Chapter 4: Managing Companies: Directors and the Board Flashcards
(131 cards)
1
Q
- Board structure and composition
A
You have already considered the different stakeholders in a company and the key features of directors and shareholders. In this element you will look in more detail at the role and
responsibilities of directors.
One key point to note is that, as a company is inanimate, it is the directors who on a day-to-day basis are responsible for managing the company. The directors are accountable to the company itself rather than to the shareholders directly.
2
Q
Role of Directors
A
- Manage the company on a day-to-day basis
-Certain actions can only be taken by directors
if the shareholders have given authority
-Owe duties to the company
3
Q
Shareholders
A
-Own the company
-Are able to control key decisions through
shareholder resolutions eg shareholders need
to vote to give directors authority to change
the articles, or name of the company, to vary
class rights etc
4
Q
1.2 Relationship between directors and shareholders
A
Directors have the day-to-day control of the company. This power derives from the articles. (Remember that the Model Articles (MA) are the default position, however the company may amend the MA or adopt its own articles.)
5
Q
MA 3
A
Subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.
Shareholders on the other hand are the owners of the company. How are they protected from the acts of a rogue director? One protection comes from MA 4 which grants to the shareholders a reserve power as follows: The shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action.
6
Q
Shareholder powers under CA 2006
A
Shareholders also have certain powers under CA 2006, such as the power to control amendments
to the company’s articles, which require approval by the shareholders by way of special resolution (s 21 CA 2006). The ultimate sanction shareholders can exercise is the removal of a
director by ordinary resolution under s 168. We will look at this process and other powers of
shareholders later during this module.
7
Q
1.3 What is a director?
A
On a day-to-day basis the shareholders are generally not involved in the management of the
company and therefore the directors have a significant amount of power. Case law is clear that directors are the agents of the company, not the agents of the shareholders. Directors may in fact take decisions against the wishes of the majority of the shareholders (Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821).
8
Q
Director definition, Companies Act 2006
A
The term ‘director’ is not defined in CA 2006; instead s 250 states that ‘director’ includes any person occupying the position of director, by whatever name called. There are a number of categories of director which we consider below.
(a) At law: de jure, de facto and shadow directors
(b) In practice: executive and non executive directors
The company’s articles may also provide for alternate directors.
9
Q
1.3.1 De jure directors
A
A de jure director is a director who has been validly appointed at law. Under s 154 CA 2006 a private limited company must have at least one director and a public
limited company must have at least two directors. Although a company can be appointed as a director, every company must have at least one director who is a natural person (s 155(1)).
Note
that the Small Business, Enterprise and Employment Act 2015 requires all company directors to be natural persons and prohibits the appointment of corporate directors subject to certain
exceptions. However, these provisions are still not yet in force
10
Q
Maximum & Minimum Directors
A
The CA 2006 does not prescribe a maximum number of directors and neither do the MA but a company can put a maximum number of directors into its own articles. Under s 157 CA 2006 a person may not be appointed as a director unless they are at least 16 years old (or if so appointed, the appointment is not effective until they reach the age of 16).
11
Q
1.3.2 De facto directors
Key case: The Commissioners for HM Revenue and Customs v Holland (2010)
A
The Supreme Court in this case reviewed the case law on de facto directorships.
In this case Mr Holland (H) was a de jure director of a Company A which was itself a corporate director of Company B. The question was whether H should be considered to be a de facto director of Company B and therefore whether H owed fiduciary duties to Company B. The court held that the basis of liability for a de facto director is an assumption of liability together with his being a part of a company’s corporate governance structure. In this case H was
not held to be a de facto director of Company B as the acts he undertook were within the scope of his duties and responsibilities as a director of Company A.
De facto director: A de facto director is someone who assumes to act as a director but has in fact not been validly appointed.
12
Q
Identifying defacto directors
A
There is no single definitive test to identify whether someone is a de facto director, but the court in
Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 stated that it must be established whether someone
is part of the corporate governance of the company and undertook decisions which would normally be taken by a director rather than tasks which could have been performed by a
manager or another person below board level.
13
Q
Key case: Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014]
EWCA Civ 939
A
In Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, the court stated that it is necessary to consider the acts performed by the person and whether those acts were directorial in nature, looking at the context but also the cumulative effects of what the individual has done.
A final point to consider is whether the company considered the person to be a director and held them out as such and whether any third parties considered them as such. It is
a question of fact in each case.
14
Q
Fiduciary Duties & Liabilities
A
The importance of recognising where a person is a de facto director is that the same fiduciary duties and liabilities in insolvency apply to all directors including de facto directors. We will consider these duties in more detail in the next element.
15
Q
Shadow Directors
A
Sometimes a person (usually a shareholder) may try to exert influence over the board but without being appointed as a director, in an effort to avoid the duties imposed on directors under CA 2006 and the common law.
Shadow director: Section 251(1) CA 2006 defines a shadow director as ‘a person in accordance with whose directions or instructions the directors of the company are
accustomed to act’.
16
Q
Professional advisors are not shadow directors
A
Section 251(2) makes it clear that professional advisers are not to be regarded as shadow
directors, although if the conduct of an adviser is such that it goes beyond the normal scope of professional capacity and is effectively controlling the company’s affairs then that person will be held to be a shadow director (Re Tasbian Ltd (No 3) [1992] BCC 358).
17
Q
Shadow Directors are subject to duties and restrictions
A
This legislation is designed to ensure that anyone who acts as a director, even if they are not technically appointed as one, is subject to the duties and restrictions which apply to all directors. Most of the provisions in the CA 2006 and the Insolvency Act 1986 imposing duties, obligations or restrictions on directors therefore apply equally to shadow directors.
18
Q
Key case: Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180
A
In this case the issue was whether two directors of the parent company could be deemed to be shadow directors of its subsidiary company and therefore liable for wrongful trading under s 214 Insolvency Act 1986.
19
Q
Conditions to identify shadow directors
A
Millett J said that to establish if a person is a shadow director, it is necessary
to prove:
(a) The identity of the formally-appointed directors of the company;
(b) That the person in question directed those formally appointed directors as to how to act in
relation to the company’s affairs;
(c) That those directors acted in accordance with that person’s directions; and
(d) That the directors were accustomed to act in that manner.
20
Q
Secretary of State for Trade and Industry v Deverell [2000] 2 WLR 907 Morritt LJ:
A
It will, no doubt, be sufficient to show that in the face of ‘directions or instructions’ from the alleged shadow director the properly appointed directors or some of them cast themselves in a
subservient role or surrendered their respective discretions.
In this case the persons in question were consultants and the company’s board were accustomed to act in accordance with their directions and suggestions, therefore the court found that they were shadow directors
21
Q
Ultraframe (UK) Ltd v Fielding [2005] EWHC 1638:
A
A position of influence, even very strong influence, does not necessarily mean that there is a shadow director. It must be shown that the governing majority of the board are accustomed to act
in accordance with the directions of the alleged shadow director.
