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Business Organisation and Private Companies – The first example assessment question

Critically analyse the relationship between a company’s articles and its shareholders, and the additional protection for shareholders provided by the Companies Act, the common law and the use of a Shareholders’ Agreement. Answering Guide: First note that you need to do several things in answering this question well: Critically analyse 1) The relationship between the company’s articles and its shareholders 2) The additional protection for shareholders provided by: i) the Companies Act ii) the common law iii) a shareholders’ agreement. Remember the Articles of Association are the major mandatory document that MUST be filed at Companies House in order for an application to create a registered limited liability company is approved. The Articles are the CONSTITUTION of the company. They contain the fundamental rights, duties and obligations of the company and its shareholders. It is also sometimes referred to as the rules of “indoor management” for the company. Look at the Model set of Articles for a Private Company online or in your statute book to see the sort of content common to all Articles. However while founders of companies may adopt the Model set as their articles it is usual for them to employ lawyers to defat a unique variation of articles to suit the wishes and needs of the founders of the company. The lawyers will be careful to make sure that in addition to what they insert into the Articles they will also ensure all the headings in the Model set are included otherwise the company will finish up with two constitutional documents – the drafted set plus those provisions of the Model set that were overlooked! The Articles according to the Companies Act s.33 are a contract between the company and its shareholders individually. This contract is usually referred to as the statutory contract and is distinguished from the normal commercial contract that you are familiar with from the law of contract. Several features make the statutory contract unique – the most significant is that the shareholders alone have the power to amend the Articles. This power is given to them by s.21 Companies Act ( the board of directors cannot alter the constitution – only the shareholders in general meeting can do that but the significant feature is that the shareholders can do this by a special resolution i.e. by a 75% voting in favour of the change. Remember in an ordinary contract alteration to the terms can only be made by unanimous agreement

of all the parties. Here 25% of the shareholders will have to accept the alteration even though they did not agree to it! In terms of the scope or ambit of this statutory contract you need to turn to the common law. The leading cases that define the scope of it are: Hickman v Romney Marsh Sheep breeders Association Eley v Positive Life Assurance Co Rayfield v Hands [In addition the better students would include a mention of the imagined limitations on enforcement of the contract which may be got around by adopting Professor Lord Wedderburn’s argument based on the decision in Salmon v Quinn Axten as well as the exception provided by Beckwith’s case. (The other academics’ views could be canvassed – Prentice, Goldberg, Usher usually referenced in your text book).]

The additional protections for shareholders over and above ss. 33 and 21 are those factors that make majority misuse of power especially to alter the constitution difficult: The Companies Act contains provisions such as s. 25 that prevent the articles being altered to require existing shareholders to contribute more capital and provisions to protect the holders of classes of shares so that only members of the class can vote an alteration to the class rights. It also sets out two minority protection provisions that can be used to impede in some instances majority exploitation of power. These are – ss. 260 -263, the derivative claim and ss. 994-996 – the unfair prejudice action. These statutory interventions have been discussed in Katherine’s lectures and are well covered in text books but for this question you do not to know every detail of those two remedies and processes – suffice to know they could be used by a disgruntled shareholder to challenge a proposed change to the company’s constitution. The Common law puts in place the original minority protection barrier which requires that any alteration even supported by the requisite 765% vote in favour cannot proceed if it is deemed by the court to be “ not bona fide and in the best interests of the company as a whole. Finally to achieve the better marks you need to be able to outline why and how a well drafted shareholders agreement can and does provide shareholders with additional protection – the very best students would be able here to give examples of the sort of prospective provisions that can be included such as the one in Russell’s case (the leading UK case on such agreements) and clause dealing with exit and transfer rights. Katherine’s lecture and slides alerted you to the benefits of such agreements and to those sorts of clause. Again every detail of the law on shareholders agreements is not important for answering this question but being able to highlight the key benefits with an example or two will do the job.

An answer to this type of question benefits from some well-judged assessment of how good these protections are as a conclusion. The second example Assessment Question: “The decision and judicial reasoning of the Supreme Court in Prest v Petrodel Resources Ltd (2013) has been controversial and, for some, confusing”. Focusing on the company law issues involved critically analyse and discuss the significance and effect of this case.

