Shareholder Action Against Company Directors

Possible action by shareholders against companies or directors in response to company policy

Question

Eco Cars Ltd is a company that makes and sells electric cars, and was set up in 2008 by millionaire and environmental campaigner Mr Daniel. Mr Daniel is also one of the directors. The articles of the company state the company is for the development, production and sale of electric vehicles.

Since the company was set up, millions of pounds have been invested in research. At the start of 2015, the research department coincidentally discovered a method to make diesel engines 10% more efficient. Due to the amount of money invested, Mr Daniel and the other directors agreed that they should start producing diesel cars.

Mrs Sarah is a shareholder in the company and a green activist. Having heard the recent news about diesel car emissions, she is against the company producing diesel cars as are a number of other shareholders.

Mrs Sarah has come to you for advice, including whether they can prevent the company producing diesel cars and whether any action can be taken against the directors.

Answer

Constitution

The company was set up in 2008.^[1] The majority of the Companies Act 2006 (CA 2006) had come into force by that date and the eighth and final Commencement Order was made in November 2008, coming into force in 2009.^[2] As the company was incorporated in or shortly after 2008, if not already in force, Part 3 CA 2006 would have been contemplated by the promoters of Eco Cars Ltd.^[3]

Mr Daniel appears to have been the promoter of Eco Cars Ltd, the person who incorporated the company, and is likely to have influenced its constitution. The suffix ‘Ltd’ reveals that Eco Cars Ltd is a private limited company.^[4] The fact Mrs Sarah is a shareholder reveals the company is limited by shares and therefore owned by its members; not Mr Daniel exclusively though he is likely to hold the majority of shares.

The constitution of Eco Cars Ltd will consist of the memorandum of association and the articles of association.^[5]

The articles state the company is “for the development, production and sale of electric vehicles”. As the statement is in the articles, the usual rules of construction apply; the words will be given their plain and ordinary meaning.^[6] The words ‘development, production and sale’ limit the actions of the company and the words ‘electric vehicles’ limit the product of the company. The statement is an objects clause as the company appears to have been set up with an environmental purpose, a proposition supported by the fact Mr Daniel is an environmental campaigner.

“Unless a company’s articles specifically restrict the objects of the company, its objects are unrestricted”.^[7] The relationship between the constitution of the company and its members is such that it “binds 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”.^[8] The company is therefore restricted by the clause. Depending on the exact date of incorporation, the objects clause may have always been in the articles or may be treated as being in the articles; however the location of the clause does not change its effect.^[9]

The constitution of Eco Cars Ltd therefore restricts the business that can be carried out.

Directors Duties

As a private company, Eco Cars Ltd must have at least one director.^[10] A director is “any person occupying the position of director, by whatever name called”.^[11] Mr Daniel calls himself director and occupies that position, thus there is at least one director in the company. The directors’ actions will be scrutinised to determine whether they have incurred any liability by engaging in the production of non-electric cars.

Mr Daniel and any other directors owe several duties to Eco Cars Ltd.^[12] The common law duties have to a certain degree been codified in to the CA 2006.^[13] Mrs Sarah should be advised that the common law rules and equitable principles should be considered when interpreting the CA 2006.^[14]

Mr Daniel has a duty to “act in accordance with the company’s constitution, and only exercise powers for the purposes for which they are conferred”.^[15] The directors must ensure that the objects clause is followed. It therefore needs to be ascertained whether the production of diesel cars falls within the objects clause.

Diesel cars do contain a battery which is required to start the car and run the electronics. There is the possibility of a hybrid; a diesel car with an electric motor. However, Eco Cars Ltd appears not to be producing hybrids, but a pure diesel car and the courts are unlikely to consider this to be an ‘electric vehicle’, nor depart from the objects clause because it creates a commercial absurdity.^[16]

The directors of Eco Cars Ltd authorised the production of diesel cars and would have exercised many of their powers in enabling production. Whilst producing cars is within their powers and would fall within the purposes for which the powers were given, the production of diesel cars is excluded from the directors’ powers as it is in contravention of the constitution of Eco Cars Ltd. Mr Daniel and the other directors therefore breached their duty not to act ultra vires.

The directors also had a duty to “act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”.^[17] To determine whether this duty has been breached, the factors that directors must have regard to when making decisions should be considered.

The first is the “likely consequences of any decision in the long term”^[18]. The facts indicate that a large investment has been made in research. It is therefore business sense that this investment needs to create a return in order for the company to remain solvent. Producing diesel cars with an increased 10% efficiency compared to competitors’ cars will enable the company to make money from the discovery. Other benefits such as increased publicity for the company could also be taken into account when considering the long term consequences.

The directors must also have regard to “the impact of the company’s operations on the community and the environment”.^[19] This triggers the principle of ‘enlightened shareholder value’; measuring success against the objectives of the company. As Eco Cars Ltd appears to have an environmental purpose, “the attainment of objectives for which the company has been established” may be prejudiced by producing diesel cars.^[20]

The test for a breach of this duty remains subjective; “The decisions taken by the directors and the weight given to the factors will continue to be a matter for his (i.e. the director’s) good faith judgment”.^[21] There appear to be several reasons why the directors would consider the decision to be for the benefit of the company, so the court is unlikely to find a lack of good faith.^[22]

The directors are required to act with “reasonable care and skill and diligence”.^[23] Whilst there ex facia appears to be a lack of care in acting outside the constitution, the reasons behind the decision to produce diesel cars took into account the financial position of the company. This awareness of the financial risk to Eco Cars Ltd of continued investment with no wieldable products displays an understanding of the business and as such there does not appear to be a breach of this duty.^[24]

Mrs Sarah should be advised that there appears to have been a breach of at least one duty owed to Eco Cars Ltd by the directors.

