C 4, Members

Question 1

Define Memorandum of Association, Guarantee, and Limited Company.

Answer 1

Memorandum of Association- A constitutional document setting out the details of the subscribers on incorporation.

Guarantee- A formal agreement under which a guarantor undertakes to meet the contractual obligations of one person to another in the event of default. A company limited by guarantee is one in which the liability of the Members is limited too a specified amount in a winding up.

Limited Company- Liability of members for the debts of the Company is limited either to the amount of share capital for which they have applied (Company Limited by Shares) or to a specific amount guaranteed in the event of a winding up (Company Limited by Guarantee).

Companies limited by guarantee have not been permitted to be formed or become a company limited by guarantee with a share capital in GB since 1980.

Question 2

Who is a Member?

Answer 2

Member- while all companies have members, not every company has shareholders(companies limited by guarantee or unlimited companies without a share capital)

• a person can become the holder of shares through transfer but is not a member until transfer/name details entered in the Register of Members.

Subscribers are first members of company on registration – s112

Any ‘legal person’:

• who agrees to become a member → explicit or implicit
• apply for issue of new shares (incl. full payment or residual payment commitment on fixed date/when called) – explicit
• purchase/transfer existing shares from 3^rd party - implicit
• apply to become guarantor in company limited by guarantee (including g’tee to pay fixed amount on winding up) - explicit
• agree to be bound by Articles

AND

• whose name appears in Register of Members (“ROM”) - s112
• post Board approved to allotment
• pre share certificate issue (if applicable)
• update ROM for allotment or transfer (or reject) within 2 months of allotment date (s554) or receipt of valid stock transfer form (s771)

Question 3

What is a Member’s Liability?

Answer 3

Members Liability:

• A company is a limited company if the liability of its members is limited by its constitution. It may be limited by shares or by guarantee. – If the members’ liability is limited to the amount, if any, unpaid on the shares held by them the company is limited by shares. A company limited by shares must issue a minimum of one share and there is no maximum number of shares that can be issued, subject to any provision in the company’s Articles.
• If the liability of the members is limited to an amount the members have agreed to contribute to the assets of the company in the event of it being wound up the company is limited by guarantee. The amount of the guarantee is often a nominal amount such as £5 or £10. As a guarantee company has no shares a distribution of profit by way of dividend is not possible.
• If there is no limit on the liability of its members, the company is an unlimited company. An unlimited company may be constituted with or without shares (CA2006 s. 4). Rights of Members will be defined by Articles.

Question 4

Define Share, Capital, Share Capital, Paid-up Capital,

Answer 4

Share- A unit of ownership of the Company, representing a share fraction of the share capital and usually conferring rights to participate in distributions. There may be several kinds of shares each carrying different rights. Shares are issued at a fixed nominal value, although the company may actually receive a larger amount, the excess representing share premium. Members may not be required to subscribe the full amount immediately; in which case the shares are partly paid- await calls which require them to pay further amounts until the shares are fully paid.

Capital- The money or money’s worth used by a Company to finance its business.

Share Capital- The capital of a Company contributed or to be contributed by Members. Nominal capital represents the nominal value of the shares issued and excludes any premium paid.

Paid-Up Capital- Refers to the amount paid up on any issued shares

Question 5

Define Share Transfer, Call, Allotment, Allottee.

Answer 5

Share Transfer- Process where ownership of shares passes from one person to another usually by way of a sale, a Stock Transfer Form is used transferor to transferee.

Call- Formal notice issued by a Company, requiring all shareholders to pay all or part of the amounts unpaid/partly paid issued shares.

Allotment- Shares are taken as allotted when a person acquires the unconditional right to be included in the Company’s register of members which is generally accepted to be once the contract of allotment is completed/acceptance of the application notified to the applicant.

Allottee- a person to whom shares have been allotted, the date of issue of shares is when the allottee acquires legal title to the shares.

Question 6

Members required, Public and Private companies.

Answer 6

• Minimum of 1 member and no maximum
• Private company limited by shares need only issue one share, and there is no minimum nominal or paid-up capital requirement
• Public companies are required to issue at least £50,000, with each share at least 25% paid up as to its nominal value and 100% of any premium before commence to trade, and to maintain this minimum at all times. Could issue one share at £50k.

