The Companies Act 2006

By Mubin123

In 2006 the UK Government passed new piece of company legislation with the intention of bringing “major benefits to business by modernising and simplifying company law”[1]. Whilst the new Act is aimed at cutting the administrative burden on companies it is interestingly enough the largest Acts to ever pass through Parliament. It contains 47 Parts with 1,300 sections and is followed by 16 Schedules. The new legislations brings our company law out of the foundations that it was based on in the 19^th century and brings it up to day. Parliament has taken the opportunity to codify directors duties, and to amend common law and equitable principles.

The benefits of this new Act[2] is that it now makes it simpler for shareholders to know what they can expect in return for owning shares of companies, and it also puts in one place what directors powers/duties are and how they can execute them and also how they are protected by the Act.[3] The hypothetical example of Ecowind Ltd. puts forward the ramification and remedies available to both shareholders and directors under the new legislation which will be discussed further throughout this paper.

The freedoms that directors have to manage the company as they wish are granted to them by the articles of association.[4] Art. 3 of the model articles confer the following powers to directors “… the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.” The prevalent school of thought is that the directors are to run the business with the best interest of past, present, and future shareholders in mind.[5] James would enjoy the freedom of running the company as he saw fit as long as he kept the best interests of the shareholders in mind, and followed the statutory duties of directors[6] as defined by the Act.[7] This should not be misconstrued as the Company Law Review Steering Group found as“ … an undue focus on the short-term and the narrow interest of members at the expense of what is in a broader and longer-term sense the best interest of the enterprise, and thus its value to members as ultimate controllers able to realize that value.”[8] This has now been rectified by the Act[9] and directors are now being advised to focus on balancing short-term profits with long term sustainability.

This does not give James free reign to act as he sees fit. Shareholders may still have an opportunity to reign in on his powers as the model articles[10] also give shareholders certain rights such as:

(1) The shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action.

Shareholders own the company stock, and appoint directors to run the day to bay affairs of the company this brings us back to the point made previously of directors running the business in the best interests of the shareholders. This leads us to the point that ownership and control of a company are normally vested in different parties.[11] As the owners of the company shareholders would feel that they have the right to control the company as they see fit, but according to the Act[12] the company is to be run as the director sees fit.

Shareholders do have rights to influence the decision making powers of the directors but the only way that they can do this is by a special resolution.[13] For a special resolution to be passed the shareholders must have a majority of at least 75%[14], so if Peter who holds a major share in the company would be able to convince other shareholders to go along with him, he would be able to pass a special resolutions. As Ecowind Ltd. is a private company and private companies are no longer required to hold AGM’s[15] the only way for any shareholder to direct the director to take or refrain from taking any specified action would be by passing a special written resolution.[16] We can assume that Peter holds at least a 5% share of the company as it has been stated that he is a “major shareholder”, as he owns the requisite shares[17] he can force “the company” to distribute the written resolution on his behalf.[18] The only action that could not be forced via a written resolution whether ordinary or special is to remove the company director or company auditors.[19] If Peter preferred he could also require the director to call a general meeting[20] where he could put his points forward, and if thought prudent he could also make the case to have James removed as director.[21] Academics have suggested that UK shareholders have great power to remove and replace directors[22] but it is very difficult for shareholders to actually discipline directors.

With the introduction of Section 174[23] the question remains to be asked; has this codification of the duties of directors made the duty of care more burdensome on directors? The codification has been found to have the desirable effect of certainty, yet it may be a moot change as the common law had offered a degree of flexibility for both the courts and company directors. The present view that the courts have taken is that the Act[24] has introduced a higher duty of care on directors. As there is now a positive obligation (in the form of supervising and controlling the company), and the ramifications of failing to perform these duties is that the director would attract a liability[25]. Though the case law has now been codified the cases are still important in interpreting the statutory provisions[26] as the new law is a reflection of the development of case law. The duties as laid down in the Act are generic[27] and can be applied to a wide group of people including shadow directors[28], and directors that have ceased being directors[29]. The statute confirms the position of the common law and gives effect to the cases in relation to the statutory interpretation of rules and equitable principles on director’s duties.[30] To understand if the new law is more burdensome than the case law we must first examine the cases.

