Legal Analysis and Advice for RTR and Its Directors

Introduction

This essay identifies the relevant legal issues involved in the problem scenario and advises RTR and its directors on the potential issues, claims and remedies for RTR and its shareholders arising from the facts of the problem scenario. The principal issues that arise in this scenario are related to the possible breach of duty by Shay, the procedure for allotment of ordinary and preference shares to Jas, the payment of fixed dividend to Jas, and the possible derivative claim action by Cleo for actions taken by the other directors with relation to aforementioned allotment of shares and payment of fixed dividend to Jas.

Shay’s breach of duty to avoid conflict of interest

The first issue in this scenario is whether Shay has breached his duty under Section 175 of the Companies Act 2006 (CA 2006) and if so, what liability arises for Shay in the case.

Section 175 provides the duty of the director to avoid conflict of interest. The avoidance of conflict of interest is a fiduciary and a statutory duty of the directors; the purpose of this duty is to ensure that the directors do not compromise the interest of the company for their personal interest. In Bhullar v Bhullar, the court explained the nature of the duty in terms of the avoidance of ‘corporate opportunity’, which are business opportunities that come to the director for the company and rightly belong to the company. In Bhullar, two directors of a company purchased a property for a new company set up by them when the same investment would have been profitable for the older company in which they were directors; for this they were held liable to have breached their duty of avoidance of conflict of interest. In a more recent case, the court held that the duty of conflict of interest requires that the directors avoid situations in which they have direct or indirect personal interest conflicting with the interests of the company; breach of duty occurs when the director acts in a way that creates a conflict of interest. Coming back to the concept of corporate opportunity that was explained in Bhullar as noted above, if the director of a company takes a corporate opportunity that righfully belongs to the company and uses it for his personal interest, then they can be made to account for any profits that were made by them using these opportunities. Liability for the breach of duties is provided as a civil liability under Section 178 CA 2006. If the director to whom the corporate opportunity was revealed, disclosed this opportunity to the board of directors and also informed them of the possible conflict due to personal interest in the matter, then such a director will be able to avoid liability for the breach of Section 175 duty. If however, no such disclosure is made by the director, then liability for breach of duty to avoid conflict of interest will arise.

In the present case, Shay has taken an action, which is in conflict of his interest as the director of RTR. Moreover, he has taken advantage of a corporate opportunity that came his way as the main point of contact for the major clients of RTR. When Shay came to know of a business opportunity for RTR for developing leadership and management training products for its employees, instead of discussing this opportunity with the board of directors, Shay recommended an alternative company, Coll Solutions Limited, of which he is the majority shareholder and his wife is the director. Similar to Bhullar case, Shay has taken advantage of an opportunity that would have benefitted RTR as the latter also develops online training products for businesses in the recruitment industry and these products are used to train employees. In this case, Shay has also not make any such disclosure to the other directors about the business opportunity as well as his own interest in the company which he recommended should take up the new opportunity. Therefore, RTR is advised that action against Shay can be taken to recover the profits made by the other company in which he

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1. Aberdeen Railway Co v Blaikie Brothers [1854] UKHL 1.
2. Bhullar v Bhullar [2003] EWCA Civ 424.
3. Ibid.
4. Towers v. Premier Waste Management Limited [2011] EWCA Civ 923.
5. Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443.
6. Guinness plc v Saunders [1989] UKHL 2.

had interest as he can be held liable for breach under Section 175 CA 2006 read with Section 178. In the event that the other company is yet to take up this opportunity, Shay is advised to disclose the matter to the board of directors in order to avoid liability.

Issue of preference shares and ordinary shares to Jas

The second issue in this scenario relates to the issuance of preference and ordinary shares to Jas. Can Jas be allotted both preference and ordinary shares in the company? If so, what is the procedure to be followed by RTR to make such allotment? Jas is a potential investor who may invest £5 million in the company’s business, for which Ralf is suggesting that Jas be allotted ordinary and preference shares in RTR. This raises the issues that will be discussed in this section.

