Company Law and Insolvency

The English Company Law is wide-ranging, complex, technical but often interesting. The main source of English company law is the Companies Act 2006; the Act does not fully in force, so reference must be made to the Companies Act 1985, as amended by the Companies Act 1989. Where relevant, European law has an increasing impact on company law as Directives are incorporated into UK law. The Act makes some major changes to the existing regime. However, in some instances the only effect of the Act is to change the existing law to a new section of the 2006 Act without altering the effect of the section in any significant manner. The legislature initial plan was to amend the 1985 Act by inserting new provision into the Act- however, it become increasingly clear during the Bill’s progress that it would be a more significant piece of legislation in its final form. After Parliamentary debate the bill received the Royal Assent on 8th November 2006 and was enacted as the Companies Act 2006. However in this new act still have some uncertainty or ambiguity of some section. Especially in section 33 of the CA 2006, in terms of its direct enforceability by individual members may be of deteriorating significance. Under the section 33 of the act a member may only enforce those rights which affect him in his capacity as a member (an insiders) but may not some other capacity (an outsiders). The Company Law Steering Grope in its reports has made several proposals with regard to amending the law on shareholder remedies, particularly with regard to the controversial issue of ‘outsider rights’. Now we critically discus that whether the steering grope proposals was appropriate for the ‘outsider rights’ or the section 33 of the CA 2006 is a satisfactory piece of legislation to enforce the ‘outsider rights’.

Now we firstly discus that what is provide by the section 33 of the CA 2006. The section 14 of the Company Act 1985 to reside almost unchanged in terms of its effect but more tidily in section 33 of the Companies Act 2006. Under the section 33 of the Company Act 2006 provided that ‘the provisions of a company’s constitution bind the company and its members to the same extant as if there were covenants on the part of the company and of each member to observe those provisions’. The scope of the section 33 contract has been considered in a number of cases, which cannot easily be reconciled. Formerly when company registered, under the company act 2006, section 33, the constitution constitutes a contract between the members and the company, and between the members inter se. In the Wood v Odessa waterworks Co [1] case, Mr. Wood has successfully obtained an injunction to prevent payment by the issue of debentures. He was able to enforce the articles against the company. This contract gives rise to contractual rights between the company and its members. Stirling J held that ‘What I have to determine is, whether that which is proposed to be done is in accordance with the articles of association as they stand, and, in my judgment, it is not, and therefore the Plaintiff is entitled to an injunction so far as relates to the payment of dividends’.

In the Hickman v Kent or Romney Marsh Sheep-Breeds Association [2] case, articles provided for disputes between a member and the company to be referred to arbitration. A member sued in court to enforce his rights as a member, including his right to have his sheep registered by the company in its published flock book. The court stayed ‘the court proceedings brought by the member as the member was bound by the articles to arbitrate the dispute and the company was entitled to enforce the arbitration clause in the articles against the member’. Asbury J held that an article constitutions a contract between the members and contractual rights for shareholders against fellow shareholders.

In the Rayfields v Hands [3] case, Vaisey J considered all the conflicting authorities on the issue and concluded that there was a contract inter se, which was directly enforceable by one member against another. Under the common law the courts made it clear that a member can only enforce those rights that she or he in his capacity as a member fall within the scope of section 33 of the CA 2006. It was also illustrated in London Sack and Bag v Dixon [4] case, a dispute between two members of the UK Jute Association. It was argued by the appellants that there was a binding submission to arbitration by virtue of the fact that both disputants were members of association. The Court held that the appellants had failed to prove that there had been a binding submission to arbitration.

Outsider rights under the section 33 of the CA 2006:

While there is considered to be a binding contract between the member and the company, that contract only binds the members in their capacity as members. Where outsider rights are at issue, the section 33 contract does not apply. The law does not recognise the enforcement of outsider rights against the company, even though they may be rights in respect of a member but not membership rights as such. This was established in the Eley v Positive Government security Life Assurance Co Ltd [5] case; Mr. Eley sued the company for breach of contract in not employing him as its solicitors. The plaintiff tried to enforce a right contained in the company’s articles that he should be the company’s solicitor for life, only removable on grounds of misconduct. It was held that the article did not create any contract between Eley and the company. The contracts (Rights of third parties) Act 1999 abrogates in part the traditional doctrine of privity of contract. The Act might have enabled a person in the position of Mr. Eley to enforce a term such as article 118, but section 6(2) of the 1999 Act expressly excludes the section 33 contract from its scope. Also the articles are not subject to sections 2–4 of the Unfair Contract Terms Act 1977.

