Introduction
Corporations in the UK are formed for various business purposes, which can be achieved through effective governance and management. This research will explore the provisions of the Companies Act (CA) 2006 and case laws before the formulation of the Act. The essay will try to answer the questions: “What was the position of law pre-CA 2006?”, “What is the position of the CA 2006, Sections 171-177, with regard to corporate governance?”, “What are soft law measures on corporate governance?”. The essay will compare the different measures to understand whether corporate governance is a shared responsibility between shareholders and directors.
Corporate Governance
Corporate governance involves a wide range of activities, from controlling the routine affairs within an organization to making crucial decisions. The board of directors and shareholders are the key organs of corporate governance. Unlike public companies, shareholders of private companies are not required to hold annual meetings under the CA 2006. Instead, they can make decisions through written resolutions under Section 281(1) of CA 2006. A combination of statutes, case laws, and soft laws provides mechanisms for governing a private limited company.
Corporate Governance Pre-CA 2006
Corporate governance was guided by Common law and soft law before the enactment of the CA 2006. The doctrine of precedent was largely applied by the English courts in combination with the UK Corporate Governance Code (CGC), which was introduced in 1992. The latter framework was non-binding and would instead guide how private entities should be governed. The Insolvency Act of 1986 was also applicable to some extent when winding up resolutions.
Corporate Governance Post-CA 2006
The CA 2006 is the primary legislation on corporate governance and spells out the powers and roles of the shareholders and directors in managing a private limited company. While in the past, the majority of the court decisions vested much power in the directors, the CA 2006 came to remedy situations where the directors tend to act ultra vires through the provision of the general duties of directors. For instance, in the case of John Shaw & Sons (Salford) Ltd v. Shaw, the shareholders had passed a resolution to discontinue a legal proceeding instituted by directors. The court held that the shareholders had no power to terminate the proceeding through a resolution.
Additionally, the UK Corporate Governance Code 2018 replaced the initial code for effective corporate governance. A comparison of the pre-CA 2006 and post-CA 2006 shows how the law has reformed to promote joint responsibilities of the shareholders and directors in a private limited enterprise.
Shareholders’ Roles in Governance
In the context of corporate governance, shareholders are regarded as ‘residual controllers. ‘Certain fundamental decisions are required to be made by the shareholders under both hard and soft laws. Private limited companies’ articles often bestow upon the directors’ management powers but reserve some shareholders’ rights under statutes, governance codes, and case laws. Organizational shareholders, as residual controllers, can have some management powers revert to them if the directors fail to act. Therefore, the role of shareholders in governing a private limited company is manifested through various actions they take.
Directing Directors to Take Action
Significant actions within a private limited company can impact the shareholders’ interests. Some of the major decisions that require approval from shareholders include the selling and acquisition of assets. Article 3 of the Model Articles for Private Limited companies under the CA 2006 allows the shareholders, by special resolution, to direct the directors to take or refrain from some actions that they feel would sabotage their interests. The Common law before the enactment of the CA 2006 only allowed extraordinary resolutions by the shareholders.
In Automatic Self-Cleansing v. Cuninghame, the BOD objected to the shareholders’ ordinary resolution to sell the company’s business. The court upheld the decision by stating that directors could lawfully refuse to comply with the ordinary resolution if it was insufficient. While in the past, the shareholders were only allowed to intervene in major decisions by extraordinary resolution, the CA 2006 no longer provides for such. Therefore, if there is a sufficient reason to direct the directors to take some actions, the courts are always ready to support such a decision.
Holding Directors Accountable
Accountability and transparency are key to effective corporate governance and management. The BOD can make decisions that are inconsistent with the shareholders’ interests and desires. In such cases, the shareholders can bring a motion to remove the Directors whose actions breached their fiduciary duties under the Companies Act. Although there is no specific legal framework for how shareholders can dispute a decision made by the BOD, in the case of Irvine & Ors v. Irvine & Anor, the High Court stated that the rights of minority shareholders must be protected. The shareholders’ right to hold the directors accountable for their inactions is established in Common law before and after the CA 2006.
Shareholder Activism
In private limited companies, the majority shareholders have the right to make significant decisions. Shareholder activism involves shareholders growing their ownership of a company by increasing their stake and equity. The move targets organizations that are mismanaged by the Directors but have a high potential for profitability.
Upon increasing their equity to a majority shareholder level, activist shareholders are involved in key decision-making. The shareholder can decide to remove the Directors who mismanaged the company and appoint those who can help lead it in a better direction. Therefore, shareholder activism can be a strategic move to promote good organizational management.
