Dealing with Insiders: the articles of association Flashcards
Salmon v Quin & Axtens Ltd [1909] 1 Ch 311
- Article Stated that voting need to unananinously and that veto would stop it.
- Court held that this must be followed and granted injunction
Facts:
In the case of Quin & Axtens Ltd v Salmon [1909], William Raymond Axtens and Joseph Salmon were the majority shareholders of the Quin and Axtens Ltd. Axten and Salmon were also chairman and managing directors of the company.
The articles of association contained a provision stating that no resolution would be effective if Axtens or Salmons dissented. As a result, Axtens and Salmons could veto any board decision on a wide range of matters.
However, when Salmons tried to exercise his veto, but others ignored it and the directors resolved to acquire premises. Then an extraordinary general meeting was held, where the same resolution was passed by a majority of shareholders.
Salmons sought an injunction restraining the directors from acting on the resolution.
Issue:
Whether an injunction sought by Salmons shall be granted by the courts?
Held:
The Court of Appeal granted the injunction. The court held that the company was trying to bypass rules on decision-making contained in its articles of association, without following the proper procedure for amending the articles. So, by granting the injunction sought by Salmons, the court would prevent the company acting on a decision taken unconstitutionally. Herewith, Indirectly, Salmon enforced his outsider right as a managing director to veto certain board decision by suing as a member for the enforcement of the relevant provisions embodied in the company’s articles of association.
The House of Lords upheld the Court of Appeal’s decision.
Rayfield v Hands [1960] Ch 1
Rayfield v Hands [1960] Ch 1 is a UK company law case, concerning the enforceability of obligations against a company.
Facts
Mr Rayfield sued the directors of Field Davis Ltd to buy his shares. Article 11 of the company’s constitution said ‘Every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at a fair value.’ The directors were refusing to follow this rule, and Mr Rayfield sought an injunction.
Judgment
Vaisey J granted the injunction and held the article imposed an obligation on the directors, not as officers, but also in their capacity as members. He referred to Re Leicester Club and County Racecourse Co[1] where Pearson J referred to directors as ‘working members of the company’ and that ‘they are doing their work in the capacity of members, and working members of the company’. He referred to the privity decisions of Denning LJ in Smith and Snipes Hall Farm Ltd v River Douglas Catchment Board[2] and Drive Yourself Hire Co (London) Ltd v Strutt[3] and also Carlill v Carbolic and The Satanita to say that the company did not need to be joined to the action to bring it, even though a members create a contractual relation with the company.
Authority
The case was approved by Scott J in Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald Newspaper & Printing Co Ltd [1986] BCLC 286.
Foss v Harbottle [1843] 2 Hare 461
Key Takeaways
- Only the company has standing to sue
- Minority shareholders must resort to derivate claim
- Secondly, the “majority rule principle” states that if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not interfere (legal term).
Foss v Harbottle
Foss v Harbottle (1843) 2 Hare 461, 67 ER 189 is a leading English precedent in corporate law. In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself. This is known as “the proper plaintiff rule”, and the several important exceptions that have been developed are often described as “exceptions to the rule in Foss v Harbottle”. Amongst these is the “derivative action”, which allows a minority shareholder to bring a claim on behalf of the company. This applies in situations of “wrongdoer control” and is, in reality, the only true exception to the rule. The rule in Foss v Harbottle is best seen as the starting point for minority shareholder remedies.
The rule has now largely been partly codified and displaced in the United Kingdom by the Companies Act 2006 sections 260–263, setting out a statutory derivative claim.
Facts
Richard Foss and Edward Starkie Turton were two minority shareholders in the “Victoria Park Company”. The company had been set up in September 1835 to buy 180 acres (0.73 km2) of land near Manchester and, according to the report, enclosing and planting the same in an ornamental and park-like manner, and erecting houses thereon with attached gardens and pleasure-grounds, and selling, letting or otherwise disposing thereof.
This became Victoria Park, Manchester. Subsequently, an Act of Parliament incorporated the company.[1] The claimants alleged that property of the company had been misapplied and wasted and various mortgages were given improperly over the company’s property. They asked that the guilty parties be held accountable to the company and that a receiver be appointed.
