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In this issue, the Company Law Memo Newsletter looks at the three main areas of reform in the Companies Bill affecting shareholders. They are shareholder decision-making, shareholder litigation and share allotments. |
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Shareholder decision-making
In keeping with the Government’s “think small first” approach to company law, the Companies Bill introduces a number of provisions to simplify the shareholder decision-making process for private companies. Public companies will not benefit from these reforms.
The current law assumes that shareholders will make decisions at a meeting. Most decisions can be made by ordinary resolution, needing more than 50% of shareholders voting in their favour to be passed. Certain important decisions however must be made by special resolution, requiring a majority of at least 75%. A written resolution procedure is available if the shareholders wish to make a decision without meeting, but such resolutions must be passed unanimously.
The Companies Bill makes it much easier for private companies to make decisions by written resolution, obviating the need for a costly and/or inconvenient meeting. The most important change to the current procedure is that written resolutions will no longer need to be passed unanimously. Instead, each resolution can be passed by the same majority as it would need at a meeting (ss 289, 290).
The second important change is that there will be no need for the resolution to be written in the sense of it having to be in hard copy. It will be possible to circulate resolutions in electronic form (e.g. by email) or by posting them on a website.
Private company shareholders will be able to make all decisions by written resolution except those to remove a director or auditor from office (s 288). The procedure will be available for resolutions proposed by the directors and those proposed by shareholders with a combined holding of at least 5%.
Since written resolutions will become a real substitute for meetings, the legislation sets out the procedure in some detail (ss 295-307). Briefly, the resolution will have to be circulated to all eligible shareholders, i.e. those who would be entitled to vote on the resolution at the date and time the first shareholder is sent a copy.
The resolution will have to be accompanied by instructions on how the shareholder is to signify his consent, which can be by electronic means. Consent will be deemed to have been given when received by the company; not when sent by the shareholder and, once given, cannot be revoked.
The resolution will also have to be accompanied by a statement setting out the last date on which the resolution may be passed. If no date is specified, this will automatically be 28 days from the date the first shareholder was sent a copy. If the last date passes without the requisite majority of consents being obtained, the resolution will lapse. There does not appear to be a mechanism for extending the length of time; the resolution will have to be proposed again.
The resolution will be passed when the requisite majority has been obtained; there will be no need to wait until the last date or until responses have been received from all shareholders. Significantly, if the resolution is passed, its validity will not be affected by the company having failed to circulate it correctly. This will make it more difficult to challenge resolutions because of procedural irregularities and increases the amount of certainty in the decision-making process.
The Bill further reduces the regulatory burden on private companies by abolishing the need for them to hold AGMs unless they opt to do so in their articles. This reverses the current law by which private companies must hold AGMs unless they elect not to do so.
These reforms are likely to be welcomed by most private companies. The new procedure, particularly the use of electronic communication between a company and its shareholders, certainly reflects modern business practice and will cut regulatory costs.
The effect of the two reforms is that shareholders of private companies will rarely, if ever, have to meet. One potential disadvantage is that shareholders may feel they lack a forum for their voices to be heard. It remains to be seen whether or not this results in greater shareholder activism, for example, by an increase in the number of shareholders requisitioning meetings or bringing derivative claims against the directors, particularly in light of the reforms in this area discussed below.
Memo points: Public companies will not be able to use written resolutions and will have to hold their AGM within six months of the end of their financial year (s 288).
Shareholder litigation
The Companies Bill gives all shareholders an important new derivative action right by which they can bring claims against the company’s directors (ss 260 – 264). A derivative action is one brought by a shareholder to enforce a right which is vested in the company. For example, if a company’s director personally profited from a business opportunity which rightly belonged to the company, the company would have the right to bring a claim against the director for breach of trust. In some circumstances, the shareholder could bring the claim instead. This is known as a derivative claim; the shareholder’s right to bring the claim derives from the company’s right.
