Учебный год 22-23 / Critical Company Law

154 Critical company law

company’.2 What they did own was title to revenue and other residual rights of ownership such as voting rights. Thus a shareholder remained the owner, by dint of owning a function of the company – the fruit of its activity, that of making profits.

With shareholders’ interests and ownership more clearly delineated, describing the boundaries of the company should have been, in principle, much simpler. The company was everything that the shareholder did not own. It was assets, human and tangible, contracts, business associations and goodwill. In short it was the productive assets of the company divorced, in law, from human ownership. Taken as a whole, companies now represented the productive assets of society as a whole.

In respect of directors’ fiduciary duties, company law has wrestled with the challenges presented by the doctrine of separate corporate personality because, as a direct result of this doctrine, the question arose – what is the company? In order for a director to fulfil his duty to the company, the law must have an answer to this question. The answers have varied. In some cases the company is construed as its assets, but in others it is construed as the function of the assets, that of making profits. When the company first emerged as a separate legal being the tendency of the judiciary was to view the company as a function of its assets. In this period directors’ duties reflected both the continuity of trustee principles and a newer pro-investor approach. By construing the company as being its function, shareholders’ interests were more directly and immediately promoted. For example, the old law on dividends emphasised the company as being a dividend-creating organisation whose interests were protected when its directors pursued dividend-creating policies. As we shall see, this approach often subordinated to the protection of company assets and thus the interests of a company creditor. Furthermore, it soon became clear that when this orientation was pursued too rigorously, the company’s assets and ultimately its potential to make profits were put at risk.

Later, this early emphasis on the company as function was superseded by a judicial understanding of the company as being its productive assets. In this period the emphasis was on a director’s duty to act in the manner of a trustee of the company’s assets, although the nature of a company’s assets could be construed quite widely including goodwill and business opportunities as well as the more obvious tangible assets. This new emphasis on the company’s

2The view taken of shareholders’ ownership rights in Macaura v Northern Assurance Co Ltd [1925] AC 619. The process of separating company property from shareholder property was a process that began with large companies. By the end of the century this conception was regarded as correct regardless of the size of the company.

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assets also brought creditors into the equation. Finally, from around the 1980s, the ideological emphasis has been upon the company as a competitive contractual being in the same way as a director may be. This contrasts with the law’s previous strict approach to a director profiting from his fiduciary position. In this climate a director’s duty to his company will only be breached when he benefits from something which the company could have enjoyed, even if the benefit is something he himself would not have enjoyed had he not been a director.

In this, English law is reflecting the long-established position of American corporate law where a director may obtain a benefit in the course of his employment as long as the company wasn’t a real competitor. This period is interesting because while the larger most significant companies have a dispersed and passive membership whose separateness is evident both materially and legally, the reigning ideology is neo-liberal contractarianism which constructs and relies upon an active capital investor. The interplay between these three factors results in the company being construed as a nexus of contracts in which the competing interests of the contractees are pursued and encapsulated. The company as competitor becomes, ideologically, the company as a nexus of competition within a competitive market, and the facility for a director to pursue corporate opportunities is understood in terms of agency costs.

These three periods will be discussed under the following headings:

•the company as defined by its function;

•the company as defined by its assets; and

•the company defined as competitor or a nexus of competition.

Within these periods, a director’s fiduciary duty to act in good faith and the duty not to profit personally from a fiduciary position will be considered. In discussing the contemporary position under the 2006 Act, the duty not to abuse given powers, the duty of confidentiality and the duty of care will also be discussed. The 2006 Act attempts to encapsulate a director’s duty within the contractarian framework and to remove linguistic references to the trustee principles established over many decades of case law. Whether the courts will eschew such a large body of law is unlikely, although in interpreting the statutory provisions some modifications are likely.

In setting out these three periods, it must be appreciated that not every case precisely conforms to the normative values of its time. The interplay of the three formative factors of company law: law; ideology and economy will often produce judgments which seem slightly out of place. Furthermore, no period abruptly stops, but instead seeps into the next, gradually losing influence and relevance.

