DIRECTOR SHAREHOLDER DUTIES THROUGH THE LOOKING-GLASS

"The horror of that moment", The King went on, "I shall never, never forget!" "You will, though", The Queen said, "if you don’t make a memorandum of it".

Through the Looking-Glass, and What Alice Found There (1871)
Lewis Carroll

SUMMARY

The duties which directors and shadow directors owe to their company have been codified in the Companies Act 2006 ("CA"). The core duties are:

• Duty to act within powers;
• Duty to promote the success of the company;
• Duty to exercise independent judgment;
• Duty to exercise reasonable care, skill and diligence;
• Duty to avoid conflicts of interest;
• Duty not to accept benefits from third parties; and
• Duty to declare an interest in a proposed transaction or arrangement;

A QUESTION ...

What happens when these core duties collide with shareholders’ interests?

For example, the duty to promote the success of the company and to avoid conflicts of interest where the directors are also the shareholders and which is of particular interest to small companies.


A SUGGESTION ...

A shareholders’ agreement can promote certainty by setting parameters, providing direct contractual remedies and effective mechanisms to resolve disputes.


DUTY TO PROMOTE THE SUCCESS OF THE COMPANY

Distribution of profits by way of dividends is, undoubtedly, one of the main areas of interest to any shareholder. Articles of Association normally stipulate that a dividend must be recommended by the Board (who normally act by majority) and voted for by a majority of the shareholders. Where a company is owned equally by two director shareholders, problems could arise if one of them refused to vote for the distribution. This would create a shareholders’ conflict, or "deadlock". What should the other director shareholder do in such a case? Do they have any legal remedies in the absence of a shareholders’ agreement?

With reference to the directors’ statutory duties, in particular those of promoting the success of the company and avoiding a conflict of interest, can the "refusing director" be said to be acting in the best interests of the company and without being personally conflicted?

One reason for blocking dividends’ distribution might be an honest belief that the company’s surplus should be re-invested into the business, which seems to be in the interests of the company. But what if the motive was to pursue a personal advantage?

A legal analysis would examine whether refusing to pay a dividend is in breach of a statutory duty, and if the answer is yes - identify any legal remedies available for the aggrieved shareholder.

The duty to promote the company’s success means that "a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to ... act fairly between members of the company" (s. 172(1) CA).

In considering whether a director acted in good faith, the question is "whether the director honestly believed that his act or omission was in the interests of the company?" (Regentcrest plc v Cohen (2001)).

In a situation such as this, the duty to promote the success of the company might have been breached where one director shareholder’s action proves to be unfair in relation to the other director shareholder.

Directors’ duties are of a cumulative nature, which means that "more than one of the general duties may apply in any given case" (s. 179 CA).


DUTY TO AVOID CONFLICTS OF INTEREST

Another duty which would apply in the above case is that of avoiding conflicts of interest. According to s. 175 CA, "a director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company".

"The interests of the company" mean the interests of the shareholders as a whole. If a director shareholder in refusing to vote for the dividend distribution is guided only by his own personal interests, he would be acting in breach of this general duty, as his interest would conflict with the interests of the company and most probably those of the other shareholder(s).


LEGAL REMEDIES

One option is for the shareholder aggrieved by unfairly prejudicial conduct, to file a petition for unfair prejudice as allowed by the CA.

According to s. 994(1), "a member of a company may apply to the court by petition for an order [...] on the ground – (a) that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or (b) 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". The relief sought is normally an order that the other shareholders (or the company itself) purchase the minority shareholding at fair value. However, the court has complete discretion to make orders to adjust the unfair prejudice suffered by the minority shareholder.

Another option is for a shareholder to bring a derivative claim in the name of and for the benefit of the company. A derivative claim may arise from an actual or proposed act or omission by a director of the company involving negligence, default, breach of duty or breach of trust (S. 260 CA). However, the shareholder has no greater right to relief than the company would have, were it to bring the action itself and any financial award would accrue to the company only.


CONCLUSION

Clearly, the question of whether a director has breached his duties is open to argument and interpretation.

If a situation of the kind described above arises, an aggrieved party should first consult a solicitor to identify whether the other director shareholder has breached his statutory duties, and, secondly, to advise on the best course of action to resolve the problem amicably if at all possible, but if necessary, by legal action.

However, following the Queen’s advice, executing a shareholders’ agreement, is the best insurance for avoiding expensive disputes and having to resort to the courts for a remedy!

This article contains general advice and comments only and therefore specific legal advice should be taken before reliance is placed upon it in any particular circumstances. 

Click here for PDF printer friendly version »