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The Division of Powers Between the Shareholders and the Board of Directors

Info: 2732 words (11 pages) Essay
Published: 12th Aug 2019

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Jurisdiction / Tag(s): UK Law

The articles of a company may regulate, inter alia, the division of powers between the shareholders and the board of directors, and the composition, structure and operations of the directors [3] . It is therefore reasonable to conclude that the articles of association may include a provision naming a person to be a governing director for life. A similar situation occurred in Elley v Positive Government Security Life Assurance Company [4] . The first issue must then be the enforceability of any provision in a company’s memorandum. The answer to this issue is found in the Companies Act 2006.

Section 33 of the Companies Act 2006 [hereafter “CA 06″] states:

“The provisions of the 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 it. [5] “

This has been generally accepted to give the effect of making the provisions in a company’s articles a legally enforceable contract. However, the contract formed is only binding on and enforceable by the members inter se [6] . Meaning, this statutory contract has binding effect amongst the shareholders and the company (as a separate legal entity, Salomon v Salomon & Co Ltd [7] ). This specially formed contract appears to have two primary traits which distinguish it from an ordinary contract.

These two traits are the crux of the ambiguity and debate surrounding the practical impact of S.33. This essentially falls into the questions of who can sue and what can they sue for? Firstly, the doctrine of privity and the rights of third parties make it abundantly clear, who has remedial rights in an ordinary ‘offer and acceptance’ contract. However, CA 06 s.33 does not stipulate for example whether members are entitled to take remedial action against other members relying on the provisions of the statutory contract it creates. Secondly, the parties in an ordinary contract are always entitled to seek the enforcement of the terms agreed upon. However a s.33 contract is not as straightforward in relation to what members are entitled to enforce. As will be illustrated, this issue becomes particularly relevant in situations like the above example, where a director is also a member. These two distinguishing traits are convientely also the second and third issue to consider having established that the provisions listed form part of a legally binding contract among company insiders.

Under a s.33 contract, who specifically has the right to sue? It stands to reason that outsiders have no right to enforce any provision in the company’s articles as they would an ordinary and extrinsic contract. That includes people who are intimately involved in the operation of a company such as a director or those upon which rights are conferred by the provisions. However, in the example being considered, the claimant is a not just a director but is also a member. As such, s.33 explicitly gives him a right to rely on the provisions of the company’s articles in order to have them enforced. This is supported by the common law in the case of Pender v. Lunshington [8] which is an authority for the position that a shareholder can successfully sue the company to have a provision of the memorandum enforced. In the interest of full disclosure, this principle works both ways as the company would be entitled to sue the claimant in the pursuit of enforcing a provision in the articles. This principle is firmly entrenched by the lead authority of Hickman v. Kent and Romney Marsh Sheep Breeders [9] .

It is possible however that to have a given provision enforced, action may have to be taken against a fellow member as opposed to the company. Section 33, is vague as to whether this would be permitted. This issue is also an example of how the judiciary has been less than definitive in resolving s.33 uncertainty. In contrast to an initial complex rule [10] , Rayfield v. Hands [11] declared articles to be multi-party contracts therefore meaning that the provisions were contracts between the individual shareholders also capable of being enforced.

It has now been established that the claimant in our example would have the right to sue either the company or other members to enforce a provision in the company’s articles of association. However, further consideration needs to be taken. The third issue of what the claimant would be able to sue for is now relevant and is somewhat contentious.

As mentioned above, in the current example, the claimant would be able to act in a capacity as an insider as well as an outsider since he is both a member and a director respectively. According to R. Drury, an insider right is not absolute, “they cannot be seen in isolation but only in relation to the rights enjoyed by other members” [12] . In other words, insider rights are those that are common among all members. Conversely, an outsider right is one that is specific to a limited group or individual as opposed to anyone who is a member. This means that an insider can have a unique outside right in addition to their insider rights. This is the case with our claimant as he is possesses the insider rights including the right to enforce the articles as well the outside right to be the company’s governing director for life. The question, and point of contention, is whether the claimant can use his inside right to enforce his outside right?

The first stage in answering this question comes from the famous dictum of Astbury J. in the Hickman case:

“An outsider to whom rights purports to be given by the articles in his capacity as such outsider, whether he is or subsequently becomes a member, cannot sue on those articles, treating them as contracts between himself and the company, to enforce those rights.” [13]

This position has come to be known simply as the “Hickman principle” and was relied on in the case of Beattie v Beattie Ltd. [14] In this later case it was held that the contractual force established by s.33 is limited to the provisions which “apply to the relationship of members in their capacity as members and does not extend to those provisions which govern the relationship of a company and its directors as such” [15] . In other words, as far as this line of authority is concerned, the answer to the question is no. The claimant would not be allowed to enforce the provision that he remain the governing director as that is a right specific to him and therefore given to him in his capacity as an outsider not a member.