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DIRECTORS’ DUTIES TO THE COMPANY AS

FUNCTION (1850–1910)

The functional is the dominant perspective of the period of early modern company law up to the first decade of the twentieth century. During this time there was a great deal of law which suggested that a director’s fiduciary duty was owed solely to the function or purpose of a company: that of making profits. Invariably, the short-term interest of the shareholders, in the form of dividends, was seen to be of greater importance than the protection of company assets, which provided comfort to creditors. And although the general principle that the company is represented by the interests of shareholders persists (and indeed has become enhanced by the recent company law reform), this period di ers in that its interpretation of that interest is both exclusive and pertains specifically to the short-term interest in dividends.3

During this period a director would not be in breach of his duty to the company if he diminished company assets in order to pay dividends. That is not to say that there was a total absence of restrictions in respect of the payment of dividends. Clause 73 of Table A stated that ‘no dividend shall be payable except out of profits arising from the business of the company’.4 However, in court this restriction was modified by the judiciary’s liberal interpretation of profit. In an 1880 case, Lord Jessel concluded that when assessing the legality of dividends, the court need not consider capital losses from previous years.5 In this case a tramway company had failed to maintain company assets, or to set aside a maintenance fund, notwithstanding that the articles stated that the directors should ‘before recommending a dividend, set aside out of the profits of the company . . . such sums as they think proper as a reserve fund for maintenance, repairs, depreciation, and renewals’.6 As a result of their failure to do so, an injunction was granted against the company’s declaration of a dividend and in response, an action to dissolve the injunction was successfully brought to court by a preference shareholder. The court held that the issue was not whether the value of the assets had diminished, or indeed whether the failure to observe the articles should be rectified, but whether or not there were su cient profits made that year to pay dividends. If there were su cient, then a dividend could be paid without consideration of the assets.

The courts did make some attempts to protect the assets of the company.

3 The ‘obligation to act bona fide in the interests of the company has been defined as an obligation to act in the interests of the shareholders.’ Farrar’s Company Law, 4th edn, p 381.

4 Companies Acts 1862 Table A. Article 74 also stated that directors may consider making appropriate repairs to company assets before declaring a dividend but were under no obligation to do so.

5Dent v London Tramways Company (1880) 16 Ch D 344.

6Ibid, p 348.

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In Trevor v Whitworth,7 the court established the capital maintenance rule that a company could not buy back its own shares. However, in stark contrast to this approach a case immediately preceding Trevor had the Court of Appeal stating that ‘it is entirely with the shareholders to decide whether the excess shall be divided among them or set apart as a reserve fund for replacing assets, and the court has no power to intervene with their decision however foolish or imprudent it may be’.8

Even in the context of the Trevor case, Lord Watson commented that ‘paid up capital may be diminished or lost in the course of trading, that is a result which no legislation can prevent’.9 There was no requirement to replace assets lost in trading before a dividend was declared. The Companies Act had made only one restriction in respect of the declaration of dividends, that no dividend could be paid except out of profits. In Flitcroft’s case,10 dividends which were paid on false accounts put forward by the directors which made debts look like assets were held to be personally repayable by the directors responsible notwithstanding that they had not personally benefited from the dividends. They were held to be trustees of the money of the company and if they, in breach of their duty, caused those moneys to be taken from the company, they were required like trustees to replace those moneys.

However, the protection of assets that might diminish in value as a result of pursuing profits for dividends was not an objective of the Companies Acts. So, in Lee v Neuchatel Asphalte Co 11 it was held that ‘there was nothing in the Companies Acts . . . to impose on the company any obligation to set apart a sinking fund to meet the depreciation in the value of a wasting product’. Furthermore, Lee emphasised that the power to restore wasting assets lay not with the creditors, who relied on the assets as security, but with the shareholders, whose sole economic interest lay in dividends. The problems for creditors were further exacerbated by the court’s failure to find an adequate definition of profit, making the funds designated available for the payment of dividends ultimately a movable feast.12

Thus in this context a director’s fiduciary duty was not breached by diminishing company assets nor by undermining creditors’ interests. The duty to the company was not to protect tangible property but to protect the shortterm interests of shareholdings. It was a narrower duty even than making the company profitable, which potentially benefits all persons connected to the

7(1887) 12 App Cas 409.

8Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1, p 10.

9Trevor v Whitworth (1887) 12 App Cas 409.

10(1882) 21 Ch D 519.

11Lee v Neuchatel Asphalte, p 1.

12Weiner, J, ‘The theory of Anglo-American dividend law: the English cases’ (1918) Columbia L Rev.

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The plainti s argued that the directors were in a fiduciary position to them and should have disclosed the negotiations with Holden. Counsel for the plainti s argued that the company should be understood as ‘merely the sum of the shares’,15 which at law belonged to the company but in equity belonged to the shareholders. Accordingly, they were the beneficiaries of the company and the directors were ‘trustees of the sale of the undertaking’.16 Counsel contended that the directors were under a duty to disclose all related negotiations to the beneficiaries. Furthermore, they argued, ‘in this respect the shareholders inter se are in the same position as partners . . . If managing partners employ an agent to sell their business, he cannot purchase the share of a sleeping partner without disclosing the fact of his employment. Incorporation cannot a ect this broad equitable principle.’17 What we can see in this argument is a clear articulation of old company law, when the company was not distinct and separate from the shareholders and where incorporation meant that the company held the legal title to the whole undertaking and members held the equity. It is a reference to companies that were not ‘its’ but ‘theys’, whose shareholders were like partners in their relationship to the assets and in their personal liability for the businesses’ debts. Thus, the most compelling argument against this argument was a firm articulation of the doctrine of separate corporate personality and its ramification:

The company is a legal entity quite distinct from the shareholders: Salomon v Salomon & Co; so that a sale by a mortgagee to a company in which he is a shareholder is neither in form or substance a sale to himself.18

In judgment, Swinfen Eady J sought to show that separate corporate personality severed the directors’ duty to the company from the interests of individual shareholders. Swinfen Eady J set out established authorities on the definition of a director’s duties in the context of the modern, separate company. The first two citations involve earlier cases, where the issue was a director’s personal liability for the company’s financial undertakings, and hence the court had been keen to stress a director’s representative function:

Directors are the mere trustees or agents of the company – trustees of the company’s money and property – agents in the transactions which they enter into on behalf of the company.19

15Ibid, p 423.

16Ibid.

17Ibid.

18Defence counsel in Percival, ibid, p 424.

19Great Eastern Ry Co v Turner (1872–3) LR 8 Ch App 149, quoted Percival, p 425.

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And,

Directors are called trustees. They are no doubt trustees of assets which have come into their hands, or which are under their control, but they are not trustees of a debt due to the company. The company is the creditor, and, as I said before, they are only the managing partners.20

And later,

Although directors are not properly speaking trustees, yet they have always been considered and treated as trustees of money which comes to their hands or which is actually under their control; and ever since joint stock companies were invented directors have been held liable to make good moneys which they have misapplied upon the same footing as if they were trustees, and it has always been held that they are not entitled to the benefit of the old Statute of Limitations because they have committed breaches of trust, and are in respect of such moneys to be treated as trustees.21

The judge goes on to explain that because the fiduciary duty is owed to the assets of the company there are necessarily strict rules on self-dealing under English law, summed up in the overarching imperative for a director to act bona fide and in the best interests of the company. This is a shift of emphasis from the previous prodividend approach. He concludes that the nature of incorporation alters the position of shareholders so that they are not like partners and cannot conjoin themselves with the business so as to make a director’s fiduciary duty, which is owed to the company, one that is owed to them also:

It was strenuously urged that, though incorporation a ected the relations of the shareholders to the external world, the company thereby becoming a distinct entity, the position of the shareholders inter se was not a ected, and was the same as that of partners or shareholders in an unincorporated company. I am unable to adopt that view.22

The decision in Percival v Wright meant that a director’s fiduciary duty was owed to the company and that the company was not the individual shareholders, but a bundle of moneys and other non-financial assets (whose value

20In Re Forest of Dean Coal Mining Co (1878–79) LR 10 Ch D 450, per Jessel MR, quoted

Percival, p 426.

