 17

The CA 2006 requires certain details about a company’s directors to be disclosed either publicly or to the members.
- Every company must maintain a register of its directors (s 162(1) CA 2006) and secretary (s 275(1) CA 2006) and should keep these registers at its registered office.
- Each company must also notify the Registrar of Companies (i.e. Companies House) of changes relating to its directors (s 167 CA 2006) or secretary (s 276 CA 2006) using forms published by Companies House (e.g. AP01 for Appointment of Director).
- The particulars which must be registered in relation to directors are specified in ss 163(1) and 164 CA 2006 (and those for secretaries in ss 277(1) and 278(1) CA 2006).
- The information kept at Companies House is available for inspection by the public (s1085(1) CA 2006) subject to some very limited exceptions, and, in addition, the register kept at a company’s registered office must be open for inspection by any member of the company without charge and by any other person on payment of a fee (ss 162(5) and 275(5) CA 2006 for the register of directors and secretaries respectively).

Question 18

Privacy for Officers of the Company

Answer 18

The provisions of CA 2006 allow the directors and secretary more confidentiality than had previously been the case.
* Section 163(1) CA 2006 specifies that a company’s register of directors must contain the following particulars in the case of an individual (a) name and any former name; (b) a service address; (c) the country or state in which he is usually resident; (d) nationality; (e) business occupation (if any); (f) date of birth.
* S.277(1) specifies that a company’s register of secretaries must contain the following particulars in the case of an individual (a) name and any former name; (b) address.. This service address can either be the director’s residential address (if they are not concerned with the need for privacy) or could simply be the company’s registered office and will be the only address available to the public generally. Residential addresses that are already on the public register will not be removed automatically.
* Individual directors (but not secretaries) will still have to provide their residential address under s 165 CA 2006, but this information will be kept on a separate, secure register. This register is not open to public inspection.

Question 19

Disclosure required: annual accounts

Answer 19

Section 412 CA 2006 relates to information about directors’ (and past directors’) remuneration and what information will need to be included in the company’s annual accounts. Two SIs currently set out in detail the information which needs to be included in the notes to a company’s annual accounts. This includes information relating to:
- the directors’ salaries, bonus payments and pension entitlements; and
- compensation paid to directors and past directors for loss of office.
Section 412 CA 2006 also requires details to be disclosed of any payments made to, or receivable by, a person connected to such a director, or a body corporate controlled by a director.
- Section 413 CA 2006 relates to the disclosure of information on advances and credits given by a company to its directors and guarantees entered into by a company on behalf of its directors. Section 413 CA 2006 applies to a person who was a director at any time during the applicable financial year.

Question 20

Removal of a director by the shareholders

Answer 20

The ability to remove a director from office is the ultimate sanction that shareholders have against a director. The director may not be performing well in their role or there may be a personality clash or a difference of opinion about company strategy and the best way to expand the business of the company.
Under s 168(1) CA 2006, a company (ie the shareholders) may by ordinary resolution remove a director before the expiration of their period of office.
Under s 168(2) CA 2006 special notice (28 days) is required of a removal resolution.
- It is not possible for the Board to remove a director (unless the Articles provide for this).
- Directors who are also shareholders are allowed to vote in their capacity as a shareholder on the ordinary resolution to remove them.
- You will learn about the process by which shareholders may remove a director in detail in ‘The rights and remedies of shareholders’ topic (‘Removal of a Director’ element).

Question 21

Resignation by notice

Answer 21

A director may simply take the decision to resign from the board by tendering a letter of resignation. This procedure is provided for in MA 18(f). It is usual, although not obligatory, in these circumstances for the board to pass a board resolution accepting the letter of resignation.

Question 22

Automatic termination

Answer 22

Under MA 18 a person ceases to be a director as soon as:
* the director becomes disqualified from being a director;
* the director becomes the subject of an individual voluntary arrangement (or similar);
* the director becomes bankrupt, or
* a registered medical practitioner who is treating the director states in writing to the company that the director has become physically or mentally incapable of acting as a director and will remain so for more than three months.

