Contract Between Company and Members

Introduction

Section 33 of the Companies Act 2006 provides for a ‘statutory contract’ between the company and its members. It is this contact that is the subject of much controversy and confusion which has spanned over a period of decades. The main controversy focuses on the question of whether the contract can be enforced by members to ensure that a right associated with them in another role, such as the right given to a director who is also a member. This question of enforcement and the long standing controversy will be examined in this essay.

Enforcement Of S.33 Companies Act 2006

Companies Act 2006, S.33 Effects of company’s constitution

1. “The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions”

This is a substantial re enactment of previous sections, however, the modern formulation does finally lay to rest one previous uncertainty – “that the constitution constitutes a contact between the members and the company, and between the members inter se The other remaining question, which S. 33 has not resolved is to what extent are ‘outsider rights’ enforceable by members ? In another words each shareholder can be held liable to each other under the articles.

In Bisgood v Henderson’s Transvaal Estates Ltd Buckley LJ stated that “The purpose of the memorandum and articles is to define the position of the shareholder as shareholder, not to bind him in his capacity as an individual.”

However, it appears that there are two distinct lines which contradict each other. One line suggests that a member cannot enforce rights other than membership rights or ‘insider rights’, and the other suggests that a member may enforce ‘outsider rights’ as long as he sues the company in his capacity as a member, and not as an outsider. In the case of Eley v Positive Government Security-Life Assurance Co Ltdin the articles it stated that Mr. Ely was to be the company’s solicitor. Mr. Eley later became a member. The directors then chose to use other solicitors and Eley sued for breach of the statutory contract on the term of the articles. It was held that Eley could not enforce the provision in such a way, as he was attempting to enforce his rights as solicitor, not as member. The court rules that the provision in the articles was “either a stipulation which would bind the members, or else a mandate to the directors. In either case it is a matter between the directors and shareholders, and not between them and the plaintiff”

This decision was later supported in the case of Browne v La Trinidad where a pre-incorporation agreement specified that Browne should become a director of a company for a specified length of time. The agreement later became part of the articles, but no specific contract between Browne and the company was drawn up. The company sought to remove Browne from office before the agreed time, and it was held that it was free to do so. Lindley LJ stated: “it would be remarkable that, upon the shares being allotted to him, a contract between him and the company, as to a matter not connected with the holding of shares, should arise.”

The opposing position is illustrated in the case of Salmon v Quin & Axtens Ltd. The articles provided that Salmon, who was one of the two managing directors, could veto board decisions. Salmon used this right, but the company ignored the veto. Salmon sought an injunction, and it was held that the company had acted on a decision which was taken unconstitutionally, and Salmon had the right to see that the company acted in compliance with the constitution. This was a right afforded to him as a member. Salmon was then able to indirectly enforce his ‘outsider rights’ by suing as a member.

The leading case in this area, which tried to reconcile the two ‘opposing’ lines of cases was the classic authority of Hinkman v Kent or Romney Marsh Sheep-Breeders’ Association. “It is difficult to reconcile these two classes of decisions and the judicial opinions therein expressed, but I think this much is clear, first, that no article can constitute a contract between the company and a third person; secondly, that no right merely purporting to be given by an article to a person, whether a member or not, in a capacity other than that of member, as, for instance, as solicitor, promoter, director, can be enforced against the company; and, thirdly, that articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the company respectively.”

From this statement it seemed that the issue of ‘outsider rights’ would not be enforceable, whether or not the ‘outsider’ was a member. However, much academic debate ensued, and three main explanations of the case were put forward by Gower, Lord Wedderburn, and Goldberg. Firstly, Gower proposed that ‘outsider’ rights can never be enforced ie. The Hinkman principle. Secondly, Lord Wedderburn gave the view that ‘outsider’ rights can be enforced by a member as long as he sues as a member, using Salmon as support. The third, Goldberga ‘middle way’ is proposed.

Gower’s view is based on a more traditional view in that S. 33 contract is: ‘the memorandum and articles have no direct contractual effect in so far as they purport to confer rights and obligations on a member otherwise than in his capacity of a member’ This view can be interpreted as the strictest interpretation of the law in this area, although it is consistent with the dicta in Hinkman, it fails to adequately explain cases such as Salmon v Quin & Axtens. Gower seems to ignore these inconsistent cases, and instead bases his view on a theory of law, instead of how it has operated in practice.

In contrast, Lord Wedderburn opinion on the matter is dually the most famous, and most liberal. He argues that ‘a member can compel the company not to depart from the contact with him under the articles, even if that means indirectly the enforcement of ‘outsider’ rights vested in third parties or himself, so long as, but only so long as, he sues qua member and not qua ‘outsider’

In Wedderburn’s opinion, if as a member sues as a member, he can always enforce ‘outsider’ rights. His explanation of those cases where ‘outsider’ rights have been unenforceable is the technical one in which the ‘outsider’ choses not to sue in his capacity as a member. However, the problem with this approach is that in essence it goes against the decision and dicta in Hinkman, which purported to finalise the debate on the issue by reviewing the two lines of cases.

For this reason, Wedderburn’s argument is seen as being overly wide. Yet, Gregoryagrees with Wedderburn’s view, on the basis that the dicta in Hinkman is obiter. He argues that the judge in Hinkman failed to consider cases which, prior to 1915 (Wood v Odessa Waterworks Co, Eley v Positive Government Security Life Assurance Company), ‘outsider’ rights had been enforced under the S.33 contract.