Question 7

Who can be entered into ROM

Answer 7

Membership

• Only ‘legal persons’ can be member and hold shares
• Only ‘legal persons’ who can be entered on ROM - Any natural person: you and me OR incorporated entity with legal capacity: private/public company
• Examples of entities who cannot be entered on ROM : unincorporated clubs and associations, sole traders.
• S126 – company cannot recognize trust or settlement over shares
  
  • shares must be registered in name of trustees (exception to this is companies whose name includes the words trust, trustee etc.)
• S136 - subsidiary company not permitted to be member of holding company except if acting:
  
  • Only as personal representative or trustee without any beneficial interest in the shares
  • as trustee for Group employee share or pension scheme (eg Employee Benefit Trust )
• Articles restrictions may exist
  
  • professional companies requiring professional membership
  • declaration of British or EU nationality by airlines companies because minimum levels of ownership per country need to be met and maintained.

Question 8

Can Minors become Members, if so what are the disadvantages?

Answer 8

Minors

• Possible but not good practice
• Why? Responsibilities are void while that person remains a minor or until repudiation or rejection of membership
  
  • if on ROM, minor enjoys full rights of membership
  • obligations, liabilities and actions against them are voidable
  • liability to pay up on any partly paid shares remains with previous owner/transferor who can be reinstated as shareholder
• Common law right (and usually Articles) allow companies to reject repudiate allotment or transfer to a minor
• For PLCs, easy for minors to become members without company knowing- LR requires that Articles of Companies contain no restrictions on transfers of fully paid shares.
  
  • eg on privatisation (Royal Mail) - parents buy shares in child’s name even if not allowed!
• Shares incorrectly registered in minor’s name requires parent or guardian to obtain court order to approve sale or transfer of shares- Courts judge- best interests of the minor.

Question 9

Who are the Shareholders?

Answer 9

Shareholders

• Majority of companies are limited by shares and accordingly their members will hold shares in the company.
• For a company limited by shares the terms member and shareholder are used interchangeably.
• Shareholders provide the working capital, often supplemented by bank loans or other forms of finance, to allow the company to operate.
• Shareholders as owners of the company will benefit from any capital growth in the value of the company in proportion to the number of shares held. They also have the risk that the value of their shares may fall and potentially lose all of their investment. Their liability is, however, limited to the amounts paid or due and payable and once their shares are fully paid they have no further or additional liability for any losses incurred by the company.
• Where shares in a company have different rights, they constitute a different share class. The majority of companies limited by shares have only one class of shares.
• All companies limited by shares must have at least one share in issue at all times and as a consequence at least one shareholder.

Question 10

Who are the Guarantors?

Answer 10

Guarantors

• The members guarantee the company’s debts, usually limited to a nominal amount. Although guarantors are the members, they are not true owners of the business, but should be viewed as trustees holding ownership temporarily until this is passed on to the next trustee.
• Guarantors are usually not entitled to participate in profits or distribution of surplus assets, and in the event of a guarantee company ceasing to trade or being wound up, any assets remaining must be passed to another guarantee or charitable company with similar objects. However, check the Articles if a distribution of income (dividend) or capital is proposed, to ensure that this is permitted under the company’s constitution.
• Transferring membership, It is not possible for a person to transfer their guarantee to another person. Instead they must resign as guarantor and a replacement must apply in their place. It should be noted however that the personal guarantee does not cease immediately but continues for a period of one year after resigning as a member (CA2006 s. 11(3)).

Question 11

Requirements for the Register of Members

Answer 11

• ROM details (Index if >50 members)
  
  • only ‘legal persons’ not unincorporated bodies – challenge/reject if necessary
  • name, address, number/class of share (or warrant), amount paid/to be paid in cash or non-cash, share certificate # and date became/ceased to be a member
  • all transfers/allotments/acquisitions/disposals during membership
  • all joint holders’ names but only one address – 1st named person counts
  • NB entering nominee account details, not beneficial owners’
  • ex-member details must remain on register for 10 years
• Option for members address not to be available for public inspection and replaced with service address – s1088
• Keep ROM (and other registers) at registered office or can elect for SAIL
  
  • only one SAIL at a time and in same country as R/O
  • Form 353a to CH incl. what kept at SAIL and notify of any changes
• Private companies: can elect for members info at CH and not have own ROM
  
  • → part of central public register available for inspection/copying at any time
  • NB loss of privacy from internally controlled and protected process
  • unanimous consent of members required must still update info within 2 months (max)
• If s123 single member company, must state in ROM and amend re changes
• Branch register consideration in country where have large sh’er presence (rare)
  
  • S129 (p222) lists countries: Form AD06 to CH
  • NB keep duplicate with ROM as forms part of it
• When should ROM be updated ?
  
