The Companys Constitution Law Company Business Partnership Essay

Published Date: 02 Nov 2017

After establishing the criteria to enable Grace and John to bring a clam themselves the situation should be broken down into four key problematic areas. The first being that the directors of QuietLife ltd are giving themselves excessive payments, which regards the third exception to Foss v Harbottle [6] . In Burland v Earle [7] it was held that fraud includes where the majority are trying to directly or indirectly appropriate to themselves property, money or advantages belonging to the company or that other shareholders can be entitled to participate, this is directly applicable to the problem of Francis and Edward and giving themselves a higher wage for services they provide for the company, which goes against their fiduciary duty to act in the best interest of the company. Furthering this Daniels v Daniels [8] held that if the breach of duty turned out to be a breach of fiduciary duty, then it should be allowed to proceed under the rule in Cook v Deeks [9] because the majority could control general meetings which mirrors this situation as both accused directors have control the majority. This situation also concerns the duties of directors and exercising powers for the purpose for which they are conferred. A company is a separate legal entity [10] , therefore someone must act on behalf of the company, with the power of management being left predominantly to directors, defined under s250 of Companies Act 2006 (CA). Directors have fiduciary and common law duties to, as per Lord Greene in Re Smith and Fawcett Ltd [11] , act "bona fide in that they consider – not what a court may consider – is in the interests of the company, and not for any collateral purpose" [12] . Under s.171(a) each director is under an obligation to act in accordance with the company’s constitution. This means that director must use their powers within the limits of the company’s constitution and that the director must not endeavour to make the company act outside the conditions of its own constitution. Furthermore, under s.171(b), director’s powers should only be used for the purpose intened. If a director breaches any of the obligations under s.171, the director will be held liable to the company for compensation of any resulting loss suffered. The test to identify an improper use of power was laid out in Extrasure Travel insurance v Scattergood [13] , which concerned powers of directors to deal with company assets. The directors of Extrasure transferred company funds to another company to enable it to pay creditors. Although acting in good faith, the directors were held to be guilty of abusing their powers.

The second issue requires the fourth exception to the Foss v Harbottle [14] rule regarding the deprivation of rights. The company is making profits and so assuming the money is not being reinvested into the company, shareholders have a right to dividends. In Pender v Lushington [15] it was held that voting rights could not be deprived. Furthermore in Odessa Waterworks [16] it was held that Shareholders could enforce rights to a dividend in cash as oppose to debentures. Thus this is applicable to the lack of payment of dividends to the shareholders despite the company making a profit. The payment of dividends has been left to the articles of association of a company (see Table A) [17] . With regard to the absence of dividend payments, it should be noted there is no expressly written article in respect to them, a referral must be made to the model articles of table A [18] . The model articles first state that dividends must be declared by ordinary resolution [19] , if this meeting has not took place then dividends do not have to be paid. The Companies act provides that a company may only pay dividends out of ‘distributional profits’ [20] , meaning that a company can only pay dividends out of its accumulated, realised profits [21] . If the directors breached this then the payment of such dividends becomes ultra vires. There is little to no protection for the minority and in the case of insubstantial dividends courts have used the basis of a provision that allows a shareholder the right to challenge a decision of the general meeting through grounds of unfair prejudice. The directors decision not issue dividends to shareholders, and instead allegedly issue the profits to themselves as a salary, then this is indeed capable of constituting unfairly prejudicial conduct; Grace v Biagioli [22] . The case of Re Sam Weller & Sons [23] where shareholders, uninvolved with the management of a company were displease with the lack of increase in dividends over a period of 37 years. In this instance the court held it to be a conduct which would be unfairly prejudicial towards shareholders’ interests. Additionally, It could be alleged that the lack of dividends correlates to the excessive payments towards the directors. The cases of Re London school electronics [24] and Re Algindata [25] where the misappropriation of assets was held to be unfairly prejudicial to the interest of members of the company. On top of these Anderton v Hogg [26] , held that excessive redundancy payments was also prejudicially unfair conduct towards company members. Applying these to the scenario, it can be said that excess money has been misappropriated by been given to the directors, as a companys wealth is seen as an asset. The above cases also illustrate a bypass of the proper claimant rule [27] , as the remedy sought was repayment to the company. Following this, the aggrieved shareholders could bring an action against the company under s994 [28] . The case of Re McCarthy Surfacing ltd could also be cited; here it was held that the board's decision to exclude shareholders from a share of the company's profits through failing to consider whether to declare dividends was unfairly prejudicial. Therefore Grace and John will be able to seek relief through s994. However it should be noted that although the total lack of dividends will most likely result in a finding of prejudicial conduct, if company’s financial performance is such that the payment of dividends cannot be justified i.e. the company is making profit but not a great amount, then it is probable that non-payment of dividends will not amount to unfairly prejudicial conduct, as seen in Re Metropolis Motorcycles [29] . If the directors actions are found to be unfairly prejudicial against the interest of the shareholders, then the courts may seek a remedy under s996(2), which will most likely be to repay the excessive money back to the company.