Over the years, the issue of directors' duties has given rise to a considerable body of case law. Under both case law and statutory definition[31] as a director James does owe Ecowind Ltd a duty of care. A duty of reasonable care and skill is found in both law and equity, the director must exercise all reasonable care and skill or else be in breach of that legal duty and of the equitable duty. The equitable duty is not one of a fiduciary nature, as equitable duty is not termed with the fiduciary duty.[32]

Prior to the Companies Act 2006 the case law with regards to duty of care and skill differed varying with the involvement of each director in each individual case. A director who had never been to board meetings or attended a few meetings over many decades could not be held with the same level of responsibly[33] as a director present for every meeting and deeply involved in the day to day running of a business. It was not until the case of City Equitable Fire Insurance Co Ltd[34] which dealt with the case of a non-executive directorwhere the judge replaced the subjective approach taken in The Marquis of Bute’s[35] Case and its place laid down the three fold test:

(1) A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.

(2) A director is not bound to give continuous attention to the affairs of his company; he is not bound to attend all meetings, though he ought to attend whenever circumstances mean he is reasonably able to do so.

(3) In respect of all duties that, having regard to the exigencies of business and the article of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.

The first test is a subjective test of personal knowledge and experience, afterwards more cases have come to light which suggest that the relevant test for the duties of a director now involve an objective element. Therefore a director would have been required to possess the skills that would reasonable be required for a person undertaking the duties of a directory. A prime example of this fact was laid down in D'Jan of London Ltd[36] where Hoffman J. compared the standard of care required by directors to those as set by the Insolvency Act.[37] He further applied this new test in the case of Norman v Theodore Goddard.[38]

Almost a century after the first test was laid down in City Equitable Fire Insurance Co Ltd[39] the present statutory requirements as set out by section 174[40] requires a director to exercise reasonable care, and the skill and diligence that can be reasonably expected of a person in the functions of a director and the knowledge, skill and experience that a director should possess.

The codification of directors duties has certainly made the duties more accessible as they are now avaible for simple viewing in one Act rather than having to have an understanding of the various cases regarding directors duties. Though as the case of West Coast Capital[41] illustrates there is still the potential for disagreement over the extent to which the duties represent a shift in the purpose and operation. The new Act[42] has not made the duties more onerous as it has merely codified the previous common law into a statutory Act.[43]

Peter who is a major shareholder in Ecowind Ltd would be able to use a section 994[44] petition to attempt to have the court force the company to carry out his wishes via a section 996[45] injunction. Whether or not he would be successful would depend on if the court find’s that he fulfils the requirements of a section 994[46] petition.

Section 994 provides shareholders with a form of statutory protection; coming into effect on October 1^st 2007 it is identical to Section 459 of the Companies Act 1985. The section 994 petition enables a shareholder to petition the court for relief where the affairs of the company are being or have been conducted unfairly and prejudicial to his individual interests or the interest of shareholders generally, the prejudice must be suffered as a shareholder and not in any other capacity,[47] or “that an actual or proposed act or omission of the company (including

an act or omission on its behalf) is or would be so prejudicial.”[48]

Peter obviously fulfils the requirement of standing in the company that is necessary for the commencement of proceedings under section 994. A claim under section 994 allows the court to have a wide discretion into how the company should proceed; the reasoning behind this is the direct route would be for Peter to sue Ecowind Ltd. It would then be up to the company to sue the directors of the company. However, the impracticality of such a situation when very often the directors whom a shareholder wishes to complain about, controls the board of Directors and holds the majority of shares in the capital of the company is the main reason why the courts have such a wide discretion As Warner J. said in J. E. Cade & Son Ltd[49].: “The court … has a very wide discretion, but it does not sit under a palm tree.”

Peter must also prove that the affairs of the company are being carried out or have been carried out in an unfair and prejudicial manner[50]. The conduct must be both unfair and prejudicial, conduct that is unfair but does not necessarily cause prejudice and prejudice that is not unfair is not actionable and the Act.[51] The wording of the Act is very obvious and practical as it ensures that shareholders can not simply complain about the poor management of the company, for example if the share value of the company falls this is obviously prejudicial to the shareholders financial position though this would not be unfair as all the shareholders would be treated equally. The same situation would apply for situations where the actions are unfair but not prejudicial i.e. the company making an investment that the shareholder finds against his morals but still adds values to the shares. Whilst the wording is very clear definitions for both words in the context of the Act have been difficult to articulate, In O’Neil[52] Lord Hoffman stated “unfairness arises where there is a breach of the terms on which it was agreed that the company's affairs would be conducted, or where a majority exercises a legal power in a manner regarded by equity as contrary to good faith”. Peter would be able to state that it was agreed that upon Jame’s fathers death he would be granted a seat on the board but this was merely a promise and not something that was written into the articles of association with regards to how seats on the boards would be allocated so the grounds that Peter would be able to bring the claim seem weak.