The defendants were the five company directors (Thomas Harbottle, Joseph Adshead, Henry Byrom, John Westhead, Richard Bealey) and the solicitors and architect (Joseph Denison, Thomas Bunting and Richard Lane); and also H. Rotton, E. Lloyd, T. Peet, J. Biggs and S. Brooks, the several assignees of Byrom, Adshead and Westhead, who had become bankrupts.
Judgment
Wigram VC dismissed the claim and held that when a company is wronged by its directors it is only the company that has standing to sue. In effect the court established two rules. Firstly, the “proper plaintiff rule” is that a wrong done to the company may be vindicated by the company alone. Secondly, the “majority rule principle” states that if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not interfere (legal term).
Eley v Positive Government Security Life Assurance Co [1876] 1 Ex D 20
Outsiders can not sue on insider contract (AOA) (in this case a solicitor who was mentioned in the articles of association could sue only as member of the company, not as an outsider)
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Eley v Positive Government Security Life Assurance Co Ltd (1876) 1 Ex D 88 is a UK company law case, concerning a company’s articles of association as a contract between member and company.
Facts
Article 118 of the constitution of Positive Government Ltd stated ‘Mr William Eley of 27 New Broad Street, City of London, shall be the solicitor to the company…’. Eley in fact drafted the articles. But then the company never employed him as its solicitor. He was a member, but he brought an action to enforce the articles in his capacity as a solicitor.
The Exchequer Division held the articles did not create any contract between Eley and the company.
Judgment
In the Court of Appeal, Lord Cairns LC affirmed the decision and held, Mr Eley had the right to sue only in his capacity as member, not as solicitor. His brief judgment was as follows.
Punt v Symons & Co Ltd [1903] 2 Ch 506
a company and its members are curtailed from entering into extrinsic contracts preventing alteration of the articles, in Punt v Symons and Co Ltd [1903]
External Contracts
It should be noted that a company and its members are curtailed from entering into extrinsic contracts preventing alteration of the articles, in Punt v Symons and Co Ltd [1903] 2 Ch 506, the members entered into a private agreement that stated:
‘The company shall not at any time alter or attempt to alter the clauses of the articles of association relating to the appointment of the vendor as governing director as originally framed or do or suffer anything to be done in contravention of the provisions contained in these clauses respectively.’
Bryne J proclaimed
‘I am prepared to hold that in the circumstances of the present case the contract could not operate to prevent the article being altered.’
Russell v Northern Bank Development Corporation [1992] BCLC 431
An Agreement can bind shareholders
An Agreement may not necessarily bind the company itself if it is against statutory provisions
House of Lords held that a private shareholders’ agreement could not fetter a company’s statutory powers but could bind the voting rights of those parties to the agreement.
Russell v Northern Bank Development Corp Ltd [1992] 1 WLR 588 is a leading case on shareholders’ rights in the United Kingdom in which the House of Lords held that a private shareholders’ agreement could not fetter a company’s statutory powers but could bind the voting rights of those parties to the agreement.
