Inside the Corporate Boxing Ring – Directors and Shareholder Disputes

Businesses business is business. But we all know that it’s not always so straightforward. Most of us are familiar with how shareholdings in a company works, but a surprising number of shareholders are not fully aware of their entitlements to those holdings. There are also a number of obligations that a company director must adhere to, as breach of these obligations may bring about significant consequences.

A lack of knowledge or a simple misunderstanding of basic rights and obligations is often the cause of significant management and ownership disputes. It is important to be informed and understand these rights and obligations to mitigate any problems that may easily arise due to simple procedural mistakes.

In small businesses especially, it is paramount for everyone in the company to understand their basic rights, as the separation between Directors and shareholders is not always clear. In smaller company contexts shareholders may also assume a Director’s role in the business. The problem with this is that there are different company law requirements for Directors in board meetings and shareholders in general meetings. So it is important to obtain legal advice in cases where a shareholder is also involved in the day-to-day running of the business.

The Companies Act 2006 deals with the rights and obligations of Directors and shareholders of a company.

Before the Companies Act 2006 introduced statutory duties on Directors, common law principles of fiduciary duties governed their duties.

Fiduciary duties commonly arise in relationships of ‘trust of confidence’ and confer on Directors duties similar to those imposed on trustees. The most significant fiduciary duty is the requirement for Directors to act in good faith and in the best interests of the company. They must not abuse the trust and confidence assigned to them. This will include duties such as providing relevant information to each other relating to the conduct of the business, and not withholding or concealing relevant information from each other relating to the business.

Section 171 to section 177 of the Companies Act outlines the general statutory duties of a Director. These are duties to:

• Act in accordance with the company’s constitution, which involves exercising those powers for the purposes for which they are granted. The latter requirement has been a long-standing common law rule known as the ‘proper purposes doctrine.’
• Promote the success of the company. Directors must focus on the long-term interests of the company, rather than say, the majority shareholders.
• Exercise independent judgement, for example by refusing instruction from any single person.
• Exercise reasonable care, skill and diligence in relation to the conduct of the administration of the affairs of the business
• Avoid any conflicts of interest. This requires that the Director’s interests do not, directly or indirectly, conflict with that of the company’s.
• Not to accept benefits from third parties
• To declare any direct or indirect interest in any proposed transaction or business entered into by the company, to the other Directors of the company.

One notable aspect of the Companies Act is the absence of a clear definition for ‘Director.’ While the Act requires all limited companies to have a Director, the definition in section 250 is very broad; it states that the term ‘Director’ “includes any person occupying the position of Director by whatever name called.”

This broad definition provides flexibility in determining whether a person is a Director, and can include quasi-partnerships. Quasi-partnerships involve a limited number of individuals, and although technically operating as a limited company, they are, in reality, operating as a small partnership between the individuals involved.

As a result, whether or not a person is considered a Director in the eyes of the law depends on the actual role they play within the company, rather than their title. This means that even if a person holds a title that does not include the word ‘Director,’ if they are a central part of the decision making process they will be considered as falling under the section 250 definition. It naturally follows that a person who falls under the definition will be subject to all the Director’s rights and obligations.

This is significant in situations such as ‘quasi-partnerships’ because the courts are essentially willing to give those in the quasi-partnerships additional rights than that of minority shareholders.

Minority shareholders, regardless of the percentage of shares they hold, have an array of general rights. A problem in practice is that many shareholders are not fully aware of all the entitlements that come with the ownership of shares. Shareholders have a general right to:

• Not to be unfairly prejudiced
• Receive notice of general meetings and their minutes, attend them, and vote.
• A dividend if one has been declared
• A share certificate and a copy of the annual accounts
• Wind up the company provided that it is just and equitable to do so, and in certain cases receive a final distribution
• A register of: Directors and Secretaries, Members, Directors’ interests in shares, and Charges.

There may be situations where the shareholder has been excluded from the business of the Company, such as Annual General Meetings (AGM) and failure to declare or pay dividends. In these situations, the following provisions apply:

• Under section 303, a shareholder with a holding of 5% and more has the ability to require the Directors to call a general meeting of the company. Unless the shareholding agreement says otherwise, generally one share will carry one vote.
• A minority shareholder with less than 5% still has an ability under section 306 to apply to the Court to order a general meeting
• There is no general obligation for Directors to declare a dividend. Whether or not a company pays dividends from profits is discretionary, however, if the right is declared shareholders have a right to demand payment of those dividends.

However there are some limitations on shareholders. There is an important distinction between shareholders and Directors; Shareholders own the company while the Directors are in charge of running it. As a result, shareholders have very little in the way of rights regarding the day–to–day matters of the operations of the organisation.

Section 178 provides that any breaches of Directors’ duties provided in the statute will have the same consequences as a common law breach of duties. Remedies available against the Director are claims for secret profits, damages for breach of contract and misrepresentation.

In the case of a breach of fiduciary duty the company can seek either of the following options:

• Attempt to recover any company property misapplied by the Director. For example, recover dividends wrongly paid out to members.
• Make the Director liable to the company for any ‘secret profits’ made as a result of the breach of their fiduciary duty.

Any breach of a term in the shareholder agreement will be granted a remedy under breach of contract, and general remedies include injunctions and specific performance.

Where the Company has been operated to such an extent that a shareholder is kept out of their rights (such as those to dividends or to attend an AGM) a claim for unfair prejudice and a derivative action could be available.

Derivative actions:

Derivative actions are claims brought on the Company’s behalf as a shareholder. It is most commonly brought against members of the company who are assumed of misconduct or as having behaved contrary to the interests of the company.

A shareholder derivate action allows redress to harm caused to the corporation by management, in situations where it is unlikely that management will redress the harm itself. This course of action enables a shareholder to initiate company changes that may not otherwise happen. This may be of indirect benefit to the shareholder, to the extent that the value of their shareholding increases.

Unfair Prejudice:

Unfair prejudice is a broad concept and does not have a restrictive definition. But it commonly includes situations where there is a legitimate expectation or when there has been an abuse of power. It is important to note that the conduct must be prejudicial to the applicant in their capacity as a member of the company.

Section 994 of the Companies Act provides a two-prong test for what constitutes unfair prejudice. It requires that:

• The conduct is prejudicial or harmful to the relevant interest of the members or some part of the members of the company; and
• It is unfair.

The test has been interpreted restrictively and the applicant must prove an actual breach of the terms that have been agreed upon.

Under s 996(1), the Courts have a discretionary power to grant remedies that it sees as fit. The powers available to a Court include the power to regulate the conduct of the Company’s affairs in future.

These are the general rights attributed to shareholders and Directors. It is easy to see the distinction between the two positions are not always clear, so it is important to obtain legal advice when there are management and/or ownership disputes, in order to understand your full set of rights.

Please click on the links to find out more about Directors’ Duties and Shareholders.