Учебный год 22-23 / Critical Company Law
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94 Critical company law
Spence (Reading) Ltd. In 1990 it went into creditors’ voluntary liquidation. The second was incorporated in 1986 and took the name of Mike Spence (Motorsport) Ltd. In 1989, it went into voluntary liquidation. The third company, Mike Spence Classic Cars Ltd, was incorporated in 1990.
Classic Cars experienced financial di culties and a joint venture was formed between the plainti , Mr Silverleaf and Mr Thorne, the defendant, whereby the plainti would fund the purchase of stock. The company’s financial position continued to deteriorate and the plainti complained that the terms of the joint venture had not been met and refused to supply any more funds. In 1992, accountants reported that the company owed the plainti £135,000 with further debts of £200,000 for unsecured creditors. The plainti commenced proceedings claiming the money lent to and used by the company, stating that ss 216 and 217 of the Insolvency Act 1986 were satis- fied in relation to the defendant as a director of the company. The plainti claimed that the defendant was personally liable, jointly and severally with the company in respect of the sum owed by the company to the plainti .
The judgment was in favour of the plainti . The defendant appealed on the basis that the plainti aided and abetted him in committing the o ence under s 216 and that on the grounds of public policy he should not be allowed to profit from his crime. However, the court held that the name of the company was so similar to that of the two previous companies as to suggest an association with them and accordingly it was a prohibited name within the meaning of s 216(2) of the 1986 Insolvency Act. The defendant satisfied the requirements of s 217 since he was involved in the management of the company in contravention of s 216. Furthermore there was no basis for denying the plainti a remedy under s 217 on the grounds of public policy as this was not a situation where the plainti was attempting to benefit from his own wrong.
As the CLR noted, proceedings under s 217 are rare, as remedies are more readily available under ss 213 and 214 of the Insolvency Act.119 It also noted that this might be because directors had become more cautious in their re-use of names as a result of s 216. The CLR considered whether the unlimited liability in s 217 should be extended to liability for the first company’s debts but ultimately concluded that this would disadvantage bona fide investors and creditors of the second company.
The CLR generally considered that phoenix companies continued to present a significant problem and were particularly concerned to tackle the problem of directors selling company assets to a second company under value, prior to putting the first company into liquidation. To deal with this problem the CLR proposed that s 320 of the 1985 Act should be extended to impose liabilities on the first company’s directors if company assets were sold in the year immediately preceding winding up, if the price of the assets were not
119 CLR Final Report, Vol 1, p 326.
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independently valued or if the sale was not approved by an independent majority of shareholders. In this situation the CLR recommended extending the liquidator’s powers under s 322 of the 1985 Act to an amended s 320. It further recommended that leave of the court under s 216(3) should not be given if there was ‘a material transfer of assets within the twelve months prior to liquidation to a new company in which the director was also interested unless the transaction complied with the amended section 320’.120
THE CONTRACT AND THE CONSTITUTION: THE LEGAL EFFECT OF THE COMPANY CONSTITUTION
The legal e ect of the company constitution is set out in s 33 of the 2006 Act and was previously held in s 14 of the 1985 Act. Both sections identify the terms of the constitutions as being binding on both the company and the members although the 2006 Act modifies the 1985 Act in some important respects. Both sections are the most direct articulation of a contract existing between company and member, the terms of which are held in the constitution. Thus the cases which have referred to these statutory provisions test the extent to which members can enforce the terms of the constitution, the extent to which the company may enforce the terms of the constitution and who may enforce the terms against whom. In other words, these cases test the extent to which there really is a contract between member and company. Their conclusion is clear. The ‘company contract’ does not conform to the standards of an ordinary contract except in some limited circumstances when the court is dealing with a small private company.
It is also worth stating that in respect of the company contract the normal remedies in respect of contract do not apply. Thus the articles may not be defeated on the grounds of misrepresentation, duress, undue influence or mistake. As Steyn LJ explained in Bratton v Oxborough,121 the articles of association are a form of statutory contract to which normal contractual principles cannot apply. So the vitiating factors noted above do not apply and neither may terms be implied into the contract even if (as in Bratton) the articles did not fully express the original intentions of the incorporators.122 Likewise, in Read v Astoria Garage (Streatham) Ltd 123 a managing director who was appointed under the articles but held no service agreement was dismissed following an ordinary resolution and in accordance with the terms
120Ibid, p 333. This recommendation in respect of the Insolvency Act is obviously not part of the reforms in the 2006 Act.
121Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693.
122Towcester Racecourse Co Ltd v Racecourse Association Ltd [2003] 1 BCLC 260.
123[1952] Ch 637.
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of the articles. Here, no agreement as to reasonable notice would be implied because the manner of dismissal was determined by the express provisions of the articles alone.
Section 33 of the 2006 Act irons out some of the inequalities between member and company which were held in s 14 of the 1985 Act. This latter section provided that the legal e ect of the memorandum and the articles124 was that they bound company and members as if signed and sealed by each member. It was treated as signed and sealed by members but not by the company. Section 33 redresses this and instead states: ‘The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions.’125 Furthermore, the old s 14 provided that money or debts payable by members to the company was a speciality debt so that the company could pursue these debts up to 12 years after they became due. Conversely, a debt owed by company to member was merely an ordinary debt giving the member just six years to pursue moneys owing. This provision has been replaced by s 33 of the 2006 Act and revised to make the constitution equally binding on both company and member and to remove the inequality inherent in making a debt owed by member to company, ‘in the nature of a speciality debt’. This section now states: ‘Money payable by a member to the company under its constitution is a debt due from him to the company. In England and Wales and Northern Ireland it is of the nature of an ordinary contract debt.’126
Clearly the Act is attempting to construct a more expressly articulated contractual relationship between member and company which is in line with the contractarian principles the reform process has adopted. However, cases hitherto showed that s 14 did not lead the courts to construe the relationship between member and company or indeed member and member as contractual unless factually they were like contracts. So it is di cult to see how tinkering with the wording in s 33 will alter this. As Steyn LJ stated in Bratton, the contract between members and company is ‘a statutory contract of a special nature with its own distinctive features. It derives not from a bargain struck between the parties but from the terms of the statute’.127
The first of these characteristics noted by Steyn LJ is that the contract is only binding in respect of the rights and obligations between the members of the company acting qua members. And it is consistently clear from the case
124Section 14 refers to ‘the memorandum and articles’ as under the old Act the former was the primary constitutional document. Section 33 replaces this phrase with the words, ‘a company’s constitution’ to reflect the new role of the memorandum, articles and other constitutional documents.
125Section 33(1).
126Section 33(2).
127Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693, p 698.
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law that the articles bind members qua members only, so individuals seeking to sue under the articles may only do so in their capacity as members.128 For example, in Beattie v E & F Beattie Ltd 129 the defendant director (who was also a shareholder) wished to have the dispute he was involved in with the company referred to arbitration as was provided for in the articles of association. The court held that he could not avail himself of this right as it was only available to members and not to directors. And, although he was a member, he was in dispute with the company qua director, rather than qua member.
The second of these characteristics is that if the articles contain provisions which confer rights and obligations on outsiders then these are not part of the terms that are enforceable by members against the company even if that outsider is a member as well.130 Indeed, the only terms that are enforceable against the company by the member are those that relate to their personal rights – Steyn’s third characteristic. Thus, there is clear authority for the proposition that a member may enforce the contract against the company in respect of his membership rights and the courts will intervene against a company that acts to deny those rights. So in Pender v Lushington 131 the court acted to ensure a shareholder’s right to have his vote counted. In this case the articles limited a member’s vote in a general meeting to 100 but certain shareholders had transferred their shares to nominees. The chairman ruled out the votes but the court held that the plainti shareholder, Mr Pender, was entitled to an injunction against the chairman’s action as he had a right to have his vote recorded. Likewise in Odessa Waterworks,132 the court upheld the shareholder’s right to an injunction in respect of a decision of the directors to pay dividends in debenture bonds rather than cash. The court held that the director’s proposal was ‘inconsistent with the articles of association, and the articles alone are what the court has to consider’.133 Furthermore, ‘there was no contract with the shareholders to pay them a dividend in shares or bonds’.134 It was their personal right to be paid in cash.
A number of cases have discussed the issue of whether the ‘contract’ is enforceable by one member against another. Clearly, if it was generally the case that members could directly enforce the contract against each other it would give credence to the nexus of contract theory, as the company would (at least for certain purposes) be a group of members engaging in commercial agreements. The company as a separate entity would have no function and its
128Ibid.
129[1938] Ch 708.