Question 23

Disqualification - Company Directors Disqualification Act 1986 (‘CDDA’)

Answer 23

• The CDDA is the key piece of legislation regarding disqualification of directors. Under this Act, the court may make a disqualification order against a person preventing them, unless they obtain leave of the court, to be a director, liquidator, receiver or in any other way directly or indirectly involved in the promotion, formation or management of a company. The purpose of such an order is to protect the public against the activities of such a director. Grounds for disqualification include fraudulent or wrongful trading or persistent breaches of company law.
• The period of disqualification is for a maximum of 15 years. If a director has been disqualified under the CDDA, it is a criminal offence to participate directly or indirectly in corporate management without leave of the court.

Question 24

Retirement by rotation

Answer 24

• The model articles for public companies require retirement and reappointment of directors by the members every three years. In addition, all directors of listed companies are subject to annual re-election.

Question 25

Companies House filing requirements

Answer 25

* When a director leaves office, the company must both update the company’s register of directors and also give notice to Companies House by filing form TM01 (Termination of appointment of director).

Question 26

derivative claim

Answer 26

- A derivative claim is one where the shareholder’s right of action is not one which is personal to that shareholder but instead it is one which is derived from the company’s right of action, which the company has not exercised. - Before the enactment of CA 2006, this claim was a common law remedy established under the exceptions to the rule in the case of Foss v Harbottle, which established the important principle that in situations where a wrong has been done to a company, the company is the proper claimant (acting through the board or in some circumstances the majority shareholder(s)). Limited exceptions to this rule developed under the common law, where the court recognised that shareholders should be allowed to bring a claim on the company’s behalf. - The rule in Foss v Harbottle: a minority shareholder is not allowed to sue for a wrong committed against a company of which they are a member, even if the company is refusing to take action. The procedure for bringing a derivative claim is now set out under s 260 CA 2006.

Question 27

Derivative claims under s260 CA 2006: what are they?

Answer 27

* Section 260 CA 2006 allows shareholders to bring a derivative claim where directors have breached their statutory duties. * Section 260 CA 2006 was a new provision introduced by CA 2006. It provides an express right to bring a derivative claim in certain circumstances. It is therefore a statutory exception to the rule in Foss v Harbottle. * Section 260 provides a wider range of circumstances in which a derivative claim may be brought by a shareholder compared with the previous common law rules. * The statutory right to bring a derivative claim supports enforcement of the directors’ wider duties. Note that any remedy granted is granted to the company itself and not to the shareholder bringing the claim. Section 260(1) CA 2006 defines a derivative claim brought under s 260 CA 2006 as one initiated by a member of a company, rather than by the company itself: a) in respect of a cause of action vested in the company; and b) seeking relief on behalf of the company.

Question 28

When can a derivative claim be brought?

Answer 28

Section 260(3) provides that a claim: “… may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.” - Note that a ‘breach of duty’ will also encompass breaches of common law duties not falling within CA 2006. Importantly, there is no requirement that the director has to have benefited personally from the breach before a derivative claim can be brought. For the purposes of s 260 CA 2006, ‘director’ includes shadow directors as well as former directors. Note that s 260(3) CA 2006 extends to all statutory duties of directors under ss 170-177 CA 2006

Question 29

Against whom can the derivative claim be brought?

Answer 29

- Under s260(3) the cause of action may be brought against ‘the director or another person (or both)’. However, a cause of action will only arise in respect of the actions or omissions of a director. - Therefore, provided the cause of action is in respect of a relevant breach by a director (including shadow directors), third parties may be defendants to the derivative claim, either in lieu of the director or in addition to the director. - According to the Explanatory Notes to CA 2006, derivative claims against third parties are only to be permitted in very narrow circumstances, for example against a third party to a contract entered into in breach of the director’s duties, where that third party knew about the breach. The cause of action against a third party is not set out in CA 2006 but derives from the common law rules relating to the concept of ‘knowing assistance’ in respect of a breach of duty by a director.