22
Q
1.3.4 De facto director vs shadow director
A
In Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 ChD, Millett J made clear the distinction between de facto directors and shadow directors as follows:
A de facto director is a person who assumes to act as a director. He is held out as a director by the company, and claims and purports to be a director, although never actually or validly appointed as such. To establish that a person was a de facto director of a company it is necessary to plead and prove that he undertook functions in relation to the company which
could properly be discharged only by a director.
A shadow director, by contrast, does not
claim or purport to act as a director. On the contrary, he claims not to be a director. He lurks in the shadows, sheltering behind others who, he claims, are the only directors of the company to
the exclusion of himself. He is not held out as director by the company
23
Q
1.3.5 Executive and non-executive directors
A
The CA 2006 does not differentiate between executive and non-executive directors, but in practice
there is a distinction. However the duties, obligations and restrictions placed on directors under CA 2006 apply to all directors, executive and non-executive.
Executive directors: An executive director is a director who has been appointed to executive office. Such a director will generally spend the majority, if not all, of his working time on the business of the company and will be both an officer and an employee of his company.
Examples include a Finance Director, Managing Director, Marketing Director
Non-executive directors: A non-executive director is also an officer of the company, but will not be an employee of the company. Non-executive directors do not take part in the day-today running of the company. Their role is generally to provide independent guidance and
advice to the board and to protect the interests of shareholders.
24
Q
1.3.6 Alternate directors
A
The office of director is a personal responsibility. However, some companies in their articles provide for alternate directors to take the place of a director where one or more directors are absent.
An alternate director is usually either a fellow director of the company or someone who has been approved by a resolution of the board of directors. The alternate director has the voting powers of the absent director.
The MA do not provide for the appointment of alternate directors and, since it is now possible to hold board meetings over the telephone and to pass board resolutions by means of written resolutions, the use of alternate directors is becoming quite rare.
25
1.3.7 Summary
* Directors are responsible for the day-to-day management of the company and are agents of the company.
* Directors who are validly appointed may be referred to as de jure directors. These directors may be executive or non-executive.
* It is possible for other individuals to act as a director where they are not in fact validly appointed as such. De facto, shadow and alternate directors fall into this category.
* All the different types of director are governed by the principles of CA 2006.
* Directors are responsible for the day-to-day management of the company and are agents of the company.
* Directors who are validly appointed may be referred to as de jure directors. These directors may be executive or non-executive.
* It is possible for other individuals to act as a director where they are not in fact validly appointed as such. De facto, shadow and alternate directors fall into this category.
* All the different types of director are governed by the principles of CA 2006.
26
1.4 Appointment, removal and disqualification of directors
1.4.1 Appointment of directors
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, as follows
(Art 17): Any person who is willing to act as a director, and is permitted by law to do so, may be appointed to be a director:
(a) by ordinary resolution (of the shareholders), or
(b) by a decision of the directors.
Consent: All persons appointed as directors must consent to act as such. This consent is required on form
AP01, the relevant form which is required to be sent to Companies House whenever a new director is appointed.
27
1.4.2 Service contracts
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 must keep a copy of all directors’ service contracts or memoranda of the terms of these contracts (s 228 CA 2006). Shareholders have a right to inspect copies of directors’ service contracts or memoranda (s 229),
which must be provided within seven days of request.
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.
28
1.4.3 Long-term service contracts
Section 188 CA 2006 applies where a service contract provides for a director’s employment to have a ‘guaranteed term’ which is, or may be, longer than two years. Where s 188 CA 2006 applies, the relevant provision of the service contract ie the provision concerning the length of the contract, requires shareholder approval by ordinary resolution. This
would apply, for instance, if a director had a service contract for one year and had an option to renew the contract for a further two-year term at their sole discretion.
29
Terminated by reasonable notice
If shareholder approval is not given, then the term incorporated into the service contract in contravention of s 188 CA 2006 is void under s 189(a) CA 2006. In addition, under s 189(b) CA 2006, the service contract will be deemed to contain a term entitling the company to terminate the contract at any time, by the giving of reasonable notice.
30
1.4.4 Termination of appointment
(a) Resignation
Subject to any provision to the contrary in the articles, a director may resign at any time by
giving notice - Glossop v Glossop [1907] 2 Ch 370. The resignation of a director will normally
be effective according to its terms and does not need to be specifically accepted by the
board.
(b) Vacation
MA 18 provides that a director is automatically deemed to vacate office where that person becomes prohibited from being a director, bankrupt, subject to a composition order made
with creditors, or physically or mentally incapable for more than three months (as stated by a registered medical practitioner).
(c) Removal Under s 168 CA 2006, a director can be removed by an ordinary resolution of the
shareholders.
31
1.4.5 Removal of a director – s 168 CA 2006
Where a removal resolution is proposed, the director has the right to be heard at the GM (s 169) in which the ordinary resolution is to be decided, and therefore written resolutions cannot be used.
Special notice of such a resolution is required to be given – at least 28 clear days before the GM. Directors who are also shareholders are allowed to vote in their capacity as a shareholder on the resolution to remove them
32
Bushell v Faith’ clause
It is possible for a company to insert into its articles a ‘Bushell v Faith’ clause. These clauses give weighted voting rights allowing director/shareholders to block such resolutions. A summary of the case of Bushell v Faith appears below.
The existence of a Bushell v Faith clause may appear to be contrary to s 168 CA 2006 because it is making it harder to remove a director beyond the simple majority vote (ordinary resolution)
required. However, such weighted voting clauses/class rights are allowed because the requirement for an ordinary resolution is not being changed.
Rather it is the way votes are amassed that makes it easier for the imperilled director/shareholder to survive. This is a matter of internal management and private contractual agreement, and is not something the court will intervene in.
33
Key case: Bushell v Faith [1970] AC 1099 (House of Lords)
In this case the company had a share capital of £300 in £1 shares. Mr Faith held 100 shares, as
did each of his sisters, Mrs Bushell and Dr Bayne. The three siblings were also the directors of the
company. The company’s articles stated: In the event of a resolution being proposed at any general meeting of the company for the
removal from office of any director, any shares held by that director shall on a poll in respect of such resolution carry the right to three votes per share […].
Faith therefore was able to defeat a resolution proposed by his sisters to remove him from office as a director as on this resolution he had 300 votes to his sisters’ collective 200 votes. The court held that this article was valid and effective.
34
1.4.6 Disqualification
The Company Directors Disqualification Act 1986 (CDDA 1986) a
Allows directors to be disqualified
in certain circumstances.
Section 1(1) CDDA 1986 states that where a person is disqualified, that person shall not, without
the leave of the court:
Be a director of a company, or a liquidator or administrator of a company, or be a receiver or
manager of a company’s property, or, in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company, for a specified period beginning with the date of the order
35
Types of Disqualification
There are two types of disqualification order: discretionary and mandatory. A mandatory disqualification order can last between 2 and 15 years. A discretionary disqualification order can last for up to 10/15 years depending on the grounds for
disqualification.