Section 629 CA 2006 allows the classification of shares and issue of different categories of shares. Thus, company can issue both ordinary and preference shares to its members. However, there are certain statutory rules that are applicable, which are discussed in this section. Allotment of shares can be effected by the resolution of the board of directors if it is permitted by the Articles of Association of the company, which is to be used to ascertain how the allotment is to be made. The shareholder authority is also required under certain circumstances under Section 549 CA 2006. Shareholder authority is required if there are certain restrictions in the Articles of Association that prevent the directors from allotting the shares without such authority of the shareholders; this is provided in Section 550 CA 2006. Whether shareholder authority is required or not also depends on the date of incorporation of the private limited company. For companies incorporated after 1 October 2009 with only one class of shares, there is no restriction on the number of shares that can be allotted by the directors and no requirement of shareholder authority as per Section 550 CA 2006. Companies set up before 1 October 2009 need shareholder authority for allotting shares of new classes under Section 551. However, as two classes of shares are being proposed to be allotted to the new member, Section 550 will not be applicable to exclude the need to get authority of the shareholders.

If there are any pre-emption clauses in the Articles of Association of the company, then Sections 560–577 CA 2006 are applicable. In Lyle & Scott Ltd v Scott’s Trustees it was held that if the articles provided a right of pre-emption to the shareholders, then the right would mean that any shareholder who wishes to transfer his shares must inform the others of the same to give them an opportunity to buy the shares. If the director offers the shares to the existing shareholders and allows them the right to refuse or accept purchase of shares, then the pre-emption is validly done. Pre-emption rights are applicable where new ordinary shares are being allotted for cash, in which case, these rights must first be offered to the existing shareholders so as to ensure that their interests in the company are not being diluted. In private companies having only one class of shares, the Articles of Association may allow the directors to allot shares without pre-emption under Section 569 CA 2006. A special resolution may also be used for this purpose. The procedure for this special resolution is that the directors provide an explanatory statement for recommending such allotment along with the recommendation through a notice of general meeting or written resolution of members under Section 571. When such a resolution is passed, a copy of the same must be sent to the Companies House with the copies of the articles under Sections 29–30 CA 2006. If there is a procedure to be followed for allotment of shares that also affect the class rights of the existing shareholders, then the procedure is to be followed; however, if rights of the existing shareholders are not affected then the procedure need not be followed.

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7. In Lyle & Scott Ltd v Scott’s Trustees [1959] AC 763.
8. Tett v Phoenix Property Investment Company Ltd [1986] BCLC 149.
9. Ibid.
10. White v Bristol Aeroplane [1953] 2 WLR 144.

As RTR was incorporated in 2015, Section 550 will apply, and directors can issue the shares to Jas if these shares contain only one class of shares. However, as per the recommendation of Ralf, which is 25 new ordinary shares and 10 non-voting preference shares, Section 550 is not applicable, and the shares cannot be allotted without a shareholders’ authorisation. Pre-emption rights in the Articles of Association or Shareholders Agreement are also to be considered. In case there are any such pre-emption rights, then the procedure written above is to be followed. In this situation, RTR is advised that they can proceed with the allotment of two classes of shares to Jas only after a shareholders’ resolution is made to that effect. Directors alone cannot make the decision to allot these shares. RTR is also advised to consider if there are any pre-emption rights in the Articles of Association or the Shareholders’ Agreement. In case of any such provisions, then the procedure explained above has to be followed before any allotment of shares is made to the new member.

Payment of dividend to Jas

The issue with relation to the payment of dividend to Jas arises because Ralf has recommended the payment of a guaranteed annual dividend of 10% of the amount invested by Jas. The question is whether such amount of dividend can be guaranteed by the company.