Gregory agrees with Wedderburn in that the judge, Astbury J, misinterpreted the previous cases, by failing to take into account relevant consideration. Gregory further relies on Eley stating that “both Amphlett B, at first instance, and Lord Cairns, in the Court of Appeal….expressly stated that the article was binding as between the parties to the statutory contract” He contends that as Eley sued as a solicitor and not as a member, there was no conflict with Wedderburn’s proposition.

In contrast to Wedderburn and Gower opinion, Goldberg has sought to find a middle way, by providing the following explanation of the cases “a member has no right under [s.33] to have enforced a right or power bestowed by the… articles on a person otherwise than in his capacity as a member of the company, whether or not that person is in fact a member, unless the enforcement of that latter right or power is incidental to the enforcement of the members’ contractual right… to have any of the company’s affairs conducted by the particular organ of the company specified in the… articles.”

From this one can understand the importance of the question as to whether the company acted constitutionally or not. If the company has not acted constitutionally, the member can then enforce the statutory contract to ensure that the company does so, even by enforcing an ‘outsider’ right. Other than this no further enforcement of ‘outsider’ right is permissible.

In support of his argument, Goldberg cites Eley. Goldberg contends that the court held that the company was entitled to appoint solicitors under the articles, and that therefore, the appointment was exercised by the proper organ of the company. If Eley had enforced his rights this would have been contrary to the enforcement of member rights to have additional solicitors recruitment conducted by the proper organ of the company.

Prentice offers what can be described as an extended version of Goldberg’s analysis in that he agrees with Goldberg, but states that the question is not so much the proper organ of the company, but whether the organ has the power to act, and whether it remains within those powers.

Prentice considers the case of Haynes v Bristol Plant Hire Ltd.where, a resolution was passed at the time when a director has been wrongly excluded. The director was also a shareholder, therefore he had the right to seek that the resolution was invalid. Prentice contends that the company could only function properly through a properly constituted board, and where the company acted outside of this power, the shareholders could sue.

It is Prentice’s conclusion that ‘a member has a right to make the company function within the limits of the powers granted by and in the manner authorised by its constitution”

However, although this ‘middle way’ is an explanation of the cases, it is given post hoc. Drury notes, it is unlikely that the courts would have used this formulation in deciding the cases, otherwise presumably the judges would have stated this to be the case.

Drury further criticizes Prentice on the ground that, with reference again to Eley, that it does not appear that Prentice sees the case as one in which it was in the company’s power to appoint a specific solicitor. Drury contends that this is inconsistent with Prentice’s proposition that a member only has rights in so far as the articles restrict or relate to the power of the company to function.

Drury offers yet another explanation, based on what he calls the ‘relational approach’. He argues that the statutory contract reflects a long – term relationship between the company and its members. He then contends that the right of a shareholder to enforce a term of the contract should be considered within the context of that long-term relationship and balanced with the rights of the other shareholders.

According to Drury, the consequence of this approach is that cases can be explained on the basis of the wishes of the majority of the members. To illustrate his point Drury uses the case of Browne v La Trinidad in which the articles provided that the agreement with the director was incorporated, and that directors could be removed by special resolution, therefore, showing that there was an inconsistency in the articles. Drury contends that the court examined the wishes of the majority of members, as has been distributed by the special resolution removing the director.

However, Drury does accept that this theory does not fully explain the Hinkman’s case, where he notes that the wishes of the majority would have to be ‘presumed’. Drury’s argument appears to further suffer from the same weakness as the one he states against Goldberg and Prentice, specifically that the judges do not appear to have had the same “relational approach” as he had in mind at the time of deciding the cases.

Finally, Gregory has the view that the two lines of cases are irreconcilable, and it has been suggested by some that this opinion is the closest to the ‘truth’ of the matter.

Conclusion

In conclusion, the contract between the company and the members, formed by the articles, is an unusual one, in particular regarding the enforcement of rights which belong to parties outside of that contract. There is a good range of cases which shows an inconsistency arising as to whether these outsider rights are enforceable and if so on what basis. Attempts have been made, both judicially and academically, to reconcile the inconsistency.

There are extreme views, from strictly following the approach that outsider are never enforceable to the liberal approach which suggests that they can be enforced in the capacity of a member. However, there are other approaches which suggest that outsider rights are sometimes enforceable depending on the circumstances.

Ultimately, there is good reason that there is a range of opinion as the cases are flimsy and not reconcilable, and will continue to be so until there is further judicial consideration in the Court of Appeal, or House of Lords, where the controversy of the S.33 contract will be settled once and for all.

Bibliography

Birds, J., et al, Boyle & Bird’s Company Law, 6th Edition (2007), Jordans

Bourne, N., Bourne on Company Law, 4th Edition (2008) Routledge-Cavendish

Drury, R.R., “The Relative Nature of a Shareholder’s Right to Enforce the Company Contract” (1986) 45 CLJ 219

French, D., Mayson, S., and Ryan, C., Mayson, French & Ryan on Company Law, 25th Edition (2008), Oxford University Press

Goldberg, G.D., “The Controversy on the Section 20 Contract Revisited” (1985) 48 (2) MLR 158

Gower, L.C.B., Gower’s Principles of Modern Company Law (4th Edition 1979)

Gregory, R.M., “The Section 20 Contract” (1981) 44 (5) MLR 526

Prentice, G., N., “The Enforcement of ‘Outsider’ Rights” (1980) 1 (4) Co Law 179

Wedderburn, K.W., “Shareholders’ Rights and the Rule in Foss v Harbottle” (1957) CLJ 197