36
1.4.7 Mandatory disqualification orders
Mandatory disqualification orders of between 2 and 15 years can be made against a person
under s 6(1) CDDA 1986 where the court is satisfied:
(a) that he is or has been a director of a company which has at any time become insolvent
(whether while he was a director or subsequently), and
(b) that his conduct as a director of that company (either taken alone or taken together with
his conduct as a director of any other company or companies) makes him unfit to be
concerned in the management of a company.
37
Section 6: Abuse of privilege
Section 6 has been taken by the courts to mean essentially that the director has abused the
privilege of limited liability in some way, either by gross negligence or deliberate disregard of
creditors’ interests (eg Secretary of Trade and Industry v Blunt (2005) where the director of a
company in insolvent liquidation who had removed and attempted to conceal from the liquidator
a substantial amount of stock was disqualified under this ground).
38
1.4.8 Discretionary disqualification orders
The discretionary grounds on which directors can be disqualified include:
* Conviction of an indictable offence in connection with the management of the company or
company property (s 2);
* Persistent breaches of company legislation requiring returns or notices to be given to the
Registrar (s 3);
* Fraud – either fraudulent trading under s 993 CA 2006, wrongful or fraudulent trading under s
213 and s 214 Insolvency Act 1986 or fraud in relation to the company or its property (s 4);
* Disqualification after investigation of the company – this ground is used where it seems to the
Secretary of State that it would be in the public interest for a disqualification order to be made
(s8). In Secretary of State for Business, Innovation and Skills v Pawson (2015).
39
1.4.9 Criminal penalties, compensation orders and disqualification undertakings
(a) Criminal Penalties
It is a criminal offence to act in contravention of a disqualification order and any person doing so is liable for a fine or imprisonment or both (s 13), as well as being
personally liable for all the debts of the company incurred during the time that the person was acting in contravention of a disqualification order (s 15).
40
(b) Compensation orders
The Secretary of State may apply to the court for a compensation
order against a director who has been disqualified where creditors have suffered losses due
to the director’s misconduct (s 15 A – s 15C).
41
(c) Disqualification undertakings
The Secretary of State may accept a disqualification undertaking by any person that for a specified period, that person will not be a director or be involved in any way with the promotion, formation or management of a company without the leave of the court (s 6(2)).
42
Disqualification based on competition law breach
Note that directors who breach competition law eg by operating a cartel (a group of independent
businesses who collude with each other in order to improve their profits and dominate the market)
may also be disqualified under s 9A – 9E CDDA 1986, for a maximum of 15 years. Disqualification undertakings may also be offered in this situation and there is potential immunity for whistleblowers in cartels.
43
1.4.10 Summary
* The appointment of directors and granting of service contracts are governed by the provisions
of the company’s articles. In general, the board decides on the appointments and terms of
service contracts. However, long-term service contracts require approval by an ordinary
resolution of the shareholders under s 188 CA 2006.
* Directors’ appointments may be terminated by resignation, vacation or removal by ordinary
resolution of the shareholders under s 168.
* Directors may also be disqualified under CDDA 1986.
* Disqualification orders may be mandatory or discretionary and may last for up to 15 years.
* It is a criminal offence to act in contravention of a disqualification order and any person doing
so is liable for a fine or imprisonment or both, as well as being personally liable for all the debts of the company incurred during the time that the person was acting in contravention of a
disqualification order.
44
2. Directors’ duties
2.1 Directors’ duties under ss 170-174 CA 2006
This section considers the development of the law in relation to directors’ duties and the duties a
director owes to the company under ss 170–174 CA 2006. Further duties under ss 175–177 and the
consequences of breach of duty are covered in the next element.
45
2.1.1 The duties of directors
As a company is inanimate, it is the directors who on a day-to-day basis are responsible for
managing the company (MA 3). How are the shareholders protected from directors exploiting or abusing their powers to act in their own self-interest? The answer to this is the extensive duties
that directors are subject to.
The duties of directors were developed by the courts of equity but were codified in the CA 2006.
An important point to appreciate is that under s 170(1) CA 2006 the general duties of directors
specified in ss 171-177 are owed by a director to the company (and not to the shareholders directly). Any breach of duty by a director is therefore a wrong done to the company and it is the company who would therefore be the claimant in proceedings in respect of a breach of duty by a director
46
Director capable of subsequent approval
If a director exceeds their powers or breaches their duties, they can be liable to the company for
the loss they have caused. Any liability for breach can be avoided if the director’s conduct is capable of subsequent approval, or ratification, by the shareholders (s 239). Although the duties
of directors were codified in CA 2006, the remedies for breach were not codified. Section 178
provides that the existing common law and equitable remedies still apply.
47
2.1.2 Directors and shareholders
Shareholders have only a limited input into the company’s decision making. CA 2006 requires the
directors to obtain prior shareholder approval for certain decisions (eg to amend the Articles, s 21 CA 2006) and directors’ powers can be further regulated, and limited, by the Articles (eg MA 4).
48
Shareholder power towards directors
Ultimately, if shareholders do not approve of the way the directors are managing the company,
they can change the composition of the board by removing directors and/or appointing new
directors (s 168 CA 2006).
49
Passing Board Resolutions through Simple Majority
In most cases this means
that the directors make decisions by passing board resolutions at a board meeting and board
resolutions are usually passed by a simple majority of those who are present at the meeting, and
voting. As an alternative the Articles usually allow directors to take decisions unanimously by
some other means that allows all the directors to indicate common consent (as an example see
MA 8).
50
2.1.3 To whom do directors owe duties?
As previously outlined, directors owe their duties to the company (s 170(1)). They do not normally
owe fiduciary duties to individual members or shareholders.
Section 170(1) gives statutory effect to this principle which was originally established in Foss v
Harbottle (1843).
51
Directors can owe fiduciary duties
(Sharp v Blank [2015] EWHC 3220 (Ch
There may be particular circumstances where directors may owe fiduciary duties to shareholders, but these will be ‘something over and above the usual relationship that any director of a company has with its shareholders’ eg where there is a special relationship between the directors and shareholders arising usually from a personal relationship and the shareholders place trust and confidence in the directors (Sharp v Blank [2015] EWHC 3220 (Ch)). This is more typical in family companies.
52
2.1.4 Fiduciary nature of director
As you saw earlier in the module, directors are agents of the company and therefore are subject
to the fiduciary duties owed by agents. The overriding principle of the equitable fiduciary duties is that fiduciaries must not benefit from their position of trust. This principle has long been recognised and can be summarised as follows.
53
Key case: Towers v Premier Waste Management Ltd [2012] BCC, 72
Mummery LJ: A director of a company is appointed to direct its affairs. In doing so it is his duty to promote its success and to protect its interests. In accordance with equitable principles the special
relationship with the company generated fiduciary duties on the part of a director. His fiduciary commitments to the company took the form of a duty of loyalty and a duty to avoid a conflict between his personal interests and his duty to the company.