21Re Lands Allotment Co [1894] 1 Ch 616, p 631, quoted Percival, p 428.

22Ibid.

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they must attempt to enhance). And it was only when the company was owned by a small number of shareholders who might reasonably expect to be acquainted with the running of the business, such as to make this company like a partnership or a ‘quasipartnership’, that this position might be modi- fied. The director was legally conceived as owing a duty to the company entity, but not to the shareholders, when materially the company was a distinct being.

It should also be noted that in certain discreet circumstances the court has taken the view, at least by implication, that a director’s duty is owed to its creditors. So in Winkworth v Edward Baron Development Co Ltd 23 a husband and wife who were directors used as their home a freehold property purchased by the company. Prior to this they had purchased shares in the company costing £115,000, using money from the company bank account.

Some months later, and without the wife’s consent, the husband mortgaged the house to the appellant, Winkworth. The company subsequently become insolvent and when it defaulted on the payment of the mortgage, Winkworth brought an action for possession. On appeal, the House of Lords held the withdrawal of £115,000 from the company’s account to purchase the company’s own shares was a breach of their fiduciary duties to the company and its creditors, as was the wife’s failure to discover the mortgaging of the property. Accordingly, equity would not operate on behalf of these parties. Likewise in West Mercia Safetywear Ltd (in liq) v Dodd,24 the director was held to be breach of his duty to the company for transferring some assets from one company to another in respect of an outstanding debt. The court held that once a company was insolvent the interests of the creditors overrode the interests of the shareholders. Therefore the transfer was against the company’s best interest because it was against the interests of the creditors.25

The emphasis on a director’s trustee relationship to the company as assets was most vividly reflected in the ‘no-profit’ rules, which stated that a director could not personally benefit from his fiduciary position. And, during most of the second period under discussion, the no-profit rules were uncompromisingly strict, requiring a director to account for all and any benefits he had gained as a result of his fiduciary position. In respect of conflict of interest situations, whether there was a breach which would allow the company to either avoid the contract or to require the directors to return to any profits made from the transaction would depend on whether consent has been received or an appropriate disclosure made. Both acts would imply that a

23[1987] 1 All ER 114.

24(1988) BCLC 250.

25Brady v Brady (1988) BCLC 20, Re DKG Contractors Ltd (1990) BCC 903, Re Purpoint Ltd

(1991) BCC 121, Knight v Frost (1999) 1 BCLC 364.

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director had acted bona fide and was not therefore in breach. However, a director remains a trustee for company assets, including non-tangible assets such as business opportunities. Thus, in respect of corporate opportunities, in the early part of this period a director would be liable regardless of whether his actions were taken in good faith and for the benefit of the company. However, later cases indicate a greater willingness to assess the bona fides of a director’s actions and to impose liability only if the director has not acted in good faith.

Self-profiting

Conflicts of interest

As we saw in Aberdeen, self-profiting from a conflict of interest situation can involve the director contracting with the company. This section will deal with a number of modifications made in respect of this sort of conflict of interest. In the following section, we will consider another species of selfprofiting, in which a director benefits from personal use of company property, such as business associates or corporate opportunities. Both involve conflicts of interest but the former breach has been subject to a number of modifications which will be considered first. The subsequent section will assess the judicial reasoning on self-profiting, illustrated by a number of important corporate opportunity cases.

The first of these modifications to note was introduced into the standard form articles of association provided for in the Companies Acts by the beginning of the twentieth century. The most recent version is Article 85, in Table A, the standard form made under the 1985 Act. The broad approach has been to prevent a director being penalised for having an interest in a transaction in which his company was involved provided he had disclosed that interest. In full, Article 85 provides:

Subject to the provisions of the Act, and provided that he has disclosed to the directors the nature and extent of any material interest of his, a director

(a)may be party to, or otherwise interested in, any transaction or arrangement with the company or in which the company is otherwise interested;

(b)may be a director or other o cer of, or employed by, or a party to any transaction or arrangement with, or otherwise interested in, any body corporate promoted by the company or in which the company is otherwise interested; and

(c)shall not, by reason of his o ce, be accountable to the company for any benefit which he derives from any such o ce or employment or