130Eley v Positive Government Security Life Assurance Co (1875) 1 ExD 20.
131(1877) 6 Ch D 70.
132Wood v Odessa Waterworks Co (1889) Ch 636.
133Ibid, p 639.
134Ibid.
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separateness would be a legal fiction while the members would be repersonalised in a partnership-like relationship. On the other hand, if the contract was only enforceable by a member against the company and vice versa then this would give credence to the notion that the distinct legal personality of the company was not a legal fiction.
In fact the authorities here are mixed but with one important proviso. Cases which allow a member to directly enforce the contract against another member are exclusively concerned with small companies. Here the relationships are like those in a partnership, based on trust and other informal understandings, and so the courts have often found it more appropriate to find a partnership-like solution to a problem. So, in Rayfield v Hands the judge stated that the memorandum and articles constituted a contract between members and was therefore directly enforceable by them without representation by the company.135 This case involved rights relating to shares where Article 11 provided that every member who intended to transfer his shares ‘shall inform the directors who will take the said shares equally between them at fair value’. The plainti shareholder tried to exercise this right but the directors refused to buy the shares, stating that the contract was an issue between shareholders and the company, an arrangement to which directors were not a party and that ‘no relief can be obtained in the absence of the company as party to the suit’.136 In judgment, Vaisey J examined the authority to date, finding little to support the plainti ’s claim bar Lord Herschell’s dissenting judgment in Welton v Sa ery137 and dicta in Hickman v Kent and Romney Marsh Sheepbreeder’s Association.138 In the latter case Astbury J stated that ‘the articles are simply a contract as between the shareholders inter se in respect of their rights as shareholders. They are the deed of partnership by which the shareholders agree inter se.’139 And, in the former case, Lord Herschell stated that ‘[i]t is quite true that the articles constitute a contract between each member and the company, and that there is no contract in terms between the individual members of the company; but the articles do not any the less, in my opinion, regulate their rights inter se’.140 However, Vaisey J found that authorities which indicated that the articles should be construed according to the realities of the situation were more pertinent in this case. The company here had four shareholders, three of whom were directors. Thus he stated that it was ‘material to remember that this private company is one of that class of companies which bears a close analogy to a partnership’.141 And as a partnership could ‘validly and properly
135[1960] Ch 1.
136Ibid, p 6.
137[1897] AC 299.
138[1915] 1 Ch 881.
139Op cit., Rayfield, p 7.
140Ibid, p 5.
141Ibid, p 9.
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provide for the acquisition of the share of one partner on terms identical with those of Article 11’, so could a quasi-partnership such as this company.
Thus the principle that the contract exists (in so much as it exists at all) between the legal entity, the company and the member was not questioned, but the reality of this situation meant that a partnership-type solution could be imposed and the articles were directly enforceable by the member against the directors. In the vast majority of cases the articles constitute a contract between company and member and there is no contract between the individual members of the company. Therefore the enforcement of rights against another member must be through the company, thus the solution is based in company law and not partnership law.142
It is finally worth noting that the statutory contract which is the articles is freely alterable by the company notwithstanding that such an alteration may cause it to breach an extrinsic contract with an outsider. Thus minority shareholders who do not want this alteration will be forced to accept it without the consent or fresh consideration required in law for a variation of an ordinary contract. So in Punt v Symons and Co Ltd,143 the court held that a company could not by contract, even an extrinsic contract, exclude its power to alter the articles. This was upheld in the case of Southern Foundries Ltd v Shirlaw.144 Mr Shirlaw was appointed managing director for 10 years under a 10-year service contract. When the company altered the articles to allow a principal shareholder to remove any director, the House of Lords held that the company could alter its articles to this e ect, as it could not contract out the right to alter its articles. However, the company would have to pay compensation for any breach of contract that emerged from the alteration in the ordinary way.
Thus it can be seen that despite the purported contract expressed in s 14 and its previous incarnations, the courts have construed the contract in an extremely limited fashion.The fact that the courts are willing to enforce the contract in respect of enforcing personal rights but not other provisions in the articles is instructive. The contract between the member and the company does not, it seems, encompass the constitution in total, which can, as noted earlier, be altered following a special resolution whether an individual member wishes it or not. Instead the contract is limited only to the rights that accrue to ownership of a particular piece of property, the share. And, those rights are largely limited to voting rights and rights to dividend if a dividend is declared. This means that in case law, far from the members emerging as equal contracting partners with the company, they are conceived as holders of particular rights in the company, which are strictly limited and protected
142Welton v Sa rey [1897] AC 299.