The third dispute revolves around Grace’s transfer of shares to her daughter, which is not being honoured by the directors. This does not require an exception to the Foss v Harbottle [30] rule. Shares are items of property to the company which can be sold or given away. This is unless stated in the articles of the company or the shareholder has entered into a shareholders contract to not transfer shares. The only article available regarding transfer of shares does not concern the transfer to lineal descent, and so does not concern this issue. There are statutory provisions in relation to this issue. S771(1) [31] provides that when a transfer of shares is lodged with the company there are two possible actions, register the transfer or give the transferee notice of refusal together with reason, it is also important to note that this refusal has to come within two months after the date of transfer is lodged [32] . This right to refuse transfer is a fiduciary power to be used in the best interest of the company, as held in Re Smith & Fawcett [33] . Therefore the directors would have to show that it is in the best interest of the company to not allow this transfer. Following the act further, if the directors fail to give reason within the specified two month period, then the company [34] and both directors [35] will be held guilty of an offence which will then incur a fine for this breach of up to £1000 [36] , and then a daily fine for continued contravention up to £100 [37] . It should be noted that this would not make the refusal void, however it would expose the directors to civil liability, a petition under s994-996 [38] .

The final problem is that the directors are again halting a transfer of shares, which falls within exception number two to Foss v Harbottle [39] that special procedures of articles must be observed. In this instance they are refusing to purchase John’s shares without reason. This situation would not follow the same course as Grace’s refusal of transfer to her daughter as section 771(5)(a) states that "this section does not apply in relation to the transfers of shares if the company has issued a share warrant in respect of the shares". Share warrants are forms of security that have been issued by a company giving the holder the right to purchase stock at a price. It could then be argued that the amended article regarding the transfer of shares is a share warrant. Therefore a more fruitful course to follow would be director’s refusal to adhere to the articles of the company and purchase John’s shares. At the heart of all companies lies a memorandum and articles of association. These determine how it shall be run and where the power to make decisions falls. Members of the company dictate he contents of these articles although the Companies Act allows for the adoption of a standard set of articles in its table A. With regard to s33 of the act which provides that "the memorandum and articles are binding on a company and its members as though they had been signed and sealed by each member and contained covenants on the part of each member to observe all their provisions". In the case of Wood v Odessa [40] , Stirling J noted that the articles were additionally a contract between each individual shareholder and every other member. Translating this to the scenario it would mean that the articles were a binding contract between the directors and shareholders to purchase the shares. This binding nature was further held by LJ Hoffman in the Harrison & sons [41] , and Hickman v Kent [42] , in which articles contained a clause stating that disputes needed to go through arbitration first. Hickman sought to begin court proceedings without this, the courts decided considering s14 [43] that it must first be put to arbitration. This would suggest that the directors are obliged to follow the article relating to John’s shares. It should be noted that the law gives shareholders total control over the articles through S21(1), but the directors themselves could not have altered the articles to better suit them as s283(3)(4) states the need for a majority of 75%, which the two directors are not. Additionally alterations may be void if majority who approve it are not acting bona fide in best interests of company as a whole. This was held in Brown v Abrasive Wheel [44] and Sidebottom v Kershaw [45] .

To conclude, the alleged appropriation of money to give excessive wages to themselves by Francis and Edward would most likely be found to be in breach of their fiduciary duty owed to the company. If this extra wage is from the company’s profits then it will most likely be ordered to be returned to the company, and the shareholders will receive dividends, however it should be noted that this is dependent on the company’s profits being high. By not honoring the transfer of shares by Grace to her daughter without a notice, the directors will be found to be in breach of their fiduciary duty unless they can show it is in the best interest of the company to refuse the transfer. Finally, by not purchasing john shares the directors are breaching one of the company’s articles of association. Following case law, John would be able to bring a derivative claim against the company for the wrong doing. It should also be noted that quasi-partnership elements are prevalent in this company. Lord Wilberforce stated in the case of Ebrahimi v Westbourne Galleries [46] 'that such partnerships were formed on the basis of personal relationship between the participants, and that there is an understanding that each of the participants will be concerned in the management of the business.' In the instance of a breakdown of mutual trust, it could be appropriate to order a winding-up of the company under the ‘just and equitable’ rule by virtue of s122 Insolvency Act 1986. Although aggravated parties may fall short of success here as the majority of small companies are in fact quasi-partnerships, the court will take regard to actual substance and reality of that association as oppose to ordering a winding-up.