Company Law - Prep 5 - Week 5 PDF

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Company Law – Prep 5 Case Notes -

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 (PC) o Facts  Two companies, A and B, held 55% of issued shares of company M  A made an offer for all the issued shares of M and another company H announced intention to make a higher offer  M’s directors considered A’s offer too low and rejected it  A and B then stated they intended to act jointly in the future operations of M and would reject any offer for their shares  H then applied to M for an allotment of 4.5M ordinary shares  M’s directors decided by majority to make the allotment and issued the shares immediately  The effect of the shares was that M had much needed capital and A and B’s shareholding was reduced to 36.6 per cent of issued shares, meaning H was in a position to make an effective takeover offer  A challenged the validity of the issue of shares to H and sought an order in the SC for the rectification of the share register by the removal of H as a member of M in respect of the allotted shares  M’s directors contended that the primary reason for the issue of the shares to H was to obtain more capital o Held  Street J. found that M’s directors had not been motivated by any purpose of personal gain or advantage or by a desire to retain their position on the board  M needed capital but the primary purpose of the allotment was to reduce the proportionate shareholding of A and B so that H could proceed with its takeover offer  Despite no motivation for personal gain, judge held that in these circumstances the directors had improperly exercised their powers  He ordered the allotment of the shares to be set aside and the share register rectified  Decision held on appeal to the judicial committee  Although the directors had acted honestly and had power to make the allotment, to alter a majority shareholding was to interfere with that element of the company's constitution which was separate from and set against the directors' powers

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Eclairs Group Ltd v JKX Oil and Gas Ltd [2015] UKSC 71 o Facts  E (Appellant) were shareholders in J’s public company, appealed against a decision that the company’s board had been entitled to impose restrictions on the rights attaching to their shares  Shareholders held significant minority shares in the company

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J believed shareholders were ‘corporate raiders’ seeking to establish and acquire the company at less than its value The board serviced a notice on E under the CA 2006 s.793 requiring disclosure of information about interests in its shares The board considered the shareholders’ responses inadequate and served restriction notices under art.42 of the articles of association Article 42 corresponded with s.794 in allowing restrictions to be placed on the rights conferred by shares where the shareholder failed to comply with a disclosure notice The shareholders were prevented from voting and transferring shares at the company’s upcoming annual general meeting CoA held that the rule that directors’ powers could only be exercised for the purpose of which they had been conferred did not apply to the instant case And the directors’ purpose of defeating the shareholders’ attempt to influence the company had been open to them E appealed and the SC allowed the appeal

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(1) A company's articles were part of the contract of association, but the proper purpose rule was not a term of that contract and did not necessarily depend on any limitation on the scope of the relevant power as a matter of construction.

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2) The proper purpose rule applied to the instant case. In many other cases, fiduciary powers had been wrongly exercised because in the pressure of a battle for control of a company, the directors had used their powers to favour their allies, Howard Smith Ltd v Ampol Petroleum Ltd [1974] A.C. 821, [1974] 2 WLUK 61 considered. The board would naturally wish to have predators disenfranchised. That was precisely why it was important to confine it to the limited purpose for which its powers existed

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(3) The company's case had been that once the shareholders had failed to provide the information, the power to impose restrictions could be exercised to defeat their attempt to influence or control the company's affairs. That was not a proper purpose

Exercise 1 -

What does each of s171(a) and s171(b) mean and what are their rationales? o S171(a) a director must act in accordance with the company’s constitution  Must be in accordance with the powers given in the articles of association o S171(b) a director must only exercise powers for the purposes for which they are conferred  Must be for the proper purpose

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Explain how the cases referred to above illustrate the judicial application of the doctrine o Howard illustrates when a purpose is considered to be improper even if directors were acting honestly o Eclair illustrates improper purpose even when the proper purpose rule was not a term of the contract How have the courts sought to identify the test for determining whether a power has been used for a proper purpose? o Must be in good faith o Must be for proper purpose

