DIRECTORS POWERS AND SHAREHOLDERS RIGHTS IN A PRIVATE LIMITED COMPANY

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1 DIRECTORS POWERS AND SHAREHOLDERS RIGHTS IN A PRIVATE LIMITED COMPANY Introduction The powers of directors and rights of shareholders have been put under the spotlight in a recent High Court case (Jackson v Dear and Anr [2012] EWHC 2060 (Ch)) where, as often, the directors were also shareholders of the company. The purpose of this note is to summarise the powers and duties of directors under the Companies Act 2006 ( 2006 Act ), the rights of shareholders in a private limited company and their interaction when directors are also shareholders. It is often difficult to identify:- which matters are dealt with exclusively by the Board of directors and matters requiring shareholders consent; what remedies the shareholders have if they do not agree with the decisions made by the Board of directors; and the limits between the powers of the directors and the rights of shareholders when the directors and the shareholders are the same individuals. In this article, we will examine the Jackson case which concerned the removal of a director who was also a shareholder. This case highlights the need to carefully draft agreements between shareholders which attempt to regulate the management and governance of the company and the interaction of a shareholders agreement with the company s articles of association. This note only deals with private companies limited by shares. A. Documents governing the Company A Company is governed by the key documents which are referred to as company s constitutional documents. Section 29 of 2006 Act sets out that the company s constitution includes the company s articles of association and any resolutions and agreements to which Chapter 3 applies (that is resolutions and agreements which affect a company s constitution). 1) The articles of association A company must adopt articles of association prescribing regulations for the company (Section 18 of the Act 2006). The articles govern the day-to day management of the company and set out the basic management and administrative structure of the company. The articles also regulate the internal affairs of the company and the rights between the members. They must 1

2 be registered with the registrar of companies in order for the company to be validly incorporated. They are legally binding on the company, its directors and shareholders. The articles of association are the company s constitution along with any agreement or resolution which the founders of the company may wish to have to regulate the relationship between the directors, shareholders and the company. Members can choose their own articles (to the extent that no provisions are contrary to the law) or they can decide to adopt the standard model articles which are set out in Companies (Model Articles) Regulations 2008 (SI 2008/3229) ( the Model Articles ). Below is a brief summary of the provisions which are commonly included in articles of association:- Directors powers and responsibilities; Decision-making by the directors; Appointment of directors; Shares and distributions; Decision-making by the shareholders; Administrative arrangements; and Directors indemnity and insurance. 2) Shareholders agreement In addition to the articles of association, the shareholders may wish to enter into a shareholders agreement in order to regulate the relationship between them. Such document will be regarded as part of the company s constitution, but does not have to be filed with the registrar of companies and can, therefore, constitute a private agreement. A shareholders agreement is a contract between all or some of the shareholders (and often the company) dealing with the relationship between the parties including the rights and obligations of shareholders. It often contains a number of provisions which are commonly found in the articles of association. However, the shareholders agreement may also include distribution policy provisions; provisions regarding the protection of the minority shareholders; provisions regarding matters that are reserved to the shareholders, that is matters which require the shareholders consent; composition of the board; and provisions relating to the compulsory transfer of shares under certain circumstances. B. Duties and powers of the directors The 2006 Act imposes various duties on directors, including:- to act in accordance with the company s constitutional documents; to promote the success of the company; to exercise independent judgment; 2

3 to exercise reasonable care, skill and diligence; to avoid conflicts of interest; not to accept benefits from third parties; and to declare their interests in any proposed transaction or arrangement. Under the Model Articles, the directors are responsible for the day to day management of the company s business for which purpose they may exercise all the powers of the company. The directors primary obligation is to promote the success of the company and the interests of the company have primacy over the interests of the shareholders or creditors (except whether the company is insolvent or on the verge of insolvency). C. Rights of the shareholders Directors deal with the day to day management of the company. However, the 2006 Act provides that some actions must be approved by the shareholders either by passing an ordinary resolution (50% of the total voting rights of all eligible members) or a special resolution (75% of the total voting rights of all eligible members). Actions which must be approved by the shareholders include but are not limited to:- amending the company s constitutional documents; altering the company s share capital; approving a reduction of capital or share buy-back; converting the company from one form into another (for example from a private to a public company; changing a company s name; approving a loan to or a substantial property transaction involving a director; and approving a payment for loss of office to a director; Shareholders also have the power to require directors to call a general meeting. If the company adopts the Model Articles, it is possible for the shareholders to pass a special resolution to overturn a decision made by the Board. The shareholders also have the possibility to amend the articles of association to limit the directors powers by passing a special resolution to that effect. In addition, the shareholders may enter into a shareholders agreement which may set out specific matters for which the board will require their prior consent. Thus shareholders have a number of ways in which they may be able to intervene if they do not agree with the decisions made at board level. Furthermore, as the directors have an obligation to comply with their statutory duties, the shareholders will be able to sanction any breach of the directors statutory duties by issuing proceedings against the directors on behalf of the company. 3

4 D. The Jackson case In the Jackson case, all the directors of the company were also shareholders of the company and were also subject to the terms of a shareholders agreement in place. The facts Three individuals, including Mr Jackson, were the shareholders of Polygon Credit Holdings II Limited ( the Parent Company ). They entered into a written agreement with various other entities and the Parent Company ( Agreement ) in relation to, amongst other things, the constitution of the board of director of the Guernsey subsidiary company ( the Company ). The Agreement provided that the voting rights of the shares of the Parent Company would be used to procure the nomination and appointment of Mr Jackson as a director of the Company at its next Annual General Meeting ( AGM ) and in favour of his re-appointment at every following AGM unless a Termination Event (as defined in the shareholders agreement) occurred. Mr Jackson was removed from his position as director of the Company by his co-directors pursuant to the terms of the Company s articles of association which allowed for a director to be removed from office at any time, by notice from all the other directors. On the basis that the directors had removed Mr Jackson as a director pursuant to the articles, the shareholders of the Company decided not to re-appoint him as a director of the company although this amounted to a breach of their obligations under the Agreement. The Court had to consider the exercise of the directors power of removal under the articles of association in the light of the Agreement which applied to the same individuals. The Court decided that the parties were contractually obliged not to take any steps to remove Mr Jackson as director of the company. The obligations of the directors under the articles did not supersede their contractual obligations on the basis that the Agreement contained a further assurance clause by which the parties agreed to take any steps available to ensure that the Agreement could be implemented without causing the directors to breach their duties. Therefore, the shareholders should have taken steps, for example by amending the articles of association, to ensure that the directors were not in a position where they could remove a director in breach of their contractual obligations. Furthermore, the Court found that there was an implied term in the Agreement that a contracting party was entitled to assume that the other parties would not do anything voluntarily to render the agreement inoperative. This case confirms that it is a breach of contract to do something voluntarily that will make performance of the contract impossible or futile. It is not clear however whether the Court would have taken the same decision if the shareholders agreement did not contain a further assurance provision. 4

5 The Jackson case highlights the importance of carefully drafting a shareholders agreement to avoid provisions that conflict with the articles of association. To avoid any conflict between the constitutional documents, a provision should be included in the shareholders agreement which specifies that the terms of the shareholders agreement will prevail over the articles of association. Should you require any further information and advice or assistance on this subject, please contact Paul Puxon (paul@puxonmurrayllp.co.uk) or Deborah Benyamine (deborah@puxonmmurrayllp.co.uk) or call us on Puxon Murray LLP [ ] December