Dividends are paid out of the distributable profits after the proper preparation of the accounts of the company. As far as the dividend is paid out of the profits of the company, such payment is permissible under the law. However, Section 830 (1) of the CA 2006 does bar the distribution of dividend from any other source but the profits of the company. The company is required to prepare proper accounts before the payment of the dividend. In the current situation, Ralf is proposing the payment of a guaranteed dividend to Jas every year. This means that the dividend is fixed. It may also mean that in a given year the dividend may go beyond the profits of the company. As per the law, dividend can only be paid from the distributable profits of the company. If a company pays dividend without having distributable profits to make such payments or pays such dividends without meeting the required standards of accounting, the payment of dividend is unlawful and ultra vires and even the majority shareholders of the company cannot ratify such a dividend payment. Under Section 212 of the Insolvency Act (IA 1986), payment of dividend without maintaining proper accounting practice prior to the payment can be a misfeasance on the part of the directors. This was held by the court in Re Loquitor. In that case, the company paid dividends to its parent company without preparing proper accounts while it also had tax liability which was not taking into account before payment of dividend; the court held the dividend to be paid in contravention of the law. Therefore, as per this discussion on the relevant authorities, there are two possible consequences of payment of unlawful dividend: it gives rise to the right of the company to recover such dividend from the member to whom it was paid; and action can be taken against the directors for authorising such under Section 212 IA 1986. However, IA 1986 is applicable when the company goes into liquidation. If RTR is in that position, then the payment of unlawful dividend will be an issue and directors can be made liable for the same.

The payment of unlawful dividend also relates to the duty of the directors to promote the success of the company and the benefit shareholders under Section 172 CA 2006. Section 172(3) specifically notes the duty of directors to consider the interest of company’s creditors. The recommendation of the dividend also relates to the duty exercising care and skill, where the directors are required to make a careful consideration of the company’s financial health before making any decisions about the payment of dividends.

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11. Re Marini Ltd., Liquidator of Marini Ltd v Dickenson [2004] BCC 172.
12. Bairstow v Queen Moat Houses Plc [2001] 2 BCLC 531, CA.
13. Re Loquitor Ltd, IRC v Richmond [2003] 2 BCLC 442.
14. Ibid.
15. Brenda Hannigan, Company Law (Oxford University Press 2015) 626.

Fixed dividends can be paid to shareholders if the Articles of Association contains an express provision authorising the same. In this case, no such change has as yet been made in the Articles of Association. RTR is advised that if a change has to be made in the articles, then a resolution to that effect has to be passed in the meeting of the shareholders and without such actions, the payment of fixed dividend to the new member will not be properly done and can expose the directors of the company to an action in unlawful payment of dividend. Dividends should be paid out of distributable profits of the company after proper accounting has been completed to ascertain the distributable profits in a given year.

Minority shareholders rights

The fourth issue in this scenario is whether Clem can take derivative action as a minority shareholder against the actions of the other shareholders on proposals related to Jas, that is, with respect to the payment of the fixed dividend and the allotment of shares.

Under the principle of Foss v Harbottle, even if a wrong is committed against the company, the only proper plaintiff to take action against the wrongdoer is the company itself as the company is a legal entity in itself. Minority shareholders who believe that a wrong is committed against the company can take action under certain circumstances that provide exceptions to the rule in Foss. In Edwards v Halliwell, the court explained what these circumstances are that will allow the minority shareholder to take action as ultra vires act, act in violation of a requirement in the articles for the decision to be taken only by special majority, invasion of personal rights, and fraud on minority. Payment of fixed dividend without altering the articles of association in a shareholders meeting can come within the purview of derivative action of minority shareholder as this would constitute an act that is in violation of a requirement of articles.



An allotment of shares if carried out as per the procedure allowed in the articles and the law, would however not constitute a fraud against the minority. In Greenhalgh case, a minority shareholder wished to prevent the majority shareholder from selling control; the Articles of Association had a pre-emption clause, but this was altered by a special resolution of the company and this change in the articles was alleged to be a fraud on the minority by the plaintiff. It was held that the alteration to the articles was not for private gain, and was done through a proper process, which could not constitute a fraud against the minority. However, in that case, the allotment was done after a special resolution was passed in the shareholders meeting. As Ralf is rushing through the allotment of the shares in the present case scenario, the issue of this being a fraud on the minority can be raised for the excluded member if shareholders’ resolution is not passed for the same because two classes of shares are being issued and for this mere directors’ resolution is not enough.