54
2.1.5 Prior to CA 2006: Fiduciary duties
These were as follows:
* Common law duty of skill and care;
* Fiduciary duties/duties in equity, eg:
- Duty to act bona fide in the best interests of the company;
- Duty to act within powers and for proper purposes and not for any collateral purpose (eg
not for personal gain, or with a conflicting interest);
- Duty not to misapply company property;
- Duty to account for a secret profit (ie a profit made by virtue of one’s office, perhaps
involving a contract between the director and a third party, which is not approved by the
company);
- Duty to avoid conflicting interests and duties; and
- Duty not to fetter discretion.
55
2.1.6 Directors’ duties under CA 2006
Before the enactment of the CA 2006, directors’ duties derived for the most part from common
law and equity. The former regime still operates to the extent not expressly provided for in the
CA 2006.
56
Section 170 (3)
Section 170(3) provides that the general duties are based on the old common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director
57
Section 170 (4)
Section 170(4) CA 2006 provides that the new duties shall be interpreted and applied in the
same way as the common law rules and equitable principles. The practical effect of this is that although any claim for breach of duty must be based on the
statutory duties, the old case law will continue to be relevant in the interpretation of the statutory
duties where it does not conflict with CA 2006
58
2.1.7 The general duties of directors under Part 10 CA 2006 (ss 170–177)
The general duties are set out in ss 171-177 CA 2006 and are as follows:
* Duty to act within powers (s 171);
* Duty to promote the success of the company for the benefit of the members as a whole (s 172);
* Duty to exercise independent judgment (s 173);
* Duty to exercise reasonable care, skill and diligence (s 174);
* Duty to avoid conflicts of interest (s 175);
* Duty not to accept benefits from third parties (s 176); and
* Duty to declare any interest in a proposed transaction (s 177).
We explore s 171 to s 174 in this element, and ss 175–177 in the next section.
59
2.1.8 Section 171: Duty to act within powers
(a) Duty to act within the company’s constitution
The company’s constitution is defined in s 257 and includes everything set out in the
company’s articles of association and decisions taken in accordance with the articles (ie
shareholder resolutions). A director is in breach of this duty if he acts without authority, eg
commits the company to borrow more than the articles allow without prior shareholder
approval.
60
(b) Duty to exercise powers for the purposes for which they are conferred (proper purpose
doctrine)
Directors should exercise their powers ‘bona fide in what they consider – not what a court may
consider – is in the interests of the company, and not for any collateral purpose’ (Re Smith & Fawcett Ltd (1942)). This duty codified the ‘proper purposes’ doctrine.
61
2.1.9 Interpretation of s 171(b)/the proper purposes doctrine
There are a number of cases on the interpretation of the ‘proper purposes’ doctrine, most of which
predate CA 2006. These are summarised below. The proper purposes doctrine has often been
challenged in the context of the directors’ power to issue shares, as this of course often diminishes
the voting rights of existing shareholders.
62
Key case: Hogg v Cramphorn [1967] Ch 254
The directors of the defendant company issued 5,707 new shares with special voting rights to the
trustees of a scheme set up for the benefit of the company’s employees in order to avoid a
takeover bid. This allotment of shares was held to be for the purpose of destroying the voting
control of the majority shareholders, so was held to be void and an improper use of the directors’ power to issue shares, although was capable of ratification by the shareholders in a general meeting.
63
Key case: Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821
This is one of the leading cases on abuse of power by directors. The facts were that rival takeover
offers for all the shares in a company, RW Miller (Holdings) Ltd, had been submitted by Howard
Smith Ltd and Ampol Ltd. Ampol already held 55% of the shares (together with an associated
company) so there was no prospect that Howard Smith’s offer would succeed.
However, a majority of Miller’s directors preferred Howard Smith’s offer as the terms were more favourable and therefore they resolved to issue $10 million of new shares to Howard Smith in order to defeat Ampol’s takeover offer. The Privy Council held that the new share issue, despite being within the powers of the directors, was unlawful as it was not in accordance with the proper purposes doctrine, since the primary purpose of the share issue was not to raise capital but to frustrate Ampol’s takeover offer
64
Key case: Eclairs Group Ltd v JKX Oil & Gas plc [2015] UKSC 71
The issue here concerned the power of directors to issue a disclosure notice calling for information about persons interested in its shares. The articles of the company (art 42) allowed the directors to disenfranchise a shareholder (ie prevent the shareholders from participating in the company) for non-compliance. The case involved a ‘corporate raid’ on JKX which was an attempt to exploit a minority shareholding in the company to obtain effective voting control without paying a proper price for shares.
The directors of JKX suspected the minority shareholder of mounting a corporate raid and therefore issued disclosure notices on the shareholders and subsequently stopped these shareholders from voting at the AGM. The shareholders challenged this exercise of power
65
Sumption LJ Judgement
There is in principle a clear line between protecting the company and its shareholders against
the consequences of non-provision of the information and seeking to manipulate the fate of particular shareholders’ resolutions or to alter the balance of forces at the company’s general meetings. The latter are no part of the purpose of article 42. They are matters for the
shareholders, not for the board.
66
Key case: Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598
Tests to determine improper purpose
The court must:
* Identify the power whose exercise is in question;
* Identify the proper purpose for which that power was delegated to the directors;
* Identify the substantial purpose for which the power was in fact exercised; and
* Decide whether that purpose was proper.
67
Overlap between 171 and 172
Note that there is an overlap between the duty to promote the success of the company (s 172) and
the proper purposes doctrine in s 171. The proper purposes doctrine operates to limit the authority
of directors even if their action was carried out in what they bona fide believed to be the best
interests of the company. If the power is exercised primarily for some collateral purpose
(construed objectively) then the action may be set aside.
68
Key case: Teck Corporation v Millar (1972) 33 DLR (3d) 288
This case explored the overlap between the old duty of good faith (now s 172) and the proper
purposes doctrine. The court held that directors may be entitled to use their powers to protect the
company if on reasonable grounds the proposed takeover will cause substantial damage to the
company.
Here the takeover would be a bad deal for the shareholders. The power of directors to
issue shares may be exercised for reasons other than the raising of capital provided those reasons
relate to a purpose benefiting the company as a whole.
69
2.1.10 Section 172: Duty to promote the success of the company
(a) The likely consequences of any decision in the long term;
(b) The interests of the company’s employees;
(c) The need to foster the company’s business relationship with suppliers, customers, and others;
(d) The impact of the company’s operations on the community and the environment;
(e) The desirability of the company maintaining a reputation for high standards of business
conduct; and
(f) The need to act fairly as between members of the company.
70
2.1.11 Interpretation of s 172
Section 172 codifies the long-settled duty of a director to act honestly and in good faith in the
best interests of the company. This derives from the formulation of Lord Greene MR in Re Smith v
Fawcett Ltd (1942), who stated that directors ‘must exercise their discretion bona fide in what they
consider – not what a court may consider – is in the interests of the company’. Although the test
is subjective, the determination of whether a director has complied with s 172 will involve an
element of objectivity.
71
Pennycuick J in Charterbridge Corpn Ltd v Lloyd’s Bank Ltd (1970) test for determining duty
Stated that the test for
determining this duty is ‘whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company’
72
Re Southern Counties Fresh Food Ltd (2009),
Warren J stated that ‘it is accepted that a breach will have occurred if it is established that the relevant exercise of power is one which could not be considered by any reasonable director to be in the interests of the company’.