Remedies

Mrs Sarah has raised two issues; firstly, whether the production of diesel cars can be stopped, and secondly, whether any action can be taken against the directors.

Mrs Sarah may be unable to prevent production of diesel cars for contracts already entered. “In favour of a person dealing with the company in good faith, the power of the directors to bind the company, or authorise others to do so, is deemed to be free of any limitation under the company’s constitution”.^[25] If Eco Cars Ltd has entered into any contracts in relation to diesel cars, which in practical terms is likely to be for the sale of the cars, these contracts will be valid and Mrs Sarah will have no ground to object to them.

However, Mrs Sarah may apply for an injunction to stop further production of diesel cars as “this section does not affect any right of a member of the company to bring proceedings to restrain the doing of an action that is beyond the powers of the directors.”^[26] Mrs Sarah may obtain the injunction personally or as a representative claim.

Whilst an injunction could be obtained, the directors may take action to prevent this; Eco Cars Ltd can change its constitution to allow the production of diesel cars. The directors would need to call a meeting and “amend its articles by special resolution”.^[27] A special resolution requires “a majority of not less than 75%”.^[28]

Mrs Sarah should therefore be advised that she may be successful in obtaining an injunction but the company could nevertheless change its articles and have the injunction set aside.

Mrs Sarah may be able to take action against the directors for breach of duty as the consequences for breach are the same as under common law and equitable principles.^[29]

However, a breach of duty is considered to be a wrong against the company and thus the company is the proper claimant; not Mrs Sarah.^[30] Depending on the constitution of Eco Cars Ltd, the decision to sue may rest with the directors and can be made at a board meeting or is a decision of the members to be made at a general meeting. In either case, the majority of the shareholders may vote against taking action.

If this occurs, Mrs Sarah may bring a derivative action as a member of the company “in respect of a cause of action vested in the company”.^[31] Obtaining permission to continue a derivative claim requires the court to be satisfied of a prima facie case for breach of duty.^[32] This could be achieved in respect of the breach of s. 171 CA 2006.

The court must refuse permission to bring a claim if it is satisfied that “a person acting in accordance with section 172… would not seek to continue the claim”.^[33] As argued above, due to the financial position of the company the decision of the directors may be seen to have promoted the success of the company, thus making it against the success of the company to bring an action against the directors for such an act. There is a real risk that the court would refuse permission.

Mrs Sarah may wish to consider selling her shares as taking action against the company is an expensive option and may fail.

Conclusion

The directors’ actions appear to show a breach of duty as the constitution contains an objects clause. However, the commercial reality of taking action against the directors and seeking an injunction against the production of diesel cars may lead Mrs Sarah to invest in a company more attune to her principles.

Footnotes

^[1] Reasonable assumptions will be made as to the nature of the company in order to provide initial advice.

^[2] S. 1300(1-2) Companies Act 2006

^[3] The Companies Act 2006 (Part 35) (Consequential Amendments, Transitional Provisions and Savings) Order 2009 S.I. 2009/1802, art 18

^[4] S.59(1) CA 2006

^[5] S. 257 CA 2006

^[6] Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896

^[7] S. 31(1) CA 2006

^[8] S. 33 CA 2006

^[9] S. 28(1) CA 2006

^[10] S. 154 CA 2006

^[11] S. 250 CA 2006

^[12] Foss v Harbottle (1843) 67 ER 189

^[13] S. 173 CA 2006

^[14] S. 170(4) CA 2006

^[15] S. 171 CA 2006

^[16] Thompson v Goblin Hill Hotels Ltd [2011] 1 BCLC 587

^[17] S.172 CA 2006

^[18] S. 172(1)(a)

^[19] S. 172(1)(d)

^[20] A-G Lord Goldsmith, Department of Trade and Industry compilation of ministerial statements on duties of company directors, (June 2007)

^[21] Margaret Hodge, Minister of State for Industry and the Regions, Department of Trade and Industry compilation of ministerial statements on duties of company directors, (June 2007)

^[22] Shuttleworth v Cox Brothers and Co (Maidenhead) Ltd [1927] 2 KB 9

^[23] S. 174 CA 2006

^[24] Re Westmid Packing Services Ltd [1998] 2 All ER 1240

^[25] S. 40(1) CA 2006

^[26] S. 40(4) CA 2006

^[27] S. 21 CA 2006

^[28] S. 283 CA 2006

^[29] S. 178 CA 2006

^[30] Foss v Harbottle (1843) 2 Hare 461

^[31] S. 260 CA 2006

^[32] S. 261(2) CA 2006, Iesini v Westrip Holdings Ltd [2011] 1 BCLC 498

^[33] S. 263(2)(a) CA 2006