Power Under the Insolvency Act 2006
The Insolvency Act 2006 is another fundamental statute that provides the shareholders with the right to residually control their private limited companies. Section 84 (1) of the Act gives the shareholders the power to voluntarily wind up a company. The Act, further in Section 91(2), allows for the appointment of a liquidator who takes over the company’s management activities during the winding up of the company. The winding-up decisions and processes must be clearly defined and described under the company’s articles of association and other relevant documents. The courts, in some cases, have refused to allow winding-up decisions that are inconsistent with the organization’s formal procedures.
However, in common law, the courts applied the ‘Duomatic principle’ that allowed the shareholders to make decisions unanimously without formal compliance. Mummery LJ, in the case of Euro Brokers Holdings Ltd v Monecor (London) Ltd, held that the Duomatic principle on matters as long as there is a unanimous assent of the shareholders who have the ultimate right to exercise power over the affairs of their organizations and a vote at a general meeting. Therefore, while the CA 2006 and the Insolvency Act set restrictive measures on the shareholders’ decision-making process, including the appointment of a liquidator, at Common law, unanimous decisions were allowed without formal processes.
Directors’ Roles
Organizations need effective leadership and management to achieve their purposes, as discussed above.Conventionally, the governance and management activities within an organization are vested in the Directors. An article of association for a particular company defines how they are nominated and voted out.
The BOD is involved in key decisions that are crucial for running a business and managing routine activities. Therefore, the BOD plays a pivotal role in protecting shareholders’ interests and ensuring that business activities are in line with its overall goal and purpose in the industry. The CA 2006 has set out the general duties of Directors under Sections 171-177, which are substantial to corporate management and governance.
The directors derive their power to manage an organization under Article 3 of the Model Articles for Private Companies Limited by Shares. At Common, the power of directors was viewed as that of the BOD as a whole and not as an individual. According to Sir George Mellish LJ, a director is simply a person appointed to act as one of a board. When acting as a board, a director has the power to bind the company but otherwise has no power to bind them. The directors’ role is also emphasized under the first principle of the UK Corporate Governance Code of 2010, which is soft law.
Duty to Act Within Powers
Companies’ constitutions provide for specific roles and responsibilities of Directors. The Directors are obliged to act within their powers, and a breach of those provisions can lead to legal consequences. The duty to act within powers is provided under Section 171 of the Companies Act 2006.
According to the provisions, when managing a private limited company, the Directors must only act under their organizational constitution and exercise powers for the purpose for which they are conferred. In the 2019 case of BTI 2014 LLC v Sequana SA & Others, the Director acted outside their powers by declaring two dividends left, making it difficult for Sequana to pay its debts. The court found the Directors to be in breach of Section 171 of the Companies Act since they acted outside their power to promote business success.
Duty for Reasonable Care and Skills
Governance and management decisions require critical thinking and strategy for organizational success. Directors are required to apply reasonable care and skills when representing their organizations or making any decision that can impact them. Section 174 of the Companies Act of 2006 requires the Directors to act skillfully, diligently, and reasonably. In the 2019 case of Fielden and another v. Leith and others, a UK High Court found the British Home Stores (BHS) Directors in breach of their duty of reasonable care and skills when they decided that the loss of 11,000 employees and £571 million pension deficit.
Avoid Conflicts of Interest
Directors of a private limited company may find themselves in situations that conflict with their interests in the course of managing and governing the entity. For instance, a director can represent a company in a business transaction that involves their company and that which they are Directors. Section 175 (1) of the Companies Act requires directors to avoid situations where their direct or indirect interests conflict with those of their companies. If they cannot avoid such situations, the directors are required to act solely in the interest of their companies and not their own. The duty to prevent conflicts of interest promotes accountable and transparent governance and management of private limited companies.
Promote the Success of the Company
Management and governance activities aim to promote overall business success. For instance, the strategic decision to expand the operations of a private limited company promotes its profitability and competitiveness. The duty to promote the company’s success is provided under Section 172 of the Companies Act.
The provision requires the Directors to manage and govern their entities in a manner that promotes a business relationship with stakeholders such as the community, suppliers, and employees, among others. In the case of Fielden and another v. Leith and others, the Directors failed to promote the success of BHS by subjecting it to financial losses. Therefore, promoting business success involves governing and managing it in a manner that does not encumber its productivity and profitability.
Duty to Exercise Independent Judgement
Effective organizational management and governance require critical judgment. An independent Director’s judgment in the context of a private limited company means making decisions that external parties do not influence. The duty is based on reasonability and diligence as espoused under Section 174 of the Companies Act.
