Company Law - The Corporate Constitution

• Cross comparisons of the concept of the Corporate Consitution in the Companies acts 1948, 1985, 2006
• Corporate constitution being defined as the contractual obligations between shareholders in their capacity as members and the company.

The Corporate Consitution

As described by Professor Rajak, the s.14 Companies Act (CA) 1985 gave rise to mutual rights and obligations between the company and shareholders in their capacity as members, creating a contractual relationship[1]. Cases such as Bratton Seymour Service Co Ltd v Oxborough[2] clearly show s.14 resulted in making the company’s articles of association a statutory contract between the company and the members of the company. With regard to Rajak’s contention, three parties can enforce this statutory contract: shareholders, the company and parties who in their dealings with the company become members of the company.[3]

Section 14 CA 1985 replaced the same provision in the earlier s.20 1948, with no change made to the law from the. Similarly s.14 CA 1985 has also now been replaced by s.33 CA 2006 with no change to the law as well. But there is a clear difference in wording. Section 14 refers to the ‘memorandum and articles’ whereas s.33 replaces this referring to it as the ‘company’s constitution’. This is the clear manifestation of the evolution of the corporate constitution from the CA 1985 to the CA 2006. Under pre-existing company law the corporate constitution consisted of a memorandum of association (that included the obligatory objects of the company)[4], articles of association and supplementary items such as shareholder agreements. It was the memorandum of association which had seniority over other components. However with the DTI’s (Department for Trade and Industry)[5] initiation of the Company Law Review resulting in the CA 2006, the law relating to the corporate constitution has changed. The Company Law Reform Steering Group suggested a shift away from the two documents: memorandum and articles in favour of the articles of association being the key element of a company’s constitution.[6] This has been implemented into UK law with the CA 2006 considering the memorandum as supplementary to the corporate constitution, with the majority of its content under the previous act now being implemented into the articles of association with the CA 2006.[7] However the extent s.33 CA 2006 is capable of heralding a ‘new era’ for the corporate constitution is debatable because as before mentioned there is no change in the law, as s.33 still applies the statutory contract from s.14 CA 1985.[8] The only difference made by s.33 CA 2006 it with its clarification that the company is also a part to this contractual relationship.[9]

However, the extent to which the company and shareholders have mutual rights, responsibilities and ability to sue for a contractual breach under the articles of association is questionable. In order to assess this, shareholder rights, in the situation of their bringing of personal action against the company and other shareholders for breaches of the articles of association (and thus contractual breaches) will be examined.

Section 14 CA 1985 and the following s. 33(1) CA 2006 govern the statutory contract binding the company and its shareholders to the company’s articles of association.[10] As a result of this contract, shareholders can take personal action in cases against the company where there has been a breach of the company’s articles of association.[11] This contractual relationship allows shareholders to bring personal action against the company. This type of action as well as the contractual relationship was demonstrated leading case of Hickman v Kent[12]. In Hickman the claimant’s action was brought against the defendant’s company. The claim failed as the claimant was held to be a member of the defendant’s company and action was brought prior to his seeking of arbitration, as was required by the company’s articles of association.[13] The claimant did not follow the articles, which they as members of the company were contractually bound to follow. Shareholders can also bring a case personal action against other shareholders, as demonstrated in Rayfeild v. Hands[14].

The fact that shareholders can bring an action only in their capacity as shareholders needs to be considered in order to judge the validity of Rajak’s contention. Three provisos can apply in these cases of personal action by minority shareholders, with relation to their capacity as shareholders to bring an action.[15] These include: the ‘rule’ in Foss v Harbottle[16] and in insider/outsider principle.[17] The first proviso is the majority rule in Foss, which outlines that if something is contradictory to the company’s articles of association but is still ratified by the company’s shareholders in a general meeting (of any type), there are no grounds for shareholders to bring any personal action. The reason for this is similar to the reasoning of the court in the later case of Beattie v E. Beattie Ltd[18] where it was held that action is only enforceable to rights common to the shareholder ‘himself and all other members’.[19] Therefore issues ratified by shareholders themselves as a group, even if contrary to the articles shouldn’t be actionable as they themselves ratified it.