  • new shares issued to new/existing shareholder
  • share reorganisation: share split/consolidation, share buy-back, cancellation, conversion
  • share transfers (normal and on death)
  • change of address or name on marriage, by deed poll etc
  • can get busy, even for private companies/group and even if electronic!
• No update notifications to CH - include in next annual Confirmation Statement
• Amending ROM (rectification)?
  
  • by court order in theory but admin errors/corrections via officer authority
• ROM value? Yes! Monitor/investigate/analysis (often by Company brokers)
  
  • regular PLC Board info, particularly post YE and interim results
  • main buyers and sellers in substantial sh’ers (3%+) and Top 50 - 100 sh’ers
  • nominee shareholder/beneficial owner/fund manager identification
  • includes ≥ 3% significant shareholders and s793 enquiries into nominee shareholdings
  • includes geography and demographics
  • gives focus to IR and Exec/C’man engagement programme

Question 12

Who are the Nominee Shareholders?

Answer 12

Nominee Shareholders

• Many beneficial owners have shares held/registered in nominee name
• Must still be ‘legal person’ as above
• Protection: Declaration of Trust and executed stock transfer form in place
• Registered member only treated as member – no company relationship with beneficial owner
• Beneficial owner details do not appear on register and remain anonymous
• PLC - identity can be requested by s793 enquiry
  
  • usually contract out to corporate broker or 3^rd party who monitor/analyse register
  • if not provide, shareholder rights/entitlements can be suspended under Articles
  • 3%+ or more substantial shareholders obliged to notify company and identify beneficial owner of shares (Listing Rules) and company must pass onto market promptly (TR1)

Question 13

What is Member Activism?

Answer 13

Member Activism

• PLC thing: more active and visible in public domain
• Major shareholders and investment funds want to have views and voice heard
  
  • not always aligned with company’s aims and objectives
  • depends on investment strategy: s/t share price opportunity, l/t capital growth and dividends, merely because of Index membership tracking or something else
  • depends how company is performing
• Aim = achieve change to improve performance, efficiency, profitability, value
• Activism can arise because Directors vs sh’ers interests are conflicted
  
  • s172 directors’ duty to promote success of company for benefit of members as whole, while considering interests of other stakeholders (eg employees, community, suppliers)
  • shareholders interests can be solely about themselves
  • recent increased emphasis in s172 may exacerbate situation?
  • reporting on Board’s stakeholder considerations in decision making (PLC/large private)
  • as governance → long term sustainability and value enhancement, other stakeholder interests become more relevant

Question 14

What is the Purpose of Activism? How can a CS anticiapte Shareholder Activism and what is Pressure Group Activism?

Answer 14

Purpose of Activism

• Institutional investors usually invest in companies whose strategies they believe in/agree with → let Directors get on with managing business
• Not looking for change or fight, but they want views listened/voices heard
• Prefer regular dialogue and influence not company ‘my way or highway’
• Poor performance is usually activism starter for 10
• Prepared to aggressively disrupt status quo and current strategy
• Will work with other sh’ers/institutional bodies (eg ISS/IA) to help persuade
• Will use all sh’er rights, now firmly in favour of owners, to pursue objectives
• Will go public to be heard and ‘vote with feet’, incl. direct and indirect actions
• Some key reasons investors may pursue shareholder activism
  
  • Corporate Governance: Board changes, Directors’ Remuneration, specific issues
  • Financial: return of capital (share buyback/special divs.), sale of poor performing assets
  • Strategic direction and transactions: M&A or demerger
  • Special interest: environmental, social, ethics

Anticipate Shareholder Activism- Engagement with shareholders through regular communications, shareholder events- presentations. Monitoring of the share register and proactive relationships- keep informed.

Pressure Group Activism- purchase only nominal number of shares- with the intention to disrupt AGM’s and gain publicity- compel a Company to change its behaviour.

