Principles of Company Law - Case Study Example

Introduction Equitable and legal principles of Company Law are structured around a concept that it is wholly unreasonable for shareholders to trust directors to act in a fair-spirited way when approving contracts or transactions that involve directors in their personal capacity and the company they direct. This is as it should be and in keeping with this concept the judiciary and parliament have developed strict guidelines for directors’ conduct and duties making them accountable to shareholders and members of the company in general. The discussion that follows examines those principles of Company Law that regulate director’s duties and accountability. These principles demonstrate why and how it is unreasonable for shareholders to trust directors to act fairly when approving contracts or transaction in which they may have a personal interest. Directors’ Duties and liabilities The Companies Act 2006 which comes into effect in 20091 does very little to improve upon directors’ duties as already contained in the Companies Act 1985 and enunciated by the judiciary in various judgments. Sections 171-188 of the 2006 Act expand existing directors’ duties by requiring that they actively promote the company’s success.2 The Companies Act 1985 together with the common law dictates that directors are in a fiduciary relationship with the companies that they direct. These duty reflect that directors are essentially required to stay away from transactions that they may have a personal interest in. Directors have three primary duties which can be summarized as follows: 1. Directors are required to act in good faith at all times and in the best interests of the company. Implicit in the duty to act in good faith is a duty to avoid acting for collateral interests. 2. If a director uses his position to gain a personal advantage he or she will be accountable to the company’s members. 3. In the event a director binds a company to a contract or transaction in which there is a conflict of interest the shareholders are at liberty to void the transaction or contract.3 British courts have consistently interpreted directors’ relationships with their respective companies as representing one of a fiduciary duty especially in matters that can be potentially or actually viewed as comprising an element of insider dealing. For example in Industrial Development Consultants v. Cooley [1972] a director negotiated the terms of a contract for himself in circumstances where the company that he served as director was not going to take the contract with the result that the court held that the director nonetheless was in breach of his fiduciary duties to the company..4 Obviously the court is less concerned with the substance of the consequences but the appearance of impropriety. Implicit in the ruling in Industrial Development Consultants v. Cooley [1972] is the notion that shareholders cannot reasonably be expected to trust directors to act fairly when approving contracts or transaction in which they may have a personal interest. In the case of Aberdeen Railway Co. v. Blaikie Bros (1854) the House of Lords adamantly maintained that it made not difference whether the director acted fairly or not.5 Expounding on this rule of law in Re Dominion International Group plc (No 2)[1996] 1 BCLC 572 the court said that the mere fact that such a transaction could possibly be a conflict of interest was sufficient to veto such a transaction.6 The courts have demonstrated little or no tolerance for directors making personal use of their company’s information or property. Obviously persons acting in fiduciary positions are required to adhere to strict principles of confidentiality and permitting them to use information that arises out of company business transactions runs counter to this principle of confidentiality. Implicit in this duty is the principle that directors are forbidden to make personal use of the company’s property or any knowledge of information derived as a result of their fiduciary relationship with the company..7 Moreover, this code of conduct is required to prevent directors’ sending company business outside of the company.8 Section 317 of the Companies Act 1985 permits directors to approve transactions or contracts in which they may have a vested interest themselves but requires that directors formally disclose any such interest. Section 317 provides as follows: “If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors.”9 The Companies Act 1985 draws strict parameters around directors and connected persons10 requiring that directors not only disclose their interests but the interest of connected persons or family members in transactions and contracts with the company and prior to approving these transactions or contracts directors are under a duty to obtain the consent of shareholders.11 Failure to do so will render the contract or transaction void.12 By virtue of Section 177 of the Companies Act 2006 directors duties in this regard will be extended to require that they disclose any interest either by themselves or connected persons to other directors if he ought to be aware of that interest.13 This provision makes it abundantly clear that shareholders are not reasonably expected to trust directors’ ability to act fairly and impartially in circumstances where they have a personal interest in a transaction or contract with the company they direct. Remedies Be that as it may, it is a fundamental principle of Company Law that directors are required to avoid placing themselves in situations in which a conflict of interest might arise.14 Although the law requires that an actual conflict of interest arises before serious action can be taken against the director himself, it is sufficiently protective of the interest of the company to strictly define the parameters in which a director can approve a transaction in which he might have a personal interest. In the event there is a conflict of interest the law permits one of two courses of actions. The company can be wound up of the offending director can be removed. Much depends on what is equitable and in the best interest of the company. These remedies are also indicative of the contention that shareholders cannot reasonably be expected to trust directors when indorsing transactions in which they have a personal interest. If they could be reasonably trusted safe guards such as remedies and guidelines would not be necessary to regulate directors’ duties and accountability in these matters. Section 122(1)(g) of the Insolvency Act 1986 permits shareholders to make an application to the court for the winding up of a company in an appropriate case. Conceivably, in a situation where a director approves a contract or transaction in which he has a personal interest without prior approval or disclosure would be sufficient grounds for winding up the company. However, it would all depend on the extent of personal profits and the losses accrued to the company. Section 122(1)(g) will not automatically arise since a court will only make such an order if it is satisfied: “that it is just and equitable that the company should be wound up”.’15 In other words if voiding the contract or transaction and/or removal of the director is sufficient to restore the integrity of the company’s business the court will not make an order for winding up. Shareholders are empowered to protect themselves against directors acting in breach of their respective fiduciary duties. Implicit in this power is the suggestion that good faith and bona fides of directors are not to be taken for granted. If a director approves a transaction in which he has a personal interest without prior approval or disclosure the law assumes that he acted in breach of his fiduciary duty. Shareholders are therefore at liberty to have that director removed by ratification.16 As noted in the case of New Zealand Netherlands Society Oranje Inc v. Kuys [1973] a director acting in breach of his or her fiduciary duties is sufficient grounds for removing that director from his or her office.17 At the end of the day, shareholders are at liberty to force directors to govern the company in accordance with the company’s purpose and best interest.18 Conclusion Company directors are always required to manage the company’s affair with due diligence and with the care and skill of a man of business.19 While shareholders can be reasonably expected that directors will conduct themselves accordingly it becomes an entirely different matter when a director is placed in a position where his interests are torn. It would be entirely unreasonable to expect that all directors would automatically place the company’s interest over and above his own personal interests. Although these incidents may be rare, it is always possible and recognizing these possibilities the law has responded accordingly. If it was reasonable for a shareholder to trust that directors will act impartially and fairly in scenarios where a conflict of interest might arise the law would not have been so particular and strict in its approach to directors’ duties and accountability. Bibliography Aberdeen Railway Co. v. Blaikie Bros (1854) 1 Macq 461 Companies Act 2006 Companies Act 1985 Drury, R. R. “The Relative Nature of a Shareholders Right to Enforce the Company Contract,” [1986] CLJ 219 Farrar, J.H.; Hannigan, B.M., Farrars Company Law London Edinburgh and Dublin: Butterworths (1998) Industrial Development Consultants v. Cooley [1972] 2 All ER 162 Insolvency Act 1986 North-West Transportation Co Ltd v. Beatty (1887) 12 App Cas 589 Regal (Hastings) Ltd v Gulliver [1942] 1 All E.R. 378 Re City Fire Equitable Insurance Co. Ltd. [1925] Ch 407 Re Dominion International Group plc (No 2)[1996] 1 BCLC 572 Read More