Legitimate expectation must also be shown by Peter. Ecowind Ltd is a small private company so the legitimate expectation as a shareholder is much different to that of a shareholder of a large listed company. The legitimate expectation of Peter may not be to only obtain a dividend but also to be employed as a director of the company and draw a salary. Therefore if he is denied the right to be a director this does not affect his shares it could be considered to be unfairly prejudicial to his interest as a member of the company as the two are clearly woven together.

The solution that could be granted to Peter under Section 996[53] after a successful 994[54] application would be as follows[55]:

(1) If the court is satisfied that a petition under this Part is well founded, it may

make such order as it thinks fit for giving relief in respect of the matters

complained of.

(2) Without prejudice to the generality of subsection (1), the court’s order may—

(a) regulate the conduct of the company’s affairs in the future;

(b) require the company—

(i) to refrain from doing or continuing an act complained of, or

(ii) to do an act that the petitioner has complained it has omitted to

do;

(c) authorise civil proceedings to be brought in the name and on behalf of

the company by such person or persons and on such terms as the court

may direct;

(d) require the company not to make any, or any specified, alterations in its

articles without the leave of the court;

(e) provide for the purchase of the shares of any members of the company

by other members or by the company itself and, in the case of a

purchase by the company itself, the reduction of the company’s capital

accordingly.

The case history has shown that unless an act has contravened the actual articles of association of a company the courts are very hesitant to step in and enforce verbal promises or commitments made in the course of running businesses.[56] This was also proved in Re Blue Arrow PLC[57] where the articles were about to be altered and the petitioner tried to stop the proceedings by trying to bring a Section 459[58] notice which is the predecessor the section 994 notice. Vinelott J refused to grant relief to the petitioner in that case as well stating “simply upon the ground that on the evidence before the court the claim is too flimsy to support interlocutory relief, and that the question of balance of convenience is not reached.”

It would seem that if the correct procedures were carried out to ensure that James was made director based on the companies’ articles, it would be very difficult for Peter to succeed in bringing fort a motion under section 994.

Appointments of directors are made by the companies’ board and or the company in the general meeting; this is usually held in accordance with the provision of the articles of association. Under Section 17 of the Model Articles directors may be appointed:

(a) By ordinary resolution, or

(b) By a decision of the directors.

(2) In any case where, as a result of death, the company has no shareholders and no directors, the personal representatives of the last shareholder to have died have the right, by notice in writing, to appoint a person to be a director.

(3) For the purposes of paragraph (2), where 2 or more shareholders die in circumstances rendering it uncertain who was the last to die, a younger shareholder is deemed to have survived an older shareholder.

In the example of new companies when incorporating section 9 of the Companies Act details the proposed officers to Companies House. After incorporation further changes to the companies’ officers will be in compliance with the articles which provide the framework for the board to appoint additional directors up to the maximum number permitted by the articles. Under paragraph 1 of section 154 of the Companies Act all private companies are to have at least one director, section 155 of the Act further states that at least one of the directors is to be a “natural person” i.e. not another corporate entity being used as the director. Section 156 of the Act deals with the procedures that would come into place should the companies not be in compliance with the Act. The 2006 Act differs from the 1985 Act in that it now requires that all directors be 16 years or older on appointment, any directors that are under 16 that were appointed before the Act came into effect would cease to be director.[59] The new rule regarding the minimum age is in compliance with contract law which that states capacity is present once the age is reached.[60] In accordance with the Act all companies must keep a director register[61] which is to hold details that are required by the Act.[62] Under Section 167 of the Act Companies House must be informed of the appointment of a director within 14 days of the appointment, previous to the Act being passed this was completed by submitting a Form 288a either through the mail or electronically to Companies House. With the inception of the Act Section 167 is now completed by completed Forms AP01 and AP02 respectively. These are the steps that are required to appoint a director after the Companies Act 2006 has been passed. Should a company fail to comply with these regulations the company and every office holder in the company would be held liable.[63] The new Act has ensured that the appointment of directors is now as transparent as possible.

