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Does company case-law illustrate a 'hands-off' approach?

Question:-

Professor Sealy, in Cases and Materials in Company Law (7th Edition) 476 states that company case-law illustrates "the traditional unwillingness of the courts to undertake to review matters of commercial judgment or policy or of internal administration" (i.e. adopts a "hands off approach") To what extent is this true, especially in the light of s. 459 of the Companies Act 1985?

Introduction

Judges, it is submitted, are legal experts, not business gurus. They are qualified and experienced to interpret and apply the law, not to evaluate business judgment or commercial acumen. If you want your car repaired you take it to a mechanic, not a vet, and if you need a heart transplant you enlist the help of a surgeon, not a professional footballer. It is perhaps a trite observation, but its horses for courses. This commonsense observation appears to underpin, at first sight, the statement under review.

Designed to address many of the weaknesses inherent in the elderly and arcane exceptions to the rule in Foss v Harbottle,[1] section 459 of the Companies Act 1985 is a purpose-built mechanism of minority protection. The so-called unfair prejudice petition that it establishes has become the primary weapon in the arsenal of the disgruntled minority shareholder. Alongside section 459, s. 122(1)(g) of the Insolvency Act 1986 is sometimes employed by shareholders, but the latter is very much an instrument of the last resort and may not derive the most beneficial exit because the company could be wound up by the court if a s.122(1)(g) petition is successful and the court is of the opinion that it is just and equitable that the company should be dissolved. Section 459 is accordingly the principle remedy at the disposal of a minority shareholder in Britain today.

Reviewing Commercial Judgment and Policy: The Context

Section 459(1) of the Companies Act 1985 (as amended by the Companies Act 1989) provides as follows:-

'A member of a company may apply to the court by petition for an order under this Part on the ground that the company's affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself) or that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.'

It is well established that a section 459 unfair prejudice petition may be founded on a number of different grounds. The test as to what may constitute unfair prejudice is an objective one. It is not necessary for the aggrieved petitioning member to demonstrate that anyone acted with intent to cause prejudice. It is submitted that the courts will regard conduct as unfair if a hypothetical reasonable bystander would consider it to be unfair.

The courts have been called upon on numerous occasions to determine the boundaries and meaning of the concept of unfairness under the Act and on several occasions they have been asked to consider whether the concept is malleable enough to include commercial ineptitude that is neither self-serving nor motivated by mala fides (bad faith). The Law Commission, in its 1997 report on Shareholder Remedies,[2] expressed concern that defining the content of the unfairness concept might unduly limit its scope and that "conduct which would appear to be deserving of a remedy may be left unremedied…" It is submitted that a balance has to be struck between the breadth of discretion given to the court and the principle of legal certainty, but in this context precedent informs us that courts are loathe to interfere with commercial judgment unless extreme or mixed with more pressing issues of law or breach of fiduciary duty.

The fiduciary duty owed by each director to the company is a duty of good faith, honesty and integrity. The very word fiduciary, connotes a position of public trust and confidence, but there are boundaries to the concept and they would appear to exclude matters of business acumen.

The Traditional Stance

In Re Brazilian Rubber Plantations & Estates Ltd,[3] a multinational rubber company made substantial losses after foolhardy speculative investments in Brazil. It transpired that the directors had no experience in the business of rubber plantations and few qualifications or personal qualities to justify their lofty posts within the company. They were sued for negligence. If there was ever a case where a court might be prompted or tempted to undertake a review of matters of commercial judgment or policy or to appraise a company’s internal administration this was it. However, the action failed. Of a director's duty of skill and care Neville J stated: "He is, I think, not bound to bring any special qualifications to his office. He may undertake the management of a rubber company in complete ignorance of everything connected with rubber, without incurring responsibility for the mistakes which result from such ignorance."[4]

Subsequently, in the seminal and often quoted Re City Equitable Fire Insurance Co Ltd[5] Romer J set down the duties of care and skill to be expected of a company director:

(a) A director does not need to exhibit in the performance of his duties a greater degree of skill than might reasonably be expected from someone of his knowledge and experience.

(b) A director is not required to lend continuous attention to the affairs and business of the company.

(c) Where duties may reasonably be delegated to another company official, a director is justified, in the absence of manifest grounds for suspicion, in relying on that official to discharge his duties honestly and in good faith.

