Company Law Problem Question

Introduction

The formation of a limited company and the management thereof is a complex set of legal principles contained in common law and statute. The fundamental basis of association between the members and directors of a company is one which is essentially based in contract[1] and as such the enforcement of decisions through the relative power of these stakeholders is primarily based on these articles, informed by legal principles contained in the common law and statute. The autonomy that limited liability affords a company is one of the associated benefits and as such, the courts are hesitant to enforce obligations which may directly undermine this principle. With this in mind, the following opinion seeks to consider the legal issues surrounding the Articles of Association and the concerns raised by Bradley and the other shareholders of TLC. Thereafter, the opinion will consider the liability of TLC for the actions of the insolvent subsidiary companies, Better Built Homes Ltd. and Retirement Villas Ltd.

1. Tony Leicester and Articles of Association

The law of companies in the United Kingdom has placed the power to run a company firmly within the hands of the directors of the company, however this does not preclude the powers of shareholders to affect certain decisions within the company.[2] Certain key concepts will be defined below in order to determine how the members may remove Tony Leicester as a director and technical consultant, as well as to change the name of the company. The role of members in a company has become increasingly passive as company law has developed and to this extent, there is the opinion that the powers of members has resorted to rubber-stamping recommendations of the directors.[3]

Articles of Association

The articles of association constitute the primary constitutional document between the members and the directors, which define the division of power between the two. The articles can be said to constitute a contract between the members of the company and the directors, and as a result orthodox rules of contractual interpretation are applied thereto. The courts have routinely taken a conservative approach to the interpretation of the articles of association and have consistently disallowed the reading in or amendment of the articles to reflect anything other than that which can be expressly interpreted from the wording thereof, regardless of any established intention to the contrary.[4]

The intention of the members at the time of signature of the articles seems to be irrelevant for the purposes of interpreting and amending the articles, and therefore whether the members of TLC were in disagreement with the terms of the articles as drafted and amended by Tony Leicester is irrelevant for the purposes of rectification. The court has stated that it has no jurisdiction to rectify the articles in such an event.[5] This means that the court will not amend the articles, despite it having been the product of Tony Leicester exclusively.

Common law principles of company law have also developed equally conservatively, with the court refusing to enforce any resolution by the members which disregards the terms of the articles themselves.[6] In Imperial Hydropathetic Hotel v Hampson refused to enforce a resolution of a general meeting to remove two directors in contrary to an article which afforded them a fixed tenure.[7] This applies equally to the power of members to overrule decisions by the directors with regards to the company’s business activities.[8] To this extent, any decision taken in contradiction of the articles will be dismissed. This approach by the court is subject to a number of exceptions contained in the Companies Act 2006. Although the Board of Directors wishes to remit the matter for adjudication in terms of Article 60, the shareholders do have some statutory power in terms of the appointment and regulation of the directors conduct and therefore, where these exceptions exist, the shareholders do not necessarily have to comply with this directive.

Changing the Name of TLC

The ratio of Quin & Axtens Ltd v Salmon[9] is analogous to the case of TLC, as the court granted an injunction against the progression of a business decision which required the unanimous support of the two directors, of which only one agreed and was supported by a resolution of the members in support thereof. To this extent therefore, the Articles of TLC are valid and no resolution by the members will have any effect to the extent that they are in contravention of the Articles themselves. Therefore, changing of the name of TLC cannot be effected without unanimous agreement by the shareholders and the allocation of shares will need the unanimous consent of all directors. In order to change the name of TLC therefore, the articles of association requiring unanimous consent from all shareholders will first need to be amended.

Removal of Tony Leicester as Director of TLC

With regards to Tony Leicester’s tenure as director of TLC, s168(1) of the Companies Act expressly states that “[a] company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him.” An ordinary resolution is one which requires a simple majority of the shareholders to pass the resolution.[10] Therefore, any term in the articles of association which disallows the removal of a director from office is not enforceable. The implication of this is that, despite the life-appointment of Tony Leicester as a director in the articles of association, the Companies Act expressly allows the removal of him from his office as a director by ordinary resolution. As Tony Leicester only holds 40% of the total shares of TLC, the remainder of the shareholders in agreement will constitute a simple majority and therefore can remove him from office by way of an ordinary resolution.