Question 30

Who may bring a derivative claim?

Answer 30

- Derivative claims brought under s 260 CA 2006 must be brought by a member. However, pursuant to s 260(4) CA 2006 it is immaterial whether the cause of action arose before or after the person bringing the claim became a member of the company. - A member may, therefore, bring a claim in respect of events that occurred before they became a member of the company. This underlines the fact that the cause of action is vested in the company, rather than the member. - By contrast, a former member cannot bring a claim even in relation to events which occurred when they were a member.

Question 31

who may bring a derivative claim - Requirement for court approval – Stage 1

Answer 31

At the first stage the member must obtain the permission of the court to continue a derivative claim (ie once the claim form has been issued) – s 261(1) CA 2006. The onus is on the member to make out a prima facie case in order to obtain permission. There are certain circumstances set out in s 263(2) CA 2006 where permission to continue the claim must be refused by the court. These include where the court is satisfied that a person acting in accordance with s 172 CA 2006 (the duty to promote the success of the company) would not seek to continue the claim. If the circumstances are not such as to be an absolute bar to the continuation of the derivative claim, the court must then take in to account the factors listed in s 263(3) in determining whether to allow the claim to continue. These include whether the member is acting in good faith and whether the act or omission which gave rise to the cause of action would be likely to be ratified by the company.

Question 32

Who may bring a derivative claim? - Requirement for court approval – Stage 2

Answer 32

The court must have “particular regard” to any evidence it has before it as to the views of the members who have no “personal interest, direct or indirect, in the matter” – s 263(4) CA 2006. This provision was introduced to make it harder for a single member to bring proceedings against the wishes of the general body of shareholders and is considered to be an important safeguard against the bringing of tactical litigation by disgruntled shareholders. Obtaining court permission to continue a derivative claim and the safeguards built into s 263 CA 2006 were designed as a counterbalance to the extension of the rights to make a derivative claim under s260 CA 2006. It was thought the new statutory provisions would be easier to use than the exceptions to the rule in Foss v Harbottleand. However, the anticipated increase in successful derivative claims has not materialised as the courts have generally adopted a restrictive approach.

Question 33

Unfair prejudice – s 994 CA 2006

Answer 33

Section 994 CA 2006 allows a member to bring an action on the grounds that the company is being run in such a way that they have suffered unfair prejudice. This is a long-established provision which is preserved under CA 2006. Examples of conduct that may be held to be unfairly prejudicial to the interests of members include: * the granting of excessive remuneration to directors; * directors’ dealing with associated persons; and * non-payment of dividends. Note that under s 994 CA 2006 the shareholder sues for themselves, whereas unders 260 CA 2006 (derivative actions) the shareholder sues on behalf of the company in respect of the company’s loss. Section 994(1) CA 2006 provides that: a member of a company may apply to the court by petition for an order….on the ground: a) that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least that shareholder), or b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial. If the shareholder can show that the company’s affairs are being conducted in a manner unfairly prejudicial to their interests, or that some act or omission of the company has unfairly prejudiced them, in terms of the reasonable bystander (objective) test – (Re Guidezone Limited), the court will decide what remedy is appropriate in the circumstances.

Question 34

unfairly prejudicial conduct - Negligent or inept management of a company

Answer 34

this will not amount to unfairly prejudicial conduct unless that conduct amounts to serious and/or repeated mismanagement which puts at risk the value of the minority shareholder’s interest;

Question 35

unfairly prejudicial conduct - Disagreements as to company policy

Answer 35

such as a change in direction of the business, will also not afford grounds for a petition under s 994 CA 2006

Question 36

unfairly prejudicial conduct - Bad faith

Answer 36

there is no need to show either bad faith or conscious intent for the conduct to be unfair