Section 173 of the Act provides that the Directors’ judgment should be independent without influence from other parties interested in gaining more from the company. Directors play various roles and responsibilities in the governance and management of private limited companies under their constitutions and the Companies Act of 2006.
Remedies for Breach of General Duties
Unlike Common law, the CA 2006 allowed codification of the general Director’s duties in the management of private limited companies. The Act provides remedies that were developed at Common law and statutorily ones. Section 260 of the CA 2006 allows the shareholders to bring a derivative claim against a director who breaches their duties. In cases where the directors’ actions are prejudicial to the company or some parts of it, Section 994 allows the shareholder to bring such a claim. At times, if the directors’ actions are found to be persistently in default of their duties, they can be disqualified under Section 1(d) of the Company Directors Disqualification Act 1986.
A breakdown in mutual trust between shareholders and directors of a private limited company can necessitate its winding up. Under the Insolvency Act Section 122(1)(g), shareholders can petition a court of law to wind up their company. Comparatively, the effects of provisions under Sections 260 and 994 of the CA 2006 are different from those under Section 122(1)(g) of the Insolvency Act since the latter will likely discontinue the business relationships among shareholders and their company.
The CA 2006 provisions, on the other hand, reinstate the company to its initial position for the continuation of normal business operations. Therefore, the courts can make decisions and offer remedies depending on whether the duty breached was equitable or in Common law. The CA 2006 categorizes the remedies for breach of general duties into two categories: remedies under Common law and equity-based ones. The duty to exercise reasonable care, skills, and diligence is a Common law duty, attracting remedies based on case precedents. The courts have adopted a tortious approach to the breach of duty as required under Section 174 of the CA.
In determining the remedy, the court in Cohen v. Selby stated that the affected company must prove two things: damage or loss to the company that is not too remote and a causal link between the loss suffered and the breach. The equity-based remedies are those arising from a violation of duties under Sections 171-173 and 175-177 of the CA. The courts have established four main remedies for breach of equity-based duties.
Firstly, the court may require the Director who breaches his duty to return the property received. In the case of Harrison (JJ) (Properties) Ltd v. Harrison, the court stated that directors are constructive trustees of their companies, and ordinary trust principles are applicable where they breach their fiduciary duties. While the case was pre-CA 2006, post-CA 2006 has held a similar rationale when deciding cases. However, the latest case has introduced circumstances where constructive trust will be imposed.
Secondly, the courts have ordered the directors to account for profits they made as a result of breaching their fiduciary duties. In the precedential case of Regal (Hastings) Ltd v. Gulliver, the Court of Appeal ordered the defendant to account for the company’s financial transaction even if the company suffered no loss. Thirdly, the rescission of contracts made in breach of fiduciary duties is another remedy offered by the courts to the shareholders. The courts intended to protect third parties who had no knowledge of the directors’ breach.
Similarly, in the case ofLogicrose Ltd v. Southend UFC Ltd, the court stated that recission could only be awarded if the third party to the contract had the requisite knowledge of the breach. Lastly, enforcing the fiduciary duties of equity-based compensation has been regarded as a sufficient remedy for the company that suffered a loss following the directors’ breach.
Corporate Governance: Statutory vs. Soft Law Measures
The CA 2006, the Insolvency Act, and the Company Directors Disqualification Act 1986 are complex laws and binding. Therefore, in case a claim is brought before a court against directors’ mismanagement, the decision made by the court following the statutes is binding. Soft law measures in the context of the private limited company involve codes and recommendations from professional organizations. The UK Corporate Governance Code (CGC) of 2018 is the primary soft law measure on how a private company can be governed and controlled.
Soft laws have tried to be consistent with the statutory law provisions. For instance, the first provision of CGC 2018 recognizes the BOD as responsible for the management of organizational activities. The provision is consistent with Article 3 of the Model Articles for Private Companies Limited by Shares.
Additionally, the third provision requires shareholders’ engagement in the running of business operations, which is provided under the CA 2006. Although the soft law measure is consistent with the statutory one, the two are distinguished in terms of enforcement. The provisions under the CGC 2018 are non-binding, while those under the statutes are binding.
Conclusion
Corporate governance and management involve various activities and actions taken by shareholders and directors. Private limited companies’ operations are guided by their constitutions and the Companies Act of 2006. Financial management, strategic planning, and organizational representation are some of the Directors’ roles. The Directors are expected to execute their roles in accordance with the Act’s provisions on various fiduciary duties.
The shareholders’ roles are regulatory ones since they ensure that the Directors are managing their companies in a manner that promotes overall business success.The shareholders can remove the Directors if they fail to satisfy their needs and those of the business. Therefore, corporate management and governance of a private limited company are shared between the BOD and shareholders.
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