Chapter 2 of the Companies Act 2006 describes the general scope and nature of the duties of a director. Included in this chapter is the duty to act within their powers (s171), to promote the success of the company (s172) and to exercise reasonable care, skill and diligence (s174). These duties are owed by a director of the company to the company. The scope of what constitutes the company was originally interpreted as including the shareholders only, however in recent years this debate has been extended to the broader group of stakeholders, which may include customers, suppliers and any group which may have an interest in the company.[11] Prior to recent codification of these duties in the statute, these were contained in the common law. As these duties are owed to a company, a company may bring an action against a director for breach of these duties. The Company’s Act provides a number of remedies in the case of breach of these duties, which include inter alia damages and restitution. Therefore, in addition to removing Tony Leicester as director, he may well face liability for any damages caused in his alcohol-fuelled outbursts.

Dismissal of Tony Leicester as a Technical Consultant

Directors are not automatically entitled to remuneration and generally, their conduct as an employee will be governed by their service contract.[12] Chapter 4 of the Companies Act provides the legal framework for application to these contracts and in the case of a service contract with a director, the provisions of Chapter 4 apply to all types of employment and therefore, Tony Leicester’s status as a consultant falls within the ambit of this provision. Section 188 specifically applies to directors whose contracts are longer than two years in duration, a provision which is application in the current case and further provides that the agreement must be made available to the shareholders for inspection. Importantly in the current case, s188 provides that a service contract with a director which is longer than 2 years in duration must be approved by the shareholders in a general meeting. In the absence of this approval, the contract is void and subject to termination with reasonable notice. On application of this provision to Tony Leicester, his employment with TLC as a consultant can be terminated with reasonable notice if the shareholders in agreement do not approve his service contract. As this provision is designed to prevent abuse by directors of the power in this capacity, the terms of Article 58 providing for indefinite employment for Tony Leicester by TLC does not preclude the requirement for approval by the shareholders. Assuming therefore that Bradley and the other shareholders are in agreement of Tony Leicester’s unsuitability for employment in the company, his employment as a technical consultant with the company can be terminated.

2. Piercing the Corporate Veil: Liability for TLC and/or its Directors

The critical issue of whether TLC or Bradley may be held liable for the transactions of Better Build Homes and Retirement Villas raises the question of the importance of limited liability and the exceptions to this rule of company law, known as piercing the corporate veil. The doctrine of separate legal personality still forms an essential cornerstone of company law in the United Kingdom. The doctrine protects the interests of shareholders allowing limited liability which is essential for the efficient running of corporations under the current legislation. Despite a number of exceptions to this doctrine in common law since its inception, these all follow a similar trend in purpose. The doctrine of separate legal personality was laid down in Solomon v Solomon where the court stated the importance of this doctrine as follows:

“The company is at law a different person altogether from the subscribers to the Memorandum and, although it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or the trustee for them. Nor are subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act.”[13]

Therefore, unless an act of the company or its directors fall within the ambit of certain exceptions a court will not pierce the corporate veil of limited liability. The application of this principle is equally important for protecting the members of a company in the advent of insolvency or liquidation. Both the legislature and the courts have recognized however that there are certain instances where the veil of corporate personality is used for improper purposes, particularly in the case of group structures as is the case with TLC.

One of the notable exceptions is fraudulent trading, which is contained in s993 of the Companies Act 2006 and the Insolvency Act 1986 (s213 – 215). These provisions are aimed at attributing liability for carrying on business with the intention of defrauding creditors or any other fraudulent purpose. The common law principles of lifting the veil echo the provision of remedies in the case of improper business purposes and indicate that there must be some element of improper conduct in order to do so. Indeed, the courts have interpreted the landmark judgment of Adams v Cape Industries[14] to create three circumstances for piercing the veil. The court is entitled to pierce the veil of corporate personality where they are interpreting a statute or document requiring them to do so, where there are special circumstances which indicate that corporate personality is a facade for concealing the true facts and in application of the agency principle. On the facts of the case of TLC, it is clear that these exceptions do not apply and therefore based on the common law and statutory principles, the veil cannot be pierced on these principles alone.