The example of Peter and James as shareholder and director respectively has been used to answer many questions with regards to what each can and can not do in their respective positions of ownership and management. Peter’s remedies as a shareholder depends gratley on just how many shares he has ownership of, and if he would be able to convince a vast majority of the remaining shareholders to go along with him. James on the other hand as director would seem safe in his position as long as it was granted to him under the model articles and not under some informal agreement that he would take over his fathers position on death and he also carried out his duties in accordance with the Act.[64] As stated by the explanatory notes: “The UK was one of the first nations to establish rules for the operation of companies. Today our system of company law and corporate governance, setting out the legal basis on which companies are formed and run, is a vital part of the legal framework within which business is conducted. As the business environment evolves, there is a risk that the legal framework can become gradually divorced from the needs of companies, in particular the needs of smaller private businesses, creating obstacles to ways that companies want and need to operate.”[65] The new legislations has now made it easier and more transparent for both directors and shareholders to ascertain what their rights are as members of a company.

[1] Companies Act 2006

[2] Companies Act 2006

[3] Companies Act 2006

[4] Model Articles Of Association (Article 3)

[5] Hutton v West Cork Railway Co (1883) 23 Ch. D. 654; Gaiman v National Association for Mental Health [1971] Ch. 317; Brady v Brady (1987) 3 B.C.C. 535, CA.

[6] Section 171-177 Companies Act 2006

[7] Companies Act 2006

[8] Company Law Review Steering Group

[9] Section 172(1) Companies Act 2006

[10] Model Articles of Association (Article 4)

[11] It is debatable whether, in strict legal terms, the shareholders are to be regarded as the owners of the company. See, e.g. M. Lipton and S. Rosenblum, “A New System of Corporate Governance: The Quinquenial Election of Directors” (1991) 58 U. Chi. L. Rev. 187 at p.195; P. Ireland, “Capitalism without the capitalist: The joint stock company share and the emergence of the modern doctrine of separate corporate personality” (1996) 17 Legal History 40; S. Worthington, “Shares and shareholders: property, power and entitlement” (Part 1) (2001) 22 Co. Law. 258 and Part 2 (2001) 22 Co. Law. 307. Also, see Short v Treasury Commissioners [1948] 1 K.B. 116 at 122, where Evershed L.J. denied the fact that shareholders were the owners of a company.

[12] Companies Act 2006

[13] Model Articles of Association (Article 4)

[14] Section 283 Companies Act 2006

[15] Section 336 Companies Act 2006

[16] Section 283 Companies Act 2006

[17] Section 292 (5) Companies Act 2006

[18] Section 292 (4) Companies Act 2006

[19] Section 288 (2) Companies Act 2006

[20] Section 303 Companies Act 2006

[21] Section 168 Companies Act 2006

[22] C. Mayer, “Corporate Governance, Competition and Performance” (1997) 24 Journal of Law and Society 152 at p.168.

[23] Companies Act 2006

[24] Companies Act 2006

[25] Daniels v Anderson [1995] 13 A.C.L.C. 614, [1995] 16 A.C.S.R. 607 NSWCA (commonly know as the AWA case)

[26] Sealy and Worthington, Cases and Materials in Company Law (2008), p.274.

[27] Companies Act 2006 s.170(1)

[28] Companies Act 2006 s.170(5)

[29] Companies Act 2006 s.170(2)(a) and (b)

[30] Sealy and Worthington, Cases and Materials in Company Law (2008), p.274.

[31] Section 174 Companies Act 2006

[32] Permanent v Wheeler (1994) 14 A.C.S.R.109 at 158. (It should be noted that Percival v Wright (1902) shows there is also no fiduciary duty to the shareholders, just the company)

[33] Cardiff Saving Bank (Re Marquis of Bute's case ) [1892] 2 Ch. 100 Ch D.

[34] City Equitable Fire Insurance Co Ltd, Re [1925] Ch. 407 CA

[35] Cardiff Saving Bank (Re Marquis of Bute's case ) [1892] 2 Ch. 100 Ch D.

[36] D'Jan of London Ltd [1993] B.C.C. 646.

[37] Insolvency Act 1986

[38] Norman v Theodore Goddard [1992] B.C.C. 14 at 15.

[39] City Equitable Fire Insurance Co Ltd, Re [1925] Ch. 407 CA

[40] Companies Act 2006

[41] [2007] B.C.C. 717

[42] Companies Act 2006

[43] Companies Act 2006

[44] Companies Act 2006