Exercise 2 The Scenario Super Priced Foods Limited (“SPFL”) is a company which runs a chain of local supermarkets with several branches across Yorkshire. The history of SPFL is as follows. It was set up by Hugh Jones 25 years ago. At that time Hugh was a young entrepreneur and SPFL only owned a small local shop. Originally the shareholders and directors were Hugh and his wife, Miriam. Since then SPFL has grown. Now Hugh is the Managing Director of SPFL and is responsible for its overall management. The board of directors comprises Hugh, Miriam, Ellen, Dhanish, and Rachel. The shares in SPFL are held as follows: Hugh 40%, Ellen 15%, Dhanish 15%, Rachel 15% and Miriam 15%. SPFL has a subsidiary company called Local Organics Limited (“LOL”). LOL trades successfully with shops selling locally sourced organic produce. LOL is not a wholly owned subsidiary, although SPFL holds the majority of the shares in it (70%). LOL has 3 directors: Dhanish (Managing Director), Tasha (Finance Director) and Stuart (Sales Director). Stuart used to be the sole shareholder of LOL. However, LOL needed further financing to expand, and so SPFL invested in LOL by subscribing for shares in it. Stuart now holds only 30% of the shares in LOL. For a year or two, Stuart has been keen to develop the business of LOL by LOL opening a restaurant or snack bar serving simple organic food. Dhanish and Tasha think Stuart’s ideas are interesting but too ambitious for LOL at the moment. Their view is that LOL needs to concentrate on consolidating its current activities. However, they asked Stuart to come up with a more detailed business plan. Stuart felt that his ideas have been given short shrift by Dhanish and Tasha. Disheartened by this, Stuart did not get around to preparing the business plan and nothing more was discussed about it at board meetings. In September 2017 Stuart attended an organic food conference in Somerset. Whilst there he met the representatives of an American company, called “Daily Bread”, which ran a small chain of breakfast/brunch restaurants selling organic food. The representatives explained that Daily Bread was thinking of expanding in the UK and were interested in working with an individual or a company who knew the UK market. Stuart thought Daily Bread’s plans were exciting and viable.

After the conference, Stuart finally prepared the long delayed business plan. The plan made no reference to Daily Bread, or to Stuart’s discussions with Daily Bread’s representatives. The board of LOL then considered Stuart’s business plan, but Dhanish and Tasha had doubts as to whether the plan contained a sufficiently good and detailed business case. At a board meeting all the directors agreed that the idea was good in principle, but immediate plans to expand in this way were rejected by a vote of 2 to 1 (Dhanish and Tasha voting against Stuart). Dhanish and Tasha doubted that LOL currently had the resources to invest in this new area, and the business plan had not persuaded them otherwise. About one month after that board meeting Stuart resigned as a director of LOL and sold his shares in LOL to SPFL. Six months after that Dhanish and Tasha found out that Stuart had set up his own company which was working with Daily Bread to enable it to establish restaurants in the UK, which made the SPFL directors furious. West Riding Flowers Limited (“WRFL”) is a company which runs flower shops in Yorkshire. The board of WRFL comprises Miriam, Hugh, William and Doreen. Its shareholders are Miriam (40%), Hugh (10%), Raihanna (12.5%), Doreen (25%) and William (12.5%). The business of WRFL is stagnating. The flower shops are rather old fashioned and are facing more and more competition from more modern flower shops and supermarkets. WRFL is Miriam’s life and she is unwilling to consider that WRFL cannot be turned around. She develops plans to make WRFL’s shops much more contemporary in feel. This requires some of the shops to be refitted. She also wants WRFL to do much more business online which will require a much more sophisticated website. For this WRFL needs more finance. Miriam and William develop a business plan using the most recent audited accounts (for the financial year ended September 2017) which show a fairly healthy position. Based on these and some other management accounts and cash flow forecasts, WRFL’s bank is willing to lend some of the money required. The remainder of cash required for the refurbishment is to be raised by SPFL lending money to WRFL. The board of WRFL votes to approve these plans. The loan to WRFL is discussed at a board meeting of SPFL at which SPFL also agrees to guarantee WRFL’s bank loan. The vote of SPFL’s board is not unanimous with Miriam, Hugh and Ellen voting in favour and Dhanish and Rachel voting against. Dhanish and Rachel did not think this to be an appropriate use of SPFL’s funds. The refurbishment plans hit problems. It soon transpires that the audited accounts did not show a true and fair view of the financial position of WRFL and contained a number of glaring errors in them. For a number of years Miriam had taken care of the financial information of WRFL. However, since William (a chartered accountant) had joined WRFL as shareholder and director 5 years ago, Miriam had relied on his competence, as had Hugh and Doreen. In fact, Hugh has viewed his role on the WRFL board as mainly to support Miriam. To compound matters, the manager of the Leeds city centre flower shop appears to have been defrauding WRFL and has now disappeared. WRFL has lost £100,000 over 3 years as a

result of this fraud. Doreen is furious. She is a florist by trade and so concentrates on this aspect rather than the financials. At board meetings she has expressed surprise at the poor performance of this branch, but Miriam has fobbed off any concerns. The manager was an old friend and Miriam trusted him completely. Consequently, WRFL’s financial position is precarious and it suffers a substantial loss for the financial year ended September 2018. Prepare and be ready to discuss in class your answer plan to the following question based on the above scenario: In relation to the s. 172 CA2006 duty consider the loan by SPFL to WRFL and the guaranteeing of WRFL’s bank loan by SPFL: explain whether the duty to promote success of the company may has been breached by the directors of SPFL. Would your answer be any different if WRFL were a subsidiary of SPFL? Your explanations should refer to statute and case law....