An area of development in current law however is piercing the corporate veil in the case of tortuous liability. The courts have held that in the case of personal injury, the veil of corporate personality may be lifted to attribute liability of a subsidiary company to the holding company.[15] Both the case of Lubbe and Connelly involved a cause of action which arose outside of the jurisdiction of the English Courts, but which was nonetheless heard in England because the interests of justice required it to be so. In both cases, it was found that the duty of care with respect to the health and safety of the employees extended to the parent company. In the case of Retirement Villas Ltd. therefore, these principles are analogous. Assuming that the elements of liability in tort are established, the courts will be willing to attribute liability for the defective construction of these houses to TLC.

Despite the analogous principles between personal and commercial torts, the treatment of these issues in law is strikingly different. In the case of BBHs, this may arguably constitute a case of a commercial tort, as they are based on the negligent misstatements of Bradley in his capacity as director of TLC. In the case of Williams v Natural Life Health Foods, the House of Lords declined to pierce the corporate veil for a number of misstatements made by an employee to the claimant.[16] The House of Lords in this case stated that there would only be personal liability of a director or employee if the negligent misstatement had created reasonable reliance by the claimant on the assumption of personal liability by the director to create a special relationship. However, if the misstatements were made with the purposes of deceiving the claimant, then personal liability will ensue.[17] It stands to reason therefore that in order for Bradley to face personal liability for the claims made about the BBH houses, it will need to be proven that either he intentionally deceived the claimants or that there was the creation of reasonable reliance according to the Williams principle.[18] There is no indication on the facts that Bradley took personal responsibility for the claims he made about the BBH houses and as such, it is unlikely that he will face personal liability for his negligent misstatements.

In order to attribute liability to TLC for the commercial tort in this case, the principles established in Adams would need to apply. There is no indication on the facts that TLC would be liable on this principle as the misstatements made were by Bradley alone and there is no indication of a facade concealing the true facts creating fraudulent intent.

Conclusion

The potential legal issues facing TLC therefore seem to have a mixed result in terms of outcomes. It seems that with regards to the situation with Tony Leicester, they are able to remove him as a director and terminate his service contract. However with regards to changing the name of TLC, there will need to be an amendment of the articles of association to remove the requirement of unanimity between the shareholders. With regards to the potential liability for the negligent tortuous acts of the subsidiary companies, it is unlikely that Bradley or TLC will face liability for the BBH houses. TLC however will face liability for the personal injuries of the claimants against RVL, as there is significant precedent in the case of tortuous liability for personal injury and unfortunately for TLC, the health and safety standards creating a duty of care between the claimants and RVL is likely to extend to TLC as the parent company. This however assumes that the elements of tort required to establish liability are established by the claimants in the case.

Bibliography

Legislation

Common Law

Adams v Cape Industries plc [1990] Ch 433

Automatic Self-Cleaning Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34

Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693

Connelly v RTZ Corporation plc [1997] UKHL 30

Daido Asia Japan Company Ltd v. Rothen [2001] EWHC Ch 163

Equitable Life Assurance Society v Hyman [2002] 1 AC 408

Imperial Hydropathetic Hotel Co, Blackpool v Hampson [1882] 23 Ch D 1

Lubbe v Cape Plc [2000] UKHL 41

Noel v Poland and another – [2001] All ER (D) 145

Quin & Axtens Ltd v Salmon [1909] AC 442

Salomon v Salomon [1897] A.C. 22 at 51

Scott v Frank F Scott (London) Ltd [1940] Ch. 794

Williams v Natural Life Health Foods Ltd [1998] UKHL 17

Secondary Sources

Blake Lapthorn Tarlo Lyons (2007) Directors Duties. [online] Available on: http://www.bllaw.co.uk/PDF/Corp_0308_Directors%20Duties%20website%2027-02-08.pdf [Accessed 3 March 2013]

Drury, R. (1986) The Relative Nature of a Shareholder’s Right to Enforce the Company Contract. The Cambridge Law Journal, vol 45, issue 2, pp. 219 – 246

Sealy, L. & Wothington. S. (2008) Cases & Materials in Company Law. (9Ed) Oxford: Oxford University Press