Secondly shareholder remedies are also limited by the second proviso of insider and outsider rights.[20] The principle of this is that litigation can only be brought by those minority shareholders of which are regarded to have insiders’ rights, allowing them to enforce those rights as a member of the contractual relationship. As explained in Beattie v E. Beattie Ltd[21] insiders’ rights are those rights which are common to the majority of the company’s shareholders. Conversely with those whose shareholding rights are not common of majority are considered to have outsiders’ rights, excluding them from contractual relationship with the company and its members.[22] Case law has shown directors have often been considered to have outsiders’ rights, even though they can also be minority or even shareholders. This was the case of the defendant in Beattie[23] who was held to have outsiders’ rights even though he was the company director. Therefore prior to shareholders enacting on the contractual rights in accordance with the articles of association under s.14 1985, and now s.33(1) CA 2006 shareholders should asses the commonality of their shareholding rights ensuring they do not have outsiders’ rights.

Thirdly the ‘proper plaintiff’ principle from Foss v Harbottle [24] is another proviso. The principle outlines that where there is wrongdoing conducted against the company itself, it is the company who should be the ‘proper plaintiff’.[25] The reasoning behind this is related the fact that the company is a separate legal entity, meaning they should bring their own action as plaintiffs. Therefore in a case of wrong doing by directors negatively affecting the company it should be the directors who approve action on behalf of the company (against themselves) so the company can pursue the case as the plaintiff. Moreover as it is highly unlikely directors would permit a case against themselves, these claims type are in-actionable for shareholders.[26] On the other hand it is arguable that this last proviso is not absolute. If the personal rights of the shareholders were involved there could be an argument that, it would still be actionable. But this would depend on the extent to which these individual rights were affected.[27]

Then again in spite of these three provisos if the shareholder can show the action of the company or another shareholder was ‘ultra vires’ they could have a successful claim. [28] With the CA 1985 and its predecessor acts it was mandatory for the company’s memorandum of association to include the objects clause.[29] The purpose of which was to define the ancillary areas in which the company could function, protecting the interests of the shareholders and creditors as they would know where there financial investments had been used.[30] Therefore minority shareholders could bring an action under the ‘ultra vires’ principle if a company was registered under the 1985 Act (or earlier) with clearly defined objects, and the company’s actions or other shareholders’ actions were in areas contrary to these as set out in the objects. The ‘ultra vires’ principle is that any breach from the defined objects is actionable, as was the case in Re Introductions Ltd where a company’s loan used to move into pig farming was held to be a contravention of the objects clause.[31]

However with companies incorporating under the new constitutional arrangements of the CA 2006, this ‘ultra vires’ principle wouldn’t be applicable. This is due to s.31(1) CA 2006 which shows there is to be a presumption made that a company’s objects are completely unfettered, unless if specified otherwise in an objects clause within the articles of association.[32] Overall it could be argued that Rajak’s contention is true to an extent. But there are many more situations where the rights and obligations of shareholders are against them in their contractual binding under s.33(1) CA 06 to their company’s articles of association. This restricts their ability to bring action as minority shareholders against the company, or other shareholders. Furthermore as companies post CA 2006 registration are no longer applicable to the ‘ultra vires’ principle to bring an action this could suggest the new constitutional arrangements of the CA 2006 have also reduced the contractual rights of shareholders with respect to being able to litigate against the company and other shareholders.

Shareholders also have the right to attend both annual general meetings as well as extraordinary general meetings.[33] However the amount of shares of the company which these shareholders are holding can often determine the extent to which they have these shareholder rights. Some individuals may own more shares than others, which can occur within in private limited companies and public limited companies (PLC) where they are referred to as institutional investors. [34] This means that shareholders only have one vote per share at the AGMs these minority shareholders are often be outvoted by the majority. But this can problematic in the situation of directors or other shareholders using their majority shareholding to ratify actions contrary to the articles of association[35]. In this scenario the case of Wood v Odessa Waterworks[36] suggests minority shareholders could bring personal action against the directors. The claimant in Wood (also a minority shareholder) argued for the enforcement of the company’s articles of association, claiming the directors’ activities in question were contrary to a provision in the articles. The claimant was successful even though the shareholders had ratified the action.[37]