In Browne v La Trinidad [6] case, before a constitution of the company a contract was entered into between Browne and a person as trustee for the intended company, by which stipulated that it Browne should be a director and should not be removable till after 1888. The sixth clause of the articles provides the directors should adopt and carry into effect the contract. The contract was acted upon but no contract adopting it was entered into between the plaintiff and a company. it was held that ‘treating the agreement as embodied in the articles, still was no contract between Browne and the company that he should not be removed from being a director, the article being only a contract between the members inter se, and not between the company and Browne’.

The third case cited in support of the unenforceability of outsider rights by a member is Hickman case, on its facts, Hickman involved membership rights, not outsider rights. The right in the articles enforced by the court was the right of members and the association to have disputes between members and the association arbitrated rather than litigated.

In the Beattie v E & F Beattie Ltd [7] case the company was engaged in an action against a director for the return of sums. It was claimed that irregularly paid to him. The articles contained a clause which referred any member disputes to arbitration. The director was a member and attempted to have the article enforced, also have his dispute referred to arbitration. The Court of Appeal held that he could not do so as the dispute related to his status as a director’.

Recently in Globalink Telecommunications Ltd v Wilmbury Ltd [8] case the court considered the validity of a director’s indemnity provision that had been placed in the company’s articles. The court found that ‘such a provision would not be binding because the articles do not constitute a contract between the company and its officers’.

It is well-established that no contract is created under section 33 of the CA 2006 between the company and outsiders. It is less clear that whether outsider rights can be enforced by a parson bringing a claim as a member, on the basis that every member has the right to have the company’s business conducted in accordance with the articles. The definition of outsider rights is very broad, however, where a member of the company holds the ‘outsider rights’ the right in certain circumstance to be indirectly enforceable. Now we see how the outsiders right indirectly enforceable.

In the Pulbrook v Richmond Mining Co [9] case the directors refused to allow him (Pulbrook) to sit on the board. Jessel MR J held that he still held the shares ‘in his own right’ and he had suffered an individual wrong for redress of which he could sue in his own name. In the Imperial Hydropathic Co v Hampson [10] case the company in this action claimed a declaration that the directors had been validly removed. The court held that ‘the articles could not be disregarded in this way’. In both cases the Court of Appeal supposed that ‘the restrictions were enforceable by the directors, suing in their capacity as members of their respective company’ which may illustrate the example of the indirect enforcement of outsider rights.

The Foss v Harbottle [11] case made an important rule and it has two closely related parts. Firstly if a wrong is done to the company, the company is the ‘proper plaintiff’, so that only the company may sue and an individual shareholder (or group of shareholders) may not sue (‘proper plaintiff rule’) and secondly if the company wrongs a member, the member may not sue if the act complained of could be done by an ordinary resolution in general meeting. This important rule that in cases Salmon and Beattie the courts have recognised a general personal right to have the articles enforced and that this was in fact the correct way to deal with the matter. This is the case; it would indirectly enforce an outsider rights under the articles, though it does not resolve the outside rights controversy.

In the Quin & Axtens Ltd v Salmon [12] case, the outsider rights have been indirectly enforced. The company’s articles provided that ‘no resolution of a meeting of the directors having for its object the acquisition or letting of certain premises should be valid if either Salmon or Axtens dissented’. In accordance with the terms of the provision, the plaintiff sought to exercise his right of veto. The veto was ignored by the company an extraordinary general meeting was then held at which the members by a majority passed similar resolutions, as a result of which the plaintiff sought an injunction. The House of Lords, upholding the decision of the Court of Apple, held that the member’s resolutions were inconsistent with the articles and succeeded in obtaining the injunction. The managing director pursued the matter as a member of the company (qua member) in accordance with section 33 of the CA 2006 (it was section 14 of the CA 1985), only a member of the company may enforce the rights contained within the articles. It should be highlighted that the enforcement of the managing director’s right was pursued qua member in accordance with section 14 of the CA 1985 [now section 33 of the CA 2006].