In the event that a company is taking important decisions like allotment of two classes of shares and fixed dividend to a new member, as the discussion in the previous sections has indicated, this would require requisite changes to be made in the articles of association for which notice is to be given to all the shareholders. In private companies, the period of notice is 14 days.

However, Clem was not informed of the proposals related to the issuance of shares to Jas and about the payment of a fixed dividend and the decision was taken in her absence. Ralf said and the others concurred that as a 25 percent shareholder Clem does not need to be consulted on the new share issues because she will not be able to affect the resolutions. This is not a correct position as indicated by the discussion on the requirement to give notice to the shareholders is concerned. Shareholders have certain rights in the company, including

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16. Evlin v Israel and Oppenheimer Ltd [1918] 1 Ch 101.
17. Foss v Harbottle[1843] 67 ER 189.
18. Edwards v Halliwell [1950] 2 All ER 1064.
19. Greenhalgh v Arderne Cinemas Ltd (No 2) [1946] 1 All ER 512.
20. Ibid
21. Nicholas Bourne, Bourne on Company Law (Routledge 2016).

the right to be informed of the actions that are being proposed to be taken and the right that written resolutions be circulated. Shareholders also have a right to notice of general meetings. If any general meeting takes place without due notice to all shareholders, then the shareholders who have been excluded can challenge the decision taken on procedural grounds of non-receipt of notice of meeting.

RTR is advised against proceeding to take a decision on the allotment of shares to Jas as well as the payment of fixed capital without passing a resolution at the shareholders meeting. This has to be done by following the following the due procedure of giving a 14 days notice to all shareholders, and then taking the decision during the shareholders meeting. RTR is also advised that as a minority shareholder, Clem can take derivative action related to the decisions as these decisions would constitute violation of a requirement of articles.

Conclusion

To conclude, action can be taken against Shay for breach of duty to avoid conflict of interest unless Shay has disclosed the matter to the board of directors. RTR is advised against allotment of two classes of shares to Jas unless a shareholders’ resolution is made to that effect for appropriate changes to be made to the articles of association; any pre-emption rights must also be considered for the same. The same applies to decision to pay fixed dividend to the new member. RTR is also advised that dividends should be paid out of distributable profits of the company after proper accounting. RTR is advised against proceeding to take a decision on the allotment of shares to Jas as well as the payment of fixed capital without passing a resolution at the shareholders meeting. RTR is also advised that as a minority shareholder, Clem can take derivative action related to the decisions as these decisions would constitute violation of a requirement of articles.

Cases

Aberdeen Railway Co v Blaikie Brothers [1854] UKHL 1.

Bairstow v Queen Moat Houses Plc [2001] 2 BCLC 531, CA.

Bhullar v Bhullar [2003] EWCA Civ 424.

Edwards v Halliwell [1950] 2 All ER 1064.

Evlin v Israel and Oppenheimer Ltd [1918] 1 Ch 101.

Foss v Harbottle[1843] 67 ER 189.

Greenhalgh v Arderne Cinemas Ltd (No 2) [1946] 1 All ER 512.

Guinness plc v Saunders [1989] UKHL 2.

Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443.

Lyle & Scott Ltd v Scott’s Trustees [1959] AC 763.

Re Loquitor Ltd, IRC v Richmond [2003] 2 BCLC 442.

Re Marini Ltd., Liquidator of Marini Ltd v Dickenson [2004] BCC 172.

Tett v Phoenix Property Investment Company Ltd [1986] BCLC 149.

Towers v. Premier Waste Management Limited [2011] EWCA Civ 923.

White v Bristol Aeroplane [1953] 2 WLR 144.

Dig deeper into Law6158 Topics in Company Law & Corporate Governance with our selection of articles.

Books

Bourne N, Bourne on Company Law (Routledge 2016).

Hannigan B, Company Law (Oxford University Press 2015).