Question 15

What Rights do Members have?

Answer 15

Member’s Right to:

• obtain relief for unfair prejudice
• bring ‘derivative claim’ against director
• apply to court for winding up
• attend and vote at general meetings
• require audit of accounts (if hold ≥ 10%) where accounts exempt from audit
• give notice of desire to acquire shares of other shareholders (if hold ≥ 90%)
• receive share certificate

But not to:

• receive a dividend unless board recommends
• increase a dividend above amount board recommends
• access board minutes or other sensitive documents

be consulted on all company business

• Usually limited to statutory rights under Act and as per Articles
• Shareholders Agreement in place or negotiated (eg minority shareholder/JV partner)?
  
  • additional rights to insight/info or even Directorship (eg if >10% holding)
• Shareholder entitled to inspect (nil fee) various statutory registers & records incl.
  
  • registers of members*/directors/secretaries/charges: * subject to “proper purpose”
  • shareholder minutes and resolutions
  • directors’ service contracts/letters of appointment and indemnities
  • contracts relating to the company’s purchase of its own shares
  • entitled to a copy for small fee
• Memo & A of A and other statutory returns/filings – available from CH
• PLC - also receive :
  
  • Latest company accounts (at least 21 days pre-AGM)
  • Notice of GMs and right to attend, ask questions and vote (subject to class rights)

Other communications to shareholders

Question 16

What are the different Share Classes?

Explain Ordinary and Ordinary non-voting shares.

Answer 16

• Ordinary shares- Giving holders the right to share in the Company’s profits in proportion to their holdings and the right to vote at general meetings. CA2006 s. 560 requires that ordinary shares must have rights to participate in distributions with no upper limit on that participation.Therefore, where a company’s share capital is divided into two or more classes the basic/default share class with full rights will most often be called the ordinary share class with the rights of the other class(es) being enhanced, fettered or removed when compared to the corresponding rights of the ordinary shares.
• Although ordinary shares carry full rights to participate in dividends this does mean that they will rank behind other classes that have a preferred or fixed dividend entitlement as otherwise it would be necessary to limit the distribution applicable to the ordinary shares to allow for the dividend on the fixed income shares which is contrary to CA2006 s. 560.
• These shares constitute the company’s ‘risk capital’ – i.e. each year, the directors declare a dividend to be paid on the ordinary shares out of the profits of the company. If the company does well, the dividends will be good and increase year by year; but if the company does badly, the dividends may be reduced or even (in a very bad year) omitted entirely. In some companies, the risk capital is called ‘deferred shares’ or ‘deferred stock’.
• Ordinary non-voting shares. Usually distinguished from the voting shares by calling them ‘non-voting’ or ‘A’ shares. Some companies have classes of ordinary shares which have restricted voting rights. In both cases, however, the shares otherwise have similar rights to those of the other ordinary shares.

Question 17

Explain Preference Shares, Return of Capital, Deferred Shares, Cumulative Preference Shares and Redeemable shares.

Answer 17

• Preference shares. These carry a preferential right to a fixed rate of dividend and, on a winding up, to return of capital with or without a premium, together with arrears of dividend. They constitute part of the company’s share capital, and repayment of capital on preference shares would rank ahead of repayment of capital on the ordinary shares (or the deferred shares or deferred stock) in a liquidation. The fixed rate of dividend is usually expressed as a percentage of the nominal value of the shares and not the issue price. Holders of preference shares get the same rate of dividend year in and year out, unless in any year the profits of the company are insufficient to pay the preference dividends, which, then take priority over payment of dividends on the ordinary shares. Alternatively, the preference dividend might be expressed as a fixed percentage of the distributable profit in any financial year.
• Return of Capital: An amount paid back to members being a repayment of the principal originally invested. A return of capital will occur if shares are redeemed or otherwise purchased by the issuing Company.
• Deferred shares. As the name implies these shares have one or more deferred rights. These might have no right to dividends either at all or not until a specified level of profit is reached. Alternatively, in situations where a company has made significant losses and new investors have been identified the majority of the existing ordinary shares might be converted to deferred shares in order to provide greater ownership for the new investors without the costs and complexity of undertaking a reduction of capital.
• Cumulative preference shares. This type of share is very similar to preference shares but has an additional right that if in any year the profits of the company are insufficient to pay the preference dividend in full or at all, any part of the dividend not paid will be carried forward to be paid when the company’s fortunes improve. The payment of such arrears would rank ahead of payment of dividends on the ordinary shares.
• Redeemable shares (preference shares) or cumulative redeemable (preference) shares. These shares will be redeemed by the company at a future date or on the achievement of a particular event. The redemption terms will be either set out in the Articles or determined by the directors at the time of allotment (CA2006 s. 685). The amount might be a fixed amount or may be determined according to a formula.