Question 37

unfairly prejudicial conduct - Breaches of the articles of association

Answer 37

see Lord Hoffmann in O’Neill v Philips:“a member of a company will not ordinarily be entitled to complain of unfairness unless there has been some breach of the terms on which he agreed that the affairs of the company should be conducted… [However,] there will be cases in which equitable considerations make it unfair for those conducting the affairs to rely upon their strict legal powers”

Question 38

unfairly prejudicial conduct - Claimant’s conduct

Answer 38

although the conduct of the claimant may be relevant in deciding whether the prejudice was unfair, there is no overriding requirement that the claimant come to court with “clean hands

Question 39

unfairly prejudicial conduct - Excessive remuneration

Answer 39

the courts will take a wide view of the prejudice that may be suffered by a minority shareholder

Question 40

unfairly prejudicial conduct - Legitimate expectation

Answer 40

in terms of certain small private companies (which are often referred to as quasi-partnerships, case law has established that shareholders may have a legitimate expectation that they be involved in the management of the company, and the prevention of such involvement may equate to unfairly prejudicial conduct.

Question 41

Unfair Prejudice – Remedies

Answer 41

- Under s 996(1) CA 2006 the court has the power to grant such order as it thinks fit to provide relief. - Section 996(2) CA 2005sets out a list of particular types of order that may be made. These include orders regulating the future conduct of the company’s affairs and requiring the company to do or refrain from doing certain acts. - The most commonly made order is to provide for the purchase of the petitioner’s shares by the wrongdoer(s) (only rarely does this result in an order entitling the minority shareholder(s) to purchase the shares of the majority shareholder(s)). The value at which such shares are to be purchased is a fundamental issue and usually a matter which is argued.

Question 42

Valuation Principles

Answer 42

The court has a wide discretion in relation to valuation matters and its aim is to set a fair price. The following principles apply to valuations generally, although the court will look at all the circumstances of the case: * Shareholders should first attempt to use a valuation mechanism set out in the articles (if any) provided that it is fair. However, if there is no fair method then a court valuation will be necessary. * The courts will generally not impose a discount on the value of a minority shareholding in a private company, on the basis that the minority shareholder is being forced to sell their shares because of the unfairly prejudicial conduct of the majority shareholder. This is particularly the case where the company has been controlled and operated by all the shareholders playing major roles (a quasi-partnership). However, the court may order a discount to be applied if the shareholding is viewed as an investment or the company is operated along more commercial lines. * As a general rule the valuation date is that on which the court order was made in respect of the sale shares. * The behaviour of the claimant/petitioner may be relevant eg if they previously rejected a reasonable offer.

Question 43

Unfair prejudice – s994 CA 2006 Commercial Points

Answer 43

- In practice, where one side is willing to buy out the shares held by the other and the dispute centres around the valuation of those shares, the court will encourage the parties to settle out of court by means of a binding third-party valuation of the shares. If the petitioner objects to such an out of court settlement, the court will usually require them to give reasons for their objection. - Therefore, if a shareholder wants to avoid the situation where the court makes an order for the purchase of their shares, a petition under s 994 CA 2006 may not be a suitable course of action. - Section 994 petitions are likely to be expensive, time-consuming and complicated to bring. Since the court has discretion to make such order as it thinks fit, such petitions also bring with them a great deal of uncertainty for the petitioner.

Question 44

Just and equitable winding up Section 122 Insolvency Act 1986

Answer 44

- The final, and most drastic, remedy available to any shareholder is the right to bring a petition to the court for the company to be wound up (liquidated) on the grounds that it is just and equitable to do so. - The right for a disgruntled shareholder to apply for the company to be wound up on the grounds that it is just and equitable to do so arises under s 122(1)(g) Insolvency Act 1986. - When a company is wound up its life is effectively brought to an end. This is therefore a rather drastic solution for a disgruntled shareholder. In such cases the court has discretion to decide whether it is just and equitable for winding up to take place. - As there is a degree of overlap between the sections, it is common for a s 122 IA 1986 and a s 994 CA 2006 petition to be made at the same time.