The current law is based on case law, not statute. It states that a shareholder may only bring a claim which is vested in the company where there has been a “fraud on the minority”. This is commonly referred to as the rule in Foss v Harbottle after the case upon which the law is based. Even where there has been a fraud on the minority, a shareholder may not bring a claim if the alleged wrongdoing has been ratified by the company (i.e. where the action has been given retrospective approval). The result is that it is difficult for shareholders to bring claims where there has been wrongdoing by the directors, especially when the directors hold a majority of the company’s shares.
The new procedure specifically will not replace the rule in Foss v Harbottle; it will be in addition to it. It will only be available for a claim that a director has breached one or more of his duties. This will include all of the new codified directors’ duties such as the duty to exercise reasonable care, skill and diligence (see Company Law Newsletter Issue 2, Focus On…). It will not be necessary for the director to have benefited personally from the wrongdoing, nor will it be necessary for him to control the majority of the company’s shares.
Many commentators expressed concerns about this procedure when the Bill was first introduced to Parliament, foreseeing a large increase in shareholder litigation. In response to concerns about frivolous claims, the Government amended its original proposals. The new procedure now consists of a two-stage process. At the first stage, the court will act as a filter for claims without merit. It will be obliged to consider the applicant shareholder’s evidence and decide whether there is a case to answer. The court will not hear evidence from any other parties, although it will be able to require evidence from the company before the substantive case begins.
The court will be obliged to refuse permission to continue the case where the director’s actions have been authorised by the company. It will also be obliged to refuse permission where the director’s actions have been ratified by the company. However, the Bill provides for a new law on ratification which makes it more difficult to achieve. A breach of duty by a director will only be capable of being ratified by the shareholders, without counting any votes in favour of the ratification cast by the director concerned or any person connected to him (e.g. his spouse). The final circumstance in which the court will have to refuse permission is where the claim would not promote the success of the company. It remains to be seen how this is interpreted by the courts, but it potentially affords them a great deal of discretion.
Where none of the mandatory grounds for refusal is present, the court will still have discretion to refuse permission. In coming to its decision, the court will have to take into account: - whether or not the applicant shareholder is acting in good faith; - the importance that a person who was under a duty to promote the success of the company would attach to the claim; - whether the director’s actions are likely to be authorised or ratified by the company, if they have not already been; - whether the company has decided not to pursue the claim in its own name; and - whether the shareholder could pursue a claim in his own right rather than on behalf of the company.
Even after these changes, there is still a great deal of concern about the new procedure amongst commentators who doubt whether the courts have the capacity to deal with any substantial increase in the amount of shareholder litigation. In addition, it remains to be seen whether or not judges exercise their “first stage” discretion robustly or lean in favour of allowing applications to go to a full hearing in the interests of justice. In any event, this procedure will provide shareholders with a valuable new way of taking action against errant company directors.
Memo points: The new derivative procedure will also result in amendments to the Civil Procedure Rules, which govern the conduct of court proceedings.
Share allotments
The Companies Bill contains an important relaxation in the law on share allotments for private companies with only one share class. Such companies will not need to have prior authority from their shareholders to allot further shares in that class (s 564). In addition, the Bill abolishes the concept of authorised share capital. This means that there will be no ceiling on the number or value of shares which a company may allot. The combination of these reforms is that it will be much easier and simpler for small private companies to allot shares.
Statutory pre-emption rights will still apply to allotments. This means that existing shareholders will have to be offered new shares in proportion to their current shareholdings before the shares can be allotted to an external person. However, as now, companies will be able to disapply the pre-emption rights by including a provision to that effect in their articles or by passing a special resolution (s 583). Companies often disapply pre-emption rights in this way and shareholders of private companies with one share class will need to check that they are not left unduly exposed. Where pre-emption rights are disapplied, such shareholders may find their holdings diluted by unrestricted directors’ allotments. |
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SHAREHOLDERS AND THE COMPANIES BILL |