143[1903] 2 Ch 506.
144[1940] AC 701.
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in both the articles and in statute. And, for the most part it is statute, not the contract, that prescribes the rights which accrue to shareholders. Shareholders are purchasers of a product and they are entitled to have certain expectations of that product. But as the case law makes clear, this does not of itself elevate them to the position of quasi-partners. Quasi-partnership solutions will be used if the company is a quasi-partnership and the principles established in these contexts are not utilisable in large companies. The company contract does not work at a similar level to other contracts. It usurps other contracts and may change its terms in accordance with majority requirements. The content of the articles and the other constitutional terms continue to be highly prescribed by statute, in a way which is appropriate to the protection of a kind of shareholding which does not or cannot protect its interests directly and requires the protection of statute. It is indicative of an absence of contractual control and active involvement by members rather than the contrary.
The doctrine of ultra vires
A company is formed for particular commercial purposes. In the case of a registered company these purposes are set out in the objects of the company which (unless under the 2006 Act) are held in the memorandum of association. Under common law a company was obliged to undertake only that business which was specified in the objects. The doctrine of ultra vires stated that if the company entered into a contract, the substance of which were purposes not stated in the objects, such a contract was ultra vires and void. Alternatively, if a company entered into a contract through an act of a director which was outside his powers to act specified in the company constitution (usually in the articles of association or a company resolution), the contract was ultra vires the director and voidable at the instance of the company. It was also a breach of fiduciary duty. Any member or creditor or persons o cially representing creditors were empowered under common law to have such transactions declared ultra vires. In this way some managerial power was retained by the individuals involved in the company. They had lent money or goods to the company or had purchased shares and so were entitled to ensure that their investment would go towards the kinds of business activities specified in the company’s constitution. They were also entitled to ensure that directors complied with the restrictions upon their powers under the constitution.
It was something of a last resort doctrine but it was an e ective mechanism by which investors could protect their investment. However, since the first application of the ultra vires doctrine to registered companies this protection has been whittled away. Company stakeholders have become increasingly passive and correspondingly so have their powers of intervention. This has occurred over three main phases.
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First, the doctrine itself was applied with increasing latitude by the judiciary who moved from a strict application in 1875 to an increasingly flexible application in the succeeding decades. Second, the 1989 Act made contracts which were outside the company’s objects or outside the directors’ authority enforceable, but made directors liable for any losses su ered by the company. It also left any residual powers to halt ultra vires acts in the hands of members only, leaving out creditors. Third, the 2006 Act no longer requires companies to specify their objects and removed the small powers of intervention left to members in the 1989 Act.
In phase one, the doctrine of ultra vires in early cases was first applied very strictly but was later applied very loosely. In early cases, a company did not have the power to do acts which were not precisely specified in its constitution and the judiciary showed little flexibility in respect of this requirement. So, in
Ashbury Railway Carriage & Iron Co v Riche,145 a company incorporated under the Companies Act 1862 stated as its objects ‘to make, sell, lend or hire, railway carriages, wagons, plant, machinery etc’.146 The House of Lords declared a contract to finance the construction of a railway in Belgium to be ultra vires and void because such a contract was not specified in the objects. Furthermore, although clause 4 of the objects provided that ‘an extension of the company business beyond or for other than the objects or purposes expressed or implied in the memorandum of association shall take place only in pursuance of a special resolution’, the House of Lords stated that ratification (even by all the shareholders) would have been ine ective.
Where a company is formed on the principle of having the liability of its members limited to the amount unpaid on their shares . . . the memorandum of association shall contain . . . the objects for which the proposed company is to be established . . . the company . . . is to be an existence and to be a coming into existence for those objects and for those objects alone.147
This case was the start of a long journey towards judicial leniency in respect of ultra vires contracts. The first step was taken in A-G v Great Eastern Railway Co 148 where a company incorporated by statute to acquire two existing railway companies and to construct another railway wanted to hire locomotives and stock from another company. The court decided that this contract would not be ultra vires as it was reasonably incidental to the main objects.
1451875 LR 7 HL 653.
146Clause 3 of the memorandum.
147Op cit., judgment p 665.
148(1880) 5 App Cas 4731.