This stance has gone down without controversy. There are “conflicting lines of authority” [16] and several academic theories challenging the principle and suggesting ways of rendering it impotent. This would mean that there is at least an argument and the potential for the claimant in the example to proceed despite doing go in his capacity as an outsider.

It would appear that one of the leading opponents of the Hickman principle is Lord Wedderburn. He asserted that a shareholder could enforce “outsider” rights under s. 33 as long as he sues in his capacity as shareholder [17] . This Lord Wedderburn maintained could be done by using a shareholder right in a very broad sense. To support this position he cited the case of Quinn & Axtens Ltd. V Salmon [18] in which the Court of Appeal and the House of Lords allowed a managing director suing as a member, to obtain an injunction stopping the company from completing a transaction. The issue was that the transaction required the consent of the two managing directors to be in compliance with their articles. This essentially “showed that a member had a membership right to require the company to act in accordance with its articles, which right could be enforced by the member even though the result was indirectly to protect a right which was afforded to him as a director” [19] but “only so long as he sues qua member and not qua outsider” [20] . Lord Wedderburn seems to be purporting that every member has a general right to have the company follow the articles despite what the provision in question relates to. The Company Law Review has taken an approach which has in effect been an acceptance of Wedderburn’s argument [21] .

On the other extreme, one can find Professor Gower and Davies, proponents of the Hickman principle. They argue that the contractual effect of s.33 only applies to the provisions, rights and obligations associated with members in their capacity as such.

It can be argued that in the middle of the Wedderburn – Gower spectrum we can find G. D. Goldberg, who first proposed the example being used for consideration. Goldberg shared with Wedderburn the view that shareholders had in inherent right to have to company operated in a manner consistent with the articles [22] . He however explains that this will only be practical if the claimant is seeking equity, namely, specific performance as opposed to damages. He reasons that “a member will not be entitled to substantial damages unless he can prove that he has suffered, as a result of a failure to observe the articles, a substantial loss. This as regards to outsider’s rights, he will rarely be able to do” [23] . In relation to our example, Goldberg would argue that the claimant should be able to sue as a member to compel that the articles be followed. If he does so he is more likely to be successful if he is seeking the court to compel the company to make him remain as governing director rather than seeking damages or compensation for no longer being that position. His work has been harshly criticized however. It has been called “superficial” in order to reconcile cases and been described as an argument which “cannot serve as a basis for understanding the nature of the contract in the memorandum and articles, and the extent of a shareholder’s right to enforce it. [24] ”

Robert Gregory, who for all intents and purposes is in line with Wedderburn has seemed to adopt a stance particularly harsh towards the Hickman case and the principle which has emerged from it. He has maintained that the now famous dicta was obiter and should not be given the weight it has been. Furthermore he argues that the number of cases such as Salmon which cannot be reconciled with the principle is unsatisfactory. He generally asserts that cases like Hickman are antiquated resulting in confusion and inconsistency [25] .

Graham N. Prentice falls in the category of academics that would align with Wedderburn and Gregory but only to a limited extent. He accepts that s.33 would allow the enforcement of outsider rights but only in certain situations. The requirement he purports is that the particular provision affects the power of the company to function in the circumstances in question. Therefore, in the Goldberg example, Prentice’s stance would depend on the effect of the claimant being the governing director on the company’s power to function. Based on his approach to the somewhat similar Elley case where the position concerned was a solicitor, it seems reasonable to conclude that he would join Gower and argue that the claimant should not be able to enforce the provision [26] .

Finally, the stance adopted by R.R. Drury is somewhat relevant to the provision in the example being considered. It has been argued by others that judges have been markedly adverse to any suggestion that they should sit in review of questions of business judgment [27] . If this is so, one can assume that under any circumstances the courts would be reluctant to impose some as the governing director of a company for life. Drury argues that the right of one shareholder to enforce a provision should be dependent on the effect on the rights of the other shareholders. This relational approach as he calls it argues that the member could only enforce outsider rights the breach of which, were not rectifiable by an ordinary resolution. This gives the shareholders the ability to decide in accordance with the articles whether to allow the claimant to be governing director [28] .

In conclusion, s.33 of the CA 06 has been a contentious matter, particularly on the issue of members seeking to enforce outsider rights. In the example considered, the Hickman principle would certainly deny the claimant enforcement of any right conferred upon him in his capacity as a director or outsider. However, Lord Wedderburn’s, highlighting of the conflicting Salmon case has sparked debate amongst numerous academics, most of which seem to disagree with Hickman. In any event, with the inconsistency on this issue the only way the claimant would be able to guarantee that the provision is enforced and he keeps his position for life is if he enters into an extrinsic contract with the company separate from the articles.

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