Facts
Four executives of a brick works in Dungannon, County Tyrone were shareholders, with 20 shares each, in a company called Tyrone Brick Limited (T.B.L) alongside Northern Bank Development Corporation, which held 120 shares.[1] Eight hundred other shares were not allotted.[2]
All executives, Northern Bank, and the company T.B.L itself, were parties to a shareholders’ agreement with a clause that stated, “No further share capital shall be created or issued in the company or the rights attaching to the shares already in issue in any way altered (save as herein set out) or any share transfer of the existing shares permitted, save in the following manner, without the written consent of each of the parties hereto.”[2]
In March 1988 the board of T.B.L issued a notice to shareholders of an extraordinary general meeting to consider a resolution allowing for a 3,999,000 new shares to be issued by the company. One of the executives, Samuel Russell, sought an injunction restraining the other executives and Northern Bank from considering or voting on the resolution and damages for breach of contract.[3]
At trial the judge held that the shareholder’s agreement was invalidated because it sought to fetter T.B.L’s statutory power to increase its capital. The Court of Appeal, by a majority, upheld this decision. Russell appealed, although now claiming only a declaration as to his rights and not also an injunction.[4]
Judgment
The House of Lords upheld the appeal. Lord Jauncey stated,
My Lords while a provision in a company's articles which restricts its statutory power to alter those articles is invalid an agreement dehors the articles between shareholders as to how they shall exercise their voting rights on a resolution is not necessarily so. — Lord Jauncey, Russell v Northern Bank Development Corp Ltd'[5]
The House of Lords thus held that while the agreement could bind the shareholders it could not bind the company itself;
This was a clear undertaking by T.B.L. in a formal agreement not to exercise its statutory powers for a period which could, certainly on one view of construction, last for as long as one of the parties remained a shareholder. [...] As such an undertaking it is, in my view, as obnoxious as if it had been in the articles of association and therefore is unenforceable as being contrary to the provisions of article 131 of the Companies (Northern Ireland) Order 1986. T.B.L.'s undertaking is, however, independent of and severable from that of the shareholders and there is no reason why the latter should not be enforceable by the shareholders inter se as a personal agreement which in no way fetters T.B.L. in the exercise of its statutory powers. — Lord Jauncey, Russell v Northern Bank Development Corp Ltd'[6]
Significance
Professor Eilís Ferran, writing in the Cambridge Law Journal noted that regarding the question of companies contracting out of statutory powers, “The decision in Russell provides a firm and unequivocal answer to the question: there can be no contracting out by a company in respect of its statutory powers.”[7] Ferran criticised the decision for making a “technical distinction which is not immediately obvious and which rests on the turning of a blind eye to the manifest practical consequences which can flow from a voting agreement.”[7]
Re Duomatic [1969] 2 Ch 365
The Duomatic Principle
The application of the Duomatic principle contains two core requirements:[1]
The consent of shareholders must be unanimous.
The shareholders must consent with full knowledge of what it is they are consenting to.
Furthermore, subsequent cases indicate that there must be some outward manifestation of the consent, either in the form of a document, a statement or by conduct. A mere “internal decision” on the part of the shareholders is not sufficient by itself. In Rolfe v Rolfe [2010] EWHC 244 Newey J stated:[7]
If all shareholders are giving consent to a decision, such as a payment salaries/dividends (even where not such resolution has been formally passed) this shall be regarded as authorized
The Duomatic principle is a principle of English company law relating to the informal approval of actions by a company’s shareholders (and, potentially, directors).[1] The principle is named after one of the earlier judicial decisions in which it was recognised: Re Duomatic Ltd [1969] 2 Ch 365, although in that case Buckley J was approving an older statement of the law from the decisions in In re Express Engineering [1920] 1 Ch 466 and Parker and Cooper Ltd v Reading [1926] Ch 975. It origins lie in the obiter dictum comments of Lord Davey in Salomon v Salomon & Co Ltd where he stated that ‘the company is bound in a matter intra vires by the unanimous agreement of its members’.[2]
The principle will apply even if the articles of association specifies a particular procedure in relation to the subject matter of the decision.[3]
It has been noted that although the principle is normally referred to as the Duomatic principle, the actual rule predates that case by several decades.[4]
Re Duomatic
The decision in Re Duomatic concerned whether certain payments made to directors of a company were valid even though none of the directors had contracts of service with the company, and no resolution had ever been passed authorising them to receive the payments. The company went into liquidation and the liquidator made an application for repayment of the money. The court held that the payments were to be regarded as properly authorised because they had been made with the full knowledge and consent of all the shareholders. Buckley J explained:[5]
I proceed upon the basis that where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be.
The broad principle has never been seriously questioned by the courts since. In EIC Services Ltd v Phipps [2003] EWHC 1507 Neuberger J stated:[6]
The essence of the Duomatic principle, as I see it, is that, where the articles of a company require a course to be approved by a group of shareholders at a general meeting, that requirement can be avoided if all members of the group, being aware of the relevant facts, either give their approval to that course, or so conduct themselves as to make it inequitable for them to deny that they have given their approval. Whether the approval is given in advance or after the event, whether it is characterised as agreement, ratification, waiver, or estoppel, and whether members of the group give their consent in different ways at different times, does not matter.