Step 1: Identify what the question wants you to do. You will have no idea unless the case it refers to is familiar. If you do not know the case then answer another question! You should remember that it is the one Supreme Court decision on the problematic issue of the paramountcy of the Salomon doctrine – the supremacy of the principle that once a company is properly registered it becomes a separate legal entity - a legal person with legal rights and obligations just like you and me. Its shareholders, provided it was registered as a limited liability company, are by law provided with protection of their personal assets so, for example , if the company runs up debts that it cannot pay – it alone suffers the legal consequences. It will be deemed insolvent and go into liquidation. Ultimately it will be deregistered which means it no longer exists. Its shareholder will lose whatever money they gave to the company in return for shares in the company but the company’s creditors will not be able to access the shareholders assets to recover their losses as creditors of the company. The shareholders are said to be hidden and protected from the company’s creditors by the “veil” of incorporation – a fictional but descriptive way of describing the benefit for shareholders of being members of a registered limited liability company. However sometimes, parties to legal disputes against the company know that the people behind the establishment and the running of the company have money whereas the company does not. Such claimants want to go behind the veil and get redress or compensation or some other remedy against the shareholders who they see as being responsible for a corporate wrong or having benefited improperly from the existence and use of the company. Point 1 – this is a case about going behind the veil of incorporation or not! –Do we need to disregard the Salomon principle ever – the principle which has provided every country with its wealth and economic prosperity today. Point 2 – the question asks you to discuss the company law issues – why? The Prest case was in fact a matrimonial case - Mrs Prest was seeking access to monies during divorce proceeding which she said belonged to her husband and to which she should have an entitlement. He argued the money in question belonged to several companies (separate entities) in which he admittedly was a shareholder. The lower courts tried to find ways of going behind the veil to access those monies for Mrs Prest. The Supreme Court finds a new solution.

Point 3 –prior to Prest the leading case that set out the possible methods or legal grounds for going behind the veil was Adams v Cape Industries (a case which complex facts where worker employed in Texas by a company allegedly a subsidiary of a UK registered parent company sort to enforce a court judgment in their favour for massive compensation for work related illness, in the UK) . The possible grounds were – sham/fraud; agency and group entity but not justice/fairness. Although recognised as possible grounds none were said to apply to the facts of the Adams case. Those possible grounds were often referred to as “lifting” or “piercing” the corporate veil. Those terms themselves were controversial – were they different or the same? Point 4 -. While this question has at its heart the Salomon doctrine and the concept of the corporate veil it clearly cannot be answered satisfactorily without a reasonable familiarity with the Prest case – its facts, and more importantly the leading judgments of Lord Sumption as well as those of Lord Neuberger and Lady Hale. The good students will have some idea of what Lord Sumption is saying – the better students will also know the thrust of what those other two judges had to say. Point 5 – Lord Sumption’s central finding was that instead of trying to find ways of getting behind the veil look for alternative remedies that do not require that, such as the one recognised in Prest itself – a Trust claim – recognising that the companies held the disputed monies on trust for Mr Prest – the beneficiary which meant the money was held for him. Other remedies can be equally successful without seeking to go behind the veil such as constructive trust, unjust enrichment and, of course, tort as illustrated by the decision in Chandler v Cape. Lord Sumption did, however, state that the one clear ground for going behind the veil is what he called “evasion” (simply his term for “fraud”). He also, however, mentions “concealment” and you need to make what you can of what it means and what the consequence of it might be! Point 6 - Lord Sumption’s judgment restricts (some would say – eliminates) the traditional approaches in those earlier cases (such as Adams) deterring abuse of the company vehicle. Lord Neuberger offers his support but does not appear to fully agree with everything said by Lord Sumption. Lady Hale speaks of retaining the concepts of “piercing and lifting” in case there is no other remedy available. Point 7- with all that background to the topic and the issues involved you have to construct your answer to the actual question asked – do you believe the decision and reasoning in Prest was” controversial” and “confusing”? AND in your view what is the” significance and effect of this decision”? You could get a good to very good mark provided you understand Prest and the reasoning of at least the three judges mentioned above provided you focus on whether it was controversial, confusing , its significance and effect.

An answer that did the above but set it in the context of the history of “lifting” and “piercing” and showed familiarity with earlier cases such as Guildford Motors v Horne, Jones v Lipman, Smith Stone Knight, DHN Foods; Adams, Creasy and Chandler would be line for a very good to excellent mark (not necessarily covered in the lectures but referred to in your textbook). The actual mark will depend at this level on structure, clarity, insight, understanding and persuasiveness of argument! The difficulty will be in compressing the key issues, principles and outcomes into a coherent 1000 words. It can be done!

Revision starting point: Your lecture notes Your textbook passages relevant to Salomon and the veil of incorporation Prest v Petrodel Ltd Guildford Motors v Horne Jones v Lipman Smith Stone Knight v Birmingham Corporation DHN Foods V London Borough of Tower Hamlets Adams v Cape Industries...