73
Definition of success
‘Success’ is defined as long term increase in value (s 172(1)(a)) and takes into account the effect of
the directors’ decision making on the members as a whole and the other stakeholders. It is clear
that where a company is insolvent, this duty extends to the directors acting in the best interests of
the creditors of a company.
74
Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244
In this case it was held that the duty to act bona fide in the interests of the company includes the duty to disclose misconduct by the director to the company.
75
Key case: Re HLC Environmental Projects Ltd [2013] EWHC 2876 Ch
The court held that a director who prefers one creditor to another by deliberately paying one over
the others (here a bank whose debt was guaranteed by the parent company, so as to assist the
parent company) may be in breach of the duty to act in the interests of the creditors as a whole.
76
2.1.12 Section 173: Duty to exercise independent judgment
Section 173:
(1) A director of a company must exercise independent judgment. This duty is not infringed by
his acting –
(2) This duty is not infringed by his acting –
(a) in accordance with an agreement duly entered into by the company that restricts the
future exercise of discretion by its directors, or
(b) in a way authorised by the company’s constitution.
This duty codifies the principle of law that directors must not fetter the future exercise of their
discretion other than in accordance with s 173(2). This is part of the overarching duty to promote
the success of the company as set out in s 172.
77
Key case: Fulham Football Club Ltd v Cabra Estates plc [1994] 1 BCLC 363 (Court of Appeal)
In this case the directors of Fulham Football Club contracted with the landlords of the football
ground which they held on lease that they would not oppose any future application which the
landlords might make for development of the ground, in return for a substantial fee. The directors later wished to go back on this and argued that it was an unlawful fetter on their ability to act in the best interests of the company in the future.
78
Court of Appeal Judgement
There are many kinds of transaction in which the proper time for the exercise of the directors’ discretion is the time of the negotiation of a contract and not the time at which the contract is to be performed […]. If at the former time they are bona fide of opinion that it is in the interests of the company that the transaction should be entered into effect I see no reason in law why
they should not bind themselves.
79
Key case: Madoff Securities International Ltd v Raven [2013] EWHC 3147
Popplewell J stated that in discharging the duty under s 173 it is legitimate for there to be division
and delegation of responsibility for particular aspects of the management of a company.
However, he went on to state that:
[…] each individual director owes inescapable personal responsibilities. He owes duties to the company to inform himself of the company’s affairs and join with his fellow directors in
supervising them. It is therefore a breach of duty for a director to allow himself to be
dominated, bamboozled or manipulated by a dominant fellow director […]
80
2.1.13 Section 174: Duty to exercise reasonable care, skill and diligence
Section 174:
(1) A director of a company must exercise reasonable care, skill and diligence.
(2) This means the care, skill and diligence that would be exercised by a reasonably diligent
person with-
(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
(b) the general knowledge, skill and experience that the director has.
81
2.1.14 Interpretation of s 174
In the early cases, the standard expected of directors was subjective, therefore poor directors
were able to escape liability for company losses. However, the landmark case of Donoghue v Stevenson (1932), in which the House of Lords recognised the existence of a general duty of care based on reasonable foresight, bringing into existence the law of negligence, changed the landscape of the case law and raised the standard expected of directors to a subjective/objective test.
The provisions of s 174 adopt this subjective/objective test. The minimum standard expected of a
director is that objectively expected of a director in that position. This standard may then be subjectively raised if the particular director has any special knowledge, skill and experience.
82
Key case: Re D’Jan of London Ltd [1994] 1 BCLC 561 ChD
(i) Directors have, both collectively and individually, a continuing duty to acquire and maintain
a sufficient knowledge and understanding of the company’s business to enable them properly
to discharge their duties as directors.
(ii) Whilst directors are entitled (subject to the articles of association of the company) to
delegate particular functions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent, the exercise of the power of delegation does
not absolve a director from the duty to supervise the discharge of the delegated functions.
(iii) No rule of universal application can be formulated as to the duty referred to in (ii) above. The extent of the duty, and the question whether it has been discharged, must depend on the
facts of each particular case, including the director’s role in the management of the company.
83
The overriding principle
Directors have a duty to be proactive in monitoring the actions of delegates and other directors
and must keep themselves informed.
84
Key case: Re Barings plc(No 5) [1999] 1 BCLC 433
In this case, proceedings were brought under the CDDA for the disqualification of directors of
Barings Bank following huge losses resulting from the unauthorised dealings of a trader, Nick
Leeson, who was based in the bank’s Singapore office.
One of the issues was the level of
supervision that should be expected of a director who was the Deputy Chairman of the Barings
Group, the Chairman of Barings Investment Bank and the Barings Investment Bank Managing
Committee.
The director argued that he was justified in trusting delegates until matters came to his attention that required his response. The court held that the directors, collectively and individually, had a duty to acquire and maintain a sufficient knowledge of the company’s
business so as to enable them to discharge their responsibilities, and that the power to delegate
did not absolve directors from the duty to supervise the way in which delegated functions are
carried out.
85
Key case: Lexi Holdings plc (In Administration) v Luqman [2009] EWCA Civ 117
This case followed the principle set out above and followed in the Barings case. The court held
that two sisters who were non-executive directors of a company were liable for failing to exercise
active oversight of the company’s affairs where their brother, who was managing director, had
stolen almost £60 million that banks had lent the company for use in its business. The sisters were held to be negligent and jointly liable with their brother for the stolen money.
86
Key case: Madoff Securities International Ltd v Raven [2013] EWHC 3147
This case illustrates that directors are however able to legitimately defer to the views of a fellow
director with greater experience where it is reasonable to do so, and that in this case this was not
a breach of the duty to exercise independent judgment.
87
2.1.15 Summary
* In general, directors’ duties are owed to the company and not to individual shareholders.
* Directors are agents of the company and therefore subject to fiduciary duties.
* The common law and equitable fiduciary duties apply to the extent not covered by CA 2006
and remain relevant in the interpretation of the statutory duties.
* The statutory directors’ duties include:
- Duty to act within their powers (s 171).
- Duty to promote the success of the company for the benefit of the members as a whole (s
172).
- Duty to exercise independent judgment (s 173).
- Duty to exercise reasonable care, skill and diligence (s 174).
88
2.2 Directors’ duties under ss 175-177 CA 2006
This section considers the statutory duties that a director owes to the company under ss 175–177
CA 2006.
2.2.1 Sections 175–177 CA 2006
Sections 175–177 are three linked duties which cover the fiduciary duties of loyalty owed by
directors to their companies.
These sections are:
Section 175: Duty to avoid conflicts of interest
Section 176: Duty not to accept benefits from third parties
Section 177: Duty to declare interest in proposed transactions or arrangements
The previous equitable duties were stated as the ‘no conflict’ and the ‘no profit/misuse of position’
rules.
The ‘no conflict’ and the ‘no profit/misuse of position’ rules were summarised in two important
cases which are set out below.