Requirements
The application of the Duomatic principle contains two core requirements:[1]
The consent of shareholders must be unanimous. The shareholders must consent with full knowledge of what it is they are consenting to.
Furthermore, subsequent cases indicate that there must be some outward manifestation of the consent, either in the form of a document, a statement or by conduct. A mere “internal decision” on the part of the shareholders is not sufficient by itself. In Rolfe v Rolfe [2010] EWHC 244 Newey J stated:[7]
I do not accept that a shareholder's mere internal decision can of itself constitute assent for Duomatic purposes. I was not referred to any authority in which it had been decided that a mere internal decision would suffice. Further, for a mere internal decision, unaccompanied by outward manifestation or acquiescence, to be enough would, as it seems to me, give rise to unacceptable uncertainty and, potentially, provide opportunities for abuse. A company may change hands or enter into an insolvency procedure; in either event, it is desirable that past decisions should be objectively verifiable. In my judgment, there must be material from which an observer could discern or (as in the case of acquiescence) infer assent. The law applies an objective test in other contexts: for example, when determining whether a contract has been formed. An objective approach must, I think, also have a role with the Duomatic principle.
Expansion
In subsequent cases courts have expanded the general principle to also apply to a wider array of situations.
In Ciban Management Corporation v Citco (BVI) Ltd [2020] UKPC 31 it was affirmed that the principle applied to the ostensible authority of persons as well as to express authority. In Shahar v Tsitsekkos [2004] EWHC 2659 (Ch) it was held that the consent of the beneficial owner of any shares would be sufficient if the trustee can be compelled to vote in accordance with the beneficial owner's wishes. But in Rolfe v Rolfe [2010] EWHC 244 (Ch) it was clarified that where shares were held for more than one beneficial owner as joint owners, the assent of only one of the joint owners would not be sufficient. In Runciman v Walter Runciman plc [1992] BCLC 1084 at 1092 and Base Metal Trading v Shamurin [2004] EWCA Civ 1316 it was held that informal and unanimous consent of the board of directors is also effective as a resolution passed at a duly convened meeting. Prior to those cases there was doubt as to whether the principle would apply to directors because of their fiduciary duties to the company might preclude informal assent. The principle has also been extended beyond company law to include committees of clubs which are unincorporated associations, see Speechley v Allott [2014] EWCA Civ 230.
Allen v Gold Reefs Co of West Africa [1900] 1 Ch 656
- alteration of the company’s articles was valid to introduce a lien on fully paid up shares. So long as the resolution was done bona fide for the benefit of the company as a whole, restrictions on freedom of a company to alter its articles are invalid.
Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656 is a UK company law case concerning alteration of a company’s articles of association. It held that alterations could not be interfered with by the court unless a change was made that was not bona fide for the benefit of the company as a whole. This rule served as a marginal form of minority shareholder protection at common law, before the existence of any unfair prejudice remedy.
Facts
Gold Reefs’ articles gave it a “first and paramount lien” (the right to retain possession) on all partly paid shares held by any member for any debt owed to the company. Mr Zuccani held some partly paid up shares. He also owned the only fully paid up shares issued by the company. He died insolvent. The company altered its articles by special resolution to create a lien on all fully paid shares (deleting the words in brackets of ‘upon all shares (not fully paid) held by such members’). Mr Allen, one of the executors of Mr Zuccani (trying to get money back) sued to get the fully paid shares’ value.
Kekewich J held the company could not enforce the lien. The company appealed.
Judgment
Lord Lindley MR held the alteration of the company’s articles was valid to introduce a lien on fully paid up shares. So long as the resolution was done bona fide for the benefit of the company as a whole, restrictions on freedom of a company to alter its articles are invalid. According to Lord Lindley MR the power to change the articles is,
like all other powers [to] be exercised to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded. These conditions are always implied, and are seldom, if ever, expressed... How shares shall be transferred, and whether the company shall have any lien on them, are clearly matters of regulation properly prescribed by a company’s articles of association... It is easy to imagine cases in which even a member of a company may acquire by contract or otherwise special rights against the company, which exclude him from the operation of a subsequently altered article... The altered articles applied to all holders of fully paid shares, and made no distinction between them. The directors cannot be charged with bad faith.
