Managing Companies - Shares and Shareholders

Question 1

Shareholders

Answer 1

• Own the company and it is their investment at risk
• Exercise ultimate control over the company
• Hope to receive a financial return on their investment

Question 2

Two key ways that shareholders exercise their control

Answer 2

• By determining the company’s constitution

- By voting on shareholder resolutions

Question 3

Key elements of shareholder control

Answer 3

Their power to vote on a resolution to remove directors from the board (s 168 CA 2006) and/or appoint new directors whose approach to managing the company the shareholders prefer (MA 17)

Question 4

Separation of powers - directors’ powers

Answer 4

• The directors have control of the company’s day to day management and have broad powers to carry out such management under MA 3 and MA 5
• CA 2006 places certain controls on directors which act as a check against abuse of power in the form of the directors duties (s 170-177)

Question 5

Separation of powers - Shareholders’ reserve powers

Answer 5

• Under MA 4, shareholders have a reserve power
• ‘(1) The shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action.
• (2) No such special resolution invalidates anything which the directors have done before the passing of the resolution.’
• The MAs envisage that the role of the shareholders is a minor one, with the power limited to constitutional decisions only, which reflects the modern reality in many companies.

Question 6

Shareholders may act where the board of directors is unable to do so

Answer 6

Barron v Potter: shareholders of the company in a GM may act in place of the directors where there is no board of directors able or competent to do so.
- the two directors were not on speaking terms. In view of the deadlock, the power to appoint directors reverted to the shareholders

Question 7

How do shareholders pass a resolution

Answer 7

They need to vote either at a GM or use the written resolution procedure (available only to private companies and not available for resolutions to remove directors/auditors)

Question 8

How are GMs usually called

Answer 8

• usually called by the directors (s 302) by passing a board resolution at a Board Meeting (usually passed by a simple majority of directors)
• The Board needs to give 14 clear days notice of a GM (s 307(1) and s 360) unless the short notice procedure is used (s 307(4-6)).
• If 90% of shareholders with voting rights agree, the short notice procedure allows the GM to take place at short notice, immediately after the Board Meeting

Question 9

Shareholders calling a GM

Answer 9

• If the Board refuses to call a GM, the shareholders have the reserve power to do so themselves
• Under s 303(1) CA 2006, shareholders together holding not less than 5% of the paid-up voting share capital can serve a request on the company i.e. the Board. The request will require the Board to call a GM (‘the s303 request’)

Question 10

S 303 Request

Answer 10

• must state the general nature of the business which the shareholders wish to be dealt with at the GM
• may include the text of the resolution they want to propose

Question 11

Directors obligations on receipt of an s 303 request

Answer 11

Under s 304(1) CA 2006, they must call the GM within 21 days from the date on which they become subject to the s 303 request. The GM must be held on a date not more than 28 days after the date of the notice convening the GM.

Question 12

What happens if the directors fail to call a general meeting

Answer 12

• All of the shareholders who submitted the s 303 request or any of them representing more than one half of the voting rights of those who submitted that 303 request can call a GM themselves pursuant to s 305 CA 2006
• If the shareholders call the GM themselves, the GM must be held within 3 months of the date that the directors received the initial s 303 request
• Under s 305(6), if the shareholders are forced to call the GM themselves, they can recover their reasonable expenses for doing so from the company. The company is then able to recoup the monies back from the directors who should have called the GM initially

Question 13

Annual General Meeting (AGM)

Answer 13

• CA 2006 abolished the requirement for private limited companies to hold an AGM, but public companies remain subject to this requirement
• For public companies, an AGM must be called by the directors (s 302) on 21 clear days notice (s 307(2), s 360(2)) within 6 months of the financial year end
• “Clear” day means the day the notice is given and the day of the meeting are discounted when calculating the number of days.
• At the AGM, the directors present an annual report to the shareholders about the company’s performance and strategy. Shareholders with voting rights then vote on current issues.

Question 14

Voting at GMs

Answer 14

Shareholders can vote either on a:

(a) Show of hands (where each shareholder has one vote)
(b) Poll vote (where each shareholder has one vote per share held)

Question 15

When can a poll vote be demanded

Answer 15

• MA 42: a resolution put to the vote of a GM must be decided on a show of hands unless a poll is duly demanded in accordance with the articles.
• MA 44: the right to demand a poll vote:
• 44(1) A:
• (a) in advance of the general meeting where it is to be put to vote, or
• (b) at a general meeting, either before a show of hands on that resolution or immediately after the result of a show of hands
• (2) A poll may be demanded by -
• (a) the chairman of the meeting;
• (b) the directors;
• (c) two or more persons having the right to vote on the resolution; or
• (d) a person or persons representing not less than one tenth of the total voting rights of all the shareholders having the right to vote on the resolution.’
• Section 321(1) CA 2006: This right cannot be excluded on any question other than (a) the election of the chairman of the meeting, or (b) the adjournment of the meeting.