Lord Wedderburn [13] developed the thought that a member would some times be able to implement indirectly an outsider right as long as he made it clear that he was suing in his capacity as a member.

Again G.D. Goldberg ‘The Enforcement of Outsider Rights under section 20(1) Companies Act 1948’ [14] (now section 33 of the CA 2006) which argues that a member’s right to have the articles complied with will only enforce outsider rights where these are incidental to the member’s right to have the affairs of the company conducted by the particular organ of the company specified in the memorandum and articles of association.

A very recent example of the indirect enforcement of an outsider rights may be found in Rayfield v Hands [15] . In this case Rayfield is a member, sought to enforce the defendants the three directors of the company to purchase his share in accordance with the provision. The company’s article 11 provided that ‘every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at a fair value…’. The Court held that a member of a company was allowed to enforce a provision of the company’s articles that compelled the directors of the company to purchase the member’s share. Vaisey J held that ‘the directors, whilst in a strict sense outsider, were, as member of the company, bound by the provision of the articles’.

In the cases involving an enforcement of an outsider rights may required to explain in three different line of though. The three theories may be identified in the following manner:

‘A member of company has a right to enforce any obligation contained within the company’s memorandum or articles irrespective of whether the right is an “insider” or “outsider right”. However, the member must sue qua member’ [16] .

‘A member of company has a right to enforce any obligation contained within the company’s memorandum or articles irrespective of whether the right is an “insider” or “outsider right”. However, the member must sue qua member and the enforcement of the obligation must constitute something more than the enforcement of an internal irregularity’ [17] .

‘A member of a company has the right to enforce obligations contained within the company’s memorandum or articles. Nevertheless, where the member seeks to enforce an “outsider right”… imposed upon it by statute’ [18] .

It might be clear that any attempted reconciliation of the academic theories in relation to outsider rights is difficult, reason that the section 33 of the CA 2006 still less clear. It should considered that the case law in relation section 33 of the CA 2006 showing a level of inconsistency which stems from the very nature of provision that fails to specify the extent of its contractual effect. A company cannot in the normal course be bound otherwise than by act or agreement and it is in this section that its obligation must be found. As far as the members are concerned, the section does not say with whom they are to be deemed to have covenanted, but the section cannot mean that the company is not to be bound when it says it is to be bound. Nor can the section mean that the members are to be under no duty to the company under the articles in which their rights and duties as corporators are to be found.

Now we critically discus the Company Law Review Steering Group reports, particularly with regard to the controversial issue of ‘outsider rights’. In the Modern Company Law For A Competitive Economy: Developing The Framework [March 2000], we see what they (CLRSG) are considered and proposed for the present position of the section 33 of the CA 2006 [was section 14 of the CA 1985] especially in ‘outsider rights’. The CLRSG gave considerable time to the issue of rights in the articles over the course of its discussions or debates but not unnaturally given the complexity of the area. The CLRSG want on to recommended a number of reforms in the reports.

The critical question which arises in the section 33 of the CA 2006 is that ‘what rights can the shareholder, or even a third party, declare as his own under the constitution and what right would be enforce by the outsiders under the constitution? Under the section 33 of the CA 2006 ‘a member may only enforce those rights which affect him in his capacity as a member and that he may not enforce rights which affect him in some other capacity’. The scope of the contract under section 33, in terms of its direct enforceability by individual members may be of deteriorating importance. The law Commission considered that ‘a complete definition of what constituted a personal right is not possible; a non-exhaustive list of personal right would not be a useful addition to the statute; that any difficulty in recognising the specific personal rights of the members caused few practical problems’ [19] .

The Company Law Review reconsidered the matters that ‘there should be a statutory provision in the legislation explaining the extent to which shareholders are entitled to enforce the constitution, the contractual character of the rights under the constitution should be abolished and that a non-exhaustive list of personal rights enforceable by a member qua member should be included in the statute, subject to the court’s power to dismiss actions where the breach complained of was trivial or the remedy fruitless’ [20] .