89
Key case: Aberdeen Rly Co v Blaikie Bros [1854] 1 Macq 61
Lord Cranworth LC: Mr Blaikie was the Chairman of Aberdeen Railway (who wanted to buy chairs
for the lowest price), yet he was also the managing director of Blaikie Bros (who wanted to sell at
the highest price). The court stated that: it is a rule of universal application that no-one, having [fiduciary] duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting,
or which possibly may conflict, with the interests of those whom he is bound to protect
90
Key case: Bray v Ford [1896] AC 44
Lord Herschell:
It is an inflexible rule of a court of equity that a person in a fiduciary position […] is not, unless
otherwise expressly provided […] allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is […] founded upon principles of morality.
I regard it rather as based on the consideration that, human nature being what it is, there is a
danger, in such circumstances, of the person holding a fiduciary position being swayed by
interest rather than by duty, and thus prejudicing those whom he was bound to protect. It has,
therefore, been deemed expedient to lay down this positive rule.
91
2.2.2 Section 175: Duty to avoid conflicts of interest
Section 175:
(1) A director of a company must avoid a situation in which he has or can have, a direct or
indirect interest that conflicts, or possibly may conflict, with the interests of the company.
(2) This applies in particular to the exploitation of any property, information or opportunity
(and it is immaterial whether the company could take advantage of the property, information
or opportunity).
(3) This duty does not apply to a conflict of interests arising in relation to a transaction or
arrangement with the company.
(4) This duty is not infringed—
(a) if the situation cannot reasonably be regarded as likely to give rise to a conflict of
interests; or
(b) if the matter has been authorised by the directors
92
Section 175
Section 175(5)(a) states that for a private company, conflicts may be authorised by independent
directors with no interest in the matter unless its constitution otherwise provides. Section 175(5)(b) states that for a public company the directors will only be able to authorise such conflicts if its
constitution expressly permits.
Section 175(6) provides that board authorisation is effective only if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid even without
the participation of the conflicted directors; the votes of the conflicted directors in favour of the
decision will be ignored and the conflicted directors are not counted in the quorum.
Section 175(7) makes clear that ‘conflict of interests’ includes a conflict of interest and duty and a
conflict of duties.
93
Section 175
Key case: Boardman v Phipps [1966] UKHL 2
Note that s 175(3) expressly excludes conflicts of interest arising in relation to transactions or arrangements with the company. These conflicts are subject to the duty of disclosure in s 177 (see
below) for transparency purposes but are not prohibited. This seems to be a statutory
acknowledgement that many directors will have interests in other companies, and most
companies’ articles permit this, provided such interests are declared.
94
2.2.4 Section 175: Corporate opportunities
Key case: Cook v Deeks [1916] 1 AC 554
In this case, three of the four directors of the company fell out with the fourth director (Cook). The
company had negotiated a series of construction contracts with a railway company and had built
up considerable goodwill. The three directors took the last contract in their own names rather than that of the company.
Cook claimed that the company was entitled to the benefit of the contract and that a shareholders’ resolution which the defendants had passed with their own votes to
ratify that the company claimed no interest in the contract was ineffective
95
Key case: Cook v Deeks [1916] 1 AC 554 Judgement
While entrusted with the conduct of the affairs of the company (the directors had) deliberately
designed to exclude, and used their influence and position to exclude, the company whose
interest it was their first duty to protect.
96
Key case: Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378
In this case Regal owned a cinema in Hastings and the directors decided to acquire two other
cinemas and then sell all three to an outsider as a going concern. In order to do this they formed a
subsidiary company (‘Amalgamated’) to lease the other two cinemas.
97
Lord Russell Judgement
[…] the directors standing in a fiduciary relationship to Regal in regard to the exercise of their
powers as directors, and having obtained these shares by reason and only by reason of the
fact that they were directors of Regal and in the course of the execution of that office, are
accountable for the profits which they have made out of them.
98
Key case: Bhullar v Bhullar [2003] EWCA Civ 424 (Court of Appeal)
This case involved two brothers, M and S, who founded and controlled a family company, BBL. Family relations broke down and negotiations to split the company assets between the families of M and S took place but were not successful. At this time, M told S and his sons at a board meeting they he did not wish any more properties to be purchased by the company. Later, S’s sons (I and J) learned that a property adjacent to one of the company’s existing properties was for sale, and they purchased it in the name of Silvercrest, a company controlled by them.
The M family issued a petition for unfair prejudice seeking relief on the basis of breach of fiduciary duty. The Court of Appeal concluded that S’s sons I and J were in breach of fiduciary duty in purchasing the
property for their own benefit, despite the fact that they came upon the opportunity to purchase the property privately.
99
Lord Parker Judgement
Whether the company could or would have taken that opportunity had it been made aware of it, is not to the point: the existence of the opportunity was information which it was relevant for the company to know, and it follows that the appellants were under a duty to communicate it to the company.
100
2.2.5 Section 175: Corporate opportunities - summary
In summary, misappropriation of a corporate opportunity will be a breach of duty by a director because the opportunity is the company’s property. The duty under s 175 is construed strictly. It is irrelevant that the company could not or would not have pursued that opportunity (Regal
(Hastings) Limited v Gulliver [1942] 1 All ER 378). If the directors make a personal profit out of the fact of their position as a director, they are liable to account to the company for this.
This principle is now expressly stated in s 175(2). Conflicts of interest may arise even when the company is not pursuing the opportunities in question, and when they are presented to the directors in their personal capacity. Taking advantage of such opportunities may still amount to a breach of duty (Bhullar v Bhullar [2003] EWCA Civ 424).
101
2.2.6 Section 175: Resigning directors
Can a director merely resign from a company in order to then exploit a corporate opportunity which would otherwise constitute a breach of s 175? The answer to this is clearly no. This is set out in section 170(2)(a) which states: a person who ceases to be a director continues to be subject
(a) to the duty in section 175: duty to avoid conflicts of interest) as regards the exploitation of any property, information or opportunity of which he became aware when he was a director. However, when a director resigns and takes up a new opportunity, again it is important to
consider all the facts in order to ascertain whether there is a breach of s 175 or not. The following
contrasting cases illustrate this clearly
102
Key case: CMS Dolphin Ltd v Simonet [2001] EWHC 415
S and B founded CMS, an advertising agency but later fell out. S resigned as managing director and set up in business, firstly under the trade name Millennium and later as a company, Blue (GB) Ltd. Following S’s resignation, all the staff of CMS left to join him in his new business, as did all the principal clients.
The court held that in exploiting a ‘maturing business opportunity’ of the company after resignation, S was in breach of his fiduciary duties. It was held that S became a ‘constructive trustee of the fruits of his abuse of the company’s property, which he has acquired in
circumstances where he knowingly had a conflict of interest and exploited it by resigning from the
company’.
103
Key case: Shepherds Investments Ltd v Walters [2006] EWHC 836
In this case the former directors of Shepherds were found liable for breach of duty where they had
set up rival companies prior to resigning from Shepherds, without disclosing their intentions to the
board of Shepherds. The court found that their activity was a breach of their fiduciary duty of good faith and put them in a position of conflict.