Reform of the law in the area of the corporate constitution is ongoing. The issue surrounding the rights of shareholders in enforcing their contractual obligations with respect to the articles of association were also considered during the Company Law Review by the Company Law Review Steering Group (CLRSG). Their findings were that the enforcement of the obligations imposed by the company’s constitution with respect to s.14 CA 85 should be promoted. [38] This is because personal action on behalf of shareholders could help with the holding of the company and other shareholders into account. But this should only be done for issues of significance.[39] Otherwise as suggested in the CLRSG’s final White Paper these shareholder disputes should go through the routes of mediation arbitration in order to resolve them.[40]

With regard to Professor Rajak’s contention, the changes made to the corporate constitution with the CA 2006 have resulted in more rights lying against shareholders. But on balance the s.33 CA 2006 reaffirmed the previous the 1985 Act continuing the statutory contractual relationship, binding shareholders, and the company to the articles of association.

---

[1] Chris Ryan, The Statutory Contract Under s.33 of the Companies Act 2006: The Legal Consequences for Banks Pt. I (2008), Journal or International Banking and Finance Law 304

[2] Saleem Sheikh, A Guide to the Companies Act (1 edition Routledge-Cavendish) 2008, p.240; [1992] BCLC 693

[3] The City Law School, Company Law in Practice, (7^th Edition Oxford University Press) 2008, ch. 3, p 38.

[4] s.2(1)(c) Companies Act 1985

[5] To which the Company Law Reform Steering Group (CLRSG) also contributed.

[6] Modern Company Law for a Competitive Economy: Final Report Volume II, The Company Law Review Steering Group p.91

[7] CA 2006 28 (1)

[8] Saleem Sheikh, A Guide to the Companies Act (1 edition Routledge-Cavendish) 2008, p.240

[9] J.Lowry and A. Reisberg, Pettet’s Company Law Ch. 4, p. 87; As was considered in Hickman v Kent [1915] 1 Ch 881

[10] Geoffery Morse, Charlesworth’s Company Law, 17^th Edition, Sweet and Maxwell), ch. 3, p. 72

[11] Ibid

[12] (1920) 37 TLR 163 (CA)

[13] 1920) 37 TLR 163 (CA)

[14] [1960] Ch 1 194

[15] The City Law School, Company Law in Practice, (7^th Edition Oxford University Press) 2008, ch. 3, p 39; Chris Taylor, Company Law, Ch. 5, p.49 (1^st Edition)

[16] (1843) 2 Hare 461

[17] Ben Pettet, Company Law, Ch. 4, p88 (2^nd Edition, Pearson Education)

[18] [1938] 1 Ch 708

[19] Ibid, at pp.718-722

[20] Pettet Ch. 4, p88; as outlined by Astbury J in Hickman v Kent [1915] 1 Ch 881

[21] [1938] 1 Ch 708

[22] Ben Pettet, Company Law, (2^nd Edition Pearson Education) 2005, ch.5, p.92

[23] [1938] 1 Ch 708

[24] (1843) 2 Hare 461

[25] Ibid

[26] A.J. Boyle, Minority Shareholders’ Remedies, (1st Edition Cambridge University Press), Ch. 1, p.4, 2002

[27] Chris Taylor, Company Law, Ch. 8, p.89 (1^st Edition Pearson Longman)

[28] As was discussed in Ashbury Railway Carriage & Iron Co. v. Richie (1875) LR 7 HL 653

[29] s.2 (1) (c) Companies Act 1985

[30] Chris Taylor, Company Law, Ch. 5, p.49 (1^st Edition, Pearson Longman)

[31] [1904] 2 Ch 608

[32] J.Lowry and A. Reisberg, Pettet’s Company Law, p. 86

[33] J.Lowry and A. Reisberg, Pettet’s Company Law, p. 145

[34] Chris Taylor, Company Law, Ch. 8, p.88 (1^st Edition Pearson Longman)

[35] Ibid

[36] (1889) 42 Ch D 636

[37] Ibid

[38] A. Hicks and S.H. Goo, Cases and Materials on Company Law, (6 edition Oxford University Press) 2008, p. 206; Modern Company Law for a Competitive Economy: Final Report, section 7.3.4

[39] Ibid

[40] Company Law Review, White Paper, Modernising Company Law, Cm.5553-I, 2002, p. 22