Question 16

GMs: Notice

Answer 16

There are strict rules on giving timely (s 307) and appropriate (s 311) notice to all shareholders entitled to attend a GM. The general notice is 14 clear days (s 307(1), s 360) although there is a procedure by which short notice can be used if sufficient members are in agreement (s 307(4-6)). The validity of resolutions passed at a GM depends on proper notice being given.

Question 17

GMs: Quorum

Answer 17

The quorum for a GM is two shareholders under s 318(2), other than for single member companies, for which the quorum is one. MA 38 confirms that no business other than the appointment of the chairman of the meeting is to be transacted at a GM if the persons attending do not constitute a quorum.

Question 18

GMs: Proxies

Answer 18

Under s 324, shareholders may appoint a proxy to exercise any or all of their rights to attend, speak and vote at a GM. Corporate shareholders must appoint a representative to attend GMs under s 323.

Question 19

Shareholder voting: enhanced voting rights

Answer 19

Bushell v Faith clause: a mechanism by which a company’s directors who are also shareholders can seek to prevent themselves from being removed as director. The clause is inserted into the articles to ensure that when voting on a resolution for the removal of a director in a GM, the director/shareholder in question will have their votes weighted by a factor of great enough magnitude that the other shareholders cannot get the requisite majority.

They do not change the requirement under s 168 that an ordinary resolution is needed to remove a director.

Question 20

Shareholder voting: written resolutions

Answer 20

• Under s 288, private companies may pass shareholder resolutions using the written resolution procedure instead of GMs. A written resolution has effect as if it was passed at a GM (s 288(4))
• Written resolutions must be sent to all eligible members. A time limit of 28 days applies for the eligible members to respond, after which time the resolution will be deemed not passed if a sufficient majority (over 50% for ordinary and not less than 75% for special) have not indicated that they vote in favour.
• Two resolutions may not be passed as written resolutions:
• Section 288(2)(a) - a resolution under s 168 removing a director before the expiration of his office
• Section 288(2)(b) - a resolution under s 510 removing an auditor before expiration of office

Question 21

Informal decision making - the ‘Duomatic’ principle

Answer 21

Re Duomatic Ltd: informal resolutions agreed by all the shareholders outside of a formal meeting will be valid and binding. There must be unqualified agreement by all shareholders, whether this is express or implied, verbal or by conduct.

Question 22

The rights of shareholders to vote

Answer 22

General principle: shareholders may vote in their own interests

• Shareholders are under no fiduciary duty to the company and can vote as they wish, regardless of whether their votes would be in the best interests of the company. However, they must act in a way that is bona fides.
• Clemens v Clemens Bros: the court refused to allow a majority shareholder to authorise an allotment of shares where the motive was to dilute the voting power of the minority shareholder.
• In exceptional circumstances the courts have made orders to restrain a shareholder from exercising their vote in a manner which was irrational e.g. Standard Chartered Bank v Walker, where a minority shareholder was ordered not to vote against a restructuring agreement where the consequence of doing so would be the company collapsing.

Question 23

Voting on a decision to amend the articles

Answer 23

• The court will look at whether reasonable shareholders could have considered that the amendment was for the benefit of the company.
• Shareholders must vote to amend the articles in good faith (Allen v Gold Reefs) and not to undermine the substantive rights of minority shareholders. If not, the company may hold the amendment invalid.
• Sidebottom v Kershaw: court held that the power to alter a company’s articles must be exercised bona fide for the benefit of the company as a whole

Question 24

How does a company fund its business?

Answer 24

• Issuing shares (equity finance)
• Borrowing (debt finance)
• Issuing a ‘hybrid’ investment which has the characteristics of both debt and equity
• Retaining its profits for use in the business (rather than paying as dividends to shareholders)

Question 25

Shares

Answer 25

• ‘Share capital’ = money raised by the issue of shares.
• A share is often described as a ‘bundle of rights.’ By investing in the share capital, an investor becomes a part owner of the company and will often have voting rights at shareholder meetings
• Most investors make a long-term investment and only get their investment back on a sale of their stake, a sale of the company itself, on a flotation or when the company is wound up
• The incentives are receipt of income (by way of dividend) and a capital gain (by growth of the company’s value) but neither are guaranteed

Question 26

Issued share capital

Answer 26

• The amount of shares in issue at any time. It is made up of:
• Shares purchased by the first members of the company, known as ‘subscriber shares’
• Further shares issued after the company has been incorporated
• New shares can be issued at any time.

Question 27

Share ownership

Answer 27

s 112 CA 2006: in order to become a member of a company a person must be entered into the company’s register of members.
- Glencoe Developments Ltd v Sneedon: because the register of members had not been updated, the only properly registered shareholder present at the meeting was S and so the sale was invalid.