The Company Law Review recommended that individual shareholders should have the right to enforce all provision in a company’s constitution both against the company itself and against other members, unless the constitution provides otherwise [21] . It rejected the view that allowing shareholders to enforce outsiders right in this way would lead to lengthening to include matters normally dealt with outside the constitution, such as shareholders agreement. [22]

Subsequently over the consultation period the CLRSG descend most of the reforms and picked for a catch-all solution whereby all the articles would be enforceable by the members against the company and each other unless the contrary was provided [23] . Also the CLR decided that the issue did not call for immediate resolution [24] and the Act in fact retains the contractual approach. Also the papa 4.90 [25] of the CLRSG proposals which the view of the New Zealand Law Commission in its report for the 1993 legislation, not adopted by the New Zealand Government.

However, the CLR final reports suggested that the effect of section 33 of the CA 2006 should, in its application to the constitution of a company, be given full contractual force in a manner favoured by ‘Theory B’ (discussed above) [26] .

The wording of section 33 of the CA 2006 would be difficult to constitute or understand to interpret it as creating a contract with anyone other than the company and the members. The contract created by section 33 is a multi-party contract, not that this feature in itself distinguishes it from many other types of contract found in the commercial world. However according to English & Colonial Produce Co, Re [27] case, a promoter (who becomes a member) cannot enforce a provision that the company shall reimburse the expenses he or she incurred nor a solicitor, a proviso that he or she shall be the company’s solicitor [28] . It is very important that this approach to the section in fact prevents a member who is also a director or other officer of the company from enforcing any rights purporting to be conferred by the articles on directors or officers. Only if they have a separate contract, than they will (the director) have contractual rights and obligations vis-a-vis the company or fellow members. Therefore executive directors will be alert to enter into service contracts with their company in order to safeguard their remuneration and non-executive directors would be well advised to do so.

It is also arguable that under the section 33 of the CA 2006 there is an economic reason for restricting the right of individual shareholders to enforce the terms of a company’s constitution so as to exclude the enforceability of outsider rights and thereby discourage outsider matters from being dealt with in the constitution [29] . This limitation maintains clear division or separation of the different contractual relationships focused on a company. It boundaries the constitution to ‘ownership’ or ‘membership’ matters.

Although there was some support for clarification of aspects of the statutory contract but the CLRSG proposal’s with respect to the abolition of the contractual status of these rights and the inclusion in the statute of a non-exclusive list was not itself clear as to nature of any alternative basis for the constitution [30] . Removing the contractual status of these rights at this point the legal professional view is that it would impact on the clarity and certainty of the current position, a point which was certainly well made.

It has recently been held in Towcester Racecourse Co Ltd v The Racecourse Association Ltd [31] case that in the absence of special provisions in the articles or some collateral agreement between the company and its members, neither the company nor its directors owed any direct legal duties to its members as such’. Therefore no terms can be inferred which would have the consequence of making the company or its directors contractually responsible to its members for the way it carried out its functions.

Conclusion: We see all above discussion that section 33 of CA 2006 did not directly give effect to enforcement of the outsider rights, also the Government did not implement the GLR proposals. In the Shareholder Remedies [32] , the Law Commission widely consulted on reform of section 33 of CA 2006 and recommended that no reform was necessary. It may reason that the CLRSG proposal’s with respect to the abolition of the contractual status of these rights and the inclusion in the statute of a non-exclusive list was not itself clear as to nature of any alternative basis for the constitution [33] . It is considered that the CLR proposals are to be favoured in so far as the quasi-contractual nature of the section 33, although having created a lot of academic interest and debate, is unnecessary ambiguity and complicated.

Finally we can say that the constitution has to launch a governance formation that is flexible, but with sufficient safeguards against the abuse of managerial discretion. It has to strike an efficient balance between these competing goals in the sense of maximising the benefits of managerial flexibility, minimising the risk of abuse and minimising the costs of the safeguards employed to reduce the risk of abuse. At that point the outsider rights would not introduce in the constitution for an economics reason. Also the outsider rights conflict with the vesting of general powers of management in the board by purporting to pre-empt certain decisions that would otherwise be for the board to take. Requiring a separate contract for an outsider rights should ensure that they are addressed properly.