They were held liable to account for the profits generated during the ‘advance start’ period that their breach had given them but not liable for damages as no loss to Shepherds was proved to have been caused by the breach
104
Key case: Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200 (Court of Appeal)
This case predates CA 2006, and it is questionable whether it would be decided the same way now, given s 170(2)(a). Here a director who was effectively forced out of the company by the other director resigned, although not to take work or clients from the company.
During his notice period the company’s major client pressed Bryant to continue working with them and he did this through
a new company of his own. He was found not to have breached his fiduciary duty.
The court held that there must be ‘some relevant connection or link between the resignation and
the obtaining of the business’. There must be a lack of good faith with which the future exploitation was planned, and the resignation was part of the dishonest plan. Key factors for the decision seem to be that there was no ulterior purpose to Bryant’s resignation as he was effectively forced out of the company, and that he did not seek the opportunity.
105
2.2.7 Section 175: Competing directorships
Can a director be a director of more than one company or will this breach s 175? The issue arises where there is a conflict due to the companies competing. The general equitable rule prevents a fiduciary from entering into a position which gives rise to conflicting fiduciary duties to another person without the informed consent of both principals (Clark Boyce v Mouat [1994] 1 AC 428).
The general position is that such a conflict will need to be authorised by the company using the process in s 175(5) and 175(6). However, all of the facts need to be clearly ascertained before it is clear whether a breach of fiduciary duty is committed when a director is an officer of a second company which competes with the first. On the (rather unusual) facts of the case of In Plus Ltd v Pyke, no breach of duty was found in this
situation. This case is summarised below.
106
Key case: In Plus Group Ltd v Pyke [2002] EWCA Civ 370 (Court of Appeal)
The facts of this case are unusual. In Plus Group Ltd (IPGL) was controlled by Pyke and Plank who were the only directors and shareholders. Pyke suffered a stroke and the business relationship deteriorated such that he was excluded entirely from the management of the company and no
longer received a salary. He therefore started a new company and entered into a contract with one of IPGL’s clients, Constructive. The claimants argued this was a breach of fiduciary duty and sought an account of profits.
107
The Court of Appeal
Although he had invested a very large sum of money in the first and second claimants on interest free accounts, he was not being permitted to withdraw any of it. At the same time he was being denied any remuneration from the companies. When he entered into business with Constructive in the autumn of 1997 he was not using any of the claimants’ property for the
purpose of that business.
Nor was he making use of any confidential information which had
come to him as a director of any of the companies. In these circumstances I consider […] that
Mr Pyke committed no breach of fiduciary duty in trading with Constructive.
108
2.2.8 Section 176: Duty not to accept benefits from third parties
Section 176:
(1) A director must not accept a benefit from a third party conferred by reason of:
(a) his being a director, or
(b) his doing (or not doing) anything as a director).
This duty replaces the equitable principle that fiduciaries must not accept secret commissions or bribes (Attorney General for Hong Kong v Reid [1994] 1 AC 324).
This duty should be read in conjunction with the wider no-conflict duty laid down in s 175.
Section 176(4) states that the duty is not infringed if acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.
109
Benefits
‘Benefits’ is not defined but is construed in the ordinary meaning of the word so will cover benefits of any description, including non-financial benefits, eg free holidays. Note that, unlike s 175, there is no provision for authorisation by the board of directors for breach
of s 176. Ratification would need to be sought from shareholders under s 239 CA 2006.
110
2.2.9 Section 177: Duty to declare an interest in a proposed transaction
Section 177:
(1) If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the
other directors. An example of a situation in which a director is interested in a proposed transaction would be
where a director was proposing to sell an asset to the company, or buy an asset from the company.
The disclosure need not be in writing: informal disclosure other members of the board will suffice (Lee Panavision Ltd v Lee Lighting Ltd (1992)). Under s 180, if directors comply with the duty to disclose in s 177, then the transaction is not liable
to be set aside, although this is expressly subject to any other provisions in the company’s constitution.
111
2.2.10 Interpretation of s 177 and s 182
Section 177 places a duty on directors to disclose an interest in a proposed transaction with the company. Section 182 applies to cases where a director has an interest in a transaction after it
has been entered into by the company and also requires directors to disclose such interests.
112
Differences between 177 & 182
There is one major difference between s 177 and s 182 which concerns the sanctions for breach. Breach of the duty under s 177 leads to civil consequences under s 178, which are the same as for
breach of all the other duties (other than s 174), whereas breach of s 182 leads to criminal sanctions under s 183.
Note that these provisions do not apply to substantial property transactions, loans, quasi-loans and credit transactions which require the approval of the company’s members (ss 190–203). We
will explore these specific provisions in the next element.
113
2.2.11 Final points on directors’ duties
Note that the way in which the duties are framed results in an overlap between them. Section 179 serves to emphasise that the effect of the duties is cumulative. It is therefore necessary for directors to comply with every duty that, in any given situation, may apply.
For example, the duty to promote the success of the company (s 172) will not authorise the director to breach his duty to act within his powers (s 171), even if he considers that it would be most likely to promote the success of the company.
The duties under s 172 and s 175 also overlap in many cases. You may find it useful to now go back to review the cases cited under each of these sections, considering in each case whether the
breach is likely under the present law to be framed as a breach of s 172, s 175 or both
114
2.2.12 Summary
* The duties imposed on directors under s 175 – 177 CA 2006 derive from the fiduciary duties of loyalty owed by directors to their companies.
* The duties are as follows:
- Section 175: Duty to avoid conflicts of interest;
- Section 176: Duty not to accept benefits from third parties;
- Section 177: Duty to declare interest in proposed transactions or arrangements.
* Section 177 relates to the duty on directors to declare a direct or indirect interest in a proposed
transaction.
* Note that section 182 imposes a duty on directors to declare an interest in a transaction which has already been entered into by the company and that this section imposes criminal sanctions on directors who do not comply.
115
2.3 Specific transactions between companies and directors
This section considers particular specific transactions between companies and directors which are regulated by CA 2006.
116
2.3.1 Transactions with directors requiring the approval of members
These types of transaction are regulated by CA 2006 through provisions which require the approval of the company’s shareholders, rather than just the board of directors, in order for the transaction to be valid. The particular types of transaction are:
(a) Directors’ long-term service contracts (ss 188–189)
(b) Substantial property transactions (ss 190–196)
(c) Loans, quasi-loans and credit transactions (ss 197–214)
(d) Payments for loss of office (ss 215–222)
117
2.3.2 Directors’ long-term service contracts (ss 188–189)
The details of the provisions of ss 188– 189 are set out in the section on appointment of directors
but we will recap these provisions below.
Section 188 applies where a service contract provides for a director’s employment to have a ‘guaranteed term’ which is, or may be, longer than two years. Where s 188 CA 2006 applies, the relevant provision of the service contract requires shareholder
approval by ordinary resolution
118
Without shareholder approval
If shareholder approval is not given, then the term incorporated into the service contract in contravention of s 188 CA 2006 is void under s 189(a) CA 2006. In addition, under s 189(b) CA 2006, the service contract will be deemed to contain a term entitling the company to terminate the contract at any time, by the giving of reasonable notice to the director.