Question 18

Explain Debentures and Loan Stocks

Answer 18

• Debentures and loan stocks. Sharing many of the same features of shares these are not shares but loans to the company carrying a fixed rate of interest. Generally, debentures are secured loans on the assets of the company, whereas loan stocks are normally unsecured.
• Payment of the interest on debentures and loan stocks ranks ahead of the payment of preference dividends and ordinary dividends. They would also rank ahead of preference and ordinary shares in repayment of capital in a liquidation. It should be noted, however, that debentures and loan stocks do not form part of the company’s capital, although quite often they are colloquially referred to as ‘loan capital’. The company’s capital is confined to its share capital.

Question 19

Explain the Rights Attatched to Shares

Answer 19

• Right to Vote- the right to attend and vote at meetings may be restricted or enhanced/ some shares may be non-voting.
• Right to Receive Dividend- the right to dividend can be excluded completely, or a class may be granted preferential right to a dividend up to a specifided amount- CA2006 requires ordinary shares have an unrestricted right to dividends.
• Right to Capital- refers to the rights to participate in a distribution of surplus capital on a winding up or on a return of capital- share classes may have enhanced right- restricted to the amounts paid for the shares. Investors may have enhanced rights to return of capital in excess based on company valuation.
• Pre-emption rights- preferential right of existing members to purchase new shares to be issued or existing shares being offered for sale by way of transfer by an existing member.
• Rights of pre-emption on allotment- give protection from dilution in the event of an issue of shares of the same class by requring that all new shares to be allotted are offered to the existing shareholders pro rata to their exisiting holding.
• Rights of Redemption- given to shares carrying enhanced dividend rights but no right to capital- redemption rights allow investors to realise their investment at a predetermined date.
• Right to conversion- rights used in conjunction with enhanced dividend rights to provide greater incentive for investors to invest in a company. Conversion rights allow the conversion of shares normally into ordinary shares- include the exchange rate- also the trigger criteria.

Question 20

Variation of Share Rights

Answer 20

Company can create classes of shares with as many/few rights as it wishes- depends on the investor. It is not possible to convert issued shares that were not redeemable into redeemable shares. Companies must always have atleast one share in issue that is not redeemable.

Special Resolution- A resolution required either by the Companies Act or a Company’s Articles which must be carreid by at least 75% of the members voting at a general meeting- such resolutions are required when the proposal changes the relationship between a Company and its members.

• Vary as per process and thresholds in AOA or, if silent, in Act. If AOA more demanding then must adhere to that
• s630 company with share capital – written consent of ≥ ¾ in nominal value of ISC of the class or 75% special resolution passed by members of that class
• S631 company without share capital – similar class consent to above
• Holders of ≥ 15% of issued shares in class which did not consent or vote in favour, can within 21 days apply to court for it to be cancellation. Will disallow if unfair prejudice on that class of holders/members. File court order with CH within 15 days
• Variation of class rights → require AOA amendment and special resolution of company members at GM in addition to class consent
• If create new class, or vary rights of existing class, of shares or members, notify CH within one month of variation date

Question 21

What is Unfair Prejudice, Can you give some Examples and the available Court Remedies?