Romer LJ agreed. Vaughan Williams LJ dissented.
Significance
Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656, inserting a lien on shares fully paid when it only affected one shareholder was valid Brown v British Abrasive Wheel Co [1919] 1 Ch 290, introducing a 'squeeze out' provision to compulsorily acquire the 2% of shares held by a minority bidder to encourage the 98% majority shareholder to contribute more capital was invalid Sidebottom v Kershaw, Leese & Co Ltd [1920] 1 Ch 154, introducing the right to compulsorily acquire the shares of anybody running a competing business was valid Dafen Tinplate Co Ltd v Llanelly Steel Co (1907) Ltd [1920] 2 Ch 124, introducing a right to compulsorily acquire any shareholders' shares to deal with one shareholder that was contracting with a competitor was invalid Shuttleworth v Cox Bros and Co (Maidenhead) [1927] 1 Ch 154, allowing a majority of directors to remove another director, to target one of the existing directors, was valid, as it was bona fide. Peter's American Delicacy Co Ltd v Heath (1939) 61 CLR 457, an amendment to rectify a drafting mistake on the distribution ratios to be equal, and dependent on amounts paid up not nominal value, for both capitalised profits as for cash dividends was valid Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701, changing the articles to allow a director to be removed before the end of his term was valid Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286, removing a pre-emption right to prevent a minority shareholder buying up shares in a battle for control was valid Rights and Issues Investment Trust Ltd v Stylo Shoes Ltd [1965] Ch 250, doubling voting rights of management shares to preserve their strength after a large new share issue when managers did not take part in the vote was valid Gambotto v WPC Ltd (1995) 182 CLR 432, an alteration to empower the majority to compulsorily buy out any minority was invalid. The Australian High Court preferred a test of whether an alteration is 'beyond any purpose contemplated by the articles or oppressive' Citco Banking Corporation NV v Pusser's Ltd [2007] UKPC 13, an amendment passed by 84% of shareholders except Citco to create a new class of shares with 50 votes each and to convert the chairman's 200,000 shares into this class was valid
Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286.
Exception to Foss v Hartbottle Rule
Greenhalgh v Arderne Cinemas [1951] is an important case concerning pre-emptive right to purchase the company shares.
Keywords:
Company law – Articles of association – Directors – Minority shareholders – Shares – Court of Appeal
Facts:
In the present case, the articles of the company originally required that any member shall only sell their shares if he/she offers them to his fellow first. Although, the company altered its articles by resolution in order to allow the majority shareholders in a family company to sell their shares to an outsider by obtaining an ordinary resolution.
So, the plaintiff, a minority shareholder, sought a declaration that the resolution altering the articles was void. The plaintiff claimed that the resolution sacrificed the interests of the minority to the interests of the majority without any benefit to the company. The lower court refused to make such a declaration. As a result, the case went to the Court of Appeal.
Issue:
Whether the newly adopted resolution, allowing the majority shareholders to sell their shares to outsiders, was detrimental to the interests of the minority shareholders?
Held:
The Court of Appeal held that the resolution altering the articles of the company was valid. It’s true that the resolution’s immediate effect was to enable the majority group to sell their shares to outsiders without first offering them to the minority shareholders. However, the articles bounded the minority shareholders to offer their shares to the majority group before selling elsewhere. In these circumstances, the Court of Appeal concluded that there was no discrimination between the majority and the minority since the resolution also allowed any member to sell his shares to an outsider.
Statute on Articles of Association
All limited companies must have articles of association. These set the rules company officers must follow when running their companies.
“Model” articles of association are the standard default articles a company can use. They are prescribed by the Companies Act 2006.
S. 168 Direct Removal of Directors
Further Reading
https://www.girlings.com/latest/can-articles-association-override-companies-act
