company law Cases

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Wood v Odessa Waterworks Co (1889) 42 Ch D 636

The constitution of a company is generally accepted as a contract between a company and its members. Comprising of the memorandum and the articles of association, the constitution of a company creates a contract, of a statutory nature, not just between the company and each of its members but also among the members themselves.1 The statutory framework for this approach was set out under section 14 of the Companies Act 1985 (CA 1985) and subsequently under section 33(1) of the Companies Act 2006 (CA 2006).

One of the key provisions of a company's constitution is in relation to the distribution of dividends. As a form of distribution of funds to members/shareholders, dividends are usually made out in cash payments or through the distribution of company assets. 2 How dividends are distributed however varies depending on the actual provisions of a company's article of association.3

Before CA 1985 and CA 2006, there was one case which firmly established the effect of a company's constitution on a company and its members - the case of Wood v Odessa Waterworks Co.4 This was a significant case which answered the fundamental question of whether the memorandum and articles of a company constituted a contract between members/shareholders.

The primary issue in Wood was whether the memorandum and articles could constitute a contract between not just the company and its shareholders but also among shareholders. The secondary issue was as to whether a minority shareholder could prevent a company from acting in a particular way, in this case paying dividends by a particular means, contrary to the stance taken by the majority shareholders.

The circumstances which arose in Wood concerned the distribution of dividends. The financial accounts of Odessa Waterworks Co (the "Company") showed that a large sum was available to be paid out as dividend. Instead of paying out a dividend to the shareholders the funds were used for the construction of productive works (an act which the claimant argued dividends were not appropriate for). An ordinary general meeting was called to pay out dividends by debenture bonds (a means which it was claimed was not allowed by the Company's articles of association). The claimant, a shareholder opposed to this motion, applied for an injunction to prevent the dividends being paid out as proposed by the resolution.

It was argued by the claimant that the proposal of the directors was inconsistent with the company's articles of association and therefore ultra vires. The claimant relied upon the matter of Oakbank Oil v Crum5 and submitted that the articles were all the Court had to consider.6 For the Company, it was argued that the there was no illegality in the proposal and that it was indeed a payment of dividends although a postponed one in the form of bonds to be paid by the Company with interest.7 Stirling, J found for the claimant and held that the majority shareholders could not bind the minority to accept a dividend payment in a means other than cash. His findings can be summed up in his conclusion:

"The articles of association constitute a contract not merely between shareholders and the company, but between each individual shareholder and every other"8

He therefore granted the claimant an injunction in relation to the payment of dividends as he found that no steps had been taken to amend the articles of association to allow for such a payment of dividends, and as such the majority could not compel the minority to accept the resolution.9

Before the case of Wood, the general approach taken by the courts was that although a company's articles regulated the rights of its members, it did not amount to a contract between members but a contract between members and the company.10 This interpretation of the effect of a company constitution was demonstrated in the case of

Thomas Abercromby,11 where it was found that although articles constitute a contract between members and the company, there was no contract between the individual members of the company or any rights other than between the individual member and the company.12 This approach can also be seen in MacDougall v Gardiner,13 where it was found that the rights of members could only be enforced against members through the company.

Following the case of Wood, several cases have found that a contract does indeed exist between individual members of a company. In the matter of Hickman v Kent,14 the approach taken by Stirling J was supported by Astbury J in his finding that a company's articles did not constitute a contract between company and an outsider.15 In Re Saul & Sons,16 the articles were accepted to be contractual terms which determine the relationship between shareholders.

A different approach was taken to the issue in the case of London Sack v Dixon.17 Although the finding in Wood was acknowledged, the Court of Appeal found that the parties to the matter were not ordinary members of the company as they had no shares in the company. It was therefore found that the principle in cases like Wood could not be extended to the members in the case.18 Similarly in Salmon v Quin,19 the Court was reluctant to accept a contract between members unless in cases where a company brought such an action.

With the advent of the CA 2006, the principles in relation to the contractual effect of a company's constitution are now somewhat defined. The Act provides that a contract exists between a company and members, and members individually.20 Although there is now some clarity regarding who can sue to enforce the articles, there is still however some confusion in regards to the right of one member to sue another. 21

One unexpected benefit of the Wood decision is in relation to the protection of minority shareholders from the interests of the majority. This issue can be seen clearly where there is a clear majority in shareholding and the majority take steps to further their own interests,22 as in Wood. What the decision in Wood did inadvertently was fight for the rights of the minority shareholder, by holding that they could not be compelled by the majority.

It may therefore be said that apart from establishing the existence of a contractual relationship between members of a company, the case of Wood also drew attention to the plight of the minority shareholder.

Footnotes

1 Dignam and Lowry, Company Law (8th edn, OUP 2014) 159.

2 Company Secretary's Review, Distributions by a Company (Sept 2012) 36 CSR 12, 94.

3 Company Secretary's Review, Declaring Dividends (Oct 2012) 36 CSR 13, 102.

4 (1889) 42 Ch D, 636.

5 (1882) 8 App. Cas. 65.

6 Buckley Q.C., (n4) 639.

7 Hastings Q.C., (n4) 640.

8 Stirling, J., (n4) 642.

9 ibid 645.

10 Halsbury's Laws of England, The Company Constitution (2009) 246.

11 1897 A.C. 299.

12 ibid 315.

13 (1875) 1 ChD 13, CA.

14 1915 1 Ch. 881.

15 (n10) 247.

16 1995 1 BCLC 14 CA.

17 1943 2 All ER 763.

18 ibid 766.

19 (1909) AC 442.

20 CA 2006, s 33(1).

21 Rayfield v Hands 1960 Ch.d 1(the observation of Vaisey J).

22 (n1) 12.