Serious Mismanagement and Section 459: The Jury is Out

In the 1991 case Re Elgindata Ltd,[6] the petitioners levelled several complaints against the majority directors, asserting exclusion from management, late dividend payment, extravagance and mismanagement. The petition in this case was eventually granted on the grounds that the directors had exploited certain company assets in their personal interest and for their personal benefit. In obiter dicta, on the issue of mismanagement, the court indicated that serious cases could perhaps amount to unfair prejudice under section 459, but it was stressed that the incidence of circumstances where this could be so would probably be very rare. Given the obiter status of these comments and the alternative resolution of this case it is uncertain whether they represent a change in emphasis in the law or an idle aside to be confined to the dusty corner of the law library. If the latter proves to be true the sentiment will certainly find itself in good company.

A Word on the Judicial Review of Internal Administration

The courts have proved themselves loath to intervene in the mechanics of internal administration per se where technical mistakes are made or procedural corners are cut. In Browne v La Trinidad[7] a directors’ meeting resolved that an Extraordinary General Meeting (EGM) be convened to dismiss B from his post as a director. Later, the resolution to remove him was passed at the EGM. B argued that his dismissal was invalid as he had not received proper and adequate notice of the relevant board meeting. The court held that the notice he had received of the said meeting was indeed inadequate, but that he should have complained immediately. By acquiescing he had waived his legal rights to challenge the EGM resolution. Moreover, the faulty notice had no bearing on the subsequent vote at the EGM (given that the members were in fact unanimous). As a consequence, the court refused to interfere in the internal administration, despite the fact it had been poorly and improperly conducted, as this would merely require lip service to be paid to the entire procedure a second time.

Similarly, in Bentley-Stevens v Jones[8] the court found that a letter sent on a Sunday convening a board meeting for the following Monday morning was inadequate notice, but the court declined to declare that a particular motion passed at the meeting was invalid, although technically it was indeed faulty, because the director's presence would not have influenced the vote.

Of course, where problems with internal administration derive more than a trivial and remediable irregularity the courts are usually predisposed to act. In Shaw v Tati Concessions Ltd [9] one factional interest commanded 58,000 shares and the other 99,000 shares. However, shortly before the poll was to be taken, the court ruled that documents appointing proxies for the 99,000 shares had not been duly delivered within the time limit stipulated by the company's articles. They were disallowed. Though again only a matter of procedure and internal administration, failure to observe the rules strictly would have made a real difference to the outcome and consequently the court was moved to act.

Concluding Observations

One could easily argue that business decisions which, albeit innocent, are grossly inept in a purely commercial sense, do indeed constitute actions unfairly prejudicial to the interests of the companies membership. However, the courts are unwilling to extend the notion encapsulated in section 459 to embrace such affairs.

In simple terms, considerably greater care should be taken at the front end of the corporate process. If you appoint an idiot to a directorship, you should neither be surprised nor disappointed if he later behaves like an idiot in the running of the business, and you certainly do not deserve the luxury of legal remedy or the moral comforts of redress.

END

WORD COUNT 1600

This is the sole and exclusive work of the author.

Bibliography

Cases and Materials in Company Law, Sealy, (7th Edition)

Mayson French and Ryan on Company Law, Stephen W Mason; Derek French; Christopher Ryan, (Blackstone Press, OUP Oxford 2001)

Charlesworth & Morse Company Law, Geoffrey Morse & Others, (16th ed Sweet & Maxwell London 1999)

Report on Shareholder Remedies, The Law Commission, (No 246, 1997) Final Report: Modern Company Law for a Competitive Economy

In what circumstances should breaches of directors' duties give rise to a remedy under s. 459 - 461 of the Companies Act 1985? Kosmin, (2003) 24(4) Company Lawyer 100

1


Footnotes

[1] Foss v Harbottle (1843) 2 Hare 461.

[2] (Law Com. No. 246) (1997) (Cm. 3769), para.4.11, p 43.

[3] [1911] 1 Ch 425.

[4] At 433.

[5] [1925] Ch 407.

[6] [1991] BCLC 959.

[7] (1887) 37 Ch D 1 A.

[8] [1974] 1 WLR 638.

[9] [1913] 1 Ch 292.


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