Question 28

The register of members

Answer 28

• Until the register of members is updated, shares are not legally transferred
• This ensures that nobody other than a company member can vote on decisions affecting the company.
• The transfer of shares should only be recorded where a stock transfer form has been completed and the appropriate Stamp Duty has been paid
• By not keeping an up to date register of members, a company is committing an offence under CA 2006. Both the company and every officer in default is liable to a fine.

Question 29

Ways of becoming a shareholder

Answer 29

• Initial subscriber: where that person subscribes for the first shares issued when the company is incorporated
• Share issue: where a person acquires further shares issued by the company after incorporation
• Share transfer: where a person acquires shares by way of transfer from an existing shareholder
• Transmission: a mechanism by which the title to shares is devolved rather than by transfer. It typically applies to devolution by death, bankruptcy or marriage.

Question 30

Allotment vs issue of shares

Answer 30

• Allotment = a contract between the company and a new/existing shareholder under which the company agrees to issue new shares in return for the payment of the subscription price. Shares are ‘allotted’ when a person acquires the unconditional right to be included in the company’s register of members in respect of those shares (s 558).
• Issue = Has been held that shares are only issued and form part of a company’s issued share capital once the shareholder has actually been registered as such in the company’s register of members, and his title has become complete.

Question 31

Transfer of shares

Answer 31

• A contract to sell existing shares in the company between an existing shareholder and the purchaser. The company is not a party to the contract.
• Under s 544, in principle shares are freely transferable, although the articles of most private companies restrict their members’ rights to transfer their shares, so as to ensure control over the ownership of the company. Private companies are also prohibited from offering their shares to the public (s 755)

Question 32

Legal definition of a share

Answer 32

(1) A fraction of the capital of the company and sets out the shareholder’s financial stake in the company, which allows them to receive dividends and capital on a winding up
(2) A measure of the shareholder’s interest in the company and their right to vote
(3) A property right which can be bought and sold and carries legal and beneficial interests.
- s 541 CA 2006- shares are ‘personal property’.
- Share ownership does not give any entitlement to ownership of company assets, which are owned by the company itself (Macaura v Northern Assurance)

Question 33

Class rights

Answer 33

• A company may have different classes of share.
• The differing rights usually relate to entitlements to vote, entitlements to dividends and to the return of capital when a company is wound up.
• There is nothing in the CA 2006 which defines classes of shares or class rights and the label attached to a share is not determinative.
• MA 22 gives companies the power to issue different classes of share.

Question 34

Ordinary shares

Answer 34

• most common type, default position
• a right to vote at GMs, a right to receive a dividend if one is declared by the directors and a right to receive a share of the capital when the company is wound up (if there is surplus capital after the creditors are paid)
• defined in s 560(1) as “shares other than shares that as respects dividends and capital carry a right to participate only up to a specified amount in a distribution.”
• This illustrates that ordinary shares are the default position and have an unlimited right to participate in dividends and surplus capital on a winding up.
• Ordinary shareholders receive dividends after preference shareholders, but one advantage is the entitlement of ordinary shareholders to a dividend is unrestricted.

Question 35

Preference shares

Answer 35

• Usually entitled to have dividends paid at a predetermined rate (e.g. 5% of their nominal value) in priority to any dividend paid on ordinary shares
• Dividends can only be paid when the company has distributable profits and the first claim will be for the preference shareholders
• Preference shareholders often have a right to priority over the ordinary shareholders when capital is returned on a winding up
• The rights of preference shareholders to a dividend may be cumulative (where arrears of preference dividends not declared in earlier years must be paid as well as that for the current year, before any is paid to ordinary shareholders) or non-cumulative (where only the current year’s right to a dividend is payable)
• They may also be participating (where the shareholders can also participate in a dividend or capital on a winding up alongside ordinary shareholders) or non-participating (where they only receive their fixed preferential rights)

Question 36

Other classes of share

Answer 36

Deferred shares - normally only have a right to dividend/capital on winding up after the claims of preference and ordinary shareholders. Not common. Usually issued to founders of the company where they offer to defer their own entitlements to those of investors.

Redeemable shares - temporary shares which may be bought back by the company at a future date

Non-voting shares: may be issued when the company seeks to restrict control of the company

Convertible shares: shares which may be converted to a different type of share according to a pre-arranged formula

Employees’ shares: often under an employees share scheme which has tax advantages. Usually issued as ordinary shares but are subject to restrictions e.g. on transfer

Question 37

Class rights where the terms of issue are silent in some respect

Answer 37

Birch v Cropper: where the terms of issue of a class of shares are silent in some respect, there is a presumption that all shareholders rank equally.