119
2.3.3 Substantial property transactions (s 190 – 196) (require shareholder approval)
Substantial property transactions: Substantial property transactions involve transactions between a company and its directors or connected persons concerning ‘substantial non-cash
assets’. These types of transaction are permitted but again require shareholder approval by ordinary resolution.
Shareholder approval must be given either before the transaction is entered into, or after, provided that the transaction is made conditional on approval being obtained. It is also possible for shareholders to approve the transaction after the event (s 196), but this does not absolve directors of potential liability under s 195.
120
Connected persons – ss 252–254 CA 2006:
The definition of ‘persons connected with a director’ is set out in ss 252–254 CA 2006. The definition is complex and where you suspect that a connected person may be involved, you should always check the details of the
legislation. However, in summary, the key categories of connected persons are:
(a) Members of the director’s family: spouse or civil partner, parents, children or step-children (s 253). Note that brothers, sisters, grandparents, grandchildren, uncles and aunts are
NOT connected persons under CA 2006.
(b) Companies in which the director (and others connected with them) hold more than 20% of the shares (s 254).
(c) A business partner of the director or those connected with them (s 252(2)(d)).
(d) Trustees of a trust the beneficiaries of which include the director or those connected with
them (s 252(2)(c).
121
Substantial property transactions: Remedies (s 195)
Where a substantial property transaction is entered into without shareholder approval, the consequences set out in s 195 apply.
Under s 195(2) the arrangement and any transaction arising from it, is voidable at the instance of the company. This is unless:
(a) Restitution of any money or other asset that was the subject matter of the arrangement or
transaction is no longer possible,
(b) The company has been indemnified in pursuance of this section by any other persons for the loss or damage suffered by it.
(c) Rights acquired in good faith, for value and without actual notice of the contravention by a person who is not a party to the arrangement or transaction would be affected by the
avoidance.
In relation to the directors involved (and those so connected under s 195(4)), the consequences are set out in s 195(3): they are liable to account to the company for any profits made and to indemnify the company for any loss incurred
122
Substantial property transactions ss 190–196 Summary
Does the transaction involve the acquisition or disposal of a non-cash asset from a company to or
from a director or connected person? IF YES:
Is the asset substantial?
* Exceeds 10% of the company’s asset value and is more than £5,000, or
* Exceeds £100,000?
IF YES:
Shareholder approval by ordinary resolution is required. If not obtained:
* Transaction may be voidable in certain circumstances
* Directors involved liable to account for profits and indemnify for loss
123
Example
Olivia is a director of PGDL Ltd. She previously had her own publishing business and PGDL Ltd
wish to purchase some printing equipment from Olivia. The value of the equipment is £70,000. The
net asset value of PGDL Ltd is £500,000.
124
Determining substantial property transaction
In order to determine whether this is a substantial property transaction, we apply the three steps:
(a) This is a purchase by the company (PGDL Ltd) of a non-cash asset (equipment) from one of
its directors (Olivia);
(b) The value of the asset is between £5,000 and £100,000 so we need to ascertain whether the
asset value exceeds 10% of PGDL Ltd’s net asset value. £70,000 does exceed 10% of £500,000 so the asset is ‘substantial’.
(c) Therefore, PGDL Ltd will require shareholder approval by way of ordinary resolution from its shareholders before proceeding with the purchase or will incur the consequences set out in s
195.
125
2.3.4 Loans to directors (ss 197–214)
Company loans to directors, although permitted, may also be subject to the requirement of shareholder approval by ordinary resolution. Before the shareholders can be asked to approve a loan to a director (or a director of a holding company), they must be given information as to the nature of the transaction, the amount and
purpose of the loan and the company’s liability (s 197(3)) in the form of a memorandum. This will help them make an informed decision.
‘Loan’ is not defined in CA 2006 but in the case of Champagne Perrier-Jouet SA v HH Finch Ltd [1982] 1 WLR 1359, the court held that this means ‘a sum of money lent for a period of time, to be returned in money or money’s worth’. Whether a payment made to a director is a loan or
remuneration is a question of fact in every case.
126
Key case: Currencies Direct Ltd v Ellis [2003] BCLC 482, CA
In this case the defendant was a shareholder and director of the claimant company, who received
sums in cash or payment by way of expenses incurred by him. After he was excluded from the management of the company, the company sought to recover £253,000 from him on the basis
that this money had been loaned to the director. The judge found that the company could only recover £43,117 as the rest of the money had been remuneration rather than a loan. It was held that remuneration is consideration for work done or to be done and may take different forms, not
only the direct payment of a regular wage.
127
Loans to directors: Exceptions (ss 204–209)
There are a number of exceptions to the requirement for shareholder approval, the details of
which are set out in ss 204–209. These are as follows:
* Section 204: Expenditure on company business (up to a maximum of £50,000)
* Section 205: Loans for defending proceedings brought against a director
* Section 206: Loans for defending regulatory actions or investigations
* Section 207: Minor and business transactions – loans of up to £10,000 do not require
shareholder approval
* Section 208: Intra group transactions
* Section 209: Money lending companies (where the loan is made in the ordinary course of the
business of the company)
128
Loans to directors: Remedies (s 213)
In relation to the transaction, the consequences are set out in s 213(2): the arrangement is voidable at the
instance of the company. This is unless:
(a) Restitution of any money or other asset that was the subject matter of the arrangement or transaction is no longer possible;
(b) The company has been indemnified in pursuance of this section by any other persons for the loss or damage suffered by it; or
(c) Rights acquired in good faith, for value and without actual notice of the contravention by a person who is not a party to the arrangement or transaction would be affected by the
avoidance
In relation to the directors involved and (and those so connected under s 213(4)), the consequences are set out in s 213(3): they are liable to account to the company for any profits made and to indemnify the company for any loss incurred.
129
2.3.5 Payments for loss of office (ss 215–222)
Under s 217, any payment for loss of office to a director needs to be approved by shareholders by way of an ordinary resolution.
There are two exceptions to this requirement. The first under s 220 is where the payment made in
good faith:
(a) In discharge of an existing legal obligation,
(b) By way of damages for breach of such an obligation,
(c) By way of settlement or compromise of any claim arising in connection with the termination
of a person’s office or employment, or
(d) By way of pension in respect of past services.
130
2.3.6 Summary
* There are four specific types of transaction between companies and directors which are
regulated by CA 2006:
- Directors’ long-term service contracts (ss 188–189)
- Substantial property transactions (ss 190–196)
- Loans, quasi-loans and credit transactions (ss 197–214)
- Payments for loss of office (ss 215–222)
* All of these transactions require the approval of shareholders by way of ordinary resolution
unless any of the exceptions apply.
* The remedies for breach of the requirements of shareholder approval differ depending on
which transaction is involved. Details are found in the relevant statutory sections.
131