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Later in this phase, the judiciary began to take an ever more lenient attitude to the construction of the objects clause. In an earlier case149 the court declared that a company had failed to achieve the business for which it was incorporated by reason that it had not attained one of the clauses (upon which all the other objects were said to be ancillary), and so the company was wound up for just and equitable reasons. But by 1918 the courts accepted a clause making each separate object in each sub-clause an equal and independent object.150 In this case, Essequibo, a rubber company, had a long objects clause that ended with a clause that the objects should not be restrictively construed and that each paragraph should be regarded as conferring a separate and independent object. Each clause was held to be substantive and not subsidiary to the main or leading object. Essequibo entered into an agreement to underwrite an issue of shares from another company. Later, when both companies were in liquidation the liquidator sought an application to render that transaction ultra vires and void. The court said that the validity of the clause could be upheld, underwriting the issue of shares was not ultra vires and the memorandum had been correctly compiled with. This case facilitated the practice of creating long lists of object clauses.
By the 1960s the courts went as far as to accept the validity of a subjective objects clause. In Bell Houses Ltd v City Wall Properties Ltd,151 the court upheld the validity of a clause that empowered the plainti company to
carry on any other trade or business whatsoever which can, in the opinion of the board of directors, be advantageously carried on by the company in connection with or as ancillary to any of the above businesses of the general business of the company.152
Furthermore, despite judicial antipathy to companies making noncommercial payments, famously encompassed in the statement that ‘there shall be no cakes and ale except such as are required for the benefit of the company’, it gradually developed an increasingly tolerant attitude to gratuitous payments.153 In the early period, even if a company held an express clause in its objects stating that it could make a gratuitous payment of some kind, the judiciary continued to test the validity of acts made in pursuance of those clauses according to whether the act was bona fide and for the benefit of the company.154 Later, however, the courts upheld some payments if they were bona fide and for the benefit of the company and reasonably incidental to the
149Re German Date Co ee Company (1882) Ch 20, 169.
150Cotman v Brougham (1918) AC 514.
151(1966) 1 QB 207.
152Ibid.
153Hutton v West Cork Ry Co (1883) 23 Ch D 654.
154Re Lee, Behrens & Co Ltd [1932] 2 Ch 46.
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business. In Evans v Brunner Mond & Co 155 the plainti , a shareholder, challenged the decision of the company to distribute to universities and scientific institutions the sum of £100,000 in furtherance of scientific education. Although a resolution authorising this distribution had been passed by an overwhelming majority of shareholders, he argued that the motion instituted an activity that was not incidental to the company’s business and was not for the benefit of the company. He argued that the rightful beneficiaries of the money would only benefit to a very small degree while the cost of the gift to the company was very great. The court, however, upheld the gift saying that as the company was
in constant need of a reserve of scientifically trained men for the purposes of its business – and the business cannot be maintained if the supply of such men is deficient – that a deficiency is almost inevitable unless substantial inducements are forthcoming to attract men to scientific study and research – that the best agencies for directing these studies are well equipped universities.156
Later still, where there was an express clause allowing the company to make gifts the courts upheld acts made in pursuance of such a clause without applying the bona fide and for the benefit of the company test. So in 1970, in the case of Charterbridge Corp Ltd v Lloyds Bank Ltd,157 the court held that an agreement to guarantee another company’s debts although made without payment in return was intra vires as there was an express object in the memorandum allowing such guarantees. Later, the courts showed even greater latitude by allowing a payment that was not necessarily incidental to the company’s business or for the benefit of the company, on the basis that noncommercial clauses would be upheld.158 However, if no such clause existed the courts would continue to assess whether such gratuitous payments were bona fide and for the benefit of the company.159
In the second phase, the provisions on ultra vires contracts in the 1989 Act radically reformulated the ultra vires doctrine. Under these new sections, which were subsequently incorporated into the Companies Act 1985, a contract entered into by the company which was beyond its capacity would no longer be void; however, a director would be liable to the company for any loss. Section 35(1) of the 1985 Act stated that a company’s capacity was not limited by its memorandum but retained directors’ liability in s 35(3) which stated that ‘it remains the duty of the directors to observe any limitations on
155(1921) 1 Ch 359.
156Ibid, p 369.
157[1970] Ch 62.
158Re Horsley & Weight Ltd (1982) 3 All ER 1045.
159Simmonds v He er [1983] BCLC 298.