Question 38

Variation of class rights

Answer 38

Section 630 CA 2006 provides that class rights can only be varied:

(1) In accordance with the relevant provisions in the company’s articles
(2) If there is no provision in the articles where:
(a) 75% in value of the shares of the affected class consent in writing
(b) A special resolution is passed at a separate meeting of the holders of the affected class of shares
- Companies may also entrench class rights in their articles (s 22) and if so, this cannot be circumvented by changing the rights attached to shares under s 630
- Shareholders voting at a class meeting to vary rights must vote with the dominant purpose of benefitting the class as a whole, or the variation may be deemed invalid (British America Nickel v O’Brien)

Question 39

What is a ‘variation’ of class rights?

Answer 39

• The provisions under s 630 only apply if the shareholders have class rights which are to be varied
• Variations which affect the exercise of the rights rather than the rights themselves are not subject to s 630
• Class rights are not varied simply if the company issues more shares of that same class, even though it may dilute. This is because the substantive legal rights of the class have not been altered. (White v Bristol Aeroplane)

Question 40

Rights to object to a variation of class rights

Answer 40

Section 633 gives the right to dissenting members of a class of shares to challenge a variation. The conditions are:

(1) Only shareholders holding at least 15% of the issued shares of that class may challenge a variation, and
(2) The variation must be challenged in court within 21 days of the date on which consent was given or the resolution was passed to vary the class rights.
- Since the common law indicates that a vote on a resolution to vary class rights must be exercised for the dominant purpose of benefitting the class as a whole, this may be a ground of challenge (British America Nickel v O’Brien)

Question 41

The legal effect of the articles

Answer 41

• s 33 CA 2006: a company’s articles constitute a contract which is binding on the company and the members themselves
• generally, the usual rules of contractual interpretation apply to the articles. However, there are a number of important differences in the manner in which the articles are interpreted by the court.

Question 42

Manner in which articles are interpreted by the court

Answer 42

• The articles cannot be supplemented by additional terms implied from extrinsic circumstances (Bratton Seymour v Oxborough)
• The court has no jurisdiction to rectify articles (Scott v Frank F Scott)
• The literal interpretation of an article has to be applied (Sugarman v CJS Investments)
• Terms can be ‘implied’ where necessary for the proper construction of the articles (Equitable Life Assurance v Hyman)

Question 43

Can the members sue the company/be sued by the company?

Answer 43

• Any member has the right to enforce the terms of the articles against the company under s 33, and the company under s 33 is also entitled to enforce and restrain breaches of the articles against its members.
• Wood v Odessa Waterworks: on the application of W, a shareholder, the court granted an injunction to prevent the company from acting on that resolution as it was inconsistent with the articles.
• Pender v Lushington: where an individual member’s rights have been infringed, that member may bring a personal action to enforce those rights.

Question 44

Qualifications to members suing the company and vice versa

Answer 44

• The articles can only create a contract between the company and the members in their capacity as members, and not in any special or personal capacity. They also do not give any rights to a person who is not a member.
• Eley v Positive Government Security Life Assurance: claim failed as E was seeking to enforce rights under the articles in his capacity as a solicitor.
• A member can sue another on the contract created by the articles without joining the company as a party

Question 45

Shareholder Agreements

Answer 45

• a contract entered into between the shareholders, supplements the articles
• usually entered into on incorporation or another significant event (e.g. when a family company invites an outsider to invest)
• usually is entered into by all the shareholders
• the company may also be a party but not to any provisions in the agreement which would have the effect of fettering the statutory powers of the company.

Question 46

Main advantages of a Shareholders Agreement

Answer 46

(1) Normal contractual rules apply, so unlike the articles (which can be altered by special resolution under s 21 CA 2006), a shareholders agreement can only be altered if all shareholders agree
(2) The provisions can be enforceable by injunction
(3) It is a private agreement and only binds those shareholders who are party to it.

Question 47

Effects of a Shareholders Agreement

Answer 47

• Although a company may not bind itself not to exercise its statutory powers, an agreement by the members in a shareholders agreement that they will not support such a resolution is binding
• It can therefore be an effective way of limiting the possibility of major changes within the company and protecting the interests of minority shareholders
  (Russell v Northern Bank Development Corpn).

Question 48

Typical terms of a Shareholders Agreement

Answer 48

• The purpose is generally for the shareholders to agree how they will vote on particularly important decisions, in a way that they cannot do in the articles due to restraints of CA 2006
• Typical provisions are: each of the shareholder is entitled to appoint a director, no shareholder will vote in support of an alteration in the company’s articles unless all agree, no shareholder will vote to remove a director unless all agree, except in specified circumstances no shareholder will require the repayment of money they had lent to the company.

Question 49

Main disadvantage of a shareholders agreement

Answer 49

• only binding on those shareholders who signed up to it
• often dealt with by requiring new shareholders to join an existing shareholders agreement by executing a “Deed of Adherence”