Answer 21

Unfair prejudice

• Directors fiduciary duty (common law and s172) to act in best interests of members as a whole – liable if act for subgroup, themselves or not at all
• Shareholders statutory right to apply to court for relief if company’s affairs have been/are/proposed to be conducted in manner ‘unfairly prejudicial’ to interests of shareholders, all or some but including himself - s994
• Shareholder must
  
  • demonstrate conduct is unfair and caused/causing prejudice or harm
  • have refused offer by majority to purchase shares at proper value (contentious!)
• ‘Unfair conduct’ = objective test by court
  
  • no need to show bad faith or intention to cause prejudice
  • reasonable bystander test
• ‘Prejudice’ actually caused/causing harm = broad view taken by court
  
  • unless can prove actions were outside Articles, difficult to succeed (see examples)
• Expensive from outset (not always recoverable) and lengthy process
• More common in private than PLC – just sell shares in market and get out

Examples

• Exclusion from management where express or implied agreement to participate exists (eg substantial shareholder)
• Majority shareholder receiving excessive financial benefits
• Fraud by director such that majority gain and minority disadvantaged
• Diversion of business or assets to another company of which the majority shareholder/directors are interested
• Failure to observe pre-emption rights thus denying shareholder right to new share and existing shares holding being diluted
• Abuse of powers and breach of Articles (eg not sending accounts or GM notice to shareholders)

Court remedies

• Most common: instructs offending shareholders to purchase prejudiced shareholders interest at proper value as if prejudice had not occurred → contentious valuation. Get on with business.
• Directs company to stop offending conduct or regulates it going forward
• Authorises civil action be brought in name of company on such terms as may direct (ie Derivative Action) – this could be at company’s cost!
• Directs that no variation to company’s Articles without Court approval

Question 22

What is a Derivative Claim, Who can Bring derivative civil action? What is the Court’s procedure and which factors does it consider?

Answer 22

Derivative claims

• A member can, on behalf of the company, bring a claim against a director (ss.260-269)
• For negligence, breach of duty or breach of trust
• Applies to court for permission- by establishing a prima facie case.
  
  • no permission if a person acting under ‘duty to promote success of the company’ would not pursue, or if act or omission was authorised/ratified by company
  • court takes into account views of other shareholders, whether acting in good faith, company likely to authorise/ratify, importance of claim to person promoting success of company, and if company decided not to bring a claim
• Only member canbringderivative civil action vsa director (or 3^rd party)
  
  • company must have cause (per examples) but doesn’t act
  • Foss v Harbottle – company is liable for contracts/tort
  • action brought on behalf of company as director owed duty of care
  • purpose: mainly to seize back assets and/or recover compensation – see examples
  • benefits awarded for company not shareholder
• NB Very different to direct sh’er action made in own name/for own benefit
• Two stage Court procedure
  
  • establish prima facie case for permission to continue new action (or past/current action pursued/completed unsatisfactorily by company/other member)
  • Court may require evidence from company before action can commence
• Factors for court to consider
  
  • shareholder acting in good faith (ie not vexatious or frivolous) and got ‘clean hands’?
  • should shareholder pursue claim/remedy in own right instead (as above)?
  • importance that director promoting success of company would attach to continuing claim
  • likelihood that conduct would be authorised or ratified company
  • whether and why company had decided not to bring a claim (or has aborted/completed)
  • most important: views of other ‘independent’ (ie disinterested) shareholders

Question 23

What is an alternative remedy to Unfair Prejudice and Derivative Action?

Answer 23

Alternative remedy to Unfair prejudice and Derivative Action

• Petition for ‘just and equitable winding-up’ – IA 1986 s122 (eg occurs particularly where 50/50 deadlock mismanagement or exclusion exists) Brought by directors, majority creditors or members.

Question 24

What are examples of Common breaches?

Answer 24

Breach of fiduciary duty

• Director is a fiduciary (ie entrusted with care of money and property) and owes legal obligation/duty to act in another’s best interests (ie to shareholders) and not derive a personal gain from their position. Duty of loyalty/care runs to company

Breach of statutory duties

• Liability of a director for breach of statutory duty also runs to company

Sale of control

• Premium obtained by certain shareholders through wrongful sale of all/part of company control. (Benefit here accrues to shareholders who lost out, not company)

Other rights belonging to company

• Fraud, breach of confidential relationship, malpractice and conspiracy if injuries are to company not shareholder individually
• Director of some companies caused them to make substantial loans to another company he owned
• Breach of fiduciary duty and required to repay the loans

Towers v African Tug Co

• Directors made dividend payments to shareholders out of capital that, while honest, were illegal (not out of distributable reserves)
• Three years later, two of the receiving shareholders, who knew at the time the payments were illegal and still had the money, brought action seeking repayment of the monies
• Claim dismissed because claimants did not have ‘clean hands’